Q1. Cost Accounting is the field of accounting that is used to record, summarise and report the cost
information on a periodical basis. Its primary function is to ascertain and control costs. It helps the users of
cost data to make decisions regarding the determination of selling price, controlling costs, projecting plans
and actions, efficiency measurement of the labour, etc.
Cost Accounting adds to the effectiveness of the financial accounting by providing relevant information
which ultimately results in the good decision-making process of the organisation. It traces the cost incurred
at each level of production, i.e. right from the input of the material till the output produced, each and every
cost is recorded.
In other words, cost accounting is one of the phases of accounting. His the process of accounting for cost
from the point at which expenditure is committed or incurred to the establishment of its ultimate relationship
with cost centres and cost units. In its widest usage it embraces the preparation of statistical data, the
application of cost control methods and the ascertainment of the profitability of the activities carried out pr.
planned. It is a management information system which analyses past, present and future data to provide a
bank of data for the management accountant to use. It answers the following questions:
 What has been the cost of goods produced or services provided?
 What have revenues been? - Profitability, price setting and stock valuation.
 What are the future costs of goods and services (and operations and so on) likely to be? Costing is an
integral part of budgeting planning for the future.
 How do actual costs compare with budgets?
 What information does management need in order to make sensible decision about profits and costs? The
Chartered Institute of Management Accountant (CIMA) defined cost accounting as "the establishment of
budgets, standard costs and actual costs of operations, processes, activities or products, and the analysis of
variances, profitability or social use of funds"
Information provided by the cost accounting is used only by the internal management of the organization
like employees, directors, managers, supervisors etc.
Financial accounting, which is concerned with classifying and recording in monetary terms the transactions
conducted by an organisation. The main purpose is to produce accounts (abbreviated in financial statements)
that can be given to those who have authority for the organisation, whether that is government, shareholders,
partners, and members of the committee of a football/tennis club, etc. It is generally geared towards the
historical stewardship aspect of external reporting as ... reflected in the income statement and the position
statement
Financial Accounting is the branch of accounting, which keeps the complete record of all monetary
transactions of the entity and reports them at the end of the financial period in proper formats that increases
readability of the financial statements among its users. The users of financial information are many i.e. from
internal management to outside parties.
Preparation of financial statement is the major objective of financial accounting in a specified manner for a
particular accounting period of an entity. It includes Income Statement, Balance Sheet, and Cash Flow
Statement which helps in, tracing out the performance, profitability and financial status of an organisation
during a period
The major differences between cost accounting and financial accounting are as follows:
1. Cost accounting helps you determine the expenses associated with each of your products. Financial
accounting helps better understand a company’s profitability through its financial statements.
2.
Cost accounting is a tool used by management to improve business process efficiency. Financial
accounting presents the business’s performance.
3.
Cost accounting focuses on the internal aspects of a company. Financial accounting focuses on its
external aspects. While cost accounting helps improve a company’s processes, financial accounting is profitoriented.
4.
The use of cost accounting is not mandatory in all companies. Only those using manufacturing
processes or activities must use cost accounting. Yet, the use of financial accounting is a must for all
organizations.
5.
Cost accounting is not performed as per any particular period. Rather, it’s performed in a short
interval of time as in the production of a unit or product. Financial accounting records an organization’s
financial activity for a given financial period.
6.
Additionally, estimation is important in cost accounting. It helps determine the per-unit cost of sales.
In contrast, every transaction in financial accounting is reporting based on actual data.
7.
Cost accounting uses tools to help improve the efficiency of business operations. These include the
cost of sales, product margin, and selling price of products. Financial accounting uses financial statements,
journals, ledgers, and trial balances.
8.
There are also differences in presentation between the two methods. Financial accounting requires
specific format parameters. As for cost accounting, the format of reports can vary.
.
Users of information provided by the financial accounting are internal and external parties like creditors,
shareholders, customers etc.
Management accounting is broader in nature than cost accounting, and is part of management's function. It
encompasses the methods and procedures of cost accounting, with the purpose of providing information for
managers so that policies can be formulated, activities planned and controlled, decision on alternative causes
of actions taken, assets safeguarded, and the activities of the enterprises reported to interested parties.
Management accounting also is known as managerial accounting and can be defined as a process of providing
financial information and resources to the managers in decision making. Management accounting is only used by
the internal team of the organization, and this is the only thing which makes it different from financial
accounting. In this process, financial information and reports such as invoice, financial balance statement is
shared by finance administration with the management team of the company. Objective of management
accounting is to use this statistical data and take a better and accurate decision, controlling the enterprise,
business activities, and development.
The information needed from final accounts of a business that will assist management in making a more
informed decision are Profit and Loss
By contrast, the profit and loss account provides a perspective on a longer time-period. If the balance sheet
is a digital snap-shot" of the business, then think of the profit and loss account as the "DVD" of the business
activities. The story of what financial transactions took place in a particular period - and (most importantly)
what the overall result of those transactions was. Not surprisingly, the profit and loss account measures
"profit".
In the Profit and Loss (P&L) Statement you will see the total revenue and total expenses o f the
business throughout the financial year.
How to work out profit or loss?
Calculating your gross profit is fairly straight forward. The first thing you will see on the P&L
is the turnover figure, this is the value of your sales. Then, minus the cost of sales from this
figure, and there you have it!
Look further down the P&L statement and you will see earnings before interest, tax,
depreciation and amortisation (EBITDA). This quite simply subtracts administrative
expenses (the next number on your Profi t and Loss Statement), from gross profit.
Administrative expenses include:

Rent of the building

The cost of utilities

The salaries of employees
A healthy number may be a fair indicator of your organisation’s future.
USERS
INTEREST IN/USE OF ACCOUNTING INFORMATION
Investors are concerned about risk and return in relation to their investments. They
require information to decide whether they should continue to invest in a business.
They also need to be able to assess whether a business will be able to pay dividends,
and to measure the performance of the business management overall. The key
accounting information for an investor is therefore:
 Information about growth-sales, volumes
 Profitability (profit margins, overall level of profit)
 Investment (amounts invested, assets owned)
 Business value (share price).  Comparative information of competitors
Owners
Having invested their earnings in the firm, the main interest of owners in financial
statements is to assess the returns on their investment and how prosperous do they
appear for the future. Owners generally have access to all financial records and files.
Management
The management team of a business needs to understand the profitability, liquidity,
and cash flows of the organization each month, so that it can make operational and
financing decisions about the business. Management will also have access to all
records.
Competitors
Firms which are in competition against a business will attempt to gain access to the
rival’s financial statements, in order to evaluate their financial position. This could be
used to craft necessary competitive strategies.
Customers of the business
When a customer is considering which supplier to select for a major contract, it wants
to review their financial statements first, in order to judge the financial ability of a
supplier to remain in business long enough to provide the goods or services mandated
in the contract.
Employees
A company may elect to provide its financial statements to employees, along with a
detailed explanation of what the documents contain. This helps increase the level of
employee involvement in and understanding of the business.
Government
A government in whose authority a company is located would request the financial
statements in order to determine whether the business is paying the right amount
of taxes and relevant laws are being adhered to.
Analysts
Outside analysts want to see financial statements in order to decide whether they
should recommend the company’s securities to their clients. Auditors will also need to
analyse financial records.
Creditors
An entity loaning money to an organization will require financial statements in order to
estimate the ability of the borrower to pay back all loaned funds and related interest
charges.
Suppliers
Suppliers will require financial statements in order to decide whether it is safe to
extend credit to a company.
Trade unions
A union requires the financial statements of a business in order to evaluate the ability of
a business to pay the due compensation to the union members that it represents.
There may even be other users of financial statements than the above mentioned. There
are many advantages of studying the financial statement for these parties. They can rely
upon the information contained in such financial statements and to act upon that
information as desired.
Public at large
Interest groups, formed by various groups of individuals who have a specific interest
in the activities and performance of businesses, will also require accounting
information
Analysts
Investment analysts are an important user group - specifically for companies quoted
on a stock exchange. They require very detailed financial and other information in
order to analyse the competitive performance of a business and its sector. Much of
this is provided by the detailed accounting disclosures that are required by
authorities such the London Stock Exchange. However, additional accounting
information is usually provided to analysts via informal company briefings and
interviews.
Q2. Business cannot simply function without money, and the money required to make a business function is
known as business finance.
LONG TERM SOURCES fulfil the financial requirements of a business for a period more than 5 years. This
includes, Equity Shares, Retained Earnings, Preference shares, Debentures, Loan from financial institutions.
Such financing is generally required for the procurement of fixed assets such as plant, equipment, machinery
etc.
Medium-term sources are the sources where the funds are required for a period of more than one year but
less than five years. The sources of the medium term include borrowings from commercial banks, public
deposits, lease financing and loans from financial institutions.
Short-term sources: Funds which are required for a period not exceeding one year are called short-term
sources. Trade credit, loans from commercial banks and commercial papers are the examples of the sources
that provide funds for short duration.
1. Personal Savings
This is the amount of personal money an owner, partner or shareholder of a business has at his disposal to do
whatever he wants. When a business seeks to borrow the personal money of a shareholder, partner or owner
for a business’s financial needs the source of finance is known as personal savings.
Advantages;

The owner would not want collateral to lend money to the business.

