MB 509 Financial Reporting & Analysis

1
 CONCEPTS & CONVENTIONS IN ACCOUNTING

Accounting provides financial information about a business organisation. For this information to be
prepared on uniform basis entire accounting is based on certain principles which are listed below:‐
Accounting Principles

Accounting Concepts Accounting Conventions

a) Entity concept a) Disclosure
b) Dual aspect concept b) Materiality
c) Going concern concept c) Consistency
d) Money measurement concept d) Conservatism
e) Cost concept
f) Cost attach concept
g) Accounting period concept
h) Accrual concept
i) Periodic matching of cost and Revenue concept
j) Realisation concept
k) Verifiable objective evidence concept

ACCOUNTING CONCEPTS
Concepts represent abstract ideas which serve to systematize function. It is an opinion formulated over
the years based on experience. Following are the accounting concepts :‐

1] ENTITY CONCEPT :‐
For accounting purposes the "business" is treated as a separate entity from the proprietor
(s). This concept helps in keeping private affairs of the proprietor away from the business affairs Thus a
proprietor invests ` 1,00,000/‐ in the business, it is deemed that the proprietor has given ` 1,00,000/‐ to
the "business" and it is shown as a "liability" in the books of the business. (because business has to
ultimately repay to the proprietor). Similarly, if the proprietor withdraws ` 10,000/‐ from the business it
is charged to him.
Accounting entity concept enables to record transactions between business and the proprietor. It
ensures that accounting records reflect only the activities of the business. It separates business transactions
from personal transactions of the proprietor.
This concept is applicable to all forms of business organisations. Although in the eyes of law a sole
trader & his business or the partners & their business are one & the same, for accounting purposes they
are regarded as separate entities. It is the "business" with which we are concerned.
2] DUAL ASPECT CONCEPT :‐
As per this concept, every business transaction has a dual effect. According to Dual Aspect Concept, every
transaction has two aspects :‐
1) It increases one asset and decreases another asset.
2) It increases an asset and simultaneously increases liability.
3) It decreases an asset and increases another asset.
4) It decreases an asset and decreases a liability.
5) It increases one liability and decreases another liability.
6) It increases a liability and increases an asset.
7) It decreases liability and increases other liability.
8) It decreases a liability and decreases an asset.
1
 Example:‐If goods are purchased on cash basis for ` 1,00,000 stock of goods is increased and
balance of cash is decreased.

3] GOING CONCERN CONCEPT (CONTINUITY OF ACTIVITY) :‐

Enterprise is normally viewed as a going concern that is continuing in operation for the foreseeable future.
It is assumed that the enterprise has neither the intention nor the necessity of liquidation of curtailing
materially the scale of the operation. It is assumed that the business concern will continue for a fairly long
time, unless & until it has entered into a state of liquidation. It does not imply permanent existence but
simply stability & continuity for a period sufficient to carry business plans. It implies that assets are
acquired for utilisation & not for sale. Similarly, depreciation on assets is provided on the basis of
expected lives of the assets rather than on their market values.
e.g. :‐ If book value of a machine is ` 1,00,000/‐ and net realisable value is ` 80,000/‐ businessman will
ignore realisable value and provide depreciation on book value.

4] MONEY MEASUREMENT CONCEPT :‐

In accounting, everything is recorded in terms of money. Events or transactions which cannot be
expressed in terms of money are not recorded in the books of accounts, even if they are very important or
useful for the business. Purchase and sale of goods, payment for expenses and receipt of income are
monetary transactions which find place in accounting. Death of an executive, resignation of a manager,
integrity of persons are the events which cannot be expressed in money. These are not included in
accounting systems.
Transactions which affect business materially but not convertible in money cannot be recorded in the
books of accounts. To assess financial health of business it is necessary to decide total value of assets &
liabilities. e.g. A business concern has a big building constructed on a plot of 1000 sq. ft., furniture
consisting of 20 chairs, 10 tables and 10 Godrej cupboards, amount to be received from the customers for
5000 units sold on credit, amount payable to supplier for 300 units purchased. From the above details it
is very difficult to assess financial health unless the above items are expressed in terms of money. It is
clear that non‐monetary events cannot be recorded in the books of accounts. The transactions, events or
assets which are expressed in terms of equivalent monetary value are recorded in the books of accounts.
5] COST CONCEPT (OBJECTIVITY CONCEPT): ‐
This concept does not recognise the realisable value, the replacement value of the real worth of an
asset. Thus as per cost concept :‐
1) An asset is ordinarily recorded at the price paid to acquire it i.e. at its cost, and
2) This cost is the basis for all subsequent accounting for the assets.
The cost concept does not mean that the asset will always be shown at cost. It only means that
the cost becomes the basis for all subsequent accounting for the asset. Thus the asset recorded at
cost at the time of purchase may systematically be reduced by the process of depreciation. The cost
concept also implies that if nothing has been paid to acquire an asset, it cannot be shown as an asset
in the books of accounts.

6] COST‐ATTACH CONCEPT:‐

This concept is also known as “cost‐merge” concept. When a finished good is produced from the
raw material there are certain process and costs which are involved like labor cost, power and other
overhead expenses. These costs have a capacity to “merge” or “attach” when they are broughtr
together.

7] ACCOUNTING PERIOD CONCEPT:‐

An accounting period is the interval of time at the end of which the income statement and financial
2
 position statement (balance sheet) are prepared to know the results and resources of the business.

8] ACCRUAL CONCEPT: ‐
It implies recording of revenues & expenses of a particular accounting period, whether they are received/
paid in cash or not. Under cash system of accounting, the revenues & expenses are recorded only if they
are actually received/ paid in cash irrespective of the accounting period to which they belong. But under
accrual method, the revenues & expenses relating to that particular accounting period only are considered.
The Accountant records revenues as they are earned and expenses as they are incurred.
Illustration 1 :‐ Mr. Memo pays to Mr. Nemo ` 5,000 on 15th March, 2015 for service to be rendered from
1st April to 30th June, 2015. Has Mr. Memo earned revenue on March, 15 ? Solution :‐ Mr. Nemo has not
earned any revenue. He has received cash but not rendered service. On 15th March, under accrual
method, Mr. Nemo will record unearned Service Revenue. It is liability because he has an obligation to
perform a service in future.

Illustration 2 :‐ Ms. Isha purchases a goods of ` 80,000 from Ms. Lara by paying a cash of ` 30,000 &
sells at ` 1,00,000 of which the customers paid only ` 75,000. Illustrate the concept of accrual.
Solution :‐Revenue of Ms. Isha is ` 1,00,000 & not ` 75,000 received from the customer Expenses are `
80,000 (cost incurred for the revenue) & not ` 30,000 paid by her to supplier Hence profit as per accrual
concept is ` 20,000 (Revenue ‐ Expenses)
9] PERIODIC MATCHING OF COST AND REVENUE CONCEPT:‐

This concept is based on the period concept. Making profit is the most important objective that keeps
the proprietor engaged in business activities. That is why most of the accountant’s time is spent in
evolving techniques for measuring the profit/profitability of the concern. To ascertain the profit
made during a period, it is necessary to match “revenues” of the period with the “expenses” of that
period. Income (profit) earned by the business during a period is compared with the expenditure
incurred to earn the revenue.

10] REVENUE RECOGNITION (REALISATION CONCEPT) :‐

According to this concept profit should be accounted for only when it is actually realised. Revenue is
recognised only when sale is affected or the services are rendered. Sale is considered to be made when
the property in goods passes to the buyer and he is legally liable to pay. However, in order to recognise
revenue, receipt of cash is not essential. Even credit sales result in realisation, as it creates a definite asset
called debtor. Similarly income like commission, interest, rent etc. are shown in Profit & Loss Account
on accrual basis though they may not be realised in cash on the date of preparing accounts.

11] VERIFIABLE OBJECTIVE EVIDENCE CONCEPT:‐

According to this concept all accounting transactions should be evidenced and supported by
objective documents. These documents include invoices, contract, correspondence, vouchers, bills,
passbooks, cheque etc.

ACCOUNTING CONVENTIONS

Conventions are the customs or traditions guiding the preparation of accounting statements. They are
3
adapted to make financial statements clear and meaningful. They represent usage or methods generally
accepted and customarily used. These exist in cases where there are different alternatives, which are
equally logical and some of these are generally accepted having consideration of cost, time, habit or
convenience. Following are the accounting conventions: ‐

1] CONVENTION OF DISCLOSURE: ‐
This means that the accounts must be honestly prepared and they must disclose all material information.
The accounting reports should disclose full and fair information to the proprietors, creditors, investors
and others. The term disclosure only implies that there must be a sufficient disclosure of information
which is of material interest to proprietors, and potential creditors and investors

2] CONVENTION OF MATERIALITY: ‐
The accountant should attach importance to material details and ignore insignificant details. If this is not
done, accounts will be overburdened with minute details. Therefore, keeping the convention of materiality
in view, unimportant items are either left out or merged with other items. Whether the information is
material or not depends upon the circumstances of the case & common sense. The rule to be kept in mind
is that if omission of the information impairs the decision or conduct of its user, it should be regarded as
material.
However, an item may be material for one purpose but immaterial for another, material for one
concern but immaterial for another or material for one year but immaterial for the next year.

3] CONVENTION OF CONSISTENCY: ‐
The comparison of one accounting period with the other is possible only when the convention of
consistency is followed. It means accounting from one accounting period to another should on the same
basis. If stock is valued at cost or market price whichever is less this principle should be followed every
year. Any change from one method to another would lead to inconsistency. However consistency does
not mean non‐flexibility. It should permit introduction of improved techniques of accounting.

4] CONVENTION OF CONSERVATISM: ‐
As per this convention all prospective losses are taken into consideration but not all prospective profits.
In other words anticipate no profit but provide for all possible losses. This convention is being criticized
on the ground that it goes not only against convention of full disclosure but also against the concept of
matching cost & revenues. It encourages creation of secrete reserves by making excess provision for
depreciation, bad and doubtful debts etc. The income statement shows a lower net income & the balance
sheet overstates the liabilities & understate the assets.
Following are the examples of application of conservatism: ‐
1) Making provision for doubtful debts and discount on debtor
2) Not providing for discount on creditor
3) Valuing stock in trade at cost or market price whichever is less.
4) Creating provisions against fluctuations in the price of investments.
5) Showing joint life policy at surrender value and not at the paid up amount.
6) Amortization of intangible assets like goodwill which has indefinite life.

4
 Accounting Standards & International Financial Reporting Standards (IFRS)

Introduction to Accounting Standards:

Financial Statements provide inputs for most business and economic decisions. However, when these
statements are not transparent and reliable, it could have a huge negative impact on growth of business
enterprises, and economy at large. Hence it is essential to regulate the accounting process that helps in
preparing financial statements. In order to provide transparency, consistency, comparability, adequacy
and reliability of financial reporting, it is essential to standardise the accounting principles and policies.
Accounting standards provide a framework and standard accounting policies so that the financial
statements of different enterprises become comparable.

Meaning of Accounting Standards:

According to ICAI, Accounting standards are “written documents, policies, procedures issued by expert
accounting body or government or other regulatory body covering the aspects of recognition,
measurement, treatment, presentation and disclosures of accounting transactions in the financial
statement.”

In short, an accounting standard may be regarded as a sort of law- a guide to action, a settled ground or
basis of conduct or practice, of accounting.

The accounting Standards deal with the issues of:

a. Recognition of events and transactions in the financial statements;

b. Measurement of these transactions and events;
c. Presentation of these transactions and events in the financial statements in a manner that is
meaningful and understandable to the reader; and
d. The disclosure requirements which should be there to enable the public at large and the
stakeholders and the potential investors in particular, to get an insight into what these
financial statements are trying to reflect and thereby facilitating them to take prudent and
informed business decisions.

Need for Accounting Standards:

5
 a) In order to avoid the variance which may arise between the accounting principles and
accounting practices and also to find uniformity among various diverse underlying principles
of accounting.
b) Comparison between two firms is possible if both of them maintain the same
principle, otherwise proper comparison is not possible. For example, if A company follows
the FIFO method of valuation of stock whereas firm B follows the LIFO method for valuing
stock, the comparison between the two firms becomes useless. The same is possible only
when both of them follow identical method of valuing closing stock.
c) To find uniformity in accounting practice while formulating financial reports and
make consistency and proper comparison of data which are contained in financial statements for
the users of accounting information.
d) To maintain fairness, consistency and transparency in accounting practices which
will satisfy the users of accounting.
e) To resolve potential conflicts of financial interest among the various external groups that use and rely
upon published financial statements.
f) Accounting standards reduce the accounting alternatives in the preparation of financial
statements within the bounds of rationality, thereby ensuring comparability of financial
statements of different enterprises. Thus, accounting standards can be seen as providing an
important mechanism to help in the resolution of potential financial conflicts interest between
the various important groups in society.
g) To harmonise accounting policies and practices followed by different business
entities so that the diverse accounting practices adopted for various aspects of accounting
can be standardised.

Objectives of Accounting Standards:

 To standardise the diverse accounting policies

 To eliminate the extent possible non comparability of financial statements
 To increase the reliability of financial statements
 To increase the arithmetical accuracy of financial statements
 To understand accounting treatment in financial statements
 To provide a set of standard accounting policies, valuation norms and disclosure
requirements

6
Significance or advantages of Accounting Standards:

The specific advantages of accounting standards to the user group are:

1. They would be useful to investors in judging the yield and risk involved in alternative
investments in different companies and different countries.
2. The standards enable the public accountants (the Chartered Accountants in India) to deal with
their clients by providing rules of authority to which the accountants have to adhere, in their
job of preparing the financial statements on a true and fair basis. This makes the accountants
ensure commitments and integrity in the profession.
3. Accounting standards raise the standards of auditing itself in its task of reporting on the
financial statements.
4. Government officials, tax authorities and other find accounting reports produced in
accordance with established standards to be reliable and acceptable.
5. Financial statements thus produced will be reliable documents for the purpose of analysis and
interpretation by analysts, researchers and consultants for economic forecasting and planning.

Limitations of Accounting Standards:

The following are some of the limitations of setting of accounting standards:

o Alternative solutions to certain accounting problems may each have arguments to recommend
them. Therefore, the choice between different alternative accounting treatments may become
difficult.
o There may be a trend towards rigidity and away from flexibility in applying the accounting
standards.
o Accounting Standards cannot override the statute. The standards are required to be framed
within the ambit of prevailing statutes.

Accounting standards in Indian context:

In India, Accounting Standards are issued by the Accounting Standards Board of the Institute of
Chartered Accountants of India in consultation with the National Advisory Committee on Accounting
Standards. The Institute of Chartered Accountants of India, recognising the need to harmonise the
diverse accounting policies and practices at

7
present in use in India, constituted the Accounting Standards Board (ASB) on 21st April, 1977.

The scope and functions of Accounting Standards Board are:

a. To formulate Accounting Standards so that such standards may be established by the council
of the Institute in India, while formulating the accounting standards, ASB
will take into consideration the applicable laws, customs, usages and business environment.
b. To support the objectives of International Accounting Standards Committees (IASC)
as the institute is one of the members of IASC. ASB will give due consideration to
International Accounting Standards while formulating the Accounting Standards to the extent
possible in the light of the conditions are practices prevailing in India.
c. To propagate the Accounting Standards and persuade he concerned parties to
adopt them in the preparation and presentation of financial statements.
d. To issue guidance notes on the Accounting Standards and give clarifications on issues arising
therefrom.
e. To review the Accounting Standards at periodical intervals.

Procedure for issuing Accounting Standards by Accounting Standards Board of Institute of Chartered Accountants
of India:

The following is the procedure followed for issuing Accounting Standards by the Accounting Standards
Board:

1. Accounting Standard Board (ASB) shall determine the broad areas in which accounting
standards need to be formulated and the priority regard to the selection thereof.
2. In the preparation of Accounting Standards, ASB will be assisted by study groups;
provision will be made for wide participation by the members of the Institute and others.
3. ASB will also hold a dialogue with the representatives of the government, public
sector undertakings, industry and other organisations for ascertaining their views.
4. On the basis of the work of the study groups and the dialogue with the organisations
referred above, an example of draft of the proposed standard will be

8
 prepared and issued for comments by members of the Institute and the public at large.
5. The draft of the proposed standard will include the following basic points:
 A statement of concepts and fundamental accounting principles relating to the standard;
 Definitions of the terms used in the standard;
 The manner in which accounting principles have been applied for formulating the
standards;
 The presentation of disclosure requirements in complying with standards;
 Class of enterprises to which the standard will become effective;
 Data from which the standards will be effective;
6. After taking into consideration the comments received the draft of the proposed standard will
be finalised by ASB and submitted to the Council of Institute.
7. The Council of the Institute will consider the final draft of the propose standards, and if found
necessary, modify the same in consultation with ASB. The Accounting Standard on relevant
subject written will be issued under the authority of the Council.

INTRODUCTION TO IFRS:

Multinational and global companies across the world prepare financial statements for each country in
which they did business, in accordance with each country’s GAAP. In order to reduce this burden of
preparing multiple sets of financial statements need for uniform International accounting standards was
felt. As a result, International Accounting Standards Committee (IASC) was constituted to issue
International Accounting Standards. It operated from 1973 to 2001, when it was restructured to become
International Accounting Standards Board (IASB). IASC when it lasted for 27 years had issued 41
accounting standards. At the time of establishment of IASB they agreed to adopt the revised set of
standards issued by IASC. But any standards to be published after that, would follow series known as
International Financial Reporting Standards (IFRS- Standards issued by IASB).

CAUSES FOR DIFFERENCES IN INTERNATIONAL ACCOUNTING:

9
The environment in which a country operates shapes its accounting practices according to Nobes “Just
as nations have different histories, values and political systems, they also have different patterns of
financial accounting development”. According to Robert et al. there are not two countries, which have
the same accounting practices.

 Factors influencing variations in national practices and regulation of financial reporting

are:
 Differences in the way that legal systems operate
 Different political systems, for example the degree of central government control.
 Different capital markets
 International variation in the type and scale of economic activity, from agricultural to
financial services and from developing economies to industrialised economies
 The degree of international influences and openness of an economy
 The stability of the economy and inflation rates
 Cultural differences
 The influence of the accounting profession; and
 National differences in corporate governance, structures and practices

While national variations in accounting practices have endured for many years, more recently there has
been pressure to harmonise financial reporting practices and regulation on a global basis in order to
reduce such inconsistencies.

Accounting practices and financial reporting should be a universal language. There have been a number
of primary drivers encouraging worldwide harmonisation of financial reporting

o Increased globalisation of trade and capital markets

o The rapid pace at which information technology has developed has led to the easing of
the electronic movement of funds across national boundaries and increased investor
willingness to invest across national borders.

10
The business community has admitted that the accounting is “the language of business”. They are using
the accounting to communicate the existence and the evolution of the financial situation and also of the
performance for the economical entities. Financial information is a form of a language and if the
language of financial information is to be putted to use,, so that investment and credit decisions can
more readily be taken, it should not only be intelligible, it should also be comparable.

 To improve comparability of financial statements, harmonisations of accounting

standards is advocated.
 Over time, different practices and regulations have evolved to meet the requirements of
national economic, financial and legal systems. The challenge of international
harmonisation is needed:
 To reduce or eliminate the differences
 To produce a level playing field for financial reporting
 To help create more efficient international capital markets
 As a reflection of the movement towards international harmonisation of financial
reporting there has been increased usage of International Financial Reporting Standards
(IFRS) worldwide.

MEANING OF IFRS:

IFRS is an acronym for International Financial Reporting Standards and covers full set of principles and
rules on reporting of various items, transactions or situations in the financial statements. Often they are
referred to as “principles based” standards because they describe principles rather than dictate rigid
accounting rules for treatment of certain items.

In simple words, IFRS are a set of International accounting standards, stating how particular types of
transactions and other events should be reported in the financial statements. They are the guidelines and
rules set by IASB which the company and organisation can follow while preparing their financial
statements.

IFRS are designed as a common global language for business affairs so the company accounts are
understandable and comparable across international boundaries.

Components of IFRS:

11
IFRS comprises the following components:

1. International Accounting Standards (IASs) issued by IASC

2. International Financial Reporting Standards (IFRSs) issued by IASB
Both IAS and IFRS are standards themselves that prescribe rules or accounting treatments for
various individual items or elements of financial statements. IASs are the standards issued
before 2001 and IFRSs are the standards issued after 2001. There used to be 41 standards
named IAS 1, IAS 2, etc.., however, several of them were superseded, replaced or just
withdrawn.
3. Interpretations originated from Standing Interpretations Committee (SIC)
4. Interpretations originated from the International Financial Reporting Interpretations Committee (IFRICS)
SICs and IFRICs are interpretations that supplements IAS/IFRS standards. SIC were issued
before 2001 and IFRIC were issued after 2001. They deal with more specific situations not
covered in the standard itself, or issues that arose after publishing of certain IFRS.

