CHAPTER 4

COST AND MANAGEMENT ACCOUNTING

- THEORITICAL BACKGROUD

Sr. No. Contains Page No

Introduction 34

4.1 Cost Accounting 35

4.2 Cost and Management Accounting 37

4.3 Financial Statement Analysis 41

4.4 Ratio Analysis 43

4.5 Cash Flow Analysis 45

4.6 Fund Flow Analysis 48

4.7 Working Capital Management 50

4.8 Budget and Budgetary Control 52

4.9 Cost Control and Cost Reduction 54

4.10 Uniform Costing and Inter-firm Comparison 57

4.11 Capital Structure and Cost of Capital 61

4.12 Pricing of Services 63

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CHAPTER 4

COST AND MANAGEMENT ACCOUNITNG

- THEORITICAL BACKGROUND

INTRODUCTION:-

This chapter takes brief review of the theoretical aspect of the following topics covered under

the Cost and Management Accounting.

4.1 Cost Accounting 4.2 Cost and Management Accounting 4.3 Financial Statement Analysis 4.4 Ratio Analysis 4.5 Cash Flow Analysis 4.6 Fund Flow Analysis 4.7 Working Capital Management 4.8 Budget and Budgetary Control 4.9 Cost Control and Cost Reduction

4.10 Uniform Costing and Inter-firm Comparison 4.11 Capital Structure and Cost of Capital 4.12 Pricing of services

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4.1 COST ACCOUNTING

4.1.1 INTRODUCTION:-

Cost accounting is the subject, which is immensely useful in all economic activities. It is a

natural instinct with all of us to measure the pros and cons of everything. A prudent

housewife who goes for shopping considers the quality and price of each product before

she buys it. In short, each economic activity, if rationally viewed, has two aspects- firstly,

the cost involved in it and secondly, the benefits obtained out of it. This analysis is

technically known as cost-benefit analysis. Cost Accounting is only a branch of accounting

in general and cannot be divorced from Financial Accounting.

4.1.2 DEFINITION:- The terminology of Cost Accountancy published by the Institute of Cost and Management

Accountants of England defines: -

Costing is defined as, the technique and process of ascertaining costs.

Cost Accounting is defined as, the process of accounting for cost which begins with the

recording of income and expenditure or the bases on which they are calculated and ends

with the preparation of periodical statements and reports for ascertaining and controlling

costs.

Cost Accountancy is defined as, the application of costing and cost accounting

principles, methods and techniques to the science, art and practice of cost control and the

ascertainment of profitability. It includes the presentation of information derived there

from for the purpose of managerial decision making.

4.1.3 OBJECTIVES OF COST ACCOUNTING:- The main objectives of Cost Accounting includes ascertainment of cost, determination of

selling prices, cost control and cost reduction, ascertaining the profit of each activity and

assisting management in decision-making.

4.1.4 DIFFERENCE BETWEEN FINANCIAL ACCOUNTING & COST ACCOUNTING The main function of financial accounting is classification, recording and analysis of

business transaction in a subjective manner according to nature of expenditure so as to

facilitate preparation of profit and loss account and balance sheet. Financial Accounts

perform the function of portraying a true and fair but overall picture of the results or

activities carried on by an institution during a period and its financial position at the end of

the year. To the extent, Financial Accounting helps to assess the overall progress of a

concern, its strength and weakness, provides the figures relating to several years are

studied. Financial Accounts suffer various limitations which includes that financial

accounts do not provide information for forecasting and planning, decision making and

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for control and assessment. The Cost Accounting provides necessary information required

for these purposes. Cost accounting is a branch of accounting which has been developed

because of the limitation of Financial Accounting from the point of view of management

control and internal reporting.

4.1.5 COST ACCOUNTING AND MANAGEMENT ACCOUNTING:- The cost accounting now a day is not mere recording and cost finding but an effective

instrument for managerial control. Management Accounting is designed to give utmost

assistance to management in formulating policies and controlling their current business

operations. The objectives of cost accounting are similar to those of management

accounting and management accounting employs all techniques of cost accounting, such as

standard costing, budgetary control, marginal costing, breakeven and cost-volume analysis,

inter-firm comparison, ratio analysis, internal audit and capital project assessment and

control. Management accounting utilizes the principles and practices of both cost

accounting and financial accounting in the best interest of business. Management

accounting is thus an extension of the managerial aspects of cost accounting.

4.1.6 IMPORTANCE OF COST ACCOUNTING TO BUSINESS CONCERNS:- Management of business concerns expects from Cost Accounting detailed cost information

and reports required for Planning, Scheduling, Controlling and Decision-making. To be

more specific management expects from cost accounting - information and reports to help

them in the discharge of the various functions namely ascertainment of cost, control on

material, labour and overheads, measuring efficiency, budgeting, price determination,

curtailment of loss during the off seasons, expansion and arriving at decision.

