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Lecture Notes
By
Dr.M.KRISHNAMOORTHI
AP/MBA
SYLLABUS
Analysis of financial statements – Financial ratio analysis, cash flow (as per Accounting
Standard 3) and funds flow statement analysis.
UNIT-I
Accounting has been termed as the language of business. The basic function of
accounting thus is to communicate the operating results of the business to the stake
holders and share holders of a business.
DEFINITION OF ACCOUNTING:
This book is maintained mainly to record credit purchases of goods. The term
‘goods’ refers to all such commodities and services in which the firm normally deals.
Hence, cash purchases of goods or purchase of assets are not recorded in this book.
Entries are made in this book from inward invoices of credit purchases. It is also known
as ‘bought book’ or ‘purchase journal’ or ‘invoice book’.
It is also known as ‘sold book’ or ‘sales journal’. All credit sales of goods are
recorded in this book. Cash sales and credit sales of assets are not shown in this book.
“Outward invoices” form the basis for making entries in the sales and must be
authenticated.
It is also called as ‘returns inward book’. Goods returned by customers which were
originally sold on credit are recorded in this book. Here it includes ‘credit note no’
instead of ‘debit note no.
This is maintained to keep a detailed record of all the bills receivable received by
the firm. This book provides a medium for posting bills receivable transactions.
This book is maintained to keep a detailed record of all bills payables accepted
by the firm.
* Cash book
In most of the business concerns, the number of cash transactions will be large.
Hence, a separate cash book is maintained for recording such transactions. This keeps a
record of cash receipt and cash payment. It plays a dual role. It is a book of original
entry as well as book of final entry (ledger). There are four types of cash book.
* Ledger
* Trial balance
It is a list of all balances standing on the ledger accounts and cash book of a
concern. It is a statement with debit and credit balance.
* Subsidiary books
* Transactions
* Goods
The term goods include all merchandise, commodities, etc, in which a trader
deals in the normal course of business. Thus, commodities bought for resale are treated
as goods. E.g. For furniture dealer, furniture is a good and for others it is a asset.
* Book – keeping.
* Assets
According to Finny & Miller ‘Assets are future economic benefits, the rights
which are owned or controlled by an organization or individual. It is also defined as
anything of value owned by a business’.
* Liabilities
* Capital
* Revenue
It is defined as the inflow of assets which result in an increase in the owners equity. It
includes all incomes like sales receipt, etc. The receipts of capital nature like additional
capital, etc are not a part of revenue.
* Expenses
It is spent in order to produce and sell the goods and services which bring in the
revenue. Expenses may be defined as ‘the cost of the use of things services for the
purpose of generating revenue. It may be capital or revenue expenses.
* Purchase
Buying of goods with the intention of resale is called purchases. If cash in paid
immediately for the purchase, it is cash purchase. If the payment is postponed, it is
credit purchases.
* Sales
* Purchase returns
These are the goods returned by the trader to the supplier because of poor
quality or defects in the goods, supplied. It is also known as ‘return outwards’ or ‘return
to suppliers’.
When the trader receives back goods from the customer for poor quality or
defects in the goods sold out, it will be called as ‘sales return’ or ‘return inwards’ or
‘returns from customers’.
* Stock
It refers to goods lying unsold on a particular date. The stock of goods at the end
of the accounting period is called ‘closing stock’ and the stock at the beginning of an
accounting period is called ‘opening stock’.
* Debtors
* Creditors
* Drawings
* Turnover
* Work – In progress
1. Personal Accounts
2. Impersonal Accounts – Real Account, Nominal Account
(i) Personal Account
Account of personal with which the business has dealings is known as personal
accounts. A separate account is prepared for each person.
The name of an individual, customer or suppliers, etc, both males and females
are included in it.
Accounts in which the business records the real things owned by it i.e., assets of
the business are known as real accounts. It is of two types, tangible and intangible real
accounts. The assets which can be touched and felt and they have no physical shape e.g
trademark, goodwill etc., are intangible real accounts.
It relates to the items which exist in name only. Accounts which record expenses,
losses, incomes and gains of the business are known as nominal accounts. E.g. rent
account, postage account, etc.The double entry system of book-keeping is a scientific
and complete system. Hence the transactions should be recorded according to the
following:
“Debit all expenses and losses, Credit all incomes and gains”.
These are the varies rules for making entries under double entry system.
Accounting principles, rules of conduct and action are described by various terms such
as concepts, conventions, tenets, assumptions, axioms, postulates, etc.
Accounting concepts are the assumptions or postulator or ideas which are essential to
the practice of accounting and preparation of financial statements.
Assets purchased are normally entered in the accounting book at the cost at
which they are purchased. The market value in immaterial.
While finalizing accounts, all expenses and losses pertaining to the accounting
period must be listed out. Outstanding and prepaid expenses and incomes also to be
recorded.
The revenues earned during an accounting period are matched with the cost
associated with the period to ascertain the profit earned.
(ix) Accounting period concept: It helps to measure the income generated during the
specific accounting period which maker it possible to distribute it to the owners.
CONVENTION OF ACCOUNTING
Accounting conventions are those customs, usage and traditions that are being followed
by the accountants.
Accounting practice should remain unchanged for a fairly long time. Ant they
should not be changed unless it becomes absolutely essential to change them. E.g.
Method of depreciation.
Materiality means relative importance. All important items and facts should be
disclosed in accounting statements. Immaterial details should be ignored else the whole
accounting process will become highly cumbersome and meaningless.
COST ACCOUNTING
In its widest usage it embraces the preparation of statistical data, the application
of cost control methods and the ascertainment of the profitability of activities carried
out or planned.”
1) to aid in the development of long range plans by providing cost data that acts
as a basis for projecting data for planning.
2) To ensure efficient cost control by communicating essential data costs at
regular intervals and thus minimize the cost of manufacturing.
3) Determine cost of products or activities, which is useful in the determination
of selling price or quotation.
Cost Accounting like other branches of accountancy is not an exact science but is
an art which was developed through theories and accounting practices based on
reasoning and commonsense. These practices are dynamic and evolving. Hence, it lacks
a uniform procedure applicable to all the industries across. It has to be customized for
each industry, company etc.
Management Accounting covers not only the use of financial data and a part of costing
theory but extends beyond. It scope covers
1. Financial accounting
2. Cost accounting
3. Financial statement analysis
4. Budgeting
5. Inflation accounting
6. Management reporting
7. Quantitative techniques
8. Tax accounting
9. Internal audit
10. Office services
FUNCTIONS OF MANAGEMENT ACCOUNTING :
➢ Financial planning
➢ Analysis of financial statements
➢ Cost accounting
Investors Investors are concerned about risk and return in relation to their
investments. They require information to decide whether they should
continue to invest in a business. They also need to be able to assess
whether a business will be able to pay dividends, and to measure the
performance of the business' management overall. The key accounting
information for an investor is therefore:
- Information about growth - sales, volumes
- Profitability (profit margins, overall level of profit)
- Investment (amounts invested, assets owned)
- Business value (share price)
- Comparative information of competitors
Creditors Suppliers and trade creditors requirement information that helps them
understand and assess the short-term liquidity of a business. Is the
business able to pay short-term debt when it falls due? Creditors will,
therefore, be looking for information on:
- Cash flow
- Management of working capital
- Payment policy
Debtors Customers and trade debtors require information about the ability of the
business to survive and prosper. As customers of the company's
products, they have a long-term interest in the company's range of
products and services. They may even be dependent on the business for
certain products or services. Customer will be particularly interested in:
-Sales growth
- New product development
Employees Employees (and organisations that represent them - e.g. trade unions)
require information about the stability and continuing profitability of the
business. They are crucially interested in information about employment
prospects and the maintenance of pension funding and retirement
benefits. They are also likely to interested in the pay and benefits
obtained by senior management!. Employees will, therefore look for
information on:
Public at large Interest groups, formed by various groups of individuals who have a
specific interest in the activities and performance of businesses, will also
require accounting information.
The starting point in understanding the profit and loss account is to be clear about the
meaning of "profit". Profit is the reward for taking risk. Profit has an important role in
allocating resources (land, labour, capital and enterprise). Put simply, falling profits
signal that resources should be taken out of that business and put into another one;
rising profits signal that resources should be moved into this business. The main task of
accounts, therefore, is to monitor and measure profits.
Profit = Revenues less Costs. So monitoring profit also means monitoring and
measuring revenues and costs. There are two parts to this:-
1) The Trading Account: This records the money in (revenue) and out (costs) of the
business as a result of the business’ ‘trading’ ie buying and selling. This might be buying
An example is interest on investments. Thus, profit and loss account contains all other
expenses and losses, incomes and gains of the business for the accounting year for
which financial statements are being prepared. In this process, it follows the mercantile
basis of accounting (i.e, it takes into account all paid and payable expenses, and received
and receivable receipts). The net result of profit and loss account is called as net profit.
The main feature of profit and loss account is that it takes into account all expenses and
incomes that belong to the current accounting year and excludes those expenses and
incomes that belong either to the previous period or the future period.
