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MANAGEMENT ACCOUNTING <ul><li>FUNDAMENTALS OF ACCOUNTS </li></ul><ul><li>An account is a summarised record of relevant tra...
Fundamentals of Accounts <ul><li>The three rules of accounting are </li></ul><ul><li>Debit the receiver and Credit the giv...
Classification of Accounts <ul><li>Personal Account </li></ul><ul><li>Real Account </li></ul><ul><li>Nominal Account </li>...
Classification of Accounts (Contd.) Type Rules for Debit Rules for Credit Personal Accounts Debit the Receiver Credit the ...
Classification of Accounts (Contd.) <ul><li>Assets accounts </li></ul><ul><li>Liabilities accounts </li></ul><ul><li>Capit...
Rules of Debit and Credit <ul><li>Increase in assets are debits and decrease are credits </li></ul><ul><li>Increase in lia...
Financial Statements <ul><li>Financial Statements are compilation of accounting information for the external users. </li><...
Financial Statements (Contd.) <ul><li>Capital Expenditure is the amount spent by an enterprise on purchase of fixed assets...
Distinction between Capital and Revenue Expenditure Purpose It is incurred for acquisition of fixed assets for use in busi...
Management Accounting <ul><li>Definition </li></ul><ul><li>Management accounting is the process of identification, measure...
Types of Decisions <ul><li>The decisions, managers are concerned with, can be categorized as – </li></ul><ul><li>Planning ...
Planning Decisions <ul><li>Planning Decisions are concerned with the establishment of goals for the organization and the c...
Control Decisions <ul><li>Control decisions result from implementing the plans and monitoring the actual results to see if...
Financial Accounting vs. Management Accounting  <ul><li>Financial Accounting covers the process of book keeping, finalizat...
Financial Accounting vs. Management Accounting <ul><li>External users vs. Internal users </li></ul><ul><li>Record of finan...
Cost Accounting vs. Management Accounting <ul><li>Cost Accounting is mainly concerned with the techniques of product costi...
Management Accounting Framework
Management Accounting Framework <ul><li>Data accumulation is done through Financial Accounting and Cost Accounting systems...
Contents of Management Accounting <ul><li>Management process is a series of activities involved in planning, implementatio...
Statements of Financial Information <ul><li>Balance Sheet </li></ul><ul><li>Profit and Loss Account </li></ul><ul><li>Stat...
Contents of Balance Sheet <ul><li>The balance sheet provides information about the financial standing/position of a compan...
Contents of Balance Sheet <ul><li>The financial position as disclosed by the balance sheet refers to its resources and obl...
Assets <ul><li>Assets are the valuable resources owned by a business </li></ul><ul><li>Assets need to satisfy three requir...
Assets <ul><li>The assets in the balance sheet are listed either in the order of liquidity i.e. promptness with which they...
Assets <ul><li>All assets are grouped into categories i.e. assets with similar characteristics are put in one category </l...
Fixed assets <ul><li>These assets are fixed in the sense that they are acquired to be retained in the business on a long t...
Categories of Fixed Assets <ul><li>Tangible </li></ul><ul><li>Intangible </li></ul>
Tangible Fixed Assets <ul><li>These assets have a physical existence and generate goods and services </li></ul><ul><li>Exa...
Tangible Fixed Assets (Contd.) <ul><li>As a result of depreciation, the amount of tangible fixed assets shown in the balan...
Intangible Fixed Assets <ul><li>These assets do not generate goods and services directly </li></ul><ul><li>They reflect th...
Current Assets <ul><li>The second category of assets in the balance sheet are current assets </li></ul><ul><li>In contrast...
Current assets (Contd.) <ul><li>Current assets are also known as “liquid assets” </li></ul><ul><li>They include- </li></ul...
Current Assets (Contd.) <ul><li>Cash </li></ul><ul><li>Most liquid form of current asset </li></ul><ul><li>Cash in hand an...
Current Assets (Contd.) <ul><li>Marketable Securities </li></ul><ul><li>Short term investments which are readily marketabl...
Current Assets (Contd.) <ul><li>Accounts Receivable </li></ul><ul><li>The amount the customers owe to the firm, arising ou...
Current assets (Contd.) <ul><li>Bills Receivable </li></ul><ul><li>Amount owed by outsiders for which written acknowledgem...
Current Assets (Contd.) <ul><li>Inventory </li></ul><ul><li>It includes </li></ul><ul><li>The goods which are held for sal...
Investments <ul><li>The third category of assets is investments </li></ul><ul><li>They represent investment of funds in th...
Other Assets <ul><li>Included in this category are the Deferred Charges </li></ul><ul><li>Example: Advertisement, Prelimin...
Liabilities <ul><li>Liabilities are defined as the claims of outsiders against the firm </li></ul><ul><li>They represent t...
Long term Liabilities <ul><li>Sources of funds included in this category are available for periods exceeding one year </li...
Current Liabilities or Short term Liabilities <ul><li>These Liabilities are payable to outsiders in a short period, usuall...
Current Liabilities (Contd.) <ul><li>Trade Credit </li></ul><ul><li>The claims of outsiders who have sold goods to the fir...
Current Liabilities (Contd.) <ul><li>Short term Bank Credit </li></ul><ul><li>Liabilities contracted through banks for a s...
Current Liabilities (Contd.) <ul><li>Tax Payable  refers to the amount payable to the Government as taxes </li></ul><ul><l...
Owners’ Equity or Capital <ul><li>The next main component of the balance sheet is the owners’ equity </li></ul><ul><li>It ...
Preference Capital <ul><li>These shareholders are entitled to a stated amount of dividend and return of principal on matur...
Equity Capital <ul><li>They are the residual claimants of the profits </li></ul><ul><li>After all the external liability h...
Common Doubts <ul><li>Why is share capital shown as a liability? </li></ul><ul><li>Depreciation – what is its nature? </li...
Contents of Profit and Loss Account <ul><li>Revenues : Turnover </li></ul><ul><li>Other income </li></ul><ul><li>Sale of f...
Revenues <ul><li>Revenue is defined as the income that accrues to the firm by sale of goods and services or through invest...
Revenue (Contd.) <ul><li>Other income  is earned through other sources of investments  </li></ul><ul><li>Examples: Interes...
Expenses <ul><li>The cost of earning the revenues are the expenses </li></ul><ul><li>Examples: variable expenses like cost...
Expenses (Contd.) <ul><li>Cost of goods consumed </li></ul><ul><li>This is the value of the inputs used to manufacture the...
Expenses (Contd.) <ul><li>Manufacturing expenses </li></ul><ul><li>These include all expenses related to plant and manufac...
Expenses (Contd.) <ul><li>Salaries and Wages </li></ul><ul><li>These are the cost of labour and other staff and will also ...
Expenses (Contd.) <ul><li>Administrative Expenses </li></ul><ul><li>These include office expenses, secretarial costs, post...
Expenses (Contd.) <ul><li>Interest </li></ul><ul><li>The interest costs consist of interest on long term loans, debentures...
Profit / Loss <ul><li>The difference between the revenue and expense is profit </li></ul><ul><li>When expense exceeds the ...
The Profit Appropriations <ul><li>Profit after Tax (PAT) is available for appropriations for  </li></ul><ul><li>Debenture ...
Profit or Loss carried over <ul><li>After appropriating the taxes and dividends, the balance surplus is transferred to Res...
Financial Ratio Analysis <ul><li>Financial Analysts use the financial ratio analysis to gain critical insights about compa...
Merits of Ratio Analysis <ul><li>Financial ratios are helpful: </li></ul><ul><li>To bankers for appraising the credit wort...
Merits of Ratio Analysis <ul><li>To the credit rating agencies (like CRISIL, ICRA, etc) in their credit rating exercise </...
Limitations of Ratio Analysis <ul><li>No uniformity in definitions </li></ul><ul><li>No norms </li></ul><ul><li>Varying si...
Financial Ratio Analysis <ul><li>Ratios on ROI </li></ul><ul><li>Activity ratios </li></ul><ul><li>Liquidity ratios </li><...
Ratios on ROI <ul><li>Return on assets = PAT  </li></ul><ul><li>----------------  * 100 </li></ul><ul><li>Total assets </l...
Ratios on ROI <ul><li>Return on Net worth = </li></ul><ul><li>Net profit after tax </li></ul><ul><li>---------------------...
