Nature of Management Accounting
Characteristics of Management Accounting:
1. It is a selective technique. It compiles only the data from balance sheet and profit and loss, which is
relevant and useful.
2. It is concerned with data not decisions. It can inform but not prescribe.
3. It deals with future. It is a kind of planning for the future because decisions are taken for future course
of action.
4. It examines the cause and effect of relationship. Normally, a profit and loss account will show the
amount of profit or loss for the year but does not tell us the reasons for it. Management accounting studies
the causes of profit or losses.
5. It does not follow rigid rules and formats like financial accounting. The necessary info is provided in the
shape of various statements or reports in order to meet the needs of the management.
Objectives of Management Accounting:
1. To help the management in promoting efficiency.
2. To finalize budgets covering all functions of a business.
3. To study the actual performance with plan for identifying deviations and their causes.
4. To analyze financial statements to enable the management to formulate future policies.
5. To help the management at frequent intervals by providing operating statements and short-term
financial statements.
6. To arrange for the systematic allocation of responsibilities for the implementation of plans and budgets.
7. To provide a suitable organization for discharging the responsibilities.
Scope of Management Accounting:
1. Financial accounting: Related to the recording of business transactions including income, expenditure,
inventory movement, assets, liabilities, cash receipts, etc.
2. Cost accounting: Costing is a branch of accounting. It is the process of and technique of ascertaining
costs. It includes standard costing, marginal costing, differential and opportunity cost analysis.
3. Budgeting and forecasting: Covers budgetary control
4. It reports financial results to the management
5. It provides statistical data to various departments.
Functions of Management Accounting:
1. It assists in planning and formulating future policies.
2. It helps to interpret and analyze the financial information.
3. It controls and monitors performance.
4. It helps to organize various functions of an organization.
5. It offers solution for strategic business problems.
6. It coordinates various departmental operations.
7. It motivates employees.
Functions of management Accountant:
1.
Collection of data
2.
Analysis
3.
Presentation of data
4.
Planning: A management accountant plans the entire accounting functions.
5.
Controlling: Examines the performance against the set standard and reports it to the management.
6.
Reporting: He reports to the management and advises them on future decisions.
7.
Coordinating: preparation of master budget
8.
Decision making
Standard costing
 What is Material Cost Variance? What are its sub-divisions?
Material Cost Variance or Material Total Variance is the Variance in material cost actually incurred on
material and the material cost estimated on material.
Material Cost Variance can be derived as follows:
MCV = (Standard Quantity x Standard Rate) – (Actual Quantity x Actual Rate)
Material Cost Variance can be sub-divided as follows:
a)
Material Rate Variance or Material Price Variance is the variance in the rate or price of material
actually spent and the material rate/price estimated.
Thus, even if there is no change in quantity consumed, if there is a difference in the total cost, then it is
due to the difference in the rate at which material is consumed.
Material Rate Variance can be derived as follows:
1
MRV = Actual Quantity (Standard Price – Actual Price)
b)
Material Usage Variance is the variance in the usage of material in actual production and the
estimated usage of material.
Thus, even if there is no change in the rate of material, if there is a change in the total cost, then it is due
to the change in consumption of material.
Material Usage Variance can be derived as follows:
MUV = Standard Rate (Standard Quantity – Actual Quantity)
 What is Material Usage Variance? What are its sub-divisions?
Material Usage Variance is the variance in the usage of material in actual production and the estimated
usage of material.
Thus, even if there is no change in the rate of material, if there is a change in the total cost, then it is due
to the change in consumption of material.
Material Usage Variance can be derived as follows:
MUV = Standard Rate (Standard Quantity – Actual Quantity)
Material Usage Variance can be further sub-divided into:
a)
Material Mix Variance: The difference between actual quantity of material and revised standard
quantity of material is the Material Mix Variance.
Revised Standard Quantity is the Actual Quantity of Material divided in the standard raw material ratio.
Material Mix Variance can be derived as follows:
MMV = Standard Rate (Revised Standard Quantity – Actual Quantity)
b)
Material Yield Variance: The difference between the actual output and the standard expected
output is the Material Yield Variance.
There are two methods of calculating Material Yield Variance. They are as follows:
Input Method:
MYV = (Standard Input – Actual Input) x Average Cost / unit
Output Method:
MYV = (Actual Output – Standard Output) x Total Cost / unit
(Note: Labour Variances can be answered in the same manner as Material Variances. Incase of any doubt
or query, please put your queries on: www.sigmaforum.tk)
Marginal Costing
 What is Marginal Costing? Why is it calculated?