3) The Appropriation Account. This shows how the profit is ‘appropriated’ or divided
between the three uses mentioned above.
To Factory overhead:
Factory rent
Carriage inwards
Octroi. Etc
TOTAL TOTAL
To Purchases By Sales
To Factory rent
To Carriage inwards
To Octroi. etc
TOTAL TOTAL
1) The main use is to monitor and measure profit. This assumes that the information
recording is accurate. Significant problems can arise if the information is inaccurate,
either through incompetence or deliberate fraud.
To Freight/ carriage
outwards
To interest on capital
To manger’s commission
To transfers to reserve
accounts
The Balance sheet is a statement that is prepared usually on the last day of the
accounting year, showing the financial position of the concern as on that date. It
comprises of a list of assets, liabilities and capital. An asset is any right or thing that is
owned by a business. Assets include land, buildings, equipment and anything else a
business owns that can be given a value in money terms for the purpose of financial
reporting. To acquire its assets, a business may have to obtain money from various
sources in addition to its owners (shareholders) or from retained profits. The various
amounts of money owed by a business are called its liabilities. To provide additional
information to the user, assets and liabilities are usually classified in the balance sheet
as:
- Current: those due to be repaid (Current liabilities) or converted into cash within 12
months of the balance sheet date(Current Assets).
- Long-term: those due to be repaid (Long term liabilities) or converted into cash more
than 12 months after the balance sheet date (Fixed Assets).
Fixed Assets:
A further classification other than long-term or current is also used for assets. A "fixed
asset" is an asset which is intended to be of a permanent nature and which is used by
the business to provide the capability to conduct its trade. Examples of "tangible fixed
assets" include plant & machinery, land & buildings and motor vehicles. "Intangible
fixed assets" may include goodwill, patents, trademarks and brands - although they
may only be included if they have been "acquired". Investments in other companies
which are intended to be held for the long-term can also be shown under the fixed asset
heading.
Capital:
As well as borrowing from banks and other sources, all companies receive finance from
their owners. This money is generally available for the life of the business and is
normally only repaid when the company is "wound up". To distinguish between the
liabilities owed to third parties and to the business owners, the latter is referred to as
the "capital" or "equity capital" of the company. In addition, undistributed profits are
re-invested in company assets (such as stocks, equipment and the bank balance).
Although these "retained profits" may be available for distribution to shareholders - and
At any time, therefore, the capital of a business is equal to the assets (usually cash)
received from the shareholders plus any profits made by the company through trading
that remain undistributed
LIABILITIES ASSETS
2. Closing stock : Closing stock appears on the credit side of trading account and
assets side of balance sheet if it is given in the adjustments. If it is given in the
trial balance it will appear only on the assets side of the balance sheet. The entry
passed is
Closing Stock A/c Dr.
To Trading Account.
To Outstanding Expenditure
4. Pre-paid expenses : They are those expenses which have been paid in advance.
They are also known as un-expired expenses. If given in adjustments, they
should be deducted from the respective expenditure account on the debit side of
the profit and loss account and must be shown on the asset side of the balance
sheet. If given in the trial balance, they must be shown only on the asset side of
the balance sheet. The adjustment entry is
To Respective Expenditure
Dr. M.Krishnamoorthi,AP/MBA Page 22
5. Outstanding or accrued income : This is the income which has been earned
during the current accounting year and has become due but not yet received by
the firm. If given in the adjustments, it must be added to the respective income
account on the credit side of the profit and loss account and must be shown on
the assets side of the balance sheet. But if given in the trial balance, it must be
shown only on the asset side of the balance sheet. The entry is
To Respective Income
6. Depreciation : It is a reduction in the value of the asset due to wear and tear,
lapse of time, obsolescence, exhaustion and accident. It is charged on fixed assets
of the business. If given in the adjustments, it must be shown on the debit side of
the profit and loss account and must be deducted from the respective asset
account in the balance sheet. If given in the trial balance, it must be shown only
on the debit side of the profit and loss account. The entry is
Depreciation A/c Dr.
7. Bad Debts : They represent that portion of credit sales (debtors) that had
become bad due to the inability of the debtor to repay the amount. It is a loss to
the business and gain to the debtor. This is a real loss to the business and as
such must be deducted from the debtors before deducting any reserves created
on debtors. If given in the adjustments it must be shown on the debit side of the
profit and loss account and must be deducted from the debtors account on the
asset side of the balance sheet. If given in the trial balance this amount must be
shown only in the profit and loss account. The entry is
Bad debts A/c Dr.
8. Provision for bad debts : This represents a provision made by the business for
any potential bad debts. It is charged to the profit and loss account debit side
and must be deducted from the debtors after deducting the bad debts if any on
the asset side of the balance sheet, if given in the adjustments. If given in the trial
balance, it must be considered only in preparing the profit and loss account. The
entry is
Profit and loss A/c Dr.
10. Provision for doubtful debts : This represents a provision made by the
business for any potential discount to be allowed to the debtors. If given in the
adjustments, it must be charged to the profit and loss account debit side and
must be deducted from the debtors after deducting the bad debts (if any),
reserve for bad debts (if any) and reserve for doubtful debts (if any) on the asset
side of the balance sheet. If given in the trial balance, it must be considered only
in preparing the profit and loss account. The entry is
Profit and loss A/c Dr.
11. Reserve for discount on creditors: This represents a provision made by the
business for any potential discount to be allowed by the creditors of the
business. If given in the adjustments, it must be charged to the profit and loss
account credit side and must be deducted from the creditors on the liabilities
side of the balance sheet. If given in the trial balance, it must be considered only
in preparing the profit and loss account. The entry is
12. Interest on capital: This is the return the owners of the business will get for
investing in the business. Usually it is paid or added to the capital at a fixed
percentage. If given in the adjustments, it is shown on the debit side of the profit
and loss account and is usually added to the capital account on the liabilities side
of the balance sheet. If given in the trial balance, it must be shown on the debit
side of profit and loss account. The entries are :
To Interest on capital
To capital A/c
To capital A/c
INFLATION ACCOUNTING
Its normally refers to the increasing trend in general price levels. In economic
sense, it refers to a state in which the purchasing power of money goes down. According
to “American Institute of Certified Public Accountants define, ‘Inflation accounting as a
system of accounting, which purports to record as a built-in mechanism, all economic
events in terms of current cost’. It is a system of accounting like traditional accounting.
It is a method designed to show the effect of changing costs and prices on affairs of a
business unit doing the course of relative accounting period. The realization principle is
not rigidly followed, particularly in the case of recording fixed assets and long-term
loans.
2. Adjustment Items: While adjusting items for inflation, there are 2 approaches
one can take – 1) covering the adjustment of all financial items, 2) covering the
adjustment of only those items that have direct impact on financial results
3. Current value accounting method [CVA] : Under this method all items of
balance sheet are shown at current values. According to this method, the net
assets at the beginning and at the end of the accounting period are ascertained
and difference is implied to be profit or loss for the period. It attempts to reflect
economic reality to the preparation of financial statements by using current
values for reporting various items in the balance sheet.
4. Current cost accounting method [CCA] : This method had been suggested as a
base for financial reporting by Sandiland Committee appointed by the British
Committee in 1973 to solve the problem of price level changes. The Committee
reported that CPP may be used along with either historical cost or value
accounting.
The concept of HR accounting was not known to the world till the early 60’s. During
this period, few experts like Hermanson, Hekimian, Jones andRensisLikert had
recognised HR as assets just like any other tangible or intangible assets.
The various advantages a firm can enjoy by establishing HR Accounting are as follows:
1. Its adoption acts as a motivating factor for the employees of the concern as it is
reflected in its financial statements
2. It helps the management in identifying and controlling several problems related
with human resources
3. It enables the management in efficiently using its man power by providing
quantified information about its HR
4. By considering HR as an asset in its financial statements, it provides a measure
of profitability
5. It helps the investors or potential investors in assessing the true value of a firm
by providing realistic information about its HR
DISADVANTAGES OF HRA
At the same time, a firm may also face certain limitations in implementing HRA such as
:
There are around eight techniques for valuation of HR. They are as follows :
3. Opportunity cost method: This method has been suggested by Hekimian and
Jones and refers to the valuation of HR on the basis of an employee’s value in
alternative uses, i.e, opportunity cost. This cost refers to the price other
divisions are willing to pay for the service of an employee working in another
division of an organization.
7. Adjusted discounted future wages method: This model has been developed by
Roger.H.Hermanson. Under this method, HR valuation is done on the basis of
Two Marks:
Prepare Profit and Loss a/c profit and loss appropriation a/c and Balance sheet in
proper form after making the following adjustments :
(i) Depreciate plant and machinery by 15%
(ii) Write off Rs.500 from preliminary expenses
(iii) Provide for 6 months interest on debentures
(iv) Leave bad and doubtful debts provision at 5% on sundry debtors
(v) Provide for income tax at 50%
(vi) Stock on 31.3.2010 was Rs. 95,000
14. The following is the trial balance of Mr. Kumar as on 31 .t March, 2008 :
(MAY/JUNE 2014)
Debit Credit
Rs. Rs.
