Segment reporting in a foundry mba finance project report

Segment Reporting in a Foundry (Alucast Foundries Belgaum
Pvt. Ltd.)

Executive Summary

TITLE
Segment Reporting in a Foundry (Alucast Foundries Belgaum Pvt. Ltd.)

NEED FOR THE STUDY
Many enterprises provide groups of products and services or operate in
geographical areas that are subject to differing rates of profitability, opportunities
for growth, future prospects, and risks. Information about different types of
products and services of an enterprise - often called segment information - is
relevant to assessing the risks and returns of a diversified and/or multi-location
enterprise but may not be determinable from the aggregated data. Therefore,
reporting of segment information is widely regarded as necessary for meeting the
needs of users of financial statements.

OBJECTIVES OF THE STUDY
• To study the foundry (Alucast Foundries Belgaum Pvt. Ltd.)
• To study and understand AS 17 and its applicability to a foundry
• To segment P&L account as per AS17
• To calculate profitability of each segment

SCOPE OF THE STUDY
The study is confined to Alucast Foundries Belgaum Pvt. Ltd. It is a study
describing the Segment Reporting system, wherein the profit and losses generated
by every segment would be studies to provide a detailed segment report in order
to understand which of the product categories is actually doing well.

BABASAB PATIL Page 1

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SAMPLE DESIGN
The study of the Segment reporting technique with regards to Alucast Foundries
Pvt. Ltd. is based on Secondary data. The secondary data is taken from published
material.

METHODOLOGY
• Calculate investment, cost and revenue for major product categories
• Identify segments in the set up
• Calculate profitability on each of the segments
• Conclude
- Which of the product categories is actually doing well and which is not
- If segment reporting is beneficial for such organizations as Alucast

LIMITATIONS
1. The time allotted to undergo the concurrent project was not sufficient to study
all the aspects of the organization.
2. There is no compulsion to maintain the books of accounts with regards to
costing records according to the law for small scale industries, therefore the
study got limited to available raw information.
3. The Accounting Standard 17 is not mandatory for the organization hence data
regarding different segments got limited to the available information.
4. The quantity details obtained are approximated values as the accurate quantity
details at different stages are difficult to asses without the maintenance of
records at every stage of the process of casting.
5. The study done in the project is purely for academic purpose only.


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RESULTS
As per the PAT values in the segment report the first segment Ventilated Disc
appears to be performing better than the other two segments. Alucast needs to do
some analysis on the Flywheel segment in order to see that all the segments are
performing as per their plans.

SUGGESTIONS
Segment reporting system should be installed in the day to day accounting of
companies irrespective of whether it is mandatory or not.

FUTURE SCOPE
The System of segment reporting has been experimented on only one of the
locations of Alucast Industries. The study may be continued to include all the
geographic segments
INDEX

PAGE
CHAPTER PARTICULARS NO.

Acknowledgement

Executive Summary

I A brief history of metal forming 1

II Foundry Industry 3

III Company Profile 4
Introduction
Share holders
Esteemed customers
Registered office and works


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Plant and Machinery used
Hours and environment
Skills and personal qualities

IV Process flow for the production of casting 8
Casting
Sand Casting
Design
Pattern making
Mould making
Machine moulding
Hand moulding
Core making
Melting and pouring
Pouring
Shot blasting, fettling and painting

V Cost Accounting 17
Introduction
Scope of cost accounting
Objectives of cost accounting
Advantages of cost accounting
Limitations of cost accounting
Traditional costing today
Job Costing

VI Accounting Standard and Financial Statements 27
Introduction
Objectives of Accounting Standards
Advantages of Accounting Standards
Disadvantages of Accounting Standards
Objectives and funtions of the Accounting Standards Board
Rationale of Accounting Standards
International harmonization of Accounting Standards
Accounting Standards setting in India
Composition of Accounting Standards Board
The Accounting Standards setting process


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Present status of Accounting Standards in India in
harmonization with the International Accounting Standards
Compliance with Accounting Standards
Objective of Financial Statements
Financial Position, Performance and Cash
Notes and Supplementary Schedules
Elements of Financial Statements
Financial Position
Assets
Laibilities
Equity
Performance
Income
Expenses
Capital maintenance adjustments
Recognition of the elements of financial statements
The probability of future economic benefits
Reliability of measurement
Recognition of Assets
Recognition of Liabilities
Recognition of Income
Recognition of Expenses

VII Accounting Standard (AS-17) 50
Segment Report
Objectives
Scope
Definition
Identifying reportable segments
Business and Geographical Segments
Reportable Segments
Segment accounting policy
Disclosure
Primary reporting format
Secondary segment information
Illustrative segment disclosures (Other Disclosures)
Illustrative I (Determination of Reportable Segments)


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Illustrative II (Segment Report)
Illustrative III (Summary of Required Disclosure)
A diagrammatic representation of segment reporting

VIII Calculations and Segment Report 85
Cost Sheet
Calculation of Profit after Tax
Segment Report

IX Conclusion 88

References and Bibliography 89

CHAPTER I
A Brief History of Metal Forming

The earliest human being inhabited the earth over 100,000 years ago.
Archaeological studies have revealed that he had already discovered the
phenomenon of fire and learnt to use it for his own benefit. Surprisingly it took
him another 95 thousand years before he discovered how to use fire to extract
metal from the earth’s crust and put it to use. Initially metals were used for
adornment – combs, necklaces and bracelets for example, which were made from
gold and silver, the easiest of metals to extract from their ores. Then he
discovered the more common and useful copper, which he learned to harden by
alloying it with other metals to form bronze. The Greeks and the Romans in the
centuries immediately before Christ became the first true masters of the art of
casting metal; their beautiful bronze sculptures, coins, ornaments and utensils are
the legacies we continue to admire. Last of all came iron, the most common metal
but the most difficult to work, Unlike the other metals whose relatively low
melting points allowed them to be cast in moulds, iron had to be forged, that is
heated to make it soft and then beaten into the necessary shapes. It was to be
several hundred years before the discovery of a method of attaining temperatures
sufficiently high to keep iron molten long enough to cast into shapes.


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Nevertheless the Iron Age was truly the beginning of history. When man learned
to shape this metal he began to transform life. For the first time he had made
himself materials that could perform miracles in providing tools, utensils and
weapons and, in the distant future, machines.
In 1709 Abraham Darby developed coke at Coalbrookdale, very often regarded as
the birthplace of the industrial revolution. In fact if it were not for coal and the
skill of iron casting it may not have been a revolution – just a prolonged
evolution. It was the coke used to smelt iron that gave the great inventors the
material from which they could make their machines, the most revolutionary
being the steam engine developed by James Watt in the 1760’s. In 1780 the world
saw its first iron bridge made from cast material; then over the turn of the century
the great iron works really came into their own as steam was harnessed to power
iron locomotives and ships. Thousands of miles of cast iron railways were laid
and scores of iron bridges were built across rivers and straits. Steel, which had
been made in relatively small amounts since 1733 when Benjamin Huntsman
developed his crucible process, suddenly became freely available when Sir Henry
Bessemer invented his famous converter in 1855 which made large scale
production possible.
Electric motors, motor cars, diesel engines, underground railways, photography,
the wireless, the computer; all appeared in this most inventive of centuries, On the
domestic front vacuum cleaners, water closets, bicycles and scores of other
products were invented. And the men of metal contributed their skills to them all.
The twentieth century opened up with the first successful powered flight and the
introduction of the mass production of motor cars. Techniques of metal casting
changed to cater for the enormous demands of these new industries and more so
when, within a few years, both modes of transport were being used in the first all-
metal war between 1914 and 1918. Aluminium, introduced to the metal industry
in 1909, provided the strong lightweight material that was to satisfy man’s long
time universal yearning to fly. Ultimately its derivatives opened up the very
heavens for him. Space exploration commenced in the 1950’s, man landed on the


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moon in 1969 and countless satellites and space probes were projected into the
universe. Once again the art of metal molding came into its own as an essential
part of the aerospace industry.
Today the casting industry contributes to information technology, food
production, telecommunications, nuclear power and world finance. It can be
confidently predicted that as the human race continues its progress, whatever new
materials are utilized, the casting industry will be there to serve it. Whoever enters
the metal casting business today will doubtless help to take it into its seventh
millennium as possibly man’s oldest and most essential skill.