The marginal cost of a product is defined as the change in cost that occurs when the volume of output is
increased or reduced by one unit.
Marginal costing is used to assess whether it is financially feasible to increase manufacturing volume or to
calculate the effect of reducing volume, perhaps due to a decline in the market. It is based on variable
costs because fixed costs are fixed. They occur and do not change if manufacturing volume changes.
Following factors are calculated on the basis of marginal costing:
 production planning
 pricing
 make or buy
 close-down
 accept or reject
 dropping a production line
 accepting additional order
 Write a note on Break Even Point.
Break Even Point is the level of sales required to reach a position of no profit, no loss. At Break Even Point,
the contribution is just sufficient to cover the fixed cost. The organisation starts earning profit when the
sales cross the Break Even Point. Break Even Point can be calculated either in terms of units or in terms of
cash or in terms of capacity utilization. It can be calculated as follows:
BEP in units = Fixed Cost / Contribution per unit
BEP in cash = Fixed Cost / P.V. Ratio
BEP in terms of capacity utilization = BEP in units / Total capacity x 100
2
Break Even Volume can
better explained with
diagram above.

Explain the concept
of Margin of Safety.
The positive difference between the operating sales volume and the break even volume is known as the
margin of safety. The larger the difference, the safer the organization is from a loss making situation. It
can be calculated either in cash or in units.
Margin of Safety can be derived as follows:
Margin of Safety = Actual Sales – Break even Sales
Margin of Safety (in cash) =
Profit___
P/V Ratio
Margin of Safety (in units) =
Profit______
Contribution/unit
be
the
 What is Profit/Volume Ratio?
Profit-Volume Ratio expresses the relationship between contribution and sales. It indicates the relative
profitability of diff products, processes and departments.
Formulae:
P/V ratio = S – V/ S X 100
= Cont / Sales X 100
= Change in profit or loss / Change in sales
 Short note on :Limiting factor
Whenever some resources required for products and are not adequately available, these resources
become limiting factor. If there are limiting factors, then the product which gives more contribution per
unit may not give more amount of total contribution because, it may not make more profitable use of
limited resources.
In such cases, we can calculate contribution per unit of limiting factor and the product which offers more
contribution per unit of limiting factor is to be treated as more profitable product and the product priority
order is to be accordingly calculated.
Contract Costing
 What are the various methods of calculating profits on almost completion of contract?
When the contract is almost at the stage of completion, profit can be calculated in four ways. It is upon the
company to adopt any of the four methods. The four methods are as follows:
1. Profit = Estimated Profit x
Work Certified___
Total Contract Price
2. Profit = Estimated Profit x Cost incurred to date
Total estimated cost
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3. Profit = Estimated Profit
x
4. Profit = Estimated Profit
x
Cash Received___
Total Contract Price
Cash Received___ x
Total Contract Price
Cost incurred to date
Total estimated cost
Explain the terms:
Contractor: A party who agrees to provide supplies or services in accordance with a valid and legal
contract. A contractor executes the work.
Contractee: A party who orders supplies or services in accordance with a valid and legal contract. A
contractee gives the contract.
Running Bill: It is a bill raised by the contractor for periodical payments.
Retention Money: It refers to that part of the contract amount which is certified but not paid.
Work Certified: It refers to that part of the running bill, which is approved by the architect of the
contractee.
Work Uncertified: It refers to that part of the running bill, which is rejected by the architect of the
contractee. It is always valued at cost.
Basic Rate Concept: Basic Rate concept refers to the method in which a fixed rate is maintained for the
raw materials throughout the contract irrespective of the fluctuations in the market price of the material.
Escalation Clause: Escalation clause is a provision of a contract which calls for an increase in contract
price in the event of an increase in certain costs beyond a certain percentage and viceversa.
Abnormal Loss: It is the part of the process loss caused due to abnormal circumstances in the factory.
For Ex, labour strike, break down of machinery. It is avoidable and controllable by mgmt. Abnormal loss
occurs in addition to normal loss.
Normal loss: It is part of process cost which is caused under normal circumstances. It is inevitable.
Example, weight loss, scrap loss, pilferage. Normal loss is calculated at a certain % of input in unit in
respective process. It may have scrap value.
Process Costing
Write a note on “Inter process profits”.
While transferring the outputs of one process to another, the company might add some amount of profits
to it. This is to get the actual cost of finished product as, if the company would have bought the inputs for
the next process, it would be inclusive of profits. But, at the end of an accounting period, this inter process
profit has to be excluded in order to get the real valuation of closing stock.
