AFM IMPORTANT QUESTIONS FOR SEMESTER EXAMINATIONS

ACCOUNTING FOR MANAGERS
AFM IMPORTANT QUESTIONS FOR SEMESTER EXAMINATIONS

1. What is accounting? Explain accounting cycle.
Accounting Process
The process of accounting involves recording classifying and summarizing of past events and
transactions of financial nature, with a view to enabling the user of accounts to interpret the
resulting summary.
Definition of Accounting
Accounting has been defined by the American accounting association committee as:
“Accounting is the art of recording, classifying and summarizing, in a significant manner and
in terms of money, transactions and events which are, in part at least, of a financial character
and interpreting the results”.
Accounting Cycle
• The Accounting Cycle is a series of steps.
• Starts with making accounting entries for each transaction and goes through closing the
books.
• Accounting cycle is a step-by-step process of recording, classification and summarization
of economic transactions of a business.
• It generates useful financial information in the form of financial statements including
income statement, balance sheet, cash flow statement and statement of changes in equity.
• The time period principle requires that a business should prepare its financial statements
on periodic basis.
• Therefore accounting cycle is followed once during each accounting period.
• Accounting Cycle starts from the recording of individual transactions and ends on the
preparation of financial statements and closing entries.
Definition: The accounting cycle refers to nine steps, repeated in each reporting period, to
verify transactions and prepare financial statements for internal and external users.
Accounting Cycle steps are-
1. Analyze
2. Journalize
3. Post A Business Transaction
4. Unadjusted Trial Balance
5. Adjusting
6. Preparing
7. Preparing Financial Statements
8. Closing the account
9. Post-Closing Trial Balance
1-Analyze-
• The first step of accounting cycle.
• First analyze a transaction and its source documents.
• Apply double-entry accounting to recognize its effect on account balances.
RAJIV GANDHI INSTITUTE OF MANAGEMENT AND SCIENCE, KAKINADA Page 1

2- Journalize-
• Transactions are recorded in a General Journal.
• Journalizing leaves a record of all transactions in one document.
• Helping to prevent mistakes and linking the debits and credits for each transaction.
3-Post a Business Transaction-
• The third step in the accounting cycle is posting.
• Also known as LEDGER Account.
• After recording in the journal, transaction are transferred and posted to the ledger.
• All transactions for the same account are collected and summarized.
• It is important to leave this paper trail to verify accuracy and troubleshoot later in the
process if accounts are not adding up.
4-Prepare an Unadjusted Trial Balance
• Preparing an unadjusted trial balance tests the equality of debits and credits as
recorded in the general ledger.
• Additionally, this provides the balances of all the accounts that may require
adjustment in the next step.
• Debit and credit merely signify position left and right, respectively .
Both sided recorded amount must be equal
5-Adjusting of Trial Balance-
• The fifth step, adjusting, accounts for internal transactions, like the use of prepaid rent
or unearned revenue.
• Adjustment may be required to record an expense that may have been incurred but not
yet recorded.
6-Prepare an adjusted trial balance-
• The sixth step is the preparation of the adjusted trial balance.
• Again tests the equality of debits and credits, encompassing all internal and external
transactions for the reporting period.
7-Preparing Financial Statements-
1. Financial statements are prepared.
2. The Income Statement and Statement of Owner's Equity are prepared first, followed
by the Balance Sheet, which pulls information from the Statement of Owner's Equity.
3. These are one of the primary outputs of the financial accounting system.
8-Closing the account
• The eighth step in the accounting cycle is to close accounts in preparation for the next
accounting period.
• Temporary or nominal accounts are closed, while permanent or real accounts carry
their balances into the next period.
• Once completed, all revenue, expense, withdrawal and Income Summary balances
should be zero.
9-Post-Closing Trial Balance-
• Finally, the post-closing trial balance lists the balances of the accounts that were not
closed, such as assets, liabilities, and owner's equity.
• This trial balance helps verify that permanent accounts balance, with equal debit and
credit sums, and that all temporary accounts were closed properly.
2. Define accounting. Explain its nature and functions.

Functions of Accounting:
(a) Keeping Systematic Records:
As a language of business, accounting is to report the results of most business events. Hence,
its main function is to keep a systematic record of these events. This function embraces

recording transactions in journal and subsidiary books like cashbook, sales book etc., posting
them to ledger accounts and ultimately preparing the financial statements [final accounts].
(b) Communicating the Results:
The second main function of accounting is to communicate the financial facts of the
enterprise to the various interested parties like owners, investors, creditors, employees,
government, and research scholars, etc.
The purpose of this function is to enable these parties to have better understanding of the
business and take sound and realistic economic decisions.
(c) Meeting the Legal Requirements:
Accounting aims at fulfilling the legal requirements, especially of the tax authorities and
regulators of the business. It discharges this function in accordance with certain fundamental
truths and uniform enforcement of generally accepted accounting principles.
(d) Protecting the Properties of the Business:
Accounting helps protecting the property of the business.
(e) Planning and Controlling the Business Activities:
Accounting also helps planning future activities of an enterprise and controlling its day-to-
day operations. This function is done mainly to promote maximum operational efficiency.
Nature of accounting
We know Accounting is the systematic recording of financial transactions and
presentation of the related information of the appropriate persons. The basic features of
accounting are as follows:
1. Accounting is a process: A process refers to the method of performing any specific
job step by step according to the objectives, or target. Accounting is identified as a
process as it performs the specific task of collecting, processing and communicating
financial information. In doing so, it follows some definite steps like collection of data
recording, classification summarization, finalization and reporting.
2. Accounting is an art: Accounting is an art of recording, classifying, summarizing and
finalizing the financial data. The word ‘art’ refers to the way of performing something. It
is a behavioral knowledge involving certain creativity and skill that may help us to attain
some specific objectives. Accounting is a systematic method consisting of definite
techniques and its proper application requires applied skill and expertise. So, by nature
accounting is an art.
3. Accounting is means and not an end: Accounting finds out the financial results and
position of an entity and the same time, it communicates this information to its users. The
users then take their own decisions on the basis of such information. So, it can be said
that mere keeping of accounts can be the primary objective of any person or entity. On
the other hand, the main objective may be identified as taking decisions on the basis of
financial information supplied by accounting.
4. Accounting deals with financial information and transactions; Accounting records

the financial transactions and date after classifying the same and finalizes their result for a
definite period for conveying them to their users. So, from starting to the end, at every
stage, accounting deals with financial information. Only financial information is its
subject matter. It does not deal with non-monetary information of non-financial aspect.
5. Accounting is an information system: Accounting is recognized and characterized as
a storehouse of information. As a service function, it collects processes and
communicates financial information of any entity. This discipline of knowledge has been
evolved out to meet the need of financial information required by different interested
groups.
3. How are the accounts classified? What are the rules of accounting?

Every business deal with other “Person”, possesses “Assets”, pay “Expenses” and receive
“Income”.
So from the above, we can see every business has to keep
Accounts in the names of persons are known as “Personal Accounts”
Accounts in the names of assets are known as “Real Accounts”
Accounts in respect of expenses and incomes are known as “Nominal Accounts”
Personal Accounts
Accounts in the name of persons are known as personal accounts.
Eg: Babu A/C, Babu & Co. A/C, Outstanding Salaries A/C, etc.
• Natural Person’s Personal Account: An account recording transactions with an
individual human being is known as a natural person’s Personal Account. (eg. Krishna
account)
• Artificial Person’s Personal Account: An account recording financial transactions
with an artificial person created by law or otherwise is called an artificial person’s
personal account. (eg. VSL College)
• Representative Person’s Personal Account: An account indirectly representing a
person or persons is known as a representative account. (eg. Salaries account)
Real Accounts
These are accounts of assets or properties. Assets may be tangible or intangible. Real
accounts are impersonal which are tangible or intangible in nature.
Eg:- Cash a/c,, Building a/c, etc are Real Accounts related to things which we can
feel, see and touch. Goodwill a/c, Patent a/c, etc Real Accounts which are of
intangible in nature.
• Tangible Real Account: An asset which can be touched, seen, and measured. (eg.
Machinery Account)
• Intangible Real Account: An asset which can’t be touched physically but can be
measured in value. (eg. Goodwill)
Nominal Accounts
These accounts are impersonal, but invisible and intangible. Nominal accounts are related to
those things which
hich we can feel, but cannot see and touch. All “expenses and losses” and all
“incomes and gains” fall in this category.
Eg:- Salaries A/C, Rent A/C, Wages A/C, Interest , Received A/C, Commission Received
A/C, Discount A/C, etc.
Debit and Credit
Each accounts have two sides – the left side and the right side. In accounting, the left side of
an account is called the “Debit Side” and the right side of an account is called the “Credit

Side”. The entries made on the left side of an account is called a “Debi
“Debitt Entry” and the entries
made on the right side of an account is called a “Credit Entry”.
Rules for Debit and Credit
Debit the Receiver

Personal Account
Credit the Giver
Debit what comes in

Real Accounts
Credit what goes out
Debit all Expenses and Losses

Nominal Accounts
Credit all Incomes and Gains
4. State how accounting is useful to different type of users?

Users of accounting information
There are several groups of people who are interested in the accounting information relating
to the business enterprise. Following are some of them:
The progress and reputation of any business firm is built upon the sound financial footing.
There are a number of parties who are interested in the accounting information relating to
business. Accounting is the language employed to communicate financial in information
formation of a
concern to such parties.
According to Slawin and Reynolds, “Conceptually, accounting is the discipline that provides
information on which external and internal users of the information may base decisions that
result in the allocation of econ
economic
omic resources in society”. That is, users of accounting
information may be grouped into two classes, viz., internal users and External users.
(A) Internal Users:
Internal users of accounting information are those persons or groups which are within the
organization.
Following are such internal users:
1. Owners:
The owners provide funds or capital for the organization. They possess curiosity in knowing
whether the business is being conducted on sound lines or not and whether the capital is
being employed properly or not.
Owners, being businessmen, always keep an eye on the returns from the investment.
Comparing the accounts of various years helps in getting good pieces of information.
Properly kept accounts are good proof in dispute, they determine the amount of goodwill and
facilitate in assessing various taxes.
2. Management:
The management of the business is greatly interested in knowing the position of the firm. The
accounts are the basis; the management can study the merits and demerits of the business

activity. Thus, the management is interested in financial accounting to find whether the
business carried on is profitable or not. The financial accounting is the “eyes and ears of
management and facilitates in drawing future course of action, further expansion etc.”
3. Employees:
Payment of bonus depends upon the size of profit earned by the firm. The more important
point is that the workers expect regular income for the bread. The demand for wage rise,
bonus, better working conditions etc. depend upon the profitability of the firm and in turn
depends upon financial position. For these reasons, this group is interested in accounting.
(B) External Users:
External users are those groups or persons who are outside the organization for whom
accounting function is performed.
Following are such external users:
1. Creditors:
Creditors are the persons who supply goods on credit, or bankers or lenders of money. It is
usual that these groups are interested to know the financial soundness before granting credit.
The progress and prosperity of the firm, to which credits are extended, are largely watched by
creditors from the point of view of security and further credit. Profit and Loss Account and
Balance Sheet are nerve centres to know the soundness of the firm.
2. Investors:
The prospective investors, who want to invest their money in a firm, of course wish to see the
progress and prosperity of the firm, before investing their amount, by going through the
financial statements of the firm. This is to safeguard the investment. For this, this group is
eager to go through the accounting which enables them to know the safety of investment.
3. Government:
Government keeps a close watch on the firms which yield good amount of profits. The state
and central Governments are interested in the financial statements to know the earnings for
the purpose of taxation. To compile national accounts the accounting is essential.
4. Consumers:
These groups are interested in getting the goods at reduced price. Therefore, they wish to
know the establishment of a proper accounting control, which in turn will reduce the cost of
production, in turn less price to be paid by the consumers. Researchers are also interested in
accounting for interpretation.
5. Research Scholars:
Accounting information, being a mirror of the financial performance of a business
organization, is of immense value to the research scholar who wants to make a study into the
financial operations of a particular firm.
To make a study into the financial operations of a particular firm the research scholar needs
detailed accounting information relating to purchases, sales, expenses, cost of materials used,
current assets, current liabilities, fixed assets, long-term liabilities and shareholders’ funds
which is available in the accounting records maintained by the firm.
6. Financial Institutions:
Bank and financial institutions that provide loan to the business are interested to know credit-
worthiness of the business. The groups, who lend money need accounting information to
analyses a company’s profitability, liquidity and financial position before making a loan to
the company. Further, they keep constant watch on the operating results and financial
position of the business through accounting data.
7. Regulatory Agencies:
Various Government departments such as Company law department, Reserve Bank of India,
Registrar of Companies etc. require information to be filed with them under law. By

examining this accounting information they ensure that concerned companies are following
the rules and regulations.
5. Explain the concept of Accounting Principles?
Imagine that you are a business owner, and you take copies of your financial records to six
different accountants. You ask each one to calculate your profit for the year. A fortnight later
they each provide you with their answers. There are six different profit figures, with very
wide variations between them. What impression do you now have of the accounting
profession?
To avoid this kind of situation arising various rules, or accepted ways of going about things
have evolved. These rules are known as 'concepts' and 'conventions' To support the
application of the "true and fair view", accounting has adopted certain concepts and
conventions which help to ensure that accounting information is presented accurately and
consistently.
Assumptions
The basic assumptions of accounting are like the foundation pillars on which the structure of
accounting is based. The four basic assumptions are as follows:
Business Entity Assumption
The concept of business entity assumes that business has a distinct and separate entity from
its owners. It means that for the purposes of accounting, the business and its owners are to be
treated as two separate entities. Keeping this in view, when a person brings in some money as
capital into his business, in accounting records, it is treated as liability of the business to the
owner. Here, one separate entity (owner) is assumed to be giving money to another distinct
entity (business unit). Similarly, when the owner withdraws any money from the business for
his personal expenses (drawings), it is treated as reduction of the owner’s capital and
consequently a reduction in the liabilities of the business.
Money Measurement Assumption
The concept of money measurement states that only those transactions and happenings in an
organization which can be expressed in terms of money such as sale of goods or payment of
expenses or receipt of income, etc. are to be recorded in the book of accounts. All such
transactions or happenings which cannot be expressed in monetary terms, for example, the
appointment of a manager, capabilities of its human resources or creativity of its research