CHAPTER II
Foundry Industry

Since the days of the first horseless carriage, engineers have relied upon the
metal-casting process to power, control and stabilize their ever-demanding
vehicles. The automobile depends on castings, from the engine to the brakes. It
also presents a platform for casting design to shine.
The ability of fluid to assume the shape of its container is exploited by casting
processes, which involve melting and pouring liquid metal into a sand or metal
mould and allowing it to solidify, yielding a shape close to that of the desired
product. Metal casting continues to be the preferred process for intricate shapes of
any size and weight with varying wall thickness and internal features. The flow of
molten metal in the mould and subsequent solidification affect casting quality.
This can be controlled by appropriate design of the mould, including the cavities
corresponding to the casting, gating channels and feeders.
The Indian Foundry Industry occupies a special place in shaping the country’s
economy. India is currently among the 10 largest producers of ferrous and non-
ferrous castings and has over 6500 foundries in the small, medium, and large


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scale sectors. Approximately 90% are in the small scale. India exports annually
above Rs.700/- crores worth of castings to countries like USA, U.K., Canada,
Germany etc.
The future holds great promise for the metal casting industry. New advances have
allowed the industry to employ materials such as aluminum, magnesium,
titanium, zinc, advanced copper- based, and advanced ferrous alloys to produce
thin wall, high-strength castings with higher precision castings and more complex
shapes. But to remain competitive and maintain a viable domestic industry,
challenges must be overcome in industry recognition, casting design, processing
efficiency, and employment attractiveness.

CHAPTER III
Company Profile

INTRODUCTION
Alucast Foundries Belgaum Pvt. Ltd. Established in 1996. Alucast Foundries is
the major driving force behind the smooth and trouble free wheeling of the
country’s passenger cars. One of the largest and specialized manufacturers of
brake discs for passenger cars. Alucast Foundries specializes in the high precision
product. The Brake discs are of the solid and ventilated type and are supplied in
either fully finished or semi-finished forms. The proved technology for porosity
free castings has been put to use, along with less than 5% Ferrite control and
absence of carbides. Advanced CNC machines provide a fine finish to all
castings. Fly Wheels and Pressure Plates for Clutches, ranging from 4 to 40 kgs.
in weight, are the other major products in this category. Alucast Foundries
supplies different grades of brake discs viz. fG 250, GH 190, GGG25 stc.
This specialized field of casting has, off late, become a routine- part and parcel –
of the product range of Alucast foundries. With the best technology and expert


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manpower, a wide range of products in the category have been instrumental in the
smooth operations of many a core sector. Alucast Foundries maintain a
modularity of more than 85 % well formed nodules and controlled proportions of
Pearite and Ferrite in the available matrix, are the basic of this flawless quality
castings.
Various grades such as 400/12, 400/15, 450/15, 500/7, 600/3 and 700/2 are among
the casting manufactured. A wide product range pertaining to international
standards is a silent feature of Alucast Foundries. Hubs, End Collars and other
castings for Earth moving machinery, adhering to DIN, BS, IS and ASTM have
been making their mark in the domestic as well as the overseas markets.
Area covered: 4 acres; Built up area: 30,000 sq. feet
Power consumption: 650 kilo watts
Installed capacity: 3000 MT
Working capital: 1,20,00,000; Export credit: 80,00,000
ISO: July 2000; ISO Technical Specification certificate: September 2004
Total share holding: 52,00,000

SHARE HOLDERS
1. Mr. Sanjay Bichu (MD)
2. Mrs. Purnima Bichu (DIR)
3. Mr. V.G. Kulkarni (DIR)
4. Mr. Gopal Bichu
5. Mrs. Sudha B. Bichu
6. Dr. Mrs. Hema Kulkarni
7. Mr. Nikhil Kulkarni

ESTEEMED CUSTOMERS
• Kalyani Brakes Ltd.
• BCSIL, Jalagaon
• Axletech, UK


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• ITM
• L&T Komatsu
• NGEF
• ILJIN Automotive Pvt. Ltd.

REGISTERED OFFICE AND WORKS
Office: Works:
B/16 KSSIDC Ind. Estate, 664/2 Waghwade Road,
Angol Belgaum Village Mache, Belgaum
India – 590008 India – 590014
Phone No.: 2440967, 5202029 Phone No.: 2411491
Fax No. : 2441098
Email : alucast@sanharnet.in
PLANT AND MACHINERY USED
• Sand mixer & Muller
• Molding machine
• Sand cooler
• Conveyer
• Core making machine & core oven
• Cupola
• Spectrometer (Alloy Testing meter)
• Induction furnace
• Automatic pouring machine
• Shot blasting
• CNC lathe


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HOURS AND ENVIRONMENT
Foundry process operators usually work 48 hours a week, often on a shift system,
which can include evenings and weekends. Overtime is likely to be available.
Foundries are not the dirty, dusty places they used to be and most have fume and
dust extractors. However, the furnace area is hot, and some processes still cause a
certain amount of dust. The use of lifting equipment has taken some of the hard
physical effort out of the work. Foundries can be dangerous places, and foundry
process operatives wear safety clothing including overalls, safety shoes, hard hats,
eye shields, earplugs and gloves.

SKILLS AND PERSONAL QUALITIES
Foundry process operators need
• to be good with their hands
• good hand-to-eye co-ordination
• a steady hand to carry out delicate work
• good communication skills
• the ability to work under supervision
• to work well as part of a team
• a flexible attitude to do a range of different jobs
• a serious attitude to safety issues
• good physical fitness.


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CHAPTER IV
Process flow for the production of casting

CASTING
Casting is a method for creating one or more copies of an original piece of
sculptural (three-dimensional) artwork. Casting is a manufacturing process, in
which we pour molten metal in the pre-made mould; mould may be of sand or of
metal, and let it be solidified. After solidification and removal of the mould the
metal takes the desired shape. Four main elements are required in the process of
casting pattern, mold, cores, and the part. The pattern, the original template from

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which the mold is prepared, creates a corresponding cavity in the casting material.
Cores are used to produce tunnels or holes in the finished mold, and the part is the
final output of the process.

SAND CASTING
Sand casting, which in a general sense involves the forming of a casting mold
with sand, includes conventional sand casting and evaporative pattern (lost-foam)
casting. In sand casting, re-usable, permanent patterns are used to make the sand
moulds. The preparation and the bonding of this sand mould are the critical step
and very often are the rate-controlling step of this process. Two main routes are
used for bonding the sand moulds:
u The "green sand" consists of mixtures of sand, clay and moisture.
The "dry sand" consists of sand and synthetic binders cured thermally or
chemically.
In conventional sand casting, the mold is formed around a pattern by ramming
sand, mixed with the proper bonding agent, onto the pattern. Then the pattern is
removed, leaving a cavity in the shape of the casting to be made. If the casting is
to have internal cavities or undercuts, sand cores are used to make them. Molten
metal is poured into the mold, and after it has solidified the mold is broken to
remove the casting. In making molds and cores, various agents can be used for
bonding the sand. The agent most often used is a mixture of clay and water.
Casting quality is determined to a large extent by foundry technique. Proper
metal-handling practice is necessary for obtaining sound castings. Complex
castings with varying wall thickness will be sound only if proper techniques are
used.

DESIGN
The first production step for all castings takes place in the design office where
ideas are converted into manufacturing drawings which guide the production team
to create the solid metal end products. Designers need a wealth of information


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before they reach for their set squares. The specified shape and size of the final
product is obviously needed but with metal casting the designers needs to know
what stresses and conditions the products will have to withstand so that the
correct metal can be chosen. They will need to know how many castings are
needed. All these factors dictate which molding techniques to choose.