There is no paperwork required.

The money need not necessarily be paid back to the owner on time.

Can be interest free or carry a lower rate of interest since the owner provides the loan.
Disadvantages;

Personal savings is not an option where very large amounts of funds are required.

Since it is an informal agreement, if the owner demands the money back in a short notice it might cause cash
flow problems for the business.
2. Retained Profits
Retained profits are the undistributed profits of a company. Not all the profits made by a company are
distributed as dividends to its shareholders. The remainder of the profits after all payments are made for a
trading year is known as retained profits. This remainder of finance is saved by the business as a back-up in
times of financial needs and maybe used later for a company’s development or expansion. Retained profits
are a very valuable no-cost source of finance.
Advantages;

They need not be paid back since it is the organisation’s own savings.

There are no interest payments to be made on the usage of retained profits.

The company’s debt capital does not increase and thus gearing ratio is maintained.

There are no costs raising the finance such as issuing costs for ordinary shares.

The plans of what is to be done with the money need not be revealed to outsiders because they are not involved
and therefore privacy can be maintained.
Disadvantages;

There maybe opportunity costs involved.

Retained profits are not available for starting up businesses or for those businesses that have been making
losses for a long period.
3. Working Capital
Working capital refers to the sum of money that a business uses for its daily activities. Working capital is the
difference of current assets and current liabilities (i.e. Working capital = Current assets — Current liabilities).
Proper working capital management is also vital as it is also a source of finance for a business
Advantages;

Since it is an internal source of finance there are no costs involved.

No repayment is needed.

External parties cannot influence business decisions.

Will not increase debt capital of the firm so gearing ratio is maintained.
Disadvantages;

Opportunity costs are involved.

Is not suitable for long term investments.

Working capital cannot raise large amounts of funds.

Total risk is undertaken by the company.

Using working capital as a source of finance will affect the current ratio of the business
4. Sale of Fixed Assets
Fixed assets are the assets a company that do not get consumed in the process of production. Some examples
of fixed assets are land and building, machinery, vehicles, fixtures and fittings and equipment. Sometimes
where the fixed asset is a surplus and is abandoned, it can be sold to raise finance in demanding times for the
business. Otherwise businesses may choose to stop offering certain products and sell its fixed assets to raise
finance. Selling fixed assets reduces the production capacity of a business affecting a business’s return.
Advantages;

Funds are again raised by the business itself and therefore need not be paid back.

No interest payments are required.

Large amounts of finance can be raised depending on the fixed asset sold.

Would be the ideal source of finance if it was for an asset replacement.
Disadvantages;

If the asset is sold then the business would lose opportunities to generate income from it.

If the business wants to buy a similar asset later on it may cost more than it was sold for.

If the asset is sold and the money is spent without return then the business is broke.

The asset may be able to generate more income than the purpose it was sold for.
5. Ordinary Share Issue
Ordinary shares also known as equity shares are a unit of investment in a company. Ordinary shareholders
have the privilege of receiving a part of company profits via dividends which is based on the value of shares
held by the shareholder and the profit made for the year by the company. They also have the right to vote at
general meetings of the company. Companies can issue ordinary shares in order to raise finance for long-term
financial needs.
Advantages;

The amount need not be paid back — it is a permanent source of capital.

Able to raise large amounts of finance.

If the company follows a rational dividend policy it can create huge reserves for its development program.

The dividends need to be paid only if the company makes a profit.

No collateral is required for issuing shares.

It will help reduce gearing ratio
Disadvantages;

Issuing shares is time consuming.

It incurs issuing costs.

There are legal and regulatory issues to comply with when issuing shares.

Possible chances of takeover where an investor buys more than 50% of the total issued shares value.

Groups of equity shareholders holding majority of shares can manipulate the control and management of the
company.

May result in over-capitalization where dividend per share falls.

