financial acccounting mba kuk

8/13/2019 Financial Acccounting MBA KUK

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Lalit Wadhwa, Assistant Professor in Management, Geeta Instititute of Management

&Technology, Kanipla, Kurukshetra

FINANCIAL

ACCOUNTING

Instructional Resource

Lalit Wadhwa

Asstt. Prof. In Management

Geeta Institute of Management & Technology, KKR

MBA 1stSemester, Kurukshetra University


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SYLLABUS

FINANCIAL ACCOUNTING

CP-106

Note: The Examiner will set the question paper in two parts encompassing the entire syllabus.Part A will comprise 10 short answer type questions of 5 marks each. Part B will comprise of 5

questions of 10 marks each. A student is required to attempt any eight questions from the part A

and any 3 questions from part B.

Objectives: The basic purpose of this course is to develop an insight of postulates, principles and

techniques of accounting and application of financial and accounting information for planning

decisionmaking and control.

Course Contents: Financial Accounting - Concept, Importance and Scope. Generally accepted

accounting principles, Preparation of Financial Statements with special reference to analysis of aBalance Sheet and Measurement of Business Income; Financial Statement Analysis; Ratio

analysis- liquidity, solvency and profitability ratios. Funds Flow Analysis; Cash Flow Analysis

Cost Accounting - Nature &Scope of costing; Preparation of cost sheet; Marginal costing and

absorption costing: Managerial application of marginal costing. Break even analysis;Responsibility Accounting - Concept and Objectives. Responsibility Centers; Budgeting: Types

of budgets & their preparation, performance budgeting and Zero based budgeting. Standard

costing - organization and establishing a standard costing system. Variance Analysis-

Classification of variances, Material cost. Labour cost, Overhead cost and sales variances;Inflation Accounting concept, impact of inflation on corporate financial statements; Human

Resource Accounting - Concept and Approaches; IFRS-An introduction. Accounting software:

Tally.

Suggested Readings:1. Anthnoy R.N. & Reece J S. Accounting Principals. Ilomevvood Illinois. Richard D. Irwin.

1995

2. Batacharya S.K.& Dearden .1. Accounting for Management- Text and Cases. Vikas New

Delhi 19963. Heitger LE and Matulich Serge Financial Accounting. McGraw Hill, New York. 1990

4. Horngren C T, Sundem G F and Stratton W. Introduction to Management Accounting.Prentice Hall of India New Delhi. 1994.

5. Khan M Y & Jain P K. Management Accounting. Tata McGraw-Hill, New Delhi.

6. Sahaf M A Management Accounting - Principles & Practice, New Delhi, Vikas Publishing

House 2009.The list of cases and specific references including recent articles will be announced in the class


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CONTENTS

1. FINANCIAL ACCOUNTING 111

1.1 Definitions1.2 Features of Accounting1.3 Objective of Accounting

1.4 Book Keeping and Accounting1.5 Difference between book keeping and Accounting1.6 Branches of Accounting1.7 Accounting as Information system1.8 Classification of Accounts

1.9 Users of Accounting informations1.10 Basis of Accounting

1.11 Double entry system1.12 Basis Of Accounting1.13 Accounting Equation

1.14 Advantages of Accounting1.15 Limitations of Accounting

2. ACCOUNTING PRINCIPLES 12162.1 Basics Concepts or Assumption s

2.2 Basic Principles2.3 Modified Principle

3. FINAL ACCOUNTS OF JOINT STOCK COMPANY 1718

4. RESPONSIBILITY ACCOUNTING 19234.1 Introduction

4.2 Definition4.3 Steps of Responsibility Accounting

4.4 Pre-requisites of an Effective Responsibility Accounting4.5 Objectives of Responsibility Accounting4.6 Advantages of Responsibility Accounting

4.7 Disadvantages of Responsibility Accounting

5. COST ACCOUNTING 24-325.1 Cost5.2 Elements of Cost

5.3 Classification of Cost5.4 Cost Accounting

5.5 Cost Accountancy5.6 Objective of Cost Accounting5.7 Advantages of Cost Accounting5.8 Limitation of Cost Accounting5.9 Difference between Financial and Cost Accounting

6. STANDARD COSTING 3349

6.1 Definitions


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6.2 Process of Standard Costing6.3 Advantages of Standard Costing

6.4 Disadvantages of Standard Costing6.5 Standard Costing and Budgetary Control6.6 Variances

6.6.1 Material Variances

6.6.2 Labour Variances7. BUDGETARY CONTROL 50 - 59

7.1 Meaning of Budget, Budgeting and Budgetary control7.2 Requirements of Budgetary Control7.3 Objectives of Budget7.4 Advantages of Budgetary Control

7.5 Types of Budget7.6 Zero base Budgeting

7.7 Performance Budgeting

8. MARGINAL COSTING 6067

8.1 Definitions

8.2 Advantages of Marginal Costing8.3 Disadvantages of Marginal Costing8.4 Difference between Absorption Costing and Marginal Costing

8.5 Main areas of decision making8.6 Cost-volume-profit-Relationship

9. INFLATION ACCOUNTING 68 - 71

9.1 Introduction9.2 Definition9.3 Impact Of Inflation on Corporate Financial Statements9.4 Significance of Inflation Accounting

9.5 Limitation of Inflation Accounting

9.6 Methods of Inflation Accounting

10. FUND FLOW STATEMENT 7278

10.1 Definitions10.2 Objectives, Uses and Importance of Fund Flow Statement10.3 Limitation of Fund Flow Statement10.4 Preparation of Fund Flow Statement

11. CASH FLOW STATEMENT 7983

11.1 Meaning11.2 Difference between fund flow statement and cash flow statement11.3 Objective of cash flow statement

11.4 Utility, importance and advantages11.5 Preparation of cash flow statement

12. RATIO ANALYSIS 8496

12.1 Meaning12.2 Liquidity Ratios12.3 Leverage Ratio12.4 Turnover Ratio

12.5 Profitability Ratio based of sale


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12.6 Profitability Ratio based of investment

13. INTERNATIONAL FINANCIAL REPORTING STANDARDS 97100

13.1 Introduction13.2 Definition13.3 Difference Between IFRS and GAAP

13.4 International Financial Reporting Standards13.5 Advantages and Disadvantages of IFRS13.6 Need For IFRS

14. HUMAN RESOURCE ACCOUNTING 10110414.1 Introduction14.2 Importance of Human Resource Accounting

14.3 Objective of Human Resource Accounting14.4 Limitations of Human Resource Accounting

14.5 Approaches of Human Resource Accounting

Question Bank 105113

Model Test Paper 114119

References 120


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CHAPTERI

FINANCIAL ACCOUNTING

Objectives: The important objectives are :

1. To introduce the subject Financial Accounting

2. To discuss the meaning and definition of Accounting

3. To identify the uses and users of Accounting informations

In the modern times during the course of business , a businessman deals with a large

number of persons-customers, suppliers, middleman, institutions etc. He keeps various types of

assets as cash, stock of goods ,furniture, plant, investments ,building etc. He has to incur various

exp. and he receives so many type of incomes. Obviously this is not possible for a human being

to remember all transactions relating to person, property ,payment and earnings. Therefore it

require a system of recording. Moreover such a record must be based on a definite and well tried

system, as to enable him to secure accurate information regarding the cumulative effect of

business transaction.

The branch of knowledge which deals with the systematic recording of transaction is

called book keeping. Accounting starts when the book keeping ends. Actually Accounting

summarizes the informations collected recorded by a book keeper.

Accounting is an art of identification of economic transactions and recording,

classifying, summarizing, analyzing and interpreting the transactions of concern to know

the results thereof.

1.1 Definitions

As per American Accounting Association: Accounting is the process of identifying ,

measuring and communicating information to permit judgment and decisions by the users.