E.g.:
Process I:
Cost- 10000
Profit- 2000
Transferred Price- 12000
Process II:
Inputs from Process I 12000
Additional Processing cost- 12000
Total Cost incurred
24000
Sales
21600
Closing Stock
2400
Inter-process profit of P-I
200
Value of Closing Stock
2200
 What is equivalent production?
At the end of a financial period, all the stock of a company needs to be assessed. All the partially
completed units are valued through the method of equivalent production. The units of production are
calculated according to the percentage of completion of processing on the partially completed units.
For example, two units that are 50 percent complete are the equivalent of one unit fully completed.
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Budgetary Control
What is Budgetary Control? What are the steps involved in Budgetary Control?
Budgetary control is the management process of using budgets to monitor and control the performance of
the organization. This is done by comparing the planned values (in the budget) with the actual values as
they occur during the year.
A budget has been defined as a financial and quantitative statement prepared and approved prior to a
defined period of time, of the policy to be pursued during that period for the purpose of attaining a given
objective.
The following steps are involved in Budgetary Control:
1. Establishment of Budgets: Targets are fixed for each function relating to the responsibilities of individual
executives.
2. Measurement of actual performance.
3. Comparison of actual performance with budgeted performance to detect deviation.
4. Analysis of the causes of variations and reporting
What are the uses of diff budgets?
 It serves a declaration of policies
 Defines the objectives/ targets for executives, at all levels.
 Means of coordination of activities
 Means of communication
 Facilitates centralised control
 Helps in planning activities
Note: The information provided in this document on each topic is limited. We do not guarantee an
inclusion of the whole scope of management accounting or of the whole syllabus of N.M.S.Y.B.M.S. We
suggest you to refer to the books recommended by your professor.
Cash Budget
The cash budget is prepared after the operating budgets (sales, manufacturing expenses or merchandise
purchases, selling expenses, and general and administrative expenses) and the capital expenditures
budget are prepared. The cash budget starts with the beginning cash balance to which is added the cash
inflows to get cash available. Cash outflows for the period are then subtracted to calculate the cash
balance before financing. If this balance is below the company's required balance, the financing section
shows the borrowings needed. The financing section also includes debt repayments, including interest
payments. The cash balance before financing is adjusted by the financing activity to calculate the ending
cash balance. The ending cash balance is the cash balance in the budgeted or pro forma balance sheet.
Flexible Budgets
A budget report is prepared to show how actual results compare to the budgeted numbers. It has
columns for the actual and budgeted amounts and the differences, or variances, between these amounts.
A variance may be favorable or unfavorable. On an income statement budget report, think of how the
variance affects net income, and you will know if it is a favorable or unfavorable variance. If the actual
results cause net income to be higher than budgeted net income (such as more revenues than budgeted
or lower than budgeted costs), the variance is favorable. If actual net income is lower than planned (lower
revenues than planned and/or higher costs than planned), the variance is unfavorable. So higher revenues
cause a favorable variance, while higher costs and expenses cause an unfavorable variance.
Cost ACCOUNTING:
• In today’s business world, the resources available are very scarce.
• Hence, every business unit must strive hard to obtain maximum output with the available input in
order to ensure the optimum utilization of scarce resources.
• The value of input is measured against the value of output.
• In the present era of cut-throat competition, the need to study this subject is growing very fast.
• Every businessman makes a constant effort to improve his/her business.
• Cost accounting is the process of accounting for cost.
• Cost accounting is generally concerned with internal reporting for management requirement.
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•
•
•
•
•
The development of cost accounting is of recent origin.
The Chartered Institute of Management Accountants, U.K. (CIMA) defines costing as ‘the technique
and process of ascertaining costs.’
Costing is a tool to determine the cost of products or service.
Cost accounting – analysis and classification of costs or expenditure.
Cost accountancy – application of costing and cost accounting principles
Functions of Cost Accounting:
• ‘Cost Accounting is to serve management in the execution of policies and in the comparison of
actual and estimated results in order that the value of each policy may be appraised and changed
to meet the future conditions.’
– To calculate cost per unit
– To prepare a correct cost analysis
– To ascertain the wastage in each process of manufacture
– To provide necessary information for the determination of selling price
– To compute product-wise profit
– To serve the management in the valuation of W-I-P
– To install and implement cost control systems
– To advice management for future expansion
– To establish an effective reporting system
– To guide the management in the preparation and implementation of incentive schemes
based on productivity and cost savings.
Objects of Cost Accounting:
• To determine the actual cost of each article, process, operation, service, department or segment of
activity.
