 Why should we learn accounting?

= Because in any decision making role, there is a financial aspect.

= For any project, we need budget, concept of financing this budget, cost control and
benefit estimation.
= Assist to manage cash flow, prepare budgets, obtain finance and do some financial
modeling.
= Determine the most effective lot size to buy and logistical solution in order to keep
supply chain costs as low as possible.
Financial Accounting Managerial Accounting
Managerial Accounting provides internal
reports to help users make decisions about
their companies.
For external users. For internal users (Business accounts
section gives report to business
management).
Example: Example:
Daily transaction. Management of business.
Bank. Decision making, Planning, Accounting
Financial reports for taking loan. information needed to run a business.
Record daily transaction and Make Management department provides
summary at the end of the year to get information at any time at any situation.
financial report.
Standard format practice maintained Customized internal design report.

 The word “ACCOUNT” has come from the Latin words “ad” + “computere” which mean
to reckon together (count up, compute or calculate).
 The word ACCOUNTANT has come from the older English word accomptant.
 Accounting is directly related with financial or economic events (earnings & expenses).
 In 1494, the first book on double-entry accounting was published by Luca Pacioli as the
"Father of Accounting,”. The first accounting book actually was one of five sections in
Pacioli's mathematics book titled SUMMA DE ARITHMETICA, GEOMETRIA, PROPORTIONI
ET PROPORTIONALITA (Everything about Arithmetic, Geometry and Proportions).
 Accounting: Accounting is an information system that identifies records and
communicates the economic events of an organization to interested users (accounting
information users).
 Purpose of accounting is to:
o Identify: Select economic events (transaction)
o Record: Record, classify and summarize
o Communicate: Prepare accounting reports
 Book-keeping Accounting
Only Identifies. Identifies, Records and Communicates.
One function of Accounting.

 Internal users: Finance, Marketing, Management, HR

 External users: Creditors, Investors
 Ethics:
o Standards of conduct by which one’s actions are judged as right or wrong,
honest or dishonest, fair or not fair, are ethics.
o The Ethics code ensures that all members of the company demonstrate integrity
and honesty in their work with clients and other professional relationships.
o The ethics code also prevents accountants from associating themselves with any
information that could be misleading or damaging to the client or the
organisation.
o Recognize an ethical situation and the ethical issues involved.
o Identify and analyze the principal elements in this situation.
o Identify the alternatives and weight the impact of each alternative on various
stakeholders.
 Engineering Accounting:
o Subset of Project Accounting with a target to properly track and report the use
of resources in relation to engineering projects.
o It combines management reporting and financial reporting for engineering based
projects.
o It differs from Construction Accounting due to the basis of the inputs and the
goals of the reporting.
o Identifies project scope then measures and communicates costs of a projects
outcome.
 Measurement Principles:
o HISTORICAL COST PRINCIPLE (or cost principle): Dictates that companies record
assets at their cost.
o FAIR VALUE PRINCIPLE: States that, assets and liabilities should be reported at
fair value (the price received to sell an asset or settle a liability).
 Assumptions:
o MONETARY UNIT ASSUMPTION requires that companies include in the
accounting records only transaction data that can be expressed in terms of
money.
o ECONOMIC ENTITY ASSUMPTION requires that activities of the entity be kept
separate and distinct from the activities of its owner and all other economic
 entities. The transactions of individual owners of a business and those of the business
must be separate. A business entity is separate from the personal affairs of its owner.
 Forms of Business Ownership:
o Proprietorship
o Partnership
o Corporation
 Functions of Management:
o Planning:
 When you think of planning in a management role, think about it as the
process of choosing appropriate goals and actions to pursue and then
determining what strategies to use, what actions to take, and deciding
what resources are needed to achieve the goals.
o Organizing:
 This process of establishing worker relationships allows workers to work
together to achieve their organizational goals.
o Leading:
 This function involves articulating a vision, energizing employees,
inspiring and motivating people using vision, influence, persuasion, and
effective communication skills.
o Staffing:
 Recruiting and selecting employees for positions within the company
(within teams and departments).
o Controlling:
 Evaluate how well you are achieving your goals, improving performance,
taking actions. Put processes in place to help you establish standards, so
you can measure, compare, and make decisions.
 Asset
 Resources a business owns or
controls.
 Production and Sales
 Provide future services or
benefits.
 Cash, Inventory, Equipment, etc.
 Pizza hut.
 There are 3 criteria’s of an asset:
1. Economic resource
2. Owned/Controlled by
business
3. Benefit in future
Liabilities Equities
 Claims against assets  Ownership claim on total
(debts and obligations). assets.
 Creditors (party to  Referred to as residual equity.
whom money is owed).  Share Capital—Ordinary and
 Accounts Payable, Retained Earnings.
Notes Payable, Salaries  Ordinary share capital is the
and Wages Payable, sum of money raised by a
Tax payable etc. corporate from private and
 Creditors can legally public sources through the
force the liquidation of issue of its common shares
a business  Retained earnings (RE) is the
 Represent negative amount of net income left over
future cash flows for for the business after it has paid
the business. out dividends to its
shareholders
 Investments by shareholders represent the total amount paid in by shareholders for the
ordinary shares they purchase.
 Revenues result from business activities entered into for the purpose of earning income.
Revenues are inflows of assets resulting from the sale of products or the rendering of
services to customers.
Common sources of revenue are: sales, fees, services, commissions, interest, dividends,
royalties, and rent. The purpose of earning revenues is to benefit the shareholders.
Increase then equity increase.
 Expenses are the cost of assets consumed or services used in the process of earning
revenue.
Common expenses are: salaries expense, rent expense, utilities expense, property tax
expense, etc.
 Revenues > Expenses = Net Income ; Revenues < Expenses = Net Loss
 Dividends are the distribution of cash or other assets to shareholders. Dividends reduce
retained earnings. However, dividends are not expenses.
Increase then equity decrease.
 Transaction: Transactions are a business’s economic events recorded by accountants.
o May be external or internal.
o Not all activities represent transactions.
o Each transaction has a dual effect on the accounting equation.
o For Example if an asset increase corresponding asset need to decrease. Increase in
liability must decrease owners’ equity.
 Share Capital- Ordinary is affected when the company issues new share for cash.
 Retained earnings is affected when the company earns revenue, incurs expense or pay
dividends.
 The share capital- Ordinary and Retained Earnings columns indicate the cause of each
change in the shareholders claim on asset.
 Companies prepare five financial statements :
o Income Statement.
o Comprehensive Income Statement