In 1941, The American Institute of Certified Public Accountant(AICPA) defined

accounting as follows: Accounting is the art of recording, classifying and summarizing in

significant manner and in terms of money, transactions and events which are , in part, at least of

a financial character and interpreting the results thereof.

R.N. Anthony: An Accounting system is a means of collecting, summarizing ,

analyzing and reporting in monetary terms, informations about the business


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Smith and Ashburne: Accounting is the science of recording and classifying business

transactions and events, primarily of a financial character and the art of making significant

summaries , analysis and interpretations of these transactions and events and communicating the

results to persons who must make decisions or form judgments

1.2 Features / Functions / Accounting Process:

Recording:In Accounting only those transactions are recorded which can be measured

in the terms of money only. For example if there is a quarrel between sales manager and

purchase manager it can not be recorded. In accounting transactions of qualitative nature are

ignored.

Classifying: In Accounting, the second step is to accumulate the transactions of same

nature in a book which is called ledger.

Summarizing: In the third step, Trial balance , Trading, P&L A/C & Balance Sheet is

prepared. Preparation of trial balance is the part of book keeping while Trading, P&L A/C &

Balance sheet is the part of final a/c.

Analyzing: In the next step after preparation of financial statements these are analyzed

with the help of fund flow statement, cash flow statement, and ratio analysis.

Interpreting: In the last step the analysis is interpreted so that result can be known and the

decisions can be made.

Accounting process / Accounting Cycle

Classifying

Summarizing

Analyzing

Interpreting

Recording


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1.3 Objectives of Accounting:

1. To know the profit and loss:The main objective of accounting is to know the profit or

loss during the year. How much gross profit or gross loss and Net profit or net loss..2. To know the financial position: The another objective of accounting is to know the

financial position. How much the assets the concern has and how much the liabilities the

concern is having.

3. For comparison: With the help of Accounting we can compare the financial

performance of concern with another concern and with the last year also.

4. For systematic recording :Accounting provides systematic recording of transactions of

the concern which are of financial nature.

5. Provides information:Accounting also provides information to the various parties

external as well as internal:

(i) To the owners(ii) To the management

(iii) To the investors

(iv) To the creditors

(v) To the government

(vi) To the employees

(vii) To the bank

1.4 Book-keeping and Accounting

Book-keeping is made of two words Book and Keeping where Book means all types ofbooks which are used to record the business transactions in business and keeping means

recording all the entries and business transactions in the account books in a systematic manner as

per rules and principles of accounts.

Hence, Book-keeping means, an the art of recording the business transactions in the

books of accounts in a proper form.

A book-keeper may be responsible for keeping the financial records of a business. The

main definitions of book-keeping are as under:

1. J.R. Batliboi: Book-keeping is the art of recording business dealings in a set of books.2. R.N. Carter: Book-keeping is the science and art of correctly recording in the book of

accounts, all those business transactions that results in the transfer of money or money

worth.

3. Spicer and Pegler: Bookkeeping is an art of recording business transactions in a

systematic manner.


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1.5 Difference between Book-keeping and Accounting

There is no line of demarcation between Bookkeeping and Accounting instead they have

a close relationship. It cannot be separated so easily. However, on the basis of working, thedifference between the two is as under:

S. No. Basis of Differences Book-keeping Accounting

1. Transactions Trading transactions are recorded in

primary books.

Entries written in primary books

are checked and verified.

2. Posting Entries are posted in ledger from

journal and subsidiary books.

Posting are checked whether

correctly posted or not.

3. Simplicity The work of Book-keeping is simple The work of Accounting is

difficult.

4. Total and Balance It includes totalling of journal and

finding of balances of ledger.

On the basis of balances of ledger

final accounts are prepared.

5. Objects The object of Book-Keeping is to

write all trading transactions in areasonable manner.

The objects of accounting is to

analysis the transactions written inthe books.

6. Adjustments and

Rectification of errors

In Book-keeping entries of

adjustments and rectification of

errors are not included.

Accounting includes entries of

adjustments and rectification of

errors.

7. Scope Scope of Books-keeping is narrow. Scope off Accounting is wide.

8. Final Accounts Final Account is not pre-pared in

Book-keeping

Final Account preparation is must.

1.6 Branches of Accounting

There are following branches of accounting

1. Financial Accounting

2. Cost Accounting

3. Management Accounting

4. Social responsibility Accounting

5. Human Resource Accounting

6. Tax Accounting

1.7 Accounting as information system:

Accounting is basically an information system because it provides the necessary, timely

and relevant information. As an information system Accounting is involved in the process of

converting inputs into outputs. Step of accounting as information system includes:-

1. Input

2. Process

3. Output

4. Report to users


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Accounting as Information System

Source: Gowda J. Made, Accounting for Managers, Himalaya Publications, 2007, pp7

1.8 Classification of Accounts

There are 3 types of accounts, namely personal accounts, real accounts, nominal

accounts.

a) Personal accounts.

i) Natural persons accounts.

ii) Artificial persons accounts.

iii) Representative persons accounts.

b) Impersonal accounts

i) Real accounts

a. Tangible Real Accounts

b. Intangible Accounts

ii) Nominal Accounts

1.9 Users of Accounting Information:

Users of accounting information are many and they can be classified into two broad

categories as internal parties and external parties.

Business

Transactions

(Purchase, Sales,

Exp. Income)

Recording

Classifying,

Analysing

Financial

Statements

(Profit & Loss

A/C, B/S)

User of

Accounting

Information

Reports to

users

Input Process Output


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Source: Gowda J. Made, Accounting for Managers, Himalaya Publications, 2007, pp8

Board of Directors

Chairman

Managing

Directors

Functional Manager

Others

Customers

Tax authorities

Trade Unions

Press

General Public

Shareholders

Debenture holders

Lender

Employees

Supplier

Internal

Parties

User with

direct

financial

stake

External

Parties

Users with

indirect

financial

stake

Users of

Accounting

Information


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1.10 Basis of Accounting

The following are the main basis of recording business transactions:

(a)Cash Basis. Under this system, actual cash receipts and actual cash payments are

recorded. Credit transactions are not recorded at all until the cash is actually received or

paid. The Receipts and Payments Account prepared in case of non-trading concerns such

as a charitable institution, a club, a school as the best example of cash system. This

system does not make a complete record of financial transactions of a trading period as it

does not record outstanding transactions like outstanding expenses and outstanding

incomes. The system being based on a record of actual cash receipts and actual cash

payments will not be able to disclose correct profit or loss for a particular period and will

not exhibit true financial position of the business on a particular day.

(b)

Accrual Basis.Under this all transactions relating to a period are recorded in the booksof account, i.e., in addition to actual receipts and payments of cash income receivable and

expenses payable are also recorded. This gives a complete picture of the financial

transactions of the business as it makes a record of all transactions relating to a period.

This being based on a complete record of the financial transaction discloses correct profit

or loss for a particular period and also exhibits true financial position of the business on a

particular day.

(c)Mixed System.Under this system both cash basis and actual basis are followed. Some

records are kept under cash basis whereas others are kept under accrual basis.

1.11 Double Entry System

This system owes its origin to an Italian merchant names Luco Pacioli who wrote the first

book entitled De Computis et Scripturis on double entry accounting in the year 1494. We have

seen earlier that every business transaction has two aspects, i.e., when we receive something we

give something else in return. For example, when we purchase goods for cash, we receive goods

and give cash in return; similarly in a credit sale of goods, goods are given to the customer and

the customer becomes debtor for the amount of goods sold to him. This method of writing every

transaction in two accounts is known as Double Entry System of Accounting. Off the two

accounts, one account is given debit while the other account is given credit with an equal

amount. Thus, on any date, the total of all debits must be equal to the total of all credits becauseevery debit has a corresponding credit.