PATTERN MAKING
Once the customer and the rest of the production team have approved the design,
a pattern or model is made. This can be produced in wood, metal or plastic or
from a combination of all three. Patterns must be precise in their shape and finish,
for any mistakes are reproduced in the moulds which are made from them and
from which the final castings are formed. They must be made to allow for the
shrinkage of the metal when it cools and they can include channels to allow metal
to flow into the casting shape. From the initial pattern a prototype or production
sample is usually made with which the customer can experiment to ensure that the
final casting will be exactly as required.

MOULD MAKING
The next manufacturing step is moulding in which the pattern is packed in a
moulding material, usually some type of sand, and then removed to leave the right
shape for the casting. Moulds can be made by hand, or machine. In one casting
process the mould is made from a heat resistant metal. Moulds are usually made
in at least two parts and for very large castings they may even start out as large
holes dug into the sand floor of the foundry. Different types of sand are used for
moulding with additives like water and clay and various chemicals, depending on
the size of the mould and the types of metal that are being cast. One important
feature of the mould is the running system which is a network of small channels


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that leads the molten metal down into the casting shape. The shapes and sizes of
these channels have to be carefully calculated to ensure that the molten metal does
not solidify before it gets to the casting shape and to make sure that it does not
flow too fast when it could wear away the mould. Many castings are designed to
have cavities in them – engine blocks, for example. These voids, which have to be
as accurate as the outer moulds, are made by forming their shape in moulding
material. The shapes, or cores as they are known, are placed in the mould and
after the molten metal has solidified, the core material is removed leaving a
precisely shaped cavity behind.
For mould preparation as per production plan a mixture of sand charge which
contains system sand, new sand, bentonite, CL4 and dextrin is collected in the
bucket. The bucket is raised and the sand is unloaded into the muller. Sand is
mixed for two minutes in dry condition with 5-15 liters of water in the muller.
Next the sand is mixed for three minutes in wet condition. After this process is
completed the sand sample is measured and once the sample is qualified as per the
required standards the mixture is dropped into the hopper.

MACHINE MOULDING
To make green sand moulds on the machine.
1. Take inspected pattern and moulding pins from pattern shop
2. Fit pattern on machine with moulding pins and clean the pattern with diesel
spray and plumbago powder.
3. Place first box on match plate and sieve on it. Take some initial system sand
and sieve it through sieve. Remove sieve.
4. Fill the half box with system sand and jolt. Place the spruce cup on position
(for top box moulding only).


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5. Do jolting and ram the sand with pneumatic hand rammer.
6. Fill full box with sand and jolt. Squeeze the sand and do simultaneous jolting.
7. Remove spruce cup from top box and do random venting.
8. Lift the box with lifting rods and remove it from machine with electrical hoist.
9. Before keeping bottom box on pallet, clean pallets thoroughly. Clean the
bottom box mould with air. Place the stained core as specified and cores for
cored items.
10. Make proper venting for top box, clean it with air and close the box.
11. Insert the closing pins into box bushes.
12. Mark the box with heat number and serial number with chalk. Move the box
for pouring.

HAND MOULDING
To make green sand moulds and CO2 sand moulds manually.
a) Green sand hand moulding
1. Take inspected pattern, propagating system for loose patterns and moulding
pins from pattern shop.
2. Select proper sized boxes and moulding pins.
3. Place pattern on ground and box on it. Clean the pattern with air and apply
diesel and plumbago powder.
4. Cover the patter with green sand mix upto 30-40 mm approximately an dram
it properly.


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5. Cover this sand with baking sand and ram it properly till box fills completely.
6. Make proper venting and scrape the surface to remove access sand if any.
7. Repeat the procedure for top box moulding. For loose pattern moulding turn
the bottom box moulded with pattern and then mould the top box on it.
8. Remove pattern from mould.
9. Close the boxes for pouring.
b) CO2 sand moulding
1. Take inspected pattern, propagating system for loose patterns and moulding
pins from pattern shop.
2. Select proper sized boxes and moulding pins.
3. Place pattern on ground and box on it. Clean the pattern with air and apply
diesel and plumbago powder.
4. Cover the patter with green sand mix upto 30-40 mm approximately and dram
it properly.
5. Cover this sand with baking sand and ram it properly till box fills completely.
6. Make proper venting and scrape the surface to remove access sand if any.
7. Pass CO2 gas through the vents for half minute approximately per vent.
8. Repeat the procedure for top box moulding. For loose pattern moulding, turn
the bottom box moulded with pattern and then mould the top box on it.
9. Remove pattern from mould.
10. Paint the moulds with spirit paint by spraying.
11. Heat the moulds with diesel or LPG burners.
12. After cooling close the boxes.

CORE MAKING
Good core making begins with high quality core sand preparation. The
preparation of cores from sand mixer consists of the following procedure
Preparation of sand mix for core making on compax machine:


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Take 20 kgs. of dry sand of AFS number 50-55. Add 0.2 to 0.25 kg of Resin and
mix manually for 2-3 minutes. Add 0.2 to 0.25 kg. of binder and mix manually for
3-4 minutes. Feed the sand into hopper.
Preparation of sand mix for oil and CO2 core making:
Oil sand core: Take 140 kgs. of new sand of AFS number 60-65 in sand muller.
Add 4.5 to 5 liters of core oil and mix it for 6 minutes. Add 4.5 to 5 kgs. of
dextrin. 2.5 to 3 kgs. of Bentonite and mix for 6 minutes. Add 0.5 to 1.5 liters of
water in sand and mix for 3 minutes.
CO2 sand core: Take 140 kgs. of dry sand of AFS number 50-55. Add 10 kgs. of
sodium silicate and mix it for 12 minutes.
Preparation of cold box cores on compax machine:
Take the inspected core boxes from pattern shop. Install the core box on the
machine with proper fittings. Operate the cycle from control panel. Take out the
core from the machine. The core hardness should be 5% with scratch hardness
tester, within 75 to 95.
To prepare CO2 and oil sand cores from sand mix:
a) Oil sand core:
1. Take the inspected core box from pattern shop.
2. Take the sand mix.
3. Fill core box with sand mix and ram with wooden rammer.
4. After ramming scrap the excess sand from top surface.
5. Make the proper venting in core.
6. Remove the core from core box and keep them batch wise.
7. Heat the cores batch wise in oven to remove moisture.
8. Paint the cores with spirit paint if applicable.
b) CO2 sand core:
1. Take the inspected core box from pattern shop.
2. Take the sand mix.
3. Fill core box with sand mix and ram with wooden rammer.
4. After ramming scrap the excess sand from top surface.


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5. Make the proper venting in core.
6. Pass the CO2 gas from the vents for half minute per vent.
7. Remove the core from core box and keep them batch wise.
8. Paint the cores with spirit paint by spray painting.
9. Heat the cores with the help of diesel/ LPG burner.

MELTING and POURING
To operate the furnace for MELTING metal:
1. Switch on the power supply to the furnace.
2. Take the furnace charge as per the charge sheet and melt it in furnace.
3. Slowly increase the power supply to full rating. Add the alloys into furnace as
per charge sheet for alloy addition add CI boring about 25-30 kgs. if available.
4. Spread slag power over molten metal surface and remove slag.
5. Pour the sample in CE cup for checking C and Si %.
6. Pour one sample in die for spectrometer analysis
7. Pour one chill before inoculation and another after inoculation.
8. Spread slag powder over molten metal surface and remove slag.
9. Mg. treatment for SG iron: add 5.5 kgs. of FeSiMg and 2-3 kgs. CRC
punching at the bottom of treatment ladle. Place cover and clamp it. Pour the
metal.

POURING
There are two ways of pouring metal. Manually pouring and poring with the help
of ladle. To prepare ladle for pouring scrap clean the ladle completely. Take
silicate 10 kgs., sand 140 kgs. and Bentonite 1 kg. Apply thin layer of sodium
silicate from inside ladle. Make the lining of sand approximately 25 mm. with flat
wooden rammer. Make spout of 25-30 mm on one side. Make spout mouth at the
bottom 40-50 mm in length, 15-20 mm in width. Spray sprit paint on lining. Heat
the ladle with diesel or LPG burner to remove moisture.