Sales 1,20,000
Purchases 82,000
Customs Duty 8,000
Royalty 5,000
Opening stock 12,000
Accounts receivable 22,000
Accounts payable 11,000
Bills receivable 10,000
Bills payable 8,000
Bad debts 2,000
Adjustments :
(i) Closing stock is valued at Rs' 22,000
(ii) Carriage on purchase outstanding amounts to Rs' 300
(iii) Interest receivable amounts to Rs ' 200
(iv) Rent received in advance amounts to Rs ' 400
(v) Depreciation @ 10% is required on furniture' Prepare Final accounts '
15. Define Cost accounting. What are the advantages of cost accounting? (JAN 2015)
16. Define management accounting. Discuss its scope. (JAN 2015)
17. Examine the various accounting concepts and conventions. (JAN 2015)
18. Explain accounting concepts and conventions. (APR/MA 2015)
NATURE OF A COMPANY.
The company is one of the forms of organization. It has its distinctive
characteristics and advantages which make it suitable for different purposes.
Legal Meaning
According to section 3(1) (i) of The Companies Act, 1956, “Company means a company
formed and registered under this Act or an existing company”.
On analyzing the aforesaid definitions the following characteristics of a company are
revealed:
1. An artificial person created by law: A company is called an artificial person
because it does not take birth like a natural person but comes into existence
through law. Being the creation of law, the company possesses only those
properties which are conferred upon it by its charter.
2. Separate Legal Entity:
A company is a separate legal entity as distinct from its members, therefore it is
separate at law from its shareholders, directors , promoters etc and as such is
conferred with rights and is subject to certain duties and obligations.
1. Basis of incorporation
2. Basis of liability
3. Basis of control
1. Basis of incorporation: This is further divided into three categories. They are as
follows:
a) Charted company: A company incorporated under a special charter granted by
the king or Queen of England is called “charted Company”. The familiar
examples of charted company are the East India Company and the Bank of
England. This type of company cannot now be formed in India.
✓ Preparation of documents
✓ Filling of documents
✓ Payments of necessary payments
✓ Registration of a company
✓ Certificate of incorporation
SHARES
Total capital of the company is divided into small unit of denomination. One of
the units into which the capital of the company is divided is called a share. No trading
concern can run without capital.
Share capital constitutes the basic of the capital structure of the company.
Ownership of a company is verified in its shareholders and a share represents the
extent of ownership or interest in the assets and profits of the company. In this sense, a
share may be defined as one of the equal parts into which the capital of a company is
divided, entitling the holder of the share to a proportion of the profits.
CLASSES OF SHARES:
a. Equity shares
b. Preference shares
c. Deferred shares
Equity shares: Equity shares are shares, one who holds are called as real owner of the
organization or company. The act defines an equity share in a negative way. An equity
share is one which is not a preference share. These are normally risk bearing shares.
In olden days the equity share holders do not receive any dividends. But in modern
days they receive substantial dividends. During liquidation of a company they are paid-
out but are usually entitled to all the surplus assets after the payment of creditors and
preference shareholders.
The value of these shares in the market fluctuates with the fortunes of the company. A
wise investor in equity shares not only receives regular dividends but is also assured of
capital appreciation.
Preference shares: Preference shares are simply called priority shares. That is at the
time of declaration of dividend and insolvency one who have priority is called as
preference share.
The company act defines a preference share as that part of the share capital of the
company which enjoy preferential right as to,
➢ The payment of dividend at a fixed rate during the lifetime of the company.
➢ The return of capital on winding up of the company.
➢ Dividend is outstanding for more than two years in the case of cumulative
preference shares.
➢ For more than three years in the case of cumulative preference shares.
DEFERRED SHARES
These are also known as founder’s shares or management shares. These
are usually allotted to promoters and their friends at the time of formation of the
company. These share usually carry disproportionate voting rights and right to
substantial dividends from the profits left after paying off preference and equity
dividend. Public limited companies, subsidiary of such companies and private
companies deemed to be public limited companies cannot issue such shares after
the commencement of the companies act, 1956.
Private limited companies are enjoying the privilege.
Partnership Company
1. Act
Indian partnership Act, 1932, regulate Indian companies act, 1956 regulate the
the business business
2. Entity
Partnership business is not stable Company is a separate legal entity which
can not affected by the changes in its
membership
3. Number
The minimum member of members The minimum number of members in a
required is two public company is seven
4. Liability
In case of partnership, the liability of the In case of the company the members
partners are not limited liabilities are limited
5. Capital
Capital of the partnership firm depends The capital of the firm can be changed
upon the financial capacity of the by increasing are limited
Statutory Books
Statutory Books are the official records kept by the company relating to all legal and
statutory matters.
A company's statutory books are usually kept at the registered office of the company.
The books should be available to the general public for inspection during reasonable
office hours.
NATURE OF STOCK
-A company can only convert fully paid shares into stock and cannot directly issue stock
capital
-While confirming the same, the Court must ensure that the interests of creditors,
shareholders and general public must be protected
-However, in the following cases, the reduction does not call for sanction of
Court/Tribunal
--Surrender of shares (The Companies Act does not expressly provide for surrender
except that surrender is possible if AOA permits and where the shares otherwise may be
forfeited
--Forfeiture of shares
--Diminution of capital (Where the company cancels shares which have not been taken
or agreed to be taken by any person)
-An unlimited company to which Section 100 does not apply, can reduce its capital in
any manner that its Memorandum and Articles of Association allow
-It must be ensured that the effect of a reduction does not disqualify any director when
it relates to qualification shares
-After confirming the reduction, the Court/Tribunal may also direct that the words “and
reduced” be added to the company’s name for a specified period, and that the company
must publish the reasons for the reduction with a view to giving proper information to
the public.
(ii) Where redeemable preference shares are redeemed in accordance with the
provisions of Section 80;
(iii) Where any shares are forfeited for non-payment of calls and such forfeiture
amounts to reduction of capital.
(iv) Where the company buys-back its own shares under Section 77A of the Act. In all
these cases, the procedure for reduction of capital as laid down in Section 100 is not
attracted.
-PENALTY: If any officer of the company knowingly conceals the name of any creditor
entitled to object to the reduction or knowingly misrepresents the nature or amount of
the debt or claim of any creditor etc, he shall be liable to be punishable with
(b) A banking company may lend money in the ordinary course of business.
(c) A company may provide financial assistance to employees other than directors for
purchasing fully paid up shares, an amount
(d) A company may buy its own shares from any member in pursuance of a Court’s
order under Section 402 of the Companies Act.
ALLOTMENT OF SHARES
-“Allotment” of shares means the act of appropriation by the Board of directors of the
company out of the previously un-appropriated capital of a company of a certain
number of shares to persons who have made applications for shares
therefore is not an allotment and a company need not file return in e-Form No. 2 in
respect of the re-issue of forfeited shares.
Notice of Allotment
-An allotment is the acceptance of an offer to take shares by an applicant, and like any
other acceptance it must be communicated by way of notice.
(1) The allotment should be made by proper authority, i.e. the Board Directors or a
committee duly authorised to allot shares. – The Board should be duly constituted and a
valid resolution for allotment must be passed
(6) Allotment should not be in contravention of any other law like allotment to a minor
(a) The Company wanting to make a public issue should apply to one or more
recognized stock exchange(s) for listing u/s 73 and if listing permission is not granted
within prescribed period by any of the stock exchanges named in the prospectus, the
entire allotment is void.
(b) The company shall file with the Registrar, a prospectus or a statement in lieu of
prospectus in e-form 19 or e-form 20, as the case may be, before making an allotment
signed by every person who is named therein as a director.
(c) The company shall receive in cash, application money which shall not be less than 5
percent of the nominal value of the shares and the amount must be kept in a scheduled
bank in a separate account till the allotment is made and until the certificate to
commence business has been obtained under Section 149 of the Companies Act, 1956.
[Section 69]
(d) If minimum subscription, as provided in the prospectus, has not been received by
the company, all amounts received must be refunded and allotment, if made is void
(f) Closing of the Subscription List — SEBI (Disclosure and Investor Protection)
Guidelines 2000 provide that the subscription list must be kept open for at least 3
working days and not more than 10 working days and in the case of Infrastructure
Company, the maximum period is 21 working days. In case of Rights issue, the SEBI
guidelines provide that the issue shall remain open for at least 30 days and not more
than 60 days.
(g) If the company having a share capital does not issue prospectus it cannot proceed
with the allotment unless it files with the Registrar of Companies at least 3 days before
the first allotment a Statement in lieu of prospectus in eform 20 in Schedule III and must
contain the particulars and reports set out therein.
-As per Section 73, every public issue must be listed and if permission is not granted
within 10 weeks from closure of subscription list or is refused before, the allotment is
void.
-As per Section 73(2) if allotment is void as above, the company must repay the
application money immediately and if it is not repaid within 8 days, the company and
every director of company who is an
Officer in default shall on and from the expiry of the eighth day, be jointly and severally
liable to repay that money with interest @ 15% p.a.
