Nature of Management Accounting

Characteristics of Management Accounting:

1. It is a selective technique. It compiles only the data from balance sheet and profit and loss, which is relevant and useful.
2. It is concerned with data not decisions. It can inform but not prescribe.
3. It deals with future. It is a kind of planning for the future because decisions are taken for future course of action.
4. It examines the cause and effect of relationship. Normally, a profit and loss account will show the amount of profit or loss for the
year but does not tell us the reasons for it. Management accounting studies the causes of profit or losses.
5. It does not follow rigid rules and formats like financial accounting. The necessary info is provided in the shape of various
statements or reports in order to meet the needs of the management.
Objectives of Management Accounting:
1. To help the management in promoting efficiency.
2. To finalize budgets covering all functions of a business.
3. To study the actual performance with plan for identifying deviations and their causes.
4. To analyze financial statements to enable the management to formulate future policies.
5. To help the management at frequent intervals by providing operating statements and short-term financial statements.
6. To arrange for the systematic allocation of responsibilities for the implementation of plans and budgets.
7. To provide a suitable organization for discharging the responsibilities.
Scope of Management Accounting:
1. Financial accounting: Related to the recording of business transactions including income, expenditure, inventory movement,
assets, liabilities, cash receipts, etc.
2. Cost accounting: Costing is a branch of accounting. It is the process of and technique of ascertaining costs. It includes standard
costing, marginal costing, differential and opportunity cost analysis.
3. Budgeting and forecasting: Covers budgetary control
4. It reports financial results to the management
5. It provides statistical data to various departments.
Functions of Management Accounting:
1. It assists in planning and formulating future policies.
2. It helps to interpret and analyze the financial information.
3. It controls and monitors performance.
4. It helps to organize various functions of an organization.
5. It offers solution for strategic business problems.
6. It coordinates various departmental operations.
7. It motivates employees.
Functions of management Accountant:
1. Collection of data
2. Analysis
3. Presentation of data
4. Planning: A management accountant plans the entire accounting functions.
5. Controlling: Examines the performance against the set standard and reports it to the management.
6. Reporting: He reports to the management and advises them on future decisions.
7. Coordinating: preparation of master budget
8. Decision making
Standard costing
 What is Material Cost Variance? What are its sub-divisions?
Material Cost Variance or Material Total Variance is the Variance in material cost actually incurred on material and the material cost
estimated on material.
Material Cost Variance can be derived as follows:
MCV = (Standard Quantity x Standard Rate) – (Actual Quantity x Actual Rate)

Material Cost Variance can be sub-divided as follows:

a) Material Rate Variance or Material Price Variance is the variance in the rate or price of material actually spent and the
material rate/price estimated.
Thus, even if there is no change in quantity consumed, if there is a difference in the total cost, then it is due to the difference in the
rate at which material is consumed.
Material Rate Variance can be derived as follows:
MRV = Actual Quantity (Standard Price – Actual Price)

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b) Material Usage Variance is the variance in the usage of material in actual production and the estimated usage of material.
Thus, even if there is no change in the rate of material, if there is a change in the total cost, then it is due to the change in
consumption of material.
Material Usage Variance can be derived as follows:
MUV = Standard Rate (Standard Quantity – Actual Quantity)
 What is Material Usage Variance? What are its sub-divisions?
Material Usage Variance is the variance in the usage of material in actual production and the estimated usage of material.
Thus, even if there is no change in the rate of material, if there is a change in the total cost, then it is due to the change in
consumption of material.
Material Usage Variance can be derived as follows:
MUV = Standard Rate (Standard Quantity – Actual Quantity)
Material Usage Variance can be further sub-divided into:
a) Material Mix Variance: The difference between actual quantity of material and revised standard quantity of material is the
Material Mix Variance.
Revised Standard Quantity is the Actual Quantity of Material divided in the standard raw material ratio.
Material Mix Variance can be derived as follows:
MMV = Standard Rate (Revised Standard Quantity – Actual Quantity)
b) Material Yield Variance: The difference between the actual output and the standard expected output is the Material Yield
Variance.
There are two methods of calculating Material Yield Variance. They are as follows:
Input Method:
MYV = (Standard Input – Actual Input) x Average Cost / unit
Output Method:
MYV = (Actual Output – Standard Output) x Total Cost / unit

(Note: Labour Variances can be answered in the same manner as Material Variances. Incase of any doubt or query, please put your
queries on: www.sigmaforum.tk)

Marginal Costing
 What is Marginal Costing? Why is it calculated?
The marginal cost of a product is defined as the change in cost that occurs when the volume of output is increased or reduced by
one unit.
Marginal costing is used to assess whether it is financially feasible to increase manufacturing volume or to calculate the effect of
reducing volume, perhaps due to a decline in the market. It is based on variable costs because fixed costs are fixed. They occur and
do not change if manufacturing volume changes. Following factors are calculated on the basis of marginal costing:
 production planning
 pricing
 make or buy
 close-down
 accept or reject
 dropping a production line
 accepting additional order
 Write a note on Break Even Point.