department or image of the organization among people in general do not find a place in the
accounting records of a firm.
Accounting Period Assumption
The users of financial statements need periodical reports to know the operational result and
the financial position of the business concern. Hence it becomes necessary to close the
accounts at regular intervals. Usually a period 52 weeks or 1 year is considered as the
accounting period.
Going Concern Assumption
As per this assumption, the business is assumed to continue for a never ending period and
therefore transactions are recorded from this point of view. There is neither the intention nor
the necessity to wind up the business in the foreseeable future.
Basic Concepts of Accounting
These concepts guide how business transactions are reported. On the basis of the above four
assumptions the following concepts (principles) of accounting have been developed.
Dual Aspect Concept
Dual aspect is the foundation or basic principle of accounting. It provides the very basis for
recording business transactions into the book of accounts. This concept states that every
transaction has a dual or two-fold effect and should therefore be recorded at two places. In
other words, at least two accounts will be involved in recording a transaction. This can be
explained with the help of an example. Ram started business by investing in a sum of Rs. 50,
00,000 the amount of money brought in by Ram will result in an increase in the assets (cash)
of business by Rs. 50, 00,000. At the same time, the owner’s equity or capital will also
increase by an equal amount. It may be seen that the two items that got affected by this
transaction are cash and capital account.All business transactions recorded in accounts have
two aspects - receiving benefit and giving benefit. For example, when a business acquires an
asset (receiving of benefit) it must pay cash (giving of benefit).
Realization Concept
The concept of revenue recognition requires that the revenue for a business transaction
should be included in the accounting records only when it is realized. Here arise two
questions in mind. First, is termed as revenue and the other, when the revenue is realized. Let
us take the first one first. Revenue is the gross inflow of cash arising from (i) the sale of
goods and services by an enterprise; and (ii) use by others of the enterprise’s resources
yielding interest, royalties and dividends. Secondly, revenue is assumed to be realized when a
legal right to receive it arises, i.e. the point of time when goods have been sold or service has
been rendered. Thus, credit sales are treated as revenue on the day sales are made and not
when money is received from the buyer. As for the income such as rent, commission, interest,
etc. these are recognized on a time basis. For example, rent for the month of March 2005,
even if received in April 2005, will be taken into the profit and loss account of the financial
year ending March 31, 2005 and not into financial year beginning with April 2005. Similarly,
if interest for April 2005 is received in advance in March 2005, it will be taken to the profit
and loss account of the financial year ending March 2006.
Historical Cost Concept
Under this concept, assets are recorded at the price paid to acquire them, which includes cost
of acquisition, transportation, installation and making the asset ready to use . For example, if
a piece of land is purchased for Rs.50,00,000 and its market value is Rs.70,00,000 at the time
of preparing final accounts the land value is recorded only for Rs.50,00,000. Thus, the
balance sheet does not indicate the price at which the asset could be sold for.
Matching Concept
The earnings and expenses shown in an income statement must both refer to the same goods
transferred or services rendered during the accounting period. The matching concept requires

that expenses should be matched to the revenues of the appropriate accounting period.
Profit is an excess of revenue over expenditure therefore it becomes necessary to bring
together all revenues and expenses relating to the period under review so we must determine
the revenue earned during a particular accounting period and the expenses incurred to earn
these revenues
Verifiable and Objective Evidence Concept
The concept of objectivity requires that accounting transaction should be recorded in an
objective manner, free from the bias of accountants and others. This can be possible when
each of the transaction is supported by verifiable documents or vouchers. For example, the
transaction for the purchase of materials may be supported by the cash receipt for the money
paid, if the same is purchased on cash or copy of invoice and delivery challan, if the same is
purchased on credit. Similarly, receipt for the amount paid for purchase of a machine
becomes the documentary evidence for the cost of machine and provides an objective basis
for verifying this transaction.
Conventions
To make the accounting information useful to various interested parties, the basic
assumptions and concepts discussed earlier have been modified. These modifying principles
are as under.
Convention of Full Disclosure
The principle of full disclosure requires that all material and relevant facts concerning
financial performance of an enterprise must be fully and completely disclosed in the financial
statements and their accompanying footnotes. This is to enable the users to make correct
assessment about the profitability and financial soundness of the enterprise and help them to
take informed decisions.
Convention of Materiality
The materiality principle requires all relatively relevant information should be disclosed in
the financial statements. Unimportant and immaterial information are either left out or
merged with other items.
For example, money spent on creation of additional capacity of a theatre would be a material
fact as it is going to increase the future earning capacity of the enterprise. Similarly,
information about any change in the method of depreciation adopted or any liability which is
likely to arise in the near future would be significant information. All such information about
material facts should be disclosed through the financial statements and the accompanying
notes so that users can take informed decisions.
Convention of Consistency
The aim of consistency principle is to preserve the comparability of financial statements. The
rules, practices, concepts and principles used in accounting should be continuously observed
and applied year after year. Comparisons of financial results of the business among different
accounting period can be significant and meaningful only when consistent practices were
followed in ascertaining them.
To illustrate, an investor wants to know the financial performance of an enterprise in the
current year as compared to that in the previous year. He may compare this year’s net profit
with that in the last year. But, if the accounting policies adopted, say with respect to
depreciation in the two years are different, the profit figures will not be comparable. Because
the method adopted for the valuation of stock in the past two years is inconsistent. It is,
therefore, important that the concept of consistency is followed in preparation of financial
statements so that the results of two accounting periods are comparable.
Convention of Conservatism
The concept of conservatism requires that profits should not to be recorded until realized but
all losses, even those which may have a remote possibility, are to be provided for in the

books of account. This principle takes into consideration all prospective losses but leaves all
prospective profits. The essence of this principle is “anticipate no profit and provide for all
possible losses”. For example, while valuing stock in trade, market price or cost price
whichever is less is considered.
6. How do you prepare final accounts of a trader? Explain.

Final accounts:
These include the following:

Trading Account:
Item written on the debit side
Items written on the credit side
Profit And Loss Account:
Items written on the debit side
Items written on the credit side
Balance Sheet:
Classification of Assets
Classification of Liabilities
Definition and Explanation of Final Accounts:
Every businessman goes into a business with the idea of making profit, which is the reward
of this effort. He tries his best to get more and more profit at the smallest economic cost.
The preparation of the final accounts is not the first stage of an accounting cycle but they are
the final products of the accounting cycle that is why, they are called final accounts.
These accounts summaries all the accounting information recorded in the original books of
entry and the ledger consisted of hundreds of thousands of pages.
The final accounts or financial statements consists of:
1. Trading and profit and loss account or income statement, which is prepare preparedd to know the
profit earned or loss suffered by the business during a specific period.
2. Balance sheet, which is prepared to know the financial position of the business on a
particular date.
These two items or statements are collectively known as ""final final accounts or financial
statements"
Trial Balance - A Starting Point for Final Accounts:
The trial balance is simply a list of ledger accounts balances at the end of an accounting
period. This summary of the ledger at the end of an accounting period, is a convenient
starting point in the preparation of the final accounts i.e. trading and profit and loss account
and balance sheet.

Trading Account:
Definition and Explanation:
The account which is prepared to determine the gross profit or gross loss of a business
concern is called trading account.
It should be noted that the result of the business determined through trading account is not
true result. The true result is the net profit or the net loss which is determined through profit
and loss account. The trading accounting has the following features:
1. It is the first stage of final accounts of a trading concern.
2. It is prepared on the last day of an accounting period.
3. Only direct revenue and direct expenses are considered in it.
4. Direct expenses are recorded on its debit side and direct revenue on its credit side.
5. All items of direct expenses and direct revenue concerning current year are taken into
account but no item relating to past or next year is considered in it.
6. If its credit side exceeds it represents gross profit and if debit side exceeds it shows gross
loss.
Profit and Loss Account:
The account, through which annual net profit or loss of a business is ascertained, is
called profit and loss account. Gross profit or loss of a business is ascertained
through trading account and net profit is determined by deducting all indirect expenses
(business operating expenses) from the gross profit through profit and loss account. Thus
profit and loss account starts with the result provided by trading account.
The particulars required for the preparation of profit and loss account are available from the
trial balance. Only indirect expenses and indirect revenues are considered in it. This account
starts from the result of trading account (gross profit or gross loss). Gross profit is shown on
the credit side of the profit and loss account and gross loss is shown on the debit side of this
account. All indirect expenses are transferred on the debit side of this account and all indirect
revenues on credit side. If the total of the credit side exceeds the debit side, the result is "net
profit" and if the total of the debit side exceeds the total of the credit side, the result is net
loss. As the net profit or net loss of a certain accounting period is determined through profit
and loss account, so its heading is:
Features of Profit and Loss Account:
1. This account is prepared on the last day of an account year in order to determine the net
result of the business.
2. It is second stage of the final accounts.
3. Only indirect expenses and indirect revenues are shown in this account.
4. It starts with the closing balance of the trading account i.e. gross profit or gross loss.
5. All items of revenue concerning current year - whether received in cash or not - and all
items of expenses - whether paid in cash or not - are considered in this account. But no
item relating to past or next year is included in it.
The following is a specimen of profit and loss account
Balance Sheet - Last Stage in Final Accounts:
Balance sheet is a list of the accounts having debit balance or credit balance in the ledger. On
one side it shows the accounts that have a debit balance and on the other side the accounts
that have a credit balance. The purpose of a balance sheet is to show a true and fair financial
position of a business at a particular date. Every business prepares a balance sheet at the end
of the account year. A balance sheet may be defined as:
1. "It is a statement of assets, liabilities and owner's equity (capital) on a particular date".

2. "It is a statement of what a business concern owns and what it owes on a particular
date". What is owns are called assets and what it owes are called liabilities.
3. "It is a statement which discloses total assets, total liabilities and total capital (owner's
equity) of a concern on a particular date".
4. "It is a statement where all the ledger account balances which remain open after the
preparation of trading and profit and loss account, find place".
Balance sheet is so called because it is prepared with the closing balance of ledger accounts at
the end of the year. It has two sides - assets side or left hand side and liabilities side or right
hand side. The accounts have a debit balance are shown on the asset side and those have a
credit balance are shown on the liabilities side and the total of the two sides will agree.
Assets mean all the things and properties under the ownership of the business i.e. building,
plant, furniture, machinery, stock, cash etc. Assets also include anything against which
money or service will be received i.e. creditors accrued income, prepaid expenses etc.
Liabilities means our dues to others or anything against which we are to pay money or render
service, i.e. creditors, outstanding expenses, amount payable to the owner of the business
(capital) etc.
Asset side of the balance sheet indicates the different types of assets owned by a concern,
while liabilities side discloses the various sources through which funds have been obtained in
order to acquire those assets. Balance sheet reveals the financial position of the firm on a
particular date at a point of time, so it is also called "position statement". It is prepared on
the last day of the accounting year and discloses concern for the whole year cannot be
determined through the balance sheet because financial position is ever changing.
Features of Balance Sheet:
Balance sheet has the following features:
1. It is the last stage of final accounts
2. It is prepared on the last day of an accounting year.
3. It is not an account under the double entry system - it is a statement only.
4. It has two sides - left hand side known as asset side and right hand side known as
liabilities side.
5. The total of both sides are always equal.
6. The balances of all asset accounts and liability accounts are shown in it. No expense
accounts and revenue accounts are shown here.
7. It discloses the financial position and solvency of the business.
8. It is prepared after the preparation of trading and profit and loss account because the net
profit or net loss of a concern is included in it through capital account.
Method of Preparation of Balance Sheet:
All the information necessary for the preparation of balance sheet is available from trial
balance and from some other ledger accounts. After transferring accounts relating to expenses
and revenues to trading and profit and loss account, the trail balance contains only the
accounts of assets, liabilities, and capital. All assets have debit balances and all liabilities and
capital have credit balances. The asses are shown on the asset side of the balance sheet and
liabilities and capital are shown on the liabilities side of the balance sheet after arranging
them properly.
Classification of Assets:
Assets may be classified as follows:
Real Assets:
Assets which have some market value are called real assets, e.g. building, machinery, stock,
debtors, cash, goodwill, etc. Real assets are further divided into two types according to their
permanence:

Fixed Assets: Assets which have long life and which are bought for use for a long period of
time are called "fixed assets". These are not bought for selling purposes, e.g. land, building,
plant, machinery, furniture etc. Fixed assets are again sub-divided into two:
1. Tangible Assets: Assets which have physical existence and which can be seen, touched
and felt are called "tangible assets", e.g. building, plant, machinery, furniture etc.
2. Intangible Assets: Assets which have no physical existence and which cannot be seen,
touched or felt are called "intangible assets", e.g. goodwill, patent right, trade mark etc.
Current Assets: Assets which are short-lived and which can be converted into cash quickly
to meet short term liabilities are called "current assets", e.g. stock debtors, cash etc. Such
assets change their form repeatedly and so, they are also known as circulating or floating
assets. For example, on purchase of goods cash is converted into stock and on sale of goods,
stock is converted into debtors, on collection from debtors, debtors take the form of cash etc.
Out of current assets those which can be converted into cash very quickly or which are
already in the form of cash are called liquid or quick assets e.g. debtors, cash in hand, cash at
bank etc.
Fictitious Assets: Assets which have no market value are called fictitious assets. examples of
fictitious assets include preliminary expenses, loss on issue of shares etc. They are also
known as nominal assets.
Besides these, there is another type of assets whose value gradually reduce on account of use
and finally exhaust completely. This type of assets is called wasting assets e.g. mine, forest
etc.
Internal Liabilities:
The total amount of debts payable by a business to its owner is called internal liability e.g.
Owner's equity (capital), reserve etc. From practical view point internal liabilities should not
be regarded as liabilities, since there is no question of meeting such liabilities al long as the
business continues.
External Liabilities:
All debts payable by a business to the outsiders (other than the owner) are called external
liabilities e.g. creditors, debentures, bills payable, bank overdraft, etc. External liabilities are
further divided into two.
Fixed or Long Term Liabilities: The liabilities which are payable after a long period of time
are called fixed or long term liabilities e.g. debentures, loan on mortgage etc.
Current or Short Term Liabilities: The debts which are repayable within a short period of
time are called current or short-term liabilities e.g. creditors, bills payable, bank overdraft etc.
Current liabilities may again be divided into two:
1. Deferred Liabilities: Debts which are repayable in the course of less than one year but
more than one month are called deferred liabilities e.g. Short term loan etc.
2. Liquid or Quick Liabilities: Debts are repayable in the course of a month are called
liquid or quick liabilities e.g. bank overdraft, outstanding expenses, creditors etc.
Besides the above, there is another type of liability which is known as contingent liability. It
is one which is not a liability at present, but which may or may not become a liability in in
future. It depends upon certain future event. For example, suppose, the buyer of goods filed a
suit in the court against the seller claiming damage of $10,000 for breach of contract. This
will be regarded as a contingent liability to the seller until the receipt of the court's order. To
the buyer, this is a contingent asset. Both contingent liability and contingent asset are not
recorded in the balance sheet.