Once issued the shares may not be bought back and therefore the capital structure cannot be changed.
6. Preference Share Issue
Preference shares are another type of shares. Preference shareholders receive a fixed rate of dividends before
the ordinary shareholders are paid. Preference shareholders do not have the right to vote at general meetings
of the company. Preference shares are also an ownership capital source of finance. There are several types of
preference shares. Some of them are Cumulative preference share, Redeemable preference share, Participating
preference share and Convertible preference share.
Advantages;

Have no voting rights and thus the management can retain control over the affairs of the company.

Preference shareholders need not be paid if the company makes a loss.

Even if the company makes large profits preference share holders need to be paid only a fixed rate of interest.

Has other benefits similar to ordinary share issue such as — no repayment required, large amounts of capital
can be raised, permanent source of capital and no collateral required.

Redeemable preference shares can be redeemed.
Disadvantages;

Even if the company makes a very small profit it will have to pay the fixed rate of dividend to its preference
shareholders.

Preference shares are usually cumulative and thus twice the amount must be paid the following year if
dividends are not paid on the year they need to be paid.

Taxable income is not reduced by preference dividends unlike debentures where interest paid reduces taxable
income.

Have other drawbacks similar to ordinary share issues such as the cost, time consumption and legal
requirements.
7. Debentures
Debentures are issued in order to raise debt capital. Debenture holders are not owners but long-term creditors
of the company. Debenture holders receive a fixed rate of interest annually whether the company makes a
profit or loss. Debentures are issued only for a time period and thus the company must pay the amount back
to the debenture holders at the end of the agreed period. Debentures can be secured,unsecured, fixed or
floating.
Advantages;

Debenture holders do not have rights to vote at the company’s general meetings.

Tax benefits — debenture interests are treated as expenses and charged against profits in the profit and loss
account.

Debentures can be redeemed when the company has surplus funds.
Disadvantages;

Debenture interests have to be paid regardless the company makes a profit or loss.

The money borrowed has to be paid back on an agreed date.
8. Bank Overdraft
Bank overdraft is a short term credit facility provided by banks for its current account holders. This facility
allows businesses to withdraw more money than their bank account balances hold. Interest has to be paid on
the amount overdrawn. Bank overdraft is the ideal source of finance for short-term cash flow problems.
Advantages;

No security is needed for a bank overdraft.

Ideal for short-term cash-flow deficits.

Easy and quick to arrange.

Interest is only paid when overdrawn and on the exact amount needed.

Since overdraft is a short term debt it is not included in calculating the firm’s gearing ratio.
Disadvantages;

There is a limit to the amount that can be overdrawn.

Interest has to be paid on an overdraft that is calculated on a daily basis and sometimes the bank charges an
overdraft facility fee too.

Overdrafts are meant to cover only short-term financing and are not a permanent or long-term source of
finance

Interest is calculated on a variable rate and therefore it is difficult to calculate the cost of borrowings.

Overdrafts can be recalled by the bank at any time if not stated in the agreement.
9. Loans
Loans are amounts of money borrowed from banks or other financial institutions for large and long-term
business projects such as the development or expansion of the business. However loans can be substituted by
other alternative sources of finance which are more suitable.
Advantages;

Large amounts can be borrowed.

Suitable for long-term investments.

The lender has no say on how the money is spent.

Need not be paid back for a fixed time period and banks do not withdraw at a short notice.

Interest rates are lower than for bank overdrafts and are set in advance.
Disadvantages;

Collateral is needed.

The amount borrowed has to be repaid at the agreed date.

Interest is charged.

Loans will affect a company’s gearing ratio.
10. Hire Purchase
Hire purchase allows a business to use an asset without paying the full amount to purchase the asset. The hire
purchase firm buys the asset on behalf of the business and gives the business the sole usage of the asset. The
business on its part must pay monthly payments to the hire purchase firm amounting to the total value of the
asset and charges of the hire purchase firm. At the end of the payment period the business has the option
of purchasing the asset for a nominal value.
Advantages;

The business gains use of the asset before paying the asset’s value in full.

The payment is made in affordable installments.

Hire purchase installments are taxable expenditures.

At the end of the payments ownership of the asset is transferred to the company.

Payments can be made from the asset’s usage and return of the asset.
Disadvantages;

Ownership remains with the lender until the last payment is made.

The asset will cost the company more than the original value.

If payments are not made on time the lender has the right to repossess the asset.

If the asset is required to be replaced due to breakdown or because it is out-dated in which case the payment
may still have to be made and the asset replaced.
11. Lease
In a lease the leasing company buys the asset on behalf of the business and the asset is then provided for the
business to its use. Unlike a hire purchase the ownership of the asset remains with the leasing company. The
business pays a rent throughout the leasing period. The leasing firm is known as the lessor and the customer
as lessee. Leasing is of two types, namely Finance lease and Operating lease.
Advantages;

The amount in full need not be paid in order to start using the asset.