4.1.7 ADVANTAGES OF A COST ACCOUNTING SYSTEM:- Important advantages of a cost accounting system includes identifying unprofitable

activities, losses or inefficiencies, continuous efforts for finding out new and improved

methods for reducing costs, providing information for making decisions, price fixation,

variance analysis, cost control, uniform costing and Inter-firm comparison, information for

the use of Government, Wage Tribunals and other bodies, cost of idle capacity, preventing

manipulation and fraud in the organization.

4.1.8 FACTORS TO BE CONSIDERED BEFORE INSTALLING COST ACCOUNTING Before setting up a system of cost accounting various factors should be studied. These

factors includes objectives of installing the system, nature of business, nature of the entire

industry and its salient features, nature of the products and services, technical aspects,

organization layout, significant variables of the organization, reconciliation of cost and

financial account, forms standardization, accuracy of data and forms, involvement and co-

operation of staff, simplicity of the system, economic factors and management by

exception.

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4.1.9 ESSENTIALS OF A GOOD COST ACCOUNTING SYSTEM:- A good Cost Accounting System should possess various important features. This includes

that Cost Accounting System should be tailor-made, practical, simple and capable of

meeting the requirements of a business concern. The data to be used by the Cost

Accounting System should be accurate; otherwise it may distort the output of the system.

Necessary cooperation and participation of executives from various departments of the

concern is essential for developing a good system of Cost Accounting. The cost of

installing and operating the system should justify the results. The system of costing should

not sacrifice the utility by using network analysis for the introduction of the system.

Management should have faith in the Costing System and should also provide a helping

had for its development and success.

4.2 COST AND MANAGEMENT ACCOUNTING

4.2.1 INTRODUCTION:-

Management is the art of getting things done. Decision-making is one of the important

functions of Management. It is defined as a process of selecting a course of action out of

two or more alternative courses. Management cannot avoid decision making, even if the

decision is to do nothing in a particular situation. An efficient management decision should

be both effective and efficient and consume minimum amount of resources to achieve the

desired goal. Cost and Management Accounting is the subject, which provides data for

comparison, to take effective and efficient decision for cost control, ascertainment of

profitability and internal and external reporting.

4.2.2 OBJECTIVES OF ACCOUNTING SYSTEM:- Accounting is the process of identifying, measuring and communicating economic

information to permit informed judgments and decisions by users of information. An

effective accounting system has three broad objectives which includes, a) Internal reporting

at appropriates levels of management for planning and control purposes, b) Internal

reporting at the appropriate levels for management making special decisions and the

formulation of overall policies and long term plans. and c) External reporting to

shareholders, Government agencies and other parties for satisfying the various information

requirements under the provisions of relevant laws, rules and regulations.

The Financial Accounting is mainly concerned with third objectives of accounting

system. The Management Accounting, on the other hand, measures past economic

changes that occurred in any segment of a business by assigning revenues and expenses to

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those segments. It helps the management in decision-making by providing the relevant

information in the required form to make decision much easier and simpler.

4.2.3 MANAGEMENT ACCOUNTING:- The International Federation of Accountants (IFAC) has defined Management Accounting, 1as the process of identification, measurement, accumulation, analysis, preparation,

interpretation and communication of information both financial and operating used by

the management to plan, evaluate and control with an organization and to assure use of

end accountability for its resources.

Chartered Institute of Management Accounting (CIMA) has defined it as an integral part of

management concerned with identification of presenting and interpreting information used

for Formulating strategy, Planning and controlling activities, Decision making, Optimizing

the use of resources, Disclosures to shareholders and others external to the entity,

Disclosure to employees and Safeguarding assets.

Management Accounting is not composed of fixed set of rules. Organizations have

different goals and are composed of different members; therefore no universal rules of

management accounting exist. Management accounting therefore is not a static process.

Instead, it adapts to organizational change. There are basically three forces namely

technological changes, Globalization and Customers which in turn churn the basics of

management accounting.

4.2.4 OBJECTIVE OF MANAGEMENT ACCOUNTING:- The objective of Management Accounting is to provide appropriate information to the

management to help them in taking better decision. Management Accounting involves

application of appropriate techniques and concepts, which help management in establishing

a plan for reasonable economic objectives. Any workable concept or technique, whether it

is drawn from financial accounting, cost accounting, economics, mathematics and

statistic, can be used in management accountancy.

It employs all those techniques such as working capital management, capital budgeting,

ratio analysis, fund flow and cash flow technique, standard costing, budgetary control,

marginal costing, break-even and cost-volume-profit analysis, uniform costing and inter

firm comparison etc. in formulation policy, fixation of plans, control of their execution and

measurement of their performance. Therefore, it is particularly concerned with supply of

information, which is useful in the management in decision making for efficient running of

the business and thus in maximizing profits.

