ACCOUNTING- accounting is the process of identifying, measuring, and

communicating economic information to permit judgement and decision by

user of information. it is recording transactions, exchange of money or money
worth. personal expenses, samples and charity are not transactions because no
exchange is happening.
accounting cycle
• Identifying and analysing transactions
• Record transaction to a journal
• post journal information to a Ledger (classifying)
• prepare an adjusted trail balance
• summarising and analysing financial statements
• Interpretation and decision making
Journal it is a statement which records all transactions of an organization in
chronological order, it is based on double entry principle where for every debit
there is a credit, it is in the form of a statement and not in the form of account
classification of accounts
• Personal account- account is that of a person, company, or an
organization such as bank debit is the receiver and credit is the giver
• real account- account of tangible and intangible items such as inventory,
machinery plant, stocks, debit is what comes in and credit is what goes
out
• Temporary account- it refers to revenue and expenses account which
are closed by transfer to profit and loss account
• Permanent accounts- it refers to assets and liabilities accounts which
are carried forward
• nominal account- debit are all expenses and losses credit are all incomes
and gains
Ledger- classification of entries made in journal it is done in the form of
various accounts or subsidiary books it helps in knowing the balances in
various accounts these balances are carried to trial balance like sales book,
sales returns book, purchase book, purchase returns book, cashbook
Posting- it is the process of transferring entry from journal to Ledger
Summarising- it is the process of presenting the final of all classified
accounts in a separate statement called trial balance
trial balance- it is a bookkeeping worksheet in which the balance of all
ledgers is compiled into debit and credit columns total that are equal, it is
prepared before preparing financial statements the difference in this
statement is transferred to suspense account all assets and expenses are
debit and all liabilities and incomes are credit
Journal entry
Date F. Transactions Debit Credit
Jan 1 cash at bank A/C 2000
Dr.
To capital account 2000
Jan 2 Purchase A/C Dr. 200
to cash account 200
Jan 3 cash account dr. 300
To sales 300
Jan 4 bank account dr. 500
to cash account 500
Jan 31 salary account dr. 100
to cash account 100
total balance carried forward 3100 3100
• on 1st January Ron and daughter started business with 2000 cash
that is received from owner Ron, this transaction deals with 2
accounts Ron’s personal account and capital account, Ron is the giver
in transaction, so his account is credited while the capital account is
debited
• on 2nd January company brought goods cash 200, this transaction
deals with 2 accounts purchase account of goods purchased and
capital account purchase account is real account since good comes in
so account is debited while cash account is credited
• on 3rd January the company sold goods for 300 this transaction deals
with 2 accounts sales account of goods sold and capital account, the
sales account is real accounts since goods goes out it is credited while
cash account is debited
• on 4th January company deposited 500 cash in its bank account this
transaction deals with 2 accounts bank account and capital account
bank account is debited while capital account is credited
• on 31st January company paid salary employees the transaction deals
with 2 accounts salary account and capital account, salary account is
nominal account which is debited while capital account is credited
 F. stands for Ledger folio it is column in which we write the page
number of the Ledger where entry is posted, Debit balance is the
excess of debit side over credit side of an account while credit balance
is excess of credit side over debit side of account
Account Is a bookkeeping device to report increases and decreases in
each asset/liability
Branches of accounting
• financial accounting- preparing financial statement of a business
• cost accounting-study of cost of production without profit
• management accounting-specially used by managers in
1. planning it is process of deciding what action should be taken in
future example budgeting (process of planning the overall
activities of an organization for a specified period usually a year)
2. implementation it involves specific action planned to fulfil the
budgets
3. control it is processed to ensure that employees perform properly

management accountants they are responsible for the design and operation of
management accounting system accountant is controller keep chief financial
officer who in turn reports to chief executive officer
functions of managerial accounting
• margin analysis- determine amount of profit or cash flow that business
generate from specific product
• breakeven analysis- calculating mix of contribution margin and unit
volume at which business breaks even which is useful in determining
price points
• constraint analysis- understanding where primary bottlenecks are there
in a company and how it affects revenue and profits
• target costing- assisting in design of new products by accumulating the
cost of new design and comparing them
• inventory valuation- determining the direct cost, cost of goods sold as
well as allocating overhead costs of items
• trend analysis
• capital budgeting analysis- examining proposals to acquire fixed assets
both to determine if they are needed and what is appropriate way to
finance them
 • Dimensions management accounting financial accounting
Structure varies according to the use of unified structure
information
sources of whatever is useful to generally accepted
principle management accounting principles
Need Optional statutory obligation
Time orientation estimates the future plans historical accounts like P/L
accounts, balance sheets,
cash flow statement
Report frequency varies with purpose Annual
Liability potential None few lawsuits maybe filed for
reporting misleading financial
information
Responsibility centre it refers to the division of an enterprise into sections,
departments, products and individual activities It is responsible for operation
and performance
ANNUAL REPORT
An annual report is a comprehensive report on a company’s activities
throughout the preceding year. Annual reports are intended to give
shareholders and other interested people information about the company’s
activities and financial performance.
IMPORTANCE
◦ It gives opportunity to take step back and look at the overall practical
and financial health of company’s business
◦ we know how well Company is doing
◦ We can find out whether the company is making more money than it is
spending
◦ we can get an idea of management’s strategic plan for the coming year
WHO USES ANNUAL REPORT?
◦ Shareholders and Potential Investor- Shareholders and potential
investors use annual reports to get a better understanding of the current
position of the company in order to make investing decisions.
◦ Customers- Customers of a company use annual reports to get an
overview of different companies and help them decide on which one to
build a relationship with.
◦ Employees- Employees often use the annual report to understand some
of a company’s different focus areas
CONTENT OF ANNUAL REPORT
1. CHAIRMAN’S SPEECH- Chairman’s speech highlights corporate activities,
strategies, researches, labour relations, main achievements, focuses on
future goals, growth.
2. DIRECTOR’S REPORT- Directors' report is a document produced by the
board of directors under the requirements of company law, which
details the state of the company and its compliance with a set of
financial, accounting and corporate social responsibility standards. It
contains
• Annual financial records (P/L ,Net turnover for sales, income,
• expenses, balance sheet, cashflow, etc.)
• Description of company's trading activity of the current year.
• Dividend recommendation of the current financial year.
• Description of board meetings along with specific date and time.
• Report of any joint venture or cessation of any subsidiary.
• Report of Intercorporate loans and investments.
• Submission of report & statement of any new joint ventures and
associates.
• Performance report of joint ventures and associates.
• Description of board meeting regarding appointment,
resignation or termination of any director or member.
• Description of Auditor's qualification, appointment along with
recommendation.
• Report of any transfer of reserves and debenture redemptions.
• Highlight of any change in nature of business.
• Risk management policies.
3. Segment Reporting- It is a reporting of the operating segments of a
company in the disclosures accompanying its financial statements.
Segment reporting is required for publicly held entities and is not
required for privately held ones It is intended to give information to
creditors regarding the financial results and position of the most
important operating units
4. AUDITOR’S REPORT- An auditor is appointed by the shareholders of a
company to audit accounts and as such, auditor addresses the report to
the shareholders of the company on the accounts audited by him.
5. Management discussion and analysis- Management discussion and
analysis (MD&A) is a section of a public company's annual report or
 quarterly filing. The MD&A addresses the company’s performance. In
this section, the company’s management and executives, also known as
the C-suite, present an analysis of the company’s performance with
qualitative and quantitative measures. In the management discussion
and analysis (MD&A) section of the annual report, management
provides commentary on financial statements, systems and controls,
compliance with laws and regulations, and actions it has planned or has
taken to address any challenges the company is facing.
6. PROFIT AND LOSS ACCOUNT
7. BALANCE SHEET
8. CASH FLOW STATEMENT-
9. ACCOUNTS OF SUBSIDIARY- Company law requires companies to
provide statement regarding information about subsidiaries duly signed
by directors and company secretary on behalf of the board of
directors during the financial year
10.CORPORATE GOVERNANCE - Corporate governance is the collection of
mechanisms, processes and relations by which corporations are
controlled and operated
11.ACCOUNTING POLICIES- Accounting policies represent choices among
different accounting methods that can be used while preparation of
financial statements.
FINANCIAL STATEMENTS
• Income Statement
• Balance Sheet
• Cashflow Statement
Trading and P&L Account
The following items will appear in the debit side of the Trading Account:
1. Opening Stock: the opening stock means the finished goods only. The
amount of opening stock should be taken from Trial Balance.
2. Purchases: The amount of purchases made during the year. Purchases
include cash as well as credit purchase.
3. Direct expenses: It means all those expenses which are incurred from
the time of purchases to making the goods in suitable condition. This
expense includes freight inward, octroi, wages etc.
4. Gross profit: If the credit side of trading A/c is greater than debit side of
trading A/c gross profit will arise.
 The following items will appear in the credit side of Trading Account:
1. Sales Revenue: The sales revenue denotes income earned from the main
business activities. The income is earned when goods or services are sold to
customers. If there is any return, it should bededucted from the sales value.
As per the accrual concept, income should be recognized as soon as it is
accrued and not necessarily only when the cash is paid for
2. Closing Stocks: there will be closing stocks of finished goods only. According to
convention of conservatism, stock is valued at cost or net realizable value
whichever is lower.
3. Gross Loss: When debit side of trading account is greater than credit side of
trading account, grossloss will appear.
TRADING ACCOUNT
Particulars Amount Particulars Amount
Opening stock: By Sales
To Purchase Less: sales returns
Less: purchase returns By Closing stock
To Gross Profit By Gross Loss
(Transferred to P & L A/c) (Transferred to P & L A/c)
Total Total
P&L ACCOUNT
Particulars Amount Particulars Amount
To gross loss By gross profit
To expense By other
income
To net profit By net loss
TOTAL TOTAL
To side of p&l account (indirect cost)
To Salary, To Rent, To Postage, To Bank Charges, To Telephone Charges, To
Legal Charges, To Audit Fee, To Advertisement, To Commission, To Bad
Debts, To Insurance, To Depreciation, To Repairs and Maintenance, To
Interest on Loans, To Discount Allowed, To loss on sale of Fixed Asset
By side of p&l account
• By Interest Received
• By Discount Received
• By Rent Received
• By Commission Received
• By Income from Investments
• By Profit on sale of Fixed Asset
PROFIT N LOSS-REVENUE ITEMS- RECURRING ITEMS/REPETITIVE/SHORT
TERM/SMALL AMOUNTS/ONE YEAR/OPERATIONAL
 Profit and Loss Appropriation Account: We know that the net profit or loss is
added to or deducted from owner’s equity. The net profit may be used by the
business to distribute dividends, to create reserves etc. To show these
adjustments, a P/L Appropriation A/c is maintained. Distribution of profits is
only appropriation and does not mean expenses. After passing such
distribution entries, the remaining surplus is added in owner’s equity.
Particulars Amount Particulars Amount
To Proposed dividend By Net profit transferred from P & L A/c
To Transfer to General Reserve
To Surplus carried to Capital A/c
Total Total
INCOME STATEMENT- An income statement is one of the three important
financial statements used for reporting a company's financial performance
over a specific accounting period, Based on income statements, management
can make decisions like expanding to new geographies, pushing sales,
increasing production capacity, increased utilization or outright sale of assets,
or shutting down a department or product line. Competitors may also use
them to gain insights about the success parameters of a company and focus
areas as increasing R&D spends. components of an Income Statement
• Revenues
• Expenses
• Net Income
Operating Items- Directly related to the operations of the business
Operating Expenses: Salaries, Selling expenses, Interest paid
Operating Income: Net sales, Rent Received (Real estate business)
Non Operating Items- Not directly related to the operations of the business
Non Operating Expenses: Depreciation, Interest Paid, Loss on sale of Fixed
Asset
Non Operating Income: Rent Received, Income from Investments, Profit on
sale of Fixed Asset
Depreciation- it is reduction in the value of asset it is known non-operating
expense, non-cash expense, it is only a book entry and is used for replacement
of asset, it is tax saving device it measures the wearing out, consumption or
other loss of value of assets arising from use or duration of time for that asset
Amortization- paying back, writing off, settling example EMI
Investment-it is defined as assets held by an enterprise for earning income by
which dividends, interests, rental, for capital appreciation or other benefits
Current investments are readily realizable and held up to one year it should be
carried at lower cost of market value, long term investment should be carried
at cost
Value in use- it is the present value of estimated future cash flow from the use
of an asset and disposal after useful life
Exceptional items- An exceptional item is a charge incurred by a company that
must be noted separately in its financial report in accordance with Generally
Accepted Accounting Principles (GAAP). Despite the name, such items are
considered to be ordinary business charges but they must be separated out for
the sake of financial reporting clarity.
Revenue- inflow of cash/receivables/other considerations,
interest/royalty/dividends and Commission
net realizable value- estimated selling price in ordinary course of business less
estimated cost of completion/make the sale
Prior period items- Incomes/expensive which arise in the current period as
result of errors/omission in a prior period.
ordinary activities- they are activities undertaken as part of business and
related activities
Extraordinary items- they are defined as income or expenses that arise from
events or transactions that are clearly distinct from the ordinary activities of
enterprises and thus are not occurred frequently
Salvage value- it is the amount realised from sales of an asset after its useful
life
Sales/revenue/turnover/cash flow of
company
Less cost of sales gross profit

less selling and admin expense EBITDA(operating profit) earnings

before interest tax depreciation and
amortization

less depreciation EBITA

less amortization EBIT

less interest EBT

less tax PAT(profit after tax)

