Unit-I: SVD & SGL College of Management and Technology: Rajahmundry

SVD & SGL COLLEGE OF MANAGEMENT AND TECHNOLOGY: RAJAHMUNDRY
UNIT-I
INTRODUCTION:
Accounting is as old as money it self. The modern system of accounting owes its
origin to Pacioli who lives in Italy in the 15th century Accounting at the initial stages perform
the functions of historical and stewardship. The conventional accounting principles and
practices prove to be insufficient Accounting today cannot be viewed as it used to be about
half a century ago. Today it has become a dynamic subject and specialized branches of
accounting such as Cost Accounting, Management Accounting, Responsible Accounting,
Social Accounting, Government Accounting, Inflation Accounting, Mechanized Accounting,
Human Resource Accounting etc. At the same time techniques such as standard costing,
Marginal costing, Budgeting control, Ratio analysis, Funds, and Cash flow analysis are also
devised.
To promote world wide uniformity in published accounts. The International Accounting
Standards Committee (IASC) has been set up in 1973 to formulate and publish guidelines and
to promote their worldwide acceptance and observance. The main objective of IASC is to
develop accounting standards which are to be observed in the presentation of audited
financial statements and to promote their world wide acceptance.
DEFTNTTION OF ACCOUNTING:
Various authorities and accountants have attempted to define accounting, but there is no
unanimity among the accountants as to the precise definition. The most acceptable definition
is given by American Institute of Certified Public accountants (AICPA).
According to AICPA Accounting is the Art of recording classifying and summarizing in a
significant 'manner and in terms of money, transactions and events which are, in part at least,
of a financial character and interpreting the results there off. In 1966 the American
Accounting Association (AAA) defined Accounting as "The Process of identifying,
measuring and communicating economic information to permit informed Judgments and
decisions by the users of information". Even to day this is the most acceptable definition on
Accounting.
Accounting helps to summarize lot of financial transitions and events and enables the
accountants to convey economic information to its users. The purpose of communicating this
information is to enable the users to make informed judgments. Since every decision involves
various alternatives, the accounting information must provide the user to decide his course of
action.
OBJECTIVES OF ACCOUNTING:
1. To maintain records of business: One of the important objectives of accounting is
the systematic maintenance of all monetary aspects of business transactions. This is
known as book keeping.
ACCOUNTING FOR MANAGERS: SEM-I
K.V. RAJESH KUMAR LECTURER
2. To calculate Profit or Loss: The profit earned or the loss suffered during a specific
period (generally) can be calculated easily from the accounting books.
3. To ascertain financial position: By preparing the financial statements (Profit and
Loss account and balance sheet) the financial position of the business can be found
out. From these statements it is possible to know the resources owned by the firm.
These statements also provide information about the obligations (liabilities) of
business
4. To communicate financial information: Accounting is called language of business.
It aims at communicating financial information to various interested parties
(managers, investors, creditors, government etc.)
BRANCHES OF ACCOUNTING:
1. Financial Accounting: The purpose of accounting is to ascertain the financial results
i.e., profit or loss in the operations during a specific period. It is also aimed at
knowing the financial position i.e., assets, liabilities and equity position at the end of
the period.
2. Cost Accounting: The purpose of cost accounting is to analyze the expenditure so as
to ascertain the cost of various products manufactured by the firm and fix the prices.
3. Management Accounting: The purpose of management accounting is to assist the
management in taking rational policy decisions. This branch of accounting is
primarily concerned with providing the necessary accounting information about
funds, costs, profits etc, and the management.
4. Inflation Accounting: It is concerned with the adjustment in the values of assets and
of profit in light of changes in the price level. In a way, it is concerned with the
overcoming of limitations they arise in financial statements on account of recording
the assets at their historical or original cost.
5. Human Resource Accounting: It is a branch of accounting which seeks to report and
emphasize the importance of human resources in a companys earning process and
total assets. It is concerned with the process of identifying and measuring data about
human resources.
FUNCTIONS OF ACCOUNTING:
1. Designing Work: It includes the designing of the accounting system, basis for
identification and classification of financial transactions and events, forms, methods,
procedures etc.
2. Recording Work: The financial transactions are identified, classified and recorded in
appropriate books of accounts according to principles. This is known as book
keeping. The recording of transactions tends to be mechanical and repetitive.
3. Summarizing Work: The recorded transactions are summarized into significant form
according to generally accepted accounting principles. The work includes the
preparation of profit and loss account, balance sheet. This phase is called preparation
of final accounts.
4. Analysis and Interpretation Work: The financial statements are analyzed by using
ration analysis, break even analysis, funds flow and cash flow analysis.
5. Reporting Work: The summarized statements along with analysis and interpretation
are communicated to the interested parties or whoever has the right to receive them.
6. Preparation of Budget: The management must be able to reasonably estimate the
future requirements and opportunities. As an aid to this process, the accountant has to
prepare budgets, like cash budget, capital budget, purchases budget, sales budget etc.
7. Taxation Work: The accountant has to prepare various statements and returns
pertaining to income-tax, sales tax, excise or customs duties etc. and file the returns
with authorities concerned.
8. Auditing: It involves a critical review and verification of the books of accounts,
statements and reports with a view to verifying their accuracy. This is Auditing
USERS OF ACCOUNTING INFORMATION:
1. Internal Users.
2. External Users.
1. Internal Users:
Managers: These are the persons who manage the business, i.e., management at the
top, middle and lower levels. Their requirements of information are different because
they make different types of decisions.
2. External Users:
a) Investors: those who are interested in buying the shares of a company are
naturally interested in the financial statement to know how safe the investment
already made is and how safe the proposed investment will be.
b) Creditors: Lenders are interested to know whether their loan, principal and
interests, will be paid when due. Suppliers and other creditors are also interested
to know the ability of the firm to pay their dues in time.
c) Workers: In our country, workers are entitled to payment of bonus which depends
on the size of profit earned. Hence, they would like to be satisfied that the bonus
being paid to them is correct. This is knowledge also helps them in conducting
negotiations for wages.
d) Customers: They are also concerned with the stability and profitability of the
enterprise. They may be interested in knowing the financial strength of the
company to take further decision relating to purchase of goods.
e) Government: Government all over the world is using financial statements for
compiling statistics concerning business which, in turn, helps in compiling
national accounts.
f) Public: The public at large is interested in the functioning of the enterprise
because it may make a substantial contribution to the local economy in many
ways including the number of people employed and their patronage to local
suppliers.
g) Researchers: The financial statements, being a mirror of business conditions, are
of greater interest to scholars undertaking research in accounting theory as well as
business affairs and practices.
ADVANTAGES OF ACCOUNTING:
1. Provides for systematic records: Since all the financial transactions are recorded in
the books, one need not rely on memory. Any information required is readily
available from these records.
2. Facilitates the preparation of financial statements: Profit and loss account and
balance sheet can be easily prepared with the help of the information in the records.
3. Provides control over assets: Book-keeping provides information regarding cash in
hand, cash at bank, stock of goods, accounts receivables from various parties and the
amounts invested in various other assets. As the trader knows the values of the assets
he will have control over them.
4. Provides the required information: Interested parties such as owners, lenders,
creditors, etc., get necessary information at frequent intervals.
5. Comparative study: One can compare the present performance of the organization
with that of its past. This enables the managers to draw useful conclusions and make
proper decisions.
6. Less scope for fraud or theft: It is difficult to conceal fraud or theft etc., because of
the balancing of the books of accounts periodically. As the work is divided among
many persons, there will be check and counter check.
LIMITATIONS OF ACCOUNTING:
1. Transactions of non-monetary nature do not find place in accounting. Accounting is
limited to monetary transaction only. It excludes qualitative elements like
management, reputation, employee morale, labor strike etc.
2. Cost concept is found in accounting, price changes are not considered. Money value is
bound to change often from time to time. This is a strong limitation of accounting.
3. Acceptable alternatives are so broad based that comparisons are likely to be confusing
or misleading. For inventory cost may be ascertained by LIFO or FIFO; or stock may
be evaluated at cost price or market price.
4. Accounting policies are framed by the Accountant The figures of balance sheet are
largely resulted by personal judgment of accountant hence it is the subjective factor
that prevails in accounting and objective factor is ignored'
ACCOUNTING PROCESS:
The accounting process consists of the following four stages:
1. Recording the Transactions.
2. Classifying the transactions.
3. Summarizing the transactions.
4. Interpreting the result.
1. Recording of the Transactions: The accounting process begins with recording of all
transactions in the book of original entry. This book is called Journal . All transactions
are recorded in the journal in a chronological order with the help of various vouchers.
2. Classifying the Transactions: The second stage consists of grouping the transactions
of similar nature and posting them to the concerned accounts in another book called
Ledger. For example all transactions related to cash are posted to Cash account and the
transactions related to different persons are entered separately in the account of each
person.
3. Summarizing the Transactions: The next step is to prepare a year end summary
known as Final Accounts. Before preparing the final accounts, we have to prepare a
statement called Trail Balance. This is prepared in order to check the arithmetical
accuracy of the books of account. If the Trail Balance tallies, it means that the
transactions have been correctly recorded and posted into ledger.
4. Interpreting the Results: The last stage consists of analyzing and interpreting the
results shown by the final accounts. This involves computation of various accounting
ratios to assess the liquidity, solvency, and profitability of the business. Such analysis is
useful for interested parties like management, investors, bankers, creditors etc.
SYSTEMS OF ACCOUNTING:
1. Cash System of accounting: In this system, accounting entries are made only when
cash is received or paid. No entry is made when a payment or receipt is merely due.
Government system of accounting is maintained on this system.
2. Mercantile System of Accounting: This is also known as accrual system of
accounting. Under this system entries are made on the basis of amounts having
become due for payment or receipt. This system attempts to record the financial
affects of the transactions, events and circumstances of the firm in the period in which
they occur.
3. Fixed System: This system is the mixed of cash system and mercantile system.
Under this system Income are recorded on cash basis and expenses are recorded on
accrual basis. The net income is ascertained by matching expenses on accrual basis
with incomes on cash basis.
MANAGEMENT ACCOUNTING:
Business of today has become very complicated and competitive. Production on large scale,
cut through competition operating system, research development, expansion etc, has
presented big challenges in front of business world. It is certain that efficient industrial and
business operation is not possible without proper managerial control. Now a day the
importance of management has increased in the business world.
Management accounting is a now system of accounting, which presents concepts of
accounting in a new form, on the basis of that suitable divisions are taken by the manager5s.
Management accounting receives and analyzes important information which may help the
managers in decision making. Management accounting has been useful in maximizing profits
and minimizing losses.
Meaning: In management accounting, accounts are classified summarized, analyzed and
presented in such a manner that all valuable information may be made available to the
managers. It facilitates the managers to take suitable decision.
DEFINITIONS:
1. T.G. Rose: Management Accounting is the adoption and analysis of accounting
information and its diagnosis and explanation in such a way to assist management
2. Robert Anthony: Management Accounting is concerned with accounting
information that useful to management.
NATURE OF MANAGEMENT ACCOUNTING:
1. A decision making system: Management Accounting helps in making decision for
the selection of best available information on the basis of various facts and
information of the concern.
2. An integrated system: Management Accounting is an integrated system, under which
targets are archived through various activities. In its various parts, cost account,
budgetary control and financial accounts, statistics etc., are included.
3. A systematic approach: Management accounting ensures a systematic process in
which various methods and techniques are used. Various activities are coordinated
with each other and it is a systematic effort for the concern.
4. Service Criterion: Management accounting provides information as and when it is
required and in this sense it provided service functions and it facilitates decision
making for the managers.
5. A corrective Action plan: various causes of variations are located out and then
corrective actions are taken under management accounting. Management accounting
is a course of actions in which problems and obstacles are solved with the help of
corrective measures.
6. Future based: Management accounting is related to future activities and managerial
decisions are taken accordingly. Thus in managements accounting, various
information, facts and figures are made available.
7. An Information System: Management Accounting is related to information systems