OBJECTIVES OF IASB:

 To achieve convergence in accounting standards around the world

 To develop a single set of high quality, understandable, enforceable and globally
accepted International Financial Reporting Standards (IFRS) (previously International
Accounting Standards (IASs))
 To develop financial reporting standards that provide a faithful portrayal of an entity’s
financial position and performance in its financial statements
 Those standards should serve investors and other market participants in making informed
resource allocation and other economic decisions
 The confidence of all users of financial statements in the transparency and integrity of
these statements is critically important for the effective functioning of capital markets,
efficient capital allocation, global financial stability and sound economic growth
 To provide guidance on IFRS
 To promote the use of those standards

12
  To take account of the financial reporting needs of emerging economies and small
and medium-sized entities (SMEs)
 To promote and facilitate adoption of IFRSs through the convergence of national
accounting standards and IFRS
 To work actively with national standard setters

IFRS SETTING PROCESS:

International Financial Reporting Standards (IFRSs) are developed through an international consultation
process, the "due process", which involves interested individuals and organisations from around the
world.

The due process comprises six stages:

1. Setting the agenda

2. Planning the project
3. Developing and publishing the discussion paper
4. Developing and publishing the exposure draft
5. Developing and publishing the standard
6. After the standard is issued

STAGE 1: SETTING THE AGENDA

 The IASB receives requests from constituents to interpret, review or amend existing
IFRS
 Reviews such requests:
 the relevance to users of the information and the reliability of information that could
be provided
 whether existing guidance is available
 the possibility of increasing convergence
 the quality of the standard to be developed
 resource constraints
 Sets agenda priorities

STAGE 2: PROJECT PLANNING

13
  IASB decides whether to:
o conduct the project alone, or
o jointly with another standard-setter
 After considering the nature of the issues a working group is established
 The project manager draws up a project plan

STAGE 3: DEVELOPMENT AND PUBLICATION OF DISCUSSION PAPER

Although a discussion paper is not mandatory, the IASB normally publishes it as its first publication on
any major new topic to explain the issue and solicit early comment from constituents.

Typically, a discussion paper includes:

 a comprehensive overview of the issue

 possible approaches in addressing the issue
 the preliminary views of its authors or the IASB
 an invitation to comment
STAGE 4: DEVELOPMENT AND PUBLICATION OF AN EXPOSURE DRAFT

 Publication of an exposure draft is a mandatory step in due process

 Irrespective of whether the IASB has published a discussion paper, an exposure
draft is the IASB’s main vehicle for consulting the public

STAGE 6: DEVELOPMENT AND PUBLICATION OF AN IFRS

The development of an IFRS is carried out during IASB meetings, when the IASB considers the
comments received on the exposure draft.

STAGE 7: PROCEDURES AFTER AN IFRS IS ISSUED

After an IFRS is issued, the staff and the IASB members hold regular meetings with interested
parties, including other standard-setting bodies, to help understand issues related to the implementation
of IFRS.

FEATURES OF IFRS:

14
 1. IFRS are principle base standards as compared to the rule based GAAP: This means that they have
distinct advantage that transactions cannot be manipulated easily.
2. IFRS lays down treatments based on the economic substance of various events and
transactions rather than their legal form.
3. Fair value accounting: Under the IFRS, the historical cost concept has been
abandoned and replaced by a current cost system for more accurate financial reporting. The
concept of fair value accounting has taken over historical cost accounting in financial
reporting to improve the relevance of the information contained in financial reports and
getting the balance sheet right.
4. Format of financial statements: Presentation of financial statements is significantly
different from presentation of financial statements in GAAP, which follows the Schedule III
of the Companies Act, 2013. For example, IFRS requires clean segregation of assets and
liabilities into current and non-current groups. At present, the liquidity basis is preferred as
per the Companies Act.
5. Functional currency: Indian entities prepare financial statements in Indian Rupees. Under IFRS,
an entity measures its assets and liabilities and revenues and
expenses in its functional currency. Functional currency is the currency of the primary
environment in which the entity operates which may be different from the local currency of a
country.
6. IFRS requires annual reassessment of useful life of the assets. Earlier depreciation
was stopped once asset is retired from active use. But under IFRS depreciation is to be
allowed till the time of actual de-recognition of asset from the books.
7. Component accounting: IFRS mandates Component Accounting. Under this
approach each major part of an item of equipment with a cost that is significant in relation to
the total cost of an item has to be maintained and depreciated separately.

Applicability of IFRS:

According to the concept paper on convergence with IFRS in India, issued by ICAI in October 2007,
the IFRS should be applicable to public interest entities (PIE). PIE has been defined to include:

15
 o All listed companies
o All banking companies
o All financial institutions
o All scheduled commercial banks
o All insurance companies
o All non-banking financial corporations (NBFCs)

Applicability of IFRS in India:

India, one of the fastest growing global economies is on the verge of converging with International
Financial Reporting Standards (IFRS). As on date 123 countries across the globe have converged with
IFRS, India is soon to join the bandwagon. The Ministry of Corporate Affairs in its press release dated
25.2.2011 notified 35 Indian Accounting Standards converged with International Financial Reporting
Standards (henceforth called Draft IND AS). Further, On 2 January 2015, the Press Information Bureau,
Government of India, Ministry of Corporate Affairs (MCA) issued a note outlining the various phases
in which Indian Accounting Standards converged with IFRS (Ind AS) is proposed to be implemented in
India, for Companies other than Banking Companies, Insurance Companies and NBFCs. Consequently,
the companies will need to convert their accounts from Indian GAAP to IFRS.
A. Voluntary adoption: Companies can voluntarily adopt Ind AS for accounting periods
beginning on or after 1 April 2015 with comparatives for period ending 31 March 2015 or thereafter.
However, once they have chosen this path, they cannot switch back.
B. Mandatory applicability:
Phase I:
Ind AS will be mandatorily applicable to the following companies for periods beginning on or after 1
April 2016, with comparatives for the period ending 31 March 2016 or thereafter:

1. Companies whose equity and/or debt securities are listed or are in the process of listing on
any stock exchange in India or outside India and having net worth of 500 crore or more.
2. Companies having net worth of 500 crore or more other than those covered above.

16
 3. Holding, subsidiary, joint venture or associate companies of companies covered above.

Phase II:
Ind AS will be mandatorily applicable to the following companies for periods beginning on or after 1
April 2017, with comparatives for the period ending 31 March 2017 or thereafter:

1. Companies whose equity and/or debt securities are listed or are in the process of being listed
on any stock exchange in India or outside India and having net worth of less than 500 Crore.
2. Unlisted companies other than those covered in Phase I and Phase II whose net worth are
more than 250 crore INR but less than 500 crore .
3. Holding, subsidiary, joint venture or associate companies of above companies.

Does not apply:

The above does not apply to the following companies:

 Companies listed or in the process of listing on SME Exchanges

 Insurance, banking and NBFCs

Beneficiaries of IFRS:
o Investors
o Industries
o Accounting professionals
o Corporate world
o Economy

RELEVANCE OF IFRS TO INDIA:

 As the world continues to globalise, discussion on convergence of national accounting

standards with International Financial Reporting Standards (IFRSs) has increased
significantly.

17
  The forces of globalisation prompt more and more countries to open their doors to foreign
investment and as businesses expand across borders the need arises to recognise the benefits
of having commonly accepted and understood financial
reporting standards.
 In India, so far as the ICIA and the Governmental authorities such as National Advisory
Committee on Accounting Standards and various regulators such as Securities and Exchange
Board of India and Reserve Bank of India are concerned,
the aim has always been to comply with the IFRSs to the extent possible, with the objective to
formulate sound financial reporting standards.
 The ICAI, being a member of the International Federation of Accountants (IFAC),
considers the IFRSs and tries to integrate them, to the extent possible, in the light of the laws,
customs, practices and business environment prevailing in India. Although, the focus has
always been on developing high quality standards,
resulting in transparent and comparable financial statements, deviation from IFRSs were made
where it was considered that these were not consistent with the laws and business environment
prevailing within the country.
 Difference in laws: different countries employ different accounting standard while
computing the profits of a company. it may happen that if the profit are computed as per US
accounting laws the profit are $ 100 billion when the same profits are computed using the UK
accounting laws, the profit may turn out to be say $ 50 billion and when computed as per the
Indian accounting laws it may turn out to be $ 200 billion.
 Uniform accounting standards: Profit computed as per different accounting laws of
different countries always yield different figures. So as to remove this discrepancy in
accounting across the globe, countries world over decided to apply uniform standards of
accounting so as to arrive at uniform profits across the globe.

The main advantages to India by converging with IFRS are as follows:

a) Common basis of comparison: Most of the countries of the European Union have switched over
to IFRS. If companies in India also switched over to IFRS, it would make transitions and
dealings with companies of other countries who operate under IFRS much easier. It would
also give stock holders and other interested parties a common basis of comparability.

18
b) Clarity and productivity: Under IFRS, financial makers use their own professional judgement as
to how to handle a specific transaction. This will lead to less time being spent trying to follow
all rules that are coupled with rule based accounting.
c) Consistent financial Reporting Basis: A consistent financial reporting basis would
allow a multinational company to apply common accounting standards with its subsidiaries
worldwide which would improve internal communication, quality of reporting and group
decision making.
IFRS also expected to result in better quality of financial reporting due to consistent
application of accounting principles and improvement in reliability of financial statements.
These are very consistent, reliable and easy to adopt ensuring better quality of financial
reporting.
d) Quality information: It is expected that the adoption of IFRS will be beneficial to
investors and other users of financial statements, by reducing the cost of comparing alternative
investments and increasing the quality of information. The companies are also expected to
benefit, as investors will be more willing to provide financing.
e) Improved access to international capital markets: Many Indian entities are
expanding and making significant acquisitions in the global market for which large amount
of capital is required. The majority of the stock exchanges require financial information
prepared under IFRS.
f) Lower cost of capital: Migration to IFRS will lower the cost of raising funds, as it will
eliminate the need for preparing dual sets of financial statements. It will also reduce
accountant’s fees abolish risk premiums and will enable access to all major capital markets as
IFRS is globally acceptable.
g) Escape multiple Reporting: Convergence to IFRS will eliminate the need for
multiple reports and significant adjustments for preparing consolidated financial statements.
Firms registered in India prepare their accounts as per Indian Accounting Standards whereas
firms registered in other countries prepare their financial statements as per the Reporting
Standards of the respective country. Adoption of IFRS ensures the elimination of multiple
financial reporting standards by these firms as they are following single set of Financial
Reporting.
h) Reflect true value of acquisition: In Indian GAAP business combinations are
recorded at carrying values rather than fair value of net assets in the acquirer’s books is not
reflected separately in the financial statements, instead the amount

19
 gets added to the goodwill. IFRS will overcome this flow as it is mandates accounting
of net assets taken over in a business combination at fair value.
i) Benchmarking with global peers: Adoption of IFRS will facilitate companies to set
targets and milestones based on global business environment, rather than merely local ones.

INDIAN ACCOUNTING STANDARDS (Ind AS):

These are a set of accounting standards notified by the Ministry of Corporate Affairs which are
converged with International Financial Reporting Standards (IFRS). These accounting standards are
formulated by Accounting Standards Board of Institute of Chartered Accountants of India. With India
deciding to converge with IFRS and not to adopt IFRS, Ind AS is certainly the way forward for Indian
Companies.

Convergence with IFRS means that India would not be following the IFRS as issued by the IASB but
would issue its own accounting standards in sync with the International Financial Reporting Standards.
And these synced Indian Accounting Standards are popularly referred to as ‘Ind-AS’.

Meaning of convergence with IFRS:

Convergence means to achieve or harmony with IFRS. It can be considered to design and maintain
national accounting standards in a way that financial statements prepared in accordance with national
draw unreserved statement of compliance with IFRS i.e., National Accounting Statements (NAS)
comply with all the requirements of IFRS. Convergence doesn’t mean that IFRS should be adopted word
by word.

Need and process of Convergence with IFRS:

In the present globalisation era a number of multinational companies are establishing their business in
various countries including in emerging economies and even companies from emerging economies are
establishing their business in developed economies. The entities in emerging economies are increasingly
accessing the global markets to fulfil their capital needs by getting their securities listed on the stock
exchanges outside their country. More and more Indian companies are being listed on overseas stock
exchanges. The use of different accounting frameworks in different countries leads to inconsistent
treatment and presentation of the same underlying

20
economic transactions which creates confusion for users of financial statements. This confusion leads
to inefficiencies in capital markets across the world. Therefore, increasing complexity of business
transactions and globalisation of capital markets call for a single set of high quality accounting standards.
Thus, IFRS came to existence to serve as single set of globally accepted accounting standards.

Process of convergence in India:

The Institute of Chartered Accountants of India (ICAI) being the accounting standards setting body in
India, way back in 2006, initiated the process of moving towards the International Financial Reporting
Standards (IFRSs) issued by the International Accounting Standards Board (IASB) with a view to
enhance acceptability and transparency of the financial information communicated by the Indian
corporates through their financial statements. This move towards IFRS was subsequently accepted by
the Government of India.

The Government of India in consultation with the ICAI decided to converge and not to adopt IFRSs
issued by IASB. The decision of convergence rather than adoption was taken after the detailed analysis
of IFRSs requirements and extensive discussion with various stakeholders. Accordingly, while
formulating IFRS-converged Indian accounting standards (Ind AS), efforts have been made to keep
these standards, as far as possible, in line with the corresponding IAS/IFRS and departures have been
made where considered absolutely essential. These changes have been made considering various factors,
such as; various terminologies related changes have been made to make it consistent with the
terminology used in law, e.g., statement of profit and loss in place of statement of comprehensive income
and balance sheet in place of statement of financial position. Certain changes have been made
considering the economic environment of the country, which is different as compared to the economic
environment presumed to be in existence by IFRS.

Government of India towards Ind AS:

Initially Ind AS was expected to be implemented from the year 2011. However, keeping in view the
fact that certain issues including tax issues were still to be

21
addressed, the Ministry of Corporate Affairs decided to postpone the date of implementation of Ind AS.

In July 2014, the Finance Minister of India at that time in his budget speech announced an urgency to
converge the existing accounting standards with the international financial reporting standards (IFRS)
through adoption of the new Ind AS by the Indian companies from the financial year 2015-16 voluntarily
and from the financial year 2016-17 on a mandatory basis.

Moving in this direction, the Ministry of Corporate Affairs (MCA) has issued the companies (Indian
Accounting Standards) Rules, 2015 vide notification dated February 16, 2015 covering the revised
roadmap of implementation of Ind AS for companies other than Banking Companies, Insurance
companies and NBFCs.

As per the notification, Indian Accounting Standards (Ind AS) converged with International Financial
Reporting Standards (IFRS) shall be implemented on voluntary basis from 1st April, 2015 and
mandatorily from 1 st April 2016.

MERITS OF IFRS:

Major advantages of IFRS can be summarised according to benefited groups which are as follows:

I. ADVANTAGES FOR COMPANIES:

Companies prepare financial statements. Therefore, the following advantages can be seen from the
standpoint of preparers of financial reports. It is quite obvious to understand that international companies
are not interested in dealing with a new set of Accounting Standards in each country they invest.

a) Uniform Accounting Standards provide efficiency gains both internally and externally.
b) Internally multinational companies would make savings if all their subsidiaries could use
the same Accounting System.
c) A similar internal reporting system gives the chance of better comparisons, less confusion and
mistakes between the parts of the company.
d) It allows uncomplicated communication and transfers of finance personnel.

22
 e) One set of Accounting Standards could be used in various jurisdictions and capital
markets.
f) With one set of Accounting Standards as well the credibility of the externally
reporting could be raised.
g) A business can present its financial statements on the same basis as its foreign competitors.
h) Further cost savings can be realised, because the preparation of consolidated financial
statements will be easier for companies. Because, there are no longer
costly changes from several different Accounting Systems of each subsidiary necessary,
when the parts of the company are consolidated to one.
i) No longer are different performance figures shown for the same company in
different companies.
j) Furthermore, international companies can realise significant cost savings if they do not
have to change their financial statements to conform to each country’s rules, when listing
on security exchanges. In other words the access to main financial markets will become
easier for global acting companies.
II. ADVANTAGES FOR USERS:

There are many beneficiaries of convergence with IFRSs such as the economy, investors and industry
and accounting professionals. From the standpoint of the users of financial statements one can see the
following advantages:

a) Investors, banks or owners are interested in obtaining information, which enables them to
make buy/sell/hold investment decisions. Similar financial statements would make it
possible for users of financial statements to make useful
comparisons between countries and companies.
b) Similar Accounting Standards lead to a better comparability between companies.
c) It would enable investors, banks or financial analysts to make better decisions. Therefore, greater
comparability results in better understanding lower risks and more efficient selections of
investments.
d) For the society at large it can be said that harmonised and converged Accounting Standards
are important, because they lead to a well-developed and good functioning of capital markets.
III. ADVANTAGES TO THE ECONOMY:

23
As the markets expands globally the need for convergence increases.

a) The convergence benefits the economy by increasing growth of its international business.
b) It facilitates maintenance of orderly and efficient capital markets and also helps to increase the capital
formation and thereby economic growth.
c) It encourages international investing and thereby leads to more foreign capital flows to the
country.
IV. ADVANTAGES TO THE INVESTORS:
a) Investors who wish to invest outside their own country want the information that is more
relevant, reliable, timely and comparable across the jurisdictions.
b) Financial statements prepared using a common set of standards help investors better
understand investment opportunities as opposed to financial statements prepared using a different
set of national standards. For better understanding of
financial statements global investors have to incur more cost in terms of the time and efforts
to convert the financial statements so that they can confidently compare opportunities.
c) Convergence with IFRSs contributes to investor’s understanding and confidence
in high quality financial statements.
V. ADVANTAGES TO THE INDUSTRY:

A major force in the movement towards convergence has been the interest of the industry.

a) The industry is able to raise capital from foreign markets at lower cost if it can create confidence in
the minds of foreign investors that their financial statements comply with globally accepted
accounting standards.
b) The burden of financial reporting is lessened with convergence of accounting standards
because it simplifies the process of preparing the individual and group financial statements
and thereby reduces the costs of preparing the financial statements using different sets of
accounting standards.
VI. ADVANTAGES TO THE ACCOUNITNG PROFESSIONALS:
a) Convergence with IFRSs also benefits the accounting professionals in a way that they are
able to sell their services as experts in different parts of the world. The

24
 thrust of the movement towards convergence has come mainly from accountants in public
practice.
b) It offers them more opportunities in any part of the world if same accounting practices
prevail throughout the world. They are able to quote IFRSs to clients to give them backing
for recommending certain ways of reporting.
c) For accounting professionals in industry as well as in practice, their mobility to
work in different parts of the world increases.

Disadvantages of IFRS:

o Small companies that have no dealings outside the countries have no incentive to adopt IFRS
unless mandated.
o It increases the cost as the accountants’ and auditor’s fees will increase for transition
process.

CHALLENGES OF CONEVRGENCE WITH IFRS:

In spite of the various benefits, adoption of IFRS in India is difficult task and faces many challenges.
Few of these have been listed below:

a. Wide Gap: IFRS is very much different from present accounting policies being followed. There
are big differences expected in accounting for financial instruments deferred taxes, business
combinations and employees benefits.
b. Increased responsibility: The change to IFRS opens up certain choices a company will
have in flow to account for some items. This carries with it the responsibility to investors the reasons
for the choices and the impact on financial statements.
c. Awareness of International Financial Reporting Practices: Convergence with IFRS
means a set of converged reporting standards have to bring in. the awareness of these reporting standards
is still not there among the stakeholders like firms, banks, stock exchanges and commodity exchanges
etc. to bring a complete awareness of these standards among these parties is a difficult task.
d. Training: Professional Accountants are looked upon to ensure successful
convergence with IFRS. Along with these accountants, government officials, chief executive officers,
chief information officers are also responsible for a smooth adoption process. India is lacking facilities
to train such a large group. It has also been

25
observed that India does not have enough number of fully trained professionals to carry out this task of
convergence with IFRS in India.
e. Amendments to Existing laws: In India, Accounting Practices are governed by
Companies Act 1956 and Indian generally accepted accounting principles (GAAP). Existing laws such
as SEBI regulations, Indian Banking Laws & Regulations, Foreign Exchange Management Act also
provide some guidelines on preparation of Financial Statements in India. IFRS does not recognise the
presence of these laws and the Accountants will have to follow the Ind AS fully with no overriding
provisions from these laws, Indian lawmakers will have to make necessary amendments to ensure a
smooth transition to IFRS.
Changes may be required to various regulatory requirements under The Companies Act, 1956, Income
Tax Act, 1961, SEBI, RBI, etc., so that IFRS financial statements are accepted generally.
f. Tax implications: IFRS convergence will have a significant impact on the financial
statements and consequently tax liabilities tax authorities should ensure that there is clarity on the tax
treatment of items arising from convergence with IFRS.
Currently, Indian tax laws do not recognise the Accounting Standards. A complete overhaul of tax laws
is the major challenge faced by the Indian Law Makers immediately. Enough changes are to be made in
Tax laws to ensure that tax authorities recognise Ind AS complaint financial statements otherwise it will
duplicate the administrative work for the firms.
g. Re-negotiation of contracts: The contracts would have to be re-negotiated which is
also a big challenge. This is because the financial results under IFRS are likely to be very different from
those under the Indian GAAP.
h. Financial Reporting systems: Companies would have to ensure that the existing
business reporting model is amended to suit the reporting requirements of IFRS. The information
systems should be designed to capture new requirements related to fixed assets, segment disclosures,
and related party disclosures.
IFRS provides a complete set of reporting systems for companies to make their financial statements. In
India, various laws and acts provide the financial reporting systems but nor=t as comprehensive as
provided by the IFRS. Indian firms will have to ensure that existing business reporting model is amended
to suit the requirements of IFRS.