less dividends Surplus/bottom line/income/reserve

transfer to balance sheet
Balance sheet-it provides information about financial position in terms of
assets, liabilities and shareholder equity at a point of time
Assets- they are the resources that are owned by the company under helpful in
future economic activities they are the investing side of the business,
application of funds are used for assets
fixed assets are required to produce goods and service and not for sale. These
represent the facilities or resources owned by the business for a longer period
of time
Intangible assets reflect the rights of a firm like goodwill, copyright, trademark,
brand name, patent
Current assets are the assets which are quickly converted into cash within
period of one year example stock, cash at bank, debtors, cash in hand, bills
receivable, inventory, loose tools, They generate liquidity, prepaid expenses
Liability- It is an obligation which business owes others, it is financing side of
business, it is the source of funds to start the business
Capital: This indicates the initial amount the owner or owners of the business
contributed. This contribution could be at the time of starting business or even
at a later stage to satisfy requirements of funds for expansion, diversification
etc
current liability they are the obligations which mature within a year like bills
payable, overdraft from bank, advances from customers, sundry creditors,
outstanding expense
trade credit- Rise out of credit purchases and are also known as accounts
payable
Outstanding Expenses: These represent services procured but not paid for.
These are usually settled within 30–60 days e.g. phone bill of Sept is normally
paid in Oct.
Bank Overdrafts: Banks may give fund facilities like overdraft whereby;
business is permitted to issue cheques up to a certain limit. The bank will
honor these cheques and will recover this money from business. This is a short-
term obligation.
Sundry Creditors - Amounts payable to suppliers against purchase of goods.
This is usually settled within 30-180 days
Solvency- ability to repay the dues
Insolvency-inability to repair the dues, extreme case of insolvency is
bankruptcy
Share capital-money received from the shareholders it is also known as
authorised capital, issued capital, subscribed capital, called up capital, paid up
capital
A share is a share in share capital of a company
Market Capitalization- All companies look for the increase in the value of
companies so they distribute the shares
Types of shares
• equity shares/common stock-any shareholder is considered as the
owner of the company, investing in the company for long period of time
in return of flexible dividends
• preference share/preferred stock-holders of the shares have no voting
rights and interfere in the business they get fixed dividends and invest
for a short period of time 10-12 years
Reserves+ share capital= equity of company/shareholder fund/net worth of
business
debentures are acknowledgement of debt or bonds, giving guarantee for
floating charges in assets of company
loans plus debenture is debt
liquidation process after selling the assets of the company money is first given
to
• liquidator's remuneration
• liquidator's Commission
• secured loans/debentures
• unsecured loans
• preference shares
• equity shares
capital redemption reserves- for Preference share redemption
Expenses-small amount-revenue items-in P/L account
Expenditure-big amount-capital items in balance sheet
Capital items appear in balance sheet they are non-recurring, non-repetitive,
long term
• money put in businesses capital it is a liability while money invested outside
the business is investment it is an asset
• retained profit that are kept aside is reserve it is liability while before the
business the money which is kept aside for specific purpose is provision
• Contingent liability are the liability which may or may not occur example
painting legal suits, contract that is approved they are in footnote outside
the balance sheet
• preliminary expenses-expense the trade occurred normally in the zero
year(Year in which we are planning to do the business) while starting the
business example listing, discount on issue of share, huge advertisement
Commission, under writers Commission
• miscellaneous expenditure is huge amount of money spent whose benefit
may or may not be received in the future they are called fictitious assets,
losses under miscellaneous expenditure, we can remove these expenditure
by writing off from the profit or internal reconstruction of business
• Bad debts are uncollectable or irrecoverable debt or debts which are
impossible to collect, it should be treated as a business loss and should be
adjusted against profit
Cash flow statement
Statement that provides data regarding all cash inflows and outflows of a
company for particular period Cashflow is based on three main components
• From Operations- This section reports about the cash inflow and outflow
in company’s main business activity including purchasing, selling, and
paying salaries to the employees.
• From Investment- In this section it records the cash flows from investing
and it is result of investment gains and losses. It includes cash invested
in property, plant, and equipment.
• From Financing- It records the cash used in business. It measures mainly
the cashflow between company its owners and its creditors.(Equity,
debt, loans taken or paid).
 BALANCE SHEET
Liabilities Rs. Assets Rs.

Share Capital xxx Fixed Assets xxx

(with all particulars of Authorised, Issued, xxx Goodwill xxx
Subscribed Capital) xxx Land & Building xxx
Called-up Capital xxx Leasehold Property xxx
Paid up capital xxx Plant & Machinery xxx
Reserves and Surplus xxx Furniture & Fittings xxx
Capital Reserve xxx Patents & Trade Marks xxx
Capital Redemption Reserve xxx Vehicles xxx
Share Premium xxx Investments xxx
Other Reserve xxx Current Assets, Loans and Advances xxx
Profit and Loss Appropriation A/c xxx (A) Current Assets xxx
Sinking Fund xxx Interest accrued on Investments xxx
Secured Loans xxx Loose tools xxx
Debentures xxx Stock in Trade xxx
Add: outstanding Interest xxx Sundry Debtors xxx
Loans from Banks xxx Less: Provision for doubtful debts xxx
Unsecured Loans xxx Cash in hand xxx
Fixed Deposits xxx Cash at Bank xxx
Short-term loans and advances xxx (B) Loans and Advances xxx
Current Liabilities and Provisions xxx Advances to Subsidiaries xxx
(A) Current Liabilities and Provisions xxx Bills Receivable
Bills Payable xxx Prepaid Expenses
Sundry Creditors xxx Miscellaneous Expenditure (to the extent not
Income received in advance Xxx written off or adjusted)
Unclaimed Dividends Preliminary Expenses
Other liabilities Discount on Issue of shares and
(B) Provisions debentures
Provision for Taxation Underwriting Commission
Proposed Dividends Profit and Loss Account (loss), if any
Provident Fund & Pension Fund
Contingent Liabilities not Provided for

Xxx xxx

GAAP- generally accepted accounting principles are concepts, principles and

practices which are followed across the business community
• separate entity concept- for accounting records, business and
businessman are treated separately example capital being treated
as liability
• going concern concept- it assumes that business entity would
continue to operate indefinitely example maintaining reserves,
depreciation, provision
 • money measurement concept- everything must be measured in
monetary terms to be written in financial statements example
goodwill
• accounting period Concept- accounting is done for period of one
year
• accrual concept- it is based on accounting period Concept it
requires that expense incurred, revenue earned should be
considered as expenses/revenues of same period Whether
paid/realised or not paid/Payable in that year (opposite to accrual
concept is cash concept- payment receipts are recorded during
the period in which they are received)
• Matching concept- it required that expenses recognised in an
accounting period are matched with the revenue recognised in
that period
• duality concept- it means that every transaction affects 2
accounts example for every debit there is a credit (accounting
equation assets= capital+ liability)
• conservatism concept- recognition of income only on actual
realization but actual as well as anticipated expenses should be
accounted for i.e., be prepared for losses don't expect profit
• cost concept- fixed assets are always recorded at acquisition cost
in contrast to their market value except at the time of sales while
inventory is always recorded at the value which is less be it the
acquisition value or market value
• realization concept-it implies that revenue should be considered
as earned/realised on the date of sales of goods not the date of
receipt of cash
• consistency concept- accounting method must be consistent
example depreciation should be comparable over the years
• materiality concept-enter those transactions which matter
example scraps sold by a large company are not included in their
annual report
• Full disclosure concept-there should be no secret or hiding of any
account
capital expenditures- they are expenses whose benefit accure beyond one
accounting period
revenue expense- they are expense which benefit one accounting year
deferred revenue expenses-they are revenue expenses which benefit more
than one accounting year example research and development expenditure
accounting standards- they provide guidelines related to the accounting
treatment as well as reporting of important accounting items with a view to
standardise the diverse accounting policies
• Disclosure of accounting policies-Refer to the specific accounting
principles and methods of applying those principles adopted by the
organization in preparation and presentation of their financial
statements like the methods of depreciation, treatment of goodwill
• Valuation of inventories-principles to be considered in computing the
value of inventory and also ensure adequate disclosure of policy
adopted by enterprise. inventories are defined as assets and should be
valued at lower cost and net realisable value. cost of inventory’s include
cost of purchase (include duties and taxes and expenditures directly
attributable to the acquisition), cost of conversion(related to the post of
production of units such as labour cost and overheads that are incurred
in converting materials to finished goods), and other costs(incurred in
bringing the inventory to present location and condition)
• cash flow statement
• contingency and events occurring after balance sheet date- deals with
the treatment in the financial statement. contingency is defined as a
condition or situation, the ultimate outcome of which gain, and loss will
be known or determined. Events occurring after balance sheet date are
significant events occurred between the balance sheet date and date on
which financial statements are approved
• net profit or loss for the period, prior period items and changes in
accounting policies- the objective is to prescribe the classification and
disclosure of certain items in the statement of profit and loss so that all
enterprises prepare and present such statements on a uniform basis
• depreciation accounting
• revenue recognition- provides the basis of recognition of revenue
arising in the ordinary course of activities of the enterprise, mainly
concerned with the timing of recognition of revenue in the statement of
profit and loss of enterprise
• accounting for fixed assets
• accounting for inventories
• segment reporting
 • earnings per share
• accounting for taxes and income
• discontinuing operations
• Interim financial reporting
• Intangible assets
• financial rating of interest in joint venture
• impairment of assets
• provisions, contingent liability, contingent assets
Accounting policies- they refer to the specific accounting principles and
methods of applying those principles in the preparation and presentation of
financial statements
Suggested List of Items to be Mandatory Included in the Report on Corporate
Governance
in the Annual Report of Companies
1. A brief statement on company’s philosophy on code of governance
2. Board of Directors
• Composition and category of directors, for example, promoter,
executive, non-executive, independent non-executive, nominee
director, which institution represented as lender or a equity
investor.
• Attendance of each director at the Board of Directors (BOD)
meetings and the last AGM.
• Number of other BODs or Board committees in which he/she is a
member or chairperson.
• Number of BOD meetings held, dates on which held.
3. Audit Committee
• Brief description of terms of reference
• Composition, name of members and chairperson
• Meetings and attendance during the year
4. Remuneration Committee
• Brief description of terms of reference
• Composition, name of members and chairperson
• Attendance during the year
• Remuneration policy
• Details of remuneration to all the directors, as per format in
main report.
5. Shareholders Committee
• Name of non-executive director heading the committee
• Name and designation of compliance officer
• Number of shareholders’ complaints received so far
• Number not solved to the satisfaction of shareholders
• Number of pending complaints
6. General Body Meetings
• Location and time, where last three AGMs were held
• Whether any special resolutions passed in the previous three
AGMs
• Whether any special resolution passed last year through postal
ballot—details of voting pattern
• Person who conducted the postal ballot exercise
• Whether any special resolution is proposed to be conducted
through
postal ballot
• Procedure for postal ballot
7. Disclosures
• Disclosures on materially significant related party transactions
that may have potential conflict with the interests of the company
at large
• Disclosure of accounting treatment, if different, from that
prescribed in Accounting Standards with explanation
• Details of non-compliance by the company, penalties, strictures
imposed on the company by stock exchange(s) or SEBI or any
statutory authority, on any matter related to capital markets,
during the last three years
• Whistle blower policy and affirmation that no personnel has been
denied access to the Audit Committee
8. Means of Communication
• Half-yearly report sent to each household of shareholders
• Quarterly results
• Newspapers wherein results normally published
• Any web site, where displayed
• Whether it also displays official news releases
• The presentations made to institutional investors or to the
analysts
 • Whether management decision and analysis (MDA) is a part of
annual report or not
9. General Shareholder Information
• AGM: Date, time and venue
• Financial calendar
• Date of book closure
• Dividends payment date
• Listing on stock exchange(s)
• Stock code
• Market price data: high, low during each month in last financial
year
• Performance in comparison to broad-based indices such as BSE
sensex, CRISIL index and so on.
• Registrar and transfer agents
• Share transfer system
• Distribution of shareholding
• Dematerialization of shares and liquidity
• Outstanding GDRs/ADRs/warrants or any convertible instruments,
conversion date and likely impact on equity
• Plant locations
• Address for correspondence
Non-Mandatory Requirements To be Included in Corporate Governance
Report
• The Board: A non-executive Chairman may be entitled to maintain a
Chairman’s office at the company’s expense and also allowed
reimbursement of expenses incurred in performance of his duties.
Independent Directors may have a tenure not exceeding, in the
aggregate, a period of nine years, on the Board of a company.
• Remuneration Committee
i) The Board may set up a remuneration committee to determine on
their behalf and on behalf of the shareholders with agreed terms of
reference,the company’s policy on specific remuneration packages
for executive directors including pension rights and any
compensation payment.
ii) To avoid conflicts of interest, remuneration committee, which would
determine the remuneration packages of the executive directors may
comprise of at least three directors, all of whom should be non-
 executive directors, the Chairman of committee being an
independent director.
iii) All the members of the remuneration committee could be present at
the meeting.
iv) The Chairman of the remuneration committee could be present at
the Annual General Meeting, to answer the shareholder queries.
However, it would be up to the Chairman to decide who should
answer the queries.
• Shareholder Rights: A half-yearly declaration of financial performance
including summary of the significant events in last six-months, may be
sent to each household of shareholders.
• Audit Qualifications: The company may move towards a regime of
unqualified financial statements.
• Training of Board Members: A company may train its Board members in
the business model of the company as well as the risk profile of the
business parameters of the company, their responsibilities as directors,
and the best ways to discharge them.
• Merchanism for Evaluating Non-executive Board Members: The
performance evaluation of non-executive directors could be done by a
peer group comprising the entire Board of Directors, excluding the
director being evaluated; and Peer Group evaluation could be the
mechanism to determine whether to extend/continue the terms of
appointment of non-executive directors.
• Whistle Blower Policy: The company may establish a mechanism for
employees to report to the management concerns about unethical
behaviour, actual or suspected fraud or violation of the company’s code
of conduct or ethics policy. This mechanism could also provide for
adequate safeguards against victimisation of employees who avail of the
mechanism and also provide for direct access to the Chairman and the
Audit Committee in exceptional cases. Once established, the existence
of the mechanism may be appropriately communicated within the
organisation.
Assets + Expenses = Liabilities + Revenue + Owner's equity
ANALYSIS AND INTERPRETATION OF FINANCIAL
STATEMENTS
Financial analysis is the process of identifying the financial strengths and weaknesses
of the firm by properly establishing relationship between the items of the balance
sheet and the profit and loss account
The main objectives of analysis of financial statements are-
• to assess the profitability of the concern.
• to examine the operational efficiency of the concern as a whole and of its
various parts or departments.
• to measure the short-term and long-term solvency of the concern for the benefit
of the debenture holders and trade creditors.
• to undertake a comparative study in regard to one firm with another firm or one
department with another department
• to assess the financial stability of a business concern.
TOOLS OF FINANCIAL ANALYSIS
1. Comparative Financial Statements
2. Common-size Statements
3. Trend Analysis
4. Cash Flow Statement
5. Ratio Analysis
1. Comparative Financial Statements:
Comparative financial statements are those statements which have been designed in a
way to provide time perspective to the consideration of various elements of financial
position embodied in such statements. In these statements figures for two or more
periods are placed side by side to facilitate comparison. Both the Income Statement
and Balance Sheet can be prepared in the form of Comparative Financial Statements.
a) Comparative Income Statement
The comparative Income Statement is the study of the trend of the same items/group
of items in two or more Income Statements of the firm for different periods. The
changes in the Income Statement items over the period would help in forming opinion
about the performance of the enterprise in its business operations.
The Interpretation of Comparative Income Statement would be as follows:
• The changes in sales should be compared with the changes in cost of goods
sold. If increase in sales is more than the increase in the cost of goods sold,
then the profitability will improve.
• An increase in operating expenses or decrease in sales would imply decrease in
operating profit and a decrease in operating expenses or increase in sales would
imply increase in operating profit.
• The increase or decrease in net profit will give an idea about the overall
profitability of the concern.
Particulars 2019 2020 Particulars 2019 2020
To Cost of goods sold 2,31,625 2,41,950 By Sales 3,60,728 4,17,125
To Office expenses 23,266 27,068 Less: Returns 5,794 6,952
To Selling expenses 45,912 57,816 3,54,934 4,10,173
To Interest paid 2,137 1,750By other incomes
Interest & Dividends 1,898 1,310
To Loss on sale of fixed 627 175 By Discount on Purchase 2,125 1,896
assets
To Income Tax 21,519 40,195 By Profit on sale of land 1,500 -
To Net Profit 35,371 44,425
3,60,457 4,13,379 3,60,457 4,13,379
Particulars 2019 2020 Increase (+) Increase (+)
Rs. Rs. Decrease (-) Decrease (-)
Rs. %
Sales 3,60,728 4,17,125 +56,397 +15.63
Less: Sales returns 5,794 6,952 +1,158 +19.98
3,54,934 4,10,173 +55,239 +15.56
Less: Cost of goods sold 2,31,625 2,41,950 +10,325 +4.46
Gross Profit (i) 1,23,309 1,68,223 +44,914 +36.42
Operating expenses:
Office expenses 23,266 27,068 +3,802 +16.34
Selling expenses 45,912 57,816 +11,904 +25.93
Total Operating expenses (ii) 69,178 84,884 +15,706 +22.70
Operating Profit (i) - (ii) 54,131 83,339 +29,208 +53.96
Add: Other incomes 5,523 3,206 -2,317 -41.95
59,654 86,545 +26,891 +45.08
Less: Other expenses 2,764 1,925 -839 -30.35
Profit before tax 56,890 84,620 +27,730 +48.74
Less: Income –tax 21,519 40,195 +18,676 +86.79
Net Profit after tax 35,371 44,425 +9,054 +25.60