Break Even Point is the level of sales required to reach a position of no profit, no loss. At Break Even Point, the contribution is just
sufficient to cover the fixed cost. The organisation starts earning profit when the sales cross the Break Even Point. Break Even Point
can be calculated either in terms of units or in terms of cash or in terms of capacity utilization. It can be calculated as follows:
BEP in units = Fixed Cost / Contribution per unit
BEP in cash = Fixed Cost / P.V. Ratio
BEP in terms of capacity utilization = BEP in units / Total capacity x 100

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 Break Even Volume can be
better explained with the
diagram above.
 Explain the concept of
Margin of Safety.
The positive difference between the operating sales volume and the break even volume is known as the margin of safety. The larger
the difference, the safer the organization is from a loss making situation. It can be calculated either in cash or in units.
Margin of Safety can be derived as follows:
Margin of Safety = Actual Sales – Break even Sales
Margin of Safety (in cash) = Profit___
P/V Ratio
Margin of Safety (in units) = Profit______
Contribution/unit

 What is Profit/Volume Ratio?

Profit-Volume Ratio expresses the relationship between contribution and sales. It indicates the relative profitability of diff products,
processes and departments.
Formulae:
P/V ratio = S – V/ S X 100
= Cont / Sales X 100
= Change in profit or loss / Change in sales
 Short note on :Limiting factor

Whenever some resources required for products and are not adequately available, these resources become limiting factor. If there
are limiting factors, then the product which gives more contribution per unit may not give more amount of total contribution
because, it may not make more profitable use of limited resources.
In such cases, we can calculate contribution per unit of limiting factor and the product which offers more contribution per unit of
limiting factor is to be treated as more profitable product and the product priority order is to be accordingly calculated.
Contract Costing
 What are the various methods of calculating profits on almost completion of contract?

When the contract is almost at the stage of completion, profit can be calculated in four ways. It is upon the company to adopt any of
the four methods. The four methods are as follows:
1. Profit = Estimated Profit x Work Certified___
Total Contract Price
2. Profit = Estimated Profit x Cost incurred to date
Total estimated cost
3. Profit = Estimated Profit x Cash Received___

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 Total Contract Price
4. Profit = Estimated Profit x Cash Received___ x Cost incurred to date
Total Contract Price Total estimated cost

Explain the terms:

Contractor: A party who agrees to provide supplies or services in accordance with a valid and legal contract. A contractor executes
the work.
Contractee: A party who orders supplies or services in accordance with a valid and legal contract. A contractee gives the contract.
Running Bill: It is a bill raised by the contractor for periodical payments.
Retention Money: It refers to that part of the contract amount which is certified but not paid.
Work Certified: It refers to that part of the running bill, which is approved by the architect of the contractee.
Work Uncertified: It refers to that part of the running bill, which is rejected by the architect of the contractee. It is always valued at
cost.
Basic Rate Concept: Basic Rate concept refers to the method in which a fixed rate is maintained for the raw materials throughout
the contract irrespective of the fluctuations in the market price of the material.
Escalation Clause: Escalation clause is a provision of a contract which calls for an increase in contract price in the event of an
increase in certain costs beyond a certain percentage and viceversa.

Abnormal Loss: It is the part of the process loss caused due to abnormal circumstances in the factory. For Ex, labour strike, break
down of machinery. It is avoidable and controllable by mgmt. Abnormal loss occurs in addition to normal loss.

Normal loss: It is part of process cost which is caused under normal circumstances. It is inevitable. Example, weight loss, scrap loss,
pilferage. Normal loss is calculated at a certain % of input in unit in respective process. It may have scrap value.

Process Costing
Write a note on “Inter process profits”.