Income Statement Comprehensive Income Statement

Presents the revenues and expenses and
resulting net income or net loss for a specific
period of time.
The net income is the result obtained by
preparing an income statement.
Summarizes both standard net income and
other comprehensive income (OCI).
Other comprehensive income consists of all
unrealized gains and losses on assets that are
not reflected in the income statement.
It is a more robust document that often is
used by large corporations with investments in
multiple countries.
 o Retained Earnings Statement: Summarizes the changes in retained earnings for
a specific period of time.
o Statement of Financial Position (balance sheet): Reports the assets, liabilities,
and equity of a company at a specific date.
o Statement of Cash Flows: Summarizes information about the cash inflows
(Receipts) and outflows (Payments) for a specific period of time.
 Sales – COGS = Gross Profit
 Gross Profit – Operating expenses = EBT
 Income Statement  Retained Earnings Statement  Statement of Financial Position
 Statement of Cash Flows
 Stock:
o Stock of a corporation, is all of the shares into which ownership of the
corporation is divided.
o In American English, the shares are collectively known as "stock".
o A single share of the stock represents fractional ownership of the corporation in
proportion to the total number of shares.
 Account: Record of increases and decreases in a specific asset, liability, stockholders’
equity, revenue, or expense item. Provide evidence of the transaction.
 An account has mainly three things:
o Account name
o Debit = “Left”
o Credit = “Right”
 Double-entry system
o Each transaction must affect two or more accounts to keep the basic accounting
equation in balance.
o Recording done by debiting at least one account and crediting at least one other
account.
o DEBITS must equal CREDITS.
 If the sum of Debit entries is greater than the sum of Credit entries, the account will
have a debit balance. If the sum of Credit entries is greater than the sum of Debit
entries, the account will have a credit balance.
 Rules of Debit and Credit / Rules of Journalizing:

Dr. Cr. Dr. Cr.

Assets Liabilities
Expenses Revenues
Dividends Equity
Increase Decrease Decrease Increase

 Normal balance is on the increase side.

 The recording process:
o Analyze each transaction
o Enter transaction in a journal
o Transfer journal information to Ledger accounts.
 The Journal:
o Book of original entry.
o Transactions recorded in chronological order.
o Contributions to the recording process:
 Discloses the complete effects of a transaction.
 Provides a chronological record of transactions.
 Helps to prevent or locate errors because the debit and credit
amounts can be easily compared.
 JOURNALIZING: Entering transaction data in the journal.
 The Ledger: General Ledger contains all the asset, liability, and equity accounts. Also
known as T account because it has 3 accounts: Debit, Credit, Balance.