The comparative income statement reveals that while the net sales has been
increased by 15.5%, the cost of goods sold increased by 4.46%. So gross profit
is increased by 36.4%. The total operating expenses has been increased by
22.7% and the gross profit is sufficient to compensate increase in operating
expenses. Net profit after tax is 9,054 (i.e., 25.6%) increased. The overall
profitability of the undertaking is satisfactory.
b) Comparative Balance Sheet
The comparative Balance Sheet analysis would highlight the trend of various
items and groups of items appearing in two or more Balance Sheets of a firm
on different dates. The changes in periodic balance sheet items would reflect
the changes in the financial position at two or more periods. The Interpretation
of Comparative Balance Sheets are as follows :
• The increase in working capital would imply increase in the liquidity
position of the firm over the period and the decrease in working capital
would imply deterioration in the liquidity position of the firm.
• An assessment about the long-term financial position can be made by
studying the changes in fixed assets, capital and long-term liabilities. If
the increase in capital and long-term liabilities is more than the increase
in fixed assets, it implies that a part of capital and long-term liabilities
has been used for financing a part of working capital as well. This will be
a reflection of the good financial policy. The reverse situation will be a
signal towards increasing degree of risk to which the long-term solvency
of the concern would be exposed to.
 • The changes in retained earnings, reserves and surpluses will give an
indication about the trend in profitability of the concern. An increase in
reserve and surplus and the Profit and Loss Account is an indication of
improvement in profitability of the concern. The decrease in these
accounts may imply payment of dividends, issue of bonus shares or
deterioration in profitability of the concern.
Comparative Balance Sheet
Particulars 31st Dec 31st Dec Increase (+) Increase (+)
2019 2020 Decrease (-) Decrease (-)
Rs. Rs. Rs. %
Assets
Current Assets:
Cash at bank and in hand 50,000 83,000 +33,000 +66
Bills receivable 20,000 60,000 +40,000 +200
Debtors 1,00,000 1,25,000 +25,000 +25
Stock 40,000 50,000 +10,000 +25
Prepaid expenses 10,000 12,000 +2,000 +20
Total current Assets 2,20,000 3,30,000 +1,10,000 +50
Fixed Assets 2,40,000 3,50,000 +1,10,000 +45.83
Total Assets 4,60,000 6,80,000 +2,20,000 47.83
Liabilities
Current Liabilities
Bank overdraft 50,000 50,000 - -
Creditors 40,000 50,000 +10,000 +25
Proposed Dividend 15,000 25,000 +10,000 +66.67
Provision for taxation 20,000 25,000 +5,000 +25
Total Current Liabilities 1,25,000 1,50,000 +25,000 +20

Capital and Reserves:

Equity Share Capital 2,00,000 3,30,000 +1,30,000 +65
Preference share capital 1,00,000 1,50,000 +50,000 +50
Reserves 20,000 30,000 +10,000 +50
Profit and Loss a/c 15,000 20,000 +5,000 +33.33
Total Capital and Reserves 3,35,000 5,30,000 +1,95,000 +58.21
Total liabilities 4,60,000 6,80,000 +2,20,000 +47.83

Interpretation:
1. The above Comparative Balance Sheet reveals the current assets has
been increased to 50% while current liabilities increase to 20% only.
Cash increased to Rs. 33,000 (i.e., 66%). There is an improvement in
liquidity position.
2. The fixed assets purchased was for Rs. 1,10,000. As there are no long-
term funds, it should have been purchased partly from share capital.
 3. Reserves and Profit and Loss a/c increased by 50% and 33.33%
respectively. The company may issue bonus shares in near future.
4. Current financial position of the company is satisfactory. It should issue
more long-term funds.

2. Common-size Financial Statements

Common-size Financial Statements are those in which figures reported are converted
into percentages to some common base. In the Income Statement the sale figure is
assumed to be 100 and all figures are expressed as a percentage of sales. Similarly in
the Balance sheet the total of assets or liabilities is taken as 100 and all the figures are
expressed as a percentage of this total.
Common Size Income Statement
In the case of Income Statement, the sales figure is assumed to be equal to 100 and all
other figures are expressed as percentage of sales. The relationship between items of
Income Statement and volume of sales is quite significant since it would be helpful in
evaluating operational activities of the concern. The selling expenses will certainly go
up with increase in sales. The administrative and financial expenses may go up or may
remain at the same level. In case of decline in sale, selling expenses should definitely
decrease.
From the following P&L A/c prepare a Common Size Income Statement:

Particulars 2019 2020 Particulars 2019 2020

To Cost of goods sold 12,000 15,000 By Net Sales 16,000 20,000
To Administrative expenses 400 400
To Selling Expenses 600 800
To Net Profit 3,000 3,800
16,000 20,000 16,000 20,000
Common Size Income Statement

Particulars 2019 2020

Rs. % Rs. %
Net Sales 16,000 100.00 20,000 100.00
Less: Cost of goods sold 12,000 75.00 15,000 75%
Gross Profit 4,000 25.00 5,000 25.00
Less: Operating Expenses
Administrative expenses 400 2.50 400 2.00
Selling Expenses 600 3.75 800 4.00
Total Operating expenses 1,000 6.25 1,200 6.00
Net Profit 3,000 18.75 3,800 19.00
Common Size Balance Sheet-For the purpose of common size Balance Sheet, the
total of assets or liabilities is taken as 100 and all the figures are expressed as
percentage of the total. In other words, each asset is expressed as percentage to total
assets/liabilities and each liability is expressed as percentage to total assets/liabilities.
This statement will throw light on the solvency position of the concern by providing
an analysis of pattern of financing both long-term and working capital needs of the
concern.
Liabilities 2019 2020 Assets 2019 2020
Equity capital 1,65,000 Fixed Assets (Net) 1,20,000 1,75,000

Pref. capital 50,000 75,000 Stock 20,000 25,000

Reserves 10,000 15,000 Debtors 50,000 62,500
P & L A/c 7,500 10,000 Bills receivable 10,000 30,000
Bank O.D. 25,000 25,000 Prepaid Expenses 5,000 6,000
Creditors 20,000 25,000 Cash at Bank 20,000 26,500
Provision for Taxation 10,000 12,500 Cash in hand 5,000 15,000
Proposed dividends 7,500 12,500
2,30,000 3,40,000 2,30,000 3,40,000

Particulars 2019 2020

Rs. % Rs. %

Capital & Reserves:

Equity Capital 1,00,000 43.48 1,65,000 48.53

Pref. Capital 50,000 21.74 75,000 22.05

Reserves 10,000 4.34 15,000 4.41

P & L Account 7,500 3.26 10,000 2.95

(i) 1,67,500 72.82 2,65,000 77.94

Current Liabilities:

Bank Overdraft 25,000 10.87 25,000 7.35

Creditors 20,000 8.70 25,000 7.35

Provisions for taxation 10,000 4.35 12,500 3.68

Proposed dividends 7,500 3.26 12,500 3.68

(ii) 62,500 27.18 75,000 22.06

Total Liabilities (i) + (ii) 2,30,000 100.00 3,40,000 100.00

Fixed Assets (Net) (a) 1,20,000 52.17 1,75,000 51.47

Current Assets:

Stock 20,000 8.70 25,000 7.35

Debtors 50,000 21.74 62,500 18.38

Bills Receivable 10,000 4.34 30,000 8.82

 Prepaid expenses 5,000 2.17 6,000 1.78

Cash at Bank 20,000 8.70 26,500 7.79

Cash in hand 5,000 2.18 15,000 4.41

(b) 1,10,000 47.83 1,65,000 48.53

(a) + (b) 2,30,000 100.00 3,40,000 100.00

Interpretation:
1. In 2020 Current Assets were increased from 47.83% to 48.53%. Cash
balance increased by Rs. 16,500.
2. Current liabilities were decreased from 27.18% to 22.06%. So, the
company can pay off the current liabilities from current assets. The
liquidity position is reasonably good.
3. Fixed Assets were increased from Rs. 1,20,000 in 2019 to Rs. 1,75,000 in
2020. These were purchased from the additional share capital issued.
4. So, the over all financial position is satisfactory.

