The document outlines the syllabus and allocation of marks for an MBA course on accounting for management and reporting, detailing concepts such as the role of accounting in organizations, types of accounting, and differentiation between accounting and bookkeeping. It discusses various accounting principles, concepts, and conventions, along with the roles of accountants and the significance of accounting standards for harmonization and comparability in financial reporting. Additionally, it addresses the use of accounting information by different stakeholders and the regulatory framework governing accounting practices.

1. ACCOUNTING FOR
MANAGEMENT AND
REPORTING
(MBA-104-18)
MBA Semester-First
1

2. Allocation of Marks
• Internal 40 Marks
– Sessionals 24 marks
– Assignments or Presentation 8 marks
– Attendance 8 Marks
• External 60 Marks
2

3. Unit –I (syllabus)
• Accounting as an information system, concepts,
• convention and principles of Accounting, Role of
accountant in an organization.
• Branches of accounting: Financial, Cost and
Management Accounting and their inter-
relationships,
• Introduction of Accounting Standards.
• Exposure to format of schedule VI of Public Limited,
Banking and Insurance Companies.
3

4. Account
• Account is a summary of relevant business
transactions at one place relating to a person,
asset, expense or revenue. An account is a
brief history of financial transactions of a
particular person or item. An account has two
sides called debit side and credit side.
4

5. Accounting
• Accounting is the process of identifying,
recording, classifying, summarising, analysing
and interpreting the final results and report to
management of the company for the decision
making.
5

6. Book-keeping
• Book-keeping is the art of recording the
transactions in a systematic manner.
6

7. Difference between Accounting & Book-keeping
Basis of
Difference
Accounting Book-keeping
Scope It is not only recording & maintenance
of books of accounts, but also includes
analysis, interpreting & communicating
the information.
Recording & maintenance
of books of accounts.
Stage Secondary Primary
Results Ascertain the net results Only maintain systematic
records
Nature Analytical & executive Routine & clerical
Responsibility An accountant is also responsible for
the work done by book-keeper
Book-keeper is responsible
for only maintenance of
books.
Knowledge level Higher level Not required higher level of
knowledge.
Staff involved Senior staff performs accounting work Work is done by junior staff
7

8. Functions/Steps of Accounting
Steps
Identifying Business transactions Source Documents
Recording Journal Entries
Classifying Ledger Posting Opening various accounts
Summarizing Trial Balance, Balance Sheet,
Income Statement.
Final accounts (Trading, Profit
& Loss Accounts and Balance
Sheet)
Analyzing Strength & Weaknesses Analyses of Financial
Statements
Interpreting Making data useful for
judgment
Ratio Analysis, Common Size &
Comparative Statements etc
Communicating Send report to management
8

9. Accounting as an Information System
(AIS)
• An Accounting Information System (AIS) is the system
of records that provides reports to various individuals
or groups about economic activities of an
organization. It is the means by which most business
information is communicated to different sections of
public having interest in the business. AIS is
considered to be the most important part of overall
management information system (MIS) on account of
the following reasons:
• It enables both the insiders & outsiders to have a
clear picture of the whole organization.
9

10. Accounting as an Information System
(AIS)
• The integration of the AIS with other important
systems like marketing, production, HR, IT, etc.,
provide useful information for financial planning.
• The Integration of non-financial information such
as social costs and benefits, development of
human resources, etc., help the business as well
as the government to take appropriate decisions
keeping in view the interests of both the society
and the business.
10

11. Users of Accounting Information
• Owners
• Creditors (Suppliers)
• Investors
• Employees
• Government
• Public
• Research Scholars / Agencies
• Managers
11

12. Branches of Accounting
BRANCH FUNCTION
FINANCIAL ACCOUNTING RECORD KEEPING
COST ACCOUNTING PRICE FIXATION & OPERATING EFFICIENCY
MANAGEMENT ACCOUNTING ANALYSIS FOR DECISION MAKING
12

13. Difference among Financial, Cost & Management
Accounting
Basis Financial
Accounting
Cost Accounting Management
Accounting
Orientation It is concerned with money
as the economic source i.e.
cash
It is also concerned with money as a
measure of economic performance
It is concerned with monetary
and non-monetary economic
activities
Scope Trading and Profit & Loss
Account and Balance
sheet
It aims at measuring the economic
performance of the cost centers
and provide suitable cost data to
measure the economic
performance of cost centers of cost
units.
It is concerned with assisting
the management in its
functions as well as evaluating
the performance of the
management.
Analysis of
Performance
It indicates the position of
the business as a whole in
the final accounts.
It is concerned with collection,
classification and analysis of cost
data.
It can be applied for making
the cost accounting more
purposeful and management
oriented
Legal
compulsion
It is compulsory for every
company on account of legal
provision
Cost records are maintained
voluntarily to meet the
requirement of management
There is no legal compulsion of
the maintenance of
management accounting
13

14. Basis of Accounting
• Cash basis
–Actual cash receipts and payments
are recorded.
–Credit transactions are not recorded.
14

15. Basis of Accounting
• Accrual basis
– The income whether received or not but has been
earned or accrued during the period forms part of
the total income of the period.
– The firm has taken benefit of a particular service,
but has not paid within that period, the expenses
will relates to the period in which the service has
been utilized and not to the period in which
payment for it is made.
15

16. Basis of Accounting
• Mixed basis
–Combination of cash and accrual basis.
16

17. System of Accounting
• Single Entry System: This system has no
complete record of business transactions
done during a specified period.
• Double Entry System: One account is given
debit while the other account is given credit
with an equal amount.
17

18. Accounting cycle
Recording monetary transactions in a systematic manner
Journal entries
Ledger
Trial balance
Trading and Profit & Loss Account
Balance Sheet
18

19. Accounting Principles
(Concepts & Conventions)
19

20. Accounting Principles
• The term principles refers to the rule of action
or conduct to be applied in accounting.
Accounting principles may be defined as
"those rules of conduct or procedure which
are adopted by the accountants universally,
while recording the accounting transactions."
20

21. ACCOUNTING PRINCIPLES
Accounting principles can be subdivided
into two categories:
· Accounting Concepts; and
· Accounting Conventions.
21

22. Accounting Concepts
Accounting concepts include necessary
assumptions or postulates or ideas which are
used to accounting practice and preparation of
financial statements.
22

23. The following are the important accounting
concepts:
(1)Business Entity Concept;
(2)Dual Aspect Concept;
(3)Accounting Period Concept;
(4)Going Concern Concept;
(5)Cost Concept;
(6)Money Measurement Concept;
(7)Matching Concept;
(8)Realization Concept;
(9)Accrual Concept.
23

24. Business Entity
• Meaning
– In Accounting business is considered as separate
legal entity from the owner. The Entity so
identified is treated different from its owners.
– Any private and personal incomes and expenses of
the owner(s) should not be treated as the incomes
and expenses of the business
24

25. • Examples
– Insurance premiums for the owner’s house should be
excluded from the expense of the business
– The owner’s property should not be included in the
premises account of the business
– Any payments for the owner’s personal expenses by
the business will be treated as drawings and reduced
the owner’s capital contribution in the business.
– Goods used from the stock of the business purposes
are treated as business expenditure but similar goods
used by the proprietor i.e. owner for his personal use
are treated as his drawings.
25

26. Dual Aspect
• According to this concept, every business transaction
involves two aspects, namely, for every receiving of
benefit and. there is a corresponding giving of
benefit. The dual aspect concept is the basis of the
double entry book keeping. Accordingly for every
debit there is an equal and corresponding credit. The
accounting equation of the dual aspect concept is:
Capital + Liabilities = Assets
26

27. Accounting Period
• According to this concept, income or loss of a
business can be analysed and determined on the
basis of suitable accounting period instead of wait
for a long period, i.e., until it is liquidated.
• Being a business in continuous affairs for an
indefinite period of time, the proprietors, the
shareholders and outsiders want to know the
financial position of the concern, periodically.
• Thus, the accounting period is normally adopted for
one year. At the end of the each accounting period
an income statement and balance sheet are
prepared.
27

28. Going Concern
• Meaning
– The business will continue in operational
existence for an indefinite period of time. The
transactions are recorded in the books of firm
on the assumption that is continuing enterprise.
– Financial statements should be prepared on a
going concern basis unless management either
intends to liquidate the enterprise or to cease
trading.
28

29. • Example
– Possible losses form the closure of business
will not be anticipated in the accounts
– Prepayments, depreciation provisions may be
carried forward in the expectation of proper
matching against the revenues of future
periods
– Fixed assets are recorded at historical cost
29

30. Historical Cost
Meaning
 Assets should be shown on the balance sheet at the cost
of purchase instead of current value.
• This concept is based on "Going Concern Concept." Cost
Concept implies that assets acquired are recorded in the
accounting books at the cost or price paid to acquire it.
• For accounting purpose the market value of assets are not
taken into account either for valuation or charging
depreciation of such assets.
• Example
– The cost of fixed assets is recorded at the date of
acquisition cost. The acquisition cost includes all
expenditure made to prepare the asset for its intended
use. It included the invoice price of the assets, freight
charges, insurance or installation costs
30

31. Money Measurement
• Meaning
– All transactions of the business are recorded in
terms of money.
– It provides a common unit of measurement.
• Limitations
– Market conditions, technological changes and
the efficiency of management would not be
disclosed in the accounts
31

32. Matching Concept
• Matching Concept is closely related to accounting
period concept. The chief aim of the business
concern is to ascertain the profit periodically.
• To measure the profit for a particular period it is
essential to match accurately the costs associated
with the revenue.
• Thus, matching of costs and revenues related to a
particular period is called as Matching Concept.
32

33. Realization Concept
• According to this concept revenue is recognized when a
sale is made. Sale is considered to be made at the point
when the property in goods passes to the buyer and he
becomes legally liable to pay. This can be well understood
with the help of following example:
• A places an order with B for supply of certain goods yet to
be manufactured. On receipt of order, B purchases raw
materials, employs workers, produces the goods and
delivers them to A. A makes payment on receipt of goods.
In this case, the sale will be presumed to have been made
not at the time of receipt of the order for the goods but at
the time when goods are delivered to A.
• Exceptions: Hire purchase, sales contract etc.
33

34. Matching Concept
• The term matching means appropriate association of
related revenues and expenses. It means income
made by the business during a period can be
measured only for earning that revenue.
• For ex. If a salesman is paid commission in May 2009,
for sales made by him in Feb. 2009. This means,
revenues of feb. 2009 should be matched with the
costs incurred for earning that revenue in feb, 2009.
On account of this concept, adjustments are made for
all outstanding expenses, accrued incomes, prepaid
expenses etc.
34

35. • Example
– Expenses incurred but not yet paid in current
period should be treated as accrual/accrued
expenses under current liabilities.
– Expenses incurred in the following period but
paid for in advance should be treated as
prepayment expenses under current asset.
– Depreciation should be charged as part of the
cost of a fixed asset consumed during the
period of use.
35

36. Accounting Conventions
Accounting Convention implies that those
customs, methods and practices to be
followed as the guidelines for preparation of
accounting statements.
36

37. The accounting conventions can be
classified as follows:
(1)Convention of Disclosure.
(2)Convention of Conservatism.
(3)Convention of Consistency.
(4)Convention of Materiality.
(5)Convention of Objectivity
37

38. Convention of Disclosure
• The disclosure of all material information is one of the important accounting
convention.
• According to this convention all accounting statements should be honestly
prepared and all facts and figures must be disclosed therein.
• Financial statements should be prepared to reflect a true and fair view of the
financial position and performance of the enterprise
• All material and relevant information must be disclosed in the financial
statements
• The disclosure of financial information are required for different parties who
are interested in the welfare of that enterprise.
• The Companies Act lays down the forms of Profit and Loss Account and
Balance Sheet. Thus convention of disclosure is required to be kept as per
the requirement of the Companies Act and Income Tax Act.
38

39. • This convention is closely related to the
policy of playing safe.
• This principle is" often described as
"anticipate no profit, and provide for all
possible losses."
• Thus, this convention emphasis that
uncertainties and risks inherent in business
transactions should be given proper
consideration.
39
Convention of Conservatism
Convention of Conservatism

40. Example
• Similarly, bad and doubtful debts is made in the
books before ascertaining the profit.
• Fixed assets must be depreciated over their useful
economic lives
40

41. Convention of Consistency
• Meaning
– Companies should choose the most suitable
accounting methods and treatments, and
consistently apply them in every period
– Changes are permitted only when the new
method is considered better and can reflect the
true and fair view of the financial position of
the company
– The change and its effect on profits should be
disclosed in the financial statements
41

42. • Examples
– If a company adopts straight line method and
should not be changed to adopt reducing
balance method in other period.
– If a company adopts Last-in-first-out method
as stock valuation and should not be changed
to other method e.g. first-in-first-out method
42

43. Convention of Materiality
According to this convention:
– Immaterial amounts may be aggregated with the
amounts of a similar nature or function and need
not be presented separately
– Materiality depends on the size and nature of the
item
43

44. • Example
– Small payments such as postage, stationery
and cleaning expenses should not be disclosed
separately. They should be grouped together
as sundry expenses
– The cost of small-valued assets such as pencil,
sharpeners and paper clips, paper weights
should be written off to the profit and loss
account as revenue expenditures, although
they can last for more than one accounting
period
44

45. Objectivity
• Meaning
– The accounting information should be free from
bias and capable of independent verification
– The information should be based upon verifiable
evidence such as invoices or contracts.
• Example
– The recognition of revenue should be based on
verifiable evidence such as the delivery of goods
or the issue of invoices
45

46. ROLE OF AN ACCOUNTANT
46

47. Accountant
• The person who records the data is called as
an accountant. The accounting system and the
accountants, who maintain it, provide useful
service to the society. Accountants can
broadly be classified into two categories:
• 1. Accountants in public practice.
• 2. Accountants in employment.
47

48. Accountants in Public Practice
Accountants in public practice offer their services for
conducting financial audit, cost audit, designing of
accounting system and rendering other professional
services for a fee. In INDIA their two recongnised
bodies where such accountants are members.
(i) The institute of cost and works accountants of India
(ii) The Institute of Chartered Accountants of India.
48

49. Accountants in Employment
These are accountants who are employed in non-
business entities or business entities. Non-business
entities are those organizations who work for the
benefit of society not for profit motive i.e.,
Educational institutes, Hospitals, Churches, Museums
etc. business entities are those who work for profit
motive. These accountants provide information for
tax returns, investment decisions, performance
evaluation, financial reporting, budgeting, etc.
49

50. Role of an accountant in industrial Organization
• Maintenance of Books of Accounts An accountant
keeps a systematic records of the transactions
entered by a business firm in normal course of its
operations. An organisation cannot work
effectively without recording all the transactions.
Every businessman wants to know about the profit
or los of the particular year. Knowledge about
financial position is very important for every
businessman for the future planning.
50

51. Role of an accountant in industrial
Organization
• Auditing of Accounts Auditing is concerned with inspecting of
accounting data for determining the accuracy and reliability of
accounting statements and reports. Auditing may be of following two
types:
• Statutory Audit: Statutory audit is compulsory for an organization
according to companies act. According to the act organization has to
get its accounts audited by a qualified chartered accountant. The
statutory auditor has to report whether the profit and loss a/c and
balance sheet a/c are showing true and fair position of the company.
• Internal Audit: Internal audit is applicable in large-scale
organizations. In this audit organization audit all the records for
maintaining proper control. They have separate internal audit
department for this. Generally professionally qualified accountant
heads this department
51