26
The amended reporting system will take care of various new requirements of IFRS. Enough control
systems have to be put in place to ensure the minimum business disruption at the time of transition.
i. Use of Fair value measurement basis: it also involves a lot of hard work in arriving at
the fair value and valuation experts have to be used. IFRS uses fair value to measure majority items in
financial statements. The use of Fair Value Accounting can bring a lot of volatility and subjectivity to
the financial statements. Adjustments to fair value result in gains or losses which are reflected in the
Income statements and valuation is reflected in Balance sheet. Indian corporate world which has been
preparing its financial statements on historical cost basis will have tough time while shifting to fair value
accounting.
j. Distributable profits: IFRS is fair value driven which often results in unrealised gains
and losses. Whether this can be considered for the purpose of computing distributable profits is still to
be debated.
k. Other challenges:
 Increase in cost initially due to dual reporting requirement which entity might have to meet
till full convergence is achieved.
 Entity would need to incur additional cost for modifying their IT systems and procedures to
enable it to collate data necessary for meeting the new disclosures and reporting
requirements.
 Differences between Indian GAAP and IFRS may impact business decisions/financial
performance of an entity.
 Limited pool of trained resource and persons having expert knowledge on
IFRSs.

List of Indian Accounting Standards:

The Accounting Standards Board of the Institute of Chartered Accountants of India has issued the
following Accounting Standards:

 AS 1 – Disclosure of Accounting policies

 AS 2 – Valuation of Inventories
 AS 3 – Cash Flow Statement
 AS 4 – Contingencies and Events Occurring after the Balance Sheet Date

27
 AS 5 – Net Profit or Loss for the period, Prior Period Items and Changes in
Accounting Policies
 AS 6 – Depreciation Accounting
 AS 7 – Construction Contracts (revised 2002)”’
 AS 8 – Accounting for Research and Development (AS-8 is no longer in force since it
was merged with AS-26)
 AS 9 – Revenue Recognition
 AS 10 – Accounting for Fixed Assets
 AS 11 – The Effects of Changes in Foreign Exchange Rates (revised 2003),
 AS 12 – Accounting for Government Grants
 AS 13 – Accounting for Investments
 AS 14 – Accounting for Amalgamations
 AS 15 – Employee Benefits (revised 2005)
 AS 16 – Borrowing Costs
 AS 17 – Segment Reporting
 AS 18 – Related Party Disclosures
 AS 19 – Leases
 AS 20 – Earnings Per Share
 AS 21 – Consolidated Financial Statements
 AS 22 – Accounting for Taxes on Income.
 AS 23 – Accounting for Investments in Associates in Consolidated Financial
Statements
 AS 24 – Discontinuing Operations
 AS 25 – Interim Financial Reporting
 AS 26 – Intangible Assets
 AS 27 – Financial Reporting of Interests in Joint Ventures
 AS 28 – Impairment of Assets
 AS 29 – Provisions, Contingent` Liabilities and Contingent Assets
 AS 30 – Financial Instruments: Recognition and Measurement and Limited Revisions
to AS 2, AS 11 revised 2003), AS 21, AS 23, AS 26, AS 27, AS 28
and AS 29
 AS 31 – Financial Instruments: Presentation
 AS 32 – Financial Instruments: Disclosures

28
List International Accounting Standards:

No Title Originall y Effecti ve Superseded by

issued Date

IAS 1 Presentation of Financial Statements 1975 1/1/19

75

IAS 2 Inventories 1976 1/1/19

76

1/1/19 IAS 27 &

IAS 3 Consolidated Financial Statements 1976
77 IAS 28

1/1/19
IAS 4 Depreciation Accounting 1976 IAS 36
77

Information to Be Disclosed in Financial 1/1/19

IAS 5 1976 IAS 1
Statements 77

1/1/19
IAS 6 Accounting Responses to Changing Prices 1977 IAS 15
78
1/1/19
IAS 7 Statement of Cash Flows 1977
79

Accounting Policies, Changes in Accounting 1/1/19

IAS 8 1978
Estimates and Errors 79

Accounting for Research and Development 1/1/19

IAS 9 1978 IAS 38
Activities 80

IAS 1/1/19
Events after the Reporting Period 1978
10 80

IAS 1/1/19
Construction Contracts 1979
11 80

IAS 1/1/19
Income Taxes 1979
12 81

29
IAS Presentation of Current Assets and Current 1/1/19
1979 IAS 1
13 Liabilities 81
IAS 1/1/19
Segment reporting 1981 IFRS 8
14 83

IAS Information Reflecting the Effects of 1/1/19

1981 N/A
15 Changing Prices 83

IAS 1/1/19
Property, Plant and Equipment 1982
16 83

IAS 1/1/19
Leases 1982 IFRS 16
17 84

IAS 1/1/19
Revenue 1982 IFRS 15
18 84
IAS 1/1/19
Employee Benefits 1983
19 85

IAS Accounting for Government Grants and 1/1/19

1983
20 Disclosure of Government Assistance 84

IAS The Effects of Changes in Foreign 1/1/19

1983
21 Exchange Rates 85

IAS 1/1/19
Business Combinations 1983 IFRS 3
22 85

IAS 1/1/19
Borrowing Costs 1984
23 86

IAS 1/1/19
Related Party Disclosures 1984
24 86

IAS 1/1/19 IAS 39 &

Accounting for Investments 1986
25 87 IAS 40
IAS Accounting and Reporting by Retirement 1/1/19
1987
26 Benefit Plans 88

30
IAS 1/1/19
Separate Financial Statements 1989
27 90
IAS Investments in Associates and Joint 1/1/19
1989
28 Ventures 90

IAS Financial Reporting in Hyperinflationary 1/1/19

1989
29 Economies 90

IAS Disclosures in the Financial Statements of 1/1/19

1990 IFRS 7
30 Banks and Similar Financial Institutions 91

IAS 1/1/19 IFRS 11 &

Interests in Joint Ventures 1990
31 92 IFRS 12

IAS 1/1/19
Financial Instruments: Presentation 1995
32 96
IAS 1/1/19
Earnings per Share 1997
33 99

IAS 1/1/19
Interim Financial Reporting 1998
34 99

IAS 1/7/19
Discontinuing Operations 1998 IFRS 5
35 99

IAS 1/7/19
Impairment of Assets 1998
36 99

IAS Provisions, Contingent Liabilities and 1/7/19

1998
37 Contingent Assets 99

IAS 1/7/19
Intangible Assets 1998
38 99

IAS Financial Instruments: Recognition and 1/1/20

1998 IFRS 9
39 Measurement 01
IAS 1/1/20
Investment Property 2000
40 01

31
 IAS 1/1/20
Agriculture 2000
41 03

LIST OF IFRS:

Originally Effective
No Title
issued Date

First-time Adoption of International Financial

IFRS 1 2003 1/1/2004
Reporting Standards

IFRS 2 Share-based Payment 2004 1/1/2005

IFRS 3 Business Combinations 2004 1/4/2004

IFRS 4 Insurance Contracts 2004 1/1/2005

Non-current Assets Held for Sale and

IFRS 5 2004 1/1/2005
Discontinued Operations

Exploration for and Evaluation of Mineral

IFRS 6 2004 1/1/2006
Resources

1/1/,
IFRS 7 Financial Instruments: Disclosures 2005
2007

IFRS 8 Operating Segments 2006 1/1/2009

2009

IFRS 9 Financial Instruments (updated 1/1/2018

2014)

IFRS 10 Consolidated Financial Statements 2011 1/1/2013

IFRS 11 Joint Arrangements 2011 1/1/2013

IFRS 12 Disclosure of Interests in Other Entities 2011 1/1/2013

IFRS 13 Fair Value Measurement 2011 1/1/2013

IFRS 14 Regulatory Deferral Accounts 2014 1/1/2016

IFRS 15 Revenue from Contracts with Customers 2014 1/1/2018

IFRS 16 Leases 2016 1/1/2019

32
LIST OF IND AS CORRESPODING TO IFRS AND IAS:

Standard Title Corresponding

IAS/IFRS

Ind AS First-time Adoption of Indian Accounting Standards IFRS 1

101

Ind AS Share based Payment IFRS 2

102

Ind AS Business Combinations IFRS 3

103
Ind AS Insurance Contracts IFRS 4

104

Ind AS Non-current Assets Held for Sale and Discontinued IFRS 5

105 Operations

Ind AS Exploration for and Evaluation of Mineral Resources IFRS 6

106

Ind AS Financial Instruments: Disclosures IFRS 7

107

Ind AS Operating Segments IFRS 8

108

Ind AS 1 Presentation of Financial Statements IAS 1

Ind AS 2 Inventories IAS 2

Ind AS 7 Statement of Cash Flows IAS 7

Ind AS 8 Accounting Policies, Changes in Accounting Estimates IAS 8

and Errors

Ind AS Events after the Reporting Period IAS 10

10

Ind AS Construction Contracts IAS 11

11

33
Ind AS Income Taxes IAS 12

12
Ind AS Property, Plant and Equipment IAS 16

16

Ind AS Leases IAS 17

17

Ind AS Revenue IAS 18

18

Ind AS Employee Benefits IAS 19

19

Ind AS Accounting for Government Grants and Disclosure of IAS 20

20 Government Assistance
Ind AS The Effects of Changes in Foreign Exchange Rates IAS 21

21

Ind AS Borrowing Costs IAS 23

23

Ind AS Related Party Disclosures IAS 24

24

Ind AS Consolidated and Separate Financial Statements IAS 27

27

Ind AS Investments in Associates IAS 28

28

Ind AS Financial Reporting in Hyperinflationary Economies IAS 29

29

Ind AS Interests in Joint Ventures IAS 31

31
Ind AS Financial Instruments: Presentation IAS 32

32

34
 Ind AS Earnings per Share IAS 33

33
Ind AS Interim Financial Reporting IAS 34

34

Ind AS Impairment of Assets IAS 36

36

Ind AS Provisions, Contingent Liabilities and Contingent Assets IAS 37

37

Ind AS Intangible Assets IAS 38

38

Ind AS Financial Instruments: Recognition and Measurement IAS 39

39
Ind AS Investment Property IAS 40

40

THEOREICAL FRAMEWORK OF IFRS:

IFRS 1: First time adoption of IFRS:

IFRS 1 sets out the rules and procedures that an entity must follow when it reports in accordance with
IFRSs for the first time. The main aim is to ensure that entity’s first financial statements and related
interim financial reports are in line with IFRS and can be generated at cost not exceeding the benefits.
It prescribes how the opening statement of financial position shall be prepared for the first time adopters
and what accounting policies shall be used.

Necessary comparative information is prescribed:

 At least 3 statements of financial position

 2 statements of comprehensive income statement
 2 separate income statement if presented
 2 statements of cash flow statements

35
  2 statements of changes in equity and
 Related notes including comparative information.

IFRS 1 then orders that an entity must explain how transition to IFRSs affected its reported financial
statements and prepare reconciliations of equity and total comprehensive income.

IFRS 2: Share Based Payments:

The objective is to set out the rules for reporting the share-based payment transactions in entity’s profit
or loss and financial position, including transactions in which share options are granted to employees.

IFRS 2 deals with 3 types of share based payments transactions:

 The first type is equity settled share based payment transactions where an entity receives goods or
services in exchange for equity instruments. For example, providing share options to
employees as a part of their remuneration package.
 The second type is cash settled share based payment transactions in which the
entity receives or acquires goods or services in exchange for liabilities to these suppliers.
Liabilities are in amounts based on the price or value of entity’s shares or other equity
instruments. For example, a company grants share appreciation rights to their employees,
whereby employees will be entitled to future cash payment based on increase of company’s
share price over some specified period of time.
 The third type is share- based payment transactions with cash alternatives, where
entity receives or acquires goods or services in exchange for either cash settlement or equity
instrument.

IFRS 2 prescribes how various transactions shall be measured and recognised, lists all necessary
disclosures and provides application guidance on various situations.

IFRS 3: Business Combinations: Objectives:

36
 o To provide rules for recognition and measurement of business combinations when an acquirer
acquires assets and liabilities of another company (acquire) and those constitute a business
(parent- subsidiary company situations)
o To prescribe what acquisition method should be applied in accounting for business
combinations.

Scope: IFRS 3 does not set out the rules for preparation of consolidated financial statements for business
combinations, such as group of companies under the control of parent, etc.

Applying the acquisition method comprises 4 steps:

 Identifying the acquirer.

 Determining the acquisition date
 Recognising and measuring the identifiable assets acquired, the liabilities assumed
and any non-controlling interest in the acuiree.
 Recognising and measuring goodwill or a gain from a bargain purchase.

IFRS 3 sets out the details for all of these steps. IFRS 4:

Insurance Contracts:

IFRS 4 is the first standard dealing with insurance contracts. It defines the rules of financial reporting
for insurance contracts (including reinsurance contracts) by entity who issues such contracts (insurer,
for example, any insurance company) and also for reinsurance contracts by entity who holds them.
Scope: IFRS 4 does not apply to other assets and liabilities of an insurer. Also, IFRS 4 does not apply
to policy holders (insured entities, etc).

IFRS 4 defines insurance contracts and establishes accounting policies applied to them, including
recognition and measurement rules. It addresses some specific issues, such as embedded derivatives in
insurance contracts, situations when insurance contract contain both insurance and deposit component,
shadow accounting practices etc.

IFRS 5: Non-Current Assets Held for Sale and Discontinued Operations: Objectives:

37
  To specify the accounting for assets or disposal groups held for sale (those whose carrying
amount will be recovered principally through a sale transaction rather than continuing use)
and the presentation and disclosure of discontinued operation (component of an entity-
subsidiary, line of business, geographical area of operations, etc.-that either has been
disposed of or is classified as held for sale).
 To establish conditions when the entity shall classify a non-current asset or disposal group
as held for sale.
 To set out the rules for measurement of assets or disposal groups held for sale, recognition
of impairment losses and their reversals, and rules for the situation when an entity makes
changes to a plan of sale and assets or disposal group can no longer be classified as held for
sale.

IFRS 5 explains the term “discontinued operations” and prescribes what shall be reported in the
statement of comprehensive income and statement of cash flows with regard to it. Additional disclosures
in the notes to the financial statements are also required.

IFRS 6: Exploration for and Evaluation of Mineral Resources:

IFRS 6 specifies financial reporting of the expenditures for the exploration for and evaluation of mineral
resources (oil, natural gas and similar non-regenerative resources.)

IFRS 6 prescribes that exploration and evaluation assets shall be measured at cost. It permits the entity
to determine accounting policy specifying which expenditures are recognised as exploration and
evaluation assets and gives examples of acceptable types of expenditures (acquisition of rights to
explore, exploratory drilling, trenching, sampling, etc).

IFRS 6 then prescribes the rules for subsequent measurement, changes in accounting policies and
impairment of these assets). In relation to presentation, IFRS 6 describes classification and
reclassification of exploration and evaluation assets and finally number of disclosures is prescribed.

IFRS-7: Financial Instruments: Disclosures:

38
IFRS 7 prescribes what disclosures an entity shall provide about financial instruments in its financial
statements and thus it complements standard IAS 32 on presentation and IAS 39/ IFRS 9 on recognition
and measurement of financial instruments. Before, standard IAS 32 dealt also with disclosures, but IAS
32’s part on disclosures was superseded by IFRS 7.

IFRS 7 requires disclosures in 2 main categories:

The first category represents disclosures about significance of financial instruments for financial position
and performance. Within this category, an entity is required to disclose the following information related
to the statement of financial position:

i. Information by categories of financial assets and liabilities.

ii. Specific disclosures about financial assets or financial liabilities at fair value through profit
or loss and financial assets valued at fair value through other comprehensive income.
iii. Reclassification of financial instruments among categories.
iv. De-recognition.
v. Collaterals
vi. Allowances for credit losses
vii. Compound financial instruments with multiple embedded derivatives
viii. Defaults and breaches of loan agreement terms, etc.

The second category represents disclosures about nature and extent of risks arising from financial instruments.
IFRS 7 then prescribes specific disclosures about credit
risk, liquidity risk and market risk. IFRS 7 sets guidelines related to disclosures about transfer of
financial assets. It states which information shall be disclosed when transferred financial asset is
derecognised in its entirety and which information shall be disclosed when transferred financial asset is
not derecognised in its entirety.

IFRS-8: Operating Segments:

IFRS 8 replaced the standard IAS 14 – Segment reporting with effective date for periods beginning 1
January 2009 or later.

39
It prescribes the information that an entity must disclose about its business activities- operating
segments, products and services, the geographical areas in which it operates and its major customers.

Scope: Standard IFRS 8 applies only to entities whose debt or equity instruments are traded in a public
market or in the process of filing its financial statements with a security commission or other regulatory
organisation for that purpose.

IFRS 8 defines operating segments and explains what can be deemed operating segment. Then it
prescribes criteria for reportable segments, including aggregation criteria and quantitative thresholds for
segment to be reported separately.

IFRS- 9: Financial Instruments:

The first version of IFRS 9 was issued in November 2009 and then it was amended in October 2010 and
November 2013. Once it is fully finalised, it will replace standard IAS 39 in the future.

IFRS 9 deals with recognition, classification, measurement and de-recognition of financial instruments
as well as with the hedge accounting rules. The current version of IFRS 9 does not include mandatory
effective date, but entities can adopt it voluntarily. IASB will add the mandatory effective date later
when all phases are completed. IFRS 9 consists of 7 chapters and 3 appendices. It sets rules when the
financial assets shall be derecognised in its entirety, or just partially. Basically, financial asset shall be
derecognised when the contractual rights to the cash flows from the financial asset expire, or the entity
transfers the financial asset as set out and the transfer qualify for de-recognition. With regard to de-
recognition of financial liabilities, an entity can remove financial liability from the statement of financial
position when it is extinguished- i.e., when the obligation specified in the contract is discharges or
cancelled or expires. IFRS 9 also deals with classification of financial assets and liabilities. Financial
assets are divided into 2 categories – those measured at amortised cost and those measured at fair value.

IFRS- 10: Consolidated Financial Statements:

40
The objective of IFRS 10 is to establish principles for consolidation related to all investees based on
control that parent exercise over the investee rather than the nature of investee. IFRS 10 defines when
investor controls the investee:

When the investor is exposed, or has rights to variable returns from its involvement with
the investee and
Has the ability to affect those returns through its power over the investee.

Investor controls the investee when it has all three elements:

 Power over the investee.

 Exposure, or rights, to variable returns from its involvement with the investee, and
 The ability to use its power over the investee to affect the amount of the investor’s returns.

IFRS 10 then sets the accounting requirements for preparation of consolidated financial statements,
consolidation procedures, reporting non-controlling interests and treatment of changes in ownership
interests. Standard does not set any requirements for disclosures, as those are covered by IFRS 12.

IFRS – 11: Joint Arrangements:

IFRS 11 sets principles for reporting of joint arrangements- arrangements of which two or more parties
have joint control. This standard effectively amends IAS 27 and IAS
28. IFRS 11 explains characteristics of joint control:

 The parties are bound by a contractual arrangement and

 The contractual arrangement gives two or more of those parties joint control of the
arrangement.

IFRS 11 classifies joint arrangements into 2 categories: Joint Operation and Joint Venture and prescribes
how each of these forms shall be recognised and reported in the financial statements of parties to a joint
arrangement.

IFRS- 12: Disclosure of Interest in Other Entities:

41
IFRS prescribes what disclosures shall be provided in the financial statements with regard to interests
in subsidiaries, joint arrangements, associates or unconsolidated structured entities. Reporting entity
must present disclosures about significant judgements and assumptions made in determining the
existence of control over another entity, the type of such control and existence and type of joint
arrangement. IFRS 12 then sets broad range of disclosures for interests in subsidiaries, interests in joint
arrangements and associates and interests in unconsolidated structured entities (entity that has been
designed so that voting or similar rights are not the dominant factor in deciding who controls the entity).
IFRS 12 also requires disclosures for interests in unconsolidated subsidiaries in line with the newest
amendments of IFRS 10.

IFRS – 13: Fair Value Measurements:

IFRS 13 defines fair value, provides guidance for its measurement as well as sets disclosure
requirements with respect to fair value. IFRS 13 defines fair value as the price that would be received
to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the
measurement date (exit price).