Cash Flow Analysis <ul><li>A cash flow statement depicts change in cash position from one period to another. </li></ul><ul...
Difference between CFS and FFS <ul><li>CFS </li></ul><ul><li>Only with change in cash position </li></ul><ul><li>Mere reco...
Advantages <ul><li>Helps in efficient cash management </li></ul><ul><li>Helps in internal financial management </li></ul><...
Limitations <ul><li>Cash flow does not reflect net income as it does not consider non cash transactions </li></ul><ul><li>...
CFS <ul><li>Sources of Cash </li></ul><ul><li>Internal  </li></ul><ul><li>External </li></ul><ul><li>Applications of Cash ...
CFS <ul><li>Internal sources </li></ul><ul><li>Cash flow from operating activities </li></ul><ul><li>Net profit + </li></u...
CFS <ul><li>Adjustment for changes in current assets and current liabilities </li></ul><ul><li>Adjusted Net profit  </li><...
CFS <ul><li>Adjustment for changes in current assets and current liabilities </li></ul><ul><li>- Increase in sundry debtor...
CFS <ul><li>Increase in cash </li></ul><ul><li>Decrease in current asset </li></ul><ul><li>Increase in current liability <...
CFS <ul><li>External sources </li></ul><ul><li>Issue of shares </li></ul><ul><li>Issue of debentures </li></ul><ul><li>Rai...
CFS <ul><li>Applications of cash </li></ul><ul><li>Purchase of fixed assets </li></ul><ul><li>Repayment of loans – secured...
Cost Concepts <ul><li>Important inputs in managerial decision making is  cost data </li></ul><ul><li>Cost data is classifi...
Relating to Income Measurement <ul><li>Product cost and Period cost </li></ul><ul><li>Absorbed cost and Unabsorbed cost </...
Relating to Income Measurement <ul><li>Product cost and Period cost </li></ul><ul><li>Only variable costs are taken as pro...
Relating to Income Measurement <ul><li>Absorbed cost and Unabsorbed cost </li></ul><ul><li>Since fixed costs also contribu...
Relating to Income Measurement <ul><li>Expired cost and Unexpired cost </li></ul><ul><li>Expired cost can not contribute t...
Relating to Income Measurement <ul><li>Joint product cost and Separable cost </li></ul><ul><li>Joint Product costs are the...
Relating to Profit Planning <ul><li>Fixed, Variable, Semi variable / Mixed cost </li></ul><ul><li>Future cost and Budgeted...
Relating to Profit Planning <ul><li>Fixed, Variable, Mixed costs </li></ul><ul><li>Fixed costs are associated with those i...
Relating to Profit Planning <ul><li>Future cost and Budgeted cost </li></ul><ul><li>Future costs are reasonably expected t...
Relating to Control <ul><li>Responsibility costs </li></ul><ul><li>Controllable and Non controllable costs </li></ul><ul><...
Relating to Control <ul><li>Responsibility costs </li></ul><ul><li>This concept applies more as responsibility accounting ...
Relating to Control <ul><li>Controllable costs  are those which can be controlled / influenced by the responsibility cente...
Relating to Control <ul><li>Direct costs  are those which can be identified in their entirety to a particular product in a...
Relating to Decision making <ul><li>Relevant cost and Irrelevant cost </li></ul><ul><li>Incremental cost and Differential ...
Relating to Decision making <ul><li>Relevant costs  are those influenced by a decision and hence are important for decisio...
Relating to Decision making <ul><li>Incremental costs  are additional costs incurred if management chooses a particular co...
Relating to Decision making <ul><li>Out of pocket costs  are costs which involve fresh outflow of cash on decision taken <...
Relating to Decision making <ul><li>Opportunity costs  represent benefits foregone by not choosing one alternative in favo...
Marginal Costing <ul><li>Marginal cost is the cost of producing one additional unit </li></ul><ul><li>Variable cost varies...
Marginal Costing (Contd.) <ul><li>If the level of capacity utilization changes, the fixed cost changes. </li></ul><ul><li>...
Marginal Costing (Contd.) <ul><li>For a given capacity level, the marginal cost is only the variable cost. This is because...
Marginal Costing (Contd.) <ul><li>Under Absorption costing, all costs, both fixed and variable costs are allocated to the ...
Break Even Analysis <ul><li>Sales </li></ul><ul><li>minus </li></ul><ul><li>Variable cost </li></ul><ul><li>= </li></ul><u...
Break Even Analysis (Contd.) <ul><li>BEP (in Units) = Fixed cost (in Rs.) </li></ul><ul><li>------------------------------...
Break Even Analysis (Contd.) <ul><li>Profit Volume Ratio = Contribution </li></ul><ul><li>(P/V ratio)  ------------------ ...
Break Even Analysis (Contd.) <ul><li>BEP (in Rs. = Fixed Coat (in Rs.) </li></ul><ul><li>----------------------- </li></ul...
Break Even Analysis (Contd.) <ul><li>Margin of safety = Actual sales – BEP sales </li></ul><ul><li>Margin of safety ratio ...
Budgetary Control <ul><li>Budgeting is tool of planning </li></ul><ul><li>Planning involves specification of the basic obj...
Budgetary Control (Contd.) <ul><li>Steps in Planning: </li></ul><ul><li>Objectives defined as the broad and long range pos...
Budgetary Control (Contd.) <ul><li>A budget is defined as a comprehensive and coordinated plan, expressed in financial ter...
Budgetary Control (Contd.) <ul><li>The essential elements of a budget are: </li></ul><ul><li>Plan </li></ul><ul><li>Financ...
Budgetary Control (Contd.) <ul><li>The main objectives of budgeting are: </li></ul><ul><li>Explicit statement of expectati...
Budgetary Control (Contd.) <ul><li>The overall budget is known as the  Master budget. </li></ul><ul><li>Classification –  ...
Budgetary Control (Contd.) <ul><li>Operating budget </li></ul><ul><li>Sales budget </li></ul><ul><li>Production budget </l...
Budgetary Control (Contd.) <ul><li>Financial Budget </li></ul><ul><li>Budgeted income statement </li></ul><ul><li>Budgeted...
Budgetary Control (Contd.) <ul><li>Budgets prepared at a single level of activity, with no prospect of modification in the...
Budgetary Control (Contd.) <ul><li>The framework of flexible budget covers- </li></ul><ul><li>Measure of volume </li></ul>...
Inventory Costing <ul><li>Inventories are assets: </li></ul><ul><li>Held for sale in the ordinary course of business (fini...
Inventory Costing <ul><li>Inventories should be valued at the lower of cost or net realizable value </li></ul><ul><li>Net ...
Inventory Costing <ul><li>The cost of inventories should comprise all  costs of purchase, costs of conversion and other co...
Inventory Costing <ul><li>Costs of conversion  include costs directly related to production like labor, factory overheads,...
Inventory Systems <ul><li>Periodic System : inventory is determined by a periodic count as of a specific date. As long as ...
Inventory Cost Methods <ul><li>In selecting the inventory cost method, the main objective is the selection of the method t...
Inventory Cost Methods <ul><li>First In First Out Method (FIFO) </li></ul><ul><li>Last In First Out Method (LIFO) </li></u...
Inventory Cost Methods <ul><li>FIFO:  here costs are charged against revenue in the order in which they occur. The invento...
Inventory Cost Methods <ul><li>LIFO:  this method matches the most recent costs incurred with the current revenue, leaving...
Inventory Cost Methods <ul><li>Weighted Average Method:  this method assumes that costs are charged against revenue based ...
Inventory Cost Methods Date Units Cost per unit Total cost Jan 15 10000 5.10 51000 Mar 20 20000 5.20 104000 May 10 50000 5...
Under FIFO <ul><li>Dec purchases  5000@5.50 = 27500 </li></ul><ul><li>Oct purchases  5000@5.30 = 26500 </li></ul><ul><li>J...
Under LIFO <ul><li>Opening inventory 10000@5.00 = 50000 </li></ul><ul><li>Jan purchases  4000@5.10 = 20400 </li></ul><ul><...
Under Weighted Average Method <ul><li>Weighted average cost =total cost/total units </li></ul><ul><li>Wei. Ave. cost = 671...
Comparison <ul><li>Under FIFO = 75600 </li></ul><ul><li>Under LIFO = 70400 </li></ul><ul><li>Under WA method = 72261 </li>...