Basis of Allotment
-As per Clause 44 of listing agreement, allotment of securities offered to public shall be
made within 30 days of closure of public Issue. If it is not done so or if refund order is
not despatched to investors within 30 days from the date of closure of issue, then the
Company shall pay interest @ 15% p.a. as per the listing agreement.
Over Subscription
Minimum Subscription
As per Section 69(1) no allotment can be made in a public issue until the minimum
subscription stated in the prospectus has been subscribed and the amount payable on
application has been received in cash by the company. – Such minimum subscriptions
should be 90 percent of the issue including devolvement on underwriters subscription
-As per the provisions of the Act, it must be received within 120 days of opening of issue
but as per SEBI requirements, it must be received within 60 days from closure - If
it is not so received, the amount received should be returned within next 10 days and if
not so returned, the directors are liable to return the same with interest
Letter of Allotment
-The company sends this letter to allottees and they surrender the same in exchange for
shares certificates when they are subsequently issued
Letter of Renunciation
-Under Section 81, when a Public Company makes a right issue to existing shareholders,
they have an option to renounce the shares in favour of any other person, through a
letter of renunciation – If the renounce does not accept the offer, BOD of the company
may dispose of those shares in any manner in the best interest of the company
Employee Stock Option Scheme means the option given to the Whole Time
Directors, Officers and Employees of the Company which gives them a right or benefit to
purchase or subscribe the securities offered by the Company at a predetermined price
at a future date. The idea behind sock option is to motivate the employees by linking the
profitability of the Company.
Compensation Committee:-
Shareholders Approval:-
Shares can be issued under ESOS with the approval of shareholders by way of
Special Resolution. The explanatory statement of the notice and the resolution
proposed to be passed in general meeting shall include details regarding the
ESOS. Approval of shareholders by way of separate resolution in the general
meeting shall required in case grant of option to identified employees, during
any one year, equal to or exceeding 1% of the issued capital of the company.
The Company, by special resolution, may variate the terms, including the pricing,
of the ESOS offered but not yet exercised by the employees provided such
variation is not prejudicial to the interest of the option holders.
Lock in Period:-
There shall be a minimum period of one year between the grant of option and
vesting of option. However the Company shall have the freedom to specify the
lock in period for the shares issued pursuant to exercise of option. The
employees shall not have any right to receive dividend or to vote or in any
manner enjoy the benefits of a shareholder in respect of option granted to him,
till the shares are issued on exercise of option.
The option granted to an employee shall not be transferable to any person, the
option can only be exercised by the employee to who the option is granted. The
option cannot be transferred, pledged, hypothecated, mortgaged or otherwise
alienated in any manner. This is a personal right only to the offeree.
Disclosure in Directors’ Report:-
2. In case of listed company advance notice to the Stock Exchange and after the
Board Meeting, outcome of the Board Meeting is also to be notified
immediately.
Buyback of Shares:
Buyback of shares means that any company may purchase their own shares or other
specified securities. According to section 77A (1) of the companies Act 1999, a company
may purchase its own shares or other securities out of:
No company shall purchase its own shares or other specified securities unless:
(b) A Special resolution has been passed in general meeting of the company authorising
the buyback.
(c) The buyback is for less than 25% of the total paid up capital and free reserves of the
company.
(d) It also provide that buyback shall not be exceed 25% of total paid up capital.
(e) The debt equity ratio should not be more than 2:1 after such buyback.
(f) All the shares or other specified securities for buyback are fully paid up.
(g) The buyback of the shares or other specified securities listed on any recognised
stock exchange is in accordance with the regulations made by the Securities and
Exchange Board of india in this behalf.
(h) The buyback in respect of shares or other specified securities other those specified
in clause
(i) The buyback should be completed within 12 months from the date of passing the
special resolution.
SEBI guidelines:
The following are the important points:
1. Buyback of shares cannot be from any person through negotiated deals whether on or
after stock exchange or through spot transactions or through private management.
Therefore a company is required to make public announcement in atleast one National
Daily all with wide circulation where registered office of the company is situated.
2. Public announcement among other things specify the following:
(j) Specified date i.e the date of the dispatch of the offer letter shall not be less than
earlier than 30 days but not later than 42 days.
(k) SEBI shall be informed by the company with in seven working days from the date of
public announcement.
(l) The offer for buyback shall remain open to the members for a period of not less than
15 days but not exceeding 30 days. However the opening date for the offer shall not be
earlier than 7 days or later than 30 days from the specified date.
1. The buyback facility enable the co.’s is manage their cash effectively. Many co.’s in this
country are faced with a problem of surplus cash without having any idea of where to
invest them. It would be better for them to return surplus cash to shareholders rather
than to go on spending simply for want to alternative.
2. Companies having large amount of free reserves are free is use funds to acquire
shares and other specified securities under the buyback process.
3. Buyback shares in helpful co. to reduce its share capital.
4. Buyback of shares is helpful to improvement in the values of shares.
5. Avoid high financial risk and ensure maximum return to the shareholders.
6. Buyback of shares helps the promoters to formulate an effective defences strategy
against hostile take over bids.
Buy back of shares or other specified securities can be done through various sources
which have been illustrated under sub section 5 of section 77A, they are as follows:-
i) stock market
c) From odd lots, that is to say where the lot of securities of a public company, whose
shares are listed on a recognised stock exchange, is smaller than such marketable
Section 77A(9) prescribes for the manner in which a register shall be maintained a
register of shares so bought back and enter therein the following particulars:-
The shares or the securities so bought back shall be physically destroyed within seven
days from the last date f completion of such buy back.
PART A
12. Mention any two methods of alteration of share capital. (MAY/JUNE 2013)
17. Explain why buy back of shares are done. (Jan 2011)
PART B
2. Illustrate the errors which are disclosed by the Trial Balance with suitable
examples. (JAN 2015)
3. Under circumstance of profit or loss prior to incorporation arises? What are the
accounting treatment for profit and loss prior to incorporation? (APR/MA 2015)
4. Define a company and state its essential characteristics. Explain the documents
that have to file with the Registrar of companies for getting a company in
corporate. (JANUARY 2014)
5. Explain the different modes of alteration of share capital as per the provision of
sections 94 to 97 of the companies act. (JANUARY 2014)
6. G Ltd. was registered on :1.7.07to acquire the running business of S & co. with
effect from 1.1.07. The following was the profit and loss a/c of the company on
31.12.07 (MAY/JUNE 2014.)
2,25,000 2,25,000
You are required to prepare a statement showing profit earned by the company in the
pre and post incorporation periods. The total sales for the year took place in the ratio of
1 : 2 before and after incorporation respectively.
7. Discus about the statutory Books of Accounts that are to be maintained by public
limited company. (NOV/DEC2013)
3) Statutory books
10. Why are stock option plans popular with software companies? (Jan 2011)
12. What are financial accounts? What purpose do they serve? Explain the various
adjustments affecting the preparation of balance sheet. (NOV/DEC2011)
Metcalf and Tigard have defined financial statement analysis and interpretations
as a process of evaluating the relationship between component parts of a financial
statement to obtain a better understanding of a firm's position and performance.
The facts and figures in the financial statements can be transformed into
meaningful and useful figures through a process called "Analysis and Interpretations."
In other words, financial statement analysis and interpretation refer to the process of
establishing the meaningful relationship between the items of the two financial
statements with the objective of identifying the financial and operational strengths and
weaknesses.
This is a major tool for making horizontal analysis. Under this technique, statements
(either Balance Sheets or Profit & Loss accounts) for two years or more are analysed.
The data is arranged side by side. And the changes from one period to another period
are calculated and analysed as to the reasons and suitable inferences are drawn from
them.
In Income Statement, Sales figure is assumed to be 100% and all other figures
are expressed as a percentage of sales. In Balance Sheet, the total of assets is taken as
100% and all other figures are expressed as a percentage of total assets. This type of
Statement so prepared is called as the Common Size Statement and the analysis
performed on the Common Size Statement is called as the Common Size Financial
Statement Analysis or otherwise called as Vertical Analysis.
Format of Comparative Common size Balance Sheet
Particulars First Year Second Year
ASSETS Amount % Amount %
Current Assets
1. Cash
Trend analysis involves the usage of past figures for comparison. Trend
percentages are calculated for some important items like sales revenue, net income etc.
Under this kind of analysis, information for a number of years is taken up and one year,
which is usually the first year, is taken as the base year. Each item of the base year is
taken as 100 and on that base, the percentage for other years are computed. This
analysis will help in finding out the percentage of increase or decrease in each item with
respect to the base year.
The main objective of a business is to earn a satisfactory return on the funds invested
in it. Financial analysis helps in ascertaining whether adequate profits are being earned
on the capital invested in the business or not. It also helps in knowing the capacity to
pay the interest and dividend.
Financial statements of the previous years can be compared and the trend regarding
various expenses, purchases, sales, gross profits and net profit etc. can be ascertained.
Value of assets and liabilities can be compared and the future prospects of the business
can be envisaged. Assessing the growth potential of the business. The trend and other
The purpose of financial analysis is to assess the financial strength of the business.