In order to increase consistency of fair value measurement, IFRS sets fair value hierarchy which
classifies inputs used in valuation techniques into 3 levels:

 Quoted prices in active markets for identical assets or liabilities that an entity can access
at the measurement date.
 Other than quoted market prices included within level 1 that are observable for the asset or
liability, either directly or indirectly (quoted prices of similar assets)
 Unobservable inputs for the asset or liability. IFRS 13 then outlines a fair value
measurement approach by stating what an entity shall determine when assessing fair value.

With reference to valuation, IFRS 13 discusses 3 valuation techniques:

a) Market approach: it utilises the information from market transactions.

b) Cost approach: it involves current replacement cost.
c) Income approach based on future cash flows, income or expenses discounted to present value.

42
IFRS 13 sets broad range of disclosures related to fair value measurement, including identification of
classes, specific disclosure for each class of assets and liabilities measured at fair value, and many more,
both in a descriptive and quantitative format.

IFRS – 14: Regulatory Deferral Accounts:

IFRS 14 is to specify the financial reporting requirements for regulatory deferral account balances that
arise when an entity provides goods or services to customers at a price or rate that is subject to rate
regulation.

Its purpose is to allow rate-regulated entities adopting IFRS for the first time to avoid changes in
accounting policies in respect of regulatory deferral accounts.

Presentation in financial statements: The impact of regulatory deferral account balances are separately
presented in an entity’s financial statements.

a. Separate line items are presented in the statement of financial position for the total of all
regulatory deferral account debit balances, and all regulatory deferral account credit
balances.
b. Regulatory deferral account balances are not classified between current and non-current,
but are separately disclosed using subtotals.
c. The net movement in regulatory deferral account balances are separately presented in the
statement of profit or loss and other comprehensive income using subtotals.

IFRS – 15: Revenue from Contracts with Customers:

The objective of IFRS 15 is to establish the principles that an entity shall apply to report useful
information to users of financial statements about the nature, amount, timing and uncertainty of revenue
and cash flows arising from a contract with a customer. Application of the standard is mandatory for
annual reporting periods starting from 1 January 2017 onwards.

IFRS 15 applies to all contracts with customers except for leases within the scope of IAS 17 Leases.

The core principle of IFRS 15 has shown in the 5 step model framework:

43
 a. Identify the contracts with customers
b. Identify the performance obligations in the contract
c. Determine the transaction price
d. Allocate the transaction price to the performance obligations in the contract
e. Recognise the revenue when the entity satisfies a performance obligation

Presentation in Financial Statements: Contracts with customers will be presented in an entity’s statement of
financial position as a contract liability, a contract asset, or a receivable, depending on the relationship
between the entity’s performance and the customer’s payment. A Contract Liability is presented in the
statement of financial
position where a customer has paid an amount of consideration prior to the entity
performing by transferring the related good or service to the customer.

When the entity has performed by transferring a good or service to the customer and the customer has
not yet paid the related consideration, a Contract Asset or a receivable is presented in the statement of
financial position.

IFRS -16: Leases

A contract is, or contains, a lease if it conveys the right to control the use of an identified asset for a
period of time in exchange for consideration. Control is conveyed where the customer has both the right
to direct the identified asset’s use and to obtain substantially all the economic benefits from that use.

An asset is typically identified by being explicitly specified in a contract, but an asset can also be
identified by being implicitly specified at the time it is made available for use by the customer.

Objective: To establish principles for the recognition, measurement, presentation and disclosure of leases,
with the objective of ensuring that lessees and lessors provide relevant information that faithfully
represents those transactions.

Scope: IFRS 16 Leases applies to all leases, including subleases, except for:

 leases to explore for or use minerals, oil, natural gas and similar non- regenerative
resources;

44
  leases of biological assets held by a lessee (IAS 41 Agriculture);
 service concession arrangements (IFRIC 12 Service Concession Arrangements);
 licences of intellectual property granted by a lessor IFRS 15 Revenue from Contracts
with Customers); and
 rights held by a lessee under licensing agreements for items such as films, videos, plays,
manuscripts, patents and copyrights within the scope of IAS 38 Intangible Assets

A lessee can elect to apply IFRS 16 to leases of intangible assets, other than those items listed above.

IFRS 17 — Insurance Contracts:

IFRS 17 establishes the principles for the recognition, measurement, presentation and disclosure of
insurance contracts within the scope of the standard.

Objective of IFRS 17:

To ensure that an entity provides relevant information that faithfully represents those contracts. This
information gives a basis for users of financial statements to assess the effect that insurance contracts
have on the entity's financial position, financial per- formance and cash flows.

IFRS 17 was issued in May 2017 and applies to annual reporting periods beginning on or after 1 January
2021. It replaces IFRS 4.

Insurance contracts combine features of both a financial instrument and a service contract. In addition,
many insurance contracts generate cash flows with substantial variability over a long period. To provide
useful information about these features, IFRS 17:

 combines current measurement of the future cash flows with the recognition of profit
over the period that services are provided under the contract;
 presents insurance service results (including presentation of insurance
revenue) separately from insurance finance income or expenses; and

45
  requires an entity to make an accounting policy choice of whether to recognise all
insurance finance income or expenses in profit or loss or to recognise some of that income
or expenses in other comprehensive income.

The key principles in IFRS 17 are that an entity:

 identifies as insurance contracts those contracts under which the entity accepts significant

insurance risk from another party (the policyholder) by agreeing to compensate the
policyholder if a specified uncertain future event (the insured event) adversely affects the
policyholder;
 separates specified embedded derivatives, distinct investment components and distinct

performance obligations from the insurance contracts;

 divides the contracts into groups that it will recognise and measure;

 recognises and measures groups of insurance contracts at:

i. a risk-adjusted present value of the future cash flows (the fulfilment cash flows) that
incorporates all of the available information about the fulfilment cash flows in a way that
is consistent with observable market information; plus (if this value is a liability) or minus
(if this value is an asset)
ii. an amount representing the unearned profit in the group of contracts (the contractual
service margin);
 recognises the profit from a group of insurance contracts over the period the entity provides

insurance cover, and as the entity is released from risk. If a group of contracts is or becomes
loss-making, an entity recognises the loss immediately;
 presents separately insurance revenue (that excludes the receipt of any investment

component), insurance service expenses (that excludes the repayment of any investment
components) and insurance finance income or expenses; and
 Discloses information to enable users of financial statements to assess the effect that that

contracts within the scope of IFRS 17 have on the financial position, financial performance
and cash flows of an entity.

Scope: An entity shall apply IFRS 17 Insurance Contracts to:

 Insurance contracts, including reinsurance contracts, it issues;

 Reinsurance contracts it holds; and

46
  Investment contracts with discretionary participation features it issues, provided the
entity also issues insurance contracts.

Insurance contract: A contract under which one party (the issuer) accepts significant insurance risk
from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain
future event (the insured event) adversely affects the policyholder.

Insurance risk: Risk, other than financial risk, transferred from the holders of a contract to the issuer.

Presentation in the statement of financial position

An entity shall present separately in the statement of financial position the carrying amount of groups
of

a. insurance contracts issued that are assets;

b. insurance contracts issued that are liabilities;
c. reinsurance contracts held that are assets; and
d. Reinsurance contracts held that are liabilities.

IFRIC Interpretations

No. NAME ISSUED

YEAR

IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar 2004

Liabilities
2004
IFRIC 2 Members' Shares in Co-operative Entities and Similar
Instruments
2004
IFRIC 3 Emission Rights (Withdrawn June 2005)
IFRIC 4 2004
Determining Whether an Arrangement Contains a Lease Will be
superseded by IFRS 16 as of 1 January 2019
IFRIC 5 2004
Rights to Interests arising from Decommissioning,

Restoration and Environmental Rehabilitation Funds

47
IFRIC 6
Liabilities Arising from Participating in a Specific Market - Waste 2005
Electrical and Electronic Equipment
IFRIC 7
Applying the Restatement Approach under IAS 29 2005
Financial Reporting in Hyperinflationary Economies
IFRIC 8 2006
Scope of IFRS 2 (Withdrawn effective 1 January 2010)
IFRIC 9 2006
Reassessment of Embedded Derivatives
IFRIC 10 2006
Interim Financial Reporting and Impairment
IFRIC 11 2006
IFRS 2: Group and Treasury Share Transactions
Withdrawn effective 1 January 2010
IFRIC 12 2006
Service Concession Arrangements
IFRIC 13 2007
Customer Loyalty Programmes (Will be superseded by IFRS 15
as of 1 January 2018)
IFRIC 14 2007
IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding
Requirements and their Interaction
IFRIC 15 2008
Agreements for the Construction of Real Estate
Will be superseded by IFRS 15 as of 1 January 2018
IFRIC 16 2008
Hedges of a Net Investment in a Foreign Operation
IFRIC 17 2008
Distributions of Non-cash Assets to Owners
IFRIC 18 2009
Transfers of Assets from Customers
Will be superseded by IFRS 15 as of 1 January 2018
IFRIC 19 2009
Extinguishing Financial Liabilities with Equity Instruments
IFRIC 20 2011
Stripping Costs in the Production Phase of a Surface Mine
IFRIC 21 2013
Levies

48
 IFRIC 22 2016
Foreign Currency Transactions and Advance
Consideration
IFRIC 23 2017
Uncertainty over Income Tax Treatments

SIC Interpretations

No. NAME ISSUED

YEAR
1997
SIC- 1 Consistency – Different Cost Formulas for Inventories
(Superseded)
1997
SIC-2 Consistency – Capitalisation of Borrowing Costs
(Superseded)
1997
SIC- 3 Elimination of Unrealised Profits and Losses on
Transactions with Associates (Superseded)
SIC- 5 1998
Classification of Financial Instruments - Contingent
Settlement Provisions (Superseded)
SIC- 6 1998
Costs of Modifying Existing Software (Superseded)
SIC- 7 1998
Introduction of the Euro
SIC- 8 1998
First-Time Application of IASs as the Primary Basis of
Accounting (Superseded)
SIC- 9 1998
Business Combinations – Classification either as
Acquisitions or Unitings of Interests (Superseded)
SIC- 10 1998
Government Assistance – No Specific Relation to
Operating Activities
SIC- 11 1998
Foreign Exchange – Capitalisation of Losses Resulting from
Severe Currency Devaluations (Superseded)
SIC-12 1998
Consolidation – Special Purpose Entities (Superseded

49
 by IFRS 10 and IFRS 12 effective 1 January 2013)
SIC- 13 1998
Jointly Controlled Entities – Non-Monetary Contributions by
Venturers (Superseded by IFRS 11 and IFRS 12, effective for
annual periods beginning on or after 1
January 2013)
SIC- 14 1998
Property, Plant and Equipment – Compensation for the
Impairment or Loss of Items (Superseded)
SIC- 15 1999
Operating Leases – Incentives (Will be superseded by IFRS
16 as of 1 January 2019)
SIC- 16 1999
Share Capital – Reacquired Own Equity Instruments (Treasury
Shares) Superseded
SIC- 17 2000
Equity – Costs of an Equity Transaction (Superseded)
SIC- 18 2000
Consistency – Alternative Methods (Superseded)
SIC- 19 2000
Reporting Currency – Measurement and Presentation of
Financial Statements under IAS 21 and IAS 29
(Superseded)
SIC- 20 2000
Equity Accounting Method – Recognition of Losses
(Superseded)
SIC- 21 2000
Income Taxes – Recovery of Revalued Non-Depreciable Assets
(Superseded by, and incorporated into, IAS 12 by amendments
made by Deferred Tax: Recovery of Underlying Assets,
effective for annual periods
beginning on or after 1 January 2012)

SIC- 22
Business Combinations – Subsequent Adjustment of 2000
Fair Values and Goodwill Initially Reported
(Superseded)

50
 SIC- 23
Property, Plant and Equipment – Major Inspection or 2000
Overhaul Costs (Superseded)
SIC- 24 2000
Earnings Per Share – Financial Instruments and Other Contracts
that May Be Settled in Shares (Superseded)
SIC- 25 2000
Income Taxes – Changes in the Tax Status of an Enterprise
or its Shareholders
SIC- 27 2000
Evaluating the Substance of Transactions in the Legal
Form of a Lease (Will be superseded by IFRS 16 as of 1 January
2019)
SIC- 28 2001
Business Combinations – 'Date of Exchange' and Fair Value
of Equity Instruments (Superseded)
SIC- 29 2001
Disclosure – Service Concession Arrangements
SIC- 30 2001
Reporting Currency – Translation from Measurement
Currency to Presentation Currency (Superseded)
SIC- 31 2001
Revenue – Barter Transactions Involving Advertising Services
(Will be superseded by IFRS 15 as of 1 January 2018)

SIC- 32 2001
Intangible Assets – Web Site Costs
SIC- 33
Consolidation and Equity Method – Potential Voting Rights
and Allocation of Ownership Interests (Superseded 2001)

Ind AS roadmap for banks, insurance companies and NBFCs:

In pursuance to the budget announcement by the Union Finance Minister, after consultation with the
Reserve Bank of India (RBI), Insurance Regulatory and Development Authority (IRDA) and Pension
Fund Regulatory and Development Authority (PFRDA), the Ministry of Corporate Affairs (MCA)
issued a press release on

51
18 January 2016, announcing the Ind AS roadmap for scheduled commercial banks (excluding regional rural banks
[RRBs]), insurers/
insurance companies and non-banking financial companies (NBFCs). Draft, notifications/rules will be issued, as required,
by MCA, RBI and IRDA in due course.
In summary, all scheduled commercial banks (except RRBs), all-India term-lending refinancing institutions,
insurers/insurance companies and NBFCs (all listed and unlisted companies having a net worth of 250 crore INR or more)
will be required to adopt Ind AS. Ind AS will be applicable to both consolidated and individual financial statements.
Mandatory for accounting periods beginning from 1 April 2018 onwards
• Scheduled commercial banks (excluding RRBs)
• All-India term-lending refinancing institutions (i.e. Exim Bank, NABARD, NHB and SIDBI )
• Insurers/insurance companies
• Notwithstanding the roadmap for companies, holding, subsidiary, joint venture or associate companies of
scheduled commercial banks
• Comparative information required for the period ending 31 March 2018 or thereafter

Phase 1: Mandatory for accounting periods beginning from 1 April 2018 onwards
• NBFCs having a net worth of 500 crore INR or more
• Holding, subsidiary, joint venture or associate companies of the above, other than those companies already
covered under the corporate roadmap announced by MCA
• Comparative information required for the period ending 31 March 2018 or thereafter

Phase 2: Mandatory for accounting periods beginning from 1 April 2019 onwards
• NBFCs whose equity and/or debt securities are listed or are in the process of listing on any stock exchange in
India or outside India and having a net worth less than 500 crore INR
• NBFCs that are unlisted companies, having a net worth of 250 crore INR or more but less than 500 crore INR
• Holding, subsidiary, joint venture or associate companies of companies covered above, other than those
companies already covered under the corporate roadmap announced by MCA

• Comparative information required for the period ending 31 March 2019 or thereafter

Management Accounting

52
 INTRODUCTION

Definition, Meaning, Nature, Scope and Objectives of Management Accounting – Distinction

between Financial, Cost and Management Accounting.

MEANING AND DEFINITION

“Management accounting is concerned with accounting information that is useful to management”.

J.Batty defines “ Management accounting is the term used to describe the accounting methods,
systems and techniques which, coupled with special knowledge and ability, assist management in
its task of maximizing the profits or minimizing losses”.
“Management accounting is the presentation of accounting information in such as way as to assit
management in the creation and in the day-to-day operations of an undertaking” -
I.C.M.A. Institute of Costs and Management Accountants.
According to H.M.Treasury, Management Accounting is “the application of accounting knowledge
to the purpose of producing and of interpreting accounting and statistical information designed to
assist management in its functions of promoting maximum efficiency and in formulating and co-
ordinating future plans and subsequently in measuring their execution”.

NATURE OF MANAGEMENT ACCOUNTING

Though Management Accounting is the latest branch in the accounting arena, it may be regarded
partly as a Science and partly as an Art. It is the science of ‘Quantifying and summarising’ and Art
of ‘Interpreting’ accounting data.
Management Accounts derives its conclusions through collection, processing and objective analysis
of data Quantified in figures. Thus it depends upon “Objectification and Quantification of progress
and problems”. From this point of view Management accounting may be regarded as a Science.

53
However, Management Accounting also involves human judgement, impulses, whims and
prejudices as evidenced in interpretation of data, deductions and conclusions drawn from analysis.
‘Subjectivity’ is inevitable in ‘deriving the meaning of data’. Deductions cannot be scientific with
precision. Personal judgement of Management accountant may influence the interpretations and
deductions significantly. From this point of view, Management Accounting may be regarded as an
Art.
(i) Technique of Selective Nature:
Management Accounting is a technique of selective nature. It takes into consideration only that
data from the income statement and position state merit which is relevant and useful to the
management. Only that information is communicated to the management which is helpful for
taking decisions on various aspects of the business.
(ii) Provides Data and not the Decisions:
The management accountant is not taking any decision by provides data which is helpful to the
management in decision-making. It can inform but cannot prescribe. It is just like a map which guides
the traveler where he will be if he travels in one direction or another. Much depends on the efficiency
and wisdom of the management for utilizing the information provided by the management
accountant.

(iii) Concerned with Future:

Management accounting unlike the financial accounting deals with the forecast with the future. It
helps in planning the future because decisions are always taken for the future course of action.

(iv) Analysis of Different Variables:

Management accounting helps in analysing the reasons as to why the profit or loss is more or less
as compared to the past period. Moreover, it tries to analyse the effect of different variables on the
profits and profitability of the concern.

(v) No Set Formats for Information:

Management accounting will not provide information in a prescribed proforma like that of financial
accounting. It provides the information to the management in the form which may be more useful
to the management in taking various decisions on the various aspects of the business.

54
SCOPE OF MANAGEMENTACCOUNTING

 Financial Accounting
Financial accounting is the general accounting, which relates to the recording of business
transaction in the books of prime entry, posting them into respective ledger accounts, balancing
them and preparing trial balance. Then a profit and loss account showing the results of the
business and also a balance sheet depicting assets, and liabilities of the business concern are
prepared. This in turn forms the basis for analysis and interpretation for furnishing
meaningful data to the management, Hence management accounting cannot obtain full
control and coordination of operations without a well designed financial accounting system.
 Cost Accounting
Cost Accounting is a branch of accounting. It is the process and technique of ascertaining costs.
Planning, decision-making and control are the basic, managerial functions. The cost accounting
system as standard costing budgetary control, Inventory control and marginal costing etc. for
carrying out such functions efficiently.
 Budgeting and Forecasting
Budgeting means expressing the plans, policies and goal of the enterprise for a definite period in
future. Forecasting, on the other Rand, is a prediction of what will happen as result of a given set
of circumstances. Targets are set for different departments and responsibility is fixed for achieving
these targets. The comparison of actual performance with budgeted figures will give an idea about
the performance of departments.
 Statistical Methods
Statistical tools such as graphs, charts, diagrams, pictorial presentation, index numbers etc. makes
the information more impressive, comprehensive and intelligible: other tools such as time series,
regression analysis, sampling techniques etc. are highly useful for planning and forecasting.
 Inventory control
It includes control over inventory from the time it is acquired till its final disposal. Inventory
control is significant as it involves large sums. The management should determine different levels
of stocks - Minimum stock level, maximum stock level, and reordering stock level, for an
inventory control, the study of inventory control will be helpful for taking managerial decisions.
 Interpretation of Data
Analysis and interpretation of financial statements, are important parts of management accounting.
Financial statements may be studies in comparison of statements of earlier periods

55
or in comparison with the statements of similar other firms. After analyzing, the interpretation is
made and the reports drawn from this analysis are presented to the management in a simple
language.
 Internal Audit
It needs devising a system of internal control by establishing internal audit coverage for Internal
audit helps the management in fixing responsibility of different individuals.
 Tax Accounting
It includes preparation of income statement, assessing the effect of tax on capital expenditure
proposals and pricing.
 Methods and Procedures
They deal with organization with methods for cost reduction, procedures for improving the
efficiency of accounting and office operations.
 Office Services
They cover a wide range of activities like data processing, filing, copying, printing,
communication, etc.
OBJECTIVES / FUNCTIONS / PURPOSES / ROLE OF MANAGEMENT
ACCOUNTING
 Helps in Planning and Policy formulation
Planning is one of the primary functions of management, it involves forecasting on the basis of
available information, setting goals, framing policies, determining alternative courses of
action and deciding on the programme of activities to be taken. Management can help greatly in
these processes. Management accounting facilitates for the preparation of statements in the light
of past results land gives estimation for the future.
 Helps in the interpretation process
The main object of management accounting is to present financial information to the management.
The management accounting presents accounting information in an intelligible manner and
explains with the help of statistical devices like charts, diagrams graphs, index numbers etc.
 Helps in Decision-making
Management accounting makes decision-making process as more modern an scientific by
providing significant information relating to various alternatives in terms of cost and revenue. With
the help of techniques provided by management accounting, data relating to cost, price, profit and
savings for each of the available alternatives are collected and analyzed and provides a base for
taking sound decisions.

