ABD NOTES

Unit 1 : BASIC CONCEPTS

OVERVIEW OF MANAGEMENT, FINANCIAL & COST ACCOUNTING

MANAGEMENT ACCOUNTING

MANAGEMENT ACCOUNTINGManagement accounting deals with providing information, including financial accounting information to the managers. The information helps them in planning, decision making, performance evaluation, control, management of cost and cost determination for financial reporting. Managerial Accounting contains reports prepared to fulfil the needs of management.

SCOPE OF MANAGEMENT ACCOUNTING1. Financial Accounting2. Cost Accounting3. Financial Statement Analysis4. Forecasting and Budgeting5. Cost Control Techniques6. Management Reporting – clear, informative, timely reports are essential

for decision making.7. Taxation8. Internal Audit – helps performance appraisal.

FUNCTIONS OF MANAGEMENT ACCOUNTING1. Planning and Forecasting 2. Furnishes information as per requirement3. Not confine merely to financial data4. Analysis and Interpretation5. Coordinating6. Tax Administration7. Controlling

FINANCIAL ACCOUNTING

FINANCIAL ACCOUNTINGFinancial Accounting aims at 1. Recording, classifying and summarising business transactions in a systematic manner.2. Transactions to be recorded in monetary terms.3. Summarising, analysing and interpreting the results of accounting information4. Communicating and explaining the information to decision makers.

OBJECTIVES OF FINANCIAL ACCOUNTING1. To identify financial events and transactions that occur in an organisation.2. Transactions to be recorded in monetary terms.3. To ascertain profit or loss position in business.4. To give a true and fair picture of the state of affairs of the business.

5. Recording historical transactions.6. To know Assets and Liabilities of business.7. To organize the accumulated financial data into meaningful information.

COST ACCOUNTING

COST ACCOUNTING‘Cost Accountancy’ is defined by CIMA, UK, as “The application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and the ascertainment of profitability”.Cost Accounting is the technique of classifying, recording and appropriate allocation of expenditure for the determination of the costs of the product or services.

OBJECTIVES OF COST ACCOUNTING1. Ascertainment of cost.2. Determination of selling price.3. Cost control and cost reduction.4. Ascertainment of profit of each activity.5. Assisting management in decision making.

RELATIONSHIP BETWEEN MANAGEMENT, FINANCIAL AND COST ACCOUNTING

Basis Management Accounting

FinancialAccounting

CostAccounting

1. Scope Scope of management accounting is broader than that of cost or financial accounting as it provides all types of information, i.e., cost accounting as well as financial accounting information for managerial uses.

Scope of financial accounting is to provide financial information to internal users (employees, proprietor) as well as external users (investors, creditors, Govt. authorities, etc.)

Scope of cost accounting is limited to providing cost information for managerial uses.

2. Emphasis Main emphasis is on planning, controlling and decision – making to maximize profit.

Main emphasis is on identifying occurrence financial event in business, classifying and recording it in a

Main emphasis is on cost ascertainment and cost control to ensure maximum profit.

systematic manner.3.Techniquesemployed

Management accounting also uses all these techniques used in cost accounting and financial accounting but in addition it also uses techniques like ratio analysis, funds flow statement, cash flow statements, statistical analysis operations research and certain techniques from various branches of knowledge like mathematics, economics, etc. which so ever can help management in its tasks

Techniques involved in financial accounting are 1) Single entry system2) Cash system3) Double entry book-keeping system.

Double entry book-keeping system is the most scientific method of recording business transactions.

Various techniques used by cost accounting include standard costing and variance analysis, marginal costing and cost volume profit analysis, budgetary control, uniform costing and inter-firm comparison, etc.

4. Evolution Evolution management accounting is due to the limitations of cost accounting and financial accounting. In fact, management accounting is an extension of the managerial aspects of cost accounting.

Evolution of financial accounting

Evolution of cost accounting is mainly due to the limitations of financial accounting.

5. Statutoryrequirements

Management accounting is purely voluntary and its use depends upon its utility to management.

Maintenance of cost records has been made compulsory in selected industries as notified by the Govt. from time to time.

6.Data base It is based on data derived from cost accounting, financial accounting and other sources.

It is based on data derived from financial accounts

7.Status inorganization

Management accounting is generally placed at a higher level of hierarchy than the cost accounting

In the organizational set up, cost accountant is placed at a lower level in hierarchy than the management accounting

CONCEPTS AND CONVENTIONS OF FINANCIAL ACCOUNTING

Sr.No. Concept Meaning Example & Purpose1 Business Entity This concept is also called as

“Separate Entity Concept”. A firm or a business is regarded as separate and distinct from the owner. All transactions of business are recorded separately without mixing the private transactions of the owner. Even the proprietor is considered as a creditor of the business and hence his capital is shown as liability in the balance sheet.

Example: If the proprietor draws some goods from the business for personal use, it is not treated as a sale, but the value of those goods consumed by the proprietor is debited to his “Drawings A/c” and reduced from the Capital A/c.Purpose: This concept has led to good results. If the distinction is not kept the personal and business transactions will get mixed and the accounting statements will become confusing.

2 Money Measurement Concept

All transactions are recorded in terms of money. This concept makes accounting information more meaningful and useful for analysis of financial statements. It should be remembered that money enables various things of diverse nature to be added up together and dealt with.