While transferring the outputs of one process to another, the company might add some amount of profits to it. This is to get the
actual cost of finished product as, if the company would have bought the inputs for the next process, it would be inclusive of profits.
But, at the end of an accounting period, this inter process profit has to be excluded in order to get the real valuation of closing stock.
E.g.: Process I: Cost- 10000 Profit- 2000 Transferred Price- 12000

Process II: Inputs from Process I - 12000

Additional Processing cost- 12000
Total Cost incurred - 24000
Sales - 21600
Closing Stock - 2400
Inter-process profit of P-I - 200
Value of Closing Stock - 2200
 What is equivalent production?
At the end of a financial period, all the stock of a company needs to be assessed. All the partially completed units are valued through
the method of equivalent production. The units of production are calculated according to the percentage of completion of
processing on the partially completed units.

For example, two units that are 50 percent complete are the equivalent of one unit fully completed.

Budgetary Control
What is Budgetary Control? What are the steps involved in Budgetary Control?
Budgetary control is the management process of using budgets to monitor and control the performance of the organization. This is
done by comparing the planned values (in the budget) with the actual values as they occur during the year.
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A budget has been defined as a financial and quantitative statement prepared and approved prior to a defined period of time, of the
policy to be pursued during that period for the purpose of attaining a given objective.

The following steps are involved in Budgetary Control:

1. Establishment of Budgets: Targets are fixed for each function relating to the responsibilities of individual executives.
2. Measurement of actual performance.
3. Comparison of actual performance with budgeted performance to detect deviation.
4. Analysis of the causes of variations and reporting
What are the uses of diff budgets?
 It serves a declaration of policies
 Defines the objectives/ targets for executives, at all levels.
 Means of coordination of activities
 Means of communication
 Facilitates centralised control
 Helps in planning activities
Note: The information provided in this document on each topic is limited. We do not guarantee an inclusion of the whole scope
of management accounting or of the whole syllabus of N.M.S.Y.B.M.S. We suggest you to refer to the books recommended by your
professor.
Cash Budget
The cash budget is prepared after the operating budgets (sales, manufacturing expenses or merchandise purchases, selling
expenses, and general and administrative expenses) and the capital expenditures budget are prepared. The cash budget starts with
the beginning cash balance to which is added the cash inflows to get cash available. Cash outflows for the period are then subtracted
to calculate the cash balance before financing. If this balance is below the company's required balance, the financing section shows
the borrowings needed. The financing section also includes debt repayments, including interest payments. The cash balance before
financing is adjusted by the financing activity to calculate the ending cash balance. The ending cash balance is the cash balance in the
budgeted or pro forma balance sheet.
Flexible Budgets
A budget report is prepared to show how actual results compare to the budgeted numbers. It has columns for the actual and
budgeted amounts and the differences, or variances, between these amounts. A variance may be favorable or unfavorable. On an
income statement budget report, think of how the variance affects net income, and you will know if it is a favorable or unfavorable
variance. If the actual results cause net income to be higher than budgeted net income (such as more revenues than budgeted or
lower than budgeted costs), the variance is favorable. If actual net income is lower than planned (lower revenues than planned
and/or higher costs than planned), the variance is unfavorable. So higher revenues cause a favorable variance, while higher costs
and expenses cause an unfavorable variance.

Cost ACCOUNTING:
• In today’s business world, the resources available are very scarce.
• Hence, every business unit must strive hard to obtain maximum output with the available input in order to ensure the
optimum utilization of scarce resources.
• The value of input is measured against the value of output.
• In the present era of cut-throat competition, the need to study this subject is growing very fast.
• Every businessman makes a constant effort to improve his/her business.
• Cost accounting is the process of accounting for cost.
• Cost accounting is generally concerned with internal reporting for management requirement.
• The development of cost accounting is of recent origin.
• The Chartered Institute of Management Accountants, U.K. (CIMA) defines costing as ‘the technique and process of
ascertaining costs.’
• Costing is a tool to determine the cost of products or service.
• Cost accounting – analysis and classification of costs or expenditure.
• Cost accountancy – application of costing and cost accounting principles

Functions of Cost Accounting:

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 • ‘Cost Accounting is to serve management in the execution of policies and in the comparison of actual and estimated results
in order that the value of each policy may be appraised and changed to meet the future conditions.’
– To calculate cost per unit
– To prepare a correct cost analysis
– To ascertain the wastage in each process of manufacture
– To provide necessary information for the determination of selling price
– To compute product-wise profit
– To serve the management in the valuation of W-I-P
– To install and implement cost control systems
– To advice management for future expansion
– To establish an effective reporting system
– To guide the management in the preparation and implementation of incentive schemes based on productivity and
cost savings.
Objects of Cost Accounting:
• To determine the actual cost of each article, process, operation, service, department or segment of activity.
• To reveal and report inefficiencies in the form of material wastage, loss of time in material buying, storing, and issuing.
• To provide actual figures of cost comparison with estimates of costs and price fixing.
• To find out the degree of efficiency and productive capacity of men and machines and ideal standard for their working.
• To implement incentive wage plans for workers.
• To reduce cost through budgetary control and standard costing.
• To study trends at different volumes of output, and to determine production policies and programs.
• To ensure continuous check and adjustment of stores and materials with the help of perpetual inventory.
• To organize internal audit system, and interlocking of financial and cost accounts to verify the accuracy of each other.
To furnish necessary data for the preparation of profit and loss account and balance sheet at short intervals [e.g., monthly, quarterly,
etc.] for each department or business as a whole