1. Explain the concept of financial statements.

Financial statement analysis

Meaning of financial statement analysis
Financial statement analysis is an analysis that highlights the important relationships in the
financial statements. It focuses on evaluation of past performance of the business firms in
terms of profitability, liquidity, solvency, operational efficiency and growth potentiality.
Financial statement analysis includes the methods used in assessing and interpreting the result
of past performance and current financial position as they relate to particular factors of
interest in investment decisions. Thus, it is an important means of assessing past
perfereamnce and in forecasting and planning future performance.
1. Assessment of past performance: past performance is often a good indicator of future
performance. Therefore, an investor or creditor is interested in the trend of past sales, cost of
goods sold, operating expenses, net income, cash flows and return on investment. These
trends offer a means for judging management's past performance and are possible indicator of
future performance.
2. Assessment of current position: the analysis of current position indicates where the
business stands today. Financial statement analysis shows the current position of the firm in
terms of the types of assets owned by a business firm and the different liabilities due against
the enterprises.
3. Prediction of profitability and growth prospects: the financial statement analysis help
in assessing and predicting the earning prospects and growth rates in earnings which are
used by investors while comparing investment alternatives and other users in judging the
earnings potential of business entries. Investors also consider the risk or uncertainty associate
with the expected return. The decision makes are futuristic are always concerned with the
future. Financial statements which contain the information on past performance are analyzed
interpreted and used as the basis for forecasting the future return and risk.
4. Predication of bankruptcy and failure: financial statement analysis is a significant tool
in assessing and predicting the bankruptcy and probability of business failure. Through the
analysis of the solvency position, the probability of business failure can be predicated to the
greater extent. After such prediction managers and investors both can take some preventive
measures to avoid or minimize losses.
5. Loan decision by banks and financial institutions: financial statement analysis is used
by banks, finance companies, lending agencies, and other to make sound loan or credit
decision. With the help different borrowers. Because it helps in determining credit risks,
deciding terms and condition of loans, interest rates, maturity date, etc.
6. Assessment of the operational, efficiency: financial statement analysis is the tool that
helps to assess the operational efficiency of the management of a company. The actual
performance of the firm which are revealed in the financial statements can be compared
performance can be used as the indicator of efficiency of the management.
7. Simplifying the information: basically, the financial statement analysis further
interprets the information disclosed in the financial statements. It attempts the tools that make
the information readable and understandable even the average types of users. For this
purpose, the information is analyzed in rations, trend percentages, graphs, diagrams, etc.
Importance of financial statement
analysis can be summarized as follows:

i. Helpful in planning and decision making.

ii. Helps in the evaluation of performance.
iii. Helps in the diagnosis of managerial and operating problems.
iv. Helpful to the bankers for credit decision.
v. Basis for tax calculations.
vi. Helps the government to formulate polices.
vii. Basis of controlling.
Limitations of the financial statement analysis
The following are the limitations of financial statement analysis:
i. It ignores the qualitative aspects of the business.
ii. The analysis is not free the business of the analysts.
iii. Accurate comparison may not be possible if the companies have followed different
accosting principles.
iv. Financial statement analysis only identifies/ diagnoses the problems but cannot suggest
the solutions.
v. It is not possible to adjust the effect of the price level changes in the analysis of financial
statements.
vi. There is the change of wrong analysis and misleading to the users.
Parties interested in financial statement analysis
The users of accounting information can be divided into two parties' namely internal and
external parties.
1. Internal parties: the internal parties of the accounting information are concerned with
the management of the concern. They need financial statement so as to perform the different
organizational activities properly and smoothly and achieve the objectives. Such activities are
planning, policy making, implementing, controlling etc. the internal uses of accounting
information might be:
• Directors
• Partners
• Managers
• Officers Etc.
2. External parties: the external parties are not directly involved in the management and
operation of a concern and they are external to the organization. They are closely associated
with the concern. They are:
a. Present as well as potential stockholder: a present stockholder needs accounting
information so that he/ she can decide whether to continue to hold the stock or sell it. On the
other hand a potential stockholder needs the financial information to choose among
competing alternative investments.
b. Bondholders, bankers and other creditors: a potential bondholder wants to be ensured
that the company will be able to pay back the amount owed at maturity and the periodic
interest payments. Similarly, a bank needs financial information that will help it to determine
the company's ability to pay the principle as well as interest. Other creditors also want the
assurance of their claims on due date and make them interested on the financial information.
c. Government agencies: the government needs financial information to decide on
permitting contraction or expansion of business, import/ export etc. in many cases, it becomes

mandatory for the business to submit

bmit its financial information to different government
agencies as prescribed by law.
d. Other external users: many other individuals and groups rely on financial information
provides by business. They are:
e. Public: the public needs financial information
information to know about the employment
opportunities, discharge of responsibility towards the society etc.
f. Employees: the employees are interested in financial information since their present as
well as future is associated with the concern.
g. Suppliers: when the suppliers sell the goods in credit, they want the payment on time.
6. What is Financial Analysis? Explain the techniques and types of financial statement
analysis.
Financial Analysis:
I. Introduction
Financial Analysis is the process of identifying the financial strength and weaknesses of the
firm by properly establishing relationship between items of financial statements. A financial
statement is an organized collection of data according to logical an and
d conceptual framework.
Consistent accounting procedure. Its purpose is to convey an understanding of some financial
aspects of a business firm. It may show a position at a moment of time as time, as in the case
of an income statement.
Financial performance refers to the act of performing financial activity. In broader
sense, financial performance refers to the degree to which financial objectivities being or has
been accomplished. It is the process of measuring the results of firm’s policies and operations
in monetary terms. It is used to measure firms over all financial health over a given period of
time.
Meaning and Definition of Financial Statement Analysis
"Financial statements should be understandable, relevant, reliable and comparable. Reported
Re
assets, liabilities, equity, income and expenses are directly related to an organization's
financial position.
FINANCIAL STATEMENT ANALYSIS
Financial statements are the summaries of the operating, financing and investment activities
of business. It must give useful information for investors and creditors in making investment,
credit and other business decisions (Pamela, 1999). Financial statement analysis in
accounting arena is effectual device for different users of financial statements, each havinhaving
dissimilar objectives to learn about the financial circumstances of the unit.
Financial statements are developed to take wise decisions for company. Financial
statement analysis compares ratios and trends calculated from data found on financial
statements. Financial ratios permit experts to compare output of busine
business
ss to industry averages
or to specific competitors. These comparisons assist recognize financial vigour and flaws.
The term 'financial analysis' also termed as 'analysis and interpretation of financial
statements', denotes to the process of determining fin financial
ancial strengths and limitations of the
company by establishing strategic affiliation between the items of the balance sheet, P&L A/c
and other operative data. It is the combined name for the tools and techniques that gives
significant information to decision
ion makers.
Techniques and types of financial analysis:

TYPES OF FINANCIAL STATEMENT ANALYSIS

Two types of analysis are undertaken to interpret the position of an enterprise.
They are
1. Vertical analysis 2. Horizontal analysis
The companies act, 1956 permits the companies to present the financial statements in vertical
as well as horizontal form.
VERTICAL ANALYSIS:
It is the analysis of relationship as between different individual components. It s also the
analysis between these se components. It is also the analysis between these components and
their totals for a given period of time it is also regarded as static analysis. Comparison of
current assets to current liabilities or comparisons of debt to equity for one point of time aare
examples of vertical analysis. Thus, the vertical analysis can be made in the following ways
Horizontal analysis:
It is the analysis of changes in different components of the financial statements over different
periods with help of a series of stateme
statements.
nts. Such an analysis makes it possible to study
periodic fluctuations in different components of the financial statements. Study of trends in
debt or share capital or their relationship over the past 10 year’s period or study of
profitability trends for a period of 5 or 10 years.
Techniques/Tools of Financial Statement Analysis

A financial analyst can adopt the following tools for analysis of the financial statements.
These are also termed as methods or techniques of financial analysis.
A. Comparative financial statements
B. Common size statements
C. Trend analysis
D. Ratio analysis
E. Funds flow analysis

F. Cash flow analysis

Comparative financial statements: comparative study of financial statements is the
comparison of the financial statements of the business with the preceding year's financial
statements. It facilitates detection of weak points and applying remedial measures.
Practically, two financial statements (balance sheet and income statement) are prepared in
comparative form for analysis purposes.
Common size statements and trend analysis: The common size statements (Balance Sheet
and Income Statement) are revealed in analytical percentages. The figures of these statements
are shown as percentages of total assets, total liabilities and total sales correspondingly. A
statement where balance sheet items are expressed in the ratio of each asset to total assets and
the ratio of each liability is expressed in the ratio of total liabilities is called common size
balance sheet. Thus the common size statement may be prepared in the following way.
Trend analysis: Trend analysis appraises an organization's financial information over a
period of time. Periods may be measured in months, quarters, or years, depending on the
circumstances. The objective is to compute and analyse the amount change and percent
change from one period to the next. For calculating the percentage change between two
periods, calculate the amount of the increase (or decrease) for the period by subtracting the
earlier year from the later year. If the difference is negative, the change is a decrease and if
the difference is positive, it is an increase. Divide the change by the earlier year's balance.
The result is the percentage change. To calculate the change over a longer period of time,
select the base year. For each line item, divide the amount in each non base year by the
amount in the base year and multiply by 100.
Ratio analysis: Ratio Analysis is used to get a fast indication of a firm's financial
performance in major areas. It is a process of determining and interpreting numerical
relationship based on financial statement. It is a technique of interpretation of financial
statement with the help of accounting ratios derived from the balance sheet and profit and
loss account. The ratios are categorized as Short-term Solvency Ratios, Debt Management
Ratios, Asset Management Ratios, Profitability Ratios, and Market Value Ratios.
Funds flow analysis: Fund flow analysis is associated with more specific information as
compared to the wide range of ratio metrics. Fund flow analysis reveals information about the
inflows and outflows of capital for a specific period of time. Fund flow analysis may disclose
why certain ratio valuations are relatively high or low in a company by digging down into the
actual movement of cash and assets into and out of a company. Fund flow analysis involves
creating fund flow statements that match capital inflows with outflows.
Cash flow analysis: Cash flow statement represents inflow and outflow of funds. It is
important tool for short term analysis.
7. Explain the Difference betweenfunds flow statement and cash flow statement.
8. What is cash flow statement? Explain the features and objectives.
Meaning of Cash Flow Statement:

A cash flow statement is a statement of changes in the financial position of a firm on cash
basis.