and various facts and statements are necessary part of information system. It helps in
smooth running and operation of the concern.
8. Analytical system: Management accounting is an analytical system, which explains
the reasons for profitability etc. of the concern. All these facts help in getting to a
correct conclusion.
9. Result oriented: Management accounting provides facts and information, which are
useful in the attainment of goals and in this manner management accounting is result
oriented.
10. Professional Growth: Now a days management accounting is used as professional
growth. All tools, procedures and methods are useful for smooth and proper operation
of any concern. If helps in the professional growth of the economy
SCOPE OF MANAGEMENT ACCOUNTING:
1. Financial Accounting: Under it all financial transactions are recorded in the books
and then they are classified and summarized. Profit and loss account and Balance
Sheet are prepared which shows the financial position of the concern.
2. Budgetary Control: Under it variances are measured by comparing actual amount
with estimation and reasons for variances are located and corrective measures are
taken. All these works are done on the basis of forecasting.
3. Tax Accounting: Management accounting proves to be useful in the conditions of
excessive tax liabilities. Efforts are to be made to minimize tax liability through
optimum use of capital.
4. Management Information system: With the help of it, information at various level
of management information is obtained easily. In this process, communication is
received and sent very smoothly, and it enables managers to take suitable decision.
5. Reporting: Reporting in an important part of management Accounting. Data, facts
and accounting information are made useful with the help of various statistical
techniques, which are more useful for management.
6. Cost Accounting: It explains various techniques of cost analysis such as Marginal
Costing, standard costing, Responsibility Accounting, P/V Ratio, Differential
accounting, Inventory Control etc.,
7. Statistical Methods: Statistical methods are extensively used in management
accounting there figures are interpreted which helps the managers to take suitable
decisions. The main statistical techniques are time series analysis, correlation, index
numbers, Regression Analysis.
8. Data Interpretation: Management accounting provides data and figures to managers,
which helps them to take proper decision. Useful and corrective measures are
undertaken, through interpretation of data.
9. Capital Budgeting: Capital budgeting is useful in proper planning of capital
expenditure. Suitable decisions regarding capital investments are taken in capital
budgeting.
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FUNCTIONS OF MANAGEMENT ACCOUNTING:

PRIMARY FUNCTIONS:
1. Managerial activities: Management accounting helps managers in their operations. It
includes the following functions:
Organizing: Entire activity of the concern is divided into groups and departments. At every
level of management, every manager is interested to know the performance of his
subordinates.
Planning: Planning is a preliminary stage of any course of action. Planning process depends
upon the intelligence, foresightedness and correct judgment of managers.
Directing: Planning directs its subordinates and supervise their work their work from time to
time. The main elements of direction are as under:
Proper guidance to subordinates
Issue directions and orders
Performance according to plan
Coordination: Every manager tries to establish better coordination in his entire activities.
Budgets are prepared according to the nature of various departments.
Motivating: It refers to development of inspiration amongst people to work, so that desired
results may be obtained. Management accounting signifies the capabilities and efficiency of
every employee and provides them financial and non financial incentives that motivate them.
Controlling: This function ensures that all the activities of organization are performed in
accordance with the objectives set in advance. With the help of control, better results are
obtained.
2. Accounting information: The function of management accounting is to provide necessary
information to the managers and other parties such as investors, financiers, creditors and
government.
Forecasting: Under it forecasts are made for certain activities at a certain level of confidence.
Forecast is necessary to attain a definite level of accuracy.
Interpretation: Management accounting evaluates all the activities, in order to reach to the
best conclusions. Standard costing, variable analysis, financial statements analysis are the
main tools for interpretation.
Implementation and communication: All information, facts and figures are interpreted and
then communicated to all related parties such as customers, financiers, investors and suppliers
etc.
Recording function: All transactions are recorded in financial accounts and costs accounts.
Thus management arrives at conclusion after analyzing them on the basis of assumption.
Reporting: Management accounting provides reports which are required by the managers at
different levels. These reports may be general as well as specific.
SECONDARY FUNCTIONS:
Protection of assets: Management accounting projects a course of action for continuity of
the concern. Various profitable and good tasks are identified and proper investment is made in
them.
Tax policies: Management accounting formulates favorable tax policy so that tax liabilities
may be made minimum. Capital gearing, capital budgetary and other tools minimize the tax
liability of the organization.
Accountability: Management accounting ensures accountability through reporting system, so
that the people may not shift their responsibilities to others.
Financial planning: Management accounting uses various accounting techniques to achieve
the desired goals of the concern. It includes cost control, ratio analysis, fund flow statements,
inflation accounting etc.
Strategic function: The task of strategy is carried out by top management. Management
accounting provides necessary informations to formulate the desired strategy.
ROLE OR IMPORTANCE OF MANAGEMENT ACCOUNTING IN MODERN

ORGANIZATION:
1. Various sources of information: Management accounting provides various types of
information relating to financial and non-financial activities of the concern. On the
basis of this information, the managers may take suitable decisions regarding concern.
2. A detail study: The management collects various information from financial and nonfinancial sources and has a detail study of it. Correct decision improves the efficiency
and capacity of borrowed capital.
3. Expansion and Development: With the help of useful informations, the organization
may develop and may plans for the expansion. In case of expansion management
accounting may be helpful in issuing and allotment of shares and proper utilization of
capital.
4. Useful in working Capital: Techniques of management accounting are very useful
relating to working capital requirements and its effective utilization. It increases the
productivity of the organization.
5. Variance Analysis: Management accounting helps the concern with the analysis of
variance. Standards are determined in advance and actual results are compared and
reasons of variance are noted down.
6. Accuracy and Reliability: With the help of various techniques of management
accounting different information are obtained from financial and cost accounting.
Level of accuracy and reliability is determined.
7. Investment opportunities: Management accounting provides various opportunities
of investment. It tests various proposals of investments and selects the best out of
them.
8. Financial Investigation: Management accounting carries out financial investigations

in such a manner that concerned parties may get maximum benefits.
9. Corporate planning: Management accounting helps in formulating long term plan
for the organization. Suggestions are given regarding amalgamation, merger and
reconstruction of the concern.
10. Corrective Actions: Under management accounting corrective action may be taken
against the adverse variations and decisions.
DISTINGUISH BETWEEN FINANCIAL ACCOUNTING AND COST ACCOUNTING
Basis for
differences
Objective
Financial accounting
Cost accounting
The objective is to find out the

profitability of operations during a
particular period for the benefit of
owners and outsiders.
The objective here is to help

management
through
the
provision of prompt cost data
and thereby improve managerial
decision making.
Here the transactions are
identified with cost units.
Attention
is
focused
on
transactions
relating
to
manufacturing.
Records
expenses
by
departments, elements, produces
or processes to study them
analytically.
The profits or loss relating to
each job, process, and operation
department can be found out.
A systematic procedure for
purchasing, storing and issuing
of materials exists.
Labor time records and wage
sheets permit management to
find out effective and idle hours
and ensure control accordingly.
Coverage
Here, the transactions are recorded

