Title of the course

Title of the course MANAGERIATACCOUNTING AND CONTROL [ABM-504]

Class, Year & Sem. MBA, I & II

Topic Management Accounting

Features of Management Accounting

Management Accounting Information and their use

Role of Management Accountancy

Unit I

Facultyi DEEPAK PAL & LAVEENA SHARMA

Institute Institute of Agribusiness Management, JNKVV

1 Disclaimer: The information contained in this note is for general guidance & collected from various direct and indirect

sources like websites, blogs, books, articles and open study sources. Author(s) make no representation for any legal

responsibility or any other aspect of information contained.

Management Accounting

Introduction :- The scope of Management Accounting is broader than the scope of cost accounting.

In cost accounting, as we have seen, the primary emphasis is on cost and it deals with collection,

analysis, relevance, interpretation and presentation for various problems of management. Management

Accounting is an accounting system which will help the Management to improve its efficiency. The

main thrust of Management Accounting is towards determining policy and formulating plans to achieve

desired objectives of management. It helps the Management in planning, controlling and analyzing the

performance of the organization in order to follow the path of continuous improvement. Management

Accounting utilizes the principle and practices of financial accounting and cost accounting in addition to

other modern management techniques for effective operation of a company. In fact there is an overlapping

in various areas of cost accounting and management accounting. However, the distinguishing features of

Management Accounting are given below.

Features of Management Accounting

The features of Management Accounting are given below.

1. The Management Accounting data are derived from both, the financial accounting and cost

accounting.

2. The main thrust in management accounting is towards determining policy and formulating plans to

achieve desired objectives of management.

3. Management Accounting makes corporate planning and strategy effective and meaningful.

4. It is concerned with short and long range planning and uses highly sophisticated techniques like

sensitivity analysis, probability techniques, decision tree, ratio analysis etc for planning, control and

evaluation.

5. It is futuristic in approach and predictive in nature.

6. Management Accounting system cannot be installed without proper cost accounting system.

7. Management Accounting systems generate various reports which are extremely useful from the

Management point of view.

Management Accounting Information and their use

In the above paragraphs, we have seen the utility of Management Accounting. One of the distinguishing

factors between the financial accounting and management accounting is that the management accounting

does not have a unified structure. The format in which it is prepared varies widely according to the

circumstances in each case and the purpose for which the information is being summarized. The

management accounting generates information, which is used for three different purposes. I] Measurement

II] Control and III] Decision making [Alternative choice problems] For each of these purposes, management

accounting generates vital information. The uses of information for each of the three purposes of

management accounting is explained below.

I. Measurement: For measurement of full costs, the management accounting system focuses on the

measurement of full costs. Full costs are the total costs required for producing goods or offering

services. These costs are divided into A] Direct costs and B] Indirect costs. Direct costs are identifiable

or traceable to the products or services offered while indirect costs are not traceable to the products or

services. Full cost accounting measures not only the total costs [direct plus indirect costs] required for

producing products or services but also the full costs required to run other activity like conducting a

research project or running a welfare scheme and so on. Thus full cost accounting is not restricted to

solely to measure the cost of manufacturing.

II. Control: An important aspect of the management accounting information is to provide information,

which can be used for ‘Control’. The management accounting system is structured in such a manner

that information is generated for each ‘Responsibility Center’. A responsibility center is an organization

unit headed by a manager who is responsible for its operations and performance. Management

accounting helps to prepare budget for each responsibility center and also facilitates comparison

between the budgeted and actual results. A report is prepared for each responsibility center, which

shows the budgeted and actual performance and also the difference between the two. This enables

the performance analysis of each responsibility center so that proper corrective action can be taken in

this respect.

III. Decision Making: Management accounting generates useful information for decision making.

Management has to take several decisions in the course of business. Some of the major decisions are,

Make or Buy, Accepting or rejecting of an Export Order, Working of second shift, Fixation of selling

price, Capital expenditure decisions, Increasing production capacity, Optimizing of Product Mix and

so on. For all these decisions, providing of information is necessary and the management accounting

generates this information, which enables the management to take such decisions.

Role of Management Accountancy

The role of management accounting and financial accounting is quite different from each other as they

have different goals altogether. Management Accounting measures, analyzes and reports financial and

non financial information that helps managers to take decisions to fulfill the goals of an organization.

Managers use management accounting information to choose, communicate and implement strategy. They

also use management accounting information to coordinate product design, production and marketing

decisions. Management accounting focuses on internal reporting. The following points highlight the role

played by Management Accounting in the business organization.

I. Implementing Strategy: Managers implement strategies by translating them into actions. Creating

value for customers is an important part of planning and implementation of strategies. Strategic

planning and implementation will include decisions regarding the design of products, services or

processes, research and development, production, marketing, distribution and customer services.

Each of this area is important for satisfying customers and keeping them satisfied. Management

accounting will help to track the costs of each of the activity mentioned above. The ultimate target

is to reduce costs in each category and to improve efficiency. Cost information also helps managers

make cost benefit analysis. For example, managers can find out that is it cheaper to buy products from

outside vendors or to do manufacturing in-house? Is it worthwhile to invest more resources in design

and manufacturing if it reduces costs in marketing and customer service?

II. Supply Chain Analysis: Companies can also implement strategy, cut costs and create value by

enhancing their supply chain. The term ‘Supply Chain’ describes the flow of goods, services and

information from the initial sources of materials and services to the delivery of products to customers

regardless of whether those activities occur in the same organization or in other organization.

Customers expect improved performance from companies through the supply chain. They expect

that the companies should perform all these activities in an efficient manner so as to reduce costs and

also maintain quality of the products and the products be available easily for them. This is no doubt a

daunting task and the management accounting plays a vital role in ensuring value for money for the

customers. Tools like standard costing and target costing can be used effectively for cost control and

cost reduction and thus ensure reasonable prices for customers. A system of budgets and budgetary

control will ensure continuous planning and monitoring various functions and thus provide for

introspection. Continuous improvement in these activities will help in creating value for customers.

III. Decision Making: One of the important functions of management is decision making. Management

Accounting helps in this crucial area by providing relevant information to the management.

Techniques like marginal costing helps to generate information, which will be useful for taking

decisions. Decisions include make or buy decisions, adding or dropping a product line, working of

additional shift, shut down or continue operations, capital expenditure decisions and so on. Decisions

based on information are expected to be more rational and objective rather than subjective.

IV. Performance Measurement: Management accounting helps immensely for the measurement of

performance of the organization. The main aspect of performance measurement is comparison

between the targets and actual. There are several tools and techniques like budgets and budgetary

control, standard costing and marginal costing, which are used in measuring the actual performance

against the target performance. This will facilitate introspection and corrective action can be taken for

further improving the performance.

Title of the course MANAGERIAL ACCOUNTING AND

CONTROL [ABM-504]


Topic TECHNIQUES OF FINANCIAL STATEMENT

ANALYSIS

Comparative Statement Analysis

Comparative Balance Sheet Analysis

Comparative Profit and Loss Account Analysis

FUNDS FLOW STATEMENT

CASH FLOW STATEMENT

Ratios analysis

Unit III



1 Disclaimer: The information contained in this note is for general guidance & collected from various direct and indirect sources like websites, blogs, books, articles and open study sources. Author(s) make no representation for any legal responsibility or any other aspect of information contained.

TECHNIQUES OF FINANCIAL STATEMENT ANALYSIS

Financial statement analysis is interpreted mainly to determine the financial and operational performance of the business concern. A number of methods or techniques are used to analyse the financial statement of the business concern. The following are the common methods or techniques, which are widely used by the business concern.

Fig. 2.3 Techniques of Financial Statement Analysis

1. Comparative Statement Analysis

A. Comparative Income Statement Analysis

B. Comparative Position Statement Analysis

Ratio Analysis

Comparative Statement

Trend Analysis

Common Size

Analysis

Funds Flow Statement

Cash Flow Statement

Techniques

2. Trend Analysis

3. Common Size Analysis

4. Fund Flow Statement

5. Cash Flow Statement

6. Ratio Analysis

Comparative Statement Analysis

Comparative statement analysis is an analysis of financial statement at different period of time. This statement helps to understand the comparative position of financial and

operational performance at different period of time.

Comparative financial statements again classified into two major parts such as comparative balance sheet analysis and comparative profit and loss account analysis.


Comparative balance sheet analysis concentrates only the balance sheet of the concern at different period of time. Under this analysis the balance sheets are compared with previous

year’s figures or one-year balance sheet figures are compared with other years. Comparative balance sheet analysis may be horizontal or vertical basis. This type of analysis helps to understand the real financial position of the concern as well as how the assets, liabilities

and capitals are placed during a particular period.

Exercise 1

The following are the balance sheets of Tamil Nadu Mercantile Bank Ltd., for the years 2003 and 2004 as on 31st March. Prepare a comparative balance sheet and discuss the operational performance of the business concern.

Balance Sheet of Tamil Nadu Mercantile Bank Limited

As on 31st March (Rs. in thousands)

Liabilities 2003

Rs.

2004

Rs.

Assets 2003

Rs.

2004

Rs.

Capital 2,845 2,845 Cash and Balance

with RBI

Balance with Banks

and Money at call &

and short notice

Investments

Advances

Fixed Assets

Other Assets

Reserve and 27,06,808 22,37,601

Surplus 39,66,009 47,65,406

Deposits 4,08,45,783 4,40,42,730

Borrowings 11,36,781 16,07,975

Other Liabilities 7,27,671 2,84,690 2,14,21,060 2,35,37,098

Provisions 16,74,165 17,99,197 1,95,99,764 2,11,29,869

4,93,996 5,36,442

18,58,064 18,35,883

4,72,16,473 5,08,94,868 4,72,16,473 5,08,94,868

Solution


Particulars

Year ending 31st March

Increased/

Decreased

(Amount)

Increased/

Decreased

(Percentage)

2003

Rs.

2004

Rs.

Rs.

Rs.

Assets

Current Assets

Cash and Balance with

RBI

Balance with Banks and

money at call and short notice

27,06,808

11,36,781

22,37,601

16,07,975

(+) 4,69,207

(–) 4,71,194

(+) 17.33

(–) 41.45

Total Current Assets 38,43,589 38,45,576 1987 0.052

Fixed Assets

Investments 2,14,21,060 2,35,37,098 (-) 21,16,038 (-) 9.88

Advances 1,95,99,764 2,11,39,869 (-) 15,40,105 (-) 7.86

Fixed Assets 4,93,996 5,36,442 (-) 42,446 (-) 8.59

Other Assets 18,58,064 18,35,883 (+) 22,181 (+) 1.19

Total Fixed Assets 4,33,72,884 4,70,49,292 (+) 36,76,408 8.48

Total Assets 4,72,16,473 5,08,94,868 36,78,395 7.79

Current Liabilities

Borrowings 7,27,671 2,84,690 (+) 4,42,981 60.88

Other Liability and

Provisions 16,74,165 17,99,197 (–) 1,25,032 7.47

Total Current Liability 24,01,836 20,83,887 3,17,949 13.24

Fixed Liability Capital 2,845 2,845 — —

Reserves surplus 39,66,009 47,65,406 (+) 7,99,397 20.16

Deposit 4,08,45,783 4,40,42,730 (+) 31,96,947 7.83

Total Fixed Liability 4,48,14,637 4,88,10,981 (+) 39,96,344 8.92

Total Liability 4,72,16,473 5,08,94,868 36,78,395 7.79

Comparative Profit and Loss Account Analysis

Another comparative financial statement analysis is comparative profit and loss account

analysis. Under this analysis, only profit and loss account is taken to compare with previous

year’s figure or compare within the statement. This analysis helps to understand the

operational performance of the business concern in a given period. It may be analyzed on

horizontal basis or vertical basis.

Trend Analysis

The financial statements may be analysed by computing trends of series of information. It

may be upward or downward directions which involve the percentage relationship of each

and every item of the statement with the common value of 100%. Trend analysis helps to

understand the trend relationship with various items, which appear in the financial

statements. These percentages may also be taken as index number showing relative changes

in the financial information resulting with the various period of time. In this analysis, only

major items are considered for calculating the trend percentage.

Exercise 2

Calculate the Trend Analysis from the following information of Tamilnadu Mercantile

Bank Ltd., taking 1999 as a base year and interpret them (in thousands).

Year Deposits Advances Profit

1999 2,05,59,498 97,14,728 3,50,311

2000 2,66,45,251 1,25,50,440 4,06,287

2001 3,19,80,696 1,58,83,495 5,04,020

2002 3,72,99,877 1,77,26,607 5,53,525

2003 4,08,45,783 1,95,99,764 6,37,634

2004 4,40,42,730 2,11,39,869 8,06,755

Solution

Trend Analysis (Base year 1999=100)

(Rs. in thousands)

Year

Deposits Advances Profits

Amount

Rs.

Trend

Percentage

Amount

Rs.

Trend

Percentage

Amount

Rs.

Trend

Percentage

1999 2,05,59,498 100.0 97,14,728 100.0 3,50,311 100.0

2000 2,66,45,251 129.6 1,25,50,440 129.2 4,06,287 115.9

2001 3,19,80,696 155.5 1,58,83,495 163.5 5,04,020 143.9

2002 3,72,99,877 181.4 1,77,26,607 182.5 5,53,525 150.0

2003 4,08,45,783 198.7 1,95,99,764 201.8 6,37,634 182.0

2004 4,40,42,730 214.2 2,11,39,869 217.6 8,06,755 230.3

Common Size Analysis

Another important financial statement analysis techniques are common size analysis in which figures reported are converted into percentage to some common base. In the balance sheet the total assets figures is assumed to be 100 and all figures are expressed as a percentage of this total. It is one of the simplest methods of financial statement analysis, which reflects the relationship of each and every item with the base value of 100%.

Exercise 3

Common size balance sheet of Tamilnadu Mercantile Bank Ltd., as on 31st March 2003

and 2004.

Particulars 31st March 2003 Amount

Percentage

31st March 2004 Amount

Percentage

Fixed Assets

Investments 2,14,21,060 45.37 2,35,37,098 46.25

Advances 1,95,99,764 41.51 2,11,39,869 41.54

Fixed Assets 4,93,996 1.05 5,36,442 1.05

Other Assets 18,58,064 3.94 18,35,883 3.61

Total Fixed Assets 4,33,72,884 91.86 4,70,49,292 94.44

Current Assets

Cash and Balance with

RBI 27,06,808 5.73 22,37,601 4.40

Balance with banks

and money at call

and short notice 11,36,781 2.41 16,07,975 3.20

Total Current Assets 38,43,589 8.14 38,45,576 7.60

Total Assets 4,72,16,473 100.00 5,08,94,868 100.00

Fixed Liabilities

Capital 2,845 0.01 2,845 0.01 Reserve and Surplus 39,66,009 8.40 47,65,406 9.36

Deposits 4,08,45,783 86.50 4,40,42,730 86.54

Total Fixed Liabilities 4,48,14,637 94.91 4,88,10,981 95.91

Current Liability

Borrowings 7,27,671 1.54 2,84,690 0.56

Other Liabilities

Provisions 16,74,165 3.55 17,99,197 3.53

Total Current Liability 24,01,836 5.09 20,83,887 4.09

Total Liabilities 4,72,16,473 100.00 5,08,94,868 100.00

FUNDS FLOW STATEMENT

Funds flow statement is one of the important tools, which is used in many ways. It helps to understand the changes in the financial position of a business enterprise between the

beginning and ending financial statement dates. It is also called as statement of sources and uses of funds.