Comparison <ul><li>In periods of inflation, the FIFO method produces the highest ending inventory, resulting in the lowest...
Emerging Concepts <ul><li>The transition from Cost Accounting to Strategic Cost Management (SCM) </li></ul><ul><li>Cost An...
SCM <ul><li>The process of SCM- </li></ul><ul><li>Target Costing </li></ul><ul><li>Activity Based Costing </li></ul><ul><l...
Target Costing <ul><li>Target Cost is defined as “a market based cost that is calculated using a sales price necessary to ...
Target Costing <ul><li>It is Cost Management tool which reduces a product’s costs over its entire life cycle.  </li></ul><...
Activity Based Costing (ABC) <ul><li>Applying overhead costs to each product or service based on the extent to which it is...
Activity Based Costing (ABC) <ul><li>The events within these activities that cause costs are called  cost drivers </li></u...
Activity Based Costing (ABC) <ul><li>The following five steps are used in ABC: </li></ul><ul><li>Choose appropriate activi...
Activity Based Costing (ABC) <ul><li>Overhead account  Cost driver </li></ul><ul><li>Indirect labor  Man hour cost </li></...
Quality Costing <ul><li>A quality costing system monitors and accumulates the costs incurred by a firm in maintaining or i...
Life Cycle Costing <ul><li>Products have definite phases of life </li></ul><ul><li>Cost, revenue and profits vary in these...
Life Cycle Costing <ul><li>Different phases are- </li></ul><ul><li>Introduction </li></ul><ul><li>Growth </li></ul><ul><li...
Value Chain Analysis <ul><li>Value chain is the linked set of value creating activities from the basic raw material source...
Value Chain Analysis <ul><li>It highlights – </li></ul><ul><li>Linkages with suppliers </li></ul><ul><li>Linkages with cus...
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Management -accounting ppt

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  1. 1. MANAGEMENT ACCOUNTING <ul><li>FUNDAMENTALS OF ACCOUNTS </li></ul><ul><li>An account is a summarised record of relevant transactions at one place relating to a particular head. It records not only the amount of transactions but also their effect and direction. </li></ul><ul><li>Debit and Credit are simply additions to or subtractions from an account. </li></ul>
  2. 2. Fundamentals of Accounts <ul><li>The three rules of accounting are </li></ul><ul><li>Debit the receiver and Credit the giver </li></ul><ul><li>Debit what comes in and Credit what goes out </li></ul><ul><li>Debit all expenses and Credit all gains and profits </li></ul>
  3. 3. Classification of Accounts <ul><li>Personal Account </li></ul><ul><li>Real Account </li></ul><ul><li>Nominal Account </li></ul>
  4. 4. Classification of Accounts (Contd.) Type Rules for Debit Rules for Credit Personal Accounts Debit the Receiver Credit the Giver Real Accounts Debit what comes in Credit what goes out Nominal Accounts Debit all expenses and losses Credit all incomes and gains
  5. 5. Classification of Accounts (Contd.) <ul><li>Assets accounts </li></ul><ul><li>Liabilities accounts </li></ul><ul><li>Capital accounts </li></ul><ul><li>Revenue accounts </li></ul><ul><li>Expenses accounts </li></ul><ul><li>Assets = liabilities + capital + profits – losses </li></ul><ul><li>Profits = revenue – expenses </li></ul><ul><li>Losses = expenses - revenue </li></ul>
  6. 6. Rules of Debit and Credit <ul><li>Increase in assets are debits and decrease are credits </li></ul><ul><li>Increase in liabilities are credits and decrease are debits </li></ul><ul><li>Increase in capital are credits and decrease are debits </li></ul><ul><li>Increase in expenses are debits and decrease are credits </li></ul><ul><li>Increase in revenues are credits and decrease are debits </li></ul>
  7. 7. Financial Statements <ul><li>Financial Statements are compilation of accounting information for the external users. </li></ul><ul><li>They include </li></ul><ul><li>Profit and Loss Account </li></ul><ul><li>Balance Sheet </li></ul><ul><li>Schedules and Notes forming part of the above </li></ul>
  8. 8. Financial Statements (Contd.) <ul><li>Capital Expenditure is the amount spent by an enterprise on purchase of fixed assets that are used in the business to earn income and not intended for resale. </li></ul><ul><li>Capital expenditure normally yields benefits over a period extending beyond the accounting period. </li></ul><ul><li>Revenue expenditure is the amount spent on running of a business </li></ul><ul><li>The benefit of the revenue expenditure is exhausted in the accounting period in which it is incurred. </li></ul>
  9. 9. Distinction between Capital and Revenue Expenditure Purpose It is incurred for acquisition of fixed assets for use in business It is incurred for running of business Capacity It increases the earning capacity of the business It is incurred for earning profits Period Its benefit is extended to more than one year Its benefit extends to only one accounting year Depiction It is shown in the balance sheet It is part of trading or Profit or Loss account
  10. 10. Management Accounting <ul><li>Definition </li></ul><ul><li>Management accounting is the process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of information that assists managers in specific decision making within the framework of fulfilling the organizational objectives. </li></ul>
  11. 11. Types of Decisions <ul><li>The decisions, managers are concerned with, can be categorized as – </li></ul><ul><li>Planning decisions </li></ul><ul><li>Control decisions </li></ul>
  12. 12. Planning Decisions <ul><li>Planning Decisions are concerned with the establishment of goals for the organization and the choosing of plans to accomplish these goals </li></ul><ul><li>Management accounting information is needed to take Planning decisions </li></ul>
  13. 13. Control Decisions <ul><li>Control decisions result from implementing the plans and monitoring the actual results to see if goals are being achieved </li></ul><ul><li>If goals are not being achieved, either corrective steps must be taken resulting in goal achievement or goals themselves have to be revised to attainable levels </li></ul><ul><li>Cost accounting data are needed for taking Control decisions </li></ul>
  14. 14. Financial Accounting vs. Management Accounting <ul><li>Financial Accounting covers the process of book keeping, finalization of accounts, preparation of financial statements, communication of accounting information to users and interpretation thereof </li></ul><ul><li>Management Accounting is concerned with accounting information that is useful to management </li></ul><ul><li>Financial Accounting emphasizes the preparation of reports of an organization for external users whereas Management Accounting emphasizes the preparation of reports for its internal users </li></ul>
  15. 15. Financial Accounting vs. Management Accounting <ul><li>External users vs. Internal users </li></ul><ul><li>Record of financial history vs. Emphasis on the future </li></ul><ul><li>GAAP vs. Own rules </li></ul><ul><li>Objectivity and verifiability vs. Flexibility </li></ul><ul><li>Emphasis on accuracy vs.Acceptance of estimates </li></ul><ul><li>Focus on company as a whole vs. Focus on segments of a company </li></ul><ul><li>Bound by conventional accounting systems vs. Use of other disciplines such as Economics, Statistics, OR, OB, etc </li></ul><ul><li>Governed by Regulatory Bodies vs. Freedom of choice </li></ul>
  16. 16. Cost Accounting vs. Management Accounting <ul><li>Cost Accounting is mainly concerned with the techniques of product costing and deals with only cost and price data. It is limited to product costing procedures and related information processing. It helps management in planning and controlling costs relating to both production and distribution channels. Cost Accounting is a “Line function” </li></ul><ul><li>Management Accounting is not confined to the area of product costing. The objective is to have a data pool which will include all information that management may need, both costing and financial. Management accounting is a “Staff function” </li></ul>
  17. 17. Management Accounting Framework
  18. 18. Management Accounting Framework <ul><li>Data accumulation is done through Financial Accounting and Cost Accounting systems. Financial records are maintained through financial accounting system and cost records are maintained through cost accounting systems </li></ul><ul><li>In Management Accounting system, data support is taken from financial accounting and cost accounting and also data accumulation is carried out from external sources. Accumulated data are reclassified as per the requirements of the management decision making process. Information is built up and then communicated to assist the decision making process </li></ul>
