Accounts Notes: COSTING

Showing posts with label COSTING. Show all posts

Tuesday, 12 April 2011

Cash flow statement

Cash From Operation : -
= Net profit + Decrease in Current Asset
+ Increase in Current Liability
- Increase in Current Asset
- Decrease in Current Liability

Tuesday, 5 April 2011

What is Costing

Cost accounting is the recording classifying the expenditure for the determination of the costs of products.For thepurpuses of control of the costs

Sunday, 20 March 2011

Process of Capital Budgeting:

• Huge cash outlay.
• Decision taken is irressable.
• Invest in lumsum the receipt is piecemeal
• Wrong decision will affect the very base of the company.

Capital Budgeting Rules:

• Ignore accounting profit and take only cash flows.
• Try only incremental basis ignore Average calculation.
• Consider all incidental effects.
• Ignore sunk cost (ie. Cost remain unaltered for various alternatives available is sunk cost)
• Consider opportunity cost (Opportunity Loss is Opportunity cost)
• Beware of allocated cost – Ignore them
• Depreciation is an important cash flow when taxation is considered. If no taxation, no depreciation.
• Interest should not be considered as part of the cost, in the arrival of cash inflow for investing decision problems. If deducted add back post tax interest.
• Separate investing decision and financing decision.
• Be consistent with inflation rates. All future cash flows is assumed as without inflation. Such cash flows are referred as real cash flows.
• Cash flows under the influence of inflation would be referred to as money cash flows. (Money cash flows (or) Nominal Cash Flows (or) Market cash flows)
• Unless otherwise stated cost of capital is considered after tax basis because cash flows will be considered only on after tax basis. (PV factor is the inverse of compounding factor)
• Equation to find out the PV of an amount if cost of capital and Inflation rate is given

Management Accounting and Financial Analysis

1. Direct Quote (eg) 1$ = Rs.49

2. Indirect Quote (eg) Rs.1 = .0204$

3. TT Rate = Telegraphic Transfer Rate

4. TOM Rate = Tomorrow Rate

5. Spot Rate = Today’s rate. Normally it will be 3td day rate from TT Rate.

Direct Quote is used in all country except UK where indirect quote is used.

Offer Rate = Selling Rate

Spread Rate = Offer Rate – Bid Rate

Spread Rate (%) = Offer Rate – Bid Rate * 100 (111lr to that of NP Ratio)
Offer Rate

Swap points is ascending stage it is at premium. If it is descending stage it is at discount.

If it is said as INR/$ then the meaning is
• Numerator factor = Local Currency = INR
• Denominator factor = Foreign Currency = $

Forward Quotation (%) (I.e. Premium/Discount expressed at annualized %)
= Forward Rate – Spot Rate * 12 * 100 (in months)
Spot Rate n

= Forward Rate – Spot Rate * 365 * 100 (in days)
Spot Rate n

If the quote is direct or Indirect is to be found and the relation is with £ (pound) both direct and Indirect quote is to be said.

Maturity Value = P (1+r) n

Interest Rate Parity:
i) Domestic Rate < Foreign Rate + Forward Premium / Discount (In this case invest in foreign currency) ii) Domestic Rate > Foreign Rate + Forward Premium / Discount
(In this case invest in Domestic Currency)

Forward Rate: It is rate negotiated for the delivery to be made / taken on a future date for present transaction.

Future spot rate: It is actual rate prevailing on the agreed future date.

Other points:-
• Currency country which has less Interest rate will have forward rate at premium and vice versa
• If two rates ie.20.23 / 35 is given then highest rate is offer rate, lowest rate is bid rate.
• If INR / DG is given and we have to DG / INR then it is 1 / (INR / DG)
• 1 / (Bid Rate) = Offer Rate.
• 1 / (Offer Rate) = Bid Rate.

Interest rate swap: - Generally interest rate differs from company to company because of their grade (reputation) and rates can be fixed rates or floting rate. If there is 2 company under different grade and different fixed / floating rate can gin advantage by reducing their interest rate by “Interest rate swap”.

In this if ‘Company A’ wants to borrow at floating rate and ‘Company B’ wants to borrow and fixed rate, then interest rate swap is applied by which company A borrows at floating Rate of company B and company B borrows at fixed rate of company A. By this swap one company gains and other company losses. Net gain is splited between two companies so that the two companies benefits by paying lower interest rate for their barrowing.

To look at the problem quickly the theory followed in “Difference in fixed rate interest of two companies is profit” and “Difference in floating rate interest of two companies is loss”. Then net gain / loss are found.

Network Analysis

• Total float = LS – ES (or) LF – EF

• Free float = Total float – Head event slack

• Independent float = Free float – Tail event slack

• In the diagram Es = Lf in the critical path

• Critical path is the longest duration

• To find the minimum time associated cost (i.e. Additional cost incurred per unit of time saved) following formula is used :-
Crash cost per day (or) Activity cost supply
= Crash cost – Normal cost
Normal time – Crash time

• Interfacing float = It is the part of the total float which causes reduction in the float of the succession activities. In other words it is the portion of activity float which cannot be continued without affecting adversely the float of the subsequent activity or activities.

• Steps in proceeding the problem : -

2. First find and fill the ES and LF column from the diagram.

3. Then find LS and EF as follows :-
Ls = Lf – Duration
Ef = Es + Duration

4. Find total float

5. Find free float. Wherever total float column has zero free float column is also taken has zero and remaining elements is filled as said above

6. Find Independent float. Wherever free float column has zero Independent float column is also taken has zero and remaining elements is filled as said above

Notes: -
1. ES = Earliest Start. Indicates earliest time that the given activity can be scheduled
2. EF = Earliest Finish. Time by which the activity can be completed at the earliest.

3. LF = Latest Finish. Latest allowable occurrence time of the head event of the activity.

4. LS = Latest Start.

5. Total duration of the critical path is the maximum time/amount consumed for the activity. This should be crashed with respect to crashing days and crashing cost. This crashing should not change the critical path.

PERT : -

• Expected (or) Average time is found by assigning weights as follows : -
1 for optimistic
4 for Most likely
1 for pessimistic
Average time = 1 optimistic + 4 most likely + 1 pessimistic
6
• Standard Deviation = (Pessimistic time – Optimistic time)
6
• Variance = (Standard Deviation)2

• Probability of completing the project in N days
= Required time(N) (-) Expected time (critical path duration)
Standard Deviation
[Nothing but Z = (X - Mean) / Standard deviation]
= Y (say)
= Find Z(y)
= Probability %
- If required time > Expected time then = 0.5 + Z(Y)
- If required time < Expected time then = 0.5 – Z(Y)

Learning Curve

Learning is the process of acquiring skill, Knowledge, and ability by an individual. According to learning curve theory the productivity of the worker increases with increase in experience due to learning effect. The learning theory suggests that the best way to master a task is to “learn by doing”. In other words, as people gain experience with a particular job or project they can produce each unit more efficiently than the preceding one.

The speeding up of a job with repeated performance is known as the learning effect or learning curve effect.

The cumulative average time per unit produced is assumed to fall by a constant percentage every time the total output is doubled. So generally learning effect is found in the multiples of 2. If learning curve effect is asked between two even numbers then Learning curve equation is formed ie. Learning curve effect is expressed mathematically as follows:

Learning curve equation =
Y = a(x) -b Where Y = Average time per unit
a = Total time for first unit
x = Cumulative number of units manufactured
b = the learning curve index

Learning curve index (b) = log (1- % decrease)
Log 2

Ratio Analysis

A) Cash Position Ratio : -

1) Absolute Cash Ratio = Cash Reservoir
Current Liabilities

2) Cash Position to Total asset Ratio = Cash Reservoir * 100
(Measure liquid layer of assets) Total Assets

3) Interval measure = Cash Reservoir
(ability of cash reservoir to meet cash expenses) Average daily cash expenses
( Answer in days)

Notes : -
• Cash Reservoir = Cash in hand + Bank + Marketable Non trade investment at market value.
• Current liabilities = Creditors + Bills Payable + Outstanding Expenses + Provision for tax (Net of advance tax) + Proposed dividend + Other provisions.
• Total assets = Total in asset side – Miscellaneous expenses – Preliminary expenses + Any increase in value of marketable non trading Investments.
• Average cash expenses =Total expenses in debit side of P & L a/c – Non cash item such as depreciation, goodwill, preliminary expenses written off, loss on sale of investments, fixed assets written off + advance tax (Ignore provision for tax) . The net amount is divided by 365 to arrive average expenses.

Remarks : - In Comparison
• When absolute cash ratio is lower then current liability is higher
• When cash position to Total Asset ratio is lower then the total asset is relatively higher.
• When cash interval is lower the company maintain low cash position. It is not good to maintain too low cash position or too high cash position.

B) Liquidity Ratio : -

1) Current ratio = Current asset
Current Liability

2) Quick ratio or Acid Test ratio = Quick Asset
Quick liability

Notes : -
• Quick Asset = Current Asset – Stock
• Quick Liability = Current liability – Cash credit, Bank borrowings, OD and other Short term Borrowings.
• Secured loan is a current liability and also come under cash credit
• Sundry debtors considered doubtful should not be taken as quick asset.
• Creditors for capital WIP is to be excluded from current liability.
• Current asset can include only marketable securities.
• Loans to employees in asset side are long term in nature and are not part of current assets.
• Provision for gratuity is not a current liability.
• Gratuity fund investment is not a part of marketable securities.
• Trade investments are not part of marketable securities.

Remarks : -
• Higher the current ratios better the liquidity position.

C) Capital structure ratios : -

1) Debt equity ratio = Debt = External Equity
(or) Leverage ratio Equity Internal Equity
= Long term debt = Share holders fund
Long term fund Long term fund

2) Proprietary ratio = Proprietary fund
Total Assets

3) Total Liability to Net worth ratio = Total Liabilities
Net worth

4) Capital gearing ratio = Preference share capital + Debt
Equity – Preference share capital

Notes : -
• Share holders fund (or) Equity (or) Proprietary fund (or) Owners fund (or) Net worth = Equity share + Preference share + Reserves and surplus – P & L a/c – Preliminary Expenses.
• Debt (or) Long term liability (or) Long term loan fund = Secured loan (excluding cash credit) + unsecured loan + Debentures.
• Total asset = Total assets as per Balance sheet – Preliminary expenses.
• Total liability = Long term liability + Current liability (or) short term liability
• Long term fund = Total asset – Current liability = Share holders fund + long term loan fund.

Remarks : -
• In debt equity ratio higher the debt fund used in capital structure, greater is the risk.
• In debt equity ratio, operates favorable when if rate of interest is lower than the return on capital employed.
• In total liability to Net worth Ratio = Lower the ratio, better is solvency position of business, Higher the ratio lower is its solvency position.
• If debt equity ratio is comparatively higher then the financial strength is better.

D) Profitability Ratio : -

1) Gross Profit Ratio = Gross Profit * 100
Sales

2) Net Profit Ratio = Net Profit * 100
Sales

3) Operating Profit ratio = Operating profit * 100
Sales

4) Return to shareholders = Net profit after interest and tax
Share holders fund

5) Return on Net Worth = Return on Net worth * 100
Net worth

6) Return on capital employed (or) Return on investment = Return (EBIT)
Capital Employed

7) Expenses Ratios :-

a) Direct expenses Ratios : -
i) Raw material consumed * 100
Sales
ii) Wages * 100
Sales
iii) Production Expenses * 100
Sales

b) Indirect expenses Ratios : -
i) Administrative Expenses * 100
Sales
ii) Selling Expenses * 100
Sales
iii) Distribution Expenses * 100
Sales
iv) Finance Charge * 100
Sales

Notes : -
• In the above the term “term” is used for business engaged in sale of goods, for other enterprises the word “revenue” can be used.
• Gross profit = Sales – Cost of goods sold
• Operating profit = Sales – Cost of sales
= Profit after operating expenses but before Interest and tax.
• Operating Expenses = Administration Expenses + Selling and distribution expenses, Interest on short term loans etc.
• Return = Earning before Interest and Tax
= Operating profit
= Net profit + Non operating expenses – Non operating Income
• Capital employed = Share holders fund + Long term borrowings
= Fixed assets + Working capital
• If opening and closing balance is given then average capital employed can be substituted in case of capital employed which is
Opening capital employed + Closing capital employed
2

E) Debt service coverage ratios = Profit available for debt servicing
Loan Installments + Interest

Notes : -
• Profit available for debt servicing = Net profit after tax provision + Depreciation + Other non cash charges + Interest on debt.

Remarks : -
• Higher the debt servicing ratio is an indicator of better credit rating of the company.
• It is an indicator of the ability of a business enterprise to pay off current installments and interest out of profits.

F) Turnover Ratios: -

i) Assets turnover = Sales
Total assets

2) Fixed assets turnover = Sales [Number of times fixed assets has
Fixed assets turned into sales]

3) Working capital turnover = Sales
Working capital

4) Inventory turnover = Cost of goods sold
(for finished goods) Average inventory

5) Debtors turnover (or) Average collection period = Credit sales (in ratio)
Average accounts receivable
(or) = Average accounts receivable * 365 (in days)
Credit sales

6) Creditors turnover (or) Average payment period Credit purchases (in ratio)
Average accounts payable
(or) = Average accounts Payable * 365 (in days)
Credit Purchases

7) Inventory Turnover (for WIP) = Cost of production
Average Inventory (for WIP)

8) Inventory Turnover (for Raw material) = Raw material consumed
Average inventory (for raw material)

10) Inventory Holding Period = 365 .
Inventory turnover ratio

11) Capital Turnover ratio = Cost of sales
Capital employed

Note : -
• Working capital = Current asset – Current liability
= 0.25 * Proprietary ratio
• Accounts Receivable = Debtors + Bills receivable
• Accounts payable = Creditors + Bills Payable

Remarks : -
• If assets turnover ratio is more than 1, then profitability based on capital employed is profitability based on sales.
• Higher inventory turnover is an indicator of efficient inventory movement. It is an indicator of inventory management policies.
• Low inventory holding period lower working capital locking, but too low is not safe.
• Higher the debtors turnover, lower the credit period offered to customers. It is an indicator of credit management policies.
• Higher the creditors turnover, lower the credit period offered by suppliers.

G) Other Ratios: -

1) Operating profit ratio = Net profit ratio + Non operating loss / Sales ratio

2) Gross profit ratio = Operating profit ratio + Indirect expenses ratio

3) Cost of goods sold / Sales ratio = 100% - Gross profit ratio

4) Earnings per share = Net profit after interest and tax
Number of equity shares

5) Price earning ratio = Market price per equity share
Earning per share

6) Pay out ratio = Dividend per equity share * 100
Earning per equity shares

7) Dividend yield ratio = Dividend per share * 100
Market price per share

8) Fixed charges coverage ratio = Net profit before interest and tax
Interest charges

9) Interest coverage ratio = Earning before interest and tax
Interest charges

10) Fixed dividend coverage ratio = Net profit .
Annual Preference dividend

11) Over all profitability ratio = Operating profit * 100
Capital employed

12) Productivity of assets employed = Net profit .
Total tangible asset

13) Retained earning ratio = Retained earnings * 100
Total earnings

H) General Remarks: -
• Fall in quick ratio when compared with last year or other company is due to huge stock pilling up.
• If current ratio and liquidity ratio increases then the liquidity position of the company has been increased.
• If debt equity ratio increases over a period of time or is greater when comparing two ratios, then the dependence of the company in borrowed funds has increased.
• Direct expenses ratio increases in comparison then the profitability decreases.
• If there is wages / Sales ratio increases, then this is to verified
a) Wage rate
b) Output / Labour rate
• Increment in wage rate may be due to increased rate or fall in labour efficiency.
• Again there are many reasons for fall in labour productivity namely abnormal idle time due to machine failure, power cut etc.
• Reduction in Raw material consumed / sales ratio may be due to reduction in wastage or fall in material price.
• Increase in production expenses ratio may also be due to price raise.
• Stock turnover ratio denotes how many days we are holding stock.
• In stock turnover ratio greater the number of days, the movement of goods will be on the lower side.
• Financial ratios are Current ratio, Quick ratio, Debt equity ratio, Proprietary ratio, Fixed asset ratio.
• Short term solvency ratios are current ratio, Liquidity ratio
• Long term solvency or testing solvency of the company ratios are Debt equity ratio, fixed asset ratio, fixed charges coverage ratio (or) Interest coverage ratio.
• To compute financial position of the business ratios to be calculated are – current ratio, Debt equity ratio, Proprietary ratio, fixed asset ratio.
• Fictitious asset are Preliminary expenses, Discount on issue of shares and debentures, Profit and loss account debit balance.

Assignment

1) Basis of Technique used is minimization Technique

2) It can also be done in maximation Technique

3) Various steps in Assignment Problem are

Step 1: Check whether the problem is balanced or unbalanced by checking
whether row is equal to column, if unbalanced add dummy column or
row to balance the problem

Step 2: Identify Least Number in each row and subtract with all number in that
Row.

Step 3: Identify least number of each column and subtract with all number in that
column.

Step 4: Check whether solution is reached with zero selection in one row and
column, ie. Cover all the zero with minimum number of lines, solution is
reached only when selected zeros is equal to number of rows or columns
or number of lines is equal to order of matrix.

Step 5: If solution is not reached so maximum sticking

Step 6: Select the least element in within the unstriked Element

Step 7: The element selected above is
i) Subtracted with all the unstriked element
ii) Added to all the double striked element (Intersection of two lines)

Step 8: Check the solution

Step 9: If solution is not reached continue with the process from step 5.

Linear Programming

Simplex Method:-
Steps:-

1. Determine the objective function Z. Objective may be maximization or minimization.

2. For maximation problem the constraints would be < sign. For minimization problem the constraints would be > sign.

3. Introduce slack variable
For < sign – add the slack variable ie. Add S1 For > sign – subtract the slack variable and add artificial variable
ie. Subtract S1, add A1.

4. Change the Objective function
For S1 – Add ‘0S1’
For A1 – Add ‘MA1’

5. Simplex table format:-
Cj
Quantity Variable Const. X Y Z S1 S2 RR
S1
S2
Zj
Cj - Zj

6. Zj is arrived by summation of constant column with X,Y,Z columns

7. Criteria for selecting the key column :-
For Maxima ion Problem – Highest value of Cj – Zj
For Minimization Problem – Lowest Value of Cj – Zj

8. Divide the Quantity Column with Key column to arrive at RR

9. Criteria for Selecting the Key row :-
For Maximation & Minimization Problem – Lowest Positive RR is selected

10. The Meeting Point is key Element

11. Criteria for deciding the optimal solution
For Maximation Problem – All elements in Cj – Zj row is negative or zero.
For Minimization Problem – All elements in Cj – Zj row is positive or zero

Note – For finding whether all the elements in Cj – Zj row is positive or zero
for minimization problem substitute all the ‘M’ with highest value.

12. If solution is not reached next table is formed.

13. Input for next table is
First key row in the next table is filled by dividing all the numbers in the key row of the previous table with the key element.
Remaining all the rows is arrived as follows: -
Corresponding previous _ (Value relating to that * Corresponding
Table row element row in the key column element in key row
in the 2nd table as
filled in previous step)

14. Check the optimal solution, if not reached form the third table.

15. If solution is reached then answer is amount in quantity column corresponding to the variable.

Other Points : -

• We can convert the Minimization Problem into Maximation Problem. This is known as duality.

• We can change the > sign to < sign to match the problem E.g. X + Y < 100 is converted into -X - Y > -100

Transportation

• The procedure followed is Minimization Procedure

• Problem is generally solved in Vogel’s Approximation Method(VAM)

• Steps for the problem is : -
1. Convert profit matrix into loss matrix.

2. Balance the problem.

3. Arrive at Row penalty and column penalty
Row penalty and column penalty is calculated at (2nd least – 1st least) in the corresponding row or column.

4. Select from the entire Row penalty and column penalty maximum number.

5. From the entire Row or Column minimum is selected.

6. Strike the row or column which gets eliminated.

7. Continue until the entire item in the table is strike.

8. Write separately Initial solution table.

9. Check for Degeneracy. Degeneracy occurs when all the elements in the initial solution is equal to (Row + column – 1)

10. If degeneracy occurs introduce efcilon – ‘e’. ‘e’ is introduced in least independent cell.

11. Form UV Matrix. It is formed by the element in the original solution corresponding to the element in the Initial solution.

12. Find unalloted elements in the UV Matrix

13. Find Ij i.e.(Original Matrix element – Unalloted element found above)

14. Check for optimal solution ie. All items must be zero or positive.

15. If not reached select the maximum negative in Ij matrix.

16. Form a loop and reallocate the solution.
17. Repeat from step 9.

Notes: -

1. If there is zero in Ij matrix while arriving at optimal solution then there is another solution for the problem.

2. Dummy column can be introduced in profit or loss matrix.

3. If there is penalty/redundancy payment for unsatisfying demand etc. is given then fills the dummy row or column with that amount or fill it with zeros.
4. If there is constraint in the problem first satisfy the constraint and then solve.

5. various other methods for solving the problem is
• Least cost method
• North west corner rule

6. Generally VAM method is used

Ratio Analysis

What is the Cash flow and fund flow statement

Rules for preparing schedule of changes in working capital :-

Increase in a current asset, results in increase in working capital – so Add
Decrease in current asset, results in decrease in working capital – so Decrease
Increase in current liability, results in decrease in working capital – so Decrease
Decrease in current liability results in increase in working capital – so Add

Funds from operations – Format

Particulars Rs. Rs.
Net profit

Add : Depreciation
Goodwill written off
Preliminary Exp. Written off
Discount on share written off
Transfer to General Reserve
Provision for Taxation
Provision for Dividend
Loss on sale of asset
Loss on revaluation of asset Less : Profit on sale of asset
Profit on Revaluation of asset
Fund flow statement

Fund flow statement

Particulars Rs.
Sources of funds : -
Issue of shares
Issue of Debentures
Long term borrowings
Sale of fixed assets
Operating profit ***

Total Sources ***
Application of funds : -
Redumption of Redeemable preference shares
Redumption of Debentures
Payment of other long term loans
Purchase of Fixed assets
Operating Loss
Payment of dividends, tax etc ***

Total Uses ***
Net Increase / Decrease in working capital
(Total sources – Total uses)

Cash flow statement

Cash From Operation : -
= Net profit + Decrease in Current Asset
+ Increase in Current Liability
- Increase in Current Asset
- Decrease in Current Liability

Cash flow statement

Sources Rs. Application Rs.
Opening cash and bank balance
Issue of shares
Raising of long term loans
Sales of fixed assets
Short term Borrowings
Cash Inflow
Closing Bank O/D
Opening Bank O/D
Redumption of Preference Shares
Redumption of Long term loans
Purchase of fixed assets
Decrease in Deferred payment Liability
Cash Outflow
Tax paid
Dividend paid
Decrease in Unsecured loans, Deposits
Closing cash and bank balance

Budgetary Control

Budget Ratios:-

1) Capacity usage Ratio
= . Budgeted Hours . * 100
Maximum possible working hours in budget period

2) Standard Capacity Employed Ratio
= Actual Hours Worked * 100
Budgeted hours

3) Level of Activity Ratio
= Standard Hours for Actual Production * 100
Standard Hours for Budgeted Production

4) Efficiency Ratio
= Standard Hours for Actual Production * 100
Actual Hours

5) Calendar Ratio
= Actual Working days * 100
Budgeted working days

Zero Base Budgeting:

The name zero base budgeting derives from the idea that such budgets are developed from a zero base: that is, at the beginning of the budget development process, all budget headings have a value of ZERO. This is in sharp contrast to the incremental budgeting system in which in general a new budget tends to start with a balance at least equal to last year's total balance, or an estimate of it.

Definition of Zero Base Budgeting (ZBB)

“A method of budgeting whereby all activities are reevaluated each time a budget is set. Discrete levels of each activity are valued and a combination chosen to match funds available”.

Objectives and Benefits of ZBB

What zero base budgeting tries to achieve is an optimal allocation of resources that incremental and other budgeting systems probably cannot achieve. ZBB starts by asking managers to identify and justify their area(s) of work in terms of decision packages (qv).

An effective zero base budgeting system benefits organisations in several ways. It will

• Focus the budget process on a comprehensive analysis of objectives and needs
• Combine planning and budgeting into a single process
• Cause managers to evaluate in detail the cost effectiveness of their operations
• Expand management participation in planning and budgeting at all levels of the organisation

Activity Based costing

In Traditional Method we split the Over Head incurred in production, based on machine hours which are not acceptable for many reasons.

In ABC method Over Head are splited according to the related activity, for each type of Over Head. Overhead are apportioned among various Production cost centers on the basis of Activity cost drivers.

Relevant Costing - some theory

Introduction: -

A management decision involves predictions of costs & revenues. Only the costs and revenues that will differ among alternative actions are relevant to the decision. The role of historical data is to aid the prediction of future data. But historical data may not be relevant to the management decision itself. Qualitative factors may be decisive in many cases, but to reduce the number of such factors to be judged, accountants usually try to express many decision factors as possible in quantitative terms.

Meaning of Relevant Costs: -

Relevant costs represent those future costs that will be changed by a particular decision. While irrelevant costs are those costs that will not be affected by a decision. In the short run, if the relevant revenues exceed the relevant costs then it will be worthwhile accepting the decision. Therefore relevant costs playa major role in the decision-making process of an organization. A particular cost can be relevant in one situation but irrelevant in another, the important point to note is that relevant costs represent those future costs that will be changed by a particular decision, while irrelevant costs are those costs that will not be affected by that decision. We shall now see what are relevant costs and revenues for decision-making process. In summary relevant information concerns:

Other Important Terminologies : -

Relevant costs are costs appropriate to aiding the making of specific management decisions. Actually, to affect a decision a cost must be:

Future: Past costs are irrelevant as they are not affected them by future decisions & decisions should be made as to what is best now.

Incremental: This refers to additional revenue or expenditure, which may appear as a result of our decision-making.
(A cash flow - Such charges as depreciation may be future but do not represent cash flows and, as such, are not relevant.)

Sunk costs: Past costs, not relevant for decision making

Committed costs: This is future in nature but which arise from past decisions, perhaps as the result of a contract.

Relevant Costs: Problem areas:

1 Problems in determining the relevant costs of materials:

When considering various decisions, if the any materials required is not taken from existing stocks but would be purchased on a later date, then the estimated purchase price would be the relevant material cost. A more difficult problem arises when materials are taken from existing stock. In this situation the relevant cost of materials for a particular job (say job X) depends on

Material is in regular use of the company
Material is not in regular use of the company
Material is in short supply.

If the material is in regular use of the company then the material taken from existing stock requires replacement for the purpose of regular use therefore the relevant cost of material will be the Replacement cost.

If the material is not in regular use of the company the relevant cost of the materials depends on their alternative use. The alternative use of the materials will be either to sell them or to use them on other jobs. Hence the cost of using the materials results in an opportunity cost consisting of either

The net sales revenue if the materials were sold (or) The expense that would be avoided if the materials were used on some other job Whichever is greater.

If the material is in short supply the only way material for the job under consideration can be obtained is by reducing production of some other product / job. This would release material for the order. but the reduced production will result in loss of contribution which should be taken in to account when ascertaining the relevant costs for the specific order. Therefore the relevant cost will be Contribution lost (before the material cost since the material cost will be incurred in any case) will be the relevant cost.
labour:
2 Determining the direct labour that are relevant to short - term decision depends on the circumstances.

Where a company has temporary sparse capacity and the labour force is to be maintained in the short - term, the direct labour cost incurred will remain same for all alternative decisions. The direct labour cost will therefore be irrelevant for short - term decision - making purposes.
However where casual labour is used and where workers can be hired on a daily basis; a company may then adjust the employment of labour to exactly the amount required to meet the production requirements. The labour cost will increase if the company accepts additional work, and will decrease if production is reduced. In this situation the labour cost be a relevant cost for decision - making purposes.

In a situation where full capacity exists and additional labour supplies are unavailable in the short - term, and where no further overtime working is possible, the only way that labour resources could then be obtained for a specific order would be to reduce existing production. This would release labour for the order. but the reduced production will result in loss of contribution, which should be taken in to account when ascertaining the relevant costs for the specific' order. Therefore the relevant cost will be Contribution lost (before the labour cost) will be the relevant cost.

PROBLEMS

1. In a firm, material A has no alternative uses and 200 units of which lie in stock. The information below has been collected. You are required to find the relevant price of 120 units and 250 units respectively.
Book value
Current price
Sale price obtainable

Rs.2 per kg Rs.3 per kg Rs.2.80 per kg

2. Assume in the above problem the material is in regular use of the company

3. Assume in the above problem the material is in short ‘supply and it is not possible to obtain the stock of material for some more time. At present the material is used in another product on which a contribution at the rate of Rs.1 O/unit is earned (after meeting the material cost). Each unit of the product requires 1 KG of Raw material A.

Budgetary Control

Transfer Pricing

A transfer price is the amount of money that one unit of an organisation charges for goods and services to another unit of an organisation.

One of the key aspects here is that a transfer price is equivalent to an ordinary selling price and that any department or division that sets a transfer price is effectively selling its goods and services at a profit or a loss to another department or division within its organisation. Any part of an organisation using transfer pricing will be classed as a profit centre: since it is operating with a view to making a profit (whether positive, profit, or negative, loss). If goods and services are transferred between departments and divisions at cost, then no profit or loss arises and the issue of transfer pricing does not, or should not, arise.

Organisations have a system of transfer pricing, therefore, in order to assess the efficiency and effectiveness of its department and divisional managers. This maybe in spite of the fact that transfer prices may be artificial in the sense that it is felt that there is no rationale for “selling” between departments and divisions.

Criteria for fixing Transfer Pricing:-

i) External Capacity not fully utilized = Variable Cost

ii) Capacity fully Utilized
a) If single product :-
Selling Price (–) Selling Expenses

b) If multiple product
Variable cost + Opportunity cost (measured on the basis of Product actually sacrificed)

iii) If no market for Intermediate product
Cost of supplying division of optimum level
(-) Cost of the supplying division at previous output level.
Difference in Output

(This would be equal to Variable cost when Fixed Cost is same at all levels)

Note:-

i) Ignore Variable Selling expenses on Inter Department Transfer
ii) In case of (ii) above If selling expenses is not given we have to assume some % as selling Expenses but it should not exceed 5% .

NON-INTEGRATED ACCOUNTS

Scheme of journal entries:-

Material:

a) For material purchases (cash or credit)
i) Material control a/c Dr
To Cost ledger control a/c

ii) Stores ledger control a/c Dr
To Material control a/c

b) Purchases for a special job
Work-in-progress ledger control a/c Dr
To Cost ledger control a/c

c) Material returned to vender
Cost ledger control a/c Dr
To Stores ledger control a/c

d) Material (direct) issued to production
Work-in-progress control a/c Dr
To Stores ledger control a/c

e) Material (indirect) issued to production
Manufacturing overheads a/c Dr
To Stores ledger control a/c

f) Material returned from shop to stores
Stores ledger control a/c Dr
To Work-in-progress control a/c

g) Material transferred from Job 1 to Job 2
Job 2 a/c Dr
To Job 1 a/c

i) Material issued from stores for repairs
Manufacturing overhead a/c Dr
To Stores ledger control a/c

Labour:

a) Direct wages paid
i) Wage control a/c Dr
To Cost ledger control a/c

ii) Work-in-progress a/c Dr
To Wage control a/c

b) Indirect wages paid to workers in Production,
Administration, Selling and Distribution departments
i) Wage control a/c Dr
To Cost ledger control a/c

ii) Production Overhead a/c Dr
Administrative Overhead a/c Dr
Selling & Distribution Overhead a/c Dr
To Wage control a/c

c) Direct Expenses on a particular job
Job a/c Dr
To Cost ledger control a/c

Overheads:-

a) Overhead expenses incurred
Production overhead a/c Dr
Administrative Overhead a/c Dr
Selling & Distribution Overhead a/c Dr
To cost ledger control a/c

b) Carriage inward
Manufacturing Overhead a/c Dr
To Cost ledger control a/c

c) Production Overheads recovered
Work-in-progress control a/c Dr
To Production Overhead a/c

d) Administrative Overhead recovered from finished goods
Finished goods ledger control a/c Dr
To Administrative Overhead a/c

e) Selling and Distribution Overhead recovered from sales
Cost of sales a/c Dr
To Selling & Distribution a/c

f) If over/under absorbed amounts are carried forward to subsequent year, the
balance of each Overhead account will have to be transferred to respective
Overhead suspense (or reserve) Accounts as follows:

i) For over recovery : Production Overhead a/c Dr
To Production overhead suspense a/c

ii) For under recovery : Administrative Overhead Suspense a/c Dr
To Administrative Overhead a/c

Selling & Distribution Overhead Suspense a/c Dr
To Selling & Distribution Overhead a/c

g) In case the Under/Over absorbed overheads are transferred to costing profit & loss
a/c then the relevant entries are:
i) For Over recovery: Production Overhead a/c Dr
To Costing Profit & Loss a/c

ii) For Under recovery: Costing Profit & Loss a/c Dr
To Administration Overhead a/c

Sales:-

For sales effected: Cost ledger control a/c Dr
To Costing Profit & Loss a/c

Profit / Loss:

a) In case of profit the entry is as follows
Costing Profit & Loss a/c Dr
To Cost ledger control a/c

b) Reverse the entry in case of loss

The main accounts which are usually prepared when a separate cost ledger is maintained is as follows:-

i) Cost ledger control a/c
ii) Stores ledger control a/c
iii) Work-in-progress control a/c
iv) Finished goods control a/c
v) Wage control a/c
vi) Manufacturing/Production/Works Overheads a/c
vii) Administrative Overhead a/c
Viii) Selling & Distribution Overhead a/c
ix) Cost of sales a/c
x) Costing profit & loss a/c

NON-INTEGRATED ACCOUNTS

STANDARD COSTING

Method one of reading:-
Material:-
SP * SQ SP * AQ SP * RSQ AP * AQ
(1) (2) (3) (4)
a) Material cost variance = (1) – (4)
b) Material price variance = (2)–(4)
c) Material usage variance = (1) – (2)
d) Material mix variance = (3) – (2)
e) Material yield variance = (1) –(3)

Labour :-
SR*ST SR*AT (paid) SR*RST AR*AT SR*AT(worked)
(1) (2) (3) (4) (5)

a) Labour Cost variance = (1) – (4)
b) Labour Rate variance = (2) – (4)
c) Labour Efficiency variance = (1) – (2)
d) Labour mix variance = (3) – (5)
e) Labour Idle time variance = (5) – (2)

Variable Overheads cost variance :-
SR * ST SR * AT AR * AT
(1) (2) (3)

a) Variable Overheads Cost Variance = (1) – (3)
b) Variable Overheads Expenditure Variance = (2) – (3)
c) Variable Overheads Efficiency Variance = (1) – (2)

[Where: SR =Standard rate/hour = Budgeted variable OH
Budgeted Hours ]

Fixed Overheads Cost Variance:-
SR*ST SR*AT(worked) SR*RBT SR*BT AR*AT(paid)
(1) (2) (3) (4) (5)

a) Fixed Overheads Cost Variance = (1) – (5)
b) Fixed Overheads Budgeted Variance = (4) – (5)
c) Fixed Overheads Efficiency Variance = (1) – (2)
d) Fixed Overheads Volume Variance = (1) – (4)
e) Fixed Overheads Capacity Variance = (2) – (3)
f) Fixed Overheads Calendar Variance = (3) – (4)
Sales value variance:-
Budgeted Price*BQ BP*AQ BP*Budgeted mix AP*AQ
(1) (2) (3) (4)

a) Sales value variance = (4)–(1)
b) Sales price variance = (4) – (2)
c) Sales volume variance = (2) – (1)
d) Sales mix variance = (2) – (3)
e) Sales quantity variance = (3) – (1)

Note :-

i) Actual margin per unit (AMPU) = Actual sale price – selling cost per unit

ii) Budgeted margin per unit (BMPU) = Budgeted sale price – selling price per unit

Sales margin variance :-

BMPU*BQ BMPU*AQ BMPU*Budgeted mix AMPU*AQ
(1) (2) (3) (4)

a) Sales margin variance = (4) – (1)
b) Sales margin price variance = (4) – (2)
c) Sales margin volume variance = (2) – (1)
d) Sales margin mix variance = (2) – (3)
e) Sales margin quantity variance = (3) – (1)

Control Ratio :-

1) Efficiency Ratio = Standard hours for actual output * 100
Actual hours worked

2) Capacity Ratio = Actual Hours Worked * 100
Budgeted Hours

3) Activity Ratio = Actual hours worked * 100
Budgeted Hours

Verification: Activity Ratio = Efficiency * Capacity Ratio

STANDARD COSTING

Method two of reading:-
Material:-

a) Material cost variance = SC – AC = (SQ*AQ) – (AQ*AP)

b) Material price variance = AQ (SP – AP)

c) Material usage variance = SP (SQ – AQ)

d) Material mix variance = SP (RSQ – AQ)

e) Material yield variance = (AY – SY for actual input) Standard material cost per
unit of output

f) Material revised usage variance (calculated instead of material yield variance)
= [standard quantity – Revised standard
for actual output quantity ] * Standard price

Labour :-

a) Labour Cost variance = SC – AC = (SH*SR) – (AH*AR)

b) Labour Rate variance = AH (SR - AR)

c) Labour Efficiency or time variance = SR (SH –AH)

d) Labour Mix or gang composition Variance = SR(RSH-AH)

e) Labour Idle Time Variance = Idle hours * SR

f) Labour Yield Variance = [Actual Output – Standard output for actual input]
* Standard labour cost/unit of output

g) Labour Revised Efficiency Variance (instead of LYV) =
[Standard hours for actual output – Revised standard hours] * Standard rate

Notes :- i) LCV = LRV + LMV + ITV + LYV
ii) LCV = LRV + LEV + ITV
iii) LEV = LMV, LYV (or) LREV

Overhead variance :- (general for both variable and fixed)

a) Standard overhead rate (per hour) = Budgeted Overheads
Budgeted Hours

b) Standard hours for actual output = Budgeted hours * Actual Output
Budgeted output

c) Standard OH = Standard hrs for actual output * Standard OH rate per hour

d) Absorbed OH = Actual hrs * Standard OH rate per hour

e) Budgeted OH = Budgeted hrs * Standard OH rate per hour

f) Actual OH = Actual hrs * Actual OH rate per hour

g) OH cost variance = Absorbed OH – Actual OH

Variable Overheads variance :-

a) Variable OH Cost Variance = Standard OH – Actual OH

b) Variable OH Exp. Variance = Absorbed OH – Actual Variable OH

c) Variable OH Efficiency Variance = Standard OH – Absorbed OH
= [Standard hours for – Actual * Standard rate
actual output hours] for variable OH

Fixed Overheads variance :-

a) Fixed OH Cost Variance = Standard OH – Actual OH

b) Fixed OH expenditure variance = Budgeted OH – Actual OH

c) Fixed OH Efficiency Variance = Standard OH (units based) – Absorbed OH
(Hours based)

d) Fixed OH Volume Variance = Standard OH – Budgeted OH
= [Standard hrs for – Budgeted * standard rate
actual output hours ]

e) Fixed OH capacity variance = Absorbed OH–Budgeted OH

f) Fixed OH Calendar Variance = [Revised budgeted hrs – Budgeted hrs]
* Standard rate/hrs

Note:- When there is calendar variance capacity variance is calculated as follows :-
Capacity variance = [Actual hours – Revised * Standard
(Revised) Budgeted hrs] rate/hour

Verification :-

i) variable OH cost variance = Variable OH Expenditure variance
+ Variable OH Efficiency variance

ii) Fixed OH cost variance = Fixed OH Expenditure variance + Fixed OH volume
variance

iii) Fixed OH volume variance = Fixed OH Efficiency variance + Capacity variance
+ Calander variance

Sales variances :-

Turnover method (or) sales value method :-

a) Sales value variance = Actual Sales – Budgeted Sales

b) Sales price variance = [Actual Price – Standard price] * Actual quantity
= Actual sales – standard sales

c) Sales volume variance = [Actual-Budgeted quantity] *Standard price
= Standard sales – Budgeted sales

d) Sales mix variance = [Actual quantity – Revised standard quantity] * Standard
price
= Standard sales – Revised sales

e) Sales quantity variance = [Revised standard variance – Budgeted quantity]
* Standard price
= Revised Standard sales – Budgeted sales

Profit method:-

a) Total sales margin variance = (Actual Profit–Budgeted price)
= {Actual quantity * Actual profit per unit}-
{Budgeted quantity * Standard profit per unit}
b) Sales margin price variance=Actual profit–Standard profit
= {Actual Profit per unit – Standard profit per unit} * Actual quantity of sales

c) Sales margin volume variance = Standard profit – Budgeted Profit
= {Actual quantity – Budgeted quantity} * Standard profit per unit

d) Sales margin mix variance = Standard profit – Revised Standard profit
= {Actual quantity – Revised standard quantity} * Standard profit per unit

e) Sales margin quantity variance = Revised standard profit - Budgeted profit
= {Revised standard quantity – Budgeted quantity} * Standard profit per unit
Labour Cost variance = SC – AC = (SH*SR) – (AH*AR)

Fixed Overhead Variance : -
a) Standard OH = Standard hrs for actual output * Standard OH rate per hour

b) Absorbed OH = Actual hrs * Standard OH rate per hour

c) Budgeted OH = Budgeted hrs * Standard OH rate per hour

d) Actual OH = Actual hrs * Actual OH rate per hour

e) Revised Budgeted Hour = Actual Days * Budgeted Hours per day
(Expected hours for actual days worked)

When Calendar variance is asked then for capacity variance Budgeted Overhead is (Budgeted days * Standard OH rate per day)

Saturday, 19 March 2011

WHAT IS MARGINAL COSTING

Statement of profit:-

Particulars Amount
Sales ***
Less:-Variable cost ***
Contribution ***
Less:- Fixed cost ***
Profit ***

1) Sales = Total cost + Profit = Variable cost + Fixed cost + Profit

2) Total Cost = Variable cost + Fixed cost

3) Variable cost = It changes directly in proportion with volume

4) Variable cost Ratio = {Variable cost / Sales} * 100

5) Sales – Variable cost = Fixed cost + Profit

6) Contribution = Sales * P/V Ratio

7) Profit Volume Ratio [P/V Ratio]:-
• {Contribution / Sales} * 100
• {Contribution per unit / Sales per unit} * 100
• {Change in profit / Change in sales} * 100
• {Change in contribution / Change in sales} * 100

8) Break Even Point [BEP]:-
• Fixed cost / Contribution per unit [in units]
• Fixed cost / P/V Ratio [in value] (or) Fixed Cost * Sales value per unit
(Sales – Variable cost per unit)
9) Margin of safety [MOP]
• Actual sales – Break even sales
• Net profit / P/V Ratio
• Profit / Contribution per unit [In units]

10) Sales unit at Desired profit = {Fixed cost + Desired profit} / Cont. per unit

11) Sales value for Desired Profit = {Fixed cost + Desired profit} / P/V Ratio

12) At BEP Contribution = Fixed cost
13) Variable cost Ratio = Change in total cost * 100
Change in total sales

14) Indifference Point = Point at which two Product sales result in same amount of
profit
= Change in fixed cost (in units)
Change in variable cost per unit

= Change in fixed cost (in units)
Change in contribution per unit

= Change in Fixed cost (in Rs.)
Change in P/Ratio

= Change in Fixed cost (in Rs.)
Change in Variable cost ratio

15) Shut down point = Point at which each of division or product can be closed

= Maximum (or) Specific (or) Available fixed cost
P/V Ratio (or) Contribution per unit
If sales are less than shut down point then that product is to shut down.

Note :-

1) When comparison of profitability of two products if P/V Ratio of one product is
greater than P/V Ratio of other Product then it is more profitable.

2) In case of Indifference point if
Sales > Indifference point --- Select option with higher fixed cost (or) select option with lower fixed cost.

WHAT IS CONTRACT COSTING

Contract costing is “A form of specific order costing; attribution of costs to individual contracts”.

A contract cost is “Aggregated costs of a single contract; usually applies to major long term contracts rather than short term jobs”.

Features of long term contracts:

• By contract costing situations, we tend to mean long term and large contracts: such as civil engineering contracts for building houses, roads, bridges and so on. We could also include contracts for building ships, and for providing goods and services under a long term contractual agreement.
• With contract costing, every contract and each development will be accounted for separately; and does, in many respects, contain the features of a job costing situation.
• Work is frequently site based.

We might have problems with contract costing in the following areas

• Identifying direct costs
• Low levels of indirect costs
• Difficulties of cost control
• Profit and multi period projects

The source of the following has eluded me: my sincere gratitude for whoever the author might be.

"Contract Costing such jobs take a long time to complete & may spread over two or more of the contractor's accounting years”.

Features of a Contract

• The end product
• The period of the contract
• The specification
• The location of the work
• The price
• Completion by a stipulated date
• The performance of the product

Collection of Costs :

Desirable to open up one or more internal job accounts for the collection of costs. If the contract not obtained, preliminary costs be written off as abortive contract costs in P&L In some cases a series of job accounts for the contract will be necessary:
• to collect the cost of different aspects
• to identify different stages in the contract

Special features

• Materials delivered direct to site.
• Direct expenses
• Stores transactions.
• Use of plant on site

Two possible accounting methods:

Where a plant is purchased for a particular contract & has little further value to the business at the end of the contract
Where a plant is bought for or used on a contract, but on completion of the contract it has further useful life to the business
Alternatively the plant may be capitalised with Maintenance and running costs charged to the contract."

Format:-

Particulars Rs. Particulars Rs.
To Materials
a. Purchased directly
b. Issue from site
c. Supplied by contractee
**
**
** By materials returned **
By Material sold (cost price)
**
To Wages and salaries ** By WIP
Work certified
Work Uncertified
**
**
To Other direct Expenses **
To Sub-contractor fees **
To Plant & Machinery (purchase
price/Book value)
** By Materials at site **
To Indirect expenditure (apportioned share of overheads) ** By Plant and machinery(WDV)
**
To Notional profit (Surplus) **
Total Total **

Profit of Incomplete contract :-

1) When % of completion is less than or equal to 25% then full Notional profit is
transferred to reserve.

2) When % of completion is above 25% but less than 50% following amount should
be credited to profit & loss a/c = 1/3 * Notional Profit * {Cash received / Work
certified}

3) When % of completion is more than or equal to 50% then the amount transferred
to profit is = 2/3 * Notional Profit * {Cash received / Work certified}
[Balance is transferred to reserve a/c]
☺ % of completion = {Work certified/Contract price} * 100

4) When the contract is almost complete the amount credited to profit & loss a/c is

a) Estimated total profit * {Work certified / Contract price}
b) Estimated total profit * {Cash received / Contract price}
c) Estimated total profit * {Cost of work done / Estimated total profit}
d) Estimated total profit*{Cost of work done*Cash received
Estimated total cost * Work certified}

5) Work-In-Progress is shown in Balance Sheet as follows:-

Skeleton Balance sheet

Liabilities (RS) Asset (Rs)
Profit & loss a/c (will include)
Profit on contract (Specify
the contract number)
Less : Loss on contract
(Specify the contract number)
Sundry creditors (will include)
Wages accrued
Direct expenses accrued
Any other expenses
(Specify) Work-in-progress
Value or work certified
Cost of work uncertified
Less :- Reserve for unrealized profit
Less :- Amount received from contractee

6) Escalation Clause = This is to safeguard against likely change in price of cost
elements rise by and certain % over the prices prevailing at the time tendering the
contractee has to bear the cost.

Accounts Notes

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Tuesday, 12 April 2011

Cash flow statement

Fund flow statement

Tuesday, 5 April 2011

What is Costing

Sunday, 20 March 2011

Capital Budgeting

Management Accounting and Financial Analysis

Network Analysis

Ratio Analysis

Ratio Analysis

What is the Cash flow and fund flow statement

Budgetary Control

Budgetary Control

Transfer Pricing

NON-INTEGRATED ACCOUNTS

NON-INTEGRATED ACCOUNTS

STANDARD COSTING

Saturday, 19 March 2011

WHAT IS MARGINAL COSTING

WHAT IS CONTRACT COSTING

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