Analysis also helps in taking decisions, whether funds required for the purchase of new
machines and equipments are provided from internal sources of the business or not if
yes, how much? And also to assess how much funds have been received from external
sources.
The different tools of an analysis tell us whether the firm has sufficient funds to meet
its short term and long term liabilities or not.
PARTIES INTERESTED
(i) Investors :
Shareholders or proprietors of the business are interested in the well being of the
business. They like to know the earning capacity of the business and its prospects of
future growth.
(ii) Management :
They are interested in financial statements for negotiating the wages or salaries or
bonus agreement with the management.
(iv) Lenders :
The suppliers and other creditors are interested to know about the solvency of the
business i.e. the ability of the company to meet the debts as and when they fall due.
Tax authorities are interested in financial statements for determining the tax liability.
(vii) Researchers:
(viii) Employees :
They are interested to know the growth of profit. As a result of which they can
demand better remuneration and congenial working environment.
Government and their agencies need financial information to regulate the activities
of the enterprises/ industries and determine taxation policy. They suggest measures to
formulate policies and regulations.
The stock exchange members take interest in financial statements for the purpose
of analysis because they provide useful financial information about companies. Thus, we
find that different parties have interest in financial statements for different reasons
COMPARATIVE STATEMENT
Along with being an excellent way to broaden the understanding of the success
of the sales effort, a comparative statement can also help address changes in production
costs. By comparing line items that catalogue the expense for raw materials in one
quarter with another quarter where the number of units produced is similar can make it
possible to spot trends in expense increases, and thus help isolate the origin of those
increases. This type of data can prove helpful to allowing the company to find raw
materials from another source before the increased price for materials cuts into the
overall profitability of the company.
A comparative statement can be helpful for just about any organization that has to deal
with finances in some manner. Even non-profit organizations can use the comparative
statement method to ascertain trends in annual fund raising efforts. By making use of
the comparative statement for the most recent effort and comparing the figures with
those of the previous year’s event, it is possible to determine where expenses increased
or decreased, and provide some insight in how to plan the following year’s event.
The common size ratio for each line on the financial statement is calculated as follows:
Item of Interest
Common Size Ratio =
Reference Item
For example, if the item of interest is inventory and it is referenced to total assets (as it
normally would be), the common size ratio would be:
Inventory
Common Size Ratio for Inventory =
Total Assets
The ratios often are expressed as percentages of the reference amount. Common size
statements usually are prepared for the income statement and balance sheet,
expressing information as follows:
The following example income statement shows both the rupee amounts and the
common size ratios:
For the balance sheet, the common size percentages are referenced to the total assets.
The following sample balance sheet shows both the dollar amounts and the common
size ratios:
The above common size statements are prepared in a vertical analysis, referencing each
line on the financial statement to a total value on the statement in a given period.
The ratios in common size statements tend to have less variation than the absolute
values themselves, and trends in the ratios can reveal important changes in the
business. Historical comparisons can be made in a time-series analysis to identify such
trends.
Common size statements also can be used to compare the firm to other firms.
Limitations
1. Different accounting policies may be used by different firms or within the same
firm at different points in time. Adjustments should be made for such differences.
2. Different firms may use different accounting calendars, so the accounting periods
may not be directly comparable.
TREND STATEMENT
Trend analysis calculates the percentage change for one account over a period of time of
two years or more.
Percentage change
Calculate the amount of the increase/ (decrease) for the period by subtracting the
earlier year from the later year. If the difference is negative, the change is a decrease
and if the difference is positive, it is an increase..
1) In case of a trend analysis all the given years are arranged in an ascending
order.
2) The first year is termed as the “Base year” and all figures of the base year are
taken as 100%.
3) Item in the subsequent years are compared with that of the base year.
4) If the percentages in the following years is above 100% it indicates an
increase over the base year and if the percentages are below 100% it
indicates a decrease over the base year.
5) A trend analysis gives a better picture of the overall performance of the
business.
6) A trend analysis helps in analyzing the financial performance over a period of
time.
7) A trend analysis indicates in which direction a business is moving i.e. upward
or downwards.
RATIO ANALYSIS
1) Limited use of a single ratio: A single ratio does not convey any meaning.
Ratios are useful only when calculated in sufficient nos.
2) Lack of adequate standards: It is difficult to set ideal ratios for each
firm/industry. And also setting of standard ratios for all the firms in every
industry is also difficult.
3) Inherent limitations of accounting: As Ratio analysis is based on financial
statements, the analysis suffers from the limitations of financial statements.
4) Change of accounting procedure: If different methods are followed by different
firms for their valuation, comparison will practically be of no use.
5) Window dressing: Ratios based on dressed up (manipulated) financial
information are not of much use as they show unreliable position of the firm
1. Liquidity Ratios (Short Term Solvency Ratios): These Ratios measure the ability of
the firm to meet its current obligations. They indicate whether the firm has
sufficient liquid resources to meet its short term liabilities. The various liquidity
ratios are :-
(i) Current Ratio: This Ratio measures the ability of the firm to pay debts in the
short term
Current Ratio = Current Assets (Ideal Ratio = 2:1)
Current Liabilities
(ii) Quick / Liquid / Acid-Test Ratio: This Ratio measures the short term debt
paying ability of the firm
Quick / Liquid / Acid-Test Ratio = Quick Assets (Ideal Raito = 1:1)
Current Liabilities
(iv) Debtor’s Turnover Ratio: This Ratio is a measure of quality of Debtors and
of the effectiveness of the collection efforts.
Debtor’s Turnover Ratio = Debtors + Bills Receivable X No. of working days
Credit sales in a year
(v) Average Debt Collection Period: This Ratio measures the time taken to
collect from Debtors
Average Debt Collection Period = Average Debtors
Net Sales / 360 days
(vi) Stock / Inventory Turnover Ratio: This Ratio measures the time taken to
turn inventory into sales.
Stock / Inventory Turnover Ratio = Cost of Goods sold
Average stock
(Where Average Stock = Opening stock + Closing Stock )
2
2. Solvency Ratios (Long Term): These Ratios measure the long term financial
condition of the firm. Bankers and creditors are most interested in liquidity. But
shareholders, debenture holders and financial institutions are concerned with the
long-term financial prospects. The various Solvency Ratios are:
(iv) Interest Coverage Ratio : This Ratio measures the ability of the firm in
meeting its interest charges and thus gives the measure of protection to creditors
for payment of interest. Interest coverage ratio less than 2.0 suggest a risky
situation
(iv) Return on Capital Employed (ROCE) : This Ratio measures the overall
profitability and efficiency of the business.
ROCE = Net Profit + Interest + Taxes X 100
Average Capital Employed
(vi) Asset Turnover: This Ratio measures the efficiency with which Assets
are utilized
(vii) Return on Assets (ROA): This Ratio measures the profitability from a
given level of investment
4. Activity Ratios: These Ratios indicate the number of times stock is replaced during
a year. A high Ratio indicates quick movement of stock and vice-versa. i.e, Activity
Ratios measure the efficiency of asset management. The efficient utilization of assets
would be reflected by the speed with which they are converted into sales.
(ii) Debtor’s Turnover Ratio = Debtors + Bills Receivable X No. of working days
Credit sales in a year
This Ratio shows the speed with which Debtors / Accounts Receivable are
collected.
Capital Structure Ratio / Capital Gearing Ratio = Preference Share Capital + Fixed
Interest Bearing Securities
Equity Shareholders’ Funds
6. Capital Market Ratios : These Ratios are usually related to the Stock Market and
are highly useful to the investors / potential investors.
(i) Price Earnings Ratio (P/E Ratio): This Ratio measures the amount investors
are willing to pay for a rupee of earnings.
Price Earnings Ratio (P/E Ratio) = Market Price per share (MPS)
Earnings per Share (EPS)
(ii) Dividend Yield : This Ratio measures the current return to investors
Illustration problems
Solution:
Comments : In this exercise, current ratio is 2 :1, which is considered satisfactory, but
quick ratio is below the optimum ratio of 1 :1. This indicates that the liquidity position
of the firm is not satisfactory as it indicates that the firm can only meet its current
obligations to the extent of 67% only. A further analysis shows that stock forms a major
part of current assets. This is a negative indication as it may imply that stock may be
slow moving. Only after further analysis of stock – its quality, its movement etc, then
only the liquidity position of the firm can be concluded.
Calculate:
i. Current Ratio
ii. Quick Ratio
Dr. M.Krishnamoorthi,AP/MBA Page 75
iii. Inventory to Working capital
iv. Debt to Equity Ratio
v. Proprietary Ratio
vi. Capital gearing Ratio
vii. Current Assets to Fixed assets
Solution:
Illustration 3
From the following information given below, calculate (a) Current Liabilities and (b)
Inventory.