  19. 19. Contents of Management Accounting <ul><li>Management process is a series of activities involved in planning, implementation and control. Each phase of management process requires decision making </li></ul><ul><li>Management Accounting supports managerial decision making providing the required information </li></ul><ul><li>Information generated in management accounting process includes- </li></ul><ul><li>- Financial Statement Analysis </li></ul><ul><li>- Cash flow information </li></ul><ul><li>- Cost information </li></ul><ul><li>- Budgets and Standards </li></ul>
  20. 20. Statements of Financial Information <ul><li>Balance Sheet </li></ul><ul><li>Profit and Loss Account </li></ul><ul><li>Statement of changes in financial position </li></ul><ul><li>- Cash flow statement </li></ul><ul><li>- Fund flow statement </li></ul>
  21. 21. Contents of Balance Sheet <ul><li>The balance sheet provides information about the financial standing/position of a company at a particular point in time i.e. as March 31, 2006 </li></ul><ul><li>It is a snapshot of the financial status of the company </li></ul><ul><li>The financial position of the company is valid for only one day i.e. the reference day </li></ul>
  22. 22. Contents of Balance Sheet <ul><li>The financial position as disclosed by the balance sheet refers to its resources and obligations and the interests of its owners in the business. </li></ul><ul><li>The balance sheet contains information regarding assets, liabilities and shareholders’ equity </li></ul><ul><li>The balance sheet can be present in either of the two forms: </li></ul><ul><li>- the account form </li></ul><ul><li>- the report form </li></ul>
  23. 23. Assets <ul><li>Assets are the valuable resources owned by a business </li></ul><ul><li>Assets need to satisfy three requirements: </li></ul><ul><li>- the resources must be valuable i.e. it is cash or convertible into cash or it can provide future benefits to the operations of the firm </li></ul><ul><li>- the resources must be owned in the legal sense. Mere possession or control would not constitute an asset </li></ul><ul><li>- the resource must be acquired at a cost </li></ul>
  24. 24. Assets <ul><li>The assets in the balance sheet are listed either in the order of liquidity i.e. promptness with which they are expected to be converted into cash or </li></ul><ul><li>In the reverse order i.e. fixity or listing of the least liquid asset first, followed by others </li></ul>
  25. 25. Assets <ul><li>All assets are grouped into categories i.e. assets with similar characteristics are put in one category </li></ul><ul><li>The standard classification of assets divides them into- </li></ul><ul><li>- fixed assets / long term assets </li></ul><ul><li>- current assets </li></ul><ul><li>- investments </li></ul><ul><li>- other assets </li></ul>
  26. 26. Fixed assets <ul><li>These assets are fixed in the sense that they are acquired to be retained in the business on a long term basis to produce goods and services and not for resale </li></ul><ul><li>They are long term resources and are held for more than one accounting year </li></ul><ul><li>These assets are significant as the future earnings/profits of the company are determined by them </li></ul>
  27. 27. Categories of Fixed Assets <ul><li>Tangible </li></ul><ul><li>Intangible </li></ul>
  28. 28. Tangible Fixed Assets <ul><li>These assets have a physical existence and generate goods and services </li></ul><ul><li>Examples are land, buildings, plant, machinery, furniture, etc </li></ul><ul><li>They are shown in the balance sheet at their cost to the firm at the time of their purchase </li></ul><ul><li>The cost of these assets are allocated over their useful life </li></ul><ul><li>The yearly allocation is called “Depreciation” </li></ul>
  29. 29. Tangible Fixed Assets (Contd.) <ul><li>As a result of depreciation, the amount of tangible fixed assets shown in the balance sheet every year declines to the extent of depreciation charged that year </li></ul><ul><li>By the end of the useful life of the asset, value becomes nil or the salvage value, if any </li></ul><ul><li>Salvage value signifies the amount realizable by the sale of the asset at the end of its useful life </li></ul>
  30. 30. Intangible Fixed Assets <ul><li>These assets do not generate goods and services directly </li></ul><ul><li>They reflect the rights of the company </li></ul><ul><li>Examples – patents, copyrights, trademarks, goodwill, etc </li></ul><ul><li>They confer certain exclusive rights on their owners </li></ul><ul><li>Intangibles are also written off over a period of time </li></ul>
  31. 31. Current Assets <ul><li>The second category of assets in the balance sheet are current assets </li></ul><ul><li>In contrast to the fixed assets, current assets are short term in nature </li></ul><ul><li>As short term assets, they refer to assets / resources which are either held in the form of cash or expected to be realized in cash within the accounting period or the normal operating cycle of the business </li></ul><ul><li>The term “operating cycle” means the time span during which the cash is converted into inventory, inventory into receivables/cash sales and receivables into cash </li></ul>
  32. 32. Current assets (Contd.) <ul><li>Current assets are also known as “liquid assets” </li></ul><ul><li>They include- </li></ul><ul><li>- cash </li></ul><ul><li>- marketable securities </li></ul><ul><li>- accounts receivables/debtors </li></ul><ul><li>- bills receivables </li></ul><ul><li>- inventory </li></ul>
  33. 33. Current Assets (Contd.) <ul><li>Cash </li></ul><ul><li>Most liquid form of current asset </li></ul><ul><li>Cash in hand and at bank </li></ul><ul><li>To meet obligations / acquire assets without any delay </li></ul>
  34. 34. Current Assets (Contd.) <ul><li>Marketable Securities </li></ul><ul><li>Short term investments which are readily marketable and can be converted into cash within a year </li></ul><ul><li>Outlet to invest temporarily available surplus/idle funds </li></ul><ul><li>Declared at cost or market value whichever is lower and the other amount is indicated in the financial statement </li></ul>
  35. 35. Current Assets (Contd.) <ul><li>Accounts Receivable </li></ul><ul><li>The amount the customers owe to the firm, arising out of the sale of goods on credit </li></ul><ul><li>They are called the sundry debtors </li></ul><ul><li>The unrecoverable portion is termed as bad debts and written off out of the P & L a/c </li></ul>
  36. 36. Current assets (Contd.) <ul><li>Bills Receivable </li></ul><ul><li>Amount owed by outsiders for which written acknowledgements of the obligations are available </li></ul><ul><li>IOUs are drawn and exchanged </li></ul><ul><li>Temporary credit can be arranged by discounting these IOUs </li></ul>
  37. 37. Current Assets (Contd.) <ul><li>Inventory </li></ul><ul><li>It includes </li></ul><ul><li>The goods which are held for sale in the course of business (finished goods) </li></ul><ul><li>The goods which are in the process of production (work in progress or semi finished goods) </li></ul><ul><li>The goods which are to be consumed in the process of production (raw materials) </li></ul>
  38. 38. Investments <ul><li>The third category of assets is investments </li></ul><ul><li>They represent investment of funds in the securities of another company </li></ul><ul><li>They are long term assets outside the business of the firm </li></ul><ul><li>The purpose is to earn a return and/or to control another comapny </li></ul>
  39. 39. Other Assets <ul><li>Included in this category are the Deferred Charges </li></ul><ul><li>Example: Advertisement, Preliminary expenses, etc </li></ul>
  40. 40. Liabilities <ul><li>Liabilities are defined as the claims of outsiders against the firm </li></ul><ul><li>They represent the amount that the firm owes to outsiders other than the owners </li></ul><ul><li>The assets are financed by different sources </li></ul><ul><li>Depending on the periodicity of the funds, liabilities are classified into - Long term and short term sources </li></ul>
  41. 41. Long term Liabilities <ul><li>Sources of funds included in this category are available for periods exceeding one year </li></ul><ul><li>Such liabilities represent obligations of a firm payable after the accounting period </li></ul><ul><li>Example: Debentures, Bonds, Mortgages, Secured loans from FIs and banks </li></ul><ul><li>They have to be redeemed/repaid either as a lump sum on maturity or over a period of time in instalments </li></ul>