• To reveal and report inefficiencies in the form of material wastage, loss of time in material buying,
storing, and issuing.
• To provide actual figures of cost comparison with estimates of costs and price fixing.
• To find out the degree of efficiency and productive capacity of men and machines and ideal
standard for their working.
• To implement incentive wage plans for workers.
• To reduce cost through budgetary control and standard costing.
• To study trends at different volumes of output, and to determine production policies and programs.
• To ensure continuous check and adjustment of stores and materials with the help of perpetual
inventory.
• To organize internal audit system, and interlocking of financial and cost accounts to verify the
accuracy of each other.
To furnish necessary data for the preparation of profit and loss account and balance sheet at short
intervals [e.g., monthly, quarterly, etc.] for each department or business as a whole
Advantages of Cost Accounting:
• Price Fixation
• Control on Unprofitable Activities
• Useful Information
• Cost Control
• Provides Valuable Data
• Effective Check
• Preparation of Budgets and Regulations of production
• Fixation of Responsibilities
• Independent Check
• Prevention of Manipulation, misappropriation, and frauds
Principles of Costing:
• Every concern must design its own costing system, keeping in view its peculiar problems.
• If financial books can afford the necessary information, separate costing system is not needed.
• Reasonable accuracy is enough, of course, this depends upon the nature of industry.
• As a rule, costing information should be collected as and when the work proceeds.
Importance of Costing
• To the Employees
– Incentive Bonus
– Higher earnings through time and motion study
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•
To
•
To
•
To
•
To
–
–
–
the
–
–
–
–
–
–
–
the
–
–
the
–
–
the
–
–
Overtime payments
Benefit of job evaluation
Continuous employment and job security
Management
Planning
Organizing
Controlling
Budgeting
Decision-making
Pricing
Evaluation of operating efficiency
creditors
Can access more information in comparison to Financial accounts
To ascertain the solvency, profitability
government
More taxes through higher production
Useful in preparing import and export policy
society
Lower prices through cost reduction
Better quality of products and services
Budget:
A plan which for a definite period, covers, all phases of operations in the future is known as a
business budget. Policies, plans, objectives & goals are formally expressed by it & are laid down in
advance for the concern as a whole & for each of its sub-divisions by the top management. Thus an overall
budget will be there for the concern comprosed of several sub-budgets which are in the form of
departmental budgets. Expense limitations are expressed by the budget in the expense budgets & in the
sales budget, revenue goals are expressed & for the purpose of realizing the desired profit objective, these
must be attained. Besides, plans relating to items such as levels of inventory, additions to capital assets,
plans of production, plans of purchasing, requirements of labour, requirements of cash etc. are expressed
by the budget. Thus, for a given period, budget is a formal management plans’ & policies’ statement which
can be used in that period as a guide or blue print.
The basic elements of a budget are:
(a) For a specified period of time, it’s a future plan of activity,
(b) Budget can be expressed in monetary or physical units or in both,
(c) Before the period during which the budget is supposed to operate, it is prepared i.e. it is prepared in
advance.
(d) Before the preparation of the budget, it is necessary to lay down the objectives which are required to
be attained & the policies which are required to be pursued for the achievement of those objectives.
Budgetary Control:
Throughout the budget period, the use of budgets & budgetary reports for the purpose of
coordinating, evaluating & controlling day-to-day operations according to the goals which are specified by
the budget is involved by budgetary control. The mere presentation of budget doesn’t have much value,
its real value lies in the aspects of the planning & its utilization during the period for the purposes of
control & coordination. Under budgetary control, actual results are constantly checked & evaluated &
comparison of actual result is made with the budgeted goals & wherever indicated, corrective action
should be undertaken. The following steps are involved in the process of budgetary control:
(a) The objectives which are required to be achieved by the business should be defined & specified by
budgetary control.
(b) For the purpose of ensuring that the desired objectives are accomplished, business plans are needed to
be prepared by budgetary control.
(c) Budgetary control translates the plans into budgets & relates to particular sections of the budget, the
responsibilities of individual executives & managers.
(d) Budgetary control constantly compares the actual results with the budget & the differences between
the actual & budgeted performance are calculated.
(e) For the purpose of establishing the causes, the major differences are investigated by budgetary
control.
(f) In a suitable form, budgetary control presents the information to the management, relating to variances
to individual responsibility.
7
(g) In order to avoid a repetition of any over-expenditure or wastage, management takes corrective
actions. Alternatively, where due to the change in circumstances, the budgeted targets cannot be
achieved, the budget is revised.