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SHOT BLASTING, FETTLING & PAINTING:
Shot blasting: Load the castings on hanger 300 to 350 kgs. push the hanger inside
the machine and close the door tightly. Start the machine and timer. After time is
over, pull the hanger out from the machine. Remove castings and hand over to
fettling.
Fettling: Remove all the excess material from castings by chipping and grinding.
Painting: Apply rust preventive polymer paint to the non-machining areas of the
casting.

In today's competitive market, you can't afford to miss the savings and
technical advantages from reclamation.
Modern foundries demand optimized control over molding sand preparation in
order to minimize costs and maximize the performance of the molding sand
preparation system. Tightly controlled sand properties allow for low-defect, high-
quality mold and casting production. For optimal performance, molding sand
control must begin long before final mulling. Molding sand at shakeout can have
wide variations in temperature, moisture content, and physical properties. Hot
sand leads to casting scrap, mixing inefficiency, material handling and
environmental problems. Precise control over final sand preparation demands
that between shakeout and final mulling, the return sand is lowered in temperature
and homogenized.
Sand is the largest foundry process waste, typically constituting about 70% of
total waste volume. Fortunately, most foundry sands are reclaimable and can be
effectively reused.

The basic reasons for reclaiming sand
It's Cost Saving: The costs of molding and core sand continue to increase
significantly and cut into foundry profitability. To lower the cost of producing a
casting foundries desire to reduce total sand cost which includes the purchase


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cost, delivery cost, unloading, storing, handling and disposal costs including, in
some instances, ever more expensive landfill fees.
It's Environmentally Responsible: Environmentally, it's becoming increasingly
more difficult to dispose of great quantities of waste sand into a landfill.
It Has Technical Advantages: Technically, reclamation is of interest because
many foundries report that better castings can be made at lower costs, from
reclaimed sand

CHAPTER V
Cost Accounting

INTRODUCTION
Cost Accounting is the classifying, recording and appropriate allocation of
expenditure for the determination of the costs of products or services, and for the


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presentation of suitably arranged data for purposes of control and guidance of
management. It includes the ascertainment of the cost of every order, job,
contract, process, service or unit as may be appropriate. It deals with the cost of
production, selling and distribution, it is the provision of such analysis and
classification of expenditure as will enable the total cost of any particular unit of
production or service to be ascertained with reasonable degree of accuracy and at
the same time to disclose exactly how such total cost is executed so as to control
and reduce its cost.
Thus, Cost Accounting relates to the collection, classification, ascertainment of
cost and its accounting and control relating to the various elements of cost. It
establishes budgets and standard costs and actual cost of operations, processes,
departments or products and the analysis of variances, profitability and social use
of funds.
Cost Accounting is the application of costing and cost accounting principles,
methods and techniques to the science, art and practice of cost control and the
ascertainment of profitability. It includes the presentation of information derived
there from for purposes of managerial decision-making. Thus ‘Cost Accountancy
is the science, art and practice of a cost accountant’. It is a science because it is a
body of systematic knowledge having certain principles which a cost accountant
should posses for proper discharge of his responsibilities. It is an art as it requires
the ability and skill with which a cost accountant is able to apply the principles of
cost accountancy to various managerial problems. Practice includes the
continuous efforts of a cost account in the field of cost accountancy. Such efforts
also include the presentation of information for the purpose of managerial
decision-making and keeping statistical records.

SCOPE OF COST ACCOUNTING
1. Cost Ascertainment: It deals with the collection and analysis of expenses, the
measurement of production of the different products at the different stages of
manufacture and the linking up of production with the expenses.


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2. Cost Accounting: It is the process of accounting for cost which begins with
recording of expenditure and ends with the preparation of statistical data. It is
a formal mechanism by means of which costs of products and services are
ascertained and controlled.
3. Cost Control: Cost Control is the guidance and regulation by executive
action of the costs of operating and undertaking. It aims at guiding the actual
towards the line of targets; regulates the actuals if they deviate or vary from
the targets; this guidance and regulation is done by an executive action.

OBJECTIVES OF COST ACCOUNTING
The Objectives of cost accounting are ascertainment of cost, fixation of
selling price, proper recording and presentation of cost data to the management
for measuring efficiency and for cost control. The aim is to know the methods by
which expenditure on materials, wages and overhead is recorded, classified and
allocated so that the cost of products and services may be accurately ascertained;
these costs may be related to sales and profitability may be determined.
a. To ascertain the cost per unit of the different products manufactured by a
business concern.
b. To provide a correct analysis of cost both by processes or operations and by
different elements of cost.
c. To disclose sources of wastage whether of material, time or expense or in the
use of machinery, equipment and tools and to prepare such reports which may
be necessary to control such wastage.
d. To provide requisite data and serve as a guide to price fixing of products
manufactured or services rendered.
e. To ascertain the profitability of each of the products and advise the
management as to how these profits can be maximized.
f. To exercise effective control of stocks of raw materials, work-in-progress,
consumable stores and finished goods in order to minimize the capital locked
up in these stocks.


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g. To reveal sources of economy by installing and implementing a system of cost
control for materials, labor and overheads.
h. To advise management on future expansion policies and proposed capital
projects.
i. To prevent and interpret data for management planning, decision-making and
control.
j. To help in the preparation of budgets and implementation of budgetary
control.
k. To organize an effective information system so that different levels of
management may get the required information at the right time in right form
for carrying out their individual responsibilities in an effective manner.
l. To guide management in the formulation and implementation of incentive
bonus plans based on productivity and cost savings.
m. To supply useful data to the management to take various financial decisions
such as introduction of new products, replacement of labor by machine etc.
n. To help in supervising the working of punched card accounting or data-
processing through computers.
o. To organize the internal audit system to ensure effective working of different
departments.
p. To organize cost reduction programs with the help of different-departmental
managers.
q. To provide specialized services of cost audit in order to prevent the errors and
frauds and to facilitate prompt and reliable information to the management.
r. To find out costing profit or loss by identifying with revenues the cost of those
products or services by selling which the revenues have resulted.

ADVANTAGES OF COST ACCOUNTING
1. Helps in optimum utilization of men, material and machine.
2. Identifies the areas requiring corrective actions.
3. Helps management in formulation of policies.


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4. Presents a tailor-made solution for the problem.
5. Helps management in making short-term decisions by use of techniques like
marginal costing, etc.
6. Provides useful data for final accounts by giving cost of closing stock of raw-
materials, work-in-progress and finished products.
7. Provides a data base for reference by government, wage tribunals and trade
unions.
8. Helps in formation of cost centers and responsibility centers to exercise
control
9. Helps to face increasing difficulties in setting prices and improving efficiency.
10. Facilitates use of specialized techniques like cost reduction, value analysis,
operations research and management by exception.
11. Threads its way through every phase of business and influences the make-up
of the entire enterprises with regards to its products, its market and its
methods of operation.
12. Focuses attention on the profitability of each product and service unlike
financial accounting, which presents profitability for company as a whole.

LIMITATIONS OF COST ACCOUNTING
The limitations of cost accounting system are -
1. It is not an exact science and involves inherent element of judgement.
2. Cost varies with purpose. Therefore, cost collected for one purpose will not be
suitable for another purpose.
3. Cost accounting presents the base for taking the best decision. It does not give
outright the solutions of the problems.


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4. Most of the cost accounting techniques are based on some pre-assumed
notions.
5. The area most vulnerable to criticism is coat accounting is arbitary
apportionment of common costs.
6. Different views are held by different cost accountants about the items to be
included in cost.

Can cost professionals overcome cost accounting limitations?
The answer can be Yes and No depending upon what you are looking for.
The job of a cost professional is to dovetail cost accounting information to suit
management objective. There may be so many factors detailed above which can
limit quality of his information. However this does not mean that cost accounting
and cost professional fail in their objective to provide accurate cost estimation.
The role of cost professional is to identify, collect, measure, analyze,
prepare and interpret cost accounting information intended for specific use by the
management. There are so many different tools available in cost accounting,
which over the period have helped industry to perform in a better way and base
their decisions on information generated by the cost professionals. It is the
selection of right mix of tools and experience which can be instrumental in
reducing impact of the limitations and optimize effectiveness of the cost
accounting in general and a cost professional in particular.