Current Ratio = 2.5
Acid test Ratio = 1.7
Current Assets = Rs.2,50,000
Solution:
Current Ratio = Current Assets
Current Liabilities
2.5 = Rs.2,50,000
Current Liabilities
Current Liabilities = Rs. 2, 50,000 = Rs.1,00,000
2.5
Acid Test Ratio / Liquid Ratio = Liquid Assets
Current Liabilities
By cross multiplication,
Liquid Assets = Liquid Ratio / Acid Test Ratio X Current Liabilities
= 1.7 X Rs.1,00,000 = Rs.1,70,000
Illustration 4
Balance sheet of ABC Ltd
Solution:
Schedule of changes in Working Capital
Particulars Amount
Net Profit / Loss as per the Profit & Loss account (Closing) 83,000
Add: 1. Items which do not result in the outflow of funds (or) all non-fund / -
non – operating items shown on the debit side of Profit and Loss account
Less: 1. Items which do not result in the inflow of funds (or) all non-fund / -
non – operating items shown on the credit side of Profit and Loss account
2. Opening Balance of Profit & Loss account
From the following Balance sheets of XYZ Co Ltd, prepare (a) Schedule of changes in
Working capital and (b) Funds Flow Statement
Liabilities 31st Dec 31st Dec Assets 31st Dec 31st Dec
‘04 ‘05 ‘04 ‘05
Capital 1,20,000 1,50,000 Plant 1,00,000 1,25,000
Sundry Creditors 37,000 25,000 Land & Buildings 75,000 90,000
Bills Payable 15,000 17,000 Patent rights 7,000 9,500
Profit & Loss A/c 60,000 69,000 Cash 17,000 23,000
Sundry Debtors 33,000 13,500
2,32,000 2,61,000 2,32,000 2,61,000
Additional Information:
Depreciation of Rs.20,000 and Rs.25,000 have been charged on Plant, Land & Building
respectively in 2005.
Solution:
Schedule of changes in Working Capital
Working Notes:
(i) Calculation of Plant purchased during the year:
Plant Account
1,45,000 1,45,000
(ii) Calculation of Land & Building purchased during the year:
Land & Buildings Account
Particulars Amount Particulars Amount
To Balance b/d 75,000 By Depreciation 25,000
To cash (Balancing figure – 40,000 By Balance c/d 90,000
purchase)
1,15,000 1,15,000
Sources of funds:
Funds from operations ****
Issue of share ****
Raising of long term loans ****
Receipts from partly paid up share, called up ****
Sale of non-current (Fixed) assets ****
Non-trading receipts, such as dividends received ****
Sale of investment (Long term) ****
Decrease in working capital (as per schedule of changes in working capital) ****
B/F ****
Total
Application or uses of funds: ****
Funds lost in operations ****
Redemption of preference share capital, Debentures & Long term loans ****
Purchase of non-current (Fixed) Assets, long term investments ****
Payments of dividends* ****
Rs.
Funds from operation 84,000
Increase in current assets 73,000
Increase in current liabilities 21,000
Decrease in current assets 20,000
17)13. From the following information, calculate gross profit ratio (MAY/JUNE
2014)
Rs.
Sales 10,00,000
Sales returns 1,00,000
Cost of goods sold 5,85,000
18)Name the various tools used for financial statement analysis. (Jan 2015)
19)Give the meaning of Floe of Funds. (Jan 2015)
20)Define Net profit ratio. (Apr/May 2015)
21)Define fund flow statement. (Apr/May 2015)
Part-B
8, 40,000 8,40,000
Calculate:
1) Current Ratio
2) Quick ratio
3) Inventory to working capital
4) Debt to equity ratio
5) Proprietary Ratio
8. Define ratio analysis. Explain the major uses and limitations of ratio analysis.
(Apr/May 2015)
9. Explain the uses of cash flow statement an discuss the difference between cash floe
statement and fund flow statement. (Apr/May 2015)
COST ACCOUNTING
COST ACCOUNTING.
Cost accounting is “ The process of accounting for costs from the point at which
expenditure is incurred or committed to the establishment of its ultimate
relationship with cost centers and cost units. In its widest usage it embraces the
preparation of statistical data, the application of cost control methods and the
ascertainment of the profitability of activities carried out or planned.”
a. According to functions
i. Production cost / factory cost / manufacturing cost
ii. Administration cost / office cost
iii. Selling cost
METHODS OF COSTING:
1. Job costing:
Job costing is the basic costing method applicable to those industries
where the work consist of separate contracts, jobs, or batches, each of which is
authorized by a specific order or contract.
2. Contract costing:
It is the form of specific order costing, generally applicable where work is
undertaken to customer’s special requirements and each order is of long
duration such as a building construction etc
3. Batch costing:
COST SHEET
1. Historical Cost
2. Estimated Cost
Cost ascertainment
The main objective of the cost sheet is to ascertain the cost of a product. Cost sheet
helps in ascertainment of cost for the purpose of determining cost after they are
ncurred. It also helps to ascertain the actual cost or estimated cost of a Job.
Fixation of selling price
To fix the selling price of a product or service, it is essential to prepare the cost
sheet. It helps in fixing selling price of a product or service by providing detailed
information of the cost.
SALES XXX
Freight 500
Advertising 125
Assuming that all the products manufactured are sold, what should be the selling price
to earn a profit of 25% on selling price?
Solution:
Statement of Cost for product A for the month of September 2005 …….
Particulars
Direct Material
Direct labor:
SALES 13,333
STANDARD COSTING:
STANDARD COSTING is a technique which uses standards for costs and revenues
for the purpose of control through variance analysis. It can be used either with
operations or processes or with specific order type of cost accounting system.
1. Measuring efficiencies
2. Controlling and reducing costs
3. Simplifying costing procedure
4. Valuing inventories and
5. Setting selling prices
ADVANTAGES OF STANDARD COSTING
Variance Analysis
Standard Costing guides as a measuring rod to the management for
determination of "Variances" in order to evaluate the production performance. The
term "Variances" may be defined as the difference between Standard Cost and actual
cost for each element of cost incurred during a particular period.
The term "Variance Analysis" may be defined as the process of analyzing variance by
subdividing the total variance in such a way that management can assign responsibility
for off-Standard Performance. The variance may be favourable variance or unfavourable
variance. When the actual performance is better than the Standard, it resents
"Favourable Variance." Similarly, where actual performance is below the standard it is
called as "Unfavourable Variance."
TYPES OF VARIANCES
Variances are computed for all the three basic elements of cost – direct material, direct
labor and overhead variance
MATERIAL VARIANCES:
This variance is an overall difference in the standard direct material cost and the
actual direct material cost. This variance may exist because of difference in either the
price of the material or the quantity that is purchased.
This may be defined as the difference between the actual price and the standard price of
the materials consumed.
This is the difference between the actual quantity of material consumed and standard
quantity which should have been consumed, expressed in terms of the standard price of
the material.
MUV = Standard price (Standard quantity for actual production – Actual quantity used)
(or) when standard is revised due to the shortage of a particular type of material
Where Revised standard quantity = Total weight of actual mix x Standard quantity
b) Direct material yield variance (MYV) : It has been defined by the ICMA, London,
as ‘the difference between the standard yield of the actual material input and the actual
yield, both valued at the standard material cost of the product’.
LABOUR VARIANCES:
According to ICMA, London, ‘Labor cost variance is the difference between the standard
direct wages specified for the production achieved, whether completed or not and
actual direct wages incurred’. If the standard cost is higher, the variation is favourable
and vice versa.
According to ICMA, London, this variance is ‘the difference between the standard and
the actual direct labor rate per hour for the total hours worked’. If the standard rate is
higher, the variance is favourable and vice versa
This variance has been defined as – ‘that portion of the direct wages cost variance which
is the difference between the standard direct wages cost for the production achieved
whether completed or not, and the actual hours at standard rates (plus incentive
bonus). This variance may be favourable or unfavourable.
This variance arises because of the time during which the labor remains idle due to
abnormal reasons such as – power failure, strikes, machine breakdowns etc.
Labor Mix Variance or Gang Composition Variance (LMV): This is that part of Labor
cost variance that results from employing different grades of labor from the standard
fixed in advance. It is the difference between the standard composition of workers and
the actual gang of workers.
Labor Yield Variance (LYV): It is the difference between the standard labor output and
actual output or yield.
If the actual production is more than the standard production, it would result in
favourable variance and vice versa.
OVERHEAD VARIANCES:
Unlike direct material and labor, the manufacturing overhead is not entirely variable
with the level of production. Therefore, standard costs for factory overheads are based
upon budgets rather than standards. These variances arise due to the differences
between the actual overhead cost incurred and the standard overhead cost charged to
production. There are two components to overhead variances – i) Variable Overhead
Variances and ii) Fixed Overhead Variances.
This variance is defined by ICMA, London, as ‘the difference between the standard
variable production overhead absorbed in the production achieved, whether completed
or not, and the actual production overhead’. This variance can be divided into – i)
Variable Overhead Expenditure Variance and ii) Variable Overhead Efficiency Variance.
VOHV= (Actual hours worked x Standard variable overhead rate per hour) – Actual
variable over heads
It is difference between actual overhead expenditure incurred and the standard variable
overheads set in for a particular period.
Fixed overhead variance has been defined by ICMA, London, as ‘the difference between
the standard cost of fixed overhead absorbed in the production achieved, whether
completed or not, and the actual fixed overhead, attributed and charged to that period’.