for a definite period. It mainly
deals
with
all
commercial
transactions.
Analysis of costs
In financial accounting the

expenditure is analyzed item wise,
e.g wages, salaries, depreciation
for offering a commentary.
The profitability of individual
products or departments is not
known.
Material control is not ensured, as
figures are not available.
Analysis of profits
Material control
Labor cost control
Cost classification
Stock valuation
Control means
Recording
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Wage sheets under financial

accounting do not reveal labor
efficiency, idle time and effective
hours of work. Hence, control not
possible.
Distinction between fixed and Costs are classified into fixed
variable costs not maintained.
and variable elements and
attention
is
focused
on
controllable costs, which can be
reduced by suitable steps.
Here, stock valued at cost price or Here stock is valued at cost.
market price, whichever is less.
Does not provide any means to Techniques like standard costing
measure the efficiency and employed to ensure control over
exercise control over costs.
operations.
Records actual costs. It is only a Actual facts are combined with
Comparison
Legal need
Approach
post mortem examination of

events that have taken place,
leaving very little room for
initiative
corrective
steps
promptly.
Data here is not sufficient for
drawing inter period and inter firm
comparisons from time to time.
estimated ones while recording

transactions. Transactions are
recorded in an objective manner,
according to the purpose for
which costs have been incurred.
Detailed comparison of results
of two periods or two firms in an
industry possible in cost
accounting.
Statements prepared as per the Statements prepared internally
legal requirements, i.e., as laid as
per
the
managerial
down by companies act, income requirements.
tax act.
Data generated for external parties. Data generated for managerial
Deals with external transactions.
decision making. Deals with
internal transactions.
DISTINGUISH BETWEEN FINANCIAL ACCOUNTING AND MANAGEMENT

ACCOUNTING
Basis
Management accounting
Users
Financial accounting provides Management accounting provides

information to external parties.
information to interval parties.
Nature
Financial accounting is related to Management accounting is in the

recording,
classification
and nature of information system.
summarizing of transaction.
Information
historical information.
Methodology
In
financial
accounting Information is divided into related
transactions are recorded on cost centers and responsibility
double entry system.
center.
Reporting
Under
financial
accounting Under management accounting
reporting is dome annually.
reporting is done as per
requirements.
Objectives
The main objectives of financial The object of management

accounting and summarizing of accounting
is
to
deliver
transactions.
information to manager.
Importance
Financial accounting is less Management accounting has more

important as related to operational importance, as it is related on
activities.
various managerial activities.
Accounting
principles
In
financial
accounting Management accounting does not
information is provided on the follow any such principle.
basis of generally accepted
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provides Management accounting collects

and interprets information for
useful for future.
accounting principles.
Compulsory
optional
Accuracy
and Financial accounts are compulsory Management accounting is not

as per companies act and their compulsory. It is optional.
audit is also compulsory.
More attention is paid towards
attaining accuracy in financial
accounting as all the transaction is
recorded
under
historical
accounting system.
Management
accounting
information is provided in time.
Availability of information at
correct time is more important.
UNIT-II
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CLASSIFICATION OF ACCOUNTING PRINCIPLES:

1. Accounting Concepts
2. Accounting Conventions.
ACCOUNTING CONCEPTS
The Business entity concept: This concept recognizes a business unit as a separate and distinct entity
from the owner or owners whose capital is used for business operations. Each business unit,
regardless of its constitution as a separate accounting unit, is treated as a distinct entity, and the
accountant treats the owners as out sliders in the accounting records of the business.
Dual Aspect Concept: This concept throws light on the point that each transaction has two fold affect
the receiving of the benefits and giving of the benefit. The receiving aspects is termed as debit, where
as the giving aspect a as Credit.
The going concern concept: The going concern concept considers every business, regardless
of its constitution, to continue its operations in future indefinitely, and not to wind up its
affairs. Since it is on this basis that financial statements are prepared, assets are valued at cost
less depreciations for their use in business, Market values or realizable values of assets are of
no relevance in the case of a going concern since assets are meant for continuous use in the
business, and not for resale at a profit.
The Money measurement Concept: According to this concept, the accounting records
should reflect only those events or facts which are capable of being measured in terms of
money and the financial statements should communicate only those events or facts which are
capable of being measured in terms of money. The need for this concept arises because of the
fact that the resources used for business operations are diverse in nature, and they are also in
different units of measurement.
Objective Evidence Concept: According to this concept all accounting transactions should
be evidenced and supported by objective documents. The documents include invoices,
receipts, cash memos etc. Accounting records are unbiased. They are not affected by the
personal judgment in recording these events.
The cost concepts: According to this concept, all assets acquired by a concern are shown in
the accounting records at cost, i.e., the price paid to acquire them. If an asset does not cost
anything, i.e., no money is paid for its acquisition, it is not shown in the books of account.
This approach is preferred because it is difficult and time consuming to ascertain the market
values.
The accounting period concept: According to the going concern concept & business
intended to continue indefinitely for a long period. As such, the results of business operations
can be ascertained only after the liquidation of the business. Since this is not practicable,
accountants choose a convenient period of time for measuring the net income for that period,
by artificially splitting business longevity accounting periods. The period of time chosen is
usually one year.
The accrual concept: While the realization concept is mainly concerned with revenue
recognition, the accrual concept, which applies both to revenues and expenses, reinforces the
realization concept. The concept distinguishes between the right to receive cash and the
actual receipt of cash, and the obligation to pay cash and the actual payment of cash.
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The matching concept: According to this principle, the expenses incurred in an accounting
period should be matched with the revenues recognized in that period. For example if
revenue is recognized on all goods sold during a period, Cost of those goods sold should also
be charged to that period.
Historical Record Concept: The Accountant shows only those transactions which have
actually taken place and not those which may take place in future. All transactions in
accounting are to be recorded in the books in the chronological order.
ACCOUNTING CONVENTIONS:
1. Full Disclosure Concept: This convention requires (hat accounting statements should
be honestly prepared and all significant information should be disclosed therein. That
is, while making accountancy records, care should be taken to disclose all material
information. Here the emphasis is only on material information and not on immaterial
information. This convention assumes greater importance in respect of corporate
organizations where the management is divorced from ownership.
2. Materiality Concept: American Accounting Association defines the term materiality
as "An item should be regarded as material if there is reason to believe that
knowledge of it would influence the decision of informed investor." It refers to the
relative importance of an item or event. Materiality of an item depends on its amount
and it nature. Theoretically, all items, large or small, should be treated alike.
3. Consistency Concept: Rules and practices of accounting should be continuously
observed and applied. In order to enable the management to draw conclusions about
the operation of a company over a number of years, it is essential that the practices
and methods of accounting remain unchanged from one period to another
Comparisons are possible only if a consistent policy of accounting is followed- If
there are frequent changes in the treatment of avowals there is little or no scope for
reliability.
4. Conservatism Concept: "Anticipate no profit and provide for all possible losses" is
the essence of this convention. Future is uncertain. Fluctuations and uncertainties are
not uncommon. Conservatism refers to the policy of choosing the procedure that leads
to under-statement as against overstatement of resources and income. The
consequences- of an error of understatement are likely to be less serious than that of
an error of overstatement. For example, closing stock is valued at cost or market price
whichever is lower.
CLASSIFICATION OF ACCOUNTS:
All business transactions are broadly classified into three categories: I those relating to
persons, ii those relating to property and iii those relating to income and expenses. Thus,
three classes of accounts are maintained for recording all business transactions. They are
personal accounts, real accounts and nominal accounts.
Personal accounts: Accounts which show transactions with persons are called personal
accounts. A separate account is kept in the name of each person for recording the benefits
received from, or given to the person in the course of dealings with him. Examples: Krishnas
account, Gopals account, Kalyans loan account etc.
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Real accounts: Accounting relating to properties or assets are known as real accounts. Every
business needs assets such as machinery, furniture, etc for running its activities. A separate
account is maintained for each asset owned by the business. All transactions relating to a
particular asset are recorded in the concerned asset account. Cash account, furniture account,
machinery account, building account etc, are some examples of real accounts.
Nominal accounts: Accounts relating to expenses, losses, incomes and gains are known as
nominal accounts. A separate account is maintained for each item of expense, loss, income or
gain. Wages account, salaries account, communication received account, and interest received
account are some examples of nominal accounts.
RULES OF DEBIT AND CREDIT:
Personal accounts: The account of the person receiving benefit is to be debited and the
account of the person giving the benefit giving the benefit is to be credited.
Personal accounts: Debit the receiver
Credit the giver
Real accounts: When an asset is coming into the business, the account of that asset is to be
debited. When an asset is going out of the business, the account of that asset is to be credited.
Real accounts: Debit what comes in
Credit what goes out
Nominal accounts: When an expense is incurred or loss suffered, the account representing
the expense or the loss is to be debited. When any income is earned or gain made, the account
representing the income or the gain is to be credited.
Nominal accounts: Debit all expenses and losses
Credit all incomes and gains
ACCOUNTING STANDARDS:
AS-1: Disclosure of accounting policies (Issued in 1979)
AS-1 deals with the requirement of disclosing significant accounting policies adopted in the
preparation of financial statement sand the manner in which they are to be disclosed in the
financial statements.
Disclosure policies accounting policies refer to the specific accounting principles and the
methods of applying those principles adopted by the enterprises in the preparation and
presentation of their financial statements.
AS-2: Valuation of inventories (Issued in 1981 & received in 1999)
AS-2 lays down the principles to be considered in computing the value of inventories and
also ensures adequate disclosure of the policy adopted by an enterprise. Inventories are
defined as assets: 1. held for sale in the ordinary course of business, 2. in the process of
production for such sale and 3. in the form of materials or suppliers to be consumed in the
production process or in the rendering of services.
15
AS-3: Cash flow statement