  42. 42. Current Liabilities or Short term Liabilities <ul><li>These Liabilities are payable to outsiders in a short period, usually within the accounting period or the operating cycle of the firm </li></ul><ul><li>Example: Accounts payable, Bills payable, Tax payable, Accrued expenses, Short term bank credit </li></ul><ul><li>Accounts and Bills payable are considered as Trade Credit </li></ul>
  43. 43. Current Liabilities (Contd.) <ul><li>Trade Credit </li></ul><ul><li>The claims of outsiders who have sold goods to the firm on credit for a short period </li></ul><ul><li>Usually these are unsecured </li></ul><ul><li>Such liabilities extended without any written commitment are Accounts Payable or Sundry Creditors </li></ul><ul><li>Such liabilities extended with formal agreements through IOUs are Bills payable </li></ul>
  44. 44. Current Liabilities (Contd.) <ul><li>Short term Bank Credit </li></ul><ul><li>Liabilities contracted through banks for a short period for the purpose of running the business </li></ul><ul><li>Example: cash credit, overdraft, loans and advances </li></ul>
  45. 45. Current Liabilities (Contd.) <ul><li>Tax Payable refers to the amount payable to the Government as taxes </li></ul><ul><li>Accrued Expenses represents obligations which are payable and kept outstanding by the firm </li></ul><ul><li>Example: outstanding wages, salaries, rent, commission, etc </li></ul>
  46. 46. Owners’ Equity or Capital <ul><li>The next main component of the balance sheet is the owners’ equity </li></ul><ul><li>It represents the residual claim of the owners on the assets of the company after settling all the external liabilities </li></ul><ul><li>The owners of the company are called the shareholders </li></ul><ul><li>Two types of shareholders – equity and preference </li></ul>
  47. 47. Preference Capital <ul><li>These shareholders are entitled to a stated amount of dividend and return of principal on maturity </li></ul><ul><li>In this sense, they are akin to that of a lender </li></ul><ul><li>But, he is entitled to the dividend only if the company has made profits </li></ul><ul><li>In this sense, they are the owners </li></ul>
  48. 48. Equity Capital <ul><li>They are the residual claimants of the profits </li></ul><ul><li>After all the external liability holders and the preference shareholders have been paid, the balance amount, if any, belongs to the Equity shareholders </li></ul><ul><li>Components: Paid up capital which is the initial investments made by this group and Retained earnings/Reserves and Surplus which is the undistributed part of the residual profits over the years which has been put back in business </li></ul>
  49. 49. Common Doubts <ul><li>Why is share capital shown as a liability? </li></ul><ul><li>Depreciation – what is its nature? </li></ul><ul><li>Accumulated losses – treatment? </li></ul><ul><li>Goodwill – what is its nature? </li></ul><ul><li>What is the significance of the auditor’s report? </li></ul>
  50. 50. Contents of Profit and Loss Account <ul><li>Revenues : Turnover </li></ul><ul><li>Other income </li></ul><ul><li>Sale of fixed assets </li></ul><ul><li>Expenses </li></ul><ul><li>Profit / Loss </li></ul>
  51. 51. Revenues <ul><li>Revenue is defined as the income that accrues to the firm by sale of goods and services or through investments </li></ul><ul><li>Sales Revenue is the amount earned through sale of goods/services </li></ul><ul><li>Gross sales is the total sales, while Net sales is gross sales minus the trade discounts </li></ul>
  52. 52. Revenue (Contd.) <ul><li>Other income is earned through other sources of investments </li></ul><ul><li>Examples: Interest, dividend, royalty, commission, fee, etc </li></ul><ul><li>Sale of Fixed Assets are the revenues which come into the business when unused / unwanted assets are sold and money recovered by the company </li></ul>
  53. 53. Expenses <ul><li>The cost of earning the revenues are the expenses </li></ul><ul><li>Examples: variable expenses like cost of manufacture, cost of selling, fixed expenses like salaries, administrative expenses </li></ul>
  54. 54. Expenses (Contd.) <ul><li>Cost of goods consumed </li></ul><ul><li>This is the value of the inputs used to manufacture the final product </li></ul><ul><li>It is calculated as – </li></ul><ul><li>Opening stock </li></ul><ul><li>+ Purchases </li></ul><ul><li>- Closing Stock </li></ul>
  55. 55. Expenses (Contd.) <ul><li>Manufacturing expenses </li></ul><ul><li>These include all expenses related to plant and manufacturing operations like power and fuel, repairs and maintenance, stores consumed, water consumed, etc </li></ul><ul><li>Excise Duty </li></ul><ul><li>This is the amount paid to the Govt. as a tax, before the goods are dispatched from the factory </li></ul>
  56. 56. Expenses (Contd.) <ul><li>Salaries and Wages </li></ul><ul><li>These are the cost of labour and other staff and will also include all other employee benefits and amenities. </li></ul><ul><li>The other benefits include Provident Fund, ESI contributions, medical benefits, LTC, bonus, gratuity, pension, other superannuation benefits, etc </li></ul>
  57. 57. Expenses (Contd.) <ul><li>Administrative Expenses </li></ul><ul><li>These include office expenses, secretarial costs, postage and telephones, director’s remuneration and other administrative expenses </li></ul><ul><li>Selling Expenses </li></ul><ul><li>These include freight, advertising and sales promotion, commissions and discounts and other selling and distribution costs </li></ul>
  58. 58. Expenses (Contd.) <ul><li>Interest </li></ul><ul><li>The interest costs consist of interest on long term loans, debentures, bank loans for working capital, interest on public deposits and other loans </li></ul><ul><li>Depreciation </li></ul><ul><li>This represents a non cash expenditure as it is only an accounting provision. This amount is not paid to an outside party </li></ul><ul><li>Other expenses </li></ul><ul><li>This includes auditor’s remuneration, petty expenses, donations, etc </li></ul>
  59. 59. Profit / Loss <ul><li>The difference between the revenue and expense is profit </li></ul><ul><li>When expense exceeds the revenue, the company ends up with a loss. </li></ul><ul><li>PBID: Profit before Interest and Depreciation </li></ul><ul><li>PBT: Profit before Tax </li></ul><ul><li>PAT: Profit after Tax </li></ul>
  60. 60. The Profit Appropriations <ul><li>Profit after Tax (PAT) is available for appropriations for </li></ul><ul><li>Debenture Redemption Reserve </li></ul><ul><li>General Reserve </li></ul><ul><li>Dividend on Preference Share </li></ul><ul><li>Dividend on Equity Share </li></ul>
  61. 61. Profit or Loss carried over <ul><li>After appropriating the taxes and dividends, the balance surplus is transferred to Reserves and Surplus in the Balance Sheet </li></ul><ul><li>The net loss reduces the Reserves and Surplus in the Balance Sheet </li></ul>
  62. 62. Financial Ratio Analysis <ul><li>Financial Analysts use the financial ratio analysis to gain critical insights about companies </li></ul><ul><li>Several ratios are worked out using the financial data drawn from the P&L account and Balance Sheet </li></ul><ul><li>These ratios are studied and compared to obtain analytical insights </li></ul>
  63. 63. Merits of Ratio Analysis <ul><li>Financial ratios are helpful: </li></ul><ul><li>To bankers for appraising the credit worthiness </li></ul><ul><li>To the financial institutions for project appraisal </li></ul><ul><li>To investors for taking investment and disinvestment decisions </li></ul><ul><li>To financial analysts for making comparisons and recommending to the investing public </li></ul>
  64. 64. Merits of Ratio Analysis <ul><li>To the credit rating agencies (like CRISIL, ICRA, etc) in their credit rating exercise </li></ul><ul><li>To the Government agencies for reviewing a company’s overall performance </li></ul><ul><li>To the company’s management for making intra-firm and inter-firm comparisons </li></ul>
  65. 65. Limitations of Ratio Analysis <ul><li>No uniformity in definitions </li></ul><ul><li>No norms </li></ul><ul><li>Varying situations </li></ul><ul><li>Limitations of published accounts </li></ul><ul><li>Diversified companies </li></ul><ul><li>Historical costs (replacement cost / market price) </li></ul><ul><li>Window dressing </li></ul>