 Asset = 101 – 199

 Liability = 200 - 299
 Equity = 300 – 399
 Posting: Transferring journal entries to the ledger accounts.
 Trial balance:
o A trial balance is a list of accounts and their balances at a given time.
o It proves the mathematical equality of debits and credits after posting.
o The steps for preparing a trial balance are:
 List the account titles and their balances.
 Total the debit and credit columns.
 Prove the equality of the two columns
o Trial balance may balance even when:
 A transaction is not journalized.
 A correct journal entry is not posted.
 A journal entry is posted twice.
 Incorrect accounts are used in journalizing or posting.
 Offsetting errors are made in recording the amount of a transaction.
 Trial Balance is does not prove that the company has recorded all
transactions or that the ledger is correct.

 Currency Signs
o Do not appear in journals or ledgers.
o Typically used only in the trial balance and the financial statements.
o Shown only for the first item in the column and for the total of that column.
 Underlining
o A single line is placed under the column of figures to be added or subtracted.
o Totals are double-underlined.
 Analyzing financial statements involves:

Characteristics Comparison Bases Tools of Analysis

Liquidity(Bank, Short Intracompany Horizontal
term )(Ability to pay back
money determined from
Income statement/
Flexibility in terms of
money)
Profitability(Bond, Industry averages Vertical
Shareholders)(The
percentage of profit)
Solvency (Bond)(Ability Intercompany Ratio
to pay)
24 Million Balance sheet(A
stable company with 24
million cash)

 Horizontal analysis, also called trend analysis, is a technique for evaluating a series of
financial statement data over a period of time.
o Purpose is to determine the increase or decrease that has taken place.
o Commonly applied to the balance sheet, income statement, and statement of
retained earnings.
 Vertical analysis, also called common-size analysis, is a technique that expresses each
financial statement item as a percent of a base amount.
o On an income statement, we might say that selling expenses are 16% of net
sales.
o Vertical analysis is commonly applied to the balance sheet and the income
statement.
 Sales revenue > Net sales
 Manufacturing unit Per average cost
 Amount Average cost upto certain limit
 Sales Average cost per unit Net income
 Ratio analysis: Ratio analysis expresses the relationship among selected items of
financial statement data.
o Classification:
 Liquidity:
 Measures short-term ability of the company to pay its
maturing obligations and to meet unexpected needs for
cash.
 Short-term creditors such as bankers and suppliers are
particularly interested in assessing liquidity.
 Ratios include
Current Asset
 Current ratio =
Current liability
 Acid-test ratio =
Cash+Short Term investment+Accounts receivables (Net)
Current liability
Acid-test ratio measures immediate liquidity.
 Accounts receivable turnover =
Net Credit Sales
times
Average Net Accounts receivables
Measures the number of times, on average, the
company collects receivables during the period.
 Average collection period in terms of days =
365 days
Accounts receivable turnover
COGS
 Inventory turnover = times
Average Inventory
Measures the number of times, on average, the
inventory is sold during the period.
365 days
 Days in inventory =
Inventory turnover
 Profitability:
 Measures the income or operating success of a company
for a given period of time.
 Income, or the lack of it, affects the company’s ability to
obtain debt and equity financing, liquidity position, and
the ability to grow.
 Ratios include:
Net income
 Profit margin = %
Net sales
, Measures the percentage of each dollar of sales that
results in net income.
Net sales
 Asset turnover = times
Average Total asset
, Measures how efficiently a company uses its assets to
generate sales.
Net Income
 Return on Assets = %
Average Total asset
, An overall measure of profitability.
 Return on common stockholders’ Equity =
Net Income
%
Average CommonStockholders Equity
, Shows how many dollars of net income the company
earned for each dollar invested by the owners.
 Earnings per Share =
Net Income
$
Weighted−Average Common Shares outstandings
, A measure of the net income earned on each share of
common stock.
Market price per share of stock
 Price-Earnings Ratio =
EPS
, Measures the net income earned on each share of
common stock. (Times)
Cash dividend
 Payout ratio = %
Net income
, Measures the percentage of earnings distributed in
the form of cash dividends.
 Solvency:
 Measures the ability of the company to survive over a long
period of time.
 Provide information about debt-paying ability.
Debt
 Debt to Assets = %
Asset
, Measures the percentage of the total assets that
creditors provide.
 Times Interest Earned =
Income before Income taxes and Interest Expense
times
Interest Expense
, Provides an indication of the company’s ability to meet
interest payments as they come due.
 Earning power: Earning power means the normal level of income to be obtained in the
future.
 Irregular items: Are separately identified on the income statement and reported net of
income taxes.
o Two types are:
 Discontinued operations:
 Disposal of a significant component of a business.
 Report the income (loss) from discontinued operations in two
parts:
 income (loss) from operations (net of tax) and
 Gain (loss) on disposal (net of tax).
 Extraordinary items:
 Nonrecurring material items that differ significantly from a
company’s typical business activities.
 Must be both of an
 Unusual Nature and
 Occur Infrequently.
 Must consider the environment in which it operates.
 Amounts reported “net of tax.”
 A company that has a high quality of earnings provides full and transparent information
that will not confuse or mislead users of the financial statements.
 Financial information may include sales, expenses, taxes and any other figure of an
economic event.
 Economic event is an event which causes changes to the financial position of an
organization.

