MANAGEMENT ACCOUNTING

Transcription

1 MANAGEMENT ACCOUNTING Introduction Management Accounting is the branch of Accounting which is concerned with procuring and providing the necessary information for the managerial decision making. Management accounting provides financial information about a particular organization to business managers so that they may make better decisions about running the organization. Management accounting is primarily concerned with data gathering from internal and external sources. After gathering the financial data, management accountants analyze, process, interpret and communicate their results. Any accounting which renders valuable information to help management may be called management accounting. It is that form of accounting which enables a business to be conducted more efficiently. A team of British industrial accountants and managers submitted their reports and defined management accounting as the presentation of accounting information in such a way as to assist management in the creation of policy and day to day operations of an undertaking. Any form of accounting which enables a business to be conducted more efficiently can be regarded as Management Accounting The Institute of Chartered Accountants of England and Wales 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-today operations of an undertaking The Anglo American Council on Productivity Report Management Accounting includes the methods and concepts necessary for effective planning, for choosing among alternative business performances The American Accounting Association Page 1

2 Scope / Subject matter of Management Accounting Management accounting, as a financial discipline, takes into consideration the implications of reporting for the entire organization or business. Business managers in all areas of an organization, including sales, production and personnel, rely on data interpreted through management accounting as an aid to making better business decisions and allocating the business resources under their control. The Scope of management accounting is broad one. An understanding, analysis and study of facts or data relating to past, present and future events of a business concern may be subject matter of management accounting. Basically management accounting is associated with economics, statistics, business law and psychology. A study of past trends may help in getting information about those factors which had been responsible for the variances between planned and actual results in the past. Similarly a study of present trends and events may avail the knowledge whether the actual results are in conformity with the planned targets or not, so that if there are variances, these could be controlled or minimized by modifying and improving the factors, methods or procedures. A study of future trends is the foundation stone of an effective planning. Therefore under the system of management accounting the past and present data of business concern are collected, classified and analyzed in such a way to solve the managerial problems and to forecast the future trends. Some of the areas included within the ambit of Management Accounting are: 1. General Accounting (Financial accounting) 2. Cost Accounting 3. Budgeting and forecasting 4. Cost control procedure Page 2

3 5. Cost and statistics 6. Taxation 7. Methods and procedures 8. Audit 9. Office services 10. Legal Provisions Role/ Functions / Objectives of Management Accounting As an integral part of strategic planning, management accounting deals with information, not just data. While financial accounting presents income statements, balance sheets and other important information, management accounting focuses on making that information useful. As a result of the information provided, management can more effectively engage in strategic planning, make decisions and control business operations. External parties such as shareholders, investors, creditors, and regulatory agencies also rely on reports generated through management accounting. The real function of all accounting work is to render a service to business management. This service lies in placing before business executives the most complete information on various issues, analyzed so as to be readily understood and used effectively in guiding and controlling their operations. On the basis of above lines it could be concluded that: 1) The basic objective of management accounting is to present the required facts and information for the use of management in a quantitative form ( known as operating function) (i) Recording of data (ii) Validation of data (iii) Interrelation data (iv) Communication data Page 3

4 2) Additionally management. accounting is concerned with effective performance of management function ( theoretical functions) (i) To help in planning. (ii) To help in organizing. (iii) To help in controlling. (iv) To help in communication. (v) To help in decision making. Tools of Management Accounting 1) Ratio Analysis 2) Comparative income statement & comparative Balance Sheet. 3) Common size income statement & comparative balance sheet. 4) Cash flow statement and fund flow statement. 5) Variance Analysis a) Material Variance b) Labor Variance c) Overhead variance 6) Marginal costing and C.V.P. Analysis 7) Business forecasting 8) Budget 9) Budgeting and budgetary control 10) Managerial reporting Limitations of Management Accounting:- 1) Most of the information used in Management Accounting is derived from Financial Accounting records or Cost Accounting records. Therefore, the accuracy of management accounting is based on the correctness of Financial Accounting and Cost Accounting. Page 4

5 2) Management Accounting should never be considered as a substitute for management, this is simply a tool for the management. Ultimate decisions and corrective steps are being taken by management and not by management Accountant. 3) There is always human judgment involved in all the information furnished by the management Accounting. So there would be differences in opinions. Functions / Role / Duties of Management Accountant 1) To establish better coordination through efficient and adequate plan for the control of operations. 2) To compare performance with operating plants with standards and to report there on. 3) To consult with all segments of management responsible for policy or decision making. 4) To administer tax policies and procedures. 5) To coordinate the preparation of report to govt. agencies 6) To assure physical protection for the assets of business through proper insurance coverage. 7) To insure the continuous audit of accounts and record. 8) To prepare various reports for different parties. 9) To insure the required approval for all the payments by the authentic person. 10) To fulfill the government norms & tax obligation. Page 5

6 Zero Based Budgeting It is a technique in which all activities are revaluated each time a budget is prepared. Under this system a number of alternatives for each activity are identified and evaluated in terms of benefits to be obtained from them. It was first used in 1924 by a British Budgeting officer but broadly it was accepted in 1960 by US department of agriculture. Zero base budgeting is an operating, planning & budgeting process which requires each manger to justify his entire budget request in detail. Having a zero base shifts the burden of proof, to each manager, to justify why he should spent any money at all. It is a new technique of preparing budgets by taking zero as a base rather than previous years budget or data. Zero based budgeting is management tool which provides a systematic method for evaluating all operations and allows reallocation of resources from low to high priority programmers. Characteristics of Zero based Budgeting 1) Optimum utilization resources 2) New budgeting techniques 3) Ranking to various projects 4) Critical analysis of budget proposals 5) Justification of allotment of resources 6) Zero based 7) Target oriented techniques Page 6