The institute of chartered accountants of India (ICAI) issued the accounting standard (AS-3)
relating to the preparation of cash flow statement for accounting periods commencing on or
after April 1, 2001 for enterprise.
AS-4: Contingencies and events occurring after the balance sheet date (issued in 1982,
received in 1995)
The AS-4 deals with the treatment in the financial statements of (a) contingencies and (b)
events occurring after the balance sheet date. Contingency is defined as a condition or
situation, the ultimate outcome of which, gain or loss, will be known or determined only on
the occurrence, or non-occurrence, of one or more uncertain future events. Events occurring
after the balance sheet date are those significant events that occur between the balance sheet
date and the date on which the financial statements are approved by the Board of Directors in
case of a company, and by the corresponding approving authority in the case of any other
entity.
AS-5: Net profit or loss for the period, prior period items and changes in accounting
policies (Issued in 1982 and revised in 1997 and 2001)
The objective of this AS is to prescribe the classification and disclosure of certain items in the
statement of profit and loss so that t all enterprises prepare and present such a statement on a
uniform basis. This enhances the comparability of the financial statements of an enterprise
over time and with the financial statements of other enterprises.
AS-6: Depreciation accounting (Issued in 1982 and revised in 1994)
The AS-6 deals with disclosure of accounting policy followed in respect of depreciation by
an enterprise. Depreciation is a measure of the wearing out, consumption or other loss of
value of a depreciable asset arising from use, effusion of time or obsolescence due to
technology and market changes. Depreciation is allocated so as to charge a fair proportion of
the depreciable amount in each accounting period during the expected useful life of the asset.
AS-9: Revenue recognition (Issued 1985)
This AS-9 provides the bases for recognition of revenue arising in the ordinary course of
activities of the enterprise. Revenue is the gross inflow of cash, receivables or other
consideration arising in the course of ordinary activities of an enterprise form the sale of
goods, from the rendering of services, and from the use by others of enterprise resources
yielding interest, royalties and dividends.
AS-10: Accounting for fixed asset (Issued in 1985)
Fixed assets often comprise a significant portion of the total assets of an enterprise, and
therefore, are important in the presentation of financial position. Furthermore, the
determination of whether expenditure represents as asset or an expense can have a material
effect on an enterprises reported results of operations.
AS-13: Accounting for investments (Issued in 1993)
16
This AS deals with accounting for investment in the financial statements of enterprise and
related disclosure requirements. Investment are defined as assets held by an enterprise for
earning income by way of dividends, interest, and rentals for capital appreciation, or for other
benefits to the investing enterprise.
AS-17: Segment reporting
The accounting standard documents principles for reporting financial information about
different types of products and services an enterprise produces and the different geographical
areas in which it operates. Such information helps the users of financial statements to 1. Have
a better understanding of the performance of the enterprise, 2. Assess the risks and returns of
the enterprise, 3. Make more informed judgments about the enterprise as a whole.
AS-18: Related party disclosures
The AS-18 documents requirements for disclosure of 1. Related party relationships and 2.
Transactions between a reporting enterprise and the related parties.
UNIT-III
17
COST ACCOUNTING:
The cost of manufacture of products or of rendering a service is, no doubt, available in
financial accounts for a division or enterprise as a whole and that too at the end of the
accounting period. But if the cost of individual products or services and the profit or loss
from each are required concurrently as the process of manufacture or of rendering the service
proceeds, recourse has to be made to cost accounting. Cost accounting developed as an
advanced phase of accounting science trying to make up the deficiencies of financial
accounts and is essentially a creation of the twentieth century.
Costing: Costing is the technique and process of ascertaining costs. It expresses faithfully the
actual cost of any particular unit of production and also discloses how such total cost is
constituted.
Cost accounting: It is a normal mechanism by means of which costs of products and services
are ascertained and controlled. It embraces all accounting procedures relating to recording of
all income and expenditure and the preparation of periodical statements with a view to
ascertain and control costs.
Cost accountancy: It is the application of costing and cost accountancy principles, methods
and techniques to the science, art and practice of cost control and the ascertainment of
profitability.
DEFINITIONS:
Walter W.Bigg: Cost accounting is the provision of such analysis and classifications of
expenditure as it will enable the total cost of any particular unit of production to be
ascertained with reasonable degree of accuracy and at the same time to disclose exactly how
such total cost is constituted.
IMPORTANCE OF COST ACCOUNTING:
Benefits of management: Cost accounting helps management in carrying out its function
efficiently and effectively in the following ways:
Planning: Cost accounting ascertains costs of different courses of action and provides a
sound basis for picking up a suitable course of action. It compiles up to date cost data,
analyses by products, o[operations, elements, functions and departments and presents them in
a suitable form.
Budgeting: Cost accounting is not a post mortem examination of past events. It is a system
of foresight. It does not merely record actual costs incurred but works out estimated and
standard costs for exercising control.
Decision making: Cost accounting compels management to arrive at decisions based on cost
data, in place of trail and error judgments. Valuable cost data enables management to decide
issues such as: make or buy, expand or contract business activities, putting scare inputs to
effective use, evaluating the profitability of various alternatives selling below cost price etc.
Organizing: Cost accounting requires that the work in an organization must be logically
divided, in the form of departments, cost centers and responsibility centers.
18
Controlling: A sound system of material control in the form of buying, receiving, inspection,
storage, issue of materials prevents wastage, pilferage, under and over stocking of materials
at various levels.
Pricing: Cost accounting provides useful data for quoting appropriate prices for domestic as
well as foreign markets well ahead of production schedule.
Efficient use of resources: Cost accounting conducts a continuous war against wastes of all
kinds. The standards for measuring efficiency are established initially.
Benefits to employees:
It facilitates the introduction of various incentive schemes and bonus plans and, thus,
offers adequate rewards for efficient and sincere workers.
Employees performance is appraised in a scientific manner, by setting standards of