56
 Helps in Controlling performance
Management accounting techniques, like standard costing and budgetary control are helpful in
controlling performance. These techniques are helpful in seeking pre-determined standards and
budgets whereby actual performance is compared to detect deviations. Such deviations are
further analysed to prevent recurrence of negative deviations and appreciation and maintenance of
positive or favourable deviations.
 Helps in Coordination operations
Management accounting- helps in overall control. and coordination of business operations, It
provides tools which are helpful' in coordinating the activities of different sections or departments.
(Ex.Budgets are important means of coordination).
 Helps in organizing
Return on capital employed is one of the tools of management accounting. Since management
accounting stress more on budget centers, investment centers, cost centers and profit centers,
with a view to control costs and responsibilities, it also contributes to principles of decentralization
to a greater extent. All these aspects are helpful in setting up effective and efficient organization
framework.
 Helps in Expansion, Diversification and Strategic business problems
Situations like new project or project for expanding or diversifying the current business,
management accounting helps in decision making by providing data to the management and
recommendations as to which alternative will be suitable. For such decisions, management
accountant takes the helps of techniques like marginal costing and capital budgeting.
 Helps in Communication of Management policies
Management accounting conveys the policies of the management downward to the personnel
effectively for proper implementation.
 Helps in Motivating employees
Through the techniques of standard costing and budgetary control, targets are fixed department-
wise, which in turn make the employees conscious of the targets. Achieving the targets leads to
satisfaction and greater motivation of employees and overall improvement in efficiency and
enhancement of profitability.
 Helps in Reporting
One of the primary objectives of management accounting is to keep the management fully
informed about efficiency and effectiveness of management policies in practice. This is helpful
to the management in reviewing the policies and making improvements.

57
IMPORTANCE OF MANAGEMENT ACCOUNTING
1. It helps to increase the efficiency of all functions of management.
2. It helps in target-fixing, decision-making, price-fixing, selection of product-mix and so on.
3. Forecasting and Budgeting help the concern to plan the future and financial activities.
4. Various tools and techniques provide reliability and authenticity to carry out the business
functions.
5. Different techniques of management accounting help in effective control of business
operations.
6. It is proactive-analyses the governmental policies and socio-economic scenario which helps
to assess the external environmental impacts on the organization.
7. It creates harmony in the relationship between the management and employees. It enables
the management to improve its services to its customers.
8. The management aims to control the cost for production and at the same time increase the
efficiency of employees. When cost of production is reduced, it will increase the profit.
9. Unacceptable standards or sub-standards, which are often responsible for unhealthy and bad
relations between management and employees, can be removed by the use of management
accounting.
10. The use of management accounting may control or even eliminate various types of wastages,
production defectives etc.
11. Management accounting helps in communicating up to date information to various parties
interested in successful working of the business organization.

1.3LIMITATIONS OF MANAGEMENT ACCOUNTING

1. It is concerned with financial and cost accounting. If these records are not reliable, it will
affect the effectiveness of management accounting.
2. Decisions taken by the management accountant may or may not be executed by the
management.
3. It is very expensive. Only big concerns can adopt this method of accounting.
4. New rules and regulations are to be framed, hence there is a possibility of opposition from
the employees.
5. It is only in the developing stage.
6. It is a tool to the management and not an alternative of management.

58
DIFFERENCES BETWEEN MANAGEMENT ACCOUNTING AND FINANCIAL
ACCOUNTING

 Objective
The main objective of financial accounting is to supply information in the form profit and loss
account and balance sheet to outsiders like shareholders, creditors, government etc. But the
objective of management accounting is to provide information for internal use of management.
 Performance Analysis
Financial accounting is concerned with the overall performance of the business. On the other hand
management accounting is concerned with the departments or divisions. It reports about the
performance and profitability of each them.
 Data Used
Financial accounting is mainly concerned with the recording of past events whereas management
accounting is concerned with future plans and policies.
 Accuracy
Accuracy is an important factor in financial accounting. But approximations are widely used in
management accounting. This is because most of the information is related to the future and
intended for internal use.
 Legal compulsion
Financial accounting is compulsory for all joint stock companies but management account is
only optional
 Control
Financial accounting will not reveal whether plans are properly implemented. Management
accounting will reveal the deviations of actual performance from plans. It will also indicate the
causes for such deviation.
 Flexibility
In financial accounting, attempts are being made to prepare accounts in accordance with the
standards fixed by and or suitable for external parties. On the other hand, management accounting
considers the standards fixed by management itself.
 Coverage
Financial accounting covers entire range of business activity while management accounting
considers only parts of activity, which relevant to management for decision-making.

59
 Publication and Audit
Financial statements like profit and loss account and balance sheet are published for the use of
general public also. They are audited by practicing chartered accountants while there is no
provision in management accounting All the reports, statements and forecasts made by
management accounting are for the internal use of management only.
 Principles
Financial accountings are governed by the generally accepted principles and convention. No such
set of principles are followed in management accounting.

DIFFERENCES BETWEEN MANAGEMENT ACCOUNTING AND COSTING

ACCOUNTING
 Objective
The objective of cost accounting is the ascertainment and control of costs of products orservices.
But the objective of management accounting is to provide information to management for
efficiently performing the functions of planning, directing and controlling.
 Scope
Cost accounting is concerned with cost ascertainment and control whereas management
accounting includes financial accounting, cost accounting, budgeting, tax planning and reporting
to management and interpretation of financial data.
 Data Used
Cost accounting uses only transactions which can be expressed in figures are taken whereas
management uses both qualitative and quantitative information.
 Nature
Cost accounting uses both past and present data whereas management accounting deals with future
projections on the basis of past and present cost data.
 Principles and Procedures
Established procedures and practices are followed in cost accounting. No such prescribed practices
are followed in management accounting. The analysis is made and the resulting conclusions are
presented in reports as per the requirements of the management.

60
 ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS
Balance sheet, Profit and loss account, functions of financial statements, meaning, objectives and
importance and limitations of financial statements, Techniques of analysis- Comparative,
Common size and Trend Analysis - Ratio Analysis - Classification of ratios - profitability ratios -
liquidity ratios - solvency ratios - Activity ratios leverage ratios -Interpretation of Financial
Statements with the above ratios.
FINANCIAL STATEMENT
MEANING
Financial Statements are the collective name given to Income Statement and Positional Statement
of an enterprise which show the financial position of business concern in an organized manner.
We know that all business transactions are first recorded in the books of original entries and
thereafter posted to relevant ledger accounts. For checking the arithmetical accuracy of books of
accounts, a Trial Balance is prepared.
Trial balance is a statement prepared as a first step before preparing financial statements of an
enterprise which record all debit balances in the debit column and all credit balances in credit
column. To find out the profit earned or loss sustained by the firm during a given period of time
and its financial position at a given point of time is one of the purposes of accounting. For achieving
this objective, financial statements are prepared by the business enterprise, which include income
statement and positional statement.
These two basic financial statements viz:
(i) Income Statement, i.e., Trading and Profit & Loss Account and
(ii) Positional Statement, i.e., Balance Sheet portrays the operational efficiency and solvency of
any business enterprise.
The income statement shows the net result of the business operations during an accounting period
and positional statement, a statement of assets and liabilities, shows the final position of the
business enterprise on a particular date and time. So, we can also say that the last step of the
accounting cycle is the preparation of financial statements.
Income statement is another term used for Trading and Profit & Loss Account. It determines the
profit earned or loss sustained by the business enterprise during a period of time. In large business

61
Organization, usually one account i.e., Trading and Profit & Loss Account is prepared for knowing
gross profit, operating profit and net profit.
On the other hand, in small size organizations, this account is divided into two parts i.e. Trading
Account and Profit and Loss Account. To know the gross profit, Trading Account is prepared and
to find out the operating profit and net profit, Profit and Loss Account is prepared. Positional
statement is another term used for Balance Sheet. The position of assets and liabilities of the
business at a particular time is determined by Balance Sheet.

OBJECTIVES OF FINANCIAL STATEMENTS

(i) Knowing Profitability of Business:
Financial statements are required to ascertain whether the enterprise is earning adequate profit and
to know whether the profits have increased or decreased as compared to the previous year(s), so
that corrective steps can be taken well in advance.
(ii) Knowing the Solvency of the Business:
Financial statements help to analyse the position of the business as regards to the capacity of the
entity to repay its short as well as long term liabilities.
(iii) Judging the Growth of the Business:
Through comparison of data of two or more years of business entity, we can draw a meaningful
conclusion as regard to growth of the business. For example, increase in sales with simultaneous
increase in the profits of the business, indicates a healthy sign for the growth of the business.
(iv) Judging Financial Strength of Business:
Financial statements help the entity in determining solvency of the business and help to answer
various aspects viz., whether it is capable to purchase assets from its own resources and/or whether
the entity can repay its outside liabilities as and when they become due.
(v) Making Comparison and Selection of Appropriate Policy:
To make a comparative study of the profitability of the entity with other entities engaged in the
same trade, financial statements help the management to adopt sound business policy by making
intra firm comparison.

62
(vi) Forecasting and Preparing Budgets:
Financial statement provides information regarding the weak-spots of the business so that the
management can take corrective measures to remove these short comings. Financial statements
help the management to make forecast and prepare budgets.
(vii) Communicating with Different Parties:
Financial statements are prepared by the entities to communicate with different parties about their
financial position. Hence, it can be concluded that understanding the basic financial statements is
a necessary step towards the successful management of a commercial enterprise.
IMPORTANCE OF FINANCIAL STATEMENTS
The importance of financial statements lies in their utility to satisfy the varied interest of different
categories of parties such as management, creditors, public, etc.
1. Importance to Management:
Increase in size and complexities of factors affecting the business operations necessitate a scientific
and analytical approach in the management of modern business enterprises.
The management team requires up to date, accurate and systematic financial information for the
purposes. Financial statements help the management to understand the position, progress and
prospects of business vis-a-vis the industry.
By providing the management with the causes of business results, they enable them to formulate
appropriate policies and courses of action for the future. The management communicates only
through these financial statements, their performance to various parties and justify their activities
and thereby their existence.
A comparative analysis of financial statements reveals the trend in the progress and position of
enterprise and enables the management to make suitable changes in the policies to avert
unfavorable situations.
2. Importance to the Shareholders:
Management is separated from ownership in the case of companies. Shareholders cannot, directly,
take part in the day-to-day activities of business. However, the results of these activities should be
reported to shareholders at the annual general body meeting in the form of financial statements.
These statements enable the shareholders to know about the efficiency and effectiveness of the
management and also the earning capacity and financial strength of the company.

63
By analyzing the financial statements, the prospective shareholders could ascertain the profit
earning capacity, present position and future prospects of the company and decide about making
their investments in this company. Published financial statements are the main source of
information for the prospective investors.
3. Importance to Lenders/Creditors:
The financial statements serve as a useful guide for the present and future suppliers and probable
lenders of a company.
It is through a critical examination of the financial statements that these groups can come to know
about the liquidity, profitability and long-term solvency position of a company. This would help
them to decide about their future course of action.
4. Importance to Labour:
Workers are entitled to bonus depending upon the size of profit as disclosed by audited profit and
loss account. Thus, P & L a/c becomes greatly important to the workers. In wages negotiations
also, the size of profits and profitability achieved are greatly relevant.
5. Importance to the Public:
Business is a social entity. Various groups of society, though directly not connected with business,
are interested in knowing the position, progress and prospects of a business enterprise.
They are financial analysts, lawyers, trade associations, trade unions, financial press, research
scholars and teachers, etc. It is only through these published financial statements these people can
analyze, judge and comment upon business enterprise.
6. Importance to National Economy:
The rise and growth of corporate sector, to a great extent, influence the economic progress of a
country. Unscrupulous and fraudulent corporate managements shatter the confidence of the
general public in joint stock companies, which is essential for economic progress and retard the
economic growth of the country.
Financial Statements come to the rescue of general public by providing information by which they
can examine and assess the real worth of the company and avoid being cheated by unscrupulous
persons.
The law endeavors to raise the level of business morality by compelling the companies to prepare
financial statements in a clear and systematic form and disclose material information.

64
This has increased the confidence of the public in companies. Financial statements are also
essential for the various regulatory bodies such as tax authorities, Registrar of companies, etc.
They can judge whether the regulations are being strictly followed and also whether the regulations
are producing the desired effect or not, by evaluating the financial statements.
LIMITATIONS OF FINANCIAL STATEMENTS
(i) Manipulation or Window Dressing:
Some business enterprises resort to manipulate the information contained in the financial
statements so as to cover up their bad or weak financial position. Thus, the analysis based on such
financial statements may be misleading due to window dressing.
(ii) Use of Diverse Procedures:
There may be more than one way of treating a particular item and when two different business
enterprises adopt different accounting policies, it becomes very difficult to make a comparison
between such enterprises. For example, depreciation can be charged under straight line method or
written down value method. However, results provided by comparing the financial statements of
such business enterprises would be misleading.
(iii) Qualitative Aspect Ignored:
The financial statements incorporate the information which can be expressed in monetary terms.
Thus, they fail to assimilate the transactions which cannot be converted into monetary terms. For
example, a conflict between the marketing manager and sales manager cannot be recorded in the
books of accounts due to its non-monetary nature, but it will certainly affect the functioning of the
activities adversely and consequently, the profits may suffer.
(iv) Historical:
Financial statements are historical in nature as they record past events and facts. Due to continuous
changes in the demand of the product, policies of the firm or government etc, analysis based on
past information does not serve any useful purpose and gives only postmortem report.
(v) Price Level Changes:
Figures contained in financial statements do not show the effects of changes in the price level, i.e.
price index in one year may differ from price index in other years. As a result, misleading picture
may be obtained by making a comparison of figures of past year with current year figures.

65
(vi) Subjectivity & Personal Bias:
Conclusions drawn from the analysis of figures given in financial statements depend upon the
personal ability and knowledge of an analyst. For example, the term ‘Net profit’ may be interpreted
by an analyst as net profit before tax, while another analyst may take it as net profit after tax.
(vii) Lack of Regular Data/Information:
Analysis of financial statements of a single year has limited uses. The analysis assumes importance
only when compared with financial statements, relating to different years or different firm.
ANALYSIS AMD INTERPRETATION OF FINANCIAL STATEMENTS
Financial statements refer to formal and original statements prepared by a business
concern to disclose its financial information. AICPA (American Institute of Certified Public
Accountants) says “Financial statements are prepared for the purpose of presenting a periodical
review or report on the progress by the management and deals with (i) the status of investment
in the business and
(ii) the results achieved during the period under review”
John N.Myer defines “the financial statements provide a summary of the accounts of a
business enterprise, the balance sheet reflecting the assets and liabilities and the Income
Statement showing the results of operations during a certain period”.
According to Kennedy and Muller, “Analysis and interpretation of financial statement
are an attempt to determine the significance and meaning of the financial statements data so that
forecast may be made of the prospects of future earnings, ability to pay interest, debt maturities,
(both current and long term) and profitability of a sound dividend policy”.
NATURE OF FINANCIAL STATEMENT
1) Recorded facts
The transactions affecting the business are recorded in the books and shown in the
financial statements at the same values. For example, fixed assets are recorded in the
books at cost price and shown in the balance sheet at cost price less depreciation. Facts
which cannot be recorded in books are not disclosed by the financial statements.
2) Accounting conventions
The financial statements are prepared by following certain accounting conventions and
principles. Accounting itself is a dynamic science and accountants have developed from
time to time, a number of conventions on the basis of experience.

66
 When accounts are finalized, some conventions are followed: For example, part of a
particular expense is charged to profit and loss account (revenue) and the rest may be
capitalised. A number of conventions have been developed for valuation of stock,
debtors, etc. Therefore, data shown in the financial statements are subject to the validity
of conventions used in their preparation.
3) Postulates
Accountants always take some facts as accepted or ‘postulates’. Business transactions are
recorded on certain assumptions such as ‘going concern’, ‘stable value of rupee’, ‘profit
accrual’, etc. These postulates or assumptions are reflected in the financialstatements.

4) Personal judgements
Even though a number of conventions and assumptions have been propounded in
Accountancy, their use is affected by the personal judgement of accountants. That is
why financial statements prepared by two different persons of the same concern give
dissimilar results and this is due to different personal judgement in suing or applying
particular conventions. Personal judgement of accountants affects the amount kept as
reserve for doubtful debts, amount of depreciation on fixed assets, valuation of stock,
etc. The financial statements are affected by the personal judgement of accountants and
as such they are subjective documents.

OBJECTIVES OF FINANCIAL STATEMENT ANALYSIS

1) To interpret the profitability and efficiency of various business activities with the help
of income statement.
2) To aid in important decision making investment and financial decision.
3) To gauge the financial position and financial performance of the concern.
4) To identify areas of mismanagement and potential danger.
5) To ascertain the investment pattern of the resources.
6) To ascertain the maintenance of financial leverage.
7) To determine the pattern of movement of inventory.

67
 8) To determine the diversion of funds, if any
9) To measure utilization of various assets during the period
10) To decide about the future prospects of the firm.
11) To compare operational efficiency of similar concerns engaged the same industry.
TOOLS OR TECHNIQUES OF FINANCIAL STATEMENT ANALYSIS

 Comparative financial statement

 Common size financial statement
 Trend analysis
 Ratio analysis
 Funds flow statement
 Cash flow statement

COMPARITIVE FINANCIAL STATEMENT

Comparative financial statement refer to those statement which summarise and present
accounting data for a number of years incorporating therein changes in individual items of
financial statements. These statements mainly include a) Comparative balance sheet b)
Comparative income statement or profit and loss account.
COMPARITIVE BALANCE SHEET
A comparative balance sheet is a balance sheet which is prepared to ascertain the
increase or decrease in proprietor’s funds, in assets and in liabilities during the course of two
years. This balance sheet is highly useful to study the progress of business.
COMPARITIVE PROFIT AND LOSS ACCOUNT
A comparative profit and loss account is a statement which is prepared to find out the
increase or decrease in various items of cost, expenses and income over a number of years at
least two.
COMMON SIZE FINANCIAL STATEMENT
Common size financial statement refers to the vertical studies single statement for the
relationship of the components of the total. It first convert each amount in the statement to the
percentage of the total amount of the group of which it is a part. It is also known as “common
percentage” or “100 percentage”.

68
TREND ANALYSIS
The term trend refers to any general tendency. Analysis of these general tendencies is
called “trend analysis” . the profit and loss account and balance sheet are taken as the base.
Every item in the base year financial statements is taken as equivalent to 100. All the
corresponding figures in the financial statements of other years are expressed as percentage of
their values in the base year’s financial statement. This trend can be computed by dividing each
amount in the other financial statements with the corresponding item found in the base financial
statements.
RATIO ANALYSIS
It is a technique of calculation of a number of accounting ratios from the date
contained in the financial statements, it is used to describe the significant relationship
between two or more
items of the financial statements connected with each other.
FUNDS FLOW STATEMENTS
If the flow of funds are summarized in the form of statement, it is called funds flow
statement. It highlights the underlying financial movements and reflects the changes in the
financial position or working capital position at two different dates. It clearly indicates the
inflows and outflows of working capital during the specified period. It is mainly prepared to
show the application and sources of working capital during the accounting period. It explains
how the increase or decrease in working capital has taken place.
CASH FLOW STATEMENT
Cash flow statement is a statement which highlights the inflows and outflows of cash
during a specified period. It indicates the sources from which the cash has been generated, uses
to which the cash has been put and change in cash balance over the period. It is a statement
which portrays the change in the cash position between two accounting period.

