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