1 ICWAI, (Oct 1999), Management Reporting and the Management Accountant The Management Accountant student edition, Vol. 2, No.10.

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4.2.5 SCOPE OF MANAGEMENT ACCOUNTING:- Management accounting permeates the whole organization. It is primarily concerned with

provision of information to people within the organization to help them make better

decisions. Management accounting focuses on accomplishment of organization objectives

by removing dysfunctional inter- department conflict. It concerns long-range decision-

making or strategic decision-making. It specifies the organization objectives. Then it

attempts to search a range of possible course of action, which might enable the objectives

to be achieved normally covered by cost accounting and are concern of lower-level

managers. The management accounting concerns strategic decisions having profound

effect on companys future position.

4.2.6 CONTEMPORARY FUNCTIONS OF MANAGEMENT ACCOUNTING:- The functions evolved in response to the new environment from the field of management

accounting includes evaluation of performance and efficiency of organization, pricing

decisions, estimation and quotation, budgeting, operational control, product and customer

costing, cost reduction and cost control, capital budgeting decision, expansion projects,

diversification project, manpower planning and usage, management control, strategic

control, quality control, inventory management and control, capacity planning, planning

and control.

4.2.7 THE MANAGEMENT PROCESS & COST AND MANAGEMENT ACCOUNTS:- The management process involves series of activities leading to definite end. It involves

the deliberate selection of a specific course of action amongst the various alternative course

of action available in light of desired corporate objectives. The management in any

organization is concerned with the various functions namely planning, controlling,

organizing, communicating and motivating. In planning process, management accountant

helps in formulation of plans by providing useful information on such matters. In control

process it provides performance reports that compare the actual outcome with the planned

outcomes for each responsibility center. In organizing function, Management accounting

performs a staff function. It provides line managers and other staff managers with a

specialized information service, which assist them in decision making planning and control

activities. Management accountant helps in tailoring of interval reporting system.

Alternatively a more appropriate organizational system is suggested to management.

Management accounting helps the communication function by installing and maintaining

an effective communication and reporting system. The management accountant assists in

motivating personnel by providing them budget and the performance reports and other

details about potential problem areas and thereby provides a supportive system to enable

managers to control their activities more effectively.

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4.2.8 BENEFIT OF A SOUND SYSTEM OF COST & MANAGEMENT ACCOUNTING:- The benefits of a sound system for cost and management accounting facilitate inter-firm

comparison and hence enable good control over operation, inculcate Cost consciousness

throughout the organization, enable optimal allocation of resources, improve the quality of

management decision, cost reduction and cost control.

4.2.9 MANAGEMENT ACCOUNTING IS AN EXTENSION OF COST ACCOUNTING:- Recent developments in management techniques and management related technology have

significantly popularized management accounting, which is basically an extension of cost

accounting. Management accounting out rightly starts with management objective. It goes

beyond usage of cost accounting. Other disciplines, especially economic, computer

science, and engineering have stimulated management accounting. Management

accounting is called extension of cost accounting. Cost accounting concerns short-term

decision-making and operational level of management. Management accounting serves the

key management with focus on overall organizational objective.

4.2.10 MANAGEMENT ACCOUNTING IN SERVICE ORGANISATION:- The main characteristics of service organizations includes that there is no product cost,

almost all costs are period cost. The out put at the service organizations is difficult to

measure. Major inputs and outputs in the service organization cannot be stored. Service

organizations are labour intensive and incur very few variable costs. These units deal in

personalized services with no reasonable degree of homogeneity, and as a result, it is

difficult to measure quantity, efficiency or effectiveness through accounting system.

Further, almost all costs are fixed in nature and the share of direct expenses is very

negligible. The basic principle of the management accounting have been so evolved that

they are equally applicable to all types of organizations, therefore almost all service

organizations are subject to control techniques, which are similar the those used to control

the manufacturing units. Managers in service companies have historically used

management accounting information far less intensively than manager in manufacturing

companies. The reason for this was because of many service organizations operated in

beginning, non-competitive markets, either highly regulated or government owned such as

national rail, roads, airlines, postal services and telecommunications. In these non

competitive environments, managers of service companies were not under great pressure to

lower costs, improve the quality or efficiency of operations, introduce new products that

made profit, or eliminate products or services that made losses. Since managers were not

making such decisions were virtually non-existent.

Situations are radically different today. The major changes in the demand for management

accounting information experienced by the manufacturing companies in recent years have

also occurred virtually in all types of service organizations. Service organizations have

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existed for hundred of years; their importance in modern economies has increased

substantially during this new century.

Even some of the power companies in India, telecom circles and hospitals, which have

become competitive, have commissioned Activity Based Costing projects. Some leading

banks in India have also started Activity Based Costing exercises. Since these service

companies are, made up of business process, which are one hundred percent activity

oriented, ABC becomes a valuable exercise.