Institute of Cost and Works Accounts of India, funds flow statement is defined as “a statement prospective or retrospective, setting out the sources and application of the funds

of an enterprise. The purpose of the statement is to indicate clearly the requirement of funds and how they are proposed to be raised and the efficient utilization and application of the same”.

CASH FLOW STATEMENT

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. It is the statement,

which involves only short-term financial position of the business concern. Cash flow

statement provides a summary of operating, investment and financing cash flows and

reconciles them with changes in its cash and cash equivalents such as marketable securities.

Institute of Chartered Accountants of India issued the Accounting Standard (AS-3) related

to the preparation of cash flow statement in 1998.

Difference Between Funds Flow and Cash Flow Statement

Funds Flow Statement Cash Flow Statement

1. Funds flow statement is the report on the

movement of funds or working capital

2. Funds flow statement explains how working

capital is raised and used during the particular

3. The main objective of fund flow statement is

to show the how the resources have been

balanced mobilized and used.

4. Funds flow statement indicates the results of

current financial management.

5. In a funds flow statement increase or decrease

in working capital is recorded.

6. In funds flow statement there is no opening

and closing balances.

1. Cash flow statement is the report showing

sources and uses of cash.

2. Cash flow statement explains the inflow and

out flow of cash during the particular period.

3. The main objective of the cash flow statement

is to show the causes of changes in cash

between two balance sheet dates.

4. Cash flow statement indicates the factors

contributing to the reduction of cash balance

in spite of increase in profit and vice-versa.

5. In a cash flow statement only cash receipt and

payments are recorded.

6. Cash flow statement starts with opening cash

balance and ends with closing cash balance.

Exercise 4

From the following balance sheet of A Company Ltd. you are required to prepare a schedule

of changes in working capital and statement of flow of funds.

Balance Sheet of A Company Ltd., as on 31st March

Liabilities 2004 2005 Assets 2004 2005

Share Capital 1,00,000 1,10,000 Land and Building 60,000 60,000

Profit and Loss a/c 20,000 23,000 Plant and Machinery 35,000 45,000

Loans — 10,000 Stock 20,000 25,000

Creditors 15,000 18,000 Debtors 18,000 28,000

Bills payable 5,000 4,000 Bills receivable 2,000 1,000

Cash 5,000 6,000

1,40,000 1,65,000 1,40,000 1,65,000

Solution

Schedule of Changes in Working Capital

Particulars 2004

Rs.

2005

Rs.

Incharge

Rs.

Decharge

Rs.

Current Assets

Stock 20,000 25,000 5,000 —

Debtors 18,000 28,000 10,000 —

Bills Receivable 2,000 1,000 — 1,000

Cash 5,000 6,000 1,000

A 45,000 60,000

Less Current Liabilities

Creditors 15,000 18,000 3,000

Bills Payable 5,000 4,000 1,000

B 20,000 22,000 17,000 4,000

A-B 25,000 38,000 — 13,000

Increase in W.C. 38,000 38,000 17,000 17,000

Fund Flow Statement

Sources Rs. Application Rs.

Issued Share Capital 10,000 Purchase of Plant and Machinery 10,000

Loan 10,000 Increase in Working Capital 13,000

Funds From Operations 3,000

23,000 23,000

Exercise 5

From the above example 4 prepare a Cash Flow Statement.

Solution

Cash Flow Statement

Inflow Rs. Outflow Rs.

Balance b/d 5,000 Purchase of plant 10,000

Issued Share Capital 10,000 Increase Current Assets

Loan 10,000 Stock

Cash Opening Profit 3,000 Decrease in Bills Payable 5,000

Decrease in Bills 1,000 Balance c/d 10,000

Receivable 3,000 1,000

Increase in Creditors 6,000

32,000 32,000

RATIO ANALYSIS

Ratio analysis is a commonly used tool of financial statement analysis. Ratio is a mathematical relationship between one number to another number. Ratio is used as an index for evaluating the financial performance of the business concern. An accounting ratio shows

the mathematical relationship between two figures, which have meaningful relation with each other. Ratio can be classified into various types. Classification from the point of view of financial management is as follows:

● Liquidity Ratio

● Activity Ratio

● Solvency Ratio

● Profitability Ratio

Liquidity Ratio

It is also called as short-term ratio. This ratio helps to understand the liquidity in a business which is the potential ability to meet current obligations. This ratio expresses the relationship between current assets and current assets of the business concern during a particular period. The following are the major liquidity ratio:

S. No. Ratio Formula Significant Ratio

1.

Current Ratio

Current Assets

Current Liability

2 : 1

2.

Quick Ratio

Quick Assets

Quick / Current Liability

1 : 1

Activity Ratio

It is also called as turnover ratio. This ratio measures the efficiency of the current assets and liabilities in the business concern during a particular period. This ratio is helpful to understand the performance of the business concern. Some of the activity ratios are given below:

S. No. Ratio Formula

1.

Stock Turnover Ratio

Costof Sales

Average Inventory

2.

Debtors Turnover Ratio

Credit Sales

Average Debtors

3.

Creditors Turnover Ratio

Credit Purchase

AverageCredit

4.

Working Capital Turnover Ratio

Sales

Net WorkingCapital

Solvency Ratio

It is also called as leverage ratio, which measures the long-term obligation of the business concern. This ratio helps to understand, how the long-term funds are used in the business concern. Some of the solvency ratios are given below:

S. No Ratio Formula

1.

Debt-Equity Ratio External Equity

Internal Equity

2.

Proprietary Ratio

Shareholder / Shareholder ' s Fund

Total Assets

3.

Interest Coverage Ratio

EBIT

Fixed Interest Charges

Profitability Ratio

Profitability ratio helps to measure the profitability position of the business concern. Some of the major profitability ratios are given below.

S. No Ratio Formula

1.

Gross Profit Ratio

Gross Profit 100

Net Sales

2.

Net Profit Ratio

Net Profit after tax 100

Net Sales

3.

Operating Profit Ratio Operating Net Profit

100 Sales

4.

Return in Investment

Net Profit after tax 100

Shareholder Fund

Exercise 6

From the following balance sheet of Mr. Arvind Industries Ltd., as 31st March 2007.

Liabilities Rs. Assets Rs.

Equity Share Capital 10,000 Fixed assets (less

depreciation Rs. 10,000)

Current Assets:

Cash

Investments (10%)

Sundry debtors Stock

26,000

7% Preference Share Capital 2,000

Reserves and Surplus 8,000

6% Mortgage Debentures 14,000 1,000

Current Liabilities: 3,000

Creditors 1,200 4,000

Bills payable 2,000 6,000

Outstanding expenses 200

Tax Provision 2,600

40,000 40,000

Other information:

1. Net sales Rs. 60,000

2. Cost of goods sold Rs. 51,600

3. Net income before tax Rs. 4,000

4. Net income after tax Rs. 2,000

Calculate appropriate ratios.

Solution

Short-term solvency ratios

Current Ratio = Current Assets

14,000 2.33 : 1

Current Liability 6,000

Liquid Ratio = Liquid Ratio

8,000

1.33 : 1 Current Liability 6,000

Long-term solvency ratios

Proprietary ratio = Proprietors funds

20,000

0.5 : 1

Total Assets 40,000

Proprietor’s fund or Shareholder’s fund=Equity share capital+Preference share

capital+Reserve and surplus

= 10,000+2,000+8,000=20,000

Debt-Equity ratio = External equities

20,000

1:1

Internal equities 20,000

Interest coverage ratio = EBIT

= 4,000+840

=5.7times Fixed interest charges 840

Fixed interest charges = 6% on debentures of Rs.14,000

= Rs. 840

Activity Ratio

Stock Turnover Ratio = Cost of Sales

= 51,600

=8.6 times Average Inventory 6,000

As there is no opening stock, closing stock is taken as average stock.

Debtors Turnover Ratio = Credit Sales

= 60,000

=10 times Average Debtors 6,000

In the absence of credit sales and opening debtors, total sales is considered as credit

sales and closing debtors as average debtors.

Creditors turn over ratio = Credit Purchases

43,200

36 times Average Creditors 1,200

In absence of purchases, cost of goods sold – gross profit treated as credit purchases and in the absence of opening creditors, closing creditors are treated as average creditors.

Working Capital Turnover Ratio = Sales

60,000 7.5times

Profitability Ratios

Gross profit ratio =

Net Working Capital 8,000

Gross Profit

100= 8,400

100=14%

Sales 60,000

Net profit ratio =

Net Profit 100=

2,000 100=3.33%

Sales 60,000

In the absence of non-operating income, operating profit ratio is equal to net profit ratio.

Return of Investment =

Net Profit after Tax 100=

2,000 100=10%

Shareholders Fund 20,000

MODEL QUESTIONS

1. What is financial statement?

2. What is financial statement analysis?

3. Discuss various types of financial statement analysis.

4. Explain various methods of financial statement analysis.

5. What are the differences between fund flow and cash flow?

6. What is ratio analysis? Explain its types.



Topic COST ACCOUNTING

-ACCOUNTING vs FINANCIAL ACCOUNTING

-Scope of Accounting

-Nature of Accounting

-Objectives of Cost Accounting

-Essentials of a good Costing system

-Important terms

-Cost vs Profit Centre

- Costing type

Unit IV

Faculty DEEPAK PAL & LAVEENA SHARMA

Institution Institute of Agribusiness Management, JNKVV

[i] Disclaimer: The information contained in this note is for general guidance & collected from various direct and indirect sources like websites, blogs, books, articles and open studysources. Author(s) make no representation for any legal responsibility or any other aspect of information contained.

COST ACCOUNTING

ACCOUNTING vs

FINANCIAL ACCOUNTING?

• In traditional accounting, the profit and loss is derived by deducting expensesfrom income whereas in cost accounting the motive is to be cost effective byreducing costs of process, production or project.

• Financial accounting views an organization in entirety whereas cost accountingsegregates the organization into various processes, projects or productionunits.

• Financial accounting is used to present the position of the organization to itsstakeholders whereas cost accounting is used for internal review of costs.

• Financial accounting is uniform across various businesses, however, costaccounting methods vary based on the type of business.

Scope of Accounting:

• Accounting has got a very wide scope and area of application.

• Not confined to the business world alone, but spread over in all the spheres ofthe society and in all professions.

• Now-a-days, in any social institution or professional activity, whether that isprofit earning or not, financial transactions must take place. So there arisesthe need for recording and summarizing these transactions when they occurand the necessity of finding out the net result of the same after the expiry of acertain fixed period.

• Need for interpretation and communication of those information to theappropriate persons.

• Only accounting use can help overcome these problems.

• In the modern world, accounting system is practiced no only in all thebusiness institutions but also in many non-trading institutions like Schools,Colleges, Hospitals, Charitable Trust Clubs, Co-operative Society etc.and alsoGovernment and Local Self-Government in the form of Municipality,Panchayat.

• The professional persons like Medical practitioners, practicing Lawyers,Chartered Accountants etc. also adopt some suitable types of accountingmethods. As a matter of fact, accounting methods are used by all who areinvolved in a series of financial transactions.

• The scope of accounting as it was in earlier days has undergone lots ofchanges in recent times. As accounting is a dynamic subject, its scope andarea of operation have been always increasing keeping pace with thechanges in socio-economic changes. As a result of continuous research inthis field the new areas of application of accounting principles and policiesare emerged.– National accounting, human resources accounting and social Accounting are examples of

the new areas of application of accounting systems.

Nature of Accounting1. Accounting is a process: A process refers to the method of performing any

specific job step by step according to the objectives, or target.– Accounting is identified as a process as it performs the specific task of collecting,

processing and communicating financial information. In doing so, it follows some definitesteps like collection of data recording, classification summarization, finalization andreporting.

2. Accounting is an art: Accounting is an art of recording, classifying,summarizing and finalizing the financial data.

The word ‘art’ refers to the way of performing something. It is abehavioral knowledge involving certain creativity and skill that may help usto attain some specific objectives. Accounting is a systematic methodconsisting of definite techniques and its proper application requires appliedskill and expertise. So, by nature accounting is an art.

3. Accounting is means and not an end: Accounting finds out the financial resultsand position of an entity and the same time,

-it communicates this information to its users. The users then take theirown decisions on the basis of such information. So, it can be said that merekeeping of accounts can be the primary objective of any person or entity.

On the other hand, the main objective may be identified as takingdecisions on the basis of financial information supplied by accounting. Thus,accounting itself is not an objective, it helps attaining a specific objective. So itis said the accounting is ‘a means to an end’ and it is not ‘an end in itself.’

4. Accounting deals with financial information and transactions; Accountingrecords the financial transactions and date after classifying the same andfinalizes their result for a definite period for conveying them to their users. So,from starting to the end, at every stage, accounting deals with financialinformation. Only financial information is its subject matter. It does not dealwith non-monetary information of non-financial aspect.

5. Accounting is an information system: Accounting is recognized andcharacterized as a storehouse of information. As a service function, it collectsprocesses and communicates financial information of any entity. This disciplineof knowledge has been evolved out to meet the need of financial informationrequired by different interested groups.

Objectives of Cost Accounting

• Determination of Cost: To accumulate, allocate and ascertain cost foreach cost object is the primary objective of the cost accounting.

• Basis for fixing selling prices: As the prices of the cost object, i.e. theproduct is determined by the external factors such as– market demand for the product,– competitor’s price, etc.

However, the basis for ascertaining the price is the total cost of productionand the cost accounting techniques helps in determining it. Along with that,it acts as a guide for estimating prices for tender and quotations.

• Cost Control: Another important objective of the cost accountingsystem is to control the costs. It keeps a check on the expenses madeby the company, against the set standards and the deviations arerecorded and reported continuously.

• Cost Reduction: The management works to further reduce the cost toincrease the profitability of the company. Cost reduction implies the actualand permanent reduction in the cost of production without compromisingwith the quality and the suitability of its desired use.

• Determination of Closing Inventory: To ascertain the value of closinginventory at the end of the period for the preparation of financialstatements of the concern.

• Assisting Management: To report to the management about theinefficiencies of the workers and eliminates wastes like material, expenses,equipment, tools and so forth. It also ensures optimum utilization ofresources of the organization by making sure that no machines are left idle,the workers get incentives for their performance, proper utilization of by-products and so forth.

• Economies of Production: To reflect different sources of economies of scale,concerning the process, type of equipment, inputs used, the outputgenerated etc.

ELEMENTS OF COST IN GENERALFor a standard manufacturing unit the various costs involved can be

segregated into the following :MaterialLabourOther expenses

These can be further segregated into the following:DirectIndirect

IllustrationSay a toy manufacturing unit procures plastic as a raw material. The

cost of plastic is direct material cost. The costs incurred in thepacking and transportation of the same is the indirect materialcost. Similarly, the labour cost for the production of toys is thedirect labour cost whereas the salary of the production supervisorwill be indirect labour cost.

Essentials of a good Costing system :-For availing of maximum benefits, a good costing system

should possess the following characteristics.

A. Costing system adopted in any organization should be suitable to its nature and size of the

business and its information needs.

B. A costing system should be such that it is economical and the benefits derived from the same

should be more than the cost of operating of the same.

C. Costing system should be simple to operate and understand. Unnecessary complications should be

avoided.

