CMA CostAccounting Jk-Merged PDF

J. K.
SHAH CLASSES CS EXECUTIVE – MANAGEMENT ACCOUNTING
CHAPTER 1 OVERVIEW OF COST
❖ COST, COSTING AND COST ACCOUNTING

Cost:
Cost is the amount of resources actual or notional which can be valued in terms of money that have
been sacrificed to attain a particular objective.
Cost Accounting:
Cost Accounting is defined as the establishment of budgets, standard costs and actual costs of
operations, processes, activities or products and the analysis of variances, profitability or the social
use of funds.
Costing:
Costing is defined as the techniques and process of ascertaining costs.
Cost Accountancy:
Cost Accountancy has been defined as “the application of costing and cost accounting principles,
methods and techniques to the science, art and practice of cost control and the ascertainment of
profitability. It includes the presentation of information derived there from for the purpose of
managerial decision making”.
Cost accounting is different from costing in the sense that the former provides only the basis and
information for ascertainment of costs. Once the information is made available, costing can be
carried out arithmetically by means of memorandum statements.
❖ COST UNITS
A unit of product or service in relation to which costs are ascertained.
Industry Cost Unit
Automobile Number
Cement Per Tonne/ Per Bag
Brick Works Per 1000 bricks
Steel Per Tonne
Transport Passenger Km
Hospitals Per Patient Per Day
Electricity Undertakings Kilowatt hour
❖ COST CENTRES
A cost centre is a location, person or item of equipment for which costs may be ascertained and
used for the purposes of cost control. In other words, a cost centre is a convenient unit of the
organisation for which cost may be ascertained.
Cost Centres are of two types

Personal Cost Centre: It consists of a person or group of persons
Impersonal Cost Centres: It consists of a location or an item of equipment
J. K. SHAH CLASSES CS EXECUTIVE – MANAGEMENT ACCOUNTING
❖ COST OBJECTS
Cost Object may be defined as anything for which a separate measurement of cost is required. It
may be a product, service, activity or process etc. Sometimes the users of accounting information
are interested in knowing cost of something which is called as cost object.
❖ COST DRIVER
A cost driver is any factor whose change causes a change in total cost of a related cost object. In
other words, a change in the level of cost driver will cause a change in the level of the total cost of
a related cost object.
❖ COST CONTROL
It is a process to ensure that appropriate action is taken if costs exceed the budgeted or standard
cost or actions which needs to be taken for the same
❖ COST REDUCTION
Cost reduction means permanent reduction in the cost of goods manufactured or services
rendered by eliminating wasteful and inessential elements but without impairing the quality and
essential characteristics of products.
❖ MANAGEMENT ACCOUNTING AND ITS FUNCTIONS

Accounting involves preparation of final accounts (balance sheet and profit and loss account) and
their analysis and interpretation.
Accounting is thus made up of

a) Financial Accounting (Preparing Final Accounts)
b) Management Accounting (analysis and interpretation or accounts).
DEFINITION:
“Any form of accounting which enables a business to be conducted more efficiently can be regarded
as Management Accounting.”
Scope:
Management accounting is the application of the principle of accounting and financial management
to create, protect, preserve and increase value for the stakeholders of for-profit and not-for-profit
enterprises in the public and private sectors. Management accounting is an integral part of
management. Its scope covers:
a) Formulation of plans to meet objectives (strategic planning);
b) formulation of short-term budgeting/profit planning (operation planning);
c) corrective action to bring plans and results into line (financial and performance control);
d) recording and reporting of financial transactions and events (financial accounting);
e) recording and reporting of costs (cost accounting);
f) acquisition and use of finance (financial management);
g) communication of financial and operating information (Management Information System-MIS);
h) reviewing and reporting on systems and operations (internal audit, management audit).
Functions:
a) Budgeting:
A budget provides a detailed analysis of how the organization intends to get and use resources.
The management accountant prepares various budgets based on strategic planning covering
sales, costs and expenses, assets, liabilities and cash-flows as well as other non-financial factors.
b) Cost management:
The management accountant helps in cost management – in identification and reduction of
waste in the organization which makes more resource available for investment and innovation.
c) Reporting:
The management account provides comprehensive reports about the organizations’ past
performance, business model, risks and strategy.
d) Investment decisions:
The management accountant performs relevant calculations and analysis of risks and returns to
determine whether the organization should make a particular investment or not. This ensures
that better investments are made and risky investments are avoided.
e) Price and product decisions:

The management accountant provides information to the management for deciding what to
produce or what service to provide and determining the selling price for products and services.
This increases the profitability of the business.
f) Project management:
The management accountant provides information about project plans, budgets and costs.
g) Resource allocation:
The management accountant helps in the optimal distribution of scarce resources across the
organization.
h) Risk management:
Risk management is the process of understanding, managing and controlling the risks that the
organization must face when attempting to achieve its corporate objectives.
❖ SCOPE, OBJECTIVES, IMPORTANCE OF COST AND MANAGEMENT ACCOUNTING

The limitations of financial accounting increase the importance of cost accounting. The
management of any company dealing in manufacturing of products or rendering services has to
ensure that there are no wastages, no idle time of labour or machines, efficiency and productivity
of labour is increased. Cost accounting increases the overall productivity of an organization and
serves as an important tool, in bringing prosperity to the nation. Cost control, elimination of
wastage and efficiency lead to the progress of industry and consequently of the country as a whole.
The basic objective of management accounting is to assist the management in proper planning,
organizing, directing and controlling based on the data available through the Cost Accounting.
• Ascertainment and classification of cost.
• To determine the selling price of the product i.e. price fixation
• Cost control and cost reduction.
• To indicate to the management any inefficiencies and various waste and sources of such
wastage.
• Ascertain profit of each activity and how these profits can be maximized.
• To exercise effective control on the stocks of raw materials, work-in-progress, consumable
stores and finished goods in order to minimize the capital locked up in these areas.
• To assist management in decision making about future expansion policies and proposed
capital projects.
• It helps in assessing the performance of workers and rewarding them suitably through
incentives and bonus.
• To organize an effective information system so that different levels of management may get
the required information at the right time in right form for carrying out their individual
responsibilities in an efficient manner;
• To organize the internal audit system to ensure effective working of different departments;
• To supply useful data to the management for taking various financial decisions, such as
introduction of new products, replacement of labour by machine etc.;
• To provide specialized services of cost-audit in order to prevent the errors and frauds, and to
facilitate prompt and reliable information to management;
• It ensures optimum utilization of the scarce economic resources of the country.
• To arrive at standard costs for comparison of actual cost
• Cost Accounting is an aid to creditors, employees and national economy
• Cost accounting involves the preparation of budgets and, come out with forecasts to make
viable and valuable decisions for the future. Many decisions are taken based on the projected
figures of the budget.
• In cost accounting the manager prepares monthly or quarterly statements which reflect the
cost and income data identified with the sale of that period.
• There are no set of rules and regulations to be followed while preparing these statements but
the management can set their own principles. In management accounting there is no specific
time span for its statement and report preparation. It makes use of both cost as well as
financial statements to analyze the data.
❖ CRITICISMS OR LIMITATIONS OF COST ACCOUNTING
• It is argued that cost accounting is duplication when a good Financial Accounting system is
already in operation.
• Cost Accounting is inapplicable in non-profit organisations, agriculture, concerns producing
single products, etc
• A Cost Accounting system is quite expensive to install and operate.
• Non co-operation from staff also may lead to failure of the system in many concerns.
• It represents the base for taking the best decisions but does not give outright solution to the
problem.
• Most of cost accounting techniques are based on presumed notions.
• If the system is not revised as per the changing circumstances, it will become a matter of
routine forms and statements.
• The results shown by cost accounts differ from those shown by financial accounts. Thus
preparation of reconciliation statements is necessary to verify their accuracy.
❖ VARIOUS REPORTS PROVIDED BY COST ACCOUNTING DEPARTMENT FOR DECISION

MAKING
• Cost sheet
• Reconciliation of Actual Profit with Budgeted Profit
• Report of Capital Expenditure, Research and Development Expenditure.
• Material Consumption Report
• Inventory report, work in Progress, finished goods report.
• Labour Utilization Report
• Labour Turnover Report.
• Overhead Report
• Sales Report
❖ ESSENTIAL FEATURES OF A GOOD COST ACCOUNTING SYSTEM

• The cost accounting system should be suitable to the nature of business.
• It should be simple and easy to operate
• Input data should be accurate
• Relevant data only should be used
• Management should have faith in costing system and should provide help as far as possible
• Executives should also provide there useful services in developing a good costing system
• It should be cost effective
• System should be smoothly and effectively implemented
• The system should enable prompt reporting
• The persons using the reports should be able to understand and use the information.
• External factors e.g. Government Regulations, market requirement should also be taken into
consideration.
❖ ESSENTIAL FACTORS FOR INSTALLING A COST ACCOUNTING SYSTEM

• Objectives of Cost Accounting system
• What would be the scope and coverage of Cost Accounting System?
• What would be the organizational set up?
• What would be the technical aspects and what techniques would be used in production?
• How the society would be benefited by the system of Cost Accounting?
• What would be the effect of expansion?
• What would be the requirement of information to serve the purpose of cost Accounting?
• The system should be flexible to adopt the changing requirements of business?
❖ Practical difficulties will you expect and how will you overcome the same.
a) Lack of Top Management Support- Installation of a Costing system do not receive the
Support of Top Management.
b) Resistance from Cost Accounting Department Staff - The staff resists because of risks of
losing their jobs.
c) Non-Co-Operation from Operating Departments- Because of increase in responsibility and
paper work, operating staff may not co-operate.
d) Shortage of Trained Staff- Since installation of Cost Accounting System involves specialized
work, there may be a shortage of trained staff.
e) Heavy Costs:
The costing system will involve heavy costs unless it has been suitably designed to suit specific
requirements.
The above problems can be overcome by the following remedies

a) To sell the idea to top management.
b) Resistance and non-co-operation can be overcome by behavioral approach.
c) Proper training should be provided
d) Regular meeting should be held with Cost Accounting Staff and other user departments.
e) Supervision and continuous evaluation
❖ CLASSIFICATION OF COST
Basis Classification
Nature Material Labour, Expenses
Cost Centre Direct Material, Direct Labour, Direct Expenses, Indirect Material, Indirect
Labour, Indirect Expenses
Functions Factory Overheads, Office Overheads, Selling Overheads
Time Historical Cost, Pre-determined Cost, Standard Cost, Estimated Cost
Management Marginal Cost, Differential Cost, Opportunity Cost, Replacement Cost,
Decision Making Relevant Cost, Imputed Cost, Sunk Cost, Normal Cost, Abnormal Cost,
Avoidable Cost, Unavoidable Cost, etc.
Production Batch Cost, Process Cost, Operation Cost, Operating Cost, Contract Cost,
Process Joint Cost
Behavior Fixed Cost, Variable Cost and Semi- Variable Cost
❖ OBJECTIVES OF MATERIAL CONTROL
a) There should be proper cooperation and coordination among the departments involved in
purchasing, receiving, inspection, storage, production, sales, accounting etc to minimize
disruption in production and lose sales
b) There should be proper scheduling of materials
c) A good method of classification and codification of materials should be followed
d) Purchase of material as per requirement.
e) Material can be purchased at optimum price.
f) Ordering quantity for each type of material should also be fixed so that Carrying cost and
holding cost can be minimized.
g) Unnecessary losses can be avoided or can be minimized.
h) Purchases can be made at right time and at right or optimum price.
i) Accounting of raw material can be properly made.
j) The storage of raw materials should be well planned to avoid losses
k) Adequate records to control materials during production should also be maintained to ensure
that there is minimum possible wastage
l) Information about availability of materials should be made continuously available to the
management so that planning may be properly done.
m) Sales manager, purchasing executive and production manager usually favour, though for
different reasons, the policy of carrying larger amount of stocks, whereas the financial
manager will prefer to keep investment in material at the lowest possible level. However, in a
large number of organizations material control is generally made the specific responsibility of
purchasing department.
❖ LABOUR COST AND WHAT ARE ITS OBJECTIVES

Labour cost means amount paid to labour and workers for getting the work done from the workers.
In other words amount paid by an enterprise to the human for work done by them is called labour
cost. Various types of payments made to labour are as follows:
MONETARY/PECUNIARY BENEFITS
a) Basic Wages
b) Dearness Allowances
c) Production Bonus
DEFERRED MONETARY BENEFITS
a) Employer’s Contribution to PF / ESIC
b) Retirement Gratuity
c) Profit Bonus
FRINGE BENEFITS/ NON- PECUNIARY BENEFITS
a) Free or subsidized food
b) Free or subsidized housing
c) Free or subsidized education to children
d) Medical & Hospital facilities
e) Expenses incurred on Canteen, sports club etc.
Objectives:
a) To keep labour cost at optimum level.
b) To keep labour cost at industry standards.
c) To motivate the workers.
d) To keep production cost at optimum level.
e) To improve the profitability and productivity.
f) To contribute employees welfare fund.
❖ TECHNIQUES OF LABOUR COST CONTROL
a) Manpower requirements should be assessed.
b) Record of time keeping and time booking should be maintained.
c) Record of idle time and its analysis should be maintained.
d) Record of time and motion study should be kept.
e) Adequate control over labour turnover should be maintained.
f) Wages and incentive system should be properly introduced.
g) Overtime should be properly authorized.
h) Control over contract, casual or other workers.
i) Job evaluation and Merit rating.
j) Improvement in labour productivity.
❖ TIME KEEPING AND ITS OBJECTIVES