7 Management Accounting, Financial & Cost Accounting Management Accounting:- Management Accounting is the branch of accounting which provides meaningful information through application of various tools & techniques in order to assist management in creation of policy, making decisions and future planning. Cost Accounting: - Cost accounting is the art of recording, analyzing & classifying the expenditure incurred in order to ascertain total cost and permit cost of a product or services. Cost accounting deals with the internal aspects of the organization and provides information to the management to control cost, improve efficiencies and helps managers in decision making process. Financial Accounting: - Financial Accounting is the primary branch of accounting in which all the financial nature transactions and events are recorded classified and analyzed to ascertain the profit & loss for a particular period and to know the financial position of business on a particular date. Distinction between Management Accounting & Cost Accounting Objective:- The primary objective of cost accounting is to record and to determine the cost of a product or a service but Management accounting emphasizes upon presentation of cost data & information in such a manner which may help the management in efficient decision making & control. Nature :- Cost accounting is based on past and present facts where as management accounting is mainly future oriented and it deals with future projections and plans with reference to past & present cost data. Page 7

8 Scope:- Management covers a much wider field than cost accounting. The scope of cost accounting is limited to cost records and determination while management accounting covers other accounting information & non-monetary facts also. Distinction between Management Accounting & Financial Accounting The process of Management Accounting is basically concerned with preparation of analytical management reports and accounts that provide accurate and timely financial and statistical information required by managers to make day-today and short-term decisions. Unlike financial accounting, which produces annual reports mainly for external stakeholders, management accounting generates monthly or weekly reports for an organization's internal audiences such as department managers and the chief executive officer. These reports typically show the amount of available cash, sales revenue generated, amount of orders in hand, state of accounts payable and accounts receivable, outstanding debts, raw material and inventory, and may also include trend charts, variance analysis, and other statistics. Managerial accounting is concerned with providing information to internal managers who are charged with directing, planning, and controlling operations and making a variety of management decisions. Managerial accounting can be contrasted with Financial Accounting which is concerned with providing information, via financial statements, to stockholders, creditors, and others outside the organization. Page 8

9 As per some authors, management accounting and financial accounting are complementary. There is no major difference between both the branches of accounting as both of these are used to ascertain and extract some meaningful information for decision making but as per the critical analysis done on the basis of their respective features, the distinction could be made as under: 1) Process: - Financial accounting is related to recording and classifying & summarizing of financial nature transactions where as management accounting picks up significant data out of collected data and presents for the use of management. 2) Objective: - Financial accounting is generally limited to the preparation of accounting for the use of external party where as Management Accounting is basically concerned with seeking the relevant information for the management. i.e. internal parties. 3) Nature :- Management accounting is subjective ( fact based) and not objective like financial accounting (Measurement based) 1) Flexibility: - Financial accounting is relatively rigid in comparison to management accounting as financial accounting is done on the basis of accounting assumptions. 2) Legal Compulsion: - Financial accounting is composed for some organization specially to file income tax return where as management accounting is advisable but not compulsory. 3) Data Use:- Financial accounting records past data where as management accounting emphasizes on future aspect. 4) Audit Requirement :- since, financial accounting is down on the basis of actual data therefore, audit program can be executed in a proper way where as in case of management accounting, the entire process is based on estimates hence, a proper audit- program can not be executed. Page 9

10 5) Publication: - In case of financial accounting under certain circumstances publication of data is mandatory but in case of management accounting not required. Standard Costing and Variance Analysis Standard costing is one of the techniques of Managerial Accounting which is used to measure the variances between the predetermined standards and the actual results. This is also known as Variance Analysis. Types of Variance 1. Material Variances 2. Labour Variances 3. Overheads Variances Material Cost Variance (MCV) (a) Material Price variance (MPV) (b) Material usage variance (MUV) Where, MCV = Remember MCV = MPV + MUV Standard cost Actual cost Page 10

11 = (SQ x SP) (AQ x AP) MPV = (SP AP) AQ MUV = (SQ AQ) SP Where, SQ is Standard Quality, SP is Standard Price, AQ is Actual Quantity, AP is Actual Price. Q. Material Standard Actual Standard Cost SQ x SP MCV SQ SP AQ AP Actual Cost AQ x AP X Y ,000 = ( SC AC) = = 2500 (Adverse Variance) MPV = (SP AP) AQ X = (10 12) 150 = 300 (Adverse) Y = (15 18) 400 = 1200 (Adverse) MUV = (SQ AQ) SP X = ( ) x 10 = 500 (favorable) Y = ( ) x 15 = 1500 (Adverse) Total= =1000(Adverse) MCV = MPV + MUV 2500 A = 1500 A A 1500 (Adverse) 1000(Adverse) Page 11

12 Q. Find Material Variance :- Material Standard Actual Standard Cost SC= (SQ x SP) Actual Cost AC=(AQ x AP) SQ SP AQ AP A B (1) MCV = Standard Cost Actual Cost = = 80 (A) (2) MPV = (SP- AP) AQ A = ( 4 6 ) 40 = 80 ( A) 60 (F) B = ( 6 4 ) 70 = 140 (F) (3) MUV = ( SQ AQ ) SP A = (50-40) 4 = 40 (F) B = (40 70) 6 = 180 (A) 140 (A) Reconciliation: MCV = MPV + MUV 80 (A) = 60 (F) (A) 80 (A) = 80 (A) MUV has two parts (i) Material Sub Usage Variance (MSUV) (ii) Material Mix Variance (MMV) Page 12

13 MSUV= (SQ RSQ) SP MMV= (RSQ AQ) SP Where RSQ stands for revised standard quality RSQ = Each Standard Quantity Total Standard Quantity Total Actual Quantity Where, RSQ= Revised Standard Quantity Total Actual Quantity Each Standard Quantity RSQ= Total Standard Quantity SQ RSQ = TAQ TSQ Total Actual Quantity Q. SQ SP AQ AP SQ RSQ= TSQ TAQ A = B = TSQ=100 TAQ=110 Page 13

14 SQ RSQ = TSQ TAQ (i) MSUV= (SQ RSQ ) x SP A B Total = (60-66) 4 = 24 (A) = (40 44)6= 24 (A) = 48 A 48 (A) (ii) MMV= (RSQ AQ ) SP A = (66 40) 4 (26) = 104 (F) 52 (A) B = (44 70) 6 (26) = 156 (A) Reconciliation: - MUV = MSUV + MMV 100 (A)= 48 (A) + 52 (A) 100 (A) = 100 (A) LABOUR VARIANCE Labour Cost Variance (LCV) Labour Rate Variance Labour Usage (Efficiency) Variance Page 14