3. Trend Analysis-
This is immensely helpful in making a comparative study of the financial statements
of several years. Under this method trend percentages are calculated for each item of
the financial statement taking the figure of base year as 100. The starting year is
usually taken as the base year. The trend percentages show the relationship of each
item with its preceding year's percentages This will exhibit the direction, (i.e., upward
or downward trend) to which the concern is proceeding.
While calculating trend percentages, the following precautions may be taken:
• The accounting principles and practices must be followed constantly over the
period for which the analysis is made. This is necessary to maintain
consistency and comparability.
• The base year selected should be normal and representative year.
• Trend percentages should be calculated only for those items which have logical
relationship with one another.
• To make the comparison meaningful, trend percentages of the current year
should be adjusted in the light of price level changes as compared to base year.
From the following data, calculate trend percentage taking 2019 as base:
2019 2020 2021
Rs. Rs. Rs.
Sales 50,000 75,000 1,00,000
Purchases 40,000 60,000 72,000
Expenses 5,000 8,000 15,000
Profit 5,000 7,000 13,000
 Particulars 2019 2020 2021 Trend percentage Base 2019
Rs. Rs. Rs. 2019 2020 2021
% % %
Purchases 40,000 60,000 72,000 100 150 180
Expenses 5,000 8,000 15,000 100 160 300
Profit 5,000 7,000 13,000 100 140 260
Sales 50,000 75,000 1,00,000 100 150 200
Uses and Importance of Cash Flow Statements
the important advantages of cash flow statements are-
• The projected cash flow statements if prepared in a business disclose surplus or
shortage of cash well in advance. This helps in arranging utilisation of surplus
cash as bank deposits or investment in marketable securities for short periods.
Should there be shortage of cash, arrangement can be mode for raising the bank
loan or sell marketable securities.
• Cash flow statements are of extreme help in planning liquidation of debt,
replacement of plant and fixed assets and similar other decisions requiring
outflow of cash from the business as they provide information about the cash
generating ability of the business.
• The cash flow statement pertaining to a particular year compared with the
budget for that year reveals the extent to which the actual sources and
applications of cash were in consonance with the budget. This exercise helps in
refining the planning process in future.
• The inter-firm and temporal comparison of cash flow statements reveals the
trend in the liquidity position of a firm in comparison to other firms in the
industry. It can serve as a pointer to the need for taking corrective action if it is
observed that the management of cash in the firm is not effective.
RATIO ANALYSIS
A ratio is a simple arithmetical expression of the relationship of one number to
another. a ratio is an expression of the quantitative relationship between two numbers
This relationship can be expressed as percentages, fraction and proportion of numbers
The rational of ratio analysis lies in the fact that it makes related information
Comparable Ratio analysis helps in financial forecasting, making comparisons,
evaluating solvency position of a firm, etc.
Ratio analysis, thus, as a quantitative tool, enables analyststo draw quantitative
answers to questions such as
• whether the net profits are adequate
• whether the assets are being used efficiently
• whether the firm meet its current obligations
INTERPRETATION OF RATIOS
The interpretation of the ratios can be done in the following ways:
• Single Absolute Ratio- single ratios may be studied in relation to certain rules
of thumb which are based upon well proven contentions as for example 2:1 is
considered to be a good ratio for current assets to current liabilities.
• Groups of Ratio- Ratios may be interpreted by calculating a group of related
ratios
 • Historical Comparisons- One of the easiest and most popular ways of
evaluating the performance of the firm is to compare its present ratios with the
past ratios called comparison over time.
• Projected Ratios-Ratios can also be calculated for future standard based upon
the projected financial statements
• Inter-firm Comparison: Ratios of one firm can also be compared with the
ratios of some other selected firms in the same industry at the same point of
time.
MANAGERIAL USES OF RATIO ANALYSIS
The following are the important managerial uses of ratio analysis –
• Helps in Financial Forecasting- Ratio analysis is very helfpful in financial
forecasting. Ratios relating to past sales, profits and financial position form the
basis for setting future trends.
• Helps in Comparison- With the help of ratio analysis, ideal ratios can be
composed and they can be used for comparing a firm's progress and
performance. Inter-firm comparison or comparison with industry averages is
made possible by the ratio analysis.
• Financial Solvency of the Firm: Ratio analysis indicates the trends in financial
solvency of the firm. Solvency has two dimensions-long-term solvency and
short-term solvency. Long-term solvency refers to the financial viability of a
firm and it is closely related with the existing financial structure. On the other
hand, short-term solvency is the liquidity position of the firm. With the help of
ratio analysis conclusions can be drawn regarding the firm's liquidity and
longterm solvency position.
• Evaluation of Operating Efficiency- Ratio analysis throws light on the degree
of efficiency in the management and utilisation of its assets and resources.
Various activity ratios measure this kind of operational efficiency and indicate
the guidelines for economy in costs, operations and time.
• Communication Value- Different financial ratios communicate the strength
and financial standing of the firm to the internal and external parties. They
indicate the over-all profitability of the firm.
• Others Uses- Financial ratios are very helpful in the diagnosis of financial
health of a firm. They highlight the liquidity, solvency, profitability and capital
gearing etc. of the firm.
DRAW BACKS OF RATIO ANALYSIS
• Limited use of a single ratio- Ratio can be useful only when they are
computed in a sufficient large number. A single ratio would not be able to
convey anything. AT the same time, if too many ratios are calculated, they are
likely to confuse instead of revealing any meaningful conclusion.
• Effect of inherent limitations of accounting- Because ratios are computed
from historical accounting records, so they also possess those limitations and
weaknesses as accounting records possess.
• Lack of proper standards: While making comparisons, it is always a
challenging job to find out an adequate standard. It is not possible to calculate
exact and well accepted absolute standard, so a quality range is used for this
 purpose. If actual performance is within this range, it may be regarded as
satisfactory.
• Past is not indicator of future- It is not always possible to make future
estimates on the basis of the past as it always does not come true.
• No allowance for change in price level- While making comparisons of ratios,
no allowance for changes in general price level is made. A change in price
level can seriously affect the validity of comparisons of ratios computed for
different time periods.
• Personal Bias- Ratios are only means of financial analysis and is not an end in
itself. Ratios have to be Interpreted carefully because the same ratio can be
looked at, in different ways.
CLASSIFICATION OF RATIOS- Ratios can be classified into five broad groups :
(i) Liquidity ratios
(ii) Activity Ratios
(iii) Leverage/Capital structure ratios
(iv) Coverage ratios
(v) Profitability ratios.
i. Liquidity Ratios- Liquidity Ratios measures the company's ability to meet it's
obligations in the SHORT-TERM period. The ratios which indicate the
liquidity of a firm are
• Net Working Capital: it is frequently employed as a measure of a
company's liquidity position. NWC represents the excess of current assets
over current liabilities. A firm should have sufficient NWC in order to be
able to meet the claims of the creditors and the day-to-day needs of
business. The greater the amount of NWC, the greater the liquidity of the
firm.
NWC = Total Current Assets – Total Current Liabilities
• Current Ratio: Current ratio is the most common ratio for measuring
liquidity. Being related to working capital analysis, it is also called the
working capital ratio. The current ratio is the ratio of total current assets to
total current liabilities The higher the current ratio, the larger the amount
of rupees available per rupee of current liability, the more the firm's ability
to meet current obligations and the greater the safety of funds of short-
term creditors. If the result is greater than 1, the firm presumably has
sufficient current assets to meet its current liabilities. A ratio of 2:1 (two
times current assets of current liabilities) is considered satisfactory as a
rule of thumb. Thus, a good
current ratio, in a way, provides a margin of safety to the creditors.
𝑪𝑼𝑹𝑹𝑬𝑵𝑻 𝑨𝑺𝑺𝑬𝑻𝑺
Current Ratio =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
• 3. Acid-Test/Quick Ratio: It is often referred to as quick ratio because it
is a measurement of a firm's ability to convert its current assets quickly
into cash in order to meet its current liabilities. Thus, it is a measure of
quick or acid liquidity. The term quick assets refers to current assets which
can be converted into cash immediately or at a short notice without
diminution of value. Included in this category of current assets are (i) cash
 and bank balances; (ii) short-term marketable securities and (iii)
debtors/receivables. An acid-test ratio of 1:1 or greater is recommended.
𝑸𝒖𝒊𝒄𝒌 𝒂𝒔𝒔𝒆𝒕𝒔
Acid-test ratio =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
• Cash-Position Ratio or Super-Quick Ratio: It is a variant of Quick ratio.
When liquidity is highly restricted in terms of cash and cash equivalents,
this ratio should be calculated. It is calculated by dividing the super-quick
current assets by the current liabilities of a firm. The super-quick current
assets are cash and marketable securities
𝑪𝒂𝒔𝒉 + 𝑴𝒂𝒓𝒌𝒆𝒕𝒂𝒃𝒍𝒆 𝑺𝒆𝒄𝒖𝒓𝒊𝒕𝒊𝒆𝒔
Cash-Position Ratio =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
ii. Activity Ratios-Activity ratios which are also called efficiency ratio or asset
utilisation ratios are concerned with measuring the efficiency in asset
management. The efficiency with which the assets are used would be reflected
in the speed and rapidity with which assets are converted into sales. The greater
is the rate of turnover or conversion, the more efficient is the
utilisation/management, other things being equal. For this reason, such ratios
are also designated as turnover ratios.
• Inventory Turnover Ratio- The ratio indicates how fast inventory is sold.
A high ratio is good from the viewpoint of liquidity and vice versa. A low
ratio would signify that inventory does not sell fast and stays on the shelf
or in the warehouse for a long time.
𝑪𝒐𝒔𝒕 𝒐𝒇 𝒈𝒐𝒐𝒅𝒔 𝒔𝒐𝒍𝒅
Inventory turnover ratio =
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝒊𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚
Cost of goods sold = sales – gross profit
𝒐𝒑𝒆𝒏𝒊𝒏𝒈 𝒔𝒕𝒐𝒄𝒌 + 𝒄𝒍𝒐𝒔𝒊𝒏𝒈 𝒔𝒕𝒐𝒄𝒌
Average inventory =
𝟐
• Debtors Turnover Ratio- The ratio measures how rapidly debts are
collected. A high ratio is indicative of shorter time-lag between credit sales
and cash collection. A low ratio shows that debts are not being collected
rapidly.
𝑵𝒆𝒕 𝒄𝒓𝒆𝒅𝒊𝒕 𝒔𝒂𝒍𝒆𝒔
Debtors Turnover Ratio=
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝒅𝒆𝒃𝒕𝒐𝒓𝒔
Net credit sales = gross credit sales - sales returns from customers
• Creditors Turnover Ratio: It is a ratio between net credit purchases and
the average amount of creditors outstanding during the year A low
turnover ratio reflects liberal credit terms granted by suppliers, while a
high ratio shows that accounts are to be settled rapidly.
𝑵𝒆𝒕 𝒄𝒓𝒆𝒅𝒊𝒕 𝒑𝒖𝒓𝒄𝒉𝒂𝒔𝒆𝒔
Creditors turnover ratio =
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝒄𝒓𝒆𝒅𝒊𝒕𝒐𝒓𝒔
Net credit purchases = Gross credit purchases - returns to suppliers
• Average Age of Sundry Debtors: The average age of sundry or average
collection period is more meaningful figure to use in evaluating the firm's
credit and collection policies. The main objective of calculating average
collection period is to find out cash inflow rate from realisation from
debtors
𝟑𝟔𝟓
Average Age of Debtors =
𝑫𝒆𝒃𝒕𝒐𝒓𝒔 𝑻𝒖𝒓𝒏𝒐𝒗𝒆𝒓 𝑹𝒂𝒕𝒊𝒐
 It can be calculated as follows also :
𝐝𝐞𝐛𝐭𝐨𝐫𝐬+ 𝐛𝐢𝐥𝐥𝐬 𝐫𝐞𝐜𝐢𝐞𝐯𝐚𝐛𝐥𝐞
Average Collection Period = × No. of working days
𝐍𝐞𝐭 𝐂𝐫𝐞𝐝𝐢𝐭 𝐒𝐚𝐥𝐞𝐬
The average of collection period should not exceed the standard or stated credit period
in sales terms plus 1/3 of such days. If it happens, it will indicate either liberal credit
policy or slackness of management in realising debts or accounts receivable.
• Assets Turnover Ratio: This ratio is also known as the investment
turnover ratio. It is based on the relationship between the cost of goods
sold and assets/investments of a firm. Depending upon the different
concepts of assets employed, there are many variants of this ratio.
𝐂𝐨𝐬𝐭 𝐨𝐟 𝐠𝐨𝐨𝐝𝐬 𝐬𝐨𝐥𝐝
Total assets turnover =
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐭𝐨𝐭𝐚𝐥 𝐚𝐬𝐬𝐞𝐭𝐬
𝐂𝐨𝐬𝐭 𝐨𝐟 𝐠𝐨𝐨𝐝𝐬 𝐬𝐨𝐥𝐝
Fixed assets turnover =
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐟𝐢𝐱𝐞𝐝 𝐚𝐬𝐬𝐞𝐭𝐬
𝐂𝐨𝐬𝐭 𝐨𝐟 𝐠𝐨𝐨𝐝𝐬 𝐬𝐨𝐥𝐝
Capital turnover =
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐜𝐚𝐩𝐢𝐭𝐚𝐥 𝐞𝐦𝐩𝐥𝐨𝐲𝐞𝐝
𝐂𝐨𝐬𝐭 𝐨𝐟 𝐠𝐨𝐨𝐝𝐬 𝐬𝐨𝐥𝐝
Current assets turnover =
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐜𝐮𝐫𝐫𝐞𝐧𝐭 𝐚𝐬𝐬𝐞𝐭𝐬
iii. Leverage/Capital Structure Ratios: Leverage ratio is one of the most
important of the financial ratios as it determines how much of the capital that is
present in the company is in the form of debts. It also analyses how the
company is able to meet its obligations. Leverage ratio becomes more critical
as it analyzes the capital structure of the company and the way it can manage
its capital structure so that it can pay off the debts. The long-term creditors
would judge the soundness of a firm on the basis of the long-term financial
strength measured in terms of its ability to pay the interest regularly as well as
repay the instalment of the principal on due dates The long-term solvency of a
firm can be examined by using leverage or capital structure ratios.
• The Debt-equity Ratio – This ratio establishes the relationship between
the long-term funds provided by creditors and those provided by the firm's
owners. It is commonly used to measure the degree of financial leverage of
the firm Generally, a ratio of 2:1 is considered satisfactory.
𝐋𝐨𝐧𝐠−𝐭𝐞𝐫𝐦 𝐃𝐞𝐛𝐭𝐬
Debt-equity Ratio =
𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓′𝒔 𝑬𝒒𝒖𝒊𝒕𝒚
• Proprietary Ratio : This ratio is also known as Shareholders' Equity to
Total Equities Ratio or Net Worth to Total Assets Ratio. It indicates the
relationship of Shareholders' equity to total assets or total equities. Higher
the ratio, better the financial position of the firm.
𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓𝒔′ 𝑭𝒖𝒏𝒅𝒔 𝒐𝒓 𝒏𝒆𝒕 𝒘𝒐𝒓𝒕𝒉
Proprietary Ratio =
𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬
• The Solvency Ratio – It is also known as Debt Ratio It measures the
proportion of total assets provided by the firm's creditors Generally, lower
the rate of total liabilities to total assets; more satisfactory or stable is the
long-term solvency position of a firm.
𝒕𝒐𝒕𝒂𝒍 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
Solvency Ratio (or Debt Ratio) =
𝒕𝒐𝒕𝒂𝒍 𝒂𝒔𝒔𝒆𝒕𝒔
 • Fixed Assets to Net Worth Ratio – One of the important aspects of sound
financial position of a firm is that its fixed assets are totally financed out of
shareholders' funds. If aggregate of fixed assets exceeds the net worth it
proves that fixed assets have been financed with outsiders' funds (or
creditors' funds). It may create difficulty in the long-run. This ratio should
not exceed 1:1. On the contrary, lower the ratio, better the position.
Usually, a ratio of 0.67 : 1 is considered satisfactory.
𝒇𝒊𝒙𝒆𝒅 𝒂𝒔𝒔𝒆𝒕𝒔
Fixed Assets-Net Worth Ratio =
𝒏𝒆𝒕 𝒘𝒐𝒕𝒉
• Proprietors' Liabilities Ratio : This ratio indicates the relationship of
proprietors' funds to total liabilities Higher the ratio, better is the position
of creditors.
𝒏𝒆𝒕 𝒘𝒐𝒕𝒉
Proprietors' Liabilities Ratio =
𝒕𝒐𝒕𝒂𝒍 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
• Fixed Assets Ratio- it is the ratio of fixed assets to all long-term funds
(net worth + long time borrowing) This ratio indicates the extent to which
the total of fixed assets are financed by long-term funds of the firm.
Generally, the total of the fixed assets should be equal to total of the long-
term funds or say the ratio should be 100%. And if total long-term funds
are more than total fixed assets, it means that part of working capital
requirement is met out.
𝐅𝐢𝐱𝐞𝐝 𝐀𝐬𝐬𝐞𝐭𝐬
Fixed Assets Ratio =
𝑻𝒐𝒕𝒂𝒍 𝒍𝒐𝒏𝒈−𝒕𝒆𝒓𝒎 𝒇𝒖𝒏𝒅𝒔
• Ratio of Current Assets to Proprietary's Funds-The ratio is calculated
by dividing the total of current assets by the amount of shareholder's
funds. This ratio indicates the extent to which proprietors’ funds are
invested in current assets.
𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒂𝒔𝒔𝒆𝒕𝒔
Ratio of Current Assets to Proprietary's Funds=
𝒏𝒆𝒕 𝒘𝒐𝒓𝒕𝒉
• Debt-Service Ratio-Net income to debt service ratio or simply debt
service ratio is used to test the debt-servicing capacity of a firm. The ratio
is also known as interest coverage ratio or fixed charges cover or times
interest earned. Interest coverage ratio indicates the number of times
interest is covered by the profits available to pay the interest charges.
Long-term creditors of a firm are interested in knowing the firm's ability to
pay interest on their long-term borrowings. higher the ratio, more safe are
long term But a too high interest coverage ratio may not be good for the
firm because it may imply that firm is not using debt as a source of finance
so as to increase the earnings per share.
𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡
Debt-Service Ratio=
𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑐ℎ𝑎𝑟𝑔𝑒𝑑
Note : Bank overdraft is not included in liquid liabilities, as it tends to become
some sort of a permanent mode of financing.
iv. Coverage Ratios: These ratios are computed from information available in the
profit and loss account. The coverage ratios measure the relationship between
 what is normally available from operations of the firms and the claims of the
outsiders
• Interest Coverage Ratio : This ratio measures the debt servicing capacity
of a firm insofar as fixed interest on long-term loan is concerned. From the
point of view of the creditors, the larger the coverage, the greater is the
ability of the firm to handle fixed-charge capabilities and the more assured
is the payment of interest to the creditors. However, too high a ratio may
imply unused debt capacity.
𝑬𝑩𝑰𝑻
Interest Coverage Ratio=
𝒊𝒏𝒕𝒆𝒓𝒆𝒔𝒕
• Dividend Coverage Ratio: It measures the ability of a firm to pay
dividend on preference shares which carry a stated rate of return. This The
ratio, like the interest coverage ratio, reveals the safety margin available to
the preference shareholders. As a rule, the higher the coverage, the better it
is from their point of view.
𝑷𝑨𝑻
Dividend Coverage Ratio=
𝒑𝒓𝒆𝒇𝒆𝒓𝒆𝒏𝒄𝒆 𝒅𝒊𝒗𝒊𝒅𝒆𝒏𝒅𝒔
• Total Coverage Ratio: The total coverage ratio has a wider scope and
takes into account all the fixed obligations of a firm, that is, (i) interest on
loan, (ii) preference dividend, (iii) Lease payments, and (iv) repayment of
principal.
• Debt-Services Coverage Ratio (DSCR): This ratio is considered more
comprehensive and apt measure to compute debt service capacity of a
business firm. It provides the value in terms of the number of times the
total debt service obligations consisting of interest and repayment of
principal in instalments are covered by the total operating funds, available
after the payment of taxes. The higher the ratio, the better it is. In general,
lending financial institutions consider 2:1 as satisfactory ratio.
v. Profitability Ratios: Profitability ratios are a class of financial metrics that are
used to assess a business's ability to generate earnings relative to its revenue,
operating costs, balance sheet assets, or shareholders' equity over time, using
data from a specific point in time.
Profitability Ratios Related to Sales: These ratios are based on the
premise that a firm should earn sufficient profit on each rupee of sales.
• Gross Profit Margin :- A high ratio of gross profit to sales is a sign of good
management as it implies that the cost of production of the firm is relatively
low. It may also be indicative of a higher sales price without a corresponding
increase in the cost of goods sold.
𝒈𝒓𝒐𝒔𝒔 𝒑𝒓𝒐𝒇𝒊𝒕
Gross Profit Margin= ×100
𝒏𝒆𝒕 𝒔𝒂𝒍𝒆𝒔
• Net profit margin is also known as net margin. This measures the relationship
between net profits and sales of a firm. Depending on the concept of net profit
employed, This ratio is indicative of management's ability to operate the business
with sufficient success not only to recover from revenues of the period, the cost
of merchandise or services, the expenses of operating the business (including
depreciation) and the cost of the borrowed funds, but also to leave a margin of
reasonable compensation to the owners for providing their capital at risk. A high
 net profit margin would ensure adequate return to the owners. this ratio can be
computed in two ways :
𝑬𝑩𝑰𝑻
Operating profit ratio =
𝒔𝒂𝒍𝒆𝒔
𝑷𝑨𝑻
Net profit ratio =
𝒔𝒂𝒍𝒆𝒔
• Expenses Ratio: Another profitability ratio related to sales is the expenses ratio.
It is computed by dividing expenses by sales. The expenses ratio should be
compared over a period of time with the industry average as well as firms of
similar type. As a working proposition, a low ratio is favourable, while a high
one is unfavourable, it is computed by
𝐂𝐨𝐬𝐭 𝐨𝐟 𝐠𝐨𝐨𝐝𝐬 𝐬𝐨𝐥𝐝
Cost of goods sold ratio = × 100
𝒏𝒆𝒕 𝒔𝒂𝒍𝒆𝒔
𝐀𝐝𝐦𝐢𝐧𝐢𝐬𝐭𝐫𝐚𝐭𝐢𝐯𝐞 𝐞𝐱𝐩𝐞𝐧𝐬𝐞𝐬
Administrative expenses ratio = × 100
𝒏𝒆𝒕 𝒔𝒂𝒍𝒆𝒔
𝐒𝐞𝐥𝐥𝐢𝐧𝐠 𝐞𝐱𝐩𝐞𝐧𝐬𝐞𝐬
Selling expenses ratio = × 100
𝒏𝒆𝒕 𝒔𝒂𝒍𝒆𝒔
𝐂𝐨𝐬𝐭 𝐨𝐟 𝐠𝐨𝐨𝐝𝐬 𝐬𝐨𝐥𝐝+ 𝐨𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐞𝐱𝐩𝐞𝐧𝐬𝐞
Operating ratio = × 100
𝒏𝒆𝒕 𝒔𝒂𝒍𝒆𝒔
• Rate of Return on Equity Share Capital: This ratio examines the earning
capacity of equity share capital.
𝐍𝐞𝐭 𝐏𝐫𝐨𝐟𝐢𝐭 (𝐚𝐟𝐭𝐞𝐫 𝐭𝐚𝐱 𝐚𝐧𝐝 𝐏𝐫𝐞𝐟.𝐃𝐢𝐯.)
Rate of Return of Equity Share Capital = × 100
𝐏𝐚𝐢𝐝−𝐮𝐩 𝐄𝐪𝐮𝐢𝐭𝐲 𝐒𝐡𝐚𝐫𝐞 𝐂𝐚𝐩𝐢𝐭𝐚𝐥
• Return on Proprietors Funds on Return on Net- This ratio helps the
proprietors and potential investors to judge the earning of the company in relation
to others and the adequacy of the return on proprietors' funds.
𝐍𝐞𝐭 𝐏𝐫𝐨𝐟𝐢𝐭 (𝐚𝐟𝐭𝐞𝐫 𝐭𝐚𝐱)
Return on Proprietors Funds =
𝐧𝐞𝐭 𝐰𝐨𝐭𝐡
• Return on Investment (ROI) Ratio: This is one of the key profitability ratios. It
examines the overall operating efficiency or earning power of the company in
relation to total investment in business. It indicates the percentage of return on
the capital employed in the business. The term capital employed has been given
different meanings by different accountants.
𝐨𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐩𝐫𝐨𝐟𝐢𝐭
ROI= × 100
𝐜𝐚𝐩𝐢𝐭𝐚𝐥 𝐞𝐦𝐩𝐥𝐨𝐲𝐞𝐝
Capital employed can be
(i) Sum-total of all assets whether fixed or current.
(ii) Sum-total of fixed assets
(iii) Sum-total of long-term funds employed in the business, i.e.,
Share Capital + Reserves and Surplus + Long term Loans + Non-business
Assets + Fictitious Assets
The term Operating Profit means Profit before Interest and Tax. The term Interest
means Interest on long-term Borrowings. Interest on short-term borrowings will
be deducted for computing operating profit. Non-trading incomes such as interest
on Government securities or non-trading losses or expenses such as loss on account
of fire, etc. will also be excluded.
Net Operating Profit = Net Profit + Provision for Tax – Income from Investments +
Interest on Debentures
Capital employed = Fixed Assets + Current Assets – Provision for Tax
Significance of ROI: The Return on Capital invested is a concept that measures the
profit which a firm earns on investing a unit of capital. Yield on capital is another
term employed to express the idea. It is desirable to ascertain this periodically. The
profit being the net result of all operations, the return on capital expresses all
efficiencies or inefficiencies of a business collectively and thus is a dependable basis
for judging its overall efficiency or inefficiency
Limitations of ROI: ROI is one of the very important measures for judging the
overall financial performance of a firm. However, it suffers from certain important
limitations. These limitations are:
➢ Manipulation is possible: ROI is based on earnings and investments. Both
these figures can be manipulated by management by adopting varying
accounting policies regarding depreciation, inventory valuation, treatment of
provisions, etc.
➢ Different bases for computation of Profit and Investments
➢ Emphasis on short-term profit: ROI emphasises the generation of short-term
profits. The firm may achieve this objective by cutting down cost such as those
on research and development or sales promotion. Cutting down of such costs
without any justification may adversely affect the profitability of the firm in the
long run, though ROI may indicate better performance in the short run.
• Return on Capital Employed (ROCE): Here the profits are related to the total
capital employed. The term capital employed refers to long-tern funds supplied
by the creditors and owners of the firm. The higher the ratio, the more efficient is
the use of capital employed.
𝑷𝑨𝑻
ROCE = × 100
𝑪𝑨𝑷𝑰𝑻𝑨𝑳 𝑬𝑴𝑷𝑳𝑶𝒀𝑬𝑫
• Earning Per Share (EPS) measures the profit available to the equity
shareholders on a per share basis, that is, the amount that they can get on every
share held.
𝐍𝐞𝐭 𝐩𝐫𝐨𝐟𝐢𝐭 𝐚𝐯𝐚𝐢𝐥𝐚𝐛𝐥𝐞 𝐭𝐨 𝐞𝐪𝐮𝐢𝐭𝐲 𝐡𝐨𝐥𝐝𝐞𝐫𝐬
EPS=
𝐍𝐮𝐦𝐛𝐞𝐫 𝐨𝐟 𝐨𝐫𝐝𝐢𝐧𝐚𝐫𝐲 𝐬𝐡𝐚𝐫𝐞𝐬 𝐨𝐮𝐭𝐬𝐭𝐚𝐧𝐝𝐢𝐧𝐠
• Divided Per Share (DPS) is the dividends paid to shareholders on a per share
basis The DPS would be a better indicator than EPS as the former shows what
exactly is received by the owners.
𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝 𝐩𝐚𝐢𝐝 𝐭𝐨 𝐨𝐫𝐝𝐢𝐧𝐚𝐫𝐲 𝐬𝐡𝐚𝐫𝐞𝐡𝐨𝐥𝐝𝐞𝐫𝐬
DPS=
𝐍𝐮𝐦𝐛𝐞𝐫 𝐨𝐟 𝐨𝐫𝐝𝐢𝐧𝐚𝐫𝐲 𝐬𝐡𝐚𝐫𝐞𝐬 𝐨𝐮𝐭𝐬𝐭𝐚𝐧𝐝𝐢𝐧𝐠
• Divided-Pay Out (D/P) Ratio: This is also known as pay-out ratio. It measures
the relationship between the earnings belonging to the ordinary shareholders and
the dividend paid to them If the D/P ratio is subtracted from 100, it will give that
percentage share of the net profits which are retained in the business.