Meaning: It means a record of time spent by a worker in a factory.In other words, total time spent
by a worker inside the factory.
Purpose of time keeping:

a) Pay roll preparation
b) Finding out the labour cost of a job
c) To distinguish between normal and over time, late attendance and early leaving
d) To provide internal check against dummy workers
e) Attendance register should be maintained.
f) Cost should be properly classified as direct cost and indirect cost to facilitate control.
g) A proper record of overtime should be maintained.
h) Record of idle time should also be kept.
i) Proper and adequate discipline should prevail in the organization.
j) A record of statutory compliance should be maintained.
k) Production overhead should be properly absorbed using labour hour rate.
❖ SHORT NOTES ON COLLECTION AND CLASSIFICATION OF OVERHEADS

Overheads
Overhead cost is also known as the total cost of Indirect Materials, Indirect Labour and Indirect
Expenses.
Overheads are the indirect costs which cannot be allocated to any specific job, process because
they are not capable of being identified with specific job or process. Overheads include cost of
indirect materials, indirect labour, indirect expenses which cannot be conveniently charged to any
job, process, cost unit etc.
Collection of Overheads:
Collection of overheads means the collecting of indirect expenses from books of account and other
records in logical groups having regard to their nature and purpose. Overheads are collected on the
basis of pre-planned groupings called cost pools (groups or heads).
Classification of overheads:
Classification of overheads means the process of grouping of overheads according to their common
characteristics. Overheads can be classified in different ways as follows:
a) On the basis of behaviour – (a) Fixed (b) Variable (c) Semi Variable Expenses
b) On the basis of Function –
a. Production Overheads
b. Administration overheads
c. Selling and Distribution Overheads
❖ NOTIONAL EXPENSES
Expenses that are usually incurred should be included in costs even if a particular firm is not
required to pay for such expenses. Rent for own premises is an example. If a firm occupies its
own buildings, it does not pay any rent for it, but for costing purposes, an appropriate amount
of rent is be included in costs
CHAPTER 2 COST SHEET

Cost Sheet of M/s for the period/year ended
Units Produced = XX
Units Sold = XX
Particulars Rs. Total Per Unit
1. DIRECT COST
Direct Materials Consumed
Opening Stock of Raw Materials xx
Add: Purchases of Raw Materials xx
Add: Carriage Inward xx
Less: Closing stock of Raw Materials (xx)
Less: Sale of Material scrap (xx) xx xx
Direct Labour xx xx
Direct Expenses xx xx
PRIME COST XXX XXX
2. INDIRECT COST
Add: Factory Overheads
Expenses xx
Expenses xx
Less: Sale of factory scrap (xx) xx xx
GROSS FACTORY COST XXX XXX
Add: Opening Stock of WIP xx -
Less: Closing Stock of WIP (xx) -
NET FACTORY COST XXX XXX
Add: Office & Administration Overheads
Expenses xx
Expenses xx xx xx
COST OF PRODUCTION XXX XXX
Add: Opening Stock of Finished goods XX XX
Less: Closing Stock of Finished goods (XX) (XX)
COST OF GOODS SOLD XXX XXX
Add: Selling & Distribution Overheads
Expenses xx
Expenses xx xx xx
COST OF SALES XXX XXX
Add: Profit XXX XXX
SALES XXX XXX
Items Included In Carriage Inwards
• Freight on Materials
• Carriage on Materials
• Dock Charges
• Import Duty
• Cartage
• Loading and Unloading Charges
• Octroi & Custom Duty
Items Included In Direct Wages

• Direct Labour
• Productive Wages
• Manufacturing Wages
• Factory Wages
Items Included In Direct Expenses

• Royalty on Production
• Special Designing charges
• Special Equipment hire charges
• Special Dyes
• Direct Power
• Sub-Contracting Expenses
• License fees for Special Orders
Items Included In Factory Overheads

Factory Overheads is also known as Works Overheads, Production Overheads, Manufacturing
Overheads
• Factory Power
• Lighting and Heating
• Factory Manager’s Salary
• Factory Supervisor’s Salary
• Defective work (Cost of Rectification)
• Drawing and Designing Expenses
• Drawing Office Salaries
• Factory Rent, Rates and Insurance
• Technical Director’s Fees
• Power and Fuel
• Motive Power
• Steam
• Coal, Gas, Grease and Water
• Excise Duty
• Depreciation on Plant and Machinery
• Depreciation on Factory Building
• Depreciation on Patterns and Patents
• Indirect Material
• Indirect Wages
• Repairs to Plant and Machinery
• Rent of Plant and Machinery
• Expenses on Trial Production
• Cost of training workers
• Normal Idle time wages
• Setup cost
• Inspection Cost
• Insurance Premium for stock of Raw Material
• Material handling charges
• Store Keeper’s salary
• Haulage Expenses
• Cost of Rectification
• Loose Tools w/off
• Service Department Expenses
Items Included In Office Overheads

• Office Rent, Rates and Insurance
• Director’s Fees
• Depreciation on Office Furniture
• Office Lighting
• General Expenses
• Printing and Stationery
• Legal Expenses
• Postage and Telephone Expenses
• Counting House Salaries
• Audit Fees
• Clerical Salaries and Management Expenses
• Cleaning and Maintenance Expenses
• Repairs and Renewal
• Refreshment and other sundry expenses
Items Included In Selling and Distribution Overheads

• Carriage outwards
• Salesmen salaries and commission
• Depreciation on Delivery Van
• Travelling Expenses
• Fees paid to Brand Ambassador
• Advertisement and Publicity Expenses
• Exhibition Expenses
• Trade Fair Expenses
• Showroom rent and expenses
• Demonstration Expenses
• Catalogue Printing
• Free Samples
• Fancy Packing Expenses
• Warehouse Rent
• Cost of tenders
• Cost of mailing literature
• Salaries of Packing Department
• Carriage on Sales
• Final Packing & Forwarding Expenses
Classification of Important Items
Royalty on Raw Material Consumed DMC
Royalty on Production DE
Technical Director's Fees FOH
Director’s Fees O&A
Special Designing Expenses DE
Designing Expenses FOH
Haulage Expenses FOH
Drawing Office Salaries FOH
General Office Salaries O&A
Counting House Salaries O&A
Power FOH
Direct Power DE
Legal Expenses O&A
Legal Expenses for criminal suit Ignore
Purchases of Plant and Machinery Ignore
Purchases of Office Furniture Ignore
Purchases of Delivery Van Ignore
Depreciation of Plant and Machinery FOH
Depreciation of Office Furniture O&A
Depreciation of Delivery Van S&D
Warehouse Rent S&D
Notes relating to Cost Sheet

1. Quantity Information
Opening Stock of Finished goods XX
Add: Production (Units Produced) XX
Less: Closing Stock of Finished goods (XX)
Sales (Units sold) XX
Note: If there is no Quantity Information in the question, there will be NO PER UNIT COLUMN.
2. How to Find Per Unit Column

• From Direct Materials consumed till Cost of Production, divide by units produced.
• From Cost of goods sold till Sales, divide by units sold.
• Opening stock of FG and Closing stock of FG will be divided by their respective units.
3. Valuation of stock
• Stock of Raw Material is valued at Purchase price of Raw Materials
• Stock of WIP is valued at Factory Cost
• Stock of Finished Goods is valued at Cost of Production
4. There are only 3 incomes which are included while preparing Cost Sheet
• Sale of Material Scrap
• Sale of Factory Scrap
• Sale of Finished goods (Sales)
5. Expenses which are not included while preparing Cost Sheet
(a) Expenses not incurred for the product
Donations, Charities, Gifts
(b) Abnormal Losses
Loss by fire, loss by theft, loss by any natural calamity,
(c) Expenses incurred after earning profits

Income Tax, Provision for tax
(d) Appropriation of Profits

Transfer to Reserves, Proposed dividend, Dividend Paid
(e) Intangible Assets written off

Goodwill, Patents, Trademark, Copyrights… w/off
(f) Miscellaneous Expenditure written off

Preliminary Expenses, Discount on issue of shares or Debentures, Underwriting Commission,
Company Formation Expenses…. w/off.
(g) Financial Expenses and Losses

Interest on Loans or Debentures, Bad Debts, Provision for bad debts, Discount allowed, Loss
on sale of FA, Legal Expenses for criminal suit, fines, Penalties, Damages etc
6. Other Notes
• All Direct Cost are Variable Cost i.e. Direct Materials, Direct Labour, Direct Expenses are
always variable cost.
• But all Variable Cost are not direct cost. They can be Indirect Cost also.
• If total cost remains same, then the cost will be termed as Fixed Cost.
If fixed cost is to be increased or decreased, it needs to be increased or decreased from
Total Cost.
• If cost per unit remains same, then the cost will be termed as Variable Cost.
If Variable cost is to be increased or decreased, it needs to be increased or decreased from
Cost per unit.
• Production Increases, Total Variable Cost increases

Production Decreases, Total Variable Cost decreases
• Production Increases, Fixed Cost per unit decreases

Production Decreases, Fixed Cost per unit increases
• Variable Cost is known as product cost

Fixed Cost is known as period cost
• In case of semi-variable overheads (partly variable and partly fixed), variable cost needs to
be calculated by Change in Cost ÷ Change in Production and fixed cost will be the balancing
figure.
PART B: PRACTICAL
Q. 1. The following extracts of costing information relate to commodity A for the year 31.3.2019.
Purchase of Raw Material ` 48,000
Direct Wages ` 40,000
Stock on 1-4-2018
of Raw Material ` 8,000
of Finished Goods 1,600 quintals ` 6,400
Stock on 31-3-2019
of Raw Material ` 6,800
of Finished Goods 3,200 quintals
Work on cost (factory overhead) ` 16,800
Work-in-Progress :
1st April 2018 ` 1,920
31st March 2019 ` 6,400
Office and Administrative Overheads (Related to Production) ` 3,200
Sales (Finished Product) ` 1,20,000
Advertising, discount allowed and selling cost is Re. 0.40 per quintal. During the year
25,600 quintals of commodity were produced. Prepare Cost sheet.
CHAPTER 3 BUDGETARY CONTROL
PART A: THEORY
❖ EXPLAIN BUDGET
A budget is a form of quantitative expression of policies, plans, objectives and goals laid down in
advance by top management for the concern as a whole and for each sub-division thereof. A
budget is a plan covering all phases of operations for a definite period in the future. A budget is a
method for translating the goals and strategies of an organization into operational terms.
As per Chartered Institute of Management Accountants (CIMA), London, Budget is,

” A financial or quantitative statement, prepared and approved prior to a defined period of time of
the policy to be pursued during that period for the purpose of attaining a given objective. It may
include Income, Expenditure and Employment of Capital.”
There are different types of budgets such as Sales Budget, Production Budget, Purchase Budget,
Labour Cost Budget, Cash Budget and Flexible Budget.
❖ ESSENTIALS OF BUDGET
• It is prepared in advance and is based on future plans
• It is future oriented i.e. it is prepared keeping in mind the future requirements.
• It is expressed in monetary and quantitative terms
• Objectives and responsibilities should be clearly communicated to various levels of
management.
• It is based on cash flow and it is used for implementation of policy.
• Budget should be monitored periodically
❖ CHARACTERISTICS OF BUDGET
• It is for a definite period.
• It is prepared in writing.
• It is a detailed plan for all economic activities.
• Co-operation from all departments is sought to be provided.
• Co-operation from all departments is sought to be provided.
• Budget is used to achieve business goals.
• Budget should be updated regularly.
• It is useful in planning, controlling and co-ordinating.
• Various types of budgets are prepared as per the needs of business.
❖ BUDGETING AND BUDGETARY CONTROL

Budgeting
Budgeting is the complete process of designing, implementing and operating budgets.
Budgetary Control
CIMA, London, defines Budgetary Control as:
“The establishment of budgets relating the responsibilities of executives to the requirements of
policy and the continuous comparison of actual with budgeted results either to secure by
individual action, the objective of that policy or to provide a basis for its revision.”
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❖ OBJECTIVES/USES OF BUDGETARY CONTROL