15 (LRC) (LUV) 1. LCV = Standard Cost Actual cost = (ST SR )- (AT AR) Q. Labor Standard time Standard Rate Actual time Actual Rate A 50 hrs. 10 Rs/hrs. 60 hrs. 12 Rs/ hrs. B 40 hrs. 8 Rs/ hrs. 30 hrs. 7 Rs/hrs. 1. LCV = ( ST SR) (AT AR) A = (50 10) (60 12) = = 220 (A) B = (40 8) (30 7) = = 110 (F) = 110 (A) 2. LPV = (SR AR)AT A = (10 12) 60 = 120 (A) B = (8 7) 30 = 30 (F) 3. LUV = (ST AT) SR A = (50 60) 10 = 100 (A) B = (40 30) 8 = 80 (F) 90 (A) 20 (A) Reconciliation :- LCV = LPV + LUV 11O (A) = 90 (A) + 20 (A) 110 (A) = 110 (A) Page 15

16 Material SQ SP Std Cost AQ AP A. cost RSQ SQ for Actual output Std. cost for Actual output A B TSQ TAQ Less: wastage (30) (35) Standard yield 70 AY 115 Working note:- Each Standard Quantity (a) RSQ = TAQ TSQ SQ for actual output = Each SQ A.Yield Standard Yield MCV = Standard cost Actual cost = = 230 (F) MPV = (SP AP) x AQ A = ( ) 80 = = 40 (F) B = (10 8) 70 = (F) = 140 (F) Page 16

17 MUV (MQV) = (SQ-AQ) SP A = ( ) 5 = (F) B = ( ) (F) = =(50) (F) = 42.9 (A) Reconciliation :- (a) MCV = MPV + MUV 230 (F) = 180(F) + 50 (F) 230 (F) = 230 (F) (b) MUV = MMV + MSUV (c) (i) MMV ( Material Mix Variance) = (RSQ AQ) SP A = (90 80) 5 = 10 5 = 50 (F) B = (60 70) 10 = ( 10) 10 50(A) = 100 (A) (i) Material Revised Used a Variance MSUV = (SQ RSQ ) SP A = ( ) 5 = Page 17

18 MUV = MMV + MSUV 50 (F)=50 (A) (F) 50(F)= 50(F) = = 43 (F) B = ( ) 10 = = 57.1 = 57 (F) = 100 (F) Budget Budget is a predetermined statement of management policy during a given period which provides a standard(base) for comparison with the result actually achieved. In other words, a budget could be stated as a formal program of future operations and expected result. Budgeting Budgeting is a part of management process which includes preparation of budget, control, budget co-ordination and all those activities which are related with budget. In other words, budgeting is a process which includes all preparations related to budget, decision related to various problems arising in the budget, implementation of budget and control on the basis of budget. Budgetary Control Budgetary control is a tool of management control which directs and coordinates the working operations on the basis of budget. If there are variances in actual result Page 18

19 then either they are corrected or budget is modifies, so that the objective of variance efficiency as per the policy of management may achieved. Difference in Budget, Budgeting& Budgetary Control Budget & Budgeting are narrower concept while budgetary control is a wider concept. If there is a budget or budgeting it is not necessary that there should be budgetary control. But if there is budgetary control then budget & budgeting are must. Budgets are business estimates for future period; Budgeting is the process of preparing estimates while budgetary control is a system of achieving performance on the basis of budgets. Budget & Budgeting are the parts of planning where as budgetary control is linked with co-ordination & control. Objectives of Budgetary Control 1. To assist in policy formulation on the basis of proper & reliable data. 2. To help administration to perform their functions according to predetermine budgets. 3. To develop coordination among employees and executives. 4. To eliminate wastage & increase in profitability. Classification of Budgets 1) On the basis of time:- a) Long term budget = 5-10 years b) Short term budget = 1-5 years c) Current Budget = up to 1years 2) On the basis of functions :- a) Master budget (over all budget) b) Functional budget (department wise or subsidiary budget) 3) On the basis of flexibility Page 19

20 a) Fixed/ static budget b) Flexible budget 4) On the basis of nature of Business activity :- a) Capital expenditure Budget ( long term investment) b) Revenue Budget ( for daily) Q. Prashant Ltd. is utilizing 60% to capacity and at that level they have produced 6000 units. The information related to cost of production is as under- Material 60,000 Labor 30,000 Variable overheads 18,000 Fixed overheads 10,000 Semi variable overheads 12,000 (out of this 50 % are fixed) and such fixed overheads increased by 10% from origin a value for every 20 % rise in output. Prepare a flexible budget at current capacity at 80% capacity and 100% capacity. Flexible Budget Particulars 60% capacity 6000 units 80% capacity 8000 units 100% capacity units Material Rs. 60,000 Rs. 80,000 Rs. 1,00,000 Labor Rs. 30,000 Rs. 40,000 Rs. 50,000 Variable overheads Rs. 18,000 Rs. 24,000 Rs. 30,000 Fixed overheads Rs. 10,000 Rs. 10,000 Rs. 10,000 Semi-variable overheads Fixed Rs Rs. 6,600 Rs. 7,200 Variable Rs Rs. 8,000 Rs. 10,000 Total Cost Rs. 1,30,000 Rs. 1,68,600 Rs. 207,200 Working Notes :- Page 20

21 For 20 % rise in output, increase is 10% of original cost Rise in output = 80% 60% = 20% 10 Increase in Cost = = 6600 for 40% rise in output, increase is 20% of original. Rise in output = 100% 60% = 40% Increase in cost 20 = = The budget for production of 10,000 units in a factory: Particular per unit Rs Material 70 Rs. Labour 25 Rs. Variable overheads 20 Rs. Variable expenses 5 Rs. Fixed overheads (100,000) 10 Rs. Selling expenses 13 Rs. (10% Fixed) Distribution expenses 7 Rs. (20% fixed) Administrative expenses 5 Rs. (50,000) Total fixed Prepare a budget at current capacity, output level of 8000 units and 6000 units Solution Particular 10,000 units 8,000 units 6,000 units Materials ( 70) Rs. 7,00,000 5,60,000 4,20,000 Labour (25) 2,50,000 2,00,000 1,50,000 Variable overheads 2,00,000 1,60,000 1,20,000 Variable expenses 50,000 40,000 30,000 Fixed overheads 1,00,000 1,00,000 1,00,000 Selling expenses: Variable 1,17,000 93,600 70,200 Page 21

