INTRODUCTION:
A business enterprise must keep a systematic record of what happens from day-
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tot-day events so that it can know its position clearly. Most of the business
enterprises are run by the corporate sector. These business houses are required
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by law to prepare periodical statements in proper form showing the state offinancial affairs. The systematic record of the daily events of a business leading
to presentation of a complete financial picture is known as accounting. Thus,
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Accounting is the language of business. A business enterprise speaks through
accounting. It reveals the position, especially the financial position through the
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language called accounting.MEANING OF ACCOUNTING:
Accounting is the process of recording, classifying, summarizing, analyzing and
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interpreting the financial transactions of the business for the benefit of
management and those parties who are interested in business such as
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shareholders, creditors, bankers, customers, employees and government. Thus, itis concerned with financial reporting and decision making aspects of the
business.
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The American Institute of Certified Public Accountants Committee on
Terminology proposed in 1941 that accounting may be defined as, "The art of
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recording, classifying and summarizing in a significant manner and in terms ofmoney, transactions and events which are, in part at least, of a financial
character and interpreting the results thereof".
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BRANCHES OF ACCOUNTING:
Accounting can be classified into three categories:
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1. Financial Accounting
2. Cost Accounting, and
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3. Management AccountingFINANCIAL ACCOUNTING:
The term ,,Accounting unless otherwise specifically stated always refers to
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,,Financial Accounting. Financial Accounting is commonly carries on in the
general offices of a business. It is concerned with revenues, expenses, assets and
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liabilities of a business house. Financial Accounting has two-fold objective, viz,1. To ascertain the profitability of the business, and
2. To know the financial position of the concern.
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NATURE AND SCOPE OF FINANCIAL ACCOUNTING:
Financial accounting is a useful tool to management and to external users such
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as shareholders, potential owners, creditors, customers, employees andgovernment. It provides information regarding the results of its operations and
the financial status of the business. The following are the functional areas of
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financial accounting:-
1. Dealing with financial transactions:
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Accounting as a process deals only with those transactions which are measurablein terms of money. Anything which cannot be expressed in monetary terms does
not form part of financial accounting however significant it is.
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2. Recording of information:
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Accounting is an art of recording financial transactions of a business concern.
There is a limitation for human memory. It is not possible to remember all
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transactions of the business. Therefore, the information is recorded in a set ofbooks called Journal and other subsidiary books and it is useful for management
in its decision making process.
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3. Classification of Data:
The recorded data is arranged in a manner so as to group the transactions of
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similar nature at one place so that full information of these items may becollected under different heads. This is done in the book called ,,Ledger. For
example, we may have accounts called ,,Salaries, ,,Rent, ,,Interest,
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Advertisement, etc. To verify the arithmetical accuracy of such accounts, trial
balance is prepared.
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4. Making Summaries:The classified information of the trial balance is used to prepare profit and loss
account and balance sheet in a manner useful to the users of accounting
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information. The final accounts are prepared to find out operational efficiency
and financial strength of the business.
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5. Analyzing:It is the process of establishing the relationship between the items of the profit
and loss account and the balance sheet. The purpose is to identify the financial
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strength and weakness of the business. It also provides a basis for interpretation.
6. Interpreting the financial information:It is concerned with explaining the
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meaning and significance of the relationship established by the analysis. Itshould be useful to the users, so as to enable them to take correct decisions.
7. Communicating the results:
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The profitability and financial position of the business as interpreted above arecommunicated to the interested parties at regular intervals so as to assist them to
make their own conclusions.
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LIMITATIONS OF FINANCIAL ACCOUNTING:
Financial accounting is concerned with the preparation of final accounts. The
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business has become so complex that mere final accounts are not sufficient inmeeting financial needs. Financial accounting is like a post-mortem report. At
the most it can reveal what has happened so far, but it can not exercise any
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control over the past happenings. The limitations of financial accounting are as
follows:-
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1. It records only quantitative information.2. It records only the historical cost. The impact of future uncertainties has
no place in financial accounting.
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3. It does not take into account price level changes.
4. It provides information about the whole concern. Product-wise, process-
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wise, department-wise or information of any other line of activity cannotbe obtained separately from the financial accounting.
5. Cost figures are not known in advance. Therefore, it is not possible to fix
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the price in advance. It does not provide information to increase or
reduce the selling price.
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6. As there is no technique for comparing the actual performance with thatof the budgeted targets, it is not possible to evaluate performance of the
business.
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7. It does not tell about the optimum or otherwise of the quantum of profitmade and does not provide the ways and means to increase the profits.
8. In case of loss, whether loss can be reduced or converted into profit by
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means of cost control and cost reduction? Financial accounting does not
answer this question.
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9. It does not reveal which departments are performing well? Which onesare incurring losses and how much is the loss in each case?
10. It does not provide the cost of products manufactured
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11. There is no means provided by financial accounting to reduce the
wastage.
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12. Can the expenses be reduced which results in the reduction of productcost and if so, to what extent and how? No answer to these questions.
13. It is not helpful to the management in taking strategic decisions like
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replacement of assets, introduction of new products, discontinuation of
an existing line, expansion of capacity, etc.
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14. It provides ample scope for manipulation like overvaluation orundervaluation. This possibility of manipulation reduces the reliability.
15. It is technical in nature. A person not conversant with accounting has
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little utility of the financial accounts.
COST ACCOUNTING:
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An accounting system is to make available necessary and accurate informationfor all those who are interested in the welfare of the organization. The
requirements of majority of them are satisfied by means of financial accounting.
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However, the management requires far more detailed information than what the
conventional financial accounting can offer. The focus of the management lies
not in the past but on the future.
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For a businessman who manufactures goods or renders services, cost accounting
is a useful tool. It was developed on account of limitations of financial
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accounting and is the extension of financial accounting. The advent of factorysystem gave an impetus to the development of cost accounting.
It is a method of accounting for cost. The process of recording and
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accounting for all the elements of cost is called cost accounting.
The Institute of Cost and Works Accountants, London defines costing as, "the
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process of accounting for cost from the point at which expenditure is incurred orcommitted to the establishment of its ultimate relationship with cost centres and
cost units. In its wider usage it embraces the preparation of statistical data, the
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application of cost control methods and the ascertainment of the profitability of
activities carried out or planned".
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The Institute of Cost and Works Accountants, India defines cost accounting as,"the technique and process of ascertainment of costs. Cost accounting is the
process of accounting for costs, which begins with recording of expenses or the
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bases on which they are calculated and ends with preparation of statistical data".
To put it simply, when the accounting process is applied for the elements of
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costs (i.e., Materials, Labour and Other expenses), it becomes Cost Accounting.OBJECTIVES OF COST ACCOUNTING:
Cost accounting was born to fulfill the needs of manufacturing companies. It is a
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mechanism of accounting through which costs of goods or services are
ascertained and controlled for different purposes. It helps to ascertain the true
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cost of every operation, through a close watch, say, cost analysis and allocation.The main objectives of cost accounting are as follows:-
1. Cost Ascertainment
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2. Cost Control3. Cost Reduction
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4. Fixation of Selling Price
5. Providing information for framing business policy.
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1. Cost Ascertainment:The main objective of cost accounting is to find out the cost of product, process,
job, contract, service or any unit of production. It is done through various
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methods and techniques.
2. Cost Control:
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The very basic function of cost accounting is to control costs. Comparison ofactual cost with standards reveals the discrepancies (Variances). The variances
reveal whether cost is within control or not. Remedial actions are suggested to
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control the costs which are not within control.
3. Cost Reduction:
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Cost reduction refers to the real and permanent reduction in the unit cost ofgoods manufactured or services rendered without affecting the use intended. It
can be done with the help of techniques called budgetary control, standard
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costing, material control, labour control and overheads control.
4. Fixation of Selling Price:
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The price of any product consists of total cost and the margin required. Cost dataare useful in the determination of selling price or quotations. It provides detailed
information regarding various components of cost. It also provides information
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in terms of fixed cost and variable costs, so that the extent of price reduction canbe decided.
5. Framing business policy:
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Cost accounting helps management in formulating business policy and decision
making. Break even analysis, cost volume profit relationships, differential
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costing, etc are helpful in taking decisions regarding key areas of the businesslike-
a. Continuation or discontinuation of production
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b. Utilization of capacity
c. The most profitable sales mix
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d. Key factore. Export decision
f. Make or buy
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g. Activity planning, etc.
NATURE AND SCOPE OF COST ACCOUNTING:
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Cost accounting is concerned with ascertainment and control of costs. Theinformation provided by cost accounting to the management is helpful for cost
control and cost reduction through functions of planning, decision making and
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control. Initially, cost accounting confined itself to cost ascertainment and
presentation of the same mainly to find out product cost. With the introduction
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of large scale production, the scope of cost accounting was widened andproviding information for cost control and cost reduction has assumed equal
significance along with finding out cost of production. To start with cost
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accounting was applied in manufacturing activities but now it is applied in
service organizations, government organizations, local authorities, agricultural
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farms, extractive industries and so on.Cost accounting guides for ascertainment of cost of production. Cost accounting
discloses profitable and unprofitable activities. It helps management to eliminate
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the unprofitable activities. It provides information for estimate and tenders. Itdiscloses the losses occurring in the form of idle time spoilage or scrap etc. It
also provides a perpetual inventory system. It helps to make effective control
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over inventory and for preparation of interim financial statements. It helps in
controlling the cost of production with the help of budgetary control and
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standard costing. Cost accounting provides data for future production policies. Itdiscloses the relative efficiencies of different workers and for fixation of wages
to workers.
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LIMITATIONS OF COST ACCOUNTING:
i)
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It is based on estimation: as cost accounting relies heavily onpredetermined data, it is not reliable.
ii)
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No uniform procedure in cost accounting: as there is no
uniform procedure, with the same information different results
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may be arrived by different cost accounts.iii)
Large number of conventions and estimate: There are number
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of conventions and estimates in preparing cost records such as
materials are issued on an average (or) standard price, overheads
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are charged on percentage basis, Therefore, the profits arrivedfrom the cost records are not true.
iv)
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Formalities are more: Many formalities are to be observed to
obtain the benefit of cost accounting. Therefore, it is not
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applicable to small and medium firms.v)
Expensive: Cost accounting is expensive and requires
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reconciliation with financial records.
vi)
It is unnecessary: Cost accounting is of recent origin and an
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enterprise can survive even without cost accounting.
vii)
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Secondary data: Cost accounting depends on financialstatements for a lot of information. Any errors or short comings
in that information creep into cost accounts also.
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MANAGEMENT ACCOUNTING
Management accounting is not a specific system of accounting. It could be any
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form of accounting which enables a business to be conducted more effectivelyand efficiently. It is largely concerned with providing economic information to
mangers for achieving organizational goals. It is an extension of the horizon of
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cost accounting towards newer areas of management. Much management
accounting information is financial in nature but has been organized in a manner
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relating directly to the decision on hand.Management Accounting is comprised of two words ,,Management and
,,Accounting. It means the study of managerial aspect of accounting. The
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emphasis of management accounting is to redesign accounting in such a way
that it is helpful to the management in formation of policy, control of execution
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and appreciation of effectiveness.Management accounting is of recent origin. This was first used in 1950 by a
team of accountants visiting U. S. A under the auspices of Anglo-American
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Council on Productivity
Definition:
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Anglo-American Council on Productivity defines Management Accounting as,"the presentation of accounting information in such a way as to assist
management to the creation of policy and the day to day operation of an
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undertaking"
The American Accounting Association defines Management Accounting as "the
methods and concepts necessary for effective planning for choosing among
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alternative business actions and for control through the evaluation and
interpretation of performances".
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The Institute of Chartered Accountants of India defines ManagementAccounting as follows: "Such of its techniques and procedures by which
accounting mainly seeks to aid the management collectively has come to be
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known as management accounting"
From these definitions, it is very clear that financial data is recorded, analyzed
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and presented to the management in such a way that it becomes useful andhelpful in planning and running business operations more systematically.
OBJECTIVES OF MANAGEMENT ACCOUNTING:
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The fundamental objective of management accounting is to enable the
management to maximize profits or minimize losses. The evolution of
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management accounting has given a new approach to the function of accounting.The main objectives of management accounting are as follows:
1. Planning and policy formulation:
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Planning involves forecasting on the basis of available information, setting
goals; framing polices determining the alternative courses of action and deciding
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on the programme of activities. Management accounting can help greatly in thisdirection. It facilitates the preparation of statements in the light of past results
and gives estimation for the future.
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2. Interpretation process:
Management accounting is to present financial information to the management.
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Financial information is technical in nature. Therefore, it must be presented insuch a way that it is easily understood. It presents accounting information with
the help of statistical devices like charts, diagrams, graphs, etc.
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3. Assists in Decision-making process:
With the help of various modern techniques management accounting makes
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decision-making process more scientific. Data relating to cost, price, profit andsavings for each of the available alternatives are collected and analyzed and
provides a base for taking sound decisions.
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4. Controlling:
Management accounting is a useful for managerial control. Management
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accounting tools like standard costing and budgetary control are helpful incontrolling performance. Cost control is effected through the use of standard
costing and departmental control is made possible through the use of budgets.
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Performance of each and every individual is controlled with the help of
management accounting.
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5. Reporting:Management accounting keeps the management fully informed about the latest
position of the concern through reporting. It helps management to take proper
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and quick decisions. The performance of various departments is regularly
reported to the top management.
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6. Facilitates Organizing:"Return on Capital Employed" is one of the tools of management accounting.
Since management accounting stresses more on Responsibility Centres with a
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view to control costs and responsibilities, it also facilitates decentralization to agreater extent. Thus, it is helpful in setting up effective and efficiently
organization framework.
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7. Facilitates Coordination of Operations:
Management accounting provides tools for overall control and coordination of
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business operations. Budgets are important means of coordination.NATURE AND SCOPE OF MANAGEMENT ACCOUNTING:
Management accounting involves furnishing of accounting data to the
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management for basing its decisions. It helps in improving efficiency and
achieving the organizational goals. The following paragraphs discuss about the
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nature of management accounting.1. Provides accounting information:
Management accounting is based on accounting information. Management
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accounting is a service function and it provides necessary information to
different levels of management. Management accounting involves the
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presentation of information in a way it suits managerial needs. The accountingdata collected by accounting department is used for reviewing various policy
decisions.
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2. Cause and effect analysis.
The role of financial accounting is limited to find out the ultimate result, i.e.,
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profit and loss; management accounting goes a step further. Managementaccounting discusses the cause and effect relationship. The reasons for the loss
are probed and the factors directly influencing the profitability are also studied.
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Profits are compared to sales, different expenditures, current assets, interest
payables, share capital, etc.
3. Use of special techniques and concepts.
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Management accounting uses special techniques and concepts according to
necessity to make accounting data more useful. The techniques usually used
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include financial planning and analyses, standard costing, budgetary control,marginal costing, project appraisal, control accounting, etc.
4. Taking important decisions.
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It supplies necessary information to the management which may be useful for its
decisions. The historical data is studied to see its possible impact on future
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decisions. The implications of various decisions are also taken into account.5. Achieving of objectives.
Management accounting uses the accounting information in such a way that it
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helps in formatting plans and setting up objectives. Comparing actual
performance with targeted figures will give an idea to the management about the
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performance of various departments. When there are deviations, correctivemeasures can be taken at once with the help of budgetary control and standard
costing.
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6. No fixed norms.
No specific rules are followed in management accounting as that of financial
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accounting. Though the tools are the same, their use differs from concern toconcern. The deriving of conclusions also depends upon the intelligence of the
management accountant. The presentation will be in the way which suits the
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concern most.
7. Increase in efficiency.
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The purpose of using accounting information is to increase efficiency of theconcern. The performance appraisal will enable the management to pin-point
efficient and inefficient spots. Effort is made to take corrective measures so that
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efficiency is improved. The constant review will make the staff cost ? conscious.8. Supplies information and not decision.
Management accountant is only to guide and not to supply decisions. The data is
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to be used by the management for taking various decisions. ,,How is the data to
be utilized will depend upon the caliber and efficiency of the management.
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9. Concerned with forecasting.The management accounting is concerned with the future. It helps the
management in planning and forecasting. The historical information is used to
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plan future course of action. The information is supplied with the object to guide
management for taking future decisions.
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LIMITATIONS OF MANAGEMENT ACCOUNTING:Management Accounting is in the process of development. Hence, it suffers
form all the limitations of a new discipline. Some of these limitations are:
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1. Limitations of Accounting Records:
Management accounting derives its information from financial accounting, cost
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accounting and other records. It is concerned with the rearrangement ormodification of data. The correctness or otherwise of the management
accounting depends upon the correctness of these basic records. The limitations
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of these records are also the limitations of management accounting.
2. It is only a Tool:
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Management accounting is not an alternate or substitute for management. It is amere tool for management. Ultimate decisions are being taken by management
and not by management accounting.
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3. Heavy Cost of Installation:
The installation of management accounting system needs a very elaborate
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organization. This results in heavy investment which can be afforded only by
big concerns.
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4. Personal Bias:The interpretation of financial information depends upon the capacity of
interpreter as one has to make a personal judgment. Personal prejudices and
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bias affect the objectivity of decisions.
5. Psychological Resistance:
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The installation of management accounting involves basic change inorganization set up. New rules and regulations are also required to be framed
which affect a number of personnel and hence there is a possibility of resistance
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form some or the other.
6. Evolutionary stage:
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Management accounting is only in a developmental stage. Its concepts andconventions are not as exact and established as that of other branches of
accounting. Therefore, its results depend to a very great extent upon the
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intelligent interpretation of the data of managerial use.
7. Provides only Data:
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Management accounting provides data and not decisions. It only informs, notprescribes. This limitation should also be kept in mind while using the
techniques of management accounting.
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8. Broad-based Scope:
The scope of management accounting is wide and this creates many difficulties
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in the implementations process. Management requires information from bothaccounting as well as non-accounting sources. It leads to inexactness and
subjectivity in the conclusion obtained through it.
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MANAGEMENT ACCOUNTANTManagement Accountant is an officer who is entrusted with Management
Accounting function of an organization. He plays a significant role in the
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decision making process of an organization. The organizational position of
Management Accountant varies form concern to concern depending upon the
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pattern of management system. He may be an executive in some concern, whilea member of Board of Directors in case of some other concern. However, he
occupies a key position in the organization.
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In large concerns, he is responsible for the installation, development and
efficient functioning of the management accounting system. He designs the
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frame work of the financial and cost control reports that provide with the mostuseful data at the most appropriate time. The Management Accountant
sometimes described as Chief Intelligence Officer because apart form top
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management, no one in the organization perhaps knows more about various
functions of the organization than him. Tandon has explained the position of
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Management Accountant as follows:"The management accountant is exactly like the spokes in a wheel, connecting
the rim of the wheel and the hub receiving the information. He processes the
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information and then returns the processed information back to where it came
from".
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Role of Management AccountantManagement Accountant, otherwise called Controller, is considered to be a part
of the management team since he has the responsibility for collecting vital
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information, both from within and outside the company. The functions of the
controller have been laid down by the Controllers Institute of America. These
functions are:
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1. To establish, coordinate and administer, as an integral part of
management, an adequate plan for the control of operations. Such a plan
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would provide, to the extent required in the business cost standards,expense budgets, sales forecasts, profit planning, and programme for
capital investment and financing, together with necessary procedures to
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effectuate the plan.
2. To compare performance with operating plan and standards and to report
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and interpret the results of operation to all levels of management, and tothe owners of the business. This function includes the formulation and
administration of accounting policy and the compilations of statistical
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records and special reposts as required.
3. To consult withal segments of management responsible for policy or
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action conserving any phase of the operations of business as it relates tothe attainment of objective, and the effectiveness of policies,
organization strictures, procedures.
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4. To administer tax policies and procedures.
5. To supervise and coordinate preparation of reports to Government
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agencies.6. The assured fiscal protection for the assets of the business through
adequate internal; control and proper insurance coverage.
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7. To continuously appraise economic and social forces and government
influences, and interpret their effect upon business.
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Duties and Responsibilities of Management Accountant
The primary duty of Management Accountant is to help management in taking
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correct policy-decisions and improving the efficiency of operations. Heperforms a staff function and also has line authority over the accountants. If
management accountant feels that a decision likely to be taken by the
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management based on the information tendered by him shall be detrimental to
the interest of the concern, he should point out this fact to the concerned
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management, of course, with tact, patience, firmness and politeness. On theother hand, if the decision taken happens to be wrong one on account t of
inaccuracy, biased and fabricated data furnished by the management accountant,
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he shall be held responsible for wrong decision taken by the management.
Controllers Institute of America has defined the following duties of
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Management Accountant or controller:1. The installation and interpretation of all accounting records of the
corporative.
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2. The preparation and interpretation of the financial statements and reports
of the corporation.
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3. Continuous audit of all accounts and records of the corporation whereverlocated.
4. The compilation of costs of distribution.
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5. The compilation of production costs.
6. The taking and costing of all physical inventories.
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7. The preparation and filing of tax returns and to the supervision of allmatters relating to taxes.
8. The preparation and interpretation of all statistical records and reports of
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the corporation.9. The preparation as budget director, in conjunction with other officers and
department heads, of an annual budget covering all activities of the
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corporation of submission to the Board of Directors prior to the
beginning of the fiscal year. The authority of the Controller, with respect
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to the veto of commitments of expenditures not authorized by the budgetshall, from time to time, be fixed by the board of Directors.
10. The ascertainment currently that the properties of the corporation are
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properly and adequately insured.
11. The initiation, preparation and issuance of standard practices relating to
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all accounting, matters and procedures and the co-ordination of systemthroughout the corporation including clerical and office methods,
records, reports and procedures.
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12. The maintenance of adequate records of authorized appropriations and
the determination that all sums expended pursuant there into are properly
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accounted for.13. The ascertainment currently that financial transactions covered by
minutes of the Board of Directors and/ or the Executive committee are
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properly executed and recorded.
14. The maintenance of adequate records of all contracts and leases.
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15. The approval for payment(and / or countersigning ) of all cheques,promissory notes and other negotiable instruments of the corporation
which have been signed by the treasurer or such other officers as shall
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have been authorized by the by=laws of the corporation or form time to
time designated by the Board of Directors.
16. The examination of all warrants for the withdrawal of securities from the
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vaults of the corporation and the determination that such withdrawals are
made in conformity with the by-laws and /or regulations established
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from time by the Board of Directors.17. The preparation or approval of the regulations or standard practices,
required to assure compliance with orders of regulations issued by duly
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constituted governmental agencies.
RESPONSIBILITY ACCOUNTING
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"Responsibility Accounting collects and reports planned and actual accountinginformation about the inputs and outputs of responsibility centers".
It is based on information pertaining to inputs and outputs. The resources
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utilized in an organization are physical in nature like quantities of materials
consumed, hours of labour, etc., are called inputs. They are converted into a
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common denominator and expressed in monetary terms called "costs", for thepurpose of managerial control. In a similar way, outputs are based on cost and
revenue data. Responsibility Accounting must be designed to suit the existing
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structure of the organization. Responsibility should be coupled with authority.
An organization structure with clear assignment of authorities and
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responsibilities should exist for the successful functioning of the responsibilityaccounting system. The performance of each manager is evaluated in terms of
such factors.
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RESPONSIBILITY CENTRES
The main focus of responsibility accounting lies on the responsibility centres. A
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responsibility centre is a sub unit of an organization under the control of amanager who is held responsible for the activities of that centre. The
responsibility centres are classified as follows:-
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1) Cost Centres,2) Profit Centres and
3) Investment centres.
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Cost Centres
When the manager is held accountable only for costs incurred in a responsibility
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centre, it is called a cost centre. It is the inputs and not outputs that aremeasured in terms of money. In a cost centre records only costs incurred by the
centre/unit/division, but the revenues earned (output) are excluded form its
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purview. It means that a cost centre is a segment whose financial performance
is measured in terms of cost without taking into consideration its attainments in
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terms of "output". The costs are the planning and control data in cost canters.The performance of the managers is evaluated by comparing the costs incurred
with the budgeted costs. The management focuses on the cost variances for
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ensuring proper control.
A cost centre does not serve the purpose of measuring the performance of the
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responsibility centre, since it ignores the output (revenues) measured in terms ofmoney. For example, common feature of production department is that there are
usually multiple product units. There must be some common basis to aggregate
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the dissimilar products to arrive at the overall output of the responsibility centre.
If this is not done, the efficiency and effectiveness of the responsibility centre
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cannot be measure.Profit Centres
When the manager is held responsible for both Costs (inputs) and Revenues
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(output) it is called a profit centre. In a profit centre, both inputs and outputs are
measured in terms of money. The difference between revenues and costs
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represents profit. The term "revenue" is used in a different sense altogether.According to generally accepted principles of accounting, revenues are
recognized only when sales are made to external customers. For evaluating the
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performance of a profit centre, the revenue represents a monetary measure ofoutput arising from a profit centre during a given period, irrespective of whether
the revenue is realized or not.
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The relevant profit to facilitate the evaluation of performance of a profit centre
is the pre?tax profit. The profit of all the departments so calculated will not
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necessarily be equivalent to the profit of the entire organization. The variancewill arise because costs which are not attributable to any single department are
excluded from the computation of the departments profits and the same are
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adjusted while determining the profits of the whole organization.
Profit provides more effective appraisal of the managers performance. The
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manager of the profit centre is highly motivated in his decision-making relatingto inputs and outputs so that profits can be maximized. The profit centre
approach cannot be uniformly applied to all responsibility centres. The
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following are the criteria to be considered for making a responsibility centre into
a profit centre.
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A profit centre must maintain additional record keeping to measure inputs andoutputs in monetary terms. When a responsibility centre renders only services to
other departments, e.g., internal audit, it cannot be made a profit centre. A profit
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centre will gain more meaning and significance only when the divisional
managers of responsibility centres have empowered adequately in their decision
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making relating to quality and quantity of outputs and also their relation to costs.If the output of a division is fairly homogeneous (e.g., cement), a profit centre
will not prove to be more beneficial than a cost centre.
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Due to intense competition prevailing among different profit centres, there will
be continuous friction among the centres arresting the growth and expansion of
the whole organization. A profit centre will generate too much of interest in the
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short-run profit to the detriment of long-term results.
Investment Centres
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When the manager is held responsible for costs and revenues as well as for theinvestment in assets, it is called an Investment Centre. In an investment centre,
the performance is measured not by profits alone, but is related to investments
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effected. The manager of an investment centre is always interested to earn a
satisfactory return. The return on investment is usually referred to as ROI, serves
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as a criterion for the performance evaluation of the manager of an investmentcentre. Investment centres may be considered as separate entities where the
manager are entrusted with the overall responsibility of inputs, outputs and
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investment.
TRANSFER PRICING
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When profit centres are to be used, transfer prices become necessary in order todetermine the separate performances of both the ,,buying profit centres.
Generally, the measurement of profit in a profit centre is further complicated by
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the problem of transfer prices. The transfer price represents the value of
goods/services furnished by a profit centre to other responsibility centres within
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an organization. When internal exchanges of goods and services take placeamong the different divisions of an organization, they have to be expressed in
monetary terms which are otherwise called the transfer price.
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Thus, transfer pricing is the process of determining the price at which goods are
transferred from one profit centre to another profit centre within the same
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company.If transfer prices are set too high, the selling centre will be favored whereas if set
too low the buying centre exercise which does not effect the overall profitability
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of the firm. However, in certain circumstances, transfer pricing may have anindirect effect on overall company profitability by influencing the decisions
made at divisional level.
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The fixation of appropriate transfer price is another problem faced by the profit
centres. The transfer price forms revenue for the selling division and an element
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of cost of the buying division. Since the transfer price has a bearing on therevenues, costs and profits or responsibility canters, the need for determination
of transfer prices becomes all the more important. But the transfer price
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determination involves choosing one among the various alternatives available
for the purpose.
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These are three objectives that should be considered for setting-out a transferprice.
(a) Autonomy of the Division. The prices should seek to maintain the
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maximum divisional autonomy so that the benefits, of decentralization
(motivation, better decision making, initiative etc.) are maintained. The
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profits of one division should not be dependent on the actions of otherdivisions,
(b) Goal congruence: The prices should be set so that the divisional
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managements desire to maximize divisional earrings is consistent with
the objectives of the company as a whole. The transfer prices should not
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encourage suboptimal decision-making.(c) Performance appraisal: The prices should enable reliable assessments
to be made of divisional performance.
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There are two board approaches to the determination of the transfer price and
they are: (1) cost-based and (2) market based. Based on the broad classification,
there are five different types of transfer prices they are" (1) cost (2) cost plus a
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normal mark-up; (3) incremental cost; (4) market price and (5) negotiated price..
Transfer Pricing Methods
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(i)Market based transfer pricing: Where a market exists outside the
firm for the intermediate product and where the market is
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competitive
(i.e., the firm is a price taker) then the use of market price as the
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transfer price between divisions will generally lead to optimaldecision-making.
(ii)
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Cost based pricing: Cost based transfer pricing systems are
commonly used because the conditions for setting ideal market prices
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frequently do not exist; for example, there may be no intermediatemarket which does exist may be imperfect. Providing that the
required information is available, a rule which would lead to optimal
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decision for the firm as a whole would be to transfer at marginal cost
up to the point of transfer, plus any opportunity cost to the firm as
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whole. The two main cost derived methods are those based on fullcost and variable cost.
(iii)
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Full cost transfer pricing: this method, and the variant which is full
costs plus a profit mark-up, has the disadvantage that suboptimal
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decision-making may occur particularly when there is idle capacitywithin the firm. The full cost (or cost plus) is likely to be treated by
the buying division as an input variable cost so that external selling
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price decisions, may not be set at levels which are optimal as far as
the firm as a whole is concerned.
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(iv)Variable cost transfer pricing: Under this system transfers would
be made at the variable costs up to the point of transfer. Assuming
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that the variable cost is a good approximation of economic marginalcost then this system would enable decisions to be made which
would be in the interests of the firm as a whole. However, variable
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cost based prices will result in a loss for the setting division so
performance appraisal becomes meaningless and motivation will be
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reduced.(v)
Negotiated transfer pricing: Transfer prices could be set by
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negotiation between the buying and selling divisions. This would be
appropriate if it could be assumed that such negotiations would result
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in decisions which were in the interests of the firm as a whole andwhich were acceptable to the parties concerned.
Relevant points
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(1) Transfer pricing is the pricing of internal transfers between profit centres.
(2) Ideally the transfer prices should, promote goal congruence, enable
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effective performance appraisal and maintain divisional autonomy.(3) Economy theory suggests that the optimum transfer price would be the
marginal cost equal for buying divisions marginal revenue product.
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Transfer prices should always be base on the marginal costs of thesupplying division plus the opportunity costs to the organization as a
whole.
(4) Because of information deficiencies, transfers pricing in practice does not
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always follow theoretical guidelines. Typically prices are market based,
cost based or negotiated.
(5) Where an appropriate market price exists then this is an ideal transfer
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price. However, there may be no market for the intermediate product, the
market may be imperfect, or the price considered unrepresentative.
(6) Where cost based systems are used then it is preferable to use standard
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costs to avoid transferring inefficiencies.
(7) Full cost transfer pricing for full cost plus a mark up) suffers from a
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number of limitations,; it may cause suboptimal decision-making, the priceis only valid at one output level, it makes genuine performance appraisal
difficult.
(8) Providing that variable cost equates with economic marginal cost then
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transfers at variable cost will avoid gross sub optimality but performanceappraisal becomes meaningless.
(9) Negotiated transfer prices will only be appropriate if there is equal
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bargaining power and if negotiations are not protracted.CONCLUSION
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Transfer price policies represent the selection of suitable methods relating to the
computation of transfer prices under various circumstances. More precisely,
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transfer pricing should be closely related to management performanceassessment and decision optimization. But the problem of choosing an
appropriate transfer pricing for the two functions of management-performance
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measurement and decision optimization ?does not hold any simple solution.
There is no single measure of transfer price that can be adopted under all
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circumstances.ACTIVITIES:
1. Bring out the differences between the Financial Accounting and Cost
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Accounting
2. Ascertain the differences between the Financial Accounting and Management
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Accounting3. Find out the differences between the Cost Accounting and Management
Accounting
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4. Extract the differences between the Financial Accounting and Management
Accounting.
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QUESTIONS:
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1.What do you understand by ,,Management Accounting?
2.
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State the objectives of Management Accounting.
3.
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Discuss in detail the nature and scope of management accounting.4.
How can financial accounting be made useful for the management
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accounting?5.
What do you understand by Financial Controller (Management
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Accountant)? What are his functions?
6.
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State the limitations of financial accounting and point out howmanagement accounting helps in overcoming them.
7.
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"Accounting provides information various users". Discuss accounting as
an information system.
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8.What is Responsibility Accounting? Explain the significance of
Responsibility Accounting.
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9.
What is Transfer Pricing? Discuss the importance of Transfer Pricing.
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10. Write a note on the following:i.
Cost Centre
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ii.
Profit Centre
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iii.Investment Centre
iv.
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Market based transfer pricing
v.
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Cost based transfer pricingvi.
Full cost transfer pricing
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vii.
Negotiated transfer pricing
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viii.Variable cost transfer pricing
UNIT - II
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2.1 BUDGETS AND BUDGETORY CONTROLIntroduction:
To achieve the organizational objectives, an enterprise should be managed
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effectively and efficiently. It is facilitated by chalking out the course of action in
advance. Planning, the primary function of management helps to chalk out the
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course of actions in advance. But planning is to be followed by continuouscomparison of the actual performance with the planned performance, i. e.,
controlling. One systematic approach in effective follow up process is
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budgeting. Different budgets are prepared by the enterprise for different
purposes. Thus, budgeting is an integral part of management.
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Definition of Budget:,,A budget is a comprehensive and coordinated plan, expressed in financial
terms, for the operations and resources of an enterprise for some specific period
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in the future. (Fremgen, James M ? Accounting for Managerial Analysis)
,,A budget is a predetermined detailed plan of action developed and distributed
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as a guide to current operations and as a partial basis for the subsequentevaluation of performance. (Gordon and Shillinglaw)
,,A budget is a financial and/or quantitative statement, prepared prior to a
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defined period of time, of the policy to be pursued during the period for the
purpose of attaining a given objective. (The Chartered Institute of
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Management Accountants, London)Elements of Budget:
The basic elements of a budget are as follows:-
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1. It is a comprehensive and coordinated plan of action.
2. It is a plan for the firms operations and resources.
3. It is based on objectives to be attained.
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4. It is related to specific future period.
5. It is expressed in financial and/or physical units.
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Budgeting:Budgeting is the process of preparing and using budgets to achieve management
objectives. It is the systematic approach for accomplishing the planning,
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coordination, and control responsibilities of management by optimally utilizing
the given resources.
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,,The entire process of preparing the budgets is known as Budgeting (J. Batty),,Budgeting may be said to be the act of building budgets (Rowland & Harr)
Elements of Budgeting:
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1. A good budgeting should state clearly the firms expectations and
facilitate their attainability.
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2. A good budgeting system should utilize various persons at differentlevels while preparing the budgets.
3. The authority and responsibility should be properly fixed.
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4. Realistic targets are to be fixed.
5. A good system of accounting is also essential.
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6. Wholehearted support of the top management is necessary.7. Budgeting education is to be imparted among the employees.
8. Proper reporting system should be introduced.
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9. Availability of working capital is to be ensured.
Definition of Budgetary Control:
CIMA, London defines budgetary control as, "the establishment of the budgets
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relating to the responsibility of executives to the requirements of a policy and
the continuous comparison of actual with budgeted result either to secure by
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individual action the objectives of that policy or to provide a firm basis for itsrevision"
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,,Budgetary Control is a planning in advance of the various functions of a
business so that the business as a whole is controlled. (Wheldon)
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,,Budgetary Control is a system of controlling costs which includes the
preparation of budgets, coordinating the department and establishing
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responsibilities, comprising actual performance with the budgeted and acting
upon results to achieve maximum profitability. (Brown and Howard)
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Elements of budgetary control:1. Establishment of budgets for each function and division of the
organization.
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2. Regular comparison of the actual performance with the budget to know
the variations from budget and placing the responsibility of executives to
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achieve the desire result as estimated in the budget.3. Taking necessary remedial action to achieve the desired objectives, if
there is a variation of the actual performance from the budgeted
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performance.
4. Revision of budgets when the circumstances change.
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Budget, Budgeting and Budgetary Control:A budget is a blue print of a plan expressed in quantitative terms. Budgeting is a
technique for formulating budgets. Budgetary Control refers to the principles,
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procedures and practices of achieving given objectives through budgets.
According to Rowland and William, ,,Budgets are the individual objectives of a
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department, whereas Budgeting may be the act of building budgets. Budgetarycontrol embraces all and in addition includes the science of planning the budgets
to effect an overall management tool for the business planning and control.
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Objectives of Budgetary Control
Budgetary Control assists the management in the allocation of responsibilities
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and is a useful device to estimate and plan the future course of action. Thegeneral objectives of budgetary control are as follows:
1. Planning:
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(a) A budget is an action plan as it is prepared after a careful study and research.
(b) A budget operates as a mechanism through which objectives and policies are
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carried out.(c) It is a communication channel among various levels of management.
(d) It is helpful in selecting a most profitable alternative.
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(e) It is a complete formulation of the policy of the concern to be pursued for
attaining given objectives.
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2. Co-ordination:It coordinates various activities of the business to achieve its common
objectives. It induces the executives to think and operate as a group.
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3. Control:
Control is necessary to judge that the performance of the organization confirms
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to the plans of business. It compares the actual performance with that of the
budgeted performance, ascertains the deviations, if any, and takes corrective
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action at once.Installation of Budgetary Control:
There are certain steps necessary to install a good budgetary control system in
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an organization. They are as follows:
1. Determination of the Objectives
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2. Organization for Budgeting3. Budget Centre
4. Budget Officer
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5. Budget Manual
6. Budget Committee
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7. Budget Period8. Determination of Key Factor
1. Determination of Objectives:
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It is very clear that the installation of a budgetary control system presupposes
the determination of objectives sought to be achieved by the organization in
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clear terms.2. Organization for Budgeting:
Having determined the objectives clearly, proper organization is essential for the
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successful preparation, maintenance and administration of budgets. The
responsibility of each executive must be clearly defined. There should be no
uncertainty regarding the jurisdiction of executives.
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3. Budget Centre:
It is that part of the organization for which the budget is prepared. It may be a
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department or any other part of the department. It is essential for the appraisal ofperformance of different departments so as to make them responsible for their
budgets.
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4. Budget Officer:
A Budget Officer is a convener of the budget committee. He coordinates the
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budgets of various departments. The managers of different departments aremade responsible for their departments performance.
5. Budget Manual:
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It is a document which defines the objectives of budgetary control system. It
spells out the duties and responsibilities of budget officers regarding the
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preparation and execution of budgets. It also specifies the relations amongvarious functionaries.
6. Budget Committee:
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The heads of all important departments are made members of this committee. It
is responsible for preparation and execution of budgets. The members of this
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committee may sometimes take collective decisions, if necessary. In smallconcerns, the accountant is made responsible for the same work.
7. Budget Period:
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It is the period for which a budget is prepared. It depends upon a number of
factors. It may be different for different concerns/functions. The following are
the factors that may be taken into consideration while determining budget
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period:
a. The type of budget,
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b. The nature of demand for the products,c. The availability of finance,
d. The economic situation of the cycle and
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e. The length of trade cycle
8. Determination of Key Factor:
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Generally, the budgets are prepared for all functional areas of the business. Theyare inter related and inter dependent. Therefore, a proper coordination is
necessary. There may be many factors that influence the preparation of a budget.
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For example, plant capacity, demand position, availability of raw materials, etc.
Some factors may have an impact on other budgets also. A factor which
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influences all other budgets is known as Key factor. The key factor may notremain the same. Therefore, the organization must pay due attention on the key
factor in the preparation and execution of budgets.
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Types of Budgeting:
Budget can be classified into three categories from different points of view.
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They are:1. According to Function
2. According to Flexibility
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3. According to Time
I. According to Function:
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(a) Sales Budget:
The budget which estimates total sales in terms of items, quantity, value,
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periods, areas, etc is called Sales Budget.(b) Production Budget:
It estimates quantity of production in terms of items, periods, areas, etc. It is
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prepared on the basis of Sales Budget.
(c) Cost of Production Budget:
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This budget forecasts the cost of production. Separate budgets may also beprepared for each element of costs such as direct materials budgets, direct labour
budget, factory materials budgets, office overheads budget, selling and
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distribution overheads budget, etc.
(d) Purchase Budget:
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This budget forecasts the quantity and value of purchase required for production.It gives quantity wise, money wise and period wise particulars about the
materials to be purchased.
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(e) Personnel Budget:
The budget that anticipates the quantity of personnel required during a period for
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production activity is known as Personnel Budget.(f) Research Budget:
The budget relates to the research work to be done for improvement in quality of
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the products or research for new products.
(g) Capital Expenditure Budget:
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The budget provides a guidance regarding the amount of capital that may be
required for procurement of capital assets during the budget period.
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(h) Cash Budget:This budget is a forecast of the cash position by time period for a specific
duration of time. It states the estimated amount of cash receipts and estimation
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of cash payments and the likely balance of cash in hand at the end of different
periods.
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(i) Master Budget:It is a summary budget incorporating all functional budgets in a capsule form. It
interprets different functional budgets and covers within its range the
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preparation of projected income statement and projected balance sheet.
II. According to Flexibility:
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On the basis of flexibility, budgets can be divided into two categories. They are:1. Fixed Budget
2. Flexible Budget
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1. Fixed Budget:
Fixed Budget is one which is prepared on the basis of a standard or a fixed level
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of activity. It does not change with the change in the level of activity.2. Flexible Budget:
A budget prepared to give the budgeted cost of any level of activity is termed as
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a flexible budget. According to CIMA, London, a Flexible Budget is, ,,a budget
designed to change in accordance with level of activity attained. It is prepared
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by taking into account the fixed and variable elements of cost.III. According to Time:
On the basis of time, the budget can be classified as follows:
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1. Long term budget2. Short term budget
3. Current budget
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4. Rolling budget
1. Long-term Budget:
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A budget prepared for considerably long period of time, viz., 5 to 10 years iscalled Long-term Budget. It is concerned with the planning of operations of the
firm. It is generally prepared in terms of physical quantities.
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2. Short-term Budget:
A budget prepared generally for a period not exceeding 5 years is called Short-
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term Budget. It is generally prepared in terms of physical quantities and inmonetary units.
3. Current Budget:
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It is a budget for a very short period, say, a month or a quarter. It is adjusted to
current conditions. Therefore, it is called current budget.
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4. Rolling Budget:It is also known as Progressive Budget. Under this method, a budget for a year
in advance is prepared. A new budget is prepared after the end of each
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month/quarter for a full year ahead. The figures for the month/quarter which has
rolled down are dropped and the figures for the next month/quarter are added.
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This practice continues whenever a month/quarter ends and a new month/quarterbegins
.
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PREPARATION OF BUDGETS:I. SALES BUDGET:
Sales budget is the basis for the preparation of other budgets. It is the forecast of
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sales to be achieved in a budget period. The sales manager is directly
responsible for the preparation of this budget. The following factors taken into
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consideration:a. Past sales figures and trend
b. Salesmens estimates
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c. Plant capacity
d. General trade position
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e. Orders in handf. Proposed expansion
g. Seasonal fluctuations
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h. Market demand
i. Availability of raw materials and other supplies
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j. Financial positionk. Nature of competition
l. Cost of distribution
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m. Government controls and regulations
n. Political situation.
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Example
1. The Royal Industries has prepared its annual sales forecast, expecting to
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achieve sales of Rs.30,00,000 next year. The Controller is uncertain about the
pattern of sales to be expected by month and asks you to prepare a monthly
budget of sales. The following sales data pertained to the year, which is
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considered to be representative of a normal year:
Month
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Sales (Rs.)Month
Sales (Rs.)
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January
1,10,000
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July2,60,000
February
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1,15,000
August
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3,30,000March
1,00,000
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September
3,40,000
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April1,40,000
October
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3,50,000
May
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1,80,000November
2,00,000
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June
2,25,000
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December1,50,000
Prepare a monthly sales budget for the coming year on the basis of the above data.
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Answer:
Sales Budget
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MonthSales (given) Sales estimation based on cash sales ratio given
January
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1,10,000 (1,10,000/25,00,000) x 30,00,000 = 1,32,000
February
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1,15,000 (1,15,000/25,00,000) x 30,00,000 = 1,38,000March
1,00,000 (1,00,000/25,00,000) x 30,00,000 = 1,20,000
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April
1,40,000 (1,40,000/25,00,000) x 30,00,000 = 1,68,000
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May1,80,000 (1,80,000/25,00,000) x 30,00,000 = 2,16,000
June
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2,25,000 (2,25,000/25,00,000) x 30,00,000 = 2,70,000
July
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2,60,000 (2,60,000/25,00,000) x 30,00,000 = 3,12,000August
3,30,000 (3,30,000/25,00,000) x 30,00,000 = 3,96,000
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September
3,40,000 (3,40,000/25,00,000) x 30,00,000 = 4,08,000
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October3,50,000 (3,50,000/25,00,000) x 30,00,000 = 4,20,000
November
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2,00,000 (2,00,000/25,00,000) x 30,00,000 = 2,40,000
December
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1,50,000 (1,50,000/25,00,000) x 30,00,000 = 1,80,000Total
25,00,000 30,00,000
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Note: Sales budget is prepared based on last years month-wise sales ratio.Example:
2. M/s. Alpha Manufacturing Company produces two types of products, viz.,
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Raja and Rani and sells them in Chennai and Mumbai markets. The following
information is made available for the current year:
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MarketProduct
Budgeted Sales
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Actual Sales
Chennai Raja
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400 units @ Rs.9 each500 units @ Rs.9 each
,,
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Rani
300 units @ Rs.21 each
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200 units @ Rs.21 eachMumbai Raja
600 units @ Rs.9 each
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700 units @ Rs.9 each
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Rani500 units @ Rs.21 each
400 units @ Rs.21 each
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Market studies reveal that Raja is popular as it is under priced. It is observed that
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if its price is increased by Re.1 it will find a readymade market. On the otherhand, Rani is over priced and market could absorb more sales if its price is
reduced to Rs.20. The management has agreed to give effect to the above price
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changes.