• It is used to achieve the targets set for the company.
• It is used to fix the responsibilities of executives, departments and personnel.
• It is used for comparison purpose.
• It is used to ensure the best use of all available resources.
• It is used for the purpose of co-ordination.
• It is used for revision purpose.
• It is used for long range plans.
• To reduce losses and wastes to the minimum.
• To bring out clearly where effort is needed to remedy the situation.
• It motivates employees if they are actively engaged in budget preparation.
• To see that the firm is not deflected from marching towards its long-term objectives without
being overwhelmed by emergencies.
• It communicates goals of the organisation to the employees.
In Short, Budgetary Control means laying down monetary and quantitative terms of what
exactly has to be done, how it is to be done, the actual results should not deviate much from
the budgeted results, a course of action if results deviate and also fixing the responsibilities
for various levels of management.
❖ ADVANTAGES OF BUDGETARY CONTROL SYSTEM

a) The use of budgetary control system enables the management of a business concern to
conduct its business activities in the efficient manner.
b) It is a powerful instrument used by business houses for the control of their expenditure.
c) It provides a yardstick for measuring and evaluating the performance of their individuals and
their departments.
d) It reveals the deviations to management from the budgeted figures after making a
comparison with actual figures.
e) It helps in the review of current trends and framing of future policies.
f) It inculcates the feeling of cost consciousness among workers.
g) Management which have developed a well ordered budget plans and which operate
accordingly, receive greater favour from credit agencies.
❖ LIMITATIONS OF BUDGETARY CONTROL SYSTEM

a) Based on estimates:
Budgets may or may not be true as they are based on estimates. Therefore, the adequacy or
otherwise of budgetary control system, to a very large extent, depends upon the adequacy or accuracy with
which estimates are made.
b) Time factor:
Budgets cannot be executed automatically. Accuracy in budgeting comes through
experience. Management must not expect too much during the development period.
c) Co-operation required:
Staff co-operation is usually not available during budgetary control exercise. The success of
the budgetary control depends upon willing co-operation and teamwork.
d) Expensive:
Its implementation is quite expensive. No budgetary programme can be successful unless
adequate arrangements are made for supervision and administration.
e) Not a substitute for management:
Budget is only a managerial tool. It cannot substitute management.
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❖ BUDGET CENTRE
Budget Centre is defined section of an organisation for which separate budgets can be prepared
and control exercised. Thus if budgets are prepared department wise then each department is
budget centre.
❖ BUDGET MANUAL
CIMA, London, defines it as,
‘”It is a document which sets out the responsibilities of the persons engaged in, the routine of and
the forms and records required for budgetary control”.
The main idea behind the budget manual is to inform line executives beforehand about
procedures to be followed rather than issuing frequent instructions from the controller’s office
regarding procedures and forms to be used. Such frequent instructions can be a source of friction
between the line and staff management. It is thus a formal record defining the functions and
responsibilities of each executive. It standardizes the methods and procedures of budgetary
control. There is synchronization of the efforts of all in an organization which result in
maximization of profits.
Advantages of Budget Manual
• An overall well coordinated plan, provided by budgetary control system shows what role
each manager is expected to play in maximizing the profits.
• Any problem arising in the working of a budgetary control system can be settled through the
manual
• New employees get acquainted with the procedure involved in the operation of the system
by referring to manual.
• Methods and procedures become standardized
• Since coordination is maintained, there is no overlapping of instructions. There is
synchronization of all efforts which leads to the attainment of the objectives with minimum
of friction.
❖ BUDGET COMMITTEE
In most of the organisations, there will be a budget committee under the chairmanship of Budget
Controller who will submit the budget to the Chief Executive after co-ordination and preparation
thereof.
The budget committee is a group of representatives of various functions in an organization. As all
functions are inter-related and as any change in one’s target will have its impact on that of the
other, it is necessary to discuss the targets so that a mutually agreed programme is finally decided.
This is what is called coordination in budget-making. It is a powerful force in knitting together
various activities of the business and enforcing real control over operations.
Budget controller has to co-ordinate with materials manager, personnel manager, production
manager, maintenance manager, sales manager and R&D manager in preparation of all the
functional budgets and finally the master budget, capital expenditure budget and cash budget.
These managers are the members of the committee and hence budget controller has to command
respect, confidence and co-operation of all the members of the budget committee. The function
of a budget officer is to assist the budget controller in preparation and finalization of budgets.
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❖ FUNCTIONS OF BUDGET COMMITTEE

• To receive and scrutinize the budget proposals in respect of the various functional budgets.
• To assist the managers in preparation of budgets.
• To suggest changes and revise the budget proposals if necessary.
• To decide the detailed policy to be followed.
• To finalize the master budget and recommend it to the Chief Executive.
• To receive from time to time budget review comparing actual with the budgets.
• To locate and fix the responsibility for action.
• To suggest and take corrective action and remedial measures.
• To participate in discussions regarding new projects or programmes which have a bearing on
new project.
❖ PRINCIPAL BUDGET FACTOR

Principal budget factor is defined as the factor which may be limited in supply and this fact must
be considered in preparation of budget. It is also known as Key Factor or Limiting Factor.
Examples:
a) Scarce raw material
b) Shortage in skilled labour
c) Limited machine capacity
d) Limited capacity of plant and machinery
e) Shortage of Capital
f) Lack of market demand
❖ DIFFERENT TYPES OF BUDGET

Coverage wise budget: Functional Budget
Master Budget
Capacity wise budget: Fixed budget
Flexible budget
Condition wise budget: Basic Budget

Current Budget
Period wise budget: Long term budget

Short term budget
Current budget
Function wise budget: Sales budget

Production budget
Direct Material Purchase budget
Direct Material Usage budget
Direct labour budget
Factory Overheads Budget
Administration budget
Selling and distribution budget
Research and Development budget
Cash budget
Capital Expenditure Budget
Plant utilisation budget
❖ MASTER BUDGET
Master Budget otherwise called Budgeted Profit and Loss Account is a summary of functional
budgets and thus it shows the overall budget plan and profit or loss during the period. After
preparation of initial Master Budget, budget officer should test whether it is within the realms of
possibility. Common faults are to be rectified and final master budget is prepared and submitted
to the budget committee. Budget Committee will discuss in a meeting and submit it to the board
of directors for final approval. At this point, the budget becomes the management plan.
Explanatory note will be submitted to the board of directors explaining the reasons for variances
in regard to the sales, cost of production and profit on the basis of information readily available in
the functional budgets.
❖ FIXED BUDGET
A budget prepared on the basis of standard or fixed level of activity is known as fixed budget. It
does not change with a change in the level of activities.
❖ FLEXIBLE BUDGET
The Chartered Institute of Management Accountants, London defines Flexible Budget,
“As a budget which by recognizing different cost behaviour patterns, is designed to change as
volume of output changes.”
It is a budget prepared in a manner so as to give the budgeted cost for any level of activity. It
recognizing the difference between fixed, semi-fixed and variable cost is designed to change in
relation to the activity attained. It is designed to furnish budgeted cost at any level of activity
attained.
The main characteristic of flexible budget is that it shows the expenditure appropriate to various
levels of output. If the volume changes, the expenditure appropriate to it can be established from
the flexible budget for comparison with actual expenditure as a means of control. It provides a
logical comparison of budget allowances with the actual cost. When flexible budget is prepared,
actual cost of actual activity is compared with budgeted cost of actual activity, i.e., two things to a
the same base.
❖ BASIC BUDGET
Basic budget has been defined as a budget which is prepared for use unaltered for a long period of
time. This does not take into consideration current conditions and can be attainable under
standard conditions.
❖ CURRENT BUDGET
A current budget can be defined as a budget which is related to the current conditions and is
prepared for use for a short period of time. This budget is more useful than basic budget, as the
target it lays down will be corrected to current conditions.
❖ LONG TERM BUDGETS

A long-term budget can be defined as a budget which is prepared for periods longer than a year.
These budgets help in business forecasting and forward planning. Capital expenditure budgets and
research developments budgets are good examples of long-term budgets
❖ SHORT TERM BUDGETS

This budget is defined as a budget which is prepared for a period less than a year and is very useful
to lower levels of management for control purposes. In an ideal situation a short-term budget
should perfectly fit into a long-term budget.
❖ ZERO BASE BUDGETING

CIMA defines Zero Base Budgeting as,
“a method of budgeting whereby all activities are re-evaluated each time a budget is set. Discrete
levels of each activity are valued and a combination chosen to match funds available.”
As the term suggests, it examines a programme or function or responsibility from scratch. The
manager proposing this activity has, therefore, to prove that the activity is essential and the
various amounts asked for are really reasonable taking into account the volume of activity. Zero
base budgeting is based on the premise that every rupee of expenditure requires justification.
a) Zero base budgeting means budgeting from the beginning i.e. it is prepared without any
reference to any base (past budgets and actual figures).
b) Zero Base budgeting may be defined as a planning and budgeting process which requires
each manager to justify its budget in detail from scratch and justify why he should spend any
money.
c) Concentration of efforts is not simply on “how much” a unit will spend but “why” it needs to
spend
d) Under zero base budgeting, all activities are identified and evaluated by systematic analysis
and ranked in order of importance.
e) Thus, the burden of proof is on manager to justify why the expenditure should be made at all
and to indicate what would happen if the proposed activity is stopped and no expenditure is
made.
f) Under zero base budgeting, all activities and costs are re-evaluated each time budget is set.
It provides number of advantages to the organisational efficiency and effectiveness.
Advantages:
• It provides proper information for decision making.
• It focuses on future and not on past.
• It identifies unwanted activities and avoids wasteful expenditure.
Disadvantages:
• It involves more paperwork.
• Proper training of managers is required for successful operation of ZBB.
• It is time consuming.
• Cost of preparing and implementing ZBB is very high.
❖ PERFORMANCE BUDGETING
Performance budgeting involves evaluation of the performance of an organization in the context
of both specific as well as overall objectives of the organization. This requires complete clarity
about both the short-term as well as long-term organizational objectives.
The responsibility of the various levels of management should be predetermined in terms of

results expected from them and the authority vested in them. In other words performance
budgeting requires fixing of the responsibility of each executive in organization and the
continuous appraisal of his performance. It is, therefore, considered to be synonymous with
responsibility accounting.
The basic features of performance budgeting are:
a) Budget is prepared for each managerial level. The manager concerned is made responsible
and held accountable for his performance at his level over the specified period of time.
b) The jurisdiction of the authority and responsibility for different costs controllable by the
executive concerned is fixed up. In other words, each individual is held responsible for
only such costs which are controllable by him.
c) The concerned executive is vested with the requisite authority required for the
responsibility entrusted to him.
Objectives and Importance

a) Performance budgeting is mainly used in Government and public sector undertakings. It
reflects government activities and expenditure thereon for the budget period.
b) The objective of performance budgeting are to provide a closer linkage between planning
and action.
c) It is a technique of presenting budgets for costs and revenue in terms of functions.
d) Performance budgeting lays immediate stress on the achievement of specific goals.
e) Performance budgeting requires preparation of Periodic Performance Reports. Such
reports compare budget and actual data and show any existing variances.
f) Performance budgeting reports are to be submitted at regular intervals to higher
authorities showing the physical performance achieved, the expenditure incurred and
variances.
❖ BUDGET VARIANCE
Budget versus actual analysis can provide insight as to what really happened in your business
against what was expected. A budget is never going to be exact. Budgets typically uses rounded
and estimated figures which are simply forecast.
The difference between the budgeted amount and actual amount is known as Variance.
If the difference is positive for the organisation, it will be known as Favourable Variance.
If the difference is negative for the organisation, it will be known as Adverse Variance.
Analysis of budget help us to provide insight for positive or negative variance. Negative variances
can be caused by an efficiency problem, utilization problem, or due to unexpected or unavoidable
occurrence whereas positive variance can provide insight as to why you did so well and what
processes are working for your business.
Importance of Budget Variance

a) It aids as effective budgeting activity
b) It acts as a control mechanism
c) It fixes responsibility
d) It helps in identifying the changes which are needed in overall strategies
e) If there is no variance analysis, Budget loses its importance
PART B: PRACTICAL
SALES BUDGET, PRODUCTION BUDGET, PURCHASE BUDGET AND LABOUR COST BUDGET
1. XYZ Ltd manufactures three products P1, P2 and P3. These are made in three production
departments from four materials M1, M2, M3 and M4.
Pre-determined product cost details:

Materials Cost per material Products
unit (Rs.)
P1 P2 P3
(Units per product)
M1 0.50 - 1 2
M2 0.20 1 - 2
M3 0.25 2 1 -
M4 0.15 2 2 1
Budget Details P1 P2 P3
Sales for the year (Rs.) 2,60,000 5,80,000 4,50,000
Selling price each 5 10 6
Stocks : Finished Products (units)
At the beginning of the year 5,000 10,000 15,000
At the close of the year 10,000 15,000 30,000
Stocks: Raw materials(units) M1 M2 M3 M4
At the beginning of the year - 1st Jan 30,000 40,000 10,000 60,000
At the close of the year – 31st Dec 40,000 30,000 20,000 60,000
The cost per unit of P1 = Rs. 2, P2 = Rs. 3, P3 = Rs. 5
Required to prepare:
a) Production budget b) Purchase budget
FLEXIBLE BUDGET
2. The expenses budgeted for production of 10,000 units in a factory are furnished below:
Particulars Per unit
(Rs.)
Materials 70
Labour 25
Variable Overheads 20
Fixed overheads (Rs. 1,00,000) 10
Other Variable overheads 5
Selling expenses (10% fixed) 13
Distribution expenses (20% fixed) 7
Administrative expenses (50,000) 5
Total Cost of sale per unit ( to make and sell) 155
Prepare a budget for production of:
a) 8,000 units b) 7,000 units
CASH BUDGET
3. Prepare a cash budget for the three months ending 30 th June, 2020 from the information given
Months Sales Materials Wages Overheads
(Rs.) (Rs.) (Rs.) (Rs.)
February 14,000 9,600 3,000 1,700
March 15,000 9,000 3,000 1,900
April 16,000 9,200 3,200 2,000
May 17,000 10,400 4,000 2,300
June 18,000 10,400 4,000 2,300
a) Credit Terms are:
i) Debtors: 10% sales are on cash. 50% of credit sales are collected next month and the
balance in the following month.
ii) Creditors for:
Materials 2 months
Wages Paid 1/4 in same month & 3/4 in next month
Overheads 1/2 of a month
b) Cash and Bank Balance as on 1st April, 2020 is expected to be Rs. 6,000.
c) Other relevant information are:
i) Plant and machinery will be installed in February 2020 at a cost of Rs. 96,000
The monthly installment of Rs. 2,000 is payable from April onwards.
ii) Dividend @ 5% on Preference share capital of Rs. 2,00,000 will be paid on 1 st June.
iii) Advances to be received for sale of vehicles Rs. 9,000 in June.
iv) Dividends from investment amounting to Rs. 1,000 are expected to be received in June.
CHAPTER 4 MARGINAL COSTING
PART A: THEORY
❖ MARGINAL COST AND MARGINAL COSTING

