III YEAR VI SEMESTER COURSE CODE: 4BCO6C2 CORE COURSE XVII MANAGEMENT ACCOUNTING

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1 III YEAR VI SEMESTER COURSE CODE: 4BCO6C2 CORE COURSE XVII MANAGEMENT ACCOUNTING Unit I Management Accounting Meaning Definition Objectives Cost Accounting Vs Financial Accounting Vs Management Accounting Unit II Financial Statements Analysis and Interpretation Accounting Ratios Significance, Utility and Limitations Analysis for Liquidity, Profitability and Solvency Unit III Fund Flow and Cash Flow Analysis Forecasting of Fund Requirements Unit IV Budgets and Budgetary Control Objectives and Advantages Limitations Master Budget and Financial Budgets Flexible Budget Cash Budget Preparation of various types of Budgets Unit V Standard Costing and Variance Analysis (Simple problems only) Marginal Costing Meaning, Objectives, Advantages and Limitations Breakeven Point (Simple Problems only)

2 MANAGEMENT ACCOUNTING Unit-I Meaning: The term management accounting refers to accounting for the management. It provides necessary information to assist the management in the creation of policy and in the da-to-day operations. It enables the management to discharge all its functions efficiently with the help of accounting information. Definition: Anglo American Council of Productivity defines, Management accounting is the presentation of accounting information in such a way as to assist management in the creation of policy and in the day- to-day operations of and undertaking. Objectives: 1. To assist the management in promoting efficiency. 2. To prepare budgets covering all functions of a business. 3. To analyse monetary and non-monetary transactions. 4. To compare the actual performance with budgeted performance. 5. To interpret financial statements to formulate future policies. 6. To arrange for the systematic allocation of responsibilities. 7. To provide a suitable organisation for discharging the responsibilities. Functions of management accounting: 1. Forecasting 2. Organising 3. Co-ordinating 4. Controlling 5. Analysis and Interpretation 6. Communicating Installation of Management Accounting System: 1. Organisational Manual for the entire organisation must be drafted and adopted. 2. Proforma for various types of statements and reports must be designed and prescribed. 3. Financial Accounts and cost Accounts should be classified, codified and integrated. 4. Cost centres, investment centres, profit centres and budget centres should be clearly set up. 5. The technique of standard costing are introduced for setting up standards. 6. The system of budget, budgeting, budgetary control should be introduced in the organisation.

3 Advantages: 1. Helps in decision making 2. Helps in planning 3. Helps in Organising 4. Facilitates Communication 5. Helps in Co-ordinating 6. Evaluation and control of performance 7. Interpretation of Financial Information 8. Economic Appraisal Limitations: 1. It derives information from past records. If past records are not reliable, it will affect the effectiveness of management accounting. 2. It has a wide scope.it will result in inaccuracy and other practical difficulties. 3. Installation of management accounting system requires large organisation. Hence it is very costly. 4. Management accounting is still in the initial stage. 5. Management accounting will not replace the management and accounting. Decisions are of management and not of the management accountant. Difference between management accounting and fianancial accounting: Content Management Accounting Financial Accounting 1. Objectives The objective of management accounting is to provide The aim of financial accounting is to supply information to information for the internal use outside parties. of management 2. Performance Analysis It is concerned with the departments or divisions. It is concerned with the overall performance of the business. 3. Data used It is concerned with future plans and policies. It is mainly concerned with the recording of past events. 4. Nature Management accounting is It is based on measurement. based on judgement. 5. Accuracy Approximations are widely used. Accuracy is very important 6. Legal Compulsion Management accounting is only optional 7. Monetary Transactions It includes both monetary and non-monetary transactions. Financial accounting is compulsory for all joint stock companies. It records only monetary transactions. Difference between Cost accounting and Management accounting:

4 Cost accounting Management accounting 1. It is to determine and record the cost of production of a product or service It is to provide information for planning and controlling. 2. It is based on past and present facts and figures It deals with future plans 3. It requires some principles and procedures No such proceedures 4. Only quantitative data are available Both quantitative and qualitative data are used 5. Facts provided are useful for outsiders and management Facts provided are useful to management only Tools of Management Accounting: Unit-II 1. Marginal costing 2. Standard costing 3. Budgetary control 4. Ratio analysis 5. Fund flow analysis 6. Cash flow analysis Fund Flow Statement: Meaning of Fund: The term fund refers to Net working capital. It is the difference between current assets and current liabilities. In a narrow sense it means cash only. Flow of Fund: The term flow means change.therefore flow of fund means change in funds or change in working capital. Any increase or decrease in working capital involves flow of funds. Fund Flow Statement: The Fund Flow Statement is a report on the movement of funds or working capital. It explains how working capital is raised and used during an accounting period. Definition: A Statement of sources and application of funds is a technical device designed to analyse the changes in the financial condition of a business enterprise between two dates. Objectives: 1. To show how the resources have been obtained and used.