FOV = (Actual production x Standard fixed overhead recovery rate) – Actual overheads
incurred
This variance may be divide into – i) Fixed Overhead Expenditure Variance and ii) Fixed
Overhead Volume Variance.
This variance has been defined by ICMA, London as ‘the difference between the budget
cost allowance for production for a specified control period and the amount of actual
fixed expenditure attributed and charged to that period’.
This variance has been defined by ICMA, London as ‘that portion of the fixed production
overhead variance which is the difference between the standard cost absorbed in the
FOVV = Standard Fixed overhead recovery rate (Actual quantity – Budgeted quantity)
Fixed Overhead Volume Variance can further be divided into – i) Capacity variance and
This variance has been defined by ICMA, London as ‘that portion of the fixed production
overhead volume variance which is due to working at higher or lower capacity than
standard’.
This variance has been defined by ICMA, London as ‘that portion of the fixed production
overhead volume variance which is the difference between the standard cost absorbed
in the production achieved, whether completed or not, and the actual direct labor hours
worked (valued at the standard hourly absorption rate).
Some times, another variance, called as calendar variance may also be calculated as –
The word ‘Sales Variance’ is denoted by the expression ‘operating profit variance
due to sales’ by ICMA. It is defined as the difference between the budgeted operating
profit and the margin between the actual sales and the standard cost of those sales’.
This variance is subdivided into – i) Sales price variance and ii) Sales volume variance
i) Sales price variance (SPV): It is the difference between actual selling price and
standard selling price.
It is the difference between the actual no of units sold and the planned sale of units.
Sales variances are significant as they have a direct bearing on profits earned by
the organization. Hence, they can be used as the basis of determining profit variance.
The overall Profit Variance is divided into – i) Sales price variance and ii) Sales Volume
Variance, which is sub-divided into – a) Sales Price variance b) Sales Volume Variance
and iii) Cost Variance. Except Cost Variance, there is no difference between the various
Sales Variances and Profit Variances.
Cost Variances: They arise when actual costs are different from standard costs.
Cost Variances = (Standard cost – Actual cost) Actual quantity sold (Favorable)
CLASSIFICATOIN OF BUDGETS
Budgets can be classified on the basis of many bases. There are three popular
bases for classifying budgets. They are – time, functions and flexibility. Apart from
these classifications, several other budgets can also be found in practice such as –
performance budget, ZBB, control ratios etc
Production budget: It includes details about the types, quantity and cost of goods
and services produced in the organization. The responsibility of preparing this
budget falls on the Works manager or departmental Works managers.
Production cost budget: It is divided into material cost budget, labour cost budget
and overhead cost budget, because cost of production includes material, labour and
overheads.
Materials budget: It includes details about the kinds and quantity of material
required, price paid for it, cost of transportation and storage, etc
Labor budget: It includes details about the types and number of workers, the
number of hours required, the wage rates and other allowances, the welfare and
other facilities provided and cost thereof etc.
Cash budget: A Cash budget deals with cash, including its equivalent, like bank
balance and bills receivable. It shows the inflows of cash and outflows of cash
during a particular period of time. It can be prepared for a year, but for better
control and management of cash, its is normally prepared on monthly basis. It takes
into account only cash transactions.
• Master budget: This budget is prepared from, and summarises the various
functional budgets. It is also called as summary budget. It generally includes details
relating to production, sales, stock, debtors, cash position, fixed assets etc, in
addition to important control ratios.
Dr. M.Krishnamoorthi,AP/MBA Page 103
On The Basis Of Flexibility
A Zero base budget is not an old budget with incremental changes, as in the case of an
incremental budget. It starts with a scratch or a zero level and if an item is found to be
necessary it is included in the new budget, and if it is necessary, how much amount
should be budgeted for.
1) It provides a solution for all the limitations of traditional budgeting by enabling the
top management to focus on key areas, alternatives and priorities of action throughout
the organization.
4) It helps in identifying wasteful expenditure, and if desired, it can also be used for
suggesting alternative courses of action.
Even though there are many advantages with this type of budgeting, there are various
disadvantages also associated with its use. Some of them are –
3. Control ratios
Budgeted Hours
b) Capacity Ratio : This ration indicates whether and to what extent budgeted
hours of activity are actually utilized.
Capacity ratio = Actual hours worked x 100
Budgeted hours
Material Rs.10
Labor Rs.3
The selling price is Rs.20 per bucket. If it is desired to work the factory at 505 capacity,
the selling price falls by 3%. At 90% capacity, the selling price falls by 5% accompanied
by a similar fall in the price of the material.
You are required to prepare a statement showing the profit at 50% and 90% capacities
and also calculate the break even points at the capacity production.
Particulars Capacity
Marginal cost
Material: Rs 10
(at 90% - Rs.9.50
per unit)
1,00,000 1,25,000 2,13,750
Labor
30,000 37,500 67,500
Variable overhead
20,000 25,000 45,000
Meaning
Marginal Cost: The tenn Marginal Cost refers to the amount at any given volume of
output by which the aggregate costs are charged if the volume of output is changed by
one unit. Accordingly, it means that the added or additional cost of an extra unit of
output.
Marginal cost may also be defined as the "cost of producing one additional unit of
product." Thus, the concept marginal cost indicates wherever there is a change in the
volume of output, certainly there will be some change in the total cost. It is concerned
with the changes in variable costs. Fixed cost is treated as a period cost and is
transferred to Profit and Loss Account.
According to J. Batty, Marginal costing is "a technique of cost accounting pays special
attention to the behaviour of costs with changes in the volume of output." This
definition lays emphasis on the ascertainment of marginal costs and also the effect of
changes in volume or type of output on the company's profit.
(1) All elements of costs are classified into fixed and variable costs.
(4) Valuation of stock of work in progress and finished goods is done on the basis of
variable costs.
(5) Profit is calculated by deducting the fixed cost from the contribution, i.e., excess of
selling
(6) Profitability of various levels of activity is detennined by cost volume profit analysis.
The following are the important decision making areas where marginal costing
technique is used :
(6) Decisions as to whether to sell in the export market or in the home market.
(1) It may be very difficult to segregation of all costs into fixed and variable costs.
(2) Marginal Costing technique cannot be suitable for all type of industries. For example,
it is
(4) It assumes that the fixed costs are controllable, but in the long run all costs are
variable.
(5) Marginal Costing does not provide any standard for the evaluation of performance
which is
(6) With the development of advanced technology fixed expenses are proportionally
increased.
(7) Under marginal costing elimination of fixed costs results in the under valuation of
stock of
* FIXED COST: Fixed cost is a period cost and is usually unrelated to changes in
production. The total fixed cost remains constant for all levels of production whereas
the fixed cost per unit changes with changes in the production level.
* VARIABLE COST: Variable cost is a product cost and is usually directly related to
production. Total variable cost changes with changes in the production level, but
variable cost per unit remains the same for all levels of production.
Contribution = Sales – Variable cost (or) Fixed cost +Profit (or) Fixed cost – Loss
* MARGIN OF SAFETY (MOS): It refers to the difference between the actual sales and
break even sales. It represents a cushion to the creditors of the firm.
MOS = Actual sales – Break even sales (or) Profit (in Rs) (or) Profit (in units)
* ANGLE OF INCIDENCE : It is an angle that is formed when the total sales line
intercepts the total cost line from below in the breakeven chart. It is inferred that
higher the angle, higher is the profit, and lower the angle lower the profit.
* PROFIT VOLUME RATIO: It is also known as contribution to sales (C/S) ratio. It is one
of the most important ratios for studying the profitability of operations of a business
and establishes the relationship between contribution and sales. The inference is –
higher the P/V ratio, lesser will be the profit.
P/V ratio = Contribution x 100 (or) S –V (or) F +P (or) F-L (or) Change in profits x 100
* BREAK EVEN POINT: It represents a level of production where there is no loss and
there is no profit. In other words, it is a point where the total cost is equal to total sales.
Sales beyond this level represent profit and sales below this point represent loss.
BEP (in value) = Fixed cost (or) Fixed overheads (or) Fixed cost x sales
P/V ratio
Contribution per unit Selling price per unit – Variable cost per unit
Illustrations
Solution:
Rs.18 – Rs.12 = 6)
2. A Company estimates that next year it will earn a profit of Rs.50,000. The budgeted
fixed costs and sales are Rs.2,50,000 and Rs.9,93,000 respectively. Find out the break-
even point for the company.
Solution :
Contribution
Contribution = S – V = F + P
3,00,000
= Rs.8,27,500
3. From the following particulars, find out the selling price per unit if B.E.P. is to be
brought down to 9,000 units.
Solution :
Let us assume that the contribution per unit at B.E. sales of 9,000 is x
9,000 x = 2,70,000 x = 30
Contribution is Rs.30 per unit, in place of Rs.25. Therefore, the selling price should have
been Rs.105 i.e. Rs.75 + Rs.30.
Rs.
Sales 10,00,000
PART B
8000 units @ Rs. 3 each were introduced to process I. There was no stock of
materials or work in progress. The output of each process passes directly to the next
process and finally to finished stock A/c.