On the above basis, the following estimates have been prepared by Sales
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Manager:% increase in sales over current budget
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Product
Chennai
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MumbaiRaja
+10%
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+ 5%
Rani
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+ 20%+ 10%
With the help of an intensive advertisement campaign, the following additional
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sales above the estimated sales of sales manager are possible:
Product
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Chennai
Mumbai
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Raja60 units
70 units
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Rani
40 units
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50 unitsYou are required to prepare a budget for sales incorporating the above estimates.
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Answer:
Sales Budget
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Budget for
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Actual sales
Budget for
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AreaProduct
current year
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future period
Units Price Value Units Price Value Units Price Value
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Rs.Rs.
Rs.
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Rs.
Rs.
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Rs.Raja
--- Content provided by FirstRanker.com ---
400
9
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3600500
9
--- Content provided by FirstRanker.com ---
4500
500
--- Content provided by FirstRanker.com ---
105000
Chennai Rani
--- Content provided by FirstRanker.com ---
300
21
--- Content provided by FirstRanker.com ---
6300200
21
--- Content provided by FirstRanker.com ---
4200
400
--- Content provided by FirstRanker.com ---
208000
Total
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700
--- Content provided by FirstRanker.com ---
9900700
--- Content provided by FirstRanker.com ---
8700
900
--- Content provided by FirstRanker.com ---
13000
--- Content provided by FirstRanker.com ---
Raja
600
--- Content provided by FirstRanker.com ---
95400
700
--- Content provided by FirstRanker.com ---
9
6300
--- Content provided by FirstRanker.com ---
70010
7000
--- Content provided by FirstRanker.com ---
Mumbai Rani
500
--- Content provided by FirstRanker.com ---
2110500 400
21
--- Content provided by FirstRanker.com ---
8400
600
--- Content provided by FirstRanker.com ---
2012000
Total
--- Content provided by FirstRanker.com ---
1100
--- Content provided by FirstRanker.com ---
15900 110014700 1300
--- Content provided by FirstRanker.com ---
19000
--- Content provided by FirstRanker.com ---
Raja
1000
--- Content provided by FirstRanker.com ---
9
9000 1200
--- Content provided by FirstRanker.com ---
910800 1200
10
--- Content provided by FirstRanker.com ---
12000
Total
--- Content provided by FirstRanker.com ---
Rani800
21
--- Content provided by FirstRanker.com ---
16800 600
21
--- Content provided by FirstRanker.com ---
12600 100020
20000
--- Content provided by FirstRanker.com ---
Total
--- Content provided by FirstRanker.com ---
180025800 1800
--- Content provided by FirstRanker.com ---
23400 2200
--- Content provided by FirstRanker.com ---
32000
Sales
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Workings:
--- Content provided by FirstRanker.com ---
1. Budgeted sales for Chennai:Raja
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Rani
Units
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UnitsBudgeted Sales
400
--- Content provided by FirstRanker.com ---
300
Add: Increase
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(10%) 40 (20%) 60440
--- Content provided by FirstRanker.com ---
360
Increase due to advertisement
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6040
Total
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500
400
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2. Budgeted sales for Mumbai:Raja
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Rani
Units
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UnitsBudgeted Sales
600
--- Content provided by FirstRanker.com ---
500
Add: Increase
--- Content provided by FirstRanker.com ---
(5%) 30 (10%) 50630
--- Content provided by FirstRanker.com ---
550
Increase due to advertisement
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7050
Total
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700
600
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II. PRODUCTION BUDGET:Production = Sales + Closing Stock ? Opening Stock
Example:
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3. The sales of a concern for the next year is estimated at 50,000 units. Each unit
of the product requires 2 units of Material ,,A and 3 units of Material ,,B. The
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estimated opening balances at the commencement of the next year are:Finished Product
:
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10,000 units
Raw Material ,,A
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:12,000 units
Raw Material ,,B
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:
15,000 units
The desirable closing balances at the end of the next year are:
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Finished Product
:
--- Content provided by FirstRanker.com ---
14,000 unitsRaw Material ,,A
:
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13,000 units
Raw Material ,,B
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:16,000 units
Prepare the materials purchase budget for the next year.
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Answer:
Production Budget
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Estimated Sales50,000 units
Add: Estimated Closing Finished Goods
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14,000 ,,
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64,000 ,,Less: Estimated Opening Finished Goods
10,000 ,,
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Production
54,000 ,,
--- Content provided by FirstRanker.com ---
Materials Purchase Budget--- Content provided by FirstRanker.com ---
Material ,,A
Material ,,B
--- Content provided by FirstRanker.com ---
Material Consumption1,08,000 units 1,62,000 units
Add: Closing stock of materials
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13,000 ,,
16,000 ,,
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1,21,000 ,,
1,78,000 ,,
--- Content provided by FirstRanker.com ---
Less: Opening stock of materials
12,000 ,,
--- Content provided by FirstRanker.com ---
15,000 ,,Materials to be purchased
1,09,000 ,,
--- Content provided by FirstRanker.com ---
1,63,000 ,,
Workings:
--- Content provided by FirstRanker.com ---
Materials consumption:Material ,,A
Material ,,B
--- Content provided by FirstRanker.com ---
Material required per unit of production
2 units
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3 unitsFor production of 54,000 units
1,08,000
--- Content provided by FirstRanker.com ---
1,62,000
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III. CASH BUDGET:
It is an estimate of cash receipts and disbursements during a future period of
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time. "The Cash Budget is an analysis of flow of cash in a business over afuture, short or long period of time. It is a forecast of expected cash intake and
outlay" (Soleman, Ezra ? Handbook of Business administration).
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Procedure for preparation of Cash Budget:
1. First take into account the opening cash balance, if any, for the
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beginning of the period for which the cash budget is to be prepared.2. Then Cash receipts from various sources are estimated. It may be
from cash sales, cash collections from debtors/bills receivables,
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dividends, interest on investments, sale of assets, etc.
3. The Cash payments for various disbursements are also estimated. It
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may be for cash purchases, payment to creditors/bills payables,payment to revenue and capital expenditure, creditors for expenses,
etc.
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4. The estimated cash receipts are added to the opening cash balance, if
any.
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5. The estimated cash payments are deducted from the above proceeds.6. The balance, if any, is the closing cash balance of the month
concerned.
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7. The closing cash balance is taken as the opening cash balance of the
following month.
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8. Then the process is repeatedly performed.9. If the closing balance of any month is negative i.e the estimated cash
payments exceed estimated cash receipts, then overdraft facility may
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also be arranged suitably.Example:
4. From the following budgeted figures prepare a Cash Budget in respect of
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three months to June 30, 2006.
Month
--- Content provided by FirstRanker.com ---
SalesMaterials
Wages
--- Content provided by FirstRanker.com ---
Overheads
Rs.
--- Content provided by FirstRanker.com ---
Rs.Rs.
Rs.
--- Content provided by FirstRanker.com ---
January
60,000
--- Content provided by FirstRanker.com ---
40,00011,000
6,200
--- Content provided by FirstRanker.com ---
February
56,000
--- Content provided by FirstRanker.com ---
48,00011,600
6,600
--- Content provided by FirstRanker.com ---
March
64,000
--- Content provided by FirstRanker.com ---
50,00012,000
6,800
--- Content provided by FirstRanker.com ---
April
80,000
--- Content provided by FirstRanker.com ---
56,00012,400
7,200
--- Content provided by FirstRanker.com ---
May
84,000
--- Content provided by FirstRanker.com ---
62,00013,000
8,600
--- Content provided by FirstRanker.com ---
June
76,000
--- Content provided by FirstRanker.com ---
50,00014,000
8,000
--- Content provided by FirstRanker.com ---
Additional information:
1. Expected Cash balance on 1st April, 2006 ? Rs. 20,000
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2. Materials and overheads are to be paid during the month following themonth of supply.
3. Wages are to be paid during the month in which they are incurred.
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4. All sales are on credit basis.
5. The terms of credits are payment by the end of the month following the
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month of sales: Half of credit sales are paid when due the other half to bepaid within the month following actual sales.
6. 5% sales commission is to be paid within in the month following sales
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7. Preference Dividends for Rs. 30,000 is to be paid on 1st May.
8. Share call money of Rs. 25,000 is due on 1st April and 1st June.
9. Plant and machinery worth Rs. 10,000 is to be installed in the month of
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January and the payment is to be made in the month of June.
--- Content provided by FirstRanker.com ---
Answer:Cash Budget for three months from April to June, 2006
Particulars
--- Content provided by FirstRanker.com ---
April
May
--- Content provided by FirstRanker.com ---
JuneRs.
Rs.
--- Content provided by FirstRanker.com ---
Rs.
Opening Cash Balance
--- Content provided by FirstRanker.com ---
20,00032,000
(-) 5,600
--- Content provided by FirstRanker.com ---
Add: Estimated Cash Receipts:
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Sales Collection from debtors
--- Content provided by FirstRanker.com ---
60,000
72,000
--- Content provided by FirstRanker.com ---
82,000Share call money
25,000
--- Content provided by FirstRanker.com ---
25,000
--- Content provided by FirstRanker.com ---
1,05,0001,04,600
1,01,400
--- Content provided by FirstRanker.com ---
Less: Estimated Cash Payments:
--- Content provided by FirstRanker.com ---
Materials
--- Content provided by FirstRanker.com ---
50,000
56,000
--- Content provided by FirstRanker.com ---
62,000Wages
12,400
--- Content provided by FirstRanker.com ---
13,000
14,000
--- Content provided by FirstRanker.com ---
Overheads6,800
7,200
--- Content provided by FirstRanker.com ---
8,600
Sales Commission
--- Content provided by FirstRanker.com ---
3,2004,000
4,200
--- Content provided by FirstRanker.com ---
Preference Dividend
---
--- Content provided by FirstRanker.com ---
30,000 ---Plant and Machinery
---
--- Content provided by FirstRanker.com ---
---
10,000
--- Content provided by FirstRanker.com ---
72,4001,10,200
98,800
--- Content provided by FirstRanker.com ---
Closing Cash Balance
32,600
--- Content provided by FirstRanker.com ---
(-) 5,6002,600
--- Content provided by FirstRanker.com ---
Workings:
--- Content provided by FirstRanker.com ---
1. Sales Collection:
Payment is due at the month following the sales. Half is paid on due and other
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half is paid during the next month. Therefore, February sales Rs. 50,000 is dueat the end of March. Half is given at the end of March and other half is given in
the next month i.e., in the month of April. Hence, the sales collection for the
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month of April will be as follows:
For April ? Half of February Sales (56,000 x ?) = 28,000
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- Half of March Sales (64,000 x ?) = 32,000
Total Collection for April
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= 60,000Similarly, the sales collection for the months of May and June may be
calculated.
--- Content provided by FirstRanker.com ---
2. Materials and overheads:
These are paid in the following month. That is March is paid in April, April is
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paid in May and May is paid in June.3. Sales Commission:
--- Content provided by FirstRanker.com ---
It is paid in the following month. Therefore,
--- Content provided by FirstRanker.com ---
For April ? 5% of March Sales (64,000 x 5 /100) = 3,200For May ? 5% of March Sales (80,000 x 5 /100) = 4,000
--- Content provided by FirstRanker.com ---
For April ? 5% of March Sales (84,000 x 5 /100) = 4,200
IV. FLEXIBLE BUDGET:
--- Content provided by FirstRanker.com ---
A flexible budget consists of a series of budgets for different level of activity.Therefore, it varies with the level of activity attained. According to CIMA,
London, A Flexible Budget is, ,,a budget designed to change in accordance with
--- Content provided by FirstRanker.com ---
level of activity attained. It is prepared by taking into account the fixed andvariable elements of cost. This budget is more suitable when the forecasting of
demand is uncertain.
--- Content provided by FirstRanker.com ---
Points to be remembered while preparing a flexible budget:
1. Cost can be classified into fixed and variable cost.
--- Content provided by FirstRanker.com ---
2. Total fixed cost remains constant at any level of activity.3. Total Variable cost varies in the same proportion at which the level of
activity varies.
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4. Fixed and variable portion of Semi-variable cost is to be segregated.
Example:
--- Content provided by FirstRanker.com ---
5. The following information at 50% capacity is given. Prepare a flexiblebudget and forecast the profit or loss at 60%, 70% and 90% capacity.
Fixed expenses:
--- Content provided by FirstRanker.com ---
Expenses at 50% capacity (Rs.)
Salaries
--- Content provided by FirstRanker.com ---
5,000Rent and taxes
4,000
--- Content provided by FirstRanker.com ---
Depreciation
6,000
--- Content provided by FirstRanker.com ---
Administrative expenses7,000
Variable expenses:
--- Content provided by FirstRanker.com ---
Materials
--- Content provided by FirstRanker.com ---
20,000Labour
25,000
--- Content provided by FirstRanker.com ---
Others
4,000
--- Content provided by FirstRanker.com ---
Semi-variable expenses:Repairs
--- Content provided by FirstRanker.com ---
10,000
Indirect Labour
--- Content provided by FirstRanker.com ---
15,000Others
9,000
--- Content provided by FirstRanker.com ---
It is estimated that fixed expenses will remain constant at all capacities. Semi-variable expenses will not change between 45% and 60% capacity, will rise by
10% between 60% and 75% capacity, a further increase of 5% when capacity
--- Content provided by FirstRanker.com ---
crosses 75%.
--- Content provided by FirstRanker.com ---
Estimated sales at various levels of capacity are:--- Content provided by FirstRanker.com ---
Capacity
--- Content provided by FirstRanker.com ---
Sales (Rs.)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
60%--- Content provided by FirstRanker.com ---
1,10,000
--- Content provided by FirstRanker.com ---
70%
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
1,30,000
--- Content provided by FirstRanker.com ---
90%
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
1,50,000
Answer:
--- Content provided by FirstRanker.com ---
FLEXIBLE BUDGET(Showing Profit & Loss at various capacities)
--- Content provided by FirstRanker.com ---
Capacities
Particulars
--- Content provided by FirstRanker.com ---
50%60%
70%
--- Content provided by FirstRanker.com ---
90%
Rs.
--- Content provided by FirstRanker.com ---
Rs.Rs.
Rs.
--- Content provided by FirstRanker.com ---
Fixed Expenses:
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Salaries
5,000
--- Content provided by FirstRanker.com ---
5,0005,000
5,000
--- Content provided by FirstRanker.com ---
Rent and taxes
4,000
--- Content provided by FirstRanker.com ---
4,0004,000
4,000
--- Content provided by FirstRanker.com ---
Depreciation
6,000
--- Content provided by FirstRanker.com ---
6,0006,000
6,000
--- Content provided by FirstRanker.com ---
Administrative expenses
7,000
--- Content provided by FirstRanker.com ---
7,0007,000
7,000
--- Content provided by FirstRanker.com ---
Variable expenses:
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Materials
20,000
--- Content provided by FirstRanker.com ---
24,00028,000
36,000
--- Content provided by FirstRanker.com ---
Labour
25,000
--- Content provided by FirstRanker.com ---
30,00035,000
45,000
--- Content provided by FirstRanker.com ---
Others
4,000
--- Content provided by FirstRanker.com ---
4,8005,600
7,200
--- Content provided by FirstRanker.com ---
Semi-variable expenses:
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Repairs
10,000
--- Content provided by FirstRanker.com ---
10,00011,000
11,500
--- Content provided by FirstRanker.com ---
Indirect Labour15,000
15,000
--- Content provided by FirstRanker.com ---
16,500
17,250
--- Content provided by FirstRanker.com ---
Others9,000
9,000
--- Content provided by FirstRanker.com ---
9,900
10,350
--- Content provided by FirstRanker.com ---
Total Cost1,05,000
1,14,800
--- Content provided by FirstRanker.com ---
1,28,000
1,49,300
--- Content provided by FirstRanker.com ---
Profit (+) or Loss (-)(-) 4,800
--- Content provided by FirstRanker.com ---
(+) 2,000
(+) 700
--- Content provided by FirstRanker.com ---
Estimated Sales1,10,000
--- Content provided by FirstRanker.com ---
1,30,000
1,50,000
--- Content provided by FirstRanker.com ---
Example:
6. The following information relates to a flexible budget at 60%
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capacity. Find out the overhead costs at 50% and 70% capacity and also
determine the overhead rates:
--- Content provided by FirstRanker.com ---
ParticularsExpenses at 60% capacity
Variable overheads:
--- Content provided by FirstRanker.com ---
Rs.
Indirect Labour
--- Content provided by FirstRanker.com ---
10,500Indirect Materials
8,400
--- Content provided by FirstRanker.com ---
Semi-variable overheads:
--- Content provided by FirstRanker.com ---
Repair and Maintenance7,000
(70% fixed; 30% variable)
--- Content provided by FirstRanker.com ---
Electricity
25,200
--- Content provided by FirstRanker.com ---
(50% fixed; 50% variable)Fixed overheads:
--- Content provided by FirstRanker.com ---
Office expenses including
70,000
--- Content provided by FirstRanker.com ---
salariesInsurance
4,000
--- Content provided by FirstRanker.com ---
Depreciation
20,000
--- Content provided by FirstRanker.com ---
Estimated direct labour hours1,20,000 hours
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Answer:FLEXIBLE BUDGET
--- Content provided by FirstRanker.com ---
50 % Capacity
60% Capacity 70% Capacity
--- Content provided by FirstRanker.com ---
Rs.Rs.
Rs.
--- Content provided by FirstRanker.com ---
Variable overheads:
--- Content provided by FirstRanker.com ---
Indirect Labour
--- Content provided by FirstRanker.com ---
8,750
10,500
--- Content provided by FirstRanker.com ---
12,250Indirect Materials
7,000
--- Content provided by FirstRanker.com ---
8,400
--- Content provided by FirstRanker.com ---
Semi-variable overheads:--- Content provided by FirstRanker.com ---
Repair and Maintenance (1)
--- Content provided by FirstRanker.com ---
6,6507,000
--- Content provided by FirstRanker.com ---
Electricity (2)
23,100
--- Content provided by FirstRanker.com ---
25,200Fixed overheads:
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Office expenses including salaries
70,000
--- Content provided by FirstRanker.com ---
70,000
70,000
--- Content provided by FirstRanker.com ---
Insurance4,000
4,000
--- Content provided by FirstRanker.com ---
4,000
Depreciation
--- Content provided by FirstRanker.com ---
20,00020,000
20,000
--- Content provided by FirstRanker.com ---
Total overheads
1,39,500
--- Content provided by FirstRanker.com ---
1,45,1001,50,700
Estimated direct labour hours
--- Content provided by FirstRanker.com ---
1,00,000
1,20,000
--- Content provided by FirstRanker.com ---
1,50,000Overhead rate per hour (Rs.)
1.395
--- Content provided by FirstRanker.com ---
1.21
1.077
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Workings:1. The amount of Repairs and maintenance at 60% Capacity is Rs. 7,000.
Out of this, 70% (i.e Rs. 4,900) is fixed and remaining 30% (i.e Rs.
--- Content provided by FirstRanker.com ---
2,100) is variable. The fixed portion remains constant at all levels of
capacities. Only the variable portion will change according to change in
--- Content provided by FirstRanker.com ---
the level of activity. Therefore, the total amount of repairs andmaintenance for 50% and 70% capacities are calculated as follows:
--- Content provided by FirstRanker.com ---
Repairs and maintenance
50%
--- Content provided by FirstRanker.com ---
60%
70%
--- Content provided by FirstRanker.com ---
Fixed (70%)4,900
4,900
--- Content provided by FirstRanker.com ---
4,900
Variable (30%)
--- Content provided by FirstRanker.com ---
1,7502,100
2,450
--- Content provided by FirstRanker.com ---
6,650
--- Content provided by FirstRanker.com ---
7,0007,350
Total
--- Content provided by FirstRanker.com ---
2. Similarly, electricity expenses at different levels of capacity are calculated as
--- Content provided by FirstRanker.com ---
follows:Electricity
--- Content provided by FirstRanker.com ---
50%
60%
--- Content provided by FirstRanker.com ---
70%Fixed (50%)
12,600
--- Content provided by FirstRanker.com ---
12,600
12,600
--- Content provided by FirstRanker.com ---
Variable (50%)10,500
12,600
--- Content provided by FirstRanker.com ---
14,700
--- Content provided by FirstRanker.com ---
23,10025,200
27,300
--- Content provided by FirstRanker.com ---
Total
--- Content provided by FirstRanker.com ---
ZERO BASE BUDGETING (ZBB)It is a management technique aimed at cost reduction. It was introduced by the
U. S. Department of Agriculture in 1961. Peter A. Phyrr popularized it. In 1979,
--- Content provided by FirstRanker.com ---
president Jimmy Carte issued a mandate asking for the use of ZBB by the
Government.
--- Content provided by FirstRanker.com ---
ZBB - Definition:"It is a planning and budgeting process which requires each manager to justify
his entire budget request in detail from scratch (Zero Base) and shifts the burden
--- Content provided by FirstRanker.com ---
of proof to each manager to justify why he should spend money at all. The
approach requires that all activities be analyzed in decision packages, which are
--- Content provided by FirstRanker.com ---
evaluated by systematic analysis and ranked in the order of importance". ? PeterA. Phyrr.
It implies that-
--- Content provided by FirstRanker.com ---
Every budget starts with a zero baseNo previous figure is to be taken as a base for adjustments
Every activity is to be carefully examined afresh
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Each budget allocation is to be justified on the basis of anticipated
circumstances
--- Content provided by FirstRanker.com ---
Alternatives are to be given due considerationAdvantages of ZBB:
1. Effective cost control can be achieved
--- Content provided by FirstRanker.com ---
2. Facilitates careful planning
3. Management by Objectives becomes a reality
--- Content provided by FirstRanker.com ---
4. Identifies uneconomical activities5. Controls inefficiencies
6. Scarce resources are used beneficially
--- Content provided by FirstRanker.com ---
7. Examines each activity thoroughly
8. Controls wasteful expenditure
--- Content provided by FirstRanker.com ---
9. Integrates the management functions of planning and control10. Reviews activities before allowing funds for them.
PERFORMANCE BUDGETING:
--- Content provided by FirstRanker.com ---
It involves evaluation of the performance of the organization in the context of
both specific as well as overall objectives of the organization. It provides a
definite direction to each employee and a control mechanism to top
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management.
Definition:
--- Content provided by FirstRanker.com ---
Performance Budgeting technique is the process of analyzing, identifying,simplifying and crystallizing specific performance objectives of a job to be
achieved over a period of the job. The technique is characterized by its specific
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direction towards the business objectives of the organization. ? The National
Institute of Bank Management.
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The responsibility for preparing the performance budget of each department lieson the respective departmental head. It requires preparation of performance
reports. This report compares budget and actual data and shows any existing
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variances. To facilitate the preparation the departmental head is supplied with
the copy of the master budget appropriate to his function.
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MASTER BUDGET:Master budget is a comprehensive plan which is prepared from and summarizes
the functional budgets. The master budget embraces both operating decisions
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and financial decisions. When all budgets are ready, they can finally produce
budgeted profit and loss account or income statement and budgeted balance
--- Content provided by FirstRanker.com ---
sheet. Such results can be projected monthly, quarterly, half-yearly and at yearend. When the budgeted profit falls short of target it may be reviewed and all
budgets may be reworked to reach the target or to achieve a revised target
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approved by the budget committee.
--- Content provided by FirstRanker.com ---
Exercise:
--- Content provided by FirstRanker.com ---
1. From the following particulars, prepare production cost budget for June,2006.Particulars
Opening Stock
--- Content provided by FirstRanker.com ---
Closing stock
(1-6-2006)
--- Content provided by FirstRanker.com ---
(30-6-2006)Finished Goods
1200 units
--- Content provided by FirstRanker.com ---
1600 units
Raw Material ,,A
--- Content provided by FirstRanker.com ---
5,000 kgs.4,800 kgs.
Raw Material ,,B
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2,000 kgs.
3,100 kgs.
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Raw Material required (per unit)4 kgs. @ Rs.8 per kg.
2 kgs. @ Rs.25 per kg.
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Budgeted sales for the month ? 7,000 units.
(Answer: Raw Material ,,A ? Rs. 2,35,200; Raw Material ,,B ? Rs. 3,97,500)
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2. From the following figures prepare Raw Materials Purchase Budget.
Materials (in Units)
--- Content provided by FirstRanker.com ---
Particulars
A
--- Content provided by FirstRanker.com ---
BC
D
--- Content provided by FirstRanker.com ---
Estimated Opening Stock
16,000
--- Content provided by FirstRanker.com ---
6,00024,000
2,000
--- Content provided by FirstRanker.com ---
Estimated Closing Stock
20,000
--- Content provided by FirstRanker.com ---
8,00028,000
4,000
--- Content provided by FirstRanker.com ---
Estimated Consumption
1,20,000
--- Content provided by FirstRanker.com ---
44,0001,32,000
36,000
--- Content provided by FirstRanker.com ---
Standard Price per unit
0.25 p
--- Content provided by FirstRanker.com ---
0.05 p0.15 p
0.10 p
--- Content provided by FirstRanker.com ---
(Answer: Material ,,A ? Rs. 31,000; Material ,,B ? Rs. 2,300; Material ,,C ?
Rs.20,400 and Material ,,D ? Rs. 3,800)
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3. Parker Ltd. manufactures two brands of pen Hero and Zero. The salesdepartment of the company has three departments in different areas of the
country.
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The sales budget for the year ending 31st December 1999 were:
Hero ? Department I 3,00,000; Department II 5,62500; Department III 1,80,000
--- Content provided by FirstRanker.com ---
and Zero ? Department I 4,00,000; Department II 6,00,000; Department III
20,000. Sales prices are Rs. 3 and Rs.1.20 in all departments.
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It is estimated that by forced sales promotion the sale of Zero in department Iwill increase by 1,75,000. It is also expected that by increasing production and
arranging extensive advertisement, Department III will be enabled to increase
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the sale of Zero by 50,000. It is recognized that the estimated sales by
department II represent an unsatisfactory target. It is agreed to increase both
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estimates by 20%. Prepare a Sales Budget for the year 2000.(Answer: Hero ? Rs.34,65,000 and Zero ? Rs.16,38,000)
4. Bajaj Co. wishes to arrange overdraft facilities with its bankers during the
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period from April to June 2006 when it will be manufacturing mostly for stock.
Prepare a Cash Budget for the above period from the following data, indicating
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the extent of the band overdraft facilities the company will require at the end ofeach month.
(a)
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Month
Sales
--- Content provided by FirstRanker.com ---
PurchasesWages
Rs.
--- Content provided by FirstRanker.com ---
Rs.
Rs.
--- Content provided by FirstRanker.com ---
February90,000
62,400
--- Content provided by FirstRanker.com ---
6,000
March
--- Content provided by FirstRanker.com ---
96,00072,000
7,000
--- Content provided by FirstRanker.com ---
April
54,000
--- Content provided by FirstRanker.com ---
1,21,0005,500
May
--- Content provided by FirstRanker.com ---
87,000
1,23,000
--- Content provided by FirstRanker.com ---
5,000June
63,000
--- Content provided by FirstRanker.com ---
1,34,000
7,500
--- Content provided by FirstRanker.com ---
(b) 50% of Credit sales are realized in the month following the sales and theremaining 50% in the second month following.
(c) Creditors are paid in the month following the month of purchase.
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(d) Lag in payment of wages ? one month.(e) Cash at bank on 1st April, 2006 estimated at Rs. 12,500.
Answer: Closing balance for April ? Rs. 26,500; May Rs. (25,500) and June Rs.
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(83,000)5. Draw up a Cash Budget for January to March 2006 from the following
information:
--- Content provided by FirstRanker.com ---
(a). Cash and bank balance on 1st January, 2006 ? Rs. 2,00,000.(b). Actual and budgeted sales:
Actual 2005
--- Content provided by FirstRanker.com ---
Rs.
Budgeted 2006
--- Content provided by FirstRanker.com ---
Rs.September
6,00,000
--- Content provided by FirstRanker.com ---
January
8,00,000
--- Content provided by FirstRanker.com ---
October6,50,000
February
--- Content provided by FirstRanker.com ---
8,20,000
November
--- Content provided by FirstRanker.com ---
7,00,000March
8,90,000
--- Content provided by FirstRanker.com ---
December
7,50,000
--- Content provided by FirstRanker.com ---
(c). Purchases ? actual and budgeted:
--- Content provided by FirstRanker.com ---
Actual 2005
Rs.
--- Content provided by FirstRanker.com ---
Budgeted 2006Rs.
September
--- Content provided by FirstRanker.com ---
3,60,000
January
--- Content provided by FirstRanker.com ---
4,80,000October
4,00,000
--- Content provided by FirstRanker.com ---
February
4,00,000
--- Content provided by FirstRanker.com ---
November4,80,000
March
--- Content provided by FirstRanker.com ---
5,00,000
December
--- Content provided by FirstRanker.com ---
4,50,000--- Content provided by FirstRanker.com ---
(d). Wages ? actual and budgeted:
--- Content provided by FirstRanker.com ---
Month
Wages (Rs.)
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Expenses (Rs.)
Actual 2005
--- Content provided by FirstRanker.com ---
November1,50,000
50,000
--- Content provided by FirstRanker.com ---
,, ,,
December
--- Content provided by FirstRanker.com ---
1,50,00060,000
Budgeted 2006 January
--- Content provided by FirstRanker.com ---
1,80,000
60,000
--- Content provided by FirstRanker.com ---
,, ,,February
1,80,000
--- Content provided by FirstRanker.com ---
80,000
,, ,, March
--- Content provided by FirstRanker.com ---
2,00,00080,000
(e) Special items:
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(i) Advance Payment of tax in March 2006 ? Rs. 50,000
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(ii) Plant to be acquired and paid in January 2006 ? Rs. 1,00,000
(f) Assume 10 % sales and purchases are on cash basis.
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(g) Lag in payment of wages ? ? month(h) Lag in payment of expenses ? ? month
(i) Period of credit allowed to debtors ? 2 month
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(j) Period of credit allowed by creditors ? 1 month
(Answer: January ? Rs.1,32,000; February ? Rs.1,62,000 and March ? Rs.
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2,41,000)6. From the following forecasts of income and expenditure, prepare a cash
Budget for the month January to April, 2006.
--- Content provided by FirstRanker.com ---
Sales
--- Content provided by FirstRanker.com ---
PurchasesWages Manufacturing Administrative
Selling
--- Content provided by FirstRanker.com ---
(Credit)
(Credit)
--- Content provided by FirstRanker.com ---
expensesexpenses
expenses
--- Content provided by FirstRanker.com ---
Months
--- Content provided by FirstRanker.com ---
Rs.Rs.
Rs.
--- Content provided by FirstRanker.com ---
Rs.
Rs.
--- Content provided by FirstRanker.com ---
Rs.2005 Nov.
30,000
--- Content provided by FirstRanker.com ---
15,000
3,000
--- Content provided by FirstRanker.com ---
1,1501,060
500
--- Content provided by FirstRanker.com ---
Dec.
35,000
--- Content provided by FirstRanker.com ---
20,0003,200
1,225
--- Content provided by FirstRanker.com ---
1,040
550
--- Content provided by FirstRanker.com ---
2006 Jan.25,000
15,000
--- Content provided by FirstRanker.com ---
2,500
990
--- Content provided by FirstRanker.com ---
1,100600
Feb.
--- Content provided by FirstRanker.com ---
30,000
20,000
--- Content provided by FirstRanker.com ---
3,0001,050
1,150
--- Content provided by FirstRanker.com ---
620
Mar.
--- Content provided by FirstRanker.com ---
35,00022,500
2,400
--- Content provided by FirstRanker.com ---
1,100
1,220
--- Content provided by FirstRanker.com ---
570Apr.
40,000
--- Content provided by FirstRanker.com ---
25,000
2,600
--- Content provided by FirstRanker.com ---
1,2001,180
710
--- Content provided by FirstRanker.com ---
Additional information is as follows:
1. The customers are allowed a credit period of 2 months.
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2. A dividend of Rs. 10,000 is payable in April.3. Capital expenditure to be incurred: Plant purchased on 15th of January
for Rs.5,000;
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4. A building has been purchased on 1st March and the payments are to bemade in monthly instalments of Rs. 2,000 each.
5. The creditors are allowing a credit of 2 months.
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6. Wages are paid on the 1st of the next month.
7. Lag in payment of other expenses is one month.
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8. Balance of cash in hand on 1st January, 2006 is Rs. 15,000(Answer: Closing balance for January ? Rs. 18,985; February Rs. 28,795;
March Rs. 30,975 and April Rs. 23,685)
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7. From the following budget date, forecast the cash position at the end of April,
May and June 2006.
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MonthsSales (Rs.) Purchases (Rs.) Wages (Rs.) Mis. Expenses (Rs.)
February
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1,20,000
84,000
--- Content provided by FirstRanker.com ---
10,0007,000
March
--- Content provided by FirstRanker.com ---
1,30,000
1,00,000
--- Content provided by FirstRanker.com ---
12,0008,000
April
--- Content provided by FirstRanker.com ---
80,000
1,04,000
--- Content provided by FirstRanker.com ---
8,0006,000
May
--- Content provided by FirstRanker.com ---
1,16,000
1,06,000
--- Content provided by FirstRanker.com ---
10,00012,000
June
--- Content provided by FirstRanker.com ---
88,000
80,000
--- Content provided by FirstRanker.com ---
8,0006,000
Additional information:
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1. Sales: 20% realized in the month of sale; discount allowed 2%. Balance
realized equally in two subsequent months.
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2. Purchases: These are paid in the month following the month of supply.3. Wages: 25% paid in arrears following month.
4. Miscellaneous expenses: Paid a month in arrears.
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5. Rent: Rs.1,000 per month paid quarterly in advance due in April.6. Income Tax : First instalment of advance tax Rs. 25,000 due on or before
15th June.
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7. Income from investments: Rs. 5,000 received quarterly in April, July,
etc.
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8. Cash in hand: Rs. 5,000 on 1st April, 2006.(Answer: April ? Rs. 5,680; May ? Rs. (-) 7,084 and June ? Rs. (-) 62,936
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8. The Expenses for the production of 5,000 units in a factory are given as
follows:
--- Content provided by FirstRanker.com ---
ParticularsPer unit (Rs.)
Materials
--- Content provided by FirstRanker.com ---
50
Labour
--- Content provided by FirstRanker.com ---
20Variable Overheads
15
--- Content provided by FirstRanker.com ---
Fixed Overheads (Rs. 50,000)
10
--- Content provided by FirstRanker.com ---
Administrative Overheads (5% variable )10
Selling expenses (20% fixed)
--- Content provided by FirstRanker.com ---
6
Distribution expenses (10% fixed)
--- Content provided by FirstRanker.com ---
5Total cost of sales per unit
Rs. 110
--- Content provided by FirstRanker.com ---
You are required to prepare a budget for the production of 7,000 units.
(Answer Total cost of sales Rs. 7,69,000; Total cost of sales per unit Rs. 109.94)
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9. Draw up a flexible budget for the overhead expenses on the basis of thefollowing data and determine the overhead rate at 70%, 80% and 90% plant
capacity.
--- Content provided by FirstRanker.com ---
Particulars
At 70 %
--- Content provided by FirstRanker.com ---
At 80%At 90%
capacity
--- Content provided by FirstRanker.com ---
capacitycapacity
Variable overheads:
--- Content provided by FirstRanker.com ---
Rs.
--- Content provided by FirstRanker.com ---
Indirect Labour
-
--- Content provided by FirstRanker.com ---
12,000
-
--- Content provided by FirstRanker.com ---
Stores including spares-
4,000
--- Content provided by FirstRanker.com ---
-
Semi-variable overheads:
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Power (30% fixed; 70%
-
--- Content provided by FirstRanker.com ---
20,000-
variable)
--- Content provided by FirstRanker.com ---
Repairs (60% fixed; 40%
-
--- Content provided by FirstRanker.com ---
2,000-
variable)
--- Content provided by FirstRanker.com ---
Fixed overheads:
--- Content provided by FirstRanker.com ---
Depreciation
--- Content provided by FirstRanker.com ---
-
11,000
--- Content provided by FirstRanker.com ---
-Insurance
-
--- Content provided by FirstRanker.com ---
3,000
-
--- Content provided by FirstRanker.com ---
Salaries-
10,000
--- Content provided by FirstRanker.com ---
-
Total Overheads
--- Content provided by FirstRanker.com ---
-62,000
-
--- Content provided by FirstRanker.com ---
Estimated direct labour hours
-
--- Content provided by FirstRanker.com ---
124000-
hrs
--- Content provided by FirstRanker.com ---
(Answer: Overhead rate at 70% - Rs. 0.536; at 80% - Rs. 0.50 and at 90% - Rs.
0.472)
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10. The cost of an article at a capacity level of 5,000 units is given under ,,Abelow. For a variation of 25% in capacity above or below this level, the
individual expenses as indicated under ,,B below:
--- Content provided by FirstRanker.com ---
Cost per unit Rs. 12.55. Find out the cost per unit and total cost for production
levels of 4,000 units and 6,000 units. Also show the total cost and unit cost for
--- Content provided by FirstRanker.com ---
5,000 units--- Content provided by FirstRanker.com ---
Particulars
,,A
--- Content provided by FirstRanker.com ---
,,B"
Rs.
--- Content provided by FirstRanker.com ---
Rs.Material cost
25,000 (100% varying)
--- Content provided by FirstRanker.com ---
Labour cost
15,000 (100% varying )
--- Content provided by FirstRanker.com ---
Power1,250 (80% varying)
Repairs and maintenance
--- Content provided by FirstRanker.com ---
2,000 (75% varying)
Stores
--- Content provided by FirstRanker.com ---
1,000 (100% varying)Inspection
500 (20% varying)
--- Content provided by FirstRanker.com ---
Depreciation
10,000 (100% varying)
--- Content provided by FirstRanker.com ---
Administration overheads5,000 (25% varying)
Selling overheads
--- Content provided by FirstRanker.com ---
3,000 (25% varying)
Total
--- Content provided by FirstRanker.com ---
62,750.(Answer: Total Cost at 4,000 units ? Rs. 51,630; at 5,000 units ? Rs. 62,750 and
at 6,000 units ? Rs. 73,870. Cost per unit is Rs.12.908; Rs.12.55 and Rs. 12.31
--- Content provided by FirstRanker.com ---
respectively.)
11. The expenses of budgeted production of 20,000 units in a factory are
--- Content provided by FirstRanker.com ---
furnished below:Particulars
Per unit (Rs.)
--- Content provided by FirstRanker.com ---
Materials
140
--- Content provided by FirstRanker.com ---
Labour50
Variable overheads
--- Content provided by FirstRanker.com ---
40
Fixed overheads
--- Content provided by FirstRanker.com ---
20Variable expenses (direct)
10
--- Content provided by FirstRanker.com ---
Selling expenses (10% fixed)
26
--- Content provided by FirstRanker.com ---
Distribution expenses (20% fixed)14
Administrative expenses
--- Content provided by FirstRanker.com ---
10
Prepare a Flexible Budget for the production of 16,000 units and 12,000 units.
Indicate cost per unit at both the levels.
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(Answer: Cost per unit at 16,000 units ? Rs.318.85; at 12,000 units ? Rs.333.60)
2.2 STANDARD COSTING
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STANDARD: According to Prof. Erie L. Kolder, "Standard is a desiredattainable objective, a performance, a foal, a model".
STANDARD COST: Standard cost is a predetermined estimate of cost to
--- Content provided by FirstRanker.com ---
manufacture a single unit or a number of units during a future period.
The Chartered Institute of Management Accountants, London, defines "Standard
--- Content provided by FirstRanker.com ---
Cost" as, "a pre-determined cost which is calculated from managementsstandards of efficient operation and the relevant necessary expenditure. It may
be used as a basis for price fixing and for cost control through variance
--- Content provided by FirstRanker.com ---
analysis".
STANDARD COSTING: It is defined by I.C.M.A. Terminology as, "The
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preparation and use of standard costs, their comparison with actual costs and theanalysis of variances to their causes and points of incidence".
According to the Chartered Institute of Management Accountants, London
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Standard Costing is "the preparation and use of Standard Cost, their comparison
with actual costs, and the analysis of variances to their causes and points of
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incidence".The study of standard cost comprises of:
1.
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Ascertainment and use of standard costs.
2.
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Comparison of actual costs with standard costs and measuring thevariances.
3.
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Controlling costs by the variance analysis.4.
Reporting to management for taking proper action to maximize
the efficiency.
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BUDGETARY CONTROL AND STANDARD COSTING
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Both standard costing and budgetary control aim at maximum efficiency andmanagerial control. Budgetary control and standard costing have the common
objective of controlling business operations by establishing pre-determined
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targets, measuring the actual performance and comparing it with the targets, for
the purposes of having better efficiency and of reducing costs. The two systems
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are said to be interrelated but they are not inter-dependent. The budgetarycontrol system can function effectively even without the system of standard
costing in operation but the vice-versa is not possible.
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STANDARD COSTING AS A CONTROLLING TECHNIQUE
It is essential for management to have knowledge of costs so that decision can
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be effective. Management can control costs on information being provided to it.The technique of standard costing is used for building a proper budgeting and
feedback system. The uses of standard costing to management areas follows.
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1. Formulation of Price and Production Policies
Standard Costing acts as a valuable guide to management in the fixation of price
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and formulation production polices. It also assists management in the field ofinventory pricing, product, product pricing profit planning and also in reporting
to higher levels.
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2. Comparison and Analysis of Data
Standard Costing provides a stable basis for comparison of actual with standard
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costs. It brings out the impact of external factors and internal causes on the costand performance of the concern. Thus, it helps to take remedial action.
3. Cost Consciousness
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An atmosphere of cost consciousness is created among the staff. Standardcosting also provides incentive to workers for efficient performance.
4. Better Capacity to anticipate
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An effective budget can be formulated for the future by once knowing the
deviations of actual costs from standard costs. Data are available at an early
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stage and the capacity to anticipate about changing conditions is developed.5. Better Economy, Efficiency and Productivity
Men, machines and materials are more effectively utilized and thus benefits of
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economies can be reaped in business together with increased productivity.
6. Delegation of Authority and Responsibility
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The net profit is analyzed and responsibility can be placed on the person incharge for any variations from the standards. It discloses adverse variations and
particular cost centre can be held accountable. Thus, delegation of authority can
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be made by management to control the affairs in different departments.
7. Management by `Exception'
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The principle of "management by exception can be applied in the business.This helps the management in concentrating its attention on cases which are off
standard, i.e., below or above the standard set. A pattern is provided for the
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elimination of undesirable factors causing damage to the business.
SETTING THE STANDARD
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While setting standard cost for operations, process or products, the followingpreliminaries must be gone through:
1. Establish Standard Committee comprising Purchase Manager, Personnel
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Manager, and Production Manager. The Cost Accountant coordinatesthe functions.
2. Study the existing costing system, cost records and forms in use.
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3. A technical survey of the existing methods of production should be
undertaken.
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4. Determine the type of standard to be used.5. Fix standard for each element of cost.
6. Determine standard costs of r each product.
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7. Fix the responsibility for setting standards.
8. Account variances properly.
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9. Ascertain the deviations by comparing the actual with standards.10. Take necessary action to ensure that adverse variances are not repeated.
DETERMINATION OF STANDARD COSTS
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The following preliminary steps are considered before setting standards:
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(a) Establishment of cost centre(b) Classification and codification of accounts
(c) Types of standards
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(d) Setting the standards.
(a) Establishment of cost centre. For fixing responsibility and defining the
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lines of authority, cost centre is necessary. "A cost centre is a location,person or item of equipment (or group of these) for which costs may be
ascertained and used of the purpose of cost control". With the help of cost
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centre, the standards are prepared and the variances are analyzed.(b) Classification and codification of accounts. Accounts are classified
according to different items of expenses under suitable heading. Each
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heading may be given codes and symbols. Coding is useful for speedy
collection and analysis.
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(c) Types of standards. The different types of standards are given below:(i)
Basic standard. It is a fixed and unaltered for an indefinite period for
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forward planning. According to I.C.M.A London, it is "an underlying
standard from which a current standard can be developed". From this
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basic standard, changes in current standard and actual standard can bemeasured.
(ii)
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Current standard. It is a short-term standard, as it is revised at regular
intervals. I.C.M.A. London refers to it as "a standard which is
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established for use over a short period of time and is related to currentconditions". This standard is realistic and helpful to business. It is useful
for cost control.
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(iii)
Normal standard. It is an average standard, and is based on normal
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conditions which prevail over a long period of a trade cycle. I.C.M.Adefines it as "the average standard which, it is anticipated, can be
attained over a future period of time, preferably long enough to cover
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one trade-cycle". It is used for planning and decision making during the
period of trade cycle to which it is related. It is very difficult to apply in
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practice.(iv)
Ideal standard. I.C.M.A. defines it as "the standard which can be
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attained under the most favorable condition possible". It is fixed and
needs a high degree of efficiency, best possible conditions of
management and performance. Existing conditions and conditions
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capable of achievement should be taken into consideration. It is difficult
to attain this ideal standard.
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(v)Expected standard. It is a practical standard. I.C.M.A defines it as,
"the standard which, it is anticipated, can be attained during a future
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specified budget period". For setting this standard, due weightage is
given for all the expected conditions. It is more realistic than the ideal
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standard.(d)
Setting the standards. After choosing the standard, the setting of
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standard is the work of the standard committee.