5 2. To indicate the results of current financial management. 3. To show how the general expansion of the business has been financed. 4. To indicate the relationship between profits from operations. 5. To have an assessment of the working capital position of the concern Significance of Fund Flow Statement: 1. Analysis of financial operations. 2. Evaluation of the Firm s financing. 3. Allocation of scare resources. 4. Helps in working capital management. 5. Act as a guide to Future. 6. Helps Financial Institutions. Limitations: 1. It is not an original statement. It is only a re-arrangement of financial data. 2. It provides only some additional information regarding changes in working capital. 3. It shows only the past position and not the future. 4. Changes in cash are more important than the working capital. 5. It cannot reveal continuous changes. 6. It is not an ideal tool for financial analysis. The following are sources and application of funds: Sources of Fund Issue of shares and debentures Raising of long term loans Income from investment Sale of fixed assets and long term investment Funds from operation Public deposit accepted Application of Fund Redemption of shares and debentures Repayment of loans Purchase of long term investment Purchase of fixed assets Funds lost in operation Payment of dividend and taxes Drawings Steps for preparing Fund Flow Statement: 1. Statement showing changes in working capital 2. Preparation of various ledger accounts 3. Calculation of Funds from operation 4. Prepare Fund flow statement Cash Flow Statement: Cash flow means incoming and outgoing of cash in an organisation during a period. It is prepared from the analysis of cash transactions. It explains the changes in cash position between two balance sheet dates. Cash flow includes cash inflows and cash outflows.

6 Cash flow statement is a statement which portrays the changes in the cash position between two accounting periods. It provides different sources of cash inflows and different uses or application for which cash is needed. Advantages: 1. It is an essential tool for short-term planning. 2. It helps to evaluate the current cash position and plan for financial policies for the future. 3. It explains the reasons for low cash balance inspite of huge profits or vice versa. 4. It shows repaying capacity of the firm 5. It compares the projected cash flow with the actual cash flow for controlling and for taking remedial actions. 6. It is an essential tool for financial management. Limitations: 1. It ignores non-cash items, hence it should not equated with income statement. 2. It may not represent the true liquid position. 3. Working capital concept gives complete picture than cash flow concept. Difference between Cash flow statement and Fund flow statement: Cash flow statement Fund flow statement 1. It starts with opening balance and ends There no balances with closing balance. 2. It deals with cash receipts and payments It deals with increase or decrease in working capital 3. It shows the changes in cash It shows the changes in working capital 4. It is useful for short term financial analysis It is useful for long term financial analaysis 5. Flow of cash means definitely be flow of Flow of funds does not mean flow of cash funds 6. Cash is a part of working capital Working capital may not necessarily mean cash 7. It is useful to make short term estimates of It is useful to make medium term estimates for cash for the preparation of cash budget. the preparation of capital expenditure budget Unit III Marginal Costing: The amount at any given volume of output by which aggregate costs are changed if the volume of output is increased or decreased by one unit. Marginal costing is a technique where by only the variable cost are considered for calculating the cost of the product. Marginal cost is nothing but prime cost and total variableoverheads.it means direct materials, direct labour, direct expenses and variable overheads.

7 Advantages: 1. It reduces the degree of over or under recovery of overheads 2. It gives better result for taking decision regarding pricing and tender. 3. It is easy to understand cost-volume-profit analysis. 4. It enables the proper apportionment of fixed costs Disadvantages: 1. It is difficult to separate fixed and variable costs. 2. It is very difficult to fix selling price. 3. Price fixation cannot be done without considering fixed costs. 4. It is not suitable for industries where fixed costs,value of work in progress occupies a major role. 5. Comparison between two jobs cannot be done without considering fixed costs. Contribution: The difference between sales and variable costs.it is equal to fixed cost plus profit. Contribution = Sales Variable Costs Profit volume Ratio: Contribution = Fixed Cost + Profit Contribution = Sales *P/V Ratio It is the relationship between contribution and sales value. It is expressed in percentage. It shows profitability of the business. Higher the ratio means greater the profitability. P/V Ratio = Contribution /sales * 100 P/V Ratio = Changes in profit for two periods/changes in sales for two periods *100 Limiting Factor: The factor which will limit the volume of production. It may arise due to shortage of raw materils, labour,plant capacity, capital, demand. It is also known as principal factor factor or critical factor.the profitability can be measured by the following formula Profitability = Contribution/Key factor Break Even point: It is a point where total sales are equal to total cost.no profit or no loss.bep is a equilibrium point or balancing point. It is also called as Cost Volume Profit anlysis. BEP = Fixed cost/p/vratio BEP in units = Fixed cost/contribution per unit