D. Costing system should ensure proper system of accounting for material, labor and overheads and

there should be proper classifi cation made at the time of recording of the transaction itself.

E. Before designing a costing system, need and objectives of the system should be identified.

F. The costing system should ensure that the final aim of ascertaining of cost as accurately possible

should be achieved.

Important termsA. Cost Center :-

• Cost Center is defined as, ‘a production or service, function, activity or item ofequipment whose costs may be attributed to cost units. A cost center is thesmallest organizational sub unit for which separate cost allocation is attempted’.• To put in simple words, a cost center is nothing but a location, person or itemof equipment for which cost may be ascertained and used for the purpose ofcost control. For example, a production department, stores department, salesdepartment can be cost centers.• Similarly, an item of equipment like a lathe, fork-lift, truck or delivery vehiclecan be cost center, a person like sales manager can be a cost center.• The main object of identifying a cost center is to facilitate collection of costs sothat further accounting will be easy. A cost center can be either personal orimpersonal,• similarly it can be a production cost center or service cost center. A cost centerin which a specific process or a continuous sequence of operations is carried out

is known as Process Cost Center.

B. Profit Center :-

Profit Center is defined as, ‘a segment of the business entity by whichboth revenues are received and expenses are incurred orcontrolled’.

• A profit center is any sub unit of an organization to which bothrevenues and costs are assigned.

• As explained above, cost center is an activity to which only costs areassigned but a profit center is one where costs and revenues areassigned so that profit can be ascertained.

• Such revenues and expenditure are being used to evaluatesegmental performance as well as managerial performance. Adivision of an organization may be called as profit center.

• The performance of profit center is evaluated in terms of the factwhether the center has achieved its budgeted profits.

• Thus the profit center concept is used for evaluation ofperformance.

Cost vs Profit Centre

• Cost centers and profit centers are bothreasons for which a business becomessuccessful.

• A cost center is a sub-unit of a company whichtakes care of the costs of that unit.

• On the other hand, a profit center is a subunitof a company which is responsible forrevenues, profits, and costs.

Costing Systems :-

A. Historical Costing :-

B. Absorption Costing

C. Marginal Costing :-

D. Uniform Costing :-

A. Historical Costing :-

In this system, costs are ascertained only after they areincurred and that is why it is called as historicalcosting system. For example, costs incurred in themonth of April, 2007 may be ascertained andcollected in the month of May. Such type of costingsystem is extremely useful for conducting post-mortem examination of costs, i.e. analysis of the costsincurred in the past.

Historical costing system may not be useful from costcontrol point of view but it certainly indicates a trendin the behavior of costs and is useful for estimation ofcosts in future.

Absorption Costing :-

In this type of costing system, costs are absorbedin the product units irrespective of theirnature.

In other words, all fixed and variable costs areabsorbed in the products. It is based on theprinciple that costs should be charged orabsorbed to whatever is being costed,whether it is a cost unit, cost center.

Marginal Costing :-

In Marginal Costing, only variable costs arecharged to the products and fixed costs arewritten off to the Costing Profit and Loss A/c.

The principle followed in this case is that sincefixed costs are largely period costs, theyshould not enter into the production units.

Naturally, the fixed costs will not enter into theinventories and they will be valued at marginalcosts only.

Uniform Costing :-

This is not a distinct method of costing but is theadoption of identical costing principles andprocedures by several units of the sameindustry or by several undertakings by mutualagreement. Uniform costing facilitates validcomparisons between organizations and helpsin eliminating inefficiencies.

Classification of Cost

A. Classification according to elements :-B. Classification according to nature :-C. Classification according to behaviorD. Classification according to functionsE. Classification according to timeF. Classification of costs for Management decision making

A. Classification according to elements :-

Costs can be classified according to the elements. There are three elements of costing, viz. material, labor and expenses.

Total cost of production/services can be divided into the three elements to find out the contribution of each element in the total costs.

B. Classification according to nature :-

As per this classification, costs can be classified intoDirect and Indirect.

Direct costs are the costs which are identifiable withthe product unit or cost center while indirect costsare not identifiable with the product unit or costcenter and hence they are to be allocated,apportioned and then absorb in the productionunits.

All elements of costs like material, labor and expensescan be classified into direct and indirect.

They are mentioned in next slide

i. Direct and Indirect Material :-

Direct material is the material which is identifiable withthe product. For example, in a cup of tea, quantityof milk consumed can be identified, quantity ofglass in a glass bottle can be identified and so thesewill be direct materials for these products.

Indirect material cannot be identified with the product,for example lubricants, fuel, oil, cotton wastes etccannot be identified with a given unit of productand hence these are the examples of indirectmaterials.

ii. Direct and Indirect Labor :-

Direct labor can be identified with a given unit ofproduct, for example, when wages are paid accordingto the piece rate, wages per unit can be identified.Similarly wages paid to workers who are directlyengaged in the production can also be identified andhence they are direct wages.

On the other hand, wages paid to workers likesweepers, gardeners, maintenance workers etc areindirect wages as they cannot be identified with thegiven unit of production

iii. Direct and Indirect Expenses :-Direct expenses refers to expenses that are specifically

incurred and charged for specific or particular job, process,service, cost center or cost unit. These expenses are alsocalled as chargeable expenses. Examples of these expensesare cost of drawing, design and layout, royalties payable onuse of patents, copyrights etc, consultation fees paid toarchitects, surveyors etc.

Indirect expenses on the other hand cannot be traced tospecific product, job, process, service or cost center or costunit. Several examples of indirect expenses can be givenlike insurance, electricity, rent, salaries, advertising etc.

It should be noted that the total of direct expenses is known as ‘Prime Cost’ while the total of all indirect expenses is known as ‘Overheads’.

• C. Classification according to behavior :-

i. Fixed Costs :- Out of the total costs, some costs remain fixedirrespective of changes in the production volume. Thesecosts are called as fixed costs.

The feature of these costs is that the total costs remain samewhile per unit fixed cost is always variable.

Examples of these costs are salaries, insurance, rent, etc.

ii. Variable Costs :-

These costs are variable in nature, i.e. they change according to the volume ofproduction. Their variability is in the same proportion to the production.

For example, if the production units are 2,000 and the variable cost is Rs. 5per unit, the total variable cost will be Rs. 10,000, if the production unitsare increased to 5,000 units, the total variable costs will be Rs. 25,000, i.e.the increase is exactly in the same proportion of the production.

Another feature of the variable cost is that per unit variable cost remainssame while the total variable costs will vary. In the example given above,the per unit variable cost remains Rs. 2 per unit while total variable costschange.

Examples of variable costs are direct materials, direct labor etc.

iii. Semi-variable Costs :-

Certain costs are partly fixed and partly variable. Inother words, they contain the features of both typesof costs. These costs are neither totally fixed nortotally variable. Maintenance costs, supervisory costsetc are examples of semi-variable costs. These costsare also called as ‘stepped costs’.

D. Classification according to functions :-

i. Production Costs :- All costs incurred for production of goods are known as production costs.

ii. Administrative Costs :- Costs incurred for administration are known as administrative costs.

Examples of these costs are office salaries, printing and stationery, office telephone, office rent, office insurance etc.

iii. Selling and Distribution Costs :- All costs incurred forprocuring an order are called as selling costs while all costsincurred for execution of order are distribution costs.

Market research expenses, advertising, sales staff salary, salespromotion expenses are some of the examples of sellingcosts.

Transportation expenses incurred on sales, warehouse rent etcare examples of distribution costs.

iv. Research and Development Costs :- In the modern days,research and development has become one of the importantfunctions of a business organization. Expenditure incurred forthis function can be classified as Research and DevelopmentCosts.

E. Classification according to time

I. Historical Costs :-

These are the costs which are incurred in the past, i.e. inthe past year, past month or even in the last weekor yesterday. The historical costs are ascertainedafter the period is over.

In other words it becomes a post-mortem analysis ofwhat has happened in the past.

Though historical costs have limited importance, stillthey can be used for estimating the trends of thefuture, i.e. they can be effectively used forpredicting the future costs.

II. Predetermined Cost :-

These costs relating to the product are computed in advance ofproduction, on the basis of a specification of all the factors affectingcost and cost data.

Pre determined costs may be either standard or estimated. StandardCost is a predetermined calculation of how much cost should beunder specific working conditions.

It is based on technical studies regarding material, labor and expenses.The main purpose of standard Financial Accounting, Cost Accounting

and Management Accounting cost is to have some kind ofbenchmark for comparing the actual performance with thestandards.

On the other hand, estimated costs are predetermined costs based onpast performance and adjusted to the anticipated changes. It canbe used in any business situation or decision making which doesnot require accurate cost.

F. Classification of costs for Management decision making

One of the important function of costaccounting is to present information to theManagement for the purpose of decisionmaking.

For decision making certain types of costs arerelevant. Classification of costs based on thecriteria of decision making can be done in thecoming manner………..

I. Marginal Cost :- Marginal cost is the change in theaggregate costs due to change in the volume ofoutput by one unit.

For example, suppose a manufacturing companyproduces 10,000 units and the aggregate costs areRs. 25,000, if 10,001 units are produced theaggregate costs may be Rs. 25,020 which meansthat the marginal cost is Rs. 20.

Marginal cost is also termed as variable cost and henceper unit marginal cost is always same, i.e. per unitmarginal cost is always fixed.

Marginal cost can be effectively used for decisionmaking in various areas.

II. Differential Costs :-

Differential costs are also known as incremental cost.This cost is the difference in total cost that will arisefrom the selection of one alternative to the other.

In other words, it is an added cost of a change in thelevel of activity. This type of analysis is useful fortaking various decisions like change in the level ofactivity, adding or dropping a product, change inproduct mix, make or buy decisions, accepting anexport offer and so on.

III. Opportunity Costs :-

It is the value of benefit sacrificed in favor of analternative course of action. It is the maximumamount that could be obtained at any given point oftime if a resource was sold or put to the mostvaluable alternative use that would be practicable.

Opportunity cost of goods or services is measured interms of revenue which could have been earned byemploying that goods or services in some otheralternative uses.

IV. Relevant Cost :-

The relevant cost is a cost which is relevant in various decisionsof management. Decision making involves consideration ofseveral alternative courses of action. In this process, whatevercosts are relevant are to be taken into consideration.

In other words, costs which are going to be affected matter themost and these costs are called as relevant costs. Relevantcost is a future cost which is different for differentalternatives.

It can also be defined as any cost which is affected by thedecision on hand. Thus in decision making relevant costs playa vital role.

V. Replacement Cost :-

This cost is the cost at which existing items of material or fixedassets can be replaced. Thus this is the cost of replacingexisting assets at present or at a future date.

VI. Abnormal Costs :-

It is an unusual or a typical cost whose occurrence isusually not regular and is unexpected.

This cost arises due to some abnormal situation ofproduction.

Abnormal cost arises due to idle time, may be due tosome unexpected heavy breakdown of machinery.They are not taken into consideration whilecomputing cost of production or for decision making.

VII. Controllable Costs :-

In cost accounting, cost control and cost reduction areextremely important.

In fact, in the competitive environment, cost control andreduction are the key words. Hence it is essential toidentify the controllable and uncontrollable costs.

Controllable costs are those which can be controlled orinfluenced by a conscious management action.

For example, costs like telephone, printing stationery etccan be controlled while costs like salaries etc cannot becontrolled at least in the short run.

Generally, direct costs are controllable whileuncontrollable costs are beyond the control of anindividual in a given period of time.

VIII. Shutdown Cost :-

These costs are the costs which are incurred if theoperations are shut down and they will disappear ifthe operations are continued.

Examples of these costs are costs of sheltering theplant and machinery and construction of sheds forstoring exposed property.

Computation of shutdown costs is extremely importantfor taking a decision of continuing or shutting downoperations

IX. Capacity Cost :-

These costs are normally fixed costs. The cost incurred by acompany for providing production, administration and sellingand distribution capabilities in order to perform variousfunctions.

Capacity costs include the costs of plant, machinery and buildingfor production, warehouses and vehicles for distribution andkey personnel for administration.

These costs are in the nature of long-term costs and are incurredas a result of planning decisions.

X. Urgent Costs :-

These costs are those which must be incurred in order tocontinue operations of the firm.

For example, cost of material and labor must be incurred ifproduction is to take place.

Title of the courseMANAGERIATACCOUNTING AND

CONTROL [ABM-504]


Topic Costing Methods

Unit IV


InstitutionInstitute of Agribusiness Management,

JNKVV


Costing Methods Introduction• The term ‘costing’ refers to the techniques and processes of determining costs

of a product manufactured or services rendered.

• The first stage in cost accounting is to ascertain the cost of the product offeredor the services provided.

• In order to do the same, it is necessary to follow a particular method ofascertaining the cost.

• The methods of costing are applied in various business units to ascertain thecost of product or service offered.

• Different methods of costing are required to be used in different types ofbusinesses.– For example, costing methods used in a manufacturing business will differ from the

methods used in a business that is offering services. Even in a manufacturing business,some business units may have production in a continuous process, i.e. output of a processis an input of the subsequent process and so on, while in some businesses production isdone according to the requirements of customers and hence each job is different fromthe other one.

• Different methods of costing are used to suit these diverse requirements.

There are two principle methods of costing. These methodsare as follows

I] Job Costing

II] Process Costing

Other methods of costing are the variations of these twoprinciple methods. The variations of these methods ofcosting are as follows.

I]Job Costing: Batch Costing, Contract Costing, Multiple Costing.

II]Process Costing: Unit or Single Output Costing, Operating Costing,

Operation Costing

I] Job Costing: *****

• This method of costing is used in Job Order Industries where theproduction is as per the requirements of the customer.

• In Job Order industries, the production is not on continuous basis,rather it is only when order from customers is received and that tooas per the specifications of the customers.

• Consequently, each job can be different from the other one.• Method used in such type of business organizations is the Job

Costing or Job Order Costing.• The objective of this method of costing is to work out the cost of

each job by preparing the Job Cost Sheet.• A job may be a product, unit, batch, sales order, project, contract,

service, specific program or any other cost objective that isdistinguishable clearly and unique in terms of materials and otherservices used.

• The cost of completed job will be the materials used for the job, thedirect labor employed for the same and the production overheadsand other overheads if any charged to the job.

The following are the features of job costing.****

• It is a specific order costing

• A job is carried out or a product is produced is produced tomeet the specific requirements of the order

• Job costing enables a business to ascertain the cost of a job onthe basis of which quotation for the job may be given.

• While computing the cost, direct costs are charged to the jobdirectly as they are traceable to the job. Indirect expenses i.e.overheads are charged to the job on some suitable basis.

• Each job completed may be different from other jobs andhence it is difficult to have standardization of controls andtherefore more detailed supervision and control is necessary.

• At the end of the accounting period, work in progress may ormay not exist.

Methodology used in Job Costing*****

The objective of job costing is to ascertain the cost of a job that is producedas per the requirements of the customers. Hence it is necessary to identifythe costs associated with the job and present it in the form of job costsheet for showing various types of costs. Various costs are recorded in thefollowing manner:

Direct Material Costs

Direct Labor Cost

Direct Expenses

Overheads:

Work in Progress:

Direct Material Costs: • Material used during the production process of a job and identified with

the job is the direct material. The cost of such material consumed is thedirect material cost.