It reveals the net effects of all business transactions of a firm during a period on cash and
explains the reasons of changes in cash position between two balance sheet dates.
It shows the various sources (i.e., inflows) and applications (i.e., outflows) of cash during a
particular period and their net impact on the cash balance.
According to Khan and Jain:
“Cash Flow statements are statements of changes in financial position prepared on the basis
of funds defined as cash or cash equivalents.”
The Institute of Cost and Works Accountants of India defines Cash Flow statement as “a
statement setting out the flow of cash under distinct heads of sources of funds and their
utilisation to determine the requirements of cash during the given period and to prepare
for its adequate provision.”
Thus, a cash flow statement is a statement which provides a detailed explanation for the
changes in a firm’s cash balance during a particular period by indicating the firm’s sources
and uses of cash and, ultimately, net impact on cash balance during that period.
Features of Cash Flow Statement:
The features or characteristics of Cash Flow Statement may be summarised in the
following way:
1. It is a periodical statement as it covers a particular period of time, say, month or year.
2. It shows movement of cash in between two balance sheet dates.
3. It establishes the relationship between net profit and changes in cash position of the firm.
4. It does not involve matching of cost against revenue.
5. It shows the sources and application of funds during a particular period of time.
6. It records the changes in fixed assets as well as current assets.
7. A projected cash flow statement is referred to as cash budget.
8. It is an indicator of cash earning capacity of the firm.
9. It reflects clearly how financial position of a firm changes over a period of time due to its
operating activities, investing activities and financing activities.
Objectives of Cash Flow Statement:
Cash Flow Statement is prepared to fulfill some objectives.
Some of the main objectives of Cash Flow Statement are:
1. It shows the cash earning capacity of the firm.
2. It indicates different sources from which cash been collected and various purposes for
which cash has been utilised during the year.
3. It classifies cash flows during the period from operating, investing and financing activities.
4. It gives answers to various perplexing questions often encountered by management, such
as why the firm is unable to pay dividend instead of making enough profit? Why is there
huge idle cash balance in spite of loss suffered? Where have the proceeds of sale of fixed
assets gone? etc.
5. It helps the management in cash planning and control so that there are no shortage or
surplus of cash at any point of time.
6. It evaluates the ability of the firm to meet obligations such as loan repayment, dividends,
taxes etc.
7. A prospective investor consults the cash flow statement to ensure that his investment gets
regular returns in future.
8. It discloses the reasons for differences among net income, cash receipts and cash
payments.
9. It helps the management in taking capital budgeting decisions more scientifically.
10. It ensures optimum use of funds for the maximum benefit of the enterprise.
9. How do you classify cash flows? Explain briefly.

Cash Flow Activities

A. Financing activities
B. Operating activities
C. Investing activities
Cash flow analysis:

In financial accounting, a cash flow statement, also known as statement of cash flows, is
a financial statement that shows how changes in balance sheet accounts and income
affect cash and cash equivalents, and breaks the analysis down to operating, investing and
financing activities.
People and groups interested in cash flow statements include:
● Accounting personnel
● Potential lenders or creditors
● Potential investors
● Potential employees or contractors
● Shareholders of the business.
Purpose
The cash flow statement is intended to
● provide information on a firm's liquidity and solvency
● provide additional information for evaluating changes in assets, liabilities and equity
● improve the comparability of different firms' operating performance
● indicate the amount, timing and probability of future cash flows
Cash Flow Activities
The cash flow statement is partitioned into three segments, namely:
● Cash flow resulting from operating activities;
● Cash flow resulting from investing activities;
● Cash flow resulting from financing activities.
The money coming into the business is called cash inflow, and money going out from the
business is called cash outflow.
Operating activities
Operating activities include the production, sales and delivery of the company's product as
well as collecting payment from its customers.

● Receipts for the sale of loans, debt or equity instruments in a trading portfolio
● Interest received on loans
● Payments to suppliers for goods and services
● Payments to employees or on behalf of employees
● Interest payments
● Buying Merchandise
Investing activities
Investing activities are
● Purchase or Sale of an asset (assets can be land, building, equipment, marketable
securities, etc.)
● Loans made to suppliers or received from customers
● Payments related to mergers and acquisition.
Financing activities
Financing activities include the inflow of cash from investors such as banks and shareholders,
as well as the outflow of cash to shareholders as dividends as the company generates income.
● Payments of dividends
● Payments for repurchase of company shares
● For non-profit organizations, receipts of donor-restricted cash that is limited to long-term
purposes
● Items under the financing activities section include:
● Dividends paid
● Sale or repurchase of the company's stock
10. Explain the concept of funds flow statement

Fund Flow Statement
Definition: Fund Flow Statement implies a snapshot of the movement of funds, i.e. inflow or
outflows of the firm’s financial assets for a specific period. It represents, “from where the
funds are received and where the funds are utilised” by the company during a particular
period.
The word ‘fund‘ refers to a sum of money, which is used to finance the firm’s day to day
operations and acquire assets for the business. The flow of funds represents the movement of
funds, i.e. the change in economic resources, from one asset or liability to another. In this
way, the fund flow statement implies a method of analysing the changes in the firm’s
financial position, between two balance sheet dates.
Fund flow statement is useful in knowing the changes in the structure of assets, liabilities and
capital. It shows whether the sources of funds coincides with its application and indicates the
accuracy of a firm’s financing and investment decisions. Unlike the cash flow statement,
which is prepared on a cash basis, the fund flow statement is prepared on an accrual basis.
Preparation of Fund Flow Statement
● Step 1: Preparation of Statement of Changes in Working Capital: Statement of Changes
in working capital is a summary that shows the net increase or decrease in the working capital
of the business.
The working capital of the firm increases if there is an increase in the current assets or
decrease in the current liabilities. However, the working capital of the firm decreases if there
is a decrease in the current assets and an increase in the current liabilities.
Further, there will be no change in the working capital if there is a realization from debtors or
bills receivable or payment made to creditors or bills payable, goods are sold on credit and
goods are purchased on credit.

● Step 2: Determination of Funds from Operations: Funds from operations refers to the
profit earned or loss incurred from the regular business operation. The ascertainment of funds
from the operation is vital for the preparation of fund flow statement.
● Step 3: Preparation of Fund Flow Statement: After recognizing the funds/loss from
operations, fund flow statement is prepared, which will show the net increase or decrease in
the working capital.

Basically, any change in the assets and liabilities may result in the inflows and outflows of
funds, but not always, as in case of depreciation or revaluation of assets, there is no inflow or
outflow of funds. Hence, only those assets or liabilities will become a part of the statement,
which actually leads to the flows of tthe fund to/from the business.
11. What are the costing methods and techniques? Explain.
Meaning and Scope of Cost Accountancy
The term cost accountancy is wider than the term cost accounting. According to the
Terminology of Management and Financial Accountancy Published by the Chartered Institute
of Management Accountants, London, cost accountancy means, “the application of costing cost
and cost accounting principles, methods and techniques to the science, art and practice of cost
control. It includes the presentation of information derived there from for the purpose of
managerial decision making.
Cost Accounting
Cost accounting is the he process of accounting for costs. It embraces the accounting
procedures relating to recording of all income and expenditure and the preparation of
periodical statements and reports with the object of ascertaining and controlling costs. It is
thus the formal
ormal mechanism by means of which costs of products or services are ascertained
and controlled.
Costing
Costing is “the technique and process of ascertaining costs.” Cost accounting is different
from costing in the sense that the former provides only the basis and information for
ascertainment of cost.
Costing methods and techniques

Methods of Costing
• Job Costing
• Contract Costing
• Batch Costing
• Process Costing
• Service (Operating) Costing
• Operation Costing
• Multiple Costing
Job Costing:
Job costing is concerned with the finding of the cost of each job or work order.
This method is followed by these concerns when work is carried on by the customer’s
request, such as printer general engineering work shop etc. under this system a job cost
sheet is required to be prepared find out profit or losses for each job or work order.
Examples: Painting, Car repair, Decoration, Repair of building etc.
Contract Costing:
Contract costing is applied for contract work like construction of dam building civil
engineering contract etc. each contract or job is treated as separate cost unit for the cost
ascertainment and control.
This is also known as Terminal Costing. Construction of bridges, roads, buildings, etc. comes
under contract costing.
Batch Costing:
A batch is a group of identical products. Under batch costing a batch of similar products is
treated as a separate unit for the purpose of ascertaining cost.
The total costs of a batch are divided by the total number of units in a batch to arrive at the
costs per unit.
This type of costing is generally used in industries like bakery, toy manufacturing etc.
Process Costing:
This method is used in industries where production is carried on through different stages or
processes before becoming a finished product.
Costs are determined separately for each process. The main feature of process costing is that
output of one process becomes the raw materials of another process until final product is
obtained.
This type of costing is generally used in industries like textile, chemical paper, oil refining
etc.
For example, manufacturing cloths goes through different process.
Service (Operating) Costing:
This method is used in those industries which rendered services instead of producing goods.
Under this method cost of providing a service is also determined. It is also called service
costing.
The organisation like water supply department, electricity department etc. are the examples of
using operating costing.
In the case of a Nursing Home, a unit is treated as the cost of a bed per day and for buses
operating cost for a kilometer is treated as a unit.
Operation Costing:
This is suitable for industries where production is continuous and units are exactly identical
to each other.
This method is applied in industries like mines or drilling, cement works etc.

Under this system cost sheet is prepared to find out cost per unit and profits or loss on
production.
Multiple Costing:
It means combination of two or more of the above methods of costing.
Where a product comprises many assembled parts or components (as in case of motor car)
costs have to be ascertained for each component as well as for the finished product for
different components, different methods of costing may be used.
Techniques of costing:
• Marginal Costing
• Standard Costing
• Historical Costing
• Direct Costing
• Absorption Costing
Marginal Costing:
It is the ascertainment of marginal cost by differentiating between fixed and variable cost. It
is used to ascertain the effect of changes in volume or type of output on profit.
Standard Costing:
A comparison is made of the actual cost with a pre-arranged standard cost and the cost of any
deviation (called variances) is analyzed by causes.
This permits the management to investigate the reasons for these variances and to take
suitable corrective action.
Historical Costing:
It is ascertainment of costs after they have been incurred.
It aims at ascertaining costs actually incurred on work done in the past.
It has a limited utility, though comparisons of costs over different periods may yield good
results.
Direct Costing:
It is the practice of charging all direct costs, variable and some fixed costs relating to
operations, processes or products leaving all other costs to be written off against profits in
which they arise.
Absorption Costing:
It is the practice of charging all costs, both variable and fixed to operations, processes or
products.
This differs from marginal costing where fixed costs are exclude.
12. Explain the differences between cost accounting and financial accounting and
management accounting.

13. Discuss the classification of costs.

Costs can be classified based on the following attributes:
Costs can be classified based on the following attributes:

The following points highlight the five main types of classification of costs. The types are: 1.
Cost Classification by Nature 2. Cost Classification in Relation to Cost Centre 3. Cost
Classification by Time 4. Cost Classification for Decision Making 5. CostCost Classification by
Nature of Production Process.

Cost Classification by Element:

The total cost of a product or service is basically classified into material cost, labour cost and
expenses as follows:
i. Material Cost:
It is the cost of material of any nature used for the purpose of production of a product or a
service. Material cost includes cost of procurement, freight inwards, taxes and duties,
insurance etc. directly attributable to the acquisition. Trade discounts, rebates, duty
drawbacks, refunds on account of modvat, cenvat, sales tax and other similar items are
deducted in determining the costs of material.
ii. Labour Cost:
Labour cost includes salaries and wages paid to permanent employees, temporary employees
and also to employees of the contractor.
The labour cost can be analyzed into the following:
a. Monetary benefits payable immediately:
Salaries and wages, dearness and other allowances, production incentive or bonus.
b. Monetary benefits after sometime in future:
Employer’s contribution to P.F., E.S.I., Pension etc. Gratuity, Profit linked bonus.
c. Non-monetary benefits (fringe benefits):
Free or subsidized food, free medical or hospital facilities, free or subsidized education to the
employees children, free or subsidized housing etc.
iii. Expenses:
These are the costs other than material cost or labour cost which are involved in an activity.
Expenditure on account of utilities, payment for bought-out services, job processing charges
etc. can be termed as expenses.
Cost Classification by Nature:
The elements of cost can be studied under the classification direct and indirect costs. If the
object of interest for identifying and measuring cost is to determine how much sacrifice is
involved in manufacturing a particular product, then initially one can define the three
elements of total cost i.e., materials, labour, and expenses.
i. Direct Costs:
The direct costs are those which can be identified easily and indisputably with a unit of
operation or costing unit or cost centre. Costs of direct material, direct labour and direct
expenses can be directly allocated or identified with a particular cost centres or a cost unit
and can be directly charged to such cost centre or cost unit. These costs are also called
‘traceable costs’.
ii. Direct Material:
The direct material costs are those which can be identified easily and indisputably with a unit
of operation or costing unit or cost centre. The direct material cost can be directly allocated or
identified with particular cost centres or cost units and can be directly charged to such cost
centres or cost units.
Raw materials are directly identifiable as part of the final product and are classified as direct
materials. For example, wood used in production of tables and chairs, steel bars used in steel
factory etc. are the direct materials that becomes part of the finished product.
iii. Direct Labour:
The labour cost incurred on the employees who are engaged directly in making the product,
their work can be identified clearly in the process of converting the raw materials into
finished product is called ‘direct labour cost’.
For example, wages paid to the workers engaged in machining department, fabrication
department, assembling department etc.
iv. Direct Expenses:

The direct expenses refers to expenses that are specifically incurred and charged for specific
or particular job, process, service, cost unit or cost centre. These expenses are also called
‘chargeable expenses’.
Some of the examples of direct expenses include the following:
(1) Cost of drawings, designs and layout.
(2) Royalties payable on use of patents copyrights etc.
(3) Hire charges of special tools and equipment for a particular job or work.
(4) Architects, surveyors and other consultation fees of particular job or work.
Sometimes, if the direct expenses are negligible or small amount, it will be treated as
overhead.
v. Indirect Costs:
Indirect costs cannot be allocated but which can be apportioned to cost centres or cost units.
These costs are also called as ‘common costs’. The indirect costs are not traceable to any
plant, department, operation or to any individual final product. All overhead costs are indirect
costs.
Costs of indirect material, indirect labour and indirect expenses in aggregate constitute the
overhead costs and are the indirect component of the total cost. Indirect costs cannot be
directly allocated to cost units or cost centres and have to be absorbed or recovered into cost
units.
vi. Indirect Material:
The costs incurred on materials used to further the manufacturing process, which cannot be
traced into the end product and the material required in the production process but not
necessarily built into the product are called ‘indirect material’.
For example cutting oil used in cutting surface, threads and buttons used in stitching clothes,
lubricants used in maintenance of plant and machinery, cotton waste used in cleaning the
machinery etc. are considered as indirect materials.
Sometimes indirect materials like coal, fuel used in kilns etc. are considered as part of the
prime cost and some materials which are contained in small quantities in the end product like
gums and threads used in binding the books even though forming part of direct material cost,
but is considered not worth analyzing to cost units and may be categorized as indirect
material cost.
vii. Indirect Labour:
The cost of indirect labour consist of all salaries and wages paid to the staff for the purpose of
carrying and tasks incidental to goods or services provided which will not form part of
salaries and wages paid in working directly upon the product.
For example, salaries and wages paid to store keepers, watch and ward, supervisors,
timekeepers, quality control, managers, clerical staff, salesmen etc. These indirect labour
costs cannot be identified with any particular job, process, cost unit or cost centre.
viii. Indirect Expenses:
Indirect expenses are those which are incurred by the organization in carrying out their total
business activities and cannot be conveniently allocated to job, process, cost unit or cost
centre. Rent, rates, taxes, insurance, lighting, telephone, postage and telegrams, depreciation
etc. are the examples of indirect expenses.
The concepts of direct and indirect costs are meaningless without identification of the
relevant cost unit or cost centre. Segregation of costs into direct and indirect costs is essential
for proper accounting and control of costs and also for managerial decision making purpose.
Advanced manufacturing technologies such as Robotics, Computer Aided Design and
Manufacture, Flexible Manufacturing Systems, Optimized Production Technology, Just-in-
Time etc., are revolutionizing the manufacturing process at shop-floor, quality and creating

areas for improved opportunities. They have dramatically changed the manufacturing cost
behaviour patterns.
The direct cost component of product cost is decreasing while depreciation, engineering and
information processing costs are increasing. These changes have resulted in higher overhead
rates and a shrinking base of direct costs over which to allocate those costs.
Cost Classification by Time:
i. Historical Cost:
The historical cost is the actual cost, determined after the event. Historical cost valuation
states costs of plant and materials, for example, at the price originally paid for them.
Costs reported by conventional financial accounts are based on historical valuations. But
during periods of changing price levels, historical costs may not be correct basis for
projecting future costs. Naturally historical costs must be adjusted to reflect current or future
price levels.
ii. Predetermined Cost:
These costs relating to the product are computed in advance of production, on the basis of a
specification of all the factors affecting cost and cost data. Predetermined costs may be either
standard or estimated.
iii. Standard Cost:
It is a predetermined calculation of how much costs should be under specified working
conditions. It is built up from an assessment of the value of cost elements and correlates
technical specifications and the quantification of materials, labour and other costs to the
prices and/or usage rates expected to apply during the period in which the standard cost is
intended to be used.
iv. Estimated Cost:
It is a predetermined cost based on past performance adjusted to the anticipated changes. No
minute appraisal of each individual component cost. It can be used in any business situation
or decision making which does not require accurate cost.
It is used in budgetary control system and historical costing system. Its emphasis is on the
level of costs not to be exceeded. It is used in decision making and selection of alternative
with maximum profitability. It is also used in price fixation and tendering. It is determined
generally for the period.
Cost Classification for Decision Making:
For the managerial decision making the cost data can be analyzed keeping in view the
following cost concepts:
i. Marginal Cost:
The term ‘marginal cost’ is defined 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. It
is a variable cost of one unit of a product or a service i.e., a cost which would be avoided if
that unit was not produced or provided.
ii. Differential Cost:
It is also known as ‘incremental cost’. It is the difference in total cost that will arise from the
selection of one alternative to the other. It is an added cost of a change in the level of activity.
This concept is similar to the economists’ concept of marginal cost which is defined as the
additional cost incurred by producing one more unit of product. It refers to any kind of
change like add or drop a new product/existing product, changing distribution channels, add
or drop business segments, adding new machinery, sell or process further, accept or reject
special orders etc.
iii. Opportunity Cost:
It is the value of a benefit sacrificed in favour of an alternative course of action. It is the
maximum amount that could be obtained at any given point of time if a resource was sold or

put to the most valuable alternative use that would be practicable. Opportunity cost of good
or service is measured in terms of revenue which could have been earned by employing that
good or service in some other alternative uses.
iv. Relevant Cost:
The relevant cost is a cost appropriate in aiding to make specific management decisions.
Business decisions involve planning for future and consideration of several alternative
courses of action. In this process the costs which are affected by the decisions are future
costs. Such costs are called relevant costs because they are pertinent to the decisions in hand.
v. Sunk Cost:
The sunk cost is one for which the expenditure has taken place in the past. This cost is not
affected by a particular decision under consideration. Sunk costs are always results of
decisions taken in the past. This cannot be changed by any decision in future. The sunk costs
are those costs that have been invested in a project and which will not be recovered if the
project is terminated.
The sunk cost is one for which the expenditure has taken place in the past. This cost is not
affected by a particular decision under consideration. Sunk-costs are always results of
decisions taken in the past;-This cost cannot be changed by any decision in future. Investment
in plant and machinery as soon as it is installed, its cost is sunk cost and is not relevant for
decisions.
vi. Replacement Cost:
The replacement cost is a cost at which material identical to that is to be replaced could be
purchased at the date of valuation (as distinct from actual cost price at the date of purchase).
The replacement cost is a cost of replacing an asset at any given point of time either at
present or in the future (excluding any element attributable to improvement).
vii. Normal Cost:
The normal cost is normally incurred at a given level of output in the conditions in which that
level of output is achieved. Normal cost includes those items of cost which occur in the
normal situation of production process or in the normal environment of the business. The
normal idle time is to be included in the ascertainment of normal cost.
viii. Abnormal Cost:
It is an unusual or a typical cost whose occurrence is usually irregular and unexpected and
due to some abnormal situation of the production. Abnormal cost arises due to idle time for
some heavy break down or abnormal process loss. They are not considered in the cost of
production for decision making and charged to Profit and Loss Account.
ix. Avoidable Cost:
The avoidable costs are those costs which under given conditions of performance efficiency
should not have been incurred. Avoidable costs are logically associated with some activity or
situation and are ascertained by the difference of actual cost with the happening of the
situation and the normal cost.
x. Unavoidable Cost:
The unavoidable costs are ‘inescapable costs’ which are essentially to be incurred, within the
limits or norms provided for. It is the cost that must be incurred under a program of business
restriction. It is fixed in nature and inescapable.
xi. Pre-Production Cost:
The costs incurred prior to the starting of commercial production are called as ‘pre-
production costs’. These costs include preliminary expenses, trail run costs etc. These costs
are incurred from the initiation of project till its formal commercial production.
When a new factory is in the process of establishment or a new product line or product is
taken-up, a new project is undertaken, but the commercial operations have not started, during
such period all costs incurred are considered as pre-production costs and are treated as

deferred revenue expenditure except the costs which have been capitalized. Such deferred
expenses are charged to future production.
xii. Product Cost:
The product cost is aggregate of costs that are associated with a unit of product. Such costs
may or may not include an element of overheads depending upon the type of costing system
in force – absorption or direct. Product costs are related to goods produced or purchased for
resale and are initially identifiable as part of inventory.
These product or inventory costs become expenses in the form of cost of goods sold only
when the inventory is sold. Product cost is associated with unit of output. The costs of inputs
in forming the product viz., the direct material, direct labour, factory overhead constitute the
product costs.
xiii. Period Cost:
The period cost is a cost that tends to be unaffected by changes in level of activity during a
given period of time. Period cost is associated with a time period rather than manufacturing
activity and these costs are deducted as expenses during the current period without previously
classified as product costs. Selling and distribution costs are period costs and are deducted
from the revenue without their being regarded as part of the inventory cost.
xiv. Traceable Cost:
The traceable costs are those which can be identified easily and indisputably with a unit of
operation or costing unit or cost centre. Costs of direct material, direct labour and direct
expenses can be directly allocated or identified with particular cost centres or cost units and
can be directly charged to such cost centres or cost units.
xv. Common Cost:
The common costs cannot be allocated but which can be apportioned to cost centres or cost
units. The indirect costs are not traceable to any plant, department, operation or to any
individual final product. All overhead costs are indirect costs. Cost of indirect material,
indirect labour and indirect expenses in aggregate constitute the overhead costs and are the
indirect component of the total cost.
xvi. Controllable Cost:
The controllable cost is a cost chargeable to a budget or cost centre, which can be influenced
by the actions of the person in whom control of the centre is vested. It is always not possible
to predetermine responsibility, because the reason for deviation from expected performance
may only become evident later.
For example excessive scrap may arise from inadequate supervision or from latent defect in
purchased material. The controllable cost is a cost that can be influenced and regulated during
a given time span by the actions of a particular individual within an organization.
xvii. Uncontrollable Cost:
These costs cannot be influenced by the action of a specified member of the organization.
The controllability of cost depends upon the level of responsibility under consideration.
Direct costs are generally controllable by the shop level management. The uncontrollable cost
is a cost that is beyond the control (i.e., uninfluenced by actions) of a given individual during
a given period of time.
xviii. Short-Run Cost:
The short-run costs are costs that vary with output when fixed plant and capital equipment
remain the same and become relevant when a firm has to decide whether or not to produce
more in the immediate future.
xix. Long-Run Cost:
The long-run costs are those which vary with output when all input factors including plant
and equipment vary and become relevant when the firm has to decide whether to setup a new
plant or to expand the existing one.

xx. Past Cost:

The past costs are actual costs incurred in the past and are generally contained in the financial
accounts. These costs report past events and the time lag between event and its reporting
makes the information out of date and irrelevant for decision-making. These costs will just
act as a guide for future course of action.
xxi. Future Cost:
The future costs are costs expected to be incurred at a later date and are the only costs that
matter for managerial decisions because they are subject to management control. Future costs
are relevant for managerial decision making in cost control, profit projections, appraisal of
capital expenditure, introduction of new products, expansion programs and pricing etc.
xxii. Explicit Cost:
These costs are also called as ‘out of pocket costs’. The explicit cost is a cost that will
necessitate a corresponding outflow of cash. These costs involve cash outlay or payment to
other parties. Explicit costs are relevant in some decision making problems such as
fluctuation of prices during recession, make or buy decisions etc. These costs are recorded in
the books of account and can be easily measured.
xxiii. Implicit Cost:
These costs are also called as ‘imputed costs’ or ‘notional costs’. The implicit cost is a cost
which doesn’t involve actual cash outlay, which are used only for the purpose of decision
making and performance evaluation. Interest on capital is common type of implicit cost. No
actual payment of interest is made but the basic concept is that, had the funds been invested
elsewhere they would have earned interest.
Thus, implicit costs are a type of opportunity costs which cannot be recorded in the books of
account but are important for certain types of managerial decisions such as replacement of
equipment, evaluation of profitability of two alternative courses of action.
xxiv. Book Cost:
The book costs are those which do not require current cash payments. Depreciation, is a
notional cost in which no cash transaction is involved. Book costs can be converted into out
of pocket costs by selling the assets and having them on hire. Rent would then replace
depreciation and interest.
xxv. Shutdown Cost:
The shutdown costs are the costs incurred in relation to the temporary closing of a department
/ division / enterprise. Such costs include those of closing, as well as, those of reopening. The
shutdown costs are defined as those costs which would be incurred in the event of suspension
of the plant operation and which would be saved if the operations are continued.
Examples of such costs are costs of sheltering the plant and equipment and construction of
sheds for storing exposed property. Further, additional expenses may have to be incurred
when operations are restored e.g., reemployment of workers may involve cost of recruitment
and training.
xxvi. Abandonment Cost:
The abandonment cost is the cost incurred in closing down a department or a division or in
withdrawing a product or ceasing to operate in a particular sales territory etc. The
abandonment costs are the cost of retiring altogether a plant from service. Abandonment
arises when there is a complete cessation of activities and creates a problem as to the disposal
of assets.
xxvii. Urgent Cost:
The urgent costs are those which must be incurred in order to continue operations of the firm.
For example, cost of material and labour must be incurred if production is to take place.
xxviii. Postponable Cost:

The postponable cost is that cost which can be shifted to the future with little or no effect on
the efficiency of current operations. These costs can be postponed at least for some time, e.g.,
maintenance relating to building and machinery.
xxix. Conversion Cost:
It is the cost incurred to convert raw materials into finished goods. It is the sum of direct
wages, direct expenses and manufacturing overheads.
Cost Classification by Nature of Production Process:
Depending on the nature of production process, the cost can be classified into the following:
1. Batch Cost:
It is the aggregate cost related to a cost unit which consists of a group of similar articles
which maintain its identity throughout one or more stages of production.
2. Process Cost:
When the production process is such that goods are produced from a sequence of continuous
or repetitive operations or processes, the cost incurred during a period is considered as
process cost. The process cost per unit is derived by dividing the process cost by number of
units produced in the process during the period. Accounts are maintained for cost of a process
for a period. The average cost per unit produced during the period is process cost per unit.
3. Operation Cost:
It is the cost of a specific operation involved in a production process or business activity.
When there are distinctly separate operations involved in a process, cost for each operation is
found out for effective control mechanism.
4. Operating Cost:
It is the cost incurred in conducting a business activity. Operating costs refer to the cost of
undertakings which do not manufacture any product but which provide services.
5. Contract Cost:
It is the cost of a contract with some terms and conditions of adjustment agreed upon between
the contractee and the contractor. Contract cost usually implied to major long- term contracts
as distinct from short-term job costs. Escalation clause is sometimes provided in the contract
in order to take care of anticipated change in material price, labour cost etc.
6. Joint Cost:
These are the common costs of facilities or services employed in the output of two or more
simultaneously produced or otherwise closely related operations, commodities or services.
When a production process is such that from a set of same input, two or more distinguishably
different products are produced together, products of greater importance are termed as joint
products and products of minor importance are termed as by-products and the costs incurred
prior to the point of separation of the products are termed as joint costs.
For example, in a petroleum refinery industry, petrol, diesel oil, kerosene oil, naptha, tar etc.
are produced jointly in the refinery process. By-product cost is the cost assigned to the by -
products.
14. What is cost accounting? Explain the importance and objectives.
Concepts of cost accounting
Cost accounting is a branch of accounting that has evolved to overcome the limitations of
financial accounting. It is the process of accounting for cost, which is concerned more with
the ascertainment, allocation, distribution and accounting aspects of cost. It is that branch of
accounting, which deals with the classification, recording, allocation, summation and
reporting of current and prospective costs. Actually, it is the formal mechanism by means of
which of products and services are ascertained and controlled.
It is an internal reporting systems that aims to assist the management for planning and
decision-making it primary emphasizes on cost and deals with collection, analysis,
interpretation and prospective for managerial decision making on various business problems.