Marginal cost is defined as cost of producing one additional unit. Thus, marginal cost is the
amount by which total cost changes when there is a change in output by one unit.
Marginal Cost means Variable Cost. Marginal cost per unit remains unchanged irrespective
of the level of activity or output. Marginal cost is the sum total of direct material cost, direct
labour cost, variable direct expenses and all variable overheads.
Under Marginal Costing technique, only variable costs are charged to cost units, the fixed
costs attributable to a relevant period are written off in Costing Profit & Loss Account against
the contribution for that period. Under Marginal Costing Technique, fixed costs are treated as
period costs.
Marginal Costing is also known as:
• Contributory Costing
• Variable Costing
• Comparative Costing
❖ ABSORPTION COSTING
Under Absorption Costing Technique, both variable cost and fixed costs are charged to cost
units. Under Absorption Costing Technique, fixed cost is treated as product cost. In short, the
cost of a finished unit in inventory will include direct materials, direct labour, and both
variable and fixed manufacturing overhead.
Absorption Costing is also known as:
• Full Costing
• Full Absorption Method
❖ STOCK VALUATION
Value of closing stock under Absorption Costing Technique will be higher as compared to
value of closing stock under Marginal Costing Technique because of fixed cost element.
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❖ DISTINCTION BETWEEN MARGINAL COSTING AND ABSORPTION COSTING
MARGINAL COSTING ABSORPTION COSTING
Only variable cost is charged to products and Total cost (both fixed and variable) is charged
inventory valuation. to the cost of products and inventory
valuation.
Fixed cost is not included in the cost of Fixed cost is included in the cost of products.
products. It is transferred to Costing Profit
and Loss Account.
Stocks are valued only at variable costs. Stock Opening and closing stocks are valued at total
values are lower in Marginal costing than in cost which inducts both fixed and variable
Absorption costing. costs. Stock values in Absorption costing are,
therefore, higher than in Marginal costing.
Profitability is judged by the contribution Profitability is measured by profit earned by
made by various products or departments. various products or departments.
Cost data helps to know the total contribution Cost data is arrived on conventional pattern
and contribution of each product. and hence is only the net profit for each
product that is arrived at.
Difference in valuation of opening and closing Valuation of opening and closing stock is
stock does not affect the unit cost of affected due to the fixed costs.
production
❖ ADVANTAGES OF MARGINAL COSTING

• Simplified Pricing Policy
Since marginal (variable) cost per unit remains constant from period to period over a
short span of time, firm’s decisions on pricing policy can be taken.
• Proper recovery of overheads
Overheads are recovered in costing on the basis of pre-determined rates. Under
marginal costing technique, fixed overheads are excluded and hence there will be no
problem of under or over recovery of overheads.
• Shows Realistic Profit
Under Marginal costing technique, the stock of finished goods and work-in-progress are
carried on variable cost basis and the fixed expenses are written off to profit and loss
account. This shows the true profit of the period.
• How much to produce
Marginal costing helps in the preparation of break-even analysis which shows the effect
of increasing or decreasing production activity on the profitability of the company.
• Helps in decision making
Marginal costing helps the management in taking a number of business decisions like
make or buy, discontinuance of a particular product, replacement of machines etc.
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❖ LIMITATIONS OF MARGINAL COSTING

• Sales staff may make mistake of marginal cost for total cost and sell at a price which will
result in loss or los profits. Hence, sales staff should be cautioned while giving marginal
cost.
• Overheads of fixed nature cannot be altogether excluded particularly in large contracts,
while valuing the work-in-progress.
• Some of the assumptions regarding the behaviour of various costs are not necessarily
true in realistic situation. For example: the assumption that fixed cost will remain static
throughout is not correct.
• Marginal cost ignores time factor and investment. The marginal cost of two jobs may be
the same but the time taken for their completion and the cost of machines used may
differ. The true cost of a job which takes longer time and uses costlier machine would be
higher. This fact is not disclosed by marginal costing.
❖ DECISION MAKING AREAS OF MARGINAL COSTING

• Fixation of Selling price
✓ Under normal circumstances
✓ Under special market (export market) or a special customer
✓ During recession
✓ At marginal cost or below marginal cost.
• Decisions relating to most profitable product mix

✓ Selection of optimal product mix
✓ Substitution of one product with another
✓ Discontinuing or dropping of a product line
• Acceptance or rejection of a special offer
• Decisions relating to make or buy
• Retaining or replacing a machine
• Expanding or Contracting
❖ COST-VOLUME-PROFIT ANALYSIS AND ITS OBJECTIVES

It is a technique that may used by the management to evaluate how costs and profits are
affected by changes in the volume of business activities. Managers are quite often faced with
decisive situations involving sales level, sales mix, selling prices and the right combination of
these factors that will produce acceptable profits. As a result of change in operating
conditions or change in economic environmental factors, the value of and the relationship
among these variables also change.
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Cost Volume Profit analysis is the analysis of three variables i.e. cost, volume and profit. Such
an analysis explores the relationship between costs, revenue, activity levels and the resulting
profit. It aims at measuring variation in cost and volume.
Importance of CVP analysis

• The behaviour of cost in relation to volume.
• Volume of production or sales, where the business will break even.
• Sensitivity of profits due to variation in output.
• Amount of profit for a projected sales volume.
• Quantity of production and sales for a targeted profit level.
An understanding of CVP analysis is extremely useful to management in budgeting and profit

planning. It elucidates the impact of the following on the net profit:
• Changes in selling prices
• Changes in volume of sales
• Changes in variable cost
• Changes in fixed cost
❖ ASSUMPTIONS OF COST VOLUME PROFIT (BREAK EVEN) ANALYSIS

• All costs are easily classified into fixed costs and variable costs.
• Both revenue and cost functions are linear over the range of activity under consideration.
• Prices of output and input remains unchanged.
• Productivity of the factors of production will remain the same.
• The state of technology and the process of production will not change.
• There will be no significant change in the levels of inventory.
• The company manufactures a single product.
• In case of a multi-product company, the sales mix will remain unchanged.
❖ PROFIT VOLUME RATIO

The Profit volume (PV Ratio) is the relationship between contribution and sales. It is also
termed as contribution to sales ratio.
Significance of PV Ratio
• PV Ratio is considered to be the basic indicator of the profitability of the business.
• The higher the PV Ratio, the better it is for a business. In the case of a firm enjoying
steady business conditions over a period of years, the PV Ratio will also remain stable
and steady.
• If PV Ratio is improved, it will result in better profits.
Improvement of PV Ratio
• By reducing the variable cost
• By increasing the selling price
• By increasing the share of products with higher PV Ratio in the overall sales ratio
Uses of PV Ratio
• To compute the variable costs for any volume of sales
• To measure the efficiency or to choose a most profitable product line. The overall
profitability of the firm can be improved by increasing the sales or output of a product
giving a higher PV Ratio
• To determine break-even point and the level of output required to earn a desired profit
• To decide more profitable sales-mix
❖ MAIN USES OF BREAK EVEN CHART

Break even chart facilitates:
• Break even point
• Margin of safety
• Angle of incidence
• Sales required to earn desired amount of profit
• Fixed Cost, Variable Cost, Total Cost, Sales, Profit at various levels of operations.
• Inter firm comparisons
• Change in sales volume
• Change in Selling price
• Change in Variable Cost
• Change in fixed cost
❖ STATE THE LIMITATIONS OF BREAK EVEN ANALYSIS

• All costs cannot be separated into variable and fixed costs with accuracy.
• Fixed costs may change because of change in management policy or after a range of
activity.
• Selling price may change because of increase or decrease in output, market demand
&supply, competition etc.
• In case of multiple products, the sales mix need not necessarily be constant.
• Entire production need not necessarily be sold in practise
• Time value of money is ignored.
❖ ANGLE OF INCIDENCE
It is the angle of intersection between total sales line and total cost line drawn in the case of
break even chart. It indicates the rate at which profits are earned. The larger the angle, the
higher the rate of profit or vice versa.
❖ KEY FACTOR OR LIMITING FACTOR

Key factor is a factor which limits the activities of an undertaking. The extent of its influence must
first be assessed while preparing functional budgets and taking decisions about the profitability of
the product. Some of the examples of key factor are:
• Shortage of Raw Material
• Shortage of Labour
• Plant Capacity available (Machines)
• Sales Capacity Available
• Cash Available
PART B: PRACTICAL
Q.1 Vidhi Corporation Ltd. has prepared the following budget for the year 2020 - 2021
Sales units 15,000
Fixed Expenses Rs. 34,000
Sales Value (Rs. 10/- per unit) Rs. 1,50,000
Variable cost Rs. 6 per unit
Find (i) P/V ratio (ii) Break even point (iii) Margin of safety (iv) MOS Ratio (v) BEP Ratio
Q.2 The following data have been extracted from the books of Alfa Ltd.
Year Sales Profit
Rs. Rs.
2019 5,00,000 (Loss) (25,000)
2020 7,50,000 1,00,000
You are required to calculate :

(i) P/V Ratio
(ii) Fixed Cost
(ii) Break-even Sales
(iv) Profit on sales of Rs. 4,00,000
(v) Sales to earn a profit of Rs. 1,25,000.
CHAPTER 5 MANAGERIAL DECISION MAKING
PART B: PRACTICAL
KEY FACTOR/LIMITNG FACTOR:
Q.1. A Company manufactures and sells two products X and Y both of which utilise the same skilled
labour. For the coming period, the supply of skilled labour is limited to 2,000 hours. Data relating to
each product are as follows:
Products X Y
Selling price per unit (Rs.) 20 40
Variable cost per unit (Rs.) 12 30
Skilled labour hours per unit 2 4
Maximum demand (units) 800 400
You are required to compute the most profitable mix.
Q.2. XYZ ltd manufactures two products which require material A. Data relating to products are:
Products Cee Dee
Selling price per unit (Rs.) 35 47
Variable cost per unit (Rs.) 21 32
Material A usage (per unit) 3.5 kgs 5 kgs
Maximum sales demand (units) 10,000 7,000
In the next period, the supply of material A will be to 35,000 kgs.
You are required to compute the most profitable mix.
SPECIAL ORDER:
Q.3. The cost sheet of a product is as follows:
Particulars Per Unit (Rs.)
Direct Material 10
Direct Labour 5
Factory Overheads:
Variable 2
Fixed 1
Administrative expenses (Fixed) 1.5
Selling and distribution expenses:
Variable 1
Fixed 0.5
The selling price per unit is Rs. 25. The above cost information is for an output of 50,000 units
whereas the capacity of the firm is 60,000 units. A foreign customer is desirous of buying 10,000
units at a price of Rs. 19 per unit. The extra cost of exporting the product is 0.50 per unit. You are
required to advise the manufacturer whether the order should be accepted.
❑ ❑ ❑
ACTIVITY BASED
COSTING
BY D R . YO G ES H PAT I L
ACTIVITY BASED COSTING
The Activity-Based Costing (ABC) is a costing system, which focuses on
activities performed to produce products. ABC is that costing in which costs
are first traced to activities and then to products.
Activity Based Costing is a technique which involves identification of cost
with each cost driving activity and making it as basis for apportionment of
costs over different cost objects or jobs or products or customers or
services.
FEATURES OF ACTIVITY BASED COSTING
• ABC is a two stage product costing method that first assigns costs to activities and
then allocates them to products based on each product’s consumption of activities
• An activity is any discrete task that an organisation undertakes to make or deliver a
product or service.
• ABC is based on the concept that products consume activities ad activities consume
resources.
• ABC can be used by any organisation that wants a better understanding of the costs
of the goods and services it provides, including manufacturing, service and even non-
profit organizations.
OBJECTIVES OF ACTIVITY BASED COSTING
• To improve product costing
• To identify non-value adding activities in the production process
which might be a suitable focus for attention or elimination
• To provide required information for decision making
• To encourage managers to evaluate the efficiency of internally
provided services
TERMINOLOGY OF ACTIVITY BASED COSTING
Cost Object:
It is an item for which cost measurement is required e.g. Product, job or a customer.
A Cost Driver:
In an ABC system, the allocation basis that are used for applying costs to services or procedures are called
cost drivers. It is a factor that causes a change in the cost of an activity
Unit level cost, Batch level cost, Product-level cost, Facility-level cost, Organizational-level cost
Cost Pool:
Costs are grouped into pools according to the activities, which drive them. In this all costs associated
with procurement i.e. ordering, inspection, storing etc would be included in this cost pool and cost
driver identified.
STAGES IN DEVELOPING ACTIVITY BASED COSTING
Step 1: Identify resources
Step2: Identify activities
Step 3: Identify cost objects
Step 4: Determine resource drivers
Step 5: Determine cost (activity) drivers
Step 6: Assign costs to the cost objects
COST ACCOUNTING RECORDS
& COST AUDIT
COST AUDIT
• The ICWAI defines statutory cost audit as “A system, of audit
introduced by the GOI for the review, examination and appraisal of
the cost accounting records.
• Cost Audit is a critical review undertaken for the purpose of
a) Verification of the correctness of cost accounts and
b) Checking that cost accounting plan is adhered to
IMPORATANT TERMS
• 1. “Cost Records” means books of account relating to utilization of
materials, labour and other items of cost as applicable to the production
of goods or provision of services as provided in Section 148 of the Act
and these rules.
• 2. Every company specified in item (A) of rule 3 shall get its cost records
audited in accordance with these rules if the overall annual turnover of
the company from all its products and services during the immediately
preceding financial year is rupees fifty crores or more as the aggregate
turnover of the individual.
IMPORATANT TERMS
• Exemption from maintenance of cost records:
a) Foreign companies having only liaison offices
b)A company which is classified as a micro enterprise or a small
enterprise including as per the turnover criteria u/s 7(9) of
the Micro, Small and Medium Enterprises Development Act,
2006.
RULE 3:
APPLICATION OF COST RECORDS
• For the purposes of Section 148(1) of the Act, the class of
companies, including foreign companies engaged in the production
of the goods or in rendering services, having an overall turnover
from all its products and services of Rs 35 crores or more during the
immediately preceding financial year, shall include cost records for
such products or services in their books of account.
RULE 5: MAINTENANCE OF COST RECORDS
a) Every company under these rules including all units and branches thereof shall in respect of each
of its financial year commencing on or after the 1st day of April, 2014, will maintain cost records in
form CRA-1.
b) The cost records referred to in the sub-rule (1) shall be maintained on regular basis in such a
manner as to facilitate calculation of per unit cost of production or cost of operations, cost of sales
and margin for each of its products and activities for every financial year on monthly or quarterly
or half yearly or annual basis.
c) The cost records shall be maintained in such a manner so as to enable the company to exercise, as
far as possible, control over the various operations and costs to achieve optimum economies in
utilization of resources and these records shall also provide necessary data which is required to be
furnished under these rules.
RULE 6: COST AUDIT
Appointment of Cost within 180 days of commencement of
Auditor financial year
Intimation to Central Within 30 days of the Board Meeting in Form CRA – 2
Government which appointment is made
Terms of Appointment Cost Auditor shall continue office till the
expiry of 180 days from close of FY
Casual Vacancy Shall be filled by BOD within 30 days of
occurrence of such vacancy
Cost Audit Report Form CRA – 3
Submission of Cost Audit Within a period of 180 days from close
Report to BOD of FY
Submission of Cost Audit Company shall submit the Cost audit Form CRA - 4
Report to Central Report to CG within a period of 30 days
Government of the receipt of the report
PROVISIONS OF COMPANIES ACT, 2013
RELATING TO COST AUDIT
Section 148 (1) Maintenance of Costing Records
Section 148 (2) Cost Audit
Section 148 (3) Appointment of Cost Auditor
Section 148 (5) Qualifications, Disqualifications, Rights,
Duties and Obligations to Cost Auditor
Section 148 (6) Submission of Cost Audit Report to Central
Government
Section 148 (7) Further Information and Explanation
FORMS
• CRA – 1: The Form CRA – 1 prescribes the form in which cost records shall
be maintained
• CRA – 2: Form of Intimation of Appointment of Cost Auditor by the
Company to Central Government
• CRA – 3: Form of Cost Audit Report
• CRA – 4: Form for filing Cost Audit Report with the Central Government
CHAPTER 8 RATIO ANALYSIS
PART A: THEORY
❖ FINANCIAL STATEMENT ANALYSIS
Financial Statement Analysis involves the examination of the relationship between financial
statement numbers and the trends in those numbers over a period of time. From an
investor’s point of view, predicting the future is what financial statement analysis is all about,
while from a management’s standpoint, financial statement analysis is useful in helping
anticipate future conditions and, more importantly, as a for starting point in planning actions that
will improve the firm’s future performance.
It is defined as the process of identifying the financial strengths and weaknesses of a firm by
adeptly establishing a relationship between the details of the Balance Sheet and the Profit
& Loss Account of the enterprises.
It is a study of the relationship among various financial factors active in a business, as disclosed by
a single set of statement. Moreover, a series of statements helps the analyses to study the trends
of these factors.
❖ OBJECTIVE OF FINANCIAL STATEMENTS