52. Role of an accountant in industrial
Organization
• Taxation An accountant has proper knowledge of his
client’s accounts. Since he can present his case in a
proper manner in front of taxation authorities. He
can also assist his client in reduction of tax by making
proper tax planning.
• Financial Services an accountant being having full
knowledge of taxation, legal, accounting matters, can
properly advice regarding financial matters. He can
suggest his client regarding most suitable sources of
finance, where to invest his hard earned money,
selection of a right and profitable project etc.
52

53. ACCOUNTING STANDARDS
• Accounting Standards are formulated with a view to
harmonize different accounting policies and practices
in use in a country. The objective of Accounting
Standards is, therefore, to reduce the accounting
alternatives in the preparation of financial
statements within the bounds of rationality, thereby
ensuring comparability of financial statements of
different enterprises with a view to provide
meaningful information to various users of financial
statements to enable them to make informed
economic decisions.
53

54. ACCOUNTING STANDARDS
• Recognizing the need for international
harmonization of accounting standards, in 1973, the
International Accounting Standards Committee
(IASC) was established. It may be mentioned here
that the IASC has been reconstituted as the
International Accounting Standards Board (IASB). The
objectives of IASC included promotion of the
International Accounting Standards for worldwide
acceptance and observance so that the accounting
standards in different countries are harmonized.
54

55. ACCOUNTING STANDARDS
• The Institute of Chartered Accountants of
India (ICAI) being a member body of the IASC,
constituted the Accounting Standards Board
(ASB) on 21st April, 1977, with a view to
harmonize the diverse accounting policies and
practices in use in India.
55

56. Need/Objectives/Significance of
Accounting Standards
• Removal of Confusing Variations
• Uniform Presentation of Accounts
• Avoidance of manipulation
• Globalised business
• Disclosure beyond Law
56

57. Composition of the Accounting Standards Board
The composition of the ASB is broad-based with a view to
ensuring participation of all interest groups in the standard-
setting process. These interest-groups include industry,
representatives of various departments of government and
regulatory authorities, financial institutions and academic and
professional bodies. Industry is represented on the ASB by their
apex level associations, viz., Associated Chambers of
Commerce & Industry (ASSOCHAM), Confederation of Indian
Industries (CII) and Federation of Indian Chambers of
Commerce and Industry (FICCI). As regards government
departments and regulatory authorities, Reserve Bank of India,
Ministry of Company Affairs, Comptroller & Auditor General of
India, Controller General of Accounts and Central Board of
Excise and Customs are represented on the ASB.
57

58. Compliance with Accounting Standards
• Accounting Standards issued by the ICAI have legal
recognition through the Companies Act, 1956, whereby every
company is required to comply with the Accounting Standards
and the statutory auditors of every company are required to
report whether the Accounting Standards have been
complied with or not. Also, the Insurance Regulatory and
Development Authority (IRDA) (Preparation of Financial
Statements and Auditor’s Report of Insurance Companies)
Regulations, 2000 requires insurance companies to follow the
Accounting Standards issued by the ICAI. The Securities and
Exchange Board of India (SEBI) and the Reserve Bank of India
(RBI) also require compliance with the Accounting Standards
issued by the ICAI from time to time.
58

59. The Accounting Standards-setting Process
• Identification of the broad areas by the ASB for formulating the Accounting Standards.
• Constitution of the study groups by the ASB for preparing the preliminary drafts of the
proposed Accounting Standards.
• Consideration of the preliminary draft prepared by the study group by the ASB and revision, if
any, of the draft on the basis of deliberations at the ASB.
• Circulation of the draft, so revised, among the Council members of the ICAI and 12 specified
outside bodies such as Standing Conference of Public Enterprises (SCOPE), Indian Banks’
Association, Confederation of Indian Industry (CII), Securities and Exchange Board of India
(SEBI), Comptroller and Auditor General of India (C& AG), and Department of Company Affairs,
for comments.
• Meeting with the representatives of specified outside bodies to ascertain their views on the
draft of the proposed Accounting Standard.
• Finalization of the Exposure Draft of the proposed Accounting Standard on the basis of
comments received and discussion with the representatives of specified outside bodies.
• Issuance of the Exposure Draft inviting public comments. Consideration of the comments
received on the Exposure Draft and finalization of the draft Accounting Standard by the ASB
for submission to the Council of the ICAI for its consideration and approval for issuance.
• Consideration of the draft Accounting Standard by the Council of the Institute, and if found
necessary, modification of the draft in consultation with the ASB. The Accounting Standard, so
finalized, is issued under the authority of the Council.
59

60. The Accounting Standards as given by the ASB
• AS 1 Disclosure of Accounting Policies
• AS 2 Valuation of Inventories
• AS 3 Cash Flow Statements
• AS 4 Contingencies and Events Occurring after the Balance Sheet Date
• AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies
• AS 6 Depreciation Accounting
• AS 7 Construction Contracts
• AS 8 Accounting for Research and Development (Withdrawn pursuant toAS 26 becoming
mandatory)
• AS 9 Revenue Recognition
• AS 10 Accounting for Fixed Assets
• AS 11 The Effects of Changes in Foreign Exchange Rates
• AS 12 Accounting for Government Grants
• AS 13 Accounting for Investments
• AS 14 Accounting for Amalgamations
60

61. The Accounting Standards as given by the ASB
• AS 15 Employee Benefits
• AS 16 Borrowing Costs
• AS 17 Segment Reporting
• AS 18 Related Party Disclosures
• AS 19 Leases
• AS 20 Earnings Per Share
• AS 21 Consolidated Financial Statements
• AS 22 Accounting for Taxes on Income
• AS 23 Accounting for Investments in Associates in Consolidated Financial Statements
• AS 24 Discontinuing Operations
• AS 25 Interim Financial Reporting
• AS 26 Intangible Assets
• AS 27 Financial Reporting of Interests in Joint Ventures
• AS 28 Impairment of Assets
• AS 29 Provisions, Contingent Liabilities and Contingent Assets
• AS 30 Financial Instruments: Recognition and Measurement
• AS 31 Financial Instruments: Presentation
• AS 32 Financial Instruments: Disclosures
61

62. Unit- III (syllabus)
• Financial Analysis-Concepts and objectives,
• Tools of Financial Analysis: trend analysis,
common size statements, comparative
statements,
• Introduction to ratio analysis,
• fund flow and cash flow statements (with
additional information).
62

63. Financial Analysis
• Financial Statement Analysis is largely is a study of
relationships among the various financial factors in a
business, as disclosed by a single set of statements, and a
study of the trends of these factors, as shown by a series of
statements.
• The analysis and interpretation of financial statements are an
attempt to determine the significance and meaning of the
financial statement data so that the forecast may be made of
the prospects for the future earnings, ability to pay interest
and debt maturities (both current and long term) and
profitability of sound dividend policy.
63

64. Introduction
• The primary objective of financial reporting
is to provide information to present and
potential investors and creditors and others
in making rational investment, credit and
other decisions.
• Effective decision making requires
evaluation of the past performance of
companies and assessment of their future
prospects.
64

65. Why Financial Statement Analysis?
• Mere a glance of the financial accounts of a company does
not provide useful information simply because they are raw
in nature.
• The information provided in the financial statements is not
an end in itself as no meaningful conclusions can be drawn
from these statements alone.
• A proper analysis and interpretation of financial statement
can provide valuable insights into a firm’s performance.
• It enables investors and creditors to:
– Evaluate past performance and financial position
– Predict future performance
65

66. Meaning of FSA
• The term ‘financial analysis’ also known as
‘analysis and interpretation of financial
statements’, refers to the process of
determining financial strengths and
weaknesses of the firm by establishing
relationship between the items of the balance
sheet, P&L A/c and other operative data.
66

67. Concept of FSA
• It is the collective name for the tools and techniques that
are intended to provide relevant information to decision
makers.
• The purpose of financial analysis is to diagnose the
information contained in financial statements so as to judge
the profitability and financial soundness of the firm.
• Just like a doctor examines his patient by recording his body
temperature, blood pressure, etc… before making his
conclusion regarding the illness and before giving his
treatment, a financial analyst analyses the financial
statements with various tool of analysis before commenting
up on the financial health or weakness of an enterprise.
67

68. Users of Financial Analysis
• For Management
• For Creditors
• For Investors
• For Labour
• For Government
• For Public
68

69. Types of Financial Analysis
• On the basis of material used:
– External Analysis
– Internal Analysis
• On the basis of modus operandi:
– Horizontal Analysis
– Vertical Analysis
69

70. On the basis of material Used
• External: It is carried out by outsiders of the business –
investors, credit agencies, govt agencies, creditors etc. who
does not access to internal records of the company –
depending mainly on published accounts
• Internal: It is carried out by persons who have access to
internal records of the company – executives, manager etc –
by officers appointed by govt or courts in legal litigations etc.
under power vested in them.
70

71. On the basis of modus operandi
• Horizontal: data relating to more than one-year comparison
with other years – standard or base year – expressed as
percentage changes – Dynamic analysis.
• Vertical: quantitative relationships among various items in
statements on a particular date – inter firm comparisons –
inter department comparisons – static analysis.
71

72. Tools &Techniques of Financial
Analysis
 Comparative Statements Analysis
 Common-Size Statement Analysis
 Trend Analysis
 Ratio Analysis
 Funds Flow Analysis
 Cash Flow Analysis
72

73. Comparative Statement Analysis
• Comparative financial statements are useful in analyzing
the changes over time.
• They carry data relating to two or more years and
facilitate the comparison of an item with previous years
and even the future figures may be projected using time
series / regression analysis.
• The two comparative statements are:
1. Balance Sheet
2. Income Statement
73

74. Illustration
• The following are the Balance Sheets of a concern for the
years 2006 and 2007. Prepare Comparative Balance Sheet
and study the financial position of the concern.
Liabilities 2006 (Rs.) 2007 (Rs.) Assets 2006 (Rs.) 2007 (Rs.)
Equity Share Capital 6,00,000 8,00,000 Land & Buildings 3,70,000 2,70,000
Reserves & Surplus 3,30,000 2,22,000 Plant& Machinery 4,00,000 6,00,000
Debentures 2,00l,000 3,00,000 Furniture 20,000 25,000
Long-term loans on Mortgage 1,50,000 2,00,000 Other Fixed Assets 25,000 30,000
Bills payable 50,000 45,000 Cash in hand & atBank 20,000 80,000
Sundry Creditors 1,00,000 1,20,000 Bills Receivables 1,50,000 90,000
Other Current Liabilities 5,000 10,000 Sundry Debtors 2,00,000 2,50,000
Stock 2,50,000 3,50,000
Prepaid Expences 2,000
14,35,000 16,97,000 14,35,000 16,97,000
Balance Sheet
As on 31st Decemeber
74

75. Guidelines for interpretation of
Comparative Balance Sheet
• The interpreter is expected to study the following
aspects:
1. Current Financial Position and Liquidity Position
• See the Working Capital in both the years. (WC is excess of CAs over CLs)
• The increase in WC will mean improve in the current financial position of the
business.
• Liquid assets like Cash in hand, cash at bank, Receivables show the liquidity
position
2. Long-term Financial Position
• Study the changes in Fixed assets, long-term liabilities and capital
• Wise policy will be to finance fixed assets by raising long-term funds.
3. Profitability of the concern
• The study of increase or decrease in retained earnings, various reserves and
surplus, etc.. will enable to see whether the profitability has improved or not.
75

76. Increase/
Decrease
(Amount)
Rs
Increase/
D
ecrease
(%)
2006 (Rs) 2007(Rs)
AS S E TS
Current Assets:
Cash in hand & at Bank 20,000 80,000 60,000 300
Bills R eceivables 1,50,000 90,000 -60,000 -40
S undry Debtors 2,00,000 2,50,000 50,000 25
S tock 2,50,000 3,50,000 1,00,000 40
Prepaid E xpences 2,000 2,000
Total Current Assets 6,20,000 7,72,000 1,52,000 24.52
Fixed Assets:
Land & Buildings 3,70,000 2,70,000 - 1,00,000 -27.03
Plant & Machinery 4,00,000 6,00,000 2,00,000 50
F urniture 20,000 25,000 5,000 25
Other F ixed Assets 25,000 30,000 5,000 20
Total Fixed Assets 8,15,000 9,25,000 1,10,000 13.49
Total Assets 14,35,000 16,97,000 2,62,000 18.26
LIABILITIE S & CAPITAL
Current Liabilities:
Bills payable 50,000 45,000 -5,000 -10
S undry Creditors 1,00,000 1,20,000 20,000 20
Other Current Liabilities 5,000 10,000 5,000 100
Total Current Liabilities 1,55,000 1,75,000 20,000 12.9
Debentures 2,00l,000 3,00,000 1,00,000 50
Long-term loans on Mortgage 1,50,000 2,00,000 50,000 33
Total Liabilities 5,05,000 6,75,000 1,70,000 33.66
E quity S hare Capital 6,00,000 8,00,000 2,00,000 33
R eserves & S urplus 3,30,000 2,22,000 -1,08,000 -32.73
Total 14,35,000 16,97,000 2,62,000 18.26
Year ending 31 Dec.
Comparative Balance S heet of a Company
for the year ending December 31, 2006 and 2007
76

77. Illustration
• The Income statements of a concern are given for the year ending 31st
Dec, 2006 and 2007. Re-arrange the figures in a comparative form
and study the profitability position of the concern.
2006
Rs.(000)
2007
Rs.(000)
Net S ales 785 900
Cost of Goods Sold 450 500
Operating Expenses:
General and Admn Expenses 70 72
selling Expenses 80 90
Non-operating Expenses:
Interest paid 25 30
Income-Tax 70 80
77

78. Guidelines for Interpretation of
Income Statements
1. The amount of GP should be studied
• The increase or decrease in sales should be compared with the increase or decrease
in CGS.
2. The study of operational profits
• Operational profits =
GP – Office &Admn expenses – Selling &Distbn Expenses
3. The study of Net Profits
• The increase or decrease in NP will give an idea about the overall profitability of the
concern.
• NP = OP – Non-operating exp + Non-operating Income
4. An opinion should be formed about profitability of the
concern whether is good or not.
78

79. Increase/
Decrease
(Amount)
Rs
Increase/
Decrease
(%)
2006 (Rs) 2007(Rs)
Net S ales 785 900 115 14.65
Less: Cost of Goods Sold 450 500 50 11.11
Gross Profit 335 400 65 19.40
Operating Expenses:
General and Admn E xpenses 70 72 2 2.86
selling Expenses 80 90 10 12.50
Total Operating Expenses 150 162 12 8.00
Operating Profit 185 238 53 28.65
Less: Non-operating Expenses:
Interest paid 25 30 5 20.00
Net Profit before Tax 160 208 48 30.00
Less: Income-Tax 70 80 10 14.29
Net Profit after-tax 90 128 38 42.22
for the year ending December 31, 2006 and 2007
Year ending 31 Dec.
Comparative Income S tatement
79

80. Common-Size Statement Analysis
• Taking sales to be equal to 100, all other items in the income
statement of a year are expressed as percentages to the
sales.
• In case of balance sheet the total assets are made equal to
100 and all other assets are expressed in relative percentages.
The same is the case with liabilities with the total liabilities
being 100.
80