TRADITIONAL COSTING TODAY
Despite the fact that it is over 75 years old, most companies still use
standard cost systems both to value inventory for financial statement purposes and
for many other management purposes as well. While it has some advantages for
financial statement purposes (simplicity, consistency, well understood by
auditors), it is, at best, meaningless and, at worst, misleading as a tool to assist in


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making effective management decisions. It’s because the business case for which
it is being used today is not the business case for which it was designed. Standard
cost accounting was designed for a company that had:
1) Homogeneous products,
2) Large direct costs compared to indirect costs,
3) Limited ability to collect data and
4) Low "below the line" costs.
Today’s company typically has:
1) A wide variety and complexity of products and services,
2) High overhead costs compared to direct labor,
3) An overabundance of data and
4) Substantial non product costs that can dramatically affect true product,
distribution channel and customer profitability.
The typical manufacturing company is still arbitrarily attaching overhead to
products using Direct Labor as the driver. They are often allocating the largest
cost (overhead) based on the smallest (direct labor). Because of product variety
and product line complexity, one homogeneous overhead rate is no longer an
appropriate average.
Finally, today, we have high tech, high speed data collection and reporting tools.
With the proper system, gathering and manipulation of data in multiple complex
ways is no longer an issue. With these tools at the disposal of a business
organization, why still use a cost accounting system that was developed over 70
years ago? With the advent of certified financial statements, accounting systems
became more structured to comply with the demands of external stakeholders
(e.g. shareholders, governments, lenders, etc.) and the purpose of cost accounting
systems changed along with the rest of accounting. The primary purpose of cost
accounting in the financial accounting system today is to value inventory for
financial statement purposes, not, as it was in 1924, a tool to aid in sound business
decisions.


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JOB-ORDER COSTING
Job-order costing is used when different types of products, jobs, or batches are
produced, typically over a rather short period of time. In a job-order costing
system, direct materials costs and direct labor costs are usually "traced" directly to
jobs. Overhead is applied to jobs using a predetermined rate. Actual overhead
costs are not "traced" to jobs. Examples of industries in which job-order costing is
used include special order printing, shipbuilding, construction, hospitals,
professional services such as law firms, and movie studios. Each job has its own
job cost sheet on which are recorded the costs that have been charged to the job.
The job cost sheet will have some code or descriptive data to identify the
particular job and will contain spaces to collect costs of materials, labor, and
overhead. When a job is started, materials that will be required to complete the
job are withdrawn from the storeroom. The document that authorizes these
withdrawals and that specifies the types and amounts of materials withdrawn is
called the materials requisition form. The materials requisition form identifies the
job to which the materials are to be charged. Care must be taken when charging
materials to distinguish between direct and indirect materials. Labor costs are
recorded on a document called a time ticket or a time sheet. Each employee
records the amount of time he or she spends on each job and each task on a time
ticket. The time spent on a particular job is considered direct labor and its cost is
"traced" to that job. The cost of time spent on other tasks, not traceable to any
particular job, is usually considered part of manufacturing overhead.
Manufacturing overhead includes all of those costs incurred in the manufacturing
process which are not "traced" to a particular job. In practice, manufacturing
overhead usually consists of all manufacturing costs other than direct materials
and direct labor. Since manufacturing overhead costs are not traced to jobs, they
must be allocated to jobs if absorption costing is used.

Overview of Cost Flows


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The basic flow of costs in a job-order system begins by recording the costs of
material, labor, and manufacturing overhead.
a. Direct material and direct labor costs are debited to the Work in Process
account. Any indirect material or indirect labor costs are debited to the
Manufacturing Overhead control account, along with any other actual
manufacturing overhead costs incurred during the period. Manufacturing
overhead is applied to Work in Process using the predetermined rate. The
offsetting credit entry is to the Manufacturing Overhead control account.
b. The cost of finished units is credited to Work in Process and debited to the
Finished Goods inventory account.
c. When units are sold, their costs are credited to Finished Goods and debited to
Cost of Good Sold.

The Manufacturing Overhead Control Account
Manufacturing Overhead is a temporary control account.
a. As stated above, actual overhead costs are recorded on the debit side of the
Manufacturing Overhead control account. Overhead costs applied to Work in
Process using predetermined rates are recorded on the credit side of the
account.
b. Any discrepancy between overhead costs incurred and overhead costs applied
shows up as a balance in the Manufacturing Overhead control account at the
end of the period. A debit balance is called under applied overhead and a credit
balance is called over applied overhead.

Under- and over applied Overhead
Since the predetermined overhead rate is based entirely on estimated data, there
will almost always be a difference between the actual amount of overhead cost


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incurred and the amount of overhead cost that is applied to the Work In Process
account. This difference is termed under applied or over applied overhead, and as
discussed above, can be determined by the ending balance in the Manufacturing
Overhead control account. An under applied balance occurs when more overhead
cost is actually incurred than is applied to the Work In Process account. An over
applied balance results from applying more overhead to Work In Process than is
actually incurred.
1. Cause of under- and over applied overhead. When a predetermined overhead
rate is used, it is implicitly assumed that the overhead cost is variable with (i.e.,
proportional to) the allocation base. For example, if the predetermined overhead
rate is $20 per direct labor-hour, it is implicitly assumed that the actual overhead
costs will increase by $20 for each additional direct labor-hour that is incurred. If,
however, some of the overhead is fixed with respect to the allocation base, this
will not happen and there will be a discrepancy between the actual total amount of
the overhead and the overhead that is applied using the $20 rate. In addition, the
actual total overhead can differ from the estimated total overhead because of poor
controls over overhead spending or because of inability to accurately forecast
overhead costs.
2. Disposition of under- and over applied Overhead. Two approaches to
dealing with an under- or over applied overhead balance in the accounts are
illustrated in the text.
a. The simplest approach is to close out the under- or over applied overhead to
Cost of Goods Sold. This is the method that is used in most of the exercises
and problems because it is easiest for students to understand and master.
b. The second approach is to allocate the under- or over applied balance to Cost of
Goods Sold and to the Work in Process and Finished Goods inventory
accounts. The basis of allocation is the amount of overhead applied during the
period in the ending balance of each of these accounts. This method is
equivalent to waiting until the end of the period to allocate the actual overhead
costs based on the actual amount of the allocation base incurred.


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3. The Effect of under- and over applied Overhead on Net Income.
a. If overhead is under applied, less overhead has been applied to inventory than
has actually been incurred. Enough overhead must be applied retroactively to
Cost of Goods Sold (and perhaps ending inventories) to eliminate this
discrepancy. Since Cost of Goods Sold is increased, under applied overhead
reduces net income.
b. If overhead is over applied, more overhead has been applied to inventory than
has actually been incurred. Enough overhead must be removed retroactively
from Cost of Goods Sold (and perhaps ending inventories) to eliminate this
discrepancy. Since Cost of Goods Sold is decreased, over applied overhead
increases net income.

CHAPTER VI


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Accounting Standard and Financial Statements

INTRODCUTION
Accounting Standards are written documents, policy documents issued by expert
accounting body or Government or other regulatories body covering the aspects
of recognition, measurement, treatment, presentation and disclosure of accounting
transaction in the financial statement. Accounting Standards in India are issued by
the Institute of Chartered Accountants of India (ICAI).

OBJECTIVES OF ACCONTING STANDARDS
Objective of Accounting Standards is to standardize the diverse accounting
policies and practices with the view to eliminate to the extent possible the non
comparability of financial statements and add the reliability to the financial
statements.

ADVANTAGES OF ACCOUNTING STANDARDS
• Standards reduce to a reasonable extent or eliminate altogether confusion
variation in the accounting treatments used to prepare the financial statements.

• There are certain areas where important information is not required by law to
be disclosed, standards may call for disclosure beyond that required by law.

• It facilitates comparison of financial statements of different companies
situated at different places.


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DISADVANTAGES OF ACCONTING STANDARDS
• There may be a trend towards rigidity and away from flexibility in applying
Accounting Standards.

• Differences in Accounting Standards are bound to be because of differences in
the traditions and legal system from one country to another.