  66. 66. Financial Ratio Analysis <ul><li>Ratios on ROI </li></ul><ul><li>Activity ratios </li></ul><ul><li>Liquidity ratios </li></ul><ul><li>Profitability ratios </li></ul><ul><li>Leverage ratios </li></ul><ul><li>Coverage ratios </li></ul><ul><li>Equity investor’s ratio </li></ul>
  67. 67. Ratios on ROI <ul><li>Return on assets = PAT </li></ul><ul><li>---------------- * 100 </li></ul><ul><li>Total assets </li></ul><ul><li>Return on total capital employed = </li></ul><ul><li>PBT + Interest </li></ul><ul><li>-------------------------- * 100 </li></ul><ul><li>Total capital employed </li></ul><ul><li>(Total cap.employed = total assets–current liabilities) </li></ul>
  68. 68. Ratios on ROI <ul><li>Return on Net worth = </li></ul><ul><li>Net profit after tax </li></ul><ul><li>------------------------ * 100 </li></ul><ul><li>Net worth </li></ul><ul><li>Net worth = Share capital + reserves & surplus – accumulated losses </li></ul>
  69. 69. Cash Flow Analysis <ul><li>A cash flow statement depicts change in cash position from one period to another. </li></ul><ul><li>“ cash” stands for cash and bank balances. </li></ul><ul><li>Cash flow statement is useful for short term planning </li></ul><ul><li>It helps to make reliable cash flow projections for the immediate future. </li></ul>
  70. 70. Difference between CFS and FFS <ul><li>CFS </li></ul><ul><li>Only with change in cash position </li></ul><ul><li>Mere record of cash receipts and payments </li></ul><ul><li>More for short term use </li></ul><ul><li>Improvement in cash improves funds position </li></ul><ul><li>FFS </li></ul><ul><li>Change in working capital position </li></ul><ul><li>Needed for short term solvency </li></ul><ul><li>Long term use </li></ul><ul><li>Improvement in funds position need not necessarily improve cash </li></ul>
  71. 71. Advantages <ul><li>Helps in efficient cash management </li></ul><ul><li>Helps in internal financial management </li></ul><ul><li>Discloses the movement of cash </li></ul><ul><li>Discloses success or failure of cash planning </li></ul>
  72. 72. Limitations <ul><li>Cash flow does not reflect net income as it does not consider non cash transactions </li></ul><ul><li>Cash position can be manipulated by collecting ahead or deferring some payments </li></ul><ul><li>FFS, CFS and Income statement – each has its own use and one can not replace the other </li></ul>
  73. 73. CFS <ul><li>Sources of Cash </li></ul><ul><li>Internal </li></ul><ul><li>External </li></ul><ul><li>Applications of Cash </li></ul>
  74. 74. CFS <ul><li>Internal sources </li></ul><ul><li>Cash flow from operating activities </li></ul><ul><li>Net profit + </li></ul><ul><li>Depreciation + </li></ul><ul><li>Amortization of non cash expenses + </li></ul><ul><li>Loss on sale of fixed assets + </li></ul><ul><li>Gain on sale of fixed assets + </li></ul><ul><li>Provisions made in the P&L account + </li></ul><ul><li>Transfer to reserves </li></ul>
  75. 75. CFS <ul><li>Adjustment for changes in current assets and current liabilities </li></ul><ul><li>Adjusted Net profit </li></ul><ul><li>+ Decrease in sundry debtors </li></ul><ul><li>+ Decrease in bills receivables </li></ul><ul><li>+ Decrease in inventories </li></ul><ul><li>+ Decrease in prepaid expenses </li></ul><ul><li>+ Decrease in accrued income </li></ul><ul><li>+ Increase in sundry creditors </li></ul><ul><li>+ Increase in bills payable </li></ul><ul><li>+ Increase in outstanding expenses contd.. </li></ul>
  76. 76. CFS <ul><li>Adjustment for changes in current assets and current liabilities </li></ul><ul><li>- Increase in sundry debtors </li></ul><ul><li>- Increase in bills receivables </li></ul><ul><li>- Increase in inventories </li></ul><ul><li>- Increase in prepaid expenses </li></ul><ul><li>- Increase in accrued income </li></ul><ul><li>- Decrease in sundry creditors </li></ul><ul><li>- Decrease in bills payable </li></ul><ul><li>- Decrease in outstanding expenses </li></ul>
  77. 77. CFS <ul><li>Increase in cash </li></ul><ul><li>Decrease in current asset </li></ul><ul><li>Increase in current liability </li></ul><ul><li>Decrease in cash </li></ul><ul><li>Increase in current asset </li></ul><ul><li>Decrease in current liability </li></ul>
  78. 78. CFS <ul><li>External sources </li></ul><ul><li>Issue of shares </li></ul><ul><li>Issue of debentures </li></ul><ul><li>Raising of deposits </li></ul><ul><li>Raising of loans – secured and unsecured </li></ul><ul><li>Raising of bank borrowings </li></ul><ul><li>Sale of assets and investments </li></ul>
  79. 79. CFS <ul><li>Applications of cash </li></ul><ul><li>Purchase of fixed assets </li></ul><ul><li>Repayment of loans – secured, unsecured </li></ul><ul><li>Repayment of bank borrowings </li></ul><ul><li>Repayment of deposits </li></ul><ul><li>Redemption of debentures </li></ul><ul><li>Redemption of preference shares </li></ul><ul><li>Loss from operations </li></ul><ul><li>Tax paid </li></ul><ul><li>Dividend paid </li></ul>
  80. 80. Cost Concepts <ul><li>Important inputs in managerial decision making is cost data </li></ul><ul><li>Cost data is classified based on managerial needs </li></ul><ul><li>Managerial needs are- </li></ul><ul><li>Income measurement </li></ul><ul><li>Profit planning </li></ul><ul><li>Costs control </li></ul><ul><li>Decision making </li></ul>
  81. 81. Relating to Income Measurement <ul><li>Product cost and Period cost </li></ul><ul><li>Absorbed cost and Unabsorbed cost </li></ul><ul><li>Expired cost and Unexpired cost </li></ul><ul><li>Joint product cost and Separable cost </li></ul>
  82. 82. Relating to Income Measurement <ul><li>Product cost and Period cost </li></ul><ul><li>Only variable costs are taken as product costs, as they are affected by production volume </li></ul><ul><li>Period costs vary with the passage of time and not with volume of production, viz., fixed costs </li></ul>
  83. 83. Relating to Income Measurement <ul><li>Absorbed cost and Unabsorbed cost </li></ul><ul><li>Since fixed costs also contribute to production, they need to be shared by the volume produced </li></ul><ul><li>SFOR – Standard Fixed Overhead Rate </li></ul><ul><li>SFOR = Fixed cost / Units produced </li></ul><ul><li>Absorbed costs = units produced * SFOR </li></ul><ul><li>Unabsorbed costs =AFC–(Units produced*SFOR) </li></ul><ul><li>AFC = Actual Fixed costs </li></ul>
  84. 84. Relating to Income Measurement <ul><li>Expired cost and Unexpired cost </li></ul><ul><li>Expired cost can not contribute to the production of future revenues </li></ul><ul><li>Unexpired cost has the capacity to contribute to the production of revenue in the future., example, inventory </li></ul>
  85. 85. Relating to Income Measurement <ul><li>Joint product cost and Separable cost </li></ul><ul><li>Joint Product costs are the costs of a single process that simultaneously produce multi products and can not be attributed to any one product </li></ul><ul><li>Separable costs can be attributed exclusively and wholly to a particular product </li></ul>
  86. 86. Relating to Profit Planning <ul><li>Fixed, Variable, Semi variable / Mixed cost </li></ul><ul><li>Future cost and Budgeted cost </li></ul>
  87. 87. Relating to Profit Planning <ul><li>Fixed, Variable, Mixed costs </li></ul><ul><li>Fixed costs are associated with those inputs which do not vary with changes in volume of production (Committed and Discretionary) </li></ul><ul><li>Variable costs which vary with volume of production </li></ul><ul><li>Mixed cost are partly fixed and partly variable </li></ul>
  88. 88. Relating to Profit Planning <ul><li>Future cost and Budgeted cost </li></ul><ul><li>Future costs are reasonably expected to be incurred at some future date as a result of a current decision </li></ul><ul><li>They are estimated costs based on expectations </li></ul><ul><li>When an operating plan involving future costs is accepted and incorporated formally in the budget for a specific period, such costs are referred as budgeted costs </li></ul>
  89. 89. Relating to Control <ul><li>Responsibility costs </li></ul><ul><li>Controllable and Non controllable costs </li></ul><ul><li>Direct and Indirect costs </li></ul>
  90. 90. Relating to Control <ul><li>Responsibility costs </li></ul><ul><li>This concept applies more as responsibility accounting </li></ul><ul><li>Costs are classified with the persons / centers responsible for their incurrence </li></ul>
  91. 91. Relating to Control <ul><li>Controllable costs are those which can be controlled / influenced by the responsibility centers/persons </li></ul><ul><li>Non controllable costs are those which can not be influenced </li></ul>