External Users Internal Users

External users are parties outside the
reporting entity (i.e. company) who are
interested in the accounting information.
They include investors, creditors, taxing
authorities, customers etc.
Investors use accounting information to make
buy, sell or keep decisions related to shares,
bonds, etc.
Creditors (suppliers, banks) utilize accounting
information to make lending decisions.
Internal users are parties inside the reporting
entity (i.e. company) who are interested in the
accounting information.
Internal users are managers, owners and
employees who actually work for the business.
A company's management uses accounting
information to run the business.
Employees utilize accounting information to
determine a company's profitability and profit
sharing.
Taxing authorities (Internal Revenue Service)
need accounting information to determine a
company's tax liabilities.
Customers may need accounting information
to decide which products and from which
company to buy.

 GAAP:
o Generally Accepted Accounting Principles.
o Standards that are generally accepted and universally practiced.
o These standers indicate how to report economic events.
 Organizations:
o A person or body of persons organized for some specific purpose.
o Organizations can be classified as either business or nonbusiness.
 Business Organizations is one or more individuals selling products or services
for profit.
 Nonbusiness Organizations serves us in ways not always measured by profit.
 Financing activities: The fund needed for business collected in a way called financing.
o Owner financing
o Non-owner financing
 Investing activities: The collected fund is spent on buying important resources.
o Buying resources
o Selling resources
 Operating activities: By using the resources, acquire business or services and finally sell
them.
o Aim at selling the organization’s products and services.
o Result in sales
and expenses.
 Types of Business according to Operating activities:
o Service companies:
 Provide services for a fee.
 Uber, Electricity, Mobile operator, Teleportation, Gas, ISP.
o Merchandising companies:
 Purchase goods that are ready for sale and then resell them to customers.
 Daraz, Evaly, small stores.
o Manufacturing companies:
 Buy materials, convert them into products, and then sell the products to
other companies or to final customers.
 Financial Statements: An entity’s financial statements are the end product of a process that
starts with transactions between the entity and other organizations and individuals.
 A statement of changes in owners’ equity shows all changes in owner's equity for a
period of time.
o Owners’ Investments
o Net Income
o Revenue
o Withdrawals by Owners
o Net Loss
o Expenses

 Assets = Claims. The first claim on asset is of the debtors.

 Capital = amount invested by owner in business.
 Drawings = amount withdrawn by owner from business.
 A business transaction is an economic event that directly changes financial condition of
a business or directly affects its results of operations.
 Effects of Business Transactions:
o A transaction that increases total assets must also increase total liabilities or
owner's equity.
o A transaction that decreases total assets must also decrease total liabilities or
owner's equity.
o Some transactions may increase one account and decrease another on the same
side of the equation i.e. one asset increases and another decreases.
 Transaction Analysis is the process of reconciling the differences made to each side of
the equation with each business transaction occurs.

Cost Expense
Cost is the amount of expenditure, i.e. An Expense is a cost with expired benefits.
Sacrifice of resources (actual or notional)
incurred on or attributable to acquisition of
a specific objective.
Generally, costs are recognized as expenses
on the income statement in the period that
benefits from the costs.

