c
c


 p c
In drawing up accounting statements, whether they are external "financial accounts" or internally-focused "management accounts", a
clear objective has to be that the accounts fairly reflect the true "substance" of the business and the results of its operation.
The theory of accounting has, therefore, developed the concept of a a


a. The true and fair view is applied in ensuring
and assessing whether accounts do indeed portray accurately the business' activities.
To support the application of the "true and fair view", accounting has adopted certain concepts and conventions which help to ensure
that accounting information is presented accurately and consistently.
c 
The most commonly encountered convention is the   . This requires transactions to be recorded at the
price ruling at the time, and for assets to be valued at their original cost.
Under the "historical cost convention", therefore, no account is taken of changing prices in the economy.
The other conventions you will encounter in a set of accounts can be summarized as follows:
 Accountants do not account for items unless they can be quantified in monetary terms. Items that are not accounted for
  (unless someone is prepared to pay something for them) include things like workforce skill, morale, market leadership,
brand recognition, quality of management etc.
 This convention seeks to ensure that private transactions and matters relating to the owners of a business are segregated

 from transactions that relate to the business.

! With this convention, accounts recognise transactions (and any profits arising from them) at the point of sale or transfer
of legal ownership - rather than just when cash actually changes hands. For example, a company that makes a sale to a
customer can recognise that sale when the transaction is legal - at the point of contract. The actual payment due from
the customer may not arise until several weeks (or months) later - if the customer has been granted some credit terms.

 An important convention. As we can see from the application of accounting standards and accounting policies, the
preparation of accounts involves a high degree of judgment. Where decisions are required about the appropriateness of
a particular accounting judgment, the "materiality" convention suggests that this should only be an issue if the judgment
is "significant" or "material" to a user of the accounts. The concept of "materiality" is an important issue for auditors of
financial accounts.
c 
Four important accounting concepts underpin the preparation of any set of accounts:
 Accountants assume, unless there is evidence to the contrary, that a company is not going broke. This has important
 implications for the valuation of assets and liabilities.
 Transactions and valuation methods are treated the same way from year to year, or period to period. Users of accounts
can, therefore, make more meaningful comparisons of financial performance from year to year. Where accounting
policies are changed, companies are required to disclose this fact and explain the impact of any change.
" Profits are not recognised until a sale has been completed. In addition, a cautious view is taken for future problems and
costs of the business (they are "provided for" in the accounts" as soon as there is a reasonable chance that such costs
will be incurred in the future.
 Income should be properly "matched" with the expenses of a given accounting period.

Ñ p # is a term describing a range of accounting systems designed to correct problems arising from historical cost
accounting in the presence of inflation. Inflation accounting is used in countries experiencing high inflation or hyperinflation. For
example, in countries experiencing hyperinflation the International Accounting Standards Board requires corporate financial
statements to be adjusted for changes in purchasing power using a price index.

ÿ p   ! c recognizes a variety of human resources and shows them on a company's balance sheet. Under
human resource accounting, a value is placed on people based on such factors as experience, education, and psychological traits,
and, most importantly, future earning power (benefit) to the company. The idea has been well received by human-resource-
oriented firms, such as those engaged in accounting, law, and consulting. Practical application is limited, however, primarily
because of difficulty and the lack of uniform, consistent methods of quantifying the values of human resources.

- p D$%#$&
rery often these two terms are considered identical but there is significant difference between these two terms. Intangible assets
refer to those fixed assets that have no physical status at all viz goodwill, patent right, copyright, etc. The Intangible assets are
written off after a specified period Fictitious assets also have no physical existence but they only include the assets having the
nature of differed revenue expenditures viz, differed advertisement expenses, and discount on issue of shares or debentures. These
are the assets out of which benefit or profit for more than one accounting is availed. The main reason for confusion is that both
have no physical status but the discussions above are big enough for all to understand the difference between the two terms.