81. Rs % Rs %
ASSETS
Current Assets:
Cash in hand & at Bank 20,000 1.39 80,000 4.71
Bills Receivables 150,000 10.45 90,000 5.30
Sundry Debtors 200,000 13.94 250,000 14.73
Stock 250,000 17.42 350,000 20.62
Prepaid Expences - 2,000 0.12
Total Current Assets 620,000 43.21 772,000 45.49
Fixed Assets:
Land & Buildings 370,000 25.78 270,000 15.91
Plant & Machinery 400,000 27.87 600,000 35.36
Furniture 20,000 40.00 25,000 1.47
Other Fixed Assets 25,000 1.74 30,000 1.77
Total Fixed Assets 815,000 56.79 925,000 54.51
Total Assets 1,435,000 100.00 1,697,000 100.00
LIABILITIES & CAPITAL
Current Liabilities:
Bills payable 50,000 3.48 45,000 2.65
Sundry Creditors 100,000 6.97 120,000 7.07
Other Current Liabilities 5,000 0.35 10,000 0.59
Total Current Liabilities 155,000 10.80 175,000 10.31
Debentures 200,000 13.94 300,000 17.68
Long-term loans on Mortgage 150,000 10.45 200,000 11.79
Total Liabilities 505,000 35.19 675,000 39.78
Equity Share Capital 600,000 41.81 800,000 47.14
Reserves & Surplus 330,000 23.00 222,000 13.08
Total Liabilities 1,435,000 100.00 1,697,000 100.00
2006 2007
Common-size Balance Sheet
as on Dec.31, 2007
81

82. Rs.(000) % Rs.(000) %
NetSales 785 100.00 900 100.00
Less: CostofGoods Sold 450 57.32 500 55.56
Gross Profit 335 42.68 400 44.44
Operating Expenses:
General andAdmnExpenses 70 8.92 72 8.00
sellingExpenses 80 10.19 90 10.00
Total Operating Expenses 150 19.11 162 18.00
OperatingProfit 185 23.57 238 26.44
Less: Non-operating Expenses:
Interestpaid 25 3.18 30 3.33
NetProfitbefore Tax 160 20.38 208 23.11
Less: Income-Tax 70 8.92 80 8.89
NetProfitafter-tax 90 11.46 128 14.22
2006 (Rs) 2007(Rs)
Common-size Income Statement
forthe years endingDec. 2006 and2007
82

83. Trend Analysis
• It determines the direction upwards or downwards.
• Under this analysis the values of an item in different
years is expressed in relation to the value in one year
called the base year.
• Taking the value of the item in the base year to be equal
to 100
• The values of the item in different years are expressed as
percentages to this value.
83

84. Illustration
• Calculate the trend percentages from the following figures of
X Ltd. taking 2003 as base and interpret them:
(Rs. In Lakhs)
Year Sales Stock Profit before Tax
2003 1,881 709 321
2004 2,340 781 435
2005 2,655 816 458
2006 3,021 944 527
2007 3,768 1,154 672
84

85. Solution:
Year
(Rs. Lakhs) Trend % (Rs. Lakhs) Trend % (Rs. Lakhs) Trend %
2003 1,881 100.00 709 100.00 321 100.00
2004 2,340 124.40 781 110.16 435 135.51
2005 2,655 141.15 816 115.09 458 142.68
2006 3,021 160.61 944 133.15 527 164.17
2007 3,768 200.32 1,154 162.76 672 209.35
Sales Stock Profitbefore Tax
Trend Percentages
(Base Year- 2003 = 100)
85

86. Ratio Analysis
• A ratio is a simple arithmetical expression of the relationship
between two variables.
• Ratio analysis is the process of determining and
Ratio analysis is the process of determining and
interpreting numerical relationship based on financial
interpreting numerical relationship based on financial
statements. It is the technique of interpretation of financial
statements. It is the technique of interpretation of financial
statements with the help of
statements with the help of accounting
accounting ratios
ratios derived from
derived from
the balance sheet and profit and loss account.
the balance sheet and profit and loss account.
• Ratio Analysis is a technique of analysis and interpretation of
Financial Statements. It is the process of establishing and
interpreting various ratios for helping in making certain
decisions.
86

87. Classification of Ratios
• Liquidity Ratios
• Solvency Ratios
• Profitability Ratios
• Turnover Ratios
87

88. Liquidity Ratios
88

89. Liquidity Ratios
• Current Ratio
• Quick or Liquid Ratio
• Absolute Liquid Ratio
89

90. Liquidity Ratios
• Current Ratio: It is a relationship between
current assets and current liabilities.
• Current Ratio= Current Assets/Current
Liabilities
• The ideal current ratio is 2: 1. It is a stark indication of the
financial soundness of a business concern. When Current
assets double the current liabilities, it is considered to be
satisfactory. Higher value of current ratio indicates more
liquid of the firm's ability to pay its current obligation in time.
90

91. Problem-1
From the following particulars calculate Current Ratio
Particulars Amount
Sundry Debtors 20,000
Bills Receivables 5000
Stock 10000
Plant & Machinery 15000
Sundry Creditors 20000
Bills Payable 15000
Provision for taxation 6000
Outstanding expenses 9000
91

92. Problem-2
• Find out current liabilities when current ratio
is 2.5:1 and current assets are Rs. 200000.
92

93. Quick or Liquid Ratio
• It is a relationship between quick assets and
current liabilities.
• Rule of thumb 1:1
• The ideal Quick Ratio is 1: 1 and is considered to
be appropriate. High Acid Test Ratio is an
accurate indication that the firm has relatively
better financial position and adequacy to meet
its current obligation in time.
93

94. Absolute Liquid Ratio
• It is the relationship between absolute liquid assets
and current liabilities.
• Absolute Liquid Ratio=
Absolute Liquid Assets/Current Liabilities
Absolute Liquid Assets=Cash in hand, Cash at bank and
marketable securities or temporary securities
The most favorable and optimum value for this ratio should be 1: 2. It indicates
the adequacy of the 50% worth absolute liquid assets to pay the 100%
worth current liabilities in time. If the ratio is relatively lower than one, it
represents the company's day-to-day cash management in a poor light. If
the ratio is considerably more than one, the absolute liquid ratio represents
enough funds in the form of cash in order to meet its short-term obligations
in time.
94

95. Calculate Current, Quick and absolute
liquid ratio
Liabilities Amount (Rs.) Assets Amount (Rs.)
Bank Loan 100000 Stock in trade 135000
Sundry Creditors 150000 S. Debtors 72000
Bills payable 20000 Less: 2000 70000
Creditors for
expenses
10000 Cash in hand 15000
6% Debentures 200000 Cash at bank 110000
Equity Sh. Capital 300000 Plant & Machinery 300000
Short term
investments
150000
Total 780000 Total 780000
95

96. Long-term Solvency Ratios
96

97. Long-term Solvency Ratios
• Debt Equity ratio: it establishes the relationship
between long-term debts and shareholders’ fund.
• Objective: the objective of computing this ratio is to
measure the relative proportion of debt and equity
in financing the assets of a firm.
• Long term debts: Long term loans whether secured
or unsecured (debentures, bonds or loans from fin.
Institutions).
• Shareholders’ Funds: Equity sh. Capl. + Pref. sh.
Capital + Reserves + P & L (Cr.) – Fictitious Assets (eg.
Preliminary expenses, Underwriting Commission).
97

98. Proprietary/Equity/Shareholders’ Fund Ratio
• Proprietary Ratio = Shareholders’ Fund/Total
Assets
Ideal ratio: 0.5:1
Higher the ratio better the long term solvency (financial)
position of the company. This ratio indicates the extent to
which the assets of the company can be lost without
affecting the interest of the creditors of the company
98

99. Interest Coverage Ratio
• It establishes the relationship between net
profits after interest and taxes and interest on
long term debts.
• objective: the objective of this ratio is to
measure the debt servicing capacity of a firm
so far as fixed interest on long term debt is
concerned.
• Interest Coverage Ratio = Net Profit before
Interest & Taxes/ Interest on long term debts
99

100. Problem
• Net Profit before interest & taxes: Rs. 320000
• Interest on long term debts: Rs. 40000
• Interest Coverage Ratio = 320000/40000 = 8
times
100

101. Problem
• Net Profit after taxes is Rs. 75000 and its fixed
interest charges on borrowings Rs. 10000. The
income tax Rate is 50%. Calculate Interest
Coverage Ratio.
• Interest Coverage Ratio =
75000 + 75000 + 10000/ 10000 =
160000/10000 = 16 times.
101

102. Dividend Coverage Ratio
• It measures the ability of a firm to pay
dividend on preference shares which carry
stated rate of return.
• DCR = EAT/ Preference Dividend.
102

103. General Profitability Ratios
• Gross profit ratio.
• Net profit ratio.
• Operating ratio.
• Operating profit ratio.
• Expense ratio.
103

104. Gross Profit Ratio
It expresses the relationship of gross profit to net sales
It expresses the relationship of gross profit to net sales
and is expressed in terms of percentage. This ratio is a
and is expressed in terms of percentage. This ratio is a
tool that indicates the degree to which selling price of
tool that indicates the degree to which selling price of
goods per unit may decline without resulting in losses.
goods per unit may decline without resulting in losses.
Gross profit
Gross profit
Gross profit ratio= X 100
Gross profit ratio= X 100
Net sales
Net sales
A low gross profit ratio may indicate unfavorable
A low gross profit ratio may indicate unfavorable
purchasing, the instability of management to develop
purchasing, the instability of management to develop
sales volume thereby making it impossible to buy goods
sales volume thereby making it impossible to buy goods
in large volume.
in large volume.
Higher the gross profit ratio better the results.
Higher the gross profit ratio better the results. 104

105. Net Profit Ratio
It expresses the relationship between net profit after
It expresses the relationship between net profit after
taxes to sales. Measure of overall profitability useful to
taxes to sales. Measure of overall profitability useful to
proprietors, as it gibes an idea of the efficiency as well
proprietors, as it gibes an idea of the efficiency as well
as profitability of the business to a limited extent.
as profitability of the business to a limited extent.
Net profit after taxes
Net profit after taxes
Net profit ratio= X 100
Net profit ratio= X 100
Net sales
Net sales
Higher the ratio better is the profitability
Higher the ratio better is the profitability
105

106. Operating Ratio
This ratio establishes a relationship between cost of
This ratio establishes a relationship between cost of
goods sold plus other operating expenses and net sales.
goods sold plus other operating expenses and net sales.
This ratio is calculated mainly to ascertain the
This ratio is calculated mainly to ascertain the
operational efficiency of the management in their
operational efficiency of the management in their
business operations.
business operations.
Cost of goods sold + operating expenses
Cost of goods sold + operating expenses
Operating ratio=
Operating ratio=
Net sales
Net sales
Higher the ratio the less favorable it is because it would
Higher the ratio the less favorable it is because it would
leave a smaller margin to meet interest, dividend and
leave a smaller margin to meet interest, dividend and
other corporate needs. For a manufacturing concern it is
other corporate needs. For a manufacturing concern it is
expected to touch a percentage of 75% to 85%. This
expected to touch a percentage of 75% to 85%. This
ratio is partial index of over all profitability.
ratio is partial index of over all profitability. 106

107. Operating Profit Ratio
This ratio establishes the relationship between
This ratio establishes the relationship between
operation profit and net sales.
operation profit and net sales.
Operating profit
Operating profit
Operating profit ratio= X 100
Operating profit ratio= X 100
Net sales
Net sales
Operating profit ratio= 100-operating ratio
Operating profit ratio= 100-operating ratio
Operating profit= Net sales – ( cost of goods sold +
Operating profit= Net sales – ( cost of goods sold +
Administrative and office expenses + selling and
Administrative and office expenses + selling and
distributive expenses.
distributive expenses.
107

108. Expenses Ratio
It establishes relationship between individual operation
It establishes relationship between individual operation
expenses and net sales revenue.
expenses and net sales revenue.
Cost of goods sold
Cost of goods sold
1. Cost of goods sold ratio= X 100
1. Cost of goods sold ratio= X 100
Net sales
Net sales
Office and admin exp
Office and admin exp
2. Admin. and office exp ratio= X100
2. Admin. and office exp ratio= X100
Net sales
Net sales
Selling and dist. exp
Selling and dist. exp
3. Selling and distribution ratio= X 100
3. Selling and distribution ratio= X 100
Net sales
Net sales
Non operating expense
Non operating expense
4. Non-operating expense ratio= X 100
4. Non-operating expense ratio= X 100
Net sales
Net sales
108

109. III. Activity Ratio
• Activity ratios indicate the performance of an
organisation.
• This indicate the effective utilization of the various
assets of the organisation.
• Most of the ratio falling under this category is based
on turnover and hence these ratios are called as
turnover ratios.
109

110. Important Ratios In Activity Ratio
• Stock turnover ratio.
• Debtors turnover ratio.
• Creditors turnover ratio.
• Wording capital turnover ratio.
• Fixed assets turnover ratio.
• Current assets turnover ratio.
• Total assets turnover ratio.
• Sales to networth ratio.
110

111. Stock Turnover Ratio
This ratio establishes the relationship between the cost
This ratio establishes the relationship between the cost
of goods sold during a given period and the average
of goods sold during a given period and the average
sock holding during that period. It tells us as to how
sock holding during that period. It tells us as to how
many times stock has turned over (sold) during the
many times stock has turned over (sold) during the
period. Indicates operational and marketing efficiency.
period. Indicates operational and marketing efficiency.
Helps in evaluating inventory policy to avoid over
Helps in evaluating inventory policy to avoid over
stocking.
stocking.
Cost of goods sold
Cost of goods sold
Inventory turnover ratio=
Inventory turnover ratio=
Average stock
Average stock
Cost of goods sold= sales-gross profit
Cost of goods sold= sales-gross profit
Gross Profit= opening stock + purchases – closing stock
Gross Profit= opening stock + purchases – closing stock
Opening stock + Closing stock
Opening stock + Closing stock
Average stock=
Average stock=
2
2
111

112. Interpretation Of Stock Turnover Ratio
• Ideal ratio: 8 times; A low inventory turnover may reflect
dull business, over investment in inventory, accumulation
of stock and excessive quantities of certain inventory items
in relation to immediate requirements.
• A high ratio may not be accompanied by a relatively high
net income as, profits may be sacrificed in obtaining a large
sales volume (unless accompanied by a larger total gross
profit). It may indicate under investment in inventories. But
generally, a high stock turnover ratio means that the
concern is efficient and hence it sells its goods quickly.
112

113. Debtor Turnover Ratio
This ratio explains the relationship of net credit sales of
This ratio explains the relationship of net credit sales of
a firm to its book debts indicating the rate at which cash
a firm to its book debts indicating the rate at which cash
is generated by turnover of receivables or debtors.
is generated by turnover of receivables or debtors.
The purpose of this ratio is to measure the liquidity of the
The purpose of this ratio is to measure the liquidity of the
receivables or to find out the period over which
receivables or to find out the period over which
receivables remain uncollected.
receivables remain uncollected.
Net credit sales
Net credit sales
Debtor turnover ratio=
Debtor turnover ratio=
Average Debtors
Average Debtors
Opening balance + closing balance
Opening balance + closing balance
Average debtors=
Average debtors=
2
2
Debtors include bills receivables along with book debts
Debtors include bills receivables along with book debts
113