Example 1: An event, even though important, like a quarrel between the production manager and sales manager, will not be recorded unless its monetary effect can be measured with a fair degree of accuracy. Example 2: The use of a building and the use of clerical services can be added up only through money values and not otherwise.Purpose: Accounting records is concerned with amounts in terms of money.

3 Cost Concept Transactions are entered in the books of accounts at the amounts actually involved. This concept has been adopted for the purpose of convenience and feasibility. It implies that the resources of a business are to be recorded at their cost. Here, cost is the cash or the cash equivalent for an asset in a transaction.

Example: Suppose a firm purchases a piece of land for Rs.5, 00,000.00 but considers it as worth Rs.7, 50,000.00. The purchase will be recorded at Rs.5, 00,000.00 and not any more.Purpose: The most important purpose of this principle is to provide reliable, verified and definite accounting information.

4 Going Concern Concept

This concept is also called as “The concept of permanency” or “continuity concept”. It is assumed that the business will exist for a long time and transactions are

Example: When a machinery is purchased, proprietor has to presume or assume that machinery is going to last for a number of years and the

recorded from this point of view. It is this that necessitates distinction between expenditure that will render benefit over a long period and that whose benefit will be exhausted quickly, say, within a year. This concept helps other business undertakings to make contract with specific business unit for business dealings in future. It also stresses emphasis on earning capacity in judging overall performance of business.

business itself will continue. Therefore, on the basis of estimated life of the machinery, depreciation is to be calculated and debited to profit & loss A/c every year. If the continuity concept is no prevalent, the whole amount of asset would have been written off in the year in which the asset was purchased.Purpose: The concept holds that continuity of business activity is the reasonable expectation for the business unit for which accounting function is being performed.

5 Dual Aspect Concept Each transaction has two aspects. If a business has acquired an asset, it must have resulted in one of the following: -

a) Some other asset has been given up, or

b) The obligation to pay for it has arisen, or

c) There has been profit, leading to an increase in the amount that the business owes to the proprietor, or

d) The proprietor has contributed money for the acquisition of the asset.

Thus, assets are always equal to capital and liabilities. ASSETS = CAPITAL + LIABILITIES

6 Realisation Concept According to this concept, revenue is considered as earned on the date on which it is realised. Thus revenue realised during the accounting period only be considered while preparing income statement or profit and loss a/c. Unearned or unrealised revenue should not be taken into account. The concept of realisation does not only mean the receipt of income in cash, but the income is also said to be realised as a right to receive the income is created. The profit is to be considered only when it is

Example 1: Cash sales of Rs. 10,000/-, here the income is received in cash.Example 2: Credit sales of Rs. 50,000/- to Ramrao, here the seller creates legal right to receive the income.

actually realised. 7 Accrual Concept Realisation concept considers only

revenue but accrual concept considers both revenue and expenses. Accordingly it makes distinction between right to receive cash or actual receipt of cash and obligation to pay cash and actual cash payment. According to this, expenses even though not paid but if it is obligatory to pay in future are recorded. Income for the period even not received but we have right to receive in future is recorded. Revenues (incomes) and Costs (expenses) are accrued, as they are earned or incurred (and not as money is received or paid).

Example: Salary Outstanding, Rent Outstanding, Insurance Premium paid in advance, Wages due accrued, Interest on loan unpaid, Taxes paid in advance, etc.Purpose: Because of this concept the net profit/ loss of any period cannot be equal to corresponding cash increase or decrease.

8 Accounting Period Concept

This concept states that accounts should be presented regularly at fixed intervals. Generally, one year period of interval is accepted by the business concerns. Accounting year for business concerns is 1st APRIL of a year to 31st MARCH of the next year.

Example: 1st APRIL, 2012 to 31st

MARCH, 2013.Purpose: This concept stated that accounts should be presented at fixed intervals regularly.

Sr.No. Convention Meaning Example & Purpose1 Consistency The accounting practices should

remain the same from one year to another. If a change becomes necessary, the change and its effect should be stated clearly.

Example: It would not be proper to value stock-in-trade according to one method one year and according to another method next year.Purpose: The principle of consistency plays an important role, which says that once a method or policy is adopted by the business, it should be consistently followed.

2 Disclosure Accounting report should give full disclosure of information, which it is supposed to give. The practice of giving footnotes and references in the statements is according to this convention in order to facilitate understanding of accounting information. Whether something should be disclosed or not will depend on whether it is material or not. Materiality depends on the amounts involved in relation to the asset or transaction group involved

or to profits.

3 Conservatism It relates to the principles and practices, which are established as a tradition. Accountants are supposed to be conservative in their approach so far as accounting work is concerned. Accountants are not supposed to take into account anticipated profit but must consider anticipated losses. Record for all anticipated losses, but do not record any anticipated profits (the profit is to be considered only when it is actually realised).

Example: Provision for Bad & Doubtful Debts (RDD), Closing stock is valued at market price or cost price, whichever is less.Purpose: This concept presents the accounting data correctly and avoids unwarranted optimism in preparing financial statements.