4.3 FINANCIAL ANALYSIS

4.3.1 INTRODUCTION:-

A business organization prepares its final accounts. However, these statements do not

disclose all the information necessary for ascertaining the financial strengths and

weaknesses of an enterprise. It is necessary to analyze the data depicted in the financial

statement. Financial information is needed to predict, compare and evaluate the

organizations financial performance. It also helps for planning and decision-making.

There are various tools of financial analysis namely ratio analysis, fund flow analysis and

cash flow analysis which helps financial managers in the financial analysis and planning.

4.3.2 FINANCIAL APPRIASAL AND FINANCIAL STATEMENT ANALYSIS:- Financial appraisal is a scientific evaluation of the profitability and financial strength of

any business concern. It is the process of scientifically making a proper, critical and

comparative evaluation of the profitability and financial health of a given concern through

the application of the techniques of financial statement analysis.

Financial statement analysis is a preliminary step towards the final evaluation of the results

drawn by the analyst or management accountant. Financial appraisal begins where

financial analysis ends and financial analysis starts where the summarization of financial

data in the form of profit and loss account and balance sheet ends. The appraisal of analysis

spotlights the significant facts and relationships concerning managerial performance,

corporate efficiency, financial strength and weakness and credit worthiness.

4.3.3 MEANING OF FINANCIAL STATEMENT:- In simple words the term financial statement is defined as2 a statement that contains

financial information . In India, the term financial statement means Balance Sheet and

Profit And Loss Account. Financial statements also contain notes and schedules and other

information.

2 BOS, Course material for CA Final (old course) Advanced Accounting, The Institute of Chartered Accountant of India, New Delhi.

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4.3.4 OBJECTIVES OF FINANCIAL STATEMENTS:- The objective of financial statements is to provide information about the financial position

performance and changes in financial position of an enterprise that is useful to a wide range

of users in making economic decisions.

4.3.5 PARTIES DEMANDING FINANCIAL INFORMATION:- There are various parties interested in financial information includes present and potential

investors, employees, lenders, suppliers, and other trade creditors, government and their

agencies and the public who use financial statements for taking economic decisions.

Although, all the above persons are interested in the financial information and operating

results of an enterprise, the type of financial analysis varies according to specific needs of

user.

4.3.6 NATURE OF FINANCIAL ANALYSIS:- The process of financial analysis consists of the application of financial analytical tools and

techniques to financial statement and data in order to derive from them measurements

relationship that are significant and useful for decision making. In the financial analysis

user-oriented approach has been adopted for these purposes instead of following the

traditional proprietary approach. The traditional view is that financial statements are

prepared for the proprietors and accounting just aids the stewardship function.

4.3.7 MEANING OF FINANCIAL STATEMENT ANALYSIS:- It is the process of identifying the financial strength and weakness of a firm from the

available accounting data and financial statement. The analysis is done by properly

establishing the relationship between the items of Balance Sheet and Profit and Loss

Account. Financial Statement Analysis refers to draw meaningful interpretation of

financial statement for the parties demanding financial information. It is the judgmental

process that aims to evaluate the current and past financial position and the results of

operations of an enterprise with the primary objectives of determining the best possible

estimates and prediction about future condition and performance. Financial analysis is

purposive and not necessarily comprehensive to cover all possible uses.

4.3.8 OBJECTIVES OF FINANCIAL STATEMENT ANALYSIS:- The primary use of financial statement are evaluating past performance and predicting

future performance and both these are facilitated by comparison. Therefore, the focus of

financial analysis is always on the crucial information contained in the financial statements.

The purpose of evaluating such financial statements is different from person to person

depending upon its relationship. In other words, even though the business unit itself and

shareholders, debenture holders, investors all undertake the financial analysis, the purpose,

means and the extent of such analysis differs. The object, scope, extent and means of any

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financial analysis vary as per the specific needs of the analyst. Thus financial statement

analysis is purposive and not necessarily comprehensive to cover all possible uses.

4.3.9 TYPES OF FINANCIAL STATEMENT ANALYSIS:- The main objective of financial analysis is to determine the financial health of a business

enterprise. The analysis may be of the external analysis, internal analysis, horizontal

analysis, vertical analysis, trend analysis, ratio analysis, funds flow statement, break even

analysis.

4.3.10 TECHNIQUES OF FINANCIAL STATEMENT ANALYSIS:- In the analysis of the financial statements the analyst uses variety of tools. First technique

is Cross Sectional Techniques under which Common size statements and Financial Ratio

Analysis techniques are used. Second technique is Time Series Techniques under which

Simple Comparison and Trend Analysis, Financial Ratio Analysis techniques are used. The

third category includes Variability Measure. Fourth technique is Combination of Financial

and Non Financial Information technique which include Product Market and Capital

Market Information.