• Direct material cost is identifiable with the job and is charged directly. Thesource document for ascertaining this cost is the material requisition slipfrom which the quantity of material consumed can be worked out.

• Cost of the same can be worked out according to any method of pricing ofthe issues like first in first out [FIFO], last in first out [LIFO] or averagemethod as per the policy of the organization.

• The actual material cost can be compared with standard cost to find outany variations between the two. However, as each job may be differentfrom the other, standardization is difficult but efforts can be made for thesame.

Direct Labor Cost:

• This cost is also identifiable with a particular job and can beworked out with the help of ‘Job Time Tickets’ which is a recordof time spent by a worker on a particular job.

• The ‘job time ticket’ has the record of starting time andcompletion time of the job and the time required for the jobcan be worked out easily from the same.

• Calculation of wages can be done by multiplying the time spentby the hourly rate. Here also standards can be set for the timeas well as the rate so that comparison between the standardcost and actual cost can be very useful.

Direct Expenses:Direct expenses are chargeable directly to the concerned job. The invoices or

any other document can be marked with the number of job and thus theamount of direct expenses can be ascertained.

Overheads:• This is really a challenging task as the overheads are all indirect expenses

incurred for the job. Because of their nature, overheads cannot beidentified with the job and so they are apportioned to a particular job onsome suitable basis.

• Pre determined rates of absorption of overheads are generally used forcharging the overheads. This is done on the basis of the budgeted data. Ifthe predetermined rates are used, under/over absorption of overheads isinevitable and hence rectification of the same becomes necessary.

Work in Progress:

• On the completion of a job, the total cost is worked out by addingthe overhead expenses in the direct cost.

• In other word, the overheads are added to the prime cost. The costsheet is then marked as ‘completed’ and proper entries are made inthe finished goods ledger. If a job remains incomplete at the end ofan accounting period, the total cost incurred on the same becomesthe cost of work in progress.

The work in progress at the end of the accounting period becomes-The closing work in progress and

-The same becomes the opening work in progress at thebeginning of the next accounting period.

• A separate account for work in progress is maintained.

Advantages of Job Costing• Accurate information is available regarding the cost of the job

completed and the profits generated from the same.• Proper records are maintained regarding the material, labor and

overheads so that a costing system is built up• Useful cost data is generated from the point of view of

management for proper control and analysis.• Performance analysis with other jobs is possible by comparing the

data of various jobs. However it should be remembered that eachjob completed may be different from the other.

• If standard costing system is in use, the actual cost of job can becompared with the standard to find out any deviation between thetwo.

• Some jobs are priced on the basis of cost plus basis. In such cases, aprofit margin is added in the cost of the job. In such situation, acustomer will be willing to pay the price if the cost data is reliable.Job costing helps in maintaining this reliability and the data madeavailable becomes credible.

Limitations of Job Costing

These are as follows.• It is said that it is too time consuming and requires

detailed record keeping. This makes the method moreexpensive.

• Record keeping for different jobs may provecomplicated.

• Inefficiencies of the organization may be charged to ajob though it may not be responsible for the same.

In spite of the above limitations, it can be said that job costing is an extremelyuseful method for computation of the cost of a job. The limitation of timeconsuming can be removed by computerization and this can also reducethe complexity of the record keeping.

II] Batch Costing:• In the job costing, we have seen that the production is as per the orders of the

customers and according to the specifications mentioned by them.

• On the other hand, batch costing is used where units of a product are manufactured in

batches and used in the assembly of the final product.

– Thus components of products like television, radio sets, air conditioners and other consumer goods are

manufactured in batches to maintain uniformity in all respects.

– It is not possible here to manufacture as per the requirements of customers and hence rather than

manufacturing a single unit, several units of the component are manufactured.

– For example, rather than manufacturing a single unit, it will be always beneficial to manufacture say, 75, 000

units of the component as it will reduce the cost of production substantially and also bring standardization

in the quality and other aspects of the product.

• The finished units are held in stock and normal inventory control techniques are used for

controlling the inventory. Batch number is given to each batch manufactured and

accordingly the cost is worked out.

• Costing procedure in batch costing is more or less similar to the job costing in the sense

that cost is worked out for each batch rather than job.

Direct costs like direct materials, direct labor and direct expenses are charged directly to the job as they are traceable to the job. The source documents used for them are material requisitions, labor records and records pertaining to the direct expenses. Indirect costs, i.e. overheads are allocated or apportioned to the batch on some suitable basis. Thus a batch cost sheet is prepared to show the total cost of the batch.

One of the important aspects of batch type production is to decide the batch size.

Actually the determination of appropriate batch size of the production has conflicting views. Ifproduction is produced in large quantities, the impact of the setting up cost will be lower as thesetting up cost is fixed per batch. But on the other hand if the production quantity is large, theinventory carrying cost will be high as more inventory will have to be carried over in the store.The carrying cost of the inventory includes cost of storage, risk of pilferage, spoilage,obsolescence and interest on the investments blocked in the inventories. Therefore the size ofthe batch should not be either too small or too large. On the basis of a trade off between largesize and small size, an appropriate size of the batch should be decided. This batch size is known asEconomic Batch Quantity that is similar to the concept of Economic Order Quantity. This quantityis determined with the help of the following formula.

Economic Batch Quantity = 2AS/C

Where A = Annual requirements of the product

S = Setting up cost per batch

C = Carrying cost per unit of inventory per annum.

III] Contract Costing:Contract Costing is a method used in construction industry to find out the

cost and profit of a particular construction assignment.

The principles of job costing are also applicable in contract costing. In factContract Costing can be termed as an extension of Job Costing as eachcontract is nothing but a job completed.

Contract Costing is used by concerns like construction firms, civil engineeringcontractors, and engineering firms.

One of the important features of contract costing is that most of the expensescan be traced to a particular contract. Those expenses that cannot betraced to a particular contract are apportioned to the contract on somesuitable basis. The cost computation in case of a contract is done on thefollowing basis.

• Material Cost

• Labor Cost

• Expenses:

• Plant and Machinery:

A. Material Cost: • Direct Material required for a particular contract is

debited to the Contract Account.• There may be some quantity of material which is

returned back to the store. In such cases, materialreturned note is prepared and is either credited to theContract Account or deducted from the materialdebited to the Contract Account.

• Similar treatment is given to the material transferredfrom one contract to another one. Material TransferNote is prepared to record these transactions oftransfer.

• Material remaining at the site at the end of a particularaccounting period is shown as closing stock aftervaluation of the same and carried forward to the nextperiod.

B. Labor Cost:

Wages paid to the workers engaged on a particularcontract should be charged to that contractirrespective of the work performed by them. Ifthere are common workers on more than onecontract and/or if the workers are transferredfrom one contract to the other contract, timesheets must be maintained and wages may bedistributed on the basis of time spent on eachcontract. Some of the workers may be working inthe central office or central stores, their wagescan be apportioned to a particular contract onsuitable basis like time spent etc.

C. Expenses:

All expenses incurred for a particular contract should be chargedto that contract. In case of any indirect expenses incurred forthe organization as a whole, they should be charged to thecontract on some suitable basis. Direct expenses can becharged directly to the contract.

D. Plant and Machinery:

Depreciation on the plant and machinery used for the contract is to be chargedto the contract account. The depreciation may be charged on any of thefollowing basis.

• If a plant is specially purchased for a particular contract and is expected tobe used for the contract for long time, thus being exhausted at site, thetotal cost of the plant will be debited to the contract account.– After the completion of the contract, if it is no longer required, it will be

sold at the site itself and the sale proceeds are credited to the contractaccount.

– If it is not sold, the contract is credited with the depreciated [revaluedamount value].

– Thus the amount of depreciation is debited to the contract account. Themain drawback of this method is that the debit side of the contractaccount is unnecessarily inflated with the cost of the plant value andthus the cost of contract is shown very high.

– For removing this drawback, the difference between the original cost atthe commencement of the contract and the depreciated value at theend of the period is worked out and charged to the contract account asdepreciation.

Continue…..

• If a plant is used for a contract for a short period, thereis no need of debiting the cost of the plant to thecontract account. The amount of depreciation isworked out on the basis of per hour and charged to thecontract on that basis. The hourly rate is calculated bydividing the depreciation and other operating expensesof the plant by the total estimated working hours ofthe plant.

• Sometimes plants may be taken on hire for a particularcontract. In such cases the amount of rent paid shouldbe debited to the contract account.

V. Subcontract:

Sometimes due to certain situations, a sub contractor is appointed to carryout certain special work for the main contract. This special work done bythe sub contractor becomes a direct charge to the main contract andaccordingly debited to the contract account. The payments made to thesub contractor are charged to the main contract as direct expenses and nodetailed break up of the same is required. Material supplied to the subcontractor without any charge, is debited to the contract account as directmaterial and machinery, tools etc supplied to him on rent should bedepreciated on appropriate basis and debited to the contract account.Rent received for the use of such tools and machines should be credited tothe contract account or deducted from the final bill of the sub contractor.

Process Costing-

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Title of the course MANAGERIAL ACCOUNTING AND CONTROL

[ABM-504]


Topic What is Cost Volume Profit Analysis ?

Importance of Cost Volume Profit Analysis

Cost Volume Profit Analysis Formula

Benefits of Cost-Volume Analysis (CVP)

Limitations of Cost-Volume Analysis (CVP) Unit IV

Faculty1 LAVEENA SHARMA


1


What is Cost Volume Profit Analysis (CVP

Analysis)? Cost Volume Profit Analysis (CVP Analysis) is an accounting

technique which helps in identifying the effect of sales volume

and product cost on the operating profit of a business. Cost

Volume Profit analysis is also known as “Break Even Analysis”.

Cost Volume Profit Analysis includes the analysis of sales

price, fixed costs, variable costs, the number of goods

sold and how it affects the profit of the business.

The aim of a company is to earn profit and profit

depends upon a large number of factors, most notable

among them are the cost of manufacturing and the

volume of sales. These factors are largely interdependent.

https://www.wallstreetmojo.com/break-even-point/

https://www.wallstreetmojo.com/fixed-cost-vs-variable-cost/

The volume of sales is dependent upon production

volume which in turn is related to costs which are

affected by Volume of production, product mix, internal

efficiency of the business, production method used etc.

CVP analysis helps management in finding out the

relationship between cost and revenue to generate profit.

CVP Analysis helps them to determine the break-even

point for different sales volume and cost structures.

With CVP Analysis information, the management can

better understand the overall performance and

determine what units it should sell to break even or to

reach a certain level of profit.

Importance of Cost Volume Profit Analysis CVP analysis helps in determining the level at which all

relevant cost is recovered and there is no profit or loss which

is also called the breakeven point. It is that point at which

volume of sales equal total expenses (both fixed and variable).

Thus CVP analysis helps decision makers understand the

effect of a change in sales volume, price and variable cost on

the profit of an entity while taking fixed cost as unchangeable.

CVP Analysis helps in understanding the relationship between

profits and costs on the one hand and volume on the other.

CVP Analysis useful for setting up flexible budgets which

indicate costs at various levels of activity. CVP Analysis also

helpful when a business is trying to determine the level of

sales to reach a targeted income.

Cost Volume Profit Analysis Formula

https://www.wallstreetmojo.com/break-even-point-formula/

https://www.wallstreetmojo.com/break-even-point-formula/

The computing of Cost volume profit analysis formula is as

follows:

Examples of Cost Volume Profit Analysis Let’s understand examples of Cost volume profit analysis with

the help of a few examples:

Cost Volume Profit Analysis Examples #1

XYZ wishes to make an annual profit of $100000 from the sale

of appliances. Details of manufacturing and annual capacity

are as follows:

Based on the above information let’s plug the numbers in CVP

equation:

10000*p= (10000*30) +$30000+$100000

10000p = ($300000+$30000+$100000)

10000p=$430000

Price per unit= ($430000/10000) = $43

Thus price per unit comes out to $43 which implies that XYZ

will have to price its product $43 and need to sell 10000 units

to achieve its targeted profit of $100000.Further, we can see

that the fixed cost remain constant ($30000) irrespective of

the level of sales.

Cost Volume Profit Analysis Examples #2

ABC Limited has entered into the business of making Electrical

fans. The management of the company is interested in

knowing the breakeven point at which there will be no

profit/loss. Below are the details pertaining to the cost

incurred:

No. of units sold by ABC limited: ($300000/$300) = 1000 units

Variable cost per unit= ($240000/1000)=$240

Contribution per unit= Selling price per unit-Variable

Cost per unit

= ($300-$240)

= $60 per unit

Break Even Point= (Fixed Cost/Variable Cost per unit)

= ($60000/$60)

=10000 units

Thus ABC limited need to sell 10000 units of electric fans to

break even at the current cost structure.

https://www.wallstreetmojo.com/contribution-margin/

Benefits of Cost-Volume Analysis (CVP)

1. CVP analysis provides a clear and simple understanding

of the level of sales which are required for a business to

break even (No profit No loss), level of sales required to

achieve targeted Profit.

2. CVP analysis helps management to understand the

different cost at different levels of production/sales

volume. CVP analysis helps decision makers in

forecasting cost and profit on account of change in

volume.

3. CVP Analysis helps business analyze during recessionary

times the comparative effects of shutting down a

business or continuing business at a loss; as it clearly

bifurcates the Direct and Indirect cost.

4. Effects of changes in fixed and variable cost help

management decide the optimum level of production

Limitations of Cost-Volume Analysis (CVP)

1. CVP analysis assumes fixed cost is constant which is not

the case always; beyond certain level fixed cost also

changes.

2. Variable cost is assumed to vary proportionately which

doesn’t happen in reality.

3. Cost volume profit analysis assumes costs are either fixed

or variable; however, in reality, some costs are semi-fixed

in nature. For example, Telephone expenses which

https://www.wallstreetmojo.com/direct-cost-vs-indirect-cost/

comprise a fixed monthly charge and a variable charge

based on the number of calls made.

Final Thoughts No business can decide with accuracy its expected level of

sales volume. Such decisions are usually based on past

estimates and market research regarding the demand for

products which are offered by the business. CVP Analysis

helps business in determining how much they need to sell to

break even i.e. no profit no loss. CVP Analysis emphasizes on

sales volume because in short run most of the estimates such

as sales price; the cost of material, Salaries can be estimated

with a good level of accuracy and is a very important

management accounting tool.


[ABM-504]


Topic MARGINAL COSTING

Unit IV

Facultyi DEEPAK PAL


i Disclaimer: The information contained in this note is for general guidance & collected from various direct and indirect sources like websites, blogs, books, articles and open study sources. Author(s) make no representation for any legal responsibility or any other aspect of information contained

In this article we will discuss about:- 1. Meaning of Marginal Costing 2.Contribution of Marginal Costing 3. Features of Marginal Costing 4. Arguments inFavour of Marginal Costing 5. Criticism against Marginal Costing 6. AbsorptionCosting and Marginal Costing: Impact on Profit.

Meaning of Marginal Costing:

Marginal costing is a principle whereby variable costs are charged to cost unitsand the fixed costs attributable to the relevant period is written off in full againstthe contribution for that period.

Marginal costing is the ascertainment of marginal cost and the effect on profit ofchanges in volume or type of output by differentiating between fixed costs andvariable cost. In marginal costing, costs are classified into fixed and variable costs.

