Sample Theory With Ques. - Ratio Analysis (COMM. UNIT-2)

UGC NET
Commerce
SAMPLE
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Commerce (Sample Theory)
1. COST AND MANAGEMENT ACCOUNTING
1. Ratio Analysis
Ratio analysis is used to evaluate relationships among financial statement items. The ratios are
used to identify trends over time for one organization or to compare two or more organizations at one
point in time.
Classification of Ratios
1. According to the Statement Upon Which They are Based
 Balance Sheet Ratios
 Operating Ratios or Profit and Loss Ratios
 Combined Ratios
2. Classification According to “Importance”
Primary Ratios : Since profit is primary consideration in all business activities, the ratio of profit
to capital employed is termed as 'Primary Ratio'. In business world this ratio is known as "Return on
Investment". It is the ratio which reflects the validity or otherwise of the existence and continuation of the
business unit. In case if this ratio is not satisfactory over long period, the business unit cannot justify its
existence and hence, should be closed down. Because of its importance for the very existence of the
business unit it is called 'Primary Ratio'.
Secondary Ratios : These are ratios which help to analyse the factors affecting "Primary Ratio".
These may be sub-classified as under:
Supporting Ratios : These are ratios which reflect the profit-earning capacities of the business
and thus support the "primary Ratio". For example sales to operating profit ratio reflects the capacity of
contribution of sales to the profits of the business. Similarly, sales to assets employed reflects the
effectiveness in the use of assets for making sales, and consequently profits.
Explanatory Ratios : These are ratios which analyse and explain the factors responsible for the
size of profit earned. Gross profit to sales, cost of goods sold to sales, stock-turnover, debtors turnover
are some of the ratios which can explain the size of the profits earned. Where these ratios are calculated
to highlight the effect of specific activity they are termed as 'Specific Explanatory Ratios'. For example,
the effect of credit and collection policy is reflected by debtors turnover ratio.
3. Functional Classification
Profitability Ratios : Profitability ratios gives some yardstick to measure the profit in relative
terms with reference to sales, assets or capital employed. These ratios highlight the end result of
business activities. The main objective is to judge the efficiency of the business.
Turnover Ratios or Activity Ratios : These ratios are used to measure the effectiveness of the
use of capital/assets in the business. These ratios are usually calculated on the basis of sales or cost
of goods sold and are expressed in integers rather than as percentages.
Financial Ratios or Solvency Ratios : These ratios are calculated to judge to financial position
of the organization from short-term as well as long-term solvency point of view. Thus, it can be sub-
divided into: (a) Short-term Solvency Ratios (Liquidity Ratios) and (b) Long-term Solvency Ratios (Capital
Structure Ratios).
Market Test Ratios : These are of course, some profitability ratios, having a bearing on the
market value of the shares.
Profitability Ratios : A measure of 'profitability' is the overall measure of efficiency. In general
terms efficiency of business is measured by the input-output analysis. By measuring the output as a
proportion of the input, and comparing result of similar other firms of periods the relative change in its
profitability can be established.
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Operating Profit (net margin)

 100
Operating Capital Employed
This ratio is also known as overall profitability ratio or return on capital employed. The income
(output) as compared to the capital employed (input) indicated the return on investment. It shows how
much the company is earning on its investment. This ratio is calculated as follows:
Net Operating Profit

Return on Investment   100
Capital Employed
Operating profit means profit before interest and tax.

Capital employed comprises share capital and reserves and surplus, long-term loans minus non-
operating assets and fictitious assets. It can also be represented as net fixed assets plus working capital
(I.e. current assets minus current liabilities).
Capital employed = Share Capital + Reserve and Surplus + Long –

Term Loans – Non-operating Assets – Fictitious Assets
OR
Capital employed = Net fixed assets + working capital
Return on Shareholders' Funds : It is also referred to as return on net worth. In this case it
is desired to work out the profitability of the company from the shareholders' point of view and it is
computed as follows :
Net Profit After Interest and Tax

 100
Shareholder's Funds
Return on Assets : Here the profitability is measured in terms of the relationship between net
profits and assets. It shows whether the assets are being properly utilized or not. It is calculated as :
Net Profit Tax

 100
Total Assets
Gross Profit Ratio or Gross Margin : Gross profit ratio expresses the relationship of gross
profit to net sales or turnover. Gross profit is the excess of the proceeds of goods sold and services
rendered during a period over their cost, before taking into account administration, selling and distribution
and financing charges.
Gross Profit
 100
Net Sales
Net Profit Ratio : One of the components of return on capital employed is the net profit ratio (or
the margin on sales) calculated as:
Operating Profit
 100
Sales
Operating Ratio : The ratio of all operating expenses (i.e., material used, labour, factory overheads,
office and selling expenses) to sales is the operating ratio.

Meterial consumed
Material cost ratio   100
Sales
Labour cost
Labour cost ratio   100
Sales
Overhead cost
Factory overheads cost ratio   100
Sales
Adminstrative expenses
Administrative expenses ratio   100
Sales
Selling and distribution expenses
Selling and distribution expenses ratio   100
Sales
Activity Ratios or Turnover Ratios
Capital Turnover (Sales to Capital Employed) Ratio : This ratio shows the efficiency of capital
employed in the business and is calculated as follow:
Net Sales
Capital Turnover Ratio 
Capital Employed
The higher the ratio the greater are the profits.
Total Assets Turnover Ratio : This ratio is ascertained by dividing the net sales by the value
of total assets. Thus,
Net Sales
Total Assets Turnover Ratio 
Total Assets
A high ratio is an indicator of overtrading of total assets while a low ratio reveals idle capacity.
The total Assets Turnover Ratio can be segregated into:
Fixed Assets Turnover Ratio : This ratio indicates the number of times fixed assets are being
turned over in a stated period. It is calculated as :
Net Sales
Fixed Assets Turnover Ratio 
Fixed Assets
This ratio is an indicator of the extent to which investment in fixed assets contributes to generate
sales. The fixed assets are to be taken net of depreciation. The higher is the ratio the better is the
performance.
Stock Turnover Ratio (Inventory Turnover Ratio) : This ratio is an indicator of the efficiency
of the use of investment in stock. It is calculated as:
Cost of Good Sold Sales

Stock Turnover Ratio  or
Average Inventory Average Inventory
Mostly opening and closing stock figures are given and these should be averaged. If monthly
figures are available, then these figures should be averaged. In case stock level fluctuates violently, then
monthly average should be calculated as under:
Opening stock+12 months figures-Closing stock

12
In this case stock turnover ratio should be as under :
Cost of Goods Sold
Average stock

Too large of inventory will depress the ratio; control over inventories and active sales promotion
will increase the ratio. If desired this ratio may be split into two ratios, for raw materials and for finished
goods:
Meterial consumed
(i) and
Average raw meterial stock
Sale or Cost of goods sold

(ii) Average stocks of finished goods
This analysis will throw a better light on the inventory position.