4.3.11 STAPES INVOLVED IN FINANCIAL STATEMENT ANALYSIS:- The focus of financial analysis is on key figures in financial statements and the significant

relationship that exists between them. Various steps followed in Financial Analysis are; 1)

The first task is to select the information relevant to the decision under consideration from

the total information relents to the financial statement. 2) The second step is to arrange the

information in a way to highlight significant relationship. Usually instead of the two-

column (T-Form) statements as ordinarily prepared, the statements are prepared in single

vertical column form.3) The final step is to interpretation of ratio and drawing of inferences

and conclusion. In brief, financial analysis is the process of selection, relation and

evaluation.

4.4 RATIO ANALYSIS

4.4.1 INTRODUCTION:-

Ratio measures relationship between two data. It is a statistical yardstick that provided a

measure of relationship between two data / figures. Absolute comparison between two

figures does not convey much sense. When expressed in terms of ratio, it becomes much

penetrating and meaningful. Not for comparison only, ratios convert the data in precise

form for easy understanding. However, one needs to be careful in his choice and

interpretation of ratios. There should be some relationship between the variable selected for

ratios; otherwise you cannot come up with any meaningful interpretation of the resulting

figures.

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4.4.2 MEANING AND DEFINITION OF RATIO ANALYSIS:- The term ratio is refer to the relationship expressed in mathematical terms between two

individual figures or groups of figures connected with each other in some logical manner

and are selected from financial statement of the concern. A ratio calculated using at least

one financial variable defined as financial ratio. Financial ratio is an index, which relates

two accounting numbers and is obtained by dividing one number by the other. If a ratio is

calculated taking numerators and denominator from the books of accounts then such ratio

can be called as accounting ratio.

Ratio Analysis:

It is defined as the systematic use of ratio to interpret the financial statements so that the

strengths and weakness of a firm as well as its historical performance and current financial

condition can be determined. It is a process of determining, interpreting and presenting

numerical relationship of items and groups of items in the financial statement.

4.4.3 FORMS OF RATIO:- The ratios are customarily presented in the different forms namely pure ratios, in the form

of rate, and percentage.

4.4.4 IMPORTANCE OF RATIO ANALYSIS:- The importance of the ratio analysis lies in the fact it presents facts on a comparative basis

and enables the drawing of inferences regarding the performance of the firm. Ratio analysis

is relevant in assessing the performance of a firm in respect of the various aspects. It

facilitates understanding of financial statements. It helps in Inter-firm and Intra-firm

comparison, planning business operations, management by exception. It helps to measure

liquidity position and long-term financial viability and efficiency in the management and

the utilization of its assets. Ratio analysis enables a firm to find out the trend of operational

performance.

4.4.5 STANDARDS FOR COMPARISON:- For making a proper use of ratios, it is essential to have fixed standards for comparison. A

ratio provides clues and symptoms of underlying conditions. A computation of ratios is

relatively an easy exercise. A ratio by itself has very little meaning unless it is compared to

some appropriate standard. Selection of proper standards of comparison is a most important

element in ratio analysis. The most common standards used in ratio analysis are absolute,

historical, horizontal and budgeted.

4.4.6 LIMITATIONS OF RATIO ANALYSIS:- In case of organization with diversified product lines ratio calculated on the basis of

aggregate data cannot be used for Inter firm comparisons. Financial data are badly

distorted by inflation so also the financial ratios. Seasonal factors may also influence

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financial data. To give a good shape to the popularly used financial ratios the business may

make some year end adjustment (Window Dressing). Different Accounting Policies and

Accounting Period make the accounting data of two firms non comparable as also the

accounting ratios. There is no standard set of ratios against which a firms ratios can be

compared. It is very difficult to generalize whether a particular ratio is good or bad. A

single ratio may not be conclusive indicator. Financial ratios provide clues but not

conclusion. Accounting Ratios may be worked out for any two figures even if they are not

significantly related Accounting ratios can be only as correct as the data on which they are

based. There is scope for diversity of opinion as to what constitute share holders equity,

current assets, quick assets, profits and so on. Ratio devoid of absolute figures may prove

dangerous as ratio analysis is primarily a quantitative analysis and not a qualitative

analysis. In brief ratio analysis suffers from serious limitations. The analyst should not be

carried away by its simplified nature, easy computation with a high degree of precision.

Nevertheless, they are important tool of financial analysis.

4.4.7 CLASSIFICATION OF ACCOUNTING RATIOS:- Various ratios used for analysis and interpretation of financial statements can be classified

according to main three bases namely classification according to sources or placement,

purpose and important or approach. The ratios according source includes Balance Sheet

Ratios, Income statement ratios or Revenues Statement Ratios and Balance Sheet and

income Statement ratio. The classification of ratios according to purpose include

Profitability Ratios, Liquidity Ratios, Capital Structure Ratios, Ratio showing use of assets

/ productivity, Investment Analysis, and Management Efficiency. The classification of

ratios according to importance or approach includes Primary Ratio and Supporting ratio /

Secondary Ratios.