Advantages of Cost Accounting:

• Price Fixation
• Control on Unprofitable Activities
• Useful Information
• Cost Control
• Provides Valuable Data
• Effective Check
• Preparation of Budgets and Regulations of production
• Fixation of Responsibilities
• Independent Check
• Prevention of Manipulation, misappropriation, and frauds
Principles of Costing:
• Every concern must design its own costing system, keeping in view its peculiar problems.
• If financial books can afford the necessary information, separate costing system is not needed.
• Reasonable accuracy is enough, of course, this depends upon the nature of industry.
• As a rule, costing information should be collected as and when the work proceeds.
Importance of Costing
• To the Employees
– Incentive Bonus
– Higher earnings through time and motion study
– Overtime payments
– Benefit of job evaluation
– Continuous employment and job security
• To the Management
– Planning
– Organizing
– Controlling
– Budgeting
– Decision-making
– Pricing
– Evaluation of operating efficiency

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 • To the creditors
– Can access more information in comparison to Financial accounts
– To ascertain the solvency, profitability
• To the government
– More taxes through higher production
– Useful in preparing import and export policy
• To the society
– Lower prices through cost reduction
– Better quality of products and services
Budget:
A plan which for a definite period, covers, all phases of operations in the future is known as a business budget. Policies, plans,
objectives & goals are formally expressed by it & are laid down in advance for the concern as a whole & for each of its sub-divisions
by the top management. Thus an overall budget will be there for the concern comprosed of several sub-budgets which are in the
form of departmental budgets. Expense limitations are expressed by the budget in the expense budgets & in the sales budget,
revenue goals are expressed & for the purpose of realizing the desired profit objective, these must be attained. Besides, plans
relating to items such as levels of inventory, additions to capital assets, plans of production, plans of purchasing, requirements of
labour, requirements of cash etc. are expressed by the budget. Thus, for a given period, budget is a formal management plans’ &
policies’ statement which can be used in that period as a guide or blue print.
The basic elements of a budget are:
(a) For a specified period of time, it’s a future plan of activity,
(b) Budget can be expressed in monetary or physical units or in both,
(c) Before the period during which the budget is supposed to operate, it is prepared i.e. it is prepared in advance.
(d) Before the preparation of the budget, it is necessary to lay down the objectives which are required to be attained & the policies
which are required to be pursued for the achievement of those objectives.
Budgetary Control:
Throughout the budget period, the use of budgets & budgetary reports for the purpose of coordinating, evaluating &
controlling day-to-day operations according to the goals which are specified by the budget is involved by budgetary control. The
mere presentation of budget doesn’t have much value, its real value lies in the aspects of the planning & its utilization during the
period for the purposes of control & coordination. Under budgetary control, actual results are constantly checked & evaluated &
comparison of actual result is made with the budgeted goals & wherever indicated, corrective action should be undertaken. The
following steps are involved in the process of budgetary control:
(a) The objectives which are required to be achieved by the business should be defined & specified by budgetary control.
(b) For the purpose of ensuring that the desired objectives are accomplished, business plans are needed to be prepared by
budgetary control.
(c) Budgetary control translates the plans into budgets & relates to particular sections of the budget, the responsibilities of individual
executives & managers.
(d) Budgetary control constantly compares the actual results with the budget & the differences between the actual & budgeted
performance are calculated.
(e) For the purpose of establishing the causes, the major differences are investigated by budgetary control.
(f) In a suitable form, budgetary control presents the information to the management, relating to variances to individual
responsibility.
(g) In order to avoid a repetition of any over-expenditure or wastage, management takes corrective actions. Alternatively, where due
to the change in circumstances, the budgeted targets cannot be achieved, the budget is revised.
Difference between Budget, Budgeting & Budgetary control:
Individual objectives of a department etc. are indicated by budget, whereas the act of setting the budgets is known as
budgeting. All are embraced by budgetary control & also the science of planning the budgets themselves & as an overall
management tool, the utilization of such budgets, for the purpose of business planning & control are included in budgetary control.
Thus, the term by budgetary control is wider in meaning & both budget & budgeting are included in by budgetary control.
Objectives of Budgetary Control:

The objectives of budgetary control are:

(1)Compel for planning: As management is forced to look ahead, responsible for setting of targets, anticipating of problems & giving
purpose & direction to the organization, this feature is the most important feature of budgetary control.
(2)Communication of ideas & plans: Communication of ideas & plans to everyone is effected by budgetary control. In order to make
sure that each person is aware of what he is supposed to do, it is necessary that there is a formal system.

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(3)Coordinating the activities: The budgetary control coordinates the activities of different departments or sub-units of the
organization. The coordination concept implies, for example, on production requirements, the purchasing department should base
its budget & similarly, on sales expectations, the production budget should in turn be4 based.
(4) Establishing a system of control: A system of control can be established by having a plan against which progressive comparison
can be made of actual results.
(5) Motivating employees: Employees are motivated for improving their performances by budgetary control.
Requisites of an effective system of budgetary control:
(a) There should be a clearly defined organizational structure where are area of responsibility is emphasized.
(b) Within the budgeting process, the employees should participate.
(c) For the purpose of relying the measurement of performance, there should be adequate accounting records & procedures.
(d) Budgetary control needs to be flexible, so that the plans & objectives may be revised.
(e) An awareness of the uses of the budgetary control system should be spread by the management.
(f) An awareness regarding the problems of budgetary control & especially the individual’s reactions to budgets should be spread by
the top management.
Advantages of Budgetary control:
The advantages of budgetary control system are as follows:
(1) The objectives of the organization as a whole & the results which should be achieved by each department within this overall
framework are defined by the budgetary control.
(2) When there is a difference between actual results & budget, then the extent by which actual results have exceeded or fallen
short of the budget is revealed by the budgetary control.
(3) The variances or other measures of performance along with the reasons of difference between the actual results with those from
budgeted is indicated by the budgetary control. Also, the magnitude of differences is established by it.
(4) As the budgetary control reports on actual performance along with variances & other measures of performance; for correcting
adverse trends, a basis for guiding executive action is provided by it.

(5) A basis by which future budget can be prepared or the current budget can be revised is provided by the budgetary control.
(6) A system whereby in the most efficient way possible the resources of the organization are being used is provided by the
budgetary control.
(7) The budgetary control indicates how efficiently the various departments of the organization are being coordinated.
(8) Situations where activities & responsibilities are decentralized, some centralizing control is provided by the budgetary control.
(9) The budgetary control provides means by which the activities of the organization can be stabilized, where the organization’s
activities are subject to seasonal variations.
(10) By regularly examining the departmental results, a basis for internal audit is established by the budgetary control.
(11) The standard costs which are to be used are provided by it.
(12) For the purpose of paying a bonus to employees, a basis by which the productive efficiency can be measured is provided by the
budgetary control.
Limitations of Budgetary Control:
The main limitations of budgetary control are:
(1) It used the estimates as a basis for the budget plan.
(2) In order to fit with the changing circumstances the budgetary programme must be continually adapted. Normally for attaining a
reasonably good budgetary programme, it takes several years.
(3) A budget plan cannot be executed automatically. Enthusiastic participation is required by all levels of management in the
programme.
(4) The necessity of having a management & administration will not be eliminated by any budgetary control system. The place of the
management is not taken by it; rather it is a tool of the management.
Sunk cost: Money already spent and permanently lost. Sunk costs are past opportunity costs that are partially (as salvage, if any) or
totally irretrievable and, therefore, should be considered irrelevant to future decision making. This term is from the oil industry
where the decision to abandon or operate an oil well is made on the basis of its expected cash flows and not on how much money
was spent in drilling it. Also called embedded cost, prior year cost, stranded cost, or sunk capital.
'Budget Manual'
A set of instructions used within large organizations to prepare budgets. As organizations become larger and more complex, it is no
longer possible for one person to prepare a budget. Instead, budgeting across the enterprise must be carefully coordinated.
Financial analysts work closely with each group to collect budget information on a pre-set schedule and then send data up through
higher rungs of financial controllers until it can be aggregated by the CFO’s office.