22 Fixed 13,000 13,000 13,000 Distribution Overhead: Variable 56,000 44,800 33,600 Fixed 14,000 14,000 14,000 Administrative overheads: 50,000 50,000 50,000 Total cost 15,50,000 12,74,400 10,00,800 Per Unit Cost Sales Budget Q. The Aman Ltd. has prepared its annual sales forecast, expecting to achieve sales of Rs. 30,00,000 next year. The controller is uncertain about the pattern of sales to be expected by month and asks you to prepare a budget of sales. The following sales data pertain to the year, which is considered to be representative of a normal year : Month Sales (Rs.) Month Sales (Rs.) January 1,10,000 July 2,60,000 February 1,15,000 August 3,30,000 March 1,00,000 September 3,40,000 April 1,40,000 October 3,50,000 May 1,80,000 November 2,00,000 June 2,25,000 December 1,50,000 Page 22

23 Prepare a monthly sales budget for the coming year on the basis of the above data. Solution : Monthly Sales Budget Month Sales (Given) Sales estimates based on sales ration (given) January 1,10,000 1,10,000 30,00,000 1,32, ,00,000 February 1,15,000 1,15,000 30,00,000 1,38, ,00,000 March 1,00,000 1,00,000 30,00,000 1,20, ,00,000 April 1,40,000 1,40,000 30,00,000 1,68, ,00,000 May 1,80,000 1,80,000 30,00,000 2,16, ,00,000 June 2,25,000 2,25,000 30,00,000 2,70, ,00,000 July 2,60,000 2,60,000 30,00,000 3,12, ,00,000 Page 23

24 August 3,30,000 3,30,000 30,00,000 3,96, ,00,000 September 3,40,000 3,40,000 30,00,000 4,08, ,00,000 October 3,50,000 3,50,000 30,00,000 4,20, ,00,000 November 2,00,000 2,00,000 30,00,000 4,40, ,00,000 December 1,50,000 1,50,000 30,00,000 1,80, ,00,000 25,00,000 30,00,000 Note : Sales budget for the next year has been made on the basis of month wise sales data given as a basis. Flexible Budget Q. The expenses for budgeted production of 20,000 units in Avnit Ltd. are furnished below : Particulars Per Unit Rs. Materials 140 Page 24

25 Labour 50 Variable overheads 40 Fixed overheads 20 Variable expenses (Direct) 10 Selling expenses (10% fixed) 26 Distribution expenses (20% fixed) 14 Administrative expenses 10 Prepare a flexible budget for the production of (a) 16,000 units (b) 12,000 units (c) Indicate cost per unit at both the levels. Assume that the Administrative Expenses are fixed for all levels of production. Flexible Budget 20,000 Units 16,000 Units 12,000 Units Particulars Total Amount Per unit Total Amount Per unit Total Amount Per unit Material 28,00, ,40, ,80, Labour 10,00, ,00, ,00, Page 25

26 Variable Overhead 8,00, ,40, ,80, Fixed Overhead 4,00, ,00, ,00, Variable expenses (Direct) 2,00, ,60, ,20, Selling expenses : 10% fixed 52, , , % Variable 4,68, ,74, ,80, Distribution expenses 20% fixed 56, , , % Variable 2,24, ,79, ,34, Administrative expenses Fixed Full 2,00, ,00, ,00, Total 62,00, ,01, ,03, Working Notes : 1. Variable Expenses Per Unit Cost remains constant. 2. Fixed Expenses Total Cost remains constant. Page 26

27 Marginal Costing & Cost-Volume-Profit Analysis Marginal Costing & Decision Making Marginal costing or Marginal analysis is a technique of decision making which recognizes the relevant cost (variable cost) as a prime factor in the process of decision making. Scope of Marginal costing/utility/key area 1) decisions in the area of production 2) make or buy decision 3) decisions in the area of Marketing 4) decisions in the area of pricing 5) other decisions Marginal Approach for Profit Distribution Sales Less: Variable Cost = Contribution Less: Fixed Cost = Profit Marginal P/L A/C To V.C. To contribution c/d By sales Page 27

28 To F.C. To profit By contribution b/d Marginal Costing Marginal Costing is a technique and not a method of cost determination. It deals with the principle of treating the cost of producing marginal unit. It is very much concerned with finding out marginal cost by segregating fixed cost and variable cost & it also studies the profitability at various levels of output/ production it is a method of ascertaining profit and generally known as Marginal approach for profit determination. Scope/Utility/Key Areas of Marginal costing 1) In Production Related Decision :- a) Increase in level of activity b) To determine best level of activity c) Dropping a line or product or department d) Introducing a line or department e) Selecting or determining optimum product mix 2) In marketing related Decisions a) Optimum sales mix b) To select channels of distribution c) For sales promotion scheme d) For market expansion Page 28

29 Costs 100 SP 110 Sales 110 VC 66 Contribution- 44 = FC-Pt VC FC VC FC Pt =44 So, 1.Sales VC = Contribution 2.FC + Pt = Contribution PVR( Profit Volume Ratio) It shows the relationship between contribution & sales. Contribution PVR = 100 Sales 44 = 100 = 40% 110 If contribution is not given then by alternative method: Page 29

30 (a) PVR Sales VC = 100 S (b) PVR Fixed cost Profit = 100 S When two years dates are given:- PVR = Change in profit (Pt) 100 Change in sale (CS) Q. Sales 2, 00,000 Variable cost 1,20,000 FC 30,000 (i) PVR =? (ii) Amount of sales to earn a profit of Rs. 90,000 (iii) Desired Profitt on sales of Rs. 5,00,000 Solution (i) PVR Sales VC = 100 S = 2,00,000 1,20, ,00,000 = 40% (ii) PVR Fixed cost Profit = 100 S 40 (30,000 90,000) = 100 S S 1,20,00,000 = 40 Page 30