Difference between Budget, Budgeting & Budgetary control:
Individual objectives of a department etc. are indicated by budget, whereas the act of setting the
budgets is known as budgeting. All are embraced by budgetary control & also the science of planning the
budgets themselves & as an overall management tool, the utilization of such budgets, for the purpose of
business planning & control are included in budgetary control. Thus, the term by budgetary control is
wider in meaning & both budget & budgeting are included in by budgetary control.
Objectives of Budgetary Control:
The objectives of budgetary control are:
(1)Compel for planning: As management is forced to look ahead, responsible for setting of targets,
anticipating of problems & giving purpose & direction to the organization, this feature is the most
important feature of budgetary control.
(2)Communication of ideas & plans: Communication of ideas & plans to everyone is effected by budgetary
control. In order to make sure that each person is aware of what he is supposed to do, it is necessary that
there is a formal system.
(3)Coordinating the activities: The budgetary control coordinates the activities of different departments or
sub-units of the organization. The coordination concept implies, for example, on production requirements,
the purchasing department should base its budget & similarly, on sales expectations, the production
budget should in turn be4 based.
(4) Establishing a system of control: A system of control can be established by having a plan against which
progressive comparison can be made of actual results.
(5) Motivating employees: Employees are motivated for improving their performances by budgetary
control.
Requisites of an effective system of budgetary control:
(a) There should be a clearly defined organizational structure where are area of responsibility is
emphasized.
(b) Within the budgeting process, the employees should participate.
(c) For the purpose of relying the measurement of performance, there should be adequate accounting
records & procedures.
(d) Budgetary control needs to be flexible, so that the plans & objectives may be revised.
(e) An awareness of the uses of the budgetary control system should be spread by the management.
(f) An awareness regarding the problems of budgetary control & especially the individual’s reactions to
budgets should be spread by the top management.
Advantages of Budgetary control:
The advantages of budgetary control system are as follows:
(1) The objectives of the organization as a whole & the results which should be achieved by each
department within this overall framework are defined by the budgetary control.
(2) When there is a difference between actual results & budget, then the extent by which actual results
have exceeded or fallen short of the budget is revealed by the budgetary control.
(3) The variances or other measures of performance along with the reasons of difference between the
actual results with those from budgeted is indicated by the budgetary control. Also, the magnitude of
differences is established by it.
(4) As the budgetary control reports on actual performance along with variances & other measures of
performance; for correcting adverse trends, a basis for guiding executive action is provided by it.
(5) A basis by which future budget can be prepared or the current budget can be revised is provided by
the budgetary control.
(6) A system whereby in the most efficient way possible the resources of the organization are being used is
provided by the budgetary control.
(7) The budgetary control indicates how efficiently the various departments of the organization are being
coordinated.
(8) Situations where activities & responsibilities are decentralized, some centralizing control is provided by
the budgetary control.
(9) The budgetary control provides means by which the activities of the organization can be stabilized,
where the organization’s activities are subject to seasonal variations.
8
(10) By regularly examining the departmental results, a basis for internal audit is established by the
budgetary control.
(11) The standard costs which are to be used are provided by it.
(12) For the purpose of paying a bonus to employees, a basis by which the productive efficiency can be
measured is provided by the budgetary control.
Limitations of Budgetary Control:
The main limitations of budgetary control are:
(1) It used the estimates as a basis for the budget plan.
(2) In order to fit with the changing circumstances the budgetary programme must be continually adapted.
Normally for attaining a reasonably good budgetary programme, it takes several years.
(3) A budget plan cannot be executed automatically. Enthusiastic participation is required by all levels of
management in the programme.
(4) The necessity of having a management & administration will not be eliminated by any budgetary
control system. The place of the management is not taken by it; rather it is a tool of the management.
Sunk cost: Money already spent and permanently lost. Sunk costs are past opportunity costs that are
partially (as salvage, if any) or totally irretrievable and, therefore, should be considered irrelevant to future
decision making. This term is from the oil industry where the decision to abandon or operate an oil well is
made on the basis of its expected cash flows and not on how much money was spent in drilling it. Also
called embedded cost, prior year cost, stranded cost, or sunk capital.
'Budget Manual'
A set of instructions used within large organizations to prepare budgets. As organizations become larger
and more complex, it is no longer possible for one person to prepare a budget. Instead, budgeting across
the enterprise must be carefully coordinated. Financial analysts work closely with each group to collect
budget information on a pre-set schedule and then send data up through higher rungs of financial
controllers
until
it
can
be
aggregated
by
the
CFO’s
office.