Cost accounting is more concerned with short-tem planning and its reporting period is much
losses that financial accounting. It deals with historic data but is also futuristic in approach.
Cost accounting systems cannot be installed without proper financial accounting systems.
Each organization can develop a costing systems best suited to its individual needs. In
financial accounting the major emphasis is in cost classification based on types of transaction
e.g., salaries, repairs, insurance, stores etc. but in cost accounting, the emphasis is laid on
functions, activities, processes and on internal planning and control and information needs of
the organization.
Similarly, according to national association of accountants USA'
From the above information definition, it can be concluded that cost accounting is accounting
for cost aimed at providing cost data, statements and reports for the purposes to assists the
managements in planning decision making and controlling.
Objective and function of cost accounting
The main objective and function of cost accounting are mentioned below:
1. To ascertain cost: the main objective of cost accounting is to ascertain the cost of goods
and services. The expenses that are incurred while producing goods or rendering services are
called costs. Some examples of costs are material, labor and other direct and indirect
expenses. Under cost accounting, cost are collected, classified and analyzed with the aim of
finding out the total as well as per unit cost of goods, services, processes, contract etc.
2. To analyses cost and loss: another objective of cost accounting is to analyze the cost of
each activity. The analysis of cost is necessary to classify the cost into controllable or
uncontrollable, relevant or irreverent, profitable or unprofitable etc. similarly, under cost
accounting the effects of material, idle time, breakdown or damage of machine on the cost is
also analyzed.
3. To control cost: cost control is a technique that is used to minimize the cost of product
and services without compromising on the quality. Cost accounting aims at controlling the
cost by using various techniques, such as standard costing and budgetary control.
4. To help in fixation of selling price: another important objective of cost accounting is to
help in fixation of selling prices. The costs are accumulated, classified and analyzed to
ascertain cost per unit. The selling price per unit is calculated by adding a certain profit on the
cost per units. Under cost accounting, different techniques such as job costing, batch costing,
output costing services costing etc are used for determine the selling price.
5. To aid the management: cost accounting aims at assisting the management in planning
and its importations by providing necessary costing information that also enable the
evaluation of the past activities as well as future planning.
Importance and advantages of cost accounting
The importance and advance of cost accounting are presented below:
1. Helps in controlling cost: cost accounting helps in controlling cost by applying some
techniques such as standard costing and budgetary control.
2. Provides necessary cost information: it provides necessary cost information to the
management for planning, implements and controlling.
3. Ascertains the total per unit cost of production: it ascertains the total and per unit cost
of production of goods and services that helps to fix the selling prices as well.
4. Introduces cost reduction programs: it helps to introduce and implement different cost
reduction programs.
5. Discloses the profitable and non profitable activities: it discloses the profitable and non
profitable activities that enable management to decide to eliminate or control unprofitable
activities and expand or develop the profitable activities.

6. Provides information for the comparison of cost: it provides reliable data and
information which enable the comparison of cost between periods, volume of output,
determent and processes.
7. Checks the accuracy of financial accounts: it helps checking the accuracy of financial
accounts. This is done by preparing cost reconciliation statement.
8. Helps invests and financial institutions: it is also advantageous to investment and
financial institutions since it discloses the profitability and financial position in which they
intend to invest.
9. Beneficial to workers: it is beneficial to workers as well since it emphasizes the efficient
utilization of labor and scientific systems of wages payment.
15. Explain the role of cost accountant.

Role of Cost Accountant
As part of their jobs, cost accountants interpret results, report them to management and
provide analysis that assist decision-making in the following departments:
1. Manufacturing
Cost accountants work closely with production personnel to measure and report
manufacturing costs. The efficiency of the production departments in scheduling and
transforming materials into finished units is evaluated for improvements.
2. Engineering
Cost accountants and engineers translate specifications for new products into estimated costs;
by comparing estimated costs with projected sales prices, they help management decide
whether manufacturing a product will be profitable.
3. Systems design
Cost accountants are becoming more involved in designing computer integrated
manufacturing (CIM) systems and databases corresponding to cost accounting needs. The
idea is for cost accountants, engineers and system designers to develop a flexible production
process responding swiftly to market needs
4. Treasury
The treasurer uses budgets and related accounting reports developed by cost accountants to
forecast cash and working capital requirements. Detailed cash reports indicate where there
are excess funds to invest or where cash deficits exist and need to be financed.
5. Financial accounting
Cost accountants work closely with financial accountants who use cost information in valuing
inventory for external reporting and income determination purposes.
6. Marketing
Marketing involves the cost accountant during the product innovation stage, the
manufacturing planning stage and the sales process. The marketing department develops sales
forecast to facilitate preparing a products manufacturing schedule. Cost estimates,
competition, supply, demand, environmental influences and the state of technology
determines the sales price that the product will be offered and will command in the market.
7. Personnel
Personnel department administers the wage rate and pay methods used in calculating each
employees pay. This department maintains adequate labour records for legal and cost analysis
purposes.
At this point, it cannot be over-emphasized that cost accounting is simply an information
system designed to produce information to assist the management of an organization in
planning and controlling the organisation’s activities. It also assists the management to make

informed decisions so as to enable the organization to operate at maximum effectiveness and

efficiently.
16. Explain the inventory valuation methods.
Inventory valuation methods are used to calculate the cost of goods sold and cost of ending
inventory. Following are the most widely used inventory valuation methods:
1. First-In, First-Out Method
2. Last-In, First-Out Method
3. Average Cost Method
First-in-First-Out Method (FIFO)
According to FIFO, it is assumed that items from the inventory are sold in the order in which
they are purchased or produced. This means that cost of older inventory is charged to cost of
goods sold first and the ending inventory consists of those goods which are purchased or
produced later. This is the most widely used method for inventory valuation. FIFO method is
closer to actual physical flow of goods because companies normally sell goods in order in
which they are purchased or produced.
Last-in-First-Out Method (LIFO)
This method of inventory valuation is exactly opposite to first-in-first-out method. Here it is
assumed that newer inventory is sold first and older remains in inventory. When prices of
goods increase, cost of goods sold in LIFO method is relatively higher and ending inventory
balance is relatively lower. This is because the cost goods sold mostly consists of newer
higher priced goods and ending inventory cost consists of older low priced items.
Average Cost Method (AVCO)
Under average cost method, weighted average cost per unit is calculated for the entire
inventory on hand which is used to record cost of goods sold. Weighted average cost per unit
is calculated as follows:
Total Cost of Goods in Inventory
Weighted Average Cost Per Unit=
Total Units in Inventory
The weighted average cost as calculated above is multiplied by number of units sold to get
cost of goods sold and with number of units in ending inventory to obtain cost of ending
inventory.
17. Define management accounting. Explain the nature and scope of management
accounting.
Management Accounts a tool to assist management in achieving better planning and control
over the organization. It is relevant for all kinds of an organization including a not-for-profit
organization, government or Sole Proprietorships. It has a significant place in the businesses
and widely used by management to achieve better control and quality decision making.
#Meaning of Management Accounting:
Management Accounts not a specific system of accounting. It could be any form of
accounting which enables a business to conduct more effectively and efficiently. It’s largely
concerned with providing economic information to managers for achieving organizational
goals. It is an extension of the horizon of cost accounting towards newer areas of
management. Much management accounting information is financial in nature but has been
organizing in a manner relating directly to the decision at hand.
Management Accounts comprised of two words ‘Management’ and ‘Accounting’. It means
the study of the managerial aspect of accounting. The emphasis of management accounting is
to redesign accounting in such a way that it is helpful to the management in the formation of
policy, control of execution and appreciation of effectiveness. Management Accounts of
recent origin. This was first used in 1950 by a team of accountants visiting U. S. A under the

auspices of Anglo-American Council on Productivity.

#Definition of Management Accounting:
Definition: It is, also called managerial accounting or cost accounting, is the process of
analyzing business costs and operations to prepare the internal financial report, records, and
account to aid managers’ decision making the process in achieving business goals. In other
words, it is the act of making sense of financial and cost data and translating that data into
useful information for management and officers within an organization.

Nature of Management Accounting:

Managerial Accounting involves the furnishing of accounting data to the management for
basing its decisions. It helps in improving efficiency and achieving the organizational goals.
The following paragraphs discuss the nature and scope of management accounting.
Provides accounting information:
Management accounting is based on accounting information. It is a service function and it
provides necessary information to different levels of management. Managerial Accounting
involves the presentation of information in a way it suits managerial needs. The accounting
data collected by the accounting department is used for reviewing various policy decisions.
Cause and effect analysis:
The role of financial accounting is limited to find out the ultimate result, i.e., profit and loss;
Managerial Accounting goes a step further. Managerial Accounting discusses the cause and
effect relationship. The reasons for the loss are probed and the factors directly influencing the
profitability are also studied. Profits are compared to sales, different expenditures, current
assets, interest payables, share capital, etc.
Use of special techniques and concepts:
It uses special techniques and concepts according to the necessity to make accounting data
more useful. The techniques usually used include financial planning and analyses, standard
costing, budgetary control, marginal costing, project appraisal, control accounting, etc.
Taking important decisions:
It supplies the necessary information to the management which may be useful for
its decisions. The historical data is studied to see its possible impact on future decisions. The
implications of various decisions are also taking into account.
Achieving objectives:
It is uses accounting information in such a way that it helps in formatting plans and setting up
objectives. Comparing actual performance with targeted figures will give an idea to the
management about the performance of various departments. When there are deviations,
corrective measures can take at once with the help of budgetary control and standard costing.
No fixed norms:
No specific rules are followed in Managerial Accounting as that of financial accounting.
Though the tools are the same, their use differs from concern to concern. The deriving of
conclusions also depends upon the intelligence of the management accountant. The
presentation will be in the way which suits the concern most.
Increase in efficiency:
The purpose of using accounting information is to increase the efficiency of the concern. The
performance appraisal will enable the management to pinpoint efficient and inefficient spots.
An effort makes to take corrective measures so that efficiency improves. The constant review
will make the staff cost-conscious.
Supplies information and not the decision:
Management accountant is only to guide and not to supply decisions. The data is to use by the
management for taking various decisions. “How is the data to utilize” will depend upon the
caliber and efficiency of the management.
Concerned with forecasting:
The management accounts concerned with the future. It helps the management in planning
and forecasting. The historical information is used to plan the future course of action. The
information is supplied to the object to guide management in making future decisions.
Scope of Management Accounting
Management accounting is related with management of accounting information in resourceful
way for the administration. Its scope is immense and includes all aspects of business

operations. The following areas can accurately be recognized as falling within the compass of
management accounting.
Financial Accounting: Management accounting is strongly associated with the rescheduling
of the information provided by financial accounting. Therefore, management cannot get full
control and synchronization of operations without a correctly designed financial accounting
system. Cost Accounting: Standard costing, marginal costing, opportunity cost analysis,
differential costing and other cost methods play a constructive role in operation and control of
the business undertaking.
Revaluation Accounting: This is related with fact that capital is maintained together in
actual terms and profit is calculated with this fact in mind.
Budgetary Control: This includes framing of budgets, comparison of actual performance
with the budgeted performance, computation of variances, finding of their causes.
Inventory Control: It consists of control over inventory from the time it is acquired till its
final disposal.
Statistical Methods: These procedures include Graphs, charts, pictorial presentation, index
numbers and other statistical methods make the information more inspiring and
understandable.
Interim Reporting: This includes groundwork of monthly, quarterly, half-yearly income
statements and the related reports, cash flow and funds flow statements, scrap reports.
Taxation: This comprises of computation of income according to the tax laws, filing of
returns and making tax payments.
Office Services: This includes upholding of appropriate data processing and other office
management services, reporting on best use of mechanical and electronic devices.
18. Define budgetary control. Explain the objectives of budgetary control.
Meaning:
Budgetary control is the process of determining various actual results with budgeted figures
for the enterprise for the future period and standards set then comparing the budgeted figures
with the actual performance for calculating variances, if any. First of all, budgets are prepared
and then actual results are recorded.
The comparison of budgeted and actual figures will enable the management to find out
discrepancies and take remedial measures at a proper time. The budgetary control is a
continuous process which helps in planning and co-ordination. It provides a method of
control too. A budget is a means and budgetary control is the end-result.
Definitions:
“According to Brown and Howard, “Budgetary control is a system of controlling costs which
includes the preparation of budgets, coordinating the departments and establishing
responsibilities, comparing actual performance with the budgeted and acting upon results to
achieve maximum profitability.” Weldon characterizes budgetary control as planning in
advance of the various functions of a business so that the business as a whole is controlled.
J. Batty defines it as, “A system which uses budgets as a means of planning and controlling
all aspects of producing and/or selling commodities and services. Welsch relates budgetary
control with day-to-day control process.” According to him, “Budgetary control involves the
use of budget and budgetary reports, throughout the period to co-ordinate, evaluate and
control day-to-day operations in accordance with the goals specified by the budget.”
From the above given definitions it is clear that budgetary control involves the follows:
(a) The objects are set by preparing budgets.
(b) The business is divided into various responsibility centres for preparing various budgets.
(c) The actual figures are recorded.
(d) The budgeted and actual figures are compared for studying the performance of different
cost centres.