Cost Object Cost Unit

A cost object is anything for which cost data A cost unit is ‘a unit of product, service or
are desired- including products, product line, time in relation to which costs may be
customers, job etc. ascertained or expressed’.
In other words cost unit is unit of
measurement of cost.
 Classification Of Costs:
o By Traceability:
1. Direct costs:
 Costs that can be easily and conveniently traced to a unit of
product or other cost objective.
 Would not be incurred if the product or activity were
discontinued.
 Examples: direct material and direct labor
2. Indirect costs:
 Costs cannot be easily and conveniently traced to a unit of
product or other cost object.
 Would be incurred even if the product or activity were
discontinued.
 Example: Manufacturing overhead, indirect material and indirect
labor
o By association:
1. Manufacturing Costs:
 Manufacturing costs are those costs related to factory operations
which are essential to the completion of the product.
 Also called Work Cost or Factory cost.
 It includes direct material costs, direct labor costs and
manufacturing overheads.
 Managers control costs by managing activities.
 Components of Manufacturing Cost: The cost to produce a unit of
product includes:
i. Direct material:
 Direct materials can be separately and readily
traced to the individual units of product being
manufactured.
 Direct materials are sufficiently significant in
amount to justify the separate tracing.
 Raw materials & component parts that become an
integral part of finished products.
 Can be traced directly and conveniently to
products.
ii. Direct labor:
 Direct labor is the effort of employees who actually
convert materials into a finished product.
  Direct labor costs are the wages of direct labor
employees.
 Payroll cost = Direct Labour hours × Wage rate.
 Direct labor costs can be separately and readily
traced to the individual units of product being
manufactured.
iii. Manufacturing overhead:
 All manufacturing costs other than direct materials
and direct labor.
 Includes:
 Indirect materials:
o The cost of employees who do not
work directly on the goods is
considered indirect labor.
o The labor costs of some employees
are considered indirect labor when
we cannot trace the labor costs
directly to a particular unit of
output, but the employee is needed
to keep the production process on
track.
o For example, the cost of
maintenance employees who work
on the equipment used to produce
our product is considered indirect
labor.
 Indirect labor.
 Machinery and equipment costs.
 Cost of regulatory compliance.
 Does not include selling or general and
administrative expenses.
 Such costs include power for the factory
equipment, depreciation on factory equipment,
and the like.
2. Administrative Costs:
 Administrative costs include all those costs incurred on the
general administration and control of the firm.
  Examples of such costs are: salaries of the office staff, rent of the
office building, depreciation and repairs of the office furniture etc.
3. Selling Costs:
 Selling costs are those costs which are incurred in connection with
the sale of goods.
 Some examples of such costs are: Cost of warehousing,
advertising, salesmen salaries etc.
4. Distribution Costs:
 Distribution costs are those costs which are incurred on dispatch
of finished products to customer including transportation.
 Examples of such costs are: packing, carriage, insurance, freight
outwards, etc.
o 2, 3, 4 are Non-Manufacturing cost.
o By Behavior:
Cost behaviour: How a cost will react to changes in the level of business activity.
1. Variable costs:
 Total variable costs change when the level of activity changes.
 A variable cost is one that changes in total in proportion to
changes in the volume of activity.
 Variable Cost per Unit: On a per unit basis, a variable cost
remains constant over a
wide range of activity.
 Typical variable costs:
i. Raw materials
ii. Direct labor
iii. Factory utilities
iv. Sales commissions
v. Shipping costs
 Semi variable Cost: A semi variable or mix cost has both fixed and
variable components. Consider Land Phone Bill example.
 2. Fixed costs:
 Total fixed costs remain unchanged when the level of activity
changes.
 A fixed cost is one that remains constant in total even when the
volume of activity changes.
 Fixed Cost per Unit: On a per unit basis, a fixed cost changes
as the volume of activity changes.
 Typical fixed costs:
i. Real estate taxes
ii. Factory rent
iii. Supervisory salaries
iv. Workers’ welfare cost
v. Depreciation

o By Function:
1. Product Costs
 Direct materials
 Direct labor
 Overhead
2. Period Costs
 Administrative Costs
 Selling Costs
 Distribution Costs
o By controllability:
1. Controllable costs:
 Those costs which can be controlled by a specified person or a
level of management.
 Example: Material cost.
 2. Uncontrollable costs:
 Those costs which cannot be controlled or influenced by a
specified person of an enterprise.
 Example: Factory rent.
o By relevance:
1. Sunk costs:
 Costs already incurred that cannot be avoided or changed.
 Irrelevant to future decision making.
 Examples: Equipment previously purchased.
2. Out-of-pocket costs:
 Costs require a future outlay of cash.
 Relevant for future decision making.
 Example: Future purchase of equipment