  92. 92. Relating to Control <ul><li>Direct costs are those which can be identified in their entirety to a particular product in a responsibility center </li></ul><ul><li>Indirect costs are “common costs” which are shared among products / departments </li></ul>
  93. 93. Relating to Decision making <ul><li>Relevant cost and Irrelevant cost </li></ul><ul><li>Incremental cost and Differential cost </li></ul><ul><li>Out of pocket cost and sunk cost </li></ul><ul><li>Opportunity cost and Imputed cost </li></ul>
  94. 94. Relating to Decision making <ul><li>Relevant costs are those influenced by a decision and hence are important for decision makers, typically variable costs </li></ul><ul><li>Irrelevant costs are not affected by the decision taken and hence decision makers do not worry about them, typically committed fixed costs </li></ul>
  95. 95. Relating to Decision making <ul><li>Incremental costs are additional costs incurred if management chooses a particular course of action as against another </li></ul><ul><li>Differential costs are difference in costs between any two available alternatives </li></ul>
  96. 96. Relating to Decision making <ul><li>Out of pocket costs are costs which involve fresh outflow of cash on decision taken </li></ul><ul><li>Sunk costs are those which have already been incurred where current decisions have no impact on. </li></ul>
  97. 97. Relating to Decision making <ul><li>Opportunity costs represent benefits foregone by not choosing one alternative in favour of another that can be quantified </li></ul><ul><li>Imputed costs are the hypothetical costs that must be considered while arriving at the right decision </li></ul>
  98. 98. Marginal Costing <ul><li>Marginal cost is the cost of producing one additional unit </li></ul><ul><li>Variable cost varies with the level of production </li></ul><ul><li>Fixed cost remains constant for a range of capacity utilization </li></ul><ul><li>Therefore for a given range of capacity utilization, the marginal cost is the variable cost per unit. </li></ul>
  99. 99. Marginal Costing (Contd.) <ul><li>If the level of capacity utilization changes, the fixed cost changes. </li></ul><ul><li>Then the incremental fixed cost has to be shared by the additional capacity produced </li></ul><ul><li>Then the Marginal Cost is the sum of variable cost per unit and the incremental fixed cost per unit </li></ul>
  100. 100. Marginal Costing (Contd.) <ul><li>For a given capacity level, the marginal cost is only the variable cost. This is because the fixed cost will not change up to a certain level of production </li></ul><ul><li>When the fixed cost changes with the change in capacity utilization, the marginal cost is the sum of variable cost per unit and the incremental cost per unit </li></ul>
  101. 101. Marginal Costing (Contd.) <ul><li>Under Absorption costing, all costs, both fixed and variable costs are allocated to the product </li></ul><ul><li>Under marginal costing, only variable costs are allocated to the product and the fixed costs are recovered out of the contribution </li></ul>
  102. 102. Break Even Analysis <ul><li>Sales </li></ul><ul><li>minus </li></ul><ul><li>Variable cost </li></ul><ul><li>= </li></ul><ul><li>Contribution </li></ul><ul><li>minus </li></ul><ul><li>Fixed cost </li></ul><ul><li>= </li></ul><ul><li>Profit or Loss </li></ul>
  103. 103. Break Even Analysis (Contd.) <ul><li>BEP (in Units) = Fixed cost (in Rs.) </li></ul><ul><li>---------------------------------- </li></ul><ul><li>Contribution per unit (in Rs.) </li></ul><ul><li>Contribution per unit (in Rs.) </li></ul><ul><li>= SP(in Rs.)/unit – VC(in Rs.)/unit </li></ul>
  104. 104. Break Even Analysis (Contd.) <ul><li>Profit Volume Ratio = Contribution </li></ul><ul><li>(P/V ratio) ------------------ * 100 </li></ul><ul><li>Sales </li></ul>
  105. 105. Break Even Analysis (Contd.) <ul><li>BEP (in Rs. = Fixed Coat (in Rs.) </li></ul><ul><li>----------------------- </li></ul><ul><li>P/V ratio </li></ul>
  106. 106. Break Even Analysis (Contd.) <ul><li>Margin of safety = Actual sales – BEP sales </li></ul><ul><li>Margin of safety ratio = </li></ul><ul><li>Actual sales – BEP sales </li></ul><ul><li>------------------------------ </li></ul><ul><li>Actual sales </li></ul><ul><li>Profit = Margin of safety * P/V ratio </li></ul>
  107. 107. Budgetary Control <ul><li>Budgeting is tool of planning </li></ul><ul><li>Planning involves specification of the basic objectives that the organisation will pursue and the fundamental policies that will guide it </li></ul>
  108. 108. Budgetary Control (Contd.) <ul><li>Steps in Planning: </li></ul><ul><li>Objectives defined as the broad and long range position of the firm </li></ul><ul><li>Specified goal targets in quantitative terms achieved in a specified period of time </li></ul><ul><li>Strategies to achieve these goals </li></ul><ul><li>Budgets to convert goals and strategies into annual operating plans </li></ul>
  109. 109. Budgetary Control (Contd.) <ul><li>A budget is defined as a comprehensive and coordinated plan, expressed in financial terms, for the operations and resources of an enterprise for some specified period I the future. </li></ul><ul><li>As a tool, a budget serves as a guide to conduct operations and a basis for evaluating actual results </li></ul>
  110. 110. Budgetary Control (Contd.) <ul><li>The essential elements of a budget are: </li></ul><ul><li>Plan </li></ul><ul><li>Financial terms </li></ul><ul><li>Operations and Resources </li></ul><ul><li>Specific future period </li></ul><ul><li>Comprehensive coverage </li></ul><ul><li>Coordination </li></ul>
  111. 111. Budgetary Control (Contd.) <ul><li>The main objectives of budgeting are: </li></ul><ul><li>Explicit statement of expectations </li></ul><ul><li>Communication </li></ul><ul><li>Coordination </li></ul><ul><li>Expectations as framework for judging performance </li></ul>
  112. 112. Budgetary Control (Contd.) <ul><li>The overall budget is known as the Master budget. </li></ul><ul><li>Classification – Operating budgets and Financial budgets </li></ul><ul><li>Operating budgets include cash flows from the operations of the firm viz., sales, collections of receivables, etc </li></ul><ul><li>Financial budgets include cash flows from collection and payments of financial nature viz., borrowings, external raising of money, taxes pais and dividend paid, etc </li></ul>
  113. 113. Budgetary Control (Contd.) <ul><li>Operating budget </li></ul><ul><li>Sales budget </li></ul><ul><li>Production budget </li></ul><ul><li>Purchase budget </li></ul><ul><li>Direct labour budget </li></ul><ul><li>Manufacturing expenses budget </li></ul><ul><li>Administrative and Selling expenses budget </li></ul>
  114. 114. Budgetary Control (Contd.) <ul><li>Financial Budget </li></ul><ul><li>Budgeted income statement </li></ul><ul><li>Budgeted statement of retained earnings </li></ul><ul><li>Cash budget </li></ul><ul><li>Budgeted balance sheet </li></ul>
  115. 115. Budgetary Control (Contd.) <ul><li>Budgets prepared at a single level of activity, with no prospect of modification in the light of changed circumstances, are referred to as fixed budgets </li></ul><ul><li>A flexible budget estimates costs at several levels of activity </li></ul><ul><li>While fixed budget is rigid in nature, flexible budget contains several estimates / plans in different assumes circumstances </li></ul><ul><li>It is a useful tool in real world situations, that is, unpredictable environment </li></ul>
  116. 116. Budgetary Control (Contd.) <ul><li>The framework of flexible budget covers- </li></ul><ul><li>Measure of volume </li></ul><ul><li>Cost behaviour with change in volume </li></ul>
  117. 117. Inventory Costing <ul><li>Inventories are assets: </li></ul><ul><li>Held for sale in the ordinary course of business (finished goods) </li></ul><ul><li>In the process of production for such sale (work in progress) </li></ul><ul><li>In the form materials or supplies to be consumed in the production process or in the rendering of services (raw materials) </li></ul><ul><li>Purchased and held for resale </li></ul>
  118. 118. Inventory Costing <ul><li>Inventories should be valued at the lower of cost or net realizable value </li></ul><ul><li>Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make such sale </li></ul>
  119. 119. Inventory Costing <ul><li>The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition </li></ul><ul><li>Cost of purchase consists of the purchase price inclusive of the taxes and duties, freight inwards and other acquisition costs directly attributable to the purchase and trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the cost of purchase </li></ul>