(A) Actual Cost

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Actual cost is defined as the cost or expenditure which a firm incurs for producing or acquiring a good or service. The actual costs or
expenditures are recorded in the books of accounts of a business unit. Actual costs are also called as "Outlay Costs" or "Absolute
Costs" or "Acquisition Costs".
Examples: Cost of raw materials, Wage Bill etc.
(B) Opportunity Cost
Opportunity cost is concerned with the cost of forgone opportunities/alternatives. In other words, it is the return from the second
best use of the firms resources which the firms forgoes in order to avail of the return from the best use of the resources. It can also
be said as the comparison between the policy that was chosen and the policy that was rejected. The concept of opportunity cost
focuses on the net revenue that could be generated in the next best use of a scare input. Opportunity cost is also called as
"Alternative Cost".
If a firm owns a land, there is no cost of using the land (ie., the rent) in the firms account. But the firm has an opportunity cost of
using the land, which is equal to the rent forgone by not letting the land out on rent.
(C) Sunk Cost
Sunk costs are those do not alter by varying the nature or level of business activity. Sunk costs are generally not taken into
consideration in decision - making as they do not vary with the changes in the future. Sunk costs are a part of the outlay/actual
costs. Sunk costs are also called as "Non-Avoidable costs" or "Inescapable costs".
Examples: All the past costs are considered as sunk costs. The best example is amortization of past expenses, like depreciation.
(D) Incremental Cost
Incremental costs are addition to costs resulting from a change in the nature of level of business activity. As the costs can be
avoided by not bringing any variation in the activity in the activity, they are also called as "Avoidable Costs" or "Escapable Costs".
More ever incremental costs resulting from a contemplated change is the Future, they are also called as "Differential Costs"
Example: Change in distribution channels adding or deleting a product in the product line.
(E) Explicit Cost
Explicit costs are those expenses/expenditures that are actually paid by the firm. These costs are recorded in the books of accounts.
Explicit costs are important for calculating the profit and loss accounts and guide in economic decision-making. Explicit costs are also
called as "Paid out costs"
Example: Interest payment on borrowed funds, rent payment, wages, utility expenses etc.
(F) Implicit Cost
Implicit costs are a part of opportunity cost. They are the theoretical costs ie., they are not recognised by the accounting system and
are not recorded in the books of accounts but are very important in certain decisions. They are also called as the earnings of those
employed resources which belong to the owner himself. Implicit costs are also called as "Imputed costs".
Examples: Rent on idle land, depreciation on dully depreciated property still in use, interest on equity capital etc.
(G) Book Cost
Book costs are those business costs which don't involve any cash payments but a provision is made in the books of accounts in order
to include them in the profit and loss account and take tax advantages, like provision for depreciation and for unpaid amount of the
interest on the owners capital.
(H) Out Of Pocket Costs
Out of pocket costs are those costs are expenses which are current payments to the outsiders of the firm. All the explicit costs fall
into the category of out of pocket costs.
Examples: Rent Payed, wages, salaries, interest etc

(I) Accounting Costs

Accounting costs are the actual or outlay costs that point out the amount of expenditure that has already been incurred on a
particular process or on production as such accounting costs facilitate for managing the taxation need and profitability of the firm.
Examples: All Sunk costs are accounting costs
(J) Economic Costs
Economic costs are related to future. They play a vital role in business decisions as the costs considered in decision - making are
usually future costs. They have the nature similar to that of incremental, imputed explicit and opportunity costs.
(K) Direct Cost
Direct costs are those which have direct relationship with a unit of operation like manufacturing a product, organizing a process or
an activity etc. In other words, direct costs are those which are directly and definitely identifiable. The nature of the direct costs are
related with a particular product/process, they vary with variations in them. Therefore all direct costs are variable in nature. It is
also called as "Traceable Costs"
Examples: In operating railway services, the costs of wagons, coaches and engines are direct costs.
(L) Indirect Costs
Indirect costs are those which cannot be easily and definitely identifiable in relation to a plant, a product, a process or a department.
Like the direct costs indirect costs, do not vary ie., they may or may not be variable in nature. However, the nature of indirect costs

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depend upon the costing under consideration. Indirect costs are both the fixed and the variable type as they may or may not vary as
a result of the proposed changes in the production process etc. Indirect costs are also called as Non-traceable costs.
Example: The cost of factory building, the track of a railway system etc., are fixed indirect costs and the costs of machinery, labour
etc.
Definition of 'Suspense Account'
In accounting, the section of a company's books where unclassified debits and credits are recorded. The suspense account
temporarily holds unclassified transactions while a decision is being made as to their classification. Transactions in the suspense
account will still appear in the general ledger, giving the company an accurate indication of how much money it has.