114. Average Collection Period
Number of working day in year
Number of working day in year
Average collection period=
Average collection period=
Debtor turnover ratio
Debtor turnover ratio
The average collection period represents the average
The average collection period represents the average
number of days for which a firm has to wait before its
number of days for which a firm has to wait before its
receivables are converted into cash
receivables are converted into cash
114

115. Interpretation Of Debtor Turnover
Ratio
• Ideal ratio: 10 to 12 times; debt collection period of
30 to 36 days is considered ideal.
• A high debtor turnover ratio or low collection
period is indicative of sound management policy.
• The amount of trade debtors at the end of period
should not exceed a reasonable proportion of net
sales. Larger the trade debtors greater the expenses
of collection.
115

116. Creditors Turnover Ratio
This ratio indicates the number of times the creditors are
This ratio indicates the number of times the creditors are
paid in a year. It is useful for creditors in finding out how
paid in a year. It is useful for creditors in finding out how
much time the firm is likely to take in repaying its trade
much time the firm is likely to take in repaying its trade
creditors.
creditors.
Net credit purchases
Net credit purchases
Creditors turnover ratio=
Creditors turnover ratio=
Average creditors
Average creditors
Opening balance + closing balance
Opening balance + closing balance
Average creditors=
Average creditors=
2
2
Number of working days
Number of working days
Average payment period=
Average payment period=
Creditors turnover ratio
Creditors turnover ratio
116

117. Interpretation Of Creditor Turnover
Ratio
• Ideal ratio: 12 times; debt payment period of 30
days is considered ideal.
• Very less creditors turnover ratio, or a high debt
payment period may indicate the firms inability in
meeting its obligation in time.
117

118. Working Capital Turnover Ratio
This ratio indicates the number of times the working
This ratio indicates the number of times the working
capital is turned over in the course of the year.
capital is turned over in the course of the year.
Measures efficiency in working capital usage. It
Measures efficiency in working capital usage. It
establishes relationship between cost of sales and
establishes relationship between cost of sales and
working capital
working capital
Cost of sales
Cost of sales
Working capital turnover ratio=
Working capital turnover ratio=
Average working capital
Average working capital
Opening + closing working
Opening + closing working
capital
capital
Average working capital=
Average working capital=
2
2 118

119. Interpretation of Working Capital
Turnover Ratio
• A higher ratio indicates efficient utilization of
working capital and a low ratio indicates
inefficient utilization of working capital.
• But a very high ratio is not a good situation for
any firm and hence care must be taken while
interpreting the ratio.
119

120. Fixed Assets Turnover Ratio
This ratio establishes a relationship between fixed
This ratio establishes a relationship between fixed
assets and sales.
assets and sales.
Net sales
Net sales
Fixed assets turnover ratio=
Fixed assets turnover ratio=
Fixed assets
Fixed assets
Ideal ratio
Ideal ratio: 5 times
: 5 times
A high ratio indicates better utilisation of fixed assets.
A high ratio indicates better utilisation of fixed assets.
A low ratio indicates under utilisation of fixed assets.
A low ratio indicates under utilisation of fixed assets.
120

121. Total Asset Turnover Ratio
This ratio establishes a relationship between total assets
This ratio establishes a relationship between total assets
and sales. This ratio enables to know the efficient
and sales. This ratio enables to know the efficient
utilisation of total assets of a business.
utilisation of total assets of a business.
Net sales
Net sales
Total assets turnover ratio=
Total assets turnover ratio=
Total assets
Total assets
Ideal ratio
Ideal ratio: 2 times
: 2 times
High ratio indicates efficient utilization and ratio less than
High ratio indicates efficient utilization and ratio less than
2 indicates under utilization.
2 indicates under utilization.
121

122. Fund Flow Statement
• Fund Flow Statement is a technical device which
analyses the changes in financial position of business
enterprise between two Balance Sheets. Flow of
funds means change in the amount of funds caused
by financial transactions. Flow of Funds means inflow
and outflows.
• Inflow means increase in the amount of funds and is
to be a source of funds and outflow of funds is a
decrease in the amount of funds and is called as the
use of funds or application of funds.
122

123. Procedure of preparing Fund Flow Statement
• Schedule of Changes in Working Capital
• Statement of Fund From Operations (Profit &
Loss Adjustment Account)
• Fund Flow Statement (Sources & applications
of funds)
123

124. FUND FLOW STATEMENT CASH FLOW STATEMENT
1. IT IS BASED ON THE CONCEPT OF
WORKING CAPITAL..
2. IT REVEALS CHANGES IN WORKING
CAPITAL POSITION BETWEEN TWO
BALANCE SHEET DATES.
3.CLASSIFICATION OF ASSETS AND
LIABILITIES INTO CURRENT AND NON
– CURRENT CATEGORIES IS ESSENTIAL.
4. THESE STATEMENTS MATCH SOURC ES
AND APPLICATION OF FUND.
1. IT IS BASED ON THE CONCEPT OF
CASH.
2. IT REVEALS CHANGE IN CASH POSITION
BETWEEN TWO BALANCE SHEET
DATES.
3. NO SUCH CLASSIFICATION NECESSARY.
4. IT COMMENCES WITH OPENING CASH
BALANCE AND ENDS WITH CLOSING
CASH BALANCE.
DIFFERNCES BETWEEN FUND FLOW AND CASH FLOW
124

125. FUND FLOW STATEMENT CASH FLOW STATEMENT
5. AN IMPROVEMENT IN CASH POSITION
RESULTS IN THE IMPROVEMENT IN
WORKING CAPITAL.
6. IT IS LONG –TERM TOOL FINANCIAL
ANALYSIS.
5. AN INCREASE IN CASH ON HAND DOES
NOT RESULT IN INCREASE IN WORKING
CAPITAL..
6. IT IS A SHORT – TERM TOOL OF
FINANCIAL ANALSIS.
DIFFERNCES BETWEEN FUND FLOW AND
CASH FLOW
125

126. 1. Schedule of Changes in Working Capital
• The purpose of preparing the schedule of changes in the
working capital is to illustrates the changes in the volume of
net working capital which relates either sources or application
of fund. The schedule of changes are focused as follows:
• Increase in Current Assets---------Increase in Working Capital
• Decrease in Current Assets-------Decrease in Working Capital
• Increase in Current Liabilities ------Decrease in Working Capital
• Decrease in Current Liabilities ------Increase in Working Capital
126

127. Schedule of Changes in Working Capital
Particulars Previous
year
Current
year
Increase in
WC
Decrease in
WC
(A) Current Assets:
Cash In Hand
Cash at Bank
Marketable Securities
Bills Receivable
Sundry Debtors
Closing Stock
Prepaid Expenses
(B) Current Liabilities:
Creditors
Bills Payable
Outstanding expenses
Pre received Income
Provision for doubtful and bad
debts
Net Working Capital(A-B)
Increase/Decrease Working
Capital
127

128. From the following information prepare schedule
of changes in Working Capital
Particulars 2009 (Rs.) 2008 (Rs.)
Equity & Liabilities
Reserves & surpluses 780000 650000
Profit & Loss Account 65000 40000
8% Debentures 250000 300000
Accounts payables 160000 170000
Bills payables 50000 40000
Outstanding expenses 30000 20000
Total 1335000 1220000
Fixed Assets 860000 830000
Stock 370000 290000
Cash 90000 80000
Prepaid expenses 15000 10000
Preliminary expenses Nil 10000
Total 1335000 1220000
128

129. Schedule of changes in Working Capital
Current Assets 2008 (Rs. ) 2009 (Rs.) Inc. in WC Dec. in WC
Stock 290000 370000 80000
Cash 80000 90000 10000
Prepaid exps. 10000 15000 5000
Total CA 380000 475000
Current Liabilities
Accounts payable 170000 160000 10000
Bills payable 40000 50000 10000
Outstanding exps 20000 30000 10000
Total CL 230000 240000
Working capital (CA-CL) 150000 235000
Net increase in WC 85000 85000
Total 235000 235000
129

130. 2. Profit & Loss Adjustment Account (Funds
from operations)
Adjusted Profit & Loss Account
To Depreciation xxxx
To Goodwill Written off xxxx
To Patent Written off xxxx
To Loss on Sale of Fixed Asset xxxx
To Loss on Sale of Investment xxxx
To Loss on redemption of Liability
xxxx
To Preliminary Expenses off xxxx
To Proposed Dividend xxxx
To Transfer to General Reserve
xxxx
To Current Year Provision for
Taxation xxxx
To Current Year Provision for
Depreciation xxxx
To Balancing Figure xxxx
(Fund Lost in Operations)
By Opening Balance Profit xxxx
By Profit on sale of Fixed Assets xxxx
By Profit on Sale of Investments xxxx
By Profit on redemption of
Liability xxxx
By Transfer from General Reserve xxxx
By Balancing Figure xxxx
Fund From Operations(FFS)
130

131. Calculate funds from operations:
• Salaries 10,000
• Rent 6,000
• Refund of Tax 6,000
• Profit on Sale of Building 10,000
• Depreciation on Plant 10,000
• Provision for Taxation 8,000
• Loss on Sale of plant 4,000
• Closing Balance of Profit & Loss A/c 1,20,000
• Opening balance on Profit & Loss A/c 50,000
• Discount on Issue of Debentures 4,000
• Provision for bad debts 2,000
• Transfer to general reserve 2,000
• Preliminary expenses written off 6,000
• Good will written off 4,000
• Dividend Received 10,000
• Proposed Dividend 12,000
131

132. Adjusted Profit & Loss Account
Adjusted Profit & Loss Account
To Depreciation on Plant 10,000
To Provision for Taxation
8,000
To Loss on Sale of Plant 4,000
To Discount on issue of debentures 4,000
To Provision for bad debts 2,000
To Transfer to general reserve
2,000
To Preliminary expenses off 6,000
To Good will written off 4,000
To Proposed Dividend 12,000
To Closing Profit B/d 1,20,000
By Opening Balance B/d 50,000
By Profit on Sale of Building 10,000
By Dividend Received 10,000
By Refund of Tax 6,000
By Balancing Figure 96,000
By Fund From operations 1,72,000
Total 172000 Total 172000
132

133. SOURCES RS. APPLICATIONS RS.
ISSUES OF SHARES
ISSUES OF DEBENTURES
LONG TERM & MIDDLE –
TERM LAONS TAKEN
SALES OF INVESTMENTS
SALES OF FIXED ASSETS
TRADING PROFITS
NON – TRADING INCOME
NET DECREASE IN
WORKING CAPITAL, AS PER
SCHEDULE OF CHANGES IN
WORKING CAPITAL
TOTAL
REDEMPTION OF SHARES
REDEMPTION OF DEBENTURES
REPAYMENT OF LOANS
PURCHASE OF INVESTMENTS
PURCHASE OF FIXED ASSETS
PAYMENT OF DIVIDENDS
(LAST YEAR AND INTERIM)
FUNDS LOST FROM OPERATIONS
NON – TRADING PYMENTS
NET INCREASE IN WORKING
CAPITAL AS PER SCHEDULE OF
CHANGES IN WORKING CAPITAL
TOTAL
3.STATEMENT OF SOURCES AND
APPLICATIONS OF FUNDS
133

134. CONCLUSION:
Fund flow statement is very important for every
organization. It can really determine how the
business should be carried on in the future. we can
proper utilize the budget of the company and the
strategy to cope the financial problems of the
company through the preparation of the fund flow
statement. As we know the aim of fund flow
statement is to know the working capital of the
company whether it increases or decreases during a
given period of time. So it is a main tool to make a
organization to survive in the future.
134

135. CASH FLOW STATEMENT
135

136. INTRODUCTION
Cash flow statement is a statement
which shows the sources of cash inflow and
uses of cash out-flow of the business
concern during a particular period of time.
“cash flow statement, also known
as statement of cash flows, is a financial
statement that shows how changes in
balance sheet accounts and income affect
cash and cash equivalents, and breaks the
analysis down to operating, investing, and
financing activities.” 136

137. • To provide information about the cash inflows
and cash outflows from operating,
financing and investing activities of the firm.
• To show the impact of the operating, financing
and investing activities on cash resources.
• To explain the causes for changes in cash
balance.
• To identify the financial needs and help in
forecasting future cash flows.
Objectives Of Study
137

138. Importance of Study
Importance of Study
 This Project will help company to find it’s
weakness and strength, and also the areas where
they can improve.
 It will help company to decide the future direction
of the company.
 It will help company in improve its financial
position.
 It gave me opportunity to apply theoretical
knowledge obtained from college in a
practical manner in the actual business
environment.
138

139. LIMITATIONS OF STUDY
Cash flow statement cannot replace the income
statement or the fund flow statement. Each of
them has a separate functions to perform.
Being a vast topic it is not possible to
cover all the matters and aspects related
to analyzing of financial statements.
Cash flow statement cannot be equated
with the income statement.
The data undertaken is of last two years ,
therefore we fail to get the whole
financial history of the organization.
139

140. Scope of Cash Flows Statement
1. Cash flow is a financial statement that presents
information about the company's.
2. The general form of the cash flow statement shows three
categories, namely: cash flow from operating activities,
cash flows from investing activities & cash flows from
financing activities.
3. Operating activities are the principal revenue-producing
activities of the company and other activities that are not
investing activities and financing activities.
4. Investment activity is the acquisition and disposal of
long-term assets and other investments that do not
include cash equivalents.
140

141. Importance of cash flow
Importance of cash flow
1.The statement cash flow is based upon, to get
the information about the cash receipts and
the cash payment during a period.
2.The preparation of cash flow statement is
very much useful to management.
3. It is one of the three main financial statement
a) Balance sheet.
b) Income statement
c) Cash flow statement.
141

142. Needs of cash flow Statement
1) Knowledge Of Magnitude : -
The cash flow statements provide us information
regarding cash generated and used in operating, investing
and financing activities.
2) Tool Of Planning : -
Cash flow statement is used as the basis
for projection of future investment and financing plans of
enterprise by management.
3) Tool Of Historical Analysis :-
The financial decision taken in the past can be evaluated
on the basis of information supplied by cash flow
statement.
142

144. Types of Cash Flow Activities
1. Operating activities:- Involve the cash effects
of transactions that enter into the
determination of net income.
2. Investing activities:- Concern with buying
and selling property, plant and equipment.
3. Financing activities: - Include issuance and
reacquisition of a firm's debt and capital stock, and
dividend
144

145. From sale of goods and services to
customers.
Payment of employee
benefit expenses.
Receipt from royalties, fees,
commission and other revenues.
Pay operating expenses.
Payment of taxes.
Operating
Activities
Sale of property, plant,
Equipment, long-term
investments.
Receipt from Interest
and dividends.
Investing
Activities
Purchase of property,
plant, equipment and
non-current investments.
Proceeds from issue of
preference or equity shares.
Proceeds from Issuance of
Debts/Bonds.
Redemption of preference shares, buy
back of equity shares.
Payment of dividends and interest.
Procurement of loans.
Financing
Activities
Classification of Cash inflows and Cash Outflows Activities:-
145

146. Unit- II (syllabus)
• Cost Accounting-Meaning, Scope and Classification of
costs,
• Absorption costing, Marginal costing.
• Introduction to Break Even Analysis, Use of Cost-data
in managerial Decision making with special reference
to pricing and make or buy decisions.
• Introduction to Standard Costing including Variance
Analysis – materials and labour variances.
• Cost Control Techniques-Preparation of budgets and
their control, Zero base budgeting.
146

147. 147
Meaning of Cost Accounting
 Cost Accounting is concerned with recording, classifying
and summarizing costs for determination of costs of
products or services ;planning, controlling and reducing
such costs and furnishing information to management for
decision making.
 According to Chartered Institute of Management
Accountants, London, cost accounting is ‘the process of
accounting for costs from the point at which the
expenditure is incurred or committed to the establishment
of its ultimate relationship with cost units. In its widest
sense, it embraces the preparation of statistical data , the
application of cost control methods and the ascertainment
of the profitability of the activities carried out or planned.’