ADVERTISEMENTS:

The concept of marginal costing is based on the behaviour of costs that vary withthe volume of output. Marginal costing is known as ‘variable costing’, in whichonly variable costs are accumulated and cost per unit is ascertained only on thebasis of variable costs. Sometimes, marginal costing and direct costing are treatedas interchangeable terms.

The major difference between these two is that, marginal cost covers only thoseexpenses which are of variable nature whereas direct cost may also include costwhich besides being fixed in nature identified with cost objective.

Contribution of Marginal Costing:

In marginal costing, costs are classified into fixed and variable costs. The conceptmarginal costing is based on the behaviour of costs with volume of output. Fromthis approach, it is not possible to identify an amount of net profit per product,but it is possible to identify the amount of contribution per product towards fixedoverheads and profits. The contribution is the difference between sales volumeand the marginal cost of sales.

S K RAO

Highlight

In marginal costing it is not possible to determine the profit per unit of productbecause fixed overheads are charged in total to the profit and loss account ratherthan recovered in product costing. Contribution is a pool of amount from whichtotal fixed costs will be deducted to arrive at the profit or loss.

ADVERTISEMENTS:

The distinction between contribution and profit is given below:

Contribution:

1. It includes fixed cost and profit.

2. Marginal costing technique uses the concept of contribution.

ADVERTISEMENTS:

3. At break-even point, contribution equals to fixed cost.

4. Contribution concept is used in managerial decision making.

Profit:

1. It does not include fixed cost.

2. Profit is the accounting concept to determine profit or loss of a businessconcern.

3. Only the sales in excess of break-even point results in profit.

4. Profit is computed to determine the profitability of product and the concern.

Formulas used in Marginal Costing:

Sales — Variable cost + Fixed cost + Profit

Sales – Variable cost = Contribution

Sales – Variable cost = Fixed cost + Profit

Contribution = Fixed cost + Profit

Contribution – Fixed cost = Profit

Features of Marginal Costing:

The main features of marginal costing are as follows:

(a) All costs are categorized into fixed and variable costs. Variable cost per unit issame at any level of activity. Fixed costs remain constant in total regardless ofchanges in volume.

(b) Fixed costs are considered period costs and are not included in product cost,only variable costs are considered as product costs.

(c) Stock of work-in-progress and finished goods are valued at marginal cost ofproduction.

(d) In marginal process costing, products are transferred from one process toanother are valued at marginal costs only.

(e) Prices are determined with reference to marginal cost and contributionmargin.

(f) Profitability of departments, products etc. is determined with reference to theircontribution margin.

(g) In accounting, marginal cost, the overhead control account in the cost ledgerrepresents only the variable overhead. Fixed costs are taken as expenses in theprofit and loss account and thus excluded from costs.

(h) Presentation of data is oriented to highlight the total contribution andcontribution from each product.

(i) The difference in the magnitude of opening stock and closing stock does notaffect the unit cost of production since all the product costs are variable costs.

Arguments in Favour of Marginal Costing:

The supporters of marginal costing technique put forth the followingpoints in support of their argument:

(a) Fixed costs are period costs in nature and it should be charged to theconcerned period irrespective of the quantum or level of production or sale.

(b) Inclusion of fixed costs in the product cost distorts the comparability ofproducts at different volumes and disturbs control actions. It highlights thesignificance of fixed costs on profits. In a highly competitive situation, it may bewise to take an order which covers marginal costs and makes some contributiontowards fixed costs, rather than loose the order.

(c) The difficulty in apportionment and absorption of fixed costs to product costwill not exist in contribution approach and it is much easier for accounting anddetermination of product costs.

(d) Marginal cost method is simple in application and is easy for exercise of costcontrol. It is more informative and simple to understand.

(e) It helps the management with more appropriate information in taking vitalbusiness decisions like make or buy, subcontracting, export order pricing, pricingunder recession, continue or discontinue a product/division, selection of suitableproduct mix etc.

(f) Profit-volume analysis is facilitated by the use of break-even charts and profit-volume graphs, and so on.

(g) The analysis of contribution per key factor or limiting resource is a useful aidin budgeting and production planning.

(h) Pricing decisions can be based on the contribution levels of individualproducts.

(i) The profit and loss statement is not distorted by changes in stock levels. Stockvaluations are not burdened with a share of fixed overhead, so profits reflect salesvolume rather than production volume.

(j) Responsibility accounting is more effective when based on marginal costingbecause managers can identify their responsibilities more clearly when fixedoverhead is not charged arbitrarily to their departments or divisions.

Criticism against Marginal Costing:

The criticism levelled against marginal costing is summarized below:

(a) Difficulty may be experienced in trying to separate fixed and variable elementsof overhead costs. Unless this can be done with reasonable accuracy, marginalcosting cannot be very accurate. Application of common sense and judgment willbe necessary.

(b) The misuse of marginal costing approach may result in setting selling priceswhich do not allow for the full recovery of overhead. This may be most likely intimes of depression or increasing competitors when prices set to undercutcompetitors may not allow for a reasonable contribution margin.

(c) The main assumption of marginal costing is that variable cost per unit will besame at any level of activity. This is only partly true within a limited range ofactivity. With a major change in activity there may be considerable change in therates and prices of men, material due to shortage of material, shortage of skilledlabour, concessions of bulk purchase, increased transportation costs, changes inproductivity of men and materials etc.

(d) The assumption that fixed costs remain constant in total regardless of changesin volume will be correct up to a certain level of output. Some fixed costs are liableto change from one period to another. For example, salaries bill may go upbecause of annual increments or due to change in the pay rates and due to paystructure. If there is a substantial drop in activity, management may takeimmediate action to cut the fixed costs by retrenchment of staff, renting of office-premises, warehouses taken on lease may be given-up etc.

(e) Increased automation and mechanization has resulted the reduction in labourcosts and increased fixed costs like installation, maintenance and operation costs,depreciation of machinery. The use of marginal costing creates a tendency todisregard the need to recover cost through product pricing. For long-runcontinuity of the business, it is not good. Assets have to be replaced in the long-run.

(f) Exclusion of fixed overheads from costs may lead to erroneous conclusions. Itmay create problems in inter-firm comparison, higher demand for salaries andother benefits by employees, higher demand for tax by the Governmentauthorities etc.

(g) The exclusion of fixed overhead from inventory cost does not constitute anaccepted accounting procedure and, therefore adherence to marginal costing willinvolve deviation from accepted accounting practices.

(h) The income-tax authorities do not recognize the marginal cost for inventoryvaluation.

Absorption Costing and Marginal Costing: Impact on Profit:

In absorption costing, stock is valued at total cost while in marginal costing stockvaluation is done at variable cost only. This means that in absorption costing,stock valuation is higher than in marginal costing. When production exceedssales, profit under absorption costing is higher than that of marginal costing. But

when sales exceed production, profit under absorption costing is lower than thatof marginal costing.

Absorption costing is a principle whereby fixed, as well as, variable costs areallotted to cost units and total overheads are absorbed according to activity level.Absorption costing confirms with the accrual concept by matching costs withrevenue for a particular accounting period. Stock valuation complies with theaccounting standard and fixed production costs are absorbed into stocks.

Absorption costing method avoids separation of costs into fixed and variableelements, which is not easily and accurately achieved. Cost plus pricing underabsorption costing ensures that all costs are covered.

Pricing at the marginal cost may, in the long-run, result in failing to cover thefixed costs. It is important to note that in absorption costing sales must be equalto or exceed the budgeted level of activity otherwise fixed costs will be underabsorbed.

The absorption of production overheads under absorption costing hasthe following impacts:

(i) When production exceeds sales during the period, a higher profit is shownunder absorption costing, since the fixed overhead is absorbed over more numberof units produced, and carried to next accounting period along with closinginventory.

(ii) When sales are in excess of production, a lower profit is reported underabsorption costing. Since, less portion of fixed production overhead is recoveredin valuation of closing stock and current period’s cost of production is higher.

The following generalizations to be made on the impact on profit ofthese two different methods of costing:

(a) Where sales and production levels are constant through time, profit is thesame under the two methods.

(b) Where production remains constant but sales fluctuate, profit rises or fallswith the level of sales, assuming that costs and prices remain constant, but thefluctuations in net profit figures are greater with marginal costing than withabsorption costing.

(c) Where sales are constant but production fluctuates, marginal costing providesfor constant profit, whereas under absorption costing, profit fluctuates.

(d) Where production exceeds sales, profit is higher under absorption costingthan under marginal costing for the reason that absorption of fixed overheadsinto closing stock increases their value thereby reducing the cost of goods sold.

(e) Where sales exceeds production, profit is higher under marginal costing. Thefixed costs, which previously were part of stock values, are now charged againstrevenue under absorption costing. Therefore, under absorption costing the valueof fixed costs charged against revenue is greater than that incurred for the period.

The choice between using absorption costing and marginal costingwill be determined by the following factors:

(a) The system of financial control in use e.g., responsibility accounting isinconsistent with absorption costing.

(b) The production methods in use e.g., marginal costing is favoured in simpleprocessing situations in which all products receive similar attention; but whendifferent products receive widely differing amounts of attention, the absorptioncosting may be more realistic.

(c) The significance of prevailing level of fixed overhead costs.


[ABM-504]


Topic PROCESS COSTING

Unit IV

Faculty1 DEEPAK PAL & LAVEENA SHARMA


1 Disclaimer: The information contained in this note is for general guidance & collected from various direct and indirect sources like

websites, blogs, books, articles and open study sources. Author(s) make no representation for any legal responsibility or any other aspect of information contained.

PROCESS COSTING

Process costing is the method of costing applied in the industries engaged in continuous or

mass production. Process costing is a method of costing used to ascertain the cost of a product at

each process or stage of manufacturing.

According to ICMA terminology, “Process Costing is that form of operation costing which

applies where standardized goods are produced”.

So it is a basic method to ascertain the cost at each stage of manufacturing. Separate

accounts are maintained at each process to which expenditure incurred. At the end of each process

the cost per unit is determined by dividing the total cost by the number of units produced at each

stage. Hence, this costing is also called as “Average Costing” or “Continuous Costing”. Process

Costing is used in the industries like manufacturing industries, chemical industries, mining works

and public utility undertakings.

Characteristics of Process Costing

1. Production is continuous

2. Products pass through two or more distinct processes of completion.

3. Products are standardized and homogeneous.

4. Products are not distinguishable in processing stage.

5. The finished product of one process becomes the raw material of the subsequent process.

6. Cost of material, labour and overheads are collected for each process and charged accordingly.

Advantages of Process Costing

1. It is easy to compute average cot because the products are homogeneous in Process Costing.

2. It is possible to ascertain the process costs at short intervals.

3. Process Costing is simple and less expensive in relation o job costing.

4. By evaluating the performance of each process effective managerial control is possible.

Disadvantages of Process Costing

1. Valuation of work in progress is difficult.

2. It is not easy to value losses, wastes, scraps etc.

3. The apportionment of total cost among joint products and by-products is difficult.

4. Process cost are not accurate, they are only average costs

5. Process costs are only historical.

Principles of Process Costing

The following points are considered while determining the cost under Process Costing.

1. Production activity should be divided into different processes or departments.

2. A separate account is opened for each process.

3. Both direct and indirect costs are collected for each process.

4. The quantity of output and costs are recorded in the respective process accounts.

5. The cost per unit is determined by dividing the total cost at the end of each process by the

number of output of each process.

6. Normal loss and abnormal loss are credited in the process account

7. The accumulated cost of each process is transferred to subsequent process along with

output. The output of the last process along with cost is transferred to the finished goods

account.

8. In case of by-products and joint products their share in joint cost should be estimated and

credited to the min process.

9. When there is work in progress at the end of the period the computation of inventory is

made I terms of complete units.

Difference between Process Costing and Job Costing

Process Costing Job Costing

1. Production is continuous

2. Production is for stock

3. All units produced are identical or

homogeneous

4. There is regular transfer of cost of one

process to subsequent processes

5. Work in progress always exists

1. Production is according to customers’ orders

2. Production is not for stock

3. Each job is different from the other

4. There is no regular transfer of cost

from one job to another

5. Work in progress may or may not

exist

Procedure for Process Costing

1. Each process is separately identified. Separate process account is opened for each process.

2. Along with ‘Particulars Column’, two columns are provided on both sides of the process

account – units (quantity) and amount (Rupees).

3. All the expenses are debited in the respective process account.

4. Wastage, sale of scrap, by-products etc are reordered on the credit side 0f the process

account.

5. The difference between debit and credit side shows the cost of production and output of that

particular process which is transferred to the next process.

6. The cost per unit in every process is calculated by dividing the net cost by the output.

7. The output of last process is transferred to the Finished Stock Account.

8. Incomplete units at the end of the each period ion every process s converted in terms of

completed units.

Specimen of Process Account

Process Account Units Rs. Units Rs.

To Direct materials

To Direct Wages

To Direct Expenses

To Indirect expenses

To Other Expenses (if any)

By Loss in weight

(Normal

Loss)

By sale of Scrap

By Next Process

Account(Transfer)

Preparation of Process Accounts

The preparation of Process Account depends upon the following situations

1. Simple Process Account

2. Process costing with normal process loss

3. Process costing with abnormal process loss

4. Process costing with abnormal process gains

5. Inter – process profits.

Simple Process Account

Under this case it is very easy to prepare process account. A separate account is opened for

each process. All costs are debited to the process account. The total cost of the process is

transferred to the next process. At the end of each process the cost per unit is obtained by dividing

the total cost by the number of units.

Process losses

The process loss is classified into two- normal process loss and abnormal process loss.

Normal process loss

This is the loss which is unavoidable on account of inherent nature of production process. It

arises under normal conditions. It is usually calculated as a certain percentage of input. Normal

process los includes either waste or scrap r both. Waste is unsalable and has no value. Loss in

weight is an example of waste. Loss in weight should be credited to the concerned process account.

It should be recorded only in terms of quantity.

Loss in weight = Opening Stock + output from the preceding process – (output of the

Concerned process + closing stock)

Abnormal Process Loss

Any loss caused by unexpected or abnormal conditions such as plant break don, substandard

materials, carelessness, accident etc. or loss in exceeds of the margin anticipated for normal process

loss can be called as abnormal process loss. It is controllable and avoidable. When actual loss in the

process is greater than the estimated normal loss, it is a case of abnormal loss. It may also be

determined by comparing actual output with expected or normal output. If actual output is les than

the normal output, the difference is abnormal loss.

Value of Abnormal loss = Normal cost of normal output x Units of Abnormal loss Normal output

Normal cost of normal output = Total expenditure (i.e., total debit of process A/c) – Sale

Proceeds of scrap (i.e. Value of normal loss)

Normal output = Input – Units of normal loss

Abnormal Gain (or Abnormal Effective)

Sometimes actual loss or wastage in a process is less than expected normal loss. In this case

the difference between actual loss and expected loss is known as abnormal gain or abnormal

effective. It is the excess of actual production over normal output.

Abnormal gain is valued in the same manner as abnormal loss. The value of abnormal gain

is debited to process A/c and credited to abnormal gain A/c. the value of scrap is debited to

abnormal gain A/.c and credited to normal loss A/c. finally abnormal loss A/c is closed by

transferring the credit balance to Costing P&L A/c.