8 Margin of Safety: The difference between the actual sales and Break sales. In other words sales over and above break even sales are known as margin of safety. Margin of Safety = Actual Sales Break Even Sales Unit IV: Margin of Safety = Profit /PV/Ratio Ratio Analysis: The relationship between two figures or variables expressed mathematically is called a Ratio. The two figures may be numerical or quantitative. It is calculated by dividing one by another. It can be expressed as simple fraction, integer, decimal fraction or percentage. Significance : 1. It summarises and simplifies the accounting data. 2. It acts as an index of the efficiency of the business. 3. It evaluate the performance over a period by comparing present and past ratio. 4. It helps the management to prepare budgets, formulate policies and prepare future plan of action. 5. It is an effective means of communication, since ratios have power to speak. 6. It can access the liquidity, solvency and profitability of the business. Classification of Ratios: 1. Current Ratio = Current Assets/Current Liabilities 2. Liquid Ratio = Liquid Assets/Liquid Liabilities 3. Gross profit Ratio = Gross profit /Sales * Net profit Ratio = Net profit /sales * Operating profit Ratio = Operating cost/sales * Proprietary Ratio = Proprietors fund/tangible Assets 7. Debt Equity Ratio = Long term debts / Shareholders Funds 8. Capital Gearing Ratio = Fixed Interest bearing securities/equity shareholders Funds 9. Stock Turnover Ratio = Cost of goods sold/average Stock 10. Debtors turnover Ratio = Net credit sales/average Debtors + Average bills Receivable 11. Creditors Turnover Ratio = Net credit purchases/average Creditors +Average bills payable 12. Fixed Assets Turnover Ratio = Net Sales/Net Fixed Assets Limitations: 1. Ratios are only indicators cannot be taken as final conclusions. 2. Lack of standard formula for working out ratios makes it difficult to compare them. 3. Limitations of financial statement affect the ratios. 4. It will not consider the effects of price level changes. 5. Different people interprets ratios in different ways.

9 6. Ratios computed from past records will not predict the future plan, because of change in the policies of the management. Unit V Budget and Budgetary control: Budget: Budget is a financial statement prepared prior to a defined period of time, of the policy to be pursued during that period for the purpose of a given objectives. It is plan of opertions integrated and coordinated, comprising all phases of business activities and summarised to show the financial results of carrying out the plan. Budgeting: Budgeting is a kind of future accounting in which the problems of future are met on the paper before the transactions actually occur. It is the formulation of plans for future activity that seek to substitute carefully considered objectives for hit and miss performances and provide yardsticks by which deviations from planned achievements can be measured. Budgetary control: Budgetary control is the establishment of budgets relating the responsibilities of executives to the requirements of policy and the conditions comparison of actual with budgeted results, either to secure by individual action the objectives of that policy or to provide a firm basis for its revision. Advantages: 1. It helps in maximising the profit through optimum utilisation of the available resources. 2. It gives a concrete shape to the objectives and policies of an organisation. 3. It results in co-ordinated effort of all persons involved. 4. It helps to identify the variances &pinpointing the centres of weakness and inefficiency. 5. It enables the organisation to estimate its credit requirements in advance. 6. It is a guide to the management in the field of research and development in future. 7. It can provide suitable basis for establishing incentive system and internal audit. Limitations: 1. It is an estimate only, which may or may be accurate. 2. It is time consuming, management cannot expect too much during development period. 3. Lack of coordination with in the organisation leads to failure. 4. It may loose its important under changing economic conditions. 5. It requires specialised staff which involves high cost. Steps involved in budgetary control:

10 1. Preparation of organisation chart. 2. Creation of budget centres. 3. Establishment of budget committee. 4. Preparation of budget manual. 5. Fixation of budget manual. 6. Locating the key factor. 7. Laying down the level of activity to be achieved. Classification of budgets: I On the basis of function: 1. Cash budget 2. Production budget 3. Material budget 4. Labour budget 5. Overhead budget 6. Sales budget 7. Capital expenditure budget 8. Plant utilisation budget 9. Research budget 10. Master budget II On the basis of Time : 1. Long term budget 2. Short term budget 3. Current budget 4. Interim budget III On the basis of flexibility: 1. Fixed budget 2. Flexible budget IV On the basis of Nature of transactions: 1. Operating budget 2. Capital budget Zero Base Budgeting: Zero Base budget is based on the idea that, there is no given base year for a budget.a fresh budgeted figure is to be determined keeping in view the circumstances andrequirements. A new technique is followed, no special budget is prepared but a different approach is followed. The concept of ZBB is a. Every budget starts with zero base b. No previous figures is to be examined afresh

11 c. Each activity is to be examined afresh d. Every budget allocation is to be justified in the light of anticipated circumstances e. Alternatives are to be given due consideration

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