Rules of Double Entry System

There are separate rules of the double entry system in respect of personal, real and

nominal accounts which are discussed below:


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1. Personal Accounts.These accounts record a businesss dealings with persons or firms.

The person receiving something is given debit and the person giving something is given

credit. For example, if Vijay sells goods to Viney on credit, Vineys Account will be

given debit (in Vijays books) as he is the receiver of goods and Vijays Account will be

credited (in Vineys Books) as he is the giver of goods. When Viney makes the payment

for these goods, Vijays Account will be debited in Vineys books as he is the receiver of

cash Vineys Account will be given credit in Vijays book as he is the giver of cash.

2. Real Accounts. There are the accounts of assets. Asset entering the business is given

debit and asset leaving the business is given credit. For example, when goods are sold for

cash. Cash Account will be given debit as cash comes in and Purchases (of Goods)

Account will be given credit in Vijays books as he is the giver of cash.

3. Nominal Accounts. These accounts deal with expenses, incomes, profits and losses.

Accounts of expenses and losses are debited and accounts of incomes and gains are

credited. For example, when rent is paid to the landlord, rent Account will be debited as it

is an expense and Cash Account (real account) will be credited as it goes out. Similarly,when commission is received, Cash Account will be debited as cash is received and

Commission Account will be credited as it is an income. Thus, the rule is debit all

expenses and losses and credit and gains.

The rules of the double entry system are shown in the following chart:

RULES OF THE DOUBLE ENTRY

1.12 Basis of Accounting

In general, accounting is known as the recording of financial transactions. In this process,

accountants are required to recognize revenues and costs. Following are the bases of accounting

for measuring the business income:

1) Cash Basis of Accounting:

This is the system of accounting under which revenues and expenses are recognized and

recorded only when they are received in cash. Similarly, expenses will be recorded when they

are paid in cash. No recording is made if an income or expense is merely due. Under cash basis,

income is measured as the excess of cash receipts over cash payment.

Personal Accounts Real Accounts Nominal Accounts

Debit the

Receiver

Credit the

Giver

Debit what

comes in

Credit what

Goes Out

Debit

Expenses

and Losses

Credit

Incomes and

Gains


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Thus, cash basis of accounting is not a sound system as it violates generally accepted

accounting principles. Financial statements do not show true and fair view of financial position

and operational results. However, cash basis of accounting is used by small business and service

organizations and professionals like advocates, medical practitioners, chartered accountants and

non profit organizations.

2) Accrual Basis of Accounting:

Accrual means recognition of revenues as it is earned and of costs as they are incurred

irrespective of the fact when revenues are received and costs are paid. Accrual basis of

accounting is the method of recording transactions by which revenues, costs, assets, and

liabilities are reflected in the accounts in the period in which they accrue. Accrual basis of

accounting is based on the revenue-recognition principle and the matching principle. This basis

is also known as mercantile system of accounting.

1.13 Accounting Equation

American accounts have derived the rules of debit and credit through accounting equation

which is given below:

Assets = Equities

The equation is based on the principle that accounting deals with property and rights to

property and the sum of the properties owned is equal to the sum of the rights to the properties.

The properties owned by a business are called assets and the rights to properties are known as

liabilities or equities of the business.

Equities may be divided into equities of creditors representing debts of the business

known as liabilities and equity of the owner known as capital. Keeping in view the two types of

equities the equation given above can be stated as below:

Assets = Liabilities + Capital

Roles of Accounting Equation

1.

Regarding Assets:Increases in assets are debits and decreases in assets are credits.

2. Regarding Liabilities:Increases in capital are credits and decreases are debits.

3. Regarding Capital:Increases in capital are credits and decreases are debits.

4. Regarding Expenses


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Increases in expenses are debits: decreases are credits.

5. Regarding Incomes or Profits:Increases in Incomes or profits are credits, decreases are debits.

ILLUSTRATION

Give Accounting equation for the following for the following transactions of Hitesh for

the year 2008.

(a)Started business with cash Rs. 18,000.(b)Paid rent in advance Rs. 400.(c)Purchased goods for cash Rs. 5,000 and on credit Rs. 2,000.(d)Sold goods for cash Rs. 4,000 (costing Rs. 2,400).(e)Rent paid Rs. 1,000 and rent outstanding Rs. 200.(f) Bought motor-cycle for personal use Rs. 8,000.(g)

Purchased equipments for cash Rs. 500.(h)Paid to creditors Rs. 600.

(i) Depreciation on equipment Rs. 25.(j) Business expenses Rs. 400.

Solution

Every transaction has two fold aspect, means it will be considered at least two items, we

can discuss the concept of accounting equation with the solution as follows:

S No. Equities Assets

Rent Out-

Standing

Creditors Capital Cash Rent in

Advance

Stock of

Goods

Equipment

Rs. Rs. Rs. Rs. Rs. Rs. Rs.

(a) 18,000 18,000

-400 +400

(b) 18,000 17,600 400

(c) +2,000 -5,000 +7,000

2,000 18,000 12,600 400 7,000

(d) +1,600 +4,000 -2,400

(e) 2,000 19,600 16,600 400 4,600

+200 - -1,200 -1,000 -

(f) 200 2,000 18,400 15,600 400 4,600

-8,000 -8,000 - -

(g) 200 2,000 10,400 7,600 400 4,600

- -500 - - +500

(h) 200 2,000 10,400 7,100 400 4,600 500

- -600 - -600 - -

(i) 200 1,400 10,400 6,500 400 4,600 500

-25 - - - -25

(j) 200 1,400 10,375 6,500 400 4,600 475

- -400 -400 -

200 1,400 9,975 6,100 400 4,600 475

Total Rs. 200+Rs. 1,400+Rs. 9,975=Rs. 11,575 Rs. 6,100+Rs. 400+Rs. 4,600+Rs. 475=Rs. 11,575


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1.14 Advantages of Accounting:

1. Compliment of memory: As everyone has limited memory. No one can remember

everything. Accounting provides informations which are recorded.

2. Comparative study: With the help of accounting we can compare the financial

performance of concern with another concern and with the last year also.3. Proof in a cour t: The proper Accounting can use as a proof in a court when there is

dispute of business with the third party.

4. Pur chase and sale of business: Accounting provides the purchase consideration of

business which helps in easy valuation of business.

5. Helpfu l in detection of err or or fr aud: Proper accounting help in the prevention and

detection of error and fraud.

6. Helpfu l in determination of tax li abil ity: With the help of accounting profit can be

ascertained so that it can be taxed.

7. Helpfu l in goodwill determination: With the help of accounting we can calculate the

amount of goodwill.

1.15 Limitations of Accounting:

1. Based on accounti ng concepts and conventions: The subject Accounting is based on

some irrelevant concepts and conventions. For example as per principle of

conservatismanticipated losses are considered as actual losses and anticipated profits

are not considered as actual profits.

2. I nf luenced by personal judgments: Some accountants valued the closing stock as per

FIFO and some valued the stock as per LIFO.Some accountants consider original

cost method and some consider written down value method for depreciation.3. Window dressing: False information are shown in the books. For example profit can

be increase by showing false sales to get the loan. Similarly profit can be reduced by

showing more expenses to avoid the tax.

4. I gnorance of quali tative information; As we know Accounting is an art of recording

classifying summarizing analyzing and interpreting the financial transactions of the

concern . qualitative transactions are ignored in Accounting.

5. I gnore price level change: Generally accounts are prepared on the basis of historical

cost other than stock . In Accounting ,price level changes are ignored.


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CHAPTERII

ACCOUNTNG PRINCIPLES


1. To discuss GAAPs and the Accounting environment

2. To distinguish between Accounting concepts and conventions.

3. Appreciate the importance of Accounting concepts and conventions

Accounting is an art of recording, classifying, summarizing, analyzing and interpreting

the transactions of the concern which are in part at least of financial nature to know the results.