(A) Actual Cost
Actual cost is defined as the cost or expenditure which a firm incurs for producing or acquiring a good or
service. The actual costs or expenditures are recorded in the books of accounts of a business unit. Actual
costs are also called as "Outlay Costs" or "Absolute Costs" or "Acquisition Costs".
Examples: Cost of raw materials, Wage Bill etc.
(B) Opportunity Cost
Opportunity cost is concerned with the cost of forgone opportunities/alternatives. In other words, it is the
return from the second best use of the firms resources which the firms forgoes in order to avail of the
return from the best use of the resources. It can also be said as the comparison between the policy that
was chosen and the policy that was rejected. The concept of opportunity cost focuses on the net revenue
that could be generated in the next best use of a scare input. Opportunity cost is also called as
"Alternative Cost".
If a firm owns a land, there is no cost of using the land (ie., the rent) in the firms account. But the firm has
an opportunity cost of using the land, which is equal to the rent forgone by not letting the land out on rent.
(C) Sunk Cost
Sunk costs are those do not alter by varying the nature or level of business activity. Sunk costs are
generally not taken into consideration in decision - making as they do not vary with the changes in the
future. Sunk costs are a part of the outlay/actual costs. Sunk costs are also called as "Non-Avoidable
costs" or "Inescapable costs".
Examples: All the past costs are considered as sunk costs. The best example is amortization of past
expenses, like depreciation.
(D) Incremental Cost
Incremental costs are addition to costs resulting from a change in the nature of level of business activity.
As the costs can be avoided by not bringing any variation in the activity in the activity, they are also called
as "Avoidable Costs" or "Escapable Costs". More ever incremental costs resulting from a contemplated
change is the Future, they are also called as "Differential Costs"
Example: Change in distribution channels adding or deleting a product in the product line.
(E) Explicit Cost
Explicit costs are those expenses/expenditures that are actually paid by the firm. These costs are
recorded in the books of accounts. Explicit costs are important for calculating the profit and loss accounts
and guide in economic decision-making. Explicit costs are also called as "Paid out costs"
Example: Interest payment on borrowed funds, rent payment, wages, utility expenses etc.
(F) Implicit Cost
9
Implicit costs are a part of opportunity cost. They are the theoretical costs ie., they are not recognised by
the accounting system and are not recorded in the books of accounts but are very important in certain
decisions. They are also called as the earnings of those employed resources which belong to the owner
himself. Implicit costs are also called as "Imputed costs".
Examples: Rent on idle land, depreciation on dully depreciated property still in use, interest on equity
capital etc.
(G) Book Cost
Book costs are those business costs which don't involve any cash payments but a provision is made in the
books of accounts in order to include them in the profit and loss account and take tax advantages, like
provision for depreciation and for unpaid amount of the interest on the owners capital.
(H) Out Of Pocket Costs
Out of pocket costs are those costs are expenses which are current payments to the outsiders of the firm.
All the explicit costs fall into the category of out of pocket costs.
Examples: Rent Payed, wages, salaries, interest etc
(I) Accounting Costs
Accounting costs are the actual or outlay costs that point out the amount of expenditure that has already
been incurred on a particular process or on production as such accounting costs facilitate for managing the
taxation need and profitability of the firm.
Examples: All Sunk costs are accounting costs
(J) Economic Costs
Economic costs are related to future. They play a vital role in business decisions as the costs considered in
decision - making are usually future costs. They have the nature similar to that of incremental, imputed
explicit and opportunity costs.
(K) Direct Cost
Direct costs are those which have direct relationship with a unit of operation like manufacturing a product,
organizing a process or an activity etc. In other words, direct costs are those which are directly and
definitely identifiable. The nature of the direct costs are related with a particular product/process, they
vary with variations in them. Therefore all direct costs are variable in nature. It is also called as "Traceable
Costs"
Examples: In operating railway services, the costs of wagons, coaches and engines are direct costs.
(L) Indirect Costs
Indirect costs are those which cannot be easily and definitely identifiable in relation to a plant, a product, a
process or a department. Like the direct costs indirect costs, do not vary ie., they may or may not be
variable in nature. However, the nature of indirect costs depend upon the costing under consideration.
Indirect costs are both the fixed and the variable type as they may or may not vary as a result of the
proposed changes in the production process etc. Indirect costs are also called as Non-traceable costs.
Example: The cost of factory building, the track of a railway system etc., are fixed indirect costs and the
costs of machinery, labour etc.
Definition of 'Suspense Account'
In accounting, the section of a company's books where unclassified debits and credits are recorded. The
suspense account temporarily holds unclassified transactions while a decision is being made as to their
classification. Transactions in the suspense account will still appear in the general ledger, giving the
company an accurate indication of how much money it has.