Value of Abnormal Gain = Normal cost of normal output x Units of Abnormal gain

Normal output

Normal cost of normal output = Total expenditure– Sale Proceeds of scrap

Normal output = Input – Units of normal loss

Units of Abnormal gain = Normal loss- Actual loss

Or = Actual output - Normal output


[ABM-504]


Topic

Standard Costing and Variance

Analysis

Determination of Standard Costs

Ways of Developing Standards

Variance Analysis

Unit IV

Faculty1 DEEPAK PAL & LAVEENA SHARMA



Standard Costing and Variance Analysis

In fast growing business world, major goal of organizations is to reduce the cost of production

and control the cost as there are limited resources in business and manufacturing concern. Cost

accounting has numerous significant tools in order to attain these goals such as standard costing.

Standard Costing

Standard costs are extensively recognized in all countries of world. It is an effectual procedure to

control cost and assist to accomplish organizational goal. Standard costs are realistic estimates of

cost based on analyses of both past and projected operating costs and conditions. In this

procedure, standard cost of the product and services is determined in advance and comparing it

with actual cost variance to ascertain and analyse. Huge accounting literature has stated that

standard costing is the preparation and use of standard costs, their comparison with actual cost

and the analysis of variance to their causes and points of incidence (ICMA, London). According

Wheldon, standard costing is the method of ascertaining the costs whereby statistics are prepared

to show standard cost, actual cost, and the difference between these costs which is termed as

variance. Other theorists like Brown and Howard described that standard costing is a technique

of accounting which compares the standard cost of product and services with actual cost to

determine the efficiency of operations so that remedial actions can be taken immediately (Gupta,

et, al., 2006).

The three components of standard costing:

1. Standard costs, which provide a standard, or predetermined performance level.

2. A measure of actual performance. 3. A measure of the variance between standard and actual performance.

Standard costing uses estimated costs completely to calculate all three elements of product costs:

direct materials, direct labour, and overhead. Managers use standard costs for planning and

control in the management process such as planning for budget development; product costing,

pricing, and distribution.

The main difference between standard costing in a service organization and standard costing in a

manufacturing organization is that a service organization has no direct materials costs. In a

standard costing system, costs are entered into the Materials, Work in Process, and Finished

Goods Inventory accounts and the Cost of Goods Sold account at standard cost; actual costs are

recorded separately.

The following elements are used to verify a standard cost per unit:

1. Direct materials price standard 2. Direct materials quantity standard 3. Direct labour rate standard

4. Direct labour time standard 5. Standard variable overhead rate

6. Standard fixed overhead rate

Determination of Standard Costs

The following initial steps must be taken before determination of standard cost:

1. Establishment of Cost Centres: It is the primary step required before setting of Standards.

2. Classification and Codification of Accounts: Categorization of Accounts and Codification of different items of expenses and incomes assist quick ascertainment and analysis of cost information.

3. Types of Standards to be applied: Determination of the type of standard to be used is vital steps before establishing of standard cost. There are numerous standards:

I. Ideal Standard II. Basic Standard III. Current Standard IV. Expected Standard V. Normal Standard

4. Organization for Standard Costing: The achievement of the standard costing system depends upon the consistency of standards, therefore the responsibility for setting standard is vested with the Standard Committee. It consists of following team:

a. Purchase Manager b. Production Manager c. Personnel Manager d. Time and Motion Study Engineers e. Marketing Manager and Cost Accountant

Setting of Standards: The Standard Committee is responsible for developing standards for each component of costs such as Direct Material, Direct Labour, Overheads ( Fixed overheads and Variable Overheads).

Features of Standard Costing

Standard costing is a technique of cost accounting.

The cost or service or product is predetermined.

The predetermined cost is known as standard cost.

Actual cost of product and service is ascertained.

The comparison is made between standard cost and actual cost and variances are noted.

Variances are analysed to find out the reason.

Variances are reported to management in order to take corrective action.

Ways of Developing Standards

The direct materials price standard is based on a vigilant estimate of all possible price increases,

changes in available quantities, and new sources of supply in the next accounting period.

The direct materials quantity standard is based on product engineering specifications, the quality

of direct materials, the age and productivity of machines, and the quality and experience of the

work force.

The direct labour rate standard is defined by labour union contracts and company personnel

policies.

The direct labour time standard is based on current time and motion studies of workers and

machines and records of their past performance.

The standard variable overhead rate and standard fixed overhead rate are found by dividing total

budgeted variable and fixed overhead costs by an appropriate application base.

Merits of standard costing: It is a very useful tool to control the cost. It is the analysis of

variances which reduces the cost and increase profitability. It is also beneficial for management

because it assists in fixation of selling price, ascertaining the value of closing stocks of work in

progress, determining idle capacity, and performs various management functions. The standards

provide incentives and motivation to work and help in increasing efficiency and productivity.

This technique is helpful in optimal use of resources. Standard costing helps in budgetary control

and in decision making. This technique is economical for users (Gupta, et, al., 2006).

Demerits of Standard costing: In this technique, establishing standards is difficult. Standards

are determined by keeping in view the marketing condition, availability, and efficiency of labour,

machine and plant. All these factors are not static. Standard costing requires specialists and

expert staff. This involves heavy expenditure for the concern. This technique is impractical for

small scale industries (Gupta, et, al., 2006).

It can be established that Standard Costing is a notion of accounting to determine of standard for

each constituent of costs. These fixed costs are compared with actual costs to realize the

deviations known as "Variances". Recognition and analysis of causes for such variances and

corrective measures should be taken in order to beat the reasons for Variances.

Variance Analysis

Variance analysis is the procedure of computing the differences between standard costs and

actual costs and recognizing the causes of those differences. Studies indicated that variance is the

difference between standard performance and actual performance. It is the process of

scrutinizing variance by subdividing the total variance in such a way that management can assign

responsibility for off-Standard Performance.

Variance analysis has four steps:

1. Compute the amount of the variance. 2. Determine the cause of any significant variance. 3. Identify performance measures that will track those activities, analyse the

results of the tracking, and determine what is needed to correct the problem.

4. Take corrective action.

variance analysis: A Four-Step Approach to Controlling Costs

The variance can be favourable variance or unfavourable variance. When the actual performance

is superior to the Standard, it resents "Favourable Variance." Likewise, where actual

performance is under the standard it is called as "Unfavourable Variance."

Variance analysis assists to fix the responsibility so that management can determine-

a. The amount of the variance b. The reasons for the difference between the actual performance and

budgeted performance.

c. The person responsible for poor performance d. Corrective actions to be taken.

Types of Variances: Variances is categorized into two categories that include Cost Variance and

Sales Variance.

Cost Variance: Total Cost Variance is the difference between Standards Cost for the Actual

Output and the Actual Total Cost sustained for manufacturing actual output. The Total Cost

Variance consists of:

I. Direct Material Cost Variance II. Direct Labour Cost Variance III. Overhead Cost Variance

Direct Material Variances: Direct Material Variances are also known as Material Cost

Variances. The Material Cost Variance is the difference between the Standard cost of materials

for the Actual Output and the Actual Cost of materials used for producing actual output. The

Material Cost Variance is computed as:

Labour Cost Variance: Labour Cost Variance is the difference between the Standard Cost of

labour allowed for the actual output achieved and the actual wages paid. It is also termed as

Direct Wage Variance or Wage Variance. Labour Cost Variance is calculated as follow:

Overhead variance: Overhead is explained as the cumulative of indirect material cost, indirect

labour cost and indirect expenses. Overhead Variances may occur due to the difference between

standard cost of overhead for actual production and the actual overhead cost incurred. The

Overhead Cost Variance may be computed as follows:

Component of Variance analysis.

Sales variance: The Variances so far analysis is linked to the cost of goods sold. Quantum of

profit is derived from the difference between the cost and sales revenue. Cost Variances affect

the amount of profit positively or unfavourably depending upon the cost from materials, labour

and overheads. Additionally, it is important to analyse the difference between actual sales and

the targeted sales because this difference will have a direct impact on the profit and sales.

Therefore the analysis of sales variances is important to study profit variances.

Sales Variances can be calculated by two methods:

I. Sales Value Method. II. Sales Margin or Profit Method.

Basis of Calculation: Variance analysis emphasizes the causes of the variation in income and

expenses during a period compared to the financial plan. In order to make variances significant,

the idea of 'flexed budget' is used when calculating variances. Flexed budget acts as a link

between the original budget (fixed budget) and the actual results. Flexed budget is prepared in

retrospect based on the actual output. Sales volume variance accounts for the difference between

budgeted profit and the profit under a flexed budget. All remaining variances are calculated as

the difference between actual results and the flexed budget.

To summarize, Variance Analysis, is administrative accounting which denotes to the analysis of

deviations in financial performance from the standards definite in organizational budgets. In

Variance Analysis, the difference between actual cost and its budgeted or standard cost

segregated into price or quality component. It has been shown that favourable variance occurs

when output exceeds input or when the price paid for the goods and services is less than

anticipated. An unfavourable variance occurs when output is less than input or when the price for

goods and services is greater than expected.



Topic Accounting standards-IntroductionHistory and evolution of accounting standardsAccounting Standards in IndiaAccounting Concepts, Principles and Basic TermsAccounting PrinciplesAccounting ConceptsAccounting ConventionsBasic Accounting TermsFinancial Accounting Basic Concepts and PrinciplesFinancial statementsFinancial Accounting StandardsComparison: Financial vs Management vs Cost Accounting

Unit I


Institution Institute of Agribusiness Management, JNKVV


Accounting standardsIntroduction

• In ancient times, traders and their groups were duty-bound to satisfyonly a small group of investors from among their relatives, friends,and acquaintances about the financial propriety of their businesses.

(Acquaintances -knowledge or experience of something or Relative relation)

• These days, millions of investors put their money into thousands ofcompanies all over the world, and business organizations are legallybound to prepare financial statements for not only their creditorsand investors, but also tax and other government authorities.

• The basic objective of accounting standards is to ensure that thereare no differences in the approach to accounting and to standardisethe presentation of accounts.

• Companies follow the general principles of accountingfollowed internationally, so that it is possible to comparetheir financial statements, which record various facets oftheir performance, with those of other companies.

• Globally, companies prepare their financial statementsunder the “Generally Accepted Accounting Principles”(GAAP), International Financial Reporting Standards (IFRS),and other standard rules and procedures followedthroughout the world.

History and evolution of accounting standards

• The evolution of the International Accounting Standards began in1966 with a suggestion to set up a worldwide study group.

• The next year, the Accountants’ International Study Group wasformed, and it began to publish papers on various accountingtopics, some of which formed the foundation for accountingstandards that came into force later.

• In 1973, the International Accounting Standards Committee (IASC)was set up with the objective of developing accounting standardsthat would be internationally followed.

• The IASC issued a series of standards called the InternationalAccounting Standards, named and numbered from IAS 1 to IAS 41(Agriculture).

• In 2001, the International Accounting Standards Board (IASB), formedunder the International Financial Reporting Standards (IFRS)Foundation, replaced the IASC.

• The IASB announced that it would follow the standards already issuedby the IASC, but stated that any new standards would be known as partof a series called the International Financial Reporting Standards,evolved by the IFRS Foundation.

• The objective of the IFRS is to develop, in the public interest, a high-quality set of comprehensible, internationally accepted, andenforceable accounting standards.

• The IFRS Foundation, an independent, not-for-profit organisation,raises funds from banks and other organisations that desire to haveinternational accounting standards in place in all countries.

• The IASB consists of board members who are accounting expertsdrawn from all over the world, who are well-versed in standards-setting and academic work.

Accounting Standards in India

• Recognizing the need to synchronise the various accounting policies andpractices, the Institute of Chartered Accountants of India (ICAI)constituted the Accounting Standards Board (ASB) in April 1977.

• Accounting standards in India are issued by the ICAI and notified by theUnion Ministry of Corporate Affairs. Thirty accounting standards havebeen issued by the ICAI so far.

• At present, “Indian Accounting Standards” (Indian AS), a set of standardsevolved under the Companies (Accounting Standards) Rules, 2006, is inforce.

• Standards in the wake of the IFRS (to be called “Ind AS”) are to benotified by the Ministry of Corporate Affairs and made mandatory forlisted companies with a net worth of Rs. 500 crore or more from April 1,2016.

• The standards will be made compulsory for other categories ofcompanies from later deadlines.

• Some categories do not have to follow the new standards, and theywill continue to follow the Companies (Accounting Standards) Rules,2006. Companies have been allowed to voluntarily follow the new IndAS rules from April 1, 2015.

• The new accounting standards are expected to improve India’s placein global rankings in corporate governance and transparency infinancial reporting.

• The standards are evolved with the assistance of the NationalAdvisory Committee on Accounting Standards (NACAs) constitutedunder Section 210(1) of the Companies Act, 1956.

• Sub-Section (3A) of Section 211 of the Companies Act, 1956, requiresthat the profit/loss accounts and balance sheet of companies shouldcomply with Indian accounting standards.

Accounting Concepts, Principles and Basic Terms

Definition and introductionThe worldview of accounting and accountants may certainly

involve some unhelpful characters poring over formidablefigures stacked up in indecipherable columns.

However, a short and sweet description of accounting does exist:

‘Accounting is the language of business efficiently communicated by well-organised and honest professionals called accountants.’

A more academic definition of accounting is given by theAmerican Accounting Association:

The process of identifying, measuring and communicating economic informationto permit informed judgments and decisions by users of the information.

The American Institute of Certified Public Accountants defines accounting as:

The art of recording, classifying, summarising in a significant manner and in terms of money, transactions and events which are, in part at least of financial character,

and interpreting the results thereof.

Accounting not only records financial transactions and conveys the financialposition of a business enterprise; it also analyses and reports the information indocuments called “financial statements.”

Recording every financial transaction is important to a business organisation andits creditors and investors. Accounting uses a formalised and regulated systemthat follows standardised principles and procedures.(formalized -give a definite structure or shape to.) cause (something) to conform to a standard.

The job of accounting is done by professionals who have educational degreesacquired after years of study. While a small business may have an accountant or abookkeeper to record money transactions, a large corporation has an accountsdepartment, which supplies information to: Managers who guide the company. Investors who want to know how the business is doing. Analysts and brokerage firms dealing with the company’s stock. The government, which decides how much tax should be collected from the

company.

Accounting Principles• Why

– Obviously, if each business organisation conveys its information in its own way, we will have a babel of unusable financial data.

• Personal systems of accounting may have worked in the days when mostcompanies were owned by sole proprietors or partners, but they do notanymore, in this era of joint stock companies.

• These companies have thousands of stakeholders who have invested millions,and they need a uniform, standardised system of accounting by whichcompanies can be compared on the basis of their performance and value.

• Therefore, accounting principles based on certain concepts, convention, andtradition have been evolved by accounting authorities and regulators and arefollowed internationally.

• These principles, which serve as the rules for accounting for financialtransactions and preparing financial statements, are known as the“Generally Accepted Accounting Principles,” or GAAP.

• The application of the principles by accountants ensures that financialstatements are both informative and reliable.

• This observance of accounting principles has helped developed a widelyunderstood grammar and vocabulary for recording financial statements.

• However, it should be said that just as there may be variations in the usageof a language by two people living in two continents, there may be minordifferences in the application of accounting rules and procedures dependingon the accountant.

• For example, two accountants may choose two equally correct methods forrecording a particular transaction based on their own professionaljudgement and knowledge.

Accounting principles involve both accounting concepts and accounting conventions. Here are brief explanations.

Accounting Concepts

• Business entity concept: A business and its owner should be treatedseparately as far as their financial transactions are concerned.

