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.

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

Classification of Accounts
Personal Account
Real Account
Nominal Account

Classification of Accounts
(Contd.)
Type

Rules for Debit

Rules for Credit

Personal
Accounts

Debit the
Receiver

Credit the Giver

Real Accounts

Debit what
comes in

Credit what goes

out

Nominal
Accounts

Debit all
expenses and
losses

Credit all
incomes and
gains

Classification of Accounts
(Contd.)

Assets accounts
Liabilities accounts
Capital accounts
Revenue accounts
Expenses accounts
Assets = liabilities + capital + profits losses
Profits = revenue expenses
Losses = expenses - revenue

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

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

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.

Distinction between Capital and

Revenue Expenditure
Purpose

It is incurred for
acquisition of fixed
assets for use in
business

It is incurred for
running of business

Capacity

It increases the earning It is incurred for

capacity of the
earning profits
business

Period

Its benefit is extended

to more than one year

Its benefit extends to

only one accounting
year

Depiction

It is shown in the
balance sheet

It is part of trading or
Profit or Loss account

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.

Types of Decisions
The decisions, managers are concerned with, can be
categorized as
Planning decisions
Control decisions

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

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

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

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 choice

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

Management Accounting
Framework

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

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

Statements of Financial
Information
Balance Sheet
Profit and Loss Account
Statement of changes in financial position
- Cash flow statement
- Fund flow statement

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

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

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

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

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

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

Categories of Fixed Assets

Tangible
Intangible

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

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

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

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

Current assets (Contd.)

Current assets are also known as liquid assets
They include- cash
- marketable securities
- accounts receivables/debtors
- bills receivables
- inventory

Current Assets (Contd.)

Cash
Most liquid form of current asset
Cash in hand and at bank
To meet obligations / acquire assets without
any delay

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

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

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

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)

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

Other Assets
Included in this category are the Deferred
Charges
Example: Advertisement, Preliminary
expenses, etc

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

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

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

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

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

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

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

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

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

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 auditors
report?

Contents of Profit and Loss

Account
Revenues : Turnover
Other income
Sale of fixed assets
Expenses
Profit / Loss

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

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

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

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

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

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

Expenses (Contd.)
Administrative Expenses
These include office expenses, secretarial costs,
postage and telephones, directors remuneration
and other administrative expenses
Selling Expenses
These include freight, advertising and sales
promotion, commissions and discounts and other
selling and distribution costs

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 auditors remuneration, petty
expenses, donations, etc

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

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

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

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

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

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 companys overall performance
To the companys management for making
intra-firm and inter-firm comparisons

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

Financial Ratio Analysis

Ratios on ROI
Activity ratios
Liquidity ratios
Profitability ratios
Leverage ratios
Coverage ratios
Equity investors ratio

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 assetscurrent liabilities)

Ratios on ROI
Return on Net worth =
Net profit after tax
------------------------ * 100
Net worth
Net worth = Share capital + reserves &
surplus accumulated
losses

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.

Difference between CFS and FFS

CFS
Only with change in
cash position
Mere record of cash
receipts and payments
More for short term use
Improvement in cash
improves funds position

FFS
Change in working
capital position
Needed for short term
solvency
Long term use
Improvement in funds
position need not
necessarily improve
cash

Advantages

Helps in efficient cash management

Helps in internal financial management
Discloses the movement of cash
Discloses success or failure of cash
planning

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

CFS

Sources of Cash
Internal
External
Applications of Cash

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

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..

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

CFS

Increase in cash
Decrease in current asset
Increase in current liability
Decrease in cash
Increase in current asset
Decrease in current liability

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

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

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

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

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

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

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

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

Relating to Profit Planning

Fixed, Variable, Semi variable / Mixed cost
Future cost and Budgeted cost

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

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

Relating to Control
Responsibility costs
Controllable and Non controllable costs
Direct and Indirect costs

Relating to Control
Responsibility costs
This concept applies more as responsibility
accounting
Costs are classified with the persons /
centers responsible for their incurrence

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

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

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

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

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

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.

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

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.

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

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

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

Break Even Analysis

Sales
minus
Variable cost
=
Contribution
minus
Fixed cost
=
Profit or Loss

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

Break Even Analysis (Contd.)

Profit Volume Ratio = Contribution
(P/V ratio)
------------------ * 100
Sales

Break Even Analysis (Contd.)

BEP (in Rs. = Fixed Coat (in Rs.)
----------------------P/V ratio

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

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

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

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

Budgetary Control (Contd.)

The essential elements of a budget are:

Plan
Financial terms
Operations and Resources
Specific future period
Comprehensive coverage
Coordination

Budgetary Control (Contd.)

The main objectives of budgeting are:

Explicit statement of expectations
Communication
Coordination
Expectations as framework for judging
performance

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

Budgetary Control (Contd.)

Operating budget
Sales budget
Production budget
Purchase budget
Direct labour budget
Manufacturing expenses budget
Administrative and Selling expenses budget

Budgetary Control (Contd.)

Financial Budget
Budgeted income statement
Budgeted statement of retained earnings
Cash budget
Budgeted balance sheet

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

Budgetary Control (Contd.)

The framework of flexible budget covers Measure of volume
Cost behaviour with change in volume

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

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

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

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.

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

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

Inventory Cost Methods

First In First Out Method (FIFO)
Last In First Out Method (LIFO)
Weighted Average Method

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.

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.

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.

Inventory Cost Methods

Date
Jan 15
Mar 20
May 10
June 8
Oct 12
Dec 21
Total
Op.inv
Cl. inv

Units
10000
20000
50000
30000
5000
5000
120000
10000
14000

Cost per unit Total cost

5.10
51000
5.20
104000
5.00
250000
5.40
162000
5.30
26500
5.50
27500
621000
5.00
50000

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)

Under LIFO
Opening inventory 10000@5.00 = 50000
Jan purchases
4000@5.10 = 20400
Ending inventory 14000
= 70400
(using LIFO)

Under Weighted Average Method

Weighted average cost =total cost/total units
Wei. Ave. cost = 671000/130000 = 5.1615
Closing inventory 14000@5.1615 = 72261

Comparison
Under FIFO = 75600
Under LIFO = 70400
Under WA method = 72261

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

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

SCM

The process of SCMTarget Costing

Activity Based Costing
Quality Costing
Life Cycle Costing
Value Chain Analysis

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

Target Costing
It is Cost Management tool which reduces a
products 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

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

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

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

Activity Based Costing (ABC)

Overhead account
Indirect labor
Depreciation-building
Depreciation-machinery
Electricity

Cost driver
Man hour cost
Sq. feet used
Machine time
Watts used

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

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

Life Cycle Costing

Different phases areIntroduction

Growth
Maturity
Saturation
Decline

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

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