31 = 3,00,000 Page 31

32 Cross check :- C PVR = 100 S C 40 = 100 3,00,000 C = 1,20,000 Contribution 1,20,000 FC Pt 30,000 90,000 Fixed cost Profit (iii) PVR = 100 S Profit 40 = 100 5,00,000 Profit + 30,000 = 2,00,000 Profit = 1,70,000 Cross check - PVR = 40% Sales = 500,000 Page 32

33 Contribution = 2,00,000 FC Profitt 30,000 1,70,000 Q. Sales Price / unit Rs -100 Sales - 1,00,000 VCR 70% FC - 20,000 (a) Find Amount of profit at sales of 6,00,000 (b) Amount of sales to earn a profit of Rs. 60,000 Solution:- (a) Since VC Ratio is 70,000 it means it is 70% then the remaining will be 30% as PVR. Or, PVR + VCR = 100% PVR + 70% = 100% PVR = 100% 70% PVR = 30 % Or, PVR = S VC 100 /S 1,00,000 70,000 = 100 1,00,000 Page 33

34 30,000 = 100 1,00,000 PVR = 30% (a) PVR C = 100 S PVR FC Pt = 100 S 30 20,000 Pt = 100 6,00,000 Pt = 1,80,000 20,000 Pt = 1,60,000 Reconciliation :- Sales PVR VCR 30% of 6, 00, ,00,000 = = 180,000 this is contribution 100 FC And contribution has two parts Profit Now, Fixed cost 20,000 1, 80,000 (contribution) Profit 160,000 Page 34

35 (b) PVR C = 100 S 30 FC Pt = 100 S 30 20,000 60,000 = 100 S 80,00,000 S = 30 S = 2,66, Sales = 2,66,667 Rs. Reconciliation Contribution is 30 % of sales : Contribution = 100 C = 80,000 Rs. And contribution has two parts 80,000 (c) Break Even Point Sales in Rupees :- FC BEP sales in Rupee = PVR FC Pt 20,000 60,000 Now, BEP sales in Rupee = 20,000 30% Page 35

36 = BEP Sales in unit FC Contribution Per 20,000 = 100 = Rs. 30 BEP sales in Rs. FC = Unit PVR Sales Per unit - Variable Cost Per unit 20,000/ (100) (70) => 20,000/30/100 20,000/30 => 20,000x100 / units => Rs. Reconciliation There is units to reach the Break even and sales 100 Rs. Per unit,then the total BEP sales in Rs. will be sales: units 100 Rs. Per unit = 66,667 Rs Q.2 The following data are related to a company Fixed cost 1,60,000 Variable Cost 60% of sales (i) Calculate PVR (ii) BEP in Rs. (iii) Sales required to earn a profit of Rs. 20,000 (iv) Profit at an estimated sales of Rs 4,40,000 (v) Margin of safety when sales Rs 8,00,000 Solution: Page 36

37 (i) PVR =? PVR + VCR = 100% PVR+60% = 100% PVR = 40% (ii) BEP in Rs =? BEP sales in Rs. FC = PVR 1,60,000 = = 4,00,000 Rs. (iii) PVR Fixed cost Profit = 100 S 40 20,000 1,60,000 = 100 S S = 1,80,00,000/ 40 S = 4,50,000 Rs. Reconciliation:- S = 4,50,000 and contribution = 40% of 4, 50,000 Contribution = 1,80,000 FC 1,60,000 Pt 20,000 (iv) PVR Fixed cost Profit = 100 S 40 1,60,000 Pt = 100 4,40,000 Page 37

38 = Pt + 1,60,000 Pt = 1,76,000 1, 60,000 Pt = 16,000 Rs. (v) Margin Safety = Actual Sales BEP sales = 8,00,000 4, 00,000 = 4,00,000 Rs. (1) FC 100,000 Rs. Selling Price Per unit =10 Rs. Variable cost Per unit =6 Rs. (ii) Find BEP in units (iii) What will be the impact of BEP in units under the following causes :- (a) If fixed cost increases by 10% (b) If FC decreases by 10% (c) If VC increases by 10% (d) If VC decreases by 10% Solution: (i) BEP sales in units = FC Contribution P. Units Sales Per units VC per units BEP sales in units = 1,00,000 (10 6) = 1,00,000 = 25,000 units 4 Page 38

39 (ii)(c) VC increase by 10% Old variable cost = 6 Rs. New VC = 6 + (6 10%) = = 6.6 1,00,000 BEP = ,00,000 = 3.4 = 100,000/3.4 = units = 29,412 FC (i) (d) BEP sales in units => Contribution Per Unit Sales Per unit - VC Per unit BEP sales in units = 1,00, = 1,00, = units = FC (a) BEP in units => Contribution P. Units 1,00,000 1,00, = Page 39

40 1,10,000 = 4 = units (b) BEP in units => FC Contribution P. Units = (1,00,000 10,000) 90,000 = =22500 units 4 Additional If fixed cost decreases by 10% & VC increases by 10% BEP in units = 90,000/ = 90000/3.4 = units = Q. Unit sold Selling Price V CPU Sales V.Cost X ,000 60,000 y ,000 45,000 Z ,000 20,000 2,00,000 1,25,000 Contribution (1) PVR Of X = 100 = Sales 1,00,000 60, ,00,000 S VC = 100 S 40,000 = Or 100 1,00,000 Page 40

41 X = = 100 1,00, ,000 X = 40% (2) PVR of Y = Contribution 100 Sales = 60,000 45, ,000 = 15, = 60,000 PVR of Y = 25% (3) PVR of Z = Contribution 100 Sales = 40,000 20, ,000 20,000 = ,000 PVR of Z = 50% Now, Combined PVR: Total Contribution PVR of whole = 100 Total Sales Page 41

42 2,00,000 1,25,000 = 100 2,00,000 75,000 = 100 2,00,000 PVR = 37.5% Q. Radhika Ltd. has submitted certain data pertaining to its capacity:- (a) Current capacity 1,00,000 units (b) At its current level of operation, its margin of safety is 50 % to its BEP (c) PVR = 25% Selling Price Per Unit Rs 40 Unutilized Capacity at present units (i) Calculate BEP in units (ii) Margin of safety in units (iii) BEP in Rs. (iv) Fixed lost (v) Variable cost per units Solution :- Current Capacity = 1, 00,000 units (Less) unutilized capacity = 10,000 units Actual Capacity used = 90,000 units Actual sales in units = 90,000 units Margin Safety = Actual Sales - BEP per sales in units (i) Let BEP in units = x 50% of x = 50 x = 0.5x 100 Therefore Margin safety = 0.5x Page 42