This Accounting is useful for debtors, creditors, Govt. investors, lenders, and other parties whoare linked with the concern directly or indirectly. To give the uniform understanding to these

various parties some uniform principles are formed by Accounting professionals, these are

called principles. The Accounting profession has certain concepts, conventions, standard

language and terminologies to enable the interested parties to understand the subject matter in the

same sense as the accountant wants to communicate. These accounting rules are usually called

General Accepted Accounting Principles (GAAP). These are also called as concepts,

conventions, doctrines, axioms and postulates. The principles which are used in the

preparation of accounts are called concepts. But the principle which are used for the presentation

of accounts are called conventions.

Accounting principles can be classified into the following three groups.:

2.1 Basic concepts or assumptions:

(i) Business entity concept: As per business entity concept, business and business man

both are separate entities. The amount invested by business man is capital and this is

the liability of business, it is to be returned by the business to the business man.

Similarly the amount which the business man takes from business this is an asset of

the business which the business has to recover from the businessman. For example

the businessman has invested Rs 1,00,000 in the business(capital) is the liability of

the business and similarly the amount which the business man has withdrawn from

the business ( say 5000) is an asset of the business.

(ii) Going concern concept: As per this concept, all the transactions records in books on

the assumptions that concern is going on for ever in future, it is not going to expire.

On the basis of the same assumption there is a concept of depreciation which is

shown as exp. in p& l a/c. If we purchase any asset only depreciation of the asset for


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the same year is shown as exp. Classification of asset and liabilities as short term and

long term is also based on the same assumption.

The following are the cases where going concern concept is not valid:

1.

When an enterprise was set up for a particular purpose which has been achievedor to be achieved shortly.

2. When a company is declared sick by BIFR.

3. When an enterprise has been in the grip of severe financial crisis and in expected

to wind up shortly.

4. When a receiver or liquidator has been appointed in case of a company which is

to be liquidated.

(iii) Money measur ement concept: As per money measurement concept only those

transactions are shown which can be measured in the terms of money only.

Qualitative transactions are ignored. For example efficiency of managers , there is a

quarrel between sales manager and purchase manager , this is a qualitative transactionit can not be recorded in the books because you can measure it in the terms of money.

The advantage of expressing business transactions in terms of money is that money

serves a common denominator by means of which heterogeneous facts about a

business can be expressed in terms of numbers (i.e. money) which are capable of

additions and subtractions. It can be illustrated by taking the following example. A

business unit has the following assets on December 31, 2008.

Cash in hand and at bank Rs. 25,000, Sundry Debtors Rs. 48,500, Bills Receivable

Rs. 6,500, Motor Cars 5, Stock 6,000 tons, Furniture 100 chairs and 20 tables,

Machines 7, Building space 5,000sq. metres, Land 10 acres.

The items given in different units of measurement cannot be added together to get

an idea of the total value of the assets owned by the business. To get an idea of the

total value of the assets, all items should be expressed in terms of money as given

below:

Cash in hand and at bank Rs. 25,000, Sundry Debtors Rs. 48,500, Bills receivable

Rs. 6,500, Motor Cars Rs. 1,15,000, Stock Rs. 4,00,000, Furniture Rs. 5,000,

Machines Rs. 2,50,000, Building Rs. 4,40,000, Land Rs. 1,00,000, Total = Rs.

13,90,000.

Money measurement concept of accounting has two major limitations as given

below:(i) It restricts the scope of accounting because it is not capable of recording

transactions which cannot be expressed in terms of money.

(ii) It does not be take care of the effects of inflation because it assumes a stability

of the money measurement unit.

Generally business entity concept and money measurement concept are called

fundamental accounting concepts.


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(iv) Accounti ng period concept: As per Accounting period concept the transactions are

recorded for the period of 12 months so that it can be useful for the various parties.

Accounting period may be from1 Jan to 31 Dec or 1stApril of year to 31 march of

next year . Income Tax Act gives recognizes to 1stApril of year to 31 march of next

year. It may from Deepawali to next Deepawali or Holi to next Holi.

2.2 Basic principles:

1. Principle of revenue realization:As per this principle revenue can be recognized on the

following basis:

(a) Cash basis: As we receive the cash we will treat it as revenue means we can

record the revenue only when we received the cash.

(b) Sales basis: As per this basis we can consider the revenue as we sold the goods

either we receive the cash or not.

(c) production basis: As per this basis we can consider the revenue as we producethe goods either we sold it or not

2. Pri nciple of matching concept: Matching concept does not mean that we have to show

only those exp. which are directly relating to that particular income but all the exp.

relating to that particular period. All the exp relating to that period are shown either these

are paid or not. If any exp. is paid in advance it must be reduced.

Let us taken an example to make the matching concept clear.

A businessman purchases 100 table fans at a cost of Rs. 30,000. He paid Rs. 1,000 as

freight and insurance, Rs. 200 as octroi and carriage and rent outstanding was Rs. 2,000.

He sells all table fans at a price of Rs. 40,000 against which should be matched cost of

table fans Rs. 30,000, freight and insurance Rs. 1,000, octroi and carriage Rs. 200 and

outstanding rent Rs. 2,000. The net profit of the period not paid for and sale price of some

of table fans may not have been realized as yet on account of being sold on credit.

It may be remembered that profit and cash are not synonymous because their nature is

different. For example, if a business has made a profit of Rs. 1,00,000, it does not mean

that it has the same amount of cash or cash in increased by the same amount. It is because

there are outstanding expenses and creditors and outstanding debtors. The profit earned

will increase the capital of the business on the liabilities side and a corresponding

increase in the assets of the business will be made. Similarly, an increase in cash does not

mean increase in profit. Cash may have increased because of issue of shares or sale of a

fixed asset. Thus, income is tied to increase in owners equity and has direct link to

changes in cash.


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3. Principle of fu ll disclosure: As per this principle all the information of the concern are

shown in the books so that it can be useful for the various parties.

4. Veri fi abil ity objectivity of dual aspect: As per this principle every transaction has two

fold aspect. This is also called as double entry system. If one account is debited another

will be credited with the same amount. This can be discussed with the followingexample:

Business started with cash of Rs 50,000 and goods purchased from ramesh of rs

20,000. Accounting equation is used :

Assets = Capital + Liabilities

Cash + stock = capital + creditor

50,000+ 20,000 = 50,000+ 20,000

5. Verifiability objective of evidence concept: This principle explains that all the

transactions recorded in the books on the basis of some evidence. For example asset isrecorded on the basis of invoice, sale and purchase of goods are also recorded on the

basis of invoice, expenses are recorded on the basis of vouchers.

2.3 Modified principles:

1. Principle of materi ality: Whether something should be disclosed or not in the financial

statements will depend on whether it is material or not. Materiality depends on the

amount involved in the transaction. For example, minor expenditure of Rs. 10 for the

purchase of waste basket may be treated as an expense off the period rather than an asset.

Customs also influence materiality. For example, only round figures (to the

nearest rupee) may be shown in the financial statements to make the figures manageable

without affecting the accounting data. Similarly, for income tax purpose the income has

to be rounded to nearest ten rupees.

The term materiality is a subjective term. The accountant should record an item

as material even though it is of small amount if its knowledge seems to influence the

decision of the proprietors or auditors or investors. For example, commission paid to sole

selling agents should be disclosed separately in the Profit and Loss Account. Similarly,

amount due to directors or others officers of the bank should be disclosed separately inthe Balance Sheet of a bank to know the amount of advances due from the directors or

officers who are managing the affairs of the bank. The Companies Act, 1956 also lays

emphasis or separate disclosure of material items. Part II of schedule VI states that any

item of expenses which exceeds 1% of the total revenue of the company or Rs. 5,000

whichever in higher should be shown as a separate and distinct item against an

appropriate head in the Profit and Loss Account. Para 17 of AS-1 also states that financial


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statements should disclose all material items the knowledge of which might influence the

decisions of the user of the financial statements.