4.4.8 SOME IMPORTANT FINANCIAL RATIOS:- With reference to co-operative bank the some important ratios are cited in Table 4.1.

4.5 CASH FLOW ANALYSIS

4.5.1 INTRODUCTION:-

The Balance Sheet and Profit and Loss Account constitute the basic financial statements of

any business organization and contains summary of items relating to income and

expenditure during a particular period of time. However, none of them shows the nature of

transactions entered into during the period of time. Financial planning of any organization

is always involve the analyzing of the financial flows of the firm as a whole, i.e.

forecasting and estimating the impact of investment made in the past and of those which

are planned to be invested in the coming future. It also involves of weighing the various

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alternatives of financing and investment and their likely impact so that the business is not

adversely affected at any time in future due to lack of funds.

4.5.2 CONCEPT OF FUNDS:- The concept of funds can be defined in various ways. The two most common usages of the

term fund are cash and working capital. If viewed in this sense, statement of changes in

financial position would explain-

a. The changes in the firms cash position (popularly known as cash flow statement); and

b. The changes in the firms working capital position (popularly known as sources or uses

statement or funds flow statement)

4.5.3 MEANING OF CASH FLOW STATEMENT:- One of the important tools with the management accountant and finance manager for

ascertaining the changes in balance of cash in hand and bank is the Cash Flow Statement.

This statement shows the inflows and outflows of cash i.e., sources and applications of

cash during particular period. Cash flow statement analyses the reasons for change in

balance of cash in hand at bank between two accounting period. All those transactions,

which have no effect on cash, are excluded from this statement.

4.5.4 OBJECITVE OF CASH FLOW STATEMENT:- Information about the cash flows of an enterprise is useful in providing users of financial

statements with a basis to assess the ability of the enterprise to generate cash and cash

equivalents and the needs of the enterprise to utilize those cash flows. The economic

decisions that are taken by users require an evaluation of the ability of an enterprise to

generate cash and cash equivalents and the timing and certainty of their generation.

The institute of Chartered Accountants of India (ICAI) has issued Accounting Standard

(AS 3) (Revised) on, Cash Flow Statement in 1.04.2001. Revised AS 3 is mandatory

w.e.f. 01.04.2004 to Level I enterprises, which includes the following enterprises a) which

has turnover more than Rs. 50 crores in a financial year, b) Listed Companies.

Level I enterprise includes Banks (including Co-operative Banks) and this AS is applicable

to banks and auditors are duty bound while discharging attest function to ensure the AS

issued and made mandatory by the ICAI are implemented.

4.5.5 ADVANTAGES / BENEFITS OF CASH FLOW STATEMENT:- It is helpful in short term planning of the business unit by indicating in advance as to how

much funds are needed in future and how much of these can be raised internally and how

much should be arranged from outside. It is helpful in making capital budgeting decisions

by indicating the availability of funds or otherwise during the period under consideration. It

is helpful to management by enabling it to know the magnitude, direction and causes of

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variation of the firm, liquidity position during an accounting period. It is helpful to

management in planning replacement of assets and in formulating dividend policies. It

enables users to evaluate the changes in net assets of an enterprise, its financial structure

(including its liquidity and solvency) and its ability to affect the amounts and timing of

cash flows in order to adapt to changing circumstances and opportunities. It is useful in

assessing the ability of the enterprise to generate cash and cash equivalents and enables

users to develop models to assess and compare the present value of the future cash flows of

different enterprises. It also enhances the comparability of the reporting of operating

performance by different enterprises because it eliminates the effects of using different

accounting treatments for the same transactions and events. Historical cash flow

information is often used as an indicator of the amount, timing and certainty of future cash

flows. It is also useful in checking the accuracy of past assessments of future cash flows

and in examining the relationship between profitability and net cash flow and the impact of

changing prices.

4.5.6 LIMITATIONS OF CASH FLOW STATEMENT:- Limitation of cash flow statement include that it fails to reveal the true liquidity position by

excluding many important transactions, which are of non-cash variety, but affecting the

change of financial position. It can be very easily manipulated by the management by

postponing payment to creditors etc.

4.5.7 PREPARATION OF A CASH FLOW STATEMENT: - Cash flow statement should report cash flows during the period classified by operating,

investing and financing activities. Sum of these three types of cash flow reflects net

increase or decrease of cash and cash equivalents. Operating activities are the principal

revenue-producing activities of the enterprise and other activities that are not investing or

financing activities. The activities of acquisition and disposal of long-term assets and other

investments not included in cash equivalents are investment activities. The activity that

results in change in size and composition of owners capital and borrowings of the

organization are financing activities.

4.5.8 METHODS OF CASH FLOW STATEMENT:- As per Accounting Standard (AS) 3, an enterprise should report cash flows from operating

activities using either Direct method or Indirect Method.

4.5.9 ANALYSIS OF CASH FLOW STATEMENT: - Cash flow statement is an important tool for short-term analysis. Like the other financial

statements, the statement of cash flows can be analyzed to reveal significant relationships.

Two areas, analysts examine while studying a cash flow statement are cash generating

efficiency and free cash flow.

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4.6 FUND FLOW STATEMENT

4.6.1 INTRODUCTION:-

The Final Accounts does not fulfil all the objectives of management though these

statements provide highly significant information. The usefulness of the statement is

limited for analysis, planning and control purpose. There is certain other fruitful

relationship between the Balance Sheet at the commencement and at the end of the

accounting period on which traditional package fails to throw any light. The financial

executive must know the fund flows underlying the balance sheet changes. The statement

of sources and uses of funds serves this end.

Law does not prescribe this statement, though a number of organizations now days

voluntarily publish this statement as part of the annual accounts. This statement is known

by various name viz. where got where gone statement, sources and application of funds,

employment and deployment of funds, inflow and outflow of funds, Money provided and

its disposition, Funds received and disbursed, Change in financial position, change in

working capital etc.

4.6.2 MEANING OF FUND FLOW STATEMENT: - Another important tool in the hands of finance manager and management accountant for

ascertaining the changes in financial position of the firm between two accounting period is

known as fund flow statement.

The Accounting Standard Board established by the Institute of Chartered Accountants of

India defines it as,3 a statement, which summaries for the period covered by it the changes

in financial position including the sources form which the funds were obtained by the

enterprise and the specific uses to which the funds were applied.

4.6.3 IMPORTANCE OF FUNDS FLOW STATEMENT:- The balance sheet and profit and loss account failed to provide the information, which is

provided by funds flow statement i.e., changes in financial position of and enterprise. This

statement indicates the changes, which have taken, place between two accounting dates. It

gives details of sources and uses of funds during a given period which are of great help to

the users of financial information. It is also a very useful tool in the hands of management

for judging the financial and operating performance of the company. It also indicates the

working capital position, which helps the management in taking policy decisions regarding

dividend etc. The projected fund flow statement can also be prepared and thus budgetary

control and capital expenditure control can be exercised in the organization.

3 Saxena and Vashist, (2000) Cost and Management Accounting, 3rd Edition, Sultan &Chand Sons, Educational Publishers, New Delhi - 110002, Chapter 3, Fund Flow Analysis, Page no 2.75.

48

4.6.4 CONCEPT OF FUNDS AND FLOW:- The term Fund has variety of meanings. The most common interpretation of funds is

working capital or net current assets. Many analysts assume that the basic purpose of

the fund flow statement is to account for the changes in working capital during the period

covered by the statement. The concept of funds as working capital has gained wide

acceptance as to make some people believe that the title change in working capital is

preferable.

The word Flow is interpreted as a Movement or a Change. Thus a movement of

funds presented in a statement is interpreted as Funds Flow Analysis. The flow of funds

is of two types, a) Sources or inflow of funds and b) Application or outflow of funds.

4.6.5 USES OF FUND FLOW STATEMENT:- Fund flow statement determines financial consequences of business operations. It provides

valuable information that help at the time of financing through borrowing form financial

institutions. The basic purpose of this statement is to indicate on a historical basis from

where cash come from and when it was used.

4.6.6 ANALYSIS OF FUNDS FLOW STATEMENT:- Fund flow statement is useful for long-term analysis. Such an analysis is of great help to

management, shareholders, creditors, brokers. It helps to know the profitability, utilization

of profit, liquidity, financial stability. It helps in working capital management, projection of

funds and uses of funds.

4.6.7 ADVANTAGES AND BENEFITS:- Fund Flow statement helps a firm to plan its financial operations properly. It is helpful in

estimating the budgets or the amount of funds required in future for modernization and

expansion programs. It leads to improvement in the rate of profit on assets by directing the

flow of funds to those activities with higher margins. It helps in the planning of dividend

payouts to the shareholders and interest to the debentures holders or creditors in such a way

that the working capital of the organization is not adversely affected. It helps in avoiding

the situations of running out of funds by obtaining additional working capital when

required. It also helps in planning the temporary investment of idle funds and in planning

the repayment schedules of long-term debts. It helps in assessing the relative points of

strength and weakness of that organization. By studying past flow; the finance manager can

evaluate future flows by means of funds statement based on forecast. The statement

prepared for the previous year compared with the budget prepared before the year

commenced will show to what extent the resources of the company or the firm were used

according to plan an to what extent the utilization was unplanned and improper. Since it

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gives the figure of cash inflow from operations, it gives much more reliable picture of the

results of operations than the usual profit and loss account.