The format for all the tools and techniques of Financial Statement Analysis is given
below:

69
 FORMAT FOR COMPARATIVE STATEMENTS
 COMPARITIVE BALANCE SHEET FORMAT
Co. Ltd.
COMPARITIVE BALANCE SHEET AS ON DD/MM/YY & DD/MM/YY
PARTICULARS PREVIOUS CURRENT INCREASE (+) OR DECREASE
YEAR YEAR (-) IN CURRENT YEAR OVER
PREVIOUS YEAR
Amount ( Rs.) Percentage (%)
A B C=B-A D=C/A×100
I. Assets:
A) Current Assets
Inventory, Debtors
Cash and Bank
Other current assets
Total CA (A)
B) Fixed Assets xxx xxx xxx xxx
Land and buildings
Plant and machinery
Furniture
Total FA (B)
xxx xxx xxx xxx
Total Assets (A+B) xxx xxx xxx xxx
II. Liabilities & Capital:
Current Liabilities
Sundry Creditors
Bills payable &Tax payable
Provision for Tax
Proposed Dividend
Total CL (A)
Long-term Liabilities xxx xxx xxx xxx
Debentures & Term Loans
Total long-term liabilities (B)
Total liabilities (A+B) = (C) xxx xxx xxx xxx
Capital and Reserves xxx xxx xxx xxx
Equity Share Capital
Preference Share Capital
Reserves & Surplus
Retained Earnings
General Reserve
Profit & Loss A/c
Total Shareholders’ fund (D) xxx xxx xxx xxx

Total liabilities & Capital (C+D) xxx xxx xxx xxx

70
  COMPARITIVE INCOME STATEMENT

Co. Ltd.
COMPARITIVE INCOME STATEMENT FOR THE YEARS ENDED DD/MM/YY &
DD/MM/YY

PARTICULARS PREVIOUS CURRENT INCREASE (+) OR DECREASE (-)

YEAR YEAR IN CURRENT YEAR OVER
PREVIOUS YEAR
AMOUNT ( RS.) PERCENTAGE (%)

A B C=(B-A) (C/A)×100
Net Sales
Less: Cost of Goods Sold
Gross Profit (A) xxx xxx xxx xxx
Operating Expenses:
Administration
Selling & Distribution
Total Operating Expenses (B) xxx xxx xxx xxx
Operating profit (A-B) = (C) xxx xxx xxx xxx
Add: Non-operating Income:
Interest on investments
Total (D) xxx xxx xxx xxx
Non-operating Expenses:
Interest
Income-tax
Finance exp
Goodwill written off
Total Non-operating Expenses (E) xxx xxx xxx xxx
Net profit (D-E) xxx xxx xxx xxx

NOTE:
 Fractions if any should be rounded off to the second digit after decimal point

71
FORMAT FOR COMMON SIZE STATEMENTS

 COMMON SIZE BALANCE SHEET

Co. Ltd.
COMMON SIZE BALANCE SHEET AS ON DD/MM/YY & DD/MM/YY
PARTICULARS PREVIOUS YEAR CURRENT YEAR
AMOUNT ( Rs.) % AMOUNT ( Rs.) %
I. Assets:
A) Current Assets
Inventory
Debtors
Cash and Bank
Other current assets
Total CA (A) xxx xxx xxx xxx
B) Fixed Assets
Land and buildings
Plant and machinery
Furniture
Total FA (B) xxx xxx xxx xxx
Total Assets (A+B) xxx xxx xxx xxx
II. Liabilities & Capital:
Current Liabilities
Sundry Creditors
Bills payable
Tax payable
Provision for Tax
Proposed Dividend
Total CL (A) xxx xxx xxx xxx
Long-term Liabilities
Debentures
Term Loans xxx xxx xxx xxx
Total long-term liabilities (B) xxx xxx xxx xxx
Total liabilities (A+B) = (C)
Capital and Reserves
Equity Share Capital
Preference Share Capital
Reserves & Surplus
Retained earnings
General Reserve
Profit & Loss A/c
Total Shareholders’ fund (D) xxx xxx xxx xxx
Total liabilities & Capital (C+D) xxx xxx xxx xxx

72
  COMMON SIZE INCOME STATEMENT

Co. Ltd.
COMMON SIZE INCOME STATEMENT FOR THE YEARS ENDED DD/MM/YY &
DD/MM/YY

PREVIOUS YEAR CURRENT YEAR

PARTICULARS AMOUNT ( ) % AMOUNT ( ) %

Net Sales
Less: Cost of Goods Sold
Gross Profit (A) xxx xxx xxx xxx
Operating Expenses:
Administration
Selling & Distribution
Total Operating Expenses (B) xxx xxx xxx xxx
Operating profit (A-B) = (C) xxx xxx xxx xxx
Add: Non-operating Income:
Interest on investments
Total (D) xxx xxx xxx xxx
Non-operating Expenses:
Interest
Income-tax
Finance exp
Goodwill written off
Total Non-operating Expenses (E) xxx xxx xxx xxx
Net profit (D-E) xxx xxx xxx xxx

73
FORMAT FOR TREND PERCENTAGES
 TREND PERCENTAGES (BALANCE SHEET)
Co. Ltd.
STATEMENT SHOWING TREND PERCENTAGES
PARTICULARS YEAR END ( Rs.) TREND
PERCENTAGES BASE
YEAR xxxx (Y1)
Y1 Y2 Y3 Y4 Y1 Y2 Y3 Y4
I. Assets:
A) Current Assets
Inventory
Debtors
Cash and Bank
Other current assets
Total CA (A) xxx xxx xxx xxx xxx xxx xxx xxx
B) Fixed Assets
Land and Buildings
Plant & Machinery
Furniture
Total FA (B) xxx xxx xxx xxx xxx xxx xxx xxx
Total Assets (A+B) xxx xxx xxx xxx xxx xxx xxx xxx
II. Liabilities & Capital:
Current Liabilities
Sundry Creditors
Bills Payable
Tax payable
Provision for tax
Proposed Dividend
Total CL (A) xxx xxx xxx xxx xxx xxx xxx xxx
Long-term Liabilities
Debentures
Term Loans xxx xxx xxx xxx xxx xxx xxx xxx
Total long-term liabilities (B) xxx xxx xxx xxx xxx xxx xxx xxx
Total liabilities (A+B) = (C)
Capital and Reserves
Equity Share Capital
Preference Share Capital
Reserves & Surplus
Retained earnings
General Reserve
Profit & Loss A/c
Total Shareholders’ fund (D) xxx xxx xxx xxx xxx xxx xxx xxx
Total liabilities & Capital (C+D) xxx xxx xxx xxx xxx xxx xxx xxx

74
  TREND PERCENTAGES (INCOME STATEMENT)

Co. Ltd.
STATEMENT SHOWING TREND PERCENTAGES FOR THE PERIOD Y1 TO Y4
PARTICULARS YEAR END ( ) TREND
PERCENTAGES
BASE YEAR xxxx (Y1)
Y1 Y2 Y3 Y4 Y1 Y2 Y3 Y4
Net Sales
Less: Cost of Goods Sold
Gross Profit (A) xxx xxx xxx xxx xxx xxx xxx xxx
Operating Expenses:
Administration
Selling & Distribution
Total Operating Expenses (B) xxx xxx xxx xxx xxx xxx xxx xxx
Operating profit (A-B) = (C) xxx xxx xxx xxx xxx xxx xxx xxx
Add: Non-operating Income:
Interest on investments
Total (D) xxx xxx xxx xxx xxx xxx xxx xxx
Non-operating Expenses:
Interest
Income-tax
Finance exp
Goodwill written off
Total Non-operating Expenses (E) xxx xxx xxx xxx xxx xxx xxx xxx
Net profit (D-E) xxx xxx xxx xxx xxx xxx xxx xxx

RATIO ANALYSIS
Analysis and interpretation of financial statements with the help of ratios is termed as
Ratio analysis. It involves the process of computing, determining and presenting the
relationship of items or groups of items of financial statements.
A ‘ratio’ is a mathematical relationship between two items expressed in quantitative
form. Ratios can be defined as “Relationships expressed in quantitative terms, between figures
which have cause and effect relationships or which are connected with each other in some,
manner or the other”.
“The analysis of financial statement data is an attempt to determine the significance and
meaning of the financial statement data so that the forecast may be made of the future prospects
for earnings, ability to pay interest and debt (both shot and long term) and profitability”.

75
ADVANTAGES/BENEFITS OF RATIOS ANALYSIS
 Forecasting
Ratio reveals the trends in costs, sales, profits and other inter-related facts, which will be helpful
in forecasting future events.
 Managerial Control
Ratios can be used as “instrument of control” regarding sales, costs and profit.
 Facilitates Communication
Ratios facilitate the communication function of management as ratios convey the information
relating to the present and future quickly, forcefully and clearly.
 Measuring Efficiency
Ratios help to know operational efficiency by comparison of present ratios with those of the
past working and also with those of other firms in the industry.
 Facilitating investment decisions
Ratios are helpful in computing return on investment. This helps the management in exercising
effective decisions regarding profitable avenues of investment.
 Useful to measure financial solvency
The financial statements disclose the assets and liabilities in a format. But they do not convey
relationship of various assets and liabilities with each other, whereas ratios indicate the liquidity
position of the company and the proportion of borrowed funds to total resources which reveal
the short term and long term solvency position of a firm.

 Inter firm Comparisons

The technique of inter-firm comparisons can be carried out successfully only with the help of
ratio analysis. Otherwise no firm may come forward to disclose full information. Inter-firm
comparisons help the management to compare its performance with an external standard.

LIMITATIONS OF RATIO ANALYSIS

 Practical knowledge
The analyst should have thorough knowledge and experience about the firm and industry.
Otherwise his analysis and interpretations are of little practical use.

76
 Ratios are means
Ratios are not an end in themselves- but they are means to achieve a particular purpose or end.

 Inter-relationship
Ratios are inter-related and therefore a single ratio cannot convey a meaning. It has to be
interpreted with reference to other related ratios to draw managerial conclusions.

 Non Availability of standards or norms

Ratios will be meaningful if they can be compared with standards or norms, except for a few
financial ratios, other ratios lack standards which are universally recognized.

 Depends on financial statements

The accuracy of a ratio depends on the accuracy of information derived from financial
statements. If the statements are inaccurate, same will be the result with ratios.

 Consistency in preparation of financial statements

Inter-firm comparisons with the help of ratio analysis will be useful only if the firms use
uniform accounting procedures consistently. Otherwise the comparison may be useless.

 Detachment from financial statements

Ratios are not substitutes to financial statements. They can be meaningful only if they are read
along with information with which they are prepared. If the information is detached, ratios
themselves cannot convey much useful message.
 Time lag
Ratio analysis will be fruitful only if the conclusions are conveyed quickly to the management.
If there is a delay, the utility of the data is diminished and the purpose itself may be defeated.

 Change in price level

Ratio analysis becomes redundant during periods of heavy price fluctuations. It may be
concluded that ratio analysis, if not done properly or done mechanically, would be both

77
 misleading and dangerous. It is an aid to management to take correct decisions, but as a
mechanical substitute for personal judgment and thinking, it would be useless.

CLASSIFICATIONS OF RATIOS

 CLASSIFICATION ACCORDING TO ACCOUNTING STATEMENTS:

This classification is based on the nature of accounting standards on which the items used
for compiling ratios appear. Accordingly, the different subdivisions are:

 Balance Sheet Ratios:

These ratios are also called as financial ratios. The components for computation of
these ratios are drawn from the balance sheet. Examples: Current ratio, debt equity ratio etc.
 Profit and loss account ratios:
These ratios are also called as operating ratios. The items used for the calculation of
these ratios are usually taken out from the income statement etc. Examples are Gross profit
ratio, net profit ratio, operating profit ratio etc.
 Combined ratios:
The information required for the computation of these ratios is normally from both
Balance Sheet and Trading and Profit and loss account. Examples are Debtors turnover ratio,
Creditors turnover ratio, Stock turnover ratio etc.

78
 CLASSIFICATION ACCORDING TO USERS:
Ratios are grouped on the basis of the parties who make use of the ratios. The following
is the classification of ratios by major users, though several others also use ratios:

 Ratios for Management:

 Turnover ratios like stock turnover, debtors turnover and fixed assets turnover relect
managerial efficiency in handling the assets.
 Profitability ratios like net profit ratio, gross profit ratio, return on investment reveal
the final result of the managerial policies and performance.
 The short term and long term solvency ratios like current ratio, liquid ratio, debt equity
ratio reveal the solvency position of the firm to the management.
 Ratios for Creditors:
Creditiors are interested in the ability of the firm to repay and the security for their loans.
Coverage ratios, Liquidity ratios and long term solvency ratios are more relevant to the lenders.
 Ratios for Shareholders:
Shareholders are concerned with profits, dividends and risk. The profitability ratios,
payout ratio, dividend cover, capital gearing, etc., are more relevant for their interests.

79
CLASSIFICATION ACCORDING TO RELATIVE IMPORTANCE:
This classification is being adopted by the British Institute of Management, where there
are four types of ratios:
CLASSIFICATION BY RELATIVE IMPORTANCE

 Primary ratios:
They are also known as explanatory ratios which include, return on capital employed,
assets turnover and profit ratios.
 Secondary performance ratios:
Secondary performance ratios include, working capital turnover, stock to current assets,
current assets to fixed assets, stock to fixed assets and fixed assets to total assets.
 Secondary credit ratios:
Secondary credit ratios include, creditors turnover, debtors turnover, liquid ratio,
current ratio and average collection period.
 Growth ratios:
Growth ratios include growth ratio in sales and growth rate in net assets.

80
 CLASSIFICATION ACCORDING TO PURPOSE/FUNCTION
Under this classification, ratios are grouped as follows:

 Profitability Ratios:
These ratios are intended to measure the end result of business operations. Examples:
Gross profit ratio, Return on capital employed and operating ratio.
 Turnover or activity ratios:
These ratios enable measurement of the effectiveness of the usage of resources at the
command of the concern. Examples: Fixed assets Turnover ratio, Stock turnover ratio. These
ratios would also indicate the profitability position of the business
 Solvency ratios:
 Liquidity ratios - These ratios are used to measure the abilities of the firm to meet its
maturing obligations or current liabilities examples: Current ratio, Acid test ratio.
 Leverage ratios - These ratios help to measure the financial contribution of the owners
compared to that of creditors as also the risk of debt financing. They are also known as
capital structure ratios. Example: Debt to Equity ratio, fixed assets to Net worth, Inter
coverage ratio.

81
 RATIO ANALYSIS FORMULA
I. PROFITABILITY RATIOS

GROSS PROFIT RATIO = Gross profit X 100

Net Sales

NET PROFIT RATIO = Net Profit X 100

Net Sales

OPERATING RATIO or OPERATING EXPENSES RATIO

= Cost of Goods Sold + Operating Expenses X 100
Net Sales

Sales = Cost of Goods Sold + Gross

profit Cost of Goods Sold = Sales - Gross Profit
Sales- Gross Profit = Cost of Goods Sold
Cost of Goods Sold = Opening Stock + Purchases - Closing Stock
Operating expenses = All expenses in Profit and Loss account - Non operating expenses
Non-Operating expenses = loss on sale of assets, by fire, Provision for Legal suit etc.

OPERATING PROFIT RATIO = Operating Profit X 100

Net Sales
Operating profit = Net Profit + Non operating exp - non operating income

Note for Verifications: Operating Ratio + Operating Profit Ratio = 100%

INTEREST COVERAGE RATIO = Net Profit,before Interest and Tax

Total Fixed Interest Payable

82
 II. SOLVENCY RATIOS (BALANCE SHEET)
CURRENT RATIO = Current Assets
Current Liabilities
Current Assets = Stock + Cash in hand \ at bank + Sundry Debtors + Bi1ls
receivable + Prepaid expenses + Accrued income
+ Any other amount receivable within a year
Current Liabilities = Sundry creditors + Bills Payable + Outstanding expenses
+ Income received in advance
Working Capital = Current Assets - Current Liabilities

QUICK RATIO OR LIQUID RATIOS = Quick Assets OR

Quick liabilities
= Quick assets
Current liabilities
Quick assets = Current Assets - Stock - Prepaid
exp. Liquid liabilities = Current Liabilities - Bank Overdraft
CASH POSITION RATIO = Cash and Bank balance + Marketable Securities
Current Liabilities
DEBT EQUITY RATIOS = Outsiders Funds OR Long term Debts
Shareholders Funds Shareholders Funds

Outsiders Funds = All external liabilities like creditors, Bills payable, overdraft,
debentures, mortgage loan etc.
Shareholders Funds = Preference share capital + Equity share capital+Reserves+Profit

FIXED ASSETS RATIO = Fixed Assets

Long term funds
Long term funds = Shareholders fund + long term liabilities
Shareholders funds or Net worth +Long term Liability + Current Liability = Fixed Assets +
Current Assets

83
 PROPRIETARY RATIO = Proprietor Fund or Shareholders Fund
Total Assets
CAPITAL SEARING RATIO = Fixed interest bearing securities
Equity capital
Fixed interest bearing securities = Debentures, Preference share Capital

III. TURNOVER RATIOS

STOCK TURNOVER RATIO = Cost of Goods Sold OR Cost of Goods sold

Average Stock Closing Stock
STOCK VELOCITY
Stock Velocity = No of days or No of months in a year
Stock Turnover Ratio

DEBTORS TURNOVER RATIO = Credit sales

Accounts
Receivable Accounts Receivable = Sundry Debtors + Bills Receivable

DEBTOR’S COLLECTION PERIOD (DCP) OR DEBTORS VELOCITY

DCP = No of days or No of months in a year
Debtors Turnover Ratio

CREDITORS TURNOVER RATIO = Credit purchases

Accounts Payable
Accounts Payable = Creditors + payable

CREDITORS PAYMENT PERIOD (CPP) OR CREDITORS VELOCITY

CPP = No of days or No of months in a year

Creditors Turnover Ratio

84
FIXED ASSETS TURNOVER RATIO = Net sales or Cost of Goods Sold
Net fixed Assets Net Fixed Assets
NOTE:
 In the problem if there is no information about cash sales, entire sales should
be considered as credit sales
 If the term "to" is used in between two information, put the first word as numerator
and the last word as denominator.
 In the problem the term TURNOVER refers cost of sales, use cost of sales in
turnover ratios.

HOW TD APPROACH THE PROBLEM

Step 1: Start the problem from the information given as amount (preferably from
working capital or gross profit)
Step 2: At the end of the first step we will get some data as amount.
Step 3: Use the formulas which will relates to the data we had.

85
FUNDS FLOW AND CASH FLOW STATEMENTS

Meaning & Concept of funds - Flow of funds - Fund flow statement - Uses - Significance
and limitations – Procedure for preparing fund flow Statements - Cash flowStatements -
Cash flow - Cash flow Statement - Uses, significance and limitations - Difference between
fund flow statement and cash flow statement - Procedure for preparing cash flow
statements. Interpretation of Funds Flow Statements.

FUNDS FLOW STATEMENT

According to R.N.Anthony, “Funds Flow is a statement prepared to indicate the increase

in cash resources and utilization of such resources of a business during the accounting
period.” According to Smith Brown, “Fund Flow Statement is prepared in summary form
to indicate changes occurring in items of financial condition between two different balance
sheet dates showing clearly the sources and application of funds.”
The major purpose of the Funds flow statement is to provide a detailed presentation
of the results of financial management, as distinguished from operating management. It
summarizes the financing and investing activities of the enterprise. The statement shows
directly the information, that the readers of financial reports could otherwise obtain only
by making an analysis and interpretation of published balance sheets and statements of
income and retained earnings.

Sources of funds Application of funds

Issue of Equity and preference shares Redemption of shares

Issue of Debentures Redemption of debentures

New loans or further loan Repayment of loans

Sale of fixed assets Purchase of fixed assets

Any other income Dividend paid, taxes paid etc

Funds from operations Funds lost in operations

OBJECTIVES
a) Indication of Financial Results
Funds flow statement should reveal the effect of financial decisions taken and their
consequences. For example, the decision to take a bank loan is reflected in the increase of
working capital
b) Emphasis on significance changes
Funds flow statement aims at revealing the changes in assets and asset sources which are
not readily evident in the Income Statement or Balance sheet.
c) Illustration of relationship
Funds flow statement aims at establishing the cause and effect relationship between
events like profit made and dividend disbursed, term loan raised and fixed assets
acquired.
d) Revealing financial strengths and Weakness
Funds flow statement has to throw light on the firm's ability to generate funds and use
them fruitfully. It also has to reveal any weakness in the financial position of the firm.
e) Distinguishing internal and external sources
The internal and external sources of.funds have to be clearly differentiated. Funds from
operation indicate the internal generation of funds. Such analysis is necessary to know
the inherent ability of the firm in generating funds.
f) Giving prominence to dynamic concept of business
Funds flow statement has Jo focus on the dynamic nature of business by revealing the
constant changes in the position of funds.

IMPORTANCE OF FUNDS FLOW STATEMENT

 It provides a detailed analysis and understanding of changes in the distribution of
financial resources between two balancesheets.
 It shows how the funds were obtained and used during a period.
 The sources from which funds were obtained are useful in computation of cost
of capital of the business.
 A detailed analysis of sources of funds in the past acts as a guide for obtaining
funds for future requirements.
  A study of the applications of funds provides an understanding about the utilization
of resources in the past. It can form the basis for selection of investment proposals
or future capital expenditure decision.
 It gives indication of any weakness or strength in the general financial position of a firm.
 It throws light on the financial consequences of business operations. It can be compared
with the relevant budget to assess the usage of funds as per plans.
 Rearrangement of capital structure, formulating long term financial plans and
policies, etc. is facilitated by funds flow analysis.
 Working capital and the causes for changes in working capital are highlighted. This
can help in the formulation of sound policy for liquidity and shot term solvency of
the firm.

LIMITATIONS

 Funds flow statement is historical in nature. It shows v/hat happened in the past.
So, necessarily, its value is limited from the point of view of future operations.
 It is nothing but secondary data. The information in financial accounts is
rearranged and presented. So its accuracy and reliability depend on the
accounting department.
 It is a summarized presentation of figures and cannot provide information
about changes on a continuous basis.
 The effects of transactions between current assets arid liabilities are not shown in
the statement. It also ignores transactions between long term assets and liabilities.
 It is not generally considered as a sophisticated technique of financial analysis.