𝐃𝐏𝐒
D/P = × 100
𝐄𝐏𝐒
• Earnings and Dividend Yield: This ratio is closely related to the EPS and DPS.
While the EPS and DPS are based on the book value per share, the yield is
expressed in terms of the market value per share. The earning yield is also called
the earning-price ratio
This ratio is calculated as follows:
𝐄𝐏𝐒
1. Earning yield = × 100
𝐦𝐚𝐫𝐤𝐞𝐭 𝐯𝐚𝐥𝐮𝐞𝐚 𝐩𝐞𝐫 𝐬𝐡𝐚𝐫𝐞
𝐃𝐏𝐒
2. Dividend yield = × 100
𝐦𝐚𝐫𝐤𝐞𝐭 𝐯𝐚𝐥𝐮𝐞𝐚 𝐩𝐞𝐫 𝐬𝐡𝐚𝐫𝐞
• Price Earnings (P/E) Ratio is closely related to the earnings yield/earnings price
ratio. It is actually the reciprocal of the latter. The P/E ratio reflects the price
currently being paid by the market for each rupee of currently reported EPS. In
other words, the P/E ratio measures investors' expectations and the market
appraisal of the performance of a firm.
BUDGETING
Budget- A budget is a detailed plan of operations for some specific future period. It is
an estimate prepared in advance of the period to which it applies. A predetermined
detailed plan of action developed and distributed as a guide to current operations and
as a partial basis for the subsequent evaluation of performance it is a financial and/or
quantitative statement, prepared prior to a defined period of time, of the policy to be
pursued during that period for the purpose of attaining a given objective. Thus, the
following are the essentials of a budget :
• It is prepared in advance and is based on a future plan of actions.
• It relates to a future period and is based on objectives to be attained.
• It is a statement expressed in monetary and/or physical units prepared for
the implementation of policy formulated by the management.
BUDGETARY CONTROL
The term 'budgetary control' applies to a system of management and accounting
control by which all operations and output are forecast as far as ahead as possible and
the actual results, when known, are compared with the budget estimates. Thus, the
term 'budgetary control' is designed to evaluate the performance in terms of goals
budgeted through budget reports.
Budgetary control consists of the following:
• Determination of the objective to be achieved. The objective may be higher
profits, better financial position, better position in the market etc.
• Knowing the steps necessary to achieve the objective, that is to say laying
down an exact and detailed course of action, month by month and over the
whole period.
• Translation of the course of action into quantitative and monetary terms.This
means drawing up budgets.
• Constant comparison of the actual with the budget (again both physical
achievement and money values involved), noting discrepancies and their
reasons and taking steps to remove causes of shortcoming, wastages, losses
etc., and to consolidate reasons leading to good results.
ADVANTAGES OF BUDGETARY CONTROL
Budgetary control has become an essential tool of management for controlling
costs and maximising profits Its advantages to management can be summarised as
• Economy in working: It brings efficiency and economy in the working of the
business enterprise.
 • Buck-passing avoided: It establishes divisional and departmental
responsibility. It thus prevents alibis and "buck-passing" when the budget
figures are not met.
• Establishes coordination: It coordinates the various divisions of a business,
namely, the production, marketing, financial and administrative divisions. It
"forces executives to think and think as a group". This results in smoother
operation of the entire plant.
• Acts as a safety signal: It acts as a safety signal for the management. It shows
when to proceed cautiously and when manufacturing or merchandising
expansion can be safety undertaken. It serves as an automatic check on the
judgement of the executives as losses are revealed in time which is a caution to
the management to stop wastage.
• Adoption of uniform policy
• Decrease in production costs
• Adoption of standard costing principles: The use of budget figures as
measures of operating performance and financial position makes possible the
adoption of the standard costing principles in divisions other than the
production division.
LIMITATIONS OF BUDGETARY CONTROL
• Based on estimates: The strength or weakness of the budgetary programme
depends to a large degree on the accuracy with which the basic estimates are
made. The estimates must be based on all available facts and good judgement.
• Need for continuous adaptation: A budgetary programme cannot be installed
and perfected in a short time. Budget techniques must be continuously adapted
not only for each particular concern but for changing conditions within the
concern
• No automatic execution of the budget : Once the budget is complete, it
will be effective only if all responsible executives get behind it and exert
continuous and aggressive efforts towards its achievement. Departmental heads
must feel the responsibility for achieving and bettering department goals laid
down in the budget.
TYPES OF BUDGETS
• Cash Budget: it is operating budget and is a summary of the firm's expected
cash inflows and outflows over a particular period of time. In other words, cash
budget involves a projection of future cash receipts and cash disbursements
over various time intervals. The cash budget consists of two parts- The
projected cash receipts (inflows) and the planned cash disbursements
(outflows). Cash receipts include collection from debtors, cash sales, dividends
received, sale of assets, loans received and issues of shares and debentures.
Payments include wages and salaries, payment to creditors and suppliers, rent
and rates, taxes, capital expenditure, dividend payable, commission payable
and repayment of loans and debentures. The main purposes of the cash budget
may be outlined as follows:
1. To indicate the probable cash position as a result of planned operations.
2. To indicate cash excess or shortages.
 3. To indicate the need for borrowing or the availability of idle cash for
investment.
4. To make provision for the coordination of cash in relation to (a) total
working capital; (b) sales; (c) investment; and (d) debt.
5. To establish a sound basis for credit.
6. To establish a sound basis for exercising control over cash and liquidity
of the firm.
PARTICULARS JUNE JULY
OPENING BALANCE
ADD RECEIPT
TOTAL RECEIPT
(OPENING BALANCE+
OTHER RECEIPTS)
LESS PAYMENTS
TOTAL PAYMENT
CLOSING BALANCE
(TOTAL RECEIPT –
TOTAL PAYMENT)
CLOSING BALANCE OF JUNE IS OPENING BALANCE OF JULY
• FIXED BUDGETS-It is a budget in which targets are rigidly fixed. Fixed
budget is a budget which is designed to remain unchanged irrespective of the
level of activity actually attained. Such budgets are usually prepared from one
to three months in advance of the fiscal year to which they are applicable. Such
budgets are preferred only where sales can be forecast with the greatest of
accuracy, otherwise, it becomes an unrealistic
• FLEXIBLE BUDGET- A flexible budget, also called a variable budget, is
financial plan of estimated revenues and expenses based on the current actual
amount of output. In other words, a flexible budget uses
the revenues and expenses produced in the current production as a baseline and
estimates how the revenues and expenses will change based on changes in the
output. It would be desirable to have a flexible budget for the following-
1. where sales cannot be predicted because of the nature of the business;
2. where the business is subject to variance of weather;
3. where progress depends upon an adequate supply of labour; and
4. in the case of a new business, where it is difficult to forecast the demand
In a flexible budgeting system, it is necessary to have the budgets quickly recast
and changed to suit the actual conditions
WHILE PREPARING FLEXIBLE BUDGET
Total fixed cost always remains same while fixed cost per unit changes
where total Variable cost changes while variable cost per unit is fixed
particulars 1000 units 1500 units
Per unit cost Total cost Per unit cost Total cost
Direct
material
Power(20%
fixed)
 if anything is not mentioned in cost we take is at variable cost here we take
direct material as a variable cost and power is 20% fixed and 80%
variable
• ZERO-BASE BUDGETING (ZBB)-The ZBB takes into account
consequences that may flow if the project or responsibility centre is scratched.
In other words, the objects of the ZBB is to formulate the budget so as to
estimate the amount of expenditure likely to be incurred if the existing project
resumes operation after being scratched. This method is called Zero-Base
Budgeting since the existing system is discontinued and a fresh is made or the
existing system is reviewed on the assumption of 'Zero-Base'.
The significant advantages of ZBB are :
1. It supplies the firm a systematic way in order to evaluate different programmes
which are undertaken by the management allocating resources according to
priority of the programmes and operations of the undertaking.
2. It helps the management to know different departmental budgets on the basis of
cost-benefit analysis, as such, no arbitrary increase or cuts in budget estimates
are done.
3. It is most appropriate both for the staff and supported areas of an organisation
since the output are not related directly to the finished products of the unit.
4. It also helps to locate the areas of wasteful expenditure, if any, and as such, it
can also suggest alternative courses of action, if so desired by the management.