In investing, a suspense account is a brokerage account where an investor places cash or short-term
securities temporarily while deciding where to invest them for a longer term.
Concept of conservatism and materiality concept
The concept of conservatism, also known as the concept of prudence, is often stated as “anticipate no
profit and provide for all possible losses”. In other words, the accountant is expected to follow a cautious
approach.
He should record lowest possible value for the assets and revenues and the highest possible value for the
liabilities and expenses. According to this concept, revenues or gains should be recognized only when they
are realized in the form of cash or assets (usually legally enforceable debts) the ultimate cash realization
of which can be assessed with reasonable certainty. Further, provision must be made for all known
liabilities, expenses and losses whether the amount of these is known with certainty or is at best an
estimate in the light of the information available. The probable losses in respect of all contingencies should
also be provided for.
A contingency is a condition or a situation, the ultimate outcome of which can be either gain or loss and
cannot be determined accurately at present. It will be known only after the event has occurred (or has not
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occurred). For example, a customer has filed a suit for damages against the company in a court of law;
Whether the judgment will be favorable or unfavorable to the company cannot be determined in an exact
manner. Hence, it will be prudent to provide for likely loss in the financial statements. As a consequence of
the application of this concept, net assets are more likely to be understood than overstated and income is
more likely to be overstated than understood. Based on this concept it is the widely advocated practice of
valuing inventory (stock of goods left unsold) at cost or market price whichever is lower.
It should be stated that the logic of this convention has been under stress recently and it has been
challenged by many writers on the ground that it stands in the way of fair determination of profit and the
disclosure of true and fair financial position of the business enterprise.
The concept is not applied as strongly today as it used to be in the past. In any case, conservatism must
be applied rationally as over conservatism may result in misrepresentation.
Materiality concept:
There are many events in business which are trivial or insignificant in nature. The cost of recording and
reporting such events cannot be justified by the usefulness of the information derived. Materiality concept
holds that items of small significance need not be given strict theoretically correct treatment. For example,
a stapler costing around $2 may last for three years; however, the efforts involved in allocating its cost
over the three year period is not worth the benefit than can be derived from this operation. Since the item
obviously is immaterial when related to overall operations, the cost incurred on it may be treated as the
expense of the period in which it is acquired.
Some of the stationery purchased for office use in any accounting period may remain unused at the end of
that period. In accounting, the amount spent on the entire stationery would be treated as expense of the
period in which the stationery was purchased, notwithstanding the fact that a small part of it still lies in
stock. The value (or cost) of the stationery lying in stock would not be treated as an asset and carried
forward as a resource to the next period. The accountant would regard the stock lying unused as
immaterial and hence, the entire amount spent on stationery would be taken as the expense of the period
in which such expense was incurred.
What is a Common-Size Statement?
The common-size statement is a financial document that is often utilized as a quick and easy reference for
the finances of a corporation or business. Unlike balance sheets and other financial statements, the
common-size statement does not reflect exact figures for each line item. Instead, the structure of the
common size statement uses a common base figure, and assigns a percentage of that figure to each line
item or category reflected on the document.
A company may choose to utilize financial statements of this type to present a quick snapshot of how
much of the company’s collected or generated revenue is going toward each operational function within
the organization. The use of a common-size statement can make it possible to quickly identify areas that
may be utilizing more of the operating capital than is practical at the time, and allow budgetary changes to
be implemented to correct the situation.
The common size statement can also be a helpful tool in comparing the financial structures and operation
strategies of two different companies. The use of percentages in the common size statements removes the
issue of which company generates more revenue, and brings the focus on how the revenue is utilized
within each of the two businesses. Often, the use of a common-size statement in this manner can help to
identify areas where each company is utilizing resources efficiently, as well as areas where there is room
for improvement.
Common-size statements can be prepared for any review period desired. Companies that choose to make
use of financial statements of this type may choose to utilize this format for quarterly, semi-annual, or
annual reviews. When there is concern about operational costs, the common-size statement may be
prepared on a more frequent basis, such as monthly. Because the common-size statement is very easy to
read and does not necessarily contain information that would be considered proprietary, the format can
often be employed as part of general information that is released to the public.
Zero Based Budgeting (ZBB)
• Start each budget period afresh-not based on historical data
• Budgets are zero unless managers make the case for resources-the relevant manager must justify the
whole of the budget allocation
• It means that each activity is questioned as if it were new before any resources are allocated to it.