STEPS INVOLVED IN PREPARATION OF FUNDS FLOW STATEMENT

1) Preparation of schedule of changes in working capital

2) Preparation of non-current accounts (Ledger accounts)
3) Calculation of funds from operations
4) Preparation of funds flow statement
1) PREPARATION OF SCHEDULE OF CHANGES IN WORKING CAPITAL
The following rules may be kept in mind while preparing working capital statement:
a) Increase in Current Asset - Increases Working Capital
b) Decrease in Current Asset - Decreases Working Capital
c) Increase in Current Liability - Decreases Working Capital
d) Decrease in Current Liability - Increases Working Capital

FORMAT STATEMENT OF SCHEDULE OF CHANGES IN WORKING CAPITAL

PARTICULARS PREVIOUS CURRENT EFFECT ON EFFECT ON
YEAR YEAR W.C. W.C
(INCREASE) (DECREASE)
CURRENT ASSET: (A)
Cash in hand xx xx xx
Cash at bank xx xx xx
Sundry debtors xx xx xx
Bills receivable xx xx xx
Short-term investment xx xx xx
Stock xx xx xx
Prepaid expenses xx xx xx
Accrued income but not received xx xx xx
Total (A) xx xx
CURRENT LIABILITIES: (B)
Sundry creditors xx xx xx
Bills payable xx xx xx
Bank overdraft xx xx xx
Short term advances/loan xx xx xx
Dividend payable xx xx xx
Outstanding expenses xx xx xx
 Provision for taxation xx xx xx
 Proposed dividend xx xx xx
Total (B) xx xx
Working capital (A-B) xx xx
Net increase or decrease in
working capital xx - xx

xx xx xx xx
  COMPUTATION OF FUNDS FOR OPERATION

There are two methods for determining funds for operation. They are:
1) Account form
2) Statement form

1) ACCOUNT FORM:

ADJUSTED PROFIT AND LOSS ACCOUNT

PARTICULARS Rs. PARTICULARS Rs.

To depreciation xx By balance b/d (opening balance) xx
To loss on sale of fixed asset xx By profit on sale of fixed asset xx
To loss on sale of investment xx By profit on sale of investment xx
To goodwill written off xx By interest on investment xx
To discount on issue of shares written off xx By dividend received or receivable xx
To preliminary expenses written off xx By excess provision written back xx
To dividend (including interim dividend) xx By refund of income tax xx
To provision for tax xx By funds from operations xx
To proposed dividend xx (balancing Figure)
To transfer to general reserve xx
To balance c/d (closing balance) xx
xx xx
 2) STATEMENT FORM:

STATEMENT SHOWING FUNDS FROM

OPERATION

PARTICULARS Rs. Rs.

Net profit made during the year xx
Add: (Items which do not decrease funds from operatons but
debited to P & L a/c) xx
Depreciation xx
Loss on sale of fixed asset xx
Loss on sale of long term investment xx
Goodwill written off xx
Discount on issue of shares written off xx
Preliminary expenses written off xx
Interim dividend xx
Provision for tax xx
Proposed dividend xx xx
Transfer to general reserve
Less: (Items which do not increase funds from operations but xx
credited to P & L a/c) xx
Profit on sale of fixed asset xx
Profit on sale of investment xx
Interest on investment xx
Dividend received xx
Excess provision written back
Refund of income tax xx
Funds From Operations xxx
  PREPARATION OF FUNDS FLOW STATEMENT

1) ACCOUNT FORM:

FUNDS FLOW STATEMENT FOR THE YEAR

ENDED

SOURCES OF FUNDS Rs. APPLICATIONS OF FUNDS Rs.

Funds from operations xx Funds lost in operations xx
Issue of shares xx Redemption of redeemable preference shares xx
Issue of debentures xx Redemption of debentures xx
Sale of investment xx Repayment of other long term loans xx
Sale of fixed asset xx Purchase of investment xx
Non trading income xx Purchase of other fixed asset xx
Decrease in working capital (B.F) xx Payment of tax xx
Payment of dividend xx
Non trading expenses xx
Increase in working capital (B.F) xx

xxx xxx
2. STATEMENT FORM

FUNDS FLOW STATEMENT FOR THE YEAR

ENDED….
PARTICULARS Rs. Rs.
Sources of funds: (A)
Funds from operations xx
Issue of shares xx
Issue of debentures xx
Sale of debenture xx
Sale of fixed asset xx
Non trading income xx
Total sources (A) xx
Applications of funds: (B)
Funds lost in operations xx
Redemption of redeemable preference shares xx
Redemption of debentures xx
Repayment of other long term loans xx
Purchase of investment xx
Payment of tax xx
Payment of dividend (for last year and interim) xx
Non trading expenses xx
Total applications (B) xx
Net increase in working capital (A-B) xx
CASH FLOW STATEMENT

It is an analysis based on the movement of cash and bank balances. Under cash
flow analysis, all movements of cash, rather than the movement of working capital would
be considered. Such movements of cash are depicted in a statement called cash flow
statement. It is a statement of changes in financial position prepared on cash basis.

ADVANTAGES OF CASH FLOW STATEMENT

a) Historical analysis as guide to forecasting

Cash flow statement presents in detail the movements of cash in the recent past. This can
provide clear indications for the cash flows in the future period, thus helping forecasting
the future commitments and needs.

b) Effective cash management

Cash flow statement can act as a guide for coordinating the inflows and outflows of cash.
The matching of the future cash receipts with payments results in effective cash
management.

c) Formulation of financial policies

A clear, insight into the cash flows of the firm is the basis for financial policies like
dividend policy, cash discount, credit terms, etc.

d) Preparations of cash budget

Cash flow statement is almost like the foundation for cash Budget. The cash flows in the
recent past indicate the quantum and direction of such flows and form the basis for
preparing monthly or quarterly budgets for cash or even the annual cash budget for ensuing
year.

e) Short term financial decisions

Short range financial decisions like repayment of overdraft loans, payment of bonus,
advertising campaigns, investments outside the firm etc., may be taken on the basis of the
analysis provided by the cash flow statement.

f) Liquidity position
It reveals the liquidity position of the firm by highlighting the various sources of cash
and its uses.

g) Revaluations
It can reveal the causes for profitable firms experiencing acute cash shortages. The reasons
for any mismanagement of cash for creating such a position can be analyzed and its
recurrence can be avoided.

LIMITATIONS OF CASH FLOW STATEMENT

Cash flow statement is a useful tool of financial analysis. However, it suffers from some
limitations, which are as follows:

 A cash flow statement only reveals the inflow and outflow of cash. The cash
balance disclosed by this statement may not depict the true liquid position. There
are controversies over a number of items like cheques, stamps, postal orders etc.
to be included in cash.
 A cash fund statement cannot be equated with the income statement. An income
statement takes into account both cash and non-cash items. Hence cash funds do
not mean net income of the business.
 Working capital being a wider concept of funds, a funds flow statement presents a
more complete picture than cash flow statement.
DISTINCTIONS BETWEEN FUNDS FLOW STATEMENT AND CASH FLOW
STATEMENT
STEPS INVOLVED IN PREPARATION OF CASH FLOW STATEMENT

1) Preparation of non current accounts (Ledger accounts)

a) Fixed asset account
b) Accumulated depreciation account
c) Investment account
d) Provision for taxation account
2) Calculation of funds from operation (refer the format given in FFS steps)
3) Calculation of cash from operations
4) Preparation of cash flow statement

III) CALCULATION OF CASH FROM OPERATIONS

CASH FROM OPERATIONS

PARTICULARS Rs. Rs.

Funds From Operations xxx

xxx
Add: Decrease in current asset except Cash & Bank xxx
Increase in current liabilities
xxx
xx
Less: Increase in current asset except Cash & Bank xx
Decrease in current liabilities xxx
Cash From Operations xxx
IV) CASH FLOW STATEMENT AS PER ACCOUNTING STANDERD 3

1) ACCOUNT FORM:

CASH FLOW STATEMENT FOR THE YEAR ENDED ......

SOURCES OF FUNDS Rs. APPLICATIONS OF FUNDS Rs.

Opening balances: Cash & Bank xx Cash outflow on account of operations xx
Cash from operations xx Redemption of preference shares xx
Issue of shares xx Redemption of debentures xx
Issue of debentures xx Repayment of loans xx
Sale of investment xx Purchase of investment xx
Sale of fixed asset xx Purchase of fixed asset xx
Loans borrowed, etc xx Payment of tax xx
Payment of dividend xx
Opening balances: Cash & Bank xx

xxx xxx
2) STATEMENT FORM

CASH FLOW STATEMENT FOR THE YEAR ENDED ......

PARTICULARS Rs. Rs.

Opening balances: Cash & Bank xx
Add: Sources of funds: (A)
Cash from operations xx
Issue of shares xx
Issue of debentures xx
Sale of debenture xx
Sale of fixed asset xx
Non trading income xx
Total sources (A) xx
Applications of funds: (B)
Cash outflow on account of operations xx
Redemption of redeemable preference shares xx
Redemption of debentures xx
Repayment of other long term loans xx
Purchase of investment xx
Payment of tax xx
Payment of dividend (for last year and interim) xx
Total applications (B) xx
Opening balances: Cash & Bank xx
 MARGINAL COSTING

Nature and Scope Basic concepts - Definition of marginal cost and marginal costing -
Assumptions of marginal costing - CVP Analysis - Meaning, Importance and limitations of
CVP analysis - Break-even Point - Breakeven chart – Margin of Safety - Profit Volume Graph
- Applications in decision making

MARGINAL COSTING

Marginal costing is defined by I.C.M.A., as “the ascertainment of marginal costs and

of the effect on profit of changes in volume or type of output by differentiating between fixed
costs and variable costs.
Marginal costing identifies the Marginal Cost of production and shows its impact on
profit for the change in the output units. Marginal cost refers to “the movement in the total cost,
due to the production of an additional unit of output”. Marginal cost is defined by I.C.M.A., as
“the amount at any given volume of output by which aggregate costs are changed if the volume
of output is increased or decreased by one unit. As such, it arises from the production of
additional increments ofoutput.
In marginal costing, all the variable costs are regarded as product related costs while

fixed costs are assumed as period costs. Therefore, fixed cost of production is posted to the
Profit & Loss Account. Moreover, fixed cost is also not given relevance while determining
the selling price of the product or at the time of valuation of closing stock.
 FEATURES

 Marginal costing is a technique of working of costing, which is fixed cost andvariable

costs are kept separate at every stage. Semi-variable costs are also separated into fixed
and variable.
 As fixed costs are period costs, they are excluded from product cost or cost of
production or cost of sales. Only variable costs are considered as the cost of the product.
 The stock of finished goods and work-in-progress are valued a t variable costs.
 As fixed costs are period costs they are charged to profit and loss account during
period in which they are occurred. They are carried forward to the next year's income.
 Contribution is ascertained by finding the difference between the marginal cost or
variable cost and the selling price.
 Profit is ascertained by finding the difference between the contribution and fixed costs
of all products or departments or processes or divisions, etc.
 The profitability at various level of activity is ascertained by calculating Cost-volume-
profit relationship.
 Fixed cost remains constant irrespective of level of activity.
 Sales price and variable cost per unit remain the same.

ADVANTAGES OF MARGINAL COSTING

1. The marginal costing technique is very simple to understand and easy to operate. The
reason is that the fixed costs are not included in the cost of production and there is no
arbitrary apportionment of fixed costs.
2. The current year fixed costs is not carried forward to the next year. As such, cost and profit
are not vitiated. Cost comparisons become meaningful.
3. The contribution is used as a tool in managerial decision-making. It provides a more
reliable measure for decision-making.
4. Marginal costing shows more clearly the impact on profit of fluctuations in the volume of
sales.
5. Under absorption and over absorption of overheads problems are not arisen under
marginal costing.
6. The marginal costing technique can be combined with standard costing.
7. The prevailing relationship between cost, selling price and volume are properly explained
in clear terms.
8. It shows the relative contributions to profit that are made by each of a number of
products and show where the sales effort should be contracted.
9. The management can take short run tactical decisions with the help of marginal costing
information.

DISADVANTAGES OF MARGINAL COSTING

1. The total costs cannot be easily segregated into fixed costs and variable costs.
2. Moreover, it is also very difficult to per-determine the degree of variability of semi-
variable costs.
3. Under marginal costing, the fixed costs remain constant and variable costs are varying
according to level of output. In reality, the fixed costs do not remain constant and the
variable costs are not varying according to level of output.
4. There is no meaning in the exclusion of fixed costs from the valuation of finished goods
since the fixed costs are incurred for the purpose of manufacture of products.
5. In the case of loss by fire, the full amount of loss cannot be recovered from the insurance
company since the stocks are undervalued.
6. Tax authorities do not accept the valuation of stock since the shock does not show true
value.
7. The calculation of variable overheads does not include all the variable overheads.
8. The profit fluctuates as per the fluctuation of sales volume. Hence, the preparation of
periodic operating statements becomes unrealistic.
9. The elimination of fixed costs renders cost comparison of jobs difficult.
10. The management cannot take a quality decision with the help of contribution alone. The
contribution may vary if new techniques followed in the production process.
11. The fixed costs are constant only for short period. In the long run, all the costs are variable.
ASSUMPTIONS OF MARGINAL COSTING
1. All costs are divided into fixed and variable
2. Fixed cost remain constant at all levels of activity
3. Variable cost varies but unit cost will not vary
4. Selling price remains same
5. Price of material, rates of labour, etc. constant
6. Volume of production only influence costs
7. There is no stock

MARGINAL COSTING PROFORMA

Particulars Amount (Rs.)

Sales xxx
- Variable cost xxx
Contribution xxx
- Fixed Cost xxx
Profit xxx

CONCEPT OF COST-VOLUME-PROFIT ANALYSIS

Cost-volume-pro fit (CVP) analysis is an analytical tool for studying the relationship
between volume, cost, prices, and profits. It is very much an extension, or a part of marginal
costing. It is an integral part of profit planning process of the firm. However, formal profit
planning and control involves the use of budgets and other forecasts and the CVP analysis
provides only an overview of the profit planning process. Besides it helps to evaluate the
purpose and reasonableness of such budgets and forecasts. Generally, CVP analysis provides
answers to questions such as:

 What will be the effect of changes in prices, costs and volume on profits?
 What minimum sales volume need be affected to avoid losses?
 Which product is the most profitable one and which product or operation of a plant
should be discontinued? etc.
IMPORTANCE

The CVP analysis is very much useful to management as it provides an insight into the effects and
inter-relationship of factors, which influences the profits of the firm. The relationship between
cost, volume and profit makes up the profit structure of an enterprise. Hence the CVP relationship
becomes essential for budgeting and profit planning. As a starting point in profit planning, it helps
to determine the maximum sales volume to avoid losses, and the sales volume at which the profit
goal of the firm will be achieved. .As an ultimate objective it helps management to find the most
profitable combination of costs and volume. A dynamic management, therefore, uses CVP
analysis to predict and evaluate the implications of its short run decisions about fixed costs,
marginal costs, sales volume and selling price for its plans on a continuous basis.

SOME IMPORTANT CONCEPTS AND TERMS IN COST-VOLUME-PROFIT

ANALYSIS

FIXED COST

Expenses that do not vary with the volume of production are known as fixed cost. It should be
noted that fixed charges are fixed only with a certain of range of plant capacity. It should also
be noted that fixed cost per units is not fixed. Examples: manager's salary, office rent, factory
rent insurance etc.

VARIABLE COST

Expenses that vary almost in direct proportion to the volume of production or sales are called
variable expenses. Example: fuel, packing expenses, materials, wage's etc.
DISTINCTION BETWEEN VARIABLE COST AND FIXED COST

FIXED COST VARIABLE COST

They do not depend on the volume of Depends upon the volume of production and
sales.
production and sales.
They do not normally change up to the They are in the nature of changing as per
full capacity of a firm. capacity utilization.
Fixed cost per unit always Changing Variable cost per unit remains same.
Total of fixed cost remains constant Total of variable always varying.
They are also termed as period cost or Time They are also termed as product costs or
cost Marginal cost

CONTRIBUTION

Contribution is the difference between sales and marginal cost (variable cost) and it
is used to recover the fixed costs first. Any excess of contribution over fixed costs would be
profits. When a, business manufactures more than one product, the Computation of profit
realized on individual products may be difficult due to the problem of apportionment of
fixed cost to different products. The rationale of contribution lies in the fact that fixed costs
are done away with under marginal costing.

The concepts of contribution help to determine the break-even point, profitability of

products departments etc., to select product mix for profit maximization, and to fix selling
prices under different circumstances such as trade depression, export sales, price
discrimination, etc.

Contribution is the definite test to ascertain whether a product or process is worthwhile

to continue among different products or processes. The contribution could be used as a measure
to solve the problem of key factor.
 CONTRIBUTION FORMULAE

Contribution = Selling price - Variable cost

Contribution = Fixed expenses + Profit
Contribution = Sales x P/V ratio

PROFIT VOLUME (P/V) RATIO (OR) CONTRIBUTION TO SALES RATIO

The ratio that shows the relationship between the value of sales and contribution is
called as P/V ratio. A more appropriate term might be the contribution/sales ratio. A higher
ratio means a greater profitability and vice versa. This ratio helps in comparison of profitability
of various products. Since high P/V ratio indicates high profits, the objective of every
organisation should be to improve or increase the P/V ratio. P/V ratio can be improved by:

a) Decreasing the variable cost by efficiently utilizing material, machines and men.
b) Selecting most profitable product mix for production and sales
c) Increasing the selling price per unit

P/V RATIO FORMULAE

P/V Ratio = Contribution or (C/S)
Sales
(or)
P/V Ratio = Sales – Variable Cost or (S – V)
Sales S
(or)
P/V Ratio = Fixed Cost + Profit or (F + P)
Sales S
(or)
P/V Ratio = Change in Profit
Change in Sales

Advantages of P/V ratio

 (a) Ascertainment of profit on a particular level of sales volume.
(b) Determination of break-even point.
(c) Calculation of sales required to earn a particular level of profit.
(d) Estimation of the volume of sales required to maintain the present level of profit in case
selling prices are to be reduced by a stipulated margin.
(e) Useful in developing flexible budgets for cost control purposes.
(f) Identification of minimum volume of activity that the enterprise must achieve to avoid
incurring losses.
(g) Provision of data on relevant costs for decisions relating to pricing, keeping or dropping
product lines, accepting or rejecting particular orders, make or buy decision, sales mix
planning, altering plant layout, channels of distribution specification, promotional
activities etc.
(h) Guiding in fixation of selling price where the volume has a close relationship with the
price level.
(i) Evaluation of the impact of cost factors on profit.

BREAK EVEN ANALYS (BEP)

Break even analysis is a method of studying relationship between revenue and costs in
relation to sales volume of a business enterprise and determination of volume of sales at
which total costs are equal to revenue.
According to Matz Curry and Frank “a break even analysis determines at what level
cost and revenue are in equilibrium”. The study of cost-volume-profit relationship is often
referred to as Break Even Analysis. Break even analysis refers to a system of determination
of that level of activity where total sales are just equal to total costs. This level of
activity generally termed as break-even point (B.E.P.). At break-even point a business man
neither earns any profit nor incurs any loss. BEP is also called no profit, no loss point or zero
profit or zero loss point.
ASSUMPTIONS OF BEP

 All costs are classified into two – fixed and variable.

 Fixed costs remain constant at all levels of output.
 Variable costs vary proportionally with the volume of output.
 Selling price per unit remains constant in spite of competition or changes in the
volume of production.
 There will be no change in operating efficiency.
 There will be no change in the general price level.
 Volume of production is the only factor affecting the cost.
 Volume of sales is equal to volume of production. Hence there is no unsold
stock.

ADVANTAGES
  Total cost, variable cost and fixed cost can be determined.
 Break even output or sales value can be determined.
 Cost, volume and profit relationship can be studied, and they are very useful to the
managerial decision making.
 Inter-firm comparison is possible.
 It is useful for forecasting plans and profits.
 The best product mix can be selected.
 Total profits can be calculated.
 Profitability of different levels of activity based on various products or profit i.e. plans
can 'be known.
 It is helpful for cost control.

LIMITATIONS

 Exact and accurate classification cost into fixed and variable is not possible. Fixed costs
vary beyond a certain level or output. Variable cost per unit is, constant and it varies in
proportion to the volume.
 Constant selling price is not true.
 Detailed information cannot be known from the BEP Chart. To know all the information
about fixed cost, variable cost and selling price, number of charts must bedrawn.
 No importance is given to opening and Closing stocks,
 Various product mixes on profits cannot be studied as the study is concerned withonly
one sled mix or product mix.
 Cost, volume and profit relation can be known; capital amount, market aspects, effect
of government policy etc., which are important for decision-making cannot considered
from Break even chart.
 If the business conditions change during a period, the break even chart becomes out of
data as it assumes no change in business condition.
BEP FORMULAE:

BEP (in units) = Fixed cost

Selling price per unit – Variable cost per unit

(or)
BEP (in units) = Fixed cost
Contribution per unit

(or)
BEP (in units) = Break even sales value
Selling price per unit

(or)
Break Even Sales = BEP in units x Selling price per unit

(or)
Break Even Sales = Fixed cost
P/V ratio

5.3.2.2 MARGIN OF SAFETY

Margin of safety is an important concept in marginal costing approach, Total sales

minus the sales at breakeven sales are known as the margin of safety. (That is margin of safety
is the excess of normal or actual sales over sales at breakeven point.) In other words margin
of safety refers to the amount by which sales revenue can fall before a loss is incurred. That
it is the difference between the actual sales and sales at the breakeven point.In High margin
of safety indicates the soundness of a business because even with substantial
 fall in sale or fall in production, some profit shall be made. On the other hand thin (low) margin
of safety is an indicator of the weak position of the business and even a small reduction in sale
or production will adversely affect the profit position of the business. Margin of safety can be
increased by decreasing the fixed cost, decreasing the variable cost, increasing the selling
price, increasing output and sales.