2. Pri nciple of consistency: There must not be any change in the method of Accounting

from year to year. For example if stock is valued at FIFO in any year It should not be

changed to LIFO. There should not be change in such a way until and unless it isnecessary for the better presentation of accounts. Similarly any particular method of

depreciation(say straight line) is used in any one year it should not be changed in coming

year. The rationale for following the convention of consistency is made clear in the

following example:

For example, a company purchased a fixed asset for Rs. 1,00,000 and it charges

depreciation @ 20% on straight line method. At the end of the second year, the book

value of the assets will be:

Rs.Cost of the fixed asset 1,00,000

Less:20% depreciation for 1 year 20,000

80,000

Less:20% depreciation for 2ndyear 20,000

Book value at the end of 2n year 60,000

Now, if the method is changed to reducing balance method in the second year, the

book value of the asset at the end of 2ndyear will be:

Rs.

Cost of the fixed asset 1,00,000

Less:20% depreciation for 1styear 20,000

80,000

Less:20% depreciation for 2ndyear 16,000

Book value at the end of 2ndyear 64,000

3. Pri nciple of conservatism/ prudence : Conservatism principle can be understand with the

following example:

a) All the anticipated losses are considered as actual losses in the accounts while

anticipated profits are not considered as actual profit.

b) Closing stock is valued at cost or market price whichever is less, while all the assets

are valued at cost.

c) Provision for bad debts.

d) Provision for fluctuation in the value of investment.

4. Principle of timelines: Accounts should be prepared with the books with in the proper

period so that it can be useful for the various parties.

5. Principle of industry practice : Any principle which is applied in any industry can

become the accounting principle.


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CHAPTERIII

FINAL ACCOUNTS OF JOINT STOCK COMPANY

Objectives: Understand the different items of balance sheet of joint stock company

Every company must prepare the final account every year. At every annual general meeting of a

company the board of directors of the company shall lay before the company.

(a) Balance Sheet as at the end of the year.

(b) Profit & Loss a/c for that period and Sec 211 of the Indian company Act,1956

requires that the final accounts of companies shall be in the prescribed form given

under schedule. The prescribed form of balance sheet has been given in part I of

schedule VI . No standard form for profit and loss a/c has been prescribed in part II

of schedule VI. However it has been laid down as to what it shall contain and

disclose. According to Schedule VI, a Balance sheet should be shown first and Profit

and loss a/c shall be annexed to it. In our curriculum only performa of balance sheet

of company so we will discuss the Balance Sheet, how company has to show the

items in Balance sheet.


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CHAPTERIV

RESPONSIBILITY ACCOUNTING


1. To discuss the concept of responsibility accounting.2. To acquaint with advantages and disadvantages of responsibility accounting.

4.1 INTRODUCTION:

Responsibility accounting is an underlying concept of accounting performance measurement

systems. The basic idea is that large diversified organizations are difficult, if not impossible tomanage as a single segment, thus they must be decentralized or separated into manageable parts.

These parts, or segments are referred to as responsibility centers that include: 1) revenue centers,

2) cost centers, 3) profit centers and 4) investment centers. This approach allows responsibility tobe assigned to the segment managers that have the greatest amount of influence over the key

elements to be managed. These elements include revenue for a revenue center (a segment that

mainly generates revenue with relatively little costs), costs for a cost center (a segment that

generates costs, but no revenue), a measure of profitability for a profit center (a segment thatgenerates both revenue and costs) and return on investment (ROI) for an investment center (a

segment such as a division of a company where the manager controls the acquisition and

utilization of assets, as well as revenue and costs).

Large organizations have operating activities which are voluminous. Controlling such activities

in details & in every sphere is not possible for the top management. The top management has the

total authority & responsibility. For the purpose of controlling efficiently, the total authority &responsibility is decentralized by forming small segments which are called responsibility centers

& to these centers, specific costs & revenues are allocated. The evaluation of performance of

each responsibility center is done at the periodical intervals on the basis of pre-determinedtargets.

4.2 DEFINITION:

Responsibility accounting may be known as decentralization of responsibility center so that

desired control can be ensured & thereby the goal of the organization can be attained.Responsibility accounting involves the following:

a. Entire organization is divided into small responsibility centers;

b. In terms of revenues & costs, the responsibility of each responsibility center is fixed;

c. In terms of its predetermined target, the performance of each responsibility center ismeasured.


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4.3 STEPS OF RESPONSIBILITY ACCOUNTING

Following steps are followed in responsibility accounting:

Step1: Determinations of Responsibility Centres: This is the first and foremost step in

responsibility accounting. For effective planning and control purposes, responsibility isclassified into various responsibility centres:

1. Cost Centres:A cost centre may be determined according to location which may be adivision, department, sales area, stock-yard, tool room and administrative office, etc. Costs are

accumulated in respect of a person who may be a Works manager, Sales manager, Purchase

manager, Personal manager, Finance Manager, or that of foreman, store-keeper, salesman,

section officer, etc. The objective cost centre is to reduce the cost and cost control

2. Revenue Centres:Revenue centres are those organizational units in which outputs aremeasured in monetary terms. These centres are marketing organizations and they are not directlyresponsible for profits. The main objective of revenue centres is to maximize revenues.

Each values centre is also an expense centre so far as marketing expense for that

responsibility centre. The primary measurement, however, is revenue. Revenue centres are not

charged for the cost of goods that they market. Consequently, they are not profit centres, becausethis important expense item is

For Example, a marketing organization is a sales revenue centre. Such a centre is devoted to

increasing the revenue and assumes no responsibility for production. In this centre, the manager

is responsible for the level of revenue or outputs of a centre, measured in monetary terms, but arenot responsible for the costs of the goods or services that they centres offers.

3. Profit Centres:A profit centre is a segment of business, which is responsible for the cost

it incurs as well as the revenue it generates. It should be able to identify all costs pertaining to the

profit centre and the revenue it generated. A profit centre should have operational independence.The manager of a profit centre should be free to make decisions in regard to the purchases of

materials economically from outside volume of production mix, methods of manufacture,

utilization of labour and equipment etc.

4. Investment Centres: An investment centres is a profit centre in which imports are

measured in terms of expense and outputs are measured in terms of revenues, and in which assetsemployed are also measured-the excess of revenues over expenditure then being related to assets

employed in the profit centre. The manager of investment centre is accountable for production

and sales decisions along with the investment decision.

Step II: Assigning Targets

Step III: Measuring Actual Performance


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Step IV: Calculate deviations and take corrective action to remove deviation.

4.4 PRE-REQUISITES OF EFFECTIVE RESPONSIBILITY ACCOUNTING:

The pre-requisites of the effective responsibility accounting are the following:

a. Under the supervision of a manager should be each responsibility center & for the

purpose of operating, it must be separable & identifiable.

b. The independent measurement of performance of each center must be capable of beingdone.

c. Each responsibility center should have clearly set targets.

d. Each responsibility centers budget should set targets which should be neither too high

nor too low i.e., the budget should be one which can be realised.

e. The top management should fully support the system.

f. All managers of responsibility centers should participate in the formulation of plans &

policies relating to responsibility centers for the purpose of providing motivation.

g. For sincere performance of each responsibility center the organizational environmentsmust be conducive.

4.5 OBJECTIVES OF RESPONSIBILITY ACCOUNTING:

The objectives of responsibility accounting are the following:

a. Overall organizational goals are broken down into small goals, each of the small goals is

meant for better achievement of a responsibility center.

b. With the attached responsibility each responsibility center is tied up & there is adequate

authority so that responsibility can be discharged.

c. At the end of a period, evaluation is done of the performance of each responsibility center

& comparison of the performance is done with the predetermined targets.

d. Thorough study is made of the achievements which are above or below the targets &

remedial measures are adopted.

e. Assessment is made of the contribution made by each responsibility center &examination is done of how far its possible for the contribution to fulfilling its share in

the ultimate organizational growth.

f. Emphasize is given on the control of cost through planning.