The following additional data is obtained :
Prepare Process Cost Accounts, Normal Cost Account and Abnormal Gain or Loss
Account
2. Prepare a flexible budget for overheads on the basis of the following data
(MAY/JUNE 2014)
■
and ascertain overhead rates at 50%, and 70% capacity.
60% At 60Vo capacity
(MAY/JUNE 2014)
(MAY/JUNE
Rs. 2014)
Variable overheads :
Indirect material 6,000
Indirect labour 18,000
Semi-variable overheads : 30,000
Electricity (40Vo fixed 60% 3,000
variable)
Repairs (80% fixed 20% variable)
Fixed overheads :
Depreciation 16,500
Insurance 4,500
Salaries 15,000
3. From the following, find the profit made by each product, apportioning
joint-costs on the sale-value basis. ( JANUARY 2014) (8)
Joint cost : ,Rs.
Direct materials 1,26,000
Power 25,000
Petrol, oil, lubricants 5,000
Labour 7,500
Other charges 4,100
Product X Product Y
Selling costs Rs. 20,000 Rs. 80,000
Sales Rs. 1,52,000 Rs. 1,68,000
4. From the following data, calculate the break-even point: ( JANUARY 2014)
Rs.
Selling price per unit 20
Direct material cost per 8
unit
Direct labour cost per 2
unit
Direct expenses per unit 2
Overheads per unit 3
Fixed overheads (total) 20,000
If sales are -20%, above the break-even point, determine the net profit. (8)
6. Calculate the materials mix variance from the following ( JANUARY 2014) (s)
8. Product X is obtained after it is processed through three processes. You are required to
prepare process accounts from the following information. (NOV/DEC2013)
Process
Total I II II
Material 5,625 2,600 2,000 1,025
Direct wages 7,330 2,250 3,680 1,400
Production overheads 7,330
500 units @ Rs. 4 per unit were introduced in process I. production overhead to be
distributed as 100% on direct wages. The actual output and normal loss of the
respective process are.
9. Explain some of the important applications of marginal costing for managerial decisions.
(MAY/JUNE 2013)
10. From the following prepare the process costing sheet. The production of each process is
moved to the next process on completion. (MAY/JUNE 2013)
11. The sales turnover and profit during two years were as follows: (MAY/JUNE 2012)
12. Cost Accounting is an essential tool of Management”. Give your comments on the
Statement. (MAY/JUNE 2012)
14. A Ltd manufactures products X and Y. during January 1998 it expects to sell 10,000
kg of X and 40,000 kg of Y at Rs. 20 and Rs.10 respectively. Direct materials P,Q and S
are mixed in equal proportions to product X and materials Q, R & S are mixed in the
ration of 3:5:2 to product Y. There is no loss of weight in production. (January 2012)
15. Actual and Budgeted stocks in quantities and costs for the month are as follows:
Y-10,000 12,000 -
16. What is cost sheet? Draw up a cost sheet for a consumer durable product.
(NOV/DEC2011)
A factory can sell 20,000 units of its product in home market at Rs. 20 each. The marginal cost is
Rs. 14 per unit and fixed overhead Rs. 60,000. It can also sell another 10,000 units in the foreign
17. “A sound costing system must place the same emphasis on cost control as on cost
management”. Comment on the statement. (APR/MAY 2011)
18. The following budget estimates are available from a factory working at 50% of its capacity:
19. Slandered equipment Co. operates on standard costing system. The budgeted
overheads for the year ending March 31, were fixed at Rs. 4,20,000 with predetermined
overheads recovery rate of Rs 7 per direct labour hour. The actual direct labour hours
for the year amounted to 61,000 against which only 60,500 hours should have been
spend for the production completed during the year. The actual overhead rate worked
out at Rs. 6.75 per direct labour –hour. You are require to compute the following
variances: (JAN 2011)
Computer is defined in terms of its functions. Computer is a device that accepts data,
stores data, processes data as desired, retrieves the stored data as and when required
and prints the result in desired format.
CHARACTERISTICS OF COMPUTER
1. Speed
It can access and process data millions times faster than humans can. It can store data
and information in its memory, process them and produce the desired results. It is used
essentially as a data processor. All the computer operations are caused by electrical
pulses and travels at the speed of light. Most of the modern computers are capable of
performing 100 million calculations per second.
2. Storage
Computers have very large storage capacity. They have the capability of storing vast
amount of data or information. Computers have huge capacity to store data in a very
small physical space. Apart from storing information, today’s computers are also
capable of storing pictures and sound in digital form.
3. Accuracy
The accuracy of computer is very high and every calculation is performed with the same
accuracy. Errors occur because of human beings rather than technological weakness,
main sources of errors are wrong program by the user or inaccurate data.
4. Diligence
5. Versatility
Computer can perform wide range of jobs with speed, accuracy, and diligence. In any
organization, often it is the same computer that is used for diverse purposes such as
accounting, playing games, preparing electric bills, sending e-mail and so on.
6. Communication
Computers are being used as powerful communication tools. All the computers within
an office are connected by cable and it is possible to communicate with others in the
office through the network of computer.
7. Processing Power
Computer has come a long way today. They began as more prototypes at research
laboratories and went on to help the business organizations, and today, their reach is so
extensive that they are used almost everywhere. I the course of this evolution, they have
become faster, smaller, cheaper, more reliable and user friendly.
COMPONENTS OF COMPUTER
1. Input unit
Input is controlling the various input devices which are used for entering data into the
computer. The mostly input devices are keyboard, mouse, and scanner. Other such
devices are magnetic tape, magnetic disk, light pen, bar code reader, smart card reader,
etc. besides; there are other devices which respond to voice and physical touch. Physical
touch system is installed at airport for obtaining the online information about departure
and arrival of flight. The input unit is responsible for taking input and converting it into
binary system.
The CPU is the control centre for a computer. It guides, directs and governs its
performance. It is the brain of the computer. The main unit inside the computer is the
Central Processing Unit. Central Processing Unit is to computer as the brain is to human
body. This is used to store program, photos, graphics, and data and obey the
instructions in program. It is divided into three subunits.
a) Control Unit
Control Unit
Control unit controls and co-ordinates the activities of all the components of the
computer. This unit accepts input data and converts it into computer binary system.
Memory Unit
This unit stores data before being actually processed. The data so stored is
accessed and processed according to instructions which are also stored in the memory
section of computer well before such data is transmitted to the memory from input
devices.
3. Output Unit
After processing the data, it ensures the convertibility of output into human readable
form that is understandable by the user. The commonly used output devices include like
monitor also called Visual Display Unit, printer etc.
A newer version of machine is evolved with increased speed, storage, and processing
capacity. A computer to which they were connected operated these machines.
The computerized accounting uses the concept of databases. For this purpose an
accounting software is used to implement a computerized accounting system. It does
away the necessity to create and maintain journals, ledgers, etc, which are essential part
of manual accounting. Some of the commonly used accounting software’s are Tally, Cash
Manager, Best Books, etc.
Computer helps in preparing accounting documents like Cash Memo, Bills and invoices
etc., and preparing accounting vouchers.
2. Recording of transactions
Every day business transactions are recorded with the help of computer software
Logical scheme is implied for codification of account and transaction. Every account and
transaction is assigned a unique code. The grouping of accounts is done from the first
stage. This process simplifies the work of recording the transactions.
After recording of transaction, the data is transferred into ledger account automatically
by the computer. Trial Balance is prepared by the computer to check accuracy of the
records. With the help of trial balance the computer can be programmed to prepare
Trading, Profit and Loss account and Balance Sheet.
It is one of the transaction processing systems which are concerned with financial
transactions only. When a system contains only human resources it is called manual
system; when it uses only computer resources, it is called computerized system and
when it uses both human and computer resources, it is called computer-based system.
These steps can be explained with an example making use of Automatic Teller Machine
(ATM) facility by a Bank-Customer.
a. Data Entry
b. Data Validation
d. Storage
e. Information
The stored data is processed making use of the query facility to produce
desired information.
f. Reporting
a. Numerous Transactions
b. Instant Reporting
d. Flexible Reporting
e. Accounting Queries
f. Online Facility
g. Scalability
h. Accuracy
i. Security
Accounting Framework
Operating Procedure
1. Cost of Installation
Computer hardware and software needs to be updated from time to time with
availability of new versions. As a result heavy cost is incurred to purchase a new
hardware and software from time to time.
2. Cost of Training
The computer cannot make a decision like human beings. It is to be guided by the user.
4. Maintenance
4. Adjusting entries are made. There is nothing like making entries to adhere to the
principle of adjusting entries for errors and matching rectifications.
2 Marks:
16 Marks:
8. What is accounting software? Why should we use it? Explain its different types.
(January 2014)
10. Explain the procedure involved in the creation, alteration and deletion of ledger
accounts in tally. (8 ) (January 2014)
13. Discuss the steps involved in computerized accounting system. (8) (January
2015)
15. What is pre packaged accounting software? Discuss its merits and demerits.
What are the factors to be considered while selecting prepackaged software?
(January 2015)