efficiency, and measuring the same through time and motion studies.
Benefits to the creditors: Bankers, debenture holders and other creditors study the data
provided by cost accountants to ascertain the solvency, profitability and future prosperity of
an enterprise before they lend.
Benefits to the Government: The procedures and techniques of cost accounting are useful in
preparing national plans aimed at achieving economic progress. In order to decide things
pertaining to taxation, import and export policies, price ceiling, granting of quotas and
subsidies, government requires cost data relating to various industries.
Benefits to society:
It wages a war against wastes of all kinds. Consumers, therefore, get quality goods at
an economical price.
It brings stability by improving managerial and operating efficiency.
METHODS OF COSTING:
Job costing: A job comprises a specific quantity of a product as per customers
specifications. This method applies where work is under taken to customers requirements. It
is used in repair shops, interior decoration, printing press etc.
Contract costing: Contract costing is a big one and the unit cost is a contract, which is of a
long duration and it may continue for more than a year.
Process costing: This method is used in mass production industries, having continuous
processes of manufacturing. In this method raw material has to put through a number of
processes up to a completion stage.
Unit costing: This method is used when production is uniform and consists of a single
variety of the same product. If the product is produced in different grades, costs are as
curtained grade wise.
Composite costing: This method is used in industries where a number of components are
manufactured separately and then assembled in a final product. Assembly of various
components into final product requires another method of costing.
19
Service costing: This method is used where services are produced for example transport
undertakings, hotels, electricity companies, cinemas, hospital etc.
Operation costing: Any process may consist of a number of operations and this costing
involves cost ascertainment for each operation.
Batch costing: In this method, the cost of a batch of identical products is ascertained and
each batch of product is a cost unit.
TECHNIQUES OF COSTING:
Standard costing: In this technique standard cost is predetermined and then actual
performance is measured against the standard. The variation between standard and actual
costs is analyzed and reasons for differences are located.
Marginal costing: In this technique total cost is separated into fixed and variable costs.
Marginal costs is related with the variable cost and fixed cost is treated as period cost and
attempts are not made to allocate this cost to individual cost units.
Budgetary costing: Budgetary control is a technique relating to control of total expenditure
on materials, wages and overheads by making comparison of actual performance with the
planned one. The budget is also used for control and coordination of business activities.
Uniform costing: It is defined as the use by several undertakings of the same costing
principles. It helps to compare the performance of one firm with that of another firms and to
derive the benefits.
Absorption costing: In this method, total costs are charged to products. It is a complete
contrast to marginal costing. But it has a very limited application.
CLASSIFICATION OF COST:
Direct & indirect cost:
Direct costs: These costs are incurred and identified with a particular cost unit. Cost of raw
materials and wages used are common examples of direct costs.
Indirect costs: These costs are incurred for the benefit which cannot be identified with a
particular costs center. Depreciation, lighting, rent, salaries, repairs etc are common examples
of indirect costs.
Committed & discretionary costs:
Committed costs are incurred in maintaining physical facilities. These costs are unavoidable,
whenever any decision has been taken for them. These expenses are invariant in the short run,
such as depreciation of plant and equipment.
Discretionary costs are those costs which can be avoided by management decisions. Such
costs are not permanent. These costs may be avoided or reduced in the short run.
Controllable and non-controllable costs:
Controllable costs are regulated directly at a given level of management. Variable costs are
controllable by department heads.
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Non-controllable costs are those costs which cannot be influenced the action of a specified
enterprise.
Normal and abnormal costs:
Normal costs are incurred on expected lines of production.
Abnormal cost is above the normal cost and it is not treated as a part of cost of production. It
is charged to profit and loss account.
Fixed and variable costs:
Fixed costs are remain constant over a wide range of activity and they do not increase or
decrease with the change in volume of production. But fixed costs per unit decreases when
volume of production increases and vice-versa.
Variable costs have a tendency to vary in direct proportion to volume of output. If output
increases, total variable costs will increase and vice-versa.
Product and period costs:
Product costs are necessary for production and they will not be incurred if there is no
production. This cost is absorbed to the units produced.
Period costs are not necessary for production and are incurred even if there is no production.
Historical and predetermined costs:
Historical costs are ascertained when they are incurred and they are the actual costs. These
costs cannot be available before the completion of manufacturing operations.
Predetermined costs: There are future costs which ascertained in advance of production.
These costs are extensively used for planning and control purpose.
ELEMENTS OF COST:
Material cost:
Direct materials: It is that material which can be conveniently identified and allocated to
cost units. It is a part of financial product.
Indirect materials: This type of materials cannot be identified conveniently with individual
costs units. It is relatively small and do not become a part of the finished product such as
cool, lubricating oil etc.
Labor cost:
Direct labor: It consists of wages paid to workers directly engaged raw materials into
finished goods. These wages can be conveniently identified with any product.
Indirect labor: It is of general character and cannot be identified with a particular cost unit.
This labor is not directly engaged in the production operations.
21
Expenses:
Direct expenses: Direct expenses are those expenses which can be identified to cost units.
These expenses are incurred in relation to particular job or cost unit.
Indirect expenses: All indirect costs other than indirect materials and indirect labor are
termed as indirect expenses.
Prime cost: It is the total of direct material, direct labor and other direct expenses.
Overheads: This is the total or aggregate of indirect material cost indirect labor cost and
other indirect expenses.
MARGINAL COSTING:
Marginal costing is a useful technique which guides management in pricing, decision
making and assessment of profitability. It classifies costs into fixed and variable ones. The
expenses which vary directly in proportion to the volume of production are termed as variable
expenses. The expenses which remain constant or unaffected by the change in output are
called fixed expensed. This distinction forms the basis of marginal costing.
Profit is influenced by the changes in fixed expenses and these expenses will remain static
and do not affect decision making. Moreover they are largely uncontrollable. The theory of
marginal costing, therefore, argues that only variable expenses should be taken into account
for purposes of product pricing, inventory valuation and other important management
decisions.
Marginal cost:
The institute of cost and works accountants, London, defined marginal costs as the amount at
any give volume of output by which aggregate costs are changed, if the volume of output is
increased or decreased by one unit of output. It is the additional cost of producing one
additional unit. It arises from the production of additional increments of output.
MEANING OF MARGINAL COST AND MARGINAL COSTING
The Chartered Institute of Management Accountants, England defines the terms Marginal
Cost and Marginal Costing as follows:
Marginal Cost: "The amount at any given volume of output by which aggregate costs are
changed if the volume of output is increased or decreased by one unit,
In this context a unit may be a single article, a batch of articles, an order, and a stage of
production capacity or a department. It relates to the change in output in the particular
circumstances under consideration".
Marginal Costing: "The ascertainment of marginal costs and the effect on profit of changes
in volume or type of output by differentiating between fixed costs and variable costs.
In this technique of costing only variable costs are charged to operations, processes or
products, leaving all indirect costs to be written off against profit in the period in which they
arise."
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The technique of marginal costing assumes that the difference between the aggregate sale
value and the aggregate marginal cost of the output sold provides a fund to meet the fixed
cost and profit of the firm. In respect of each product, the difference between its sale value
and the marginal cost is, technically known as "contribution", or gross marginal made by the
product to this fund. This contribution is the difference between the sale value and the
marginal cost of sales and it contributes towards fixed expenses and profit Contribution can
be represented as:
Contribution = Selling Price - Marginal Cost
Contribution = Fixed Expenses Profit/Loss
Contribution - Fixed Expenses = Profit/Loss
ABSORPTION COSTING:
The ascertainment of the total cost of the product to be manufactured or for providing
a service by including all relevant costs including fixed cost is called as absorption costing.
The net profit ascertained under the absorption costing method will not be the same as under
the marginal costing method because of
(1)Difference in Stock Valuation: Stock of work-in-progress and finished goods are valued
at marginal cost not including fixed costs under the marginal costing method whereas in the
absorption costing or total cost method, they are valued at cost of production which includes
fixed costs. In other words, the valuation of stocks will be done at lower figure in the
marginal costing method as compared to the total cost method; therefore, profits under these
two methods of costing will differ.
(2) Over- or Under-absorption of Overheads: In absorption costing method, there can
never be hundred per cent absorption of fixed overheads because of the difficulty in
forecasting costs and volume of output. There will be either over-absorption or underabsorption, whereas in the marginal costing method, the actual amount of fixed overheads is
wholly charged to Profit and Loss Account. Hence, profits under the two methods will differ.
ADVANTAGES OF ABSORPTION COSTING:
(1) It suitably recognizes the importance of including fixed manufacturing costs in product
cost determination and framing a suitable pricing policy. In tact all costs (fixed and variable)
related to production should be charged to units manufactured. Price based on absorption
costing ensures that all costs are covered. Prices are well regulated where foil cost is the
basis.
(2) It will show correct profit calculation in case where production is done to have sales in
future (e.g., seasonal sales) as compared to variable costing.
(3) It helps to conform to accrual and matching concepts which require matching cost with
revenue for a particular period.
(4) It has been recognized by various bodies as FASB (USA), ASC (UK), ASB (India) for the
purpose of preparing external reports and for valuation 01 inventory.
(5) It avoids the serration of casts into fixed and variable elements which cannot be done
easily and accurately.
23
(6) It discloses inefficient or efficient utilization of production resources by indicating under

absorption or over absorption of factory overheads.
(7) It helps to make the managers more responsible for the costs and services provided to
their centers/departments due to correct allocation and apportionment of fixed factory
overheads.
(8) It helps to calculate the gross profit and net profit separately in income statement.
LIMITATIONS OF TOTAL COST (OR ABSORPTION COSTING) METHOD
1 Difficulty in comparison and control of cost: Absorption costing method is dependent
on level of output, so different unit costs are obtained for different levels of output. An
increase in the volume of output normally results in reduced unit cost and a reduction m
output results in an increased cost per unit due to the existence of fixed expenses. This makes
comparison and control of cost difficult and obscures cost-volume-profit relationship.
2. Not helpful in managerial decisions. Absorption costing is not very helpful in taking
managerial decisions such as selection of suitable product mix, whether to buy or
manufacture, whether to accept the export order or not, choice of alternatives, the minimum
price to be fixed during the depression, number of units to be sold to earn a desired profit etc
In all such decisions, the technique of marginal costing is suitable because it takes into
consideration the additional cost involved (i.e., variable expenses) only assuming fixed
expenses remaining constant.
3 Cost vitiated because affixed cost. Under absorption costing method, a portion of fixed
cost is carried forward to the next period because closing stock is valued at cost of production
which is inclusive of fixed cost. In marginal costing technique, it is not so because all fixed
expenses of a particular period are deducted from the fund (i.e., total contribution ot various
products) for arriving at the figure of profit. Therefore, in marginal costing technique, costs
pertaining to a particular period are not vitiated as they are vitiated in absorption costing
method because in absorption costing method all fixed costs are not charged against the profit
of the year in which they are incurred.
4 Fixed cost inclusion in cost not justified. Many accountants argue that fixed
manufacturing, administration and selling and distribution overheads are period costs and do
not produce future benefits and, therefore, should not be included in the cost of product.
5 Apportionment affixed overheads on arbitrary methods. The validity of product costs
under this technique depends on correct apportionment of overhead costs. But in practice
many overhead costs are apportioned by using arbitrary methods which ultimately make the
product costs inaccurate and unreliable
6. AW helpful for preparation of flexible budget Under absorption costing no distinction is
made between the fixed and variable costs. It is not possible to prepare flexible budget
without making this distinction. Flexible budget is very important for control function.
24
DISTINGUISH BETWEEN MARGINAL COSTING AND ABSORPTION COSTING

Basis of difference
Absorption costing
Marginal costing
Fixed costs
Fixed overheads are charged to Fixed costs are included while

the product to be subsequently computing cost per unit.
released as a part of cost of
goods sold i.e. it is included in
cost per unit.
Profit
Profit is the difference between Profit in marginal costing is

sales and cost of goods sold.
ascertained by establishing the
total contribution and then
deducting therefore the total fixed
expenses. Contribution is the
excess of sales over variable cost.
Classification of
costs
Costs are rarely classified into

variable and fixed. Although
such a classification is possible,
it fails to establish a cost volume
profit relationship.
Cost volume profit relationship is

an essential part of marginal
costing. Costs have to be
classified into fixed costs and
variable costs.
Valuation of
inventories
If inventories increase during a

period, this method will reveal
more profit than marginal
costing.
When
inventories
decrease, less profit are reported
because in this method closing
stock is valued at higher figures.
If inventories increase during a

period, this method generally
reports
less
income
than
absorption costing but when
inventories decrease this method
reports more net income.
Recovery of
overheads
Apportionment of fixed costs is There no arbitrary apportionment

arbitrary and this may result in of fixed overheads, as fixed costs
under recovery of overheads.
is excluded.
BREAK-EVEN (OR COST-VOLUME PROFIT) ANALYSIS:

A logical extension of marginal costing is the concept of break-even analysis. It is
based on the same principles of classifying the operating expenses into fixed and variable.
Now-a-days it has become a powerful instrument in the hands of policy-makers to maximize
profit. There may be change in the level of production due to many reasons, such as
competition, introduction of a new product, trade depression or boom, increased demand for
the product, scarce resources, change in the selling prices of products, change in the unit cost,
etc. In such cases, management wants to know the effect on profit on account of the changing
levels of production, a number of techniques can be used as an aid to management in this
respect. One such technique is the break-even analysis.
The term break-even analysis is interpreted in the narrower as well as broader sense.
Used in its narrow sense, it is concerned with finding out the "crisis point", (i.e., breakeven
point), i.e., level of activity when the total cost equals total sales value. In other words, it
helps in locating the level of output which evenly breaks the costs and revenues. Used in its
25
broader sense, it means that system of analysis which determines profit, cost and sales value
at different levels of output. The break-even analysis establishes the relationship of cost,
volume and profits, so this analysis is also known as 'Cost Volume Profit Analysis'. The
results of such analysis are usually presented in the form of Break Even Charts, so it is
proposed to give below the description of break-even charts.
BREAK EVEN CHART
A break even chart is a graphical representation of marginal costing. It is considered
to be one of the most useful graphic presentations of accounting data. Out put is taken alone
the X axis and cost and revenue is taken on Y axis. A BEP chart with hypothetical figures is
shown in the following diagram. The intersection point of total cost line with that of the sales
line is Break even point. Area below this is loss area and above it is profit area. The degrees
of angle made at this point are called angle of incidence.
Fixed Cost
BEP (in units): ----------------------
Fixed Cost
or
---------------------
Contribution per unit
P/V Ratio
ASSUMPTIONS UNDERLYING BREAK EVEN CHART

1 Ali costs can be separated into fixed and variable costs
2. Fixed costs will remain constant and will not change with the change in level of output.
3. Variable costs will fluctuate in the same proportion in which the volume of output varies.
In other words, prices of variable cost factors i.e., wage rates; price of material etc. will
remain unchanged.
4. Selling price will remain constant even though there may be competition or change in
volume of production.
5. The number of units produced and sold will be the same so that there is no opening or
closing stock. There will be no change in operating efficiency.
6. There is only one product or in the case of many products', product mix will remain
unchanged.
ADVANTAGES OF BREAK EVEN CHARTS
1. Information provided by the break even chart can be understood by the management more
easily than that contained in the Profit and Loss Account and the Cost Statements because a
break even chart is the simple presentation of cost, volume and profit structure of the
company. It summarizes a great mass of detailed information in a graph in such a way that its
significance may be grasped even with a cursory glance.
2. Being future-oriented, it serves as a valuable aid in forecasting costs, sales and profits at
various volumes of sales. It is useful for studying the relationship of cost, volume, and profit.
The chart is very useful for taking managerial decisions because it shows the effect on profits
of changes in variable costs, selling price, volume of sales and fixed costs. It is a tool for cost
control because it shows the relative importance of the fixed costs and the variable cost.
26
3. It is helpful in the determination of the sale price which would give a desired profit or
break even point.
4. The profit potentialities can be best judged from a study of the position of the break even
point and the angle of incidence in the break even chart. Low break even point and large
angle of incidence in the break even chart indicates that fixed costs are low and margin of
safety is high. It is a sign of financial stability because it indicates a low margin of safety
and a low rate of profit.
5. Profitability of various products can be compared with the help of break even charts and a
most profitable mix can be adopted.
6. It is helpful in knowing the effect of increase or reduction in selling price.
LIMITATIONS OF BREAK EVEN CHARTS
Break even charts are beset with certain limitations given as follows:
1. A break even chart is based on a number of assumptions (as discussed earlier which may
not hold good. Fixed costs assumed to be fixed vary somewhat with a change in the level of
output. Variable costs assumed to be cent per cent variable do net vary proportionately if the
law of diminishing or increasing returns is applicable in the business. Similarly, sales revenue
does not vary proportionately with changes in volume of sales due to reduction in selling
price as a result of competition of increased production.
2. A limited amount of information can be shown, in a break even chart. A number of charts
will have to be drawn up to study the effects of change in fixed costs, variable costs and
selling prices.
3. The effect of various product mixes on profits cannot be studied from a single break even
chart.
4. A break even chart does not take into consideration capital employed which is very
important factor in taking managerial decisions. Therefore, managerial decisions on
27
UNIT-IV
MANAGERIAL DECISION MAKING:
The process of managing is a process of decision making. It is the process of choosing the
best alternative cause of action out of many available. The main objective of every firm is to
earn maximum of profit and the selection of right course is directed towards this situation.
The problem of division making arise, when there are many alternative courses available for
doing a particular job.
STEPS TAKEN IN MANAGERIAL DECISION MAKING:
Problem diagnosis: It involves defining and recognizing the problem and to diagnose the
problem at length, so that proper decision may be taken immediately.
Developing the alternatives: The division maker has to formulate several alternatives
solutions for solving the problems.
Selecting the best alternative: Several basic approaches are open before the manager and
while taking any decision. He will be guided by the past experience.
Feedback and control: Inspire of the best efforts and analysis, managers cannot take
infallible decision. The management should receive continues information and evaluate them
regarding the effects of such division.
Setting objectives: Before taking any decision, it is necessary to know about the objectives
to be achieved. Exact goals should be known before making any planning.
Analysis of problems: The problems should be analyzed to find out adequate background
information and data relating to any situation. A number of factors may be there in any
problem out of them some may be pertinent and others may not be.
Quantifying the alternative: After collecting all the alternatives the analyst should quantify
each alternative by calculating their revenues, costs and capital.
Implementation: Whatever decision has been taken by the management, it should be
implemented by the manager and is should be carried out promptly and quickly.
TYPES OF DECISION MAKING COST:
Inputted costs: Cost of self owned factors of production, such as interest on capital, rent of
self owned premises, salary of the proprietor are termed as imputed costs. Such costs are
required to be considered to make a fair competition between alternative proposals.
Sunk cost: These costs are due to the division made in the past, and which now cannot be
changed in the future time to come.
Postponeable costs: These costs can easily be deferred temporarily from one period to
another period. This concept is very important in railways and in other transport
organizations.
Escapable and non-escapable costs: Whenever any section is closed, the costs can be
eliminated easily and it is known as escapable costs. Whereas non escapable costs are those
cost that cannot be eliminated even after the closure of that department.
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Abandonment costs: These costs are incurred in abandoning any particular plant. It may
include the cost of removing get a plant from workshop.
Marginal costs: Any change in total costs arises as a result of an increase or decrease by one
unit in column or output is known as marginal cost.
Differential costs: The difference in total costs between two volumes if known as differential
costs.
Shutdown costs: These are the costs which continue to occur even if there is temporary
closure of the production activities.
Avoidable costs: These are the costs that can be eliminated at the discretion of the
management.
Out of pocket costs: There are the costs that give rise to cash expenditure immediately.
These are relevant in decision making.
Opportunity costs: These are the costs of foregone opportunities. When a decision to follow
one cause of action is made the opportunity to pursue some other course is foregone.
MAKE OR BUY DECISION:
Management sometimes may be confronted with the problem of making a choice
between manufacturing the component parts of a product or buying them from outside. Such
a problem will arise when the firm has the idle capacity and the technical capacity of
manufacturing the component parts. In arriving at such a make or buy decision, qualitative
and quantitative factors relating to the problem will be taken into consideration.
The quantitative factors to be considered are the differential costs of the make and buy
alternatives and the consequences of the alternative uses of the idle capacity which exists in
the firm. The relevant costs of buying the component part will include the purchase price and
other costs related to purchasing the component part. Similarly, costs relevant for make
decision will include the variable cost of making the component and fixed costs which are
avoidable if the component is not made.
Fixed costs which are not expected to change would be ignored being irrelevant in the
make or buy decision. Management should compare the differential cost of the two
alternatives and follow the course which is cheaper one. It should also be seen that if a more
profitable use of the idle capacity than manufacturing the component part is available, then
the firm may use the idle capacity for the more profitable alternative and buy the component
part from outside.'
For example, the total cost of making a component part comes to Rs. 8, consisting of
Rs. 6 as variable cost and Rs. 2 as fixed cost. Suppose further an outside supplier is ready to
supply the same component part at Rs. 7. On the basis of total cost method, it appears that it
is cheaper to buy the component. But on the basis of marginal cost, the offer of the outside
supplier should be rejected because the acceptance will mean that the total cost of the
purchased part from the outside supplier will come to Rs. 9 L?.. Rs 7 (supplier's price) plus
Rs 2 (fixed cost which cannot be saved even if the component is purchased from outside
source).
29
The qualitative factors which are taken into consideration to influence the make or buy
decision are as follows:
(1) Quality of goods supplied by the supplier.
(2) Uninterrupted supply by the supplier meeting the delivery dates.
(3) If secrecy is to be maintained and manufacturing know-how is not to be passed on to the
supplier of the component part, the decision will be to manufacture the product.
30
UNIT-V
BUDEGETING
DEFINITION:
1. W.j batty: Budgeting is a kind of future accounting in which the problems of future or met
on paper before the transactions actually occur.
2. George R.Terry:A budget is an estimate of future needs arranged according to an orderly
basic covering some or all of the activities of an enterprise for a definite period of Time.
OBJECTIVES OF BUDGETING CONTROL:
1. Cost control: The main aim of budgetary control is to control the production and the other
cost with maximum out put.
2. Coordination: Establishing coordination amongst various departments is primary
objective of budgetary control.
3. Control on various activities: Various activities are control to budgetary control for the
attainment of budget estimates.
4. Help to administrators: Budgetary controls helps administration in smooth running of the
business it can be used in production, administration, sales, and in estimating financial
requirements.
5. Targets: Targets for various departments are ascertained through budgetary control. Proper
steps can be taken against those people who are not in a position to attain the targets.
6. Determination of policies: Business policies are determined through budgetary control;
this shows the path for the future growth of organization.
7. Motivation: Work process of every person each examined and efforts are made to achieve
the targets. Persons are motivated through increase in the salary packages, promos ion etc.
8. Planning: Business activities are presented in planned manner in the form of practical
budgets. Works are forecasted, which may be helpful in the growth of organization.
IMPORTANCE OF BUDGETING:
1. Planning: Setting up of objectives and proper organization of various factors is
known as planning. Budget plays an important role in the attainment of determined
objectives. Production cost, research etc help in the attainment of objectives related to
business planning.
2. Control: Control is very essential for the growth of business. Functions of control can
be performed better with the help of budget.
3. Coordination: It is a system under which every department function for its own
interest and for that purpose mutual cooperation is required. Budgeting helps in
bringing coordination amongst various business activities.
31
PRECAUTIONS IN BUDGET:
1. Budget period: In every business house, long term as well as short term budget is
needed .sales budget, cost budget are short term budget, where as capital expenditure,
research budget and development budgets are known as long term budgets.
2 Flexibility of budgets: Budget should not be rigid, but proper flexibility should be there in
the budget. When budgets are prepared efforts should be made to have proper flexibility in it.
3 Statistical information: Necessary information relating to every department should be
made available at the time of preparation of budget.
4 Top management supports: Support from all the heads of department should be ensures
while preparing budgets and proper coordination amongst them is to be maintained.
5 Proper knowledge and limitations of budgeting: Every offer should know use and
limitations of budgeting. It should be known that how budgets help in planning, coordination
and control.
6 Business policies: Budget is prepared for the attainment of business objectives. While
preparing business objectives of the business should be given proper attention.
7 Sound forecasting: Due consideration should be given to past records also. Knowledge of
past condition is necessary for the budget.
8 Budget committee: A budget committee is to be formed for the preparation of budget. In
this committee all departmental heads should be taken.
CLASSIFICATION OF BUDGETS:
1 Fixed and flexible budgets
2 Long term and short term budgets
1. Production budget: It is a forecast of total production of a business origination during
a definite period. It is prepared in view the sales budget, production capacity, probable
changes in stock and loss in production.
2. Material budget: It is a forecast of quantity, quality and cost of material used in
production. While preparing this budget, value of material to be purchased, availability
of finance should be given due consideration, quantity of material is an important
function of material budget.
3. Factory overhead budget: It is a forecast indirect expense to be incurred in relation to
production for budget period. Both fixed and variable expenses included in it. Separate
budgets can prepared for fixed and variable budgets.
4. Selling and distribution overheads budgets: It is forecast of expenses incurred on
selling and distributing the product. This budget is based on sales budget.
5. Cash budget: It is a forecast of cash required for successful and smooth operation of
activities the budget is prepared by giving due consideration to receipts and payments.
Cash budget can be prepared for short term as well as for long term basis.
6. Capital expenditure budget: It is forecast of expenditure to be incurred in purchase
and expansion of fixed assets. It is prepared keeping in mind the probable increasing
demand of products, finances available in long term production capacity.
32
7. Plant budget: It is prepared in factory where maximum work is performed by