In investing, a suspense account is a brokerage account where an investor places cash or short-term securities temporarily while
deciding where to invest them for a longer term.
Concept of conservatism and materiality concept
The concept of conservatism, also known as the concept of prudence, is often stated as “anticipate no profit and provide for all
possible losses”. In other words, the accountant is expected to follow a cautious approach.
He should record lowest possible value for the assets and revenues and the highest possible value for the liabilities and expenses.
According to this concept, revenues or gains should be recognized only when they are realized in the form of cash or assets (usually
legally enforceable debts) the ultimate cash realization of which can be assessed with reasonable certainty. Further, provision must
be made for all known liabilities, expenses and losses whether the amount of these is known with certainty or is at best an estimate
in the light of the information available. The probable losses in respect of all contingencies should also be provided for.
A contingency is a condition or a situation, the ultimate outcome of which can be either gain or loss and cannot be determined
accurately at present. It will be known only after the event has occurred (or has not occurred). For example, a customer has filed a
suit for damages against the company in a court of law; Whether the judgment will be favorable or unfavorable to the company
cannot be determined in an exact manner. Hence, it will be prudent to provide for likely loss in the financial statements. As a
consequence of the application of this concept, net assets are more likely to be understood than overstated and income is more
likely to be overstated than understood. Based on this concept it is the widely advocated practice of valuing inventory (stock of
goods left unsold) at cost or market price whichever is lower.
It should be stated that the logic of this convention has been under stress recently and it has been challenged by many writers on
the ground that it stands in the way of fair determination of profit and the disclosure of true and fair financial position of the
business enterprise.

The concept is not applied as strongly today as it used to be in the past. In any case, conservatism must be applied rationally as over
conservatism may result in misrepresentation.
Materiality concept:
There are many events in business which are trivial or insignificant in nature. The cost of recording and reporting such events cannot
be justified by the usefulness of the information derived. Materiality concept holds that items of small significance need not be given
strict theoretically correct treatment. For example, a stapler costing around $2 may last for three years; however, the efforts
involved in allocating its cost over the three year period is not worth the benefit than can be derived from this operation. Since the
item obviously is immaterial when related to overall operations, the cost incurred on it may be treated as the expense of the period
in which it is acquired.
Some of the stationery purchased for office use in any accounting period may remain unused at the end of that period. In
accounting, the amount spent on the entire stationery would be treated as expense of the period in which the stationery was
purchased, notwithstanding the fact that a small part of it still lies in stock. The value (or cost) of the stationery lying in stock would
not be treated as an asset and carried forward as a resource to the next period. The accountant would regard the stock lying unused
as immaterial and hence, the entire amount spent on stationery would be taken as the expense of the period in which such expense
was incurred.
What is a Common-Size Statement?
The common-size statement is a financial document that is often utilized as a quick and easy reference for the finances of a
corporation or business. Unlike balance sheets and other financial statements, the common-size statement does not reflect exact
figures for each line item. Instead, the structure of the common size statement uses a common base figure, and assigns a percentage
of that figure to each line item or category reflected on the document.

A company may choose to utilize financial statements of this type to present a quick snapshot of how much of the company’s
collected or generated revenue is going toward each operational function within the organization. The use of a common-size
statement can make it possible to quickly identify areas that may be utilizing more of the operating capital than is practical at the
time, and allow budgetary changes to be implemented to correct the situation.

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The common size statement can also be a helpful tool in comparing the financial structures and operation strategies of two different
companies. The use of percentages in the common size statements removes the issue of which company generates more revenue,
and brings the focus on how the revenue is utilized within each of the two businesses. Often, the use of a common-size statement in
this manner can help to identify areas where each company is utilizing resources efficiently, as well as areas where there is room for
improvement.
Common-size statements can be prepared for any review period desired. Companies that choose to make use of financial
statements of this type may choose to utilize this format for quarterly, semi-annual, or annual reviews. When there is concern about
operational costs, the common-size statement may be prepared on a more frequent basis, such as monthly. Because the common-
size statement is very easy to read and does not necessarily contain information that would be considered proprietary, the format
can often be employed as part of general information that is released to the public.