4 Materiality American Accounting Association defined materiality as, “an item should be regarded as material if there is reason to believe that knowledge of it would influence the decision of informed investors.” Materiality depends on the amounts involved and account so affected. It emphasises that accounting records should consist only of such events, which are significant from the point of view of income determination and status assessment.

Example: Purchase of stationery is not recorded separately for each day. Aggregate amount of stationery purchased is recorded in the books of accounts.Purpose: The concept refers to the significance of the transaction. It is not worthwhile to record every minute details in accounting as it will be uneconomical and cumbersome.

Unit 2 : UNDERSTANDING FINANCIAL STATEMENTS

CLASSIFICATION OF ACCOUNTS IN FINANCIAL ACCOUNTING

ACCOUNTS

PERSONAL A/c IMPERSONAL A/c

(persons & institutions)

REAL A/c NOMINAL A/c

(things & property) (expenses/losses & incomes/gains)

RULES FOR DEBIT AND CREDIT

ACCOUNT RULE

Personal Account Debit the receiverCredit the giver

Real Account Debit what comes inCredit what goes out

Nominal Account Debit all expenses and lossesCredit all incomes and gains

FINANCIAL STATEMENTS

JOURNAL

Features of a Journal

1) It maintains original record of all the transactions.2) It records transactions in the order of date of their occurrence.3) It maintains a detail record of transactions by writing the narration at the end of every journal entry.4) It is the original record, which provides base for subsequent accounting work.5) It analyses each transaction in such a way to get knowledge of debit and credit effect of the accounts,

which are affected in the transaction.

Advantages of Journal

1) It helps the ledger keeper to maintain the ledger clearly and accurately.2) Every transaction entered in the journal is supported by narration, which facilitates to understand the

details of transactions at any future time.3) It records all the transactions daily in a day to day order, and therefore there is no possibility of any

particular transaction omitted to be recorded in the journal.4) The analytical method of recording the transaction into debit and credit helps posting in the ledger

books.5) It strengthens the understanding of the principles of double entry system and the importance of such

system.

Explanation of the form of Journal

A specimen Journal can be illustrated from the following fig.3.1

Fig.3.1

Journal

Date Particulars L.F.Debit

Rs.

Credit

Rs.

11/03

1 Cash A/c …………………Dr. 20,000.00

To Goods A/c 20,000.00

( Being Goods sold for cash)

The information to be filled in the above columns can be explained as given below:

1) DateThe date of the transaction is recorded in the date column. The date, month and year are entered in this column. Generally year and month is recorded on top of the page and the date is recorded whenever it changes.

2) ParticularsThe account to be debited is written first and close to the date column. Just before the L.F. column the word Dr. is written. The account to be credited is written on the next line in particulars column leaving some space on the left hand side so that credit entry can be separated from debit entry. The word ‘To’ is written before the account to be credited.

3) Ledger FolioIt displays the page number of ledger on which debit and credit effect of an account is recorded in the summarised manner.

4) Debit amount / Credit amountThe amount to be debited is written in front of the debit entry in the debit column; and the amount to be credited is written in front of the credit entry in the credit column.

5) NarrationThere is no separate column in the journal for writing the narration. At the end of the journal entry, explanation called narration should be written in the Particulars column. It generally begins with the word ‘being’. It gives the complete details of the transaction passed at any time.

Since Journal is a basic accounting record, it should be written in neat and legible handwriting and maintained safely. It forms the basis for preparation of ledger books and subsidiary books.

LEDGER

The ledger is the book of final entry. There is a account-wise classification of transactions. The book that contains accounts is known as the ledger. Ledger is called as the Principal book, since final information pertaining to the financial position of a business. Other books like the Purchases Book, Sales book or Journal merely facilitate the preparation of accounts of the ledger and hence are known as Subsidiary books.

The benefits of preparation of ledger accounts are:

1) Profit & Loss account is prepared with the help of ledger accounts only.

2) It differentiates information on the basis of various accounts, whether it is an income or expense or an asset or liability, which helps in controlling the business.

3) By preparation of Profit & loss account and Balance Sheet, we get the knowledge about the business condition, and overall business position.

Transactions recorded in journal or other subsidiary books are posted in the ledger. Posting means the process of transfer of entries from journal to ledger. After posting the transactions, each account undergoes the process of casting. Casting means totalling of an account. Casting is done to obtain the balance of that particular account. Balance is the difference between the debit and credit total of the account. DEBIT BALANCE: When debit total is heavier than the credit total.CREDIT BALANCE: When credit total is heavier than the debit total.

Example continued form above journalCASH ACCOUNT

DATE PARTICULARS J.F. DEBIT (Rs) DATE PARTICULARS J.F. CREDIT (Rs)

01/11/03

To Balance b/d

01/11/03

To Goods A/c 20,000

GOODS ACCOUNTDATE PARTICULARS J.F. DEBIT (Rs) DATE PARTICULARS J.F. CREDIT (Rs)

01/11/03 To Balance b/d01/11/03 By Cash A/c 20,000

TRIAL BALANCE

Trial Balance for the year ended 31-03-2013

PARTICULARS DEBIT (Rs) CREDIT (Rs)Capital xxxCash xxxPurchases xxxSales xxxLand & Building xxxOpening Stock xxxSalary xxxTOTAL xxx xxx

Trial Balance is always prepared on a certain date. Trial Balance consists of balances of all the accounts. The total of both the debit side as well as the credit side must be equal. Trial Balance shows whether there are any errors committed while recording, posting, or casting.