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g. Use is made of the principle of management by exception for the purpose of recording

only those data where the actual performance of responsibility center falls short of the set

target & where the variance is beyond the reasonable limit.

4.6 ADVANTAGES OF RESPONSIBILITY ACCOUNTING:

For the purpose of exercising control, responsibility accounting is an important tool in the

hands of management. For the purpose of effecting efficient control on operations & achieving

the organizational goal, responsibility accounting system should be introduced by theorganizations which have large dimensions & complex & operations which are decentralized.

Since for the purpose of achieving the overall goal in a piecemeal way; to various

responsibility centers, overall responsibility & authority are decentralized, continuouscommunication should be there between the overall responsibility center & various sub-

responsibility centers. Thus a communication system is automatically established byresponsibility accounting.

The following advantages can be expected from responsibility accounting system:

a. Assigning of Responsibility: Allocation is made of all the activities of the organization,

all the items of income & expenditure including capital expenditure to the well definedresponsibility centers. Profit of each responsibility center is also identified. It should be

understood by the manager of the centre what has to be performed by him with what

resources & in what time period. He gets the things done by making his own way without

any interference. Thus much importance is given to human resources.

b. Detection of Loopholes: There is a relationship between efforts & achievement,

thereby, loopholes, if any, in the operations gets easily detected.

c. Cost-Consciousness:Among the managers & their subordinates, cost-consciousness getsgenerated which results in automatically reducing cost.

d. Weak Areas: It becomes easy to detect the weak areas in the organization. So for the

purpose making the weak areas strong, corrective measures are taken.

e. Management by Exception: By recording the negative variances between the actual

performance & target, introduction of management by exception can be done.

f. Budgetary Control: For the purpose of exercising best managerial control over the

affairs of the organization & achieving the desired goal, responsibility accounting system

& budgetary control system can work together.

g. Belongingness: As realistic goals are fixed for a responsibility centre, its achievement by

the employees becomes easy. Their contribution can be assessed by themselves for thepurpose of achieving the goal of the organization as a whole. A sense of belonging to the


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organization is created among the employees by the systematic responsibility accounting

as the reward of the employees for accomplishment is not unsatisfactory.

h. Helpful and Decision Making: As managers of responsibility centers are allowed to sit

with the top management for exchanging of views & opinions, appropriate decision

making is almost assumed.

As against expected advantages there are also some apprehended disadvantages.

4.7 DISADVANTAGES OF RESPONSIBILITY ACCOUNTING:

The following are the apprehended disadvantages of responsibility accounting:

a. Solely upon the sincere efforts put in by the managers of the responsibility centers, thesuccess of the responsibility accounting depends. Whether the system will succeed or not

shall be decided by the personal factors of the managers.

b. The place of good management cannot be ever taken by the responsibility accounting

because the latter is only a tool in the hands of the former.

c. Although theoretically, the manager of each organization is given free hand, in actual

practice, neglect of employees reaction, interference etc. is often noticed. Thus, in theway of proper discharging of responsibility, this stands.

d. In modern organizations, among the departments, inter-relations & inter-departments are

mostly observed. So it becomes almost impossible to demarcate responsibility centers byclear-cut outlines.

e. Manager of the responsibility center prepares & communicates performance reports. Thedesired result will not be achieved by the responsibility accounting system, if there is any

shortcoming in the report.

f. Remuneration, future prospects, rewards, good working condition, welfare work & manyothers account for the individual interest of employees. Co-operation from the employees

may be required where there is a clash between individual interest & the organizational

interest.

In brief we can say the responsibility accounting which provides so many advantages, but it

is a difficult process which require more efforts, more time consuming and some times

which provides some irrelevant informations.


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CHAPTERV

COST ACCOUNTING

Objectives:

1. To understand the concept of cost, elements of cost and classification of cost.

2. To explain the meaning of Cost Accounting, Cost Accountancy and costing.

3. To distinguish between financial Accounting and Cost Accounting

4. To understand the different techniques of costing

5.1 Cost

Cost means all the expenses incurred to produce a thing. For proper control and

managerial decisions, management is to be provided with necessary data to analyze and classify

costs. For the same purpose cost is classified by elements of cost, by nature of expenses.

5.2 Elements of cost

1. Material

2. Labour

3. Expenses

We can understand the concept of cost with the help of cost sheet. Cost sheet is a statement used

to record the expenses incurred to know the cost.

Cost Sheet Units produced

Particulars Amount

Direct material

Direct labour

Direct exp

Prime cost

Factory exp/works exp.

Factory cost /works cost

Office and administration exp.

Office cost / cost of production

Selling and distribution exp.

Selling cost/Total cost

Profit

Selling price

1. Prime cost: Direct material + Direct labour + Direct exp.

2. Factory cost:Prime cost + factory exp.


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3. Cost of production:factory cost + office and administration exp.

4. Total cost:Cost of production + selling and distribution exp.

Now all these terms will be examined in detail one by one.

1. Direct Materialsare those materials which can be identified in the product and can beconveniently measured and directly charged to the product. Thus, these materials directly

enter the production and form a part of the finished product. For example, timber in

furniture making, cloth in dress making and bricks in building a house. The following are

normally classified as direct materials:

(i) All raw materialslike jute in the manufacture of gunny bags, pig iron in foundry,

and fruits in canning industry.

(ii) Materialsspecifically purchasedfor a specific job, process or order like glue for

book-binding, starch powder for dressing yarn.

(iii)

Parts or components purchased or produced like batteries for transistor-radiosand tyres for cycles.

(iv) Primary packing materials like cartons, wrapping, cardboard boxes, etc. used to

protect finished product from climatic conditions or for easy handling inside the

factory

2. Direct Labor is all labour expended in altering the construction, composition,

confirmation or condition of the product. In simple words, it is that labour which can be

conveniently identified or attributed wholly to a particular job, product or process or

expended in converting raw materials into finished goods. Wages of such labour are

known as direct wages. Thus, it includes payment made to the following groups oflabour.

(i) Labour engaged on the actual production of the product or carrying out of an

operation or process.

(ii) Labour engaged in aiding the manufacture by way of supervision, maintenance,

tools setting, transportation of material etc.

(iii) Inspectors, analysts etc. specially required for such production.

3. Direct Expenses (or Chargeable Expenses). All expenses which can be identified to a

particular cost centre and hence directly charged to the centre are known as direct

expenses. In other words all expenses (other than direct materials and direct labour)

incurred specifically for a particular product, job, department etc. are called direct

expenses. These are directly charged to the product. Examples of such expenses are

royalty, excise duty, hire charges of a specific plant and equipment, cost of any

experimental work carried out specially for a particular job, travelling expenses incurred

in connection with a particular contract or job etc.


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4. Overheads may be defined as the aggregate of the cost of indirect materials, indirect

labour and such other expenses including services as cannot conveniently be charged

direct to specific cost units. Thus overheads are all expenses other than direct expenses.

In general terms, overheads comprise all expenses incurred for or in connection with the

general organization of the whole or part of the undertaking i.e., the cost of operating

supplied and services used by the undertaking and including the maintenance of capital

assets. The main groups into which overheads may be sub-divided are: (i) Manufacturing

Overheads: (ii) Administration Overheads (iii) Selling Overheads; (iv) Distribution

Overheads and (v) Research and Development Overheads.