Zero Based Budgeting (ZBB)

• Start each budget period afresh-not based on historical data
• Budgets are zero unless managers make the case for resources-the relevant manager must justify the whole of the budget
allocation
• It means that each activity is questioned as if it were new before any resources are allocated to it.
• Each plan of action has to be justified in terms of total cost involved and total benefit to accrue, with no reference to past
activities.
• Zero based budgets are designed to prevent budgets creeping up each year with inflation
Advantages of ZBB
• Forces budget setters to examine every item.
• Allocation of resources linked to results and needs.
• Develops a questioning attitude.
• Wastage and budget slack should be eliminated.
• Prevents creeping budgets based on previous year’s figures with an added on percentage.
• Encourages managers to look for alternatives.
Disadvantages of ZBB
• It a complex time consuming process
• Short term benefits may be emphasised to the detriment of long term planning
• Affected by internal politics - can result in annual conflicts over budget allocation

Double Entry System of Accounting

Earlier transactions in the books of accounts were recorded under single entry system. But this system had some shortcomings as
there was not a complete record of all the transactions. Also problems were faced while preparing final accounts. Problems were
also faced as there was no self balancing system of accounting which could guarantee, to some extent, the accuracy of the books of
accounts. So a need was felt for some uniformly accepted system of accounting which could help in the verification of the accuracy
of books to some extent. These problems were solved by the Double Entry System of accounting. This system has totally replaced
the single entry system. This system is now followed universally.
Under this system of accounting, every transaction in business involves atleast two accounts. That is why this system of accounting
is called the ' Double Entry System'. Under this system every transaction has two aspects i.e. debit aspect and credit aspect. Under
this system every transaction is entered into atleast two accounts in the Ledger. In one account the transaction is entered on the Left
hand side i.e on the debit sideof the account and on the other account an entry for equal amount is made on the right side of the
account i.e. the credit side of the account.
For example suppose X paid cash salaries to his staff. The two accounts affected are cash account and salaries account. As cash is
going out it, cash account is credited. Salaries is an expenditure for the business, salaries account is debited.
Again X bought raw material for the production unit, the two accounts involved are
Cash account and Purchases account.
He paid carriage to bring goods to his factory, the two accounts involved are cash account and carriage account.
He sold finished goods to customers on credit, the two accounts involved are the customer's personal account(debtor) and sales
account.
He further purchased furniture for his office on credit. The two accounts involved are furniture account and the personal account of
the seller(creditor).
Thus we can see that every transaction has two aspects in the Double entry system of accountancy.
Now which account is debited and which is to be credited depends on the types of accounts involved and the rules of debit and
credit for that type of account.

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Profit and loss accountis the account whereby a trader determines the net result of his business transactions. It is the account which
reveals the net profit (or net loss) of the trader.

Theprofit and loss accountis opened with gross profit transferred from thetradingaccount (or with gross loss which will be debited
toprofit and loss account). After this all expenses and losses (which have not been dealt in thetradingaccount) are transferred to the
debit side of theprofit and loss account. If there are any incomes or gains, these will be credited to theprofit and loss account. The
excess of the gain over the losses is called the net profit and that of the loss over the gain is called the net loss. The account is closed
by transferring the net profit or loss to capital account of the trader.

Format of the Profit and Loss Account:

Profit and Loss Account

For the year ended ..............

To Gross Loss xxxx By Gross Profit xxxx

To Salaries xxxx By Interest Received xxxx
To Rent xxxx By Discount Received xxxx
To Rent and Rates xxxx By Commission Received xxxx
To Discount Allowed xxxx By Other Receipts xxxx
To Commission Allowed xxxx By Etc., Etc. xxxx
To Insurance xxxx  
To Bank Charges xxxx
To Legal Charges xxxx By Net Loss (transferred to capital account of
To Repairs xxxx the trader) xxxx
To Advertising xxxx    
To TradeExpenses ex.    
To Office Expenses xxxx  
 
To Bad Debts xxxx
   
To Traveling Expenses xxxx
   
To Etc., Etc. xxxx
   
To Net Profit (transferred to capital account of  
 
the trader)  
 
   
xxxx  
   
 
 
 

Why cash book show debit balance?

Cash Account is a real account and also the asset of company and assets have normally debit balance according to basic
accountingrules.

So debit balance of cash means we have positive amount in cash account and will be shown as asset in balance sheet.

But banks also provide overdraft facilities as well in this case we have normally credit balance of cash which means that we have
negative balance in cash account and so it is liability of company to clear bank overdraft and make cash balance debit again

bcoz cash a/c is real a/c and our asset. assets have normally debit balance according to basic accounting rules. So debit balance of
cash means we have positive amount in. if cash book show negative balance then it will not remain our asset. it will be our
liability.....

When the rule of "debit what comes in and credit what goes out " is followed in cash book,it cannot show credit balance since
you cannot spend more than the receipt ie.,what goes out can not be more than what comes in. Therefore cash book show debit
balance.

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