148. 148
Cost Accounting Activities
Cost accounting provides useful data for both internal and
external reporting. Internal report presents details of cost
information regarding cost of specific products or services
while external reports contain cost data in a summarized
and aggregate form.
To satisfy requirements of both internal and external reporting,
the following activities are undertaken by cost accounting :
 Cost Determination for specific product or activity.
 Cost Recording
 Cost Analysis : concerned with the critical evaluation of
cost information to assist the management in planning and
controlling the business activities.
 Cost Reporting :Concerned with reporting cost data both
for internal and external reporting purposes.

149. 149
Financial Accounting Vs. Cost Accounting
 Aims at safeguarding the
interest of the business, its
proprietors and others
connected with it.
 Financial Accounts are
prepared according to some
accepted accounting concepts
and conventions.
 Reveals the profit of business
as a whole
 Prepared and submitted
usually at the end of the
accounting period.
 Provides information useful
to outsiders, hence high
degree of accuracy
 Renders information for
guidance of the management
for proper planning,
operational control &
decision making.
 Maintenance of cost records
are voluntary and there are
no statutory forms regarding
their presentation.
 Reveals the profit made on
each product, job or process.
 Prepared more frequently,
sometimes even weekly.
 Provides information useful
to insiders, degree of
accuracy is less.

150. 150
Cost Accounting and Management Accounting
Management Accounting has a wider scope as compared to cost
accounting. Cost Accounting deals primarily with cost data
while management accounting involves the consideration
of both costs and revenue. Management accounting is an
all inclusive accounting information system which covers
financial accounting, cost accounting and all aspects of
financial management. But it is not a substitute for other
accounting functions. It involves a continuous process of
reporting cost, financial and other relevant data in an
analytical and informative way to the management.

151. 151
Cost Accounting and Cost Accountancy
The term Cost Accountancy has a wider meaning as compared to
the term cost accounting. According to CIMA, London, cost
accountancy means ‘the application of costing and cost
accounting principles, methods and techniques to the
science, art and practice of cost control. It includes the
presentation of information there from, for the purpose of
managerial decision making’. Cost accountancy is thus the
science, art and practice of the cost accountant.
Cost Accountancy includes the following:
 Cost Accounting : It is the process of accounting for costs.
 Costing : It is the technique and process of ascertaining costs.
 Cost Control
 Cost Reduction
 Cost Audit: It is the verification of cost accounts and a check
on the adherence to the cost accounting plan.

152. 152
Objectives of Cost Accounting
i. Ascertainment of cost : Involves computation of cost
incurred
ii. Estimation of costs : As compared to ‘what has been the cost’
it emphasizes on ‘what is likely to be the cost’ or ‘what
should be the cost’.
iii. Cost Control : Involves i) determination of standard costs and
ii) analyzing the cause of variations between standard and
actual cost.
iv. Cost Reduction
v. Determining selling price
vi. Facilitating preparation of financial and other statements: A
developed cost accounting system provides immediate
information regarding stock of raw materials, work-in-
progress and finished goods. This helps in speedy
preparation of financial statements.
vii. Provides basis for operating policy: ex. make or buy, Shut
down or operate at loss etc.

153. 153
Importance of Cost Accounting
To the Management:
 Aids in price fixation
 Costing makes comparison possible.
 Provides data for periodical profit and loss account.
 Wastages are eliminated: Cost of the article can be known at
every stage and hence it is possible to check various forms of
waste.
 Aids in determining and enhancing efficiency: Losses due to
wastage are minimized thus enhancing efficiency.
 Helps in Inventory Control
 Helps in determining break even point:
Break Even Point = Fixed Costs / Contribution per unit
where, Contribution = Selling price – Variable cost.

154. 154
Importance of Cost Accounting ( Contd. )
vii. Helps in determining the level of output for a desired profit :
Level of Output = (Fixed Cost + Desired Profit)/ Contribution
per unit
viii. It helps in periods of trade depression and competition: In
periods of depression, a firm may have to sell its product
even below the total cost. While deciding whether to shut
down or sell, the firm should keep operating as long as the
fixed costs are being recovered.
To the Employees:
Workers are benefited indirectly through increase in
consumer goods and directly through continuous
employment and larger remuneration.

155. 155
Installation of Costing System
Practical Difficulties
 Lack of Support from Top Management: This due to
resistance to the additional work involved. The difficulty
can be overcome by instilling a sense of cost
consciousness in the minds of the top management.
 Resistance from the existing staff : They should be
explained that the costing system would not replace but
strengthen the existing system and open to them new
areas of development.
 Non-cooperation at other levels
 Heavy Costs: Unnecessary sophistication and formalities
should be avoided .

156. 156
Installation of Costing System ( Contd )
Main Considerations
 The product : Nature of product determines the type of
costing system to be adopted e.g a product requiring
high value of material content requires an elaborate
system of material control.
 The organization :The existing organization should be
disturbed as little as possible.
 The objective : The objective and information that the
management wants to acquire should also be cared for
while adopting a costing system.
 The technical details : The system should be adopted
after a detailed study of the technical aspect of the
business.
 Informative and simple
 Elastic : Should be capable of adapting to changing
requirements of the business.

157. 157
Functions of the Cost Accountant
 Determining cost and analyzing income: Analyses and
classifies costs according to different cost elements viz.
material, labour and expenses. Advises the
management about the profitability or otherwise of
each job, product or process.
 Providing cost data for planning and control: Collects,
classifies and presents in appropriate form, suitable
data to the management for planning and controlling
the operations of the business.
 Undertaking special cost studies for managerial decision
making : Studies regarding -
i. Introduction of new products, replacement of manual
labour with machines etc.
ii. Make or buy decisions, accepting orders below cost etc.
iii. Expansion plans, Utilization of idle capacity etc.
iv. Installation of cost audit system

158. 158
Cost Accounting and Other Departments
Relationship of Cost department with other departments is
summarized below :
 Manufacturing Department : Cost Accounting
department is concerned with ascertaining, controlling
and reducing costs of each of the manufacturing
departments.
 Research and Design Department: Cost department
provides information to decide whether a particular
design or result of the research activity should be
accepted or rejected.
 Personnel Department :Cost department prepares the
wages abstract on the basis of the information provided
by the time or job cards maintained by the personnel
department.

159. 159
Cost Accounting and Other Departments
 Finance and Accounts Department: This department has
to depend heavily on cost accounting department for
preparing various budgets, cash flow statement, income
statements etc.
 Marketing Department: This department provides
information regarding the price at which the product
should be positioned in the market. Information about
the cost of the product is pre requisite for this.
 Public relations Department : Cost accounting
department provides information regarding the costs of
the products manufactured, wages paid to employees
and the profitability of different products or processes.
This information definitely improves the relations
between the company and different sections of the
public.

160. 160
Concept of Cost
 The term cost refers to the amount of resources given up in
exchange for some goods or services. The resources so
given up are always expressed in terms of money.
According to CIMA, London, the term cost in general
means, ‘ the amount of expenditure ( actual or notional )
incurred on or attributable to a given thing or activity.
 Cost refers to the total resources foregone, which may or
may not bring matching economic benefits. In the former
case, it will be termed as an expense while in the latter
case it will be termed as a loss. Both the expense and loss
are charged to the P & L account while deferred cost or
unexpired cost is shown as an asset in the Balance Sheet.

161. 161
Elements of Cost
Material : Substance from which the product is made. It can
further be divided as :
 Direct Material : All material which becomes an integral
part of the finished product and which can be assigned to
specific physical units ex.
i. All material components specifically purchased, produced
or requisitioned from the stores
ii. Primary packing material (carton, wrapping, cardboard box)
iii. Purchased or partly produced components.
 Indirect Material: All material which is used for purpose
ancillary to the business and which can not be assigned to
specific physical units ex. Consumable stores, oil and waste,
printing and stationery material etc.

162. 162
Elements of Cost ( Contd )
Labour : Conversion of Material into finished goods requires
human effort which is called labour. It can further be
subdivided as :
 Direct Labour : Labour which takes an active and direct part
in the production of a particular commodity. It is
specifically and conveniently traceable to specific products.
 Indirect Labour : Labour employed for the purpose of
carrying out tasks incidental to goods or services provided.
It does not alter the construction, composition or condition
of the product. It can not be traced to specific units of
output ex. wages for store keeper, foremen, time keepers,
directors’ fee, salaries for sales men etc.

163. 163
Elements of Cost ( Contd )
Expenses : Any other cost besides material and labour is termed
as expense.
 Direct Expense : Expenses which can be directly,
conveniently and wholly allocated to specific cost centers
ex. hire of special machinery for a particular contract, cost
of defective work incurred in connection with a particular
job.
 Indirect Expense : Expenses which can not be directly,
conveniently or wholly allocated to specific cost centres or
cost units ex. rent, insurance, salaries etc.
Overheads : All indirect costs ( material, labour and expenses )
are overheads. May be subdivided as :
 Factory Overheads : They include
i. Indirect material used in factory such as lubricants, oil,

164. 164
Elements of Cost ( Contd )
consumable store etc.
ii. Indirect labour ex. salary for gatekeeper , time keeper etc.
iii. Indirect expenses ex. factory rent, factory insurance etc.
 Office & Administration Overheads: They include:
i. Indirect material used in office ex. printing and stationery.
ii. Indirect labour ex. salaries payable to office manager, clerks.
iii. Indirect expenses ex. office rent, office insurance etc.
 Selling and Distribution Overheads : They include :
i. Indirect material used ex. packing material, printing and
stationery etc.
ii. Indirect labour ex. salaries of salesmen, sales manager etc.
iii. Indirect expenses ex. rent, insurance, advertising expenses
etc.

165. 165
Components of Total Cost
 Prime Cost : Also known as basic, first or flat cost.
Prime Cost =Direct material + Direct Labour + Direct Expenses
The term ‘ Direct Material’ means the cost of direct material
consumed, which equals : Opening Stock + Purchases – Closing
Stock
 Factory Cost : Also called Works cost or manufacturing cost.
Factory Cost = Prime Cost + Factory Overheads.
Adjustment for Scrap : In case certain materials ( before being
used ) are found to be defective and hence sold, the value of
materials used should be reduced by the cost of such materials
Adjustment for Work-in-progress :Work-in progress means units
which are not yet complete but on which some work has been
done. Generally such goods bear a proportionate part of
factory overheads, apart from raw material & direct wages.
Thus, opening and closing stock of work-in progress is kept in
mind while computing works cost of goods manufactured.

166. 166
Components of Total Cost ( Contd )
 Office Cost : Also known as administrative cost or cost of
production.
Office Cost = Factory Cost + Office and Administration
Overheads.
Office & Administration overheads are included on the presumption
that they relate solely to production. The amount of office and
administration overheads relating to sales are a part of selling
overheads and must have already been included in them
Adjustment for Finished Goods :
Cost of production of goods sold = Cost of production + Opening
Stock of Finished Goods – Closing Stock of Finished Goods.
 Total Cost or Cost of Sales:
Cost of Sales = Cost of Production of goods sold + Selling and
distribution overheads.

167. 167
Cost Sheet
According to CIMA, London cost sheet is ‘ a document which
provides for the assembly of the estimated detailed cost in
respect of a cost centre or a cost unit’.
Cost Sheets may be of the following two types :
 Historical Cost Sheet: Prepared periodically and after the costs
have been incurred.
 Estimated Cost Sheet: Prepared before the actual
commencement of production. The estimation process is
repeated at regular intervals. The estimates are compared with
the actual costs so that costs can be effectively controlled.
Importance of Cost Sheet:
 Ascertainment of Cost
 Controlling Costs
 Fixation of Selling Price
 Submitting of tenders: Preparation of an estimated cost sheet
about relevant product or job facilitates this.

168. 168
Classification Of Costs
Fixed, variable, Semi-variable and step costs:
Fixed Cost : A cost which tends to be unaffected by variations in
volume of output. Depend mainly on passage of time and do
not vary directly with volume or rate of output ex. rent,
insurance.
Variable Cost : the cost which varies directly in proportion to every
increase or decrease in the volume of output or production ex.
wages of labourers, cost of direct material.
Semi- Variable Cost: The cost which does not vary proportionately
but simultaneously cannot remain stationery at all times . Also
called semi-fixed cost ex. Depreciation, repairs.
Step up costs : Costs which remain fixed over a range of activity and
then jump to a new level as activity changes. They are a type of
semi variable costs.

169. 169
Classification Of Costs ( Contd )
Shut down and sunk costs:
Shut down Cost :If a plant is idle due to temporary difficulties,
certain fixed costs have to be incurred even if no work is being
done ex. rent, insurance of building, depreciation etc. Such
costs of the idle plant are known as shut down costs.
Sunk Cost :Historical or past costs. Created by a decision that was
made in the past and cannot be changed by any decision that
will be made in the future ex. Investment in building, plant and
machinery. Such costs are irrelevant for decision making.
Differential, Incremental or Decremental cost :
Differential Cost :Difference in total cost between two alternatives.
Incremental Cost: increase in total cost as a result of choice of
alternative.
Decremental Cost : Decrease in total cost as a result of choice of
alternative.

170. 170
Classification Of Costs ( Contd )
Opportunity Cost: The advantage which has been foregone on
account of not using the facilities in the manner originally
planned. It is the alternative revenue foregone. Ex. If an owned
building is proposed to be utilized for housing a new project
plant, the likely revenue which the building could fetch, is the
opportunity cost.
Product Costs and Period Costs :
Costs which become part of the cost of the product rather than an
expense of the period in which they are incurred are called
‘Product costs’. They are included in inventory values. They can
be fixed or variable ex. Cost of raw material, direct wages.
Costs which are not associated with production are called ‘ Period
costs’. They are treated as an expense of the period in which
they are incurred. They can be fixed or variable ex. general
administration costs, salesmen salaries etc.

171. 171
Cost Ascertainment
Cost Unit and Cost Centre :
Cost Unit : CIMA London, defines a unit of cost as, ‘ a unit of
quantity of product, service or time in relation to which costs
may be ascertained or expressed’. Unit selected should be
unambiguous, simple and commonly used ex:
i) Brick Kilns - per 1000 bricks made
ii) Electricity Companies - per unit of electricity generated
Cost Centre :According to CIMA London, cost centre means , ‘a
location, person or item of equipment ( or group of these )for
which costs may be ascertained and used for the purpose of
cost control’. Thus cost centre refers to one of those
convenient units into which the whole factory organization has
been appropriately divided for costing purposes.