43 (ii) 0.5 x = 90,000 units x 0.5x + x = 90,000 units X = 90, x = 60,000 BEP in units = 60,000 units Margin Safety = ,000 = 30,000 units So, BEP sales in Rupees => BEP in units selling price per units = 60, = 24, 00,000 Rs. (iii) FC =? BEP in Rs. = FC PVR 24,00,000 = FC FC = 24,00, FC = 6, 00,000 Rs. PVR + VCR = % + x = 100 % x = 100% 25% X = 75% VCR = 75% (V) Variable Cost per units => selling price units x VCR Page 43

44 => 40 75% 75 => => 30 units 1) Particular Sales 3, 00,000 5, 00,000 Cost 1, 50,000 2, 00,000 Find P/V Ratio? 2) Sales 10,00,000 Variable cost 75% Fixed cost 1,00,000 a) Find the amount of profit on sales volume of Rs. 15, 00,000? b) What will be the volume of sales for a desired profit of Rs. 9, 00,000? c) Find the break even sales? d) What will be the margin of safety at profit of Rs. 5,00,000? e) 3) Describe the various tools of Management Accounting? Solution :- 1) Profit Volume Ratio Change in Profit = 100 Change in Sales 3,00,000 1,50,000 = 100 5,00,000 3,00,000 1,50,000 = 100 2,00,000 = 75% Page 44

45 2) Here, variable cost is 75% VC+ PVR = 100% PVR = 25% (a) PVR = FC PT 100 S 25 = 1,00,000 PT ,00,000 Profit = 3,75,000 1,00,000 Profit = 2,75,000 Rs. (b) PVR = FC Pt 100 S 1,00,000 9,00, = 100 S S = 10,00, /25 S = 40,00,000 Rs. c) BEP = FC PVR = 1,00,000/25% = 4,00,000 Rs. d) MOS = Profit or Sales BEP PVR = 10,00,000 5,00,000 = 5,00,000 Page 45

46 Analysis and Interpretation of financial statement Interpretation of financial statement is a technique and it involves difference steps like arrangement, analysis, establishing relationship between available facts & drawing conclusions on that basis. It has really become a very interesting & significant function of management accounting. It broadly includes the following- 1. Interpretation 2. Analysis 3. Comparison 4. Study of trends 5. Drawing conclusion Merits/Importance of Analysis & Interpretation of Financial statements:- 1) To ascertain the short term paying capacity of the organization. 2) To know the solvency of the organization. 3) To ascertain the deficiency of the business 4) For the critical evaluation of profitability of the business organization. 5) To know the various inflow & out flow of cash 6) To measure the working capital need of the organization. 7) For the comparative study & using the inter-firm comparison & intra. Firm comparison. 8) For the decision making process. 9) For the make or buy decision. 10) To ascertain the break even point. 11) To measure the margin of safety for the organization. Limitations Page 46

47 Such analysis is always dynamic in nature. Such analysis is based on past data which may not be accurate for the future because the nature of business environment is dynamic & one cannot predict anything for the future with accuracy. Personal business of the enumeration/mgt. accountant may lead towards wrong conclusions. Application of the required tools requires high of knowledge & Skill in the absence of such skills interpretation can never be effective. Absorption Costing is a convention technique of as curtaining cost & is also known as full Costing,under this technique of costing first of all prime cost is obtained by adding direct material, direct labor & direct exp. There after total cost is calculated on the basis of prime cost+ overheads. These overheads includes works overheads, administrative over head & selling & distribution overheads & eventually profit is determined by defueling T.C. from sales or S.P. is determined by adding desired profit to T.C. on the other and in marginal costing T.C. is divided into 2 components, fixed cost & variable cost. The excess of sales over variable cost is known as contribution & after deducting the amount of fixed cost from contribution, we obtain the amt of profit. Tools and Techniques for the Analysis and Interpretation of financial statement There are few tools which are used by management accountant to get detailed information regarding a actual profitability of business and true financial position of business. Profit & Loss A/C & Balance Sheet (which are part of financial accounting ) merely reflect the net profit and loss and the financial position of business on a particular data but for the business forecasting and decision making the role of Page 47

48 different tools for the analysis and interpretation of data ( financial statement), essential such tools and techniques of are- 1. Cash flow statement 2. Fund flow statement 3. Comparative statement(horizontal analysis) 4. Common size statement(vertical analysis) 5. Accounting Ratio 1. Cash flow statement :- It is a periodic statement which is prepared to know the various inflow and outflow of cash during a particular period to explore the reasons for the change in the position of cash during a stipulated time period and cash flow statement are prepared using three different actives Cash flow from operating activity Cash flow from investing activity Cash flow from financial activity 2. Fund flow statement:- It is also a periodic statement where is prepared to know the various changes in working capital position during a given time. Net increase or decrease into working capital is reflected by fund flow statement. 3. Comparative Statement:- It is prepared to know the absolute changes and relative changes in various heads of financial statement during a particular period. Comparative Statement is further classified into two parts- Comparative balance sheet Comparative Income statement Page 48

49 4. Accounting Ratio:- Accounting ratio is mainly used to ascertain the- (i) Short Term paying capacity of the organization through liquidity ratios. (ii) Long term paying capacity of business through solvency ratio. (iii) Efficiency of business through efficiency ratio, turnover ratio. (iv) Profitability of business through profitability ratio. 5. Common Size Statement:- Common Size Statement is prepared to represent the percentage value of different heads of financial statement having a common base.usually in common size balance sheet The total of balance sheet is considered, a Common Base and in common size income statement Sales Amount is considered as common base. These are also classified into two parts Common size Income statement Common size Balance sheet statement Page 49