• Helps in preparing budgets
• Helps in analysing past performances with respect to current earnings and financial position
• Helps in projections
• Helps in inter- firm comparison
• To provide financial information regarding economic resources and obligations of a business
enterprise.
• To study solvency and liquidity
• To provide information about available resources
• To show strengths and weaknesses of the organisation
• To provide better insights to stakeholders for evaluation of organisation’s performance
❖ USERS OF FINANCIAL STATEMENTS

Preparation of Financial Statements is the beginning of ratio analysis. It doesn’t usually provide
detailed answers to the management’s questions but it does identify the areas in which further
data should be generated.
Shareholders
Financial Statements act as an important source for the shareholders of the company. They can
help in examining efficiency and effectiveness of the management and position, progress and
prospects of the company.
Investors:
A purchaser of business would like to ascertain the value of shares on the basis of the earnings of the
company as revealed in the Financial Statements. A small investor may like to know the dividends paid by
the company in the past as shown in the Financial Statements to ascertain the value of shares. A company
wishing to take over or absorb another company may want to study the Financial Statements of the
absorbed company to ascertain its financial position and the price to be paid for the acquisition. Thus,
potential investors have to study the Financial Statements before deciding upon whether to buy or not a
business or shares
Lenders
Short-term as well as long-term solvency information is needed by the lenders of the company to
accurately assess the position of the business. Trade creditors are interested in short-term
solvency, whereas debenture holders, long-term loan provider are interested in long-term
solvency.
Management
Financial statements help the management in acquiring accurate information regarding the
progress, position and prospects of business. They help the management in finding out the
relationship between the working and progress of the business; and therefore, help the
management in analyzing the trends in the present and future prospectus of the enterprise.
Public
Various groups such as financial analysts, lawyers, trade associations, researchers, financial
press, labour unions are interested in the trend analysis, working and growth of a business. With
the help of published financial information or statement of the enterprise, these interested
groups are able to analyze and interpret, and therefore judge the working and growth of an
enterprise.
Government
The growth of the economy is associated with the growth of the companies registered in the
country. Any fraudulent activity or unscrupulous act affects the industry which percolates the
growth of the economy. This can retard the economic growth of the country which would have
an adverse effect on our national economy.
Labour and Trade Union

In India, workers are entitled to bonus under the payment of bonus act. Thus, the statement of
Profit & Loss becomes greatly important to the workers.
❖ SOURCES OF FINANCIAL STATEMENT ANALYSIS

Financial statements are prepared on the basis of:
a) Recorded facts
b) Accounting conventions
c) Postulates
d) Personal judgements
e) Accounting standards and guidance notes
❖ TECHNIQUES USED FOR FINANCIAL STATEMENT ANALYSIS

Following techniques are used for analyzing financial statements:
a) Comparative Statements
b) Common – Size Statements
c) Trend Analysis
d) Ratio Analysis
e) Fund Flow Analysis
f) Cash Flow Analysis
❖ COMPARATIVE STATEMENTS
A business concern does not exist in isolation. It co-exists with other competing concerns in the
same industry. It has to therefore constantly compare its performance with such competing
concerns to find out where it scores over its rivals and where it lags behind them. Such
comparison is called inter-firm comparison.
It also needs to compare its own past performance with its current performance to ascertain its
progress or decline over the years. This is known as inter-period comparison. Such statement
proves that “the accounts of one period are but an installment of the continuous history of a
going concern”.
❖ COMMON SIZE STATEMENTS

In common size financial statements, all items on the statement are expressed as a percentage
of the base item. Common size statements are useful for seeing how significant the components
of the individual items of the statements are.
Generally the Financial Statements show odd amounts such as 67,689.92 and 57,324.96 and so
on. It is a difficult job to compare such odd amounts especially if the Financial Statements run
into many pages. Accountants have devised a short-cut known as Common Size Statements for a
quick comparison of the items in the Financial Statements shown in odd amounts.
The inability of financial analyst to understand and interpret the changes in the total assets,
liabilities or Proprietors Funds and their composition, financial statements are reduced to
percentage statements. This facilitates comparison of two or more business entities with a
common base.
In the case of balance sheet, total assets or liabilities or capital can be taken as the common base
and in the case of income statement, net sales can be taken as the base.
These common size statements are often called “common measurement” or “Component
Percentage” or “100 percent” statements, since each statement is reduced to the total of 100
and each individual component of the statement is represented as a percentage of the total of
100 which invariably serves as the base.
Thus, the statement prepared to bring out the ratio of each asset or liability to the total of the
balance sheet and the ratio of each item of expense or revenue to net sales is known as the
common size statement.
❖ TREND ANALYSIS
Trend Analysis treats year 1 as the base year and compares the figures of all the years (year 2,
year 3) with those of the base year to ascertain the trend in figures. Thus trend analysis of sales
will reveal whether as compared to the base year, i.e. Year I, the sales show a trend of increase
or decrease in subsequent years, i.e. Year 2, Year 2, Year 3 ….. And so on.
Trend Analysis is useful because:
(a) Trends show the direction (up or down) of the changes.
(b) Trends are easy to calculate and interpret.
(c) It is a quick method of analysis.
(d) It is more accurate because it is based on percentages and not absolute figures.
Trend ratios can be defined as index numbers of the movements of the various financial items in
the financial statements for a number of periods. It is a statistical device applied to the analysis
of financial statements to reveal the trend of the items with the passage of time. Trend ratios
show the nature and rate of movements in various financial factors. They provide a horizontal
analysis of comparative statements and reflect the behaviour of various items with the passage
of time.
❖ FUND FLOW ANALYSIS

Fund Flow Statement also referred to as statement of “Source and Application of Funds”
presents the movement of funds and helps to understand the changes in the structure of assets,
liabilities and equity capital. Whereas, the Balance Sheet provides only a summary of the assets
and liabilities at a particular point of time. It reveals the financial state of any organization the
assets side of a balance sheet shows the deployment of resources, while the liabilities side
indicates its obligations. The statement of Profit and Loss shows the operating result of the
business during a specified period. Both the statements provide the essential basic information
about the financial activities of the business, but their usefulness is limited to analysis and
planning process. From the management point of view, the usefulness of information provided
by these income statements functions effectively and efficiently.
❖ CASH FLOW ANALYSIS

When it is required to explain to management the sources of cash and its uses during a particular
period of time, a statement known as Cash Flow is prepared. The statement of cash flow reports
the inflows (receipts) and outflows (payments) of cash and its equivalents of an organization
during a particular period. It provides important information that compliments Statement of
Profit & Loss and balance sheet. The statement of cash flow reports cash receipts and payments
classified according to the entities’ major activities - operating, investing and financing during the
period. This statement reports a net cash inflow or net cash outflow for each activity and for the
overall business. It also reports from where cash has come and how it has been spent. It explains
the causes for the changes in the cash balance. In substance, the cash flow statement
summarizes a myriad of specific cash transactions into a few categories for a business entity. The
statement of cash flow reports the cash receipts, cash payments, and net changes in cash
resulting from operating, investing and financing activities of an enterprise during a period in a
format that reconciles the beginning and ending of cash balances.
❖ RATIO ANALYSIS
A ratio shows the relationship between two numbers. Accounting ratio shows the relationship
between two accounting figures. Ratio analysis is the process of computing and presenting the
relationships between the items in the financial statement. It is an important tool of financial
analysis, because it helps to study the financial performance and position of a concern. Ratios
show strengths and weaknesses of the business.
❖ OBJECTIVES OF RATIO ANALYSIS

Inter company comparison is a technique of comparing the information of other similar concerns
for Assessing company's own performance. Reasons for any difference in efficiency can be
ascertained with the help of such comparison.
Ratio Analysis has been widely used as a tool for analyzing the performance of the company over
the years. Trend of the ratios indicates whether the company is moving in the right direction or
not. There are certain ratios for which no standard is available to compare the performance with
e.g. Gross Profit ratio, operating ratio etc. These ratios can be studied & interpreted only when
they compared with the last years' ratios. Such comparison is known as inter-period comparison
of the same company.
• To show the firm’s relative strengths and weaknesses.

• To help to analyze the past performance of the firm and to make future projections.
• To allow interested parties like shareholders, investors, creditors and the government to
analyze and make evaluation of certain aspects of firm’s performance.
• To concentrate on inter-relationship among the figures appearing in the financial statements.
• To provide an easy way to compare present performance with the past.
• To depict the areas in which the business is competitively advantageous and
disadvantageous.
• To determine the financial condition and performance of the firm.
• To help to make suitable corrective measures when the financial conditions and financial
performance are unfavourable to the firm.
❖ ADVANTAGES OF RATIO ANALYSIS

Simplifies Financial Statements
Ratio analysis simplifies the comprehension of financial statements. Ratios tell the whole story of
changes in the financial condition of a business.
Analyze Past and Forecast Future
It helps to analyze and understand the financial health and trend of a business, indicating past
performance and making it possible to forecast the future trends.
Decision-Making and Cost Control
It serves as a useful tool in management control process for decision-making and cost control
purpose.
Summaries Accounting Figures
It makes the accounting figures easy to understand and highlight the inter-relationship between
various segments of the business.
Overall Profitability
Different users of accounting information make use of specific ratios to meet or satisfy their
requirements. But the management is always interested in overall profitability and efficiency of
the business enterprise.
Liquidity Position
The short-term creditors are more interested in the liquidity position of a firm in the sense that
their money would be repaid on due dates. The ability of the firm to pay short-term obligations
can be found by computing liquidity ratios.
Long term Solvency
This is required by long-term creditors, security analyst and the present and potential
shareholders of the company. The help of capital structure ratios kept the above in assessing the
financial status of the organization.
❖ LIMITATIONS OF RATIO ANALYSIS

The ratio analysis is not a full-proof method in financial statement analysis. It suffers from a
number of limitations. Some of the important one are:
Ratios ignore qualitative factors
Ratios are obtained from the figures expressed in monetary terms. In this way, qualitative
factors, which may be important are ignored.
Trends are not the actual ratios
The different ratios calculated from the financial statements of a business enterprise for one
single year are of limited value. It would be more useful to calculate the important figures in the
case of income, dividends, working capital, etc., for a number of years. Such trends are more
useful than absolute ratios.
Defective accounting information
The ratios are calculated from accounted data in the financial statements. It means if the
information is defective then the calculation of ratios would be wrong. Thus, the deliberate
omissions would affect the ratios too.
Change in accounting procedures
A comparison of result of two firms becomes difficult when we find that the firms are using
different procedures related to certain items, such as inventory valuation and treatment of
intangible assets.
Variations in general operating conditions
While interpreting the results based on ratio analysis, all business enterprises have to work
within given general economic conditions, state of the industry in which the firms are operating
and the position of the individual companies within the industry. For example, if the firm is
forced by the government to sell their products at a fixed price, its comparison with other firms
would become impossible.
Single ratio not sufficient
It is very necessary to take into account the combined effect of various ratios so that the results
are correctly interpreted regarding the financial condition and the profit-making performance of
the business. Each ratio plays a part in interpreting the financial statement.
The use of standard ratio
The financial statements represent historical data and, therefore, the ratios based on them
would only disclose what happened in the past.
❖ CLASSIFICATION OF RATIOS
Profitability Ratios:
Profitability ratios gives some yardstick to measure the profit in relative terms with reference to
sales, assets or capital employed. These ratios highlight the end result of business activities. The
main objective is to judge the efficiency of the business.
Turnover Ratios or Activity Ratios:

These ratios are used to measure the effectiveness of the use of capital/assets in the business.
These ratios are usually calculated on the basis of sales or cost of goods sold, and are expressed
in integers rather than as percentages.
Financial Ratios or Solvency Ratios:

These ratios are calculated to judge the financial position of the organization from short-term as
well as long-term solvency point of view.
Thus, it can be subdivided into:
(a) Short term Solvency Ratios (Liquidity Ratios)
(b) Long term Solvency Ratios (Capital Structure Ratios)
Market Test Ratios:

These are of course, some profitability ratios, having a bearing on the market value of the shares.
The ratio analysis in made under the following categories:
FINANCIAL RATIOS ACTIVITY RATIOS PROFITABILITY RATIOS MARKET TEST

SOLVENCY RATIOS TURNOVER RATIOS RATIOS
Short Term Solvency Ratios Stock Turnover Ratio Gross Profit Ratio Earnings Per Share
Current Ratio Debtors Turnover Ratio Net Profit Ratio Price Earnings Ratio
Liquidity Ratio Creditors Turnover Ratio Cash Profit Ratio Dividend Payout
Cash Ratio Fixed Assets Turnover Ratio Return on Investment Dividend Yield Ratio
Long Term Solvency Ratios Total Assets Turnover Ratio Return on Net Worth
Debt Equity Ratio Working Capital Turnover Debt service Coverage
Capital Gearing Ratio Sales to Capital Employed Operating Ratio
Fixed Asset Ratio
Proprietary Ratio
Interest Cover
Dividend Cover
❖ DIFFERENT FORMS IN WHICH RATIO CAN BE EXPRESSED
There are three different forms in which an accounting ratio can be expressed:
a) Pure ratio
b) Percentage
c) Rate
Pure Ratio:
A pure ratio is a simple division of one number by another. The relationship between Current
Assets & Current Liabilities is expressed in this way. If the Current assets are Rs. 2,00,000 and
Current Liabilities Rs. 1,00,000, the ratio is derived by dividing Rs. 2,00,000 by Rs. 1,00,000. It will
be expressed as 2:1
Percentage :
Certain accounting ratios become more meaningful if expressed as a percentage. The relationship
between profits and sales is expressed in this way. For example, if sales are Rs. 4,00,000 and Gross
Profit is Rs. 2,00,000 then it is expressed as gross profit being 50% of sales.
Rate:
Sometimes ratios are expressed as rates i.e. 'number of times' over a certain period. Relationship
between stock and sales is expressed in this way. If stock turnover rate is said to be '8' times in a
year, it means that the stock is converted into sales 8 times in 12 months.
❖ EXPLAIN OVER - CAPITALISATION AND UNDER - CAPITALISATION
OVER-CAPITALISATION
A company is said to be over capitalized, when total capital of the company is much more than its
requirements. As a result company is unable to use its funds and produce good results. Returns of
the company are just not sufficient to pay the fair dividend to the equity shareholders. Over-
capitalization may be due to under-trading.
UNDER-CAPITALISATION
When capital employed is low in relation to the turnover, the concern is said to be under-
capitalized. Also, when owned capital of the business is lesser than the borrowed capital, it is a
sign of under capitalization. It means company is more dependent on borrowed funds for its day-
to-day operations. Under capitalization may be the result of over-trading. Business expands with
the help of borrowed funds. This is not a favourable situation as company does not have a sound
base of shareholders' fund. Compulsory interest payments are very high and in depression it might
lead to insolvency.
FORMAT OF VERTICAL BALANCE SHEET

Particulars Rs. Rs. Rs.
I. SOURCES OF FUNDS
1. Shareholder’s Funds/ Proprietor’s Funds/ Owners Funds/ Net Worth

A. Capital
…………. xx
…………. xx xx
B. Reserves and Surplus
…………. xx
…………. xx xx
C. Less: Fictitious Assets
…………. xx
…………. xx (xx) XX
2. Loan Funds
A. Secured Loans
…………. xx
…………. xx xx
B. Unsecured Loans
…………. xx
…………. xx xx XX
CAPITAL EMPLOYED XX
II. APPLICATION OF FUNDS
1. Fixed Assets
…………. xx
…………. xx XX
2. Investments (Long Term)
…………. xx
…………. xx XX
3. Working Capital
A. Current Assets
…………. xx
…………. xx xx
B. Less: Current Liabilities
…………. xx
…………. xx (xx) XX
CAPITAL EMPLOYED XX
NOTES FOR VERTICAL BALANCE SHEET
Particulars Total
1. Items included in Capital
Preference Share Capital xx
Equity Share Capital xx
Add: Share Forfeiture xx
Less: Calls – in – Arrears (xx)
XX
2. Items included in Reserves and Surplus
Capital Reserve xx
Capital Redemption Reserve xx
Share Premium or Securities Premium xx
General Reserve xx
Profit and Loss Account (Credit Balance - Profit) xx
Debenture Redemption Fund xx
Dividend Equalization Reserve xx
Sinking Fund xx
XX
3. Items included in Fictitious Assets
Profit and Loss Account (Debit Balance - Loss) xx
Miscellaneous Expenditure xx
Preliminary Expenses xx
Share Issue Expenses xx
Discount on issue of Shares and Debentures xx
Deferred Revenue Expenditure xx
Underwriting Commission xx
XX
4. Items included in Secured Loans
Debentures xx
Bonds xx
Loan from Banks xx
Loan from Financial Institutions xx
XX
5. Items included in Unsecured Loans
Loan from Friends xx
Loan from Relatives xx
Public Deposits xx
XX
6. Items Included in Fixed Assets
Land and Building (Less: Depreciation) xx
Plant and Machinery (Less: Depreciation) xx
Furniture and Fittings (Less: Depreciation) xx
Vehicles (Less: Depreciation) xx
Computer (Less: Depreciation) xx
Equipment (Less: Depreciation) xx
Premises xx
Freehold Property xx
Leasehold Property xx
Capital work-in-progress xx
Livestock xx
Goodwill xx
Patents xx
Trademarks xx
Copyrights xx
Designs xx
XX
7. Items included in Investments (Long Term)
Trade Investments xx
Long Term Investments xx
Government Securities xx
Government Bonds xx
Government Promissory Note xx
Investment in Immovable Properties xx
Investment in Capital of Partnership Firms xx
Investment in Shares of Co-operative Society xx
Long term Investment in Shares or Debentures of other xx
Company xx
Long term loans given
XX
8. Items included in Current Assets
Short term investments xx
Marketable investments xx
Loose tools xx
Loans and Advances xx
Prepaid Expenses xx
Advance Tax xx
Advances to Suppliers xx
Stock of Raw Material or stores or spare parts xx
Stock of WIP xx
Stock of Finished Goods xx
Debtors (Less: Provision for Bad Debts) xx
Accounts receivables xx
Cash in hand xx
Bank Balances xx
Bills receivables xx
Interest accrued or receivable on investments xx
XX
9. Items included in Current Liabilities
Creditors xx
Accounts payables xx
Bills payable xx
Trade payables xx
Advances received xx
Outstanding expenses xx
Accrued interest xx
Provision for tax xx
Proposed dividend xx
Unclaimed dividend xx
Short term loans taken xx
Bank overdraft xx
XX
IMPORTANT ITEMS TO REMEMBER

Particulars Heads
Profit and Loss Account (Credit Balance) Reserves and Surplus
Profit and Loss Account (Debit Balance) Fictitious Assets
Trade Investments Investments
Government Securities Investments
Government Bonds Investments
Government Promissory Note Investments
Long Term Loans given Investments
Marketable Investments Current Assets
Short term investments Current Assets
Loose Tools Current Assets
Loans and advances given Current Assets
Proposed Dividend Current Liabilities
Provision for tax Current Liabilities
Unclaimed Dividend Current Liabilities
Short term loans Current Liabilities
FORMAT OF VERTICAL REVENUE STATEMENT

Particulars Rs. Rs. Rs.
Sales XX
Less: Cost of Goods Sold (XX)
Gross Profit XX
Less: Operating Expenses
A. Office and Administration Expenses
…………. xx
…………. xx xx
B. Selling and Distribution Expenses
…………. xx
………… xx xx (XX)
Operating Profit before Interest XX

Less: Interest (XX)
Operating Profit after Interest XX
Add: Non Operating Incomes XX
Less: Non Operating Expenses (XX)
Net Profit before Tax XX
Less: Tax (XX)
Net Profit after Tax XX
Add: Profit and Loss Account (Opening Balance) XX
Total Profit Available XX
Less: Appropriations (XX)
Retained Earnings XX
Another Format to find Net Profit interest and tax

Particulars Rs.
Operating Profit before Interest XX
Add: Non Operating Incomes XX
Less: Non Operating Expenses (XX)
Earnings before Interest and Tax XX
Less: Interest (XX)
Net Profit before Tax XX
Less: Tax (XX)
Net Profit after Tax XX
Add: Profit and Loss Account (Opening Balance) XX
Total Profit Available XX
Less: Appropriations (XX)
Retained Earnings XX
NOTES FOR VERTICAL REVENUE STATEMENT
Particulars Total
1. Items included in Sales
Cash Sales xx
Credit Sales xx
XX
2. Items included in Cost of Goods Sold
Opening stock of Raw Materials xx
Add: Purchases of Raw Materials xx
Add: Carriage inwards, Octroi, Freight, Duty xx
Less: Closing stock of Raw Materials (xx)
Less: Sale of Material scrap (xx)
XX
Direct Wages xx
Direct Expenses xx
Factory Power xx
Lighting and Heating xx
Factory Manager’s Salary xx
Factory Supervisor’s Salary xx
Defective work (Cost of Rectification) xx
Drawing and Designing Expenses xx
Factory Rent, Rates and Insurance xx
Technical Director’s Fees xx
Power and Fuel xx
Motive Power xx
Coal, Gas and Water xx
Royalty on Production xx
Royalty on Purchases xx
Custom Duty xx
Excise Duty xx
Depreciation on Plant and Machinery xx
Depreciation on Factory Building xx
Depreciation on Patterns and Patents xx
Less: Sale of Factory Scrap (xx)
XX
Add: Opening stock of WIP xx
Less: Closing stock of WIP (xx)
Opening stock of Finished goods xx

Add: Purchases or Production of Finished goods xx
Less: Closing stock of finished goods (xx)
XX
3. Items included in Office and Administration Expenses
Office Rent, Rates and Insurance
Director’s Fees xx
Depreciation on Office Furniture xx
Office Lighting xx
General Expenses xx
Printing and Stationery xx
Legal Expenses xx
Postage and Telephone Expenses xx
Audit Fees xx
Clerical Salaries and Management Expenses xx
Cleaning and Maintenance Expenses xx
Repairs and Renewal xx
Refreshment xx
Sundry Expenses xx
xx
XX
4. Items included in Selling and Distribution Expenses
Carriage outwards xx
Salesmen salaries and commission xx
Depreciation on Delivery Van xx
Travelling Expenses xx
Fees paid to Brand Ambassador xx
Advertisement and Publicity Expenses xx
Exhibition Expenses xx
Trade Fair Expenses xx
Showroom rent and expenses xx
Normal Bad Debts xx
Discount allowed xx
XX
5. Items included in Interest
Interest on Debentures xx
Interest on Bonds xx
Interest on Loans xx
Interest on Public Deposits xx
Interest on short term loans xx
XX
6. Items Included In Non Operating Incomes
Dividend Received On Shares xx
Interest Received On Debentures xx
Interest Received On Loans xx
Damages Received xx
Profit on Sale of Assets xx
Profit on sale of Investments xx
Royalty Received xx
Share Transfer Fees Received xx
Rent Received xx
Discount Received xx
Commission received xx
Bad Debts recovery xx
XX
7. Items included in Non Operating Expenses
Damages paid xx
Loss on sale of Assets xx
Loss on Sale of Investment xx
Fines paid xx
Penalty paid xx
Preliminary Expenses w/off xx
XX
8. Items included in Appropriations
Dividend paid xx
Transfer to reserves xx
Transfer to Sinking Fund xx
XX
IMPORTANT ITEMS TO REMEMBER

Particulars Heads
Carriage Inwards COGS
Custom Duty and Excise Duty COGS
Legal Expenses Office and AdmnExp
General Expenses Office and AdmnExp
Carriage outwards Selling and DistrnExp
Trade Fair Expenses Selling and DistrnExp
Normal Bad Debts Selling and DistrnExp
Discount allowed Selling and DistrnExp
Abnormal Bad Debts Finance Charges
Interest paid Interest
Interest received Non Operating Income
Dividend received and Discount received Non Operating Income
Bad Debts recovery Non Operating Income
Preliminary Expenses w/off Non Operating Expenses
Dividend paid Appropriations
IMPORTANT FORMULAS
a. Shareholders’ Funds Preference Share Capital + Equity Share Capital +
Shareholders’ Funds are also Reserves and Surplus – Fictitious Assets
known as Owners Funds,
Proprietors Funds, Net Worth
b. Equity Shareholders Funds Equity Share Capital + Reserves and Surplus –
Fictitious Assets
c. Capital Employed Shareholders’ Funds + Loan Funds
Capital Employed Fixed Assets + Investments + Working Capital

d. Working Capital Current Assets – Current Liabilities
e. COGS Sales – Gross Profit
COGS Opening stock + Purchases (including factory

expenses) – Closing Stock
SHORT TERM SOLVENCY RATIOS

a. Current Ratio Current Assets
Current Liabilities
b. Quick Ratio Quick Assets
Quick Liabilities
Quick Assets = CA – Stock – Prepaid Expenses