The cost accountant
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has to supply the necessary cost figures and co-ordinate the activitycommittee. He must ensure that the setting standards are accurate.
Standards cost is determined for each element of the following costs.
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(i)
Direct Material cost. Standard material cost is equal to the standard
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quantity multiplied by the standard price. The setting of standard costsfor direct materials involves
(a)
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Standard Material Quantity. For each product or part or the
process, mechanical calculation or mechanical analysis is made.
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The allowance for normal wastage or loss must be fixed verycarefully. Similarly, where different kinds of materials are used
as a mix for a process, a standard material mix is determined to
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produce the desire quality product.
(b)
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Standard Material Price. Setting of material standard price isdone by the cost accountant and the purchase manager. The
current standard is the desirable and effective for fixing the price.
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Normally one year is the period for fixation of standard price. Ifthere are more fluctuations in prices, then revision of standard
price is necessary. Before fixing the standard, the following
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points must be considered:
Prices of materials in stock
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Price quoted by suppliersTrade and cash discounts received
Future prices based upon statistical data
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Material price already contracted
(ii)
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Setting standard for Direct Labour. The standard labour cost isequal to the standard time for each operation multiplied by the
standard wage rate. Setting of standard cost of direct labour
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involves:
(a) Fixation of standard time
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(b) Fixation of standard rate(a) Fixation of standard time: Standard time is fixed by time or
motion study or past records or test runs or estimates. Labour
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time is fixed by the work study engineer. While fixing standard
time, normal ideal time is allowed for fatigue, normal delays or
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other contingencies.(b) Fixation of standard rate. With the help of the personnel
manager, the accountant determines the standard rate. Fixation of
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standard rate is influenced by (i) Unions policy (ii) Demand for
labour (iii) Policy the be followed. (iv) Method of wage payment.
(iii)
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Setting standard for Overhead. Overheads are divided
into fixed, variable and semi-variable. Standard overhead
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rate is determined on the basis of past records and futuretrend of prices. It is calculated for a unit or for an hour.
Standard variable overhead rate=
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Standard variable overhead for the budge Period
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----------------------------------------------------------------------Budgeted production units or budgeted hours for the
budgeted period (or some other base)
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Standard fixed overhead rate=
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Standard overheads for the budget period
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Budgeted production units or budgeted hours for thebudgeted period (or some other base)
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REVISION OF STANDARDS
Standard cost may be established for an indefinite period. There are no definite
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rules for the selection for a particular period. If the standards are fixed for a
short period, it is expensive and frequent revision of standards will impair the
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utility and purpose for which standard is set.At the same, if the standard is set for a longer period, it may not be useful
particularly in the days of high inflation and large fluctuations of rates in case of
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materials and labour.
Standards have to be revised from time to time taking into consideration
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changing circumstances. The circumstances may change on account of technicalinnovations, changed market conditions, increase or decrease in plant capacity,
developing new products or giving up unprofitable production lines. If
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variations from actual occur in practice, they may be due to controllable oruncontrollable causes. Standards should be revised only on account of those
causes which are beyond the control of the management. Changes in product
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design, supply of labour and material, changes in market conditions for a long
period, trade or cyclical variations would impel the management to revise the
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standards. The objective, while comparing the actual performance with thestandard performance and revising standards, is to facilitate better control over
costs and improve the overall working and profitability of the organization.
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Apart from the above, basic standards are revised in the course of time under the
following circumstances, when:
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1. There are permanent changes in the method of production ?designsand specifications.
2. Plant capacity is changed
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3. There is a large variation between the standard and the actual.
BUDGETARY CONTROL AND STANDARD COSTING
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The systems of budgetary control and standard costing have the commonobjective of controlling business operations by establishing pre-determined
targets, measuring the actual performance and comparing it with the targets, for
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the purposes of having better efficiency and of reducing costs. The tow systems
are said to be interrelated but they are not inter-dependent. The budgetary
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control system can function effectively even without the system of standardcosting in operation but the vice-versa is not true. Usually, the two are used in
conjunction with each other to have most fruitful results. The distinction
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between the two systems is mainly on account of the field or scope and
technique of operation.
Budgeting
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Standard costing
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1. Budgetary control is concerned 1. Standard Costing is related withwith the operation of the business
the control of the expenses and
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as a whole and hence its more
hence it is more intensive
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extensive2. Budget is a projection of financial 2. Standard cost is the projection of
accounts
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cost accounts
3. It does not necessarily involve 3. It requires standardization of
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standardization of products.products.
4. Budgetary control can be adopted 4. It is not possible to operate this
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in part also.
system in parts
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5. Budgeting can be operated without 5. Standard costing cannot exist withstandard costing.
out budgeting.
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6. Budgets determine the ceilings of 6. Standards are minimum targets
expenses above which actual
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which are to be attained by actualexpenditure should not normally
performance at specific efficiency
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rise.
level.
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2.3 VARIANCE ANALYSISIt involves the measurement of the deviation of actual performance form the
intended performances. It is based on the principle of management by exception.
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The attention of management is drawn not only to the variation in monetary gain
but also to the responsibility and causes for the same.
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Favourable and Unfavourable variancesVariances may be favorable (positive or credit) or unfavorable (or negative or
adverse or debit) depending upon whether the actual cost is less or more than the
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standard cost.
Favorable variance: When the actual cost incurred is less than the standard cost,
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the deviation is known as favorable variance. The effect of the favorablevariance increases the profit. It is also known as positive or credit variance.
Unfavorable variance: When the actual cost incurred is more than the standard
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cost, the variance is known as unfavorable or adverse variance. It refers todeviation to the loss of the business. It is also known as negative or debit
variance.
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Controllable and Uncontrollable variance:
Variances may be controllable or uncontrollable, depending upon the
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controllability of the factors causing variances.Controllable variance: It refers to a deviation caused by such factors which
could be influenced by the executive action. For example, excess usage of
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materials, excess time taken by a worker, etc. When compared to the standard
cost it is controllable as the responsibility can be fixed on the in-charge.
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Uncontrollable variance: When variance is due to the factors beyond thecontrol of the concerned person (or department), it is uncontrollable. For
example, the wage rate increased on account of strike, government restrictions,
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change in market price etc. Only revision of standards is required to remove
such in future.
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UsesThe variance analysis are important tools of cost control and cost reduction and
they generate and atmosphere of cost consciousness in the organization.
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1. Comparison of actual with standard cost which reveals the efficiency
or inefficiency of performance. The inefficiency or unfavorable
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variance is analyzed and immediate actions are taken.2. It is a tool of cost control and cost reduction
3. It helps to apply the principle of management by exception.
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4. It helps the management to maximize the profits by analyzing thevariances into controllable and uncontrollable; the controllable
variances are further analyzed so as to bring a cost reduction,
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indirectly more profit.
5. Future planning and programmes are based on the variance analysis.
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6. Within the organization, a cost consciousness is created along withthe team spirit.
Computation of variances
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The causes of variance are necessary to find remedial measures; and therefore a
detailed study of variance analysis is essential. Variances can be found out with
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respect to all the elements of cost, i.e., direct material, direct labour andoverheads. The following are the common variances, which are calculated by
the management. Sub-divisions of variances really give detailed information to
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the management in order to control the cost.
1. Material variances
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2. Labour variances3. Overhead variances (a) variable (b) fixed
Material variance:
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The following are the variances in the case of materials
a) Material Cost Variance (MCV). It is the difference between the standard
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cost of direct materials specified for the output achieved and the actual cost ofdirect materials used. The standard cost of materials is computed by multiplying
the standard price with the standard quantity for actual output; and the actual
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cost is computed by multiplying the actual price with the actual quantity. The
formula is:
Material Cost Variance (or) MCV:
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(Standard cost of materials - Actual cost of materials used)
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(or)(Standard Quantity for actual output x Standard Price) - (Actual Quantity x
Actual Rate)
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(or)
(SO x SP) - (AQ x AP)
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b) Material Price Variance (MPV). Material price variance is that portion of
the direct materials cost variance which is the difference between the standard
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price specified and the actual price paid for the direct materials used. Theformula is:
Material Price Variance:
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(Actual Quantity consumed x Standard Price) ? (Actual Quantity consumed x
Actual Price)
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(or)
Actual Quantity consumed (Standard Price - Actual Price)
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(or)MPV= AQ (SP-AP)
c). Material Usage (Quantity) Variance (MUV). It is the deviation caused by
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the standards due to the difference in quantity used. It is calculated by
multiplying the difference between the standard quantity specified and the actual
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quantity used by the standard price.Thus material usage variance is "that portion of the direct materials cost
variance which is the difference between the standard quantity specified for the
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production achieved, whether completed or not, and the actual quantity used,
both valued at standard prices".
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Material Usage or Quantity Variance:
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Standard Rate (Standard Quantity - Actual Quantity)--- Content provided by FirstRanker.com ---
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(or)
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MUV = SR (SQ-AQ)
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d) Material Mix Variance (MMV). When two or more materials are used in
the manufacture of a product, the difference between the standard composition
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and the actual composition of material mix is the material mix variance. Thevariance arises due to the change in the ratio of material and the standard ratio.
The formula is:
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Material Mix Variance = Standard Rate (Standard Mix ? Actual Mix)
Standard is revised due to the shortage of a particular type of material.
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The formula is:MMV = Standard Rate (Revised Standard Quantity - Actual Quantity)
Revised Standard Quantity (RSQ) =
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Total weight of actual mix------------------------------------------------ x Standard Quantity
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Total weight of standard mixAfter finding out this revised standard mix it is multiplied by the revised
standard cost of standard mix and then the standard cost of actual mix is
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subtracted form the result.
Example:1
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The standard cost of material for manufacturing a unit a particular product isestimated as 16kg of raw materials @ Re. 1 per kg.
On completion of the unit, it was found that 20kg. of raw material costing Rs.
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1.50 per kg. has been consumed.Compute Material Variances.
Answer:
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MCV = (SQ x SP) - (AQ x AP)
= (16 x Rs.1) - (20 x Rs.1.50)
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= Rs.16 - Rs.30--- Content provided by FirstRanker.com ---
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= Rs. 14 (Adverse)
MPV = (SP ? AP) x AQ
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= (1 ? 1.50) x 20
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= Rs. 10 (Adverse)MUV = (SQ ? AQ) x SP
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= (16 ? 20) x 1
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= Rs. 4 (Adverse)
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Example:2Calculate the materials mix variance from the following:
Material
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Standard
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Actual
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A
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90 units at rs12 each100 units at rs. 12 each
B
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60 units at rs.15 each
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50 units at rs. 16 eachAnswer:
Material
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Standard
Actual
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Qty Rate Amount
Qty Rate Amount
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A
90 12 1080
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100 12 1200B
60 15 900
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50 16 800
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150 1980150 2000
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MMV = SR (SQ-AQ)
Material ,,A: MMV = Rs.12 (90-100)
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= Rs 12 x10
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= Rs. 120(A)Material ,,B: MMV = Rs. 15 (60-50)
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= Rs. 15 x 10--- Content provided by FirstRanker.com ---
= Rs 150 (F)
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Total MMV = Rs. 120(A) + Rs. 150 (F)= Rs. 30 (F)
(e) Material Yield Variance: It is that portion of the direct material usage
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variance which is due to the difference between the standard yield specified and
the actual yield obtained. The variance arises due to abnormal contingencies like
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spoilage, chemical reaction etc. Since the variance is a measure of the waste orloss in the production, it known as material loss or waste variance.
ICMA, LONDON, it is defined as " the difference between the standard yield of
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the actual material input and the actual yield, both valued at the standard
material cost of the produce". in case actual yield is more than the standard
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yield, the material yield variance is favourable and, if the actual yield is less thanthe standard yield, the variance is unfavourable or adverse.
(i) When actual mix and standard mix are the same, the formula is:
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MYV = Standard Yield Rate (Standard Yield - Actual Yield)
or = Standard Revised Rate (Actual Loss - Standard Loss)
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Here Standard Yield Rate =
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Standard cost of standard mix
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Net standard output
Net standard output = Gross output ? Standard loss
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(ii) When the actual mix and the standard mix differ from each other, the
formula is:
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Standard Rate =
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Standard cost of revised standard mix
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-------------------------------------------------------------------- Content provided by FirstRanker.com ---
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Net Standard OutputMaterial Yield Variance=
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Standard Rate (Actual Standard Yield ? Revised Standard Yield)
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Labour Variances
Labour Variances arise because of (I) Difference in Actual Rates and Standard
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Rates of Labour and (Ii) The variation in Actual Time taken y workers and the
Standard Time allotted to them for performing a job. These are computed on the
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same pattern as that of Material Variances. For Labour Variances by simplyputting the word "Time" in place of "Quantity" in the formula meant for
Material Variances. The various Labour Variances can be analysed as follows:
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(A) Labour Cost Variance
(B) Labour Rate Variance
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(C) Labour Time Or Efficiency Variance(D) Labour Idle Time Variance
(E) Labour Mix Variance Or Gang Composition Variance
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a) Labour Cost Variance (LCV)This variance represents the difference between the Standard Labour Costs and
the Actual Labour Costs for the production achieved. If the Standard Cost is
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higher, the variation is favourable and vice versa. It is calculated as follows:
Labour Cost Variance: = (Standard Cost of Labour - Actual Cost of Labour)
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= (Standard Time x Standard Rate) - (Actual Time x Actual Rate)--- Content provided by FirstRanker.com ---
= (ST x SR) - (AT x AR)
b) Labour Rate Variance (LRV)
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It is the difference between the Standard Rate of pay specified and the ActualRate Paid. According to ICMA, London, the variance is "the difference
between the standard and the actual direct Labour Rate per hour for the total
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hours worked. If the standard rate is higher, the variance is Favourable and vice
versa.
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Labour Rate Variance = Actual Time (Standard Wage Rate x Actual Wage Rate)V
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
=AT (SR-AR)C) Labour Time Or Labour Efficiency Variance (LEV)
It is the difference between the Standard Hours for the actual production
--- Content provided by FirstRanker.com ---
achieved and the hours actually worked, valued at the Standard Labour Rate.
When the workers finish the specific job in less than the Standard Time, the
--- Content provided by FirstRanker.com ---
variance is Favourable. If the workers take more time than the allotted time, thevariance is Adverse.
Labour Efficiency Variance (LEV):
--- Content provided by FirstRanker.com ---
=Standard Rate (Standard Time - Actual Time)
=SR (ST-AT)
d) Idle Time Variance: It arises because of the time during which the Labour
--- Content provided by FirstRanker.com ---
remains idle due to abnormal reasons, i.e. power failure, strikes, machine
breakdown, shortage of materials, etc. It is always an Adverse variance
--- Content provided by FirstRanker.com ---
Labour Idle Time Variance = Actual Idle Time x Standard Hourly Ratee) Labour Mix Variance or Gang Compostion Variance (LMV):
It is the difference between the standard composition of workers and the actual
--- Content provided by FirstRanker.com ---
gang of workers. It is a part of labour efficiency variance. It corresponds to
material mix variance. It enables the management to study the labour cost
--- Content provided by FirstRanker.com ---
variance occurred because of the changes in the composition of labour force.The rates of pay of the different categories of workers-skilled, semi-skilled and
unskilled are different. Hence, any change made in composition of the workers
--- Content provided by FirstRanker.com ---
will naturally cause variance. How much is variance due to the change, is
indicated by Labour Mix Variance.
--- Content provided by FirstRanker.com ---
(i) When the total hours i.e. time of the standard composition and actual
composition of workers does not differ the formula is:
--- Content provided by FirstRanker.com ---
Labour Mix variance= (Standard Cost of Standard Mix) - (Standard cost of
Actual Mix)
--- Content provided by FirstRanker.com ---
(ii) When the total hours i.e. time of the standard composition and actualcomposition of workers differs, the formula is:
Labour Mix variance
--- Content provided by FirstRanker.com ---
Total Time of Actual mix
.................................. x Std cost of Std. mix) - (Std. cost of Actual Mix)
--- Content provided by FirstRanker.com ---
Total Time of Standard mixIf, on account of short availability of some category of workers, the standard
composition is itself revised, then Labour Mix Variance will be calculated by
--- Content provided by FirstRanker.com ---
taking revised standard mix in place of standard mix.Labour Yield Variance (LYV)
It is just like Material Yield Variance. It is the difference between the standard
--- Content provided by FirstRanker.com ---
labour output and actual output of yield. It is calculated as below:
Labour Yield Variance
--- Content provided by FirstRanker.com ---
=Standard cost per unit {Standard production of Actual mix - ActualProduction}
OVERHEAD VARIANCE
--- Content provided by FirstRanker.com ---
Overhead Cost Variance
It is the difference between standard overheads for actual output i.e. Recovered
--- Content provided by FirstRanker.com ---
Overheads and Actual Overheads. It is the total of both fixed and variableoverhead variances. The variable overheads are those costs which tend to vary
directly in proportion to changes in the volume of production. Fixed overheads
--- Content provided by FirstRanker.com ---
consist of costs which are not subject to change with the change in the volume
of production. The variances under overheads are analysed in two heads, viz
--- Content provided by FirstRanker.com ---
Variable Overheads and Fixed Overheads:Overheads Cost Variance= Standard Total Overheads-Actual Total Overheads
The term overhead includes indirect material, indirect labour and indirect
--- Content provided by FirstRanker.com ---
expenses and the variances relate to factory, office or selling and distribution
overheads. Overhead variances are divided into two broad categories: (i)
--- Content provided by FirstRanker.com ---
Variable overhead variances and (ii) Fixed overhead variances. To computeoverhead variances, the following terms must be understood:
--- Content provided by FirstRanker.com ---
a) Standard overhead rate per unitBudgeted overheads
= ........................
--- Content provided by FirstRanker.com ---
Budgeted output
--- Content provided by FirstRanker.com ---
b) Standard overheads rate per hourBudgeted overheads
= ...........................
--- Content provided by FirstRanker.com ---
Budgeted hours
--- Content provided by FirstRanker.com ---
c) Standard hours for actual output--- Content provided by FirstRanker.com ---
Budgeted hours
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
......................... x Actual output
--- Content provided by FirstRanker.com ---
Budgeted output
--- Content provided by FirstRanker.com ---
d) Standard output for actual time
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Budgeted output
--- Content provided by FirstRanker.com ---
......................... x Actual hours
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Budgeted hours
e) Recovered or Absorbed overheads = Standard rate per unit x Actual output
--- Content provided by FirstRanker.com ---
f) Budgeted overheads = Standard rate per unit x budgeted output
g) Standard overheads = Standard rate per unit x Standard output for actual time
--- Content provided by FirstRanker.com ---
h) Actual overheads = Actual rate per unit x Actual output--- Content provided by FirstRanker.com ---
VARIABLE OVERHEAD VARIANCE
--- Content provided by FirstRanker.com ---
Variable cost varies in proportion to the level of output, while the cost is
fixed per unit. As such the standard cost per unit of these overheads remains the
--- Content provided by FirstRanker.com ---
same irrespective of the level of output attained. As the volume does not affectthe variable cost per unit or per hour, the only factors leading to difference is
price. It results due to the change in the expenditure incurred.
--- Content provided by FirstRanker.com ---
(i)
Variable Overhead Expenditure Variance:
--- Content provided by FirstRanker.com ---
It is the difference between actual variable overhead expenditure incurred andthe standard variable overheads set in for a particular period. The formula is:-
{Actual Hours Worked x Standard Variable Overhead Rate per hour}-Actual
--- Content provided by FirstRanker.com ---
Variable overheads
(ii)
--- Content provided by FirstRanker.com ---
Variable Overhead Efficiency Variance:It shows the effect of change in labour efficiency on variable overheads
recovery. The formula is:- Standard
--- Content provided by FirstRanker.com ---
Rate
(Standard
--- Content provided by FirstRanker.com ---
Quantity-ActualQuantity)
Standard Overhead Rate= (Standard Time for Actual output- Actual Time)
--- Content provided by FirstRanker.com ---
(iii)
Variable Overhead Variance
--- Content provided by FirstRanker.com ---
It is divided into two: Overhead Expenditure Variance and Overhead EfficiencyVariance. The formula is:-
Variable overhead Expenditure Variance + Variable overhead Efficiency
--- Content provided by FirstRanker.com ---
variance
FIXED OVERHEAD VARIANCE (FOV):
--- Content provided by FirstRanker.com ---
Fixed overhead variance depends on (a) fixed expenses incurred and (b) thevolume of production obtained. The volume of production depends upon (i)
efficiency (ii) the days for which the factory runs in a week (calendar variance)
--- Content provided by FirstRanker.com ---
(iii) capacity of plant for production.FOV = Actual Output (Fixed Overhead Rate - Actual Fixed Overheads)
--- Content provided by FirstRanker.com ---
(a)
Fixed Overhead Expenditure Variance. (Budgeted or cost Variance).
--- Content provided by FirstRanker.com ---
It is that portion of the fixed overhead which is incurred during a particularperiod due to the difference between the budgeted fixed overheads and the
actual fixed overheads.
--- Content provided by FirstRanker.com ---
Fixed Overhead expenditure variance=Budgeted fixed overhead-Actual fixed
overhead
--- Content provided by FirstRanker.com ---
(b)Fixed Overhead Volume Variance. This variance is the difference
between the standard cost of overhead absorbed in actual output and the
--- Content provided by FirstRanker.com ---
standard allowance for that output. This variance measures the over of under
recovery of fixed overheads due to deviation of actual output form the budgeted
--- Content provided by FirstRanker.com ---
output level.(i)
On the basis of units of output:
--- Content provided by FirstRanker.com ---
Fixed Overhead Volume Variance = Standard Rate (Budgeted Output-Actual
Output)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
OR
--- Content provided by FirstRanker.com ---
=Budgeted Cost ?Standard Cost)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
OR
--- Content provided by FirstRanker.com ---
= (Actual Output x Standard Rate)-Budgeted fixed overheads(ii)
On the basis of standard hours:
--- Content provided by FirstRanker.com ---
Fixed Overhead Volume Variance
--- Content provided by FirstRanker.com ---
=Standard Rate per hour (Budgeted Hours-Standard Hours)Standard Hour = Actual Output + Standard Output per hour
Example: 3
--- Content provided by FirstRanker.com ---
A manufacturing concern furnished the following information:Standard: Material for 70kg, finished products:100kg; Price of materials:Re.1
per kg
--- Content provided by FirstRanker.com ---
Actual: Output: 2,10,000 kg; Material used: 2,80,000; cost of material:
Rs.5,52,000.
--- Content provided by FirstRanker.com ---
Calculate:-(a) Material Usage Variance (b) Material Price Variance (c) Material Cost
Variance
--- Content provided by FirstRanker.com ---
Answer:
1. Standard quantity:
--- Content provided by FirstRanker.com ---
For 70kg standard outputStandard quantity of material = 100 kg
2,10,000 kg of finished products
--- Content provided by FirstRanker.com ---
2,10,000 x 100
--- Content provided by FirstRanker.com ---
= ............................................ =3,00,000 kg--- Content provided by FirstRanker.com ---
70
2. Actual Price per kg
--- Content provided by FirstRanker.com ---
2,52,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
=.................. = Re. 0.90--- Content provided by FirstRanker.com ---
2,80,000
(a) Material Usage or Quantity Variance
--- Content provided by FirstRanker.com ---
=SP (SQ-AQ)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
=Re.1 (3,00,000-2,80,000)--- Content provided by FirstRanker.com ---
=Re.1 * 20,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Rs.20,000 (Favourable)
(b) Material Price Variance
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= AQ (SP - AP)--- Content provided by FirstRanker.com ---
=2, 80,000 (Re.1 ? Re.0.90)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
=2, 80,000 * 0.10 paise
--- Content provided by FirstRanker.com ---
= Rs. 28,000 (Favourable)
--- Content provided by FirstRanker.com ---
(C) Material Cost Variance (MCV):
= (SQ x SP) - (AQ x AP)
--- Content provided by FirstRanker.com ---
= (3, 00,000 x 1) ? (2,80,000 x 0.90)
--- Content provided by FirstRanker.com ---
= Rs. 3, 00,000 ? Rs.2,52,000
--- Content provided by FirstRanker.com ---
= Rs. 48,000 (Favorable)--- Content provided by FirstRanker.com ---
Example: 4
--- Content provided by FirstRanker.com ---
Standard mix for production of "X
--- Content provided by FirstRanker.com ---
Material A: 60 tonnes @ Rs. 5 per tonne
--- Content provided by FirstRanker.com ---
Material B: 40 tonnes @ Rs.10 per tonne
--- Content provided by FirstRanker.com ---
Actual mixture being:
--- Content provided by FirstRanker.com ---
Material A: 80 tonnes @ Rs.4 per tonne
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Material B: 70 tonnes @ Rs. 8 per tonne.Calculate
--- Content provided by FirstRanker.com ---
(a) Material Price Variance
(b) Material sub-usage Variance, and
--- Content provided by FirstRanker.com ---
(c) Material Mix VarianceAnswer:
(a) Material Price Variance
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= AQ (SP - AP)
--- Content provided by FirstRanker.com ---
Material A= 80 (5-4) = Rs.80 (Favourable)Material B= 70 (10-8) = Rs. 140 (Favourable)
--- Content provided by FirstRanker.com ---
MPV = 80 +140 -= Rs 220 (Favourable)
--- Content provided by FirstRanker.com ---
(b) Revised standard quantity=--- Content provided by FirstRanker.com ---
Total weight of actual mix
--- Content provided by FirstRanker.com ---
------------------------------------------------ * standard quantity--- Content provided by FirstRanker.com ---
Total weight of standard mix
RSQ for material ,,A
--- Content provided by FirstRanker.com ---
150= ......... * 60 = 90 tonnes
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
100RSQ for material ,,B
150
--- Content provided by FirstRanker.com ---
= ......... * 40 = 60 tonnes
--- Content provided by FirstRanker.com ---
100
--- Content provided by FirstRanker.com ---
Material sub usage (Revised usage) Variance =
--- Content provided by FirstRanker.com ---
Standard Price (Standard. Quantity ? Revised Standard Quantity)RUV for material ,,A= 5(60-90) = 150 (Adverse)
--- Content provided by FirstRanker.com ---
RUV for material ,,B = 10(40-90) = 200(Adverse)
--- Content provided by FirstRanker.com ---
MRV = 150+200= Rs. 350 (Adverse)
--- Content provided by FirstRanker.com ---
Material Mix Variance = Standard Rate x (Revised std. Quantity - Actual qty.)
MVV for material ,,A= 5(90-80) =50 (Adverse)
--- Content provided by FirstRanker.com ---
MVV for material ,,B= 10(60-70) =100 (Adverse)
--- Content provided by FirstRanker.com ---
MVV=50-100=-50=Rs.540 (Adverse)
--- Content provided by FirstRanker.com ---
Example: 5
Vinak Ltd. produces an article by blending two basic raw materials. It operates a
--- Content provided by FirstRanker.com ---
standard costing system and the following standards have been set for newmaterials.
--- Content provided by FirstRanker.com ---
Material
--- Content provided by FirstRanker.com ---
Standard MixStandard price per kg
--- Content provided by FirstRanker.com ---
A
--- Content provided by FirstRanker.com ---
40%Rs. 4.00
--- Content provided by FirstRanker.com ---
B
--- Content provided by FirstRanker.com ---
60%
--- Content provided by FirstRanker.com ---
Rs. 3.00
The standard loss in processing is 15%
--- Content provided by FirstRanker.com ---
During April 1994 the company produced 1700 kgs of finished output. Theposition of stocks and purchases for the month of April 1994 is as under:
Material
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Stock on 1-4-94
Stock on 30-4-94
--- Content provided by FirstRanker.com ---
Purchasedduring
April 1994
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Kgskgs
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kgs
--- Content provided by FirstRanker.com ---
kgs
A
--- Content provided by FirstRanker.com ---
35
--- Content provided by FirstRanker.com ---
5
--- Content provided by FirstRanker.com ---
800
--- Content provided by FirstRanker.com ---
3400B
--- Content provided by FirstRanker.com ---
40
--- Content provided by FirstRanker.com ---
501200
--- Content provided by FirstRanker.com ---
3000
Calculate: Material Price Variances, Material Usage Variances, Material yield
--- Content provided by FirstRanker.com ---
variances, Material Mix Variances and Total Material Cost Variances.--- Content provided by FirstRanker.com ---
Answer:
--- Content provided by FirstRanker.com ---
Finished output 1,700 kgs. Standard Loss in processing 15%.
--- Content provided by FirstRanker.com ---
Therefore, input is--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
1001,700 x ........ = 2000kgs
--- Content provided by FirstRanker.com ---
85
For an input of 2,000 kgs., the standard cost will be as follows
--- Content provided by FirstRanker.com ---
A - 40% of 2000 = 800 kgs. at Rs. 4.00 = Rs. 3,200
--- Content provided by FirstRanker.com ---
B - 60% of 2,000 =1,200 kgs at Rs.3.00 = Rs. 3,600
--- Content provided by FirstRanker.com ---
.............
--- Content provided by FirstRanker.com ---
.................
--- Content provided by FirstRanker.com ---
2,000kgs
--- Content provided by FirstRanker.com ---
Rs.6,800
--- Content provided by FirstRanker.com ---
Loss 15%300kgs
-
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
.............
.................
--- Content provided by FirstRanker.com ---
Finished output
1,700 kgs
--- Content provided by FirstRanker.com ---
Rs. 6,800--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
6,800Standard Yield Rate =.........= Rs. 4 per kg
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
1,700Actual Costs:
--- Content provided by FirstRanker.com ---
A - 35+800-5 = 830kgs. consumed 35 x 4 (assumed) = Rs. 140.00
--- Content provided by FirstRanker.com ---
795 x 4.25 (purchase price) = Rs. 3,378.75
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
................
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Rs. 3,518.75
--- Content provided by FirstRanker.com ---
B 40+ 1,200-50=1190kgs. consumed 40 x 3 (assumed)= 120.00
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
1150
x
--- Content provided by FirstRanker.com ---
2.50(purchaseprice)
=2,875.00
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
...........
--- Content provided by FirstRanker.com ---
.............
--- Content provided by FirstRanker.com ---
Total--- Content provided by FirstRanker.com ---
2,020
--- Content provided by FirstRanker.com ---
6,513.75
Less: Loss
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
320--- Content provided by FirstRanker.com ---
_
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
.........
--- Content provided by FirstRanker.com ---
...........
Finished output
--- Content provided by FirstRanker.com ---
1,700
--- Content provided by FirstRanker.com ---
6,513.75
--- Content provided by FirstRanker.com ---
Material Price Variance = AQ (SP-AP)
--- Content provided by FirstRanker.com ---
A = 830 x 4 = 3,320 - 3,518.75 = Rs.198.75 (A)
--- Content provided by FirstRanker.com ---
B = 1,190 x 3=3,570 - 2,995 = Rs. 575.00 (F)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
.................
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Rs. 376.25 (F)--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
..................
Material Usage Variance = SP(SQ-AQ)
--- Content provided by FirstRanker.com ---
A = 4 (800-830)
=120(A)
--- Content provided by FirstRanker.com ---
B= 3 (1,200-1,190) =30(F)--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
..........--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Rs. 90(A)Material Yield Variance = SYR* (AY-SY)
=4(1,700-1,717)=68(A)
--- Content provided by FirstRanker.com ---
If SY For 2,000 kgs. input SY=1,700
Then, For 2,020 kgs. input SY = ?
--- Content provided by FirstRanker.com ---
2,020--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
=............. x 1,700=1,717 kgs }--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
2,000Material Mix Variance = SP (RSQ-AQ)
--- Content provided by FirstRanker.com ---
Revised standard quantity=Total weight of actual mix
--- Content provided by FirstRanker.com ---
------------------------------------------------ x Standard Quantity
--- Content provided by FirstRanker.com ---
Total weight of standard mix
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
2.020
--- Content provided by FirstRanker.com ---
For ,,A = 800 x ............ = 808
--- Content provided by FirstRanker.com ---
2,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
2,020For ,,B= 1,200 x ..............=1,212
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
2,000
--- Content provided by FirstRanker.com ---
MMV - For ,,A = 4 (808-803) = 88(A)
--- Content provided by FirstRanker.com ---
For ,,B = 3 (1,212-1,190) = 66(F)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
..... ...................
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Rs. 22(A)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
........................
--- Content provided by FirstRanker.com ---
Material Cost Variance
--- Content provided by FirstRanker.com ---
= (SC - AC) = (6,800 - 6,513.75) = Rs. 286.25(F)Labour Variance:
Example: 6
--- Content provided by FirstRanker.com ---
With the help of following information calculate
(a) Labour Cost Variance
(b) Labour Rate Variance
--- Content provided by FirstRanker.com ---
(c) Labour Efficiency Variance
Standard hours: 40@ Rs. 3 per hour
--- Content provided by FirstRanker.com ---
Actual hours: 50@ Rs. 4 per hourAnswer:
(a) Labour Cost Variance = (Standard Time x Standard Rate) - (Actual Time x
--- Content provided by FirstRanker.com ---
Actual Rate)--- Content provided by FirstRanker.com ---
= (40 x Rs.3) ? (50 x Rs.4)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= (Rs.120 - 200) = Rs.80
--- Content provided by FirstRanker.com ---
= Rs.80 (Adverse)
--- Content provided by FirstRanker.com ---
(b) Labour Rate Variance = Actual Time (Standard Rate x Actual Rate)
--- Content provided by FirstRanker.com ---
= 50 (Rs.3 - Rs.4) = Rs. 50
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Rs. 50 (Adverse)
(c) Labour Efficiency Variance = Standard Rate (Standard Time-Actual Time)
--- Content provided by FirstRanker.com ---
= Rs.3 (40-50) = Rs.30
= Rs.30 (Adverse)
--- Content provided by FirstRanker.com ---
Example; 7The Labour budget of a company for a week is as follows:
20 skilled men @ 50 paise per hour for 40 hours
--- Content provided by FirstRanker.com ---
=400
40 skilled men @ 30 paise per hour for 40 hours
--- Content provided by FirstRanker.com ---
=480--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
........
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
880
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
........
--- Content provided by FirstRanker.com ---
The actual labour force was used as follows:30 skilled men @ 50 paise per hour for 40 hours` =600
30 skilled men @ 35 paise per hour for 40 hours
--- Content provided by FirstRanker.com ---
=420
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
.......
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
1,020
Analyses labour variances.
--- Content provided by FirstRanker.com ---
Answer:
1. Labour Rate Variance
--- Content provided by FirstRanker.com ---
= AT (SR - AR)(a) Skilled men
--- Content provided by FirstRanker.com ---
= 1,200 (Rs.50 - Rs.50) = 0
(b) Unskilled men
--- Content provided by FirstRanker.com ---
= 1,200 (Rs.30 - Rs.35) = Rs.60 (A)2. Labour Mix variance
= SR (ST - AT)
--- Content provided by FirstRanker.com ---
(a) Skilled men
--- Content provided by FirstRanker.com ---
= Rs.0.50 (800 -1200) = Rs.200 (A)(b) Unskilled men
--- Content provided by FirstRanker.com ---
= Rs.0.30 (1600 -1200) = Rs.120 (F)
Total Labour Cost Variance = Standard labour cost - Actual cost
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= 880-1020 = 140 (A)
Example; 8
--- Content provided by FirstRanker.com ---
Standard labour hours and rate for production of Article A are given
below:
--- Content provided by FirstRanker.com ---
Hrs.
--- Content provided by FirstRanker.com ---
Rate (Rs.)Total
Skilled worker
--- Content provided by FirstRanker.com ---
5
1.50 per hour
--- Content provided by FirstRanker.com ---
7.50Unskilled worker
8
--- Content provided by FirstRanker.com ---
0.50 per hour
4.00
--- Content provided by FirstRanker.com ---
Semi-skilled worker4
0.75 per hour
--- Content provided by FirstRanker.com ---
3.00
--- Content provided by FirstRanker.com ---
Actual dataRate per hour
Total
--- Content provided by FirstRanker.com ---
Articles produced 1,000 units
--- Content provided by FirstRanker.com ---
Skilled worker 4,500 hrs
2.00
--- Content provided by FirstRanker.com ---
9,000
Unskilled worker 10,000 hrs
--- Content provided by FirstRanker.com ---
0.454,500
Semi skilled worker 4,200 hrs
--- Content provided by FirstRanker.com ---
0.75
3,150
--- Content provided by FirstRanker.com ---
Calculate: Labour Cost Variance, Labour Rate Variance, LabourEfficiency Variance and Labour Mix Variance
--- Content provided by FirstRanker.com ---
Answer:(a) Labour Cost Variance
= (Standard Time x Standard Rate) - (Actual Time x Actual Rate)
--- Content provided by FirstRanker.com ---
Standard Time for Actual Production =Actual Units x ST.
Skilled Worker = 1,000 x 5 = 5000 Hrs.
--- Content provided by FirstRanker.com ---
Unskilled worker = 1,000 x 8 = 8,000 Hrs.Semi-skilled worker= 1,000 x 4 = 4,000 Hrs.
--- Content provided by FirstRanker.com ---
Labour Cost Variance
Skilled worker
--- Content provided by FirstRanker.com ---
= (5000 x Rs.1.50) ? (4,500 x 2)--- Content provided by FirstRanker.com ---
= Rs.7,500 ? Rs.9,000 = Rs.1,500 (A)
--- Content provided by FirstRanker.com ---
Unskilled worker= Rs. (8,000 x Rs.0.50) ? (10,000 x 0.45)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= 4,000 - 4,500 = Rs.500 (A)Semi skilled worker = (4,000 x Rs.0.75) ? (4,200 x Rs.0.75)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= 3,000-3,150) = Rs.150 (A)Total Labour Cost Variance = Rs.2150 (A)
--- Content provided by FirstRanker.com ---
(b) Labour Rate Variance = Actual Time (Standard Rate x Actual Rate)
Skilled worker
--- Content provided by FirstRanker.com ---
= 4500 (1.50 - 2) = Rs.2250 (A)Unskilled worker
= Rs.4,200 (0.75 ? 0.75) = Nil
--- Content provided by FirstRanker.com ---
Semi skilled worker = 1,000 (0.50 - 0.45) = Rs.500 (F)
Total Labour Rate Variance = Rs.1,750 (A)
--- Content provided by FirstRanker.com ---
(c) Labour mix variance: = SR (Revised std. Mix of Actual hours worked) ?
Actual Mix
--- Content provided by FirstRanker.com ---
Revised std. Mix of Actual hours worked--- Content provided by FirstRanker.com ---
Std Mix
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
=........................... x Total Actual Hrs.
--- Content provided by FirstRanker.com ---
Total Std. Hours
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
5,000
--- Content provided by FirstRanker.com ---
Skilled worker = ............... x 18,700 = 5,500 Hrs--- Content provided by FirstRanker.com ---
17,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
8,000
--- Content provided by FirstRanker.com ---
Unskilled worker=............ x 18,700 = 8,800 Hrs.
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
17,000--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
4,000Semi skilled worker =............ x 18,700 = 4,400 Hrs
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
17,000
--- Content provided by FirstRanker.com ---
Labour Mix Variance:
--- Content provided by FirstRanker.com ---
Skilled worker= 1.50 (5,500 - 4,500) = Rs.1,500 (F)
Unskilled worker
--- Content provided by FirstRanker.com ---
= 0.50 (8,800-10,000) = Rs.600 (A)
Semi skilled worker = 0.75 (4,400 - 4,200) = Rs.150 (F)
--- Content provided by FirstRanker.com ---
Total Labour Mix Variance = Rs.1050 (F)(d) Labour Efficiency Variance = SR (ST for Actual output ? Revised Std.
--- Content provided by FirstRanker.com ---
Hrs)Skilled worker
= 1.50 (5,000 - 5,500) = Rs.750 (A)
--- Content provided by FirstRanker.com ---
Unskilled worker
= 0.50 (8,000 - 8,800) = Rs.400 (A)
--- Content provided by FirstRanker.com ---
Semi skilled worker = 0.75 (4,000 - 4,400) = Rs.300 (A)Total Labour Efficiency Variance = Rs. ,450 (A)
--- Content provided by FirstRanker.com ---
Overhead Variance:Example: 9
S.V. Ltd has furnished you the following data:
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Budget
--- Content provided by FirstRanker.com ---
Actual July 1994No. of working days
--- Content provided by FirstRanker.com ---
25
--- Content provided by FirstRanker.com ---
27
Production in units
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
20,000
--- Content provided by FirstRanker.com ---
22,000
Fixed overheads
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Rs.30,000
--- Content provided by FirstRanker.com ---
Rs.31,000Budgeted fixed overhead rate is Re. 1 per hour. In July 1994, the actual hours
worked were 31,500.
--- Content provided by FirstRanker.com ---
Calculate the following variance: (i) Efficiency Variance (ii) Capacity variance
(iii) Volume variance (iv) Expenditure variance and (v) Total overhead variance.
--- Content provided by FirstRanker.com ---
Answer:--- Content provided by FirstRanker.com ---
Budgeted overhead
--- Content provided by FirstRanker.com ---
Recovered overhead =........................ x Actual output--- Content provided by FirstRanker.com ---
Budgeted output
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
30,000
--- Content provided by FirstRanker.com ---
=........... x 22,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
20,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= 33,000
--- Content provided by FirstRanker.com ---
(i) Efficiency Variance = Standard Rate per hour (Standard hours for actual
production ? Actual hours)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Re. 1 x (33,000 ? 31,500)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Rs.1,500 (F)
--- Content provided by FirstRanker.com ---
(ii) Capacity Variance = Standard Rate per hour x (Actual hours - Budgeted
--- Content provided by FirstRanker.com ---
hours)--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Standard overheads - Budgeted overheads--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Re. 1 x (31,500 ? 30,000)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Rs.1500 (F)
(iii) Volume variance = Recovered overhead ? Budgeted overheads
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Rs. 33,000 ? Rs. 30,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Rs. 3,000 (F)
--- Content provided by FirstRanker.com ---
(iv) Expenditure variance = Budgeted overheads ? Actual overheads
\
--- Content provided by FirstRanker.com ---
= Rs.30,000 ? Rs.31,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Rs.1,000 (A)
--- Content provided by FirstRanker.com ---
(v) Total overhead variance = Recovered overhead ? Actual overheads
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Rs.33,000 ? Rs.31,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Rs.2,000 (F)Example: 10
--- Content provided by FirstRanker.com ---
Vinak Ltd.has furnished you the following for the month of August 1994.
--- Content provided by FirstRanker.com ---
BudgetActual
Output (Units)
--- Content provided by FirstRanker.com ---
30,000
32,500
--- Content provided by FirstRanker.com ---
Hours30,000
33,000
--- Content provided by FirstRanker.com ---
Fixed hours
Rs. 45,000
--- Content provided by FirstRanker.com ---
50,000Variable overhead
Rs. 60,000
--- Content provided by FirstRanker.com ---
68,000
Working days
--- Content provided by FirstRanker.com ---
2526
Calculate the variances.
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Answer:
--- Content provided by FirstRanker.com ---
Standard Overhead Rate per UnitBudgeted Overheads
=....................................
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Budgeted Output
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
30,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
............= 1 hours--- Content provided by FirstRanker.com ---
30,000
--- Content provided by FirstRanker.com ---
Total standard overhead rate per hour--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Budgeted overheads--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
=..........................--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Budgeted hours--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
1,05,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= ............. = Rs.3.50 per hour--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
30,000Standard fixed overhead rate per hour
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Budgeted fixed overheads
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= ................................
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Budgeted hours
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
45,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= .......... = Rs.1.50
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
30,000
Standard variable overhead rate per hour
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Budgeted variable overheads
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
=.....................................
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Budgeted hours
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
60,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= ........... = Rs.2
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
30,000
Overhead cost variance = Recovered overheads ? Actual overheads
--- Content provided by FirstRanker.com ---
Recovered overhead = Actual output x Standard Rate per unit--- Content provided by FirstRanker.com ---
= 32,500 x Rs.3.50 = Rs.1,13,750
--- Content provided by FirstRanker.com ---
Overhead cost variance = 1,13,750 ? 1,18,000--- Content provided by FirstRanker.com ---
= Rs.4,250 (A)
--- Content provided by FirstRanker.com ---
Variable overhead cost variance = Recovered overheads ? Actual overheads--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= 32,500 hrs x Rs.2 ? Rs.68,000--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Rs.3,000 (A)Fixed overhead cost variance = Recovered overheads ? Actual overheads
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= 32,500 hrs x Rs.1.50 ? Rs.50,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= 48,750 ? 50,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
=Rs.1,250 (A)
Expenditure variance = Budgeted overheads ? Actual overheads
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Rs.45,000 ? Rs.50,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Rs.5000 (A)Volume variance
= Recovered overheads- Budgeted overheads
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= 32500 hrs x Rs.1.50 ? 45,000
--- Content provided by FirstRanker.com ---
= 48,750 ? 45,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Rs.3,750 (F)
Efficiency variance = Recovered overheads- standard overheads
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
OR
Standard rate (Standard hours for actual output ? Actual hours)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= 1.50 (32,500 ? 33,000)
--- Content provided by FirstRanker.com ---
= Rs.750 (A)
--- Content provided by FirstRanker.com ---
Capacity variance = standard overheads ? Budgeted overheads
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Or
--- Content provided by FirstRanker.com ---
= Standard Rate (Actual hours - Budgeted hours)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= Rs.1.50 (33,000 ? 30,000)--- Content provided by FirstRanker.com ---
= Rs.4,500 (F)
Calendar variance = Extra / Deficit hours worked x Standard Rate.