50 Objectives of Accounting Ratio To know the short terms capacity of the business To know the long terms capacity of the business To check the efficiency of business To estimate the profitability of business Classification of Accounting Ratios & their Objective: 1. Liquidity Ratio 2. Solvency Ratio 3. Turnover Ratio 4. Profitability Ratio 1.Liquidity Ratio Current Ratio Liquid/quick/Acid test Ratio A. Current Ratio Current Ratio= Current Assets Current Liability Where, Current Assets=Cash Bank balance+ debtor+ accrued income+ short term investment +marketable security+ closing stock+ prepaid+ B/R. Current Liability= Creditors+ outstanding + B/P+ Received in advance + unaccrued income+ overdraft B. Liquid ratio Page 50

51 Liquid ratio = Liquid Ratio = Liquid Assets Current Liability Or Liquid Assets Current Liability Overdraft Where, Liquid Assets=All Current Assets-closing Stock-Prepaid Bench Mark=1:1 or more (Liquid Ratio) 2. Solvency Ratio Debt Equity Proprietary Debt to Ratio Ratio total assets A. Debt Equity Ratio = Where, Long Term Debt Equity 2:1 or less (Debt Equity Ratio) Long Term Debt =Debenture + Bank loan etc. Page 51

52 Equity=Shareholder fund Equity= Equity Share capital + Preference Share capital + All reserve + P/L A/c credit balance + Accumulated profit + Security Premium- P/L A/c debit balance Accumulated losses-fictitious Assets. Where, Fictitious Assets= Expenses on issue of share/debenture + Underwriting Comm. + Preliminary expenses etc. B. Proprietary Ratio = Total Assets C. Debt to total Asset Ratio Equity Total Assets = Fixed Assets + Current Assents DTAR = Long Term Debt/ Total Asset 3. Turnover Ratio Stock Debtor Creditor Working Turnover Turnover Turnover Turnover Page 52

53 A. Stock Turnover Ratio or Inventory Turnover Ratio:- Cost of goods sold Inventory Turnover Ratio = Average Inventory Where, Stock COGS = Opening Stock + Purchases + Direct Expenses - Closing COGS = Sales - Gross Profit Opening stock Closing stock Average Inventory = 2 B. Inventory holding period or Stock holding period = Days C. Debtor or Receivable Turnover Ratio Net Credit Sales Debtor Turnover Ratio = Average Receivables Where, Net credit Sales = Total sales Sales Return Cash sales or Months ITR Average Receivable = Opening Debtor & B/R Closing debtors& B/R 2 D. Average Collection Period ACP (Average Collection Period) = Days or Months Debtor Turnover Ratio E. Creditor Turnover Ratio Where, Creditor Turnover Ratio = Net Credit Purchases Average Creditors Page 53

54 Net credits Purchases = Total Purchases Purchase Return Cash Purchase Average Creditors = Opening Creditor & B/P Closing Creditors& B/P 2 F. Average Payment Period APP (Average Payment Period) = Days or Months Creditor Turnover Ratio G. Working Capital Turnover Ratio Working Capital Turnover Ratio = Net Sales Or Working Capital Cost of Goods Sold Working Capital Working capital = Current Assets Current liabilities Profitability Ratios A. Gross Profit Ratio Gross Profit Gross Profit Ratio = 100 Net Sales Where, Gross Profit Ratio = Sales Cost Of Goods Sold Net Profit B. Net Profit Ratio Net Profit Ratio = 100 Net Sales C. Operating Profit Ratio Operating Profit Operating Profit Ratio = 100 Net Sales Where, Page 54

55 Operating Profit = Gross Profit Operating expenses Operating Expenses = Indirect expenses debited to Profit & loss A/c except interest on long term loans & abnormal losses. Or Operating Expenses = Office expenses + selling expenses+ administrative expenses etc. D. Operating Ratio Cost of sold Operating Expenses Operating Ratio / Operating cost Ratio = 100 Net Sales Operating Profit Ratio + operating cost Ratio = 100% Example: Sales = 1,000 ( ) COGS 600 Gross Profit = 400 ( ) Indirect expenses (except Interest on long term loans) 250 Earning/Profit before tax & interest operating Profit EBIT = 150 ( ) Interest on Long Term Loan 50 Net Profit before tax =EBT = 100 (EAT) ( ) Tax 40% 40 Net profit after tax = EAT = 60 (EAT) ( ) Preference dividend = 10 EAT & PD 50 EAT & PD EPS = No. Eq.of Shares 50 = 100 EPS = 0.5 RS. Page 55

56 Or EAT & PD = 50 ( ) Reserve = 20 Dividend to Equity Share 30 Dividend per share Dividend to Equity Shareholder = No. of Equity Shareholder = = 0.30 Rs. Q. I) Preference share capital 3,00,000 Long term loans 2,00,000 Debentures 1,00,000 Bank loan 50,000 Reserves 1,00,000 P/L A/c Dr 40,000 Share Issue Expenses 10,000 Fixed Assets - 4,00,000 Cash 1,00,000 Bank Balance 50,000 Debtors 70,000 Find Debt Equity Ratio? And comment on it. 2) Opening stock 10,000 Purchases 60,000 Direct expenses 40,000 Closing stock 20,000 Indirect expenses 10,000 Find Inventory or stock turn over Ratio and stock holding period. Page 56

57 3) EBIT 1,00,000 10% debentures 2,00,000 Tax 40% 10,000 equity shares of Rs. 10 each Retention Ratio 50% Find EPS and DPS. 4) Cost of good sold 1,00,000 Operating expenses 50,000 Sales 2,00,000 Abnormal losses 10,000 Find Operating Ratio or Operating Cost Ratio. 5) Creditors 10,000 B/P 40,000 Received in advance 10,000 Unaccrued income - 20,000 Short term loan - 20,000 Debtors - 1,50,000 Cash - 10,000 Bank balance - 15,000 B/R - 15,000 Closing stock - 60,000 Prepaid - 10,000 Find current Ratio & liquid Ratio & comment on it. Solutions 1) Debt Equity Ratio = Long term debts Equity Page 57