FINAL ACCOUNTS

SOLE PROPRIETOR

TRADING ACCOUNT for the year ended 31-03-2013

Dr. Cr.

DATE PARTICULARS AMOUNT DATE PARICULARS AMOUNTTo Opening StockTo Purchases By Sales(-) Purchase Returns (-) Sales ReturnsTo WagesTo Carriage InwardTo Power By Closing Stock

To Gross Profit c/d to P&L A/c

To Gross Loss c/d to P&L A/c

PROFIT & LOSS ACCOUNT for the year ended 31-03-2013

Dr. Cr.

DATE PARTICULARS AMOUNT DATE PARICULARS AMOUNTTo Gross Loss b/d By Gross Profit b/d

To Office Salary By Discount receivedTo Office Rent By Interest receivedTo Taxes By Commission

receivedTo Insurance By Rent receivedTo Printing & Stationery

By RDD

To Postage & TelegramTo RepairsTo Audit FeesTo Carriage OutwardTo Advt.To Bad DebtsTo RDDTo DepreciationTo Travelling Exp.To Interest on CapitalTo Discount given

To Net Profit c/d to Balance Sheet

To Net Loss c/d to Balance Sheet

BALANCE SHEET as on 31st March, 2013

LIABILITIES AMOUNT ASSETS AMOUNTCapital Goodwill(+) Net Profit or Fixed Assets(-) Net Loss Land & Building(-) Drawings Plant & MachineryCreditors FurnitureBills Payable Current AssetsLoans InvestmentsBank Overdraft Cash in handOutstanding Exp. Cash at bank

Bills ReceivableSundry DebtorsPrepaid Exp.

PARTNERSHIP FIRM

In partnership accounts there are two methods:

1. Fluctuating Capital Method : In this method only one capital account is prepared, i.e., Capital A/c.2. Fixed Capital Method : In this method two accounts are prepared,

1) Capital A/c : only capital brought by the partners will be recorded.2) Current A/c : all entries related to partners, i.e., interest on capital, interest on drawings, share

of profit or loss, etc.

PROFIT & LOSS APPROPRIATION A/cIn case of partnership, the net profit is transferred to Profit & Loss Appropriation A/c to show the distribution of profit (or loss) after deducting with the interest on capital, partners salaries, commission and after adding interest on drawings.

PROFIT & LOSS APPROPRIATION A/c

Dr. Cr.

PARTICULARS AMOUNT PARTICULARS AMOUNTTo Salary to Partners : X : Y

By Profit & Loss A/c

To Commission : X to Partners : Y

By Interest on : X drawings : Y

To Interest on : X Partner’s capital : Y To Reserve A/cTo Profit transferred : Xto Partner’s capital or current A/c : Y

By Loss transferred : Xto Partner’s capital or current A/c : Y

FLUCTUATING CAPITAL METHOD

CAPITAL ACCOUNT

Dr. Cr.

PARTICULARS X Y PARTICULARS X YBy Balance b/d xxx Xxx

To Drawings xxx xxx By Salary xxx XxxBy Interest on Capital

xxx Xxx

To Loss xxx xxx By Profit xxx XxxTo Balance c/d

FIXED CAPITAL METHOD

CAPITAL ACCOUNT

Dr. Cr.

PARTICULARS X Y PARTICULARS X YTo Balance b/d By Balance b/d xxx Xxx

To Balance c/d xxx xxx By Balance c/d

CURRENT ACCOUNT

Dr. Cr.

PARTICULARS X Y PARTICULARS X YTo Drawings xxx xxx By Salary xxx Xxx

By Interest on Capital

xxx Xxx

To Loss xxx xxx By Profit xxx XxxTo Balance c/d By Balance c/d

LIMITED COMPANIES ( SCHEDULE VI )

Trading, Profit & Loss A/c and Balance Sheet of a Company is prepared as per Schedule VI.

BALANCE SHEET as on 31st March, 2012

Particulars NoteNo.

Figures as at the end of current reporting period

Figures as at the end of previous reporting period

I. EQUITY AND LIABILITIES

(1) Shareholder's Funds (a) Share Capital (b) Reserves and Surplus (c) Money received against share warrants

(2) Share application money pending allotment

(3) Non-Current Liabilities (a) Long-term borrowings (b) Deferred tax liabilities (Net) (c) Other Long term liabilities (d) Long term provisions

(4) Current Liabilities (a) Short-term borrowings (b) Trade payables (c) Other current liabilities (d) Short-term provisions

TOTAL

II. ASSETS

(1) Non-current assets (a) Fixed assets (i) Tangible assets (ii) Intangible assets (iii) Capital work-in-progress (iv) Intangible assets under development (b) Non-current investments (c) Deferred tax assets (net) (d) Long term loans and advances (e) Other non-current assets

(2) Current assets (a) Current investments (b) Inventories

(c) Trade receivables (d) Cash and cash equivalents (e) Short-term loans and advances (f) Other current assets

TOTAL

PROFIT & LOSS A/c for the year ended 31st March, 2012

Particulars NoteNo.