• Accounting Standards cannot override the law. The standards are required to
be framed within the ambit of prevailing statute even though it is not an
acceptable standard.

OBJECTIVES AND FUNCTIONS OF THE ACCONTING STANDARDS
BOARD
1. The following are the objectives of the Accounting Standards Board
a. To conceive of and suggest areas in which Accounting Standards need to
be developed
b. To formulate Accounting Standards with a view to assisting the Council of
the ICAI in evolving and establishing Accounting Standards in India
c. To examine how far the relevant International Accounting
Standard/International Financial Reporting Standard (see paragraph 3
below) can be adapted while formulating the Accounting Standard and to
adapt the same
d. To review, at regular intervals, the Accounting Standards from the point of
view of acceptance or changed conditions, and, if necessary, revise the
same
e. To provide, from time to time, interpretations and guidance on Accounting
Standards
f. To carry out such other functions relating to Accounting Standards
2. The main function of the ASB is to formulate Accounting Standards so that
such standards may be established by the ICAI in India. While formulating the


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Accounting Standards, the ASB will take into consideration the applicable
laws, customs, usages and business environment prevailing in India.
3. The ICAI, being a full-fledged member of the International Federation of
Accountants (IFAC), is expected, inter alia, to actively promote the
International Accounting Standards Board’s (IASB) pronouncements in the
country with a view to facilitate global harmonization of accounting
standards. Accordingly, while formulating the Accounting Standards, the ASB
will give due consideration to International Accounting Standards (IASs)
issued by the International Accounting Standards Committee (predecessor
body to IASB) or International Financial Reporting Standards (IFRSs) issued
by the IASB, as the case may be, and try to integrate them, to the extent
possible, in the light of the conditions and practices prevailing in India.
4. The Accounting Standards are issued under the authority of the Council of the
ICAI. The ASB has also been entrusted with the responsibility of propagating
the Accounting Standards and of persuading the concerned parties to adopt
them in the preparation and presentation of financial statements. The ASB will
provide interpretations and guidance on issues arising from Accounting
Standards. The ASB will also review the Accounting Standards at periodical
intervals and, if necessary, revise the same.

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


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INTERNATIONAL HARMONIZTION OF ACCONTING STANDARDS
Recognizing the need for international harmonization of accounting standards, in
1973, the International Accounting Standards Committee (IASC) was established.
The IASC has been restructured as International Accounting Standards Board
(IASB). The objectives of IASC include promotion of the International
Accounting Standards for worldwide acceptance and observance so that the
accounting standards in different countries are harmonized. In recent years, need
for international harmonization of Accounting Standards followed in different
countries has grown considerably as the cross-border transfers of capital are
becoming increasingly common.

ACCONTING STANDARDS SETTING IN INDIA
The Institute of Chartered Accountants of India (ICAI) being a member body of
the then IASC, constituted the Accounting Standards Board (ASB) on 21st April,
1977, with a view to harmonize the diverse accounting policies and practices in
use in India. After the avowed adoption of liberalization and globalization as the
corner stones of Indian economic policies in early ‘90s, the Accounting Standards
have increasingly assumed importance. While formulating accounting standards,
the ASB takes into consideration the applicable laws, customs, usages and
business environment prevailing in the country.
The ASB also gives due consideration to International Financial Reporting
Standards/ International Accounting Standards issued by IASB and tries to
integrate them, to the extent possible, in the light of conditions and practices
prevailing in India. Although the Accounting Standards Board is a body
constituted by the Council of the Institute of Chartered Accountants of India, it is
independent in the formulation of accounting standards since in case the Council
considers it necessary that certain modifications be made in the draft accounting
standards formulated by the ASB, it can only be done in consultation with the
ASB.


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COMPOSITION OF ACCONTING STANDARDS BOARD
The composition of the ASB is broad-based with a view to ensuring participation
of all interest-groups in the standard-setting process. These interest groups include
industry, representatives of various departments of government and regulatory
authorities, financial institutions and academic and professional bodies. Industry
is represented on the ASB by their apex level associations, viz., Associated
Chambers of Commerce (ASSOCHAM), Federation of Indian Chambers of
Commerce and Industry (FICCI) and Confederation of Indian Industries (CII). As
regards government departments and regulatory authorities, Reserve Bank of
India, Ministry of Company Affairs, Central Board of Direct Taxes, Comptroller
& Auditor General of India, Controller General of Accounts, Securities and
Exchange Board of India and Central Board of Excise and Customs are
represented on the ASB. Besides these interest-groups, representatives of
academic and professional institutions such as Universities, Indian Institutes of
Management, Institute of Cost and Works Accountants of India and Institute of
Company Secretaries of India are also represented on the ASB. Apart from these
interest-groups, members of the Central Council of ICAI are also on the ASB.

THE ACCOUNTING STANDARDS SETTING PROCESS
The accounting standard setting, by its very nature, involves reaching an optimal
balance of the requirements of financial information for various interest groups
having a stake in financial reporting. With a view to reach consensus, to the extent
possible, as to the requirements of the relevant interest-groups and thereby
bringing about general acceptance of the Accounting Standards among such
groups, considerable research, consultations and discussions with the
representatives of the relevant interest-groups at different stages of standard
formulation becomes necessary. The standard-setting procedure of the ASB, as


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briefly outlined below, is designed in such a way so as to ensure such consultation
and discussions:

a Identification of the broad areas by the ASB for formulating the Accounting
Standards.
S  Constitution of the study groups by the ASB for preparing the preliminary
drafts of the proposed Accounting Standards.
d  Consideration of the preliminary draft prepared by the study group by the ASB
and revision, if any, of the draft on the basis of deliberations at the ASB.
a  Circulation of the draft, so revised, among the Council members of the ICAI
and 12 specified outside bodies such as Standing Conference of Public
Enterprises (SCOPE), Indian Banks’ Association, Confederation of Indian
Industry (CII), Securities and Exchange Board of India (SEBI), Comptroller
and Auditor General of India (C& AG), and Ministry of Company Affairs, for
comments.
c  Meeting with the representatives of specified outside bodies to ascertain their
views on the draft of the proposed Accounting Standard.
v  Finalization of the Exposure Draft of the proposed Accounting Standard on the
basis of comments received and discussion with the representatives of
specified outside bodies.
s  Issuance of the Exposure Draft inviting public comments.
s  Consideration of the comments received on the Exposure Draft and finalization
of the draft Accounting Standard by the ASB for submission to the Council of
the ICAI for its consideration and approval for issuance.
t  Consideration of the draft Accounting Standard by the Council of the Institute,
and if found necessary, modification of the draft in consultation with the ASB.
a  The Accounting Standard, so finalized, is issued under the authority of the
Council.


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PRESENT STATUS OF ACCONTING STANDARDS IN INDIA IN
HARMONIZATION WITH THE INTERNATIONAL ACCONTING
STANDARDS
So far, 29 Indian Accounting Standards on the following subjects have been
issued by the Institute:
AS 1 Disclosure of Accounting Policies
AS 2 Valuation of Inventories
AS 3 Cash Flow Statements
AS 4 Contingencies and Events Occurring after the Balance Sheet Date
AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes in
Accounting Policies
AS 6 Depreciation Accounting
AS 7 Construction Contracts (revised 2002)
AS 8 Accounting for Research and Development (withdrawn pursuant to the
issuance of AS 26)
AS 9 Revenue Recognition
AS 10 Accounting for Fixed Assets
AS 11 The Effects of Changes in Foreign Exchange Rates (revised 2003)
AS 12 Accounting for Government Grants
AS 13 Accounting for Investments
AS 14 Accounting for Amalgamations
AS 15 Accounting for Retirement Benefits in the Financial Statements of
Employers (recently revised and titled as Employee Benefits)
AS 16 Borrowing Costs
AS 17 Segment Reporting
AS 18 Related Party Disclosures
AS 19 Leases