172. 172
Cost Ascertainment
Cost Allocation and Cost Apportionment:
Cost allocation and cost apportionment are the two procedures
which describe the identification and allotment of cost centres
or cost units. Cost allocation refers to , ‘ the allotment of whole
items of costs to cost centres or cost units’ while cost
apportionment refers to ‘ the allotment of proportions of items
of costs to cost centres or cost units’. Thus the former involves
the process of charging direct expenditure to cost centres or
cost units while the latter involves the process of charging
indirect expenditure to cost centres or cost units.

173. 173
Methods of Costing
Costing has been defined as ‘ the technique and process of
ascertaining costs’. Various types of Costing :
 Job Costing : Used where the production is not highly
repetitive and consists of distinct jobs or lots. An account is
opened for each job and all appropriate expenditure is charged
thereto. Variants of Job costing :
i. Contract Costing : A contract is a big job , while job is a small
contract.
ii. Cost Plus Costing: In contracts where besides cost, an agreed
sum or percentage to cover overheads and profit is paid to the
contractor, the method is termed as contract plus costing.
iii. Batch Costing : Where order jobs are arranged in different
batches after taking into account the convenience of producing
articles, batch costing is employed. The unit of cost is batch or
group of identical products , instead of single job order or
contract.

174. 174
Methods of Costing ( Contd )
 Process Costing :If a product passes through different stages,
each distinct and well- defined, it is desirable to know the cost
of production at each stage. For this, process costing is used,
under which separate account is opened for each process.
Variants of process costing :
i. Operation Costing : This method is employed where mass or
repetitive production is carried out or where articles have to
be stocked in semi-finished stage. The cost unit is an operation
instead of a process.
ii. Unit Costing :Cost per unit of output is ascertained and the
amount of each element constituting such cost is determined.
iii. Operating Costing :This method is employed where expenses
are incurred for providing services such as those rendered by
bus companies or railway companies. The total expenses
regarding operation are divided by the appropriate unit and
cost per unit is calculated.

175. 175
Techniques of Costing
 Marginal Costing : It is a technique of costing in which
allocation of expenditure to production is restricted to those
costs which arise as a result of production i.e costs which vary
with production.
 Direct Costing : It is the practice of charging all direct costs to
operations , processes of products, leaving all indirect costs to
be written off against profits in the period in which they arise.
 Absorption or full costing : It is the practice of charging all
costs both variable and fixed to operations, products or
processes.
 Uniform Costing : It is the technique where standardized
principles and methods of cost accounting are employed by a
number of different companies or firms.

176. 176
Systems of Costing
 Historical Costing : It is the determination of cost by actuals. It
may be :
i. Post Costing : It means ascertainment of cost after production
is completed. It is done by analyzing the financial accounts at
the end of the period in such a way as to disclose the cost of
units which have been produced.
ii. Continuous Costing : Cost is ascertained as soon as the job is
completed or even when the job is in progress. This is done by
charging to the job the actual expenditure on material and
wages, and estimated share of overheads.
 Standard Costing : System under which :
i. Cost are predetermined on the basis of laid down standards.
ii. Actual costs are compared with pre determined costs.
iii. Variances are found out as to their causes.
iv. Remedial measures including revision of standards, is taken.

177. 177
Emerging terms
 Activity Based Costing : The technique which involves
identification of costs with each cost driving activity and
making it as the basis for apportionment of costs over different
products or jobs.
 Back Flush Costing :A cost accounting system which focusses
on the output of an organization and then works back to
attribute costs to stock and cost of sales. Also termed as
delayed costing or post-deduct costing . This is because the
costing of inventories is delayed almost till the goods are sold.
 Life Cycle costing : According to CIMA London, it is the ‘practice
of obtaining over their lifetimes, the best use of physical assets
at the lowest total cost to the entity’.
 Value Added Concept : It is a performance measure and it
reports the wealth generated by a business undertaking over a
period of time . It represents the sale value ‘ less the cost of
bought in goods and services used in producing those sales’.

178. Absorption & Marginal
Costing
178

179. MARGINAL COSTING
“Marginal costing means that when there is a
change in total costs due to increase or
decrease in one unit of production or output,
that change in total cost is termed as marginal
cost”.
179

180. 180
Marginal Costing
Marginal Costing is a technique where only the variable costs are
considered while computing the cost of a product. The
fixed costs are met against the total fund arising out of the
excess of selling price over total variable cost. This figure is
known as Contribution in marginal costing.
Absorption Costing and Marginal Costing
 Incase of absorption costing, both fixed and variable
overheads are charged to production, while in case of
marginal costing, only variable overheads are charged to
production and fixed overheads are transferred in full to
the costing and profit and loss account.
 In case of absorption costing stocks of work-in-progress
and finished goods are valued at works cost and total cost
of production respectively. In case of marginal costing, only
variable costs are considered while computing the value of
work-in- progress or finished goods. Thus, closing stock in
marginal costing is under valued as compared to
absorption costing.

181. 181
Marginal Costing ( Contd )
Marginal Costing and Direct Costing: Direct costing is the
technique where only direct costs are considered while
calculating the cost of the product. Indirect cost are met
against the total margin given by all the products taken
together. While marginal costs deal with variable costs,
direct costs may be fixed as well a variable.
Marginal Costing and Differential Costing : Differential costing
means , ‘ a technique used in the preparation of adhoc
information in which only the cost and income differences
between alternative courses of action are taken into
consideration’. Thus a comparison is made between the
cost differential and income differential between two or
more situations and decision regarding adopting a
particular course of action is taken if it is on the whole
profitable.

182. 182
Segregation of Semi Variable Costs
Marginal Costing requires segregation of costs into fixed and
variable. This means that semi variable costs will have to be
segregated into fixed an variable elements. Various
methods for segregation are :
 Level of output compared to level of expenses method :
Output at two different levels is compared with the
corresponding level of expenses . Since the fixed expenses
remain constant, the variable overheads are arrived at by
the ratio of change in expense to change in output.
 Range Method : Similar to the previous method except that
only the highest and lowest points of output are
considered.
 Degree of Variability Method : Degree of variability is noted
for each item of semi variable expense ex some items may
have 30% variability and others 70% variability.

183. 183
Segregation of Semi Variable Costs ( Contd )
 Scatter Graph Method : The data is plotted on a graph
paper, with volume of production on the x-axis and the
corresponding costs on the y- axis. A line of best fit is
drawn, which is the total cost line. The point at which this
line intersects the y-axis is taken to be the amount of fixed
element.
 Method of Least Squares : This method is based on the
mathematical technique of fitting an equation with the
help of observations.

184. Features Of Marginal Costing
• Marginal costing is used to ascertain the marginal
cost and to show the effect of variable cost on
the volume of output or production.
• Fixed costs find no place in cost of production
and they are written off during the period in
which they are incurred.
• Only variable costs are taken in account in
computing the cost of production.
• The profitability of the products or departments
is determined in term of the marginal
contribution.
184

185. Cost-Volume-Profit Analysis
In CVP analysis we study the relationship of
cost, volume and profit i.e. what will be effect
on profit due to change in costs and change in
level of production, output, or levels of
activity.
185

186. 186
Cost Volume Profit Analysis
Cost Volume Profit ( CVP ) analysis is an important tool of profit
planning. It provides information about :
- The behaviour of cost in relation to volume.
- Volume of production or sales where the business will
break even.
- Sensitivity of profits due to variation in output.
- Amount of profit for a projected sales volume.
- Quantity of production and sales for a target profit level.
Thus CVP analysis is an important media through which the
management can have an insight into effects on profit and
loss account, of variations in costs ( fixed and variable ) and
sales ( value and volume ) to take appropriate decisions.

187. Assumptions used in CVP Analysis
• All type of costs and expenses can be differentiated into
fixed and variable elements.
• Selling price/unit remains constant. No discounts are
assumed to be available.
• Total of the fixed costs remain constant throughout the
range of volumes shown on the base line.
• The per unit variable cost remain constant but the total
variable cost vary in direct proportion to change in volume.
• There will be no change in managerial policies,
technological methods, and efficiency of men and
machines.
• Total sales are equal to total production.
187

188. 188
Utility of CVP Analysis
 Fixation of Selling Price: The cost of the product and the
desired profitability are two important factors which govern
the fixation of selling price.
 Maintaining a desired level of profit: In the face of price cuts,
in case the demand for the company’s product is elastic, the
minimum level of profit can be maintained by pushing up the
sales. The volume of such sales can be found out by the
marginal costing technique.
 Accepting of price less than total cost: Sometimes prices have
to be fixed below the total cost of the product. In such a
scenario, a price less than the total cost but above the
marginal cost may be acceptable because in such periods any
material contribution towards recovery of fixed costs is
acceptable rather than no contribution at all.

189. 189
Utility of CVP Analysis ( Contd )
 Decisions involving alternative choices: The technique of
marginal costing helps in making decisions involving
alternative choices ex. Discontinuance of a product line,
changes of sales mix, make or buy, own or lease, exapand or
contract etc. The technique used is differential costing, which
is an extension of the technique of marginal costing.

190. Tools of Marginal Costing or
CVP ANALYSIS
• Contribution
• Profit Volume Ratio
• Break Even Chart/Analysis
• Margin of Safety
190

191. Contribution
Income can be ascertained under marginal costing approach as follows:
Sales revenue XXX
Less: Variable cost
Direct Material XXX
Direct Labour XXX
Direct Expenses XXX XXX
________ _______
Contribution XXX
Less: Fixed cost XXX
_______
Profit/Loss XXX
_______
So, contribution is the excess of sales revenue over the variable cost.
191

192. Contd…
The same thing can be put in the form of following
equation.
Contribution= Sales revenue – Variable cost
C= S – V
Contribution= Fixed cost + Profit/Loss
C=F + P/L
S –V=F + P/L
C=S –V
C=F+ P/L
This equation is also known as marginal costing equation.
192

193. Profit Volume Ratio (p/v ratio)
Profit volume ratio tells about rate of profitability by
establishing the relationship between contribution margin
and sales revenue. It is expressed in following manner:
P/V Ratio = Contribution margin x 100
Sales Revenue
P/V Ratio can also be shown in the following manner
P/V Ratio = S –V x 100
S
In case profits and sales are given for two different points of
line then P/V ratio can be calculated in the following
manner
P/V Ratio = Change in Profit x 100
Change in Sales
193

194. Contd…
Example:
The sales of A ltd. In the first half of 2001 amounted to Rs. 2,70,000
and profits earned was Rs. 7,200. The sales in the second half of
2001 amounted to Rs.3,42,000 and profit earned was Rs. 20,700 for
that half year. Assuming no change in fixed cost. Calculate P/V
Ratio.
Solution:
P/V Ratio = Change in Profit x 100
Change in Sales
= 13,500 x 100
72,000
= 18.75%
194

195. Break Even Chart
The break even chart is the graphic presentation
which shows the varying costs along with
varying sales revenue. It depicts the point of
production at which neither profit nor loss can
result and also shows the estimated profit or
loss at different levels of production.
195

196. Break Even Chart
196

197. Angle of Incidence
• Taking the break even point as the base if we
draw an angle in the profit area it is called
‘angle of incidence.’ Larger is the angle, more
are the profits. A small angle indicates a low
rate of profit and reveals that variable costs
form the major part of cost of production. A
large angle of incidence along with a high
margin of safety indicates the most favorable
position and even may mean the existence of
monopoly conditions.
197

198. 198
Break Even Analysis
Break even analysis is a widely used technique to study CVP
relationship. Certain basic important terms are :
 Contribution : Excess of Selling Price over Variable Cost
Contribution = Selling Price – Variable Cost
= Fixed Price + Profit
 Profit Volume Ratio ( P/V ratio): Establishes relationship
between contribution and sales value.
P/ V Ratio = Contribution / Sales
= ( Sales – Variable Cost) / Sales
 Break-even Point :It is the point which breaks the total cost
and selling price evenly to show the level of output at which
there shall be neither profit nor loss.
Break-even Point ( Output) = Fixed Cost/ Contribution per unit
Break-even Point ( Sales ) = Fixed Cost x Selling price per unit
Contribution per unit
= (Fixed Cost) / (P/V ratio)

199. Break Even Point
Break even point is said to that level of production or output
or level of activity whereby the firm is in no profit no loss
situation.
It is calculated in following manner:
B.E.P (in units) = Fixed Expenses or Cost
Contribution per unit
B.E.P (in Rs.) = Fixed cost
P/V Ratio
Sales (in units) = Fixed cost + Desired Profit
Contribution per unit
Sales (in Rs.) = Fixed cost + Desired Profit
P/V Ratio
199

200. Contd…
Example:
Sales 5,000 units @ Rs. 30 per unit.
Variable costs Rs. 15 per unit.
Fixed costs Rs. 90,000.
Find out the B.E.P in units as well as in value,
and also profits earned. What should be the
sales for earning profit of Rs. 60,000?
200

201. Contd…
Solution:
(a) B.E.P (in units) = Fixed costs
Contribution per unit
= 90,000
15
= 6,000 units.
(b) B.E.P (in Rs.) = Fixed costs
P/V Ratio
= 90,000
50%
= Rs. 1,60,000.
(c) Profit earned or loss suffered:
S –V = F + P
P = S –V –F
= Rs. 15,000
(d) Sales to earn profit of Rs. 60,000:
Sales = Fixed cost + Desired profit
P/V Ratio
= 90,000 + 60,000 = Rs. 3,00,000
50%
Sales in terms of units: 3,00,000 = 10,000 units.
30
201

202. 202
Break Even Charts ( Contd )
Advantages of break even charts :
 Provides detailed and clearly understandable information.
 Profitability of products and business can be known.
 Effect of changes in cost and selling price can be
demonstrated.
 Cost control can be demonstrated.
 Economy and efficiency can be effected.
 Forecasting and planning is possible.
Limitations of break even charts:
 Limited information can be presented in a single chart.
 No necessity : There is no necessity of preparing break even
charts because:
- Simple tabulation is sufficient
- Conclusive guidance is not provided
- No basis of comparative efficiency

203. Margin Of Safety
The margin of safety is the difference between sales
revenue or actual sales and the sales at break even
level. So it can be expressed as:
Margin of safety = Actual sales –Sales at break even point
Profit
M/S Ratio (in units) = _____________________
Contribution per unit
Profit
M/S Ratio (in Rs.) = _________________________
P/V Ratio
203

204. Applications of Marginal Costing or
Break Even Analysis
• 1. Cost Control
• 2. Profit Planning
• 3. Evaluation of Performance
• 4. Fixation of Selling Prices
• 5. Key/Limiting factor
• 6. Make or Buy decisions
• 7. Selection of a suitable product mix
• 8. Effect of change in price
• 9. Maintaining a desired level of profit
• 10. Alternative methods of production
• 11. Diversification of products
• 12. Closing down or suspending activities 204

205. Advantages Of Marginal Costing
 Marginal costing is aid to management in taking many
valuable decisions such as pricing, to make or buy, etc.
 Simple to understand
 Effective control over cost is possible.
 Since fixed costs are avoided, it eliminates the difficult
work of allocating, apportioning, and absorbing
overhead.
 Where a number of products are being manufactured
marginal costing facilitates the study of relative
profitability of different products.
205

206. Limitations of Marginal Costing
 Segregation of all overheads into fixed and variable is
difficult because many overheads considered to be fixed or
variable may not exactly be the same at various levels of
production.
 In marginal costing, there is no place of semi-varaiable
overheads which are to be segregated into fixed and
variable elements.
 The ‘time factor’ is completely ignored in marginal costing.
 The technique of marginal costing is unsuitable in many
industries like ship building or big contracts where the
value of Work In Progress is high in relation to turnover.
206

207. Standard Costing
Standard Cost is a predetermined cost. It is a
determination in advance of production, of what
should be the cost. When standard costs are used for
purposes of cost control, the technique is know as
standard costing.
Standard Cost is the preparation of standard
costs and applying them to measure the variations
from actual costs and analyzing the causes of
variations with a view to maintain maximum efficiency
in production. It is a technique which uses standards
for costs and revenues for the purpose of control
through variance analyses.
207

208. 208
Meaning of Standard Costing
According to CIMA London, Standard Costing is, ‘ the
preparation and use of standard costs, their comparison
with actual costs, and the analysis of variances to their
causes and points of incidence’. Standard Costing discloses
the cost of deviations from standard and classifies these as
to their causes, so that management is immediately
informed of the sphere of operations in which remedial
action is necessary.
Thus Standard Costing is a method of ascertaining costs whereby
statistics are prepared to show :
 The standard costs
 The actual costs
 The difference between these costs which is termed as
variance

209. 209
Budgetary Control Vs. Standard Costing
 Concerned with the operation
of the business as a whole
and hence more extensive.
 Budget is a projection of
financial accounts.
 It does not necessarily involve
standardization of products.
 Budgetary control can be
adopted in part also.
 Budgeting can be operated
without standard costing.
 Budgets determine the
ceilings of expenses above
which actual expenses should
not rise.
 Related with the control of
expenses and hence it is
more intensive.
 Standard cost is the
projection of cost accounts.
 It requires standardization of
products.
 It is not possible to operate
this system in parts.
 Standard costing cannot exist
without budgeting.
 Standards are minimum
targets which are to be
attained by actual
performance a t a specific
efficiency level.