• Money measurement concept: Only business transactions that can beexpressed in terms of money are recorded in accounting, thoughrecords of other types of transactions may be kept separately.

• Dual aspect concept: For every credit, a corresponding debit is made.The recording of a transaction is complete only with this dual aspect.

• Going concern concept: In accounting, a business is expected tocontinue for a fairly long time and carry out its commitments andobligations. This assumes that the business will not be forced to stopfunctioning and liquidate its assets at “fire-sale” prices.

• Cost concept: The fixed assets of a business are recorded on the basisof their original cost in the first year of accounting. Subsequently,these assets are recorded minus depreciation. No rise or fall in marketprice is taken into account. The concept applies only to fixed assets.

• Accounting year concept: Each business chooses a specific timeperiod to complete a cycle of the accounting process—for example,monthly, quarterly, or annually—as per a fiscal or a calendar year.

• Matching concept: This principle dictates that for every entry ofrevenue recorded in a given accounting period, an equal expenseentry has to be recorded for correctly calculating profit or loss in agiven period.

• Realisation concept: According to this concept, profit is recognisedonly when it is earned. An advance or fee paid is not considered aprofit until the goods or services have been delivered to the buyer.

Accounting ConventionsThere are four main conventions in practice in accounting:

conservatism; consistency; full disclosure; and materiality.

• Conservatism is the convention by which, when two values of atransaction are available, the lower-value transaction is recorded.By this convention, profit should never be overestimated, and thereshould always be a provision for losses.

• Consistency prescribes the use of the same accounting principlesfrom one period of an accounting cycle to the next, so that thesame standards are applied to calculate profit and loss.

• Materiality means that all material facts should be recorded inaccounting. Accountants should record important data and leaveout insignificant information.

• Full disclosure entails the revelation of all information, bothfavourable and detrimental to a business enterprise, and which areof material value to creditors and debtors.

Basic Accounting Terms

• Accounting equation: The accounting equation, the basis

for the double-entry system (see below), is written as follows:

Assets = Liabilities + Stakeholders’ equity

This means that all the assets owned by a company have been

financed from loans from creditors and from equity frominvestors. “Assets” here stands for cash, account receivables,inventory, etc., that a company possesses.

• Accounting methods: Companies choose between twomethods—– cash accounting and accrual accounting.

– Under cash basis accounting, preferred by smallbusinesses, all revenues and expenditures at the timewhen payments are actually received or sent are recorded.

– Under accrual basis accounting, income is recorded whenearned and expenses are recorded when incurred.

The difference between cash and accrual accounting lies in thetiming of when sales and purchases are recorded in youraccounts. Cash accounting recognizes revenue and expensesonly when money changes hands, but accrual accountingrecognizes revenue when it’s earned, and expenses whenthey’re billed (but not paid).

https://www.youtube.com/watch?time_continue=30&v=T_TSsCYPRgA

• Account receivable: The sum of money owed by yourcustomers after goods or services have been deliveredand/or used.

• Account payable: The amount of money you owe creditors,suppliers, etc., in return for goods and/or services theyhave delivered.

• Accrual accounting: See “accounting methods.”

• Assets (fixed and current): Current assets are assets thatwill be used within one year.

For example, cash, inventory, and accounts receivable (seeabove). Fixed assets (non-current) may provide benefits toa company for more than one year—for example, land andmachinery.

• Balance sheet: A financial report that provides a gist of a company’s assetsand liabilities and owner’s equity at a given time.

• Capital: A financial asset and its value, such as cash and goods. Workingcapital is current assets minus current liabilities.

• Cash accounting: See “accounting methods.”

• Cash flow statement: The cash flow statement of a business shows thebalance between the amount of cash earned and the cash expenditureincurred.

• Credit and debit: A credit is an accounting entry that either increases aliability or equity account, or decreases an asset or expense account. It isentered on the right in an accounting entry. A debit is an accounting entrythat either increases an asset or expense account, or decreases a liability orequity account. It is entered on the left in an accounting entry.

• Double-entry bookkeeping: Under double-entry bookkeeping, everytransaction is recorded in at least two accounts—as a credit in one accountand as a debit in another.

• Financial statement: A financial statement is a document that reveals thefinancial transactions of a business or a person. The three most importantfinancial statements for businesses are the balance sheet, cash flowstatement, and profit and loss statement

• General ledger: A complete record of financial transactions over the life of acompany.

• Journal entry: An entry in the journal that records financial transactions inthe chronological order.

• Profit and loss statement (income statement): A financialstatement that summarises a company’s performance byreviewing revenues, costs and expenses during a specificperiod.

• Single-entry bookkeeping: Under the single-entrybookkeeping, mainly used by small or businesses, incomesand expenses are recorded through daily and monthlysummaries of cash receipts and disbursements.

• Types of accounting: Financial accounting reports informationabout a company’s performance to investors and credits.Management accounting provides financial data to managersfor business development.

Financial Accounting Basic Concepts and Principles

Definition and introduction• Profit is the sole objective of business. Therefore, for those running a

business, information about the financial performance of the enterpriseis a most important requirement.

• This information is not available easily and can be obtained only bysystematically recording, classifying, and summarising all the businesstransactions.

• The branch of accounting that accomplishes these tasks underinternationally standardised procedures is called financial accounting.

• However, financial accounting is not limited to recording, classifying,and summarizing information about business transactions.

• It also deals with reporting this information to stakeholders outside theorganisation, such as investors and creditors, who are the important,primary recipients of the information.

• There may be secondary recipients, too, such as competitors, customers, employees, and stock-market analysts, but the information generated by financial accounting is mainly aimed at external stakeholders who are not part of the business organisation.

• Therefore, to put together a formal definition of financial accounting, it is a specialized branch of accounting that records and reports information about the financial position and performance of a company, mainly for use by the business entity’s external stakeholders.

• How does financial accounting achieve its tasks? – Financial accounting mainly generates three financial statements to provide

the information required—the balance sheet, income statement, and cash flow statement.

• These documents provide the stakeholders a clear idea about the performance of the business during a particular period and its financial position at a specific time.

• The objective of the financial accountants is not to estimate the value of a company but to facilitate this valuation by others.

• According to the International Financial Reporting Standards, financial accounting provides information about a business organisation that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the organisation.

Objectives

• The objectives of financial accounting can be put in four categories,as follows:

• Record financial transactions as and when they occur (bookkeeping),so that the data can be analysed for preparing financial statements

• Calculate profit or loss, to enable management to take course-correction strategies if required

• Ascertain the financial strength of the company by determining itsassets and liabilities

• Communicate the information to stakeholders through statementsand reports, so that these stakeholders can take appropriatedecisions on their investments in the business

Financial statements• For meeting these objectives, financial accountants mainly

prepare three types of documents—– The balance sheet, which reflects the assets and liabilities;

– Income statement, which shows the profit and loss; and,

– Cash flow statement, which charts the cash inflow and outflow.

• The external users of financial statements look at the– Balance sheet to find out how strong the business is, financially (assets

vs. liabilities), and at the

– Income statement to find out how well the business is doing (profit vs.loss).

• Creditors and other lenders would be happy to see a positivebalance sheet so that they know their investments are safe, andinvestors would like to see an income sheet with profit so thatthey know some money would be coming to them from thecompany in the form of dividend or interest.

• Almost all stakeholders want to see the cash flow statement toknow the cash availability with the company and whether it willbe able to clear its liabilities.

• Among the internal users of financial statements are managers,who can take decisions on the basis of the financial statements,and among the external users are government authorities, whocan initiate tax measures.

Some additional notes on the three financial statements mentioned above.

• Balance sheet: The balance sheet of a company shows its assets,liabilities, and stockholders’ equity as on the last day of theaccounts-reporting period. Assets include cash, stocks, buildings,and machinery, while liabilities include loans, interest, and wages.Stockholders’ equity is the difference between the assets and theliabilities. Read more about balance sheets.

• Income statement: The income statement (issued quarterly orannually) reports the company’s profitability in a given period. Itpresents the revenues (sales and service revenues), expenses(operating expenses, such as wages and rent, and non-operatingexpenses, such as loan interest), gains, and losses. Read moreon Profilt and Loss.

• Cash flow statement: The cash statement shows the inflow andoutflow of cash and its use for operating, financing, and investingactivities. Here are some details on the cash flow statement.

https://www.mbacrystalball.com/blog/finance/balance-sheet/

https://www.mbacrystalball.com/blog/finance/profit-and-loss/

https://www.mbacrystalball.com/blog/finance/cash-flow/

Concepts of Financial AccountingPrinciples of Financial Accounting

» You have done it in First sem….

Financial Accounting Standards

• Most or all of the general principles of accounting apply tofinancial accounting, too. These principles are kept in mind inthe preparation of financial statements under the “GenerallyAccepted Accounting Principles,” or GAAP, followedinternationally.

• In India, financial accounting standards are notified by theMinistry of Corporate Affairs in tune with the guidelines of theInternational Financial Reporting Standards.

Comparison: Financial vs Management vs Cost Accounting

• A final word on financial accounting: it differs frommanagement accounting and cost accounting in that it mainlycaters to external stakeholders, such as investors.

• Management accounting, however, is intended for acompany’s internal use and provides managers with theinformation necessary for taking steps to improve theperformance of their company.

• The objective of cost accounting, which is also an internaltool, is to calculate the cost of production and help managerscome up with cost-reduction ideas.

Title of the course MANAGERIATACCOUNTING AND CONTROL

[ABM-504]


Topic INTRODUCTION-FM

MEANING OF FINANCE

DEFINITION OF FINANCE

DEFINITION OF BUSINESS FINANCE

TYPES OF FINANCE

SCOPE OF FINANCIAL MANAGEMENT

OBJECTIVES OF FINANCIAL MANAGEMENT

APPROACHES TO FINANCIAL MANAGEMENT

FUNCTIONS OF FINANCE MANAGER

IMPORTANCE OF FINANCIAL MANAGEMENT

Unit I



i Disclaimer: The information contained in this note is for general guidance & collected from various direct and indirect sources like websites, blogs, books, articles and open study sources. Author(s) make no representation for any legal responsibility or any other aspect of information contained.

INTRODUCTIONBusiness concern needs finance to meet their requirements in the economic world. Anykind of business activity depends on the finance. Hence, it is called as lifeblood of businessorganization. Whether the business concerns are big or small, they need finance to fulfiltheir business activities.

In the modern world, all the activities are concerned with the economic activities andvery particular to earning profit through any venture or activities. The entire businessactivities are directly related with making profit. (According to the economics concept offactors of production, rent given to landlord, wage given to labour, interest given to capitaland profit given to shareholders or proprietors), a business concern needs finance to meetall the requirements. Hence finance may be called as capital, investment, fund etc., buteach term is having different meanings and unique characters. Increasing the profit is themain aim of any kind of economic activity.

MEANING OF FINANCEFinance may be defined as the art and science of managing money. It includes financialservice and financial instruments. Finance also is referred as the provision of money at thetime when it is needed. Finance function is the procurement of funds and their effectiveutilization in business concerns.

The concept of finance includes capital, funds, money, and amount. But each word ishaving unique meaning. Studying and understanding the concept of finance become animportant part of the business concern.

DEFINITION OF FINANCE

According to Khan and Jain, “Finance is the art and science of managing money”.

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2 Financial Management

According to Oxford dictionary, the word ‘finance’ connotes ‘management of money’.Webster’s Ninth New Collegiate Dictionary defines finance as “the Science on study

of the management of funds’ and the management of fund as the system that includes thecirculation of money, the granting of credit, the making of investments, and the provisionof banking facilities.

DEFINITION OF BUSINESS FINANCE

According to the Wheeler, “Business finance is that business activity which concernswith the acquisition and conversation of capital funds in meeting financial needs and overallobjectives of a business enterprise”.

According to the Guthumann and Dougall, “Business finance can broadly be definedas the activity concerned with planning, raising, controlling, administering of the fundsused in the business”.

In the words of Parhter and Wert, “Business finance deals primarily with raising,administering and disbursing funds by privately owned business units operating in non-financial fields of industry”.

Corporate finance is concerned with budgeting, financial forecasting, cashmanagement, credit administration, investment analysis and fund procurement of thebusiness concern and the business concern needs to adopt modern technology andapplication suitable to the global environment.

According to the Encyclopedia of Social Sciences, “Corporation finance deals withthe financial problems of corporate enterprises. These problems include the financial aspectsof the promotion of new enterprises and their administration during early development,the accounting problems connected with the distinction between capital and income, theadministrative questions created by growth and expansion, and finally, the financialadjustments required for the bolstering up or rehabilitation of a corporation which hascome into financial difficulties”.

TYPES OF FINANCE

Finance is one of the important and integral part of business concerns, hence, it plays amajor role in every part of the business activities. It is used in all the area of the activitiesunder the different names.

Finance can be classified into two major parts:

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Introduction to Financial Management 3

Finance

Private Finance

Public Finance

IndividualFinance

PartnershipFinance

BusinessFinance

CentralGovernment

StateGovernment

SemiGovernment

Fig. 1.1 Types of Finance

Private Finance, which includes the Individual, Firms, Business or CorporateFinancial activities to meet the requirements.

Public Finance which concerns with revenue and disbursement of Government suchas Central Government, State Government and Semi-Government Financial matters.

DEFINITION OF FINANCIAL MANAGEMENTFinancial management is an integral part of overall management. It is concerned with theduties of the financial managers in the business firm.

The term financial management has been defined by Solomon, “It is concerned withthe efficient use of an important economic resource namely, capital funds”.

The most popular and acceptable definition of financial management as given by S.C.Kuchal is that “Financial Management deals with procurement of funds and their effectiveutilization in the business”.

Howard and Upton : Financial management “as an application of general managerialprinciples to the area of financial decision-making.

Weston and Brigham : Financial management “is an area of financial decision-making,harmonizing individual motives and enterprise goals”.

Joshep and Massie : Financial management “is the operational activity of a businessthat is responsible for obtaining and effectively utilizing the funds necessary for efficientoperations.

Thus, Financial Management is mainly concerned with the effective fundsmanagement in the business. In simple words, Financial Management as practiced bybusiness firms can be called as Corporation Finance or Business Finance.

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SCOPE OF FINANCIAL MANAGEMENTFinancial management is one of the important parts of overall management, which is directlyrelated with various functional departments like personnel, marketing and production.Financial management covers wide area with multidimensional approaches. The followingare the important scope of financial management.

1. Financial Management and EconomicsEconomic concepts like micro and macroeconomics are directly applied with thefinancial management approaches. Investment decisions, micro and macroenvironmental factors are closely associated with the functions of financial manager.Financial management also uses the economic equations like money value discountfactor, economic order quantity etc. Financial economics is one of the emergingarea, which provides immense opportunities to finance, and economical areas.

2. Financial Management and AccountingAccounting records includes the financial information of the business concern.Hence, we can easily understand the relationship between the financial managementand accounting. In the olden periods, both financial management and accountingare treated as a same discipline and then it has been merged as ManagementAccounting because this part is very much helpful to finance manager to takedecisions. But nowaday’s financial management and accounting discipline areseparate and interrelated.

3. Financial Management or MathematicsModern approaches of the financial management applied large number ofmathematical and statistical tools and techniques. They are also called aseconometrics. Economic order quantity, discount factor, time value of money,present value of money, cost of capital, capital structure theories, dividend theories,ratio analysis and working capital analysis are used as mathematical and statisticaltools and techniques in the field of financial management.