(e) If actual performance is less than the budgeted norms, a remedial action is taken
immediately.
Objectives of Budgetary Control:
Budgetary control is essential for policy planning and control. It also acts an instrument of
co-ordination.
The main objectives of budgetary control are the follows:
1. To ensure planning for future by setting up various budgets, the requirements and expected
performance of the enterprise are anticipated.
3. To operate various cost centres and departments with efficiency and economy.
4. Elimination of wastes and increase in profitability.
5. To anticipate capital expenditure for future.
6. To centralise the control system.
7. Correction of deviations from the established standards.
8. Fixation of responsibility of various individuals in the organization.
19. Elucidate the essentials of budgeting.
Essentials of Budgetary Control:
There are certain steps which are necessary for the successful implementation budgetary
control system.
These are as follows:
1. Organisation for Budgetary Control
2. Budget Centres
3. Budget Mammal
4. Budget Officer
5. Budget Committee
6. Budget Period
1. Organization for Budgetary Control:
The proper organization is essential for the successful preparation, maintenance and
administration of budgets. A Budgetary Committee is formed, which comprises the
departmental heads of various departments. All the functional heads are entrusted with the
responsibility of ensuring proper implementation of their respective departmental budgets.
The Chief Executive is the overall in-charge of budgetary system. He constitutes a budget
committee for preparing realistic budgets A budget officer is the convener of the budget
committee who co-ordinates the budgets of different departments. The managers of different
departments are made responsible for their departmental budgets.
2. Budget Centres:
A budget centre is that part of the organization for which the budget is prepared. A budget
centre may be a department, section of a department or any other part of the department. The
establishment of budget centres is essential for covering all parts of the organization. The
budget centres are also necessary for cost control purposes. The appraisal performance of
different parts of the organization becomes easy when different centres are established.
3. Budget Manual:
A budget manual is a document which spells out the duties and also the responsibilities of
various executives concerned with the budgets. It specifies the relations amongst various
functionaries.
4. Budget Officer:
The Chief Executive, who is at the top of the organization, appoints some person as Budget
Officer. The budget officer is empowered to scrutinize the budgets prepared by different
functional heads and to make changes in them, if the situations so demand. The actual
performance of different departments is communicated to the Budget Officer. He determines

the deviations in the budgets and the actual performance and takes necessary steps to rectify
the deficiencies, if any.
He works as a coordinator among different departments and monitors the relevant
information. He also informs the top management about the performance of different
departments. The budget officer will be able to carry out his work fully well only if he is
conversant with the working of all the departments.
5. Budget Committee:
In small-scale concerns the accountant is made responsible for preparation and
implementation of budgets. In large-scale concerns a committee known as Budget Committee
is formed. The heads of all the important departments are made members of this committee.
The Committee is responsible for preparation and execution of budgets. The members of this
committee put up the case of their respective departments and help the committee to take
collective decisions if necessary. The Budget Officer acts as convener of this committee.
6. Budget Period:
A budget period is the length of time for which a budget is prepared and employed. The
budget period depends upon a number of factors. It may be different for different industries
or even it may be different in the same industry or business.
The budget period depends upon the following considerations:
(a) The type of budget i.e., sales budget, production budget, raw materials purchase budget,
capital expenditure budget. A capital expenditure budget may be for a longer period i.e. 3 to 5
years purchase, sale budgets may be for one year.
(b) The nature of demand for the products.
(c) The timings for the availability of the finances.
(d) The economic situation of the country.
(e) The length of trade cycles.
20. Define budget. Explain the types of budgets.

A budget is a financial plan for a defined period, often one year. It may also include planned
sales volumes and revenues, resource quantities, costs and expenses, assets, liabilities and
cash flows. Companies, governments, families and other organizations use it to express
strategic plans of activities or events in measurable terms.[1]
A budget is the sum of money allocated for a particular purpose and the summary of intended
expenditures along with proposals for how to meet them. It may include a budget surplus,
providing money for use at a future time, or a deficit in which expenses exceed income.
Types of Budgets
(i) Sales Budget (ii) Production budget (iii) Financial budget (iv) Overheads budget (v)
Personnel budget and (vi) Master budget!
(i) Sales Budget:
A sales budget is an estimate of expected total sales revenue and selling expenses of the firm.
It is known as a nerve centre or backbone of the enterprise. It is the starting point on which
other budgets are also based. It is a forecasting of sales for the period both in quantity and
value. It shows what product will be sold, in what quantities, and at what prices.
The forecast not only relates to the total volume of sales but also its break-up product wise
and area wise. The responsibility for preparing sales budget lies with the sales manager who
takes into account several factors for making the sales budget.
Some of these factors are:
(i) Past sales figures and trend ;
(ii) Estimates and reports by salesmen ;
(iii) General economic conditions ;
(iv) Orders in hand ;

(v) Seasonal fluctuations ;

(vi) Competition ; and
(vii) Government’s control.
(ii) Production budget:
Production budget is prepared on the basis of the sales budget. But it also takes into account
the stock levels required to be maintained. It contains the manufacturing programmes of the
enterprise. It is helpful in anticipating the cost of production.
The nature of production budget will differ from enterprise to enterprise. For practical
purposes, the overall budget should be divided into production per article per month, looking
into the estimate of the likely quantity of demand. It is the responsibility of production
department to adjust its production according to sales forecast.
It is made by the production manager keeping in mind the following important factors:
(i) The sales budget ;
(ii) Plant capacity ;
(iii) Inventory policy ; and
(iv) Availability of raw-materials, labour, power, etc.
The production budget is often divided into several budgets:
(i) Material Budget- which fixes the quantity, quality and cost of raw materials needed for
uninterrupted production ;
(ii) Labour Budget-which specifies the requirements of labour in terms of the number and
type of workers for various jobs ;
(iii) Plant and equipment Budget- which lays down the needs of machines, equipment and
tools including their repairs and maintenance ; and
(iv) Research and Development Budget-which specifies the estimated cost on research and
development for developing new products and for improving existing ones.
(iii) Financial budget:
This budget shows the requirement of capital for both long-term and short-term needs of the
enterprise at various points of time in future. Its objective is to ensure regular supply of
adequate funds at the right time. An important part of the financial budget is the cash budget.
Cash budget contains estimated receipts and payments of cash over the specified future
period. It serves as an effective device for control and coordination of activities that involves
receipt and payment of cash. It helps to detect possible shortage or excess of cash in business.
The financial budget also contains estimates of the firm’s profits and expenditure i.e., the
operating budget.
(iv) Overheads budget:
It includes the estimated costs of indirect materials, indirect labour and indirect factory
expenses needed during the budget period for the attainment of budgeted production targets.
In other words, an estimate of factory overheads, distribution overheads and administrative
overheads is known as the overheads budget. The capital expenditure budget contains a
forecast of the capital investment.
This budget is prepared on departmental basis for effective control over costs. The factory or
manufacturing overheads can be divided into three categories: (i) fixed, (ii) variable, (iii)
semi-variable. This classification helps in the formulation of overhead budgets for each
department.
(V) Personnel budget:
It lays down manpower requirements of all departments for the budget period. It shows
labour requirements in terms of labour hours, cost and grade of workers. It facilitates the
personnel managers in providing required number of workers to the departments either by
transfers or by new appointments.

(Vi) Master budget:

The Institute of Cost and Management Accountants, England defines master budget as the
summary budget incorporating all the functional budgets, which is finally approved, adopted
and applied. Thus, master budget is prepared by consolidating departmental or functional
budgets.
21. Explain the concept of standard costing.
Meaning of Standard Costing:
It is a method of costing by which standard costs are employed. According to ICMA,
London, Standard Costing is “the preparation and use of standard costs, their
comparison with actual cost and the analysis of variances to their causes and points of
incidence”.
According to Wheldon, it is a method of ascertaining the costs whereby statistics are
prepared to show:
(i) The standard cost;
(ii) The actual cost;
(iii) The difference between these costs which is termed the variance.
But W. Bigg expresses:
“Standard Costing discloses the cost of deviations from standards and clarifies these as
to their causes, so that management is immediately informed of the sphere of operations
in which remedial action is necessary.”
Thus, from the above, it becomes clear that Standard Costing involves:
(i) Ascertainment and use of Standard Costs;
(ii) Recording the actual costs;
(iii) Comparison of actual costs with standard costs in order to find out the variance;
(iv) Analysis of variance; and
(v) After analysing the variance, appropriate action may be taken where necessary.
Objectives of Standard Costing:
The objectives of Standard Costing for which it is implemented are:
(a) It helps to implement budgetary control system in operation;
(b) It helps to ascertain performance evaluation.
(c) It supplies the ways to utilise properly material, labour and also overhead which will be
economic in character.
(d) It also helps to motivate the employees of a firm to improve their performance by setting
up a ‘standard’.
(e) It also helps the management to supply necessary data relating to cost element to submit
quotations or to fix up the selling price of a firm.
(f) It also helps the management to make proper valuations of inventory (viz., Work-in-
progress, and finished products).
(g) It acts as a control device to the management.
(h) It also helps the management to take various corrective decisions viz., fixation of price,
make-or-buy decisions etc. which will be more beneficial to the firm.
Development of Standard Costing:
Importance of Standard Costing cannot be ignored for the following and that is why the
same is well-developed in the present-day world:
(i) Compilation of Historical Cost is very expensive and difficult:
A manufacturing firm making large number of parts requires too much clerical work which is
required in order to compile the materials, labour and overhead charges to each and every
cost of parts produced for ascertaining the average cost of the product.

(ii) Historical Costs are inadequate:

In order to measure the manufacturing efficiency, historical costs are not practically adequate.
It fails to explain the reasons of increased cost or any change in cost structure.
(iii) Historical Costs are too old:
In many firms, costs are determined and selling prices are ascertained even before the
production starts—which is not desirable.
(iv) Historical Costs are not typical:
This is due to the wide fluctuation in market for which there is no relation between the selling
price per unit and cost price per unit.
Advantages of Standard Costing:
The following advantages may be derived from Standard Costing:
(i) Standard Costing serves as a guide to the management in several management functions
while formulating prices and production policies etc.
(ii) More effective cost control is possible under standard costing if the same is reviewed and
analysed at regular intervals for improvements and immediate action can be taken if
deviations from standards are found out which, ultimately, leads to cost reduction.
(iii) Analysis of variance and its measurement helps to detect inefficiencies and mistakes
which enable the management to investigate the reasons.
(iv) Since standard costs are predetermined costs they are very useful for planning and
budgeting. It also helps to estimate the effect of changes in Cost-Price-Volume relationship
which also helps the management for decision-making in future.
(v) As standard is fixed for each product, its components, materials, process operation etc. it
improves the overall production efficiency which also ultimately reduces cost and thereby
increases profit.
(vi) Once the Standard Costing System is implemented it will lead to saving cost since most
of the costing work can be eliminated.
(vii) Delegation of authority and responsibility becomes effective by setting up standards for
each cost centre as the supervisors or executives of each cost centre will know the standard
which they have to maintain.
(viii) This system also helps to prepare Profit and Loss Account promptly for short period in
order to know the trend of the business which helps the management to take decisions
promptly.
(ix) Standard costing also is used for inventory valuation purposes. Stock can be valued at
standard cost which can reduce the fluctuation of profit for different methods of valuation for
the same.
(x) Efficiency of labour is promoted.
(xi) This system creates cost-consciousness among all employees, executives and top
management which increase efficiency and productivity as well.
Disadvantages of Standard Costing:
The alleged disadvantages of Standard Costing are:
(i) Since Standard Costing involves high degree of technical skill, it is, therefore, costly. As
such, small organisations cannot, introduce the system due to their limited financial
resources. But, once introduced, the benefits achieved will be far in excess to its initial high
costs.
(ii) The executives are liable for those variances that are found from actions which are
actually controllable by them. Thus, in order to fix up the responsibilities, it becomes
necessary to segregate variances into non-controllable and controllable portions although that
is not an easy task.