Average inventory is calculated on the basis of the average inventory at the beginning and at the
end of the accounting period.
Debtors Turnover Ratio (Debtors' Velocity) : These days some amount of sales always
locked up in the form of book debts. Efficient credit control and prompt collection of amounts due will
mean lower investments in book debts. This ratio measures the net credit sales of a firm to the recorded
trade debtors thereby indicating the rate at which cash is generated by turnover of receivable or debtors.
This ratio is calculated as :
Net Sales
Debtors Turnover Ratio 
Average Debtors
Average debtors refer to the average of opening and closing balance of debtors for the period.
Debtors include bills receivables but exclude debts which arise on account of transactions other than
sale of goods. While calculating debtors turnover, it is important to note that provision for bad and
doubtful debts are not deducted from total debtors in order to avoid the impression that a larger amount
of receivables have been collected.
Debt Collection Period : This ratio indicates the extent to which the debts have been collected
in time. This ratio is infect, interrelated with and dependent upon the debtors turnover ratio. It is calculated
by dividing the days in a year by the debtors turnover. This ratio can be computed as follow:
Months/Day in a year
(i)
Debtors Turnover
Average Debtors  Months/Day is a year
Net Credit Sales for the year
Average Debtors
or
Average Monthly/Daily Credit Sales
Debtors' collection period shows the quality of debtors since it measures the speed with which
money is collected from them. It is rather difficult to specify a standard collection period for debtors. It
depends upon the nature of the industry, seasonal character of the business and credit policy of the firm
etc.
Creditors Turnover Ratio (Creditors' Velocity) : Like debtors' turnover ratio, this ratio indicates
the speed at which the payments for credit purchases are made to creditors. This ratio is computed as
follow :
Credit Purchases
Creditors Turnover Ratio 
Average Creditors
The term 'creditors' include, trade creditors and bills payable. In case the details regarding credit
purchases, opening and closing balances of creditors are not available, then instead of credit purchases,

total purchases may be taken in place of average creditors, the balance available may be substituted.
Debt Payment Period: This ratio gives the average credit period enjoyed from the creditors. It can be
computed as under :
Months/Days in a year
Creditors Turnover
or
Averag Creditors × Months/Day in a year
Credit Purchases in the year
or
Average Creditors
Aaverage Monthly/Daily Credit Purchases
Both above ratios determine the average age of payables, on the basis of which it can be
compensated as to how prompt or otherwise the company is making payments for credit purchases
effected by it. A high creditors' turnover ratio or a low debt payment period shows that creditors are being
paid promptly, hence enhancing the credit worthiness of the company. However, a very favorable ratio
to this effect also shows that the business is not taking full advantage of credit facilities allowed by the
creditors.
Financial : Financial statements of a firm are analysed for ascertaining its profitability as well as
financial position. A firm is said to be financially sound provided if it is capable of meeting its commitments
both short-term and long- term. Accordingly, the ratios to be computed for judging the financial position
are also known as solvency ratios and those ratios which are computed for short-term solvency are
known as liquidity ratios.
Liquidity Ratio : In a short period, a firm should be able to meet all its short-term obligations i.e.
current liabilities and provisions. It is current assets that yield funds in the short period - current assets
are those assets which the firm can convert into cash within one year or in short run. Current assets
should not only yield sufficient funds to meet current liabilities as they fall due but also enable the firm
to carry on its day to day activities. The ratios to test the short-term solvency or liquidity position of an
enterprise are mainly the following:
Current Ratio : Current ratio is also known as the working capital ratio, is the most widely used
ratio. It is the ratio of total current assets to current liabilities and is calculated by dividing the current
assets by current liabilities.
Current Assets
Current Ratio 
Current Liabilities
Generally 2 : 1 ratio is considered ideal for a concern.

Liquid Ratio : This ratio is also known as Quick Ratio or Acid Test Ratio
Liquid Assets
Liquid Ratio 
Current Liabilities
Liquidity ratio may also be computed by substituting liquid liabilities in place of current liabilities.
Liquid Liabilities mean those liabilities which are payable within a short period. Bank overdraft and cash
credit facilities, if they become a permanent mode of financing are to be excluded from current liabilities
to arrive at liquid liabilities. This :
Liquid Assets
Liquid Ratio 
Liquid Liabilities

Liquid Ratio = (Liquid Assets)/(Liquid Liabilities)

Generally, a liquid of 1:1 is considered as ideal as the firm can easily meet all current liabilities
Long-term Solvency Ratios : Long-term sources and uses of funds form the basic input for
computation of long-term solvency ratios.
Debt-Equity Ratio : Debt-equity ratio is the relation between borrowed funds and owners' capital
in a firm, it is also known as external-internal equity ratio. The debt- equity ratio is used to ascertain the
soundness of long-term loans from financial institutions. Equity means shareholders' funds i.e., preference
share capital, equity share capital, reserves less loss and fictitious assets like preliminary expenses. It
is calculated in the following ways :
Debts
(i)
(Equity Shareholers' Funds)
or
Debts
(ii)
Long-term Funds (Shareholders' Funds + Debts)
Proprietary Ratio : This ratio is a variant of debt-equity ratio which establishes the relationship
between shareholders funds and total assets. Shareholders' fund means, share capital both equity and
preference and reserves and surplus less losses. This ratio is worked out as follows :
Shareholder's Funds
Proprietary Ratio 
Total Assets
This ratio indicates the extent to which shareholders' funds have been invested in the assets.
Fixed Assets Ratio : The ratio of fixed assets to long-term funds is known as fixed assets ratio.
It focuses on the proportion of long-term funds invested in fixed assets. The ratio is expressed as follow:
Fixed Assets
Fixed Assets Ratio 
Long-term Funds
Fixed assets refer to net fixed assets (i.e. original cost-depreciation to date) and trade investments
including shares in subsidiaries. Long-term funds include share capital reserves and long-term loans.
This ratio should not be more than 1. It is the principle of financial management that not merely
fixed assets but a part of working capital also should be financed by long-term funds. As such it is
desirable to have the ratio at less than one i.e. say, 0.67 to indicate the fact that the entire fixed capital
plus a portion of the working capital are financed by long-term funds.
Debt-Service Ratio : This ratio is also known as Fixed Charges Cover or Interest Cover. This
ratio measures the debt servicing capacity of a firm in so far as fixed interest on long-term loan is
concerned. It is determined by dividing the net profit before interest and taxes by the fixed charges on
loans. Thus :
Net Profit before Interest and Tax

Debt Service Ratio 
Interest Charges
The ratio is expressed as 'number of times' to indicate that profit is number of times the interest
charges. It is also a measure of profitability. Since higher the ratio, higher the profitability. The ideal ratio
should be 6 to 7 times.
Capital Gearing Ratio : The proportion between fixed interest or dividend bearing funds and non-
fixed interest or dividend bearing funds in the total capital employed in the business is termed as capital
gearing ratio. Debentures, long-term loans and preference share capital belong to the category of fixed
interest/dividend bearing funds. Equity share capital, reserves and surplus constitute non-fixed interest
or dividend bearing funds. This ratio is calculated as follows:

Fixed Interest Bearing Funds

Capital Gearing Ratio 
Equity Shareholders' Funds
Market Test Ratios : These ratios are calculated generally in case of such companies whose
shares and stocks are traded in the stock exchanges
Earning per Share (EPS) : This is calculated as under :
Net Profit
EPS 
No. of Equity Shares
This ratio measures the profit available to the equity shareholders on a per share basis. Suppose,
the net income of company after preference dividend is Rs. 40,000 and the number of equity shares is
6,000 then,
Rs. 40,000
EPS   Rs. 6.66 Per Share
Rs. 6,000
Price Earning Ratio : This ratio establishes relationship between the market price of the shares
of a company and it's earning per share (EPS). It is calculated as under :
Market Value Per Equity Share

Price Earning Ratio (P/E) 
Earning Per Share
Pay-out Ratio : This ratio expresses the relationship between what is available as earnings per
share and what is actually paid in the form of dividends out of available earnings. It is a good measure
of the dividend policy of the company. A higher payout ratio may mean lower retention and ploughing back
of profits, a deteriorating liquidity position and little or no increase in the profit-earning capacity of the
company. This ratio is calculated with the help of the following formula :
Dividend Per Equity Share

Pay-out-Ratio 
Earning Per Share
Dividend Yield Ratio : This ratio establishes the relationship between the market price and the
dividend paid per share. It is expressed as a percentage and gives the rate of return on the market value
of the shares and helps in the decision of investors who are more concerned about returns on their
investment rather than its capital appreciation. This ratio is calculated as under.
Dividend Per Share

 100
Market Price Per Share
2. Marginal Costing and Break - even Analysis

Direct Costing
1. Direct costing is method of costing in which the product charged with only those costs,
which vary with volume e.g. direct materials, direct labour direct/variable manufacturing
expenses etc.
2. In the method a unit cost is assigned only the direct cost.
Marginal Costing
'The term' 'Marginal cost' is defined as " the amount at any given volume of output, by which
aggregate costs are changed, if the volume of output is increased or decreased by one unit. It is a
variable cost of one unit of a product or a service i.e. a cost, which would be avoided is that unit was
not produced or provided".

It is technique of decision-making, which involves

1. Ascertainment of total costs.
2. Classification of costs into one fixed and variable.
3. Use of such information for analysis and decision-making
Marginal costing is mainly concerned with providing information to management to assist in
decision-making and to exercise control.
Marginal costing is also known as 'Variable costing' or 'out of pocket costing'.
Important Factors to be Considered in Marginal Costing Decisions
In all recommendations of marginal costing decisions, the following factors are to be considered
Contribution Where the product or production line in question makes contribution.
Specific Fixed Cost Where a choice is to be made between two courses of action, the additional
fixed overhead. If any, should be taken into account.
Cost volume Profit Relationship The effect of increase in volume on profit and the rate of
earning, additional profits, should be analyzed.
Incremental Contribution Where additional quantities can be sold only at reduced prices,
incremental contribution will be more effective in decision-making, as it takes into account the additional
sale quantity and additional contribution per unit.
Capacity Where acceptance of the incremental order or additional product line is within the firm
capacity or whether key factor comes into play, should be analyzed.
Performa of Cost Sheet under Marginal
Costing Approach
Amt Amt
Particulars (Rs) (Rs)
A. Sales xx x
Direct Material xx x
Direct Labour xx x
Direct Expense xx x
Prime Cost xx x
Variable Factory Overhead xx x
Variable Administrative Overhead xx x
Variable Selling and Distribution xx x xx x
Overheads
B Total Variable Cost xx x
C Contribution (A-B) xx x
Fixed Factory Overheads xx x
Fixed Administrative Overheads xx x
Fixed Selling and Distribution xx x
Overheads
D Total Fixed Cost xx x

E Profits loss (C-D) xx x
Contribution
Contribution is the excess of sales revenue over the variable cost, i.e.
Contribution = Sales - Variable cost.
Absorption Costing
It is a conventional technique of ascertaining cost. It is the practice of charging all costs both
variable and fixed to operations, processes or products and is also known as 'full costing technique'.
Under this technique of costing, cost is made up of direct costs plus overhead cost absorbed on some
suitable basis.
Absorption costing is useful, if there is only one product, there is no inventory and overhead
recovery rate is based on normal capacity instead of actual level of activity.
Income Statement
Particulars Amt (Rs.) Amt (Rs.)

Sales ………….
(–) Cost of Goods Manufactured
Direct Material ………….
Direct Labout ………….
Factory Overheads ………….
Variable ………….
Fixed (at actual production basis)
(+) Value of Opening Stock ………….
(–) Value of Closing Stock at Current Cost ………….
(+) Under absorption – Overabsorption of ………….
fixed factory overheads …………. ………….
Gross Profit
(–) Administration, Selling and Distribution
Expenses
Fixed ………….
Variable ………….
Profit ………….
Features of Absorption Costing
1. All cost are categorized into fixed and variable costs. Variable cost per unit is same at any
level of activity. Fixed costs remain constant in total regardless of changes in volume.
2. Fixed costs are considered period costs are not included in product cost, only variable
costs are considered as product costs.
3. Stock of Work-in-progress and finished goods are valued at marginal cost of production.
4. In marginal process costing, products are transferred from one process to another are
valued at marginal costs only.
5. Prices are determined with reference to marginal cost and contribution margin.
6. Profitability of departments, products etc is determined with reference to their contribution
margin.
Profit Volume Ratio (P/V Ratio)
This ratio is a very useful figure as, it indicates profitability of the concern. It indicates the relation
of contribution to sales. This ratio shows a percentage relationship between profits and sales volume
only after fixed costs have been recorded and the break- even point has been reached. This ratio is
usually expressed in percentage.
This ratio is calculated by using the following formula
Sales – Total var iable cos t

1. P / V Ratio   100
Sales

Or
Total contribution
P / V Ratio   100
Sales
Net profit
2. P / V Ratio   100
Margin of safety
Change in profits
3. P / V Ratio   100
Change in sales
Significance of P/V Ratio

1. P/V ratio is considered to be the basic indicator of the profitability of the business.
2. The higher the P/V ratio, the better it is for the business. In case, a firm is enjoying steady
business conditions over a period of years, P/V ratio will also remain stable and steady.
3. If P/V ratio is improved, it will result in better profits.
Uses of P/V Ratio
1. To compute the variable costs for any volume of sales.
2. To measure the efficiency or to choose a most profitable time. The overall profitability of
the firm can be improved by increasing the sales/output of a product giving a higher P/
V ratio.
3. To determine break-even point and the level of output required to earn a desired profit.
4. To decide more profitable sales mix.
Improvement of P/V Ratio
P/V ratio can be improved by the following means
1. By reducing the variable cost.
2. By increasing the selling price.
3. By increasing the share of products with higher P/V ratio in the overall sales mix.
(Where a firm produces a number of products.
Break-even Analysis
Break-even analysis is a useful technique of profit planning and prediction. This analysis is
principally concerned with the study of revenues and costs of a firm in relation to profit at different levels
of sales. In fact break-even analysis is cost volume profit relationship analysis. It magnifies a set of
interrelationship of fixed cost, the level of activity and sales mix to the profitability of the concern.
Break-even Point
Break-even point may be described as that point of output and sales volume, at which total sales
revenue equals the total cost to make and sell the product and no profit or loss is reported. This is why
this point is also called as 'no profit, no loss point'. At this point the amount of contribution is equal to
fixed costs.
The significance of break-even point may be summarized as
Condition Impact
1 Sales< BEP Firm incurs losses i.e. Contribution < Fixed cost
2 Sales< BEP No profit and no loss i.e. Contribution = Fixed
cost
2 Sales> BEP Firms earn profits i.e. Contribution > Fixed cost

Total fixed cos ts

Break-even point (in units) = Contribution per unit
Total fixed cos ts

Break-even point (in units) = P / V ratio
Margin of Safety
Margin of safety represents the difference between the actual total sales and sales at break-even
point. It can be expressed as a percentage of total sales or in value or in terms of quantity.
On the break-even chart and profit-volume graph this is represented as the distance between the
break-even point and the present product sales.
Pr ofit
Margin of safety = P / V ratio
Pr ofit  Sales
Or
Contribution
Pr ofit percentage
Or P / V ratio × 100
Improvement in Margin of Safety

1. Increase in the selling price, provided the inelastic demand so as to absorb the increased
price.
2. Reduction in fixed expenses.
3. Reduction in variable expenses.
4. Increasing the sales volume.
5. Substitution or introduction of a product mix such that more profitable lines are introduced.
Cost Volume Profit Analysis
Cost volume profit analysis is the analysis of three variables viz cost, volume and profit, which
explores the relationship existing amongst cost, revenue, activity levels and the resulting profit.
In performing this analysis, there are several assumptions made, including
1. Sales price per unit is constant
2. Variable costs per unit is constant
3. Total fixed costs are constant
4. Everything produced is sold
5. Costs are only affected because activity changes
6. If a company sells more than one product, they are sold in the same mix.
3. Fund Flow Analysis
Meaning of Funds
In the broader sense, it includes all resources used in the business whether in the form of men,
material, money, machinery, methods etc. In the narrow sense, funds include only cash resources of the
business. But with reference to the preparation of the funds flow statement, it is referred to working
capital i.e. the difference between the current assets and current liabilities.
The following transactions will bring the change in the working capital

Current Assets and Non-current Assets

Whenever in any transaction one aspect affects the current assets and the other non-current
assets, there is flow in the working capital. e.g. when machinery is purchased for cash, non-current
assets will increase and current assets will reduce without any corresponding change in current liabilities.
So working capital will decrease.
Current Assets and Non-current Liabilities
If in any transaction, one aspect affect the current assets and the other non-current liabilities,
there will be flow in the working capital e.g. if equity shares are issued for cash, it will increase current
assets (cash) without any corresponding increase in current liabilities, there is increase in working
capital.
Current Liabilities and Non-current Liabilities
If in any transaction, one aspect affects the current liabilities and the other non-current liabilities,
there will be flow in the working capital. e.g. if debentures are issued to the creditors, it will increase the
non-current liabilities and decrease the current liabilities without any change in current assets; so there
will be increase in the working capital.
Current Liabilities and Non-current Assets
If in any transaction, one aspect the current liabilities and the other non-current assets, there is
flow in the working capital. e.g. if building is purchased on credit, it will increase the non-current assets
and also current liabilities; so there will be decrease in the working capital.
Significance of Fund flow statement
The basic purpose of fund flow statement is to reveal the changes in the working capital on the
two balance sheet dates. It also mention the sources from where additional working capital has been
financed and the uses to which working capital has been applied. It basically assess the growth of the
firm.
Procedure for preparing the Fund Flow Statement
In fund flow analysis, we can study about the change, which is effected between the two balance
sheet dates.
Hence, the preparation of fund flow consists of two parts
1. Schedule of changes in working capital
2. Statement of sources and application of funds

Schedule of Changes in Working Capital
Effect on Working
Particulars Previous Current Capital
year year increase Decrease
Current Assets
Cash in hand xxx xxx xx xx
Cash at Bank xxx xxx xx xx
Bills Receivable xxx xxx xx xx
Sundry Debtors xxx xxx xx xx
Marketable Investments xxx xxx xx xx
Stock/Inventory xxx xxx xx xx
Prepaid Expenses xxx xxx xx xx
Accrued income xxx xxx xx xx
A. Total Current Assets xxx xxx xx xx
Current Liabilities
Bills payable xx xx xx xx
Sundry Creditors xx xx xx xx
Outstanding Expenses xx xx xx xx
Bank Overdraft xx xx xx xx
Short-term Advances xx xx xx xx
Dividend payable xx xx xx xx
Proposed Dividend xx xx xx xx
Provision for Taxation xx xx xx xx
B. Total current Liabilities
C. Working Capital (A-B) xxx xxx
(Current assets - Current
liabilities
D. Net Increase or
Decrease in working xxx xxx
Capital

1. Statement Form
Fund flow Statement
Particulars Amt (Rs)
Sources of Fund
Funds from Operation xxx
Issue of Share Capital xxx
Raising of Long-term Loans xxx
Sale of Fixed Assets xxx
Sale of Investments xxx
Receipts from partly paid-up Shares xxx
Non-operating income (i.e. dividend, interest received) xxx
Decrease in working Capital xxx
Total xxx
Application of Funds
Funds lost in Operations xxx
Redemption of Debenture xxx
Redemption of preference Shares xxx
Repayment of Long-term Loans xxx
Purchase of Fixed Assets xxx
Purchase of an Investments xxx
Non-operating Expenses xxx
Payment of Dividends xxx
Payment of Tax xxx
Increase in Working Capital xxx
Total xxx
2. Account Form
Fund Flow Statement
(For the year ended on……)
Source Amt (Rs) Applications Amt(Rs)
Funds From
Operation xx Funds Lost in Operation xx
Redemption of
Issue of share xx preference xx
Share Capital
Redemption of
Issue of Debentures xx Debenture xx
Raising of Long-term xx Repayment of Long-term xx

Loans Loan
Purchase of Fixed
Receipts from partly xx Assets xx
paid-up Shares
Sale of Fixed Assets xx Purchase of an xx
Investment
Non-operating Expenses xx
Non-Operating
Income xx Payment of Dividends xx
Sale of Investments xx Payment of Tax xx

Net Decrease in xx Net Increase in Working xx
Working Capital Capital
xx xx

Computation of Funds from/Operations
Particulars Amt (Rs.)

Closing Balance of Profit and Loss A/c ×××
(As per as balance sheet)
(+) Non-cash and Non-Operating Item, which is Debited to
Profit and Loss A/c
(i) Depreciation and Depletion ×××
(ii) Amortisation of Intagible Assets and Ficititious
Assets, such as
(a) Preliminary Expenses ×××
(b) Goodwill ×××
(c) Patents ×××
(d) Trademarks ×××
(e) Copyright ×××
(f) Discount on issue of Shares or Deentures, etc. ×××
(iii) Appropriation of Retained Earning, such as
(a) Transfer to General Reserves ×××
(b) Dividend Equalisation Fund ×××
(c) Transfer to Sinking Fund ×××
(d) Contingency Reserves, etc. ×××
(iv) Loss on Sale of Fixed Assets, such as
(a) Sale of Land and Building ×××
(b) Sale of Machinery ×××
(c) Sale of Furniture ×××
(d) Sale of Long-term Investments, etc ×××
(v) Dividend, such as
(a) Interim Dividend ×××
(b) Proposed Dividend ×××
(if it is an appropriation of profit and not current liability)
(vi) Provision for Taxation (if not taken as current liabilities) ×××
(vii) Other Item of Non-cash and Non-operating Item ×××
Total (A)
(–) Non-cash and Non-operating Item, which are Credited
to Profit and Loss A/c
(i) Profit on Sale of Fixed Assets, such as
(a) Sale of Land and Building ×××
(b) Sale of Machinery ×××
(c) Sale of Long-term Investments ×××
(ii) Dividends Received
(iii) Excess Provision retransferred to Profit and Loss A/c or Written of
(vi) Any other Non-operating Item
(v) Opening Balance of Profit and Loss A/c (as given in the balance sheet) ×××
Total (B) ×××
3. (Total (A) – Total (B) Funds from Operation* ×××
*If the difference is positive, then it is classified as funds from operation, but if the difference is
negative, it is classified as funds lost in operation.
Computation of issue of Share Capital When the company issues their share then it can be
at par, premium and discount. As issue of share capital classified under the heading of sources of funds,
hence the actual realization will be as considered as amount against the issue of shares.

Issue of Debenture of Raising of Long-term Loans Proceeds from issue of debenture will be
taken into consideration and raising of loan against the current asset should be taken as generation of
funds.
Sale of Fixed Assets On the sale of fixed assets, the amount received as consideration is the
source of funds.
Non-operating Income The income generates from the non-operating source like rent from
property, interest from investment, dividend from investment, etc.
Decrease in Working Capital Decrease in Working capital of current year as compared to
previous year means the amount blocked in working capital is released.
Funds Lost in Operation When the business suffers losses from their trading operations.
Redemption of preference Share Capital The amount paid on the redemption of preference
share capital is considered as outflow of funds or application of fund. It can be at premium or discount,
hence amount should be taken into consideration.
Purchase of Fixed Assets The amount paid on purchase of fixed assets, such as land and
building, plant and machinery etc, will be considered as location of funds.
Payment of Dividend and tax Actual payment of dividend and tax will be deemed as application
of funds.
Notes :
1. Issue of bonus share will not be considered under the heading of sources of funds.
2. Shares issued for consideration other than cash will not be considered as sources of
funds.
3. Conversion of debenture into shares will not be considered as in flow of funds.
4. Loan raised for purchase of fixed asset should not be considered as source of fund.
5. Sale of fixed asset as exchange for other should not be taken into account as source of
funds.
6. If preference shares are redeemed in exchange of some other type of shares or debenture
as it does not constitutes out flow of funds, hence not taken as application of funds.
7. Here, declaration of dividends or creating of a provision for taxation will not be considered
as application of funds.
8. In case of sole proprietor, drawings considered as application of funds
4. Cash Flow Analysis.
A cash statements can be defined as a statement, which summaries sources of cash inflows
and uses of cash outflows of a firm during a particular period of time, say a month or a year. Such a
statement can be prepared from the data made available from comparative balance sheets, profit and
loss account and additional information.
Some feature of cash flow statements are :
1. Cash flow statement highlights the factors that bring in changes in cash position of an
enterprise.
2. Cash flow statement are prepared under three heads
(i) Cash Flow from Operating Activities
(ii) Cash Flow from Investing Activities
(iii) Cash Flow from Financing Activities
Uses of Cash Flow-Statement
1. Helps in Understanding Liquidity and Solvency
Cash flow statement helps to know whether the company is able to meet his liabilities or not.

2. Short-term Planning
Cash flow statement provides information about sources and application of cash and cash
equivalent for a specific period.
3. Efficient Cash Management
Cash flow statement provides the information about the surplus or deficit of cash. If there is
surplus then it can be invested in some short-term investment and in case of deficit it can be arrange
from short-term credit.
4. Reasons for Cash Position
Cash flow statement explains the reasons for lower and higher cash balances.
Limitations of Cash Flow Statement
1. Non-cash transactions are ignored.
2. Historical in nature.
3. Not a substitute for income statement
4. Fundamental accounting concepts ignored.
Note : Cash equivalents are short-term liquid investments that are readily convertible into cash.
It has a maturity period of 3 months or 10.
Cash Flows from Three Activites
Operating Investing Financing

Activities activities activities
Principal revenue Acquisition or Which change the size and

Producing activities of disposal of long-term composition of owner’s
The enterprise assets and other capital and borrowing of
investments the enterprise
Computation of Cash Flow from Operating Activities
Step-1 : Determine net profit before tax and extra ordinary item
Difference in the closing and opening balance xxx
of statement of profit and loss account
(+) Proposed dividend for the current year xxx

Interim dividend paid during the year xxx
Transfer to Reserves xxx
Provision for tax made during the year xxx
(-) Refund of Tax credited xxx
Extra ordinary items, if any credited to the xxx

statement of profits and loss account
Net profit before tax and extraordinary Items xxx
Step-2 : Adjust net profit before tax and extraordinary item for non-cash and non-operating Items.
Non-cash and Non operating Expenses Depreciation, interest on long-term borrowing, discount
on issue of shares or debentures written off, goodwill/patent/copyright, loss on sale of fixed assets or
investment, premium payable on redemption of preference shares or debentures are added back.
Non-operating Income and Gains Profit on sale of fixed assets and investments, interest, rent
or dividend received are deducted.
Step-3 : Adjust operating profit before working capital for changes in working capital
 Current assets and  Current liabilities are added.
Current assets and  Current liabilities are deducted.
Step-4 : deduct the income tax paid or add refund of income tax.
Step-5 : Add or deduct extra ordinary items.
Computation of Cash Flow from Investing Activities
Investing activities of an enterprise are acquisition and disposal of long- term assets and other
investments not included in cash equivalent.
Fixed Asset Account (At written down value)
Particulars Amt Rs Particulars Amt Rs

To Balance b/d xxx By bank A/c (Sale of xxx
fixed assets)
To Bank A/c (Purchases) xxx By Profit and Loss A/c xxx
(Loss on sale)
To Profit and Loss A/c xxx By Depreciation A/c xxx
(Profit on Sale) By Balance c/d xxx
xxx xxx
Fixed Assets At Cost
Amt Amt
Particulars Rs Particulars Rs
To Balance b/d xxx By bank A/c xxx
(Sale of fixed assets)
To Bank A/c xxx By Accumulated Depreciation xxx
(Purchases) A/c (Accumulated depreciation
or fixed assets sold)
To Profit and Loss xxx By Profit and Loss A/c xxx
A/c (Profit on Sale) (loss on sale xxx
By Balance c/d
xxx xxx
Accumulated Depreciation Account
Particulars Amt Rs Particulars Amt Rs

To Fixed Assets A/c xxx By Balance b/d xxx
(Accumulated
Depreciations on fixed
assets sold
To Balance b/d xxx By Profit and Loss A/c xxx

(Depreciation charged
for current year)
xxx xxx

Computation of Cash Flow from Financing Activities

Financing activities of an enterprise includes those activities which results change in the size and
composition of owner's capital and borrowing of the enterprise It includes proceeds from issue of shares
or other similar instruments, issue of debenture, loans, bonds, other short-term or long-term borrowing
and repayment of amounts borrowed.
Proposed Dividend
Of current year Of previous year
Add back to current year profit Deduct net dividend paid

Interim Dividend
Add to current year profits
Show as cash out flow from financing activities

Format of Cash Flow Statement (Indirect Method)
Particulars Amt (Rs.)

I. Cash Flow from Operating Activities
Net Profit as per Statement of Profit and Loss or difference between
Closing Balance and Opening Balance of Statement of Profit and
Loss Account
(+) Transfer to Reserves
Proposed Dividend for Current Year
Interim Dividend paid during the Year
Provision for Tax made during the Current Year
Extra ordinary item, if any, Debited to Statement of Pprofit and loss
Extra ordinary item, if any, Credited to Statement of Pprofit and loss
Refund of Tax Credited to Statement of Profit and Loss
Net Profit before Taxation and Extraordinary Item
Adjustment for Non-cash and Non-operating Items
(A) Net Profit before Taxation and Extraordinary Item
Adjustment for Non-cash and Non-operating Items
(B)
(+) Items to be Added
Depreciation
Preliminary Expenses/Discount on issue Shares and
Debenture written off
Interest or Borrowing and Debentures
Goodwill, Patents and Trademarks Amortised
Loss on Sale of Fixed Assets
(C)
(–) Items to Deducted
Interest Income
Dividend Income
Rental Income
Profiting Sale of Fixed Assets
(D) Operating Profit before Working Capital Changes (A + B – C)
(E)

(+) Decrease in Current Assets and

Increase in Current Liabilities
(F)
(–) Increase in Current Assets and
Decrease in Current Liabilities
(G) Cash Generated from Operation (D + E – F)
(–) H Income Tax Paid (Net of Tax refund received)
(I) Cash Flow before Extraordinary Items (+/–)
(J) Net Cash from (or used in) Operating Activities
II. Cash Flow Investing Activities
Proceeds from Sale of Fixed Assets
Proceeds from Sale of Investments
Proceeds from sale of Intangible Assets
Interest and Dividend Received
(for Non-financial Companies only)
Rent Income
Purchase of Fixed Assets
Purchase of Investments
Purchase of Intangible Assets like goodwill
Extraordinary Item (+/–) Net Cash from (or used in)
Investing Activities
III. Cash Flow From Financing Activities
Proceeds from lssue of Shares and Debentures
Proceeds from other Long-term Borrowing
Final Dividend paid
Interim Dividend paid
Interest on Debentures and Loans paid
Repayment of Loans
Redemption of Debentures/Preference Shares
Extraordinary Item (+/–)
Net Cash from (or used in) Financing Activities
IV. Net Increases/Decreases in Cash and Cash Equivalent (I + II + III)
(+) Cash and Cash Equivalents in the beginning of the Year
Cash in Hand
Cash at Bank
Short-term Deposits
Marketable Securities
V. Cash and Cash Equivalents at the End of the Year
Cash in Hand
Cash at Bank
(–) Bank Overdraft)
Short-term Deposits
Marketable Securities

Illustration From the following balance sheet of Reeta' Ltd. Prepare cash flow statement.
Liabilities 2011 2012 Assets 2011 2012

Equity Share Capital 4,50,000 5,00,000 Goodwill 1,10,000 90,000
Profit and Loss A/c 70,000 1,20,000 Building 1,50,000 2,00,000
Proposed Dividend 40,000 50,000 Plant 1,30,000 2,00,000
Creditors 70,000 95,000 Current Assets 2,50,000 3,07,000
Tax Provision 40,000 50,000 Cash 30,000 18,000

6,70,000 8,15,000 6,70,000 8,15,000
Additional Information
1. Income tax Rs. 38,000 was paid during the year.
2. Depreciation provided on plant during the year Rs. 30,000.
Cash Flow Statement
Particulars Amt (Dr) Amt (Cr)

A. Cash Flow from Operating Activities
Net-Profit before Tax 1,48,000
(+) Non-Cash and Non-operating Expenses
Depreciation on Plant 30,000
Goodwill written off 20,000
Operating Profit of Before Working Capital charges 1,98,000
(+) Increase in Creditors 25,000
(–) Increase in Current Assets (57,000)
Cash in Operating Activities 1,66,000
(–) Payment of Tax 38,000
Cash Inflow from Operating Activities
B. Cash Flow from Investing Activities 1,28,000
Purchase of Building 50,000
Purchase of Plant (1,00,000)
Cash Outflow from Investing Activities (1,50,000)
C. Cash Flow from Financing Activities
Issue of Equity Shares 50,000
Payment of Proposed Dividend -40,000
Cash Outflow from Financing Activities 10,000
Net Decrease in Cash and Cash (12,000)
equivalents (A + B + C)
(+) Opening balance of Cash and Cash Equivalents 30,000
Closing Balance of Cash and Cash Equivalent 18,000
Working Notes
Calculation of Net Profit before Tax
Increase in Profit and Loss A/c 50,000
(+) Proposed Dividend 50,000
Provision for Tax 48,000
Net Profit before Tax 1,48,000

Dr Plant Account Cr
Particulars Amt (Rs) Particulars Amt(Rs)

To Balance b/d 1,30,000 By Depreciation A/c 30,000
To Bank A/c (Purchase 1,00,000 By Balance c/d 2,00,000

2,30,000 2,30,000
Dr Provision for Tax Account Cr
Particulars Amt (Rs) Particulars Amt (Rs)

To Bank A/c (Tax paid) 38,000 By Balance b/d 40,000
To Balance c/d 50,000 By Profit and Loss A/c 48,000

88,000 88,000
5. Standard Costing
Standard costing is a system of accounting, in which all expenses (fixed and variable) are
considered for the determination of standard cost for a prescribed set of working conditions.
Standard Cost
Standard cost is defined as a pre-determined cost, which is calculated from management standards
of efficient operation and the relevant necessary expenditure. It may be used as a basis for price fixing
and for cost control through variance analysis.
Features of Standard Costing
1. Predetermined estimates.
2. Established for inputs and outputs.
3. Applicable to all routine aspects of an organisation operations.
4. Accounting for standard costs and obtaining variance.
5. Reporting to management for taking appropriates action wherever necessary.
Types of Standard
1. Ideal Standards These represent the levels of performance attainable, when prices for
material and labour are most favourable, when the highest output is achieved with the best
equipment and layout, when the maximum efficiency in utilization of resources results in
maximum output with minimum costs.
2. Normal Standards Normal standards are the standards, which may be achieved under
normal operating conditions. The normal activity has been defined as "the number of
standard hours, which will produce at normal efficiency sufficient goods to meet the
average sales demand over a term of years". These standards are difficult to set, because
they require a degree of forecasting.
3. Basic Standards These standards are used only, when they are likely to remain constant
or unaltered over a long period. According to this standard, a base year is chosen for
comparison purpose in the same way as statisticians use price indices.
4. Current Standards These standards reflects the management anticipation of what actual
costs will be for the current period. These are the costs, which the business will ensure,
if the anticipated prices are paid for the goods and services and the usage correspond
to that believed to be necessary to produce the planned output. The variances arising from
expected standard represent the degree of efficiency in usage of the factors of production.

Uses of Standard Costs

1. Use of standard cost is an effective way for planning and controlling costs.
2. Pricing decisions and decisions involving submission of questions, answering tenders etc,
are also facilitated by the use of standard costs.
3. Facilitates management by exception.
4. Identification and measurement of variances from standards has been made possible with
the use of standard cost, with a view to improve performance or to correct loose standard,
if any.
Process of Standard Costing
The following preliminaries should be gone through before a standard costing system is established
1. Establishment of Cost Centres
2. Types of Standards
3. Setting the Standards
Establishment of Cost Centres It is necessary for fixing responsibilities for unfavourable variances.
Types of Standards Three types of standards (current, basic, normal).
Setting the standards Of all the persons, the cost accountant plays a very important role n
setting the standards because he is to supply the necessary cost figures and coordinate the activities
of the committee, so that standards set are as accurate as possible.
Types of Variance
Variance
Controllable Un-Controllable
Variances which can be controlled Variances which are beyond the

By the departmental head control of departmental head
Variances can be computed under the following cost heads :
1. Material In the manufacturing industry, the main expenditure head is the material. There are
two types of variances are calculated they are
(i) Material Usage Variance
(ii) Material Price Variance
Material Usage Variance
= Standard price x Standard quantity - Standard price x Actual quantity
= Standard price (Standard quantity - Actual quantity)
Material Price Variance
= Actual quantity x Standard price - Actual quantity x Actual price
= Actual quantity x (Standard price - Actual price)
 Note How to learn the above formula
SQ×SP AQ×SP AQ×AP
Material usage Variance Material price variance
Material Cost Variance

Here, SQ Standard Quantity, AQ Actual Quantity

SP Standard Price, AP Actual Price
2. Labour Second important component in manufacturing expenses is amount spent on labour.
The variance computed under this head are as under
(i) Labour Efficiency Variance
(ii) Labour Rate Variance
Labour Efficiency Variance
Standard rate x Standard hours - Standard rate x Actual hours
= Standard rate x (Standard hours - Actual hours)
Labour Rate Variance
= Actual hours x Standard rate - Actual hours x Actual rate
= Actual hours x (Standard rate - Actual rate)
 Note How to learn the above formula's
SH×SR AH×SR AH×AR
Labour efficiency variance Labour rate variance
Labour Cost Variance

Here, SH standard Hour, SR Standard rate
AH Actual Hour, AR Actual Rate
3. Overheads
Overheads
Variable Fixed
Variable Overhead
Variable overhead represents the other manufacturing expenses. It depends upon working hours.
The following are the variances computed
(i) Variable Overhead Efficiency Variance
(ii) Variable Overhead Expenditure Variance
Variable Overhead Efficiency Variance
= Standard hours × Standard rate – Actual hours × Standard rate
= Standard rate (Standard rate – Actual hours)
Variable Overhead Expenditure Variance
= Actual hours x Standard rate - Actual overhead
 Note How to learn the above formula
SH×SR AH×SR Actual overhead
Efficiency variance Expenditure variance
Variable overhead variance

Here, SH Standard Hours, SR Standard Rate
AH Actual Hours
Fixed Overhead
Fixed overhead are the types of manufacturing expenses, which remains fixed over a period of
time. It does not depend upon working hour.
The following types of variance computed under this head
1. Efficiency Variance
2. Capacity Variance
3. Calendar Variance
4. Volume Variance
5. Expenditure Variance
Fixed Overhead Efficiency Variance
= Standard Hour × Standard rate – Actual hour × Standard rate
= Standard rate × Standard hour – Actual hour
Fixed Overhead Capacity Variance
Actual hour × Standard rate – Calendar hour x Standard rate
Standard rate × (Actual hour – Calendar hour)
Fixed Overhead Calendar Variance
= Calendar hour × Standard rate – Budgeted overhead
Fixed Overhead Volume Variance
= Standard hour × Standard rate - Budgeted overhead Or
= Can be derived as efficiency variance + Capacity variance + Calendar variance
Hence, Standard hour x Standard rate - Budgeted overhead
Fixed Overhead Expenditure Overhead
= Budgeted overhead - Actual overhead
 Note How to learn the above formula's
Budgeted Actual
SH × SR AH × SR CH × SR overhead overhead
Efficiency Capacity Calender Expenditure

variance variance variance variance
Volume Variance
Fixed Overhead Variance
Here, SH Standard Hour, SR Standard Rate

AH Actual Hour, CH Calendar Hour
Calendar Hours are the maximum possible hours worked in actual number of days. Standard
hours are the hours for actual production.
6. Budgetary Control
Budget
According to CIMA, England, "A financial and/or quantitative statement, prepared and approved
prior to a defined period of time of the policy to be pursued during that period for the purpose of attaining
a given objective. It may include income, expenditure and employment of capital.

Determining the objective to be achieved
Activities for achievement of objective
Drawing-up a plan
Laying out a system for

comparing of actual performance
Corrective action
Procedure of budgetary control

Objectives of Budgetary Control System
1. Determining targets of performance for each section of the business.
2. Laying down the responsibilities of each of the executives so, that every one known what
is expected of him and how will be judged.
3. Providing a basis for the comparison of actual performance with the predetermined targets
and investigation of deviation, if any.
4. Ensuring the best use of all available resources to maximize profit or production subject
to the limiting factors.
5. Providing a basis for revision for current and future policies.
6. Coordinating the various activities of business.
Essentials of Budgetary Control
The essentials of budgetary control are given below
 Establishment of budgets are for each function given below and section of the organisation.
 Continuous comparison of the actual performance with that of the budget, so as to know
the variations from budget and placing the responsibly of executives for failure to achieve
the desired result as given in the budget.
 Taking suitable remedial action to achieve the desired objective, if there is a variation of
the actual performance from the budgeted performance.
 Revision budgets in the light of changed circumstances.
Working of a Budgetary Control system
The responsibility for successfully introducing and implementing a budgetary control system rests
with the budget committee acting through the budget officer. The budget committee would be composed
of all functional heads and a member from the board to preside over and guide the deliberation.
Components of Budgetary Control System
The policy of a business for a defined period is represented by the master budget, the details of
which are given in a number of individual budgets called functional budgets.
The functional budgets are broadly grouped under the following heads :
1. Physical Budget The budget which contains information in terms of physical units about
sales, production, etc.
2. Cost Budget Budget, which provides cost information in respect of manufacturing, selling,
administration, etc.
3. Profit Budget A budget which enables in the ascertainment of profits.

Conventional Budgeting
Conventional budgeting is done in any organisation to compute the maximum amount given to
each department for a year. The main disadvantage of this budgeting is that the inefficiencies of the
previous year creep into this year's budget. In such a budget, justification is to be given only for now or
additional funds required.
Types of Budget by Functions

Production budget
Direct material usage budget
Direct material purchase budget
Direct labour budget
Factory overhead budget
Production cost budget
Inventory budget
Cost of goods sold Budget
Production Budget
Particulars Amt (A) Amt (B)

Budgeted Sales ×× ××
(+) Closing Stock Desired ×× ××
Total Quantity Required ×× ××
(–) Opening Stock (××) (××)
Units to be Produced ×× ××
Direct Material Usage Budgets
Total
Types of Material Cost Total Cost of
Direct Material Material
Material Per Unit Material Used
Usage
Product A Product B
Direct Labour Cost Budget
Units to be Labour Hour Total Budgeted

Product Total Hours
Produced Per Unit Cost
Direct Material Purchase Budget

Material X Material Y
Particulars
(Units) (Units)
Desired Closing Stock ×× ××
(+) Production Required ×× ××
Total Requirement ×× ××
(–) Opening Stock (××) (××)
A. Units to be Purchased ×× ××
B. Unit Price × ×
C. Purchase Cost (A × B) ×× ××

Factoring Overhead Budget

Particulars
Variable Overhead ××
(+) Fixed Overhead ××
Total Factory Overhead ××
Inventory Budget
Type Units Unit Cost Amt (Rs) Toal
Direct Material
X
Y
Z
Finished Goods
A
B
Total
Cost of Goods Sold Budget
Particulars Amt(Rs)
Direct Material (a) ××
Direct Labour (b) ××
Factory Overhead (c) ××
Total Manufacturing (a+b+c) ××
(+) Finished Goods (Opening) ××
(–) Finished Goods (Closing) ××
Total Cost of Goods Sold ××
7. Costing for Decision-Making
Key Factor or Limiting Factor
Key factor is that factor, which is most important one for taking decisions about profitability of a
product. A key factor or limiting factor is a factor which limits production or sales and thus, prevent the
company from making unlimited profits. The limiting factor may be raw material, labour, plant capacity,
capital, etc. The extent of its influence must be assumed first so, as to maximize the profits. On the
basis of contribution, the decision regarding the product mix is taken.
Thus, profitability can be measured by
Contribution
Key factor
Fixation of Selling Price
Marginal cost of a product represents the minimum price for that product and any sale below the
marginal cost would entail a cash loss. The price for the product should be fixed at a level which not
only covers the marginal cost, but also makes a reasonable contribution towards the common fund to
cover fixed overheads. The fixation of such price for a product would be easier, if its marginal cost and
overall profitability of the concern is known.
Maintaining a Desired level of profit
The industry has to cut prices of its products from time to time on account of competition,
government regulations and other compelling reasons. The contribution per unit on account of such
cutting is reduced, while the industry is interested in maintaining a minimum level of its profits. In case,

the demand for the company's product is elastic, the minimum level of profits can be maintained by
pushing-up the sales.
Determination of Sales Mix
When an organisation manufactures more than one product then a problem often arises as to
the product mix or sales mix which will yield the maximum profits. In determining the profitable sales mix,
the product, which gives the maximum contribution are to be retained and their production should be
increased. A product giving a negative contribution should be discontinued or given-up, unless there are
other reasons to continue production.
Exploring new Markets
Decision regarding selling goods in a new market whether Indian or foreign should be taken after
considering the following factors
1. Whether the firm has surplus capacity to meet the new demand ?
2. What price is being offered by new market ?
3. Whether the sale of goods in new market will affect the present market for the goods ?
It is particularly true in case of sale of goods in a foreign market at a price lower than the domestic
market at a price. Before accepting such an order from a foreign buyer, it must be seen that the goods
sold are not dumped in the domestic market itself.
Discontinuance of a product Line
The following factors should be considered before taking a decision about the discontinuance of
a product line
1. The contribution given by the product.
2. The Capacity utilization.
3. The availability of product to replace the product which the firm want to discontinue and,
which is already accounting for a significant proportion of total capacity.
4. The long-term prospects in the market for the product.
5. The effect on sale of other products.
Making or Buy Decision
Whether a particular part of a finished product is to be manufactured within the industry or it has
to be bought from outside will depend on the consideration of marginal costs. The marginal cost of
manufacturing is to be compared with the purchase price of the relevant material and if the marginal cost
is more than the purchase price, a decision as to buying it from the market can be taken. However, there
are certain non-cost factors also which must be taken into account before making a final decision.
The factors are as under :
1. The part to be bought should be available whenever it is needed and at the same price
at which we are considering to buy it at present.
2. If there is difference in quality, specification etc of the component to be bought, it must be
workable.
3. If production is not carried out, labour problems should not occur up. The surplus labour
force should be absorbed in other productive work.
Profit Planning
Marginal costing techniques can be applied for profit planning as well. Profit planning involves the
planning of future operations to achieve maximum profits or to maintain a desired level of profits. With
the help of marginal costing, the required value of sales for maintain or attaining a desired level of profit
may be ascertained as follows:
Fixed cos t  Disired Pr ofit
Desired sales = P / V ratio

SAMPLE QUESTIONS
1. Assertion (A) : Legal fee paid to acquire any property is part of the cost of that property.
Reason (R) : Legal fee is incurred to posses the ownership right of that property and hence, a
capital expenditure.
Codes :
(A) Both A and R are true and R is the correct explanation of A
(B) Both A and R true, but R is not the correct explanation of A
(C) A is true, but R is false
(D) A is false, but R is true
2. Accounting principles are divided into two types. These are :

(A) Accounting Concepts (B) Accounting Conventions
(C) Accounting Standard (D) (A) and (B) both
3. Assertion (A) : General reserve is created by appropriation of profits without any specific or
particular purpose.
Reason (R) : The aim of general reserve is to provide additional working capital or to strengthen
the cash resources of the business.
Codes :
(A) Both A and R are true and R is the correct explanation of A
(B) Both A and R true, but R is not the correct explanation of A
(C) A is true, but R is false
(D) A is false, but R is true
4. Which of the following equation is related with Dual Aspect Concept ?

(A) Total Assets = Total Liabilities
(B) Total Assets = Capital + Outsider’s Liabilities
(C) Capital = Total Assets – Outsider’s Liabilities
(D) All of the above
5. Recording of capital contributed by the owner as liability ensures the adherence of principle of :
(A) Double entry (B) Going concern
(C) Separate entity (D) Materiality
6. From the given information calculated working capital

Fixed assets = Rs. 40,000
Current ratio = 1.2 : 1
Proprietary ratio = 0.75
Proprietary fund = Rs. 75,000
(A) Rs. 25,000 (B) RS. 20,000
(C) RS. 10,000 (D) Rs. 5,000

7. Which expense is of a Capital Nature ?

(A) Depreciation (B) Wages
(C) Salary (D) Stationary
8. XYZ holds an average inventory of Rs. 36,000 (CP) with an inventory turnover of 5 times. If the
firm makes a gross profit of 25% on sales. Find the total sales of the company.
(A) Rs. 2,40,000 (B) Rs. 2,10,000
(C) RS. 2,00,000 (D) RS. 1,80,000
9. Which of the following practices is not consonance with the convention of conservatism?
(A) Creating provision for bad debts
(B) Creating provisions for discount or creditors
(C) Creating provisions for discount on debtors
(D) Creating provisions for tax
10. Dividend can be declared from :

(A) Revenue Profit (B) Capital Profit
(C) Secret Reserve (D) All of these
ANSWER KEYS
1 2 3 4 5 6 7 8 9 10
A D A D C C A A B A

SOLUTIONS
1. (A) Both A and R are true and R is the correct explanation of A

2. (D) (A) and (B) both
3. (A) Both A and R are true and R is the correct explanation of A
4. (D) All of the above
5. (C) This ensure the adherence of principle of the “separate entity” or “Business entity concept”
which requires the business to be treated as distinct from the person who own it, then
it becomes possible to record transactions of the business with the proprietor also. Without
such a distinction, the affairs of the firm will be mixed up with the private affairs of the
proprietor and true picture of the firm will not be available.
6. (C) Rs. 10,000
7. (A) Depreciation
8. (A) Rs. 2,40,000
9. (B) The principle of conservation seeks provisions for all the probable losses. Creating provision
for discount on creditors tantamount to recognition of probable gain in the form of discount
and hence it is not in consonance with conservatism.
10. (A) Revenue Profit

Sample Theory With Ques. - Ratio Analysis (COMM. UNIT-2)

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Sample Theory With Ques. - Ratio Analysis (COMM. UNIT-2)

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1. COST AND MANAGEMENT ACCOUNTING

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Operating Profit (net margin)

Net Operating Profit

Operating profit means profit before interest and tax.

Capital employed = Share Capital + Reserve and Surplus + Long –

Net Profit After Interest and Tax

Net Profit Tax

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Cost of Good Sold Sales

Opening stock+12 months figures-Closing stock

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Sale or Cost of goods sold

This analysis will throw a better light on the inventory position.

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Generally 2 : 1 ratio is considered ideal for a concern.

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Liquid Ratio = (Liquid Assets)/(Liquid Liabilities)

Net Profit before Interest and Tax

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Fixed Interest Bearing Funds

Market Value Per Equity Share

Dividend Per Equity Share

Dividend Per Share

2. Marginal Costing and Break - even Analysis

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It is technique of decision-making, which involves

B Total Variable Cost xx x

D Total Fixed Cost xx x

Particulars Amt (Rs.) Amt (Rs.)

Sales – Total var iable cos t

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Significance of P/V Ratio

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Total fixed cos ts

Total fixed cos ts

Improvement in Margin of Safety

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Current Assets and Non-current Assets

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Schedule of Changes in Working Capital

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Raising of Long-term xx Repayment of Long-term xx

Sale of Investments xx Payment of Tax xx

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Computation of Funds from/Operations

Particulars Amt (Rs.)

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Operating Investing Financing

Principal revenue Acquisition or Which change the size and

(+) Proposed dividend for the current year xxx

(-) Refund of Tax credited xxx

Extra ordinary items, if any credited to the xxx

Net profit before tax and extraordinary Items xxx

Particulars Amt Rs Particulars Amt Rs

Accumulated Depreciation Account

Particulars Amt Rs Particulars Amt Rs

To Balance b/d xxx By Profit and Loss A/c xxx

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Computation of Cash Flow from Financing Activities

Of current year Of previous year