58 Long term Debt = Long term Loan + Debentures + Bank loan = 2,00, ,000 = 3,50,000 Equity = Equity share capital + Preference share capital + Cr. Bal. of P/L + Reserves + Accumulated Profit Dr bal. of P/L A/c Fictitious Assets = 3,00, ,00,000 + (-40,000) 10,000 = 3,50,000 Debt Equity Ratio = Long term debts Equity = 3,50,000 = 1:1 3,50,000 Idle 2:1. And the Ratio is less than 2:1.. So our paying capacity is good. 2) Stock or Inventory turnover Ratio = = Opening stock Cost of goods sold Avg. Inventory purchases direct expenses closing stock Avg. Inventory 10,000 60,000 40,000 20,000 = 10,000 20,000 /2 = 90,000/15000 = 6:1 = 6 times Days or Months Stock holding period = ITR Page 58

59 = or 6 6 = 60.8 day = 2 months 3) EBIT 1,00,000 ( ) int = 20,000 EBT 80,000 ( ) Tax = 32,000 PAT 48,000 20, ( ) Pref. divided = EAT & PD = EPS = EAT & PD/Eq. Share = 46,000 10,000 = 4.6 Rs. DPS = 46,000 23, ,000 = 23,000 10,000 = 2.3 Rs. 4) Operating cost Ratio = Cost of good sold Operating expenses 100 Net Sales (50% retention) Page 59

60 5) Current Ratio = 1,00,000 50,000 = 100 2,00,000 1,50,000 = 100 2,00,000 = 75% Current Asset Current Laibility Debtors Cash Bank Balance B/R Closing Stock Prepaid Creditors B/P Recd. inadvance Unaccrued income short term loan = 2,60,000 1,00,000 = 2.6:1 (idle 2:1 or more) Liquid Ratio = Liquid Assets Current Laibility = 26,000 (closing Stock prepaid)(60,000 10,000) 1,00,000 = 1,90,000 1,00,000 =1.90:1 ( idle 1:1 or more) Page 60

61 Comparative Statements Q.1 Prepare a Comparative Income statement with the help of the following information Particulars Sales Gross Profit 40% 30% Indirect Expenses 50% 40% Income Tax 50% 50% Ans. Comparative Income Statement For the year ended 31 st Dec, 2006 Particulars Absolute Change Change in Percentage Rs. % Changes Sales % Less: Cost of Goods sold % Gross Profit % Less : Indirect Exp (40000) 10% Profit before tax % Less: Tax 50% % Net Profit after tax % Q.2 From the following Balance Sheets U.K Ltd. on 31 st Dec 2006 & 2007.Prepare comparative Balance Sheet. Page 61

62 Balance Sheet As on 31 st Dec 2006 & 2007 Liabilities Assets Current Liabilities Current Assets Reserves Fixed Assets % Loan Share Capital Ans. Comparative Balance Sheet For the year ended 31 st Dec, 2006 & 2007 Particulars Increase or Decreases % Increase or Decrease Fixed Assets Working Capital % 66.7% (C.A-C.L) Capital Employed Less 12% Loan % 60% Shareholders fund % Represented by share capital % Reserves (-) % % Q.3 With the help of the following information. Prepare Comparative Income Statement of XYZ Ltd Sales Cash of Goods Sold 60% of Sales 70% of Sales Indirect Expenses 10% of Gross profit Page 62

63 Rate of Income Tax 50% of Net profit before tax Ans 13 Comparative Income Statement of XYZ Ltd. For the year ended 31 st, Dec 1997 & 1998 Particulars Absolute Change Percentage Change A Sales % B Less Cost of Goods Sold % C Gross Profit (A-B) % D Less Indirect Expenses % E Profit Before Tax (C-D) % F Less Income Tax % % Common Size Statement Q.1 From the following asset side of the balance sheet of Sachin Ltd. for the year ended 31 st December 1999 and 1992, you are required to prepare asset side of common size balance sheet as on 31 st December 1991 and Assets (Rs. in Lakhs) Cash Debtors Stock Land and Buildings Page 63

64 Plants Furniture ,300 1,520 Solution : Common size balance sheet for 1991 and 1992 Assets (Rs. in Lakhs) 1991 % 1992 % Current Assets Cash Debtors Stock Total of Current Assets Fixed Assets Land and Buildings Plants Furniture Total Fixed Assets Page 64

65 Total Assets Working Notes In case of common size statement, total asset will be taken as 100. Based on this percentage, each item of asset has been computed as follow, e.g. : 100 Cash = Cash Amount Total AssetValue 1991 = = 7.69% 1, = = 9.21% 1, Debtors = Debtors Total AssetValue 1991 = = 15.38% 1, = 300 = 19.74% 1,520 Similarly other figures have been computed. Q.2 From the following Income Statement of Dravid Ltd. for the years 1992 and 1993, prepare common size income statement. Page 65

66 Assets 1992 Rs Rs. Gross Sales Less : Sales Returns Net Sales Cot of Sales 7,25,000 25,000 7,00,000 5,95,000 8,15,000 15,000 8,00,000 6,15,000 1,05,000 1,85,000 Operating Expenses : Selling and Distribution Expenses Administrative Expenses 23,000 12,700 24,000 12,500 35,700 36,500 Operating Income Other Incomes 69,300 1,200 1,48,500 8,050 70,500 1,56,550 Non Operating Expenses 1,750 1,940 68,750 1,54,610 Solution : Common size Statement Page 66

67 Particulars Amount % Amount % Gross Sales 7,25,000-8,15,000 - Less : Return 25,000-15,000 - Net Sales 7,00, ,00, Less : Cost of Sales 5,95, ,15,000 76,88 Gross Profit 1,05, ,85, Operating Expenses : Selling and Distribution Expenses 23, ,000 3 Administrative Expenses 12, , , , Operating Income 69, ,48, Add : Non Operating Income other Income 1, , , ,56, Less : Non Operating Expenses 1, , Net Profit 68, ,54, Page 67

68 Working Notes Net sales has been taken as 100%. On this basis the percentage of each item to sales has been computed. Funds Flow Statement Q.1 From the following balance sheet of a Saurav Ltd., prepare a statement showing the changes in working capital. BALANCE SHEET Liabilities 1999 Rs Rs. Assets 1999 Rs Rs. Creditors 7,000 4,500 Cash 3,000 4,700 Capital 20,000 25,000 Debtors 12,000 11,500 Profit & Loss A/c 1,000 2,300 Land 5,000 6,600 Stock 8,000 9,000 28,000 31,800 28,000 31,800 Solution : Statement of changes in working capital Page 68