--- Content provided by FirstRanker.com ---
One extra day has been worked... The Total number of extra hours worked
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
30,000--- Content provided by FirstRanker.com ---
= ........... = 1,200
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
25
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
=1,200 x 1.50 = Rs.1,800 (F)
Note:
1. (F) ? Favourable; (A) ? Adverse (or) Unfavaourable
--- Content provided by FirstRanker.com ---
2. When Standard is more than the Actual, it is favourable variance
3. When Actual is more than the Standard, it is unfavourable or
--- Content provided by FirstRanker.com ---
adverse variance4. In place of ,,Time, the term ,,Hours may also be used.
Disposal of Variances:
--- Content provided by FirstRanker.com ---
Cost variances are disposed of in one of the following ways:
--- Content provided by FirstRanker.com ---
1. Transfer to profit and loss account, keeping work-in-progress, finishedgoods and cost of sales at standard cost.
2. Transfer to cost of sales, thus practically converting the standard cost of
--- Content provided by FirstRanker.com ---
sales into actual cost of sales.
3. Prorating to cost of sales and inventories, either on the basis of units or
--- Content provided by FirstRanker.com ---
value, so that both the inventories and cost of goods sold will be shownat actual costs.
Exercises:
--- Content provided by FirstRanker.com ---
1.
Following is the data of a manufacturing concern. Calculate:-
--- Content provided by FirstRanker.com ---
Material Cost Variance, Material Price Variance and Material usage variance.The standard quantity of materials required for producing one ton of output is 40
units. The standard price per unit of materials is Rs. 3. During a particular period
--- Content provided by FirstRanker.com ---
90 tons of output was undertaken. The materials required for actual production
were 4,000 units. An amount of Rs. 14,000 units. An amount of Rs.14, 000 was
--- Content provided by FirstRanker.com ---
spent on purchasing the materials.(MCV:Rs.3,200(A), MPV: Rs.2,000 (A), MUV Rs.1,200 (A)
2
--- Content provided by FirstRanker.com ---
The standard materials required for producing 100 units is 120 kgs. Astandard price of 0.50 paise per kg is fixed 2,40,000 units were produced during
the period. Actual materials purchased were 3,00,000 kgs. at a cost of Rs.
--- Content provided by FirstRanker.com ---
1,65,000. Calculate Materials Variance. ( MCV - 21,000)
3
--- Content provided by FirstRanker.com ---
From the data given below, calculate: Material Cost Variance, MaterialPrice Variance and Material Usage Variance
Products
--- Content provided by FirstRanker.com ---
Standard
Standard
--- Content provided by FirstRanker.com ---
Actual QuantityActual
Quantity (units)
--- Content provided by FirstRanker.com ---
Price Rs.
(units)
--- Content provided by FirstRanker.com ---
PriceA
1,050
--- Content provided by FirstRanker.com ---
2.00
1,100
--- Content provided by FirstRanker.com ---
2.25B
1,500
--- Content provided by FirstRanker.com ---
3.25
1,400
--- Content provided by FirstRanker.com ---
3.50C
2,100
--- Content provided by FirstRanker.com ---
3.50
2,000
--- Content provided by FirstRanker.com ---
3.75(MCV (-) Rs.550 (A), MPV: (-) Rs.1,125 (A), MUV(-) Rs.575 (A)
4
--- Content provided by FirstRanker.com ---
From the following information, calculate material mix variance:
--- Content provided by FirstRanker.com ---
StandardActual
Materials
--- Content provided by FirstRanker.com ---
Quantity
Price per unit
--- Content provided by FirstRanker.com ---
QuantityPrice per unit
(units)
--- Content provided by FirstRanker.com ---
Rs.
(units)
--- Content provided by FirstRanker.com ---
Rs.A
40
--- Content provided by FirstRanker.com ---
10
50
--- Content provided by FirstRanker.com ---
12B
60
--- Content provided by FirstRanker.com ---
5
50
--- Content provided by FirstRanker.com ---
8(Materials Mix Variance: Rs.50 (A)
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
5
--- Content provided by FirstRanker.com ---
Calculate material mix variance form the data given as such:Standard
--- Content provided by FirstRanker.com ---
Actual
Materials
--- Content provided by FirstRanker.com ---
QuantityPrice per unit Quantity
Price per unit
--- Content provided by FirstRanker.com ---
(units)
Rs.
--- Content provided by FirstRanker.com ---
(units)Rs.
A
--- Content provided by FirstRanker.com ---
50
2.00
--- Content provided by FirstRanker.com ---
602.25
B
--- Content provided by FirstRanker.com ---
100
1.20
--- Content provided by FirstRanker.com ---
901.75
Due to the shortage of material A, the use of material ,,A was reduced by 10%
--- Content provided by FirstRanker.com ---
and that of ,,B increased by 5% Ans: (Material Mix Variance = -12 (A)
6.
--- Content provided by FirstRanker.com ---
From the following data calculate various material variances:Standard
--- Content provided by FirstRanker.com ---
Actual
Materials
--- Content provided by FirstRanker.com ---
QuantityPrice per unit
Quantity
--- Content provided by FirstRanker.com ---
Price per unit
(units)
--- Content provided by FirstRanker.com ---
(units)Rs.
Rs.
--- Content provided by FirstRanker.com ---
A
80
--- Content provided by FirstRanker.com ---
8.0090
7.50
--- Content provided by FirstRanker.com ---
B
70
--- Content provided by FirstRanker.com ---
3.0080
4.00
--- Content provided by FirstRanker.com ---
(MCV; Rs.145 (A), MPV: Rs.35 (A), MUV: Rs.110 (A), MMV: Rs.3.3 (F)
7.
--- Content provided by FirstRanker.com ---
From the following information, Calculate material yield variance:Standard
--- Content provided by FirstRanker.com ---
Actual
Materials
--- Content provided by FirstRanker.com ---
QuantityPrice per unit Quantity
Price per unit
--- Content provided by FirstRanker.com ---
(units)
Rs.
--- Content provided by FirstRanker.com ---
(units)Rs.
A
--- Content provided by FirstRanker.com ---
80
5
--- Content provided by FirstRanker.com ---
604.50
B
--- Content provided by FirstRanker.com ---
70
9
--- Content provided by FirstRanker.com ---
908.00
......
--- Content provided by FirstRanker.com ---
.....
--- Content provided by FirstRanker.com ---
150150
--- Content provided by FirstRanker.com ---
There is a standard loss of 10%. Actual yield is 125 units. (MYV: Rs.76.3 (A)
8.
--- Content provided by FirstRanker.com ---
The standard Mix of a product is as under:A
--- Content provided by FirstRanker.com ---
60 units at 15p per unit--- Content provided by FirstRanker.com ---
Rs.9
--- Content provided by FirstRanker.com ---
B80 units at 20 P. per unit
--- Content provided by FirstRanker.com ---
Rs.16
--- Content provided by FirstRanker.com ---
C
--- Content provided by FirstRanker.com ---
100 units at 25P per unit
--- Content provided by FirstRanker.com ---
Rs. 25
--- Content provided by FirstRanker.com ---
.......
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
........
--- Content provided by FirstRanker.com ---
240Rs. 50
Ten units of finished product should be obtained from the above mentioned mix.
--- Content provided by FirstRanker.com ---
During the month of January, 1978, ten mixes were completed and the
consumption was as follows:
--- Content provided by FirstRanker.com ---
A640 units at 15p per unit
--- Content provided by FirstRanker.com ---
Rs.128
--- Content provided by FirstRanker.com ---
B
960 units at 20 P. per unit
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Rs.144--- Content provided by FirstRanker.com ---
C
840 units at 25P per unit
--- Content provided by FirstRanker.com ---
Rs. 252
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
.......--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
........2,440
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Rs.524
.......
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
.........
--- Content provided by FirstRanker.com ---
The actual output was 90 units. Calculate various material variances.
(MCV: Rs.74 (A), MPV: Rs.26 (A), MUV: Rs.48 (A), MMV: Rs.0.35 (F)
--- Content provided by FirstRanker.com ---
9.Vinak Ltd. produces an articles by blending two basic raw materials. It
operates a standard costing system and the following standards have been set
--- Content provided by FirstRanker.com ---
for raw materials.
Material
--- Content provided by FirstRanker.com ---
Standard Mix
Standard price per kg.
--- Content provided by FirstRanker.com ---
A
--- Content provided by FirstRanker.com ---
40%
--- Content provided by FirstRanker.com ---
Rs.4.00
--- Content provided by FirstRanker.com ---
B--- Content provided by FirstRanker.com ---
60%
--- Content provided by FirstRanker.com ---
Rs. 3.00
The standard loss in processing is 15%. During April, 1980, the company
--- Content provided by FirstRanker.com ---
produced 1,700 kg of finished output. The position of stock and purchase for themonth of April, 1980 are as under:
Material
--- Content provided by FirstRanker.com ---
Stock on 1-4-80
Stock on 30-4-80
--- Content provided by FirstRanker.com ---
Purchasedduring
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
April, 1980
--- Content provided by FirstRanker.com ---
kg
--- Content provided by FirstRanker.com ---
kg
--- Content provided by FirstRanker.com ---
kg
--- Content provided by FirstRanker.com ---
Cost
Rs.
--- Content provided by FirstRanker.com ---
A35
--- Content provided by FirstRanker.com ---
5
--- Content provided by FirstRanker.com ---
800
--- Content provided by FirstRanker.com ---
3,400
B
--- Content provided by FirstRanker.com ---
40--- Content provided by FirstRanker.com ---
50
--- Content provided by FirstRanker.com ---
1,200 3,000
Calculate the following variances:
--- Content provided by FirstRanker.com ---
Material Cost Variance, Material Price Variance, Material Usage Variance,
Material Yield Variance and Material Mix Variance.
--- Content provided by FirstRanker.com ---
(MCV: Rs.286 (F), Material Price Variance: Rs. 376.75 Favourable, MaterialUsage Variance. Rs.90 unfavoruable, Material Mix Variance: Rs. 22 Adverse)
10.
--- Content provided by FirstRanker.com ---
In a manufacturing concern, the standard time fixed for a month is 8,000
hours. A standard wage rate of Rs. 2.25 P. per hour has been fixed. During one
--- Content provided by FirstRanker.com ---
month, 50 workers were employed and average working days in a month are 25.A worker works for 7 hours in a day. Total wage bill of the factory for the
month amounts to Rs. 21,875. There was a stoppage of work due to power
--- Content provided by FirstRanker.com ---
failure (idle time) for 100 hours. Calculate various labour variances.
(LCV: Rs.3875 (A), Rate of pay variance: Rs. 2187.50 (A), LEV: Rs.1462.50
--- Content provided by FirstRanker.com ---
(A)Idle Time Variance: Rs.225 Adverse.)
11.
--- Content provided by FirstRanker.com ---
The information regarding the composition and the weekly wage rates of
labour force engaged on a job scheduled to be completed in 30 weeks are as
--- Content provided by FirstRanker.com ---
follows:Standard
--- Content provided by FirstRanker.com ---
ActualCategory of
No. of
--- Content provided by FirstRanker.com ---
Weekly wage
No. of
--- Content provided by FirstRanker.com ---
Weekly wagewokers
workers
--- Content provided by FirstRanker.com ---
rate per
workers
--- Content provided by FirstRanker.com ---
rate perworker
worker
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Rs.Rs.
--- Content provided by FirstRanker.com ---
Skilled
75
--- Content provided by FirstRanker.com ---
6070
70
--- Content provided by FirstRanker.com ---
Semi skilled
45
--- Content provided by FirstRanker.com ---
4030
50
--- Content provided by FirstRanker.com ---
Unskilled
60
--- Content provided by FirstRanker.com ---
2080
20
--- Content provided by FirstRanker.com ---
The work was completed in 32 weeks. Calculate various labour
--- Content provided by FirstRanker.com ---
variances.12. The following data is taken out from the books of a manufacturing concern.
Budgeted labour composition for producing 100 articles
--- Content provided by FirstRanker.com ---
20 Men @ Rs. 1.25 hour for 25 hours
30 women @ 1.10 per hour for 30 hours
--- Content provided by FirstRanker.com ---
Actual labour composition for Producing 100 articles25 Men @ Rs. 1.50 per hour for 24 hours
25 women @ Re. 1.20 per hour for 25 hours
--- Content provided by FirstRanker.com ---
Calculate: (i) Labour Cost Variance, (ii) Labour Rate Variance, (iii) Labour
--- Content provided by FirstRanker.com ---
Efficency Variance, (iv) Labour Mix Variance.Ans:(Labour Cost Variance: Rs. 35 Adverse, Labour Rate Variacne Rs. 212.50
Adverse, LEV:Rs.177.50 Favourable and LMV: Rs.24.38 unfavourable)
--- Content provided by FirstRanker.com ---
13.
--- Content provided by FirstRanker.com ---
Calculate labour variances from the following data:
Standard
--- Content provided by FirstRanker.com ---
ActualOut put in units
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
2,0002,500
Number of workers employed
--- Content provided by FirstRanker.com ---
50
--- Content provided by FirstRanker.com ---
60Number of working days in a month
20
--- Content provided by FirstRanker.com ---
22
Average wage per man per month (Rs.)
--- Content provided by FirstRanker.com ---
280330
Ans: LCV Rs.2300 (A), LRV Rs. 1320 (A), LEV Rs 980 (A)
--- Content provided by FirstRanker.com ---
14.
From the following information compute;
--- Content provided by FirstRanker.com ---
(i)Fixed Overhead Variance
(ii)
--- Content provided by FirstRanker.com ---
Expenditure Variance
(iii)
--- Content provided by FirstRanker.com ---
Volume Variance(iv)
Capacity Variance
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(v)
Efficiency Variance
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BudgetActual
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Fixed overheads for November
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Rs. 20,000
20,400
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Units of production in November
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10,000
10,400
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Standard time for 1 unit
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= 2 hours
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Actual Hours Worked
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=20,100 hours
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Ans: Fixed Overhead Variance: Rs. 300 (A), Expenditure Variance: Rs. 400 (A),
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Volume Variance: Rs. 100 (F), Capacity Variance: Rs. 800 (F), EfficiencyVariance: Rs. 700 (A)
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15.
From the following information, calculate various overhead variances:
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Budget`
Actual
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Output in units
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12,00014,000
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Number of working days
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20
22
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Fixed Overheads
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36,000
49,000
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Variable Overheads
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24,000
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35,000There was an increase of 5% in Capacity.
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(Total Overhead cost Variance: Rs.14,000 (A), Variable Overhead Variance: Rs.
7,000 (A), Fixed Overhead Variance: Rs.7000 (A),Expenditure Variance: Rs.
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13,000 (A), Volume Variance: Rs.6000 (F), Capacity Variance: Rs.1,800 (F),
Calendar Variance: Rs.32,780 (F), Efficiency Variance: Rs.420 (F)
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Unit IIILesson I
Marginal Costing ? Basic Concepts
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Structure of the Lesson:
The lesson is structured as follows:
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IntroductionDefinition
Features of Marginal Costing
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Assumptions in Marginal Costing
Characteristics of Marginal Costing
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Advantages of Marginal CostingLimitations of Marginal Costing
Marginal Costing and Absorption Costing
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Distinction between Absorption Costing and Marginal CostingDifferential Costing
Marginal Cost
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Features of Marginal Cost
Marginal Cost Statement
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Marginal Cost EquationContribution:
Profit / Volume Ratio
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Angle of incidence:
Profit goal:
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Operating leverageObjectives of the Lesson:
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On completion of this lesson, you should be able to define and explain the
following concepts:
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Marginal Costing
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Absorption Costing or Full Cost Costing
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Differential CostingMarginal Cost
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Fixed Cost
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Variable Cost
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ContributionP / V ratio
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Margin of Safety
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Angle of Incidence
Introduction
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By analyzing the behaviour of costs in relation to changes in volume of output it
becomes evident that there are some items of costs which tend to vary directly
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with the volume of output, whereas there are others which tend to vary withvolume of output, are called variable cost and those remain unaffected by
change in volume of output are fixed cost or period costs.
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Marginal costing is a study where the effect on profit of changes in the volume
and type of output is analysed. It is not a method of cost ascertainment like job
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costing or contract costing. It is a technique of costing oriented towardsmanagerial decision making and control.
Marginal costing, being a technique can be used in combination with other
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technique such as budgeting and standard costing. It is helpful in determining
the profitability of products, departments, processes, and cost centres. While
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analyzing the profitability, marginal costing interprets the cost on the basis ofnature of cost. The emphasis is on behaviour of costs and their impact on
profitability.
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Definition
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Marginal costing is defined by the ICWA, India as "the ascertainment of
marginal costs and of the effect on profit of changes in volume or type of output
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by differentiating between fixed costs, and variable costs"Batty defined Marginal Costing as, "a technique of cost accounting which pays
special attention to the behaviour of costs with changes in the volume of output"
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Kohlers Dictionary for Accounting defines Marginal Costing "as the
ascertainment of marginal or variable costs to an activity department or
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products as compared with absorption costing or direct costing"The method of charging all the costs to production is called absorption costing.
Kohlers dictionary for Accountants defines it as "the process of allocating all
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or a portion of fixed and variable production costs to work ? in ? process, cost
of sales and inventory". The net profits ascertained under this system will be
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different from that under marginal costing because ofDifference in stock valuation
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Over and under ? absorbed overheads
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Direct costing is defined as the process of assigning costs as they are incurredto products and services
Features of Marginal Costing
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The following are the special features of Marginal Costing:
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Marginal costing is a technique of working of costing which is used inconjunction with other methods of costing (Process or job)
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Fixed and variable costs are kept separate at every stage. Semi ?
Variable costs are also separated into fixed and variable.
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As fixed costs are period costs, they are excluded from product cost or
cost of production or cost of sales. Only variable costs are considered as
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the cost of the product.As fixed cost is period cost, they are charged to profit and loss account
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during the period in which they incurred. They are not carried forward to
the next years income.
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Marginal income or marginal contribution is known as the income or
profit.
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The difference between the contribution and fixed costs is the net profit or
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loss.Fixed costs remains constant irrespective of the level of activity.
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Sales price and variable cost per unit remains the same.
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Cost volume profit relationship is fully employed to reveal the state of
profitability at various levels of activity.
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Assumptions in Marginal Costing
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The technique of marginal costing is based on the following assumptions:1.
All elements of costs can be divided into fixed and variable.
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2.
The selling price per unit remains unchanged at all levels of activity.
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3.Variable cost per unit remains constant irrespective of level of output and
fluctuates directly in proportion to changes in the volume of output.
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4.
Fixed costs remain unchanged or constant for the entire volume of
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production.5.
Volume of product is the only factor which influences the costs.
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Characteristics of Marginal CostingThe essential characteristics and mechanism of marginal costing technique may
be summed up as follows:
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1. Segregation of cost into fixed and variable elements: In marginal costing,
all costs are segregated into fixed and variable elements.
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2. Marginal cost as product cost: Only marginal (variable) costs are chargedto products.
3. Fixed costs are period costs: Fixed cost are treated as period costs and are
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charged to costing profit and loss account of the period in which they are
incurred.
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4. Valuation of inventory: The work ? in ? progress and finished stocks arevalued at marginal cost only.
5. Contribution is the difference between sales and marginal cost: The
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relative profitability of the products or departments is based on a study of
"contribution" made by each of the products or departments.
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Advantages of Marginal Costing
Marginal costing is an important technique of managerial decision making.
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It is a tool for cost control and profit planning. The following are the advantages
of marginal costing technique:
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1.Simplicity
The statement propounded under marginal costing can be easily followed as it
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breaks up the cost as variable and fixed.
2.
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Stock Valuation
Stock valuation cab be easily done and understood as it includes only the
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variable cost.3.
Meaningful Reporting
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Marginal costing serves as a good basis for reporting to management. The
profits are analyzed from the point of view of sales rather than production.
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4.Effect on Fixed Cost
The fixed costs are treated as period costs and are charged to Profit and Loss
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Account directly. Thus, they have practically no effect on decision making.
5. Profit Planning
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The Cost ? Volume Profit relationship is perfectly analysed to reveal efficiencyof products, processes, and departments. Break ? even Point and Margin of
Safety are the two important concepts helpful in profit planning.
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6. Cost Control and Cost Reduction
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Marginal costing technique is helpful in preparation of flexible budgets as thecosts are classified into fixed and variable. The emphasis is laid on variable cost
for control. The constant focus is on cost and volume and their effect on profit
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pave the way for cost reduction.
7. Pricing Policy
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Marginal costing is immensely helpful in determination of selling prices underdifferent situations like recession, depression, introduction of new product, etc.
Correct pricing can be developed under the marginal costs technique with the
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help of the cost information revealed therein.
8. Helpful to Management
Marginal costing is helpful to the management in exercising decisions regarding
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make or buy, exporting, key factor and numerous other aspects of business
operations.
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Limitations of Marginal CostingFollowing are the limitations of marginal costing:
Classification of Cost
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Break up of cost into fixed and variable portion is a difficult problem. More
over clear cost division of semi ? variable or semi ? fixed cost is complicated
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and cannot be accurate.Not Suitable for External Reporting
Since fixed cost is not included in total cost, full cost is not available to
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outsiders to judge the efficiency.
Lack of Long ? term Perspective
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Marginal costing is most suitable for decision making in a short term. Itassumes that costs are classified into fixed and variable. In the long term all the
cost are variable. Therefore it ignores time element and is not suitable for long
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term decisions.
Under Valuation of Stock
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Under marginal costing only variable costs are considered and the output aswell as stock are undervalued and profit is distorted. When there is loss of stock
the insurance cover will not meet the total cost.
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Automation
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In these days of automation and technical advancement, huge investments are
made in heavy machinery which results in heavy amount of fixed costs.
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Ignoring fixed cost in this context for decision making is irrational.Production Aspect is Ignored
Marginal costing lays too much emphasis on selling function and as such
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production aspect has been considered to be less significant. But from the
business point of view, both the functions are equally important.
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Not Applicable in all Types of BusinessIn contract type and job order type of businesses, full cost of the job or the
contract is to be charged. Therefore it is difficult to apply marginal costing in all
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these types of businesses.
Misleading Picture
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Each product is shown at variable cost alone, thus giving a misleading pictureabout its cost.
Less Scope for Long ? term Policy Decision
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Since cost, volume, and profits are interlinked in price determination, which can
be changed constantly, development of long term pricing policy is not possible.
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Marginal Costing and Absorption CostingAbsorption costing charges all the costs i.e., both the fixed and variable fixed to
the products, jobs, processes, and operations. Marginal costing technique
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charges variable cost. Absorption is not any specific method of costing. It is
common name for all the methods where the total cost is charged to the output.
Absorption Costing is defined by I.C.M.A, England as "the practice of charging
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all costs, both fixed and variable to operations, processes, or products"
From this definition it is inferred that absorption costing is full costing. The full
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cost includes prime cost, factory overheads, administration overheads, sellingand distribution overheads.
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Distinction between Absorption Costing and Marginal Costing
Absorption Costing
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Marginal Costing1. Total cost technique is the practice
1. Marginal costing charges only
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variable cost to products, process, orof charging all cost, both variable and
operations and excludes fixed cost
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fixed to operations, process or products. entirely.
2. It values stock at the cost which
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2. It values stock at total variable costincludes fixed cost also.
only. This results in higher value of
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stock under absorption costing than in3. It is guided by profit which is the
marginal costing.
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excess of sales over the total costs in
3. It focuses its attention on
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solving managerial problemsContribution which is excess of sales
4. In total cost technique, there is a
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over variable cost.
problem of apportionment of fixed
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4. It excludes fixed cost. Therefore,there is no question of arbitrary
costs which may result in under or over apportionment.
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recovery of expenses.The difference between marginal costing and absorption costing is shown with
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the help of the following examples.
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Illustration No: 1 Cost of Production
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(10000 units)Per Unit Total
(Rs. P) (Rs)
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Variable cost 1.50 15000
Fixed Cost 0.25 2500
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---------Total cost 17500
---------
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Sales 5000 units at Rs. 2.50 per unit Rs. 125000
Closing stock 5000 units at Rs. 1.75 Rs. 8750
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Solution:Under absorption costing, the profit will be calculated as follows:
Rs.
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Sales 12500
Closing stock 8750
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-----------21250
Less: Total cost 17500
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-----------
Profit 3750
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Under marginal costing method, the profit will be calculated as follows:
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Rs.
Sales 12500
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Less: MarginalCost of 5000 units (5000 X 1.50) 7500
-----------
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5000
Less: Fixed cost 2500
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-----------Profit 2500
----------
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Closing stock will be valued at Rs.7500 only at marginal cost.
Illustration No: 2
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The monthly cost figures for production in a manufacturing company are asunder:
Rs.
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Variable cost 120000Fixed cost 35000
-------------
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Total cost 155000
-------------
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Normal monthly sales is Rs. 200000/-. Actual sales figures for the three separatemonths are:
Ist Month IInd Month IIIrd Month
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Rs. 200000 Rs. 165000 Rs. 235000
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If marginal cost is not used, stocks would be valued as follows:
Ist Month IInd Month IIIrd Month
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Opening Stock Rs. 108500 Rs. 108500 Rs. 135625Closing Stock Rs. 108500 Rs. 135625 Rs. 108500
Prepare two tabulations side by side to summarize these results for each of the
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three months basing one tabulation on marginal costing theory and the other
tabulation along side on absorption cost theory.
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Solution:Marginal Costing
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Absorption Costing
Ist IInd IIIrd Ist IInd IIIrd
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Month Month Month Month MonthMonth
Opening
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Stock ( Rs)
84000 84000 105000 108500 108500 135625
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Variable
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Cost ( Rs)120000 120000 120000 120000 120000 120000
Fixed
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Cost ( Rs)
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--
-
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35000 35000 35000
Total ( Rs)
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204000 204000 225000 263500 263500 290625Less:
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Closing
84000 105000 84000 108500 135625 108500
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Stock(Rs.)
Cost of
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Sales (A)
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120000 99000 141000 155000 127875 182125--- Content provided by FirstRanker.com ---
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Sales (B)
200000 165000 235000 200000 165000 235000
Contribution
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(B ? A)
80000 66000 94000 45000 37125 52875
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Less:--- Content provided by FirstRanker.com ---
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Fixed
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Cost (Rs)
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35000 35000 35000 --
-
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Profit ( Rs)
45000 31000 59000 45000 37125
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52875Note: Stocks at marginal cost is based on variable portion of the monthly total
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cost given as follows:
120000
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Marginal cost in Rs.108500 = 108500 X ------------- = Rs. 84000155000
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120000
Marginal costs in Rs. 135625 = 135625 X ----------- = Rs. 105000
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155000Differential Costing
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The concept of differential cost is a relevant cost concept in those decision
situations which involve alternative choices. It is the difference in the total costs
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of two alternatives. This helps in decision making. It can be determined bysubtracting the cost of one alternative from the cost of another alternative.
Differential costing is the change in the total cost which results from the
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adoption of an alternative course of action. The alternative may arise on account
of sales, volume, price change in sales mix, etc decisions. Differential cost
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analysis leads to more correct decisions than more marginal costing analysis. Inthis technique the total costs are considered and not the cost per unit.
Differential costs do not form part of the accounting system while marginal
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costing can be adapted to the routine accounting itself. However, whendecisions involve huge amount of money differential cost analysis proves to be
useful.
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In the illustration given below, differential cost at levels of activity has been
shown:
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Alternative I Alternative II Differential costActivity level 80% 100%
Sales (Rs) 80000 100000 20000
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-----------------------------------------------------
Direct materials 40000 50000 10000
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Direct labour 16000 20000 4000Variable overheads 4000 5000 1000
Fixed overheads 3000 3000 -
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------------------------------------------------------
Cost of sales 63000 78000 15000
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------------------------------------------------------Differential cost is generally confused with marginal cost. Of course, these two
techniques are similar in some aspects but these also differ in certain other
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respects.
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Similarities
(i) Both the differential cost analysis and marginal cost analysis are based on
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the classification of cost into fixed and variable. When fixed costs do not
change, both differential and marginal costs are same.
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(ii) Both are the techniques of cost analysis and presentation and are used by themanagement in formulating policies and decision making.
Dissimilarities
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(i) Marginal cost may be incorporated in the accounting system where as
differential cost are worked out for reporting to the management for taking
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certain decisions.(ii) Entire fixed cost are excluded from costing where as some of the relevant
fixed costs may be included in the differential cost analysis.
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(iii)In marginal costing, contribution and p/v ratio are the main yardstick for
evaluating performance and decision making. In differential cost analysis
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emphasis is made between differential cost and incremental or decrementalrevenue for making policy decisions.
(iv) Differential cost analysis may be used in absorption costing and marginal
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costing.
Marginal Cost
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Marginal cost is the cost of producing one additional unit of output. It is theamount by which total cost increases when one extra unit is produced or the
amount of cost which can be avoided by producing one unit less.
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The ICMA, England defines marginal cost as, "the amount of any given volume
of output by which the aggregate cost are charged if the volume of output is
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increased or decreased by one unit".In practice, this is measured by the total cost attributable to one unit. In this
context, a unit may be single article, a batch of articles, an order, a stage of
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production, a process etc., often managerial costs, variable costs are used tomean the same.
Features of Marginal Cost
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It is usually expressed in terms of one unit.
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It is charged to operation, processes, or products.
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It is the total of prime cost plus variable overheads of one unit.
Marginal Cost Statement
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In marginal costing, a statement of marginal cost and contribution is prepared toascertain contribution and profit. In this statement, contribution is separately
calculated for each of the product or department. These contributions are totaled
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up to arrive at the total contribution. Fixed cost is deducted from the total
contribution to arrive at the profit figure. No attempt is made to apportion fixed
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cost to various products or departments.Marginal Cost Equation
For convenience the element of cost statement can be written in the form of an
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equation as given below:
Sales ? Variable Cost = Fixed Cost plus or minus Profit or Loss.
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OrSales ? Variable Cost = Fixed Cost plus or minus Profit or Loss
In order to make profit, contribution must be more than fixed cost and to avoid
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loss, contribution should be equal to fixed cost.
The above equation can be illustrated in the form of a statement.
Marginal Cost Statement
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Rs.
Sales xxxxx
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Less: Variable Cost (xxxx)------------
Contribution xxxxx
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Less: Fixed Cost (xxxx)
-------------
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Profit / Loss xxxx------------
Illustration No.3:
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A company is manufacturing three products X, Y and Z. It supplies you the
following information:
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Products--------------------------------------------
X Y Z
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(Rs) (Rs) (Rs)
Direct Materials 2500 10000 1000
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Direct Labour 3000 3000 500Variable Overheads 2000 5000 2500
Sales 10000 20000 5000
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Total fixed overheads Rs. 3000/-
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Prepare a marginal cost statement and determine profit and loss.Solution:
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Marginal Cost Statement
Products
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----------------------------------------------------------X Y Z Total
(Rs) (Rs) (Rs) (Rs)
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Sales (A) 10000 20000 5000 35000
------------------------------------------------------------
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Direct materials 2500 10000 1000 13500Direct Labour 3000 3000 500 6500
Variable Overheads 2000 5000 2500 9500
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------------------------------------------------------------
Marginal Cost (B) 7500 18000 4000 29500
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------------------------------------------------------------Marginal Contribution
(A ? B) 2500 2000 1000 5500
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Less:FixedCost 3000
--------
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NetProfit 2500--------
Contribution:
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Contribution is the difference between selling price and variable cost of one
unit. The greater contribution from the selling unit indicates that the variable
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cost is less compared to selling price. Total contribution is the number of unitsmultiplied by contribution per unit. Contribution will be equal to the total fixed
costs at break even point where profit is zero.
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Illustration No.4:Calculate contribution and profit from the following details:
Sales Rs. 12000
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Variable Cost Rs. 7000
Fixed Cost Rs. 4000
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Solution:Contribution = Sales ? Variable cost
Contribution = Rs. 12000 ? Rs. 7000 = Rs. 5000
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Profit = Contribution ? Fixed Cost
Profit = Rs. 5000 ? Rs. 4000 = Rs. 1000
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Profit / Volume RatioThis is the ratio of contribution to sales. It is an important ratio analysing the
relationship between sales and contribution. A high p/v ratio indicates high
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profitability and low p/v ratio indicates low profitability. This ratio helps in
comparison of profitability of various products. Since high p/v ratio indicates
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high profits, the objective of every organisation should be to improve orincrease the p/v ratio.
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P / V Ratio = Contribution / Sales x 100 or C / S x 100
(Or)
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Fixed Cost + Profit-----------------------
Sales
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(Or)
Sales ? Variable Cost
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-------------------------Sales
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When profits and sales for two consecutive periods are given, the following
formula can be applied: Change in Profit
--------------------
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Change in Sales
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P / V ratio is also used in making the following type of calculations:a) Calculation of Break even point.
b) Calculation of profit at a given level of sales.
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c) Calculation of the volume of sales required to earn a given profit.
d) Calculation of profit when margin of safety (discussed below) is given.
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e) Calculation of the volume of sales required to maintain the present level ofprofit if selling price is reduced.
Margin of safety:
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The excess of actual or budgeted sales over the break-even sales is known as the
margin of safety.
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Margin of safety = actual sales - break-even salesSo this shows the sales volume which gives profit. Larger the margin of safety
greater is the profit.
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Budget sales - break-even salesMargin of safety ratio = ----------------------------
Budget sales
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(Or)
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Profit
----------
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P/V Ratio
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When margin of safety is not satisfactory, the following steps may be taken intoaccount:
a)
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Increase the volume of sales.
b)
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Increase the selling price.c)
Reduce fixed cost.
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d)
Reduce variable cost.
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e)Improve sales mix by increasing the sale of products with
P/V ratio.
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The effect of a price reduction will always reduce the P / V ratio, raise the break
? even point shorten the margin of safety.
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Angle of incidence:This is obtained from the graphical representation of sales and cost. When sales
and output in units are plotted against cost and revenue the angle formed
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between the total sales line and the total cost line at the break-even point is
called the angle of incidence.
Large angle indicates a high rate of profit while a narrow angle would show a
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relatively low rate of profit.
Profit goal:
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To earn a desired amount of profit i.e., a profit goal can be reached by theformula given below
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Fixed cost + Desired profitability
Sales volume to reach profit goal = --------------------------------
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Contribution ratioIf the profit goal is stated in terms of profit after taxes
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Fixed cost + {(desired after-tax
profit)/1-tax rate}
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Sales volume to reach profit goal = --------------------------------
Contribution ratio
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Operating leverage: An important concept in context of the CVP analysis is
the operating leverage. This refers to the use of the fixed costs in the operation
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of a firm, and it accentuates fluctuations in the firm's operating profit due to
change in sales. Thus the degree of operating leverage may be defined as the
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percentage change in operating profit (earning before interest and tax) onaccount of a change in sales.
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% Change in operating profit
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Degree of Leverage DOL= --------------------------------------
% Change in sales
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(Or)Change in EBIT
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-------------
EBIT
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Degree of Leverage DOL= --------------------------------------Change in sales
------------
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Sales
Test Yourself:
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1. What is marginal costing? What are its main features?2. Define marginal cost?
3. What is absorption costing?
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4. State the differences between absorption costing and marginal costing.
5. State the limitations of marginal costing.
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6. What is contribution? What are the uses of contribution to management?7. What is margin of safety? How is it calculated?
8. What is angle of incidence? What does it indicate?
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9. What are the advantages and disadvantages of marginal costing?
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Problems
1. The selling price of a particular product is Rs.100 and the marginal cost is
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Rs.65. During the month of April, 800 units produced of which 500 were sold.There was no opening at the commencement of the month. Fixed costs
amounted to Rs. 18000. Provide a statement using a) Marginal costing and b)
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Absorption costing, showing the closing stock valuation and the profit earned
under each principle.
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2. From the following information, calculate the amount of contribution andprofit.
Rs.
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Sales 1000000
Variable cost 600000
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Fixed cost 1500003. Determine the amount of fixed cost from the following.
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Rs.
Sales 300000
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Variable cost 200000Profit 50000
4. Determine the amount of variable cost from the following.
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Rs.
Sales 500000
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Fixed cost 100000Profit 100000
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References
1. Dr .S. Ganeson and Tmt. S. R. Kalavathi, Management Accounting,
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Thirumalai Publications, Nagercoil.
2. T.S. Reddy and Y. Hari Prasad Reddy Management Accounting, Margam
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Publications, Chennai.3. Anthony, Robert: Management Accounting, Tarapore-wala, Mumbai.
Lesson II
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Marginal Costing and CVP Analysis
Structure of the Lesson:
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The lesson is structured as follows:Introduction
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Break Even Chart
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Profit Volume Graph
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Cost-volume-profit relationship with the help of an example
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Basic Assumptions of Cost ? Volume Profit AnalysisUses and limitations of Break even analysis
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Objectives of the Lesson:
On completion of this lesson, you should be able;
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Explain CVP Analysis
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Know the construction of BEP chart
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Define BEPExplain CVP Analysis with example
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List out the uses and limitations of BEP
Introduction
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Break-even analysis is the form of CVP analysis. It indicates the level of sales at
which revenues equal costs. This equilibrium point is called the break even
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point. It is the level of activity where total revenue equals total cost. It isalternatively called as CVP analysis also. But it is said that the study up to the
state of equilibrium is called as break even analysis and beyond that point we
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term it as CVP analysis.
Cost ? Volume Profit analysis helps the management in profit planning. Profits
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are affected by several internal and external factors which influence salesrevenues and costs.
The objectives of cost-volume profit analysis are:
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i)
To forecast profits accurately.
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ii) To help to set up flexible budgets.iii) To help in performance evaluation for purposes of control.
iv) To formulate proper pricing policy.
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v)
To know the overheads to be charged to production at various levels.
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Volume or activity can be expressed in any one of the following ways:1.
Sales capacity expressed as a percentage of maximum sales.
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2.
Sales value in terms of money.
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3.Units sold.
4.
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Production capacity expressed in percentages.
5.
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Value of cost of production.
6.
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Direct labour hours.7.
Direct labour value.
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8.
Machine hours.
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The factors which are usually involved in this analysis are:a)
Selling price
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b)
Sales volume
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c)Sales mix
d)
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Variable cost per unit
e)
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Total fixed costBreak Even Chart
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These depict the interplay of three elements viz., cost, volume, and profits. The
charts are graphs which at a glance provide information of fixed costs, variable
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costs, production / sales achieved profits etc., and also the trends in each one ofthem. The conventional graph is as follows:
This is a simple break even chart. The procedure for drawing the chart is as
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follows:
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1) Depict the X - axis as the volume of sales or capacity or production.
2) Depict the Y ? axis as the costs or revenue.
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3) Having known the ,,0 level of activity the same fixed cost is incurred, the
fixed cost line is depicted as being parallel to the X ? axis.
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4) At ,,0 level of activity, the total cost is equal to fixed cost. Therefore thetotal cost line starts from the point where the fixed cost line meets the Y ?
axis.
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5) Next plot the sales line starting from ,,0 .
6) The meeting point of the sales and the total cost line is the Break Even
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Point.It is also called Break Even Point because at that point there is no profit and loss
either.
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The costs are just recovery by sales. If a perpendicular line is drawn to the X-
axis from the BEP, the meeting point of the perpendicular and X- axis will show
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the break even volume in units. If a perpendicular line is drawn to meet the Y-axis from the BEP, the meeting point shows the break even volume in money
terms.
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Other details shown in the break even charts are:
Angle of Incidence
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This is the angle of intersection between the sales line and the total cost line.The larger the angle the greater is the profit or loss, as the case may be.
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Margin of Safety
This is the difference between the actual sales level and the break even sales. It
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represents the "cushion" for the company. The larger the distance between the
break even sales volume and the actual sales volume, the company can afford to
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allow the fall in sales without the danger of incurring losses. If the margin ofsafety is low i.e., if the distance between the actual sales line and the break even
sales line is too short, even a small fall in the sales volume will drive the
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company into the loss area.
The position of break even point should be ideally closer to the y ? axis. This
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will mean that even a small increase in sales will immediately make thecompany break even. I t should be noted that beyond the break even point all
contribution (Sales ? Marginal Cost) will directly increase the profits.
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Profit Volume Graph
Profit volume graph is a pictorial representation of the profit volume
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relationship. It shows profit and loss account at different volumes of sales. It issimplified form of break even chart as it clearly represents the relationship of
profit to volume of sales. It is possible to construct a profit volume graph for
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any data relating to a business firm where a break even chart can be drawn. A
profit volume graph may be preferred to a break even chart as profit or losses
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can be directly read at different levels of activity.The construction of profit volume graph involves the following steps:
1. Scale of sale is selected on horizontal axis and that for profit or loss are
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selected on vertical axis. The area below the horizontal axis is the loss area and
that above it is the profit area.
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2. Points of profits of corresponding sales are plotted and joined. The resultantline is profit / loss line
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Illustration No. 1Draw up a profit ? volume of the following:
Sales Rs. 4 Lakhs
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Variable cost Rs. 2 Lakhs
Fixed cost Rs. 1 Lakhs
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Profit Rs. 1 LakhsSolution
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The calculation of BEP is based on some assumptions. They are as follows:1.The costs are classified as fixed and variable costs.
2.The variable costs vary with volume and the fixed costs remain constant.
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3.The selling price remains constant in spite of the change in volume.
4.The productivity per employee also remains unchanged.
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Break-even point can be calculated in terms of units or in terms of rupees.--- Content provided by FirstRanker.com ---
Fixed CostsBreak-Even Point (in Rupees) = -------------
P/V Ratio
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(OR)
Fixed Costs
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Break-Even Point (in Rupees) = ------------- ----------Marginal cost per unit/1- Selling price per unit
Fixed Costs
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Break-Even Point (in units) = ------------------------
Contribution per unit
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Where contribution is sales - variable cost and P/V Ratio is Contributiondivided by sales.
Cost-volume-profit relationship with the help of an example
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The relationship between cost volume and profit are well defined in CVP
analysis. With the given example we can elaborately see the relationship
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AB Company is a single product manufacturer whose selling price is Rs. 20 perunit and the variable cost is Rs. 12 per unit. The annual fixed cost is Rs. 160000.
The number of units produced and sold is 20000. Now if we analyse the CVP
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relationship
The contribution per unit is = Selling price -variable cost
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= 20 - 12 = Rs.8/-The total contribution for 20000 units is = 8 x 20000 = 160000
Since the profit = total contribution - fixed cost, we get nil profit. 160000-
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160000=0
This is the break even point where the total cost is equal to the total revenue and
the company has no profit and no loss.
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Let us see a few alternatives
If the fixed cost is Rs. 120000, then the company may earn a profit of Rs.
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(160000-120000) = 40000. If the fixed cost is Rs.200000, then it may end in aloss of Rs (200000-160000) = 40000
If the variable cost per unit is increased, say to Rs. 15 in the existing condition,
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then the contribution will come to Rs (20000 x (20-15) = 100000 and that will
result in a loss of Rs. 160000-100000 =40000. If the variable cost per unit is
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decreased say to Rs.10 then the contribution will come to Rs.20000x (20-10) =200000. Then the profit will be 200000-160000=40000
The above proves that the variation in the costs varies the profitability of the
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firm.
If the cost decreases, profit increases and vice versa.
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Now we can see how the change in volume alters the profitability. If the salesvolume is 10000 instead of 20000 as above and the all the other conditions
being the same, the result will be (10000x8) - 160000 = 80000 loss. Likewise
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if the volume is increased to 30000 it will result in a profit of Rs 30000x8 -
160000 = 80000. This shows that the profit increases with the increase in
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volume when other conditions are unchanged.Basic Assumptions of Cost ? Volume Profit Analysis
Cost volume profit (C-V-P) analysis, popularly referred to as breakeven
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analysis, helps in answering questions like: How do costs behave in relation to
volume? At what sales volume would the firm breakeven? How sensitive is
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profit to variations in output? What would be the effect of a projected salesvolume on profit? How much should the firm produce and sell in order to reach
a target profit level?
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A simple tool for profit planning and analysis, cost-volume-profit analysis isbased on several assumptions. Effective use of this analysis calls for an
understanding of the significance of these assumptions which are discussed
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below:
The behaviour of costs is predictable. The conventional cost-volume-profit
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model is based on the assumption that the cost of the firm is divisible into twocomponents; fixed costs vary variable costs. Fixed costs remain unchanged for
all ranges of output; variable costs vary proportionately to volume. Hence the
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behaviour of costs is predictable. For practical purposes, however, it is not
necessary for these assumptions to be valid over the entire range of volume. If
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they are valid over the range of output within which the firm is most likely tooperate ? referred to as the relevant range ? cost volume profit analysis is a
useful tool.
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The unit selling price is constant. This implies that the total revenue of the firm
is a linear function of output. For firms which have a strong market for their
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products, this assumption is quite valid. For other firms, however, it may not beso. Price reduction might be necessary to achieve a higher level of sales. On the
whole, however, this is a reasonable assumption and not unrealistic enough to
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impair the validity of the cost-volume- profit model, particularly in the relevant
range of output.
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The firm manufactures a stable product ? mix. In the case of a multi-productfirm, the cost volume profit model assumes that the product ? mix of the firm
remains stable. Without this premise it is not possible to define the average
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variable profit ratio when different products have different variable profit ratios.
While it is necessary to make this assumption, it must be borne in mind that the
actual mix of products may differ from the planned one. Where this discrepancy
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is likely to be significant, cost-volume-profit model has limited applicability.
Inventory changes are nil. A final assumption underlying the conventional cost-
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volume-profit model is that the volume of sales is equal to the volume ofproduction during an accounting period. Put differently, inventory changes are
assumed to be nil. This is required because in cost-volume-profit analysis we
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match total costs and total revenues for a particular period.
Uses and limitations of Break even analysis
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Uses of BE analysis are as follows:1.It is a simple device and easy to understand.
2.It is of utmost use in profit planning.
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3.It provides the basic information for further profit improvement studies.
4.It is useful in decision making and it helps in considering the risk implications
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of alternative actions.5.It helps in finding out the effect of changes in the price, volume, or cost.
6.It helps in make or buy decisions also and helpful in the critical circumstances
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to find out the minimum profitability the firm can maintain.