Figures as at the end of current reporting period

Figures as at the end of previous reporting period

I. Revenue from operations II. Other Income III. Total Revenue (I +II)

IV. Expenses: Cost of materials consumed Purchase of Stock-in-Trade Changes in inventories of finished goods, work-in-progress and Stock-in-Trade Employee benefit expense Financial costs Depreciation and amortization expense Other expenses Total Expenses

V. Profit before exceptional and extraordinary items and tax (III - IV) VI. Exceptional Items VII. Profit before extraordinary items and tax (V - VI) VIII. Extraordinary Items IX. Profit before tax (VII - VIII)

X. Tax expense: (1) Current tax (2) Deferred tax XI. Profit(Loss) from the period from continuing operations (VII-VIII) XII. Profit/(Loss) from discontinuing operations XIII. Tax expense of discounting operations XIV. Profit/(Loss) from Discontinuing operations (XII - XIII) XV. Profit/(Loss) for the period

(XI + XIV)

XVI. Earning per equity share: (1) Basic (2) Diluted

OBJECTIVES OF FINANCIAL STATEMENTS

JOURNAL

1) Journal is prepared to keep a systematic record of financial transactions.2) Journal is prepared to show financial transactions in chronological order.3) Journal is prepared to present necessary information about the financial transactions.4) Journal is prepared to use as a legal evidence of financial transactions.5) Journal is prepared to facilitate the preparation of ledger book.

LEDGER

1) To Provide Classified Financial InformationThe ledger is a permanent book of record which contains a number of accounts of different subjects. Its purpose is, therefore to provide classified financial information about the subjects such as a person, asset and an expense or income.

2) To Provide Check on Arithmetical AccuracyThe fundamental double-entry principle provides that debit is always equal to credit or vice verse. Since the ledger account is prepared under the double-entry system, it helps to prepare a trial balance that provides a check on the arithmetical accuracy of the recording transactions in the books of accounts.

3) To Help Ascertain Profit Or LossThe ledger is a book of accounts relating to all the financial transaction of the business. It contains the accounts of all expenses, losses, incomes and gains. Therefore it helps to prepare the profit and loss account of the business so as to ascertain the profit earned or loss suffered during a specified period.

4) To Help Reveal the Financial PositionThe ledger also contains the accounts of the financial transactions relating to capital, all liabilities and assets of the business. With the help of the balances of these accounts and profit and loss of the business, a balance sheet may be prepared to show its financial position at a certain point in time.

TRIAL BALANCE

1) To Check the Arithmetical AccuracyTrial balance is based on the double-entry principle of debit equals credit or credit equals debit. As a result, the debit and credit columns of trial balance must always be equal. If they do, it is assumed that the recordings of financial transactions are accurate. Conversely, if they do not, it is assumed that they are not arithmetically accurate. Therefore, one important purpose of preparing trial

balance is to provide a check on the arithmetical accuracy of the recordings of the financial transactions.

2) To Help Locate Accounting ErrorsSince the trial balance indicates if there is any error committed in the journal and the ledger, it helps the accountant to locate the error because the starting point of locating errors is trial balance itself.

3) To Summarize the Financial TransactionsA business performs several numbers of financial transactions during a certain period of time. The transactions themselves can not portray any picture of the financial affairs of the business. For that purpose, a summary of the transactions has to be drawn. The trial balance is prepared with a view to summarize all the financial transactions of the business.

4) To Provide the Basis For Preparing Final AccountsFinal accounts are prepared to show profit and loss and the financial position of the business at the end of an accounting period. These accounts are prepared by using the debit and credit of all ledger accounts. Therefore, since the trial balance is a statement of the debit and credit balances of the ledger accounts, it provides the basis for the preparation of the final accounts.

TRADING ACCOUNT

1) Trading account helps to know gross profit or loss.2) Trading account provides information about the direct expenses.3) Trading account provides safety against possibilities of loss.4) Trading account helps in comparison of closing stock with last year's stock

PROFIT & LOSS ACCOUNT

1) Profit and loss account gives the actual information about net profit or net loss of the business for an accounting period.

2) Profit and loss account gives the actual information about indirect expenses.3) Profit and loss account serves to determine the ratio between net profit to sales.4) Profit and loss account helps in determining the ratio between net profit to operating expenses.5) Profit and loss account helps in controlling indirect expenses.

BALANCE SHEET

UNIT 3 : COST ACCOUNTING

ELEMENTS OF COST

Elements of Cost

Material Labour Expenses

Direct Indirect Direct Indirect Direct Indirect Material Material Labour Labour Expenses Expenses

Prime Cost Overheads

Total Cost

Prime Cost = Direct Material + Direct Labour + Direct Expenses

Overheads = Indirect Material + Indirect Labour + Indirect Expenses

Total Cost = Prime Cost + Overheads

Overheads

Works Administrative Selling & Distribution Overheads Overheads Overheads

CLASSIFICATION OF COSTS

1) According to TIMEa) Historical Costb) Future / Estimated Cost

2) According to FUNCTIONa) Manufacturing / Production Costb) Administration Costc) Selling & Distribution Costd) Research & Development Cost

3) According to VARIABILITYa) Fixed Costb) Variable Costc) Semi-variable Cost or Semi-fixed Cost

4) According to PRODUCTa) Direct Costb) Indirect Cost

5) CONTROLLABILITYa) Controllable Costb) Uncontrollable Cost

6) NORMALITYa) Normal Costb) Abnormal Cost

COST CENTER AND COST UNIT

COST CENTER: Cost Center refers to a section of business to which costs can be charged. It may be a location (a department, a sales area), an item of equipment (a machine, a delivery van), a person (a salesman, a machine operator) or a group of these (two automatic machines operated by one workman).Cost Centers are of two types:

a) Personal Cost Center: consisting of a person or a group of persons.b) Impersonal Cost Center: consisting of a location or an item of equipment.

In case of manufacturing concerns cost centers are mainly of two types:a) Production Cost Center: where actual production activity is carried on.

Example: machine shop, assembly shop.b) Service Cost Center: this provides ancillary services to production cost centers.

Example: power plant maintenance department.

COST UNIT: Cost unit is a unit of measurement in which cost may be ascertained or expressed.Example:

Product / Service Cost UnitSoaps Number / CartonWire / Cable Meter / KilometerDairy (Milk) Litre / Bag / PouchGoods transport Tonne KilometerPassengers transport Passenger KilometerWood / Gas Cubic Feet (cft.)

Food grains Kg. / Quintal / TonneSugar Per Tonne / QunitalHospital Per Patient DayAutomobile Per Vehicle / Number

RELEVENT, IRRELEVENT, DIFFERENTIAL, SUNK COST

RELEVENT COST: A cost which is affected by a decision is relevant cost and hence it is important in decision making.

IRRELEVENT COST: A cost which is not affected by a decision is irrelevant cost, i.e. it will remain the same irrespective of the decision taken.

DIFFERENTIAL COST: Differential cost is the additional costs which will be incurred, if the management chooses one course of action as oppose and to another. They are the extra or incremental costs, by a particular decision.

SUNK COST: A cost which requires current or future cash expenditure is out of pocket cost or sunk cost. However those costs which have already being incurred in the past and will not required cash expenditure are called as sunk cost.

COST SHEET

COST SHEET – FORMAT

Particulars Amount Amount

Opening Stock of Raw Material

Add: Purchase of Raw materials

Add: Purchase Expenses

Less: Closing stock of Raw Materials

Raw Materials Consumed

Direct Wages (Labour)

Direct Charges

***

***

***

***

***

***

***

Prime cost (1) ***Add :- Factory Over Heads:

Factory Rent

Factory Power

Indirect Material

Indirect Wages

Supervisor Salary

Drawing Office Salary

Factory Insurance

Factory Asset Depreciation

***

***

***

***

***

***

***

***Works cost Incurred ***Add: Opening Stock of WIP

Less: Closing Stock of WIP

***

***Works cost (2) ***Add:- Administration Over Heads:-

Office Rent

Asset Depreciation

General Charges

Audit Fees

Bank Charges

Counting house Salary

Other Office Expenses

***

***

***

***

***

***

***Cost of Production (3) ***Add: Opening stock of Finished Goods

Less: Closing stock of Finished Goods

***

***Cost of Goods Sold ***Add:- Selling and Distribution OH:-

Sales man Commission

Sales man salary

Traveling Expenses

Advertisement

Delivery man expenses

***

***

***

***

***

Sales Tax

Bad Debts

***

***Cost of Sales (5) ***Profit (balancing figure) ***Sales ***

Notes:-

1) Factory Over Heads are recovered as a percentage of direct wages

2) Administration Over Heads, Selling and Distribution Overheads are recovered as a percentage of works cost.

UNIT 4 : COST CONTROL

MATERIAL

DIRECT MATERIAL : 1) All material specifically required for a job order or process. 2) All materials transferred from one process to another process. 3) Primary packing materials .

INDIRECT MATERIAL : Materials which are not directly traceable to finished products such as consumable stores used in operations, lubricating oil, grease, fuel oil, etc.

MATERIAL CONTROLMaterial or inventory control may be define as , ‘ systematic control and regulation of purchase, storage and usage of material in such a way so as to maintain an even flow of production, at the same time avoiding excessive investment in inventories. Efficient material control cuts out losses and wastes of material that otherwise pass unnoticed’ .

OBJECTIVE OF MATERIAL OR INVENTORY CONTROL1) No under-stocking2) No over-stocking3) Economy in purchasing4) Proper quality5) Minimum wastage6) Information about material

INVENTORY CONTROL TECHNIQUES1) ABC Analysis2) Stock Levels – Minimum, Maximum and Reorder Level

3) Economic Order Quantity4) Perpetual Inventory System5) Control Ratios

1) ABC Analysis: This method of stores control is based on the concept of ‘Selective Inventory Management‘. Under this method, the total number of items of materials are classified into three categories namely A, B, and C according to their value, availability, importance, etc.ABC Analysis (or) Pareto Analysis :- In this materials are categorized into

Particulars Quantity Value “A” – Important material 10% 70%“B” – Neither important nor unimportant 20% 20%“C” – UN Important 70% 10%

Note:-1) Material received as replacement from supplier is treated as fresh supply2) If any material is returned from Department after issue, it has to be first disposed in the next issue of material3) Loss in the book balance of stock and actual is to be transferred to Inventory adjustment a/c and from there if the loss is normal it is transferred to Over Head control a/c. If it is abnormal it is transferred to costing profit and loss a/c. 4) CIF = Cost Insurance and Freight (This consignment is inclusive of prepaid insurance and freight)5) FOB = Free on Board (Materials moving by sea – insurance premium is not paid)

6) FOR = Free on Rail (Insurance and freight is not borne by the supplier but paid by the company or purchase)7) For each receipt of goods = Goods Receipt note8) For each issue of goods = Materials Requisition note (or) Material Issue note

2) Stock Levels1) Reorder level = Maximum usage * Maximum lead time (Or) Minimum level + (Average usage * Average Lead time)

2) Minimum level = Reorder level – (Average usage * Average lead time)

3) Maximum level = Reorder level + Reorder quantity – (Minimum usage * Minimum lead time)

4) Average level = Minimum level +Maximum level (or) 2

Minimum level + ½ Reorder quantity

5) Danger level (or) safety stock level =Minimum usage * Minimum lead time (preferred) (or) Average usage * Average lead time (or) Average usage * Lead time for emergency purposes

3) Economic Order Quantity: EOQ may be defined as that level of inventory order that minimises the total cost inventory management.

1) EOQ (Economic Order Quantity - Wilson’s Formula) = √2AO/C Where A = Annual usage units O = Ordering cost per unit

C = Annual carrying cost of one unit i.e. Carrying cast % * Carrying cost of unit2) Associated cost = Buying cost pa + Carrying cost pa3) Under EOQ Buying cost = Carrying cost4) Carrying Cost = Average inventory * Carrying cost per unit pa * Carrying cost %

(Or) Average Inventory * Carrying cost per order pa5) Average inventory = EOQ/26) Buying cost = Number of Orders * ordering cost7) Number of Orders = Annual Demand / EOQ

4) Perpetual Inventory System: Stores Ledger (FIFO, LIFO, Simple Average, Weighted Avg.)

DATE PARTICULARS RECEIPT ISSUES BALANCEQTY RATE AMOUNT QTY RATE AMOUNT QTY RATE AMOUNT

5) Control Ratios1) Inventory Turnover (T.O) Ratio = Material consumed

Average Inventory2) Inventory T.O Period = 365 .

Inventory Turn over Ratio 3) safety stock = Annual Demand *(Maximum lead time - Average lead time)

365 4) Total Inventory cost = Ordering cost + Carrying cost of inventory +Purchase cost

5) Input Output Ratio = Quantity of input of material to production Standard material content of actual output

Remarks :-1) High Inventory T.O Ratio indicates that the material in the question is fast moving2) Low Inventory T.O Ratio indicates over investment and locking up of working Capital in inventories

LABOUR

DIRECT LABOUR : Cost which can be identified with and allocated to cost centers or cost units.

INDIRECT LABOUR : Cost which is not possible and economically feasible to trace to any specific product.

LABOUR RECORDSThere are two types of records maintained in case of Labour:

1) Time Keeping2) Time Booking

1) Time Keeping: Time keeping refers to the correct recording of the empoyee’s attendance time.Methods of Time Keeping

a) Hand – written recordsb) Disc or Token methodc) Punch Card System

2) Time Booking: It refers to the recording of time spent by a worker on each job, process or operation.Methods of Time Booking

a) Time Cardb) Job Card

LABOUR TURNOVERIt is the rate of change in the labour force during a specified period. There are different causes for labour turnover, which can be classified under the following three heads:

a) Personal Causesb) Unavoidable Causesc) Avoidable Causes

Effect of Labour Turnover: It increases the cost of production in the following ways:a) Normal flow of production is disturbed.b) Efficiency of new workers is lesser than the old or experienced workers.c) Additional cost of recruitment and training.d) Untrained or new workers cause more breakage of tools, wastage of material, defectives, etc.

Labour Turnover Ratios : -

1) Separation rate method = Separation during the period

Average No. of worker’s during the period

2) Net labour T.O rate (or) Replacement method = Number of replacements

Average No. of worker’s during the period

3) Labour flux rate = No. of separation + No. of replacement

Average No. of worker’s during the period

Accounting Treatment

1) Normal Idle time = Charged to factory overheads

2) Normal but un-controllable = It should be charged to job by inflating wage rate.

3) Abnormal = It should be charged to costing P & L a/c

OVERHEADS

The cost of indirect material, indirect labour and indirect expenses which cannot conveniently be charged to a specific unit is called as overheads.

CLASSIFICATION OF OVERHEADS

1) By Functiona) Manufacturing Overheadsb) Administration Overheadsc) Selling Overheadsd) Distribution Overheads

2) By Variabilitya) Fixed Overheadsb) Variable Overheadsc) Semi-variable Overheads

3) By Controllabilitya) Controllable Overheadsb) Non-controllable Overheads

ABSORPTION OF OVERHEADS

Overhead absorption is a process by which overheads are included in the total cost of a product. It is also defined as the charging of overheads to cost units by means of rates calculated for each cost center (department). Overhead absorption is all the more essential when dissimilar products are made which require different production processes or for jobs using identical facility.

Overhead Absorption Rate = Total Overheads No. Of units of absorption base Applicable to cost center

Different bases of Absorption

Sr.No.

Method Formula

1. % of Direct Materials = Total Factory Overheads x 100 Direct Material

2. % of Direct Labour Cost = Total Factory Overheads x 100 Direct Labour Cost

3. % of Prime Cost = Total Factory Overheads x 100 Prime Cost

4. Direct Labour Hour Rate = Total Factory Overheads Direct Labour Hours

5. Machine Hour Rate = Total Factory Overheads Machine Hours

6.Per unit of output basis(can be used only if there is one product)

= Total Factory Overheads Output units

UNDER / OVER ABSORPTION OF OVERHEADS

Under Absorption: When the overheads charged (absorbed) to production are less than the actual overheads incurred, then it is known as under absorption of overheads.

Over Absorption: When the overheads charged (absorbed) to production are more than the actual overheads incurred, then it is known as over absorption of overheads.

Accounting for under and over absorption: There are three methods to deal with the under or over recovery / absorption of overheads –

1) Use of Supplementary Rate: When the amount of under or over recovery of overheads is sizeable (big) especially on account of price changes, then the supplementary rates are used to account for the amount of under or over recovery of overheads.

2) Write off to Costing Profit & Loss Account: If the amount of under or over recovery is negligible or small, then it is transferred to Costing Profit & Loss Account. ( if under or over absorption is due to abnormal reasons, then also it is transferred to Costing P&L A/c)

3) Carry Forward of Overheads: Sometimes management carries forward the amount of under or over absorption of overheads in ‘Overheads Suspense A/c’ or ‘Overheads Reserve A/c’ to be set-off against the under or over absorption of the subsequent years’ overheads. (the amount is carried forward if it is a small amount)

UNIT 4 : DECISION MAKING TOOLS

STANDARD COSTING

Material Cost Variance

Material Price Usage Variance Variance

Mix Variance Yield Variance OR Material sub-usage Variance

Formulae for Material Cost Variance:

1. Material Cost Variance (MCV) = (Standard Qty (SQ)*Standard Price (SP)) - (Actual Qty (AQ) * Actual Price (AP))

2. Material Usage Variance (MUV) = (SQ - AQ) *SP

3. Material Price Variance (MPV) = (SP - AP) * AQ

4. Material Mix Variance (MMV) = ( Revised Standard Qty (RSQ) - AQ) * SP

5. Revised Standard Hour = SQ of 1 material * Total qty of all Actual material

Total SQ of all material

6. Material Sub usage/ Material Revised usage Variance (MRUV)

= ( SQ- RSQ) *SP

To verify the above the following can be used :

MCV = MUV +MPV

MUV = MMV + MRUV

* If the Answer is in negative '-' then we should mark as Adverse (A) or else Favourable (F)

Labour Cost Variance

Labour Rate Variance Labour Efficiency Variance

Idle Time Variance Labour Mix Variance Labour Yield Variance OR Labour sub-efficiency Variance

Formulae for Labour Cost Variance

1. Labour Cost Variance = ( Standard Hour * Standard Rate) - ( Actual Hour * Actual Rate)

2. Labour efficiency Variance = ( Standard Hour- Actual hour) * Standard Rate

3. labour rate variance = (Standard Rate - Actual rate) * Actual hour

4. Labour mix variance = (Revised Standard Hour - Actual hour) * Standard Rate

5. Revised standard hour = SH of 1 grade * Total of Actual Hour

Total SH

6. Labour revised efficiency variance =(Standard Hour-Revised Standard Hour)*Std rate

* If the Answer is in negative '-' then we should mark as Adverse (A) or else Favourable (F)

MARGINAL COSTING

(I) Marginal costing statement

Sales (S) *****

Less : Variable Costs(VC) *****

Contribution (C) *****

Less : Fixed Costs (FC) *****

Profit/Loss (P) *****

(II) Profit Volume Ratio ( P/V Ratio)

The profit volume ratio , which is also called the ‘contribution ratio', expresses the relation of contribution to sales. It is an indicator of the rate which profit is being earned. It reveals the effect on profit of changes in the volume.

P/V Ratio = Contribution

Sales

P/V ratio may also be computed by comparing the change in contribution to change in sales or change in profits to change in sales.

P/V ratio = Change in Profit * 100

Change in Sales

(III) Break Even point

Break-even point means that levels of sales at which sales revenue exactly equal to total costs, both variable and fixed. Break even analysis refers to the study of relationship between costs ,volume and

profit at different levels of sales or production. ‘A break even analysis indicates at what level of costs and revenue are in an equilibrium’.

BEP (in units) = Fixed Cost

Contribution PER UNIT

BEP (in money terms) = Fixed Cost * Sales

Contribution

BEP (if p/v ratio is given) = Fixed Cost

P/V ratio

(IV) Margin of Safety (MOS)

MOS may be defined as the difference between actual sales and sales at break-even point . In other words , it is the amount at which actual volume of sales exceeds the break – even point.

1. MOS = Actual Sales – Break-even point

2. Profit = MOS * P/ V ratio

3. In percentage MOS % = Sales – BEP * 100

Sales

Calculation of Sales for desired profit

= (fixed cost + desired profit ) Sales

Sales – Variable Costs

= (fixed cost + desired profit )

P/V ratio

CASH BUDGET : Both Fixed and Flexible Budget done in Accounts Note Book.