MARGIN OF SAFETY FORMULAE

MARGIN OF SAFETY = Actual Sales – Break even sales

(or)
MARGIN OF SAFETY = Profit
P/V ratio

MARGIN OF SAFETY in units = Profit

Contribution per unit

REQUIRED SALES FOR GIVEN PROFIT FORMULAE

Required sales in units = Required profit + Fixed cost

Contribution per unit

Required sales value in rupees = Required profit + Fixed cost

P/V ratios
PROFIT FROM GIVEN SALES

Contribution = Given sales x P/V

ratio Profit = Contribution – Fixed
cost
APPLICATIONS OF MARGINAL COSTING IN DECISION MAKING:
"Marginal costing is a valuable aid for Managerial Decisions”. It helps in taking a
decision in the following situations:
 FIXATION OF SELLING PRICE
Price is one of the most significant factors that determines the market for the products
as well as the volume of the profit for the organization. Under normal circumstances the price
of a product must cover the total costs of that product plus a margin of profit. However,
under certain special circumstances, prices have to be fixed below the total cast, For example,
when there is general trade depression or exploring new markets or accepting additional
orders, the producer has to cut the price even below the total of the concerned product. Under
these special circumstances, the concept of marginal cost is usefully applied to fix the prices.
 ACCEPTING BULK ORDERS OR FOREIGN MARKET ORDERS
Some bulk orders may be received from local dealers or foreign dealer asking for a
price, which is below the market price. This calls for a decision to accept or reject the order.
This order from a local dealer should not be accepted at a price below the market price because
it will affect the normal market and affect the good will of the company. On the other hand,
the order from the foreign dealer should be accepted because it will give additional
contribution as the fixed costs have already been met.
 MAKE OR BUY DECISION
In a make or buy decision the price quoted by the outside suppliers should be compared
with the marginal cost of producing the component parts. If the outside price of the component
is lower than the marginal cost of producing it, it is worth buying. On the other hand, 'if the
outside prices are higher than the marginal cost in the factory be preferred.
 SELECTION OF SUITABLE PRODUCT MIX
When a factory manufactures more than one product, the management faces a problem
as to which product will give maximum profits. The solution is the products, which give the
maximum contribution, are to be retained ad their production should be increased.
 KEY FACTOR
It is also known as limiting Factor. A key factor is one, which restricts production and
profit of a business. It may arise due to the shortage of material, labor, capital, plant
 capacity or sales. Normally, when there is no limiting factor, the selection of the product will
be on the basis of the highest p/v ratio. But when there are limiting factors, selection of the
product will be on the basis of highest contribution per unit of the key factor.
 MAINTAINING A DESIRED LEVEL OF PROFIT
Management may be interested in maintaining a desired level of profits. The sales
required to earn a desired level -of profits can be ascertained by the marginal costing
techniques.
 ALTERNATIVE METHODS OF PRODUCTION
Marginal costing is helpful it comparing the alternative methods of production. The
method, which gives maximum contribution, is to be adopted keeping the mind the limiting factor.
 DETERMINATION OF OPTIMUM LEVEL OF ACTIVITY
Marginal costing is helpful it comparing the alternative methods of production. The
method, which gives maximum contribution, is to be adopted keeping the mind the limiting
factor.
The technique of marginal costing helps the management in determining the optimum
level of activity. To make such a decision, contribution at different levels of activity can be
found. The level of activity, which gives the highest contribution, will be the optimum level.
The level of production can be raised till the marginal cost does not exceed the selling price.
 EVALUATION OF PERFORMANCE
Evaluation of performance efficiency of various departments or product lines can be
made with the help of marginal costing. The management has to discontinue the production
of non-profitable products or departments so as to maximize the profits. In such cases, decision
to discontinue will be on the basis of the lowest contribution or PV ratio.
 MARIGINAL ASCERTAINMENT
Marginal costing technique facilitates not only the recording of costs but their
reporting also. The classification of costs into fixed and variable components makes the. job
of cost ascertainment easier. The main problem in this regard is only the segregation of the
semi- variable cost into fixed and variable elements. However, this may be overcome by
adopting any of the methods in this regard.
 COST CONTROL
Marginal cost statements can be understood easily by the management than those
presented under absorption costing. Bifurcation of costs into fixed and variable enables
management to exercise control over production cost and thereby affect efficiency. In fact
while variable costs are controllable at the lower levels of management, fixed costs can be
controlled at the top level. Under this technique, management can study tire behavior of costs
at varying conditions of output and salts and thereby exercise batter control over costs.
 DECISION-MAKING
Modern management is faced with a number of decision-making problems every
day. Profitability is the main criterion for selecting the best course of action. Marginal costing
through contribution assists management in solving problems. Some of the decision- making
problems that can be solved by marginal costing are: profit planning, pricing of products, make
or buy decisions product mix etc.
 STANDARD COSTING AND VARIANCE ANALYSIS

Standard Costing and Variance Analysis: Meaning of Standard cost and Standard Costing - Steps
involved in Standard Costing - Advantages and Limitations of Standard Costing - Variance analysis
- Material Variances, Labour Variances.

INTRODUCTION
Financial Accounting is only historical costing and is only a post – marten examination of
cost and hence, is not very much useful to management for cost control and cost reduction
purposes. Besides this, historical costing is not useful to managerial decision making and
policy formulating purposes. Hence, to the accounting world, a new concept (or) tool by
name “Standard Costing” appeared as a very big way out.
CONCEPT OF STANDARD COSTING
Normally it is understood as a long step by step process of fixing standards, using standards,
and their comparisons with the actuals, finding out of variances in between standards and
actuals, analysing these variances, finding out of causative factors for these variances,
classifying these causes into controllable and uncontrollable, controlling and taking
remedial actions, revising these standards if necessary etc. Thus, it is a cost controlling and
cost reducing device.
ICMA, London Defines “Standard Costing is the preparation and use of Standard costs, their
comparison with actual costs and analysing of variances to their causes and points of
incidence”.
Controlling Process in standard Costing:
 Formulation of Standard Costs : For all elements of cost viz., Materials,Labour
and Expenses, standard costs are fixed very much scientifically by experts based onmultiple
criteria.

 Matching Actuals with Standards : In this step, actual costs are compared with
standard costs for the purposes of verifying whether actual cost is more or less than the
standard costs.

 Variances and Analysis thereof : The difference between actual and the standard
is known as variance and this is further analysed to find out whether variance is debit
variance (or) Credit variance.

 Analysis of causative factors for variances : For all debit (or) unprofitable
variances, causative factors (or) reasons responsible are unearthed and then are classified
into controllable and uncontrollable reasons.

 Corrective Measures : In relation to controllable causes, the people responsible

are held up and are instructed to take necessary remedial measures and see that they do not
repeat in the time to come.

 Reporting to Management : Depending upon the degree of severity of the

variances, information by following the principle of “Management by Exception”, will be
reported to the concerned management level for necessary cost control measures.

 Revising the standards : With regard to uncontrollable variances, an idea of

revising the standards watching the changed scenario, may be though of.

STANDARD COST

The whole of standard costing revolves around standard costs. Hence, we are very much
obliged to explain what is standard cost. It is a predetermined cost computed in advance of
production on the basis of specification of all factors affecting costs.

Blocker and Weltmer defines, Standard cost is a common sense cost reflecting the best
Judgement of management as to what costs ought to be if this plant is operated with the highest
degree of efficiency.
TYPES OF STANDARDS
Importantly, there are : Basic, current, Ideal, Expected and Normal standards.
 Basic standards : It is a standard set for a long term in an unaltered way. It is
suitable mostly to those products whose costs / prices do not change much.
 Current Standard : It is a standard set for a relatively shorter period based on
current market conditions. It claims to be more realistic and most companies use it.
 Ideal Standard : It is self explanatory as this is set based on all idealistic
conditions which are never seen.
 Expected Standard : It is a standard set based on certain conditions which are
expected to be attained. Conditions prevailing in industry and that are likely to hit the
industry in future are all considered while this standard is set. So, it is attainable standard.
 Normal Standard : It is a standard set on the basis of average conditions (or)
normal conditions. Since we do not have any control over future, this normal standard may
not be of much use.
Process in setting Standards:
The function of setting standards for costs (or) revenues is a rational and professional job.
Hence, it is entrusted to a committee called – standards Committee consisting of Production
Manager, purchase manager, personnel Manager, Cost Accountants etc. This committee sets
standards for each and every element of cost viz., Materials, Labour and expense. Let us see
them separately.
Standard for Direct Material Cost: [SMC]
This SMC is a product of standard quantity and standard price. So, it is clear that standard
quantity and standard price are to be determined first and SMC is obtained by multiplying
these two. SMC is briefly called as SC (Standard Cost).
Standard Material Quantity [SMQ]:
SMQ is briefly called – Standard Quantity (SQ). Based on input – output relations, normal
material losses as per are laboratory tests, SQ is determined.
Standard price [SP] :
SP is determined taking multiple criteria into account like : price of material in Stock,
materials already contracted, future price trends, discounts etc. So, SC for material is the
product of SQ and SP. Therefore SC = SQ x SP
Standard for Direct Labour Cost [SLC]
This resembles SMC in that it is a product of standard hours and standard rate.
SLC = SH x SR
In this also, SH and SR are to be found out.

 Standard Hours : With the help of time and motion studies in a laboratory, work
study job analysis, Normal idle time, Therbligs etc. standard time (or) Hours are fixed.

 Standard Rate : This is 2nd aspect in finding SLC. It is fixed based on the past,
going rates, consultations with Trade union, demand for labour, supply of labour etc.
Thus, the product of SH and SR gives SLC.

 Standard for Expenses : [Overheads] While we fix standards for expenses (or)
overheads (OH) we need to go in three steps.
(1) Determination of total overhead
(2) Determination of production in units
(3) Calculation of standard overhead rate.

Sometime, for the entire overhead, a standard rate can be calculated. On the other hand,
overhead can see split into fixed and variable overheads and separately, standard Overhead
rates can be determined. The following formula can be used to calculate the overhead rate.

This rate can be calculated in hours also.

Total OH
Standard OH. Rate per unit =
Budgeted output
Standard overhead rate per hour = Standard overhead Budgeted
Hours in the period
VARIANCE ANALYSIS

This part is the most integral part of standard costing. The purposes of cost Accounting can
be achieved by costing through variance analysis in standard costing. Variances are to be
calculated for all the elements of cost viz., Materials, Labour and Expenses (or)overhead
(OH). We now examine Material Variance Analysis in the first place. The following chat
will explain it best.

MATERIAL VARIANCE ANALYSIS :

(1) (SQ x SR – AQ x AR)

Material Cost Variance

(2) (SR – AR) AQ

Price Quantity
Variance Variance

MUV = (SQ – RQ) SR

Mix variance Yield
Variance
(1) Material cost variance: This is the difference between standard cost of
standard quantity for Actual output and actual cost of actual Material used for actual output. The
formula for this is :
MCV = SC – AC = SQ x SR – AQ x AR
Where : SC = Standard cost, AC = Actual cost, SQ = SQ for AY, SR = Standard Rate, AQ
= Actual Quantity, AR = Actual Rate.
Importantly, SQ = SQ for AY
Where AY = Actual Yield (or) Actual output.

(2) Material Price Variance: From the above chart, it is understood that 2nd variance
is price variance and this will also lead to MCV. This is a part of the MCV and
arises due to the difference in standard price set and the actual price paid.The
formula is :
MPV = (SR – AR) AQ where SR = Standard Rate, AR = Actual Rate and AQ = Actual
Quantity of material.

(3) Material quantity variance: (MQV) It is also known as usage variance and it is
a part of the MCV as per the above chart. This may arise due to any of the reasons viz.,
workers, quality of Materials, skill and efficiency of workers, changes in product design etc.
Mostly, it arises due to the difference in utilisation of raw materials. Its formula is : MQV =
(SQ – AQ) SR where SQ = SQ for AY, AQ = Actual Quantity, SR = Standard Rate, AY =
Actual Yield.

(4) Material mix variance [MMV]: As per the chart of material variances, MMV is
that portion of MQV due to changes in standard mix of materials and actual mix of the
materials. It may be also due to subsequent shortage of raw materials. In this case,standard
quantities are to be revised as per a formula and with these revised quantities the MMV is
to be calculated. How do we revise the Quantity?
For the sake of convenience, MMV is discussed in a phased manner. Some assumptions are
made here. In the 1st phase, the following are the assumptions.
(1) only mix ratio differs.
(2) Total weights of the mixes are the same
MMV in this case uses the same formula used for MQV.
Therefore, MMV = (SQ – AQ) SR
In the 2nd phase, the assumption are:
(1) Mix compositions differ.
(2) Total weights of the mixes are also different

MMV in this case is calculated with the following formula.

MMV = (RSQ – AQ) SR where:
RSQ = Revised Standard Quantity, AQ = Actual Quantity, SR = Standard Rate.
RSQ = Total weight of Actual Mix x old standard ratio.
Further, it is to be noted that MQV calculated as per the earlier said formula will be divided
into two parts viz., (1) MMV (due to change in mix Ratio) and (2) MUV (due to efficiency
(or) in efficiency in the utilization of materials).
So, MMV = (RSQ – AQ) SR and
MUV = (SQ – RSQ) SR
From the above it is to be noted that MQV must be equal to the total of MMV and MUV.

(5) Material yield variance (MYV) :

In all processing industries, material loss is inevitable. So, while setting standards for
material and output from materials, a provision is made for normal loss while abnormal loss
is not provided for. Though a provision is made for normal loss in the Standard, some
difference is bound to arise between standard output for the actual input and the actual
output. Hence, need for calculation of yield variance arises. Thus, there is difference
between standard yield and actual yield because of efficiency (or) in efficiency of workers,
poor quality of materials, etc. As per the material variances. Chart given above, it is 5 th
variance which is a part of the MQV which is due to reasons said above. For the sake of
convenience, it is sought to be handled in two situations. They are:

(1) (a) Mix varies , (b) Weights do not vary.

In the above case, the formula for MYV is MY = (AY – SY) SC, where: AY = Actual Yield,
SY = Standard yield for actual input of material used, SC = Standard cost of unit.

(2) (a) Mix Varies, (b) Weights also vary.

In this case, since there is alround change standards set are to be revised and Revised Mix
is to be calculated and Revised yield also is to be found out. The earlier yield variance
formula is expressed now in Revised Terms. The formula is:
MY = (AY – RY) RC
SC (or) RC calculation:
It is standard cost per unit of finished goods. It is calculated as per the following:
SC (pu) (or) RC = Total Standard cost (OR)
Total input - Normalloss
Normal cost of Normal output
Normal output
Verifications (or) checking:
(1) MCV = MPV + MQV
(2) MQV = Mix + Yield
(3) MQV = Mix + usage
(4) MQV = Mix + usage (or) yield
(5) MUV = MYU

DIRECT LABOUR COST VARIANCES

These variances are about the 2 nd element of cost, i.e. Labour. We get reminded of all
material variance formula when we look at Labour variances. There is a lot of similarity.
The first variance is Direct Labour Cost Variance (DLCV). This is difference between
standard cost of labour and actual cost of labour. This is like MCV. Formula is given below:
DLCV = SC – AC = SH X SR – AH X AR
SC = Standard cost,
AC = Actual Cost,
SH = SH for actual output,
SR= Standard Rate,
AH = Actual Hours,
AR = Actual Rate.
1. Labour Rate Variance [LRV]:
This is just like Material Price Variance. This is part of the DLCV which is due to
difference between standard wage rate and actual wage rate paid. Formula is: LRV
= (SR – AR) AH,
Where: SR = Standard Rate AR = Actual Rate, AH = Actual Hours.
2. Labour Time (or) Total Efficiency Variance : (LTV (or) LEV)
This is again like material quantity variance. This is post of DLCV which is due to differencein
standard Hours for Actual output and Actual Hours. The relevant formula is:
LTV (or) LEV : (SH – AH) SR where:
SH = Standard Hours, AH = Actual Hours, SR = Standard Rate.

3. Labour Efficiency variance : (LEV)

(1) Idle Time Variance : As per the chart of labour variances, it is portion of the
Labour Efficiency (or) Time variance. As there is material loss in the case of materials, there
is problem of idle time is the case of Labour. This idle time is due to abnormal reasonsviz.,
non – availability of raw materials, of special kind of labour, break down of Plant &
Machinery etc. Formula is:
ITV = Abnormal Idle Hours x SR
Note: This is always adverse variance.

(2) Labour Mix variance : This is similar to material mix variance and all the
formula of material mix variance can be used by using SH in the place of SQ and RSH
(Revised standard hours) in the place of RSQ (or) RQ the relevant formula are:
(a) LMV = (RSH – AH) SR
(b) LUV = (SH – RSH) SR
From the above it can be understood that the total Labour Efficiency (or) Time variance is
a sum of (1) Idle Time variance, (2) Mix variance and (3) usage variance. When LUV is
calculated in Labour time variance, there is no need to specially calculate Labour yield
variance as it is very much equal to LYU.

(3) Labour yield variance : This is very much similar to MYV. The formula are :
(1) LYU = (AY – SY) SC
(2) LYU = (AY – RY) RC
 SC – AC = SH x SR – AH x AR
Direct Labour Cost Variance

(SR – AR) AH (SH – AH) SR

Total Efficiency

Idle Hrs x HR [SH – [AH – IT Hrs] SR]

Efficiency Variance

4. Labour Efficiency Variance : [LEV]

As per the chart, this is part of Total Efficiency variance. When we seek to calculate the real
efficiency variance, from out of total Hrs. actually worked, Idle Hours lost due to abnormal
condition shall be set aside and with these actual hours, efficiency variance is to be
calculated. The formula is:
LEV = [SH – (AH – Idle Hours)] SR

(SH – AH) SR
When there is mix = =
Total Efficiency
Variance
(AY – SY) SC
(or)
Idle Hrs. x SR (RH – AH) SR (SH – RH) SR (AY – RY) RC

(or)
Idle Time Mix Usage Yield
+ + Variance Variance Variance Variance

TLEV = Idle + Mix + Usage (or) Yield

1. Denotes Total Actual Hours worked including idle Time Hours.
Verifications:
(1) LCV = Rate + Total Time (or) Total Efficiency.
(2) Total Efficiency Variance = Idle Time + Efficiency.
(3) Total Efficiency Variance = Idle + Mix + usage (or) Yield
(4) Usage = Yield.

Advantages of Standard Costing:

In the areas of Accounting, Cost Accounting and Management Accounting,
Standard Costing enjoys a significant place in acting as a cost controlling and cost
reducing managerial tool. The utility of standard costing is unlimited. The following are
some important merits.

1. Application of “Management by Exception” principle: here is no need to waste

away the most significant time of Top management with negligible and
inappropriate things in controlling. With the help of variance analysis, attention
of the Management towards exceptional areas of performance may be drawn and
accordingly, they may be contained. Management by Exception principle says that
only exceptional aspect needs to be reported to the most right level of
management.
2. Optimum utilisation of Resources: Because of the cost consciousness developed
in the minds of people in the organisation, people tend to make the best utilisation
of all scarce resources for the maximisation of profits and minimisation of costs.
3. People are motivated: Since standards are set with the involvement and
participation of lower level people also, they are very much motivated to
accomplish the standards that they also set, along with higher ups in the
organisation.
4. Most Important Managerial Tool of Cost control / Cost Reduction: There
are several tools and techniques to control costs and performance aspects. Among
all these tools, standard costing is a significant tool to control and reduce costs.
5. Weak sports un earthed: The efficient and inefficient areas of working in the
 entire organisation are revealed by the variance analysis. Accordingly, remedial
action can be planned.
6. Valuation of Inventory at Standard Rates: Since stocks can be valued at
standard costs, this will reduce fluctuation of profits due to adoption of different
methods for stock valuation.
Disadvantages of Standard Costing:
 Setting standards itself is the most difficult task.
 Categorising the causes for variances into controllable and un controllable itself
is another difficult barrier.
 Standard costing is not very much suitable to those industries which are exposed
to constant changes in the market.
 Standards set once are never revised as per the changed scenario and hence, they
may prove to be of no use.
 It is a costly and time-consuming tool.
 Employees resist the new life style in the organisation, because of standard costing.
 Not very much suitable to small and medium sized organisations.

In spite these problems (or) criticisms, standard costing has got its own value and
no limitations can stand against the utility of standard costing.