210. 210
Estimated Cost Vs. Standard Cost
 Estimated cost can be used in
any business which is running
under historical costing
system.
 Computation of estimated
costs may be made at any
time for any specific purpose
and may reflect
approximation.
 Primary emphasis is on
ascertainment of costs which
depend on expected actuals
of average of past
performance.
 Estimated costs can be
ascertained for a part of the
business also for a particular
purpose.
 Standard cost can be applied
in a business operating under
the standard costing system.
 Calculation on scientific basis
is to be made for arriving at
standard costs.
 Cost control is the main
aspect involved under this
system. Standard costs serve
as yardsticks for
performance measurement.
 Standard costs are to be
fixed in respect of every
element of cost and,
therefore, it incorporates the
whole of the manufacturing
process.

211. 211
Standard Costing As A Management Tool
The utility of standard costing to management is as under :
 Formulation of price and production policies: Assists
management in the field of inventory pricing, profit
planning and also reporting to higher levels.
 Comparison and Analysis of Data : Provides a stable and
sound basis for comparison of actual with standard costs,
according to different elements separately, thus indicating
places where remedial action is necessary and how far
improvement is possible in the long run.
 Cost Consciousness: Provides incentives to workers, middle
and top executive personnel for efficient work.
 Better Capacity to anticipate: Data are available at an early
stage and the capacity to anticipate about changing
conditions is developed.

212. 212
Standard Costing As A Management Tool
 Delegation of Authority and Responsibility :The sphere of
operation of adverse variations is disclosed and particular
production department or centre can be held accountable.
The delegation of responsibility and authority can be made
by the management to control the affairs in different
departments.
 Management by ‘Exception’: Management by exception
can be made applicable in the business and the
management can concentrate on cases which are off
standard.
 Better Economy, Efficiency and Productivity: Managerial
review of costs is more effective as the operations are
scrutinized carefully and inefficiencies are disclosed.

213. 213
Limitations of Standard Costing
 Heavy costs :Fixation of standards may be costly and may
require high skill and competence.
 Frequent Revision Required :Revision of standards is a
tedious and costly process.
 Unsuitable for Non-standardized Products: Industries
dealing in non- standardized products may find the system
unsuitable and costly.
 Fixation of Responsibility Difficult: Responsibility can be
fixed only when controllable and non controllable factors
are distinctly known
 Adverse Psychological Effects: Standards may be fixed at a
high level which is unachievable, resulting in frustration or
building up of resistance.

214. 214
Meaning of Standard Costs
Different meanings may be attached to the term ‘ Standard Cost’:
 Ideal Costs :These are costs which should be there under ideal
working conditions, ideal management and ideal plant capacity.
Such ideal is a myth, and far from reality.
 Normal Costs: Such costs can be determined on the basis of the
prevailing conditions of the business. It is assumed that the plant
is working at normal level of capacity and efficiency, workers are
engaged in production activities performing their normal
functions and the normal efficiency operations are being carried
out. The cost shall thus be an average standard cost which is
normally there in business.
 Cost based on ‘ Average Past performance’: The costs which have
been incurred during the past three or five years, for instance,
are averaged out and the same may be taken as the standard
costs for the following period. However, past results are not
enough and self sufficient to constitute standards.

215. 215
Meaning of Standard Costs ( Contd )
 Current Costs : These are costs which are currently being
incurred. They are not a useful guide for standard costs
since they are neither in rhythm with past trends nor are
inclusive of factors and conditions following ahead.
 Expected or Anticipated Costs: These are costs which
closely follow the pattern of present costs, though adjusted
according to past behavioural patterns as well a future
tendencies.
 Reasonably attainable costs: Costs which can be attained
reasonably if the management tries for them i.e it makes a
sincere and integrated effort to achieve the targets set in,
can be regarded as the satisfactory yardstick or benchmark
for standards.

216. 216
Determination of Standard Costs
Preliminaries to setting of Standards:
 Establishment of Cost Centres : Though all the processes
combined together manufacture the final product, but for
measuring productivity and controlling labour and
overheads, classification into cost centres becomes
necessary.
 Classification and Codification of Accounts: Helps in quick
collection and analysis of cost information.
 Period of Use: This involves the length of the operating
period for which standards are to be used. The standards,
which may be long term or short term, may be categorized
as :
a) Basic Standards: Not altered over a long period of time,
revisions are not frequent and there is a stability and
stagnancy in standards fixed.
b) Current Standards: These are short term standards.

217. 217
Determination of Standard Costs ( Contd )
 Reasonable or Desired Level of Attainment :Standards are
to be set assuming efficient working conditions and
reasonable good performance.
 Active Level: The level of activity or performance required
must be decided upon before establishing any standards. It
should be computed keeping in mind the capacity of the
plant and the marketability of the products.

218. 218
Setting of Standards
The Standard Cost is determined for each and every element of
cost distinctly.
Standards for Direct Material Cost: Here two standards will have
to be fixed up :
 Quantity Standards : The factors that should be considered
while determining the quantity that should be consumed
for manufacturing one unit of commodity:
- Past experience
- Technical estimates based on mathematical or scientific
computation.
- Test runs and experiments
- Standard bills of materials
 Price Standards: The standards regarding the price at
which material should be available can be fixed by
considering:
- Price prevailing in the past
- Current prices and prevalent market trends
- Experience of similar concerns

219. 219
Setting of Standards ( Contd )
Standards for Direct Labour Cost:
 Time Standards : The time which a worker should take in
completing a particular job can be fixed up by taking into
consideration:
- Trial Runs
- Time and Motion Studies
- Technical Estimates
- Past Experience
- Experience of Similar Concerns
- Other factors like standardization of products, efficient
plant and equipments, efficient tools to handle, efficiency
and skill of workers etc.
 Rate Standards: The following factors must be considered:
- Type of labour required for performing a specific job
- Past experience
- Current Market Rates
- Trends

220. 220
Setting of Standards ( Contd )
Standards for Overhead Cost:
 Standard Level Of Activity : It should be carefully fixed and
should represent a reasonably attainable level.
 Fixed, variable and semi-variable overheads:
- Fixed Overheads: Remain constant irrespective of the
quantum of output ex rent, insurance etc.
- Variable Overheads: Vary in proportion with output ex.
Power, selling commission etc.
- Semi-variable overheads: Vary according to output but not
in direct proportion. Include an element of fixed as well as
an element of variable cost ex. Depreciation and repairs.
 Fixed Overhead Standards: Can be determined on the basis
of past experience and current market trends.
 Variable Overhead Standards: Standards for variable
overheads are fixed on the basis of trial runs, technical
estimates, past experience and experience of other people
in the same line.

221. 221
Setting of Standards ( Contd )
Standards for Sales:
 Quantity Standards: Quantity standards regarding sales will
have to be fixed up for each of the products in which the
business deals. Past sales figures, orders in hand,
production capacity, presence of competitors etc. should
be taken into consideration while determining quantity
standards.
 Price Standards: Price standards should be fixed up
regarding each product in which the business deals. Past
experience, current market trends, cost of product, price at
which other manufacturers are selling the goods etc.
should be considered while fixing the standard.
The standard quantity multiplied by the standard price will give
us ‘Budgeted Sales’. It is different from ‘Standard Sales’
which stands for actual quantity of sales multiplied by
standard selling price.

222. 222
Setting of Standards ( Contd )
Standards for Overhead Cost:
 Standard Level Of Activity : It should be carefully fixed and
should represent a reasonably attainable level.
 Fixed, variable and semi-variable overheads:
- Fixed Overheads: Remain constant irrespective of the
quantum of output ex rent, insurance etc.
- Variable Overheads: Vary in proportion with output ex.
Power, selling commission etc.
- Semi-variable overheads: Vary according to output but not
in direct proportion. Include an element of fixed as well as
an element of variable cost ex. Depreciation and repairs.
 Fixed Overhead Standards: Can be determined on the basis
of past experience and current market trends.
 Variable Overhead Standards: Standards for variable
overheads are fixed on the basis of trial runs, technical
estimates, past experience and experience of other people
in the same line.

223. 223
Setting of Standards ( Contd )
Standards for Sales:
 Quantity Standards: Quantity standards regarding sales will
have to be fixed up for each of the products in which the
business deals. Past sales figures, orders in hand,
production capacity, presence of competitors etc. should
be taken into consideration while determining quantity
standards.
 Price Standards: Price standards should be fixed up
regarding each product in which the business deals. Past
experience, current market trends, cost of product, price at
which other manufacturers are selling the goods etc.
should be considered while fixing the standard.
The standard quantity multiplied by the standard price will give
us ‘Budgeted Sales’. It is different from ‘Standard Sales’
which stands for actual quantity of sales multiplied by
standard selling price.

224. Analysis of Variances
• The deviation of actual cost or profit or sales
from the standard cost or profit or sales is
known as “Variance”. When actual cost is less
than standard cost or actual profit is better
than standard profit, it is known as favourable
variance. Variances of different items of cost
provide the key to cost control because they
disclose whether and to what extent
standards set have been achieved.
224

225. Types of Variances
• Direct Material Variances
• Direct Labour Variances
• Overhead Variances*
• Sales Variances*
*not in syllabus
225

226. Material Variances
226

227. Material Variances
• MCV = MPV + MQV
• MQV = MMV + MYV
227

228. Material Cost Variance
• MCV= (SQ x SP) – (AQ x AP)
• For ex. Standard Quantity 2,000 kg
• Standard Price Rs. 5 per kg.
• Actual Qty. 2,200 kg
• Actual Price 4.5 per kg
• Calculate MCV
• MCV= (2000 x 5) – (2200 x 4.5)
• 10,000 – 9,900
• 100 (Favourable)
228

229. Material Price Variance
• MPV = (SP – AP) x AQ
• Standard qty. 3,000 kg.
• Standard Price Rs. 2.5 per kg
• Actual qty 3,500 kg.
• Actual Price 3 per kg
• MPV = ?
• MPV = (2.5 – 3) x 3500 = -1,750 (Adverse)
229

230. Material Quantity/Usage Variance
• MQV = (SQ – AQ) X SP
• Standard qty. 3,000 kg.
• Standard Price Rs. 2.5 per kg
• Actual qty 3,500 kg.
• Actual Price 3 per kg
• MQV = ?
• MQV = (3000 – 3500) x 2.5
• MQV = -500 X 2.5
• MQV = -1250 (Adverse)
230

231. Material Mix Variance
• This variance arises because the ratio of
materials being changed from the standard
ratio set. It is calculated as the difference
between the standard price of standard mix
and standard price of actual mix.
• Std. Unit Cost (Revised Std. Qty. – Actual Qty.)
231

232. Problem
• From the following information, calculate
Material Mix variance.
• Materials Standard Actual
A 200 units @12 160 units @13
B 100 units @10 140 units @10
Due to shortage of material A, it was decided to
reduce consumption of A by 15% and increase
that of material B by 30%.
232

233. Answer
• Revised Standard mix is:
• Material A: 200 units – 15% of 200 = 170 units
• Material B: 100 units + 30% of 100 = 130 units
• Material Mix Variance:
• Standard Unit Cost (Revised Std. Qty. – Actual
Qty.)
• Material A: Rs. 12 (170 – 160) = 120 Favorable
• Material B: Rs. 10 (130 – 140) = -100 Adverse
• Material Mix Variance = 20 Favorable
233

234. Material Yield Variance
• Yield Variance = Standard Rate (Actual Yield –
Standard Yield)
• Standard Rate = Standard Cost of Standard
Mix/ Net Std. Output
• Net Std. Output = Gross output – Std. loss
234

235. Problem
• From the following calculate MYV.
Standard Mix Actual Mix
Material A 200 units @12 160 units @ 13
Material B 100 units @ 10 140 units @ 10
Standard loss allowed is 10% of input. Actual output is 275 units
235

236. Answer
• Standard Mix Actual Mix
• Material A 200 @12=2400 160@13=2080
• Material B 100 @10=1000 140@10=1400
• 300 3400 300 3480
• Less: Loss 30 (10%) 25
• Output 270 3400 275 3480
Std. Cost per unit = 3400/270 = 12.593
MYV = Std. Rate (Actual yield – Std. Yield)
12.593 (275-270)
12.593 x 5 = 62.695 Favourable
236

237. Labour Variance
• Labour Cost Variance
• Labour Rate Variance
• Labour Efficiency (time) Variance
237

238. 238
Direct Labour Variance
Direct Labour Cost Variance
Direct Labour Rate Variance Direct Labour Efficiency Variance
Direct Labour Mix Direct LabourYield
Variance Variance
 Direct Labour Cost Variance: It is the difference between
standard direct wages specified for the activity achieved and the
actual direct wages paid.
= ( Std. cost for actual output ) - ( Actual Cost )
= ( Std rate x Std Time for Actual Output) –
( Actual rate – Actual Time )

239. 239
Direct Labour Variance ( Contd )
 Direct Labour Rate Variance : That portion of direct labour
cost variance which is due to the difference between the
standard rate of pay specified and the actual rate paid.
= Actual Time x ( Std. Rate – Actual Rate )
 Direct Labour Efficinecy Variance: That portion of direct
labour cost variance which is due to the difference between
the standard labour hours specified for the activity achieved
and the actual labour hours expended.
= Std Rate x ( Std. Time for Actual Output – Actual Time)
 Direct Labour Mix Variance : This variance arises if during a
particular period, the grades of labour used in production are
different from those budgeted.
= Std. Rate x ( Revised Std. Time – Actual Time )

240. 240
Direct Labour Variance ( Contd )
where, Revised Std. Time = (Total Actual Time ) x Std. Time
( Total Std. Time)
 Direct Labour Yield Variance : It is the variance in labour cost
on account of increase or decrease in yield or output as
compared to the relative standard.
= Std. Cost per unit x ( Std. Output of _ Actual
Actual mixture output )
 Total Direct Labour Efficiency Variance : In those cases where
there is an idle time variance ;
Total Direct Labour efficiency variance = ( Idle Time variance )+
(Direct Labour efficiency variance)
Idle Time Variance = Idle Time x Std. Rate

241. Cost Control Techniques-Preparation of Budgets
& Their Control
Budgetary Control
241

242. 242
Meaning of Budget
A budget is ‘ a predetermined detailed plan of action developed
and distributed as a guide to current operations and as a
partial basis for the subsequent evaluation of
performance’.
Following are the essentials of a budget:
 It is prepared in advance and is based on a future plan of
action.
 It relates to a future period and is based on objectives to be
attained.
 It is a statement expressed in monetary and/or physical
units prepared for the implementation of policy formulated
by the management.