(i) Manufacturing or Production or Works Overhead. It is indirect expenses of

operating the manufacturing divisions of a concern and covers all indirect expenditure

incurred by the undertaking from the receipt of the order until its completion ready for

despatch either to the customer or to the finished goods store. Examples, of such

expenses are: depreciation and insurance charges on fixed assets like plant and

machinery, works, building, and electric equipments and floating assets like stores,

finished goods etc.; repairs and maintenance of fixed assets; electricity charges; coal and

other postage, telegrams and telephone charges; welfare services like canteen and

recreation clubs; medical services like dispensary and hospital and service department

expenses. It also includes wages of indirect works, indirect materials such as lubricants,

cotton wastes and other factory supplies, salaries and other costs related to tool room,

design and drawing office, production control and progress department.

(ii ) Admini stration Overhead. It is the indirect expenditure incurred in formulating

the policy, directing the organization, controlling and managing the operations of an

undertaking which is not related directly to a research, development, production or selling

activity or function. It consists of all expenses incurred in the direction, control and

administration (including secretarial, accounting and financial control) of an undertaking.

Examples are the expenses in running the general office e.g. office rent, light, heat,

salaries and wages of clerks, secretaries and accountants, credit approval, cash collection

and treasurers department, general managers, directors, executives; legal and accounting

machine service; investigations and experiments and miscellaneous fixed charges.

(ii i) Sell ing Overhead. It is the cost of seeking to create and stimulate demand and of

securing orders and comprises the cost of soliciting and recurring orders for the articles or

commodities dealt in and of efforts to find and retain customers. It refers to those indirect

costs which are associated with marketing and selling (exclusing distribution) activities.

Examples aare sales office expenses; salesmens salaries and commission; showroom

expenses; advertisement charges; fancy packing to attract sales; samples and free gifts;

after sales service.


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(iv) Distri bution Overhead. It is the expenditure incurred in the process which begins

with making the packed product available for dispatch and ends with making the

reconditioned return empty package, if any available for reuse. It comprises all

expenditure incurred from the time the product is completed in the works until it reaches

its destination. Under these would be included warehouse rent; warehouse staff salaries,

insurance etc.; expenses on delivery van and trucks; expenses on special packing for bulk

transport like bales, crates, chests etc.; losses in warehouse stocks and finished goods

damaged in transit and cost of repairing and reconditioning of empties and wastage of

finished goods.

(v) Research and Development Expenses. Research cost is the cost of searching for

new and improved products, new applications of materials or products, and new

applications and improved methods. Development cost is the cost of the process which

begins with the implementation of the decision to produce a new or improved method and

ends with the commencement of formal production of that product or by that method.

Overheads can also be classified as indirect materials, indirect

(i) I ndir ect Materi als.Such materials refer to those materials which do not normally

form a part of the finished product. It has been defined as materials which cannot be

allocated but which can be appointed to or absorbed by cost centres or cost units. There

are:

(a)Stores used in maintenance of machinery, building etc. like lubricants, cotton waste,

bricks and cements;

(b)

Stores used by the service departments i.e. non-productive departments like powerhouse, boiler house and canteen etc.; and

(c)Materials which due to their cost being small, are not considered worthwhile to be

treated as direct materials.

Examples of indirect materials are stores consumed for repair and maintenance work,

sundry stores of small value expended for factory use, small tools for general use,

lubricating oil, losses, deficiencies and deterioration of stores etc.

(ii) I ndirect Labour.The wages of that labour which cannot be allocated but which

can be apportioned to or absorbed by cost centres or cost units is known as indirect

labour. In order words wages paid to labour which is employed other than on production

constitute indirect labour costs. Examples of such labour are: charge-hands and

supervisors; maintenance workers; departmental coolies; men employed in service

departments, material handling and internal transport; apprentices, trainees and

instructors; works clerical staff and labour employed in time office and security office,


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(ii i) I ndi rect Expenses. Such expenses which cannot be allocated but can be

apportioned to or absorbed by cost centres or cost units as rent, rates, insurance,

municipal taxes, general managers salary, canteen and welfare expenses, power and fuel,

cost of training new employees, lighting and heating, telephone expenses. So, under

indirect expenses two types of expenses are included; (a) such type of expenditure in

respect of which payments are made for services rendered or supplies made. Amount in

respect of such expenditure will be found from the voucher registers on the dates on

which they are incurred, (b)such items which do not involve any payments and are mere

adjustment transactions i.g., depreciation.

5.3 Classification of cost :

1. On the basis of elements:

(i) Material

(ii) Labour

(iii) Exp.

2. On the basis of functions:(i) Factory exp.:factory exp are those which are incurred for

factory. For example factory rent, depreciation on machine, power ,lighting ,fuel, etc

(i) Office and administration exp.: Office rent, depreciation on furniture, printing

and stationary postage and telegraph, salaries of staff, managing director salary.

(ii) Selling exp.: for example discount allowed to customers, bad debts, commission to

sales agents, advertisement, etc.

(iii)Distribution exp.: the exp. Incurred for the distribution of products such astravelling exp., warehouse rent, etc.

3. On the basis of behaviour(i) Var iable exp.: variable exp .are those exp .which varies as per production. If

production increases the exp also increases and when production decreases the exp.

also decreases.

Units Cost Cost per

unit

100 1000 10

200 2000 10

300 3000 1050 500 10

In the above example as the units increased the cost also increased and as the units

decreased cost also decreased.


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(ii) F ixed exp:Fixed exp. are those exp. which remain fixed irrespective of production.

For example factory rent , supervisor salary, accountant salary.

Units Cost Cost per unit

100 1000 10

200 1000 05300 1000 3.33

50 1000 200

In the above example the cost remains constant irrespective of units produced.

(iii) Semi- variable exp: Semi variable are the exp. Which are fixed to a certain extent

after that it varies. For example telephone bill.

Units Cost Cost per unit

200 2400 12

300 2600 8.66400 2800 7

In the above example we found that there is an increased of Rs. 200/- in the cost

with the increase of 100 units means the variable cost is Rs. 2/- per units and Rs.

2000/- is the fixed.

4. On the basis of controllabil ity: (i) Controllable exp: All variable exp. are considered as

controllable exp.

(ii)Uncontrollable exp.: All the fixed exp. are considered as uncontrollable exp.

5. For decision making:

(i) Shut down cost : The cost which is to incur for the period for which business will be

closed temporily.

(ii) Sunk cost: The cost incurred in the past. For example building purchased, machine

purchased ,etc.

(iii)Opportunity cost: For example rent on owned building used in his own business.

(iv) Imputed cost :For example interest on owned capital used in his own business.

(v) Differential cost: The change in cost because of change in units.

5.4 Cost Accounting:

Cost Accounting is the process of accounting for costs. It embraces the accounting

procedures relating to recording of all income and expenditure and the preparation of periodicalstatements and reports with the object of ascertaining and controlling costs. It is thus the formal

mechanism by means of which costs of products or services are ascertained and controlled.


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5.5 Cost Accountancy:

Cost Accountancy is the practice of cost accountant because he has to make constant

efforts in the field of cost accountancy. The techniques of cost accounting is cost accountancy.

There may be three type of businesses:

(I) Manufacturing

(II) Trading

(III) Service rendering concerns

Every business man has to use accounting. Every trader has to use Financial

Accounting. Every manufacturer and service rendering concern has to follow

financial as well as cost accounting also. The main objective of cost accounting is

to ascertain the cost to produce a thing and the cost of a service provided by a

particular service renderer, i.e. transport concern, communication, hotel, hospital

etc.

Cost accounting is an art of recording material, labour and expenses employed per unit of

production.

Costing is the technique of ascertaining the cost per unit of a product.

There are different techniques of cost accounting which are used by different type of

manufacturers as per the nature of their product, The following are the various techniques of cost

accounting:

(i) Process costing: This method is suitable to industries where production is undertaken

on mass scale and on continuous basis. Further the raw material pass through two ormore processes before converting into finish products. Raw material introduced into

first process are transferred after processing in the first process to the second process,

they will be transferred to next process for further process and this process continues

till processing in the final process to obtain finished product. Hence the output of the

first process becomes the input for the second process and the output of the second

process will be the input for the final product.