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• Each plan of action has to be justified in terms of total cost involved and total benefit to accrue, with no
reference to past activities.
• Zero based budgets are designed to prevent budgets creeping up each year with inflation
Advantages of ZBB
• Forces budget setters to examine every item.
• Allocation of resources linked to results and needs.
• Develops a questioning attitude.
• Wastage and budget slack should be eliminated.
• Prevents creeping budgets based on previous year’s figures with an added on percentage.
• Encourages managers to look for alternatives.
Disadvantages of ZBB
• It a complex time consuming process
• Short term benefits may be emphasised to the detriment of long term planning
• Affected by internal politics - can result in annual conflicts over budget allocation
Double Entry System of Accounting
Earlier transactions in the books of accounts were recorded under single entry system. But this system had
some shortcomings as there was not a complete record of all the transactions. Also problems were faced
while preparing final accounts. Problems were also faced as there was no self balancing system of
accounting which could guarantee, to some extent, the accuracy of the books of accounts. So a need was
felt for some uniformly accepted system of accounting which could help in the verification of the accuracy
of books to some extent. These problems were solved by the Double Entry System of accounting. This
system has totally replaced the single entry system. This system is now followed universally.
Under this system of accounting, every transaction in business involves atleast two accounts. That is why
this system of accounting is called the ' Double Entry System'. Under this system every transaction has
two aspects i.e. debit aspect and credit aspect. Under this system every transaction is entered into atleast
two accounts in the Ledger. In one account the transaction is entered on the Left hand side i.e on the debit
sideof the account and on the other account an entry for equal amount is made on the right side of the
account i.e. the credit side of the account.
For example suppose X paid cash salaries to his staff. The two accounts affected are cash account and
salaries account. As cash is going out it, cash account is credited. Salaries is an expenditure for the
business, salaries account is debited.
Again X bought raw material for the production unit, the two accounts involved are
Cash account and Purchases account.
He paid carriage to bring goods to his factory, the two accounts involved are cash account and carriage
account.
He sold finished goods to customers on credit, the two accounts involved are the customer's personal
account(debtor) and sales account.
He further purchased furniture for his office on credit. The two accounts involved are furniture account and
the personal account of the seller(creditor).
Thus we can see that every transaction has two aspects in the Double entry system of accountancy.
Now which account is debited and which is to be credited depends on the types of accounts involved and
the rules of debit and credit for that type of account.
Profit and loss accountis the account whereby a trader determines the net result of his business
transactions. It is the account which reveals the net profit (or net loss) of the trader.
Theprofit and loss accountis opened with gross profit transferred from thetradingaccount (or with gross
loss which will be debited toprofit and loss account). After this all expenses and losses (which have not
been dealt in thetradingaccount) are transferred to the debit side of theprofit and loss account. If there are
any incomes or gains, these will be credited to theprofit and loss account. The excess of the gain over the
losses is called the net profit and that of the loss over the gain is called the net loss. The account is closed
by transferring the net profit or loss to capital account of the trader.
Format of the Profit and Loss Account:
Profit and Loss Account
For the year ended ..............
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To
To
To
To
To
To
To
To
To
To
To
To
To
To
To
To
Gross Loss
Salaries
Rent
Rent and Rates
Discount Allowed
Commission Allowed
Insurance
Bank Charges
Legal Charges
Repairs
Advertising
TradeExpenses
Office Expenses
Bad Debts
Traveling Expenses
Etc., Etc.
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
ex.
xxxx
xxxx
xxxx
xxxx
By
By
By
By
By
By
Gross Profit
Interest Received
Discount Received
Commission Received
Other Receipts
Etc., Etc.
By Net Loss (transferred to capital
account of the trader)
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
To Net Profit (transferred to capital
account of the trader)
xxxx
Why cash book show debit balance?
Cash Account is a real account and also the asset of company and assets have normally debit
balance according to basic accountingrules.
So debit balance of cash means we have positive amount in cash account and will be shown as
asset in balance sheet.
But banks also provide overdraft facilities as well in this case we have normally credit balance
of cash which means that we have negative balance in cash account and so it is liability
of company to clear bank overdraft and make cash balance debit again
bcoz cash a/c is real a/c and our asset. assets have normally debit balance according to basic
accounting rules. So debit balance of cash means we have positive amount in. if cash
book show negative balance then it will not remain our asset. it will be our liability.....
When the rule of "debit what comes in and credit what goes out " is followed in cash book,it
cannot show credit balance since you cannot spend more than the receipt ie.,what goes
out can not be more than what comes in. Therefore cash book show debit balance.
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