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AS 20 Earnings per Share
AS 21 Consolidated Financial Statements
AS 22 Accounting for Taxes on Income
AS 23 Accounting for Investments in Associates in Consolidated Financial
Statements
AS 24 Discontinuing Operations
AS 25 Interim Financial Reporting
AS 26 Intangible Assets
AS 27 Financial Reporting of Interests in Joint Ventures
AS 28 Impairment of Assets
AS 29 Provisions, Contingent Liabilities and Contingent Assets
AS 30 Financial Instruments: Recognition and Measurement
AS 31 Financial Instruments: Presentation
AS 32 Financial Instruments: Disclosures

COMPLIANCE WITH ACCONTING STANDARDS
Accounting Standards issued by the ICAI had got legal recognition through
insertion of sections 211(3A), (3B) and (3C) in the Companies Act, 1956, which
may be prescribed by the Central Government in consultation with the National
Advisory Committee on Accounting Standards. Recent development in this regard
is Accounting Standards 1to 7 and 9 to 29 as recommended by the ICAI, have
been prescribed by Ministry of Company Affairs, Government of India vide its
notification dated December, 7, 2006, in the Gazette of India. This notification
provides that every company and its auditor(s) shall comply with the notified
Accounting Standards. The Securities and Exchange Board of India (SEBI)
through the listing agreement requires that listed companies shall mandatorily
comply with all the Accounting Standards issued by ICAI from time to time.
Also, the Insurance Regulatory and Development Authority (IRDA) requires
insurance companies to follow the Accounting Standards issued by the ICAI.
Apart from the corporate bodies, the Council of the Institute of Chartered


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Accountants of India has made various accounting standards mandatory in respect
of certain non-corporate entities such as partnership firms, sole-proprietary
concerns/individuals, societies registered under the Societies Registration Act,
trusts, associations of persons, and Hindu Undivided Families, where financial
statements of such entities are statutorily required to be audited, for example,
under Section 44AB of the Income-tax, 1961. The Council has cast a duty on its
members to examine compliance with the Accounting Standards in the financial
statements covered by their audit in the event of any deviations therefrom, to
make adequate disclosures in their audit reports so that the users of the financial
statements may be aware of such deviations.

OBJECTIVES OF FINANCIAL STATEMENTS
The objective of financial statements is to provide information about the financial
position, performance and cash flows of an enterprise that is useful to a wide
range of users in making economic decisions.
Financial statements prepared for this purpose meet the common needs of most
users. However, financial statements do not provide all the information that users
may need to make economic decisions since (a) they largely portray the financial
effects of past events, and (b) do not necessarily provide non-financial
information.
Financial statements also show the results of the stewardship of management, or
the accountability of management for the resources entrusted to it. Those users
who wish to assess the stewardship or accountability of management do so in
order that they may make economic decisions; these decisions may include, for
example, whether to hold or sell their investment in the enterprise or whether to
reappoint or replace the management.

FINANCIAL POSITION, PERFORMANCE AND CASH
The economic decisions that are taken by users of financial statements require an
evaluation of the ability of an enterprise to generate cash and cash equivalents and


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of the timing and certainty of their generation. This ability ultimately determines,
for example, the capacity of an enterprise to pay its employees and suppliers,
meet interest payments, repay loans, and make distributions to its owners. Users
are better able to evaluate this ability to generate cash and cash equivalents if they
are provided with information that focuses on the financial position, performance
and cash flows of an enterprise.
The financial position of an enterprise is affected by the economic resources it
controls, its financial structure, its liquidity and solvency, and its capacity to adapt
to changes in the environment in which it operates.
Information about the economic resources controlled by the enterprise and its
capacity in the past to alter these resources is useful in predicting the ability of the
enterprise to generate cash and cash equivalents in the future. Information about
financial structure is useful in predicting future borrowing needs and how future
profits and cash flows will be distributed among those with an interest in the
enterprise; it is also useful in predicting how successful the enterprise is likely to
be in raising further finance. Information about liquidity and solvency is useful in
predicting the ability of the enterprise to meet its financial commitments as they
fall due. Liquidity refers to the availability of cash in the near future to meet
financial commitments over this period. Solvency refers to the availability of cash
over the longer term to meet financial commitments as they fall due.
Information about the performance of an enterprise, in particular its profitability,
is required in order to assess potential changes in the economic resources that it is
likely to control in the future. Information about variability of performance is
important in this respect. Information about performance is useful in predicting
the capacity of the enterprise to generate cash flows from its existing resource
base. It is also useful in forming judgments about the effectiveness with which the
enterprise might employ additional resources.
Information concerning cash flows of an enterprise is useful in order to evaluate
its investing, financing and operating activities during the reporting period. This
information is useful in providing the users with a basis to assess the ability of the


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enterprise to generate cash and cash equivalents and the needs of the enterprise to
utilize those cash flows.
Information about financial position is primarily provided in a balance sheet.
Information about performance is primarily provided in a statement of profit and
loss. Information about cash flows is provided in the financial statements by
means of a cash flow statement.
The component parts of the financial statements are interrelated because they
reflect different aspects of the same transactions or other events. Although each
statement provides information that is different from the others, none is likely to
serve only a single purpose nor to provide all the information necessary for
particular needs of users.

Notes and Supplementary Schedules
The financial statements also contain notes and supplementary schedules and
other information. For example, they may contain additional information that is
relevant to the needs of users about the items in the balance sheet and statement of
profit and loss. They may include disclosures about the risks and uncertainties
affecting the enterprise and any resources and obligations not recognized in the
balance sheet (such as mineral reserves). Information about business and
geographical segments and the effect of changing prices on the enterprise may
also be provided in the form of supplementary information.

ELEMENTS OF FINANCIAL STATEMENTS
Financial statements portray the financial effects of transactions and other events
by grouping them into broad classes according to their economic characteristics.
These broad classes are termed the elements of financial statements. The elements
directly related to the measurement of financial position in the balance sheet are
assets, liabilities and equity. The elements directly related to the measurement of
performance in the statement of profit and loss are income and expenses. The cash
flow statement usually reflects elements of statement of profit and loss and


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changes in balance sheet elements; accordingly, this Framework identifies no
elements that are unique to this statement.
The presentation of these elements in the balance sheet and the statement of profit
and loss involves a process of sub-classification. For example, assets and
liabilities may be classified by their nature or function in the business of the
enterprise in order to display information in the manner most useful to users for
purposes of making economic decisions.

FINANCIAL POSITION
The elements directly related to the measurement of financial position are assets,
liabilities and equity. These are defined as follows:
(a) An asset is a resource controlled by the enterprise as a result of past events
from which future economic benefits are expected to flow to the enterprise.
(b) A liability is a present obligation of the enterprise arising from past events, the
settlement of which is expected to result in an outflow from the enterprise of
resources embodying economic benefits.
(c) Equity is the residual interest in the assets of the enterprise after deducting all
its liabilities.
The definitions of an asset and a liability identify their essential features but do
not attempt to specify the criteria that need to be met before they are recognized
in the balance sheet. Thus, the definitions embrace items that are not recognized
as assets or liabilities in the balance sheet because they do not satisfy the criteria
for recognition.
In particular, the expectation that future economic benefits will flow to or from an
enterprise must be sufficiently certain to meet the probability criterion before an
asset or liability is recognized.
In assessing whether an item meets the definition of an asset, liability or equity,
consideration needs to be given to its underlying substance and economic reality
and not merely its legal form. Thus, for example, in the case of hire purchase, the
substance and economic reality are that the hire purchaser acquires the economic


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benefits of the use of the asset in return for entering into an obligation to pay for
that right an amount approximating to the fair value of the asset and the related
finance charge. Hence, the hire purchase gives rise to items that satisfy the
definition of an asset and a liability and are recognized as such in the hire
purchaser’s balance sheet.

ASSETS
The future economic benefit embodied in an asset is the potential to contribute,
directly or indirectly, to the flow of cash and cash equivalents to the enterprise.
The potential may be a productive one that is part of the operating activities of the
enterprise. It may also take the form of convertibility into cash or cash equivalents
or a capability to reduce cash outflows, such as when an alternative
manufacturing process lowers the costs of production.
An enterprise usually employs its assets to produce goods or services capable of
satisfying the wants or needs of customers; because these goods or services can
satisfy these wants or needs, customers are prepared to pay for them and hence
contribute to the cash flows of the enterprise. Cash itself renders a service to the
enterprise because of its command over other resources.
The future economic benefits embodied in an asset may flow to the enterprise in a
number of ways. For example, an asset may be:
(a) used singly or in combination with other assets in the production of goods or
services to be sold by the enterprise;
(b) exchanged for other assets;
(c) used to settle a liability; or
(d) distributed to the owners of the enterprise.
Many assets, for example, plant and machinery, have a physical form. However,
physical form is not essential to the existence of an asset; hence patents and
copyrights, for example, are assets if future economic benefits are expected to
flow from them and if they are controlled by the enterprise.