machines it is a forecast of availability of plant for proposed production.
8. Administration overheads: it is a forecast of expenses to be incurred on
administrative works for budget period. For this purpose, expenses incurred in past
years should be analyzed.
9. Labor budget: It is forecast of number of labor hours to be worked by labor in
production. Amount paid to workers and other perquisites are recorded in this budget.
10. Production cost budget: It is a forecast of cost of that production, which has been
ascertain in production budget. Material, labor and direct other expenses are included
in production cost.
11. Sales budget: It is an estimate of total sales to be made during definite period. Sales
budget is prepared in quantity as well as in rupees it should be prepared with great
caution.
ADVANTAGES OF BUDGETARY CONTROL:
1. Simplicity: It becomes simple to control cost by application of budgetary control.
Standard are fixed in budget and efforts are made to control them. Every department
rise to control waste expenditure and to complete the work is the budgeted amount.
2. Coordination: Budgetary control establishes coordination amongst various
departments and the work becomes very simple. Complete business organization
function as a single unit and work targets are achieved.
3. Help to administrators: budgetary control is helpful in ascertainment of various
policies of the organization.
4. Maximum utilization of Resources: Budgeting control brings maximum utilization
of resources and they provide maximum profit to the organization.
5. Work Efficiency: The targets are fixed for every department and efforts are made to
achieve these targets. It increases the efficiency of every department and of every
person.
6. Advantages of planning: The amount and kind of work to be done by each
department is ascertained through budget if any work is performed according to the
pre determined plan it brings rate increases.
LIMITATIONS OF BUDGETARY CONTROL:
1.
2.
3.
4.
5.
Incorrect forecasting.
Rigidity in control.
More weightage to paper work.
Expensive.
Departmental Competition.
VARIOUS TYPES OF BUDGETS:

1. Production budget: It is a forecast of total production of a business origination during
a definite period. It is prepared in view the sales budget, production capacity, probable
changes in stock and loss in production.
2. Material budget: It is a forecast of quantity, quality and cost of material used in
production. While preparing this budget, value of material to be purchased, availability
of finance should be given due consideration, quantity of material is an important
function of material budget.
33
3. Sales budget: It is an estimate of total sales to be made during definite period. Sales
budget is prepared in quantity as well as in rupees it should be prepared with great
caution.
4. Master Budget: The master budget is expressed in financial terms and set out plan for
the operation and resources of the firm. It is a summary of the budget schedules high
lighting the budget period. The master-budget called the comprehensive budget is the
complex blueprint of the planned operations of the firm.
5. Flexible Budget: Flexible budget is a budget which, by recognizing the difference
between fixed, semi fixed and variable costs is designed to change to change in relation
to the level of activity attained. A flexible budget is a series of cost of budget each
prepared for a different level of capacity. Flexible budgeting can be incorporated in two
ways:
i)
Step Budgets
ii)
Variable budget.
6. Cash budget: It is a forecast of cash required for successful and smooth operation of
activities the budget is prepared by giving due consideration to receipts and Payments.
Cash budget can be prepared for short term as well as for long term basis
7. Performing budget: It is an important technique of management accounting which is
prepared in accordance with the activities of the organization. Valuation of various
activities is carried out for making the policies more effective. The deficiencies of
traditional budgeting are removed under it. Both public and private sectors are free to
use this technique.
8. Zero based Budget: In business zero base budgeting was introduced by Peter Payal of
USA in 1969. But in military it was in use since 1960. it helps the manager in
implementation and formation of various managerial activities. Under this system,
every item is checked independently before the preparation of the budget, so that it
utility can be ascertained in real life.
Under conventional budget amendments are made to previous budget, whereas in zero
budgets every activity and item is tested and then budget is prepared accordingly for
the future.
DRAWBACKS OF CONVENTIONAL BUDGETS:
i)
ii)
iii)
iv)
v)
34
Lack of interest: The people working in conventional budget do not take interest
and they feel the work quite monotonous.
Wrong Conclusions: Due to lack of analysis, the decision derived is affected and
wrong conclusions are drawn on it.
Problem of identification: Under conventional system, items are not analyzed
property consequently it increases cost due to lack of identification.
Lack of Analysis: Irrelevance items are not detected easily and it increases the
cost unnecessary.
No Accountability: Proper accountability is not defined and due to it the targets of
the organization are affected.
ZERO BASED BUDGETING (ZBB)