 A company purchases direct materials. Direct materials, direct labor, and manufacturing
overhead are charge to the product. When the product is complete it is transferred to
finished goods inventory. When the goods are sold, they are removed from finished
goods inventory and charged to cost of goods sold.
 Conversion Cost: The costs of converting the materials into finished products consist of
direct labor and factory overhead. These two costs combined are often referred to as
conversion costs.
 Profit = Revenue – Expense
 Production cost profit
 Cost Accounting Systems:
o Cost Accounting involves
 Measuring
 Recording
 Reporting of product costs
o Accounts are fully integrated into the general ledger.
o Perpetual inventory system provides immediate, up-to-date information.
o Two basic types:
 Job order cost system
 A process cost system.
 Job Order Cost System:
o Costs are assigned to each job or batch.
o A job may be for a specific order or inventory.
o A key feature: Each job or batch has its own distinguishing characteristics.
o The objective: To compute the cost per job.
o Measures costs for each job completed – not for set time periods.
o Cost of goods manufactured is prepared for those manufacturers who
manufacture the same types of goods again and again.
 o There are other businesses where the product is prepared after getting order
from customer. This type of system is called Job Order Costing.
 Difference between COGMS & JOCS:

COGMS
Only the manufacturing cost items are
included.
The manufacturer knows the exact amount
of money spent and he makes the price of
goods according to that.
JOCS
The manufacturing, non-manufacturing,
expenses are included in a single statement
to find sales.
The sell price of product is needed to be
informed to customer before manufacturing.
So the customer can choose between
different prices of different manufacturers
to find the lowest one. So this is challenging
for manufacturer because:
 Either they can lower the price.
When the manufacturing cost is high,
they will occur loss or no profit.
 But if they raise the price, then they
may not get any customer.

 Process Cost System:

o Used when a large volume of similar products are manufactured - (Cereal,
Automobiles, Compact Discs, Paint).
o Costs are accumulated for a specific time period – (week or month).
o Costs are assigned to departments or processes for a set period of time.
 Cost accounting involves the measuring, recording, and reporting of Product costs.
 Cost-volume-profit (CVP) (Here volume means Sales Volume) analysis:
o Cost-volume-profit analysis will allow us to make important decisions involving
the relationships between the volume of activity and costs and revenues.
o To study cost behavior, we need to target sale, check its achievability, monitor
the market demand and do many calculations. So CVPa acts as a supporting tool
for that.
o To increase sales, a common practice is to reduce Unit-Selling Price. But Unit-
selling price increases with Per Unit Profit.
o So profit only occurs when sales is of large volume (Minimum a certain amount).
 Fixed cost is Total amount constant with activity change.
o Example: Factory rent, Employee Salary, Property tax, Depreciation cost.
o A factory can shut down due to fixed cost.
o Your basic land-line telephone has a monthly connect charge that
remains constant regardless of the number of local calls that you might
make. The monthly charge that is independent of call activity is a fixed
cost.
o Dividing your fixed monthly connect fee by more local calls reduces the
cost per call by spreading the fixed amount over a higher number of calls.
o For example, if your monthly connect charge is twenty Tk and you make
forty local calls in a month, your cost per local call is fifty cents. If you
make one hundred local calls in a month, your cost per local call is twenty
cents.
 Total Amount: Monthly Amount.
 Variable Costs:
o Total variable costs increase as activity increases.
o Direct material cost increases with production.
o Direct material cost, direct labour cost, wages.
o The cost per land-line long distance minute talked is normally constant.
o For example, for your service, it may be ten cents per minute. Talking more or less
minutes will not change per minute charge.
o So, on a per unit basis, variable costs remain unchanged.
 Semi variable Costs (Mixed Costs):
o Mixed costs contain a fixed portion that is incurred even when facility is unused, and
a variable portion that increases with usage.
o Example: Monthly fixed phone bill, fixed line rent, Variable charge per minute
talked.
o Many costs are mixed in nature. That is, they have both a fixed and variable
component.
o Think about your utility bill. You have a fixed monthly charge for the hook-up, and
the variable portion of your bill depends upon the number of kilowatt hours you use.
The more the kilowatt hours you use, the higher your total utility bill will be.
 Contribution margin (CM) is the difference between sales revenue and variable expenses.
o CM can be expressed in total or per unit.
o The CM ratio is computed by dividing the per unit contribution margin by the per
unit selling price, Tk 200 ÷ Tk 500 = 40%.
 After fixed expenses are covered, any additional contribution margin results in net income.
Traditional Income Statement Contribution Income statement
Used primarily for external reporting. Used primarily by management.
Expenses classified by Functions. Expenses classified by Behaviour.
Manufacturing & Non-Manufacturing Cost. Fixed & Variable Cost.