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Many assets, for example, receivables and property, are associated with legal
rights, including the right of ownership. In determining the existence of an asset,
the right of ownership is not essential; thus, for example, an item held under a hire
purchase is an asset of the hire purchaser since the hire purchaser controls the
benefits which are expected to flow from the item. Although the capacity of an
enterprise to control benefits is usually the result of legal rights, an item may
nonetheless satisfy the definition of an asset even when there is no legal control.
For example, know-how obtained from a development activity may meet the
definition of an asset when, by keeping that know- how secret, an enterprise
controls the benefits that are expected to flow from it.
The assets of an enterprise result from past transactions or other past events.
Enterprises normally obtain assets by purchasing or producing them, but other
transactions or events may also generate assets; examples include land received
by an enterprise from government as part of a programme to encourage economic
growth in an area and the discovery of mineral deposits. Transactions or other
events expected to occur in the future do not in themselves give rise to assets;
hence, for example, an intention to purchase inventory does not, of itself, meet the
definition of an asset.
There is a close association between incurring expenditure and obtaining assets
but the two do not necessarily coincide. Hence, when an enterprise incurs
expenditure, this may provide evidence that future economic benefits were sought
but is not conclusive proof that an item satisfying the definition of an asset has
been obtained. Similarly, the absence of a related expenditure does not preclude
an item from satisfying the definition of an asset and thus becoming a candidate
for recognition in the balance sheet.

LIABILITIES
An essential characteristic of a liability is that the enterprise has a present
obligation. An obligation is a duty or responsibility to act or perform in a certain
way. Obligations may be legally enforceable as a consequence of a binding


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contract or statutory requirement. This is normally the case, for example, with
amounts payable for goods and services received. Obligations also arise, however,
from normal business practice, custom and a desire to maintain good business
relations or act in an equitable manner. If, for example, an enterprise decides as a
matter of policy to rectify faults in its products even when these become apparent
after the warranty period has expired, the amounts that are expected to be
expended in respect of goods already sold are liabilities.
A distinction needs to be drawn between a present obligation and a future
commitment. A decision by the management of an enterprise to acquire assets in
the future does not, of itself, give rise to a present obligation. An obligation
normally arises only when the asset is delivered or the enterprise enters into an
irrevocable agreement to acquire the asset. In the latter case, the irrevocable
nature of the agreement means that the economic consequences of failing to
honour the obligation, for example, because of the existence of a substantial
penalty, leave the enterprise with little, if any, discretion to avoid the outflow of
resources to another party.
The settlement of a present obligation usually involves the enterprise giving up
resources embodying economic benefits in order to satisfy the claim of the other
party. Settlement of a present obligation may occur in a number of ways, for
example, by:
(a) payment of cash;
(b) transfer of other assets;
(c) provision of services;
(d) replacement of that obligation with another obligation; or
(e) conversion of the obligation to equity.
An obligation may also be extinguished by other means, such as a creditor
waiving or forfeiting its rights.
Liabilities result from past transactions or other past events. Thus, for example,
the acquisition of goods and the use of services give rise to trade creditors (unless
paid for in advance or on delivery) and the receipt of a bank loan results in an


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obligation to repay the loan. An enterprise may also recognize future rebates
based on annual purchases by customers as liabilities; in this case, the sale of the
goods in the past is the transaction that gives rise to the liability.
Some liabilities can be measured only by using a substantial degree of estimation.
Such liabilities are commonly described as ‘provisions’. Examples include
provisions for payments to be made under existing warranties and provisions to
cover pension obligations.

EQUITY
Although equity is defined in paragraph 49 as a residual, it may be subclassified
in the balance sheet. For example, funds contributed by owners, reserves
representing appropriations of retained earnings, unappropriated retained earnings
and reserves representing capital maintenance adjustments may be shown
separately. Such classifications can be relevant to the decision making needs of
the users of financial statements when they indicate legal or other restrictions on
the ability of the enterprise to distribute or otherwise apply its equity. They may
also reflect the fact that parties with ownership interests in an enterprise have
differing rights in relation to the receipt of dividends or the repayment of capital.
The creation of reserves is sometimes required by law in order to give the
enterprise and its creditors an added measure of protection from the effects of
losses. Reserves may also be created when tax laws grant exemptions from, or
reductions in, taxation liabilities if transfers to such reserves are made. The
existence and size of such reserves is information that can be relevant to the
decision-making needs of users. Transfers to such reserves are appropriations of
retained earnings rather than expenses.
The amount at which equity is shown in the balance sheet is dependent on the
measurement of assets and liabilities. Normally, the aggregate amount of equity
only by coincidence corresponds with the aggregate market value of the shares of


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the enterprise or the sum that could be raised by disposing of either the net assets
on a piecemeal basis or the enterprise as a whole on a going concern basis.
Commercial, industrial and business activities are often undertaken by means of
enterprises such as sole proprietorships, partnerships and trusts and various types
of government business undertakings. The legal and regulatory framework for
such enterprises is often different from that applicable to corporate enterprises.
For example, unlike corporate enterprises, in the case of such enterprises, there
may be few, if any, restrictions on the distribution to owners or other beneficiaries
of amounts included in equity. Nevertheless, the definition of equity and the other
aspects of this Framework that deal with equity are appropriate for such
enterprises.
PERFORMANCE
Profit is frequently used as a measure of performance or as the basis for other
measures, such as return on investment or earnings per share. The elements
directly related to the measurement of profit are income and expenses. The
recognition and measurement of income and expenses, and hence profit, depends
in part on the concepts of capital and capital maintenance used by the enterprise in
preparing its financial statements. These concepts are discussed in paragraphs 101
to 109.
Income and expenses are defined as follows:
(a) Income is increase in economic benefits during the accounting period in the
form of inflows or enhancements of assets or decreases of liabilities that result in
increases in equity, other than those relating to contributions from equity
participants.
(b) Expenses are decreases in economic benefits during the accounting period in
the form of outflows or depletions of assets or incurrences of liabilities that result
in decreases in equity, other than those relating to distributions to equity
participants.


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The definitions of income and expenses identify their essential features but do not
attempt to specify the criteria that need to be met before they are recognized in the
statement of profit and loss.
Income and expenses may be presented in the statement of profit and loss in
different ways so as to provide information that is relevant for economic decision-
making. For example, it is a common practice to distinguish between those items
of income and expenses that arise in the course of the ordinary activities of the
enterprise and those that do not. This distinction is made on the basis that the
source of an item is relevant in evaluating the ability of the enterprise to generate
cash and cash equivalents in the future. When distinguishing between items in this
way, consideration needs to be given to the nature of the enterprise and its
operations. Items that arise from the ordinary activities of one enterprise may be
extraordinary in respect of another.
Distinguishing between items of income and expense and combining them in
different ways also permits several measures of enterprise performance to be
displayed. These have differing degrees of inclusiveness.
For example, the statement of profit and loss could display gross margin, profit
from ordinary activities before taxation, profit from ordinary activities after
taxation, and net profit.

INCOME
The definition of income encompasses both revenue and gains. Revenue arises in
the course of the ordinary activities of an enterprise and is referred to by a variety
of different names including sales, fees, interest, dividends, royalties and rent.
Gains represent other items that meet the definition of income and may, or may
not, arise in the course of the ordinary activities of an enterprise. Gains represent
increases in economic benefits and as such are no different in nature from
revenue. Hence, they are not regarded as a separate element in this Framework.
The definition of income includes unrealized gains. Gains also include, for
example, those arising on the disposal of fixed assets. When gains are recognized


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