  120. 120. Inventory Costing <ul><li>Costs of conversion include costs directly related to production like labor, factory overheads, etc. In this process, if any byproduct, waste or scrap are produced, their net realizable value is removed from the cost of conversion </li></ul><ul><li>Other costs included in the cost of inventories are only those incurred in bringing the inventories to their present level like design cost, etc. </li></ul>
  121. 121. Inventory Systems <ul><li>Periodic System : inventory is determined by a periodic count as of a specific date. As long as the check is frequent enough to avoid negligence, this system is acceptable. The net change between the beginning and ending inventories enters the calculation of cost of goods sold </li></ul><ul><li>Perpetual System : inventory records are maintained and updated continuously as items are purchased and sold. It has the advantage of providing up to date inventory information on a timely basis, but needs a full fledged record maintenance </li></ul>
  122. 122. Inventory Cost Methods <ul><li>In selecting the inventory cost method, the main objective is the selection of the method that clearly reflects its usage and the periodic income. Frequently, the identity of the goods and their specific related costs are lost between the time of acquisition and the time of their use. When similar goods are purchased at different times, it may not be possible to identify and match the specific costs of the item sold. This has resulted in certain accepted costing methods </li></ul>
  123. 123. Inventory Cost Methods <ul><li>First In First Out Method (FIFO) </li></ul><ul><li>Last In First Out Method (LIFO) </li></ul><ul><li>Weighted Average Method </li></ul>
  124. 124. Inventory Cost Methods <ul><li>FIFO: here costs are charged against revenue in the order in which they occur. The inventory remaining on hand is presumed to consist of the most recent costs. In other words, items are converted and sold in the order in which they are purchased. </li></ul>
  125. 125. Inventory Cost Methods <ul><li>LIFO: this method matches the most recent costs incurred with the current revenue, leaving the first cost incurred to be included as inventories. </li></ul>
  126. 126. Inventory Cost Methods <ul><li>Weighted Average Method: this method assumes that costs are charged against revenue based on an average of the number of units acquired at each price level. The resulting average price is applied to the ending inventory to find its value. The weighted average is determined by dividing the total cost of the inventory available, including any beginning inventory, by the total number of units. </li></ul>
  127. 127. Inventory Cost Methods Date Units Cost per unit Total cost Jan 15 10000 5.10 51000 Mar 20 20000 5.20 104000 May 10 50000 5.00 250000 June 8 30000 5.40 162000 Oct 12 5000 5.30 26500 Dec 21 5000 5.50 27500 Total 120000 621000 Op.inv 10000 5.00 50000 Cl. inv 14000
  128. 128. Under FIFO <ul><li>Dec purchases 5000@5.50 = 27500 </li></ul><ul><li>Oct purchases 5000@5.30 = 26500 </li></ul><ul><li>June purchases 4000@5.40 = 21600 </li></ul><ul><li>Ending inventory 14000 = 75600 </li></ul><ul><li>(using FIFO) </li></ul>
  129. 129. Under LIFO <ul><li>Opening inventory 10000@5.00 = 50000 </li></ul><ul><li>Jan purchases 4000@5.10 = 20400 </li></ul><ul><li>Ending inventory 14000 = 70400 </li></ul><ul><li>(using LIFO) </li></ul>
  130. 130. Under Weighted Average Method <ul><li>Weighted average cost =total cost/total units </li></ul><ul><li>Wei. Ave. cost = 671000/130000 = 5.1615 </li></ul><ul><li>Closing inventory 14000@5.1615 = 72261 </li></ul>
  131. 131. Comparison <ul><li>Under FIFO = 75600 </li></ul><ul><li>Under LIFO = 70400 </li></ul><ul><li>Under WA method = 72261 </li></ul>
  132. 132. Comparison <ul><li>In periods of inflation, the FIFO method produces the highest ending inventory, resulting in the lowest cost of goods sold and the highest gross profit. </li></ul><ul><li>LIFO produces the lowest ending inventory resulting in the highest of goods sold and the lowest gross profit </li></ul><ul><li>The WA method yields results between those of the above two methods </li></ul>
  133. 133. Emerging Concepts <ul><li>The transition from Cost Accounting to Strategic Cost Management (SCM) </li></ul><ul><li>Cost Analysis is traditionally viewed as the process of assessing the financial impact of alternative managerial decisions </li></ul><ul><li>SCM involves usage of cost data to develop superior strategies to gain sustainable competitive advantage </li></ul>
  134. 134. SCM <ul><li>The process of SCM- </li></ul><ul><li>Target Costing </li></ul><ul><li>Activity Based Costing </li></ul><ul><li>Quality Costing </li></ul><ul><li>Life Cycle Costing </li></ul><ul><li>Value Chain Analysis </li></ul>
  135. 135. Target Costing <ul><li>Target Cost is defined as “a market based cost that is calculated using a sales price necessary to capture a predetermined market share” </li></ul><ul><li>Target Cost = Sales Price (for the target market share – desired profit) </li></ul><ul><li>Target costing is market driven design methodology </li></ul><ul><li>It estimates the cost for a product and then designs the product to meet the cost </li></ul>
  136. 136. Target Costing <ul><li>It is Cost Management tool which reduces a product’s costs over its entire life cycle. </li></ul><ul><li>It includes actions management must take to- </li></ul><ul><li>Establish reasonable target costs </li></ul><ul><li>Develop methods for achieving those targets </li></ul><ul><li>Develop means to test the cost effectiveness of different cost-cutting scenarios </li></ul>
  137. 137. Activity Based Costing (ABC) <ul><li>Applying overhead costs to each product or service based on the extent to which it is caused by them is the primary objective of overhead costing </li></ul><ul><li>This is carried out using a single pre determined overhead rate based on a single activity measure </li></ul><ul><li>With ABC, multiple activities are identified in the production process that are associated with costs </li></ul>
  138. 138. Activity Based Costing (ABC) <ul><li>The events within these activities that cause costs are called cost drivers </li></ul><ul><li>The cost drivers are used to apply overheads to products and services when using ABC </li></ul>
  139. 139. Activity Based Costing (ABC) <ul><li>The following five steps are used in ABC: </li></ul><ul><li>Choose appropriate activities </li></ul><ul><li>Trace costs to activities </li></ul><ul><li>Determine cost drivers for each activity </li></ul><ul><li>Estimate the application rate for each cost driver </li></ul><ul><li>Apply costs to products </li></ul>
  140. 140. Activity Based Costing (ABC) <ul><li>Overhead account Cost driver </li></ul><ul><li>Indirect labor Man hour cost </li></ul><ul><li>Depreciation-building Sq. feet used </li></ul><ul><li>Depreciation-machinery Machine time </li></ul><ul><li>Electricity Watts used </li></ul>
  141. 141. Quality Costing <ul><li>A quality costing system monitors and accumulates the costs incurred by a firm in maintaining or improving product quality </li></ul><ul><li>The cost of lowering the tolerance for defective units come from the increased cost of using a better tehnolgy </li></ul><ul><li>Total Quality Control (TQC)/ Total Quality Management (TQM) is a management process based on the belief that quality costs are minimized with zero defects </li></ul>
  142. 142. Life Cycle Costing <ul><li>Products have definite phases of life </li></ul><ul><li>Cost, revenue and profits vary in these phases </li></ul><ul><li>Each phase has different threats and opportunities </li></ul><ul><li>Different functional emphasis comes with each phase </li></ul>
  143. 143. Life Cycle Costing <ul><li>Different phases are- </li></ul><ul><li>Introduction </li></ul><ul><li>Growth </li></ul><ul><li>Maturity </li></ul><ul><li>Saturation </li></ul><ul><li>Decline </li></ul>
  144. 144. Value Chain Analysis <ul><li>Value chain is the linked set of value creating activities from the basic raw material sources to the end use product delivered into final customer </li></ul><ul><li>The primary focus is to create low cost strategy relative to competitors </li></ul>
  145. 145. Value Chain Analysis <ul><li>It highlights – </li></ul><ul><li>Linkages with suppliers </li></ul><ul><li>Linkages with customers </li></ul><ul><li>Process linkages within the value chain of a business unit </li></ul><ul><li>Linkages across business unit value chain within the firm </li></ul>
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