COSTING
Costing is the reporting and analysis of a company's cost structure. Costing
involves assigning costs to cost objects that can include a company's products,
services, and any business activities.
Costing in Internal Reporting- Management uses costing to learn about the
cost of operations, so that it can work on refining operations to improve
profitability.
Costing in External Reporting- External reporting is the issuance of financial
statements to parties outside of the reporting entity
Cost = expenditure + expense
Cost accounting helps the management foresee the cost price and selling price
of a product or a service, which helps them formulate business policies. With
cost value as a reference, the management can produce techniques to control
costs with an aim to achieve maximum profitability. Cost accounting
techniques help in determining the total per-unit cost of a product or a service,
so that the business can fix the selling price for it.
Sunk cost- In economics and business decision-making, a sunk cost (also
known as retrospective cost) is a cost that has already been incurred and
cannot be recovered.
Opportunity cost-Opportunity cost measures the impact of making one
economic choice instead of another. Or the cost of next best alternative
Marginal cost- the cost added by producing one additional unit of a product or
service.
Incremental/Differential Cost- Differential Cost or Incremental Cost is
the difference in total relevant cost between two alternatives.
Out of Pocket Cost-Out-of-pocket expenses refer to costs that individuals pay
out of their own cash reserves.
Traceable and untraceable Costs- TRACEABLE OR UNTRACEABLE COSTS Costs
which can be easily identified with a department, process or product are
termed as traceable costs. Example: the cost of direct material, direct labour
etc. Costs which cannot be so identified are termed as untraceable or common
costs. In other words common costs are costs incurred collectively for a
number of cost centres and are to be suitably apportioned for determining the
cost of individual cost centres. Example: overheads incurred for a factory as a
whole etc.
Relevant and Irrelevant Costs- Irrelevant costs are costs, either positive or
negative, that would not be affected by a management decision. Irrelevant
costs, such as fixed overhead and sunk costs, are therefore ignored when that
decision is made. Relevant costs are affected by a managerial choice in a
certain business situation. In other words, these are the costs which shall be
incurred in one managerial alternative and avoided in another. Example future
cash flow, opportunity cost
Product costs and Period costs- Product costs are any costs incurred in the
manufacture of a product. These costs include direct materials, direct labor,
and factory overhead. A period cost is any cost consumed during a reporting
period that has not been capitalized into inventory, fixed assets, or prepaid
expenses
Imputed or Hypothetical costs- Imputed Costs are hypothetical notional costs
which is not recorded in the books of accounts or which is not paid in cash or
kind. This costs also refer as implicit costs or hidden costs which is not needed
to report on the financial statement of the company as a separate costs.
Example interest on capital, rent on building
Controllable and Non-controllable Costs- Controllable cost is an expense that
can be increased or decreased based on a particular business decision. In other
words, the management has the power to influence such decisions. These
costs can be altered in the short term. Uncontrollable cost is a cost that cannot
be increased or decreased based on a business decision. In other words, it is an
expense that a manager has no power to influence. Many uncontrollable costs
can only be altered in the long term.
Normal and Abnormal Costs- Normal Cost are the normal or regular costs
which are incurred in the normal conditions during the normal operations of
the organization. They are the sum of actual direct materials cost, actual
labour cost and other direct expense. Example: repairs, maintenance, salaries
paid to employees. Abnormal Cost are the costs which are unusual or irregular
which are not incurred due to abnormal situation s of the operations or
productions. Example: destruction due to fire, shut down of machinery, lock
outs, etc.
Types of Costing
 Unit Costing- This method is followed by concerns producing a single
article or a few articles which are identical and capable of being
expressed in simple, quantitative units. This is used in industries like
mines, quarries, oil drilling, cement works, breweries, brick works etc.
 Job Costing- Job costing is used where production is not repetitive and is
done against orders. The work is usually carried out within the factory.
Each job is treated as a distinct unit, and related costs are recorded
separately.
 Contract Costing- A contract is a big job and, hence, takes a longer time
to complete. For each individual contract, account is kept to record
related expenses in a separate manner. It is usually followed by concerns
involved in construction work e.g. building roads, bridge and buildings
 Process Costing- Where an article has to undergo distinct processes
before completion, it is often desirable to find out the cost of that article
at each process. A separate account for each process is opened and all
expenses are charged thereon. E.g. oil, textile industry
Techniques of Costing
• Marginal Costing- It refers to the ascertainment of costs by
differentiating between fixed costs and variable costs. In this technique
fixed costs are not treated as product costs. They are recovered from the
contribution
• Absorption Costing-traditional method of costing where the fixed cost
and variable cost both are allotted to cost units which is not correct
method but cost plus pricing issues all the costs are covered
 Total (Absorption) Costing Method
Product Product Y Total
X Rs. Rs.
Rs.
Sales 7,500 12,000 19,500
Direct Materials 2,200 3,200 5,400
Direct Wages 1,500 4,500 6,000
Variable 1,000 3,000 4,000
Overheads 500 1,500 2,000
Fixed Overheads 5,200 12,200 17,400
Total Costs 2,300 (-200) 2,100
Profit Loss

 Uniform Costing- Uniform costing is a financial practice that uses

standardization to create comparisons cross an industry or among the
branches of large business. Uniform costing insures that everyone uses
the same methods report financials.
 Standard Costing- Standard cost is a predetermined cost which is
computed in advance of production on the basis of a specification of all
factors affecting costs. The standards are fixed for each element ofcost.
To find out variances, the standard costs are compared with actual costs.
 Activity based costing- ABC is a methodology that assigns cost to
activities rather than products or services, this enables resources and
overhead cost to be more accurately assigned to products and services
that consume them. Organisations who wants to know the total cost to
make a product with precise accuracy will have to use ABC method.
KEY TERMS IN ABC
1. Activity - Refers to an event that incurs cost.Eg: production
2. Cost object - It is an item for which cost measurement is required. Eg:
product
3. Cost driver - It is a factor that causes changes in the cost of the
activity. Eg: direct labour hours worked
4. Cost pool - It represents a group of various individual cost items. Eg:
cost of maintenance
STAGES IN ACTIVITY BASED COSTING
1. Identify the different activities within the organisations.
2. Relate the overheads to the activities.
 3. Support activities are then spread across the primary activities.
4. Determine the activity cost drivers. ( wages , labour hours ,etc)
5. Calculate activity cost driver rates for each activity.
Activity cost driver rate = Total cost of activity/ Activity driver
ADVANTAGES OF ABC
1) Most accurate costings of products/services.
2) Overhead allocation is done on logical basis.
3) It enables better pricing policies by supplying accurate cost information.
4) Utilises unit cost rather than just total cost.
5) It highlights problem areas which require attention of the management.
LIMITATIONS OF ABC
1) It is more expensive particularly in comparison to traditional costing
system.
2) It is not helpful to small organisations. It may not be applied to
organisations with very limited products.
3) Selection of most suitable cost driver may not be useful.
Cost Center – Is a production or service location center where the costs are
accumulated. The cost of operating the cost center is determined for the
period and then this cost is related to cost units which have passed through
the cost center Ex: Power house, stores, canteen
Cost Unit – Unit of product or service in relation to which cost is ascertained
i.e. a quantitative unit Ex: One brick, one call, one kwhr, one student
ELEMENTS OF COSTING- The elements of cost are those elements which
constitute the cost of manufacturing of a product. These elements of cost is
broadly divided into three types:
1. Material: Direct Material and Indirect Material
2. Labour: Direct Labour and Indirect Labour
3. Expenses: Direct Expenses and Indirect Expenses / Overheads
Direct Material: The raw materials that become part of the product. It is a cost
of materials which enter into and form part of finished product.
Indirect Material: It is the cost of material which do not form part of product
but necessary in production process but not become integral part of product.
Direct labour: are the wages paid to employees engaged in converting raw
material in finished product.
Indirect Labour: Wages paid to employees those who are not engaged in
production process. E.g.: Security guard.
Direct Expenses: Expenses which are specifically incurred in a particular job or
product.
Indirect Expenses: All the indirect costs other than indirect material and
indirect labour are indirect expenses. e.g., telephone bill, rent, insurance etc.
Factory Overhead: is the cost incurred during the manufacturing process, that
are not including the costs of direct material and direct labour. E.g. factory rent
insurance etc.
Administrative Overhead: are those costs not involved in the development or
production of goods or service. E.g. front office salaries, commissions etc.
Selling and Distribution Overhead: E.g. sales office expenses, advertisement ,
sales manger’s salary , travel expenses etc.
TYPES OF COSTS IN COST ACCOUNTING
Fixed cost: These are costs that do not change based on the number of items
produced.
Variable cost: These costs are tied to a company’s level of production.
Indirect Cost: Indirect costs often cannot be traced back to an individual
department.
Direct costs: These costs can be directly associated with production.
PRIME COST:
Prime Cost =Direct Material+Direct Labour+Direct Expenses
WORK COST:
Work Cost=Prime cost+factory overhead+(op.stck of Work In Progess - cl.stock
of Work In Progress)
COST OF PRODUCTION:
Cost of Production = Work Cost + Administration Overhead
TOTAL COSTS
Total Cost= Cost of Production of Goods Sold + Selling and Distribution
Overhead
Profit=Sales-Total Cost
Manufacturing Costs: Materials Labour Factory rent Depreciation Power &
lighting Insurance Stores Keeping
Administration Costs: Accounts office expenses Audit fees Legal expenses
Office rent Director's remuneration Postage
Selling Costs: Advertising Salaries & Commissions of salesmen Showroom
expenses Samples Travel expenses Distribution Costs
Packing costs Carriage outward Warehousing costs Upkeep and running costs
of delivery vans
Break-even analysis is a technique widely used by production management
and management accountants. It is based on categorizing production costs
between those which are "variable" (costs that change when the production
output changes) and those that are "fixed" (costs not directly related to the
volume of production). Total variable and fixed costs are compared with sales
revenue in order to determine the level of sales volume, sales value or
production at which the business makes neither a profit nor a loss (the "break-
even point").
 Particulars Of Cost Amount Per Unit
(Rs.) (Rs.)
Opening Stocks of Raw Materials XXX XXX XXX
Add : Purchase of Raw Materials XXX XXX XXX
XXX XXX XXX
Less : Closing Stock of Raw Materials XXX XXX XXX
Material consumption XXX XXX
Direct Labour XXX XXX
Direct Expenses XXX XXX
Prime Cost XXX XXX
Factory Overheads XXX XXX
Add: Opening Work-in-Progress XXX XXX
Less : Closing Work-in-Progress XXX XXX
Less : Sale of By-Products or Scrap XXX XXX
Factory Cost XXX XXX
Administration Overheads XXX XXX
Cost Of Production XXX
Add : Opening Stock of Finished goods XXX
Less: Closing Stock of Finished goods XXX
Cost of Goods Sold XXX
Selling and Distribution Overheads
Cost of Sales
Profit
Sales