(iii) Standards are always changing since conditions of the business are equally changing. So,
standards are to be revised in order to make them comparable with actual results. But revision
of standards creates many problems, particularly in inventory adjustment.
(iv) Standards are either too liberal or rigid since the same are based on average past results,
attainable good performance or theoretical maximum efficiency. So, if the standards are very
high, it will adversely affect the morale and motivation of the employees.
22. What are steps involving in standard costing?
As Standard Costing is an important management tool, important should be given in its
installation. The following steps are involved for establishing standard costing system in an
organization.
1. Determination of Cost Centre
The cost centre is necessary for fixing costs and fixation of responsibility. In the
manufacturing concern, cost centres are created according to the number of products
produced and the number of sections, departments or divisions are involved in the production
process.
A cost centre relating to a person is called personnel cost centre and a cost centre relating to
products and equipment is called impersonal cost centre.
2. Classification of Accounts
The costs are incurring at various stages of production process. These costs should be
recorded properly for accurate calculation of total costs incurred. Hence, there is a need of
classification of accounts for cost control under standard costing system.
3. Codification of Accounts
The different accounts can be codified and different symbols can be used to facilitate speedy
collection, communication and reporting. The following codes can be used for elements of
cost.
4. Setting of Standards
A standard is an ideal which is anticipated and can be attained over a future period of time,
normally in the next accounting year. The success of standard costing system is based on the
genuineness, reliability and acceptance of these standards.
There are three types of standards. They are current standard, basic standard and normal
standard. The current standard is dividend into two i.e. ideal standard and expected or
attainable standard.
5. Establishing Standard Costs
Standard costs are established for each elements of cost separately. Generally, elements of
cost is grouped as material, labor and overhead. Moreover, standard cost is set for the sales
also.
6. Preparing Standard Cost card or Standard Cost Sheet
Standard cost card or standard cost sheet is prepared separately for product wise or process
wise.
7. Organization for Standard Costing
A committee is formed to set the standards. If so, the objectives of standard costing system
can be easily achieved.
23. Explain the concept of variance analysis.
Variance analysis can be summarized as an analysis of the difference between planned and
actual numbers. The sum of all variances gives a picture of the overall over-performance or
under-performance for a particular reporting period. For each individual item, companies
assess its favorability by comparing actual costs and standard costs in the industry. For
example, if the actual cost is lower than the standard cost for raw materials, assuming the
same volume of materials, it would lead to a favorable price variance (i.e., a cost savings).
However, if the standard quantity was 10,000 pieces of material and 15,000 pieces were

required in production, this would be an unfavorable quantity variance because more

materials were used than anticipated.
Types of Variances
Material Variances
The difference between the standard cost of direct materials and the actual cost of direct
materials that an organization uses for production is known as Material Variance.
Material Cost Variance Formula:
Standard Cost – Actual Cost
In other words, (Standard Quantity x Standard Price) – (Actual Quantity x Actual Price)
Material Variance is further sub-divided into two heads:
● Material Price Variance:
MPV = (Standard Price – Actual Price) x Actual Quantity
● Material Usage Variance:
MUV = (Standard Quantity – Actual Quantity) x Standard Price
Labour Variances
Labor Variance arises when there is a difference between the actual cost associated with a
labour activity from the standard cost.
Labor Variance Formula:
Standard Wages – Actual Wages
In other words, (Standard Hours x Standard Rate) – (Actual Hours x Actual Rate)
Labor Variance is further sub-divided into two heads:
● Labor Rate Variance:
LRV = (Standard Rate – Actual Rate) x Actual Hours
● Labor Efficiency Variance:
LEV = (Actual Hours – Standard Hours) x Standard Rate
Overhead (Variable) Variance
Variable Overhead Variance arises when there is a difference between the actual variable
overhead and the standard variable overhead based on budgets.
Variable Overhead Variance Formula:
Standard Variable Overhead – Actual Variable Overhead
In other words, (Standard Rate – Actual Rate) x Actual Output
Variable Overhead Variance is further sub-divided into two heads:
● Variable Overhead Efficiency Variance:
VOEV = (Actual Output – Standard Output) x Standard Rate
● Variable Overhead Expenditure Variance:
VOEV = (Standard Output x Standard Rate) – (Actual Output x Actual Rate)
Fixed Overhead Variance
It arises when there is a difference between the standard fixed overhead for actual output and
the actual fixed overhead.
Fixed Overhead Variance Formula:
= (Actual Output x Standard Rate per unit) – Actual Fixed Overhead
Fixed Overhead Variance is further sub-divided into two heads:
● Fixed Overhead Expenditure Variance:
FOEV = Standard Fixed Overhead – Actual Fixed Overhead
● Fixed Overhead Volume Variance:
FOVV = (Actual Output x Standard Rate per unit) – Standard Fixed Overhead
Sales Variance
Sales Variance is the difference between the actual sales and budgeted sales of an
organization.
Sales Variance Formula:

= (Budgeted Quantity x Budgeted Price) – (Actual Quantity x Actual Price)

Sales Variance is further sub-divided into two heads:
● Sales Volume Variance:
SVV = (Budgeted Quantity – Actual Quantity) x Budgeted Price
● Sales Price Variance:
SPV = (Budgeted Price – Actual Price) x Actual Quantity
24. Explain in briefly about marginal costing.

Marginal Costing
Definition: Marginal Costing is a costing technique wherein the marginal cost, i.e. variable
cost is charged to units of cost, while the fixed cost for the period is completely written off
against the contribution.
The term marginal cost implies the additional cost involved in producing an extra unit of
output, which can be reckoned by total variable cost assigned to one unit. It can be calculated
as:
Marginal Cost = Direct Material + Direct Labor + Direct Expenses + Variable
Overheads
Characteristics of Marginal Costing
● Classification into Fixed and Variable Cost: Costs are bifurcated, on the basis of
variability into fixed cost and variable costs. In the same way, semi variable cost is
separated.
● Valuation of Stock: While valuing the finished goods and work in progress, only
variable cost are taken into account. However, the variable selling and distribution
overheads are not included in the valuation of inventory.
● Determination of Price: The prices are determined on the basis of marginal cost and
marginal contribution.
● Profitability: The ascertainment of departmental and product’s profitability is based on
the contribution margin.
In addition to the above characteristics, marginal costing system brings together the
techniques of cost recording and reporting.

Marginal Costing Approach
The difference between product costs and period costs forms a basis for marginal costing
technique, wherein only variable cost is considered as the product cost while the fixed
cost is deemed as a period cost, which incurs during the period, irrespective of the level of
activity.
Facts Concerning Marginal Costing
● Cost Ascertainment: The basis for ascertaining cost in marginal costing is the nature of
cost, which gives an idea of the cost behavior, that has a great impact on the profitability
of the firm.
● Special technique: It is not a unique method of costing, like contract costing, process
costing, batch costing. But, marginal costing is a different type of technique, used by the
managers for the purpose of decision making. It provides a basis for understanding cost
data so as to gauge the profitability of various products, processes and cost centers.
● Decision Making: It has a great role to play, in the field of decision making, as the
changes in the level of activity pose a serious problem to the management of the
undertaking.
Marginal Costing assists the managers in taking end number of business decisions, such as
replacement of machines, discontinuing a product or service, etc. It also helps the
management in ascertaining the appropriate level of activity, through break even analysis,
that reflect the impact of increasing or decreasing production level, on the company’s overall
profit.
25. Explain the concept of Break Even analysis.

Break-even point:
The point at which total of fixed and variable costs of a business becomes equal to its total
revenue is known as break-even point (BEP). At this point, a business neither earns any
profit nor suffers any loss. Break-even point is therefore also known as no-profit, no-loss
point or zero profit point. Calculation of break-even point is important for every business
because it tells business owners and managers how much sales are needed to cover all fixed
as well as variable expenses of the business or the sales volume after which the business will
start generating profit. The computation of sales volume required to break-even is known
as break-even analysis. The concept explained above can also be presented as follows:

After reading this article you will be able to compute the break-even
even point of a single product
company using two popular methods – equation method and contribution margin method.
First we shall compute break-eveneven popoint
int using these two methods and then present the
information graphically (preparation of break
break-even chart).
Computation of break-even even point:
(1). Use of equation method:
The application of equation method facilitates the computation of break
break-even
even point both
bot in
units and in sales volume. As we have already described that the sales are equal to total
variable and fixed expenses at break
break-even
even point, the equation can therefore be written as
follows:
SP × Q = VC × Q + FC
(2). Use of contribution margin method:
The method described above is known as equation method of calculating break-even break
point. Some people use another method called contribution margin method (read about
contribution margin and its calculation). Under this method, the total fixed expenses are
divided by contribution margin per unit. Consider the following computations:
Total fixed expenses / Contribution per unit
A little variation of this method
hod is to divide the total fixed expenses by the price volume ratio.
Doing so results in break-even
even point in sales volume. It is shown below:
Total fixed expenses / PV ratio
Graphical presentation (Preparation of break-even
break chart or CVP graph):
The graphical presentation of dollar and unit sales needed to breakbreak-even
even is known as break-
even chart orCVP graph:
Explanation of the graph:

1. The number of units have been presented on the X-axis X axis (horizontally) where as dollars
have been presented on Y-axis
axis (vertically).
2. The straight line in red color represents the total annual fixed expenses of $15,000.

3. The blue line represents the total expenses. Notice that the line has a positive or upward
slop that indicates the effect of increasing variable expenses with the increase in
production.
4. The green line with positive or upward slop indicates that every unit sold increases the
total sales revenue.
5. The total revenue line and the total expenses line cross each other. The point at which
they cross each other is the break-even point. Notice that the total expenses line is above
the total revenue line before the point of intersection and below after the point of
intersection. It tells us that the business suffers a loss before the point of intersection and
makes a profit after this point. The break-even point in the above graph is 2,000 units or
$30,000 that agrees with the break-even point computed using equation and contribution
margin methods above.
6. The difference between the total expenses line and the total revenue line before the point
of intersection (BE point) is the loss area. The loss area has been filled with pink color.
Notice that this area reduces as the number of units sold increases. It means every
additional unit sold before the break-even point reduces the loss.
7. The difference between the total expenses line and the total revenue line after the point
of intersection (BE point) is the profit area. The profit area has been filled with green
color. Notice that this area increases as the number of units sold increases. It means
every additional unit sold after the break-even point increases the profit of the business.
Managerial Uses of Break-Even Analysis
To the management, the utility of break-even analysis lies in the fact that it presents a
microscopic picture of the profit structure of a business enterprise. The break-even analysis
not only highlights the area of economic strength and weakness in the firm but also sharpens
the focus on certain leverages which can be operated upon to enhance its profitability.
It guides the management to take effective decision in the context of changes in government
policies of taxation and subsidies.
The break-even analysis can be used for the following purposes:
(i) Safety Margin:
The break-even chart helps the management to know at a glance the profits generated at the
various levels of sales. The safety margin refers to the extent to which the firm can afford a
decline before it starts incurring losses.
(ii) Target Profit:
The break-even analysis can be utilised for the purpose of calculating the volume of sales
necessary to achieve a target profit.
When a firm has some target profit, this analysis will help in finding out the extent of
increase in sales by using the following formula:
(iii) Change in Price:
The management is often faced with a problem of whether to reduce prices or not. Before
taking a decision on this question, the management will have to consider a profit. A reduction
in price leads to a reduction in the contribution margin.
This means that the volume of sales will have to be increased even to maintain the previous
level of profit. The higher the reduction in the contribution margin, the higher is the increase
in sales needed to ensure the previous profit.
(iv) Change in Costs:
When costs undergo change, the selling price and the quantity produced and sold also
undergo changes.
Changes in cost can be in two ways:
(i) Change in variable cost, and
(ii) Change in fixed cost.

(i) Variable Cost Change:

An increase in variable costs leads to a reduction in the contribution margin. This reduction in
the contribution margin will shift the break-even point downward. Conversely, with the fall
in the proportion of variable costs, contribution margins increase and break-even point moves
upwards.
(ii) Fixed Cost Change:
An increase in fixed cost of a firm may be caused either due to a tax on assets or due to an
increase in remuneration of management, etc. It will increase the contribution margin and
thus push the break-even point upwards. Again to maintain the earlier level of profits, a new
level of sales volume or new price has to be found out.
(v) Decision on Choice of Technique of Production:
A firm has to decide about the most economical production process both at the planning and
expansion stages. There are many techniques available to produce a product. These
techniques will differ in terms of capacity and costs. The breakeven analysis is the most
simple and helpful in the case of decision on a choice of technique of production.
(vi) Make or Buy Decision:
Firms often have the option of making certain components or for purchasing them from
outside the concern. Break-even analysis can enable the firm to decide whether to make or
buy.
(vii) Plant Expansion Decisions:
The break-even analysis may be adopted to reveal the effect of an actual or proposed change
in operation condition. This may be illustrated by showing the impact of a proposed plant on
expansion on costs, volume and profits. Through the break-even analysis, it would be
possible to examine the various implications of this proposal.
(viii) Plant Shut Down Decisions:
In the shut down decisions, a distinction should be made between out of pocket and sunk
costs. Out of pocket costs include all the variable costs plus the fixe cost which do not vary
with output. Sunk fixed costs are the expenditures previously made but from which benefits
still remain to be obtained e.g. depreciation.
(ix) Decision regarding Addition or Deletion of Product Line:
If a product has outlive utility in the market immediately, the production must be abandoned
by the management and examined what would be its consequent effect on revenue and cost.
Alternatively, the management may like to add a product to its existing product line because
it expects the product as a potential profit spinner. The break-even analysis helps in such a
decision.

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ACCOUNTING FOR MANAGERS

AFM IMPORTANT QUESTIONS FOR SEMESTER EXAMINATIONS

RAJIV GANDHI INSTITUTE OF MANAGEMENT AND SCIENCE, KAKINADA Page 1

2. Define accounting. Explain its nature and functions.

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4. Accounting deals with financial information and transactions; Accounting records

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RAJIV GANDHI INSTITUTE OF MANAGEMENT AND SCIENCE, KAKINADA Page 4

Debit the Receiver

Debit what comes in

Debit all Expenses and Losses

4. State how accounting is useful to different type of users?

RAJIV GANDHI INSTITUTE OF MANAGEMENT AND SCIENCE, KAKINADA Page 5

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6. How do you prepare final accounts of a trader? Explain.

These include the following:

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1. Explain the concept of financial statements.

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Financial statement analysis

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i. Helpful in planning and decision making.

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mandatory for the business to submit

Techniques and types of financial analysis:

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TYPES OF FINANCIAL STATEMENT ANALYSIS

Techniques/Tools of Financial Statement Analysis

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F. Cash flow analysis

8. What is cash flow statement? Explain the features and objectives.

Meaning of Cash Flow Statement:

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9. How do you classify cash flows? Explain briefly.

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Cash Flow Activities

Cash flow analysis:

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10. Explain the concept of funds flow statement

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13. Discuss the classification of costs.

Costs can be classified based on the following attributes:

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Cost Classification by Element:

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xx. Past Cost: