Accounting For Manager Complete Notes

MBA I SEM ACCOUNTING FOR MANAGERS UNIT I
Introduction:
Accounting is known as the `language of the business‟. It communicates the financial results of an enterprise to
various interested parties by means of financial statements. Like any language, accounting has its own
complicated set of rules. However, these rules have to be used with a reasonable degree of flexibility keeping in
view the changes in the economic environment, social needs, legal requirements and technological
developments. Therefore, these rules cannot be absolutely rigid like those of the physical science. However, this
does not imply that accounting rules can be applied arbitrarily. They have to operate within the bounds of
rationality. Therefore, formulation of proper accounting standards is a vital step in developing accounting as a
business language. Need for Accounting Standards While preparing accounting records, sometimes there is a
choice about an accounting policy. For example, closing stock may be valued on the basis of LIFO (Last in First
Out) or FIFO (First in first out). Since the value of stock is different in both the methods, the profit shown by
accounts will also be different. Similarly, in charging depreciation, one can adopt Straight Line Method or
Reducing Balance Method. The profit will depend upon the choice of the method.
The above two examples show that the profit the profit and value of asset shown in Balance Sheet will depend
on management decision regarding the policy adopted. Therefore, it is essential that certain standards should be
followed for preparing the financial statements, so that there is minimum possible uncertainty about the figures
contained in Profit & Loss Account and Balance Sheet. The main purpose of accounting standards is to provide
information to the user about the basis on which the accounts have been prepared. This in making the
accounting records of different business enterprises comparable. In the absence of accounting standards, if we
compare the accounting records of various business organizations, it may lead to misleading conclusions. For
this, it is essential that the accounting standards must be well understood and they should be able to reduce the
chances of manipulation in accounting data.
Basic Accounting Terms

Here is a quick look at some important accounting terms.
Accounting methods: Companies choose between two methods—cash accounting or accrual

accounting. Under cash basis accounting, preferred by small businesses, all revenues and expenditures
at the time when payments are actually received or sent are recorded. Under accrual basis accounting,
income is recorded when earned and expenses are recorded when incurred.
Account receivable: The sum of money owed by your customers after goods or services have been
delivered and/or used.
Account payable: The amount of money you owe creditors, suppliers, etc., in return for goods and/or
services they have delivered.
Assets (fixed and current): Current assets are assets that will be used within one year.
For example, cash, inventory, and accounts receivable (see above). Fixed assets (non-current) may
provide benefits to a company for more than one year—for example, land and machinery.
CH Institute of Management & Commerce Page 1

Balance sheet: A financial report that provides a gist of a company‟s assets and liabilities and owner‟s
equity at a given time.
Capital: A financial asset and its value, such as cash and goods. Working capital is current assets
minus current liabilities.
Cash flow statement: The cash flow statement of a business shows the balance between the amount
of cash earned and the cash expenditure incurred.
Credit and debit: A credit is an accounting entry that either increases a liability or equity account, or
decreases an asset or expense account. It is entered on the right in an accounting entry. A debit is an
accounting entry that either increases an asset or expense account, or decreases a liability or equity
account. It is entered on the left in an accounting entry.
Double-entry bookkeeping: Under double-entry bookkeeping, every transaction is recorded in at

least two accounts—as a credit in one account and as a debit in another.
For example, an automobile repair shop that collects Rs. 10,000 in cash from a customer enters this
amount in the revenue credit side and also in the cash debit side. If the customer had been given credit,
“account receivable” (see above) would have been used instead of “cash.”
Financial statement: A financial statement is a document that reveals the financial transactions of a
business or a person. The three most important financial statements for businesses are the balance
sheet, cash flow statement, and profit and loss statement (all three listed here alphabetically).
General ledger: A complete record of financial transactions over the life of a company.
Journal entry: An entry in the journal that records financial transactions in the chronological order.
Profit and loss statement (income statement): A financial statement that summarises a company‟s
performance by reviewing revenues, costs and expenses during a specific period.
Single-entry bookkeeping: Under the single-entry bookkeeping, mainly used by small or businesses,
incomes and expenses are recorded through daily and monthly summaries of cash receipts and
disbursements.
Types of accounting: Financial accounting reports information about a company‟s performance to

investors and credits. Management accounting provides financial data to managers for business
development.
Accounting equation: The accounting equation, the basis for the double-entry system (see below), is
written as follows:
Assets = Liabilities + Stakeholders’ equity

This means that all the assets owned by a company have been financed from loans from creditors and
from equity from investors. “Assets” here stands for cash, account receivables, inventory, etc., that a
company possesses.
Accounting Principles
If each business organisation conveys its information in its own way, we will have a bible of unusable
financial data. Personal systems of accounting may have worked in the days when most companies
were owned by sole proprietors or partners, but they do not anymore, in this era of joint stock
companies. These companies have thousands of stakeholders who have invested millions, and they
need a uniform, standardised system of accounting by which companies can be compared on the basis
of their performance and value.
Therefore, accounting principles based on certain concepts, convention, and tradition have been
evolved by accounting authorities and regulators and are followed internationally. These principles,
which serve as the rules for accounting for financial transactions and preparing financial statements,
are known as the “Generally Accepted Accounting Principles,” or GAAP.
The application of the principles by accountants ensures that financial statements are both informative
and reliable. It ensures that common practices and conventions are followed, and that the common
rules and procedures are complied with. This observance of accounting principles has helped
developed a widely understood grammar and vocabulary for recording financial statements.
However, it should be said that just as there may be variations in the usage of a language by two
people living in two continents, there may be minor differences in the application of accounting rules
and procedures depending on the accountant. For example, two accountants may choose two equally
correct methods for recording a particular transaction based on their own professional judgement and
knowledge.
Accounting principles are accepted as such if they are
(1) Objective;
(2) Usable in practical situations;
(3) Reliable;
(4) Feasible (they can be applied without incurring high costs); and
(5) Comprehensible to those with a basic knowledge of finance.

Accounting principles involve both accounting concepts and accounting conventions. Here is brief
explanation
Accounting Concepts
1. Business entity concept: A business and its owner should be treated separately as far as their
financial transactions are concerned.
2. Money measurement concept: Only business transactions that can be expressed in terms of
money are recorded in accounting, though records of other types of transactions may be kept
separately.
3. Dual aspect concept: For every credit, a corresponding debit is made. The recording of a
transaction is complete only with this dual aspect.
4. Going concern concept: In accounting, a business is expected to continue for a fairly long
time and carry out its commitments and obligations. This assumes that the business will not be
forced to stop functioning and liquidate its assets at “fire-sale” prices.
5. Cost concept: The fixed assets of a business are recorded on the basis of their original cost in
the first year of accounting. Subsequently, these assets are recorded minus depreciation. No
rise or fall in market price is taken into account. The concept applies only to fixed assets.

6. Accounting year concept: Each business chooses a specific time period to complete a cycle of
the accounting process—for example, monthly, quarterly, or annually—as per a fiscal or a
calendar year.
7. Matching concept: This principle dictates that for every entry of revenue recorded in a given
accounting period, an equal expense entry has to be recorded for correctly calculating profit or
loss in a given period.
8. Realisation concept: According to this concept, profit is recognised only when it is earned. An
advance or fee paid is not considered a profit until the goods or services have been delivered to
the buyer.
Accounting Conventions
There are four main conventions in practice in accounting: conservatism; consistency; full disclosure;
and materiality.
Conservatism is the convention by which, when two values of a transaction are available, the lower-
value transaction is recorded. By this convention, profit should never be overestimated, and there
should always be a provision for losses.
Consistency prescribes the use of the same accounting principles from one period of an accounting
cycle to the next, so that the same standards are applied to calculate profit and loss.
Materiality means that all material facts should be recorded in accounting. Accountants should record
important data and leave out insignificant information.
Full disclosure entails the revelation of all information, both favourable and detrimental to a business
enterprise, and which are of material value to creditors and debtors.
Meaning of Accounting Standards: In order to ensure transparency consistency, comparability,

adequacy and reliability of financial reporting, it is essential to standardize the accounting principles
and policies, Accounting Standards provide framework and standard accounting polices so that the
financial statements of different enterprises become comparable.
Accounting Standards are selected set of accounting policies or broad guidelines regarding the
principles and methods to be chosen out of several alternatives. The Accounting Standards Board
(ASB) of the Institute of Chartered Accountants of India (ICAI) formulas Accounting Standards to
be established by the Council of the ICAI.
Objective of Accounting Standards:
Objective of Accounting Standards is to standardize the diverse accounting policies and practices with
a view to eliminate to the extent possible the non-comparability of financial statements and the

reliability to the financial statements. The institute of Chartered Accountants of India, recognizing the
need to harmonize the diverse accounting policies and practices, constituted at Accounting Standard
Board (ASB) on 21st April, 1977.
IFRS:
IFRS is a set of international accounting standards stating how particular types of transactions and
other events should be reported in financial statements. IFRS are generally principles-based standards
and seek to avoid a rule-book mentality. Application of IFRS requires exercise of judgment by the
preparer and the auditor in applying principles of accounting on the basis of the economic substance of
transactions. IFRS are issued by the International Accounting Standards Board (IASB). The term IFRS
comprises IFRS issued by IASB; IAS issued by IASC; and Interpretations issued by the Standing
Interpretations Committee (SIC) and the International Financial Reporting Interpretations Committee
(IFRIC) of the IASB.
“FOR THE EFFECTIVE STUDY OF ACCOUNTING STANDARDS AND IFRS THERE IS A

STRONG NEED TO STUDY THE LINKAGE BETWEEN THESE TWO TERMS THAT MEANS
CONVERGENCE.”
Meaning of convergence: The convergence of accounting standards refers to the goal of establishing
a single set of accounting standards that will be used internationally, and in particular the effort to
reduce the differences between the US generally accepted accounting principles (USGAAP) and the
International financial reporting standards (IFRS)
Convergence of Indian accounting standards with International financial reporting standards

(IFRS):
Meaning of convergence with IFRS: Convergence means to achieve harmony with IFRSs; in
precise terms convergence can be considered “to design and maintain national accounting standards in
a way that financial statements prepared in accordance with national accounting standards draw
unreserved statement of compliance with IFRSs”, i.e., when the national accounting standards will
comply with all the requirements of IFRS.
But convergence doesn‟t mean that IFRS should be adopted word by word, e.g., replacing the term
„true & fair‟ for „present fairly‟, in IAS 1, ‘Presentation of Financial Statements’. Such changes do not
lead to non-convergence with IFRS.
The reason behind convergence is:

As, Availability of essential financial information about a company to its shareholders and other
stakeholders in accordance with internationally accepted financial norms is considered as an integral
and important part of good corporate governance. To ensure this and to implement the G-20
commitment to achieve a single set of high quality global accounting standards, the Government has
taken decision to achieve convergence of Indian accounting standards with International financial
reporting standards (IFRS) in a phased manner in accordance with the roadmap suggested by the
Government.

Convergence in Indian Scenario:

With regard to India, the Ministry of Corporate Affairs (MCA) has committed to converge the Indian
Accounting Standards with the IFRS effective 1st April 2011. The convergence process is picking up
momentum with the credit going to the Ministry of Corporate Affairs. The Ministry has extended its
unstinted support and guidance to the various regulatory and legal bodies that are spearheading a
smooth transition process. Laudably, the highest authorities of the Indian Government have concluded
that convergence of Indian Accounting Standards with IFRS is very vital for the country to take a lead
role in the global foray.
Entities covered under convergence;

Keeping in view the complex nature of IFRSs and the extent of differences between the existing ASs
and the corresponding IFRSs and the reasons therefore, the ICAI is of the view that IFRSs should be
adopted for the public interest entities from the accounting periods beginning on or after 1st April,
2011.
Public interest entities:

With a view to determine which entities should be considered as public interest entities for the purpose
of application of IFRSs, the criteria for Level I enterprises as laid down by the Institute of Chartered
Accountants of India and the definition of „small and medium sized company‟ as per Clause 2(f) of the
Companies (Accounting Standards) Rules, 2006, as notified by the Ministry of Company Affairs (now
Ministry of Corporate Affairs) in the Official Gazette dated December 7, 2006, were considered. The
ICAI is of the view that in view of the complexity of recognition and measurement principles and the
extent of disclosures required in various IFRSs, and the fact that about four years have elapsed since
the ICAI laid down the criteria for Level I enterprises, as far as the size is concerned, it needs a
revision. Accordingly, the ICAI is of the view that a public interest entity should be an entity:
(i) Whose equity or debt securities are listed or are in the process of listing on any stock
exchange, whether in India or outside India; or
(ii) Which is a bank (including a cooperative bank), financial institution, a mutual fund, or an
insurance entity; or
(iii) Whose turnover (excluding other income) exceeds rupees one hundred crore in the
immediately preceding accounting year; or
(iv) Which has public deposits and/or borrowings from banks and financial institutions in
excess of rupees twenty five crore at any time during the immediately preceding accounting
year; or
(v) which is a holding or a subsidiary of an entity which is covered in (i) to (iv) above.
Role of ICAI in convergence:

 India, though being an important emerging economy in the world, is yet to adopt the IFRS.
Internationally, in so far as cross-border investments are concerned, a non-IFRS compliant
country is perceived as an additional risk factor.

 After a series of discussion with various legal and regulatory authorities, the Ministry of
Corporate Affairs has committed itself for convergence of Indian entities with IFRS from April
2011. ICAI was given the responsibility of formulating the convergence process and ensure
smooth convergence.
 For this purpose, the Accounting Standard Board (ASB) of ICAI constituted a Task Force in
the year 2006 to explore the approach for convergence with IFRS and lay down the road map
for convergence with IFRS.
 Since then, ICAI has been relentlessly making extensive analysis of various phases the
convergence process would go through. It has identified the legal and regulatory requirements
arising out of convergence with IFRS.
 ICAI has also recommended changes in the respective Acts, guidelines and other regulatory
provision related to RBI, SEBI, NACAS and IRDA and has submitted its recommendations to
the respective authorities. This would eventually pave the way to a smooth transition process.
 In addition, the ICAI Accounting Board has pointed out several national issues requiring
debates and conclusions that would enable the convergence process to meet the deadline.
Role of SEBI:
SEBI has been pro-actively involved in the process of convergence of Indian Accounting Standards
with IFRS.
As a step towards encouraging convergence with IFRS, listed entities having subsidiaries have been
allowed an option to submit consolidated accounts as per IFRS.
SEBI has set up a group under the chairmanship of Shri Y.H. Malegam with representation from RBI,
ICAI, accounting and auditing firms, and industry to discuss and submit comments on the exposure
drafts issued by the IASB in an objective and streamlined manner. Since formation in February 2010,
the group has had four meetings and has provided comments to IASB on the following exposure
drafts:
a. Management Commentary (proposed new IFRS)

b. Financial Instruments: Amortised Cost and Impairment (IFRS9)
c. Conceptual Framework for Financial Reporting
d. Fair Value Option for Financial Liabilities (proposed new IFRS replacing IAS 39)
Role of Industry Associations:

Industry associations such as Federation of Indian Chambers of Commerce and Industry (FICCI),
Associated Chambers of Commerce (Assocham) and Confederation of Indian Industries (CII) can also
play an important role in preparing their constituents for the adoption of the IFRSs in the following
ways:

(i) Holding round-tables on the Exposure Drafts of the IFRSs so that the views of the Association can
be sent to the IASB/ICAI.
(ii) Conducting seminars/workshops on IFRSs for the industry participants to provide them
appropriate training.
(iii) Provide industry-specific forums to their constituents to discuss the industry specific issues in
implementation of IFRSs.
Advantages of convergence:
 Improves investor confidence across the world with transparency and comparability
 Improves inter-unit/ inter-firm/inter-industry comparison
 Group consolidation made easy with same standard by all companies in group wherever
located
 Acceptability of financial statements across all stock exchanges, which facilitates entry of any
Indian company to any stock exchange across the globe.
 A business can present its financial statements on the same basis as its foreign competitors.
Challenges (Limitations) envisaged in convergence:
Change to regulatory environment:

For the success of convergence in India, certain regulatory amendment is required.
For example, The Companies Act (Schedule VI) prescribes the format for presentation of financial
statements for Indian companies, whereas the presentation requirements are significantly different
under IFRS. So, the companies act needs to be amended in line with IFRS.
Lack of Preparedness
Corporate India and accounting professionals need to be trained for effective migration to IFRS.
Additionally auditors would need to train their staff to audit under IFRS environment
Significant cost
Significant one-time costs of converting to IFRS (including costs of adapting IT systems, training
personnel and educating investors)
Impact on financial performance:
Due to the significant differences between Indian GAAP and IFRS, adoption of IFRS is likely to have
a significant impact on the financial position and financial performance of most Indian companies
Communication of Impact of IFRS to investors:

Companies also need to communicate the impact of IFRS convergence to their investors to ensure they
understand the shift from Indian GAAP to IFRS.
Implementation Phase in India:

The applicability of International Financial Reporting Standards for convergence of Indian entities
would be in several phases as the issues involved in one-shot adoption are complex.
Hence, in the first phase, ICAI has submitted a suggested list of companies that come under different
parameters for adoption of IFRS standards. These entities include companies listed with BSE / NSE
Sensex, insurance companies, mutual funds, entities with a capital base of over 50 million dollars
outside India, companies that are publicly accountable with an aggregate borrowing of over Rs. 1,000
crores and such others.
Accounting Standards after convergence:

A set of accounting standards notified by the Ministry of Corporate Affairs which are converged with
International Financial Reporting Standards (IFRS) which are now termed as IND AS‟s.
Now India will have two sets of accounting standards viz. existing accounting standards under
Companies (Accounting Standard) Rules, 2006 and IFRS converged Indian Accounting Standards(Ind
AS). The Ind AS are named and numbered in the same way as the corresponding IFRS.
Thirty five Indian Accounting Standards converged with International Financial Reporting Standards
(henceforth called IND AS) are being notified by the Ministry and placed on the website.
An accounting standard is a selected set of accounting policies regarding the principles and methods to be
chosen. Accounting standards ensure that the Financial Statements are prepared in accordance with generally
accepted accounting principles.
Utility and advantages of Accounting Standards

The management of every business wants to obtain reliable accounting data for correct decision making. Other
users of accounting information like shareholders, investors, creditors, employees and Government etc. also
want reliable accounting data. Accounting standards play a very important role for this purpose. They make it
possible that people get reliable accounting data. Thus, investors can take better decision. Government can
make better policies. Sometimes, there is a conflict of interest among the various interest groups. Accounting
standards help in solving such a conflict because they are acceptable by all the parties. Accounting standards are
most important because they remove complexities in accounting practices and incorporate credibility in the
system. Financial statements are prepared according to prescribed standards. It brings harmony in accounting
policies and financial reports are made simple and comparable.
The main advantage of setting accounting standards is to bring uniformity, comparability and qualitative
improvement in the preparation and presentation of financial statements. Accounting Standards in India In
almost each country, an expert regulatory accounting body at national level has been setup to control the
direction of accounting. Realizing the need of accounting standards in India and keeping in view the

international developments in the field of accounting, the Council of the Institute of Chartered Accountants of
India constituted the Accounting Standards Board (ASB) on 21st April 1977. The main function of board is to
formulate the accounting standards. The Accounting Standards Board (ASB) takes into account the applicable
laws, customs and business environment. It given representation to all the interested parties. The Board consists
of representatives of industries, Central Board of Direct Taxes (CBDT) and the Comptroller and Auditor
General of India.
Functions of Accounting Standards Board

The main function of ASB is to formulate accounting standards and ensure their applicability. While
formulating the Accounting Standards, ASB given due consideration to International Accounting Standards
issued by IASC and tries to integrate them, in the light of the conditions and practices prevailing in India. The
ASB has adopted a very objective approach to rules and limitations relating to the publication of financial
statements with a view to eliminate the double accounting policy and also to limit the alternatives in selecting in
selecting from the diverse alternate methods of accounting. If the enter price, for whom the Board has
formulated the Accounting Standards, have any problem or difficulty in complying or applying the standards,
they can have guidelines from the Board. The Board also revises and modifies Standards from time to time as
per the changed situation.
Formulation of Accounting Standards

Broadly the following procedure is adopted for formulating Accounting Standards:
(i) The Accounting Standards Board (ASB) determines the broad areas in which accounting
standards are to be formulated.
(ii) In preparation of accounting standards ASB takes assistance of different study groups.
(iii) ASB holds a dialogue with the representatives of the Government, Public Sector Undertakings
and other organizations for ascertaining their views also.
(iv) After taking into consideration the comments and views from different groups, the draft of the
standard is issued. The exposure draft includes the following basis points:
(a) A statement of concepts and fundamental accounting principles.
(b) The manner in which the accounting principles have been applied for formulating the
standard.
(c) Definitions of the terms used in the standards.
(d) The presentation and disclosure requirement in complying with standard.
(e) Class of enter price to which the standard will apply.
(f) Date from which the standard will be effective.
Limitations
1. There are some alternative solutions of certain problems in Accounting Standards. Therefore selection
among alternatives for accounting treatment may be difficult.
2. Accounting Standards cannot override the statute, so it should be framed within prevailing statutory
ambit.
3. There is no flexibility in applying the accounting standards. It is rigid in nature.
Benefit and Limitation of Accounting Standards Accounting Standards describe the valuation
techniques, accounting principle and methods of applying those in the accounting system for

preparation and presentation of financial statements. So they give “True and Fair” view of enter price to
its users.
Accounting Standards have some benefits which are as under:
1. Accounting Standards are mandatory to follow by companies (except some) hence it reduces variation
and confusion to reasonable extent of financial statement of companies.
2. Accounting Standards call for material disclosures of companies in financial statements beyond the
requirement of laws and regulations.
2. After application of Accounting Standards, comparison of financial statements of different companies is
too easy and now financial statements are easy to understand by user of financial statements.
Scope of Accounting Standards
1. Efforts are made that Accounting Standards should be accounting to the applicable laws, customs and
business environment of out country. If there is any amendment in law, the financial statements should
be prepared according to such law.
2. The Accounting Standards can not override the local regulations in preparation and presentation of
financial statements in our country. However, the Institute will determine what disclosures would be
needed.
3. The Accounting Standards will apply only to the items which are material. Any limitations with regard
to the applicability of a specific standard will be made clear from time to time.
4. The intention of Accounting Standards is to concentrate on basic matters. It should not be made so
complex that it can not be applied effectively.
5. The Board shall try to persuade the Government, appropriate authorities and business community to
adopt these standards in order in order to achieve uniformity in the presentation of financial statements.
Accounting Standards Issued By ICAI
The Institute of Chartered Accountants of India (ICAI)has issued the following standards effective from the
data mentioned against them:
(1) AS-1 Disclosure of Accounting Policies 1-4-1991
(2) AS-2 Valuation of Inventories 1-4-1999 (Revised)
(3) AS-3 Cash Flow Statement 1-4-2001 (Revised)
(4) AS-4 Contingencies and events occurring after the Balance Sheet Date 1-4-1995
(5) AS-5 Net Profit or Loss for period, prior items and changes in Accounting Policies 1-4-1996
(6) AS-6 Depreciation Accounting 1-4-1995
(7) AS-7 Accounting for Construction Contract 1-4-2003 (Revised)
(8) AS-8 Accounting for Research and Development 1-4-1991(Withdrawn) hence not applicable
(9) AS-9 Revenue Recognition 1-4-1991
(10) AS-10 Accounting for Fixed Assets 1-4-1991
(11) AS-11 Accounting for the effects of changes in Foreign Exchange Rates 1-4-2004 (Revised)
(12) AS-12 Accounting for Government Grants 1-4-1995

(13) AS-13 Accounting for Investments 1-4-1995

(14) AS-14 Accounting for Amalgamation 1-4-1995

(15) AS-15 Accounting for retirement benefits in the financial statements of employers 1-4-2006 (Revi.)
(16) AS-16 Borrowing Costs 1-4-2001

(17) AS-17 Segment Reporting 1-4-2001
(18) AS-18 Related Party Disclosures 1-4-2001
(19) AS-19 Leases 1-4-2001
(20) AS-20 Earning per share 1-4-2001
(21) AS-21 Consolidated Financial Statements 1-4-2001
(22) AS-22 Accounting for Taxes on Income 1-4-2001
(23) AS-23 Accounting for Investments in Associates in Consolidated Financial Statements 1-4-2002
(24) AS-24 Discontinuing Operations 1-4-2004
(25) AS-25 Interim Financial Reporting 1-4-2002
(26) AS-26 Intangible Assets 1-4-2002
(27) AS-27 Financial Reporting of Interest in Joint Ventures 1-4-2002
(28) AS-28 Impairment of Assets 1-4-2004
(29) AS-29 Provisions Contingent Liabilities and Contingent Assets 1-4-2004
(30) AS-30 Financial Instruments: Recognition and Measurement 1-4-2009
(31) AS-31 Financial Instruments: Presentation 1-4-2009
(32) AS-32 Financial Instruments: Disclosures. 1-4-2011
AS-1 to AS-29 issued and AS-30, 31 & 32 are published, they will come into effect from 1-4-2009.
It mandatory on & after 1-4-2011.
Differences between the India Accounting Standards and the US GAAP

Following are some of the significant differences between India Accounting Standards and the US GAAP-
S.N. Base Indian Accounting Standard US GAAP

1. Preparation of In India, financial statements are prepared
No specific format is required for
Financial statement in accordance with the presentation the preparation of financial
requirement of Schedule VI to The statement as long as they comply
Companies Act, 1956. with the disclosure requirements
of US accounting standards.
2. Consolidation of Consolidation of accounts of holding and Consolidation of group company
Accounts subsidiary companies is not required in account is compulsory.
India.
3. Disclosure of EPS Disclosure of earnings per share is not Disclosure of earning per share
required in India. data is compulsory.
4. Revaluation of Assets Revaluation of assets is permitted in Revaluation of assets is not
India. Depreciation is usually based on permitted. Depreciation is
the rates set out in schedule XIV to The calculated on the basis of useful
Companies Act, 1956. economic life of the assets and is
based on historical costs.
5. Investment in own Investment is own shares is prohibited. Investment is own shares is
shares Buy back of shares is now permitted but permitted. It is shown as a
only for reduction of capital and not for reduction from shareholder`s

treasury operations. equity.

6. Disclosure of related No specific disclosure of related party Related party transactions
party transactions transactions are required. Auditors are disclosure are essential. The
liable to report certain transactions nature of relationship and control,
entered into by related parties as defined transaction, amount involved and
under The Companies Act, 1956. amounts due must be disclosed
clearly.
7. Pre-operative expenses Pre-operative expenses are allowed to be The concept of pre-operative
deferred and written off over a period of 5 expenses does not exist.
to 10 years.
8. Classification of Assets Asset and liabilities have to be classified Current and long term
and Liabilities into current and long term. components of assets and
liabilities should be disclosed
separately. Current component
normally refers to one year of the
period of the operating cycle.
9. Impairment evaluation No standards for impairment evaluation Impairment evaluation is
are provided India. compulsory for all assets.
Impairment loss is recognized on
the basis of the fair value of the
asset. Disclosure of the facts and
circumstances that led to
impairment is compulsory.
10. Segmental Reporting Segmental reporting is not compulsory. Segmental reporting is mandatory
Disclosure of quantitative particulars only for SES registered companies.
is required as per schedule VI to the
Companies Act, 1956.
11. R and D Costs Research and development costs can be Research and development costs
capitalized subject subject to the are treated as expenses.
conditions of AS-8, issued by the ICAI.
12. Cash flow statement Cash flow statement is not compulsory in Cash flow statement is
India. compulsory.
13. Capitalization of lease Capitalization of lease is not required. Financial leases are to be
capitalized.
14. Goodwill Goodwill arising from amalgamations can Goodwill is treated as any other
be written off over 5 years. No separate intangible asset and is capitalized
standard for goodwill is provided except and amortized. The carry forward
for brief references in AS-10 AS-14. period is 40 years.

MBA I SEM ACCOUNTING FOR MANAGER UNIT II
Concept of 'Double Entry'

Double entry accounting is based on the fact that every financial transaction has equal and opposite
effects in at least two different accounts. It is used to satisfy the equation Assets = Liabilities + Equity,
whereby each entry is recorded so as to maintain the relationship. In the double entry system,
transactions are recorded in terms of debits and credits. Since a debit in one account will be offset by a
credit in another account, the sum of all debits must therefore be exactly equal to the sum of all credits.
Basic Knowledge of Accounting Process
Journal
Definition and Explanation:
The word "journal" has been derived from the French word "jour". Jour means day. So journal means
daily. Transactions are recorded daily in journal and hence it has been named so. It is a book of
original entry to record chronologically (i.e. in order of date) and in detail the various transactions of a
trader. It is also known Day Book because it contains the account of every day's transactions.
Characteristics of Journal:
Journal has the following features:
1. Journal is the first successful step of the double entry system. A transaction is recorded first of
all in the journal. So the journal is called the book of original entry.
2. A transaction is recorded on the same day it takes place. So, journal is called Day Book.
3. Transactions are recorded chronologically, So, journal is called chronological book
4. For each transaction the names of the two concerned accounts indicating which is debited and
which is credited, are clearly written in two consecutive lines. This makes ledger-posting easy.
That is why journal is called "Assistant to Ledger" or "subsidiary book"

5. Narration is written below each entry.

6. The amount is written in the last two columns - debit amount in debit column and credit
amount in credit column.
Advantages of Journal:
The following arte the advantages of journal:
1. Each transaction is recorded as soon as it takes place. So there is no possibility of any

transaction being omitted from the books of account.
2. Since the transactions are kept recorded in journal, chronologically with narration, it can be
easily ascertained when and why a transaction has taken place.
3. For each and every transaction which of the two concerned accounts will be debited and which
account credited, are clearly written in journal. So, there is no possibility of committing any
mistake in writing the ledger.
4. Since all the debits of transaction are recorded in journal, it is not necessary to repeat them in
ledger. As a result ledger is kept tidy and brief.
5. Journal shows the complete story of a transaction in one entry.
6. Any mistake in ledger can be easily detected with the help of journal.
Objective of an Entry:
While recording transactions in journal the following two objects must be aimed at:
1. That each entry in the journal should be so clear that at any future time we may, without the aid
of memory, perceive the exact nature of the transactions.
2. That each transaction should be so classified that we may easily obtain the aggregate effect of
such transactions at the end of a certain period.
Narration of an Entry:
It is the remark or explanation put below each entry in the journal. The journal is a book of original
entry and all possible details have to record in connection with each and every transaction entered
there. The details are laid out in the form of a remark at the end of each journal entry, which is called
narration.
Form of Journal:
Date Particulars L.F. Dr. Amount Cr. Amount
(1) (2) (3) (4) (5)
Column (1) is meant for writing the date of the transaction.

Column (2) is used for recording the names of the two accounts affected by transactions.
Column (3) is meant for noting the number of the page of the ledger on which the particular
account appears in that book.
Column (4) shows the amount to be debited to the account named.
Column (5) shows the amount to be credited to the account stated.
Rules of Journalising:
The act of recording transactions in journal is called journalising. The rules may be summarised as
follows:
1. Use two separate lines for writing the names of the two accounts concerned in each transaction.
2. write the name of the debtor or account to be debited in the first line and the name of the
creditor or the account to be credited in the next line
3. Write the name of the account to be debited close to the line starting the particulars column and
that of the account to be credited at a short distance from this line.
4. Use "Dr" after each debit item and "To" before each credit. The term "Cr." after a credit item is
unnecessary, as if one account is debtor, the other must be creditor.
5. To separate one entry from another a line is drawn below every entry to cover particulars
column only. The line does not extend to amount column.
The Ledger
The ledger is the principal book of accounting system. It contains different accounts where
transactions relating to that account are recorded. A ledger is the collection of all the accounts, debited
or credited, in the journal proper and various special journals. A ledger may be in the form of bound
register, or cards, or separate sheets may be maintained in a loose leaf binder. In the ledger, each
account is opened preferably on separate page or card. The ledger system of double-entry bookkeeping
involves the use of a number of account-ruled books (known as a set of books) for the purpose of
recording accurate information, in money values, of the day-to-day trading operations of a business.
From these permanent records, periodical statements are prepared to show the trading profit or loss
made by the business and its assets and liabilities, at any given date. In the past, these records would
quite literally have been kept in bound ledger books. However, even before the widespread
introduction of computers, mechanized systems based upon mechanical accounting machines were
used by many larger companies. In smaller organizations, loose-leaf systems with multipart forms and
carbon paper reduced the number of times that bookkeepers had to write out the same data.
Now any business with a full-time bookkeeper is likely to have computerized its accounting. However,
computerization can only speed up the arithmetic of accounting; it cannot replace an understanding of
the concepts. Underlying all modern computer accounting programs is the same double-entry system.
The second phase of accounting
The ledger is the principal book of accounts where transactions of similar nature relating to a particular
person or thing are recorded in classified form.
Ledger (or general ledger) is a book in which all accounts relating to a business enterprise are kept. In
other words, it is a collection or group of all accounts of a business enterprise. The accounts kept in the
ledger are sometimes termed as ledger accounts. One account usually occupies one page in the ledger

but if the account is big one, it may extend to two or more pages. All entries recorded in the general
journal must be transferred to ledger accounts.
The ledger may be in a bounded form or loose-leaf form. It is the master reference book of the
accounting system. It provides a permanent and classified record of every element in the business
operation. Because of these features, ledger is sometimes called the king of all the books of accounts.
Advantages of ledger
1. Double-entry system is successfully applied through ledger because it records the twofold
aspect of each transaction.
2. Through ledger information related to various persons or things are recorded separately in the
account. This enables business to look at the accumulated figure of each account.
3. Ledger has made it possible to analyse the total incomes and expenses of a business for a
particular period (Trading and Profit & Loss account).
4. By opening separate accounts for various assets and liabilities it is also possible to see the
financial position of a business.
5. The transaction is recorded in Journal at first. Ledger is the second stage where transactions are
posted, thus minimizing the chance of errors and omissions.
6. It helps the management by providing important information, which helps in running the
business smoothly.
Method of posting
The posting process consists of the following steps:
1. Trace the ledger account in which the entries are to be posted.

2. If an account is debited in the general journal, it will be posted on the debit side in the ledger
account and if it is credited in the general journal, it will be posted on the credit side.
3. In description column, the title (name) of the account included in other part of the journal entry
is written. For example, if we are posting an account included in the debit part of the journal
entry, the account or accounts in the credit part will be written in description column.
4. The amount of the entry is written in the amount column of the ledger account.
Balancing the ledger account
Balancing means finding out the debit or credit balance of a ledger account. This process may be
divided into the following steps:
1. Total the debit and credit sides of the account.

2. Find out the difference between the two totals found in step one.
3. Put the difference on the lighter side. The difference so placed is the balance of the account. If the
debit side of account is heavier than its credit side, the account is said to have a debit balance. In case
the credit side of the account is heavier than its debit side, the account is said to have a credit balance.
If the total of two sides of account is equal, the balance will be zero.
Distinction between Journal and Ledger

The Journal and the Ledger are the most important books of the double entry mechanism of
accounting and are indispensable for an accounting system. Following points of comparison are
worth noting:
1. The Journal is the book of first entry (original entry); the ledger is the book of second entry.
2. The Journal is the book for chronological record; the ledger is the book for analytical record.
3. The Journal, as a book of source entry, gets greater importance as legal evidence than the
ledger.
4. Transaction is the basis of classification of data within the Journal; Account is the basis of
classification of data within the ledger.
5. Process of recording in the Journal is called Journalising; the process of recording in the
ledger is known as Posting.
Classification of Ledger Accounts

All ledger accounts are put into five categories namely, assets, liabilities, capital, revenues/gains and expense
losses. All these accounts may further be put into two groups, i.e. permanent accounts and temporary accounts.
All permanent accounts are balanced and carried forward to the next accounting period. The temporary
accounts are closed at the end of the accounting period by transferring them to the trading and profit and loss
account. All permanent accounts appear in the balance sheet. Thus, all assets, liabilities and capital accounts
are permanent accounts and all revenue and expense accounts are temporary accounts. This classification is
also relevant for preparing the financial statements.
Posting from Journal

Posting is the process of transferring the entries from the books of original entry (journal) to the
ledger. In other words, posting means grouping of all the transactions in respect to a particular
account at one place for meaningful conclusion and to further the accounting process. Posting
from the journal is done periodically, may be, weekly or fortnightly or monthly as per the
requirements and convenience of the business.
The complete process of posting from journal to ledger has been discussed below:
Step 1 : Locate in the ledger, the account to be debited as entered in the journal.
Step 2 : Enter the date of transaction in the date column on the debit side.
Step 3: In the ‘Particulars’ column write the name of the account through which it has been
debited in the journal. For example, furniture sold for cash ` 34,000. Now, in cash
account on the debit side in the particulars column ‘Furniture’ will be entered signifying
that cash is received from the sale of furniture. In Furniture account, in the ledger on the
credit side is the particulars column, the word, cash will be recorded. The same
procedure is followed in respect of all the entries recorded in the journal.
Step 4 : Enter the page number of the journal in the folio column and in the journal write the
page number of the ledger on which a particular account appears. Step 5 : Enter the
relevant amount in the amount column on the debit side. It may be noted that the same
procedure is followed for making the entry on the credit side of that account to be
credited. An account is opened only once in the ledger and all entries relating to a
particular account is posted on the debit or credit side, as the case may be.
TRAIL BALANCE
A trial balance is a statement showing the balances, or total of debits and credits, of all the accounts in
the ledger with a view to verify the arithmetical accuracy of posting into the ledger accounts. Trial
balance is an important statement in the accounting process as it shows the final position of all
accounts and helps in preparing the final statements. The task of preparing the statements is simplified
because the accountant can take the balances of all accounts from the trial balance instead of going
through the whole ledger. It may be noted that the trial balance is usually prepared with the balances of
accounts.
It is normally prepared at the end of an accounting year. However, an organisation may prepare a trial
balance at the end of any chosen period, which may be monthly, quarterly, half yearly or annually
depending upon its requirements.
In order to prepare a trial balance following steps are taken:

• Ascertain the balances of each account in the ledger.
• List each account and place its balance in the debit or credit column, as the case may be. (If an
account has a zero balance, it may be included in the trial balance with zero in the column for its
normal balance). • Compute the total of debit balances column.
• Compute the total of the credit balances column.
• Verify that the sum of the debit balances equal the sum of credit balances. If they do not tally, it
indicate that there are some errors. So one must check the correctness of the balances of all accounts.
It may be noted that all assets expenses and receivables account shall have debit balances whereas all
liabilities, revenues and payables accounts shall have credit balances.
Objectives of Preparing the Trial Balance

The trial balance is prepared to fulfil the following objectives :
1. To ascertain the arithmetical accuracy of the ledger accounts.
2. To help in locating errors.
3. To help in the preparation of the financial statements. (Profit & Loss account and Balance Sheet).
Advantages of Trial Balance

1. To Ascertain the Arithmetical Accuracy of Ledger Accounts - the purpose of preparing a trial
balance is to ascertain whether all debits and credit are properly recorded in the ledger or not and
that all accounts have been correctly balanced. As a summary of the ledger, it is a list of the
accounts and their balances. When the totals of all the debit balances and credit balances in the trial
balance are equal, it is assumed that the posting and balancing of accounts is arithmetically correct.
However, the tallying of the trial balance is not a conclusive proof of the accuracy of the accounts.
It only ensures that all debits and the corresponding credits have been properly recorded in the
ledger.
2. To Help in Locating Errors - When a trial balance does not tally (that is, the totals of debit and
credit columns are not equal), we know that at least one error has occurred. The error (or errors)
may have occurred at one of those stages in the accounting process:
(1) Totalling of subsidiary books,

(2) Posting of journal entries in the ledger,
(3) Calculating account balances,

(4) Carrying account balances to the trial balance, and

(5) Totalling the trial balance columns.
It may be noted that the accounting accuracy is not ensured even if the totals of debit and credit
balances are equal because some errors do not affect equality of debits and credits. For example, the
book-keeper may debit a correct amount in the wrong account while making the journal entry or in
posting a journal entry to the ledger. This error would cause two accounts to have incorrect balances
but the trial balance would tally. Another error is to record an equal debit and credit of an incorrect
amount. This error would give the two accounts incorrect balances but would not create unequal debits
and credits. As a result, the fact that the trial balance has tallied does not imply that all entries in the
books of original record (journal, cash book, etc.) have been recorded and posted correctly. However,
equal totals do suggest that several types of errors probably have not occurred.
3. To help in the Preparation of the Financial Statements - Trial balance is
considered as the connecting link between accounting records and the preparation of financial
statements. For preparing a financial statement, one need not refer to the ledger. In fact, the availability
of a tallied trial balance is the first step in the preparation of financial statements. All revenue and
expense accounts appearing in the trial balance are transferred to the trading and profit and loss
account and all liabilities, capital and assets accounts are transferred to the balance sheet.
Preparation of Trial Balance

Theoretically spreading, a trial balance can be prepared in the following three ways:
(i) Totals Method
(ii) Balances Method
(iii) Totals-cum-balances Method
Totals method
Under this method, total of each side in the ledger (debit and credit) is ascertained separately and shown
in the trial balance in the respective columns. The total of debit column of trial balance should agree with
the total of credit column in the trial balance because the accounts are based on double entry system.
However, this method is not widely used in practice, as it does not help in assuming accuracy of balances
of various accounts and preparation of the financial statements.
Balances Method
This is the most widely used method in practice. Under this method trial balance is prepared by showing
the balances of all ledger accounts and then totalling up the debit and credit columns of the trial balance to
assure their correctness. The account balances are used because the balance summarises the net effect
of all transactions relating to an account and helps in preparing the financial statements. It may be noted
that in trial balance, normally in place of balances in individual accounts of the debtors, a figure of sundry
debtors is shown, and in place of individual accounts of creditors, a figure of sundry creditors is shown.
Totals-cum-balances Method
This method is a combination of totals method and balances method. Under this method four columns for
amount are prepared. Two columns for writing the debit and credit totals of various accounts and two
columns for writing the debit and credit balances of these accounts. However, this method is also not used
in practice because it is time consuming and hardly serves any additional or special purpose.
Common errors even the Trial Balance Tally

It is important for an accountant that the trial balance should tally. Normally a tallied trial balance
means that both the debit and the credit entries have been made correctly for each transaction.
However, as stated earlier, the agreement of trial balance is not an absolute proof of accuracy of
accounting records. A tallied trial balance only proves, to a certain extent, that the posting to the ledger
is arithmetically correct. But it does not guarantee that the entry itself is correct. There can be errors,
which affect the equality of debits and credits, and there can be errors, which do not affect the equality
of debits and credits. Some common errors include the following:
• Error in totalling of the debit and credit balances in the trial balance.
• Error in totalling of subsidiary books.
• Error in posting of the total of subsidiary books.
• Error in showing account balances in wrong column of the trial balance, or in the wrong amount.
• Omission in showing an account balance in the trial balance.
• Error in the calculation of a ledger account balance.
• Error while posting a journal entry: a journal entry may not have been posted properly to the ledger,
i.e., posting made either with wrong amount or on the wrong side of the account or in the wrong
account.
• Error in recording a transaction in the journal: making a reverse entry, i.e., account to be debited is
credited and amount to be credited is debited, or an entry with wrong amount.
• Error in recording a transaction in subsidiary book with wrong name or wrong
amount.

MBA I SEM ACCOUNTING FOR MANAGER UNIT III
Meaning of Depreciation
Depreciation may be described as a permanent, continuing and gradual shrinkage in the book value of
fixed assets. It is based on the cost of assets consumed in a business and not on its market value.
Definition: The monetary value of an asset decreases over time due to use, wear and tear or obsolescence.
This decrease is measured as depreciation.
Depreciation, i.e. a decrease in an asset's value, may be caused by a number of other factors as well such
as unfavourable market conditions, etc. Machinery, equipment, currency are some examples of assets that
are likely to depreciate over a specific period of time. Opposite of depreciation is appreciation which is
increase in the value of an asset over a period of time.
Accounting estimates the decrease in value using the information regarding the useful life of the asset.
This is useful for estimation of property value for taxation purposes like property tax etc. For such assets
like real estate, market and economic conditions are likely to be crucial such as in cases of economic
downturn.
In accounting terms, depreciation is defined as the reduction of recorded cost of a fixed asset in a
systematic manner until the value of the asset becomes zero or negligible.
An example of fixed assets is buildings, furniture, office equipment, machinery etc. A land is the only
exception which cannot be depreciated as the value of land appreciates with time.
Depreciation allows a portion of the cost of a fixed asset to the revenue generated by the fixed asset. This
is mandatory under the matching principle as revenues are recorded with their associated expenses in the
accounting period when the asset is in use. This helps in getting a complete picture of the revenue
generation transaction.
An example of Depreciation – If a delivery truck is purchased a company with a cost of Rs. 1,00,000
and the expected usage of the truck are 5 years, the business might depreciate the asset under depreciation
expense as Rs. 20,000 every year for a period of 5 years.
According to Institute of Cost and Management Accounting, London (ICMA) terminology -

“The depreciation is the diminution in intrinsic value of the asset due to use and/or lapse of time.”
Accounting Standard-6 issued by The Institute of Chartered Accountants of India (ICAI) defines
depreciation as “a measure of the wearing out, consumption or other loss of value of depreciable asset
arising from use, effluxion of time or obsolescence through technology and market-change. Depreciation
is allocated so as to charge fair proportion of depreciable amount in each accounting period during the
expected useful life of the asset. Depreciation includes amortisation of assets whose useful life is pre-
determined”.
• Depreciation is “a measure of the wearing out, consumption or other loss of value of depreciable
asset arising from use, effluxion of time or obsolescence through technology and market-change.
Depreciation is allocated so as to charge fair proportion of depreciable amount in each accounting

period during the expected useful life of the asset. Depreciation includes amortisation of assets whose
useful life is pre-determined”.
• Depreciation has a significant effect in determining and presenting the financial position and results
of operations of an enterprise.
• Depreciation is charged in each accounting period by reference to the extent of the depreciable
amount.
• The subject matter of depreciation, or its base, are „depreciable‟ assets which. “Are expected to be
used during more than one accounting period have a limited useful life; and are held by an enterprise
for use in production or supply of goods and services, for rental to others, or for administrative
purposes and not for the purpose of sale in the ordinary course of business.”
• The amount of depreciation basically depends upon three factors, i.e. Cost, Useful life and Net
realisable value.
• Cost of a fixed asset is “the total cost spent in connection with its acquisition, installation and
commissioning as well as for add item or improvement of the depreciable asset”.
• Useful life of an asset is the “period over which it is expected to be used by the enterprise”.
There are two main methods of calculating depreciation amount.

• Straight line method
• written down value method
• Selection of appropriate method depends upon the following factors:
• Type of the asset
• Nature of the use of such asset
• Circumstances prevailing in the business.
• The selected depreciation method should be applied consistently from period to period. Change in
depreciation method may be allowed only under specific circumstances.
Features of Depreciation
1. It is decline in the book value of fixed assets.
2. It includes loss of value due to effluxion of time, usage or obsolescence.
For example, a business firm buys a machine for 1,00,000 on April 01, 2017. In the year 2017,
a new version of the machine arrives in the market. As a result, the machine bought by the
business firm becomes outdate. The resultant decline in the value of old machine is caused by
obsolescence.
3. It is a continuing process.
4. It is an expired cost and hence must be deducted before calculating taxable profits. For example,
if profit before depreciation and tax is 50,000, and depreciation is 10,000; profit before tax will
be:
Profit before depreciation & tax 50,000
(-) Depreciation (10,000)
Profit before tax 40,000
5. It is a non-cash expense. It does not involve any cash outflow. It is the process of writing-off the
Capital expenditure already incurred.
Depreciation and other Similar Terms

There are some terms like „depletion‟ and „amortisation‟, which are also used in connection with
depreciation. This has been due to the similar treatment given to them in accounting on the basis of
similarity of their outcome, as they represent the expiry of the usefulness of different assets.

Depletion
The term depletion is used in the context of extraction of natural resources like mines, quarries, etc.
that reduces the availability of the quantity of the material or asset. For example, if a business
enterprise is into mining business and purchases a coal mine for 10,00,000. Then the value of coal
mine declines with the extraction of coal out of the mine. This decline in the value of mine is termed
as depletion. The main difference between depletion and depreciation is that the former is concerned
with the exhaustion of economic resources, but the latter relates to the usage of an asset. In spite of
this, the result is erosion in the volume of natural resources and expiry of the service potential.
Therefore, depletion and depreciation are given similar accounting treatment.
Amortisation
Amortisation refers to writing-off the cost of intangible assets like patents, copyright, trademarks,
franchises, goodwill which have utility for a specified period of time. The procedure for amortisation
or periodic write-off of a portion of the cost of intangible assets is the same as that for the
depreciation of fixed assets. For example, if a business firm buys a patent for 10,00,000 and estimates
that its useful life will be 10 years then the business firm must write off 10,00,000 over 10 years. The
amount so written- off is technically referred to as amortisation.
Causes of Depreciation
These have been very clearly spelt out as part of the definition of depreciation in the Accounting
Standard 6 and are being elaborated here.
Wear and Tear due to Use or Passage of Time

Wear and tear means deterioration, and the consequent diminution in an assets value, arising from its
use in business operations for earning revenue. It reduces the asset‟s technical capacities to serve the
purpose for, which it has been meant. Another aspect of wear and tear is the physical deterioration.
An asset deteriorates simply with the passage of time, even though they are not being put to any use.
This happens especially when the assets are exposed to the rigours of nature like weather, winds,
rains, etc.
Expiration of Legal Rights

Certain categories of assets lose their value after the agreement governing their use in business comes
to an end after the expiry of pre-determined period. Examples of such assets are patents, copyrights,
leases, etc. who‟s utility to business is extinguished immediately upon the removal of legal backing
to them.
Obsolescence
Obsolescence is another factor leading to depreciation of fixed assets. In ordinary language,
obsolescence means the fact of being “out-of-date”. Obsolescence implies to an existing asset
becoming out-of-date on account of the availability of better type of asset. It arises from such factors
as:
• Technological changes;
• Improvements in production methods;
• Change in market demand for the product or service output of the asset;
• Legal or other description.

Abnormal Factors
Decline in the usefulness of the asset may be caused by abnormal factors such as accidents due to
fire, earthquake, floods, etc. Accidental loss is permanent but not continuing or gradual. For example,
a car which has been repaired after an accident will not fetch the same price in the market even if it
has not been used.
Need for Depreciation

The need for providing depreciation in accounting records arises from conceptual, legal, and practical
business consideration. These considerations provide depreciation a particular significance as a
business expense.
Matching of Costs and Revenue

The rationale of the acquisition of fixed assets in business operations is that these are used in the
earning of revenue. Every asset is bound to undergo some wear and tear, and hence lose value, once
it is put to use in business. Therefore, depreciation is as much the cost as any other expense incurred
in the normal course of business like salary, carriage, postage and stationary, etc. It is a charge
against the revenue of the corresponding period and must be deducted before arriving at net profit
according to „Generally Accepted Accounting Principles‟.
Consideration of Tax
Depreciation is a deductible cost for tax purposes. However, tax rules for the calculation of
depreciation amount need not necessarily be similar to current business practices,
True and Fair Financial Position

If depreciation on assets is not provided for, then the assets will be overvalued and the balance sheet
will not depict the correct financial position of the business. Also, this is not permitted either by
established accounting practices or by specific provisions of law.
Compliance with Law

Apart from tax regulations, there are certain specific legislations that indirectly compel some
business organisations like corporate enterprises to provide depreciation on fixed assets.
Factors Affecting the Amount of Depreciation

The determination of depreciation depends on three parameters, viz. cost, estimated useful life and
probable salvage value.
1 Cost of Asset
Cost (also known as original cost or historical cost) of an asset includes invoice price and other costs,
which are necessary to put the asset in use or working condition. Besides the purchase price, it
includes freight and transportation cost, transit insurance, installation cost, registration cost,
commission paid on purchase of asset add items such as software, etc. In case of purchase of a
second hand asset it includes initial repair cost to put the asset in workable condition. According to
Accounting Standand-6 of ICAI, cost of a fixed asset is “the total cost spent in connection with its

acquisition, installation and commissioning as well as for addition or improvement of the depreciable
asset”. For example, a photocopy machine is purchased for ` 50,000 and ` 5,000 is spent on its
transportation and installation. In this case the original cost of the machine is ` 55,000 (i.e. ` 50,000 +
`5,000 ) which will be written-off as depreciation over the useful life of the machine.
2 Estimated Net Residual Value

Net Residual value (also known as scrap value or salvage value for accounting purpose) is the
estimated net realisable value (or sale value) of the asset at the end of its useful life. The net residual
value is calculated after deducting the expenses necessary for the disposal of the asset. For example,
a machine is purchased for 50,000 and is expected to have a useful life of 10 years. At the end of 10th
year it is expected to have a sale value of 6,000 but expenses related to its disposal are estimated at `
1,000. Then its net residual value shall be 5,000 (i.e. 6,000 – 1,000).
3 Depreciable Cost
Depreciable cost of an asset is equal to its cost less net residual value. Hence, in the above example,
the depreciable cost of machine is 45,000 (i.e., 50,000 – 5,000.) It is the depreciable cost, which is
distributed and charged as depreciation expense over the estimated useful life of the asset. In the
above example, 45,000 shall be charged as depreciation over a period of 10 years. It is important to
mention here that total amount of depreciation charged over the useful life of the asset must be equal
to the depreciable cost. If total amount of depreciation charged is less than the depreciable cost then
the capital expenditure is under recovered. It violates the principle of proper matching of revenue and
expense.
4 Estimated Useful Life

Useful life of an asset is the estimated economic or commercial life of the asset. Physical life is not
important for this purpose because an asset may still exist physically but may not be capable of
commercially viable production. For example, a machine is purchased and it is estimated that it can
be used in production process for 5 years. After 5 years the machine may still be in good physical
condition but can‟t be used for production profitably, i.e., if it is still used the cost of production may
be very high. Therefore, the useful life of the machine is considered as 5 years irrespective of its
physical life. Estimation of useful life of an asset is difficult as it depends upon several factors such
as usage level of asset, maintenance of the asset, technological changes, market changes, etc. As per
Accounting Standard – 6 useful life of an asset is normally the “period over which it is expected to be
used by the enterprise”. Normally, useful life is shorter than the physical life. The useful life of an
asset is expressed in number of years but it can also be expressed in other units, e.g., number of units
of output (as in case of mines) or number of working hours. Useful life depends upon the following
factors :
• Pre-determined by legal or contractual limits, e.g., in case of leasehold asset, the useful life is
the period of lease.
• The number of shifts for which asset is to be used.
• Repair and maintenance policy of the business organisation.
• Technological obsolescence.
• Innovation/improvement in production method.
• Legal or other restrictions.
Methods of Calculating Depreciation Amount

The depreciation amount to be charged for during an accounting year depends upon depreciable amount
and the method of allocation. For this, two methods are mandated by law and enforced by professional
accounting practice in India. These methods are straight line method and written down value method.
Besides these two main methods there are other methods such as – annuity method, depreciation fund
method, insurance policy method, sum of years digit method, double declining method, etc. which may be
used for determining the amount of depreciation.
The selection of an appropriate method depends upon the following:
• Type of the asset;
• Nature of the use of such asset;
• Circumstances prevailing in the business;
As per Accounting Standard-6, the selected depreciation method should be applied consistently from
period to period. Change in depreciation method may be allowed only under specific circumstances.
Methods of Depreciations

1. Straight Line Method: Also known as Fixed Installment Method, an equal amount is charged as
depreciation every year throughout the working life of the asset, with the view of reducing the cost
of the asset to zero, at the end of its economic life.
2. Written Down Value Method: In this method, a fixed percentage of the written down value of
the depreciable asset is charged as depreciation, so that the value of the asset equals its break-up
value at the end of its working life. This method is also known as the diminishing value method,
reducing balance method.
3. Sum of Years of Digit Method: This method is a variation of written down value method and is
used to accelerate the depreciation.
4. Annuity Method: This method is mainly concerned with the cost recovery and a uniform rate of
return on any depreciable asset. In the annuity method, along with the value of the asset, interest
lost over its life is also written off.
5. Sinking Fund Method: Under this method, a certain amount is written off as depreciation every
year and placed to the credit of sinking fund account. Further, Government Securities are
purchased with the equivalent amount and the interest received, is reinvested and credited to the
sinking fund account.
6. Machine Hour Method: When a record of actual running hours of each machinery is kept, the
calculation of depreciation is based on hours, machines worked.
7. Production Units Method: In this method, the depreciation is ascertained by making a
comparison of actual production with the estimated production.
8. Depletion Method: As the name suggests, the depletion method is used when there is the
exhaustion of natural resources like oil reserves, coal deposits and so on.
Depreciation is non-cash expenditure, and so, it does not result in cash outflow from the business.
Moreover, it does not create funds rather it highlights the fact that a fixed amount should be retained from
the profits, for the replacement of asset, to continue operations.
1 Straight Line Method

This is the earliest and one of the widely used methods of providing depreciation. This method is based
on the assumption of equal usage of the asset over its entire useful life. It is called straight line for a
reason that if the amount of depreciation and corresponding time period is plotted on a graph, it will result
in a straight line It is also called fixed instalment method because the amount of depreciation remains
constant from year to year over the useful life of the asset. According to this method, a fixed and an equal
amount is charged as depreciation in every accounting period during the lifetime of an asset. The amount
annually charged as depreciation is such that it reduces the original cost of the asset to its scrap value, at
the end of its useful life. This method is also known as fixed percentage on original cost method because
same percentage of the original cost (infect depreciable cost) is written off as depreciation from year to
year.

The depreciation amount to be provided under this method is computed by using the following formula:
Depreciation = Cost
of asset - Estimated net residential value
Estimated useful life of the asset
Rate of depreciation under straight line method is the percentage of the total cost of the asset to be
charged as deprecation during the useful lifetime of the asset. Rate of depreciation is calculated as
follows:
Rate of Depreciation = Annual amount of Depreciation / Acquisition Cost * 100

Consider the following example, the original cost of the asset is 2,50,000. The useful life of the asset is 10
years and net residual value is estimated to be 50,000. Now, the amount of depreciation to be charged
every year will be computed as given below:
Annual Depreciation Amount = (Acquisition cost of asset - residential value) / Estimated life
``
`
Advantages of Straight Line Method - Straight Line method has certain advantages which are
stated below:
• It is very simple, easy to understand and apply. Simplicity makes it a popular method in practice;
• Asset can be depreciated up to the net scrap value or zero value. Therefore, this method makes it
possible to distribute full depreciable cost over useful life of the asset;
• Every year, same amount is charged as depreciation in profit and loss account. This makes
comparison of profits for different years easy;
• This method is suitable for those assets whose useful life can be estimated accurately and where
the use of the asset is consistent from year to year such as leasehold buildings.
Limitations of Straight Line Method

Although straight line method is simple and easy to apply it suffers from certain limitations which are
given below.
• This method is based on the faulty assumption of same amount of the utility of an asset in different
accounting years;

• With the passage of time, work efficiency of the asset decreases and repair and maintenance
expense increases. Hence, under this method, the total amount charged against profit on account of
depreciation and repair taken together, will not be uniform throughout the life of the asset, rather it
will keep on increasing from year to year.
Advantages of Straight Line Method

Straight Line method has certain advantages which are stated below:
• It is very simple, easy to understand and apply. Simplicity makes it a popular method in practice;
• Asset can be depreciated up to the net scrap value or zero value. Therefore, this method makes it
possible to distribute full depreciable cost over useful life of the asset;
• Every year, same amount is charged as depreciation in profit and loss account. This makes
comparison of profits for different years easy;
• This method is suitable for those assets whose useful life can be estimated accurately and where the
use of the asset is consistent from year to year such as leasehold buildings.
Limitations of Straight Line Method

Although straight line method is simple and easy to apply it suffers from certain limitations which are
given below.
• This method is based on the faulty assumption of same amount of the utility of an asset in different
accounting years;
• With the passage of time, work efficiency of the asset decreases and repair and maintenance
expense increases. Hence, under this method, the total amount charged against profit on account of
depreciation and repair taken together, will not be uniform throughout the life of the asset, rather it
will keep on increasing from year to year.
Written Down Value Method

Under this method, depreciation is charged on the book value of the asset. Since book value keeps on
reducing by the annual charge of depreciation, it is also known as „reducing balance method‟. This
method involves the application of a pre-determined proportion/percentage of the book value of the
asset at the beginning of every accounting period, so as to calculate the amount of depreciation. The
amount of depreciation reduces year after year.
The amount of depreciation goes on reducing year after year. For this reason, it is also known
„reducing instalment‟ or „diminishing value‟ method. This method is based upon the assumption that
the benefit accruing to business from assets keeps on diminishing as the asset becomes old (refer
figure 7.2). This is due to the reason that a pre-determined percentage is applied to a gradually
shrinking balance on the asset account every year. Thus, large amount is recovered depreciation
charge in the earlier years than in later years.
Advantages of Written Down Value Method

Written down value method has the following advantages:
• This method is based on a more realistic assumption that the benefits from asset go on diminishing
(reducing) with the passage of time. Hence, it calls for proper allocation of cost because higher
depreciation is charged in earlier years when asset‟s utility is higher as compared to later years
when it becomes less effective.

• It results into almost equal burden of depreciation and repair expenses taken together every year on
profit and loss account;
• Income Tax Act accepts this method for tax purposes;
• As a large portion of cost is written-off in earlier years, loss due to obsolescence gets reduced;
• This method is suitable for fixed assets which last for long and which require increased repair and
maintenance expenses with passage of time. It can also be used where obsolescence rate is high.
Limitations of Written Down Value Method
Although this method is based upon a more realistic assumption it suffers from the following
limitations.
• As depreciation is calculated at fixed percentage of written down value, depreciable cost of the asset
cannot be fully written-off. The value of the asset can never be zero;
• It is difficult to ascertain a suitable rate of depreciation.
Difference between Straight line method and Written Down Value Method
Basis for SLM WDV

Comparison
Meaning A method of depreciation in which the A method of depreciation in which a
cost of the asset is spread uniformly over fixed rate of depreciation is charged
the life years by writing off a fixed on the book value of the asset, over its
amount every year. useful life.
Calculation of On the original cost On the written down value of the
depreciation asset.
Annual depreciation Remains fixed during the useful life. Reduces every year
charge
Value of asset Completely written off Not completely written off
Amount of Initially lower Initially higher
depreciation
Impact of repairs Increasing trend Remains constant
and depreciation on
P&L A/c
Appropriate for Assets with negligible repairs and Assets whose repairs increase, as they
maintenance like leases, copyright. get older like machinery, vehicles etc.
Legality Not Approved by Income tax law Approved by Income tax law

MBA I SEM ACCOUNTING FOR MANAGERS UNIT IV
Financial Statements
It has been emphasised that various users have diverse informational requirements. Instead of generating
particular information useful for specific users, the business prepares a set of financial statements, which
in general satisfies the informational needs of the users.
The basic objectives of preparing financial statements are :

(a) To present a true and fair view of the financial performance of the business;
(b) To present a true and fair view of the financial position of the business; and
For this purpose, the firm usually prepares the following financial statements:
1. Trading and Profit and Loss Account
2. Balance Sheet
Trading and Profit and Loss account, also known as Income statement, shows the financial performance
in the form of profit earned or loss sustained by the business. Balance Sheet shows financial position in
the form of assets, liabilities and capital. These are prepared on the basis of trial balance and additional
information, if any.
Trading and Profit and Loss Account

Trading and Profit and Loss account is prepared to determine the profit earned or loss sustained by the
business enterprise during the accounting period. It is basically a summary of revenues and expenses of
the business and calculates the net figure termed as profit or loss. Profit is revenue less expenses. If
expenses are more than revenues, the figure is termed as loss. Trading and Profit and Loss account
summarises the performance for an accounting period. It is achieved by transferring the balances of
revenues and expenses to the trading and profit and loss account from the trial balance. Trading and Profit
and Loss account is also an account with Debit and Credit sides. It can be observed that debit balances
(representing expenses) and losses are transferred to the debit side of the Trading and a Profit and Loss
account and credit balance (representing revenues/gains) are transferred to its credit side.
Relevant Items in Trading and Profit and Loss Account

The different items appearing in the trading and profit and loss account are explained hereunder:
Items on the debit side
(i) Opening stock: It is the stock of goods in hand at the beginning of the accounting year. This is the
stock of goods which has been carried forward from the previous year and remains unchanged
during the year and appears in the trial balance. In the trading account it appears on the debit side
because it forms the part of cost of goods sold for the current accounting year.
(ii) Purchases less returns: Goods, which have been bought for resale appears as purchases on the
debit side of the trading account. They include both cash as well as credit purchases. Goods
which are returned to suppliers are termed as purchases return. It is shown by way of deduction
from purchases and the computed amount is known as Net purchases.
(iii) Wages: Wages refer to remuneration paid to workers who are directly engaged in factory for
loading, unloading and production of goods and are debited to trading account.
(iv) Carriage inwards/Freight inwards: These expenses are the items of transport expenses, which
are incurred on bringing materials/goods purchased to the place of business. These items are paid
in respect of purchases made during the year and are debited to the trading account.
(v) Fuel/Water/Power/Gas: These items are used in the production process and hence are part of

expenses.
(vi) Packaging material and Packing charges : Cost of packaging material used in the product are
direct expenses as it refers to small containers which form part of goods sold. However, the
packing refers to the big containers that are used for transporting the goods and is regarded as
an indirect expense debited to profit and loss account.
(vii) Salaries: These include salaries paid to the administration, go down and warehouse staff for the
services rendered by them for running the business. If salaries are paid in kind by providing
certain facilities (called perks) to the employees such as rent free accommodation, meals,
uniform, medical facilities should also be regarded as salaries and debited to the profit and loss
account.
(viii) Rent paid: These include office and godown rent, municipal rates and taxes, factory rent, rates
and taxes. The amount of rent paid is shown on the debit side of the profit and loss account.
(ix) Interest paid: Interest paid on loans, bank overdraft, renewal of bills of exchange, etc. is an
expense and is debited to profit and loss account.
(x) Commission paid: Commission paid or payable on business transactions undertaken through
the agents is an item of expense and is debited to profit and loss account.
(xi) Repairs: Repairs and small renewals/ replacements relating to plant and machinery, furniture,
fixtures, fittings, etc. for keeping them in working condition are included under this head. Such
expenditure is debited to profit and loss account.
(xii) Miscellaneous expenses: Though expenses are classified and booked under different heads, but
certain expenses being of small amount clubbed together and are called miscellaneous
expenses. In normal usage these expenses are called Sundry expenses or Trade expenses.
Items on the credit side

(i) Sales less returns: Sales account in trial balance shows gross total sales (cash as well as credit)
made during the year. It is shown on the credit side of the trading account. Goods returned by
customers are called return inwards and are shown as deduction from total sales and the
computed amount is known as net sales.
(ii) Other incomes: Besides salaries and other gains and incomes are also recorded in the profit and
loss account. Examples of such incomes are rent received, dividend received, interest received,
discount received, commission received, etc.
Closing Entries
The preparation of trading and profit and loss account requires that the balances of accounts of all
concerned items are transferred to it for its compilation.
• Opening stock account, Purchases account, Wages account, Carriage inwards account and direct
expenses account are closed by transferring to the debit side of the trading and profit and loss
account. This is done by recording the following entry:
Trading …………….A/c…Dr.
To Opening stock ……A/c
To Purchases …………A/c
To Wages …………… A/c
To Carriage inwards …A/c
To All other direct expenses………… A/c
• The purchases returns or return outwards are closed by transferring its balance to the purchases
account. The following entry is recorded for this purpose:

Purchases return ……A/c…Dr.
To Purchases ………… A/c
• Similarly, the sales returns or returns inwards account is closed by transferring its balance to the
sales account as :
Sales ………………A/c …Dr.
To Sales return .............A/c
• The sales account is closed by transferring its balance to the credit side of the trading and profit and
loss account by recording the following entry:
Sales ………A/c………… Dr.
To Trading ……………A/c
• Items of expenses, losses, etc. are closed by recording the following entries:
Profit and Loss ……A/c…. Dr.
To Expenses (individually)…. A/c
To Losses (individually) …….A/c
• Items of incomes, gains, etc. are closed by recording the following entry:
Incomes (individually) …..A/c…..Dr.
Gains (individually) …….A/c….. Dr.
To Profit and Loss ……………A/c
(i) For closing the accounts of expenses
Trading ……….A/c……….. Dr.
To Purchases ……………A/c
To Wages ……………….A/c
(ii) Profit and Loss ……A/c…… Dr.
To Salaries ………………...A/c
To Rent of building ……….A/c
To Bad debts ………………A/c
(i) For closing the accounts of revenues
Sales …………A/c …………Dr.
To Trading ……………..A/c
(ii) Commission received …….A/c…… Dr.
To Profit and Loss ………A/c
Concept of Gross Profit and Net Profit

The trading and profit and loss can be seen as combination of two accounts, viz. trading account and
Profit and Loss account. The trading account or the first part ascertains the gross profit and profit and loss
account or the second part ascertains net profit.
Trading Account
The trading account ascertains the result from basic operational activities of the business. The basic
operational activity involves the manufacturing, purchasing and selling of goods. It is prepared to
ascertain whether the selling of goods and/or rendering of services to customers have proved profitable
for the business or not. Purchases are one of the main constituents of expenses in business organisation.
Besides purchases, the remaining expenses are divided into two categories, viz. direct expenses and
indirect expenses.
Direct expenses means all expenses directly connected with the manufacture purchase of goods and
bringing them to the point of sale. Direct expenses include carriage inwards, freight inwards, wages,

factory lighting, coal, water and fuel, royalty on production, etc. In our example-1, besides purchases,
four more items of expenses are listed. These are wages, salaries, rent of building and bad debts. Out of
these items, wages is treated as direct expense while the other three are treated as indirect expenses.
Similarly, sales constitute the main item of revenue for the business. The excess of sales over purchases
and direct expenses is called gross profit. If the amount of purchases including direct expenses is more
than the sales revenue, the resultant figure is gross loss. The computation of gross profit can be shown in
the form of equation as:
Gross Profit = Sales – (Purchases + Direct Expenses)
The gross profit or the gross loss is transferred to profit and loss account. The indirect expenses are
transferred to the debit side of the second part, viz. profit and loss account. All revenue/gains other than
sales are transferred to the credit side of the profit and loss account. If the total of the credit side of the
profit and loss account is more than the total of the debit side, the difference is the net profit for the period
of which it is being prepared. On the other hand, if the total of the debit side is more than the total of the
credit side, the difference is the net loss incurred by the business firm. In an equation form, it is shown as
follows:
Net Profit = Gross Profit + Other Incomes – Indirect Expenses
Net profit or net loss so computed is transferred to the capital account in the balance sheet by way of the
following entry:
(i) For transfer of net profit
Profit and Loss …….A/c……. Dr.
To Capital …………………A/c
(ii) For transfer of net loss
Capital …………….A/c……. Dr.
To Profit and Loss ………..A/c
Balance Sheet
The balance sheet is a statement prepared for showing the financial position of the business summarising
its assets and liabilities at a given date. The assets reflect debit balances and liabilities (including capital)
reflect credit balances. It is prepared at the end of the accounting period after the trading and profit
and loss account have been prepared. It is called balance sheet because it is a statement of balances of
ledger accounts that have not been transferred to trading and profit and loss account and are to be carried
forward to the next year with the help of an opening entry made in the journal at the beginning of the next
year.
Preparing Balance Sheet
All the account of assets, liabilities and capital are shown in the balance sheet. Accounts of capital and
liabilities are shown on the left hand side, known as Liabilities. Assets and other debit balances are shown
on the right hand side, known as Assets. There is no prescribed form of Balance sheet, for a proprietary
and partnership firms. (However, Schedule III Part I of the Companies Act 2013 prescribes the format
and the order in which the assets and liabilities of a company should be shown).
Relevant Items in the Balance Sheet

Items which are generally included in a balance sheet are explained below:
(1) Current Assets: Current assets are those which are either in the form of cash or a can be converted
into cash within a year. The examples of such assets are cash in hand/bank, bills receivable, stock
of raw materials, semi-finished goods and finished goods, sundry debtors, short term investments,
prepaid expenses, etc.

(2) Current Liabilities: Current liabilities are those liabilities which are expected to be paid within a
year and which are usually to be paid out of current assets. The examples of such liabilities are
bank overdraft, bills payable, sundry creditors, short-term loans, outstanding expenses, etc.
(3) Fixed Assets: Fixed assets are those assets, which are held on a long-term basis in the business.
Such assets are not acquired for the purpose of resale, e.g. land, building, plant and machinery,
furniture and fixtures, etc. Sometimes the term ‘Fixed Block’ or ‘Block Capital’ is also used for
them.
(4) Intangible Assets: These are such assets which cannot be seen or touched. Goodwill, Patents,
Trademarks are some of the examples of intangible assets.
(5) Investments: Investments represent the funds invested in government securities, shares of a
company, etc. They are shown at cost price. If, on the date of preparation the balance sheet, the
market price of investments is lower than the cost price, a footnote to that effect may be appended
to the balance sheet.
(6) Long-term Liabilities: All liabilities other than the current liabilities are known as long-term
liabilities. Such liabilities are usually payable after one year of the date of the balance sheet. The
important items of long term liabilities are long-term loans from bank and other financial
institutions.
(7) Capital: It is the excess of assets over liabilities due to outsiders. It represents the amount
originally contributed by the proprietor/ partners as increased by profits and interest on capital and
decreased by losses drawings and interest on drawings.
(8) Drawings: Amount withdrawn by the proprietor is termed as drawings and has the effect of
reducing the balance on his capital account. Therefore, the drawings account is closed by
transferring its balance to his capital account. However it is shown by way of deduction from
capital in the balance sheet.
Marshalling and Grouping of Assets and Liabilities

A major concern of accounting is about preparing and presenting the financial statement. The information
so provided should be decision useful for the users. Therefore, it becomes necessary that the items
appearing in the balance sheet should be properly grouped and presented in a particular order.
Marshalling of Assets and Liabilities
In a balance sheet, the assets and liabilities are arranged either in the order of liquidity or permanence.
Arrangement of assets and liabilities in a particular order is known as Marshalling.
In case of permanence, the most permanent asset or liability is put on the top in the balance sheet and
thereafter the assets are arranged in their reducing level of permanence.
In case of liquidity, the order is reversed. The information presented in this manner would enable the user
to have a good idea about the life of the various accounts. The assets account of the relatively permanent
nature would continue in the business for a longer time whereas the less permanent or more liquid
accounts will change their forms in the near future and are likely to become cash or cash equivalent.
Grouping of Assets and Liabilities

The items appearing in the balance sheet can also be properly grouped. The term grouping means putting
together items of similar nature under a common heading. For example, the balance of accounts of cash,
bank, debtors, etc. can be grouped and shown under the heading of ‘current assets’ and the balances of all
fixed assets and long-term investment under the heading of ‘non-current assets’.

Opening Entry
The balances of various accounts in balance sheet are carried forward from one accounting period to
another accounting period. In fact, the balance sheet of an accounting period becomes the opening trial
balance of the next accounting period. Next year an opening entry is made which opens these accounts
contained in the balance sheet.

MBA (Full Time) I SEM ACCOUNTING FOR MANAGERS UNIT V
Costing: Preparation & Presentation of cost records and cost statements is the
responsibility of the Management. Therefore, Cost Accounting Standards are guidelines
for the companies [for the management] that specify the cost accounting treatment for
various cost elements, minimum disclosure requirements and ensure the comparability,
consistency, and completeness of cost records. le to use the word ‘Cost’ with an adjective
or a phrase, so that the intended meaning is conveyed.“
Objectives of Cost Accounting
Cost Accounting refers to the classifying, recording and appropriate allocation of
expenditure for the purpose of determining the costs of products or services. It also helps in
the presentation of arranged data for the control purposes and guidance to the management.
Cost accounting deals with the production, selling and distribution costs. It involves the
ascertainment of the cost of every job, order, product, process or service. Here, we shall
discuss the various Objectives of Cost Accounting.
Objectives of Cost Accounting

The objective of the cost accounting is to determine the methods by which expenditure on
materials, wages and overhead are recorded, classified and allocated. This is necessary so
that the
cost of products and services may be accurately ascertained. Thus, the following are the
main objectives of cost accounting:
1. Ascertainment of the cost per unit of the different products that a business concern
manufacturers.
2. To correctly analyze the cost of both the process and operations.
3. Disclosure of sources for wastage of material, time, expenses or in the use of the
equipment and the preparation of reports which may be necessary to control such
wastage.
4. Provide requisite data and help in fixing the price of products manufactured or
services rendered.
5. Determination of the profitability of each of the products and help management in the
maximization of these profits.
6. Exercise effective control of stocks of raw material, work-in-progress, consumable
stores, and finished goods so as to minimize the capital invested in them.
7. Present and interpret data for management planning, decision-making, and control.
8. Help in the preparation of budgets and implementation of budgetary control.

9. Aid management in the formulation and implementation of incentive bonus plans on

the basis of productivity and cost savings.
10. Organization of cost reduction programmes with the help of different departmental
managers.
11. To provide specialized services for cost audit in order to prevent errors and frauds.
12. To facilitate prompt and reliable information to management.
13. Determination of costing profit or loss by linking the revenues to costs of those
products or services by selling which the revenues have arisen.
The various types of costs can be classified as follows:

On the Basis of Traceability
Direct Cost
Direct cost is a cost, which can be economically identified with a specific saleable cost
unit. The term ‘direct’ indicates that elements of costs which are traceable to a particular
unit of output.
Indirect Cost
Indirect cost is the cost, which cannot be directly identified to a particular unit of output
or to the segment of a business operation.
On the Basis of Behaviour
Period cost / Fixed cost/ fixed overhead
It is a cost which is incurred for a period, and which, within certain output and turnover
limits, tends to be unaffected by fluctuations in the levels of activity. Examples: rent,
rates, insurance, etc.
Variable cost
It is the cost, which tends to vary with the level of activity.
Semi Variable Cost
It is the cost, which changes with the change in activity but doesn’t change, in the same
proportion. The semi variable cost is further segregated (divided) into fixed cost and
variable cost by following certain methods.
On the Basis of Element Wise
Material
It is the cost of basic raw materials, components, consumables, spares, packing material,
etc. are used to make a product. It is a major proportion of costs of manufactured items.
Labour
It means the payment of expenses in the name of salaries, wages, bonus, benefits, staff
welfare, etc.

Prime Cost
Prime cost is the aggregate of direct material cost and direct labour cost. (The term direct
expenses have been excluded from prime cost as per latest CIMA terminology).
Conversion Cost
The sum of direct wages, direct expenses & Overhead cost of converting raw material to
the finished stage or converting a material from one stage of production to other.
On the Basis of Function Wise

Manufacturing Cost
It represents prime cost plus absorbed production overhead.
Administrative Cost
Costs incurred for carrying overall administration of the entity.
Selling and Distribution Cost
Post-Production costs incurred to advertise the product to public and to sell the same.
They include the cost of getting the goods distributed to the customers. Eg. Carriage
Outwards, Salesman Commission.
Research & Development Cost
These are the costs incurred on innovation and inventions of new processes, products and
technologies. Normally they are not charged to cost units. Cost of unsuccessful projects
are written off to Costing P&L A/c.
On the Basis of Averaging

Total Cost
When the costs are calculated in aggregate for all the units produced, they are total costs.
Unit Cost
If the total cost is divided by the number of units on which such costs is incurred, we get
the cost per unit of product or service. Such unit cost can also be taken out element wise,
depending on the need of the enterprise.
On the Basis of Assets or Expenses

Product Cost
Product cost is cost of a finished product built up from its cost element. Such costs are
assigned to the product and are included in inventory valuation.
Period Cost
Period costs are those costs which can be assigned against particular product but charged
as expenses against the revenue of the period in which they are incurred. For example
administrative overhead, selling and distribution overhead etc.

On the Basis of Production Process

Job/Contract Cost
These are costs assigned to a particular job or work of non-standardized nature, which is
calculated for each job. Eg. Cost of Construction of a Building, Costs in a Vehicle
Service Shop assigned to specific vehicles.
Process Cost
In industries where a systematic procedure is followed for production of goods, process
costs are calculated for each level of activity and assigned over all the units processed in
that process. The output of one process becomes input for the next. The cost cannot be
ascertained with each specific item produced.
Operation Cost
In case of industries having large number of homogenous items produced, operation cost
is ascertained for each operation. It is a variant of process cost.
Service Cost/Operating Cost
It is the cost of operating and running a service like transport, hotel, education, etc. The
output is measured in units such as tonne Km, and cost is ascertained for each such unit.
On the Basis of Decision Making

Relevant Cost
Relevant cost helps in specific management decision making. business decisions involve
planning for future and consideration of various alternative courses of action. In the
planning process the costs which are affected by the decisions are future costs. Such
future costs are called relevant cost because they are pertinent to the decisions in hand.
Relevant cost is a future cost which causes the difference between alternatives.
Opportunity Cost
Opportunity cost refers to the value of sacrifice made or benefit of opportunity foregone
in accepting alternative course of action.
Target Cost
It is derived by deducting the desired amount of profit from the estimated selling price.
All efforts are made to keep the total cost within the limit of the target cost.
Standard Cost
Standard cost is a scientifically per-determined cost, which is arrived at assuming a
particular level of efficiency in utilisation of material, labour and indirect services. In this
method actual costs incurred are compared with standard cost and reasons for difference
or variations are found out so that management may take remedial measures to control
the costs.

Marginal Cost
It is the cost of providing one additional unit of the product. With increase in production,
the fixed costs do not rise, but the difference in production cost is due to variable cost,
which is termed as marginal cost.
Budgeted/ Estimated Cost
Estimated cost is an approximate assessment of what the cost will be. It is based on past
averages adjusted to anticipated future changes. Estimated costs are used for the
evaluation of performance by comparison with the actual but are less accurate than the
standard costs.
Historical/Sunk Cost
Historical cost or ‘post-mortem’ costs which are collected after they have been incurred.
These costs report past events and the time lag between event and its reporting makes the
information out-of-date and irrelevant for decision-making.
Future Cost
Future costs are costs expected to be incurred at a later date.
Replacement Cost
Replacement cost is the cost of replacement in the current market.
Explicit Cost
These are actual costs incurred which involve some payment to outsiders either in
advance, or simultaneously or later. They are recorded in books of accounts.
Chargeable Cost
A chargeable cost is an expense which is specifically incurred in connection with the
execution of a particular job or work order. It includes all direct expenses other than
those of direct material and direct labour. It forms a part of prime cost of the product.
On the Basis of Controllability

Controllable Cost
The term controllable refers to costs which can be influenced by the action of the
executive in undertaking and is capable of control. Direct costs comprising direct labour,
direct material, direct expenses and some of the overheads are generally controllable by
the middle level management.
Uncontrollable Cost
Cost which cannot be influenced by the action of a special member of undertaking and is
beyond control is known as uncontrollable cost. For example, fixed expenses like salary,
rent, insurance and taxes.

Cost Control and Cost Reduction

Most of the enterprise is want to maximize the profit, which is possible by decreasing the
production cost. For this purpose, management uses two efficient tools, i.e. cost control and
cost reduction. Cost Control is a technique which makes available the necessary information
to the management that actual costs are aligned with the budgeted costs or not. Cost
Reduction is a technique which we used to save the unit cost of the product without
compromising its quality.
Definition of Cost Control

Cost Control is a process in which we focus on controlling the total cost through
competitive analysis. It is a practice which works to align the actual cost in agreement with
the established norms.
It ensures that the cost incurred on production should not go beyond the pre-determined
cost. Cost Control involves a chain of various activities, which starts with the preparation of
the budget in relation to production.
Thereafter we evaluate the actual performance. After that we compute the variances
between the actual cost & the budgeted cost and further, we find out the reasons for the
same. Finally, we implement the necessary actions for correcting discrepancies.
The major techniques which used in cost control are standard costing and
budgetary control. It is a continuous process which helps in analyzing the causes for
variances. For example- control wastage of material, any embezzlement and so on.
It involves:
1. Determination of standards;
2. Ascertaining actual results comparing the standards;
3. An analysis of the variances;
4. Establishing the action that may be taken.
Definition of Cost Reduction

Cost Reduction is a process, which aims to lower the unit cost of a product manufactured or
service rendered without affecting its quality. It can be done by using new and improved
methods and techniques. It ascertains substitute ways to reduce the production cost of
a unit.
Thus, cost reduction ensures savings in per unit cost and maximization of profits of the
enterprise. Cost Reduction aims at cutting off the unnecessary expenses which occur during

the production Process, storage, selling and distribution of the product. To identify cost
reduction we should focus on the following major elements:
 Savings in per unit production cost.

 The quality of the product should not be affected.
 Savings should be non-volatile in nature.
Tools of cost reduction focus on Quality operation and research, Improvement in product
design, Job Evaluation & merit rating, variety reduction, etc.
Difference between Cost Control and Cost Reduction

The following are the main differences between Cost Control and Cost Reduction:
1. Cost Control focuses on decreasing the total cost of production while cost reduction
focuses on decreasing per unit cost of a product.
2. Cost Control is a temporary process in nature. Unlike Cost Reduction which is a
permanent process.
3. The process of cost control will be completed when the specified target is achieved.
Conversely, the process of cost reduction is a continuous process. It has no visible
end. It targets for eliminating wasteful expenses.
4. Cost Control does not guarantee quality maintenance of products. However, cost
reduction assured 100% quality maintenance.
5. Cost Control is a preventive function because it ascertains the cost before its
occurrence. Cost Reduction is a corrective function.

MBA(FT) I SEM ACCOUNTING FOR MANAGERS UNIT VI
UNIT COST
Meaning of Unit Costing
Unit or output costing is that method of costing in which cost are ascertained per unit of a single
product in a continuous manufacturing activity. Per unit cost is calculated by dividing total
production cost by number of units produced. This method is also known as single costing. This
method is known as ‗single costing‘ as industries adopting this method manufacture, in most
cases, a single variety of product.
This method is also known as ‗unit costing‘, as not only the cost of the total output, but also the
cost per unit of output is ascertained under this method. Under this method cost units are
identical. This method is also called ‗output costing‘, as cost is ascertained for the total output
of a product.
Definitions
―Unit costing or output costing may be defined as single or output cost system is used in
business where a standard product is turned out and it is desired to find out the cost of a basic
unit of production.‖
According to J.R. Batliboi
―Unit Costing Method is a method of costing applied to ascertain the cost per unit of production
where standard and identical products are manufactured.‖
According to Walter W. Bigg
―Production Cost Accounting or Unit Cost Accounting is such a method of cost ascertainment
which is based on production unit. It is applicable where the production work is done
continuously and the units are of same types or manufactured identical.‖
According to Harold J. Wheldon
From above definitions it is clear that single costing is a method of costing under which there is
the costing of a single product which is produced by a continuous manufacturing activity.
Though under this method of costing a single variety of product is manufactured, it may vary in
respect of size, grade, colour, etc. The example of industries which make use of this method of
costing are – brick, sugar, cloth, coal, cement, fisheries, food canning, quarries, plantation
industries, etc.
Features or Element or Characteristics of Output Costing:

UNIT COST
(1) Output costing is the method of costing adopted in concerns where there is a production
of single product or a few grades of the same product differing only in size, shape or
quality by continuous process of manufacture. The units of production or output are
identical and the costs of units are physical and natural.
(2) Under this method, the cost per unit of output, say, per ton, per barrel, per kilogram, per
metre, per quintal, per bag, etc. is ascertained. The cost per unit of output is ascertained
by dividing the total cost incurred on a product during a given period of time by output
produced during the period. Where the products manufactured are of different grades,
first, the costs of products are ascertained grade-wise, and then the total cost of each
grade of the product is divided by the number of units of that grade so as to ascertain the
cost per unit of each grade of the product.
(3) Equality of cost is an important feature of this method. That is, under this method, cost
units, which are identical, will have identical cost.
(4) Under this method, the cost of product is ascertained at the end of the accounting period.
(5) Under this method, the cost information relating to a product may be presented in the
form of either cost sheet or production account.
(6) This method is the simplest method of all the methods of costing; in the sense that the
cost collection and the cost ascertainment are quite simple.
(7) The cost per unit of output, determined under single. Costing enables the management to
make real comparison between different periods and between different firms within the
same industry, as the unit of output is a common factor between different periods and
between different firms within the same industry.
Objectives of Output Costing
(1) To ascertain the total cost of the output as well as the cost per unit of output.
(2) To ascertain the profit or loss on production.
(3) To analyse the expenditure by nature, classify them into element of cost and know the
extent to which each element of cost contributes to the total cost.
(4) To facilitate comparison of the cost of one period with the cost of another period to know
the efficiency or otherwise of the production.
(5) To facilitate the preparation of tender or quotation.

UNIT COST
(6) To control the cost of the product through comparative study of the costs of any two
periods or through the comparison of the actual costs with the pre-determined standard
cost.
Important Items Regarding Preparation of Statement of Cost and Cost Sheet:
Normal Loss of Materials:
This type of loss is unavoidable and arises due to the nature of material. For example – loss by
evaporation of liquid materials, loss due to loading and unloading of materials, etc. This loss is
not deducted from the cost of material rather it is charged to the output because it is a principle
of costing that all normal expenses which are necessarily to be incurred should be included in
the cost of production.
Therefore, in order to absorb normal material losses in cost, the rates of usable materials are
inflated so that such losses are covered. In other words, such normal loss should be ignored and
this will get automatically charged to output.
Abnormal Loss of Materials:
Abnormal losses are those losses which arise due to abnormal reasons such as loss by theft, loss
by fire, careless handling etc. The cost of materials abnormally lost should be deducted from the
value of materials purchased so that output is charged only for the materials used in production.
Abnormal losses are charged to Costing Profit and Loss Account.
Wages of Normal Idle Time
Normal idle time is inherent in any work situation and cannot be reduced. The cost of normal
idle labour time is charged to the cost of production. Hence, wages of normal idle time is not
subtracted from the labour cost.
Wages of Abnormal Idle Time
Abnormal idle time arises due to unanticipated causes such as strikes, lockouts, fire, accidents,
major machine break-down, earthquakes, etc. Loss of time due to such abnormal causes cannot
be planned. Such causes are sudden and non-frequent.
The cost of abnormal idle time is not included in cost of production. The wages paid for
abnormal idle time should be debited to Costing P/L A/c. Hence, wages of abnormal idle time is
subtracted from the labour cost.
Sale of Scrap, Defective, Salvage or Residue

UNIT COST
If clear information is given, then adjustment of these sales will be made accordingly. But, if it
is not clear that what the nature of scrap defective, etc., the sale value of scrap etc. is deducted
before computing factory cost.
Defective or Rejected Work
Sometimes, under production process there might be defective goods. The production not
conforming to the standard set is known as defective. If such goods cannot be rectified, then it
may be sold in the market at lower rate. Whatever the amount is collected from such sale is
deducted from the factory cost. Similarly the defective units are also deducted from the number
of units produced.
On the other hand, the defective units which can be rectified by incurring extra expenses, then
such extra expenses incurred on such a rectification can be added in factory overhead as an
extra factory overhead. After that the saleable units and their costs can be determined
Cash Discount and Trade Discount
Cash discount is not considered as the part of cost of production, since it is of financial nature.
Whereas, trade discount is treated as sales promotion expense and is included in selling and
distribution expenses or may be deducted from gross sales.
Allocation of Joint Expenses
In absence of clear-cut information factory overhead is allocated on the basis of wages ratio and
office and administration expenses and selling and distribution expenses on the basis of works
cost ratio.
Packing Charges
Treatment of packing charges depends upon its nature. If, in absence of packing, goods cannot
be sold, then it should be treated as direct expense (i.e. packing of mustard oil etc.). Packing
charges in respect of partly finished goods are considered as factory overhead. In the same way,
packing expenses concerned with finished goods are included in selling and distribution
expenses.

UNIT COST
Advantages of Cost Accounting
Measuring and Improving Efficiency: - Cost accounting allows for data that enables the firm
to measure efficiency. This could be efficiencies with respect to cost, time, expenses etc.
Standard costing is then used to compare actual numbers with the industry or economy
standards to indicate changes in efficiency. Say for example the cost of producing one unit
increased from Rs.100/- to Rs. 110/-. Now was this due to an increase in prices or due to
inefficiency and wastages.
Identification of Unprofitable Activities: - just because a firm is making overall profits, it

does not mean all activities are profitable. Cost accounting will help us identify the profitable
and unprofitable activities of the firm. So activities that cause the firm losses can be made
profitable or eliminated. This can happen due to the cost ascertainment done in cost accounting.
Fixing Prices: - This is one of the important advantages of cost accounting. Many businesses
price their products based on the cost of production of these products. To enable this, we first
need to calculate the actual cost of production of these products. Costing makes the distinction
between fixed cost and variable cost, which allows the firm to fix prices in different economic
scenarios. Prices that we fix without the help of cost accounting can be too high or low, and
both cause losses to the business.
Price Reduction: - Sometimes during tough economic conditions, like depression, the prices
have to be reduced. In some cases, these prices are reduced to below the total cost of the
product. This is to help the company survive this tough period. Such decisions the management
has to take are guided by cost accounting.
Control over Stock: - Another important advantage of cost accounting is that it helps with
restocking and control over materials. Cost accounting will help us calculate the most ideal and
economic re-order level and quantities.
This will ensure that the firm is never overstocked or under stocked. Also costing allows the
management to keep a check over these raw materials, WIP etc.
Evaluates the Reasons for Losses: - Every firm has to deal with periods of profits and losses.
But now they must always evaluate or investigate the reasons for the losses suffered. This will
help to tackle the problem or overcome the cause by some other means necessary. So if you
cannot eliminate the reason you can at least minimize the losses. Cost accounting plays a huge
role in determining the cause of any losses.

UNIT COST
Say, for example, your cost of production is low, and prices are high but yet losses persist. This
can be due to low output levels due to inefficiency. Cost accounting helps us determine this.
Aids Future Planning: - One of the biggest advantages of cost accounting is that it will help
the management with future plans they may have. For any production or selling plans, it is
important to have detailed data about the machines, the labour capacity, output levels, levels of
efficiency of each process etc.
Say for example the management wishes to expand the production to accommodate sales, cost
accounting will help determine if the current machines can handle these levels of production or
not.

UNIT COST

UNIT COST

UNIT COST

UNIT COST

UNIT COST

UNIT COST

UNIT COST

UNIT COST
Q. 1 Mr. Gopal furnishes t he following data relating to t he manufacture of a standard product

during the month of April 2013 :
Raw materials consumed 15,000
Direct labour charges 9,000
Machine hours worked 900
Machine hour rat e 5
Administ rat ion overheads 20% on works cost
Selling overhead Re. 0.50 per unit
Q. 1 The accounts of Hindustan liver Company Ltd. show for 2012

Materials Rs 3,50,000; Labour Rs 2,70,000; Factory Overheads Rs 81,000 and
Administration Overheads Rs 56,080.
What price should the company quote for a refrigerator? It is estimated that Rs 1,000 in
material and Rs 700 in labour will be required for one refrigerator. Absorb factory overheads
on the basis of labour and administration overheads on the basis of works cost. A profit of
12½ % on selling price is required.
Q. 2 Following are the particulars for the production of 2,000 sewing machines of Bhagwati
Engineering Co. Ltd., for the year 2011
Cost of Materials Rs. 1,60,000; Wages Rs. 2,40,000; Manufacturing Expenses Rs.
1,00,000; Salaries Rs. 1,20,000; Rent, Rates and Insurance Rs. 20,000; Selling Expenses
Rs. 60,000; General Expenses Rs. 40,000 and Sales Rs. 8,00,000.
The company plans to manufacture 3,000 sewing machines during 2012. You are
required to submit a statement showing the price at which machines would be sold so as
to show a profit of 10% on selling price.
Following additional information is supplied to you: -
(a) Price of material is expected to rise by 20%

(b) Wages rates are expected to show an increase of 5%.

UNIT COST
(c) Manufacturing expenses will rise in proportion to the combined cost of materials and
wages
(d) Selling expenses per unit will remain the same,
(e) Other expenses will remain unaffected by the rise in output.
Q. 3 In respect of a factory the following figures have been obtained for the year 2011
Cost of material Rs. 6,00,000; Direct wages Rs. 5,00,000; Factory overheads Rs.
3,00,000; Administrative overheads Rs. 3,36,000; Selling overheads Rs. 2,24,000 ;
Distribution overheads Rs. 1,40,000 and Profit Rs. 4,20,000.
A work order has been executed in 2012 and the following expenses have been incurred:
Materials Rs. 8,000 and wages Rs. 5,000.
Assuming that in 2012 the rate of factory overheads has increased by 20%, distribution
overheads have gone down by 10% and selling and administration overheads have each
gone up by 12½%, at what price should the product be sold so as to earn the same rate of
profit on the selling price as in 2011?
Factory overhead is based on direct wages while all other overheads are based on factory
cost.
Q. 4 The Managing Director of a small manufacturing concern consults you as to the

minimum price at which he can sell the output of one of the departments of the company
which is intended for mass production in future. The company‘s records show the
following particulars for this department for the past year for production and sales of 100
units.
Materials Rs. 14,000;

Direct Labour Rs. 7,000;
Works Overheads Rs. 7,000;
Administration Overheads Rs. 2,800;
Selling Overheads Rs. 3,200;
Profit Rs. 6,000.
You ascertain that 40% of the works overheads fluctuate directly with production and
70% of the selling overheads fluctuate with sales. It is anticipated that the department
would produce 500 units per annum and that direct labour charges per unit will be
reduced by 20%, while fixed works overheads will increase by Rs. 3,000. Administration
overheads and fixed selling overheads are expected to show an increase of 25% but
otherwise no changes are anticipated.

UNIT COST
Q. 4 A factory‘s normal capacity is 1,20,000 units per annum. The estimated costs of
production are as under
Direct Materials Rs. 3 per unit; Direct Labour Rs. 2 per unit (subject to a minimum of Rs.
12,000 p.m.).
Overheads—Fixed Rs. 1,60,000 per annum; variable Rs. 2 per unit; semi-variable Rs.
60,000 p.a. up to 50% capacity and an additional Rs. 20,000 for every 20% increase in
capacity or part thereof. Each unit of raw material yields scrap which is sold at the rate of
20 paise. In 2012 the factory worked at 50% capacity for the first three months but it was
expected that it would work @ 80% capacity for the remaining 9 months.
During the first three months, the selling price per unit was Rs. 12. What should be the
price in the remaining nine months to produce a total profit of Rs. 2,18,000?
Q. 5 A company presently sells an equipment for Rs. 35,000. Increase in prices of labour and
material cost are anticipated to the extent of 15% and 10% respectively in the coming
year. Material cost represents 40% of cost of sales and labour cost 30% of cost of sales.
The remaining relates to overheads. If the existing selling price is retained, despite the
increase in labour and material prices, the company would face a 20% decrease in the
existing amount of profit on the equipment.
You are required to arrive at a selling price so as to give the same percentage of profit on
increased cost of sales, as before. Prepare a statement of profit/loss per unit, showing the
new selling price and cost per unit in support of your answer.

UNIT COST
Contract costing is the method of costing which is applied in a business where separate
contracts of non-repetitive nature are undertaken.
According to Sharie, ―Contract or terminal cost accounts are applicable to a concern which
makes specific contracts and requires to know the cost of each.‖
A contract is a job of large size may extend even beyond one accounting period. The person
executing the contract is known as a Contractor and the person for whom it is executed is
known as Contractee. Contract costing is a special form of job costing wherein big jobs are
involved which requires considerable time to complete and comprises a lot of activities. Here in
a separate account is opened for each contract in the Contract Ledger (or in General Ledger).
The account is debited with all direct and indirect expenses and is credited with the amount of
contract price on completion of the contract. The balance of this account is transferred to Profit
and Loss Account. However, if the contract is not completed before the end of the accounting
period, a reasonable amount of profit (or logs) is transferred to Profit and Loss Account.
Contract costing is most suitable to ship-building, road construction, building construction, civil
engineering works, etc.
Features of Contract Costing
The main features of Contract Costing may be summarized as follows:
1. Contracts are executed at contract site away from executor‘s or contractor‘s premises.
2. Contracts are jobs of large size and may continue over more than one accounting period.
3. Each contract is treated as a separate unit of cost for the purpose of cost ascertainment.
4. The contracts are executed as per the specifications given by the contractee.
5. Since the work is executed at the contract site, most of the items of cost to be incurred are
direct in nature.
6. The contract is executed by the contractor for some agreed amount of consideration
known as Contract Price.
7. The payments by the contractee are made to the contractor in installments on the basis of
the extent of the work already completed by him and certified as complete by
contractee‘s engineer or architect.
Difference between Contract Costing, Job Costing and Terminal Costing
Contract Costing, Job Costing and Terminal Costing do not differ from each other so far as the
nature of the work involved is concerned. But contract costing differs from job costing in as

UNIT COST
much as a contract is executed at the site outside the factory premises of the contractor, whereas
a job is executed by the contractor inside his factory premises.
Moreover, the ascertainment of the cost of a contract is very simple as compared to the
ascertainment of the cost of a job. A contract is executed at the site of the contract outside the
factory premises and as such most of the expenses incurred by the contractor in its execution are
direct in nature. A job is performed inside the factory premises where a number of different jobs
are completed simultaneously and a number of items of indirect expenses have to be
apportioned to these jobs on some equitable basis. Contract costing and job costing differ
slightly from terminal costing as in case of terminal costing a deadline is fixed by the contractee
within which a job or contract must be completed failing which the contractor shall pay
damages to the contractee on account of loss suffered by him due to the delay in the completion
of the job or contract.
Objects of Contract Costing : - The main objects of Contract Costing are:
(i) To ascertain the total cost of a contract, and

(ii) To ascertain the profit or loss on the contract.
Specific Aspects of Contract Costing
Materials: - Here three specific accounting may be required to be done. In case materials are
purchased for the contract and directly delivered at the site of the contract, naturally, there arises
no specific accounting system. However, if the materials purchased are, first, delivered to the
stores department, then the contract account will be debited and Store control account will be
credited. If however, certain materials are charged to contract account but returned to stores,
stores contract account will be debited and the contract account will be credited.
Materials sold at the contract site is credited to the Contract Account. However, if because of
some extraneous reasons sale is made then the profit or loss incurred due to such a sale is
credited to Profit and Loss Account. In case of sale of contract assets and property also for
profit or loss the Profit and Loss Account is credited.
In some cases, the contractee may himself supply the materials to the contractor. Here also the
value of such materials should not be charged to the contract account. The unused materials are
to be returned to the contractee.
Labor: - All labor employed for the completion of the contract is direct labor and is treated as
such. For maintaining a proper record and for having control over the labor expenses the wages
abstract is prepared.

UNIT COST
Plant and Machinery: - Where a plant, machinery or equipment is specially purchased for a
particular contract and will be exhausted at the site. If it is so it will naturally be debited in the
contract account and any amount of depreciation shall be charged to the credit side of the
contract account. However, if it is acquired for a shorter period; then, the amount is debited only
with the usual depreciation of the assets. The sale proceeds, if any, at the end or mid-way of the
contract is credited to the contract account and profit or loss on such a sale is transferred to
Profit and Loss Account.
Indirect Expenses: - Indirect expenses are, treated and apportioned in the same manner in
which they are treated and apportioned in any costing system.
Cost plus contract: - is one wherein the contractee agrees to pay to the contractor the cost price
of the work done on the contract plus an agreed amount or percentage thereof by way of
different overheads and profit.
Sub-contracts: - The contractor (if thinks proper and allowed to do so by the agreement entered
into) may entrust some portion of the work to be done by one or more than one sub-contractor.
The cost in this connection is the direct charge on the contract and is treated as such in the
contract costing.
Escalation Clause: - In a contract agreement, there is a usual practice of making a provision for
the escalation clause the contractor is interested in safeguarding himself against any charge in
the price level. The agreement itself specifies the procedure for the calculation of adjustment in
order to avoid all disputes etc.
Work-in-progress — Work Certified and Uncertified
When the contract is not completed till the end of the accounting year, the architect is required
to value the work-in-progress. Such work-in-progress is classified into work certified and work
uncertified
Work Certified: - This is that part of the work-in-progress which has been approved by the
contractee‘s architect or engineer for payment. Work certified is valued at contract price (i.e ,
selling price), and includes an element of profit.
Work Uncertified: - This is that part of the work-in-progress which is not approved by the
architect or engineer. This is valued at cost and thus does not include an element of profit. Both
work certified and uncertified appear on the credit side of the contract account and also on the
assets side of the balance sheet.

UNIT COST
Payment: - In case of small contracts, the usual practice is to make the payment to the
contractor in lump sum after the completion of the contract. However, in large contract the
payment is made in installment on the basis of progress made in the contract. The progress is
judged by technical personnel‘s —architect, survey. or, engineer, etc.
Such personnel‘s are required to issue a certificate certifying the complete work. Such work for
which certificate is granted is known as Work Certified which may be expressed in terms of
percentage. Here also the contractee may not pay for 100% work certified. He may withheld or
retain some payment. This is called retention money. The work for which certificate is not
granted is known as works uncertified.
The following are the ways in which the value of work certified is treated in cost accounts:
(1) The amount of work certified is debited to the Contractee‘s Personal Account and
Contract Account is
credited.
(2) Cash or Bank Account is debited and Contractee‘s Personal Account is credited or
receipt of the money for certified work.
(3) Balance of Contractee‘s Personal Account is shown as an asset in the Balance Sheet.
OR ALTERNATIVELY
(1) A memorandum record of work certified may be kept.
(2) The amount received from the contractee may be debited to his personal account.
(3) The amount of the work certified may be debited to the Work-in-Progress Account
and credited to the Contract Account.
(4) On completion of the contract, the Contractee‗s Personal Account may be debited
and the Contract Account may be credited.
Profit on Incomplete Contracts. If the contract is not complete and the accounting year has
come to close then profit on incomplete contracts is required to be calculated and accounted for.
In this respect the following rules may be followed:
(1) In respect of work certified the profit should be calculated and accounted for. Work
uncertified should be valued at cost.
(2) If the work certified is less than 25% of the contract price, the profit should neither be
calculated nor Accounted for.

UNIT COST
(3) If the work certified is more than 25% of the contract price but it is less then 50% of the
contract price, then, of the profit disclosed, as reduced by the percentage of cash received
from the contractee, should be shown in the Profit and Loss Account. The balance
naturally is to remain as a Reserve.
(4) If, however, the certified work is more than 50%, the 66-2/3% of the profit disclosed, as
reduced by the percentage of cash received from the contractee, should be shown in the
Profit and Loss Account. The remaining be shown and kept as a reserve.
(5) If the contract is nearing completion, the total cost of contract be estimated and the
estimated total profit on the contract should be calculated by deducting the total estimated
cost from the agreed total contract price and Profit and Loss Account, then, be credited
by the proportion of total estimated profit vis-à-vis cash received from the contractee.
(6) The loss, if any, shall naturally be transferred to Profit and Loss Account.
Rules for Profit calculation
There are no hard and fast rules in this regard. However, the following general rules may be
followed:
1. When work-in-progress certified is less than 1/4 of the contract price, no profit is
transferred to Profit and Loss Account. This is based on the principle that no profit should
be taken into account unless the contract has reasonably advanced.
2. When work-in-progress certified is 1/4 or more but less than 1/2 of the contract price, then
generally 1/3 of the profit is transferred to Profit and Loss Account. The balance amount
is treated as reserve. Thus, profit to be transferred to Profit and Loss Account is computed
by the following formula:
Transfer to P&L A/c = Notional profit × 1 / 3
Alternatively, a more common practice is to further reduce this amount by the cash ratio.
Transfer to P&L A/c = Notional profit × 1 × Cash received

3 Work certified
3. When work certified is 1/2 or more but less than 9/10 of the contract price, (i.e., 50%to
90%), then the profit to be transferred to P & L Account is computed as follows:
Transfer to P&L A/c = Notional profit × 23
Here also a more common practice is to further reduce this amount by cash ratio. This is
shown below:
UNIT COST
Transfer to P&L A/c = Notional profit × 2 × Cash received
3 Work certified
4. When contract is near completion then the estimated profit should be calculated on the
whole contract. The proportion of estimated profit to be transferred to Profit and Loss
Account is computed by any one of the following formulas:
(a) Estimated profit × Work certified / Contract price
(b) Estimated profit ×Work certified / Contract price × Cash received / Work certified
(c) Estimated profit × Cost of work to date estimated / total cost of work
(d) Estimated profit × Cost of work to date estimated / total cost of work × Cash received
/ Work certified
5. Loss on Uncompleted Contracts. In the event of a loss on uncompleted contracts, this
should be Transferred in full to the Profit and Loss Account, whatever is the stage of
completion of the contract.
Practical Problems
Q. 1 The following expenditure was incurred on a contract of Rs. 12,00,000 for the year
ending 31-12-2015.
Materials Rs. 2,40,000

Wages Rs. 3,28,000
Plant Rs. 40,000
Overheads Rs. 17,200
Cash received on account of the contract to 31st Dec., 2015 was Rs. 4,80,000, being 80%
of the work certified. The value of materials in hand was Rs. 20,000. The plant had
undergone 20% depreciation. Prepare Contract Account.
Q. 2 The following expenses were incurred on an unfinished contract during the year 2015.
Materials Rs.90,000
Wages Rs.60,000
Other expenses Rs.30,000
Rs.2,00,000 was received by the contractor, being 80% of the work certified. Work done
but not certified was Rs. 5,000. Determine the profit to be credited to profit and loss
account and profit kept reserve in all the three alternatives given below:
(i) Contract price is Rs. 3,00,000

(ii) Contract price is Rs. 5,50,000
(iii) Contract price is Rs. 12,00,000

UNIT COST
Q. 3 How much of profit, if any, you would consider in the following case:
Contract price Rs. 20,00,000
Cost incurred Rs. 11,20,000
Cash received Rs. 10,80,000
Work not certified Rs. 1,20,000
Deduction from bills by way of security deposit is 10%.
Q. 4 The following were the expenses on a contract which commenced on 1st January 2015.
Materials purchased Rs. 1,10,000
Material at the end Rs. 1,250
Direct wages Rs. 15,000
Plant issued Rs. 5,000
Direct expenses Rs. 8,000
The contract price was Rs. 1,50,000. It was duly received when the contract was
completed on 31-3-2015. Charge indirect expenses at 15% on wages and provide Rs.
1,000 for depreciation on plant. Prepare the contract account and contractee‘s account.
Q. 5 The kedar accepted a contract for the construction of a building for Rs. 10,00,000 the
contractee agreeing to pay 90% of work certified by the architect. During the first year,
the amounts spent were:
Material Rs. 1,20,000
Machinery Rs. 30,000
Labour Rs. 1,50,000
Other expenses Rs. 90,000
At the end of the year, the machinery was valued at Rs. 20,000 and materials at site were
of the value of Rs. 5,000. Work certified during the year totaled Rs. 4,00,000. In addition
work-in-progress not certified at the end of the year had cost Rs. 15,000. Prepare
Contract Account in the books of The kedar. Also show the various figures of profit that
can be reasonably transferred to the Profit and Loss Account.
Q. 6 The BBA Construction Company undertakes large contracts. The following particulars
relate to contract No. 125 carried out during the year ended on 31st March, 2015.
Work certified by architect Rs.1,43,000

Wages accrued on 31st March 2015 Rs.1,800
Cost of work not certified Rs. 3,400
Direct expenditure Rs.2,400
Plant installed at site Rs.11,300
Materials on hand on 31st March 2015 Rs.1,400
Plant on 31st March 2015 Rs.8,200
UNIT COST
Materials returned to store Rs.400
Materials sent to site Rs.64,500
Direct expenditure accrued on Labour Rs. 54,800 31st March 2015 200
Establishment charge Rs.3,250.
Contract price Rs. 2,00,000
Cash received from contractee Rs. 1,30,000
Prepare a Contract Account for the period ending 31st March 2015 and find out the
profit. It was decided to transfer 2/3 of the profit on cash basis to Profit and Loss
Account.
Q. 7 The Indian Construction Co. Ltd. has undertaken the construction of a bridge over the
River Yamuna for a Corporation. The value of the contract is Rs. 15,00,000 subject to
retention of 20% until one year after certified completion of the contract, and final
approval of the Corporation‘s engineer. The following are the details as shown in the
books on 30th June, 2015.
Labour on site Rs. 4,05,000

Materials on hand on June 30th, 2015 Rs. 6,300
Materials direct to site Rs. 4,20,000
Wages accrued on June 30th, 2015 Rs. 7,800
Materials from stores Rs. 81,200
Direct expenses accrued on June 30th 2015 Rs. 1,600
Hire and use of plant Rs. 12,100
Works not yet certified at cost Rs. 16,500 Direct expenses Rs. 23,000 Amount certified
by the Corporation‘s General overhead allocated to the engineer Rs. 11,00,000 contract
Rs. 37,100
Cash received on account Rs. 8,80,000 Prepare
(a) Contract Account,
(b) Contractee‘s Account, and
(c) Show how it would appear in the Balance Sheet.
Q. 8 Modern Contractors have undertaken the following two contracts on Ist January, 2015
Contract A Contract B
Materials sent to sites 85,349 73,267
Labour engaged on sites 74,375 68,523
Plants installed at sites at cost 15,000 12,500
Direct expenditure 3,167 2,859

UNIT COST
Establishment charges 4,126 3,852
Materials returned to store 549 632
Work certified 1,95,000 1,45,000
Cost of work not certified 4,500 3,000
Materials in hand 31st Dec., 2015 1,883 1,736
Wages accrued 31st Dec., 2015 2,400 2,100
Direct expenditure accrued 31st Dec., 2015 240 180
Value on plant 31st Dec., 2015 11,000 9,500
The contract prices have been agreed at Rs. 2,50,000 for contract A and Rs.2,00,000 for
contract B. Cash has been received from the contractee‘s as follows: Contract A
Rs.1,80,000 and Contract B Rs.1,40,000.
Prepare Contract Accounts, Contractee‘s Accounts and show how the work-in-progress
shall appear in the Balance Sheet of the contractor
Q. 9 T.K. Construction Ltd. is engaged on two contracts A and B during the year. The
following particulars are obtained at the year end (Dec. 31):
Contract A Contract B
Date of commencement April 1 September 1
Contract price 6,00,000 5,00,000
Materials issued 1,60,000 60,000
Materials returned 4,000 2,000
Materials on site (Dec. 31st) 22,000 8,000
Direct labour 1,50,000 42,000
Direct expenses 66,000 35,000
Establishment expenses 25,000 7,000
Plant installed at cost 80,000 70,000
Value of plant (Dec. 31st) 65,000 64,000
Cost of contact not yet certified 23,000 10,000
Value of contract certified 4,20,000 1,35,000
Cash received from contractee‘s 3,78,000 1,25,000
Architect‘s fees 2,000 1,000
During the period, materials amounting to Rs. 9,000 have been transferred from contract
A to contract B. You are required to show:
(a) Contract Accounts, (b) Contractee‘s Accounts, and (c) Extracts from Balance Sheet as
on December 31st, clearly showing the calculation of work-in-progress.

UNIT COST
Q. 10 A firm of contractors undertook three contracts on 1st April, 2014, I st October, 2014
and1st Jan., 2015. On 31st March, 2015, when their accounts were made up, the position
was as follows:
Contract I II III
Contract price 4,00,000 1,35,000 1,50,000
Materials 72,000 29,000 10,000
Wages 1,10,000 56,200 7,000
General expenses 4,000 1,400 500
Plant 20,000 8,000 6,000
Materials on hand 4,000 2,000 1,000
Wages outstanding 3,400 1,800 800
Work certified 2,00,000 80,000 18,000
Cash received 1,50,000 60,000 13,500
Work uncertified 6,000 4,000 1,050
General expenses outstanding 600 200 100
The plants were installed on the respective dates of the contract and depreciation is taken
at 10% p. a. Prepare contract accounts.
Q. 11 Compute a conservative estimate of profit on a contract (which is 80% complete) from

the following particulars. Illustrate at least four methods of computing the profit
transferable to P&L A/c.
Total expenditure Rs.85,000
Estimated further expenditure to complete the contract
(including contingencies) Rs.17,000
Contract price Rs.1,53,000
Work certified Rs.1,00,000
Work not certified Rs.8,500
Cash received Rs. 81,600
Q. 12 An expenditure of Rs.3,88,000 has been incurred on a contract up to the end of 31st

December,2015. The value of work certified is Rs.4,40,000. The cost of work uncertified
is ` 12,000. It is estimated that contract will be completed by 31st March, 2015 and an
additional expenditure of Rs. 80,000 will have to be incurred to complete the contract.
The total estimated expenditure on the contract is to include a provision of 2.5% for
contingencies. The contract price is Rs.5,60,000 and Rs.4,00,000 has been realized in
cash up to 31st December, 2015. Calculate the proportion of profit to be taken to Profit
and Loss Account as on 31st December, 2015 under different methods.

UNIT COST
Q. 13 The following information relates to a building contract for Rs.10,00,000.

Year 2014 Year 2015
Materials issued 3,00,000 84,000
Direct wages 2,30,000 1,05,000
Direct expenses 22,000 10,000
Indirect expenses 6,000 1,400
Work certified 7,50,000 10,00,000
Work uncertified 8,000 —
Materials at site 5,000 7,000
Plant issued 14,000 2,000
Cash received from contractee 6,00,000 10,00,000
The value of plant at the end of 2014 and 2015 was Rs. 7,000 and Rs. 5,000, respectively.
Prepare: (i) Contract Account, (ii) Contractee‘s Account for two years 2014 and 2015
taking into consideration such profit for transfer to Profit and Loss Account as you think
proper.
Q. 14 XY Co. undertook a contract for Rs.15,00,000 on an arrangement that 80% of the value
of work done as certified by the architects of the contractee, should be paid immediately
and the remaining 20% be retained until the contract is completed. In 2013, the amounts
expended were:
Materials Rs. 1,80,000;
Wages Rs. 1,70,000;
Carriage Rs. 6,000;
Cartage Rs. 1,000;
Sundry expenses Rs. 3,000.
The work was certified for Rs.3,75,000 and 80% of this was paid as agreed. In 2014, the
amounts expended were: Materials Rs.2,20,000, Wages Rs. 2,30,000, Carriage Rs.
23,000. Cartage Rs. 2,000 and Sundry expenses Rs. 4,000. Three-fourths of the contract
was certified as done by 31st December, 2005 and 80% of this received accordingly. The
value of unused and work-in-progress was ascertained at Rs. 20,000.
In 2015, the amounts expended were: Materials Rs. 1,26,000; Wages Rs. 1,70,000;
Cartage Rs.6,000; Sundry expenses Rs.3,000, and on 30th June the whole contract was
completed. Show how the Contract Account as also the Contractee‘s Account would
appear for each of these years in the books of the contractor, assuming that balance due to
him was received on completion of the contract.
Q. 15 The following figures are extracted from the books of a contractor, for the year ending
31stDec., 2015:
Work-in-progress on 31st Dec., 2014 17,00,000

UNIT COST
Less: Advances from contractee‘s 11,00,000 6,00,000
Materials supplied to contracts direct 1,20,000
Materials issued from store 2,10,000
Wages 1,70,000
Working expenses 30,000
Materials returned to store 11,000
Contracts finished 4,50,000
Work certified 3,00,000
Profit taken to Profit and Loss Account upon contracts completed
2,30,000
Administrative expenses (out of which5,000 is chargeable to P&L Account) 25,000
Plant issued 50,000
Materials returned from contract to suppliers 9,000
Advances from contractee‘s 8,00,000
Plant at site 40,000
Prepare the Contract Ledger Control Account in general ledger and total contractee‘s
account. Show also how the work-in-progress would appear in the Balance Sheet as on
31st December, 2015.

UNIT COST
Process Costing
Calculating process costing for goods produced can allow manufacturing or production
companies to evaluate how much product is being produced and how much it costs to
produce it.
However, factors like the number of products completed and the number left in-process at
the end of an accounting period can affect the total costs a company is responsible for
during production. This is why many large corporations use process costing methods to
help them track total costs and total inventory being produced.
In this article, you will learn what process costing is, the three main types of process
costing and how to calculate process costing with an example.
What is process costing?
Process costing refers to a cost accounting method that is used for assigning production
costs to mass-produced goods.
For instance, large manufacturing companies that mass-produce inventory might use
process costing to calculate the total amount of direct and indirect costs associated with
products that are completed and left in-process at the end of a given time period.
Some industries where process costing methods might be applied are the food industry,
fuel and oil industries and chemical processing industries.
Example of process costing
Different departments, such as a design team, a floor team, an assembly department and
even a shipping and receiving department can have separate processing costs associated
with unit production. As the inventory moves through each stage of development, each
department may add its calculated costs to the overall process costing of producing
goods.
A company that produces ink cartridges applies process costing through several
departments. The first department—the design department—is where the overall shape,
dimensions and other design elements of the cartridges are processed.
During a 30-day period, the design department accumulates a total amount of $80,000 of
direct costs for materials and resources and $100,000 of converted costs for labor and
overhead costs. The design department processes 10,000 cartridges during the 30-day
UNIT COST
period, which means that the per-unit cost of the cartridges amounts to $8 for direct costs
(materials and resources) and $10 for conversion, or indirect, costs.
As the ink cartridges move through other departments during the production period,
different costs will be added to the total amount of costs incurred during production.
The importance of using process costing
Process costing is a vital tool companies and production supervisors use to track product
costs in industries that deal with mass amounts of produced goods and are subject to
regular price fluctuations due to process and multiple production lines. Process costing
results in a cost of goods manufactured (COGM) figure that is often listed on your
company‘s income statement.
More specifically, process costing is important because it helps companies:
Control inventory numbers and be able to distribute accurately
Monitor profits to know precisely how much they are spending and earning
Report numbers from each department uniformly and accurately
Types of process costing
A company can use several different methods of process costing to determine the total
costs incurred before, during and after production, as well as the total amount of units
produced. Standard process costing may be used for simply calculating production costs,
while averaging assigns costs to specific units of production, and first-in, first-out
calculates unit costs as they are started and completed.
A company may use one or all methods of calculating process costing, depending on
what they produce, how they produce it and how they track their production processes.
The most common methods of process costing include:
Standard cost
Standard cost refers to calculating costs for production units instead of actual costs.
Actual costs are compared with the total costs accumulated based on standard costs, and
the difference between the total costs accumulated and the actual costs accumulated is
recorded and charged to another account, in this instance, a variance account.

UNIT COST
Weighted average
This type of process costing groups together all the costs associated with production and
assigns them to the units the company produced. This type of method may not take into
account the time period of production and can be the simplest type of process costing to
calculate.
First-in, first-out
This method of process costing focuses on assigning costs to units in the order that they
are produced. Products that are produced first are assigned a cost first, and then, they are
the first products to ship or otherwise put out. Furthermore, first-in, first-out assigns one
set of costs to products started in prior accounting periods but not finished, and another
set of costs for products started in the current accounting period.
Using the process costing method
There are five steps in the process costing method that can be used to assign relevant
costs to inventory, completed at the beginning, during and the end of an accounting or
production period. By following the steps of the process costing method, you can
calculate the total costs associated with any inventory and production processes that
occur within your company.
Analyze the inventory.
Convert inventory costs.
Calculate applicable costs.
Calculate the cost per unit.
Designate costs for complete and incomplete products.
1. Analyze the inventory
The first step in calculating process costing is to analyze the inventory by evaluating cost-
flow of the inventory. By determining the costs of each process of production, a company
can determine the amount of inventory that was accounted for at the start of the period,

UNIT COST
the amount that was completed during the accounting period and how much of the
inventory was left as in-process at the end of the accounting period.
2. Convert inventory costs
The second step in calculating process costing is to convert any inventory that was
considered as in-process at the end of the period to an amount of equal units.
For example, if a manufacturing company that produces ink cartridges determined 4,200
cartridges were in-process at the end of the accounting period, and each of these
cartridges were 50% completed, then the company would consider that inventory as equal
to 2,100 cartridges produced.
3. Calculate applicable costs
Then, after converting any inventory to its equivalent amount in produced units, calculate
the total costs, both indirect and direct, that are accumulated through the manufacturing
process. This amount is then applied between the inventory that is completed and the
inventory that was left in-process. Both indirect and direct costs of production include the
costs of the inventory at the starting period and the costs accumulated during the period.
4. Calculate the cost per unit
Once you have calculated all costs associated with the production process for complete
and in-process inventory, calculate the costs per unit. This includes the costs for
completed units and equivalents of finished units at the end of the accounting period.
For instance, if the company that manufactures ink cartridges completed 3,000 cartridges
and left 2,000 cartridges 50% complete, the company would divide the costs by 4,000.
5. Designate costs for complete and incomplete products
Finally, split up the costs by allocating the appropriate amounts to the number of products
completed, as well as to the inventory that was considered in-process at the end of the
period.

MBA (FT) I SEM ACCOUNTING FOR MANAGER UNIT VII
Introduction to Management Accounting

One of the definitions of Management accounting says that it is the application of professional skills and
knowledge in the preparation of financial and accounting information in a manner in which it will assist the
internal management in the formulation of policies, planning, and control of the operations of the firm.
The basic function of management accounting is to help the management make decisions. There is no fixed
structure or format for it.
Financial accounting, costing, business analysis, economics, etc are some tools and techniques of
management accounting.
The only need for management accounting is that the data should serve its purpose, which is helping the
management take important business decisions.
Management Accounting Definition
Management accounting also is known as managerial accounting and can be defined as a process of
providing financial information and resources to the managers in decision making. Management accounting
is only used by the internal team of the organization, and this is the only thing which makes it different from
financial accounting. In this process, financial information and reports such as invoice, financial balance
statement is shared by finance administration with the management team of the company. Objective of
management accounting is to use this statistical data and take a better and accurate decision, controlling the
enterprise, business activities, and development.
Financial accounting is the recording and presentation of information for the benefit of the various
stakeholders of an organization. Management accounting, on the other hand, is the presentation of financial
data and business activities for the internal management of the organization. In this article, we will learn what
is management accounting and its functions.
Advantages and Objectives of Management Accounting
There are many objectives of but the prime objective is to assist the management team of an organization in
improving the quality of their decisions. Purpose of management accounting is to help the managerial team
with financial information so that they can execute business operations and activities more efficiently.
Following is the list of all benefits of management accounting –
1. Decision Making
2. Planning
3. Controlling business operations

4. Organizing
5. Understanding financial data
6. Identifying business problem areas
7. Strategic Management
Decision Making
This is the most important benefit of the process of management accounting. In fact, it is the main purpose of
it. In this form of accounting, we use techniques from all fields like costing, economics, statistics, etc.
It provides us with charts, tables, forecasts and various such analysis that makes the process of decision
making easier and more justified.
Read Costing – An Aid to Management here in detail
Planning
Managerial accounting does not have any strict timelines like financial accounting. It is, in fact, a continuous
and ongoing process.
So financial and other information is presented to the management at regular intervals like weekly, monthly
or sometimes even daily.
Hence managers can use this analysis and data to plan the activities of the organization. For example, if the
recent data shows a dip in the sales for a certain region, then the sales manager can advise his team and plan
some action to rectify the situation.
Identifying Business Problem Areas

If some product is not performing well, or some department is running into unexpected losses, etc.
managerial accounting can help us identify the underlying cause.
Actually, if the management is diligent and their data and reports are frequent, they can identify the problem
very early on. This will allow the management to get ahead of the problem.
Strategic Management
Concept of management accounting is not mandatory by any law. So it can have its own structure according
to the company’s requirements. So if the company feels certain areas need more in-depth analysis or
investigation it can do so freely.
This allows them to focus on some core areas. The information presented to them allows them to make
strategic management decisions.
Like if the company wishes to launch a new product line, or discontinue an existing one, management
accounting will play a huge part in this strategy.
Limitations of Management Accounting
 Data based on Financial accounting – Decisions taken by the management team are based on the
data provided by Financial Accounting
 Less knowledge – Management has insufficient knowledge of economics, finance, statistics, etc.
 Outdated data – Management team receives historical data, which may change eventually when
management is taking the decisions.
 Expensive – Setting up a management accounting system requires a lot of investment.
Difference between Management Accounting and Financial Accounting
Basis for Management accounting Financial accounting

Comparison
Purpose It is used for internal purpose It is used for external reporting

primarily, although the management
also reviews it
Regulation It is not regulated by any law It has to be presented as per standards
Users Its users are the management of an Its users are shareholders, investors
organization and regulators
Objective It aids in internal decision making It aids in investment decision by

outsiders and monitoring by
regulators
Mandatory Preparation and presentation of Preparation and presentation is

financial statements is not mandatory.
mandatory

Audit It is not subject to audit Financial statements must be audited
Frequency There is no defined frequency for Financial statements must be

preparation and presentation of the prepared for the financial year and
statements presented
Contents Management accounts include Financial accounts include only

both monetary and non-monetary monetary information
information
Techniques in Managerial Accounting
In order to achieve its goals, managerial accounting relies on a variety of different

techniques, including the following:
1. Margin analysis
Margin analysis is primarily concerned with the incremental benefits of optimizing

production. Margin analysis is one of the most fundamental and essential techniques
in managerial accounting. It includes the calculation of the breakeven point that
determines the optimal sales mix for the company’s products.
2. Constraint analysis
The analysis of the production lines of a business identifies principal bottlenecks, the
inefficiencies created by these bottlenecks, and their impact on the company’s ability
to generate revenues and profits.

3. Capital budgeting
Capital budgeting is concerned with the analysis of information required to make the
necessary decisions related to capital expenditures. In capital budgeting analysis,
managerial accountants calculate the net present value (NPV) and the internal rate of
return (IRR) to help managers to decide on new capital budgeting decisions.
4. Inventory valuation and product costing
Inventory valuation involves the identification and analysis of the actual costs
associated with the company’s products and inventory. The process generally implies
the calculation and allocation of overhead charges, as well as the assessment of the
direct costs related to the cost of goods sold (COGS).
5. Trend analysis and forecasting
Trend analysis and forecasting are primarily concerned with the identification of
patterns and trends of product costs, as well as with recognition of unusual variances
from the forecasted values and the reasons for such variances.
Relationship between management accounting and Cost accounting
Management accounting collects data from cost accounting and financial accounting. Thereafter, it
analyzes and interprets the data to prepare reports and provide necessary information to the management.
On the other hand, cost books are prepared in cost accounting system from data as received from
financial accounting at the end of each accounting period.
The difference between management and cost accounting are as follows:
S.No. Cost Accounting Management Accounting
1 The main objective of cost accounting is The primary objective of management accounting is
to assist the management in cost control to provide necessary information to the management
and decision-making. in the process of its planning, controlling, and
performance evaluation, and decision-making.
2 Cost accounting system uses quantitative Management accounting uses both quantitative and
cost data that can be measured in monitory qualitative data. It also uses those data that cannot

terms. be measured in terms of money.
3 Determination of cost and cost control are Efficient and effective performance of a concern is
the primary roles of cost accounting. the primary role of management accounting.
4 Success of cost accounting does not Success of management accounting depends on

depend upon management accounting sound financial accounting system and cost
system. accounting systems of a concern.
5 Cost-related data as obtained from Management accounting is based on the data as

financial accounting is the base of cost received from financial accounting and cost
accounting. accounting.
6 Provides future cost-related decisions Provides historical and predictive information for
based on the historical cost information. future decision-making.
7 Cost accounting reports are useful to the Management accounting prepares reports
management as well as the shareholders exclusively meant for the management.
and creditors of a concern.
8 Only cost accounting principles are used Principals of cost accounting and financial
in it. accounting are used in management accounting.
9 Statutory audit of cost accounting reports No statutory requirement of audit for reports.
are necessary in some cases, especially big
business houses.
10 Cost accounting is restricted to cost- Management accounting uses financial accounting

related data. data as well as cost accounting data.

MBA(FT) I SEM ACCOUNTING FOR MANAGERS UNIT VIII
(Cash Budget)
Standard Costing: Definition
Standard costing is a system of accounting that uses predetermined standard costs for direct material,
direct labor, and factory overheads.
Standard costing is the second cost control technique, the first being budgetary control. It is also one of
the most recently developed refinements of cost accounting.
The standard costing technique is used in many industries due to the limitations of historical costing.
Historical costing, which refers to the task of determining costs after they have been incurred, provides
management with a record of what has happened.
For this reason, historical costing is simply a post-mortem of a case and has its own limitations.
For managers within a company, exercising control through standards and standard costs is a creative
program aimed at determining whether the organization’s resources are being used optimally.
Standard costs are typically determined during the budgetary control process because they are useful for
preparing flexible budgets and conducting performance evaluations.
The use of standard costs is also beneficial in setting realistic prices. Along with this, standard costs help
to identify any production costs that need to be controlled.
Importantly, comparison of actual cost with standard cost shows the variance. When correctly analyzed,
this shows how to correct adverse tendencies.
The current category “Standard Costing and Variance Analysis” discusses the technique of standard
costing and variance analysis, which is aimed at profit improvement mainly by reducing materials,
labor, and overhead costs.
Standard Cost: Definition
There are different definitions of standard costing, all of which emphasize the use and determination
of standard cost. Hence, it is useful to understand the meaning of standard cost.
A standard cost is one that a company expects at the outset of a year under a normal level of operational
efficiency. Standard costs are used periodically as a basis for comparison with actual costs.
Standard costs may be termed commonsense costs. This reflects the view that a standard cost represents
the best judgment of management about what costs the business operations will involve when
undertaken efficiently.

(Cash Budget)
According to Brown & Howard, “standard cost is a pre-determined cost which determines what each
product or service should cost under given circumstances.”
Blocker defined standard cost as follows:
A pre-determined cost based upon engineering specifications and representing highly efficient
production for quality standard with a fixed amount expressed in terms of dollars for materials, labor,
and overhead for any estimated quantity of production.
The Institute of Cost and Management Accountants (ICMA) defined standard cost in the following way:
A pre-determined cost which is calculated from management’s standards of efficient operation and the
relevant necessary expenditure. It may be used as a basis for price fixation and for cost control through
variance analysis.
In ICMA’s definition of standard cost, the phrase “management’s standards of efficient operation” is
important. This is because standard cost is ascertained on this basis.
The standard of efficient operation is decided based on previous experience, research findings, or
experiments. The standard is generally defined as that which is attainable but only after substantial
effort.
Standard cost serves as a measure against which actual cost is compared. If actual cost does not exceed
standard cost, performance is treated as fully efficient.
Standard cost also plays a role in evaluating staff performance. For example, by analyzing the difference
between actual costs and standard costs, management can identify the factors leading these differences.
Standard costs also assist the management team when making decisions about long-term pricing.
Features of Standard Costing System
Standard cost is a predetermined cost. It is based on past experience and is referred to as a common
sense cost, reflecting the best judgment of management.
Standard cost relates to a product, service, process or an operation. It is also determined for a normal
level of efficiency of operation.
Standard cost is used to measure the efficiency of future production or future operations. For this reason,
it provides a useful basis for cost control.
Also, standard cost may be expressed in terms of money or other exact quantities.

(Cash Budget)
Advantages of Standard Cost
This section highlights the most important advantages of standard cost.
First, standard costs serve as a yardstick against which actual costs can be compared.
The difference between standard cost and actual cost are called variances. For proper control and
performance measurement in an organization, variances should be measured and analyzed. This also
ensures that regular checks are made on expenditures.
The second advantage is that if immediate attention is taken, control over costs is greatly facilitated. A
proper standard costing system assists in achieving cost control and cost reduction.
Standard cost also helps to motivate employees. This is because the system can be used to provide an
incentive scheme wherein variance is minimized.
Production and pricing policies are formulated with certainty when standard cost systems are in place.
This helps to keep costs in check.
The last advantage of using standard cost is that even when other standards and guidelines are constantly
being revised, standard cost serves as a reliable basis for evaluating performance and control costs.
Nature and Purpose of Standard Costing System
The main purpose of standard cost is to provide management with information on the day-to-day control
of operations.
Standard costs are predetermined costs that provide a basis for more effectively controlling costs.
Standard cost offers a criterion against which actual costs incurred by the business can be measured and
analyzed.
The difference between actual costs and standard costs is known as variance. Variance is identified and
carefully analyzed, and it is reported to managers to inform suitable corrective actions.
Applicability of Standard Costing
Standard costing is applicable under diverse conditions. It requires the following:
 There should be an output or the production of a sufficient volume of a standard product

 The methods, operations, and processes of production should be capable of standardization
 The costs should be controllable

(Cash Budget)
Standard costing techniques have been applied successfully in all industries that produce standardized
products or follow process costing methods.
Examples of such industries include sugar, fertilizers, cement, footwear, breweries and distilleries, and
others.
Public utilities such as transport organizations, electricity supply companies, and waterworks can also
apply standard costing techniques to control costs and increase efficiency.
In jobbing industries, as well as industries that produce non-standardized products, it is not possible to
apply the technique advantageously.
Objectives of Using Standard Costing System
Within an organization, there are several objectives that a standard costing system may be established to
help achieve.
First, a standard costing system may be used to control costs, which is achieved mainly by setting
standards for each type of cost incurred: material, labor, and overhead.
This also helps to analyze variance and, hence, enables managers to be effective in controlling the costs
for which they are held responsible.
The second objective that a standard costing system may be used to achieve is to help in setting budgets.
Third, such a system may be used to provide useful and detailed information for managerial planning
and decision-making.
Fourthly, a standard costing system may be used to assess the performance and efficiency of staff and
management.
Finally, standard costing is a control technique that follows the feedback control cycle. Therefore, the
feedback system may help to eliminate unwanted costs in the future, leading to a potential reduction in
costs.
Preliminaries to Consider Before Using a Standard Costing System
When deciding whether to use standard costing in a business, several preliminaries have to be
considered. These preliminaries are:
1. Establishing cost centers

2. Classification and codification of accounts
3. Types of standards
4. Setting the standards
(Cash Budget)
Establishing Cost Centers
A cost center is a location, person, or item of equipment (or a group of these) for which costs may be
ascertained and used for the purpose of cost control.
Cost centers may be personal cost centers or impersonal cost centers. Personal cost centers are related to
a person, while impersonal cost centers are related to a location or item of equipment.
Establishing cost centers is needed to allocate responsibilities and define lines of authority.
Classification and Codification of Accounts
Classification or grouping of accounts is essential for standard costing.
Accounts should be classified in such a way that the cost elements of every cost center are clearly and
precisely reflected. Codes and symbols are assigned to different accounts to make the collection and
analysis of costs more quick and convenient.
Types of Standards
A standard is a predetermined measure relating to materials, labor, or overheads. It is a reflection of

what is expected, under specific conditions, of plant and personnel.
A standard is essentially an expression of quantity, whereas a standard cost is its monetary expression
(i.e., quantity multiplied by price). It shows what the cost should be.
In setting standards, the key question is to decide on the type of standard to be used in fixing the cost.
The main types of standards are ideal, basic, and currently attainable standards.
1. Ideal Standards
Ideal standards, also called perfection standards, are established on a maximum efficiency level with no
unplanned work stoppages.
They are tight standards which in practice may never be obtained. They represent the level of attainment
that could be reached if all the conditions were perfect all of the time.
Ideal standards are effective only when the individuals are aware and are rewarded for achieving a
certain percentage (e.g., 90%) of the standard.

(Cash Budget)
2. Basic Standards
Basic standards are long-term standards and they remain the same after being computed for the first
time. They are projections that are rarely revised or updated to reflect changes in products, prices, and
methods.
Basic standards provide the basis for comparing actual costs over time with a constant standard. They
are used primarily to measure trends in operating performance.
3. Currently Attainable Standards
A currently attainable standard is one that represents the best attainable performance. It can be achieved
with reasonable effort (i.e., if the company operates with a “high” degree of efficiency and
effectiveness).
These standards make proper allowances for normal recurring interferences such as machine breakdown,
delays, rest periods, unavoidable waste, and so on.
It is assumed that these are unavoidable interferences and are a fact of life. However, allowances are not
made for any avoidable interferences with output.
The currently attainable standard is the most popular standard, and standards of this kind are acceptable
to employees because they provide a definite goal and challenge to them.
Setting the Standards or Establishing a Standard Costing System
Establishing a standard costing system for materials, labor, and overheads is a complex task, requiring
the collaboration of a number of executives.
For this purpose, a Standards Committee is established. The Standards Committee generally consists of:
 Production Manager
 Purchase Manager
 Personnel Manager
 Production Engineer
 Sales Manager
 Cost Accountant
The Budget Committee and Standards Committee can be combined into one committee.
The Standards Committee is responsible for fixing standards. It also assists in the effective application
of standards, as well as making necessary changes as new circumstances render previous standards
obsolete.

(Cash Budget)
Before fixing standards, a detailed study of the functions involved in the manufacturing of the product is
necessary.
While fixing standard costs, the fundamental principle to be observed is that the set standards are
attainable so that these are taken as yardsticks for measuring the efficiency of actual performances.
The setting up of standard costs requires the consideration of quantities, price or rates, and qualities or
grades for each element of cost that enters a product (i.e., materials, labor, and overheads).
Cash Budget
Cash budget is nothing but an estimation of cash receipts and cash payments for specified period. It is
prepared by the head of the accounts department i.e., chief accounts officer.
The utility of the cash budget is as follows:
 To meet the revenue and capital expenditures with adequate funds

 It should highlight the additional requirement cash whenever the need arises
 Keeping of excessive funds available in the business firm wont fetch any return to the enterprise
but this estimate of future cash needs and resources will guide the firm to plan for an effective
investment out of the surplus funds estimated ; enhances the wealth of the investors through
proper investment planning out of the future funds available.
Cash budget can be prepared in three different ways:

1. Receipts and payments method
2. Adjusted profit and loss account
3. Balance Sheet Method
Cash receipts can be classified into various categories
Cash payments are as follows:

(Cash Budget)

(Cash Budget)
Cash Budget
For the period ending………..

(Cash Budget)
Q. 1 From the following information prepare a cash budget for the months of June and July
Additional Information:
1. Advance tax of Rs 4,000 payable in June and in December 1994

2. Credit period allowed to debtors is two months
3. Credit period allowed by the vendors or suppliers
4. Delay in the payment of other expenses one month
5. Opening balance of cash on 1st June is estimated as Rs.20,000/-
Q. 2 From the estimates of income and expenditure, prepare cash budget for the months from April to
June.
Additional Information:
1. Plant worth Rs. 20,000 purchase in June 25% payable immediately and the remaining in two
equal installments in the subsequent months
2. Advance payment of tax payable in Jan and April Rs 6,000
3. Period of credit allowed
o By suppliers 2 months
o To customers 1 month
4. Dividend payable Rs.10,000 in the month of June
5. Delay in payment of wages and office expenses 1 month and selling expenses ½ month.
Expected cash balance on 1st April is Rs. 40,000.

(Cash Budget)
Q. 3 The following sales figures are for the months of November 2015 to June 2016. The figures from
January 2016 onward are estimated:
(i) Half the sales are normally paid for in the month in which they occur and the customers are
rewarded with a 5% cash discount. The remaining sales are paid for net in the month following
the sale.
(ii) Goods are sold at a mark-up of 25% on the goods purchased one month before sale. Half of the
purchases are paid for in the month of purchase and a 4% prompt settlement discount is
received. The remainder is paid in full in the following month.
(iii) Wages of Rs.12000 per month are paid in the month in which they are earned. It is expected
that the wages will be increased by 10% from 1 March 2016.
(iv) Rent will cost Rs. 60,000 per annum payable three monthly in advance in January, April, July
and December each year.
(v) The directors have arranged a bank loan of Rs. 60,000 which would be credited to company’s
current account in February 2016.
(vi) The half-yearly interest on Rs. 200000, 8% debentures of Re. 1 each is due to be paid on 15
January 2016.
(vii) The ordinary dividend of Rs. 12000 for the year 2015 will be paid in March 2016.
(viii) The bank balance at 31 December 2015 is Rs.12000.

(Cash Budget)
Q. 4. From the following information, prepare cash budget for the month of January to April
Expected Sales Expected Purchase

Rs. Rs.
Jan. 60,000 Jan. 48,000
Feb. 40,000 Feb. 80,000
Mar. 45,000 Mar. 81,000
Apr. 40,000 Apr. 90,000
Wages to be paid to workers Rs. 5,000 each month. Balance at the bank on 1st Jan. Rs. 8,000.
It has been decided by the Management that:

(i) In case of deficit fund within the limit of Rs.10,000 arrangements can be made with bank.
(ii) In case of deficit fund exceeding Rs. 10,000 but within the limits of Rs. 42,000 issue of
debentures is to be preferred.
(iii) In case of deficit fund exceeding Rs. 42,000, issue of shares is preferred (considering the
fact that it is within the limit of authorized capital).
Q. 5 Prepare Cash Budget of a Company for April, May and June 2019 in a columnar form using the
following information:
Month Sales Purchase Wage Exp.
Jan. (Actual) 80,000 45,000 20,000 5,000

Feb. (Actual) 80,000 40,000 18,000 6,000
March (Actual) 75,000 42,000 22,000 6,000
April Budget 90,000 50,000 24,000 6,000
May Budget 85,000 45,000 20,000 6,000
June Budget 80,000 35,000 18,000 5,000
You are further informed that:

(a) 10% of purchase and 20% of Sale are for cash
(b) The average collection period of the Co. is 1/2 month and credit purchase is paid off regularly
after one month
(c) Wages are paid half monthly and the rent of Rs. 500 excluded in expense is paid monthly
(d) Cash and Bank Balance on April 1, was Rs. 15,000 and the company wants to keep it on end
of
every month below this figure, the excess cash being put in fixed deposits.

(Cash Budget)
Q. 6 From the following information prepare a monthly cash budget for the three months ending 31st
Dec.2019.
Month Sales Materials Wages Production Admin.

Rs. Rs. Rs. Exp. Selling Exp.
Rs. etc
Rs.
June 3,000 1,800 650 225 160
July 3,250 2,000 750 225 160
Aug. 3,500 2,400 750 250 175
Sep. 3,750 2,250 750 300 175
Oct. 4,000 2,300 800 300 200
Nov. 4,250 2,500 900 350 200
Dec. 4,500 2,600 1,000 350 225
(i) Credit terms are:

(a) Sales — 3 months to debtors. 10% of sales are on cash. On an average, 50% of credit sales
are paid on the due dates while the other 50% are paid in the month following
(b) Creditors for material — 2 months.
(ii) Lag in payment:
Wages. 1/4 month, overheads — 1/2 month.
(iii) Cash and Bank Balance on 1st Oct. expected Rs. 1,500.
(iv) Other information
(a) Plant and Machinery to be installed in Aug. at a cost of Rs. 24,000. It will be paid for by
monthly installments of Rs. 500 each from 1st Oct.
(b) Preference share dividend @ 5% on Rs. 50,000 is to be paid on 1st Dec.
(c) Calls on 250 equity shares @ Rs. 2 per share expected on 1st November.
(d) Dividends from investments amounting to Rs.250 are expected on 31st Dec.;
(e) Income tax (advance) to be paid in December Rs. 500

MBA (FT) I SEM ACCOUNTING FOR MANAGERS UNIT IX
Shares and Debentures
Both shares and debentures are used to raise capital, however, debentures are borrowed capital, whereas
shares are part of the company’s own capital.
Shares are fractions of a corporation’s capital. Investors purchase a share or a number of shares in a
company when it goes public for the first time and is listed on the stock exchanges to raise funds from the
market.
The purchase of shares entitles shareholders to ownership of the company. In other words, the percentage
of shares you possess determines how much of the company you own. Shareholders who possess 50% or
more of the company’s stock are the majority owners, while other shareholders have a right to ownership.
As a corporation shareholder, you are entitled to receive dividend payments on a regular basis. Dividend
payments are only possible if the company is profitable. Otherwise, shareholders might participate in
stock market trading to increase the value of their investment.
Shareholders are a portion of the company’s ownership. They get voting rights in the firm and a portion
of the earnings in the form of dividends, but as the company’s owners, they stand to lose if the company
is in debt or needs to go into liquidation, regardless of when their contribution is paid out.
Types of shares
A company’s shares are primarily divided into three categories:
 Equity shares.: The shares that are exchanged on the stock exchange are known as equity shares.
Ordinary shares are another name for them. These shares have voting rights and are entitled to dividends,
and they are the most commonly traded sort of stock.
 Preference shares: Preference shares are shares that allow shareholders a “first look” at the company’s
dividends before equity shareholders. The dividend amount is predetermined, but unlike equity shares,
these shares do not have voting rights. In the case of a company’s liquidation, preference shareholders
take precedence over equity shareholders. Convertible preference shares are also available, which can be
converted into equity shares at a later date.
These restrictions, however, are only applicable to preference shares issued by public businesses or
private companies with a public subsidiary. A private business can also issue preference shares with
identical voting rights through its articles of organization.
Equity Shares
Equity shares were earlier known as ordinary shares. The holders of these shares are the real owners of
the company. They have a voting right in the meetings of holders of the company. They have a control
over the working of the company. Equity shareholders are paid dividend after paying it to the preference
shareholders.
The rate of dividend on these shares depends upon the profits of the company. They may be paid a higher
rate of dividend or they may not get anything. These shareholders take more risk as compared to
preference shareholders.
CH College, Indore Campus Page1

Equity capital is paid after meeting all other claims including that of preference shareholders. They take
risk both regarding dividend and return of capital. Equity share capital cannot be redeemed during the life
time of the company.
Features of Equity Shares:

Equity shares have the following features:
(i) Equity share capital remains permanently with the company. It is returned only when the company is
wound up.
(ii) Equity shareholders have voting rights and elect the management of the company.
(iii) The rate of dividend on equity capital depends upon the availability of surplus funds. There is no
fixed rate of dividend on equity capital.
Advantages of Equity Shares:

1. Equity shares do not create any obligation to pay a fixed rate of dividend.
2. Equity shares can be issued without creating any charge over the assets of the company.
3. It is a permanent source of capital and the company has to repay it except under liquidation.
4. Equity shareholders are the real owners of the company who have the voting rights.
5. In case of profits, equity shareholders are the real gainers by way of increased dividends and
appreciation in the value of shares.
Disadvantages of Equity Shares:

1. If only equity shares are issued, the company cannot take the advantage of trading on equity.
2. As equity capital cannot be redeemed, there is a danger of over capitalisation.
3. Equity shareholders can put obstacles for management by manipulation and organising themselves.
4. During prosperous periods higher dividends have to be paid leading to increase in the value of shares in
the market and it leads to speculation.
5. Investors who desire to invest in safe securities with a fixed income have no attraction for such shares.
Deferred Shares:
These shares were earlier issued to Promoters or Founders for services rendered to the company. These
shares were known as Founders Shares because they were normally issued to founders. These shares rank
last so far as payment of dividend and return of capital is concerned. Preference shares and equity shares
have priority as to payment of dividend.
These shares were generally of a small denomination and the management of the company remained in
their hands by virtue of their voting rights. These shareholders tried to manage the company with
efficiency and economy because they got dividend only at last. Now, of course, they cannot be issued and
they are only of historical importance. According to Companies Act 1956, no public limited company or
which is a subsidiary of a public company can issue deferred shares.

Preference Share Meaning
Preference shares, also known as preferred stock, is an exclusive share option which enables shareholders
to receive dividends announced by the company before the equity shareholders.
Preference shares provide the shareholders with the special right to claim dividends during the company
lifetime, and also with the option to claim repayment of capital, in case of the wind up of the company.
It is considered as a hybrid security option as it represents the characteristics of both debt and equity
investments.
The capital raised by issuing preference shares is known as preference share capital and preference
shareholders can be regarded as owners of the company. They however do not enjoy any kind of voting
rights, unlike equity shareholders.
Features of Preference Shares

The following are the features of preference shares:
1. Preferential dividend option for shareholders.

2. Preference shareholders do not have the right to vote.
3. Shareholders have a right to claim the assets in case of a wind up of the company.
4. Fixed dividend payout for shareholders, irrespective of profit earned.
5. Acts as a source of hybrid financing.
Types of Preference Shares

The various types of preference share are discussed below:
1. Cumulative preference share: Cumulative preference shares are a special type of shares that
entitles the shareholders to enjoy cumulative dividend payout at times when a company is not
making profits. These dividends will be counted as arrears in years when the company is not
earning profit and will be paid on a cumulative basis, the next year when the business generates
profits.
2. Non-cumulative preference shares: These types of shares do not accumulate dividends in the
form of arrears. In the case of non-cumulative preference shares, the dividend payout takes place
from the profits made by the company in the current year. If there is a year in which the company
doesn’t make any profit, then the shareholders are not paid any dividends for that year and they
cannot claim for dividends in any future profit year.
3. Participating preference shares: These types of shares allow the shareholders to demand a part
in the surplus profit of the company at the event of liquidation of the company after the dividends
have been paid to the other shareholders. In other words, these shareholders enjoy fixed dividends
and also share a part of the surplus profit of the company along with equity shareholders.
4. Non-participating preference shares: These shares do not yield the shareholders the additional
option of earning dividends from the surplus profits earned by the company. In this case, the
shareholders receive only the fixed dividend.

5. Redeemable Preference Shares: Redeemable preference shares are shares that can be
repurchased or redeemed by the issuing company at a fixed rate and date. These types of shares
help the company by providing a cushion during times of inflation.
6. Non-redeemable Preference Shares: Non-redeemable preference shares are those shares that
cannot be redeemed during the entire lifetime of the company. In other words, these shares can
only be redeemed at the time of winding up of the company.
7. Convertible Preference Shares: Convertible preference shares are a type of shares that enables
the shareholders to convert their preference shares into equity shares at a fixed rate, after the
expiry of a specified period as mentioned in the memorandum.
8. Non-convertible Preference Shares: These type of preference shares cannot be converted into
equity shares. These shares will only get fixed dividend payout and also enjoy preferential
dividend payout during the dissolution of a company.
Advantages of Preference Shares:
1. Appeal to Cautious Investors:

Preference shares can be easily sold to investors who prefer reasonable safety of their capital and want a
regular and fixed return on it.
2. No Obligation for Dividends:

A company is not bound to pay dividend on preference shares if its profits in a particular year are
insufficient. It can postpone the dividend in case of cumulative preference shares also. No fixed burden is
created on its finances.
3. No Interference:
Generally, preference shares do not carry voting rights. Therefore, a company can raise capital without
dilution of control. Equity shareholders retain exclusive control over the company.
4. Trading on Equity:
The rate of dividend on preference shares is fixed. Therefore, with the rise in its earnings, the company
can provide the benefits of trading on equity to the equity shareholders.
5. No Charge on Assets:
Preference shares do not create any mortgage or charge on the assets of the company. The company can
keep its fixed assets free for raising loans in future.
6. Flexibility:
A company can issue redeemable preference shares for a fixed period. The capital can be repaid when it is
no longer required in business. There is no danger of over-capitalisation and the capital structure remains
elastic.

7. Variety:
Different types of preference shares can be issued depending on the needs of investors. Participating
preference shares or convertible preference shares may be issued to attract bold and enterprising
investors.
Preference shares can be made more popular by giving special rights and privileges such as voting rights,
right of conversion into equity shares, right of shares in profits and redemption at a premium.
Disadvantages of Preference shares :

1. Fixed Obligation:
Dividend on preference shares has to be paid at a fixed rate and before any dividend is paid on equity
shares. The burden is greater in case of cumulative preference shares on which accumulated arrears of
dividend have to be paid.
2. Limited Appeal:
Bold investors do not like preference shares. Cautious and conservative investors prefer debentures and
government securities. In order to attract sufficient investors, a company may have to offer a higher rate
of dividend on preference shares.
3. Low Return:
When the earnings of the company are high, fixed dividend on preference shares becomes unattractive.
Preference shareholders generally do not have the right to participate in the prosperity of the company.
4. No Voting Rights:
Preference shares generally do not carry voting rights. As a result, preference shareholders are helpless
and have no say in the management and control of the company.
5. Fear of Redemption:
The holders of redeemable preference shares might have contributed finance when the company was
badly in need of funds. But the company may refund their money whenever the money market is
favourable. Despite the fact that they stood by the company in its hour of need, they are shown the door
unceremoniously.
Debentures
Debentures are long-term debt instruments issued under a company’s seal. One distinction between shares
and debentures is that debentures become the company’s borrowed capital. It’s similar to a debt that a
firm takes out from debenture holders and promises to repay with interest when the time comes.
You get paid in the form of interest at regular intervals if you invest in the company’s long-term debt
instruments and are effectively lending money to the company. Interest payments are made in addition to
the company’s profit, thus they will not be held back if the company is losing money.
Debenture holders are the company’s creditors. Debenture holders’ money is effectively borrowed capital
for the company, which it must repay with interest on a regular basis. Debenture holders are thus creditors
of the corporation and have a higher standing than shareholders.

This means that if the firm gets into huge difficulties and has to file for bankruptcy, the company’s
creditors, such as banks and debenture holders, will be paid first. Shareholders are placed last on the
priority list. Debenture holders, unlike shareholders, do not have voting rights. This is a crucial property
for distinguishing between shares and debentures
Types of Debentures
The following are the several types of debentures available in India:
 Registered and bearer debentures: A registered debenture is one that has been registered with the firm
and can be transferred via a transfer document. Bearer debentures, on the other hand, do not have a record
in the company books and can be transferred simply by delivery.
 Secured debentures and unsecured debentures: Secured Debentures put a charge on the company’s
assets, whereas unsecured debentures do not. As a result, holders of secured debentures can reclaim their
principle and any unpaid interest from the company’s mortgaged assets. There is no such fee or right on
unsecured debentures.
 Redeemable and non-redeemable debentures: The principal amount of redeemable debentures is paid
back over a certain period of time, whereas non-redeemable debentures are only repaid when the firm is
liquidated.
 First and second debentures: First debentures are repaid before second debentures, whereas second
debentures are repaid after first debentures.
 Convertible and non-convertible debentures: Convertible debentures can be exchanged into shares
under predetermined terms and conditions. Debentures that are not convertible into shares are known as
non-convertible debentures.
Difference between Share and Debentures
Particulars Shares Debentures
Meaning A small fraction of a company’s Long-term debt instruments issued
capital under the company’s seal
Nature of capital for the Capital that is owned Borrowed funds
company
Returns Only earnings generate returns in the Interest is paid, and the enterprise
form of dividends. does not have to be profitable.
Fixed or adjustable interest rates
are available.
Investors Shareholders are a portion of the Debenture holders are the
company’s ownership. company’s creditors.
In the event of a Priority is given to stockholders last. Debenture holders are paid first,
liquidation followed by creditors.
The right to vote Yes No

Convertibility Debentures cannot be converted
Shares can be converted from from shares
debentures.

Capital
means amount invested in the business for the purpose of earning revenue. In case of company money is
contributed by public and people who contributed money are called shareholders.
Share Capital: Capital raised by issue of shares is called share capital.
Authorised Capital: Also called as Nominal or registered capital. It is the maximum amount of capital a
company can issue. It is stated in Memorandum of Association.
Issued Capital: This is part of authorized capital which is offered to public for subscription. It cannot
exceed authorized capital.
Called Up Capital: It is the amount of nominal value of shares that has been called up by the company
for payment by the subscriber towards the share.
Paid Up Capital: It is part of called up capital that the members of company or shareholders have paid.
Reserve Capital: It is part of increased capital and/or portion of uncalled share capital of an unlimited
company which can be called only in case of winding up of the company.
Capital Reserve: It is capital profit not available for distribution as dividend. It is represented in balance
sheet of company as Reserves and Surplus under the heading Shareholder’s Funds.
Issues of Shares at Premium: It is issue of share at more than face value.
This premium can be utilized for: (Section 52)
1. Issue of fully paid bonus shares to the shareholders.

2. Write off preliminary expenses of the company.
3. Writing off securities issue expenses commission paid discount on issue of securities.
4. For providing the premium payable on redemption of Redeemable preference shares or debentures
of the company.
5. For Buy back of its own shares as per Section 68.
Journal Entries for accounting of securities premium, the securities premium may be collected by the
company with application money / Allotment money / First call/Final Call depend upon the terms of issue
of shares. If questions are silent regarding the securities premium amount due, it is assumed that securities
premium money is due with the allotment money. Following are the various situation of securities
premium received with application, allotment and call.
or Application money Bank Account Dr. (No. of Application X application amount

To Share Application A/c per share)
On acceptance of Share Application A/c Dr. (No. of share allotted X application

Applications To Share Capital A/c amount called on cash) (Amount of
Securities Premium Received if any)

To Securities Premium A/c
2. For allotment money Share Allotment A/c Dr. (No. of Shares Allotted X amount called
due To Share Allotment A/c on allotment for each share (Securities
Premium due)
On receipt of allotment Bank Account Dr. (No. of allotment share x amount

money To Share Allotment A/c received on allotment for each share) or
actual amount received)
3. For all money due Share Call A/c Dr. (No. of shares allotted x amount called on
To Share Capital A/c each call share (Securities Premium due)
On receipt of cells Bank A/c Dr. (No. of application allotted x amount

money To Share Call A/c received on each share)
Issue of shares at discount [Section 53] : A company cannot issue shares at discount other than sweat
equity shares.
Shares Issue for Consideration Other than Cash
When a company purchases any fixed asset or business and makes the payment to the vendor in form of
issue of shares in place of cash it is called the issue of shares for consideration other than cash.
Share can be issued at par, at premium.
Journal entries for issue of shares to vendors/consideration other than cash
date Particulars L.F Debit (Rs.) Credit(Rs.)
Amount of
On Purchases of asset:
purchase price
Sundry Asset Account Dr.
To vendor
On Purchases of business:
When purchases consideration is more then net

asset
Sundry Asset Account Dr. Agreed
Goodwill Account (B/F) Value
To Sundry Liabilities Consideration Agreed Value
To Vendor -Net assets Purchase

Consideration
When purchase consideration is less than net

asset
Sundry Assets Account Agreed Value Agreed
To Sundry Liabilities Value
To Vendor Purchases
To capital Reserve A/c (B/F) Consideration
Difference
On Issue of Shares (a) at Par
Vendor Dr.
To share Capital
(b) On Issue of Share At Premium
Vendor Dr.
To Share Capital A/c
To Securities Premium Reserve A/c
Private Placement of Shares [Section 42]: This is an issue of shares to institutional investors or some
selected group of persons subject to prior approval of existing shareholders.
There is no need of issuing formal prospectus and it is cost and time saving method of raising capital.
Under subscription: When the number of Share application received is less than the number of shares
offered to public it is under subscription.
Over subscription: When the number of Share application received is more than the number of shares
offered to public it is over subscription
1. Either reject the excess applications
2. Make pro-rata allotment
3. Partially refund amount and on other applications pro-rata allotment is made.
Calls in arrear : Any Amount which has been called or demanded by company from shareholders but
not paid by the shareholder till the last date mentioned in call letter is called as call in arrear, Company
can charge interest on this at rate mentioned in Article of Association or 10% p.a. as per Table F.
Calls in advance : Any amount paid in excess of what they has asked to pay is called as call in advance.
Interest is paid on this at rate mentioned in Article of Association or 12% p.a. as per Table F.

Accounting For Manager Complete Notes

Uploaded by

Copyright:

Available Formats

Accounting For Manager Complete Notes

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Accounting For Manager Complete Notes

Uploaded by

Copyright:

Available Formats

MBA I SEM ACCOUNTING FOR MANAGERS UNIT I

Basic Accounting Terms

Accounting methods: Companies choose between two methods—cash accounting or accrual

CH Institute of Management & Commerce Page 1

Double-entry bookkeeping: Under double-entry bookkeeping, every transaction is recorded in at

Types of accounting: Financial accounting reports information about a company‟s performance to

Assets = Liabilities + Stakeholders’ equity

CH Institute of Management & Commerce Page 2

Accounting principles are accepted as such if they are

CH Institute of Management & Commerce Page 3

CH Institute of Management & Commerce Page 4

Meaning of Accounting Standards: In order to ensure transparency consistency, comparability,

Objective of Accounting Standards:

CH Institute of Management & Commerce Page 5

“FOR THE EFFECTIVE STUDY OF ACCOUNTING STANDARDS AND IFRS THERE IS A

Convergence of Indian accounting standards with International financial reporting standards

The reason behind convergence is:

CH Institute of Management & Commerce Page 6

Convergence in Indian Scenario:

Entities covered under convergence;

Public interest entities:

Role of ICAI in convergence:

CH Institute of Management & Commerce Page 7

a. Management Commentary (proposed new IFRS)

Role of Industry Associations:

CH Institute of Management & Commerce Page 8

Challenges (Limitations) envisaged in convergence:

Change to regulatory environment:

Impact on financial performance:

Communication of Impact of IFRS to investors:

CH Institute of Management & Commerce Page 9

Implementation Phase in India:

Accounting Standards after convergence:

Utility and advantages of Accounting Standards

CH Institute of Management & Commerce Page 10

Functions of Accounting Standards Board

Formulation of Accounting Standards

CH Institute of Management & Commerce Page 11

Scope of Accounting Standards

Accounting Standards Issued By ICAI

(12) AS-12 Accounting for Government Grants 1-4-1995

CH Institute of Management & Commerce Page 12

(14) AS-14 Accounting for Amalgamation 1-4-1995

(16) AS-16 Borrowing Costs 1-4-2001

Differences between the India Accounting Standards and the US GAAP

S.N. Base Indian Accounting Standard US GAAP

CH Institute of Management & Commerce Page 13

treasury operations. equity.

CH Institute of Management & Commerce Page 14

Concept of 'Double Entry'

Basic Knowledge of Accounting Process

Definition and Explanation:

Journal has the following features:

CH Institute of Management & Commerce Page 1

5. Narration is written below each entry.

The following arte the advantages of journal:

1. Each transaction is recorded as soon as it takes place. So there is no possibility of any

Column (1) is meant for writing the date of the transaction.