The limitations of BE analysis is:
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1.The basis assumptions are at times base less. For example, we can say that thefixed costs cannot remain unchanged all the time. And the constant selling price
and unit variable cost concept are also not acceptable.
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2.It is difficult to segregate the cost components as fixed and variable costs.
3.It is difficult to apply for multinational companies.
4.It is a short-run concept and has a limited use in long range planning.
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5.It is a static tool since it gives the relationship between cost, volume and profit
at a given point of time and
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6.It fails to predict future revenues and costs.Despite the limitation it is remains an important tool in profit planning due to
the simplicity in calculation.
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Illustration No. 2
From the following data calculate:
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(a) P/V Ratio (b) Variable Cost and (c) ProfitRs.
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Sales 80000
Fixed expenses 15000
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Break even point 50000Solution:
Calculation of P/V Ratio
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Break even point =Fixed Cost / P/V Ratio
50000 = 15000 / P/V Ratio = 15,000 / 50,000 = 3/10 or 30%
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Calculation of variable costContribution = Sales x P/V
= 80,000 x 30 / 100 = Rs.24000
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Variable cost = Sales ? Contribution
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Rs.80000 ? Rs.24000 = Rs.56000Calculation of Profit
Profit = Contribution ? Fixed cost
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= Rs.24000 ? Rs.15000 = Rs.9000Illustration No. 3
From the following data, calculate the break-even point of sales in rupees:
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Selling price Rs.20
Variable cost per unit:
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Manufacturing Rs.10Selling Rs.5
Overhead (fixed):
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Factory overheads Rs.500000
Selling overheads Rs.200000
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Solution:Selling price per unit: Rs. 20
Variable Cost per unit:
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Manufacturing: Rs. 10
Selling: Rs.5
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Rs.15--------
Contribution per unit Rs. 5
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Contribution ratio = Rs.5 / Rs.20 =25%
Fixed overheads Factory- Rs.500000
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Selling- Rs.200000--------------
Rs.700000
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Break even sales in rupees = Fixed overheads /Contribution ratio= Rs.700000/25%
= Rs.2800000
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Break even sales in units = FC/Contribution per unit
= Rs. 700000/Rs.5
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= 140000 unitsIllustration No. 4
The following data have been obtained from the records of a company
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I Year II Year
Rs. Rs.
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Sales 80000 90000Profit 10000 14000
Calculate the break-even point.
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Solution:
Changes in profit
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P/V Ratio = ------------------------------- x 100Changes in sales
= 14000 ? 10000
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--------------------- X 100 = 40%
90000- 80000
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Contribution = Sales x P/V Ratio = 90000 x 40% = Rs.36000
To find the break-even point, we should first find out the fixed cost because
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B.E.P = Fixed cost / P/V RatioFixed cost = Contribution ? Profit
= 36000- 14000 = 22000
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{This can be cross checked by using the first years figures (80000 x 40%) ?
10000}
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Therefore B.E.P. = Fixed cost / P/V Ratio= 22000/40% = Rs. 55000
Illustration No. 5
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A.G. Ltd., furnished you the following related to the year 1996.
First half of the year (Rs.) Second half of the year (Rs.)
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Sales 45,000 50,000Total Cost 40,000 43,000
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Assuming that there is no change in prices and variable cost and that the fixed
expenses are incurred equally in the 2 half year periods, calculate for the year
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1996:(a) The profit volume ratio (b) Fixed expenses (c) Break even sales and (d) %
of margin of safety.
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Solution:
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First
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half Second half (Rs.) Change in sales and profit(Rs.)
(Rs.)
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Sales
45,000
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50,0005,000
Less Cost
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40,000
43,000
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3,000Profit
5000
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7000
2000
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a) P/V ratio=Change in profit / Change in sales x 100
=2000 / 5000 x 100 = 40%.
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Contribution during the first half=Sales x P/V Ratio
=Rs.45000 x 40% = Rs.18000
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b)Fixed cost = Contribution ? ProfitFor1sthalfyear=18,000 ? 5,000 = Rs.13,000Fixed cost for the full year =13,000 x 2 = Rs.26000
c) Break even sales=Fixed cost / P/V Ratio for the year1996=26000 / 40% =
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Rs.65000
d)Margin of safety=Sales ? Break even sales for the year1996(MOS)=95000 ?
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65000 = Rs.30000Percent of margin of safety=Margin of safety / Sales for the year x 100
=30000 / 95000 x 100
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Note: (1) Since fixed expenses are incurred equally in the 2 half years,
Rs.13000 is multiplied with 2 to get fixed cost of the full year.
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(2)Sales of both 1st and 2nd half years are added and are taken as actual sales i.e.,
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Rs.95000 to calculated margin of safety.
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Illustration No.6
From the following information relating to Palani Bros. Ltd., you are required to
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find out:P/V Ratio (b) Break even point (c) Profit (d) Margin of safety (e) Volume of
sales to earn profit of Rs.6000.
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Rs. Total Fixed Cost
4500
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Total variable cost7500
Total
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Sales
15000
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Solution:Marginal Cost and Contribution Statement
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Amount
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(Rs.)Sales 15000
Less:Variablecost 7500
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--------
Contribution 7500
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Less: Fixed cost 4500
--------
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Profit 3000
(a)P/V ratio =Contribution / Sales x 100
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= 7500 / 15000 x 100 = 50%(b)Break even sales = Fixed expenses / P/V Ratio
= 4500+ 6000 / 50% = Rs.21000
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Illustration No. 7The sales turnover and profit during two years were as follows:
Year Sales (Rs.) Profit (Rs.)
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1991 140000 15000
1992 160000 20000
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Calculate:
(a) P/V Ratio (b) Break-even point (c) Sales required to earn a profit of
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Rs.40000
(d) Fixed expenses and (e) Profit when sales are Rs.120000
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Solution:When sales and profit or sales and cost of two periods are given, the P/V ratio is
obtained by using the ,,Change formula
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Fixed cost can be found by ascertaining the contribution of one of the periods
given by multiplying sales with P/V Ratio. Then, contribution ? Profit can
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reveal the fixed cost.Ascertaining P/V ratio using the change formula and finding cost are the
essential requirements in these types of problems.
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a) P/V ratio
= Change in profit / Change in sales x 100
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Change in profit=20000 ? 15000 = Rs. 5000Change in sales
= 160000 ? 140000 = Rs.20000
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P/V Ratio = 5000 / 20000 x 100 = 25%b) Break-even point = Fixed expenses / P/V ratio Fixed expenses =
contribution ? profit
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Contribution = Sales x P/V Ratio
Using1991sales, contribution=140000 x 25 / 100 = Rs.35000
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Fixed Expenses=35,000 ? 15,000 = Rs.20000Note: The same fixed cost can be obtained using 1992 sales also.
Break-even point=20,000 / 25%= Rs.80000
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c) Sales required to earn a profit of Rs.40000.
Required sales = Required profit + Fixed cost / P/V Ratio
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=40,000 + 20,000 / 25% = Rs.240000d) Fixed expenses=Rs.20000 (as already calculated)
e) Profit when sales are Rs.120000
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Contribution=Sales x P/V Ratio
=120000 x 25/100=Rs.30000
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Profit=Contribution ? Fixed Cost=30,000 ? 20,000= Rs.10000.
Illustration No. 8
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From the following information, calculate
a. Break-even point
b. Number of units that must be sold to earn a profit of Rs.60000 per year.
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c. Number of units that must be sold to earn a net income of 10% on sales
Sales Price-Rs.20 per unit
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Variable cost-Rs.14 per unitFixed cost-Rs.79200
Solution:
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Contribution per unit = Sales price per unit ? Variable cost per unit
=20 ? 14 = 6.
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P/V Ratio = Contribution / Sales x 100 = 6 / 20 x 100 = 30%(a)Break even point in units = Fixed expenses/contribution per unit
= 79200 / 6 = 13,200 units.
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Break even point (in rupees) =Fixed expenses / P/V Ratio
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= 79200 / 30%= Rs.264000
(b) Number of units to be sold to make a profit of Rs.60,000 per year :
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Required sales = Fixed expenses + Required Profit / P/V Ratio
= 79200 + 60000 / 30%
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= Rs.464000Units = 464000 / Selling Price
= 464000 / 20 = 23200 units.
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(c) Number of units to be sold to make a net income of 10% on salesIf `x is number of units:
20x = Fixed Cost + Variable Cost + Profit
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20x = 79200 + 14x + 2x
20x ? 16x = 79200
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x=79200 / 4 = 19800 unitsProof: Sales = 19800 x 20 = 396000
less: Variable cost 19800 x 14 = 277200
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----------
Contribution = 118000
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Less: Fixed Cost = 79200----------
Profit = 39600
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----------
Profit as a % of sales = 39600 / 396000 x 100 = 10%
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Illustration No. 9You are given the following data for the year 1986 for a factory.
Output: 40000 units
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Fixed expenses: Rs.200000
Variable cost per unit: Rs.10
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Selling price per unit: Rs.20How many units must be produced and sold in the year 1987, if it is anticipated
that selling price would be reduced by 10%, variable cost would be Rs.12 per
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unit, and fixed cost will increase by 10%? The factory would like to make aprofit in 1987 equal to that of the profit in 1986.
Solution:
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Margin Cost and contribution statement for the year 1986Particulars
Rs.
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8,00,000Sales
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40,000 x 20
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Less :4,00,000
Variable Cost
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40,000 x 10--- Content provided by FirstRanker.com ---
4,00,000
Contribution
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Less :2,00,000
Fixed Cost
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2,00,000
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Profit
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Calculation of units to be produced and sold in 1987 to make the sameprofit as in 1986:
New Selling Price=20 ? (20 x 10%) = 20 ? 2 = Rs.18
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New variable cost = Rs.12 (given New fixed cost=200000 + (200000 x 10%)
=200000 + 20000 = 220000
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New P/V Ratio=Sales ? Variable Cost / Sales x 100=18 ? 12 / 18 x 100 = 33 1/3 %
Required sales=Required profit + Fixed expenses / P/V Ratio
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=200000 + 220000 / 33 1/3 %
=Rs.1260000
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Units to be sold=Required Sales / New Selling Price=1260000 / 18 = 70,000 units.
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Illustration No. 10
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The P/V Ratio of a firm dealing in precision instruments is 50% and margin of
safety is 40%. You are required to work-out break even point and the net profit
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if the sales volume is Rs.5000000. If 25% of variable cost is labour cost, whatwill be the effect on BEP and profit when labour efficiency decreases by 5%.
Solution:
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Calculation of Break-even point
Margin of safety is 40% of sales = 5000000 x 40 / 100 = Rs.2000000
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Break-even sales= Sales ? Margin of safety
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=
5000,000 ? 2000000
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=
Rs.3000000
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Calculation of fixed cost
Break-even Sales
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= Break-even sales x p/v ratio--- Content provided by FirstRanker.com ---
= 3000000 x 50 / 100 = Rs.1500000
(2)Calculation of profit
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Contribution = Sales x P/V Ratio = 5000000 x 50 / 100 = Rs.2500000Net Profit =Contribution ? Fixed Cost = 2500000 ? 1500000 = Rs.1000000
(3) Effects of decrease in labour efficiency by 5%
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Variable cost = Sales ? Contribution = 5000000 ? 2500000 = Rs.2500000
Labour cost =2500000 x 25 / 100 = Rs.625000
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New labour cost when labour efficiency decreases by 5%= 625000 x 100 / 95 = Rs.657895
= 657895 ? 625000 = Rs.32895
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Net Variable Cost =2500000 + 32,895=Rs.2532895
Contribution = 5000000 ? 2532895 = Rs.2467105
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Profit = Contribution ? Fixed cost
= 2467105 ? 1500000=Rs.967105
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New P/V=2467105 / 5000000 x 100=49.3421 %New BEP= Fixed Cost / P/V
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= 1500000 / 49.3421 = Rs.3040000
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Note: If for 100 units labour cost is Rs.100, 5% decrease in efficiency makesthe labour to produce only 95 units in the same time.
Cost of 95 units = Rs.100
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Cost of 100 units=100 x 100 / 95= 1052635
Original labour cost has to be multiplied with 100 / 95 to get new labour cost.
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Illustration No. 11
From the following find out the break even point
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P Q R
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Selling price Rs 100 80 50
Variable cost Rs. 50 40 20
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Weightage 20% 30% 50%
Fixed cost Rs 1480000
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Solution:
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P Q R--- Content provided by FirstRanker.com ---
1. Selling price Rs 100 80 50
2. Variable cost Rs. 50 40 20
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3. Weightage 20% 30% 50%4. Contribution (1-2) 50 40 30
5. P/V Ratio (4/1) 50% 50% 60%
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6. Fixed cost (14.8lacx3) 2.96 4.44 7.4
7. BEP (6/5) 5.92 lac 8.88 lac 12.33 lac
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Combined p/v ratio = 50% x20% + 50% x30% + 60%x50%
10% + 15% +
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30% = 55%
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Combined BEP will be = Fixed cost / 55%= 1480000 /55% = Rs. 2690909
Illustration No. 12
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Raviraj Ltd. Manufactures and sells four types of products under the brand
names of A, B, C and D. The sales mix in value comprises 33 1/3%, 41 2/3%,
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16 2/3% and 8 1/3% of products A, B, C and D respectively. The total budgetedsales (100%) are Rs. 60,000 per month.
Operating costs are
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Variable cost:Product A 60% of selling price
B 68% of selling price
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C 80% of selling price
D 40% of selling price
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Fixed cost: Rs. 14,700 per monthCalculate the break even point for the products on an overall basis and also the
B.E. Sales of individual products. Show the proof for your answer.
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Solution:
P/V Ratio for individual products = 100-% of variable cost to sales
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A = 40 %( 100-60)B = 32 %( 100-68)
C = 20 %( 100-80)
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D = 60 %( 100-40)
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Calculation of Composite P/V Ratio
(1)
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(2)(3)
(4)
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(Col 3 x Col 4)
Products
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Sales% to total sales P/v Ratio
Composite
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P/V Ratio
A
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2000033 1/3%
40%
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13.33%
B
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2500041 2/3%
32%
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13.33%
C
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1000016 2/3%
20%
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3.33%
D
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50008 1/3%
60%
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5.00%
60000
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(After adjusting 35%fractions)
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Total Fixed cost
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Composite BEP in Rs. = -----------------Composite P / V Ratio
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Rs. 14,700
= --------- = Rs. 42,000
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35%Proof of validity of composite B.E.P
Break even sales of:
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A Rs. 42000 x 33 1/3% = Rs. 14000 14000 x 40% = 5600
B Rs 42000 x 41 2/3% = Rs. 17500 17500 x 32% = 5600
C Rs. 42000 x 16 2/3 % = Rs. 7000 7000 x 20% = 1400
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D Rs. 42000 x 8 1/3% = Rs. 3500 3500 x 60% = 2100
Total contribution 14700
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Total fixed cost 14700Profit/Loss Nil
Test yourself
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1.What is break even point? How do you calculate it?
2. What do you understand by cost volume profit analysis? What is its
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significance?3.What is composite break even point?
4. What is a break even chart? How isit useful?
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5.Mention the assumptions underlying a break even chart?
Problems
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1. Calculate BEP in units and value for the following:Total cost Rs. 50000
Total variable cost Rs. 30000
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Sales (5000 units) Rs. 50000
2. A Ltd. has two factories X and Y producing same article whose selling price
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is Rs. 150 per unit. Other details are:X Y
Capacity in units 10000 15000
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Variable cost per unit (Rs) 100 120Fixed expenses (Rs) 300000 210000
Determine the BEP for the two factories assuming constant sales mix also
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composite BEP.
3.From the following data calculate
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a.Break even point (Units)
b.
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If sales are 10% and 15% above the break even sales volume
determine the net profit.
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Selling price per unit - Rs.10Direct material per unit - Rs. 3
Fixed overheads - Rs. 10000
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Variable overheads per unit ? Rs.2
Direct labour cost per unit - Rs. 2
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References1.Dr .S. Ganeson and Tmt. S. R. Kalavathi, Management Accounting,
Thirumalai Publications, Nagercoil.
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2.T.S. Reddy and Y. Hari Prasad Reddy Management Accounting, Margam
Publications, Chennai.
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3. N. Vinayakam and I.B. Sinha, Management Accounting ? Tools andTechniques, Himalaya Publishing House, Mumbai.
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Lesson III
Marginal Costing and Decision-making
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Structure of the Lesson:The following lesson is structured as follows:
Introduction
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Fixation of selling price.
Make or buy decision
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Selection of a suitable product mix.Alternative methods of production.
Profit planning
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Suspending activities i.e., closing down
Objectives of the Lesson:
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On completion of this lesson, you should be able;
Know the role of marginal costing in decision making
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Explain managerial decisions which are taken with the help of marginal
costing decisions in different situations.
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Introduction
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During normal circumstances, Price is based on full cost, a certain desiredmargin, or profit. But in certain special circumstances, products are to be sold at
a price below total cost based on absorption costing. In such circumstances, the
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price should be fixed on the basis of marginal cost so as to cover the marginal
cost and contribute something towards fixed cost. Sometimes it becomes
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necessary to reduce the selling price to the level of marginal cost.The most useful contribution of marginal costing is that it helps management in
vital decision making. Decision making essentially involves a choice between
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various alternatives and marginal costing assists in choosing the best alternative
by furnishing all possible facts. The information supplied by marginal costing
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technique is of special importance where information obtained from totalabsorption costing method is incomplete.
The following are some of the managerial decisions which are taken with the
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help of marginal costing decisions:
Fixation of selling price.
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Make or buy decisionSelection of a suitable product mix or sales mix.
Key factor:
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Alternative methods of production.
Profit planning
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Suspending activities i.e., closing down--- Content provided by FirstRanker.com ---
Fixation of selling priceOne of the main purposes of cost accounting is the ascertainment of cost for
fixation of selling price. Price fixation is one of the fundamental problems
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which the management has to face. Although prices are determined by market
conditions and other factors, marginal costing technique assists the management
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in the fixation of selling prices under various circumstances which is as follows.a) Pricing under normal conditions.
b) Pricing during stiff competition.
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c) Pricing during trade depression.
d) Accepting special bulk orders.
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e) Accepting additional orders to utilize idle capacity.f) Accepting orders and exporting new materials.
Decision to Make or Buy
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It is a common type of business decision for a company to determine whether to
make to buy materials or component parts. Manufacturing or making often
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requires a capital investment so that a decision to make must always be madewhenever the expected cost savings provide a higher return on the required
capital investment that can be obtained by employing these funds in an
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alternative investment bearing the same risk. In practice, difficulties are
encountered in identifying and estimating relevant costs and in calculating non-
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cost considerations.In case a firm decides to get a product manufactured from outside, besides
savings in cost, it must also take into account the following factors:
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(a) Whether the outside supplier would be in a position to maintain the quality
of the product?
(b) Whether the supplier would be regular in his supplies?
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(c) Whether the supplier is reliable? In other words is the financially and
technically sound?
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Selection of a Suitable Product Mix or Sales MixWhen a concern manufactures a number of products a problem often raises as to
which product mix or sales mix will give the maximum profit. In other words,
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what should be the best combination of varying quantities of the different
products/? Which would be selected from amongst the various alternative
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combinations available? Such a problem can be solved with the help ofmarginal contribution cost analysis: the product mix which gives the best
optimum mix. Eg, let us consider the following analysis made in respect of three
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products manufactured in a company:
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Product I (Rs)Product II (Rs)
Product III (Rs)
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Per unit sales price
25
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3018
Materials
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6
8
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2Labour
5
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4
6
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Variable Overheads4
3
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5
Marginal cost
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1515
13
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Marginal
10
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155
contribution
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Out of the three products, product II gives the highest contribution per unit.Therefore, if no other factors no others factors intervene, the production
capacity will be utilized to the maximum possible extent for the manufacture of
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that product. Product I ranks second and so, after meeting the requirement of
Product II, the capacity will be utilized for product I. What ever capacity is
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available thereafter may be utilized for Product III.Key Factor
Firms would try to produce commodities which fetch a higher contribution or
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the highest contribution. This assumption is based on the possibility of sellingout the product at the maximum. Sometimes it may happen that the firm may
not be able to push out all products manufactured. And, sometimes the firm may
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not be able to sell all the products it manufactured but production may be
limited due to shortage of materials, labour, plant, capacity, capital, demand,
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etc.A key factor is also called as a limiting factor or principal budget factor or
scarce factor. It is factor of production which is scarce and because of want of
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which the production may stop. Generally sales volume, plant capacity,
material, labour etc may be limiting factors. When there is a key factor profit is
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calculated by using the formulaWhen there is no limiting factor, the production can be on the basis of the
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highest P / V ratio. When two or more limiting factors are in operation, they will
be seriously considered to determine the profitability.
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ContributionProfitability = -------------------------
Key factor (Materials, Labour, or Capital)
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Alternative Methods of Production
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Sometimes management has to choose from among alternative methods ofproduction, i.e., mechanical or manual. In such circumstances, the technique of
marginal costing can be applied and the method which gives the highest
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contribution can be adopted.
Profit Planning
Profit planning is the planning of the future operations to attain maximum profit
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or to maintain level of profit. Whenever there is a change in sale price, variable
costs and product mix, the required volume of sales for maintaining or attaining
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a desired amount of profit may be ascertained with the help of P / V ratio.Fixed Cost + Profit
Expected Sales = -------------------------
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P / V Ratio
Suspending Activities i.e., closing down
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When a firm is operating for loss sometime, the management has to decide uponits shut down.
a) Complete shut down: The firm may be permanently closed any intention to
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revive it. Such a decision is warranted.
i) When the selling price does not even cover the variable cost: or
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ii) The demand for the output is very low and the future prospects are bleak.Complete shut down saves the management from the fixed of running the
factory or division or firm.
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b) Partial or temporary shut down: Here the intention is to close down for
sometime and reopen the firm when circumstances favour it. Some fixed cost
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will continue in the form of irreducible minimum, like Skelton staff to maintainthe factory, some managerial remuneration, salaries, irreplaceable technical
experts, etc. The saving from the partial shut down should be compared with the
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position if the firm continues. If there is substantial savings, shut down may be
preferable. Minor savings in expenditure does not warrant shut down because
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reviving a firm is a cumbersome process.Decision to Make or Buy
Illustration No. 1
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An automobile manufacturing company finds that the cost of making Part No.208 in its own workshop is Rs.6. The same part is available in the market at
Rs.5.60 with an assurance of continuous supply. The cost data to make the part
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are:
Material Rs.2.00
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Direct labour Rs.2.50Other variable cost Rs.0.50
Fixed cost allocated Rs.1.00
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----------
Rs.6.00
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----------Should be part be made or brought?
Will your answer be different if the market price is Rs.4.60? Show your
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calculations clearly.
Solution:
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To take a decision on whether to ,,make or buy the part, fixed cost beingirrelevant is to be ignored. The additional costs being variable costs are to be
considered.
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Materials Rs.2.00
Direct labour Rs.2.50
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Other variable cost Rs.0.50---------
Total variable cost Rs.5.00
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----------
The company should continue ,,to Make the part if its market price is Rs.5.60
,,Making results in saving of Rs.0.60 (5.60 ? 5.00) per unit.
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(b)The company should ,,Buy the part from the market and stop its production
facilities which become ,,Idle if the production of the part is discontinued
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cannot be used to derive some income.Note: The above conclusion is on the assumption that the production facilities
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which become ,,Idle if the production of the part is discontinued cannot be used
to derive some income.
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However, if the ,,Idle facilities can be leased out or can be used to producesome other product or part which can result in some amount of ,,contribution,
that should also be considered while taking the ,,Make or buy decision.
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Key Factor
Illustration No. 2
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Two businesses S.V.P. Ltd., and T.R.R. Ltd., sell the same type of product inthe same type of market. Their budgeted Profit and Loss Accounts for the
coming year are as follows:
S.V.P. Ltd. T.R.R. Ltd.
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Rs. Rs.
Sales 150000 150000
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Less: Variable cost 120000 100000Fixed cost 15000 35000
------------ ------------
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Budgeted Net Profit 15000 15000
------------ ------------
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You are required to:
Calculate break-even point of each business
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Calculate the sales volume at which each business will earn Rs.5000/- profit.State which business is likely to earn greater profit in conditions of:
Heavy demand for the product
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Low demand for the product
Briefly give your reasons.
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Solution:Marginal Cost and Contribution Statement
Particulars
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SVP Ltd. Rs.
TRR Ltd. Rs.
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Sales150000
150000
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Less :
120000
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100000Variable Cost
Contribution
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30000
50000
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Less :15000
35000
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Fixed Cost
Profit
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1500015000
(a) Calculation of break-even point
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P/V Ratio = Contribution / Sales x 10030000 / 150000 x 50000 / 150000 x
100
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100= 20%
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= 33 1/3 %
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Break even point = Fixed cost / PV 15000 / 20 x 100
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35000 / 33 1/3 x
Ratio
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100= Rs.75,000
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= Rs.1,05,000
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(b) Sales required to earn profit of
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Rs.5,000--- Content provided by FirstRanker.com ---
Required Sales = Required Profit + Fixed cost / P/V Ratio5000 + 15000 / 20
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5000 + 35000 / 33
1/3 x 100
x 100
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= Rs.1,00,000
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= Rs.1,20,000(c) (1)In condition of heavy demand, a concern with higher P/V Ratio can earn
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greater profits because of higher contribution. Thus TRR Ltd., is likely to earn
greater profit.
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(2) In conditions of low demand, a concern with lower break even point is likelyto earn more profits because it will start making profits at lower level of sales.
Therefore in case of low demand SVP Ltd., will make profits when its sales
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reach Rs.75000, whereas TRR Ltd., will start making profits only when its sales
reach the level of Rs.105000.
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Illustration No. 3The following particulars are extracted from the records of a company.
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Product A
Product B
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Sales (per unit)Rs.100
Rs.120
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Consumption of material
2 Kg.
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3 Kg.Material cost
Rs.10
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Rs.15
Direct wages cost
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1510
Direct expenses
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5
6
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Machine hours used3
2
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Overhead expenses :
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Fixed
5
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10
Variable
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1520
Variable
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Direct wages per hour is Rs.5. Comment on the profitability of each product(both use the same raw materials) when:
(i) Total sales potential in units is limited.
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(ii) Production capacity (in terms of machine hours) is the limiting factor.
(iii)Material is in short supply.
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Sales potential in value is limited.Solution:
Statement showing key-factor contribution
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Particulars
Product A Per unit ? Rs.
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Product B per unit ?Rs.
Selling Price
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100120
Less : Variable cost
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10
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15
Materials
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15
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10
Direct Wages
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5
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6Direct Expenses
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15
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20Variable overhead
45
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51
Contribution per unit
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55
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69Contribution per machine hour 55 / 3
69 / 2
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18.33
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34.5
Combination per kg. of 55 / 2
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69
/
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327.5
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material
23
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P/V Ratio55/100 x 100 = 55%
69/120 x 100 =
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57.5%--- Content provided by FirstRanker.com ---
Comments on the profitability of products `A' and `B' on the basis of
different key-factors
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When total sales potential in units is limited, product ,,B will be more profitable
compared to ,,A as its ,,Contribution per unit is more by Rs.14 (69 ? 55).
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When production capacity in terms of machine hours is the limiting factor,product ,,B is more profitable as its ,,contribution per hour is more by Rs.16.17
(34.5 ? 18.33)
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When raw material is in short supply product ,,A is more profitable as its
,,contribution per kg is higher by Rs.4.5 (27.5 ? 23)
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When sales potential in value is the limiting factor product ,,B is better as itsP/V Ratio is higher than that of product ,,A.
Note: Contribution per unit can be divided with any given ,,Key Factor or
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,,Limiting factor to obtain ,,Key-factor contribution (K.F.C.). The Product
which gives higher contribution in terms of key-factor is decided to be better
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and more profitableIllustration No. 4
S & Co. Ltd., has three divisions, each of which makes a different product.
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The budgeted data for the next year is as follows:
Divisions
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A (Rs.)B (Rs.)
C (Rs.)
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Sales
1,12,000
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56,00084,000
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Costs :
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Direct Material14,000
7,000
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14,000
Direct Labour
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5,6007,000
22,400
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Variable overhead14,000
7,000
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28,000
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Fixed Costs
28,000
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14,00028,000
Total Costs
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61,600
35,000
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92,400The management is considering closing down Division C. There is no
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possibility of reducing variables costs. Advise whether or not division C
should be closed down.
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Solution:
Divisions
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A (Rs.)
B (Rs.)
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C (Rs.)Sales
112000
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56000
84000
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Less : Variable Costs :
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Direct Material
14000
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700014000
Direct Labour
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5600
7000
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22400Variable overhead
14000
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7000
28000
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33600
21000
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64000
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7840035000
20000
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Less : Fixed Costs
28000
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1400028000
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Loss
50400
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21000
8000
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Since Division C is giving a positive contribution of Rs.20000/- it should not be
discharged.
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Test Yourself:Discuss the role of marginal costing in taking managerial decisions.
What is key factor? What is it importance?
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Explain the different factors to be considered while taking a make or buy
decision.
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When is selling below cost is permissible or necessary?How do you decide upon the optimal sales mix?
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Problems
Present the following information to management:
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The managerial product cost and the contribution per unit and ii. The totalcontribution and profits resulting from each of the sales mixes:
Product per unit
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Rs.
Direct materials A 10
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Direct materials B 9Direct wages A 3
Direct wages B 2
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Fixed expenses - Rs. 800
(Variable expenses are allotted to products 100% of direct wages)
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Sales Price - A Rs. 20Sales Price - B Rs. 15
Sales mix:
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100 units of product A and 200 of B
150 units of product B and 150 of B
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200 unit of product A and 100 of BRecommend which of the sales mixes should be adopted.
Pondicherry Trading Corporation is running its plant at 50% capacity. The
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management has supplied you the following details:Cost of Production
Per Unit (Rs)
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Direct materials
4
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Direct labour2
Variable overheads 6
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Fixed overheads (Fully absorbed)
4
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------16
Production per month 40000 units
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Total cost of production
40000 X Rs. 16
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640000Sales price 40000 X Rs. 14
560000
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---------------
Rs. 80000
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----------------An exporter offers to purchase 10000 units per month at Rs. 13 per unit and the
company is hesitating in accepting the offer due to the fear that it will increase
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its already large operating losses.
Advise whether the company should accept or decline this offer.
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References1. Dr .S. Ganeson and Tmt. S. R. Kalavathi, Management Accounting,
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Thirumalai Publications, Nagercoil.
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2. T.S. Reddy and Y. Hari Prasad Reddy Management Accounting, MargamPublications, Chennai.
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3. Barfield, Jessie, Celly A. Raiborn and Michael R. Kenney: Cost Accouting;Traditions and Innovations, South - Western College Publishing, Cincinnati,
Ohio.
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UNIT ? IV
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SECTION ? AANALYSING FINANCIAL STATEMENTS
Objectives: In this section, we will introduce you to the meaning and types of
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financial statements; analysis and interpretation of financial statements; types of
financial statements; steps involves in financial statements analysis; techniques
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of financial analysis; limitations of financial analysis; ratio analysis and cashflow analysis. This section is theory cum practical problems of financial
statements analysis. After you workout this section, you should be able to:
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develop the ability to analyze the financial statements of any
organization.
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obtain a better understanding of firms position and performance.MEANING AND TYPES OF FINANCIAL STATEMENTS
A financial statement is an organized collection of data according to logical and
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consistent accounting procedures. 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 in the
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case of a balance sheet, or may reveal a series of activities over a given period of time, asin the case of an Income Statement.
Thus, the term 'financial statements' generally refers to two basic statements: (i)
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the Income Statement and (ii) the Balance Sheet. A business may also prepare
(iii) a Statement of Retained Earnings, and (iv) a Statement of Changes in
Financial Position in addition to the above two statements.
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The meaning and significance of each of these statements is being explained
below:
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1.Income Statement
The Income statement (also termed as Profit and Loss Account) is generally
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considered to be the most useful of all financial statements. It explains what has
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Financial Statements--- Content provided by FirstRanker.com ---
Income
Balance
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Statement ofStatement of Changes
Statement
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Sheet
Retained
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in Financial PositionEarning
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EEEEEEarni
ngs
happened to a business as a result of operations between two balance sheet
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dates. For this purpose it matches the revenues and costs incurred in the process
of earning revenues and shows the net profit earned or less suffered during a
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particular period.The nature of the 'Income' which is the focus of the Income Statement can be
well understood if a business is taken as an organization that uses 'inputs' to
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'produce' output. The outputs are the goods and services that the business
provides to its customers. The values of these outputs are the amounts paid by
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the customers for them. These amounts are called 'revenues' in accounting. Theinputs are the economic resources used by the business in providing these goods
and services. These are termed as 'expenses' in accounting.
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2. Balance Sheet
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It is a statement of financial position of a business at a specified moment of
time. It represents all assets owned by the business at a particular moment of
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time and the claims of the owners at outsiders against those assets at that time. Itis in a way a snapshot of the financial condition of the business at that time.
The important distinction between an income statement and a Balance Sheet is
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that the Income Statement is for a period while Balance Sheet is on a particular
date. Income Statement is, therefore, a flow report, as contrasted with the
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Balance Sheet which is a static report. However both are complementary to eachother.
3. Statement of Retained Earnings
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The term retained earnings means the accumulated excess of earnings over
losses and dividends. The balance shown by the Income Statement is transferred
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to the Balance Sheet through this statement, after making necessaryappropriations. It is thus a connecting link between the Balance Sheet and the
Income Statement. It is fundamentally a display of things that have caused the
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beginning of the period retained earnings balance to be changed into the one
shown in the end- of the period balance sheet. The statement is also termed as
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Profit and Loss Appropriation Account in case of companies.4. Statement of Changes in Financial Position (SCFP)
The Balance Sheet shows the financial condition of the business at a particular
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moment of time while the Income Statement discloses the results of operations
of business over a period of time. However, for a better understanding of the
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affairs of the business, it is essential to identify the movement of working capitalor cash in and out of the business. This information is available in the statement
of changes in financial position of the business. The statement may emphasize
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any of the following aspects relating to change in financial position of thebusiness:
i.
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Change in working capital position. In such a case the statement is
termed as SCFP (Working Capital basis) or popularly Funds Flow
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Statement.ii.
Change in cash position. In such a case the statement is termed as
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SCFP (Cash basis) or popularly Cash Flow Statement.
iii.
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Change in overall financial position. In such a case the statement istermed simply as Statement of Changes in Financial Position (SCFP).
ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS
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Financial Statements are indicators of the two significant factors:
i.
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Profitability, andii.
Financial soundness
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Analysis and interpretation of financial statements, therefore, refers to such a
treatment of the information contained in the Income Statement and the Balance
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Sheet so as to afford full diagnosis of the profitability and financial soundness ofthe business.
.
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A distinction here can be made between the two terms - 'Analysis' and
,,interpretation. The term' Analysis' means methodical classification of the data
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given in the financial statements. The figures given in the financial statementswill not help one unless they are put in a simplified form. For example, all items
relating to 'Current It Assets' are put at one place while all items relating to
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'Current Liabilities' are put at another place. The term 'Interpretation' means
explaining the meaning and significance of the data so simplified. However,
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both' Analysis' and 'Interpretation' are complementary to each other.Interpretation requires Analysis, while Analysis is useless without Interpretation.
Most of the authors have used the term' Analysis' only to cover the meanings of
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both analysis and interpretation, since analysis involves interpretation.According to Myres, "Financial statement analysis is largely a study of the
relationship among the various financial factors in a business as disclosed by a
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single set of statements and a study of the trend of these factors as shown in a
series of statements." For the sake of convenience, we have also used the term
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'Financial Statement Analysis' throughout the chapter to cover both analysis andinterpretation. '
TYPES OF FINANCIAL ANALYSIS
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Financial Analysis can be classified into different categories depending upon (i)
the material used, and (ii) the modus operandi of analysis.
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1.On the Basis of Material Used
According to this basis, financial analysis can be of two types:
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(i) External Analysis. This analysis is done by those who are outsiders for the
business. The term outsiders include investors, credit agencies, government
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agencies and other creditors who have no access to the internal records of thecompany. These persons mainly depend upon the published financial statements.
Their analysis serves only a limited purpose. The position of, these analysts has
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improved in recent times on account of increased governmental control over
companies and governmental regulations requiring more detailed disclosure of
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information by the companies in their financial statements.(ii) Internal Analysis. This analysis is done by persons who have access to the
books of account and other information related to the business. Such an analysis
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can, therefore, be done by executives and employees of the organization or by
officers appointed for this purpose by the Government or the Court under
powers vested in them. The analysis is done depending upon the objective to be
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achieved through this analysis.
2.
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On the basis of modus operandiAccording to this, financial analysis can also be of two types:
(i) Horizontal Analysis. In case of this type of analysis, financial statements for
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a number of years are reviewed and analyzed. The current year's figures are
compared with the standard or base year. The analysis statement usually
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contains figures for two or more years and the changes are shown regardingeach item from the base year usually in the fom1 of percentage. Such an analysis
gives the management considerable insight into levels and areas of strength and
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weakness. Since this type of analysis is based on the data from year to year
rather than on one date, it is also tern as 'Dynamic Analysis'.
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(iii) Vertical Analysis. In case of this type of analysis a study is made of thequantitative relationship of the various items in the financial Statements on a
particular date. For example, the ratios of different items of costs for a particular
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period may be calculated with the sales for that period. Such an analysis is
useful in comparing the performance of several companies in the same group', or
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divisions or department in the same company. Since this analysis depends on thedata for one period, this is not very conducive to a proper analysis of the
company's financial position. It is also called 'Static Analysis' as it is frequently
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used for referring to ratios developed on one date or for one accounting period.
It is to be noted that both analyses-vertical and horizontal-can be done
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simultaneously also. For example, the Income Statement of a company forseveral years may be given. Horizontally it may show the change in different
elements of cost and sales over a number of years. On the other hand, vertically
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it may show the percentage of each element of cost to sales.
STEPS INVOLVED IN FINANCIAL STATEMENTS ANALYSIS
The analysis of the financial statements requires:
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(i)
Methodical classification of the data given in the financial statements.
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(ii)Comparison of the various inter-connected figures with each other by
different 'Tools of Financial Analysis'.
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.
Each of the above steps has been explained in the following pages.
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Methodical ClassificationIn order to have a meaningful analysis it is necessary that figures should be
arranged properly. Usually instead the two-column (T form) statements, as
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ordinarily prepared the statements are prepared in single (vertical) column form
"which should throw up significant figures by adding or subtracting". This also
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facilitates showing the figure of a number of firms or number of years side byside for comparison purposes.
TECHNIQUES OF FINANCIAL ANALYSIS
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A financial analyst can adopt one or more of the following techniques/tools of
financial analysis:
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1.Comparative Financial Statements
Comparative financial statements are those statements which have been
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designed in a way so as to provide time perspective to the consideration of
various elements of financial position embodied in such statements. In these
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statements figures for two or more periods are placed side by side to facilitatecomparison.
Both the Income Statement and Balance Sheet can be prepared in the form of
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Comparative Financial Statements.
(i) Comparative Income Statement. The Income Statement discloses Net
Profit or Net Loss on account of operations. A Comparative Income Statement
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will show the absolute figures for two or more periods, the absolute change from
one period to another and, if desired, the change in terms of percentages. Since
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the figures for two or more periods are shown side by side, the reader canquickly ascertain whether sales have increased or decreased, whether cost of
sales has increased or decreased, etc. Thus, only a reading of data included in
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Comparative Income Statements will be helpful in deriving meaningful
conclusions.
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(ii) Comparative Balance Sheet. Comparative Balance Sheet as on two or moredifferent dates can be used for comparing assets and liabilities and finding out
any increase or decrease in those items. Thus; while in a single Balance Sheet
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the emphasis is on present position, it is on change in the comparative Balance
Sheet. Such a Balance Sheet is very useful in studying the trends in an
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enterprise. The preparation of comparative financial statements can be wellunderstood with the help of the following example:
Example (i): From the following Profit and Loss Account and the Balance
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Sheet of Swadeshi Polytex Ltd. for the year ended 31st December, 1997 and
1998, you are required to prepare a Comparative Income Statement and a
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Comparative Balance Sheet.Profit and Loss Account
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(In LAkhs of Rs.)Particulars
1997
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1998 Particulars
1997
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1998To Cost of Goods sold
600
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750
By Net Sales
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8001,000
To Operating Expenses:
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Administration Expenses
20
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20--- Content provided by FirstRanker.com ---
Selling expenses
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3040
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To Net Profit150
190
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800
1,000
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800
1,000
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BALANCE SHEET
As on 31 sf December (In Lakhs of Rs)
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Liabilities
1997
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1998Assets
1997
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1998
Bills Payable
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5075 Cash
100
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140
Sundry Creditors
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150200 Debtors
200
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300
Tax Payable
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100150 Stock
200
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300
6% Debentures
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100150 Land
100
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100
6% Preference Capital
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300300 Building
300
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270
Equity Capital
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400400 Plant
300
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270
Reserves
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200245 Furniture
100
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140
--- Content provided by FirstRanker.com ---
1,3001,520
1,300
--- Content provided by FirstRanker.com ---
1,520
Solution:
--- Content provided by FirstRanker.com ---
Swadeshi Polytex Limited--- Content provided by FirstRanker.com ---
COMPARATIVE INCOME STATEMENT
for the years ended 31st december 1997 and 1998 (In Lakhs of Rs.)
--- Content provided by FirstRanker.com ---
Absolute Percentage
increase or
--- Content provided by FirstRanker.com ---
increase orParticulars
decrease
--- Content provided by FirstRanker.com ---
decrease
in
--- Content provided by FirstRanker.com ---
in1997
1998
--- Content provided by FirstRanker.com ---
1998
1998
--- Content provided by FirstRanker.com ---
Net Sales800
1,000
--- Content provided by FirstRanker.com ---
+200
+25
--- Content provided by FirstRanker.com ---
Cost of Goods Sold.600
750
--- Content provided by FirstRanker.com ---
-150
+25
--- Content provided by FirstRanker.com ---
Gross Profit200
250
--- Content provided by FirstRanker.com ---
+50
+25
--- Content provided by FirstRanker.com ---
Operating Expenses:-
-
--- Content provided by FirstRanker.com ---
-
--- Content provided by FirstRanker.com ---
Administration Expenses20
20
--- Content provided by FirstRanker.com ---
-
-
--- Content provided by FirstRanker.com ---
Selling Expenses30
40
--- Content provided by FirstRanker.com ---
+10
+33.33
--- Content provided by FirstRanker.com ---
Total Operating Expenses50
60
--- Content provided by FirstRanker.com ---
10
+20
--- Content provided by FirstRanker.com ---
Operating Profit150
190
--- Content provided by FirstRanker.com ---
+40
+26.67
--- Content provided by FirstRanker.com ---
Swadeshi Polytex Limited--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
COMPARATIVE BALANCE SHEET
As on 31st december 1997, 1998 (Figures in lakhs of rupees)
--- Content provided by FirstRanker.com ---
Absolute
Percentage
--- Content provided by FirstRanker.com ---
increaseincrease(+)
or
--- Content provided by FirstRanker.com ---
Assets
1997
--- Content provided by FirstRanker.com ---
1998or decrease
decrease
--- Content provided by FirstRanker.com ---
(-) during
during
--- Content provided by FirstRanker.com ---
19981998
Current Assets:
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Cash
100
--- Content provided by FirstRanker.com ---
140
40
--- Content provided by FirstRanker.com ---
+40Debtors
200
--- Content provided by FirstRanker.com ---
300
100
--- Content provided by FirstRanker.com ---
+50Stock
200
--- Content provided by FirstRanker.com ---
300
100
--- Content provided by FirstRanker.com ---
+50Total Current Assets
500
--- Content provided by FirstRanker.com ---
740
240
--- Content provided by FirstRanker.com ---
+50Fixed Assets:
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Land100
100
--- Content provided by FirstRanker.com ---
-
-
--- Content provided by FirstRanker.com ---
Building300
270
--- Content provided by FirstRanker.com ---
-30
-10
--- Content provided by FirstRanker.com ---
Plant300
270
--- Content provided by FirstRanker.com ---
-30
-10
--- Content provided by FirstRanker.com ---
Furniture100
140
--- Content provided by FirstRanker.com ---
+40
+40
--- Content provided by FirstRanker.com ---
Total Fixed Assets800
780
--- Content provided by FirstRanker.com ---
-20
-2.5
--- Content provided by FirstRanker.com ---
Total Assets1,300
1,520
--- Content provided by FirstRanker.com ---
220
+17
--- Content provided by FirstRanker.com ---
Liabilities & Capital:--- Content provided by FirstRanker.com ---
Current Liabilities
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Bills Payable
50
--- Content provided by FirstRanker.com ---
75+25
+50
--- Content provided by FirstRanker.com ---
Sundry Creditors
150
--- Content provided by FirstRanker.com ---
200+50
+33.33
--- Content provided by FirstRanker.com ---
Tax Payable
100
--- Content provided by FirstRanker.com ---
150+50
+50
--- Content provided by FirstRanker.com ---
Total Current Liabilities
300
--- Content provided by FirstRanker.com ---
425+125
41.66
--- Content provided by FirstRanker.com ---
Long term Liabilities
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
6% Debentures100
150
--- Content provided by FirstRanker.com ---
+50
+50
--- Content provided by FirstRanker.com ---
Total Liabilities400
575
--- Content provided by FirstRanker.com ---
+175
+43.75
--- Content provided by FirstRanker.com ---
Capital & Reserves--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
6% Pref. Capital300
300
--- Content provided by FirstRanker.com ---
-
-
--- Content provided by FirstRanker.com ---
Equity Capital400
400
--- Content provided by FirstRanker.com ---
-
-
--- Content provided by FirstRanker.com ---
Reserves200
245
--- Content provided by FirstRanker.com ---
45
22.5
--- Content provided by FirstRanker.com ---
Total Shareholders' Funds900
945
--- Content provided by FirstRanker.com ---
45
5
--- Content provided by FirstRanker.com ---
Total Liabilities and Capital 1,3001,520
220
--- Content provided by FirstRanker.com ---
17
--- Content provided by FirstRanker.com ---
Comparative Financial Statements can be prepared for more than two periods ormore than two dates. However, it becomes very cumbersome to study the trend
with more than two periods data. Trend percentages are more useful in such
--- Content provided by FirstRanker.com ---
cases.