Quick Liabilities = CL – Bank Overdraft
Quick Ratio is also known as Liquid Ratio and Acid

Test Ratio
c. Stock to Working Capital Ratio Stock
Working Capital
d. Absolute Cash Ratio Cash + Bank + Short term Invs
Current Liability
e. Defence Interval Ratio Current Assets
Daily Operating Expenses
LONG TERM SOLVENCY RATIOS

a. Debt Equity Ratio Loan Funds
SH Funds
b. Capital Gearing Ratio Loan Funds + PSC
ESH Funds
c. Proprietary Ratio Proprietor Funds X 100
Total Assets
Total Assets will not include Fictitious Assets
PROFITABILITY RATIOS
a. Gross Profit Ratio Gross Profit X 100
Sales
b. Operating Ratio COGS + O&A + S &D X 100
Sales
c. COGS Ratio COGS X 100
Sales
d. Office Expense Ratio O & A X 100
Sales
e. Selling Expense Ratio S & D X 100
Sales
f. Net Profit Ratio Net Profit before Tax X 100
Sales
OR
Net Profit after Tax X 100

Sales
TURNOVER RATIOS
a. Stock Turnover Ratio COGS
Average Stock
Stock Holding Period Average Stock X 365/52/12

COGS
b. Debtors Turnover Ratio Credit Sales
Average Debtors
Debtors Collection Period Average Debtors X 365/52/12

Credit Sales
Debtors include Bills Receivables
c. Creditors Turnover Ratio Credit Purchases
Average Creditors
Creditors Payment Period Average Creditors X 365/52/12

Credit Purchases
Creditors include Bills Payables
Note:
a) Turnover ratio will always be expressed in Times
b) Always remember whenever turnover ratios are asked, there will be
Average in Denominator
c) Whenever Calculation of Average is not Possible, take closing in
denominator
TURNOVER RATIOS (BASED ON SALES)
a. Total Asset Turnover Ratio Sales
Average Total Assets
b. Fixed Assets Turnover Ratio Sales
Average Fixed Assets
c. Working Capital Turnover Ratio Sales
Average Working Capital
d. Capital Employed Turnover Ratio Sales
Average Capital Employed
e. Proprietors Fund Turnover Ratio Sales
Average Proprietors Funds
Note:
a) Turnover ratio will always be expressed in Times
b) Always remember whenever turnover ratios are asked, there will
be Average in Denominator
c) Whenever Calculation of Average is not Possible, take closing
figures in denominator
INCOME STATEMENT
Sales xx
Less: Variable Cost (xx)
Contribution xx
Less: Fixed Cost (xx)
EBIT (Earnings before interest and tax) xx
Less: Interest (xx)
EBT (Earnings before tax) xx
Less: Tax (xx)
NPAT (Net Profit after tax) xx
Less: Preference Dividend (xx)
Net Profit for Equity Shareholders xx
Less: Equity Dividend xx
Retained Earnings xx
INVESTMENT RATIOS (RETURN RATIOS)
a. Return on Capital Employed EBIT X 100
(Return on Total Assets) Average Capital Employed
(Return on Investment)
b. Return on Proprietor’ Funds NPAT X 100
(Return on SH Funds) Average Proprietors’ Funds
c. Return on ESH Funds Net Profit for ESH X 100
Average ESH Funds
d. Return on Equity Share Capital Net Profit for ESH X 100
Average ESC
Note:
a) Always remember whenever Return ratios are asked, there will be
Average in Denominator
b) Whenever Calculation of Average is not Possible, take closing figures in
denominator
MARKET TEST RATIOS

a. Earnings per Share (EPS) Net Profit for ESH
No. of Equity Shares
b. Dividend Payout Ratio Dividend Per Share (DPS)

Earnings Per Share (EPS)
c. Retention Ratio EPS – DPS

EPS
d. Price Earnings Ratio (PE Ratio) Market Price Per Share (MPS)
Earnings Per Share (EPS)
e. Earnings Yield Ratio EPS X 100

MPS
f. Dividend Yield Ratio DPS X 100

MPS
OTHER RATIOS
a. Interest Coverage Ratio EBIT
Interest
b. Pref Dividend Coverage Ratio NPAT

Preference Dividend
c. Equity Dividend Coverage Ratio Net Profit for ESH

Equity Dividend
d. Debt Service Coverage Ratio NPAT + Depreciation + Interest

Interest + Installments on Loans
PART B: PRACTICAL
Q.1. Following is the Balance Sheet of JBL Ltd. as on 31st March,2020
Liabilities Rs. Assets Rs.
Equity Share Capital 2,00,000 Goodwill 70,000
8% Preference Share Capital 2,00,000 Land and Buildings 4,40,000
16% Debentures 80,000 Plant and Machinery 2,00,000
15%Bank Loan 40,000 Furniture 60,000
Reserves 3,00,000 Investments 40,000
Creditors 1,20,000 Debtors 1,40,000
Bank Overdraft 80,000 Prepaid Insurance 20,000
Outstanding Rent 14,000 Stock 60,000
Provision for tax 40,000 Cash in Hand 14,000
Proposed Dividend 20,000 Cash at Bank 70,000
Profit and Loss A/c 40,000 Preliminary Expenses 20,000
11,34,000 11,34,000
You are required to calculate the following ratios:
(a) Proprietary Ratio (d) Current Ratio
(b) Stock Working Capital Ratio (e) Liquid Ratio
(c) Capital Gearing Ratio (f) Debt equity ratio.
Q.2. Following are the ratios of the trading activities of National Traders Limited
Debtors velocity 3 months
Stock velocity 8 months
Creditors Velocity 2 months
Gross Profit ratio 25%
st
Gross Profit for the year ended 31 March, 2019 amounted to Rs. 4,00,000. Closing stock of the
year is Rs. 10,000 more than the opening stock. Bills receivable amount to Rs. 25,000. Bills
payable amount to Rs. 10,000.
Find out:
a) Opening and Closing Stock
b) Purchases
c) Average Sundry Debtors
d) Average Sundry Creditors
CHAPTER 9 VALUATION OF SHARES / GOODWILL
PART A: THEORY
This Chapter includes
- Valuation of shares - Special factors for valuation factor of
- Methods of valuation of shares – net asset shares
basis or intrinsic value method, yield basis, - Valuation of intangible : brand, goodwill
valuation based on rate of return, valuation and IPRs
basis and productivity
Chapter at a Glance
Topic Important Highlight

1. Need for valuation of The necessity for valuation of shares arises inter alia in the
shares following circumstances :
i) Purchase of a book of shares which may or may not give the
holder thereof a controlling interest in the company.
ii) Purchase of shares by employees of the company where the
retention of such shares is limited to the period of their
employment
iii) Formulation of schemes of amalgamation, absorption, etc
iv) Acquisition of interest of dissenting shareholders under a
scheme of reconstruction
v) Compensating shareholders on the acquisition of their shares
by the Government under a scheme of rationalization
vi) Conversion of shares, say, conversion of preference shares
into equity
vii) Advancing a loan on the security of shares
2. Methods of valuation of shares
(a) Net assets basis of The method relating to net asset basis may take various forms
intrinsic value depending upon circumstances :
method
i) Break-up value method (or liquidation value method)
ii) Appraised value method; and
iii) Book value method
Depending on the circumstances of the case, goodwill may or may
not be included. Goodwill comes in for distinct consideration only
when the number of shares involved is large giving to the holder a
measure of control. Normally, earning represents the result of
application of all assets of every description in the business,
whether it is plant and machinery or goodwill or patent or know-
how, for a small number of shares in a going concern, earning is
the only appropriate basis.
(b) Yield basis i) Valuation based on rule of return

ii) Valuation based on rate of dividend
Value of share
Possible rate of dividend x paid up value per share
normal rate of dividend
dividend (in rupees) per share x 100

normal rate of dividend
possible rate of dividend
Total profit available for dividend x 100
Total paid up equity capital
iii) Valuation based on rate of earning :

Value of share
Rate of earning x paid-up value per share
Normal rate of earning
Rate of earning = actual profit earned x 100
Capital employed
iv) Valuation based on price earnings ratio :
Market value of share = price earnings ratio x earning per share
Earning per share
= profit available for equity shareholders
Number of equity shares
Price earnings ratio = market value per share
Earnings per share
v) Capitalization factor
Capitalization factor = 100______
Normal rate of return
3. Special factors for a) Importance of the size of the block of shares
valuation of shares b) Restricted transferability
c) Dividends and valuation
d) Bonus and right issues
4. Valuation of These are valued on yield basis in a going concern. Compared to
preference shares equity shares, the rate of return in preference shares would be,
generally, lower because of greater safety. With fluctuations in the
normal rate of return in respect of preference shares, the value of
preference share will fluctuate but in the opposite direction, i.e., if
the normal rate of return increases, the value tends to diminish.
5. Intangible assets Following features of intangible assets :
i) It is non-physical in nature
ii) It gives the specific rights to the holders over several future
years
iii) It is possible for multiple uses at the same time
iv) It creates future value

v) It is identifiable as non-monetary asset
vi) It has limited ability to protect property rights
vii) Investment in intangible assets is basically risky
6. Recognition of an Expenditure on an intangible item should be recognized as an
expense on expense when it is incurred unless :
intangible asset
a) It forms part of the cost of an intangible asset that meets the
recognition criteria
b) The item is acquired in an amalgamation in the nature of
purchase and cannot be recognized as an intangible asset
If this is the case, this expenditure (included in the cost of
acquisition) should form part of the amount attributed to goodwill
(capital reserve) at the date of acquisition.
In some cases, expenditure is incurred to provide future economic
benefits to an enterprise, but no intangible asset or other asset is
acquired or created that can be recognized as an expense when it
is incurred. For example, expenditure on research is always
recognized as an expense when it is incurred. Examples of other
expenditure that its recognized as an expense when it is incurred
include :
a) Expenditure on start up activities (start up costs), unless this
expenditure is included in the cost of an item of fixed asset.
Start up costs may consist of preliminary expenses incurred in
establishing a legal entity
b) Expenditure on training activities
c) Expenditure on advertising and promotional activities; and
d) Expenditure on relocating on re-organizing part or all of an
enterprise.
7. Amortization on 1. Amortization period
intangible assets 2. Amortization method
3. Residual value
4. Review of amortization period and amortization method
8. Factors affecting The factors leading to goodwill are the following :
goodwill 1. Special locational advantages
2. Special commercial advantages such as a long term contract
for supply of raw materials at a low price or for sale of finished
goods at remunerative prices
3. Advantages because of prior entry specially if later is very
difficult
4. Advantages enjoyed by it because of certain patents available
to it
5. Technical know-how possessed by the firm
6. The research and development effort
9. Methods of valuing There are basically two methods of valuing goodwill :
goodwill i) Average profits method
ii) Super profits method
❖ PHASES OF GENERATION OF INTANGIBLE ASSETS
S. No. Heading Description

1. Meaning Identifiable non-monetary asset, without physical substance, held
for use in the production or supply of goods or services for rental to
others or for administrative purposes
2. Classification of Internally generated goodwill should not be recognized as an asset.
phases The generation of asset is classified into two phases :
a) Research phase : expenditure on research should not be
recognized as an intangible asset. These should be recognized
as an expenses when it is incurred.
b) Development phase : an intangible asset arising from
development phase should be recognized only if following
conditions are fulfilled.
- The technical feasibility of completing the intangible asset
so that it will be available for use or sale
- Its intention to complete the intangible asset and use or sell
it
- Its ability to use or sell the intangible asset
- The availability of adequate technical, financial and other
resources to complete the development and to use or sell
the intangible asset
❖ PURPOSES OF VALUATION OF SHARES
S. No. Heading Purposes of valuation of shares
1. Purpose of valuation of The valuation of shares may arise under the following
shares circumstances :
(a) Taxation Assessment under various direct tax laws
(b) Controlling interest Purchase of block of shares generally involving acquisition of

controlling interest in the company.
(c) Purchase by employees Purchase of shares by employees of the company
(d) Formulation of Formulation of schemes of amalgamation, absorption etc.

company
(e) Acquisition of interest Acquisition of interest of dissenting shareholder under a

scheme of reconstruction.
(f) Advancing loans Advancing loans on the security of shares
(g) Conversion Conversion of shares say preference into equity
(h) Deadlock resolution Resolving a deadlock in the management of a private limited

company on the basis of the controlling block of shares being

given to either of the parties.
(i) Compensation from Compensating shareholders on the acquisition of their shares

Government by the government under a scheme of rationalization.
❖ FAIR VALUE OF SHARES
S. No. Heading Fair value of shares
1. Meaning - Fair value of the current price or value of an item. More

specifically, it is the amount that the item could be sold for
that is fair for both the buyer and the seller.
- Fair value does not relate to products being sold in
liquidation; rather it refers to products that are being sold
under normal, reasonable conditions
- Fair value becomes increasingly important when assets are
sold or a company is acquired.
2. Method of valuation
i) Net asset or intrinsic In this method value per share is arrived by dividing the net
value or net worth or asset of the company by number of equity shares. The
breakup value method calculation of net asset is done by adding all the asset at the
market value, net investments are included and if there is
preference share capital it should be deducted from it.
For example : land and building + plant and machinery +

furniture + stock + debtors + bill receivable + cash + goodwill –
debentures – current liabilities – preference share capital –
dividend arrears / number of equity shares.
ii) Yield or earning In this method the valuation of share is done by comparing
capacity valuation or expected rate of return with normal rate of return. If ERR > NRR
income method than market value of share is more than the paid up amount.
Otherwise market value of share is less than the paid up value.
iii) Fair value or dual This method is the combination of both the above methods.
method
Fair value of share = intrinsic value + yield value / 2
This method is also known as dual method of share valuation.