‰ p ! is a method of analyzing data to determine the overall financial strength of a business. Financial analysts take the
information off the balance sheets and income statements of a business and calculate ratios that can then be used to make
assessments of the operating ability and future prospects of that business. These ratios are useful only when compared to other
ratios, such as the comparable ratios of similar businesses or the historical trend of a single business over several business cycles.
There are various ratios that measure a company's efficiency, short-term strength, profitability, and solvency.

  p £ £%   summarize a firm¶s inflow and outflow of funds. Simply put, it tells investors where funds have come
from and where funds have gone. The statements are often used to determine whether companies efficiently source and utilize
funds available to them. Fund flow statements are prepared by taking the balance sheets for two dates representing the coverage
period. The increases and decreases must then be calculated for each item. Finally, the changes are classified under four
categories: (1) Long-term sources, (2) long-term uses, (3) short-term sources, (4) short-term uses. Fund flow statements can be
used to identify a variety of problems in the way a company operates. For example, companies that are using short-term money to
finance long-term investments may run into liquidity problems in the future. Meanwhile, a company that is using long-term
money to finance short-term investments may not be efficiently utilizing its capital.

å p The è' is, in general, the point at which  ( . The point where sales or  ( ). Or also the point
where (. There is no profit made or loss incurred at the break-even point. This is important for anyone that manages a
business since the break-even point is the lower limit of profit when setting prices and determining margins.
Breaking even today does not return the losses occurred in the past, or build up a reserve for future losses, or provide a return on your investment (the
reward for exposure to risk).
The è'  can be applied to a á
, an 
 , or the  
á 's operations and is also used in the
á

world. In options,
the break-even point is the market price that a stock must reach for option buyers to avoid a loss if they exercise. For a call, it is the strike price plus the
premium paid. For a put, it is the strike price minus the premium paid.
 p cè *cè + is an accounting technique that allows an organization to determine the actual cost associated with each product and
service produced by the organization without regard to the organizational structure. It is developed to provide more-accurate ways of assigning the costs
of indirect and support resources to activities, business processes, products, services, and customers. ABC systems recognize that many organizational
resources are required not for physical production of units of product but to provide a broad array of support activities that enable a variety of products
and services to be produced for a diverse group of customers. The goal of ABC is not to allocate common costs to products. The goal is to measure and
then price out all the resources used for activities that support the production and delivery of products and services to customers.

* p  is a pricing method used by firms. It is defined as "a cost management tool for reducing the overall cost of a product over its entire life-
cycle with the help of production, engineering, research and design". A target cost is the maximum amount of cost that can be incurred on a product and
with it the firm can still earn the required profit margin from that product at a particular selling price.

, p !$  is an underlying concept of accounting performance measurement systems. The basic idea is that large diversified
organizations are difficult, if not impossible to manage as a single segment, thus they must be decentralized or separated into manageable parts. These
parts, or segments are referred to as responsibility centers that include: 1) revenue centers, 2) cost centers, 3) profit centers and 4) investment centers. This
approach allows responsibility to be assigned to the segment managers that have the greatest amount of influence over the key elements to be managed.
These elements include revenue for a revenue center (a segment that mainly generates revenue with relatively little costs), costs for a cost center (a
segment that generates costs, but no revenue), a measure of profitability for a profit center (a segment that generates both revenue and costs) and return
on investment (ROI) for an investment center (a segment such as a division of a company where the manager controls the acquisition and utilization of
assets, as well as revenue and costs).

 p  - The vital aspect of managerial control is cost control. Hence, it is very important to plan and control costs. Standard costing is a
technique which helps you to control costs and business operations. It aims at eliminating wastes and increasing efficiency in performance through
setting up standards or formulating cost plans.


 
 c
c

 p cc"- The common set of accounting principles, standards and procedures that companies use to compile their financial statements. GAAP are a
combination of authoritative standards (set by policy boards) and simply the commonly accepted ways of recording and reporting accounting
information. GAAP are imposed on companies so that investors have a minimum level of consistency in the financial statements they use when
analyzing companies for investment purposes. GAAP cover such things as revenue recognition, balance sheet item classification and outstanding share
measurements.