The American Institute of Certified Public Accountants has explained the utility
--- Content provided by FirstRanker.com ---
of repairing the Comparative Financial Statements as follows:The presentation of comparative financial statements is annual and other reports
enhances the usefulness of such reports and brings out more clearly the nature
--- Content provided by FirstRanker.com ---
and trend of rent changes affecting the enterprise. Such presentation emphasizes
the fact that statement for a series of periods is far more significant than those of
--- Content provided by FirstRanker.com ---
a single period and that the accounts of one period are but an installment of whatis essentially a continuous history. In anyone year, it is ordinarily desired that
the Balance Sheet, the Income Statement and the Surplus Statement be given for
--- Content provided by FirstRanker.com ---
one or more preceding years as well as for the current year."
The utility of preparing the Comparative Financial Statements has also been
--- Content provided by FirstRanker.com ---
realized in our country. The Companies Act, 1956, provides that companiesshould give figures for different items for the previous period, together with
current period figures in their Profit and loss Account and Balance Sheet.
--- Content provided by FirstRanker.com ---
2.Common-size Financial Statements
Common-size Financial Statements are those in which figures reported are
--- Content provided by FirstRanker.com ---
converted into percentages to some common base. In the Income Statement the
sale figure is assumed to be 100 and all figures are expressed as a percentage of
--- Content provided by FirstRanker.com ---
this total.Example (ii): On the basis of data given in example (i), prepare a Common-size
Income statement and Common Size Balance Sheet of Swadeshi Polytex Ltd.,
--- Content provided by FirstRanker.com ---
for the years ended 31st March, 1997 and 1998.
Swadeshi Polytex Limited
--- Content provided by FirstRanker.com ---
COMPARATIVE BALANCE SHEET(As on 31st december 1997, 1998) (Figures in lakhs of rupees)
Particulars
--- Content provided by FirstRanker.com ---
1997
1998
--- Content provided by FirstRanker.com ---
Net Sales100
100
--- Content provided by FirstRanker.com ---
Cost of Goods Sold
75
--- Content provided by FirstRanker.com ---
75Gross Profit
--- Content provided by FirstRanker.com ---
25
--- Content provided by FirstRanker.com ---
25Opening Expenses:
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Administration Expenses
--- Content provided by FirstRanker.com ---
2.50
2
--- Content provided by FirstRanker.com ---
Selling Expenses3.75
4
--- Content provided by FirstRanker.com ---
Total Opening Expenses
--- Content provided by FirstRanker.com ---
6.256
--- Content provided by FirstRanker.com ---
Operating Profit
--- Content provided by FirstRanker.com ---
18.7519
--- Content provided by FirstRanker.com ---
Interpretation: The above statement shows that though in absolute terms, the
cost of goods sold has gone up, the percentage of its cost to sales remains
--- Content provided by FirstRanker.com ---
constant at 75%. This is the reason why the Gross Profit continues at 25% of the
sales. Similarly, in absolute terms the amount 01 administration expenses
--- Content provided by FirstRanker.com ---
remains the same but as a percentage to sales it has come down by 5%. Sellingexpenses have increased by 0.25%. This all leads to net increase in net profit of
0.25% (i.e. from 18.75% to 19%).
--- Content provided by FirstRanker.com ---
Swadeshi Polytex Limited
COMPARATIVE BALANCE SHEET
--- Content provided by FirstRanker.com ---
As on 31st december 1997, 1998 (Figures in lakhs of rupees)Particulars
--- Content provided by FirstRanker.com ---
1997
--- Content provided by FirstRanker.com ---
1998
--- Content provided by FirstRanker.com ---
%
%
--- Content provided by FirstRanker.com ---
Assets100
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
100Current Assets:
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Cash
--- Content provided by FirstRanker.com ---
7.70
--- Content provided by FirstRanker.com ---
9.21
--- Content provided by FirstRanker.com ---
Debtors
--- Content provided by FirstRanker.com ---
15.38
--- Content provided by FirstRanker.com ---
19.74
--- Content provided by FirstRanker.com ---
Stock
--- Content provided by FirstRanker.com ---
15.38--- Content provided by FirstRanker.com ---
19.74
--- Content provided by FirstRanker.com ---
Total Current Assets38.46
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
48.69Fixed Assets:
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Building
--- Content provided by FirstRanker.com ---
23.07
--- Content provided by FirstRanker.com ---
17.76
--- Content provided by FirstRanker.com ---
Plant
--- Content provided by FirstRanker.com ---
23.07
--- Content provided by FirstRanker.com ---
17.76
--- Content provided by FirstRanker.com ---
Furniture
--- Content provided by FirstRanker.com ---
7.70--- Content provided by FirstRanker.com ---
9.21
--- Content provided by FirstRanker.com ---
Land7.70
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
6.68Total Fixed Assets
--- Content provided by FirstRanker.com ---
61.54
--- Content provided by FirstRanker.com ---
51.41
--- Content provided by FirstRanker.com ---
Total Assets
--- Content provided by FirstRanker.com ---
100
--- Content provided by FirstRanker.com ---
100
--- Content provided by FirstRanker.com ---
Current Liabilities
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Bills Payable3.84
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
4.93Sundry Creditors
--- Content provided by FirstRanker.com ---
11.54
--- Content provided by FirstRanker.com ---
13.16
--- Content provided by FirstRanker.com ---
Taxes Payable
--- Content provided by FirstRanker.com ---
7.69
--- Content provided by FirstRanker.com ---
9.96
--- Content provided by FirstRanker.com ---
Total Current Liabilities
--- Content provided by FirstRanker.com ---
23.07
--- Content provided by FirstRanker.com ---
27.95
--- Content provided by FirstRanker.com ---
Long Term Liabilities
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
6% Debentures7.69
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
9.86Capital & Reserves:
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
6% Preference Share Capital
--- Content provided by FirstRanker.com ---
23.10
--- Content provided by FirstRanker.com ---
19.72
--- Content provided by FirstRanker.com ---
Equity Share Capital
--- Content provided by FirstRanker.com ---
30.76
--- Content provided by FirstRanker.com ---
26.32
--- Content provided by FirstRanker.com ---
Reserves
--- Content provided by FirstRanker.com ---
15.38--- Content provided by FirstRanker.com ---
16.15
--- Content provided by FirstRanker.com ---
Total Shareholders Funds69.24
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
62.19Total Liabilities and Capital
--- Content provided by FirstRanker.com ---
100
--- Content provided by FirstRanker.com ---
100
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Interpretation: The percentage of current assets to total assets was 38.46 in1997. It has gone up to 48.69 in 1998. Similarly the percentage of current
liabilities to total liabilities (including capital) has also gone up from 23.07 in
--- Content provided by FirstRanker.com ---
1997 to 27.95 in 1998. Thus, the proportion of current assets has increased by a
higher percentage (about 10) as compared to increase in the proportion of
--- Content provided by FirstRanker.com ---
current liabilities (about 5). This has improved the working capital position ofthe Company. There has been a slight deterioration in the debt-equity ratio
though it continues toil very sound. The proportion of shareholder's funds in the
--- Content provided by FirstRanker.com ---
total liabilities has come down from 69.24% to 62.19% while that of the
debenture-holders has gone up from 7.69% to 9.86%.
--- Content provided by FirstRanker.com ---
Comparative Utility of Common-size Financial Statements: Thecomparative common size financial statements show the percentage of each item
to the total in each period but not variations in respective items from period to
--- Content provided by FirstRanker.com ---
period. In other words common-size financial statements when read horizontallydo not give information about the trend of individual items but the trend of their
relationship to total. Observation of these trends is not very useful because there
--- Content provided by FirstRanker.com ---
are no definite norms for the proportion of each item to total. For example, if it
is established that inventory should be 30% of total assets, the computation of
--- Content provided by FirstRanker.com ---
various ratios to total assets would be very useful. But since there are no suchestablished standard proportions, calculation of percentages of different items of
assets or liabilities to total assets or total liabilities is not of much use. On
--- Content provided by FirstRanker.com ---
account of this reason common size financial statements are not much useful for
financial analysis. However, common-size financial statements are useful for
--- Content provided by FirstRanker.com ---
studying the comparative financial position of two or more businesses.However, to make such comparison really meaningful, it is necessary that the
financial Instatements of all such companies should be prepared on the same
--- Content provided by FirstRanker.com ---
pattern, e.g., all the companies should be more or less of the same age, they
should be following the same accounting practices, the method of depreciation
--- Content provided by FirstRanker.com ---
on fixed assets should be the same.3.
Trend Percentages
--- Content provided by FirstRanker.com ---
Trend percentages are immensely helpful in making a comparative study of the
financial statements for several years. The method of calculating trend
--- Content provided by FirstRanker.com ---
percentages involves the calculation of percentage relationship that each itembears to the same item in the base year. Any year may be taken as the base year.
It is usually the earliest year. Any intervening year may also be taken as the base
--- Content provided by FirstRanker.com ---
year. Each item of base year taken as 100 and on that basis the percentages for
each of the items of each of the fears is calculated. These percentages can also
--- Content provided by FirstRanker.com ---
be taken as Index Numbers showing relative changes in the financial dataresulting with the passage of time.
The method of trend percentages is a useful analytical device for the
--- Content provided by FirstRanker.com ---
management since by substituting percentages for large amounts; the brevity andreadability are achieved. However, trend percentages are not calculated for all of
the items in the financial statements. They are usually calculated only for major
--- Content provided by FirstRanker.com ---
items since the purpose is to highlight important changes.
While calculating trend percentages, care should be taken regarding the
--- Content provided by FirstRanker.com ---
following matters:1. The accounting principles and practices followed should be constant throughout
the period for which analysis is made. In the absence of such consistency, the
--- Content provided by FirstRanker.com ---
comparability will be adversely affected.
2. The base year should be carefully selected. It should be a normal year and be
--- Content provided by FirstRanker.com ---
representative of the items shown in the statement.3. Trend percentages should be calculated only for items having logical
relationship with one another.
--- Content provided by FirstRanker.com ---
4. Trend percentages should be studied after considering the absolute figures on
which they are based; otherwise, they may give misleading results. For example,
--- Content provided by FirstRanker.com ---
one expense .may increase from Rs. 100 to Rs. 200 while the other expense mayincrease from Rs. 10,000 to Rs. 15,000. In the first case trend percentage will
show 100% increase while in the second case it will show 50% increase. This is
--- Content provided by FirstRanker.com ---
misleading because in the first case the change though 100% is not at al
significant in real terms as compared to the other. Similarly, unnecessary doubts
--- Content provided by FirstRanker.com ---
may be created when the trend percentages show 100% increase in debt whileonly 50% increase in equity. This doubt can be removed if absolute figures are
seen, e.g., the amount of debt may increase from Rs. 20,000 to Rs. 40,000 while
--- Content provided by FirstRanker.com ---
that of equity from Rs. 1,00,000 to Rs. 1,50,000. .
5. The figures for the current year should also be adjusted in the light of price level
--- Content provided by FirstRanker.com ---
changes as compared to the base year, before calculating the trend percentages.In case this is not done, the trend percentages may make the whole comparison
meaningless. For example, if prices in the year 1998 have increased by 100% as
--- Content provided by FirstRanker.com ---
compared to 1997, the increase in sales in 1998 by 60% as compared to 1997will give misleading results. Figures of 1998 must be adjusted on account of rise
in prices before calculating the trend percentages.
--- Content provided by FirstRanker.com ---
Example (iii): From the following data relating to the assets side of the Balance
Sheet of Kamdhenu Ltd., for the period 31st Dec., 1995 to 31st December, 1998,
--- Content provided by FirstRanker.com ---
you are required to calculate the trend percentage taking 1995 as the base year.(Rupees in thousands)
--- Content provided by FirstRanker.com ---
Assets
--- Content provided by FirstRanker.com ---
19951996
1997
--- Content provided by FirstRanker.com ---
1998
Cash
--- Content provided by FirstRanker.com ---
100120
80
--- Content provided by FirstRanker.com ---
140
Debtors
--- Content provided by FirstRanker.com ---
200250
325
--- Content provided by FirstRanker.com ---
400
Stock-in-trade
--- Content provided by FirstRanker.com ---
300400
350
--- Content provided by FirstRanker.com ---
500
Other Current Assets
--- Content provided by FirstRanker.com ---
5075
125
--- Content provided by FirstRanker.com ---
150
Land
--- Content provided by FirstRanker.com ---
400500
500
--- Content provided by FirstRanker.com ---
500
Building
--- Content provided by FirstRanker.com ---
8001,000
1,200
--- Content provided by FirstRanker.com ---
1,500
Plant
--- Content provided by FirstRanker.com ---
1,0001,000
1,200
--- Content provided by FirstRanker.com ---
1,500
--- Content provided by FirstRanker.com ---
2,8503,345
3,780
--- Content provided by FirstRanker.com ---
4,690
Solution
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
COMPARATIVE BALANCE SHEET
As on december 31, 1995-96
--- Content provided by FirstRanker.com ---
Assets
December 31
--- Content provided by FirstRanker.com ---
Trend Percentage(Rs. in thousands)
Base year 1995
--- Content provided by FirstRanker.com ---
1995 1996 1997 1998 1995 1996 1997 1998
Current Assets:
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Cash
100
--- Content provided by FirstRanker.com ---
12080
140
--- Content provided by FirstRanker.com ---
100
120
--- Content provided by FirstRanker.com ---
80140
Debtors
--- Content provided by FirstRanker.com ---
200
250
--- Content provided by FirstRanker.com ---
325400
100
--- Content provided by FirstRanker.com ---
125
163
--- Content provided by FirstRanker.com ---
200Stock-in-trade
300
--- Content provided by FirstRanker.com ---
400
350
--- Content provided by FirstRanker.com ---
500100
133
--- Content provided by FirstRanker.com ---
117
167
--- Content provided by FirstRanker.com ---
OtherCurrent
50
--- Content provided by FirstRanker.com ---
75
125
--- Content provided by FirstRanker.com ---
150100
150
--- Content provided by FirstRanker.com ---
250
300
--- Content provided by FirstRanker.com ---
AssetsTotal
Current
--- Content provided by FirstRanker.com ---
650
845
--- Content provided by FirstRanker.com ---
880 1,190100
129
--- Content provided by FirstRanker.com ---
135
183
--- Content provided by FirstRanker.com ---
Assets--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Fixed AssetsLand
400
--- Content provided by FirstRanker.com ---
500
500
--- Content provided by FirstRanker.com ---
500 100125
125
--- Content provided by FirstRanker.com ---
125
Building
--- Content provided by FirstRanker.com ---
800 1,000 1,200 1,500 100125
150
--- Content provided by FirstRanker.com ---
175
Plant
--- Content provided by FirstRanker.com ---
1,000 1,000 1,200 1,500 100100
120
--- Content provided by FirstRanker.com ---
150
Total
--- Content provided by FirstRanker.com ---
Fixed 2,200 2,500 2,900 3,500 100114
132
--- Content provided by FirstRanker.com ---
159
Assets
--- Content provided by FirstRanker.com ---
4. Funds Flow AnalysisFunds flow analysis has become an important tool in the analytical kit of
financial analysts, credit granting institutions and financial managers. This is
--- Content provided by FirstRanker.com ---
because the Balance Sheet of a business reveals its financial status at a particular
point of time. It does not sharply focus those major financial transactions which
--- Content provided by FirstRanker.com ---
have been behind the Balance Sheet changes. For example, if a loan of Rs.2,00,000 was raised and pail during the accounting year, the balance sheet will not
depict this transaction However, a financial analyst must know the purpose for
--- Content provided by FirstRanker.com ---
which the loan was utilized and the source from which it was obtained. This willhelp him in making a better estimate about the company's financial position and
policies.
--- Content provided by FirstRanker.com ---
Funds flow analysis reveals the changes in working capital position. It tells
about the sources from which the working capital was obtained and the purposes
--- Content provided by FirstRanker.com ---
for which is used. It brings out in open the changes which have taken placebehind the Ice Sheet. Working capital being the life-blood of the business, such
an analysis is extremely useful. The technique and the procedure involved in
--- Content provided by FirstRanker.com ---
funds flow analysis has been discussed in detail later in the book.
5.
--- Content provided by FirstRanker.com ---
Cost-Volume-Profit AnalysisCost-Volume-Profit Analysis is an important tool of profit planning. It studies
the relationship between cost, volume of production, sales and profit. Of course,
--- Content provided by FirstRanker.com ---
it is not strictly a technique used for analysis of financial statements. However, it
is an important tool for the management for decision-making since the data is
--- Content provided by FirstRanker.com ---
provided by both cost and financial records. It tells the volume of sales at whichfirm will break-even, the effect on profit on 'account of variation in output,
selling price and cost, and finally, the quantity to be produced and sold to reach
--- Content provided by FirstRanker.com ---
the, target profit level.
6.
--- Content provided by FirstRanker.com ---
Ratio AnalysisThis is the most important tool available to financial analysts for their work. An
accounting ratio shows the relationship in mathematical terms between two
--- Content provided by FirstRanker.com ---
interrelated accounting figures. The figures have to be interrelated (e.g., Gross
Profit and Sales, Current Assets and Current Liabilities), because no useful
--- Content provided by FirstRanker.com ---
purpose will be served if ratios are calculated between two figures which are notat all related to each other, e.g., sales and discount on issue of debentures.
A financial analyst may calculate different accounting ratios for different
--- Content provided by FirstRanker.com ---
purposes.LIMITATIONS OF FINANCIAL ANALYSIS
Financial analysis is a powerful mechanism which helps in ascertaining the
--- Content provided by FirstRanker.com ---
strengths and nesses in the operations and financial position of an enterprise.
However, this analysis is subject to certain limitations. Most of these limitations
--- Content provided by FirstRanker.com ---
are because of the limitations of the financial statements themselves. Theselimitations are as follows:
1.
--- Content provided by FirstRanker.com ---
Financial Analysis is only a Means
Financial analysis is a means to an end and not the end itself. The analysis
--- Content provided by FirstRanker.com ---
should be used as a starting point and the conclusion should be drawn not inisolation, but keeping view the overall picture and the prevailing economic and
political situation.
--- Content provided by FirstRanker.com ---
2.
Ignores Price Level Changes
--- Content provided by FirstRanker.com ---
Financial statements are normally prepared on the concept of historical costs.They do not reflect values in terms of current costs. Thus, the financial analysis
based on such financial statements or accounting figures would not portray the
--- Content provided by FirstRanker.com ---
effects of price level changes over the period.
3.
--- Content provided by FirstRanker.com ---
Financial Statements are Essentially Interim ReportsThe profit shown by Profit and Loss Account and the financial position as
depicted by the Balance Sheet is not exact. The exact position can be known
--- Content provided by FirstRanker.com ---
only when the business is closed down. Again, the existence of contingent
liabilities and deferred revenue expenditure make them more imprecise.
--- Content provided by FirstRanker.com ---
4.Accounting Concepts and Conventions
Financial statements are prepared on the basis of certain accounting concept and
--- Content provided by FirstRanker.com ---
conventions. On account of this reason the financial position as disclosed by
statements may not be realistic. For' example, fixed assets in the balance sheet,
shown on the basis of going concern concept. This means that value placed on&
--- Content provided by FirstRanker.com ---
assets may not be the same which may be realized on their sale. On account
convention of conservatism the income statement may not disclose true income
--- Content provided by FirstRanker.com ---
of the business since probable losses are considered while probable incomes areignored.
5.
--- Content provided by FirstRanker.com ---
Influence of Personal Judgment
Many items are left to the personal judgment of the accountant. For example, the
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method of depreciation, mode of amortization of fixed assets, treatment ofdeferred revenue expenditure - all depend on the personal judgment of the
accountant. The soundness of such judgment will necessarily depend upon his
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competence and integrity. However convention of consistency acts as a
controlling factor on making indiscreet personal judgments.
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6.Disclose only Monetary Facts
Financial statements do not depict those facts which cannot be expressed in
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terms of money. For example, development of a team of loyal and efficient
workers, enlightened management, the reputation and prestige of management
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with the public are matters which are of considerable importance for thebusiness, but they are nowhere depicted by financial statements.
RATIO ANALYSIS
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Ratio Analysis is a very important tool of financial analysis. It is the process of
establishing a significant relationship between the items of financial statements
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to provide a meaningful understanding of the performance and financial positionof a firm.
Meaning of Ratio
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Since, we are using the term 'ratio' in relation to financial statement analysis; it
may properly mean 'An Accounting Ratio' or 'Financial Ratio'. It may be defined
as the mathematical expression of the relationship between two accounting
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figures. But these figures must be related to each other (i.e., these figures must
have a mutual cause and effect relationship) to produce a meaningful and useful
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ratio. For example, the figure of turnover cannot be said to be significantlyrelated to the figure of share premium. It indicates a quantitative relationship
which the analyst may use to make a qualitative judgment about the various
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aspects of the financial position and performance of a concern. It may be
expressed as a percentage or as a rate (i.e., in 'x' number of times) or as a pure
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ratio, e.g., if gross profit on sales of Rs. 1,00,000 is Rs. 20,000, the ratio of grossRs 20
.
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000
,
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profit to sales is 20%. .ie
100
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Rs. 00
,
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1000
,
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In another example of Capital Turnover Ratio, if Sales with a Capital Employed
of Rs. 20,000 is Rs. 1, 00,000, the Capital Turnover Ratio may be expressed as 5
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times i.e., Rs. 1, 00,000 / Rs. 20,000. In the case of a Current Ratio, if currentassets are Rs. 1,00,000 and current liabilities are Rs. 50,000, Current Ratio may
be expressed as 2 : 1 i.e., Rs. 1,00,000 : Rs. 50,000.
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In view of the requirements of various users (e.g., Short-term Creditors, Long-
term Creditors, Management, Investors) of the ratios, one may classify the ratios
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into the following four groups:Liquidity Ratios, Solvency Ratios, Activity Ratios and Profitability Ratios
Liquidity Ratios
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These ratios measure the concern's ability to meet short-term obligations as and
when they become due. These ratios show the short-term financial solvency of
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the concern. Usually the following two ratios are calculated for this purpose:1.
Current Ratio and 2. Quick Ratio
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1. Current Ratio(a) Meaning: This ratio establishes a relationship between current assets and
current liabilities.
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(b) Objective: The objective of computing this ratio is to measure the ability of
the firm to meet its short-term obligations and to reflect the short-term financial
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strength / solvency of a firm. In other words, the objective is to measure thesafety margin available for short-term creditors.
(c) Components: There are two components of this ratio which are a under:
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(i)
Current Assets which mean the assets which are held for their
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conversion into cash within a year and include the following:Cash Balance
Bank Balances
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Marketable Securities
Debtors (less Provision)
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Bills Receivable (less Provisions)Stock of all types, viz., Raw-
Materials
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Prepaid ExpensesWork-in-progress, Finished Goods
Incomes accrued but not due
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Short-term Loans and Advances
Advance Payment of tax
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(Debit Balances)
Tax reduced at source (Debit
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Incomes due but not received
Balance)
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(ii) Current Liabilities which mean the liabilities which are expected to bematured within a year and include the following:
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Creditors for Goods
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Creditors for ExpensesBills Payable
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Bank OverdraftShort-term Loans and Advances
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Income received-in-advance
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Provision for Tax--- Content provided by FirstRanker.com ---
Unclaimed dividend
(d) Computation: This ratio is computed by dividing the current assets by the
current liabilities. This ratio is usually expressed as a pure ratio e.g. 2 : I. In the
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form of a formula, this ratio may be expressed as under:
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.Current Assets
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Current Ratio =
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Current Liabilities
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(e) Interpretation: It indicates rupees of current assets available for each rupee
of current liability, Higher the ratio, greater the margin of safety for short-term
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creditors and vice-versa. However, too high / too low ratio calls for furtherinvestigation since the too high ratio may indicate the presence of idle funds
with the firm or the absence of investment opportunities with the firm and too
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low ratio may indicate the over trading/under capitalization if the capital
turnover ratio is high.
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Traditionally, a current ratio of 2: 1 is considered to be a satisfactory ratio. Onthe basis of this traditional rule, if the current ratio is 2 or more, it means the
firm is adequately liquid and has the ability to meet its current obligations but if
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the current ratio is less than 2, it means the firm has difficulty in meeting its
current obligations. The logic behind this rule is that even if the value of current
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assets becomes half, the firm can still meet its short-term obligations.However, the traditional standard of 2: I should not be used blindly since there may be
firms having current ratio of less than 2, which are working efficiently and meeting their
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short-term obligations as and when they become due while the other firms having
current ratio of more than 2, may not be able to meet their current obligations in time.
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This is so because the current ratio measures the quantity of current assets and not theirquality. Current assets may consist of doubtful and slow paying debtors and slow
moving and obsolete stock of goods. That is why, it can be said that current ratio is no
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doubt a quick measurement of a firm's liquidity but it is crude as well.
(f) Precaution: While computing and using the current ratio, it must be ensured
(a) that the quality of both receivables (debtors and bills receivable) and
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inventory has been carefully assessed and (b) that all current assets and current
liabilities have been properly valued.
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Example (iv): The Balance Sheet of Tulsian Ltd. as at 31 st March 19X1 is asunder:
Liabilities
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Rs.
Assets
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Rs.
Equity Share Capital
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1,00,000
Land & Building
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6,00,000
18% Pref. Share capital 1,00,000
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Plant & Machinery
5,00,000
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Reserves60,000
Furniture & Fixtures
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. 1.00,000
Profit & Loss A/c
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2,40,000--- Content provided by FirstRanker.com ---
12,00,000
15% Debentures
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8,00,000Less: Depreciation
2 00 000
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Trade Creditors
40,000
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10,00,000
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Bills Payable
30,000
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Trade Investments (long-term)1,00,000
Outstanding Expenses 20,000
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Stock
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95,000Bank overdraft
10,000
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Debtors
3,40,000
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Provision for Tax2,40,000
Less: Provision
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30,000
3,10,000
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Marketable Securities
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10,000
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Cash
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10,000
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Bills receivables
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10,000
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Prepaid Expenses
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5,000
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Preliminary Expenses
60,000
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Underwriting
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40,000
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Commission
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16,40,00016,40,000
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Net Sales for the year 19XI-19X2 amounted to Rs. 20.00.000. Calculate Current
Ratio.
Solution:
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Current Assets =Stock + Debtors - Provision on Debtors +Marketable Securities
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+ Cash + B/R + Prepaid Expenses= Rs. 95,000 + Rs. 3,40,000 - Rs. 30,000 + Rs. 10,000 + Rs. 10,000 + Rs.
10,000 + Rs. 5,000 = Rs. 4,40,000
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Current Liabilities= Trade Creditors + B/P + O/s Exp + Bank O/D + Provision
for Tax = Rs. 40,000 + Rs. 30,000 + Rs. 20,000 + Rs. 10,000 + Rs. 2,40,000
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= Rs. 3,40,000--- Content provided by FirstRanker.com ---
Current Assets
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Rs. 4,40,000Current Ratio =
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= = 22:17
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Current Liabilities
Rs.3,40, 000
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2. Quick Ratio(a) Meaning: This ratio establishes a: relationship between quick assets and
current liabilities.
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(b) Objective: The objective of computing this ratio is to measure the ability of
the firm to meet its short-term obligations as and when due without relying upon
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the realization of stock.(c) Components There are two components of this ratio which are as under:
(i) Quick assets: which mean those current assets which can be converted
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into cash immediately or at a short notice without a loss of value and
include the following:
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Cash Balances
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Bank Balances
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Marketable Securities
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Debtors
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Bills Receivable--- Content provided by FirstRanker.com ---
Short-term Loans and Advances
(ii) Current liabilities: (as explained earlier in Current Ratio)
(d) Computation This ratio is computed by dividing the quick assets by the
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current liabilities. This ratio is usually expressed as a pure ratio e.g., 1: 1. In the
form of a formula, this ratio may be expressed as under:
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--- Content provided by FirstRanker.com ---
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Quick Assts
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Quick Ratio =
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Current Liabilities
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(e) Interpretation: It indicates rupees of quick assets available for each rupee of
current liability. Traditionally, a quick ratio of 1:1 is considered to be a
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satisfactory ratio. However, this traditional rule should not be used blindly sincea firm having a quick ratio of more than 1, may not be meeting its short-term
obligations in time if its current assets consist of doubtful and slow paying
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debtors while a firm having a quick ratio of less than 1, may be meeting its
short-term obligations in time because of its very efficient inventory
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management.(f) Precaution: While computing and using the quick ratio, it must be ensured,
(a) that the quality of the receivables (debtors and bills receivable) has been
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carefully assessed and (b) that all quick assets and current liabilities have been
properly valued.
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Example (v): Current Assets Rs.2,00,000, Inventory Rs.40,000, WorkingCapital Rs.1, 20 000. Calculate the Quick Ratio.
Solution: Current Liabilities = Current Assets - Working Capital
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= Rs. 2,00,000 - Rs. 1,20,000 = Rs. 80,000
Quick Assets = Current Assets - Inventory
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= Rs. 2,00,000 - Rs. 40,000 = Rs. 1,60,000--- Content provided by FirstRanker.com ---
Quick Assets
RS.l,60,000
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Quick Ratio =--- Content provided by FirstRanker.com ---
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= 2:1Current Liabilities
Rs. 80000
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SOLVENCY RATIOS
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These ratios show the long-term financial solvency and measure the enterprise's
ability to pay the interest regularly and to repay the principal (i.e. capital
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amount) on maturity or in pre-determined installments at due dates. Usually, thefollowing ratios are calculated to judge the long-term financial solvency of the
concern.
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Debt-Equity Ratio
(a) Meaning: This ratio establishes a relationship between long-term debts and
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share-holders' funds.(b) Objective: The objective of computing this ratio is to measure the relative
proportion of debt and equity in financing the assets of a firm.
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(c) Components: There are two components of this ratio, which are as under:
(i)
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Long-term Debts, which mean long-term loans (whether secured orunsecured (e.g., Debentures, bonds, loans from financial institutions).
(ii)
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Shareholders' Funds which mean equity share capital plus preference
share capital plus reserves and surplus minus fictitious assets (e.g.,
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preliminary expenses).(d) Computation: This ratio is computed by dividing the long-term debts by the
shareholders' funds. This ratio is usually expressed as a pure ratio e.g., 2: 1. In
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the form of a formula, this ratio may be expressed as under:
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..
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Long - term Debts
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Debt-Equity Ratio =--- Content provided by FirstRanker.com ---
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Shareholders 'Funds(e) Interpretation: It indicates the margin of safety to long-term creditors. A
low debt equities ratio implies the use of more equity than debt which means a
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larger safety margin for creditors since owner's equity is treated as a margin ofsafety by creditors and vice versa.
Example (vi): Capital Employed Rs. 24,00,000, Long-term Debt Rs. 16,00,000
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Calculate the Debt-Equity Ratio.
Solution: Shareholders' 'Funds = Capital Employed - Long-ter
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= Rs. 24,00,000 - Rs. 16,00,000 = Rs. 8,00,000--- Content provided by FirstRanker.com ---
Long-term Debts
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Rs. 16,00,000Debt-Equity Ratio =
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=
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= 2 :1
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Shareholders ' Funds Rs 8,00,00
Example (vii): Capital Employed Rs. 8,00,000, Shareholders' Funds Rs.
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2,00,000 Calculate the Debt Equity Ratio.Solution: Long-term Debt
= Capital Employed - Shareholders' Funds
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= Rs. 8,00,000 - Rs. 2,00,000 = Rs. 6,00,000
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Long-term Debts- Rs. 6,00,000
Debt equity Ratio =
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=
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= 3:1
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Shareholders Funds Rs. 2,00,000
Debt Total Funds Ratio
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This ratio is a variation of the debt-equity ratio and gives the similar indicationsas the debt-equity ratio. In this ratio, the outside long-term liabilities are related
to the total capitalization of the firm and not merely to the shareholders' funds.
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This ratio is computed by dividing the long-term debt by the capital employed.
In the form of a formula, this ratio may be expressed as under:
Long-term Debt
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Debt-Total Funds Ratio =
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Capital EmployedWhere, the Capital Employed comprises the long-term debt and the
shareholders' funds.
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Interest Coverage Ratio (or Time-interest Earned Ratio or Debt-Service
Ratio)
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(a) Meaning: This ratio establishes a relationship between net profits beforeinterest and taxes and interest on long-term debt.
(b) Objective: The objective of computing this ratio is to measure the debt-
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servicing capacity of a firm so far as fixed interest on long-term debt is
concerned.
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(c) Components: There are two components of this ratio which are as under:(i)
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Net profits before interest and taxes;
(ii)
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Interest on long-term debts.(d) Computation: This ratio is computed by dividing the net profits before
interest and taxes by interest on long-term debt. This ratio is usually expressed
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as 'x' number of times. In the form of a formula, this ratio may be expressed as
under:
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Net Profit before interest and taxesInterest Coverage Ratio =
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Interest on Long-term debt
(e) Interpretation: Interest coverage ratio shows the number of times the
interest charges are covered by the profits out of which they will be paid. It
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indicates the limit beyond which the ability of the firm to service its debt would
be adversely affected. For instance, an interest coverage of five times would
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imply that even if the firm's net profits before interest and tax were to decline to20% of the present level, the firm will still be able to pay interest out of profits.
Higher the ratio, greater the firm's ability to pay interest but very high ratio may
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imply lesser use of debt and/or very efficient operations.
Example (viii): Net Profit before Interest and Tax Rs. 3,20,000, Interest on long
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term debt Rs. 40,000. Calculate Interest Coverage Ratio.Solution:
Net Profit before Interest and Taxes
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Interest Coverage Ratio =
Interest on Long-term Debt
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Rs.3,20,000--- Content provided by FirstRanker.com ---
=
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
= 8 Times
Rs.40,000 8 Times
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ACTIVITY RATIOSThese ratios measure the effectiveness with which a firm uses its available
resources. These ratios are also called 'Turnover Ratios' since they indicate the
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speed with which the resources are being turned (or converted) into sales.
Usually the following turnover ratios are calculated:
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I. Capital Turnover RatioII. Fixed Assets Turnover Ratio,
III. Net Working Capital Turnover Ratio IV. Stock Turnover Ratio
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V. Debtors Turnover Ratio.
VI. Creditors Turnover Ratio.
Capital Turnover Ratio
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(a) Meaning: This ratio establishes a relationship between net sales and capital
employed.
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(b) Objective: The objective of computing this ratio is to determine theefficiency with which the capital employed is utilized.
(c) Components: There are two components of this ratio which are as under:
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(i)
Net Sales which mean gross sales minus sales returns; and
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(ii)Capital Employed which means Long-term Debt plus Shareholders'
Funds.
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(d) Computation: This ratio is computed by dividing the net sales by the capital
employed. This ratio is usually expressed as 'x' number of times. In the form of a
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formula this ratio may be expressed as under:Net Sales
Capital Turnover Ratio =
--- Content provided by FirstRanker.com ---
Capital Employed
(e) Interpretation: It indicates the firm's ability to generate sales per rupee of
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capital employed. In general, the higher the ratio the more efficient themanagement and utilization of capital employed. A too high ratio may indicate
the situation of an over-trading (or under. capitalization) if current ratio is lower
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than that required reasonably and vice versa.
Fixed Assets Turnover Ratio
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(a) Meaning: This ratio establishes a relationship between net sales and fixedassets.
(b) Objective: The objective of computing this ratio is to determine the
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efficiency with which the fixed assets are utilized.(c) Components: There are two components of this ratio which are as under:
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(i) Net Sales which means gross sales minus sales returns;
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(ii) Net Fixed (operating) Assets which mean gross fixed assets minusdepreciation thereon.
(d) Computation This ratio is computed by dividing the net sales by the net
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fixed assets. This ratio is usually expressed as 'x' number of times. In the form of
a formula, this ratio may be expressed as under:
--- Content provided by FirstRanker.com ---
Net Sales
Fixed Assets Turnover Ratio =
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Net Fixed Assets
(e) Interpretation: It indicates the firm's ability to generate sales per rupee of
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investment in fixed assets. In general, higher the ratio, the more efficient themanagement and utilization of fixed assets, and vice versa. It may be noted that
there is no direct relationship between sales and fixed assets since the sales are
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influenced by other factors as well (e.g., quality of product, delivery terms,
credit terms, after sales service, advertisement and publicities.)
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Example (ix): Fixed Assets (at cost) Rs. 7,00,000, Accumulated Depreciationtill date Rs. 1,00,000, Credit Sales Rs. 17,00,000, Cash Sales Rs., 1,50,000,
Sales Returns Rs. 50,000. Calculate Fixed Assets Turnover Ratio.
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Solution: Net Sales
= Cash Sales + Credit Sales - Sales Returns
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= Rs. 1,50,000 + Rs. 17,00,000 - Rs. 50,000 = Rs. 18,00,000Net Fixed Assets = Fixed Assets (at cost) - Depreciation
= Rs. 7,00,000 - Rs. 1,00,000 = Rs. 6,00,000
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Net Sales
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Rs. 18,00,000 .
Fixed Assets Turnover Ratio =
--- Content provided by FirstRanker.com ---
=
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= 3 Times
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Net Fixed Assets
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Rs. 600000
Example (x): Capital Employed Rs. 2,00,000, Working Capital Rs. 40,000,
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Cost of goods sold Rs. 6,40,000, Gross Profit Rs. 1,60,000. Calculate FixedAssets Turnover Ratio.
Solution: Net Sales = Cost of Goods Sold + Gross Profit
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= Rs. 6,40,000 + Rs. 1,60,000 = Rs. 8,00,000
Net fixed Assets = Capital Employed - Working Capital
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= Rs. 2,00,000 - Rs. 40,000 = Rs. 1,60,000--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Net Sales
Rs. 8,00,000 .
--- Content provided by FirstRanker.com ---
Fixed Assets Turnover Ratio =
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== 5 Times
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Net fixed Asset Rs. 1,60,000
Working Capital Turnover Ratio
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(a) Meaning: This ratio establishes a relationship between net sales andworking capital.
(b) Objective: The objective of computing this ratio is to determine the
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efficiency with which the working capital is utilized.
(c) Components: There are two components of this ratio which are as under:
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(i) Net Sales which mean gross sales minus sales returns; and(ii) Working Capital which means current assets minus current liabilities.
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(d) Computation: This ratio is computed by dividing the net sales by theworking i capital. This ratio is usually expressed as 'x' number of times. In the
form of a formula, this ratio may be expressed as under:
--- Content provided by FirstRanker.com ---
Net Sales
Working Capital Turnover Ratio =
--- Content provided by FirstRanker.com ---
Working Capital(e) Interpretation: It indicates the firm's ability to generate sales per rupee of
working capital. In general, higher the ratio, the more efficient the management
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and utilization of, working capital and vice versa.
Example (xi): Current Assets Rs. 6,00,000, Current Liabilities Rs. 1,20,000,
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Credit Sales Rs. 12,00,000, Cash Sales Rs. 2,60,000, Sales Returns Rs. 20,000.Calculate Working Capital Turnover Ratio.
Solution:
--- Content provided by FirstRanker.com ---
Net Sales = Cash Sales + Credit Sales - Sales Returns
--- Content provided by FirstRanker.com ---
= Rs. 2,60,000 + Rs. 12,00,000 - Rs. 20,000 = Rs. 14,40,000Working Capital
= Current Assets - Current Liabilities
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= Rs. 6,00,000 - Rs. 1,20,000 = Rs, 4,80,000
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Net SalesRs. 14,40,000
Working Capital Turnover Ratio =
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=
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=3 TimesWorking Capital Rs. 4,80,000
Stock Turnover Ratio
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(a) Meaning: This ratio establishes a relationship between costs of goods sold
and aver age inventory.
(b) Objective: The objective of computing this ratio is to determine the
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efficiency with which the inventory is utilized.
(c) Components: There are two components of this ratio which are as under:
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(i) Cost of Goods Sold, this is calculated as under.
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Cost of Goods Sold = Opening Inventory + Net Purchases + Direct
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Expenses - Closing Inventory = Net Sales - Gross Profit(ii) Average Inventory which is calculated as under:
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Average Inventory = (Opening Inventory plus Closing Inventory)/2
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(d) Computation: This ratio is computed by dividing the cost of goods sold bythe average inventory. This ratio is usually expressed as 'x' number of times. In
the form of a formula, this ratio may be expressed as under: -
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Cost of Goods Sold
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Stock Turnover Ratio =
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Average Inventory
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(e) Interpretation: It indicates the speed with which the inventory is converted
into sales. In general, a high ratio indicates efficient performance since an
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improvement in the ratio shows that either the same volume of sales has beenmaintained with a lower investment in stocks, or the volume of sales has
increased without any increase in the amount of stocks. However, too high ratio
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and too low ratio calls for further investigation. A too high ratio may be the
result of a very low inventory levels which may result in frequent stock-outs and
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thus the firm may incur high stock-out costs. On the other hand, a too low ratiomay be the result of excessive inventory levels, slow-moving or obsolete
inventory and thus, the firm may incur high carrying costs. Thus, a firm should
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have neither a very high nor a very low stock turnover ratio, it should have a
satisfactory level. To judge whether the ratio is satisfactory or not, it should be
compared with its own past ratios or with the ratio of similar firms in the same
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industry or with industry average.
(f) Stock Velocity- This velocity indicates the period for which sales can be
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generated with the help of an average stock maintained and is usually expressedin days. This velocity may be calculated as follows:
Average stock
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Stock Velocity = __________________________________
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Average Daily cost of Goods Sold
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12 months /52 weeks /365 days
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Or __________________________________Stock Turnover Ratio
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CASH FLOW ANALYSIS
Cash flow analysis is another important technique of financial analysis. It
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involves preparation of Cash Flow Statement for identifying sources andapplications of cash; Cash flow statement may be prepared on the basis of actual
or estimated data. In the latter case, it is termed as 'Projected Cash Flow
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Statement', which is synonymous with the term 'Cash Budget'. In the following
pages we shall explain in detail in preparation of cash flow statement, utility and
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limitations of cash flow analysis etc.MEANING OF CASH FLOW STATEMENT
A Cash Flow Statement is a statement depicting change in cash position from
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one period to another. For example, if the cash balance of a business is shown
by its Balance Sheet on 31st December, 1998 at Rs. 20,000 while the cash
balance as per its Balance Sheet on 31st December, 1999 is Rs. 30,000, there has
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been an inflow of cash of Rs. 10,000 in the year 1999 as compared to the year
1998. The cash flow statement explains the reasons for such inflows or outflows
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of cash, as the case may be. It also helps management in making plans for theimmediate future. A Projected Cash Flow Statement or a Cash Budget will help
the management in ascertaining how much cash will be available to meet
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obligations to trade creditors, to pay bank loans and to pay dividend to the
shareholders. A proper planning of the cash resources will enable the
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management to have cash available whenever needed and put it to someprofitable or productive use in case there is surplus cash available.
The term "Cash" here stands for cash and bank balances. In a narrower sense,
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funds are also used to denote cash. In such a case, the term "Funds" will exclude
from its purview all other current assets and current liabilities and the terms
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"Funds Flow Statement" and "Cash Flow Statement" will have synonymousmeanings. However, for the purpose of this study we are calling this part of
study Cash Flow Analysis and not Funds Flow analysis.
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PREPARATION OF CASH FLOW STATEMENT
Cash Flow Statement can be prepared on the same pattern on which a Funds
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Flow Statement is prepared. The change in the cash position from one period toanother is computed by taking into account "Sources" and" Applications" of
cash.
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Sources of Cash
Sources of cash can be both internal as well as external:
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Internal Sources- Cash from operations is the main internal source. The NetProfit shown by the Profit and Loss Account will have to be adjusted for non-
cash items for finding out cash from operations. Some of these items are as
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follows:i) Depreciation. Depreciation does not result in outflow of cash and, therefore,
net profit will have to be increased by the amount of depreciation or
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development rebate charged, in order to find out the real cash generated from
operations.
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(ii) Amortization of Intangible Assets. Goodwill, preliminary expenses, etc.,when written off against profits, reduce the net profits without affecting the cash
balance. The amounts written off should, therefore, be added back to profits to
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find out the cash from operations.
iii) Loss on Sale of Fixed Assets. It does not result in outflow of cash and,
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therefore, should be added back to profits.iv) Gains from Sale of Fixed Assets. Since sale of fixed assets is taken as a
separate source of cash, it should be deducted from net profits.
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v) Creation of Reserves. If profit for the year has been arrived at after charging
transfers to reserves, such transfers should be added back to profits. In case
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operations show a net loss, such net loss after making adjustments for non-cashitems will be shown as an application of cash.
Thus, cash from operations is computed on the pattern of computation of 'Funds'
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from operations, as explained in an earlier chapter. However, to find out real
cash from operations, adjustments will have to be made for 'changes' in current
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assets and current liabilities arising on account of operations, viz., trade debtors,trade creditors, bills receivable, bills payable, etc.
For the sake of convenience computation of cash from operations can be studied
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by taking two different situations:
(1) When all transactions are cash transactions, and
(2) When all transactions are not cash transactions.
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When all Transactions are Cash Transactions:
The computation of cash from operations will be very simple in this case. The
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net profit as shown by the Profit and Loss Account will be taken as the amountof cash from operations as shown in the following example:
Example (xii):
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PROFIT AND LOSS ACCOUNT (for the year ended 31st Dec.1998)
Dr.