The total cost and the lease period is pre-determined and thus helps with budgeting cash flow.

In an operating lease, payments are made only for the usage duration of the asset.

Lease is inflation friendly where the agreed rate is paid even after five years when other costs increase due
to inflation.

It is easier to obtain a lease than a commercial loan.
Disadvantages;

The ownership of the asset remains with the lessor even after payments but however in a finance lease the
option is provided to buy the asset at a nominal value.

In a finance lease the lessee ends up paying more than the value of the asset.

Lease cannot be terminated whenever at lessee’s will.
12. Grants
Grants are funding given to businesses for programs or services that benefit the community or public at large.
Grants can be given by the government or private firms.
Advantages;

Grants do not have to be paid back.

There are no costs involved in obtaining a grant.
Disadvantages;

Grants are given on certain restrictions and laws imposed by the government.

Not all organisations are eligible for grants.

Grants are given freely and therefore are very competitive because lots of firms try for the same source of
fund.
13. Venture Capital
Venture capital is the capital that is contributed at the initial stages of an uncertain business. The chance of
failure of the business is great while there is also a possibility of providing higher than average return for the
investor. The investor expects to have some influence over the business.
Advantages;

Venture capitalists invest large sums of money in the business.

They may also bring a lot of experience and expertise along with the money.

Since they become owners by investing in the business they have equal interests in the business’s success.

Venture capitalists are only periodical investors wanting to exit the business at some stage.
Disadvantages;

The profits will be shared with the investor.

Acquiring venture capitals is a lengthy and complex process where a business plan and financial projections
must be submitted to the potential venture capitalist.

As an owner of the business the venture capitalist may want to influence the strategic decisions and take
control of the business.
14. Factoring
This is where the factoring company pays a proportion of the sales invoice of the business within a short timeframe to the business. The remainder of the money is paid to the business when the factoring company receives
the money from the business’s debtor. The remainder of the money will be paid only after deducting the
factoring company’s service charges. Some factoring companies even offer to maintain the sales ledger of the
business. Factoring is of two types: Recourse factoring and Non-recourse factoring.
Advantages;

A large proportion of money is received within a short time-frame.

The sales ledger of the business can be outsourced to the factor.

The money collections from debtors are undertaken by the factoring company.

Helps a business to have a smooth cash flow operation.

Non-recourse factoring protects the client company from bad debts.
Disadvantages;

The business has to pay interests and fees for the factor for its services.

The cost will be a reduction on the company’s profit margin.

Lack of privacy since the sales ledger is maintained by the factor.

Costumers would not like factoring companies collecting debts from them.
15. Invoice Discounting
In invoice discounting the client company send out a copy of the invoice to the invoice discounting firm. The
client then receives a portion of the invoice value. In contrast to factoring, the client company collects the
money from its debtors. Once the payment is received it is deposited in a bank account controlled by the
invoice discounter. The invoice discounter will then pay the remainder of the invoice less any charges to the
client.
Advantages;

The client company receives the money in a short period.

There is some amount of privacy since the sales ledger is maintained by the client company and only some
invoices are submitted for immediate cash.

Less costly than factoring since the sales ledger is maintained by the client company.

Unlike factoring customers are not aware of invoice discounting since the debt collection is undertaken by
the client firm.
Disadvantages;

Debt should be collected by the client company itself and thus resources and time are wasted in debt collection.

Sales ledger has to be maintained by the client company itself.
Q3 Understandability This implies the expression, with clarity, of accounting information in such a way that
it will be understandable to users - who are generally assumed to have a reasonable knowledge of business
and economic activities
Relevance: This implies that, to be useful, accounting information must assist a user to form, confirm or
maybe revise a view - usually in the context of making a decision (e.g. should I invest, should I lend money
to this business? Should I work for this business?)
Consistency: This implies consistent treatment of similar items and application of accounting policies
Comparability This implies the ability for users to be able to compare similar companies in the same
industry group and to make comparisons of performance over time. Much of the work that goes into setting
accounting standards is based around the need for comparability.
Reliability This implies that the accounting information that is presented is truthful, accurate, complete
(nothing significant missed out) and capable of being verified (e.g. by a potential investor).
Objectivity This implies that accounting information is prepared and reported in a "neutral" way. In other
words, it is not biased towards a particular user group or vested interest