Ñ p The resources controlled by a business are referred to as its assets. For a new business, those assets originate from two possible sources:
p Investors who buy ownership in the business
p Creditors who extend loans to the business
Those who contribute assets to a business have legal claims on those assets. Since the total assets of the business are equal to the sum of the assets contributed
by investors and the assets contributed by creditors, the following relationship holds and is referred to as the accounting equation :
Assets = Liabilities + Owners' Equity
Resources Claims on the Resources

ÿ p £  is defined as the process of identifying financial strengths and weaknesses of the firm by properly
establishing relationship between the items of the balance sheet and the profit and loss account. There are various methods or
techniques that are used in analyzing financial statements, such as comparative statements, schedule of changes in working
capital, common size percentages, funds analysis, trend analysis, and ratios analysis.
(#£ c-
1.p Horizontal and rertical Analysis
2.p Ratios Analysis

- p c- A type of accounting process that aims to capture a company's costs of production by assessing the input costs
of each step of production as well as fixed costs such as depreciation of capital equipment. Cost accounting will first measure and
record these costs individually, then compare input results to output or actual results to aid company management in measuring
financial performance.

‰ p   c: Process of preparing management accounts that provide accurate and timely key financial and
statistical information required by managers to make day-to-day and short-term decisions. Unlike financial
accounting (which produces annual reports mainly for external stakeholders such as creditors, investors,
and lenders) management accounting generates monthly or weekly reports for the firm's internal audiences such
as department managers and the chief executive officer. These reports typically show the amount of available cash, sales
revenue generated, amount of orders in hand, state of accounts payable and accounts receivable, outstanding debts, raw
material and in-process inventory, and may also include trend charts, variance analysis, and other statistics. Also
called managerial accounting.

  p Dc- Depreciation is defined as the reduction in the value of a product arising from the passage of time due
to use or abuse, wear and tear. Depreciation is not a method of valuation but of cost allocation. This cost allocation can be based
on a number of factors, but it is always related to the estimated period of time the product can generate revenues for the company
(economic life). Depreciation expense is the amount of cost allocation within an accounting period. Only items that lose useful
value over time can be depreciated. That said, land can't be depreciated because it can always be used for a purpose.
p p
å p è-A control technique whereby actual results are compared with budgets. Any differences (variances) are made
the responsibility of key individuals who can either exercise control action or revise the original budgets.

 p r - To analyze the specific activities through which firms can create a competitive advantage, it is useful to model the
firm as a chain of value-creating activities. Michael Porter identified a set of interrelated generic activities common to a wide
range of firms. The resulting model is known as the  and is depicted below:
" r c

$
$ '

/
 / / / 
. . 0

The goal of these activities is to create value that exceeds the cost of providing the product or service, thus generating a profit
margin.

* p ! #D ': A relevant cost or benefit is one that will be affected by the decision. This means that the
following can be disregarded as they are irrelevant in the decision-making process:

ùp Fixed overheads. These will be incurred regardless of the decision.

ùp otional costs. For example, notional rent - these costs are only a book exercise and do not represent a real cash flow.
ùp Past or sunk costs. These have already happened, so they cannot be affected by a future decision. It is vital to note that
relevant costs are always future costs.
ùp Book values. Similar to sunk costs. For example, the price paid for stock in the past is not a relevant cost to the decision.