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--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Cr.
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Rs.
--- Content provided by FirstRanker.com ---
Rs.
To Purchases
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15,000
--- Content provided by FirstRanker.com ---
50,000To Wages
10,000
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By Sales
To Rent
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500To Stationery
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2,500
To Net Profit
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22,00050,000
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50,000
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In the example given above, if all transactions are cash transactions, i.e., allpurchases' and expenses have been paid for in cash and all sales have been
realized in cash, the cash from operations will be Rs. 22,000. i.e., the net profit
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shown in the Profit and Loss Account. Thus, in case of all transactions being
cash transactions, the equation for computing cash from operations can be made
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out as follows:--- Content provided by FirstRanker.com ---
Cash for Operations = Net Profit
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When all Transactions are not Cash Transactions:
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In the example given above, we have computed cash from operations on thebasis that all transactions are cash transactions. It does not really happen in
actual practice. The business sells goods on credit. It purchases goods on credit.
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Certain expenses are always outstanding and some of the incomes are not
immediately realized. Under such circumstances, the net profit made by a firm
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cannot generate equivalent amount of cash. The computation of cash fromoperations in such a situation can be done conveniently if it is done in two
stages:
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(i)
Computation of funds (i.e., working capital) from operations.
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(ii)Adjustments in the funds so calculated for changes in the current
assets (excluding cash) and current liabilities.
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We are giving below an illustration for computing 'Funds' from operations.
However, since there are no credit transactions, hence the amount of 'Funds'
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from operations is as a matter of cash from operations as shown below:TRADING AND PROFIT AND LOSS ACCOUNT
for the year ending 31st March, 1998
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Dr.
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--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Cr.
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Rs.Rs.
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Rs.
To Purchases
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20,000By Sales
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30,000
To Wages
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5,000--- Content provided by FirstRanker.com ---
To Gross Profit c/d
--- Content provided by FirstRanker.com ---
5,000--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
30,000--- Content provided by FirstRanker.com ---
30,000
To Salaries
--- Content provided by FirstRanker.com ---
1,000By
Gross
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5,000
Profit/b/d
To Rent
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1,000
By Profit on sale
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out building
To Depreciation on Plant
--- Content provided by FirstRanker.com ---
1,000
Book
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10,000Value
To Loss on sale of 500
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Sold for
15,000 5,000
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furnitureTo Goodwill written off
1,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
To Net Profit
5,500
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
10,000
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
10,000Calculate the cash from operations.
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Solution:
CASH FROM OPERATIONS
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Rs.
Rs.
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Net Profit as per P & L Account
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5,500Non-cash items (items which do not result in
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Add
outflow of cash):
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Depreciation1,000
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Loss on sale of furniture
500
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Goodwill written off
1,000
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2,500
Non-cash items (items which do not result In
8,000
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Inflow of cash):
Profit on sale of building
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5,000
Less:
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(Rs. 15,000 will be taken as a separate source of
cash)
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Cash from operations3,000
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Adjustments for Changes in Current Assets and Current Liabilities
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In the illustration given above, the cash from operations has been computed onthe same pattern on which funds from operations are computed. As a matter of
fact, the fund from operations is equivalent to cash from operations in. this case.
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This is because of the presumption that all are cash transactions and all goods
have been sold. However, there may be credit purchases, credit sales,
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outstanding and prepaid expenses, etc. In such a case, adjustments will have tobe made for each of these items in order to find out cash from operations. This
has been explained in the following pages:
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(i)
Effect of Credit Sales. In business, there are both cash sales and
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credit sales. In case, the total sales are Rs. 30,000 out of which thecredit sales are Rs. 10,000, it means sales have contributed only to
the extent of Rs. 20,000 in providing cash from operations. Thus,
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while computing cash from operations, it will be necessary that
suitable adjustments for outstanding debtors are also made.
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(ii)Effect of Credit Purchases. Whatever has been stated regarding
credit sales is also applicable to credit purchases. The only difference
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will be that decrease in creditors from one period to another will
result in decrease of cash from operations because it means more
cash payments have been made to the creditors which will result in
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outflow of cash. On the other hand, increase in creditors from one
period to another will result in increase of cash from operations
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because less payment has been made to the creditors for goodssupplied which will result in increase of cash balance at the disposal
of the business.
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(iii)
Effect of Opening and Closing Stocks. The amount of opening
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stock is charged to the debit side of the Profit & Loss Account. Itthus reduces the net profit without reducing the cash from operations.
Similarly, the amount of closing stock is put on the credit side of the
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Profit and Loss Account. It thus increases the amount of net profit
without increasing the cash from operations.
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(iv)Effect of Outstanding Expenses, Incomes received in Advance,
etc. The effect of these items on cash from operations is similar to the
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effect of creditors. This means any increase in these items will result
in increase in cash from operations while any decrease means
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decrease in cash from operations. This is because net profit fromoperations is computed after charging to it all expenses whether paid
or outstanding. In case certain expenses have not been paid, this will
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result in decrease of net profit without a corresponding decrease in
cash from operations. Similarly, income received in advance is not
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taken into account while calculating profit from operations, since itrelates to the next year. It, therefore, means cash from operations will
be higher than the actual net profit as shown by the Profit and Loss
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Account. Consider the following example:
Example (xiii):
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Net Profit for the year 1998
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10,000Expenses outstanding as on 1.1.1998
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2,000
Expenses outstanding as on 31.12.1998
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3,000
Interest received in advance 1.1.1998
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1,000
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Interest received in advance 31.12.19982,000
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The Cash from Operations will be computed as follows:
Net Profit for the year
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10,000
Add: Expenses outstanding on 31.12.1998
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3,000
--- Content provided by FirstRanker.com ---
Income received in advance on 31.12.1998
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2,000
--- Content provided by FirstRanker.com ---
15,000
--- Content provided by FirstRanker.com ---
Less: Expenses outstanding on 1.1.1998
2,000
--- Content provided by FirstRanker.com ---
Interest received in advance on 1.1.1998
--- Content provided by FirstRanker.com ---
1,000
3,000
--- Content provided by FirstRanker.com ---
Cash from Operations12,000
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Alternatively, Cash from Operations can be computed as follows:
--- Content provided by FirstRanker.com ---
Net profit for the year10,000
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Add: Increase in Outstanding Expenses
--- Content provided by FirstRanker.com ---
1,000Add: Increase in Interest received in Advance
--- Content provided by FirstRanker.com ---
1,000
--- Content provided by FirstRanker.com ---
Cash from Operations12,000
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Thus, the effect of income received in advance and outstanding expenses on
cash from operations can be shown as follows:
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+ Increase in outstanding expenses
+ Increase in income received in advance
Cash from Operations = Net Profit - Decrease in outstanding expenses
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- Decrease in income received in advance
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(v) Effect of Prepaid Expenses and Outstanding Incomes. The effect' of
prepaid expenses and outstanding income on cash from operations is similar to
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the effect of debtors. While computing net profit from operations, the expenses
only for the accounting year are charged to the Profit and Loss Account.
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Expenses paid in advance are not charged to the Profit and Loss Account. Thus,pre-payment of expenses does not decrease net profit for the year but it
decreases cash from operations. Similarly, income earned during a year is
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credited to the Profit arid Loss Account whether it has been received or not.
Thus, income, which has not been received, but which has become due,
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increases the net profit for the year without increasing cash from operations.This will be clear with the help of the following example:
Example (xiv):
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Rs.
--- Content provided by FirstRanker.com ---
Gross Profit30,000
--- Content provided by FirstRanker.com ---
Expenses paid
10,000
--- Content provided by FirstRanker.com ---
Interest received
2,000
--- Content provided by FirstRanker.com ---
The expenses paid include Rs. 1,000 paid for the next year. While interest of Rs.
500 has become due during the year, but it has not been received so far. The net
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profit for the year will be computed as follows:--- Content provided by FirstRanker.com ---
PROFIT AND LOSS ACCOUNTRs.
--- Content provided by FirstRanker.com ---
Rs.
--- Content provided by FirstRanker.com ---
Rs.Rs.
To Expenses paid
--- Content provided by FirstRanker.com ---
10,00
--- Content provided by FirstRanker.com ---
By Gross Profit30,000
--- Content provided by FirstRanker.com ---
0
Less:
--- Content provided by FirstRanker.com ---
Prepaid 1,000 9,000--- Content provided by FirstRanker.com ---
expenses
--- Content provided by FirstRanker.com ---
To Net Profit23,500
--- Content provided by FirstRanker.com ---
By Interest received 2,000
--- Content provided by FirstRanker.com ---
Add:
--- Content provided by FirstRanker.com ---
Interest 500
2,500
--- Content provided by FirstRanker.com ---
accrued--- Content provided by FirstRanker.com ---
32,500
--- Content provided by FirstRanker.com ---
32,500
Now, the cash from operations will be computed as follows:
--- Content provided by FirstRanker.com ---
Rs.
--- Content provided by FirstRanker.com ---
Net Profit for the year23,500
Less: Prepaid Expenses
--- Content provided by FirstRanker.com ---
1,000
--- Content provided by FirstRanker.com ---
Outstanding Interest500
1,500
--- Content provided by FirstRanker.com ---
Cash from operations
--- Content provided by FirstRanker.com ---
22,000
External Sources
--- Content provided by FirstRanker.com ---
The external sources of cash are:
(i)
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Issue of New Shares. In case shares have been issued for cash, the netcash received (i.e., after deducting expenses on issue of shares or
discount on issue of shares) will be taken as a source of cash.
--- Content provided by FirstRanker.com ---
(ii)
Raising Long-term Loans. Long-term loans such as issue of debentures,
--- Content provided by FirstRanker.com ---
loans from Industrial Finance Corporation, State Financial Corporations,I.D.B.I., etc., are sources of cash. They should be shown separately.
(iii)Purchase of Plant and Machinery on Deferred Payments. In case plant
--- Content provided by FirstRanker.com ---
and machinery has been purchased on a deferred payment system, itshould be shown as a separate source of cash to the extent of deferred
credit. However, the cost of machinery purchased will be shown as
--- Content provided by FirstRanker.com ---
an application of cash.
(iv) Short-term Borrowings-Cash Credit from Banks. Short-term borrowings,
--- Content provided by FirstRanker.com ---
etc., from banks increase cash available and they have to be shownseparately under this head.
(v) Sale of Fixed Assets, Investment, etc. It results in generation of cash and
--- Content provided by FirstRanker.com ---
therefore, is a source of cash.
Decrease in various current assets and increase in various current liabilities
--- Content provided by FirstRanker.com ---
may be taken as external sources of cash, if they are not adjusted whilecomputing cash from operations.
Applications of Cash
--- Content provided by FirstRanker.com ---
Applications of cash may take any of the following forms:
(i)
--- Content provided by FirstRanker.com ---
Purchase of Fixed Assets. Cash may be utilized for additional fixedassets or renewals or replacement of existing fixed assets.
(ii)
--- Content provided by FirstRanker.com ---
Payment of Long-term Loans. The payment of long-term loans such
as loans from financial institutions or debentures results in decrease
--- Content provided by FirstRanker.com ---
in cash. It is, therefore, an application of cash.(iii)
Decrease in Deferred Payment Liabilities. Payments for plant and
--- Content provided by FirstRanker.com ---
machinery purchased on deferred payment basis have to be made as
per the agreement. It is, therefore, an application of cash.
--- Content provided by FirstRanker.com ---
(iv)Loss on Account of Operations. Loss suffered on account of business
operations will result in outflow of cash.
--- Content provided by FirstRanker.com ---
(v)Payment of Tax. Payment of tax will result in decrease of cash and
hence it is an application of cash.
--- Content provided by FirstRanker.com ---
(vi)
Payment of Dividend. This decreases the cash available for business
--- Content provided by FirstRanker.com ---
and hence it is an application of cash.(vii) Decrease in Unsecured Loans, Deposits, etc. The decrease in these
liabilities denotes that they have been paid off to that extent. It
--- Content provided by FirstRanker.com ---
results, therefore outflow of cash.
--- Content provided by FirstRanker.com ---
Increase in various current assets or decrease in various current liabilities may
be shown as applications of cash, if changes in these items have not been
--- Content provided by FirstRanker.com ---
adjusted while finding out cash from operations.
Format of a Cash Flow Statement
--- Content provided by FirstRanker.com ---
A cash flow statement can be prepared in the following form.CASH FLOW STATEMENT for the year ending on.................
Balance as on 1.1.19..
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Cash Balance
..........
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Balance...........
--- Content provided by FirstRanker.com ---
Add: Sources of Cash:
___
--- Content provided by FirstRanker.com ---
Issue of Shares
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Raising of Long-term Loans
--- Content provided by FirstRanker.com ---
.........
--- Content provided by FirstRanker.com ---
Sale of Fixed Assets.........
--- Content provided by FirstRanker.com ---
Short-term Borrowings
--- Content provided by FirstRanker.com ---
..........
--- Content provided by FirstRanker.com ---
Cash from operations:..........
--- Content provided by FirstRanker.com ---
Profit as per Profit and Loss Account
--- Content provided by FirstRanker.com ---
..........Add/Less: Adjustment for Non-cash Items
--- Content provided by FirstRanker.com ---
.............
--- Content provided by FirstRanker.com ---
Add: Increase in Current Liabilities...............
--- Content provided by FirstRanker.com ---
Decrease in Current Assets
............
--- Content provided by FirstRanker.com ---
Less: Increase in Current Assets
--
--- Content provided by FirstRanker.com ---
............
--- Content provided by FirstRanker.com ---
Decrease in Current Liabilities............
--
--- Content provided by FirstRanker.com ---
--- Content provided by FirstRanker.com ---
Total Cash available (1)--
............
--- Content provided by FirstRanker.com ---
Less: Applications of Cash:
--- Content provided by FirstRanker.com ---
--Redemption of Redeemable Preference Shares
--- Content provided by FirstRanker.com ---
........
--- Content provided by FirstRanker.com ---
Redemption of Long-term Loans..........
Purchase of Fixed Assets
--- Content provided by FirstRanker.com ---
........
Decrease in Deferred Payment Liabilities
--- Content provided by FirstRanker.com ---
............Cash Outflow on account of Operations
.............
--- Content provided by FirstRanker.com ---
Tax paid
............
--- Content provided by FirstRanker.com ---
Dividend paid...........
Decrease in Unsecured loans, Deposits, etc.,
--- Content provided by FirstRanker.com ---
............
Total Applications (2)
--- Content provided by FirstRanker.com ---
............Closing Balances*
.............
--- Content provided by FirstRanker.com ---
Cash balance
Bank balance
* These totals should tally with the balance as shown by (1) - (2).
--- Content provided by FirstRanker.com ---
DIFFERENCE BETWEEN CASH FLOW ANALYSIS AND FUNDS
--- Content provided by FirstRanker.com ---
FLOW ANALYSISFollowing are the points of difference between a Cash Flow Analysis and a
Funds Flow Analysis:
--- Content provided by FirstRanker.com ---
(1) A Cash Flow Statement is concerned only with the change in cash position
while a Funds Flow Analysis is concerned with change in working capital position
--- Content provided by FirstRanker.com ---
between two balance sheet dates. Cash is only one of the constituents of workingcapital besides several other constituents such, as inventories, accounts receivable,
prepaid expenses.
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(2)
A Cash Flow Statement is merely a record of cash receipts, and
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'disbursements. Of course, it is valuable in its own way but it fails tobring to light many important changes involving the disposition of
resources. While studying the short-term solvency of a business one is
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interested not only in cash balance but also in the assets which are easily
convertible into cash.
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(3)Cash flow analysis is more useful to the management as a tool of
financial analysis in short period as compared to funds flow analysis. It
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has rightly been said that shorter the period covered by the analysis,
greater is the importance of cash flow analysis. For example, if it is to be
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found out whether the business can meet its obligations maturing after 10years from now, a good estimate can be made about firm's capacity to
meet its long-term obligations if changes in working capital position on
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account of operations are observed. However, if the firm's capacity to
meet a liability maturing after one month is to be seen, the realistic
approach would be to consider the projected change in the cash position
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rather than an expected change in the working capital position.
(4)
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Cash is part of working capital and, therefore, an improvement in cashposition results in improvement in the funds position but the reverse is
not true. In other words, "inflow of cash" results in "inflow of funds" but
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"inflow of funds" may not necessarily result in "inflow of cash". Thus
sound funds position does not necessarily mean a sound cash position
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but a sound cash position generally means a sound funds position.(5)
Another distinction between a cash flow analysis and a funds flow
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analysis can be made on the basis of the techniques of their preparation.
An increase in a current liability or decrease in a current asset results in
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decrease in working capital and vice versa. While an increase in acurrent liability or decrease in current asset (other than cash) will result
in increase in cash and vice versa,
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Some people, as stated earlier, use term 'Funds' in a very narrow sense of cash
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only. In such an event the two terms 'Funds' and 'Cash' will have synonymous inmeanings.
UTILITY OF CASH FLOW ANALYSIS
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A Cash Flow Statement is useful for short-term planning. A business enterprise
needs sufficient cash to meet its various obligations in the near future such as
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payment for purchase of fixed assets, payment of debts maturing in the nearfuture, expenses of the business, etc. A historical analysis of the different
sources and applications of cash will enable the management to make reliable
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cash flow projections for the immediate future. It may then plan out for
investment of surplus or meeting the deficit, if any. Thus, a cash flow analysis is
an important financial tool for the management. Its chief advantages are as
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follows:
1. Helps in Efficient Cash Management
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Cash flow analysis helps in evaluating financial policies and cash position. Cashis the basis for all operations and hence a projected cash flow statement will
enable ill management to plan and co-ordinate the financial operations properly.
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The management can know how much cash is needed, from which source it will
be derived, how much can be generated internally and how much could be
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obtained from outside.2. Helps in Internal Financial Management
Cash flow analysis provides information about funds which will be available
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from operations. This will help the management in determining policies
regarding internal financial management, e.g., possibility of repayment of long-
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term debt, dividend policies, planning replacement of plant and machinery, etc.3. Discloses the Movements of Cash
Cash flow statement discloses the complete story of cash movement. The
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increase in or decrease of, cash and the reason therefore can be known. It
discloses the reasons for low cash balance in spite of heavy operating profits or
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for heavy cash balance in spite of low profits. However, comparison of originalforecast with the actual results highlights the trends of movement of cash which
may otherwise go undetected.
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4. Discloses Success or Failure of Cash Planning
The extent of success or failure of cash planning can be known by comparing
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the projected cash flow statement with the actual cash flow statement andnecessary remedial measures can be taken.
LIMITATIONS OF CASH FLOW ANALYSIS
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Cash flow analysis is a useful tool of financial analysis. However, it has its ownlimitations. These limitations are as under:
(1) Cash flow statement cannot be equated with the Income Statement. An Income
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Statement takes into account both cash as well as non-cash items and, therefore, net
cash flow does not necessarily mean net income of the business.
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(2) The cash balance as disclosed by the cash flow statement may not represent the
real liquid position of the business since it can be easily influenced by postponing
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purchases and other payments.
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(3)Cash flow statement cannot replace the Income Statement or the Funds
Flow Statement. Each of them has a separate function to perform.
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In spite of these limitations, it can be said that cash flow statement is a useful
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supplementary instrument. It discloses the volume as well as the speed at whichthe cash flows in the different segments of the business. This helps the
management in knowing the amount of capital tied up in a particular segment of
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the business. The technique of cash flow analysis, when used in conjunction
with ratio analysis, serves as a barometer in measuring the profitability and
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financial position of the business.The concept and technique of preparing a Cash Flow Statement will be clear
with the help of the following illustration.
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Cash from Operations
From the following balances, you are required to calculate cash from operations:
December 31
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1997
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1998Rs.
Rs.
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Debtors
50,000
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47,000Bills Receivable
10,000
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12,500
Creditors
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20,00025,000
Bills Payable
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8,000
6,000
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Outstanding Expenses1,000
1,200
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Prepaid Expenses
800
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700Accrued Income
600
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750
Income received in Advance
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300250
Profit made during the year
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-
1,30,000
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Solutions:
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CASH FROM OPERATIONS
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December 31st1997
1998
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Rs.
Rs.
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Profit made during the year1,30,000
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Add:--- Content provided by FirstRanker.com ---
Decrease in Debtors
3,000
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Increase in Creditors
5,000
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Increase in Outstanding Expenses
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200Decreases in prepaid expenses
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100
8,300
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1,38,300
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Less:
Increase in Bills Receivable
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2,500Decrease in Bills payable
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2,000
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Increases in Accrued Income150
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Decrease in Income received in advance
50
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4,700Cash from Operations
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1,33,600
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SECTION ? BContemporary Issues in Management Accounting: Value Chain Analysis;
Activity-Based Costing; Quality costing; Target and Life-Cycle Costing.
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In this section, we will introduce you to Value chain analysis; Activity based
costing; Quality costing; the concept, phases and benefits of Target costing;
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Life-cycle costing (Production and Project). After you workout this section, youshould be able to:
develop the power of understanding the important issues in the
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area of Management Accounting.
decide the use of costing in Management Accounting.
VALUE CHAIN ANALYSIS
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Value chain is the linked set of value-creating activities from the basic raw
material sources for suppliers to the ultimate end-use product delivered into the
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final customers' hands. No individual firm is likely to span the entire valuechain. Each firm must be understood in the context of the overall value chain of
value-creating activities. Note that the value chain requires an external focus,
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unlike conventional management accounting in which the focus is internal to the
firm. According to Michael Porter, a business unit can develop a sustainable
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competitive advantage based on cost or on differentiation or on both, as shownin the following diagram.
Developing Competitive Advantage:
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Differentiation
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Differentiation
with Cost
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Advantage
Superior
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Advantage--- Content provided by FirstRanker.com ---
Relative
Stuck-in-the
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Low CostDifferentiation
Middle
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Advantage
Position
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Inferior
Relative Cost Position
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The primary focus of the low-cost strategy is to achieve low cost relative tocompetitors. Cost leadership can be achieved through, for example, economies
of scale of production, learning curve effects, tight cost control, cost
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minimization in R&D, service sales force, or administration. Examples of
companies following the low-cost strategy are Nirma in detergents, Shiva in
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computers, and Times in wrist watches.The differentiation strategy consists in differentiating the product by creating
something perceived as unique. Product differentiation can be achieved through
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brand loyalty, superior customer service, dealer network, and product design and
features. Examples of companies following the differentiation route are
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Hindustan Lever in detergents, WIPRO in computers and Titan in wrist watches.Whether or not a firm can develop and sustain differentiation or cost advantage
or differentiation with cost advantage depends on how well the firm manages its
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value chain relative to the value chain of its competitors. Value chain analysis is
essential to determine exactly where in the chain customer value can be
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enhanced or costs lowered.Note that no single firm spans the entire value chain in which it operates.
Typically, a firm is only apart of the larger set of activities in the value delivery
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system. The value chain concept highlights four profit improvement areas:
l.
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Linkages with suppliers2.
Linkages with customers
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3.
Process linkages within the value chain of a business unit
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4.Linkages across business unit value chain within.
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ACTIVITY-BASED COSTING
Applying overhead costs to each product or service based on the extent to which
that product or service causes overhead cost to be incurred is the primary
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objective of accounting for overhead costs. In many production processes, when
overhead is applied to products using a single pre-determined overhead rate
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based on a single activity measure. With Activity-Based Costing (ABC),multiple activities are identified in the production process that is associated with
costs. The events within these activities that cause work (costs) are called cost
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drivers. Examples of overhead cost drivers are machine setups, material-
handling operations, and the number of steps in a manufacturing process.
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Examples of costs drivers in non-manufacturing organizations are hospital bedsoccupied, the number of take-offs and lending for an airline, and the number of
rooms occupied in a hotel. The cost drivers are used to apply overhead to
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products and services when using ABC.
The following five steps are used to apply costs to products under an ABC
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system:1.
Choose appropriate activities
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2.
Trace costs to activities
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3.Determine cost drivers for each activity
4.
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Estimate the application rate for each cost driver
5.
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Apply costs to products.These steps are discussed in more detail above.
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Choose Appropriate Activities
Involve producing a product or providing a service. The various activities within
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an organization. The first step of ABC is to choose the activities that will be theintermediate cost objectives of overhead costs. These activities do not
necessarily coincide with existing departments but rather represent a group of
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transactions that support the production process. Typical activities used in ABCare designing, ordering, scheduling, moving materials, controlling inventory,
and controlling quality.
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Each of these activities is composed 'of transactions that result in costs. More
than one cost pool can be established for each activity. A cost pool is an account
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to record the costs of an activity with a specific cost driver.Trace Costs to Activities
Once the activities have been chosen, costs must be traced to the cost pools for
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different activities. To facilitate this tracing, cost drivers are chosen to act as
vehicles for distributing costs. These cost drivers are often called resource
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drivers. A pre-determined rate is estimated for each resource driver.Consumption of the resource driver in combination with the pre-determined rate
determines the distribution of the resource costs to the activities.
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Determine Cost Drivers for Activities
Cost drivers for activities are sometimes called activity drivers. Activity drivers
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represent the event that causes costs within an activity. For example, activitydrivers for the purchasing activity include negotiations with vendors, ordering
materials, scheduling' their arrival, and perhaps inspection. Each of these
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activity drivers represents costly procedures that are performed in the purchasing
activity. An activity driver is chosen for each cost pool. If two cost pools use the
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same cost driver, then the cost pools could be combined for product-costingpurposes.
Cooper has developed several criteria for choosing activity drivers. First, the
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data on the cost driver must be easy to obtain. Second, the consumption of the
activity implied by the activity driver should be highly correlated with the actual
consumption of the activity. The third criterion to consider is the behavioral
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effects induced by the choice of the activity driver. Activity drivers determine
the application of costs, which in turn can affect individual performance
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measures.The judicious use of more activity drivers increases the accuracy of product
costs. Ostrenga concludes that there is a preferred sequence for accurate product
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costs. Direct costs are the most accurate in applying costs to products. The
application of overhead costs through cost drivers is the next most accurate
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process. Any remaining overhead costs must be allocated in a somewhatarbitrary manner, which is less accurate.
Estimate Application Rates for each Activity Driver
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An application rate must be estimated for each activity driver. A pre-determined
rate is estimated by dividing the cost pool by the estimated level of activity of
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the activity driver. Alternatively, an actual rate is determined by dividing theactual costs of the cost pool by the actual level of activity of the activity driver.
Standard costs, could also be used to calculate a pre-determined rate.
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Applying Costs to Products
The application of costs to products is calculated by multiplying the application
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rate times the usage of the activity driver in manufacturing a product orproviding a service.
Examples of Activity-Based Costing
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Modison Motors Inc. produces electric motors. The company makes a standard
electric-starter motor for a major auto manufacturer and also produces electric
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motors that are specially ordered. The company has four essential activities:design, ordering, machinery, and marketing. Modison Motors incurs the
following costs during the month of, January:
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Standard MotorsSpecial Order Motors
Direct Labor
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Rs. 10,00,000
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Rs. 2,00,000Direct materials
Rs. 30,00,000
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Rs. 10,00,000
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Overhead:--- Content provided by FirstRanker.com ---
Indirect labour
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Rs. 35,00,00
Depreciation of building
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Rs. 2,00,000
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Depreciation of equipmentRs.
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10,00,000
Maintenance
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Rs. 3,00,000
Utilities
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Rs.
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10,00,000
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Rs.
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60,00,000
Traditional cost accounting would apply the overhead costs based on a single
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measure of activity. If direct labor dollars were used, then the overhead rate
would be Rs.60, 00,000 / (Rs.10, 00,000 + Rs.2, 00,000), or Rs.5, per direct-
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labor dollar. Hence: Overhead to standard motors= (Rs.5/Direct-labor dollar)(Rs. 10,00,000 of direct labor)
= Rs. 50,00,000
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Overhead to special-order motors
= (Rs.5/Direct-labor dollar)(Rs.2,00,000 of direct labor) = Rs. 10,00,000
With ABC, activities are chosen and the overhead costs are distributed to cost
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pools within these activities through resource drivers. The costs of activities are
then applied to products through activity drivers. Suppose that Modison Motors
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uses the following activities: designing, ordering, machining, and marketing.Each activity has one cost pool. The overhead costs are distributed to the cost
pools of the activities using the following resource drivers:
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Overhead Account
Resource Driver
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Indirect laborLabor dollars
Depreciation of building
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Square feet of building
Depreciation of equipment
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Machine timeMaintenance
Square feet of building
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Utilities
Amps used
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The usages of the resource drivers by activity are:Designin Orderin
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Machining Marketing Totals
g
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g10,00,00
Labor Dollars
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20,000
1,00,000
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1,30,0003,50,000
0
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Sq.ft
of 50,000 30,000 1,00,000 20,000
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2,00,000building
Machine time
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0
0
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10,00,0000
10,00,000
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Amps
2,00,000 1,00,000 16,00,000
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1,00,00020,00,000
The resource driver application rates are calculated by dividing overhead costs
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by total resource driver usage:
Overhead Resource
Cost of
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Total Driver Application
Account
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DriverOverhead Usage
Rate
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Indirect labor Labor dollars Rs.35,00,000 Rs.3,50,000
Rs,10/ Labor dollar
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Depreciation Square feet of2,00,000
2,00,000
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Rs.1/sq.ft.
of building building
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SqftDepreciation
50.000
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Machine time 10,00,000
Rs.20/hr.
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of machineryhrs.
Sq.
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ft.
of
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2,00,000Maintenance
3,00,000
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Rs.1.50/sq.ft.
building
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sqft.20,00,000
Utilities
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Amps used
10.00.000
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0.50/ampamps
By multiplying the application rate times the resource usage of each activity,
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overhead costs can be allocated to the different activities. For example, the cost
of the indirect labor allocated to the designing activity is Rs. 10/labor dollar
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times Rs. 10,000 in labor, or Rs. 100,000.Designing Ordering Machining
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Marketing Totals
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Rs.Rs.
Rs.
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Rs.
Rs.
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Indirect labor 10,00,000 2,00,00010,00,000
13,00,000
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35,00,000
Depreciation 50,000 30,000 1,00.000
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20,0002,00,000
of building
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Depreciation
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10,00,00010,00,000
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of equipment
Maintenance 75,000
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45,0001,50,000
30.000
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3,00,000
Utilities
1,00,000
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50,000
8,00,000
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50,00010,00,000
Totals
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12,25.000 3,25,000
30,50,000
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14,00,00060,00,000
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Once the overhead costs have been distributed to the activity cost pools, activity
drivers must be chosen to apply the costs to the .products. Suppose the following
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activity drivers are chosen:Activity
Activity Driver
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Designing
Design changes
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OrderingNumber of orders
Matching
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Machine time
Marketing
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Number of contract with customerModison Motors uses actual costs and activity levels to determine the
application rates shown below:
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Costs 0f
Total Driver
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Activity DriverApplication Rate
Activity
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Usage
Design changes
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RS.12,25,000 12,250 changesRs. 1 00 /change
Number 0f orders 3.25,000
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6,500 orders
RS.50 /order
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Machine time30,50.000
152.5 hours
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RS.2000 / hour
Number of contracts 14.00,000
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7,000 contractsRs.200 /contract
The application rates are then multiplied by the cost driver usage for each
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product to determine the costs applied to each product.
Product
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ActivityApplication Rate Driver Usage
Cost
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StandardDesigning
Rs. 100/change
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225 changes
Rs.22,500
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Ordering
Rs.50/order
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150 orders
7,500
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Machining Rs.2000/hour
100 hours
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200,000
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Marketing Rs.200/contract200 contracts
40,000
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Total overhead costs applied to the standard electric motors
Rs.270,000
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Special-Designing
1000 changes
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Rs.100,000
Rs.100/change
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ordered--- Content provided by FirstRanker.com ---
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Ordering Rs.50/order500 orders
25,000
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Machining RS.2000 / hour
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52.5 hours105,000
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Marketing Rs.200 /contract
500 contract
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100,000Total overhead costs applied to the special-order motors
Rs.330,000
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The ABC method applied a much higher amount of the overhead cost to the
special-order electric motors than when all overhead was applied by direct-labor
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dollar (Rs.330, 000 versus Rs.100, 000). The reason for the greater overheadapplication to the special-order electric motors is the greater usage of the
activities that enhance the manufacturing of the electric motors during their
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production. Use of direct-labor dollars to allocate overhead does not recognize
the extra overhead requirements of the special-order electric motors.
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Misapplication of overhead could lead to inappropriate product line decisions.The greater the diversity of requirements of products on overhead-related
services and other overhead costs, the greater the need for an ABC system.
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Other Benefits of Activity-Based Costing
ABC is valuable for planning, because the establishment of an ABC system
requires a careful study of the total manufacturing or service process of an
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organization. ABC highlights the causes of costs. An analysis of these causes
can identify activities that do not add to the value of the product. These activities
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include moving materials and accounting for transactions. Although theseactivities cannot be completely eliminated, they may be reduced. Recognition of
how various activities affect costs can lead to modifications in the planning of
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factory layouts and increased efforts in the design process stage to reduce future
manufacturing costs.
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An analysis of activities can also lead to better performance measurement.Workers on the line often understand activities better than costs and can be
evaluated accordingly. At higher management levels, the activities can be
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aggregated to coincide with responsibility centers. Managers would be
responsible for the costs of the activities associated with their responsibility
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centers.Weaknesses of Activity-Based Costing
First, ABC is based on historical costs. For planning decisions, future costs are
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generally the relevant costs. Second, ABC does not partition variable and fixed
costs. For many short run decisions, it is important to identify variable costs.
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Third, ABC is only as accurate as the quality of the cost drivers. The distributionand application of costs becomes an arbitrary allocation process when the cost
drivers are not associated with the factors that are causing costs. And finally,
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ABC tends to be more costly than the more traditional methods of applying
costs to products.
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QUALITY COSTINGThe benefits from increased product quality come in lower costs for reworking
discovered defective units and from more satisfied customers who find fewer
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defective units. The cost of lowering the tolerance for defective units results
from the increased costs of using a better production technology. These costs
could be due to using more highly skilled and experienced workers, from using a
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better grade of materials, or from acquiring updated production equipment.
A quality-costing system monitors and accumulates the costs incurred by a firm
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in maintaining or improving product quality.Measuring Quality Costs
The quality costs discussed here deal with costs associated with quality of
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conformance as opposed to costs associated with quality of design. Quality of
design refers to variations in products that have the same functional use.
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Quality of Conformance refers to the degree with which the final product meetsits specifications. In other words, quality of conformance refers to the product's
fitness for use. If products are sold and they do not meet the consumers'
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expectations, the company will incur costs because the consumer is unhappy
with the product's performance. These costs are one kind of quality costs that
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will be reduced if higher-quality products are produced. Thus higher quality maymean lower total costs when quality of conformance is considered.
The costs associated with quality of conformance generally can be classified
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into four types: prevention costs, appraisal costs, internal failure costs, and
external failure costs. The prevention and appraisal costs occur because a lack of
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quality of conformance can exist. The internal and external failure costs occurbecause a lack of quality of conformance does exist.
Prevention Costs are the costs incurred to reduce the number of defective units
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produced or the incidence of poor-quality service. Prevention costs begin with
the designing and engineering of the product or service. Designers and engineers
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should work together to develop a product that is easy to assemble with aminimal number of mistakes.
Appraisal Costs are the costs incurred to ensure that materials, products, and
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services meet quality standards. Appraisal costs begin with the inspection of rawmaterials and part from vendors. Further inspection costs are incurred
throughout the production process. Quality audits and reliability tests are
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performed on products and services to determine if they meet quality standards.
Appraisal costs also occur through field inspections at the customer site before
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the final release of the product.Internal Failure Costs are the costs associated with materials and products that
fail to meet quality standards and result in manufacturing losses. These defects
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are identified before they are shipped to customers. Scrap and the costs of
spoiled units that cannot be salvaged are internal failure costs. The cost of
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analyzing, investigating and reworking defects is also internal failure costs.Defects create additional costs because they lead to down time in the production
process.
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External Failure Costs are the costs incurred when inferior-quality products or
services are sold to customers. These costs begin with customer complaints and
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usually lead to warranty repairs, replacement, or product recall.The problem management faces is choosing the desired level of product quality.
If all the costs can be measured accurately, then the desired level of product
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quality occurs when the sum of prevention, appraisal, and failure costs is
minimized. Quality costs are minimized at a specific percentage of planned
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defects.The magnitude of quality costs has prompted many companies to install quality-
costing systems to monitor and help reduce the costs of achieving high-quality
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production. Several examples follow.
Quality at Bavarian Motor Works (BMW)
Quality Costs in Banking
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Reducing Quality Costs at TRW
Cost of a faulty electrical component at Hewlett-Packard
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Although the concepts of quality costing are easy to understand, the costmeasurement of many quality efforts is difficult. Many of the costs are not
isolated in a traditional cost accounting system, and some costs are opportunity
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costs that are not part of a historical cost accounting system.
Quality cost reports provide management with only a partial picture of the costs
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of quality. Management would also like to know the potential trade-off amongthe different types of quality costs relating to new technologies. Cost trade-offs
are not part of a historical cost accounting system, and estimates of these cost
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trade-offs must be made.
Typical Quality Cost Report
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Current months cost Percentage of TotalPrevention costs:
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Quality training
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Rs.2,0001.3%
Reliability engineering
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10.000
6.5
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Pilot studies5,000
3.3
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Systems development
8,000
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5.2Total prevention
RS.25,000
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16.3%
Appraisal costs:
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Materials inspection
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Rs. 6,000
.3.9%
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Supplies inspection3,000
2.0
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Reliability testing5,000
3.3
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Laboratory
25,000
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16.3Total appraisal
Rs. 39,000
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25.5%
Internal failure costs:
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Scrap
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Rs.15,000
9.8%
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Repair18,000
11.8
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Rework
12,000
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7.8Down time
6.000
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3.9
Total internal failure
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Rs. 51.00033.3%
External failure costs:
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Warranty costsRs. 14.000
9.2%
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Out-of-warranty
repairs 6.000
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3.9and replacement
Customer complaints
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3.000
2.0
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Product liability10.000
6.5
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Transportation losses
5,000
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3.3Total external failure
Rs. 38.000
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24.9%
Total quality costs
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Rs.153,000100.0%
Total Quality Control
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Total quality control (TQC) is a management process based on the belief that
quality costs are minimized with zero defects. The phrase quality is free is
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commonly advocated by proponents of TQC, who argue that the reduction offailure costs due to improved quality outweigh additional prevention and
appraisal costs.
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It is not surprising, then, that U.S. Auto Manufacturers have recently becomeleaders in advocating TQC.
TQC begins with the design and engineering of the product. Designing a product
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to be resistant to workmanship defects may not be incrementally more costly
than the present design process, but the reduction in other quality costs can be
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substantial.TQC is often associated with just-in-time (JIT) manufacturing. Under JIT each
worker is trained to be a quality inspector. Therefore teams specializing in
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quality inspection become unnecessary. With suppliers delivering high-quality
parts and materials, a company can substantially reduce if not eliminate
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appraisal costs.Total quality control is sometimes referred to as total quality management
(TQM) because a completely new orientation must be taken by management to
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make TQC successful. New performance measures that reinforce quality
improvements must be initiated. Standard cost variance such as the materials
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price variance and labor efficiency variance tend to emphasize price andquantity rather than quality and should not be used to reward employees. The
productivity measures described in the next section are more useful in
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motivating workers to achieve both quality and productivity.
TARGET COSTING
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IntroductionTarget costing has recently received considerable attention. Computer Aided
Manufacturing-International defines target cost as "a market-based cost that is
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calculated using a sales price necessary to capture a predetermined market
share." In competitive industries a unit sales price would be established
independent of the initial product cost. If the target cost is below the initial
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forecast of product cost, the company drives the unit cost down over a designed
period to compete.
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Target cost = Sales price (for the target market share) - Desired profitJapanese cost management is known to be guided by the concept of target cost.
Management decides, before the product is designed, what a product should
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cost, based on marketing (rather than manufacturing) factors. The following
write-up on target costing for the Sony Walkman describes the target costing
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approach.The Walkman: Setting the price before the Cost
Sony's Walkman was a classic example of how a company uses the "PROFITS =
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SALES - COSTS" equation to full advantage: First set the price at which the
customer will buy, then bring down your costs so you can make profits. "I
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dictated the selling price (of the Walkman) to suit a young person's pocketbook,even before we made the first machine," wrote Sony Corp. Chairman Akio
Morita in his book Made In Japan. "I said I wanted the first models ... to retail
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for no more than Yen 30,000. The accountants protested but I persisted. I told
them I was confident we would be making our new product in very large
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numbers and our cost would come down as volume climbed."The target costing philosophy leads to a market-driven approach to accounting.
Target costs are conceptually different from standard costs. Standard costs are
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predetermined costs built up from an internal analysis by industrial engineers.
Target costs are based on external analysis of markets and competitors. Several
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Japanese firms are known to compute two separate variances, one comparingactual costs with target costs and other comparing actual costs with standard
costs.
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While introducing a new product, a company might test the market to determinethe price it can charge in order to be competitive with products already on the
market of similar function and quality. A target cost is the maximum
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manufactured cost for a product. It is arrived at by subtracting its expected
market price from the required margin on sales.
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Target costing is a market-driven design methodology. It estimates the cost for aproduct and then designs the product to meet that cost. It is used to encourage
the various departments involved in design and production to find less expensive
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ways of achieving similar or better product features and quality.
It is a cost management tool which reduces a product's costs over its entire life
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cycle. Target costing includes actions management must take to: establishreasonable target costs, develop methods for achieving those targets, and
develop means by which to test the cost effectiveness of different cost-cutting
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scenarios.
There are several phases to the methodology.
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Conception (Planning) PhaseBased upon its strategic business plans, a company must first establish what type
of product it wishes to manufacture.
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Traditionally (before target costing), once the type of product was determined,
its development was assigned to the product design department. Then the
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produced product was sent to the costing department, which assessed the cost ofthe design and frequently found it more expensive to produce than the market
would tolerate.
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The design was then returned to the design department with instructions to
reduce its costs, usually by promising its quality. The product design was sent
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back and forth between the two departments until consensus was reached. Theproduct was then sent to the manufacturing department, which often concluded
that it was impossible to manufacture it in its proposed e. It was then sent back
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to the design department, so on. Much time, money and effort were spent [orethe product reached the production stage. As a result, profit suffered.
Under target costing, a product's design begins at the opposite end. It first
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establishes a price at which the product can be competitive and then assigns a
team to develop cost scenarios and search for ways to design d manufacture the
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product to meet those cost constraints. Several steps must be taken in order toestablish a reasonable target cost.
i)
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Market research should be done to determine several factors. First,
the products of competitors' should be analyzed with regard to price,
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quality, service and support, delivery, and technology. After apreliminary test of competitor's product, it is necessary to establish
the features consumers value in this type of product, and the
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important features that are lacking.
ii)
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After preliminary testing, a company should be able to pinpoint amarket niche it believes is undersupplied, and in which it believes it
might have some competitive advantage. Only then can a company
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set a target cost close to competitors' products of similar functions
and value. The target cost is bound to change in the development and
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design stages. However, the new target costs should only be allowedto decrease, unless the company can provide added features that add
value to the product.
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Development Phase
The company must find ways to attain the target cost. is involves a number of
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steps.1.
First, an in-depth study of the most competitive product on the market
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must be conducted. This study will show what materials were used andwhat features are provided, and it will give an indication of the
manufacturing process needed to complete the product.
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Once a better understanding of the design has been achieved, the
organization can target the costs against this "best" design. But its
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competition will probably be engaged in similar analysis and will furtherimprove its product toward this "best" design. It is necessary when
performing comparative cost analysis, and trying to establish the
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competitor's cost structure, that adequate attention be paid to the
competitive advantages of the competitor, such as technology, location,
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and vertical integration.2.
After trying to identify the cost structure of the competitor, the company
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should develop estimates for the internal cost structure of its own
products. This is most effectively done by analyzing internal costs' of
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similar products already being produced by the company and should takeinto account the different needs of the new product in assessing these
costs.
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3.
After preliminary analysis of the cost structures of both the competition
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and itself, the company should further define these cost structures interms of cost drivers. Focusing on cost drivers can help reduce waste,
improve quality, minimize non-value-added activities, and identify
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ineffective product design. The use of multiple drivers leads both to a
better understanding of the inputs and resources required to produce
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products, and a better cost analysis through more detailed costinformation.
When enough cost information is available, the product development team is
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able to generate cost estimates under different scenarios. After this, thedesigners, manufacturers, marketers, and engineers on the team should conduct
a session of brainstorming to generate ideas on how to substantially reduce costs
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(by smoothing the process, using different materials, and so on) or add a number
of different features to the product without increasing target costs. In these
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brainstorming sessions, no idea is rejected, and the best ideas are integrated intothe development of the product.
Production Phase
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In these stages, target costing becomes a tool for reducing costs of existing
products. It is highly unlikely that the design, manufacturing, and engineering
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groups will develop the optimal, cost-efficient process at the beginning ofproduction. The search for better, less expensive products should continue in the
framework of continuous improvement.
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1.
The ABC technique can be useful as a tool for target costing of existing
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products. ABC assists in identifying non value-added activities and canbe used to develop scenarios on how to minimize them. Target costing at
the activity level makes opportunities for cost reduction highly visible.
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2. Target costing is also strongly linked to consumer requirement, and tries to
identify the features such as performance specifications, services, warranties, and
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delivery consumers want products to provide. These consumers may also bequestioned about which features they prefer in products, and how much they are
worth to them. The surveys on preferable features and value of these features help
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management do cost-benefit analysis on different features of a product, and then try
to reduce costs on features that are not ranked highly.
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3.Target costing also provides incentives to move toward less expensive
means of production, as well as production techniques that provide a
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more even flow of goods. JIT provides an environment where there is
better monitoring of costs and product quality as well as access to ideas
for continues improvement and better production strategies.