(ii) Single costing: When the concern produces only one product of standard ones and of

identical nature this method is adopted. The total cost is divided by number of units

produced. This method is suitable for Mines, Quarries, Steel works, bricks etc.

(iii) Contract costing: Contract costing is used by the builders constructors etc who

builds and constructs.

(iv) Operating costing:This method is suitable for concerns who are involved in services

as doctors, hotels, communication, electricity manufacturers, transport concerns, etc.

(v) Uniform costing:The comman method followed by the concerns uniformally doing

same nature of business.


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5.6 Objectives of cost accounting:

1. To know the cost per unit: With recording all the material, labour and all the

expenses the cost per unit of a product can be known.

2. To determine the selling price:We can decide the profit per unit after availing the

cost per unit and can decide the selling price per product.3. To make decisions :such as make or buy product, repair or purchase of new

machinery, introduce of a new product .

4. To determine profitability: With the help of Cost Accounting profitability of the

concern can be known how much profit the concern can earn.

5. To cost control: With the help of two techniques of cost accounting budgetary

control and standard costing cost can be controlled.

5.7 Advantages of cost accounting:

To management:

(i) Planning:In Cost Accounting plan are made for sales dept., production dept,

purchase dept .for which budgetary control technique is used.

(ii) Controlling:With the help of standard costing comparison is analyzed with

the standard made .

(iii) Co-ordination: Cost Accounting provides coordination also among various

depts. Production dept. depends on sales dept. and purchase dept. depends on

production dept all these are coordinated with each other.

(iv) Motivation:In cost accounting there are so various tools in providing wages

to labourers so that they can be motivated for more production.

To Employee: With the help of cost accounting the profit can be known and the

employee can demand more salary as per their better profit.

To consumer : Consumer can know the cost per product produced.

To Govt.: Govt. has to impose the tax on income as well as on sales also which

information can be availed with cost accounting.

5.8 Limitations of cost accounting:

1. Cost Accounting is not an exact Science. Cost Accounting aims at ascertain cost,

It is impossible to ascertain the actual cost of the goods and services . In order to

ascertain the cost of goods and services it is necessary to use a number of

estimates bases for apportionment ,etc.


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2. Availability of a number of accounting treatments for each of a few major

elements of costs results in the operating performance influenced even by

accounting standards and methods . the company is free to use any method of

accounting.

3. Cost Accounting identifies the deficiencies in the performance of company. But itdoes not provide the solution.

4. It does not record some expenses which are considered in financial accounting

5. It is based on so many assumptions so the results can not be uniform.

5.9 Difference between financial and cost accounting

Basis of difference Financial Accounting Cost Accounting

1. Purpose The purpose is to know

the profit or loss andfinancial position of a

concern.

The objective is to know

the cost of a product.

2. Compulsory Financial Accounting iscompulsory for all type of

concern

Cost Accounting ismandatory for

manufacturing concern.

3. Period The period is consideredof 12 months.

In Cost Accounting the

period is considered as

required.

4. Stock valuation In Financial Accountingstock is valued at cost ormarket price whichever isless.

In Cost Accounting stockis valued at cost only.

5. Chart In Financial Accountingcharts are not used.

In Cost Accounting breakeven charts are used.

6. Product wise cost In Financial Accountingproduct wise cost is not

shown.

In Cost Accounting

product wise cost is

shown.7. Analysis of profit Financial Accounting

analyze the profit of the

concern.

Cost Accounting analyzethe profit of the product,

job or service only.


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CHAPTERVI

STANDARD COSTING

Objectives:

1. To understand the meaning of standard costing

2. To know the advantages and limitation of standard costing.

3. To discuss the different kinds of variances.

Standard costing are the scientifically predetermined costs of manufacturing a single unit, or a

number of units of products during a specified period in the immediate future. Standard cost are

the planned costs of a product under current and anticipated operating conditions.

6.1 Definitions

As per Chartered Institute of Management Accountants LondonStandard Costing is

the preparation and use of standard costs, their comparison with actual cost and the analysis of

variances to their causes and points of incidence

As per W.W. Bigg:Standard costing discloses the cost of deviations from standard and

classifies these as to their causes so that management is immediately informed of the sphere of

operations in which remedial action is necessary.

6.2 Process of standard costing

(i) The setting of standards

(ii) Ascertaining actual results

(iii) Comparing actual with standard and calculate the variance

(iv)

Investigate the variance and take corrective action to remove deviation.

6.3 Advantages of standard costing

1. Formulation of price and production policies: It act as a valuable guide to management in

the formulation of price and production policies. It assists management in the field of inventory

pricing, product pricing, profit planning and also further reporting to higher levels.


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2. Comparison and analysis of data: standard costing provides a stable and sound basis for

comparison of actual with standard costs according to different elements separately . It brings out

clearly the impact of external and internal causes on the cost and performance of the concern.

3. Cost Consciousness: Cost consciousness is created among the staff , managerial as well as

workmen of the business.

4. Management by exception:It helps the management in concentrating its attention on cases

which are of important issues.

5. Better economy, efficiency: operations of the business are scrutinized carefully and

inefficiencies are disclosed .Men, material and machines are utilized effectively.

6.4 Disadvantages of standard costing

1. Heavy costs: fixation of standards may be costly and may require high order skill and

competence. Small concerns therefore feel difficulty in the operation of such system.

2. Fixation of responsibility difficult: This is very hard nut to crack to fix the

responsibility of any dept, any person and process.

3. Frequent revision required:For the better results it is necessary to revise the standards

frequently and revision of the standards is a costly process.

4. Unsuitable for non standardized product: The industries which deal with nonstandardized products and jobs which change according to customers specification may

find the system of standard costs unsuitable and costly.

5. User resentment:The managers who have to use the standard they resent it because it is

a threat to their freedom of action.

The cost comprises with material, labour and expenses. So variances may be in the

standards of material, labour and expenses.

6.5 Standard Costing and Budgetary Control

Both standard costing and budgetary control achieve the same objective of maximum

efficiency and cost reduction by establishing predetermined standards, comparing actual

performance with the pre-determined standards and taking corrective measures, where necessary.


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Thus, although both are useful tools to the management in controlling costs, they differ in the

following respects:

Basis of

Difference

Budgetary Control Standard Costing

1) Concept The budgets are prepared for

the concern as a whole

The standards are set for producing

a product or for providing a service.

2) Basis The budget are fixed on the

basis of past records and

future expectations.

Standard costs are fixed on the

basis of technical information.

3) Scope The scope of budgetary

control is much wider than the

scope of standard costing.

Budgets are prepared for

incomes, expenditures andother activities, etc.

On the other hand standards, are set

up for expenditures only and,

therefore, for manufacturing

departments standards are set for

different elements of cost i.e.,material, labour and overheads.

4) Emphasis In budgetary control, the

targets of expenditure are set

and these targets cannot be

exceeded. In this system the

emphasis is on keeping the

expenditures within the

budgeted figures.

In standard costing the standards

are set and an attempt is made to

achieve these standards. The

emphasis is on achieving the

standards.

5) Objective Budgets are set on the basis of

present level of efficiency.

Standard costs are based on the

basis of standards set by the

management.

6) Relationship Budgetary Control is related

to financial accounts.

Standard costing is related to the

cost accounts.

7) Variance Analysis Budgetary control deals with

total variance only. The

variances may be calculated

for different departments or

for the concern as a whole.

Standard costing variances are

calculated for different elements of

cost. i.e., material, labour and

overheads. In standard costing

variances are studied according to

their causers.

6.6 Variances

1.Material variances

2. Labour variances


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Lalit Wadhwa, Assistant Professor in M

financial acccounting mba kuk

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