Management accounting-ppt-RJ

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 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

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 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

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.
 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.
 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

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”

Framework

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

 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

 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

 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

 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

 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 auditor’s
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, 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

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

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
company’s overall performance
 To the company’s 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 investor’s 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 assets–current 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  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

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

 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

 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

 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

 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

 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

 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

 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

 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

 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.

 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

 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

 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

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

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

 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

 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

 The essential elements of a budget are:
 Plan
 Financial terms
 Operations and Resources
 Specific future period
 Comprehensive coverage
 Coordination

 The main objectives of budgeting are:
 Explicit statement of expectations
 Communication
 Coordination
 Expectations as framework for judging
performance

 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

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

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

 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

 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

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

 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.

 LIFO: this method matches the most recent
costs incurred with the current revenue,
leaving the first cost incurred to be included
as inventories.

 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.

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

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 SCM-
 Target 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
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

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

 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

 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

 Overhead account Cost driver
 Indirect labor Man hour cost
 Depreciation-building Sq. feet used
 Depreciation-machinery Machine time
 Electricity 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 are-
 Introduction
 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

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