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BENEFITS OF TARGET COSTING
1.
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The process of target costing provides detailed information on the costsinvolved in producing a new product, as well as a better way of testing
different cost scenarios through the use of ABC.
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2.
Target costing reduces the development cycle of a product. Costs can be
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targeted at the same time the product is being designed, bringing in theresources of the manufacturing and finance departments to ensure that all
avenues of cost reduction are being explored and that the product is
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designed for manufacturability at an early stage of development.
3.
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The internal costing model, using ABC, can provide an excellentunderstanding of the dynamics of production costs and can detail ways to
eliminate waste, reduce non-value-added activities, improve quality,
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simplify the process, and attack the root causes of costs (cost drivers). It
can also be used for measuring different cost scenarios to ensure that the
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best ideas available are incorporated from the outset into the productiondesign.
4.
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The profitability of new products is increased by target costing through
promoting reduction in costs while maintaining or improving quality. It
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also helps in promoting the requirements of consumers, which leads toproducts that better reflect consumer needs and find better acceptance
than existing products.
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5.
Target costing is also used to forecast future costs and to provide
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motivation to meet future cost goals.6.
Target costing is very attractive because it is used to control costs before
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the company even incurs any production costs, which save a great dealof time and money.
7.
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There is one major drawback to target costing. It is difficult to use with
complex products that require many subassemblies, such as automobiles.
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This is because tracking costs becomes too complicated and tedious, andcost analysis must be performed at so many levels.
LIFE CYCLE COSTING
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CAM-l defines life-cycle costing as "the accumulation of costs for activities that
occur over the entire life cycle of a product, from inception to abandonment by
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the manufacturer and the customer," Life-cycle analysis provides a frameworkfor managing the cost and performance of a product over the duration of its life.
The life-cycle commences with the initial identification of a consumer need and
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extends through planning, research, design, development, production, and
evaluation, and use, logistics support in operation, retirement, and disposal.
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Life-cycle is important to cost control because of the interdependencies ofactivities in different time periods. For example, the output of the design activity
has a significant impact on the cost and performance of subsequent activities.
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Cost systems have focused primarily on the cost of physical production, without
accumulating costs over the entire design, manufacture, market, and support
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cycle of a product. Resources committed to the development of products and themanufacturing process represents a sizeable investment of capital. The benefits
accrue over many years, and under conventional accounting, are not directly
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identified with the product being developed. They are treated instead as a period
expense and allocated to all products. Even companies which use life-cycle
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models for planning and budgeting new products do not integrate these modelsinto cost systems. It is important to provide feedback on planning effectiveness
and the impact of design decisions on operational and support costs. Period
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reporting hinders management's understanding of product-line profitability andthe potential cost impact of long-term decisions such as engineering design
changes. Life-cycle costing and reporting provide management with a better
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picture of product profitability and help managers to gauge their planning
activities.
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Product Life Cycle Costing:The cycle begins with the identification of new consumer need and the invention
of a new product and is often followed by patent protection and further
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development to make it saleable. This is usually followed by a rapid expansion
in its sales as the product gains market acceptance. Then competitors enter the
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field with imitation and rival products and the distinctiveness of the new productstarts diminishing. The speed of degeneration differs from product to product.
The innovation of a new product and its degeneration into a common product is
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termed as the 'life cycle of a product'.
Characteristics
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The major characteristics of product life-cycle concept are as follows:The products have finite lives and pass through the cycle of
development, introduction, growth, maturity, decline and deletion at
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varying speeds.
Product cost, revenue and profit patterns tend to follow predictable
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courses through the product life cycle. Profits first appear during thegrowth phase and after stabilizing during the maturity phase, decline
thereafter to the point of deletion.
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Profit per unit varies as products move through their life cycles.
Each phase of the product life-cycle poses different threats and
opportunities that give rise to different strategic actions.
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Products require different functional emphasis in each phase - such as an
R&D emphasis in the development phase-arid a cost control emphasis in
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the decline.Activities in product life cycle
Typically the life cycle of a manufactured product will consist of the following
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activities:
1. Market research 2. Specification 3. Design 4. Prototype manufacture
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5. Development of the product Tooling 7. Manufacturing 8. Selling9. Distribution 10. Product support through after sales service
10. Decommissioning or Replacement.
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Phases in Product Life-Cycle
There are five distinct phases in the life cycle of a product as shown.
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Introduction phase: The Research and engineering skills lead to productdevelopment and when the product is put on the market and its awareness and
acceptance are minimal. Promotional costs will be high, sales, revenue low and
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profits probably negative. The skill that is exhibited in testing and launching the
product' will rank high in this phase as critical factor in securing success and
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initial market acceptance. Sales of new products usually rise slowly at first.Despite little competition profits are negative or low. This owns to high unit
costs resulting from low output rates, and heavy promotional investments
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incurred to stimulate growth. The introductory stage may last from a few months
to a year for consumer goods and generally longer for industrial products.
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Growth phase: In the growth phase product penetration into the market andsales will increase because of the cumulative effects of introductory promotion,
distribution. Since costs will be lower than in the earlier phase, the product will
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start to make a profit contribution. Following the consumer acceptance in thelaunch phase it now becomes vital to secure wholesaler/retailer support. But to
sustain growth, consumer satisfaction must be ensured at this stage. If the
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product is successful, growth usually accelerates at some point, often catching
the innovator by surprise.
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Profit margins peak during this stage as 'experience curve' affects lower unitcosts and promotion costs are spread over a larger volume.
Maturity phase: This stage begins after sales cease to rise exponentially. The
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causes of the declining percentage growth rate the market saturation eventually
most potential customers have tried the product and sales settle at a rate
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governed by population growth and the replacement rate of satisfied buyers. Inaddition there are no new distribution channels to fill. This is usually the longest
stage in the cycle, and most existing products are in this stage. The period over
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which sales are maintained depends upon the firm's ability to stretch, the cycle
by means of market segmentation and finding new uses for it.
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Profits decline in this stage because for the following reasons.The increasing number of competitive products.
The innovators find market leadership under growing pressure.
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Potential cost economies are used up.
Prices begin to soften as smaller competitors struggle to obtain market
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share in an increasingly saturated market.Sales growth continues but at a diminishing rate because of the diminishing
number of potential customers who remain last of the unsuccessful competing
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brands will probably withdraw from the market. For this reason sales are likelyto continue to rise while the customers for the withdrawn brands are mopped up
by the survivors. In this phase there will be stable prices and profits and the
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emergence of competitors. There is no improvement in the product but changes
in selling effort are common, profit margin slip despite rising sales.
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Saturation phase: As the market becomes saturated, pressure is exerted for anew product and sales among with profit begin to fall. Intensified marketing
effort may prolong the period of maturity, but only by increasing costs
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disproportionately.
Decline phase: Eventually most products and brands enter a period of declining
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sales. This may be caused by the following factors:Technical advances leading to product substitution.
Fashion and changing tastes.
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The average length of the product life cycle is tending to shorten as a
result of economic, technological and social change.
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Turning point indices in product life cycleThe following checklist indicates some of the detailed information necessary to
identify turning points in the product life cycle:
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Market saturation
Is the growth rate of sales volume declining?
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What is the current level of ownership compared to potential?Are first time buyers a declining proportion of total sales?
Nature of competition
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How many competitors have entered or plan to enter?
Is long-term over capacity emerging?
Are prices and profit margins being cut?
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Are advertising and promotional elasticity declining and price
elasticity increasing?
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Alternative products and technologiesAre new products being created in this industry or others which may
meet consumer needs more effectively?
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Is significant technical progress taking place which threatens existing
products?
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Project Life Cycle Costing:The term 'project life cycle cost' has been defined as follows: 'It includes the
costs associated with acquiring, using, caring for and disposing of physical
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assets, including the feasibility studies, research, design, development,
production, maintenance, replacement and disposal, as well as support, training
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an operating costs generated by the acquisition, use, maintenance andreplacement of permanent physical assets'.
Project life cycle costs
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Product life cycle costs are incurred for products and services from their design
stage through development to market launch, production and sales, and their
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eventual withdrawal from the market. In contract project life cycle costs areincurred for fixed assets, i.e. for capital equipment and so on. The component
elements of a project's cost over its life cycle could include the following:
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Acquisition cost, i.e. costs of research, design, testing, production,
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construction, or purchase of capital equipment.Transportation and handling costs of capital equipment
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Maintenance costs of capital equipment
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Operations costs, i.e. the costs incurred in operations, such as energy
costs, and various facility and other utility costs.
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Training costs i.e. operator and maintenance training.
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Inventory costs i.e. cost of holding spare parts, warehousing etc.
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Technical data costs, i.e. costs of purchasing any technical data.Retirement and disposal costs at the end of life or the capital
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equipment life.
Management Accountants' Role in Project Life Cycle Costing
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Project life-cycle costing is a new concept which places new demands upon theManagement Accountant. The development of realistic project life cycle costing
models will require the accountant to develop an effective working relationship
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with the operational researcher and the systems analyst, as well as with those
involved in the terrotechnological system, particularly engineers. Engineers
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require a greater contribution from accountants in terms of effort and interestthroughout the life of a physical asset. A key question for many accountants will
be whether the costs of developing realistic life cycle costs will outweigh the
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benefits to be derived from their availability. Lifecycle costing in the
management of Physical Assets, much value can be obtained by thinking in life-
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cycle costing concepts whenever a decision affecting the design and operation ofa physical asset is to be made.
The concept project life cycle costing has become more widely accepted in
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recent years. The philosophy of it is quite simple. It involved accounting for all
costs over the life of the decision which is influenced directly by the decision.
Terrotechnology is concerned with pursuit of economic life cycle costs. This is
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quite simply means trying to ensure that the assets produce the highest possible
benefit for least cost. To do this, it is necessary to record the cost of designing,
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buying, installing, operating, and maintaining the asset, together with a record ofthe benefits produced. Most organizations keep a record of the initial capital
costs, if only for asset accounting purposes.
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Uses of project life cycle costing
The project life cycle costing is especially useful in the following:
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Projects operate in capital intensive industriesProjects have a sizable, on-going constructing program
Projects dependent on expensive or numerous items of plant with
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consequent substantial replacement programs
Projects considering major expansion
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Projects contemplating the purchase/design/ development of expensivenew technology
Projects sensitive to disruption due to down-time.
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SELF ? ASSESSMENT QUESTIONS (SAQs)
1. What are Common-size Financial Statements?
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2. Example the salient features of the various methods of FinancialStatements.
3. What tools are used to analyze the financial statements?
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4. What significant inferences are brought out by the statement of cash
flow?
5. What are the limitations of cash flow statements?
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6. What are the categories under which the various ratios are grouped?
7. What does Debt-equity Ratio indicate?
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8. What is an activity cost pool?9. Describe the benefits of Target Costing.
10. Describe the major characteristics of product life cycle concept.
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Reference:
1. Garrison, Ray H. and Eric W. Noreen: Management Accounting.
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2. N. Vinayakam and I. B. Sinha: Management Accounting ? Tools andTechniques.
3. Hansen, Don R. and Maryanne M. Moreen: Management Accounting.
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4. P. C. Tulsian: Financial Accounting.
5. IGNOU Course Material.
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6. Journal of Management Accounting (Various Issies).7. CA Study Material.
Unit V
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Reporting to ManagementObjectives of the study:
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The objectives of this unit are to help one understand, in general
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The general format of report and ReportingImportance of Reporting in the Finance field.
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Contents Design:
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5.1. Introduction.
5.2. Objectives of Reporting.
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5.3. Principles of Reporting.
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5.4. Importance of Reporting.5.5. Qualities of a good Report.
5.6. Types of Reports.
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5.7. Forms of Report.
5.8. Reports submitted to various levels of Management.
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5.9. Management reporting requirements.5.10. General format of reports.
5.11. Summary.
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5.12. References.
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5.1. INTRODUCTION
5.1. The term 'reporting' conveys different meanings on different circumstances.
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In a narrow sense it means: supplying facts and figures. On the other hand, whena committee is appointed to study a problem, a report is taken to mean : review
of certain matter with its pros and cons and offering suggestions. In case of
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dealing with routine matters, a report refers to supplying the information at
regular intervals in standardized forms. A report is a means of communication
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which is in written form and is meant for use of management for the purpose ofplanning decision-making and controlling.
Simply stated it is a communication of result by a subordinate to superior. It
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serves as a feedback to the management. The contents of report, the details of
the data reported and the method of presentation depend upon the size and type
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of the business enterprise, extent of power delegated to subordinates and theexistence of various levels of management for whom information is meant.
5.2. OBJECTIVES OF REPORTING;
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Traditionally, reporting was aimed at showing compliance with the budget.
While this function is met in countries with a parliamentary tradition and
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adequate audit capacity, in other countries, improving compliance remains thepriority challenge. Nevertheless, transparency and accountability call for wider
scope of reporting. A budget reporting system should provide a means of
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assessing how well the government is doing. Ideally, therefore it should answer
following questions.
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Budgetary integrity. Have resources been used in conformity with legalauthorizations and mandatory requirements? What is the status of resources
and expenditures (uncommitted balances and undisbursed commitments)?
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2.Operating performance. How much do programs cost? How were they
financed? What was achieved? What are the liabilities arising from their
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execution? How has the government managed its assets?
Stewardship. Did the governments financial condition improve or
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deteriorate?What provision has been made for the future?
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Systems and control. Are there systems to ensure effective compliance,
proper management of assets and adequate performance?
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Reports are an important instrument for planning and policy formulation. For
this purpose, they should provide information on ongoing programs and the
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main objectives of government departments. Reports can also be used for public
relations and be a source of facts and figures. They give an organization the
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opportunity to present a statement of its achievements, and to provideinformation for a wide variety of purposes.
Reporting must take into account the needs of different groups of users
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including:
(i) the Cabinet, core ministries, line ministries, agencies, and program
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managers;(ii) the legislature; and
(iii) outside the government, individual citizens, the media, corporations,
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Universities, interest groups, investors, and creditors.According to surveys carried out in several developed countries,2 all users need
comprehensive and timely information on the budget. The executive branch of
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government needs periodic information about the status of budgetary resources
to ensure efficient budget implementation and to assess the comparative the
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costs of different programs. Citizens and the legislature need information oncosts and performance of programs that affect them or concern their
constituency. Financial markets need cash based information, etc.
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5.3. PRINCIPLES OF REPORTING
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Reports prepared by the government for internal and external use are governedby the following principles:
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1. Completeness. The measures, in the aggregate, should cover all aspects of
the reporting entity's mission.
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Legitimacy. Reports should be appropriate for the intended users and
consistent in form and content with accepted standards.
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User friendliness. Reports should be understandable to reasonably informedand interested users, and should permit information to be captured quickly and
communicated easily. They should include explanations and interpretations for
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legislators and citizens who are not familiar with budgetary jargon and
methodological issues. Financial statements can be difficult for non accountants;
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where possible, charts and illustrations should be used to improve readability.Of course, reports should not exclude essential information merely because it is
difficult to understand or because some report users choose not to use it.
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Reliability. The information presented in the reports should be verifiable and
free of bias and faithfully represent what it purports to represent. Reliability
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does not imply precision or certainty. For certain items, a properly explained
estimate provides more meaningful information than no estimate at all (for
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example, tax expenditures, contingencies, or superannuation liabilities).Relevance. Information is provided in response to an explicitly recognized
need. The traditional function of year-end reports is to allow the legislature to
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verify budget execution. The broader objectives of financial reporting require
that reports take into account the different needs of various users. A frequent
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criticism of government financial reports is that they are at the same timeoverloaded and useless.
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6. Consistency. Consistency is required not only internally, but also over time,
that is, once an accounting or reporting method is adopted, it should be used for
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all similar transactions unless there is good cause to change it. If methods or thecoverage of reports have changed or if the financial reporting entity has
changed, the effect of the change should be shown in the reports.
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7.Timeliness. The passage of time usually diminishes the usefulness of
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information. A timely estimate may then be more useful than preciseinformation that takes longer to produce. However, the value of timeliness
should not preclude compilation and data checking even after the preliminary
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reports have been published.
8. Comparability. Financial reporting should help report users make relevant
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comparisons among similar reporting units, such as comparisons of the costs of
specific functions or activities.
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Usefulness. Agency reports, to be useful both inside and outside the agency,
reports should contribute to an understanding of the current and future activities
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of the agency, its sources and uses of funds, and the diligence shown in the use
of funds.
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5.4 IMPORTANCE
In cost accounting, there are three important divisions, viz., cost ascertainment,
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cost presentation, and cost control. Cost presentation serves as a link between
cost ascertainment and cost control. The management of every organisation is
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interested in maximisation of profit through minimisation of wastages, losses,and ultimately cost. So management will have to be furnished with frequent
reports on all functional areas of business to achieve these objectives.
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One of the important functions of cost accounting is to provide the required
information to all levels of management at the appropriate time. The various
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aspects of reporting such as: nature of reports to be prepared, the details ofinformation to be included and mode of presentation, are all decided at the time
of installation of cost accounting system. In fact, cost ascertainment. and cost
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control are designed in such a way that they suit the scheme of information to be
presented so that they serve all levels of management but not the other way
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round.Efficient reporting is critical to an enterprise for many reasons, including:
1.Performance Measurement. Reporting enables company performance to be
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evaluated on many levels, including:2.Enterprise Performance. Consolidated executive reporting enables
executives to determine the success of their corporate vision and resulting
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initiatives.
3.Divisional Performance. Management reporting provides managers with a
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team performance report that can be used to manage and evaluate the resultsagainst
forecasts.
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4.Asset Performance. Detailed reporting provides individual personnel and
their managers with either an individual or asset performance report to manage
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and evaluate the results against forecasts.5.Capital Utilization Optimization. Reporting enables management to
compare and prioritize assets to optimize capital utilization.
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6.Informed Decision Making. Reporting provides a basis for forecast
development, goal setting, result evaluation and management, and informed
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decision-making. These decisions can range from corporate-wide initiatives anddivisional budgeting considerations to the hiring and firing of individual
personnel.
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7. Through reporting, management can steer the enterprise towards optimal
profitability. In order for profitability to be optimal, it is critical that enterprise
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reporting is informative, timely, accurate and available with simplified access tothe required detail. This allows management to take an active role to ensure
continuous fiscal improvement and cost efficacy.
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5.5.QUALITIES OF A GOOD REPORT.
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The draft of the report should be reviewed for an appropriate number of times so that the
errors are completely avoided. While reviewing the draft, certain guidelines are to be
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followed, as indicated below:1. The text of the report should be free from ambiguity.
2.
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The text should convey the intended message.
3.
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Because the readers are with different profiles, the style and presentationof the text of the report should suit the profile of the targeted group of
readers; otherwise, the purpose of the report will be lost.
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4.
The content of the report should fully reveal the scope of the research in
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logical sequence without omitting any item and at the same time itshould be crisp and clear.
5.
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The report should be organized in hierarchical form with chapters, main
sections, subsections within main sections, etc.,
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6.There should be continuity between chapters and also between sections
as well subsections.
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7.
The abstract at the beginning should reveal the essence of the entire
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report which gives the overview of the report.8.
The chapter on conclusions and suggestion is again enlarged version of
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the abstract with more detailed elaboration on the inferences and
suggestions.
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9.A reading of abstract and conclusion of a report should give the clear
picture of the report content to the readers.
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10. Avoid using lengthy sentences unless warranted.
11. Each and every table as well as figure should be numbered and it must be
referred in the main text.
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12. The presentation of the text should be lucid so that every reader is able to
understand and comprehend the report content without any difficulty.
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13. The report should have appropriate length. The research report can befrom 300 to 400 pages, but the technical reports should be restricted to
50 to 75 pages.
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A good report should satisfy the following requisites in order to enable the
receiver of report to understand and get interested in the report.
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(a) Title: This contains the subject-matter of the report. It should be brief butnot vague. Where a lengthy report is to be prepared the subject-matter is to be
presented in various ,
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paragraphs under different sub-titles.
(b) Period: It should mention the duration covered by the report.
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(c) Units of measurement: In case of quantitative information is to bereported the units in which quantities are expressed should be clear. For
example, production in tonnes. sales in lakh rupees, idle time in hours.
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(d) Date: The date on which the report is presented is to be mentioned. This
helps receiver of the report to know what changes must have occurred during the
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time lag of period covered under the report and date of presentation of report.(e) Name: The report must contain the name of the person by whom a report is
prepared, the name of person to whom it is meant and the names of those for
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whom copies are sent.
(f) Standard: The reports prepared must meet the standard expected by its
receiver. Use of highly technical words may not be readily understood by lower
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level management.
(g) Use of diagrams: Wherever possible the reports must be illustrated by
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diagrams and charts in addition to description of the report. This facilitates readyunderstanding.
(h) Recommendations: Recommendations are to be offered to facilitate the
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reader as to what course of action is to be taken to set right the defects.
(i) Promptness: The reports should be prepared periodically and submitted to
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all levels of management promptly. It is said that report delayed is report denied.If the time lag between the period of preparation and period of submission is
more it may give rise to wrong decisions.
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(j) Accuracy: The information furnished in the report must be accurate. It is
important to avoid furnishing unnecessary details in the report.
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(k) Comparison: A comparative study must be incorporated in the report so asto facilitate the receiver of the report to know the progress and prospects of the
performance. Comparison can be based on past performance or predetermined
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performance.
(I) Economy: The expenses incurred in maintaining reporting system must be
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less than the benefits derived there from or loss sustained by not reporting.(m) Simplicity: The report should be brief, clear and simple to understand.
The form of report should be designed to suit different levels of management.
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Where it is inevitable to prepare a lengthy report, a brief synopsis should
precede the report.
(n) Controllability: Where variances are incorporated it is essential to stress
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on controllable aspects and to drop out uncontrollable element. But this depends
upon the circumstance under which the report is prepared.
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(o) Source of information: The source of information must be included inthe report.
5.6.TYPES OF REPORTS
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Reports are classified into different types according to different bases. This is
shown in the following chart:
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TYPES OF REPORT--- Content provided by FirstRanker.com ---
On the basis of purpose On the basis of period of submission On the basis of
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functionExternal
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Internal Routine Special Operating Financial
Report Report Report Report
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Report
Report
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I. On the Basis of Purpose
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On the basis of purpose, reports can be classified into two types, viz., (a)External report, and (b) Internal report.
(a) External report: External report is prepared for meeting the requirements of
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persons outside the business, such as shareholders, creditors, bankers,government, stock exchange and so on. An example of external report is the
published accounts, viz., profit and loss account and balance sheet. External
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report is brief in size as compared to internal report and they are prepared as per
the statutory requirements.
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(b) Internal report: Internal report is meant for different levels of management.This can again be classified into three types: (a) Report meant for top level
management, (b) Report meant for middle level management, and (c) Report
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meant for lower level management. Report to top level management should be
in summary form giving an overall view of the performance of the business.
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Whereas external reports are prepared annually, internal reports are preparedfrequently to serve the needs of management. Internal report need not conform
to any standard form as it is not statutorily required to be prepared.
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II. On the Basis of Period of Submission
According to this basis. reports can be classified into two types, viz., (I) Routine
--- Content provided by FirstRanker.com ---
reports, and (2) Special reports.(a) Routine reports: They are prepared periodically to cover normal activities
of the business. They are submitted to different levels of management according
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to a time schedule fixed. While some reports are prepared and submitted at a
very short intervals, some are prepared and submitted at a long interval of time.
--- Content provided by FirstRanker.com ---
Some examples of routine reports relate to monthly profit and loss account,monthly balance sheets, monthly production. purchases, sales, etc.
(b) Special reports: Special reports are prepared to cover specific or special
--- Content provided by FirstRanker.com ---
matters concerning the business. Most of the special reports are prepared after
investigation or survey. There is no standard form used for submitting this
--- Content provided by FirstRanker.com ---
report. Some of the matters which are covered by special reports are: causes forproduction delays, labour disputes, effects of machine breakdown, problems
involved in capital expenditure, make or buy problems, purchase or hire of fixed
--- Content provided by FirstRanker.com ---
assets, price fixation problems, closing down or continuation of certaindepartments, cost reduction schemes, etc.
III. On the Basis of Function
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According to the purpose served by the reports, it can be classified into two
types, viz., -(a) operating report, and (b) financial report.
--- Content provided by FirstRanker.com ---
(a) Operating report: These reports are prepared to reveal the variousfunctional results. These reports can again be classified into three types, viz., (a)
Control reports, which are prepared to exercise control over various operation of
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the business, (b) Information report, which are prepared for facilitating planning
and policy formulation in a business, (c) Venture measurement report which is
--- Content provided by FirstRanker.com ---
prepared to show the result of a specific venture undertaken as for example anew product line introduced.
(b) Financial report: Such reports provide information about financial position
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of the undertaking. These reports may be prepared annually to show the
financial position for the year as in the case of balance sheet or periodically to
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show the cash position for a given period as in the case of fund flow analysisand cash flow analysis.
The following list briefly defines several other types of reports.
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1.Physical Description Report
Physical description reports describe the physical characteristics of a machine, a
--- Content provided by FirstRanker.com ---
device, or some other type of object. They also explain the relationship of onepart of the object to other parts so that the reader can visualize the object as a
unit. Physical description reports are many times combined with process,
--- Content provided by FirstRanker.com ---
analysis, or investigation reports.
2.Process Report
Process reports explain how products are produced, tests are completed, or
--- Content provided by FirstRanker.com ---
devices operate by describing the details of procedures used to perform a series
of operations. Process reports may be general or detailed. General process
--- Content provided by FirstRanker.com ---
reports are addressed to persons not directly involved in performing the process.Detailed process reports are designed to give the readers all the necessary
information needed to complete the process.
--- Content provided by FirstRanker.com ---
3.Analytical Report
Analytical reports critically examine one or more items, activities, or options.
--- Content provided by FirstRanker.com ---
They are structured around an analysis of component parts or other commonbasis for comparison between options. This type of report usually results in
conclusions and recommendations.
--- Content provided by FirstRanker.com ---
4.Examination Report
Examination reports are used to report or record data obtained from an
--- Content provided by FirstRanker.com ---
examination of an item or conditions. Examination reports differ from oneanother in subject matter and length. Some are similar to analytical reports but
are less complicated because the information is obtained from personal
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observations. Examination reports are logically organized records investigating
topics such as accidents or disasters. They are usually prepared for people
--- Content provided by FirstRanker.com ---
knowledgeable about the subject and not for the general reader.5.Laboratory Report
Laboratory reports record and communicate the procedures and results of
--- Content provided by FirstRanker.com ---
laboratory activities. Equipment, procedures, findings, and conclusions are
clearly presented at a level appropriate for readers with some expertise in the
--- Content provided by FirstRanker.com ---
subject. They are sometimes presented in laboratory notebooks using neatlyhandwritten text and charts.
6. Literature Review
--- Content provided by FirstRanker.com ---
Literature reviews are logically organized summaries of the literature on a givensubject. It is important that they are correctly documented and accurately
represent the scope and balance of the available literature. Conclusions drawn
--- Content provided by FirstRanker.com ---
reflect the collection as a whole and should appropriately reflect various points
of view. Overuse of direct quotations should be avoided.
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7. Design PortfolioDesign portfolios are organized presentations of preliminary and final designs of
items such as mechanisms, products, and works of art. When part of an
--- Content provided by FirstRanker.com ---
educational activity, they may also include an analysis of the problem, review of
related designs, evaluation, and other information. The presentation may be in
--- Content provided by FirstRanker.com ---
the form of notes, sketches, and presentation illustrations.8. Detail Report
Detail Report: Prints a text report outlining each audit question as well as the
--- Content provided by FirstRanker.com ---
scoring criteria and responses entered for each question. Compliance level is
calculated as a percentage at the end of the report.
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9. Graphical Report (points): Compares your possible score (in compliancepoints) to your actual score in a bar graph format. Then calculates your
compliance score as a percentage and sorted by audit section number.
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10. Graphical Report (%): Compares your possible score (percentage) to your
actual score in a bar graph format.
--- Content provided by FirstRanker.com ---
11. Non-Compliance Report: Prints a listing of the audit questions on whichyou failed to reach compliance. Includes the audit section number for each
question and the actual score vs. possible score.
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12. Non-Compliance Graphical Report: Prints a bar graph report of thoseaudit questions on which you failed to reach compliance.
13. Summary Report
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A report allowing users to summarize responses based on the selection from four
fields.
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14. Trend ReportA report allowing users to view trends over a defined time frame.
Management Reporting
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A research report can be classified into decision-oriented (technical) report and
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research - oriented report. Further, the research-oriented report can be classifiedinto survey-based research report and algorithmic research report.
1 Decision-oriented (Technical) Report
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The steps of preparing decision-oriented report are presented below:
i. Identification of the problem
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ii. Establishment objectivesiii. Generation of decision alternatives
iv. Evaluation of decision alternatives
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v. Selection of the best decision alternative
vi. Development of action plan
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vii. Provision for correction plan after implementation of the decision.2. Survey-based Research Report
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The main body of the report for the survey-based research contains thefollowing:
i. Problem definition
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n. Objectives of the research
ill. Research methodology
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iv. Data analysisv. Interpretation of results and suggestion
vi. Conclusions.
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3. Algorithmic Research Report
There are problems, viz., production scheduling, JIT, supply chain management,
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line balancing, layout design, portfolio management, etc., exist in reality. Thesolution for each of the above problems can be obtained through algorithms. So,
the researchers should come out with newer algorithms or improved algorithms
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for such problems. For a combinatorial problem, the researcher should attempt
to develop an efficient heuristic. The algorithmic research report can be
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classified into the following categories:1.
.Algorithmic research report for combinatorial problem
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2.
.Exact algorithmic research report for polynomial problem.
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Algorithmic research report with modeling for combinatorial problemThe main body of this type of research report will contain the following:
i. Problem identification
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ii. Literature review
iii. Objectives of the research
iv. Development of mathematical model
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v. Design of algorithm (heuristic)
vi. Experimentation and comparison of the algorithm with the model in terms
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of solution accuracyvii. Experimentation and comparison of the algorithm with the best existing
algorithm (heuristic) in terms of solution accuracy
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viii. Case study
ix. Conclusions.
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In this type of research, the results of the algorithm will be compared with theoptimal results of the mathematical model as well as with the results of the best
existing algorithm to check its solution accuracy through a carefully designed
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experiment
Note: In a research related to combinatorial problems in new and complex area,
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development of a mathematical model to obtain the optimal solution may not beeasy. Under such situation, the results of the algorithm (heuristic) should be
compared with that of the best w existing heuristic alone for checking its
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solution accuracy through a carefully designed experiment
Exact algorithmic research report for polynomial problem
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The main body of this type of research report will contain the following:i.
Problem identification
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ii.
Literature review
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iii. Objectives of the researchiv. Design of exact algorithm
v.
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Experimentation arid comparison of the exact algorithm with the bestexisting exact algorithm in terms of computational time
vi. Case study
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vii. Conclusions.
In a research related to polynomial problem, the researcher will have to develop
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an efficient exact algorithm in terms of computational time and compare it withthe best existing exact algorithm for that problem through a carefully designed
experiment. The comparison in terms of solution accuracy does not apply here
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because all exact algorithms will give optimal solution.
5.7 FORMS OF REPORT
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Reporting of information management takes different forms. They are explainedbelow:
1. Oral Report
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An oral report is not very popular as it does not serve any evidence and cannot
be referred to in future. Oral report may take the form of a meeting with
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individuals or a conference.2. Descriptive Reports
These are written in narrative style. They are frequently supported by tables and
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charts to illustrate certain points covered in the report. One important point that
must be considered in drafting this form of report is the language. The language
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used must be simple, easy to understand and lucid. Where the report is verylong, it must be suitably divided into paragraphs with headings. They must cover
all the principles of .good report discussed earlier.
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3. Comparative Statement
This form of report is used for preparing the routine report. Under this method
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the particulars of information are shown in a comparative form, i.e., the actual
results an compared with planned results and the deviations between the two arc
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indicated. The various tools used to prepare this form of report arc comparativefinancial statements, ratio analysis, fund flow analysis and so on.
4. Diagrammatic and Graphic representation
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This is more popular form of preparing reports. They occupy lesser space and
gives at a glance the whole picture about a particular aspect of study. They also
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facilitate in comparative study and shows the trend over a period of time. Thisform of report can b used where a report contains presentation of statistical
numbers and other facts and figures It overcomes the language barrier and is
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very easily understood by everyone. Of course when large numbers are
involved, it is to be reduced by selecting a convenient scale Diagrammatic
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representation involves the following forms:(a) Bar diagram: They make use of horizontal and vertical axes to show the
magnitude of values, quantity and period. Bar diagrams are of the following
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types.
(i) Simple bar diagram: These are most popularly used in preparing reports.
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The consider only length but not the width to indicate the change. In formationrelating to volume of production, cost of production sales, etc. for different years
can be shown under this form.
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(ii) Multiple bar diagram: This type of diagram is used to report related
matters such as production and sales, sales and profit, advertisement and sales
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and so on.(iii) Sub-divided bar diagram: This form of diagram is used to report matters
which involved different component parts as for example, the cmponents of
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total cost of production such as prime cost, factory cost, office cost, cost ,ofsales.
(iv) Percentage bar diagrams: These diagrams depict the information on a
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percentage basis.
(b) Pre-diagram: They take the form of circles instead of bars. They facilitate
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comparison besides depicting the actual information under review.5. Break-even Chart
This type of chart is prepared to show the relationship between variable and
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fixed cost and sales. It shows the point of no-profit and no-loss or where total
cost equals total revenue received.
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6. Gantt ChartThis chart was first introduced by Heny L. Gantn. It is a special type of bar
diagram under which bars are drawn horizontally. This chart shows the bars of
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planned schedule and attained performance. They are largely used to denote
utilisation of machine capacity.
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5.8.REPORTSSUBMITTED
TO
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VARIOUS
LEVELS
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O?MANAGEMENT
1. Top Level Management
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The top level management comprises of board of directors, managing director,
and other executives who are concerned with determination of objectives and
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formulation of policies. Top management is to be furnished with reports atregular intervals in order to enable them to exercise control over the activities of
the business. The following are some of the matters to be reported to board of
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directors.a) Master budget which covers all functional budgets for taking remedial actions
where there are significant deviations from budgeted figures.
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b) Various functional budgets prepared by various departmental managers for
holding departmental managers for any shortfall in their performance.
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c) Capital expenditure budget and cash budget to know the extent of variancesfor taking remedial measures.
d) Reports relating to production and sales, which shows the trend of the
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performance of business.
e) Report covering important ratios such as stock turnover ratio, fixed assets
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turnover ratio, liquidity ratio, solvency ratio, profitability ratios, etc. to know theimprovement in business.
f) Appraisal of various projects undertaken by the organisation.
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2. Middle Level Management
It comprises of different departmental managers such as production manager,
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purchase manager, sales manager, chief accountant, etc. These managers requirereports to improve the efficiency of their respective departments. The following
are some of the matters reported to production manager:
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(a) Report relating to actual capacity utilised as compared to budgeted capacity.
(b) Report relating to actual output as against standard output.
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(c) Labour and machine capacity utilised.(d) Idel time lost.
(e) Report on scraps, wastages and losses in production.
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(/) Report relating to stock of raw materials, work-in-progress and finishedgoods.
(g) Report relating to cost of production, operation of different departments.
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The following are some of the matters reported to sales manager:
(a) Report relating to number of orders executed, orders received and orders on
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hand.(b) Reports relating to actual sales and budgeted sales and actual selling and
distribution expenses and budgeted selling and distribution expenses.
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(c) Summary of selling expenses incurred in different territories and their
corresponding sales.
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(d) Gross profit earned on different products and in different areas.(e) Market survey reports.
(/) Report relating to present and potential demand.
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The following are some of the matters reported to financial manager:
(a) Report relating to cash position.
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(b) Summary of receipts and payments.(c) Report relating to outstanding debts on credit sales.
(d) Report on debts due on credit purchases.
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(e) Monthly profit and loss account.
(/) Quarterly report on capital expenditure.
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3. Lower Level Management
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The lower level management include supervisors, foremen and inspectors whoare concerned with the operations of the factory. They are interested in
increasing the efficiency of the production departments. The reports that are to
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be sent to them are variances relating to planned and actual performance. The
report must also emphasise cost control aspects.
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5.9.MANAGEMENT REPORTING REQUIREMENTS(a) General.
This document prescribes management reports required if the offer requests
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progress payments and a progress payments clause is included in the
subcontract. They are in addition to technical reports required under the
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subcontract, but must be consistent with data furnished under thoserequirements. Preferred formats for the Billing Plan/Management Report and the
Milestone Schedule and Status Report are attached.
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(b) Description of Reports.
(1) BILLING PLAN/MANAGEMENT REPORT, FORM
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This report shows the planned rate of progress payment billings and billings foraccepted supplies under each major task for the remainder of the subcontract
performance period. For each task, the planned billings are to be projected in
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monthly increments for each of the twelve months of the current or succeeding
fiscal year, and in fiscal year increments thereafter for the remainder of the
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subcontract. (Projected billings should be directly related to the activitiesscheduled to be performed during each billing period, as reflected on the
Milestone Schedule and Status Report.) or schedule. Each time it is necessary to
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alter the plan, a new plan and narrative explanation for the change will be
provided to the Company.
(B) As a monthly report, this document provides a comparison of the planned
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billings with the actual billings for work performed as of the cut-off period for
the report. Variances from the plan are computed, and explanations for variances
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exceeding + 10% will be provided by the Seller in the Narrative HighlightsReport. In addition, upon the occurrence of a variance exceeding + 10%, the
Seller must reevaluate the estimated billings for the balance of the current fiscal
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year and to the completion of the subcontract. Narrative explanations must be
provided for significant changes to these estimated billings.
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(2) MILESTONE SCHEDULE AND STATUS REPORTThis is used as both a baseline plan and status report.
As a baseline plan, it establishes the Seller's schedule for accomplishing the
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planned events and milestones of each reporting category identified in the
subcontract.
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As a status report, it measures status or progress against the baseline plan. It willreflect planned and accomplished events, milestones, slippages, and changes in
schedule.
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(3) NARRATIVE HIGHLIGHTS REPORT .
The Narrative Highlights Report permits management presentation of the
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technical aspects of subcontract performance along with an overview ofsignificant project highlights, accomplishments, and problems. The report will
continue discussions of items identified in the previous report through
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completion of an activity or resolution of a problem. Typical reporting elements
to be covered by brief statements are:
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(A) Major accomplishments and significant highlights.(B) Major subcontract awards, including award date, subcontract amount, and
scheduled completion date.
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(C) Developments affecting estimates and schedules. This will specificallyinclude explanations of deviations from the Billing Plan which exceed + 10%
and deviations from Milestone Schedule Plan which exceed 30 days.
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(D) Revised estimates or schedules.
(E) Technical problems encountered and resolution actions proposed.
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(F) Planned major accomplishments during the next 60 days.5.10.General Format of a Report:
The mechanical format of a report consists of three parts: the preliminaries, the
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text, and the reference materials. The length of any of these three parts is
conditional on the extent of the study.
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1. The Preliminaries(a) Title page
(b) Preface, including acknowledgments (if desired or necessary)
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(c) Table of contents
(d) List of tables
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(e) List of Figures or illustrations2. The Text
(a) Introduction (introductory chapter or chapters)
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(b) Main body of the report (usually divided into chapters! and sections)
(c) Conclusion
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3. The Reference Material
(a) Bibliography
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The order of these may be
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(b) Appendix (or Appendixes)--- Content provided by FirstRanker.com ---
reversed.
(c) Index (if any)
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THE PRELIMINARIES1. TITLE PAGE
Most universities and colleges prescribe their own form of title page for theses,
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dissertations and research papers and these should be complied with in all
matters of content and spacing. Generally, the following information is required:
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Written Report(a) Title of the report
(b) Name/s of the writer/s
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2. PREFACE
The preface (often used synonymously with foreword) may included: the
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writer's purpose in conducting the study, a brief resume of the background,scope, purpose, general nature of the research upon which the report is being
based and acknowledgments.
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3. TABLE OF CONTENTS
The table of contents includes the major divisions of the report: the introduction,
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the chapters with their subsections, and the bibliography and appendix. Pagenumbers for each of these. divisions are given. Care should be exercised that
titles of chapters and captions of subdivisions within chapters correspond
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exactly with those included in the body of the report. In some cases, sub-
headings within chapters are not included in the table of contents. It is optional
whether the title page, acknowledgments, list of tables and list of Figures are
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entered in the table of contents. The purpose of a table of contents is to provide
an analytical overview of the material included in the study or report together
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with the sequence of presentation. To this end, the relationship between majordivisions and minor subdivisions needs to be shown by an appropriate use of
capitalisation and indentation or by the use of a numeric system.
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A table of contents is necessary only in those papers where the text has been
divided into chapters or several subheadings. Most short written assignments do
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not require a table of contents. The basic criterion for the inclusion ofsubheadings under major chapter division is whether the procedure facilitates
the reading of a report and especially the location of specific sections within a
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report.
4. LIST OF TABLES
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After the table of contents, the writer needs to prepare a list of tables. Theheading LIST OF TABLES, should be centered on a separate page by itself.
5. LIST OF FIGURES (OR ILLUSTRATIONS)
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The list of Figures appears in the same form as the list of tables. The page is
headed LIST OF FIGURES, without terminal punctuation, and the numbers of
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the Figures are listed at the left of the page under the heading Figure.6. INTRODUCTION
An introduction should be written with considerable care: with two major aims
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in view: introducing the problem in a suitable context, and arousing and
stimulating the reader's interest. If introductions are dull, aimless, confused,
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rambling, and lacking in precision, direction and specificity; there is littleincentive for the reader to continue reading. The reader begins to expect an
overall dullness and aimlessness in the whole paper. The length of an
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introduction varies according to the nature of the research project.7. MAIN BODY OF THE REPORT
There are certain general principles which should be followed:
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(a) Organise the presentation of the argument or findings in a logical and orderly
way, developing the aims stated or implied in the introduction.
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(b) Substantiate arguments or findings.(c) Be accurate in documentation.
8.CONCLUSION
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The conclusion serves 'the important function of tying together the whole thesis
or assignment. In summary form, the developments of the previous chapters
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should be succinctly restated, important findings discussed and conclusionsdrawn from the whole study. In addition, the writer may list unanswered
questions that have occurred in the course of the study and which require further
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research beyond the limits of the project being reported. The conclusion should
leave the reader with the impression of completeness and of positive gain.
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9. BIBLIOGRAPHYThe bibliography follows the main body of the text and is a separate but integral
part of a thesis, preceded by a division sheet or introduced by a centered
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capitalized heading BIBLOGRAPHY. Pagination is continuous and follows the
page numbers in the text. In a written assignment, the word bibliography may
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be a little pretentious and the heading REFERENCES may be an adequatealternative.
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10. APPENDIX
It is usual to include in an appendix such matters as original data, tables that
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present supporting evidence, tests that have been constructed by the research
student, parts of documents or any supportive evidence that would detract from
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the major line of argument and would make the body of the text unduly largeand poorly structured. Each appendix should be clearly separated from the next
and listed in the table of contents.
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11. INDEX
If an index is included, it follows the bibliography and the appendix. An index is
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not required for a written assignment or for an unpublished thesis. If a thesis issubsequently published as a book, monograph or bulletin, an index is necessary
for any or of complexity.
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12. THE ABSTRACT
An abstract consists of the following parts:
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1.A short statement of the problem.
2.
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A brief description of the methods and procedures used in collecting the
data.
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3. A condensed summary of the findings of the study.The length of the abstract may be specified, for example, 200 words. Usually an
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abstract is short.
13.THE FINAL PRODUCT
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From the outset, the aim is, at the production of a piece of work of high quality.The text should be free of errors and untidy corrections. Paper of standard size
(usually quarto) and good quality should be used.
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5.11.SELF ASSESMENT QUESTIONS1. What are the different types of report? Explain them in brief.
2. Discuss the guidelines for reviewing the draft of a report.
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3. What are the qualities of a research report? Explain them in brief.
4. Give a sample cover page of a research report.
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5. Discuss the items of the introductory pages in detail.6. Give a sample table of-contents of a survey based research report.
7. Give a sample table of contents of an algorithmic research report.
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8. What are the items under the text of a research report? Explain them in brief.
9. Discuss the guidelines for preparing bibliography.
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10. Give a brief account of typing/printing instructions while preparing aresearch report.
11. Discuss the guidelines for oral presentation of a research report.
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12. Assume a research topic of your choice and give the complete format of its
research report.
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13. What do you understand by the term "reporting to management" ?.Discuss briefly the matters that you would deal with while reporting to the board
of directors.
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14. Discuss the general principles to be observed while preparing reports.
15. Describe the various forms of reporting to management.
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16. Distinguish between routine and special reports. State the various matterswhich are sent to management under routine and special reports.
17. Explain different types of reports submitted to the management of an
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organisation.18. Explain the information submitted to different levels of management.
5.12. REFERENCES:
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1. Anthony, Robert: Management Accounting, Tarapore-wala, Mumbai.
2. Barfield, Jessie, Celly A. Raiborn and Michael R. Kenney: Cost Accouting;
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Traditions and Innovations, South - Western College Publishing, Cincinnati,Ohio.
3. N. Vinayakam and I.B. Sinha, Management Accounting ? Tools and
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Techniques, Himalaya Publishing House, Mumbai.
4. Decoster, Don T. and Elden L. Schater: Management Accounting: A Decision
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Emphasis, John Wiley and Sons Inc., New York.5. Garrison, Ray H. and Eric W. Noreen: Management Accounting, Richard D.
Irwin, Chicago.
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6. Hansen, Don R. and Maryanne M. Moreen: Management Accounting, South-
western College Publishing, Cincinnati, Ohio.
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