 Break-Even Point:
o No profit, No loss stage;
o Total sales Revenue = Total Expense (variable and
fixed).
o The point where total contribution margin equals total fixed expenses.
o Break-even analysis can be approached in two ways:
 Contribution margin method
 Equation method.
o The break-even point is the level of sales where a company’s income is exactly equal
to zero. At breakeven, total costs equal total revenues.
o The break-even point (expressed in units of product or Tk of sales) is the unique
sales level at which a company neither earns a profit nor incurs a loss.
𝐅𝐢𝐱𝐞𝐝 𝐂𝐨𝐬𝐭
o Break-Even Point in units =
𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐦𝐚𝐫𝐠𝐢𝐧 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭
o Contribution margin per unit = Unit sales price less unit variable cost.
𝐅𝐢𝐱𝐞𝐝 𝐂𝐨𝐬𝐭
o Break-even point in Tk =
𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐦𝐚𝐫𝐠𝐢𝐧 𝐫𝐚𝐭𝐢𝐨
 Contribution margin per unit
o Contribution margin ratio =
Unit sales price

 Margin of Safety: Margin of safety is the amount by which sales may decline before
reaching break-even sales.
o Margin of safety = Actual sales - Break-even sales
o Margin of safety provides a quick means of estimating operating income at any level
of sales.
o Operating Income = Margin of safety × Contribution margin ratio
 o The margin of safety is the excess of expected sales (or actual sales) over the break-
even sales.
o It’s the amount by which expected sales can drop before the company begins to
incur losses.

 Above the break-even point, fixed costs

have been covered, so every additional dollar
of contribution is operating income.

 High-low method: When presented with a semi variable (mixed) cost, we will separate the
variable portion of the cost from the fixed portion of the cost. The High-low method is one
way that we can accomplish that.
 In this graph we have plotted costs and revenues on the vertical axis and volume in units on
the horizontal axis.
 The sales revenue line begins at the origin and has a slope equal to the unit sales price.
 The total fixed cost line is horizontal, indicating no change in fixed cost when volume
increases.
 The total cost line has a slope equal to the variable cost per unit and intercepts the vertical
cost axis at the fixed cost.
 We see the break-even point where the sales revenue line crosses the total cost line.
 The sales line is steeper, that is increases at a faster rate, than the total cost line because
the unit sales price is greater than the unit variable cost.
 Below the break-even point, we see losses, and above the break-even point, we see profits.

 Assumptions Underlying CVP Analysis:

o A limited range of activity, called the relevant range, where CVP relationships are
linear.
 Unit selling price remains constant.
 Unit variable costs remain constant.
 Total fixed costs remain constant.
o Sales mix remains constant.
o Production = sales (no inventory changes).

 The Challenge of Changing Markets:

o Product markets can change quickly due to competitor price cuts, changing
customer preferences, and introduction of new products by competitors.
o Managers must make short-run decisions,
 Special order decisions
 Product mix decisions
 Make or buy decisions
 Joint product decisions
o With a fixed set of resources, to react to the changing market place.
 o In the short-run, resources are usually fixed, so in most cases, managers must make
these decisions without the possibility of acquiring additional capacity, operating
time, or materials.
 Incremental Analysis:
o Occurs when there is more than one alternative choice of action.
o Short term decision making tool of management.
 Long-Run:
o The planning and implementation takes a long time.
o Because there is a need of huge investment, it takes time to get the investment
back.
o Example: Buying new machine.
 Short-Run:
o Make or Buy decision.
o Example: Walton Company sells laptop. So they can either make each component or
buy them.
 Relevant Information in Business Decisions:
o Cost & revenue that varies among the possible alternative courses of action being
considered.
 Decision Making:
o Define the problem.
o Identify the alternatives.
o Collect information on alternatives.
o Eliminate irrelevant information.
o Make a decision with the remaining relevant information.
 Relevant Cost: A relevant cost is a future cost that differs between alternatives.
 Opportunity Cost:
o Opportunity cost is the potential benefit that is given up when one alternative is
selected over another.
o Opportunity costs are the potential benefits that are given up when one alternative
is selected over another.
o Opportunity costs are not actual dollar outlays; however, they may impact our
decisions.
o For example, some of you may have made the decision to attend college rather than
go straight into the work force. The opportunity cost of attending college is the lost
salary that you could have earned, had you worked.
o Opportunity costs are not recorded in the accounting records, but are relevant to
decisions because they are a real sacrifice.
 Sunk Cost:
o A sunk cost is a cost that has already been incurred and that cannot be changed by
any decision made now or in future.
o Sunk costs should not be considered in decisions.
o Sunk costs cannot be changed by any decision we make as they have been incurred
in the past and cannot possibly differ between any alternative that we might
currently choose.
o Dwelling on sunk costs can frequently be the cause of decision errors.
o Sunk costs should not be considered in the decision process.
o For example, if you bought an automobile two years ago for $10,000, that amount is
a sunk cost. Whether you drive the car, park it, trade it, or sell it, the $10,000 cost
will not change.
 Out-of-Pocket Costs:
o An out-of-pocket cost is a cost requiring cash disbursements in the current
accounting period.
o Out-of-Pocket costs should be considered in decisions.
o Example: You wish to buy a new automobile that cost
Tk 1,000,000 today. The Tk 1,000,000 cost is Out-of-Pocket cost because it requires
an actual cash outlay in the current accounting period to materialize the acquisition.
 Types of Incremental Analysis:
o Accept an order at a special price
o Make or buy components or finished products
o Sell products or process further
o Retain or replace equipment
o Eliminate an unprofitable business segment
o Allocate limited resources
 On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special
Committee on Financial Reporting suggest should be included in future financial
statements?
o Non-financial Measurements (customer satisfaction indexes, backlog information,
and reject rates on goods purchases).
o Forward-looking Information
o Soft Assets (a company’s know-how, market dominance, marketing setup, well-
trained employees, and brand image).
o Timeliness (no real time financial information)
 Special Order Decisions:
o The decision to accept additional business should be based on incremental costs and
incremental revenues.
o Incremental amounts are those that occur only if the company decides to accept the
new business.
o On occasion, we may have the opportunity to accept additional business through a
special order. We should make the decision to accept or reject the additional
business using incremental revenues and incremental costs. Some of our costs may
not change if we accept additional business. Those costs are not relevant as they do
not differ between the alternative accept or reject the additional business.
 The “Make or Buy” decision involves the question of whether it is more economical to
produce some goods internally or purchase them from an outside supplier.
o Incremental costs also are important in the decision to make a product or buy it
from a supplier.
o The cost to produce an item must include
(1) Direct materials,
(2) Direct labor and
(3) incremental overhead.
o The direct labor and direct material costs to make a product are incremental costs.
o Some part of overhead might be incremental, but most of the overhead will
probably remain unchanged with the make or buy decision.
 Production Constraint Decisions:
o Managers often face the problem of deciding how scarce resources are going to be
utilized.
o They must make decisions to best utilize constrained resources.
o Usually, fixed costs are not affected by this particular decision, so management can
focus on maximizing total contribution margin.
 If there were no working progress inventory, then the input and output would have been
same.
 COGS: The goods which are completely manufactured and available for selling.
 Finished goods inventory, Dec 31: Manufactured products which are unsold and makes the
opening inventory for next year.
 Finished goods inventory, Jan 1: Manufactured products which are sold and makes the
closing inventory of Dec 31.
 Calculation of base rates:
Manufacturing overhead
o Manufacturing Overhead = × 100
Direct Labour
= % of direct labour
Administration overhead
o Administration Overhead = × 100
Manufacturing Cost
= % of Manufacturing Cost
Selling overhead
o Selling Overhead = × 100
Manufacturing Cost
= % of Manufacturing Cost
Distribution overhead
o Distribution Overhead = × 100
Manufacturing Cost
= % of Manufacturing Cost
Profit
o Profit = × 100
Cost of Sales
= % of Cost

 Adjusting entry:
o Adjusting entries are changes to journal entries you’ve already recorded.
o Specifically, they make sure that the numbers you have recorded match up to the
correct accounting periods.
o To make sure the activities of your business are recorded accurately in time.
o Adjusting journal entries are essential for depreciating assets.
o Classification:
 Accrued revenues:
 When you generate revenue in one accounting period, but don’t
recognize it until a later period, you need to make an accrued
revenue adjustment.
 Accrued expenses:
 Once you’ve wrapped your head around accrued revenue, accrued
expense adjustments are fairly straightforward.
 They account for expenses you generated in one period, but paid for
later.
 Deferred revenues:
 If you’re paid in advance by a client, it’s deferred revenue.
 Even though you’re paid now, you need to make sure the revenue is
recorded in the month you perform the service and actually incur the
prepaid expenses.
  Prepaid expenses:
 Prepaid Expenses work a lot like deferred revenue.
 Except, in this case, you’re paying for something up front—then
recording the expense for the period it applies to.
 Depreciation expenses:
 When you depreciate an asset, you make a single payment for it, but
disperse the expense over multiple accounting periods.
 This is usually done with large purchases, like equipment, vehicles, or
buildings.
 At the end of an accounting period during which an asset is
depreciated, the total accumulated depreciation amount changes on
your balance sheet.
 And each time you pay depreciation, it shows up as an expense on
your income statement.
 Depreciation:
o Depreciation is what happens when assets lose value over time until the value of the
asset becomes zero, or negligible.
o Depreciation can happen to virtually any fixed asset, including office equipment,
computers, machinery, buildings, and so on.