This budget is the preparation of budget starting from Zero or from a clean state. As
new technique it was proposed by Peter Payal of Texas Instruments Inc., U.S.A. This
technique was introduced in the budgeting in the state of Georgia by Mr. Jimmy Costar who
was then the Governor of that state. When Mr. Carter later on became president of the U.S.A.,
ZBB was tried in federal budgeting as a means of controlling stale expenditure. The use of
zero-base budgeting (ZBB) as a managerial tool has become increasingly popular since the
early 1970s. It is steadily gaining acceptance in the business world because it is proving its
utility as a tool integrating the managerial function of planning and control.
Conventional Budgets are prepared mainly on past performance and actual costs.
Thus conventional budget represents a quantification of the firm's objectives and the
efficiency of budgeting as a planning and control device depends upon the activity in which it
is being used. Budgets are best used as a managerial control in activities which are directly
related to the final output of the organization because the inputs used by these activities can
be compared with the output of these activities.
Thus a more accurate budget can be framed once the relationship between inputs and
outputs is established. But are some activities which are not directly related to the firm's
output such as the legal staff and the personnel office. A more accurate budget cannot be
developed for such activities because the tasks assigned and resources allocated to such
activities are not directly related to the firm's output and it is difficult to develop and use
standard cost for such activities. Zero-base budgeting is most appropriate in controlling these
staff and support areas, (i.e. non-manufacturing overhead).
A conventional budget is developed mainly on the concept of instrumentalism. Under this
approach cost levels of the previous year are often taken as a base to start within, and budget
units focus their attention on ascertaining what changes from the previous year are required.
Thus, a budget is developed on the basis of incremental changes from the previous year's
figures taken as base.
An incremental approach to budgeting carries forward previous year's inefficiencies and
extravagances because previous year's figures are taken as a base for the development of a
budget. Thus incremental approach does not promote operational efficiency because it does
not require managers to review their past activities.
On the other hand, zero-base budgeting is not based on the incremental approach and
previous year's figures are not adopted as a base. Rather, zero is taken as a base as the name
goes. Taking zero as a base, a budget is developed on the basis of likely activities for the
future period. In ZBB, by delinking the budget from the past, the past mistakes are not
repeated. Funds required for any activity for the next budget period should be obtained by
presenting a convincing case. Funds will not be available as a matter of course. Zero-base
budgeting has been defined by its originator Peter A Pyher as follows:
35
"A planning and budgeting process which requires each manager to justify his entire budget
request in detail from scratch (hence zero base) and shifts the burden of proof to each
manager to justify why he should spend any money at all. The approach requires that all
activities be analyzed in 'decision packages' which are evaluated by systematic analysis and
ranked in order of importance."
CIMA has defined it "as a method of budgeting whereby all activities are revaluated each
time a budget is set. Discrete levels of each activity are valued and a combination chosen to
match funds available". In short an elaborate practice of having a manager justifies activities
from the ground up as though they were being launched for the first time.
A unique feature of zero-base budgeting is that it tries to help management answer the
question. "Supposing we are to start our business from scratch, on what activities would be
spends our money and to what activities would we give the highest priority? Thus, zero-base
budgeting tries to overcome the weaknesses of conventional budgeting, especially in those
areas where it is difficult to apply flexible budgeting. It can be successfully applied to
government expenditure and, within the business would, items of expenditure other than
direct material, labor and overheads such as research and development, data processing,
quality control, marketing and transportation, legal staff and personnel office.
STEPS IN ZBB ARE
(1) Identification of decision units in order to justify each item of expenditure in their
proposed budget.
(2) Preparation of Decision Packages. Each package is a separate and identifiable activity.
These packages are linked with corporate objectives.
(3') Ranking of Decision Packages based on cost benefit analysis,
(4) Allotment of funds based on the above resulting by following pyramid ranking system to
ensure optimum results.
ADVANTAGES OF ZERO BASE BUDGETING
(1) Zero-base budgeting is not based on incremental approach, so it promotes operational
efficiency because it requires managers to review and justify their activities or the funds
requested. Past efficiencies are not repeated.
(2)Zero-base budgeting is most appropriate for the staff and support areas (i.e.. nonmanufacturing overheads) of an organization because the inputs of these areas are not directly
related to the final outputs of the organization.
(3)Zero-base budgeting considers every time alternative ways of performing the same job
because zero is taken as a base every time at the preparation of a budget. Thus management
has an opportunity to get a critical appraisal of its activities.
36
(4)It focuses management process on analysis and decision-making because it requires

managers to review their activities every time when a budget is developed.
(5)It is helpful to the management in making optimum allocation of scarce resources because
a unique aspect of zero-base budgeting is the evaluation of both current and proposed
expenditure and placing it in some order of priority. Funds are used on priority basis and
hence there is better allocation of resources.
(6)Coordination within the firm is improved and communication channels are strengthened.
(7)Increased participation in ZBB creates a motivational impact.
(8)ZBB is particularly useful for service departments and Governments.
(9)It makes managers cost conscious and helps them in identifying priorities in the overall
interest of the organization.
ADVANTAGES OF ZERO-BASE BUDGETING:
1) Increase in Efficiency: Under its budget are allocated in proper manner, which
increases the efficiency in management.
2) Control on expenditure: It emphasizes an optimum utilization of resources and a
proper control on unnecessary expenditure. Due to detailed study and analysis of
allotted amount control is made on expenditure.
3) Proper Evaluation: Evaluation of every activity is possible under zero base
budgeting system. Proper provision is made in the budget for it.
4) No unfair influence: Under it old and new proposals are evaluated without any unfair
influence. Therefore resources are allocated properly.
5) Past record are not considered: Under this system, past records of expenses are not
taken into account and expenditure is studied in isolation.
6) Encourages profitable issues: Zero base budgeting emphasizes on preparation of
different alternative plans, which are helpful in the selection of profitable channels.
7) Proper Coordination: Proper coordination is established between top level
management an various managerial decision making units.
PROCESS OF ZERO BASE BUDGETING:
1. Segmental Objectives: Various departmental objectives are to be defined in
accordance with the corporate objectives.
2. Determination of Scope: Under the activities of zero base budgeting scope of
organization is determined.
3. Cost Benefit analysis: It is supposed to be necessary to carryout cost benefit analysis
for every decision unit, and on the basis of which alternative activities are assigned in
priorities.
4. Compliance of operating expenses: Budget officers should check the compliance of
operating expenses, so that difference between sanctioned and allotted expenditure
does not arise.
5. Corporate objectives: under zero based budgeting, corporate objectives are defined.
It is determined in advance through detailed study.
6. Decision units: where as decision units are identified and made in accordance with
the activities of the organization.
37
7. Development of alternatives: Various alternatives are selected and objectives are

attained.
8. Compliance of operating expenses: On the recommendation of top management
budget officers try to check. The compliances of operating expenses so that difference
between sanctioned and allotted expenditure does not arise.
38

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SVD & SGL COLLEGE OF MANAGEMENT AND TECHNOLOGY: RAJAHMUNDRY

ACCOUNTING FOR MANAGERS: SEM-I

K.V. RAJESH KUMAR LECTURER

SVD & SGL COLLEGE OF MANAGEMENT AND TECHNOLOGY: RAJAHMUNDRY

ACCOUNTING FOR MANAGERS: SEM-I

K.V. RAJESH KUMAR LECTURER

SVD & SGL COLLEGE OF MANAGEMENT AND TECHNOLOGY: RAJAHMUNDRY

ACCOUNTING FOR MANAGERS: SEM-I

K.V. RAJESH KUMAR LECTURER

SVD & SGL COLLEGE OF MANAGEMENT AND TECHNOLOGY: RAJAHMUNDRY

ACCOUNTING FOR MANAGERS: SEM-I

K.V. RAJESH KUMAR LECTURER

SVD & SGL COLLEGE OF MANAGEMENT AND TECHNOLOGY: RAJAHMUNDRY

ACCOUNTING FOR MANAGERS: SEM-I

K.V. RAJESH KUMAR LECTURER

SVD & SGL COLLEGE OF MANAGEMENT AND TECHNOLOGY: RAJAHMUNDRY

ACCOUNTING FOR MANAGERS: SEM-I

K.V. RAJESH KUMAR LECTURER

SVD & SGL COLLEGE OF MANAGEMENT AND TECHNOLOGY: RAJAHMUNDRY

7. An Information System: Management Accounting is related to information systems

ACCOUNTING FOR MANAGERS: SEM-I

K.V. RAJESH KUMAR LECTURER

SVD & SGL COLLEGE OF MANAGEMENT AND TECHNOLOGY: RAJAHMUNDRY

FUNCTIONS OF MANAGEMENT ACCOUNTING:

Proper guidance to subordinates

Issue directions and orders

Performance according to plan

ACCOUNTING FOR MANAGERS: SEM-I

K.V. RAJESH KUMAR LECTURER

SVD & SGL COLLEGE OF MANAGEMENT AND TECHNOLOGY: RAJAHMUNDRY

ROLE OR IMPORTANCE OF MANAGEMENT ACCOUNTING IN MODERN

ACCOUNTING FOR MANAGERS: SEM-I

K.V. RAJESH KUMAR LECTURER

SVD & SGL COLLEGE OF MANAGEMENT AND TECHNOLOGY: RAJAHMUNDRY

8. Financial Investigation: Management accounting carries out financial investigations

The objective is to find out the

The objective here is to help

Here, the transactions are recorded

In financial accounting the

Wage sheets under financial

ACCOUNTING FOR MANAGERS: SEM-I

K.V. RAJESH KUMAR LECTURER

SVD & SGL COLLEGE OF MANAGEMENT AND TECHNOLOGY: RAJAHMUNDRY

post mortem examination of

estimated ones while recording

DISTINGUISH BETWEEN FINANCIAL ACCOUNTING AND MANAGEMENT

Financial accounting provides Management accounting provides

Financial accounting is related to Management accounting is in the

The main objectives of financial The object of management

Financial accounting is less Management accounting has more

ACCOUNTING FOR MANAGERS: SEM-I

provides Management accounting collects

K.V. RAJESH KUMAR LECTURER

SVD & SGL COLLEGE OF MANAGEMENT AND TECHNOLOGY: RAJAHMUNDRY

and Financial accounts are compulsory Management accounting is not

ACCOUNTING FOR MANAGERS: SEM-I

K.V. RAJESH KUMAR LECTURER

SVD & SGL COLLEGE OF MANAGEMENT AND TECHNOLOGY: RAJAHMUNDRY