243. 243
Budgetary Control
It is the system of management control and accounting in which
all operations are forecasted and so far as possible planned
ahead, and the actual results compared with the forecasted
and planned ones. Thus, budgetary control involves :
 Establishment of budgets.
 Continuous comparison of actual with budgets for target
achievement and variance analysis.
 Revision of budgets in the light of changed circumstances.
The difference between, budgets, budgeting and budgetary
control has been stated as , ‘Budgets are the individual
objectives of a department etc., where as budgeting may be
said to be the act of building budgets. Budgetary control
embraces all and in addition includes the science of planning
the budgets themselves and the utilization of such budgets
to effect an overall management tool for the business
planning and control.’

244. 244
Budgetary Control As A Management Tool
Advantages of Budgetary Control :
 Brings economy in working
 Buck passing is avoided
 Established Coordination
 Decrease in Production Costs
 Adoption of Standard Costing Principles
 Guards against Undue Optimism
 Adoption of Uniform Policy
 Management by Exception
 Finds favour with Credit Agencies
 Optimum Capitalization.

245. 245
Limitations of Budgetary Control
 Opposition against the very spirit of budgeting : The
opposition is due to human tendency to resist change.
Moreover, any system of budgetary control cannot be
successful unless it has the full support of the top
management.
 Budgeting and changing economy: Preparation of a budget
which gives a realistic position of the firm’s affairs under
inflationary pressures and changing government policies is
very difficult.
 Time factor : Accuracy in budgeting comes through
experience. Management must not expect too much during
the development period.
 Not a substitute for management : It is a management tool
and cannot substitute management.
 Cooperation required : Its success depends upon willing co-
operation and teamwork.

246. 246
Classification of Budgets
According to time:
 Long term Budget: Designed for a long period, generally 5
to 10 yrs. Concerned with the planning of the operations of
a firm over a considerably long period of time.
 Short term Budget : Designed for a period generally not
exceeding 5 yrs.
 Current budgets: Cover a very short period, say a month or
a quarter. They are essentially short term budgets adjusted
to current conditions.
 Rolling Budgets: A new budget is prepared at the end of
each month or quarter for a full year ahead. The figures for
the month or quarter which has rolled down, are dropped
and the figures for the next month or quarter are added.

247. 247
Classification of Budgets ( Contd )
According to function:
 Sales Budget:
It is a forecast of sales to be achieved in a budget period.
Factors to be considered while preparation of sales budget
include past sales figures and trends, Salesmen’s estimates,
Plant capacity, Orders in hand, Seasonal fluctuations,
Potential market etc.
 Production Budget:
Provides an estimate of the total volume of production
product-wise, with the scheduling of operations by days,
weeks and months and a forecast of the closing finished
product inventory.
 Purchase Budget:
Forecasts the quantity and value of purchases required for
production.
 Capital Expenditure Budget :
Forecasts the amount of capital that may be required for
procurement of capital assets during the budget period.

248. 248
Classification of Budgets ( Contd )
 Cash Budget:
Forecasts the estimated amount of cash receipts and
payments and the likely cash balance in hand at the end of
different periods. A cash budget helps the management in
i) Determining the future cash needs of the firm.
ii) Planning for financing of those needs
iii) Exercising control over cash and liquidity of the firm.
A Cash budget can be prepared in any of the following
three ways:
i. Receipts and Payments Method : Cash receipts and
payments from various sources are estimated and a budget
is prepared using the estimates.
ii. Adjusted Profit & Loss Account Method: Cash budget is
prepared on the basis of opening cash and bank balances,

249. 249
Classification of Budgets ( Contd )
projected profit and loss account and the balance of various
assets and liabilities.
iii. Balance Sheet Method: Under this method, at the end of
each period a projected balance sheet is drawn up listing
various assets and liabilities except cash and bank balances.
The balancing figure is taken as the closing cash/ bank
balance.
 Master Budget : It is a summary budget incorporating all
functional budgets in capsule form.

250. 250
Classification of Budgets ( Contd )
According to Flexibility:
Fixed Budget : According to CIMA London, ‘ a fixed budget is a
budget which is designed to remain unchanged irrespective
of the level of activity actually attained’. Hence it is
unrealistic yardstick incase the level of activity actually
attained does not conform to the one assumed for
budgeting purposes.
Flexible Budget : According to CIMA London, a flexible budget is ,
‘ a budget designed to change in accordance to the level of
activity actually attained’.
A flexible budget can be constructed in any of the three ways:
 The Multi- Activity Method :Involves computing budget
figures for different levels of activity within a range.

251. 251
Classification of Budgets ( Contd )
 Formula Method: Involves preparing budgets for the
expected normal level of activity and then working out
ratios showing the relationship of each expenses or group
of expenses per unit level of activity.
 Graphic Method : Costs are classified according to their
variability – fixed, variable or semi variable. Estimates are
then made for different costs at different levels of activity.
The data are then plotted on the graph paper showing the
costs at different levels of activity.

252. 252
Performance Budgeting
 According to National Institute of Banking Management,
performance budgeting technique is ‘ the process of
analyzing, identifying, simplifying and crystallizing specific
performance objectives of a job to be achieved over a
period ,in the framework of the organizational objectives,
the purpose and objectives of the job. The technique is
characterized by its specific direction towards the business
objectives of the organization’.
 Thus, performance budgeting lays immediate stress on the
achievement of specific goals over a period of time.
However, in the long run it aims at the continuous growth
of the organization.
 It requires preparation of performance reports which
compare budget and actual data and show any existing
variances. The responsibility of preparing the performance
budget of each department lies on the respective
Departmental Head.

253. 253
Control Ratios
Ratios that are commonly used by the management to find out
whether the deviations of actual from budgeted results are
favourable or otherwise.
 Activity Ratio : It is a measure of the level of activity
attained over a period of time.
Activity ratio = Standard hrs for actual production x 100
Budgeted hrs
 Capacity Ratio : Indicates whether and to what extent
budgeted hrs of activity are actually utilized.
Capacity ratio = (Actual hrs worked / Budgeted hrs) x 100
 Efficiency Ratio : Indicates the degree of efficiency attained
in production.
Efficiency ratio : Standard hrs for actual production x 100
Actual hrs worked

254. 254
Zero Base Budgeting
 The traditional budgeting technique is quite meaningless
under the present dynamic conditions where the
management must review and evaluate every task in the
light of changed circumstances.
 Zero base Budgeting ( ZBB ) examines a programme or
function or responsibility from ‘scratch’. Nothing is allowed
simply because it was being done in the past. The manager
proposing the activity has, therefore, to prove that the
activity is essential and the various amounts being asked
for, are reasonable taking into account the volume of the
activity.

255. 255
Zero Base Budgeting ( Contd )
Process of Zero Base Budgeting
 Determination of objectives of Budgeting : The objective
may be to effect cost reduction in staff overheads or
analyze and drop the projects which do not fit in the
organizational structure etc.
 Determination of the extent to which ZBB is to be
introduced: Whether it is to be introduced in all areas of
activities or only in a few selected areas on a trial basis.
 Development of decision units : Decision units refer to units
regarding which a cost benefit analysis will be done to
arrive decide whether they should be allowed to continue
or not. It may be a functional department, a programme, a
product line or a sub-line.

256. 256
Zero Base Budgeting ( Contd )
 Development of decision packages: After identification of
decision units, the manager of each decision unit reviews
the activities of his unit and examines alternative ways of
accomplishing the objectives. He does a cost benefit
analysis and selects the best alternative. He then prepares
a decision packages which effectively summarize his plans
and the resources required to achieve them.
 Review and ranking of decision packages: The management
ranks the decision packages in order of increasing benefit
or importance to the organization.
 Preparation of Budgets: After the choice of decision
package to be implemented is made, resources are
allocated to different decision units and budgets relating to
each unit are prepared.

257. 257
Zero Base Budgeting ( Contd )
Advantages of ZBB
 Provides the organization with a systematic way to
evaluate different operations and programmes.
 Ensures that every programme being undertaken by the
manager is essential to the organization and is being
performed in the best possible way.
 No arbitrary cuts or increase in budget estimates are made.
All approvals are made on the basis of cost benefit analysis.
 Helps identify areas of wasteful expenditure.
 Links budgets with corporate objectives. Nothing will be
allowed simply because it was being done in the past.
 It can be used for introduction and implementation of the
system of ‘management by objectives’.

258. Unit- IV (syllabus)
• Introduction to recent developments in cost management:
• Introduction to concept of Price Level Accounting,
• Human Resource Accounting,
• Transfer Pricing.
• Target Costing,
• Kaizen costing ,
• Activity based costing,
• Life Cycle Costing.
258

259. Price Level Accounting
Accounting for price level is that accounting
technique by which transactions are recorded
at current prices and the effect of changes in
price-level on accounting items is neutralized
or such effects are made clear along with
transactions recorded at historical costs.
259

260. Features of Price Level Accounting
• The recording procedure is automatic
• The unit of measurement is not assumed to be
stable.
• It considers all elements of the financial
statements.
260

261. Objectives of Price Level Accouniting
• To correct conventional historical cost
accounts for the understatement of inventory
and plant used in production i.e. cost of goods
sold and depreciation.
• To eliminate the money illusion.
261

262. Techniques of Price Level Accounting
• Current Purchase Power Method
• Current Cost Accounting Method
• Cost of Sales Adjustment
• Calculation of Conversion Factor
• Mid Period Conversion
• Monetary and non-monetary items
• Loss or gain on monetary items
• Cost of Sales and inventories
• Replacement Cost Accounting
• Current Value Accounting Technique
• Current Cost Accounting Technique
262

263. Human Resource Accounting
• Human Resource Accounting may be
considered as such an accounting system
which recognizes the human resources as an
asset and records it in the books or accounts
after measuring its value in the same way as
other physical resources.
263

264. Objectives of HRA
• HRA helps in determining the return on
investment on human resources.
• It helps in knowing whether the human resources
have been properly utilized or not.
• It provides quantitative information on human
resources which will help the managers as well as
investors in making decisions.
• To communicate the worth of human resources
to the organization and the society at large.
264

265. Methods of HRA
• Historical Cost Method
• Replacement Cost Method
• Opportunity Cost Method
• Standard Cost Method
• Present Value Method
265

266. Transfer Pricing
• A transfer price is a price used to measure the price
of goods or services furnished by a profit centre to
other responsibility centre to other responsibility
centers within a company.
• Some companies have the problem of pricing goods
and services which are transferred to other units of
the same company; such pricing is referred to as
‘transfer pricing’. It is the pricing of goods and
services exchanged in intra corporate purchase
transactions.
266

267. Methods of Transfer Pricing
• Cost based Transfer pricing
• Market based Transfer pricing
• Negotiated Transfer pricing
• Dual pricing method
267

268. Target Costing
• Target Costing is a disciplined process for
determining and realizing a total cost at which
a proposed product with specified
functionality must be produced to generate
the desired profitability at its anticipated
selling price in the future.
268

269. Features of Target Costing
• It is market driven strategy and process
• It is calculated by subtracting the desired profit
margin from this target price.
• It is treated as an independent variable that must
be satisfied along with other customer
requirements.
• It is a disciplined process that uses data and
information in a logical series of steps to
determine and achieve a target cost for the
product.
269

270. Kaizen Costing
• Kaizen is a Japanese term meaning “Change
for the Better”. The concepts relates to wide
range of ideas; it involves making the work
environment more efficient and affective by
creating a team atmosphere, improving
everyday procedures, ensuring employee
satisfaction and making a job more fulfilling,
less tiring and safer.
270

271. Features
• Main focus on cost reduction not to obtain
more accurate product cost.
• Cost reduction is a team not an individual
responsibility.
• Work teams are responsible for generating
ideas to achieve cost reduction targets; they
have authority to make small scale
investments if these can be demonstrated to
have cost reduction paybacks.
271

272. Objectives
• Elimination of waste
• Quality control
• Just in time delivery
• Standardized work
• Use of efficient equipment
272

273. Difference between Kaizen Costing
and Standard Costing
Kaizen Costing Standard Costing
Cost reductions system concepts Cost control system concepts
Assume continuous improvement in
manufacturing
Assume current manufacturing conditions
Achieve cost reduction targets Meet cost performance standards
Cost reduction targets are set and applied
monthly
Standards are set annually or semi-
annually
Cost variance analysis involving target
kaizen costs and actual costs reduction
amounts
Cost variance analysis involving standard
costs and actual costs.
Investigate and respond when target
kaizen amounts are not attained
Investigate and respond when standards
are not met.
273

274. Activity Based Costing
• Activity based costing is a system focuses on
activities as the fundamental cost objects and
uses the costs of these activities as building
blocks for compiling the costs of other objects.
274

275. Features of ABC
• It increases the number of cost pools used to accumulate
overhead costs. The number of cost pools depends upon the
cost driving activities.
• It improves the traceability of the overhead costs, which
results in more accurate unit cost data for management.
• Identification of cost during activities and their causes not
only help in computation of more accurate cost of a product
but also eliminate non-value added activities would drive
down the cost of the product.
275

276. Core areas of ABC
• Cost Object
• Activities
– Support Activities
– Product Process Activities
• Cost Pool
• Cost Drivers
276

277. Steps of ABC
• Identify major activities
• Assigning cost to cost centers
• Selecting cost centers for allocating cost to cost directs
– Transaction Drivers
– Duration Cost Drivers
– Intensity Cost Drivers
• Allocating the cost of an activity to cost objects on the basis of
cost driver rates
• Identify activities and cost drivers.
277

278. Life Cycle Costing
• Life Cycle Costing (LCC) is an important
economic analysis used in the selection of
alternatives that impact both pending and
future costs. It compares initial investment
options and identifies the least cost
alternatives for a twenty year period.
278

279. Product Life Cycle Costing
• Each product has a life cycle. The life cycle of a
product vary from a few months to several years. For
example, in the case of fixed assets like machinery,
equipments, furniture & fixtures etc the life is more
than 100 years. Whereas in the case of electronic
devices, it was for few years only. Product life cycle
costing is a pattern of expenditure, sale level,
revenue and profit over the period from new idea
generation to the deletion of product from product
range.
279

280. Phases of PLC
• Introductory Phase
• Growth Phase
• Maturity Phase
• Decline Phase
280