This method attempts to minimize the demerits of both the
methods.
❖ SUPER PROFIT METHOD OF VALUATION OF GOODWILL

1. Meaning Super profit is the excess of estimated future maintainable
profits over normal profits. An enterprise may possess some
advantages which enable it to earn extra profits over and
above the normal profit that would be earned if the capital of
the business was invested in some other business with similar
risks. The goodwill under this method is ascertained by
multiplying the super profits by certain number of year’s
purchase.
2. Information require Under this method of valuing goodwill would require the
following information :
- A normal rate of return for representative firms in the
industry
- The fair value of capital employed
- Estimated future maintainable profit
3. Calculation steps - Calculate capital employed (it is the aggregate of
shareholders’ equity and long term debt or fixed assets
and net current assets)
- Calculate normal profits by multiplying capital employed
with normal rate of return
- Calculate average maintainable profit
- Calculate super profit as follows :
Super profit = average maintainable profits – normal
profits
- Calculate goodwill by multiplying super profit by number
of year’s purchase
2017 – June [2] (c) Write a short note on valuation of shares bases on price earnings ratio.
(3 marks)
Answer :
1. Meaning This method is suitable for ascertaining the market value of
shares which are quoted on a recognized stock exchange
2. Calculation of price According to this method, the shares are valued on the
earnings ratio basis of earning per share multiplied by price earnings ratio.
Thus,
Market value of share =
Price earnings ratio x earning per share
Earning per share =

Profit available for equity shareholders
Number of equity shares
Price earnings ratio =
Market value per share
Earning per share
❖ INTERNALLY GENERATED INTANGIBLE ASSETS IN THE BOOKS OF ACCOUNT
1. Meaning - Internally generated assets like goodwill are recognized in

the books of accounts of the internally generated intangible
assets meets the criteria for recognition.
- An enterprise should distinguish the generation of the asset
into the research phase and the development phase. If the
enterprise cannot make such distinction, then expenditure
on that project should be considered to be in the research
phase only.
2. Classification of ➢ Research phase : intangible asset arising from research or
phases on the research phase of an internal project should be
recognized as an expenses when it is incurred.
➢ Development phase : an intangible assets arising from
development phase of an internal project should be
recognized only if, an enterprises can demonstrate of the
following conditions :
- The technical feasibility of completing the intangible
asset so that it will be available for use or sale
- Its intention to complete the intangible asset and use or
sell it
- Its ability to use or sell the intangible asset
- How the intangible asset will generate probable future
economic benefits. Among other things, the enterprise
should demonstrate the existence of a market for the
output of the intangible asset or the intangible asset
itself or, If it is to be used internally, the usefulness of
the intangible asset
- The availability of adequate technical, financial and
other resources to complete the development and to
use or sell the intangible asset; and
- Its ability to measure the expenditure attributable to
the intangible assets during its development reliably.
Internally generated brands, mastheads, publishing titles,
customer lists and items similar in substance should not be
recognized as intangible assets.
❖ AMORTIZATION PERIOD IN RELATION TO INTANGIBLE ASSETS
Heading Provision for Amortization on intangible assets
Amortization on - The depreciable amount of an intangible asset should

intangible assets be allocated on a systematic basis over the best
estimate of its useful life.
- There is a rebuttable presumption that the useful life of
an intangible asset will not exceed ten years from the
date when the asset is available for use.
- Amortization should commence when the asset is
available for use
- As the future economic benefits embodied in an

intangible asset are consumed over time, the carrying
amount of the asset is reduced to reflect that
consumption.
- This is achieved by systematic allocation of the cost of
the asset, less any residual value, as an expense over
the asset’s useful life. Amortization is recognized
whether or not there has been an increase in, for
example, the asset’s fair value or recoverable amount.
- Given the history of rapid changes in technology,
computer software and many other intangible assets
are susceptible to technological obsolescence
- Therefore, it is likely that their useful life will be short
- If control over the future economic benefits from an
intangible asset is achieved through legal rights that
have been granted for a finite period, the useful life of
the intangible asset should not exceed the period of the
legal rights unless the legal rights are renewable and
renewal is virtually certain.
- The amortization period should be reviewed at least at

each financial year end
Review of
- If the expected useful life of the asset is significantly
amortization period different from previous estimates, the amortization
and amortization period should be changed accordingly.
method
Retirement and An intangible asset should be derecognized or disposal or

disposal when no future economic benefits are expected from its
use and subsequent disposal.
❖ METHODS FOR VALUATION OF GOODWILL
✓ SUPER PROFIT METHOD
Goodwill Super Profit X No. of years of purchase
Super Profit Average Profit – Normal Profit
Normal Profit Average Capital Employed X NRR
Average Profit Note I

Average Capital Employed Note II
NRR Note III
Note I: Average Profit
For the purpose of Goodwill Valuation, problem provides past profits
If any adjustments are given year wise, then we should complete such adjustments
before calculating average profits
After completing the adjustments, we have to observe the trend to decide whether
to calculate Weighted Average or Simple Average
If the profits show rising trend, prefer weighted average. If the profits shows
declining trend or uneven trend, prefer Simple Average
If there is a loss in a particular year and the sum is silent regarding the same i.e. loss
is not justified or quantified, then ignore the loss making year.
Adjustments
a) Non Operating & Non Recurring Elements
Loss by fire, theft, any natural calamity
Profit on sale of fixed assets
Profit on sale of investments
b) Non Operating & Recurring Elements

Interest received on Non Trade Investments
Dividend received on Non Trade Investments
Rent received by letting out part of business premises
✓ Future Adjustments
After the above adjustments are over, we have to adjust the profits with respect
to future adjustments also:
a) Expenses incurred so far but not likely to be incurred in future
b) Expenses not incurred so far but likely to be incurred in future
c) Incomes received so far but not likely to be received in future
d) Incomes not received so far but likely to be received in future
✓ After completing all the adjustments with respect to past, present and future, the
profits so arrived are called as Future Maintainable Profits (FMP)
✓ So basically Average Profits are also known as Future Maintainable Profits (FMP)
Note II: Average Capital Employed
• Closing Capital Employed = Assets

• Assets should not include Goodwill, Non Trade Investments, Fictitious Assets
• Liabilities should only include external liabilities such as Secured Loans, Unsecured
Loans, Current Liabilities, Provisions
• Assets and Liabilities should be taken at revised values and if revised values are not
given in the question, then take book values
• Normally, Closing Capital Employed = Average Capital Employed
• But if in the Balance Sheet, proposed dividend is given, then ½ of profits should be
deducted while calculating average capital employed.
Note III: Normal Rate of Return (NRR)
• NRR is also called as expected rate of return, fair rate of return on capital invested,
standard return in similar business of similar industry
• NRR will always be given in the question
• If NRR is given with some risk factor, then NRR = Given % + % of Risk Factor
• NRR based on Dividend Basis (Dividend Yield Ratio)
NRR = DPS X 100
MPS
• NRR based on Yield Basis (Earnings Yield Ratio)

NRR = EPS X 100
MPS
✓ ANNUITY METHOD
Goodwill = Super Profit X Annuity Value
✓ CAPITALISATION OF SUPER PROFIT

Goodwill = Super Profit
NRR
✓ CAPITALISATION OF AVERAGE PROFITS (FMP)

Goodwill = Average Profit - Actual Capital Employed
NRR
❖ METHODS FOR VALUATION OF SHARES
✓ INTRINSIC VALUE METHOD

It is also known as
• Liquidation Method
• Balance Sheet Method
• Asset Backing Method
• Net Assets Method
Value Per Share Net assets for ESH

No. of Equity Shares
How to calculate Net Assets for Equity Shareholders (ESH)
Closing Capital Employed as per Goodwill XX
Add: Goodwill XX
Add: Non Trade Investments XX
Less: Preference Share Capital (XX)
Net Assets for Equity Shareholders (ESH) XX
If in the question, Premium on Redemption is given or Proposed Preference Dividend is given or

arrears of Preference Dividend is given, then the same should also be deducted while calculating
Net Assets for Equity Shareholders (ESH).
✓ YIELD VALUE METHOD

It is also known as
• Profitability Method
• Going Concern Method
• Productivity Method
Value Per Share ARR X Paid up value or Face value

NRR
How to calculate Average Rate of Return (ARR)
ARR Average Profits for ESH X 100

Paid up Equity Share Capital
Average Profits for Equity Shareholders (ESH)
Average Profits as per Goodwill XX
Less: Transfer to reserves (XX)
Less: Preference Dividend (XX)
Average Profits for Equity Shareholders (ESH) XX
✓ FAIR VALUE METHOD

Value Per Share Intrinsic value per share + Yield value per share
2
PART B: PRACTICAL
VALUATION OF GOODWILL
Q.1.The net profit of a business after providing for taxation, for the past five years are: ` 40,000, `
42,500, ` 46,000, ` 52,500 and ` 59,000. The capital employed in the business is ` 4,00,000. The
normal rate of return expected in this type of business is 10%. It is expected that the company will
be able to maintain its-super profit for the next 5 years.
Calculate the value of goodwill on the basis of:
(i) Five years' purchase of super profits;
(ii) Annuity method, taking the present value of annuity of Re. 1 for five years at 10% as 3.78;
and
(iii) Capitalisation of super profits.
VALUATION OF SHARES
Q.2. Balance Sheet of Diamond Ltd. on 30th June, 2020

Liabilities `
Share capital:
2,000 shares of Rs.100 each 2,00,000
General reserve 40,000
Profit and loss account 32,000
Sundry creditors 1,28,000
Income Tax provision 60,000
4,60,000
Assets `
Land and Buildings 1,10,000
Plant and machinery 1,30,000
Patents and trade marks 20,000
Stock 48,000
Debtors 88,000
Bank balance 52,000
Preliminary expenses 12,000
4,60,000
The expert valuer valued the land and buildings at ` 2,40,000, goodwill at ` 1,60,000 and Plant and
Machinery at ` 1,20,000. Out of the total debtors, it is found that debtors of `8,000 are bad. The
profits of the company have been as follows:
Years `
2016 80,000
2017 90,000
2018 1,06,000
The company follows the practice of transferring 25% of profits to general reserve. Similar type of
companies earn at 10% of the value of their shares.
Ascertain the value of shares of the company under:
(i) Intrinsic value method.
(ii) Yield value method; and
(iii) Fair value method.
Ignore taxation. Note: Assume that depreciation is charged on land & Building at 10% & plant at
15%.

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J. K.

SHAH CLASSES CS EXECUTIVE – MANAGEMENT ACCOUNTING

CHAPTER 1 OVERVIEW OF COST

❖ COST, COSTING AND COST ACCOUNTING

Cost Centres are of two types

❖ MANAGEMENT ACCOUNTING AND ITS FUNCTIONS

Accounting is thus made up of

e) Price and product decisions:

❖ SCOPE, OBJECTIVES, IMPORTANCE OF COST AND MANAGEMENT ACCOUNTING

❖ VARIOUS REPORTS PROVIDED BY COST ACCOUNTING DEPARTMENT FOR DECISION

❖ ESSENTIAL FEATURES OF A GOOD COST ACCOUNTING SYSTEM

❖ ESSENTIAL FACTORS FOR INSTALLING A COST ACCOUNTING SYSTEM

The above problems can be overcome by the following remedies

❖ LABOUR COST AND WHAT ARE ITS OBJECTIVES

❖ TIME KEEPING AND ITS OBJECTIVES

Purpose of time keeping:

❖ SHORT NOTES ON COLLECTION AND CLASSIFICATION OF OVERHEADS

CHAPTER 2 COST SHEET

Items Included In Direct Wages

Items Included In Direct Expenses

Items Included In Factory Overheads

Items Included In Office Overheads

Items Included In Selling and Distribution Overheads

Notes relating to Cost Sheet

2. How to Find Per Unit Column

(c) Expenses incurred after earning profits

(d) Appropriation of Profits

(e) Intangible Assets written off

(f) Miscellaneous Expenditure written off

(g) Financial Expenses and Losses

• Production Increases, Total Variable Cost increases

• Production Increases, Fixed Cost per unit decreases

• Variable Cost is known as product cost

Purchase of Raw Material ` 48,000

Direct Wages ` 40,000

of Raw Material ` 8,000

of Finished Goods 1,600 quintals ` 6,400

of Raw Material ` 6,800

of Finished Goods 3,200 quintals

Work on cost (factory overhead) ` 16,800

1st April 2018 ` 1,920

31st March 2019 ` 6,400

Office and Administrative Overheads (Related to Production) ` 3,200

Sales (Finished Product) ` 1,20,000

CHAPTER 3 BUDGETARY CONTROL

As per Chartered Institute of Management Accountants (CIMA), London, Budget is,

❖ BUDGETING AND BUDGETARY CONTROL

❖ OBJECTIVES/USES OF BUDGETARY CONTROL

❖ ADVANTAGES OF BUDGETARY CONTROL SYSTEM

❖ LIMITATIONS OF BUDGETARY CONTROL SYSTEM

❖ FUNCTIONS OF BUDGET COMMITTEE

❖ PRINCIPAL BUDGET FACTOR

❖ DIFFERENT TYPES OF BUDGET

Condition wise budget: Basic Budget

Period wise budget: Long term budget

Function wise budget: Sales budget

❖ LONG TERM BUDGETS

❖ SHORT TERM BUDGETS

❖ ZERO BASE BUDGETING