, p   sometimes called marginal or differential analysis is used to analyze the financial information needed for
decision making. It identifies the relevant revenues and/or costs of each alternative and the expected impact of the alternative on
future income.p
 r "#c
r #*CrP+1managerial economics is a form of cost accounting. # 1## 
#
Cost-volume-profit (CrP) analysis expands the use of information provided by breakeven analysis. A critical part of CrP analysis is
the point where total revenues equal total costs (both fixed and variable costs). At this breakeven point (BEP), a company will
experience no income or loss. This BEP can be an initial examination that precedes more detailed CrP analysis.
Cost-volume-profit analysis employs the same basic assumptions as in breakeven analysis. The assumptions underlying CrP analysis
are:
The behavior of both costs and revenues is linear throughout the relevant range of activity. (This assumption precludes the concept of
volume discounts on either purchased materials or sales.) Costs can be classified accurately as either fixed or variable. Changes in
activity are the only factors that affect costs. All units produced are sold (there is no ending finished goods inventory). When a
company sells more than one type of product, the sales mix (the ratio of each product to total sales) will remain constant.
The components of Cost-rolume-Profit Analysis are:
p Level or volume of activity
p Unit Selling Prices
p rariable cost per unit
p Total fixed costs
p Sales mix
c 
CrP assumes the following:
p Constant sales price;
p Constant variable cost per unit;
p Constant total fixed cost;
p Constant sales mix;
p Units sold equal units produced.
These are simplifying, largely linearizing assumptions, which are often implicitly assumed in elementary discussions of costs and
profits. In more advanced treatments and practice, costs and revenue are nonlinear and the analysis is more complicated, but the
intuition afforded by linear CrP remains basic and useful.
One of the main Methods of calculating CrP is Profit volume ratio: which is (contribution /sales)*100 = this gives us profit volume
ratio.
p contribution stands for Sales minus variable costs.
Therefore it gives us the profit added per unit of variable costs.

è
Basic graph of CrP, demonstrating relation of Total Costs, Sales, and Profit and Loss
The assumptions of the CrP model yield the following linear equations for total costs and total revenue (sales):

These are linear because of the assumptions of constant costs and prices, and there is no distinction between Units Produced and Units
Sold, as these are assumed to be equal. ote that when such a chart is drawn, the linear CrP model is assumed, often implicitly.
In symbols:

where
p  =  
p £ = £) 
p r = r$  (r$ )
p l =  $#
p ! =  = ! = 
p " = *+"
Profit is computed as TR-TC; it is a profit if positive, a loss if negative.
è'%
Costs and Sales can be broken down, which provide further insight into operations.

Decomposing Total Costs as Fixed Costs plus rariable Costs.

One can decompose Total Costs as Fixed Costs plus rariable Costs:
Decomposing Sales as Contribution plus rariable Costs.
Following a matching principle of matching a portion of sales against variable costs, one can decompose Sales as Contribution plus
rariable Costs, where $ is "what's left after deducting variable costs". One can think of contribution as "the marginal
contribution of a unit to the profit", or "contribution towards offsetting fixed costs".
In symbols:

where
p =  $* +

Profit and Loss as Contribution minus Fixed Costs.

Subtracting rariable Costs from both Costs and Sales yields the simplified diagram and equation for Profit and Loss.
In symbols:
Diagram relating all quantities in CrP.
These diagrams can be related by a rather busy diagram, which demonstrates how if one subtracts rariable Costs, the Sales and Total
Costs lines shift down to become the Contribution and Fixed Costs lines. ote that the Profit and Loss for any given number of unit
sales is the same, and in particular the break-even point is the same, whether one computes by Sales = Total Costs or as Contribution =

Fixed Costs. Mathematically, the contribution graph is obtained from the sales graph by a shear, to be precise , where r are
Unit rariable Costs.
c
CrP simplifies the computation of breakeven in break even analysis, and more generally allows simple computation of Target Income
Sales. It simplifies analysis of short run trade-offs in operational decisions.
. 
CrP is a  ,  analysis: it assumes that unit variable costs and unit revenues are constant, which is appropriate for
small deviations from current production and sales, and assumes a neat division between fixed costs and variable costs, though in the
long run all costs are variable. For longer-term analysis that considers the entire life-cycle of a product, one therefore often prefers
activity-based costing or throughput accounting