contribution is the excess of sales over variable cost which is also known as
total margin
Formulas
1. Sales – V.C – F.C= PROFIT
2. CONTRIBUTION- F.C = PROFIT
3. CONTRIBUTION – F.C = 0 (at BEP)
4. CONTRIBUTION = (Total Revenue- Variable costs)/units sold.
5. BREAK EVEN POINT (UNITS) = F.C/CONTRIBUTION
6. BREAK EVEN POINT (SALES)= BEP units * S.P or F.C/PV RATIO
7. P/V RATIO is profit volume ratio = (CONTRIBUTION/SALES)*100
8. DESIRED PROFIT (units)= (F.C+ DESIRED PROFIT)/CONTRIBUTION
9. DESIRED PROFIT(sales)= (F.C+ DESIRED PROFIT)/PV RATIO
10.MARGIN OF SAFETY= ACTUAL SALES – BEP(sales) or PROFIT/PV RATIO
 Responsibility accounting- Responsibility accounting is a type of management
accounting in which a company's management, budgeting, and internal
accounting are all held accountable. The fundamental goal of this accounting is
to assist all of a company's planning, costing, and responsibility centers.
Objectives of Responsibility Accounting
• Each responsibility center is given a target, which is communicated to
the relevant management level.
• At the end of the time period, there is a comparison between the target
and the actual performance.
• The variations that are detected in the budgeted plan are examined for
fixing responsibility to the center.
• Due measures are taken by the top management which is
communicated to the responsible personnel.
• The responsibility for costs does not include the policy costs and various
other apportioned costs.
A variance in accounting is the difference between a forecasted amount and
the actual amount. Variances are common in budgeting, it can be favourable or
adverse
Types of variance in costing
• Material variance
• labour variance
• overhead variance
• purchase variance
• sales variance
material variance- The following variances constitute materials variances:
1. Material Cost Variance: Material cost variance is the difference between
the actual cost of direct material used and stand-ard cost of direct
materials specified for the output achieved. This variance results from
differences between quantities consumed and quantities of materials
allowed for production and from differences between prices paid and
prices predetermined.
Material cost variance = (SQ X SP)- (AQ X AP)
Where AQ = Actual quantity, AP = Actual price, SQ = Standard
quantity for the actual output, SP = Standard price
II. Material Usage Variance: The material quantity or usage variance results
when actual quantities of raw materials used in production differ from
 standard quantities that should have been used to produce the output
achieved. It is that portion of the direct materials cost variance which is due
to the difference between the actual quantity used and standard quantity
specified. A material usage variance is favourable when the total actual
quantity of direct materials used is less than the total standard quantity
allowed for the actual output. The materials usage or quantity variance can
be separated into mix variance and yield variance.
Materials usage variance = (Standard Quantity- Actual Quantity) x Std. Price
(a) Material Mix Variance: A mix variance will result when
materials are not actually placed into production in the same
ratio as the standard formula. For instance, if a product is
produced by adding 100 kg of raw material A and 200 kg of raw
material B, the standard material mix ratio is 1: 2. Actual raw
materials used must be in this 1: 2 ratio, otherwise a materials
mix variance will be found. Material mix variance is usually
found in industries, such as textiles, rubber and chemicals, etc.
A mix variance may arise because of attempts to achieve cost
savings, effective resources utilisation and when the needed
raw materials quantities may not be available at the required
time
Material mix variance = std. price*(revised std. quantity – actual quantiy)
𝐭𝐨𝐭𝐚𝐥 𝐪𝐮𝐚𝐧𝐭𝐢𝐭𝐲 𝐨𝐟 𝐚𝐜𝐭𝐮𝐚𝐥
Revised std quantity= ×std. quantity
𝐭𝐨𝐭𝐚𝐥 𝐪𝐮𝐚𝐧𝐭𝐢𝐭𝐲 𝐨𝐟 𝐬𝐭𝐝
(b) Materials Yield Variance: Materials yield variance explains the
remaining portion of the total materials quantity variance. It is
that portion of materials usage variance which is due to the
difference between the actual yield obtained and standard
yield specified (in terms of actual inputs.
Yield Variance = std. price*(std. loss – actual loss)
III. Materials Price Variance: A materials price variance occurs when raw
materials are purchased at a price different from standard price. It is that
portion of the direct materials which is due to the difference between
actual price paid and standard price specified and cost variance multiplied
by the actual quantity. Expressed as a formula,
Materials price variance = (Standard price -Actual price ) x Actual quantity

Verification 1= 2 + 3 & 2 = a + b
MATERIAL PRICING
• FIFO – The First-in First-out (FIFO) method of inventory valuation is
based on the assumption that the sale or usage of goods follows the
same order in which they are bought. In other words, under the first-in,
first-out method, the earliest purchased or produced goods are
sold/removed and expensed first. Therefore, the most recent costs
remain on the balance sheet, while the oldest costs are expensed first
Date Receipt issue Balance
quant rate Amt. quant rate Amt. quant rate Amt.

1stoct 10000 10 100000

7thoct 4000 12.50 50000 10000 10 100000

4000 12.50 50000

14thoct 6000 15 90000 10000 10 100000

4000 12.50 50000
6000 15 90000

16thoct 10000 10 100000 4000 15 60000

4000 12.5 50000
2000 15 30000

24th oct 8000 16.50 132000 4000 15 60000

8000 16.50 132000
28th oct 4000 15 60000 2000 16.50 33000
6000 16.50 99000
• WEIGHTED AVERAGRE- Weighted average inventory is the costing
method that allocated equal cost to all inventory. It is the method that
 determines the amount of Cost of goods sold on income statement and
remains inventory in the balance sheet. At the end of the month, some
inventory may remain in the store, and some are sold to the customers.
We can the quantity of inventory from physical count or system
generated. The quantity of inventory is the same, but its valuation may
be different if we apply different methods.
Rate = previous amount/ previous quantity
Date Receipt Issue Balance
quant rate Amt. quant Rate Amt. quant Amt.

2ND oct 2000 10 20000 2000 20000

6th oct 300 12 3600 2300 23600
9th oct 1200 23600/2300=10.26 12312 1100 11288
10thoct 200 14 2800 1300 14088
11th oct 1000 14088/1300=10.8 10840 300 3248
22th oct 300 11 3300 600 6548

31st oct 200 6348/600=10.91 2182 400 4366

• Labour Cost Variance=

(Standard hours X Standard Rate) – (Actual hours X Actual Rate)
• Labour Rate Variance = Actual Hours (Standard Rate - Actual Rate)
 • Labour Efficiency Variance =
Standard Rate(Standard hours for actual output - Actual hours)
• Labour Mix Variance =
(Revised Standard – Actual Hours Worked) X Standard Rate
𝑡𝑜𝑡𝑎𝑙 𝑎𝑐𝑡𝑢𝑎𝑙 𝑡𝑖𝑚𝑒
Revised std. time = × std. time
𝑡𝑜𝑡𝑎𝑙 𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑡𝑖𝑚𝑒
• Labour Yield Variance=
(std. yield – actual yield) X Standard labour cost per unit of output
• Idle Time Variance = Idle Hours * Standard rate
Transfer pricing
Transfer pricing is an accounting practice that represents the price that one
division in a company charges another division for goods and services
provided. Transfer pricing allows for the establishment of prices for the goods
and services exchanged between subsidiaries, affiliates, or commonly
controlled companies that are part of the same larger enterprise. Transfer
pricing can lead to tax savings for corporations, though tax authorities may
contest their claims. Methods of transfer pricing-
• Comparable Uncontrolled Price Method- The comparable uncontrolled
price (CUP) method compares the price and conditions of products or
services in a controlled transaction with those of an uncontrolled
transaction between unrelated parties. To make this comparison, the
CUP method requires what’s known as comparable data. In order to be
considered a comparable price, the uncontrolled transaction has to
meet high standards of comparability. In other words, transactions must
be extremely similar to be considered comparable under this method.
• The Resale Price Method- The resale price method (RPM) uses the
selling price of a product or service, otherwise known as the resale price.
This number is then reduced with a gross margin, determined by
comparing the gross margins in comparable transactions made by similar
but unrelated organizations. Then, the costs associated with purchasing
the product—such as customs duties—are deducted from the total. The
final number is considered an arm’s length price for a controlled
transaction made between affiliated companies
• The Cost Plus Method- The cost plus method (CPLM) works by
comparing a company’s gross profits to the overall cost of sales. It starts
by figuring out the costs incurred by the supplier in a controlled
transaction between affiliated companies. Then, a market-based
markup—the “plus” in cost plus—is added to the total to account for an
 appropriate profit. In order to use the cost plus method, a company
must identify the markup costs for comparable transactions between
unrelated organizations.
• The Comparable Profits Method- The comparable profits method
(CPM), also known as the transactional net margin method (TNMM),
helps determine transfer prices by looking at the net profit of a
controlled transaction between associated enterprises. This net profit is
then compared to the net profits in comparable uncontrolled
transactions of independent enterprises
LABOUR COST control

Direct Labor Costs: The cost of remuneration for an employee’s efforts and
skills applied directly to a product or saleable service”. For example, in
furniture making, the wages paid to the carpenter is direct labor cost.
Cost of direct labor allocated = (Total direct labor cost/Total man-hours
employed) × Man hours on specific product
Indirect Labor Costs: Indirect labor cost means “wages cost other than direct
wages”. In other words, indirect labor expenses are those that cannot be
directly linked to cost units. E.g.- Supervisors, repairmen, and inspectors are
among the workers., Maintenance employees, such as mechanics, workshop
cleaners, and so on., Employees who work in purchasing, retail, manufacturing
offices, timekeeping, and canteens, among other things.
Indirect labor costs might be fixed or variable based on the circumstances.
Moreover, it's just as crucial to keep track of indirect labor expenditures as it is
of direct labor costs. Indirect labor, on the other hand, is recorded as overhead
rather than the cost of products sold.
Indirect labor allocated Cost = (Total indirect labor cost/Total of basis i.e.,
labor hours, machines or rent, etc.) × Basis utilized for certain product
Direct Labor Cost Indirect Labor Cost
Direct labor may be identified It cannot be traceable or identified.
or traceable to a specific cost
center or cost unit.
In the production process, Indirect labor is not involved in the
direct labor is directly manufacturing process directly.
involved.
Direct labor can be assigned Indirect labor cannot be fully allocated or
to a cost center or charged charged to any cost center.
entirely to it.
Direct labor produces a Indirect labor does not produce a productive
productive operation operation.
Direct labor costs are an Indirect labor costs are not an important
important component of total component of total production cost.
production costs.
Direct labor costs vary in Indirect labor costs do not change
direct proportion to proportionally to production.
production.
It's simple to calculate direct It's more difficult to assess indirect labor
labor costs. costs.
The cost of direct labor can be Indirect labor costs, on the other hand, are
easily regulated difficult to manage.
To keep direct labor costs Budgetary control is used to keep indirect
under control, the standard labor costs under control.
costing technique is applied.
Direct labor costs are Indirect labor costs are included in
included in the direct cost or overheads, such as administrative overhead,
prime cost. factory overheads, or sales and distribution
overhead.
Labor turnover calculation-
• Calculating Labour Turnover by Separation Method- Under the Separation
Method, the relationship between the number of workers separated or left
from the organization and average number of workers of the organization
in the period is expressed in terms of percentage. A worker may be left or
separated from the organization due to surplus workers, poor working
conditions and wages, less chance for promotion and the like.
Labour Turnover = No. of workers left or separated during a period /
Average number of workers on role during that period x 100
Average No.of. Workers = (No. of workers at the beginning of the period +
No. of workers at the end of the period) / 2
• Calculating Labour Turnover by Replacement Method- There is no need of
replacement if the surplus workers left from the organization. The workers
whose services are required by the organization are to be replaced by new
 appointments if they leave. Hence, the relationship between the number of
workers replaced and average number of workers of the organization in a
period is expressed in terms of percentage under the replacement method.
Generally, the replacement of labour is followed by the organization if
skilled labourers are left from the organization. The following formula is
used to measure the labour turnover by replacement method.
Labour Turnover = No. of workers replaced during a period / Average number
of workers on role during that period x 100
• Calculating Labour Turnover by Flux Method- This is the combination of
separation method and replacement method. Both separation and
replacement are taken into consideration to calculate labour turnover in
Flux method. Hence, the relationship between both separation and
replacement of labour force of the organization in a period and average
number of workers on roll during that period is expressed in terms of
percentage. The following formula is used to calculate labour turnover by
flux method.
Labour Turnover = (No.of workers separated in a period + No. of workers
replaced in the same period) / Average number of workers on role during
that period x100