4. Financial Management and Production ManagementProduction management is the operational part of the business concern, whichhelps to multiple the money into profit. Profit of the concern depends upon theproduction performance. Production performance needs finance, becauseproduction department requires raw material, machinery, wages, operating expensesetc. These expenditures are decided and estimated by the financial departmentand the finance manager allocates the appropriate finance to production department.The financial manager must be aware of the operational process and financerequired for each process of production activities.

5. Financial Management and MarketingProduced goods are sold in the market with innovative and modern approaches.For this, the marketing department needs finance to meet their requirements.


The financial manager or finance department is responsible to allocate the adequatefinance to the marketing department. Hence, marketing and financial managementare interrelated and depends on each other.

6. Financial Management and Human ResourceFinancial management is also related with human resource department, whichprovides manpower to all the functional areas of the management. Financialmanager should carefully evaluate the requirement of manpower to eachdepartment and allocate the finance to the human resource department as wages,salary, remuneration, commission, bonus, pension and other monetary benefitsto the human resource department. Hence, financial management is directlyrelated with human resource management.

OBJECTIVES OF FINANCIAL MANAGEMENTEffective procurement and efficient use of finance lead to proper utilization of the financeby the business concern. It is the essential part of the financial manager. Hence, the financialmanager must determine the basic objectives of the financial management. Objectives ofFinancial Management may be broadly divided into two parts such as:

1. Profit maximization2. Wealth maximization.

Wealth

Profit

Fig. 1.2 Objectives of Financial Management

Profit MaximizationMain aim of any kind of economic activity is earning profit. A business concern is alsofunctioning mainly for the purpose of earning profit. Profit is the measuring techniques tounderstand the business efficiency of the concern. Profit maximization is also the traditionaland narrow approach, which aims at, maximizes the profit of the concern. Profitmaximization consists of the following important features.

1. Profit maximization is also called as cashing per share maximization. It leads tomaximize the business operation for profit maximization.

2. Ultimate aim of the business concern is earning profit, hence, it considers all thepossible ways to increase the profitability of the concern.

Objectives


3. Profit is the parameter of measuring the efficiency of the business concern.So it shows the entire position of the business concern.

4. Profit maximization objectives help to reduce the risk of the business.

Favourable Arguments for Profit MaximizationThe following important points are in support of the profit maximization objectives of thebusiness concern:

(i) Main aim is earning profit.(ii) Profit is the parameter of the business operation.

(iii) Profit reduces risk of the business concern.(iv) Profit is the main source of finance.(v) Profitability meets the social needs also.

Unfavourable Arguments for Profit MaximizationThe following important points are against the objectives of profit maximization:

(i) Profit maximization leads to exploiting workers and consumers.(ii) Profit maximization creates immoral practices such as corrupt practice, unfair

trade practice, etc.(iii) Profit maximization objectives leads to inequalities among the sake holders such

as customers, suppliers, public shareholders, etc.

Drawbacks of Profit MaximizationProfit maximization objective consists of certain drawback also:

(i) It is vague: In this objective, profit is not defined precisely or correctly. It createssome unnecessary opinion regarding earning habits of the business concern.

(ii) It ignores the time value of money: Profit maximization does not consider thetime value of money or the net present value of the cash inflow. It leads certaindifferences between the actual cash inflow and net present cash flow during aparticular period.

(iii) It ignores risk: Profit maximization does not consider risk of the businessconcern. Risks may be internal or external which will affect the overall operationof the business concern.

Wealth MaximizationWealth maximization is one of the modern approaches, which involves latest innovationsand improvements in the field of the business concern. The term wealth means shareholderwealth or the wealth of the persons those who are involved in the business concern.

Wealth maximization is also known as value maximization or net present worthmaximization. This objective is an universally accepted concept in the field of business.


Favourable Arguments for Wealth Maximization

(i) Wealth maximization is superior to the profit maximization because the main aimof the business concern under this concept is to improve the value or wealth ofthe shareholders.

(ii) Wealth maximization considers the comparison of the value to cost associated withthe business concern. Total value detected from the total cost incurred for thebusiness operation. It provides extract value of the business concern.

(iii) Wealth maximization considers both time and risk of the business concern.(iv) Wealth maximization provides efficient allocation of resources.(v) It ensures the economic interest of the society.

Unfavourable Arguments for Wealth Maximization

(i) Wealth maximization leads to prescriptive idea of the business concern but it maynot be suitable to present day business activities.

(ii) Wealth maximization is nothing, it is also profit maximization, it is the indirectname of the profit maximization.

(iii) Wealth maximization creates ownership-management controversy.(iv) Management alone enjoy certain benefits.(v) The ultimate aim of the wealth maximization objectives is to maximize the profit.

(vi) Wealth maximization can be activated only with the help of the profitable positionof the business concern.

APPROACHES TO FINANCIAL MANAGEMENTFinancial management approach measures the scope of the financial management invarious fields, which include the essential part of the finance. Financial management isnot a revolutionary concept but an evolutionary. The definition and scope of financialmanagement has been changed from one period to another period and applied variousinnovations. Theoretical points of view, financial management approach may be broadlydivided into two major parts.

Approach

Traditional Approach Modern Approach

Fig. 1.3 Approaches to Finance Management


Traditional ApproachTraditional approach is the initial stage of financial management, which was followed, inthe early part of during the year 1920 to 1950. This approach is based on the past experienceand the traditionally accepted methods. Main part of the traditional approach is rising offunds for the business concern. Traditional approach consists of the following importantarea.

Arrangement of funds from lending body.Arrangement of funds through various financial instruments.Finding out the various sources of funds.

FUNCTIONS OF FINANCE MANAGER

Finance function is one of the major parts of business organization, which involves thepermanent, and continuous process of the business concern. Finance is one of the interrelatedfunctions which deal with personal function, marketing function, production function andresearch and development activities of the business concern. At present, every businessconcern concentrates more on the field of finance because, it is a very emerging part whichreflects the entire operational and profit ability position of the concern. Deciding the properfinancial function is the essential and ultimate goal of the business organization.

Finance manager is one of the important role players in the field of finance function.He must have entire knowledge in the area of accounting, finance, economics andmanagement. His position is highly critical and analytical to solve various problems relatedto finance. A person who deals finance related activities may be called finance manager.

Finance manager performs the following major functions:1. Forecasting Financial Requirements

It is the primary function of the Finance Manager. He is responsible to estimatethe financial requirement of the business concern. He should estimate, how muchfinances required to acquire fixed assets and forecast the amount needed to meetthe working capital requirements in future.

2. Acquiring Necessary CapitalAfter deciding the financial requirement, the finance manager should concentratehow the finance is mobilized and where it will be available. It is also highly criticalin nature.

3. Investment DecisionThe finance manager must carefully select best investment alternatives and considerthe reasonable and stable return from the investment. He must be well versedin the field of capital budgeting techniques to determine the effective utilizationof investment. The finance manager must concentrate to principles of safety,liquidity and profitability while investing capital.


4. Cash ManagementPresent days cash management plays a major role in the area of finance becauseproper cash management is not only essential for effective utilization of cash butit also helps to meet the short-term liquidity position of the concern.

5. Interrelation with Other DepartmentsFinance manager deals with various functional departments such as marketing,production, personel, system, research, development, etc. Finance manager shouldhave sound knowledge not only in finance related area but also well versed inother areas. He must maintain a good relationship with all the functionaldepartments of the business organization.

Department-I

Department-II

Departm

ent-IIIDep

artm

ent-I

V

Forecasting Funds

Man

agin

gFu

nds

Investing Funds

FinanceManager

Accquring Funds

Fig 1.4 Functions of Financial Manager

IMPORTANCE OF FINANCIAL MANAGEMENT

Finance is the lifeblood of business organization. It needs to meet the requirement of thebusiness concern. Each and every business concern must maintain adequate amount offinance for their smooth running of the business concern and also maintain the businesscarefully to achieve the goal of the business concern. The business goal can be achievedonly with the help of effective management of finance. We can’t neglect the importance offinance at any time at and at any situation. Some of the importance of the financialmanagement is as follows:

Financial Planning

Financial management helps to determine the financial requirement of the business concernand leads to take financial planning of the concern. Financial planning is an important partof the business concern, which helps to promotion of an enterprise.

Acquisition of Funds

Financial management involves the acquisition of required finance to the business concern.Acquiring needed funds play a major part of the financial management, which involvepossible source of finance at minimum cost.


Proper Use of FundsProper use and allocation of funds leads to improve the operational efficiency of the businessconcern. When the finance manager uses the funds properly, they can reduce the cost ofcapital and increase the value of the firm.

Financial DecisionFinancial management helps to take sound financial decision in the business concern.Financial decision will affect the entire business operation of the concern. Because there isa direct relationship with various department functions such as marketing, productionpersonnel, etc.

Improve ProfitabilityProfitability of the concern purely depends on the effectiveness and proper utilization offunds by the business concern. Financial management helps to improve the profitabilityposition of the concern with the help of strong financial control devices such as budgetarycontrol, ratio analysis and cost volume profit analysis.

Increase the Value of the FirmFinancial management is very important in the field of increasing the wealth of the investorsand the business concern. Ultimate aim of any business concern will achieve the maximumprofit and higher profitability leads to maximize the wealth of the investors as well as thenation.

Promoting SavingsSavings are possible only when the business concern earns higher profitability andmaximizing wealth. Effective financial management helps to promoting and mobilizingindividual and corporate savings.

Nowadays financial management is also popularly known as business finance orcorporate finances. The business concern or corporate sectors cannot function withoutthe importance of the financial management.

MODEL QUESTIONS

1. What is finance? Define business finance.2. Explain the types of finance.3. Discuss the objectives of financial management.4. Critically evaluate various approaches to the financial management.5. Explain the scope of financial management.6. Discuss the role of financial manager.7. Explain the importance of financial management.

Title of the course MANAGERIATACCOUNTING AND CONTROL

[ABM-504]


Topic International Financial Reporting Standards

• What is IFRS?

• What is IASB?

• Components of Financial Statements under IFRS

• List of International Financial Reporting

Standards (IFRS)

Unit I

Facultyi LAVEENA SHARMA


International Financial Reporting

Standards The field of financial reporting in India has seen major changes in the last 5 years. As the trade increasingly moves beyond the national boundaries, the compliance and reporting requirements move too. Presenting the financial statements of an entity in accordance with the reporting requirements of every country it has a presence in, is becoming increasingly difficult.

In this article we will deal with the following:

What is IFRS? What is IASB? Components of Financial Statements under IFRS List of International Financial Reporting Standards (IFRS)

What is IFRS? The International Financial Reporting Standards (IFRS) are accounting standards that are issued by the International Accounting Standards Board (IASB) with the objective of providing a common accounting language to increase transparency in the presentation of financial information.

What is IASB? The International Accounting Standards Board (IASB), is an independent body formed in 2001 with the sole responsibility of establishing the International Financial Reporting Standards (IFRS). It succeeded the International Accounting Standards Committee (IASC), which was earlier given the responsibility of establishing the international accounting standards. IASB is based in London. It has also provided the ‘Conceptual Framework for Financial Reporting’

https://cleartax.in/s/ifrs/#What

https://cleartax.in/s/ifrs/#IASB

https://cleartax.in/s/ifrs/#Components

https://cleartax.in/s/ifrs/#International

https://www.iasplus.com/en/resources/ifrsf/iasb-ifrs-ic/iasb

https://www.iasplus.com/en/resources/ifrsf/iasb-ifrs-ic/iasb

issued in September 2010 which provides a conceptual understanding and the basis of the accounting practices under IFRS.

Components of Financial Statements

under IFRS A complete set of financial statements prepared in compliance with the IFRS would ideally comprise of the following:

A statement of financial position as at the end of the period – more commonly known to us as the ‘Balance sheet’.

A statement of profit and loss for the year and the statement of other comprehensive income – Other comprehensive incomewould include those items of income/expense that are not recognized in the profit and loss account to comply with the other relevant standards.

Both these statements may either be combined or shown separately.

A statement of changes in equity – This would include a reconciliation between amounts shown at the beginning and the end of the year.

A statement of cash flows for the period Notes to the financial statements – including a summary of

significant accounting policies followed and other explanatory information

The financial statements would sometimes also include a statement of the financial position of an earlier period in the following scenarios:

When an entity applies an accounting policy retrospectively; When an entity retrospectively restated an item in its financial

statements; or When an entity reclassifies an item in its financial statements.

https://cleartax.in/s/balance-sheet

https://cleartax.in/s/profit-loss-statement

https://cleartax.in/s/other-comprehensive-income

https://cleartax.in/s/other-comprehensive-income

https://cleartax.in/s/cash-flow-statement

https://cleartax.in/s/as-1-disclosure-of-accounting-policies

List of International Financial

Reporting Standards (IFRS) As already discussed, the Standards issued by the IASB are called IFRS. The predecessor body, IASC, had however already issued certain International Standards which are called International Accounting Standards (IAS). These IAS were issued by the IASC between 1973 and 2001. Both IAS and the IFRS continue to be in force. The standards are listed below:

Standard

No.

Standard Title

IFRS 1 First-time Adoption of International Financial Reporting Standards

IFRS 2 Share-based Payment

IFRS 3 Business Combinations

IFRS 4 Insurance Contracts

IFRS 5 Non-current Assets Held for Sale and Discontinue Operations

IFRS 6 Exploration and Evaluation of Mineral Resources

IFRS 7 Financial Instruments: Disclosures

IFRS 8 Operating Segments

IFRS 9 Financial Instruments

IFRS 10 Consolidated Financial Statements

IFRS 11 Joint Arrangements

IFRS 12 Disclosure of Interests in Other Entities

IFRS 13 Fair Value Measurement

IFRS 14 Regulatory Deferral Accounts

IFRS 15 Revenue from Contracts with Customers

IFRS 16 Leases

IFRS 17 Insurance Contracts

IAS 1 Presentation of Financial Statements

IAS 2 Inventories

IAS 7 Statement of Cash Flows

IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors

IAS 10 Events after the Reporting Period

IAS 11 Construction Contracts

IAS 12 Income Taxes

IAS 16 Property, Plant, and Equipment

IAS 17 Leases

IAS 18 Revenue

IAS 19 Employee Benefits

IAS 20 Accounting for Government Grants and Disclosure of Government

Assistance

IAS 21 The Effects of Changes in Foreign Exchange Rates

IAS 23 Borrowing Costs

IAS 24 Related Party Disclosures

IAS 26 Accounting and Reporting by Retirement Benefit Plans

IAS 27 Separate Financial Statements

IAS 28 Investments in Associates and Joint Ventures

IAS 29 Financial Reporting in Hyperinflationary Economies

IAS 32 Financial Instruments: Presentation

IAS 33 Earnings per Share

IAS 34 Interim Financial Reporting

IAS 36 Impairment of Assets

IAS 37 Provisions, Contingent Liabilities, and Contingent Assets

IAS 38 Intangible Assets

IAS 39 Financial Instruments: Recognition and Measurement

IAS 40 Investment Property

IAS 41 Agriculture

i Disclaimer: The information contained in this note is for general guidance & collected from various direct and indirect sources like websites, blogs, books, articles and open study sources. Author(s) make no representation for any legal responsibility or any other aspect of information contained.

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