𝐥𝐚𝐛𝐨𝐮𝐫 𝐭𝐮𝐫𝐧𝐨𝐯𝐞𝐫 𝐫𝐚𝐭𝐞

Equivalent annual rate = ×365or52or30
𝒑𝒂𝒚𝒔 𝒊𝒏 𝒅𝒂𝒚𝒔 𝒐𝒓 𝒘𝒆𝒆𝒌𝒔 𝒐𝒓 𝒎𝒐𝒏𝒕𝒉𝒔
Methods of remuneration
• TIME RATE SYSTEM- Time Rate System is otherwise called as Time Work,
Day Work, Day Wages and Day Rate. It is the oldest method of
remuneration. The time rate system is that system of wage payment in
which the workers are paid on the basis of time spent by them in the
factory. Under this system, the workers and employees are paid wages on
the basis of the time they have worked rather than the volume of output
they have produced. The wage rate is fixed on hourly, daily weekly,
fortnightly or monthly on the basis of the nature of work. The time is the
prevalent rate of the industry or area. The rate may either be a fixed one or
there may be a progressive scale of pay that starts at minimum and rises up
to a maximum, in various stages by way of increments.
Time Rate System Formula- This time rate system calculation is based on the
working hours of the employee, that is the amount of time spent on the work
along with the amount of work delivered within the specific period of time.
And the actual formula that helps to calculate the total amount by using this
formula:
Formula: Wages= Total hours worked X Wages rate per hour.
PIECE-RATE SYSTEM- This is that system of wage payment in which the
workers are paid on the basis of the units of output produced. This system
does not consider the time spent by the workers. Piece rate system is the
method of remunerating the workers according to the number of unit
produced or job completed. It is also known as payment by result or output.
Piece rate system pays wages at a fixed piece rate for each unit of output
produced. Piece-rate pay is also sometimes referred to as Payment by Results
System. The total wages earned by a worker is calculated by using the
following formula.
Total Wages Earned= Total units of outputs produced x Wage rate per unit of
output.
OR
Total Wages Earned= Output x Piece Rate
Incentives/bonus system
Incentive bonus schemes of two types:.
• Individual Incentive Bonus Scheme:
1. Time-Based Individual Incentive Bonus Scheme:
I. Halsey’s Time-Based Incentive Bonus Plan: Incentive Bonus
based on Time Saved in Performing Standard Task: Time-based
incentive bonus plan was formulated by Frederick A Halsey It is
a simple combination of time and piece wage plan. Under this
plan, bonus is paid to a worker if he performs any task, process
or operation in less time than the standard time prescribed for
the purpose. There is no bonus if he consumes the standard
time in completing the assigned task and even if he completes
more than the assigned task. He will only be paid wage
calculated as per fixed time rate. Bonus will become payable to
him only if he completes the assigned task in less than the
standard time. The bonus in such a case will be calculated at
equal to 50% of the value of the time saved. The worker will
get the bonus even if he takes more than the standard time in
performing another task. Halsey’s plan divides the benefit of
increased productivity between the employer and the worker
on an equal basis.
Calculation of Bonus under Halsey Plan:
A worker’s bonus and total earnings in the Halsey plan are calculated as
follows:
Bonus = 50% (Timed saved × Time rate)
Total earning = Time rate × Time taken + 50% of
(Time saved x Time rate)
Merits of Halsey Plan:
✓ It is easy to understand and simple to implement.
✓ It guarantees a minimum wage to all. Thus, untrained or relatively
inefficient workers will have nothing to lose.
✓ The benefit resulting from saving in time is equally divided between
employer and the worker.
✓ Bonus in respect of each job is not allowed to be adjusted against
excess time taken by him on another job.
✓ It encourages workers to improve their performance level.
Demerits of Halsey Plan:
✓ Efficiency of worker is not fully rewarded. In fact, after a point, he has
no incentive to work harder.
✓ It is not favoured by employers because if the normal wage rate itself is
high, payment of bonus will create additional burden for them.
✓ It does not do justice to efficient workers. The time saved is wholly due
to their efficiency and hard work, the employer unjustly takes away 50%
of the resulting benefit.
II. Rowan’s Time-Based Incentive Bonus Scheme: Similar to
Halsey Plan Except for Difference in Calculation of Bonus: Time-
based incentive bonus plan formulated by James Rowan is
similar to the Halsey plan. The only difference is in the method
of calculation of bonus. Thus, under Rowan plan, if the worker
completes the work in less than the standard time, then in
addition to the hourly rate of wage, he receives a bonus equal
to that proportion of the wages of time actually taken which
time saved bears to the standard time.
Calculation of Bonus and Total Earnings under Rowan Plan:
Bonus = Standard time (S) minus Actual time taken (T) divided by Standard
time (S) and multiplied by Actual time taken (T) × Hourly rate (R)
Total earning = Actual time taken (T) × Hourly rate (R) + Standard time (S) –
Actual time taken (T) divided by Standard time (S) × Actual time taken (T) ×
Hourly rate (R).
Merits of Rowan Plan:
✓ Like Halsey plan, Rowan plan provides the worker a guaranteed
minimum wage as also an incentive to work better.
✓ It is favoured by employers for the reason that bonus can never reach
100% of the time wage which is likely under the Halsey Plan.
✓ It is preferred by employers because they get a larger share of benefits
arising from the time saved, and they can increase production to any
limit.
✓ It discourages the worker from over-exerting himself. This is because up
to 50% of the standard time saved by him in performing the task, he
become entitled to a larger amount of bonus as compared to the Halsey
plan, but if he saves more than 50% of the standard time, there is a
gradual decrease in the amount of bonus.
Demerits of Rowan Plan:
✓ Workers find it difficult to understand the calculation of bonus under
the Rowan plan. They may suspect the employer’s motive in working
the plan.
✓ It lacks simplicity and involves high costs of operation.
✓ It is unjust to efficient workers. This is because it rewards them
adequately only to the extent that the time saved by them is 50% of the
time allowed. If a worker exceeds this point, the amount of bonus in his
case would gradually decline.
III. Emerson’s Output-Based Incentive Bonus Plan: Main Features
of Emerson’s Plan:
✓ Minimum day wage is guaranteed to each worker.
✓ The standard output fixed in the case of each category of worker is
regarded as the sign of 100% efficiency.
✓ A worker becomes eligible for bonus only after his output exceeds two-
thirds (66.67%) of the standard output.
✓ The amount of bonus increases in a pre-determined ratio, and it may go
up to, and even exceed 100% efficiency level. For different levels of
efficiency between 66.67% and 100% of standard output, there are
different rates of bonus. A worker producing 100% of the standard
output gets 20% over and above the minimum wage rate. For a worker
 who achieves more than 100% output, in other words, if he produces
more than the standard output, there is an extra 10% of the minimum
daily wage for every increase of 1% in production.
IV. Bedeaux’s Efficiency Bonus Plan: Standard Time Divided into
Standard Minutes, Each Minute Called Bedeaux Points, or ‘B’s:
Under the incentive bonus plan formulated by Charles Bedeaux
(1886-1944); standard time fixed for a job is divided into
standard units, called Bedeaux Points, or simply B’s. These are
supplied by experts working in the Bedeaux Company. For
determining B’s for each type of work involving different
degrees of strain, there is thorough analysis of the work and
provision is made for rest period for worker if the work is
strenuous. The B’s earned by a worker is mentioned in his job
ticket. A worker is only paid minimum day wages till he reaches
100% efficiency level. Bonus under this system is calculated as
a percentage (usually 75%) of the hourly rate for the time
saved. Obviously, bonus is paid in addition to the time rate for
the actual time taken.
2. Output-Based Individual Incentive Bonus Schemes:
I. Taylor’s Differential Wage Plan: F.W. Taylor’s wage plan is one
of the earliest incentive wage plans. It was devised as a part of
the scheme of Scientific Management. In essence, it is a piece
rate method of wage payment where the rate of payment
increases as the worker speeds up his work performance. In
this respect, it is different from other incentive bonus schemes
under which the rate falls as the work gets completed. The
Taylor System offers an even greater incentive than straight
piece-rates to the really efficient worker. Two Piece Rates for
Standard and above Standard and another for Below-Standard
Performance: The standard task is set after a careful time and
motion study. There are two piece rates—one for below
standard performance(83% of ordinary piece wage), and the
other for the standard or above-standard performance. (175%
of ordinary piece wage)
Merits of differential Wage Plan:
✓ It is easy to understand and simple to implement.
✓ It offers an attractive incentive to the efficient workers.
 ✓ It is favoured by employers because by offering higher rates to efficient
workers, they can increase the output.
✓ There is not much impact on the cost of production per unit as there is
also increase in the quantity of goods produced.
Demerits of differential Wage Plan:
✓ It strikes at the root of labour unity and solidarity. By paying a higher
rate to efficient workers and lower one to less efficient workers, it sows
the seeds of division between them. Those who are paid less are
obviously jealous of those who are paid more.
✓ It severely punishes the slow and inefficient workers. Even the slightest
fall from standard output may drastically reduce their earnings.
✓ It offers no minimum daily wage. In the event, it creates a sense of
insecurity among workers.
✓ Because there are two different rates for two different levels of
performance, it is not easy to determine the labour costs accurately.
II. Merrick’s Multiple Piece Rate Plan: Improved Version of
Taylor’s Differential Wage Plan: Merrick’s multiple piece rate
plans is less harsh on the beginners or less efficient workers;
but it is generous towards the efficient ones. Like Taylor’s plan,
here also a standard task is set for workers. The difference is in
respect of the number of piece rates. In the Taylor’s plan there
are two piece rates, while in Merrick’s there are three. Average
Rate for Less Efficient and Higher Rate for Efficient Workers:
Accordingly, the lowest rate is for beginners and less efficient
workers, i.e., those who achieve up to 83% of the standard
task(normal piece rate). For average workers, who achieve
between 83% and 100% of the standard task(110% of piece
rate),above 100% of std. work(120%)
Merits of Merrick’s Plan:
✓ It is easy to understand and simple to operate.
✓ It offers a strong incentive to the more efficient or experienced workers
and at the same time, provides the minimum needs of beginners and
less efficient workers.
Demerits of Merrick’s Plan:
✓ The lines between inefficient, average and efficient workers are rather
arbitrarily drawn, a worker achieving up to 83% of the standard output
is treated as inefficient worker, but the moment he moves up by just
 1%, he becomes an average worker. Likewise, an average worker will be
paid like an average worker until he achieves up to 100% of the
standard task. He will be paid at the rate prescribed for an efficient
worker only when he exceeds 100% of the standard task.
✓ Multiplicity of wage rates makes it impossible to accurately ascertain
the labour costs of a project.
III. Gantt’s Task Based Bonus System: The main features of the
system are:
✓ It combines three-in-one, i.e., time rate, differential piece rate and
bonus.
✓ It guarantees minimum daily wage.
✓ If the standard task is very hard to perform, it demands double the
efficiency and diligence as compared to an average worker.
✓ If the standard task is completed within the standard time, the worker
becomes entitled to bonus at a high rate. If he does not, he is not paid
any bonus.
✓ The bonus is a fixed percentage of the time taken in completing the
task.
✓ If a worker accomplishes the standard task within the stipulated time,
he is paid a bonus which is usually @ 20% of his time rate. In case his
performance is better than the standard, he is paid at a higher piece
rate on the whole of his output.
There are different types of group incentives schemes, important among
them being as follows:
4. Priestman Plan: This system of wage payment was first used by
Priestman’s of Hull in 1917. It is applied to workers who work in groups.
It provides for payment of group bonus in addition to the ordinary time
wage rate.
For example, if during any year an organization achieves the predetermined
standard output, or exceeds the previous year’s output, workers are paid
increased wages in the same ratio in which output has increased. Thus, if in
2015, the output per worker-hour was 10 units, and in 2016 it rose to 11 units
per worker-hour, the wages in 2016 would be 10% higher as compared to
wages paid in 2015.
2. Scanlon Plan:- Named after Mr. Joseph Scanlon of the United Steel Works of
U.S.A., this plan is by far the most popular for sharing gains attributable to
increase in productivity. It provides for payment of 1% participating bonus for
every 1% increase in productivity. The benefit is extended to all employees,
except the top level management.
3. Productive Bargaining:-The management and workers of an organization
may reach an agreement under which workers agree to give up negative and
wasteful practices such as “go-slow” and “work-to-rule” and, in return, the
management agrees to link wages and concessions to resulting increase in
productivity.
(4) Co-Partnership:- Under co-partnership arrangement, senior and highly-paid
workers are given an option to buy shares of the organization at concessional
price and pay for it in instalments. The recently developed concept of sweat
equity works along the same lines.
Merits of Group Incentive Bonus Schemes:
• Promotion of Spirit of Cooperation and Team-Spirit:-Group bonus
schemes create a ‘one for all and all for one’ feeling among workers.
They help one another in performance of the assigned tasks, being
aware that this will enable the organization to earn increased profits
and distribute a part of it as bonus among workers.
• Low Absenteeism among Workers: Group incentive bonus scheme
promotes a spirit of co-operation and team-work among workers. They
rarely, if ever, absent themselves from work for fear of criticism from
co-workers and a genuine apprehension that their absence from work
will harm their individual as well as group interests.
• Reduction of Expenditure on Clerical Work: Group incentive bonus
schemes result in saving on expenditure on maintaining records of
output of individual workers. This is because the record of output of a
group, and not of its individual members, needs to be maintained.
• Minimum Expenditure on Supervision of Workers: Group incentive
bonuses schemes help reduce the cost of supervision. In fact, they turn
every worker into an alert and active supervisor himself. As it happens,
lazy and inefficient workers are better supervised by co-workers, than
by a supervisor especially appointed for the purpose.
• Beneficial for Indirect Workers too: Often the coverage of incentive
bonus schemes is extended to workers who do not directly contribute
to performance of the standard tasks. They are made members of one
group of workers or another.
Demerits of Group Incentive Bonus Schemes:
• Unfair to Sincere, Efficient and Ambitious Workers: Group incentive bonus
schemes do not discriminate between competent and sincere workers and
those who do not pass this test. Sincere hardworking workers have to suffer
low amount of bonus because of laziness or inefficiency of their fellow-
workers.
• Sincere, Hardworking Workers Not Favourably Inclined: Workers,
particularly the hard-working and efficient among them, are not inclined to
accept such schemes. Why, they justifiably ask, under-performers should
enjoy the right to share in the gains largely attributable to their performer
colleagues?
• Difficult to Frame a Reasonable Scheme: It is not easy to determine the
amount of incentive bonus for each group and fix the amount of incentive
for each group and evolve an acceptable formula for its distribution.
• Amount of Bonus Not Sufficiently Motivating: The amount of bonus per
individual may turn out to be too small, and therefore lose its motivational
value.
Overhead costs
Costs-
1. Prime cost- Prime Cost (or Flat Cost or First Cost) in managerial
accounting is the direct cost that the company incurs in manufacturing a
product or providing a service.
✓ direct material
✓ direct labour
✓ direct expenses
2. overhead costs- overhead or overhead expense refers to an
ongoing expense of operating a business. Overheads are
the expenditure which cannot be conveniently traced to or identified
with any particular revenue unit, unlike operating expenses such as raw
material and labor. Therefore, overheads cannot be immediately
associated with the products or services being offered, thus do not
directly generate profits. However, overheads are still vital to business
operations as they provide critical support for the business to carry out
profit making activities
✓ indirect material
✓ indirect labour
✓ indirect expenses
Overhead distribution-
✓ classification of overheads
 ✓ Allocation and Apportionment of Overhead
✓ Apportionment of Service Departments Overhead to Producing
Departments
Example
Primary Distribution:
Some overhead costs can be directly identified with a particular department or
cost centre as having been incurred for that cost centre. These items of
overhead cannot be traced to products or jobs but can be allocated specifically
to departments. Examples of such overhead costs are repairs and maintenance
expenses incurred in specific departments, supervision, indirect labour,
overtime, indirect materials and factory supplies, equipment depreciation.
Expenses, such as power, light, rent, depreciation of factory building, expenses
shared by all departments, cannot be charged directly to a department, be it
production or service. They are incurred for all and must, therefore, be
apportioned or prorated to any or all departments using such items. Cost
apportionment is the process of charging expenses in an equitable proportion
to the various cost centres or departments.
Secondary Distribution:
The primary distribution of factory overhead apportions all overhead costs to
the different departments or cost centres — production and service
departments. It is necessary that overhead costs of service departments
(accumulated through direct allocation or primary distribution) should be
further assigned to producing departments.
This is due to the reason that service departments do not themselves
manufacture anything and it is the production departments or cost centres
which are involved in manufacturing activities. The reassignment or
reapportionment of service departments overhead to producing departments
or centres is termed as secondary distribution.