4.6.8 LIMITATIONS:- This statement does supply information not otherwise available in the conventional

statement but ignores non-fund transactions. It does not provide the original evidence in

support of financial status or change but merely rearranges the data appearing elsewhere in

the accounts in a special manner. Sometimes a study of changes in cash is more important

than a study of changes in funds. In such a case, fund flow statement does not serve the

purpose, and cash flow statement has to be prepared. Fund flow statement is expected to

deal with only those transactions, which cause movement of funds. Where a transaction

involves the exchange of one source of funds for another, these transactions are not

reflected in the statement. Fund flow statement cannot take the place of the final accounts,

the Balance sheet and the Profit and Loss Account, but it is a very useful supplementary

statement.

4.6.9 CONSTRUCTION OF FUND FLOW STATEMENT:- Based on the interpretation of the term, Funds, the statement of changes in financial

position can be prepared on working capital basis, total resources basis, and Cash basis.

Three approaches can be made to carry out adjustments in net profit/loss for the period for

determining funds from operations. These are Direct method, Add back method and

Adjusted P& L a/c method.

4.7 WORKING CAPITAL MANAGEMENT

4.7.1 INTRODUCTION:- One of the most important areas in the day to day management of the firm is the

management of working capital. It is concerned with management of the level of individual

current assets as well as the management of total working capital.

4.7.2 MEANING OF WORKING CAPITAL:- Working capital refer to the funds invested in the current assets i.e. investment in stocks,

sundry debtors, cash and other current assets. The management of working capital includes

the management of these assets and liabilities such as accounts payable, wages payable and

other current liabilities. The working capital management helps to decide how much the

cash balance should be kept by the organization. It also helps to decide the level of

inventories, credit period to be offered to customers, composition of current assets and

current liabilities.

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4.7.3 CONCEPTS OF WORKING CAPITAL:- In working capital management, two concepts are followed. First concept is Gross working

capitals which represent the total of all current assets and is also referred to as circulating

capital. Second concept is Net working capita which represent excess of total current assets

over total current liabilities.

4.7.4 OBJECTIVES OF WORKING CAPITAL MANAGEMENT:- The objective of working capital management is to minimize the amount of capital

employed in financing the current assets. This will also lead to an improvement in the

Return on capital employed". Secondly to manage the current assets in such a way that the

marginal return on investment in these assets is not less than the cost of capital acquired to

finance them. This will ensure the maximization of the value of the business unit. Third to

maintain the proper balance between the amount of current assets and the current liabilities

in such a way that the firm is always able to meet its financial obligations, whenever due.

This will ensure the smooth working of the unit without any production held ups due to

paucity of funds. Thus we see that, in short, the objectives is to ensure the maintenance of

satisfactory level of working capital in such a way that it is neither inadequate not

excessive. It should not only be sufficient to cover the current liabilities but ensure a

reasonable margin of safety also.

4.7.5 IMPORTANCE OF ADEQUATE WORKING CAPITAL: - Whatever be the size of a business, working capital is lifeblood and controlling nerve

center of every business. Thus, working capital management is significant facet of financial

management. Both excessive as well as inadequate working capital positions are dangerous

from the firm's point of view. Excessive working capital means idle fund, which earns no

profits for the enterprise. Paucity of working capital not only impairs profitability but also

results in production interruptions and inefficiencies. An over all control over working

capital can ensure functioning of the business operations.

4.7.6 SOURCES OF WORKING CAPITAL:- The various sources for financing the working capital requirements are trade credit, bank

credit, current provision and non banking short term borrowing; and long term sources, i.e.

equity share capital, preference share capital and other long-term borrowings. The relative

importance of these vary from unit to unit but these sources can be further divided into two

broad groups, namely short term and long term source of funds. Short term sources of

funds are generally available at comparatively lower costs but theoretically these funds can

be called back any moment and therefore it is more appropriate to meet at least two thirds

of the permanent working capital requirements from the long term sources.

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4.7.7 WORKING CAPITAL FORECASTS:- An adequate amount of working capital is essential for the smooth running of a business

enterprise. The finance manager should forecast working capital requirement carefully to

determine an optimum level of investment in working capital. While forecasting working

capital requirements, it should be borne in mind that working capital requirements are to be

determined on an average basis and not at any specific point of time. The important

methods used for forecasting working capital requirements are estimation of components of

working capital, percentage sales and operating cycle approach.

4.7.8 FACTORS TO BE CONSIDERED WHILE DETERMINING WORKING CAPITAL REQUIREMENT:-

There are various factors which need to consider while determining the requirement of

working capital like production polices, nature of business, credit policy, inventory policy,

abnormal factors, market conditions, conditions of supply, business cycle, growth and

expansion, level of taxes, dividend policy, price level changes and operating efficiency.

4.7.9 WORKING CAPITAL MANAGEMENT:- Working capital management is usually concerned with the administration of all the current

assets and current liabilities. It is basically concerned with determining the need for

working capital, determining the optimum levels in investment in various current assets

and examining the salient points regarding each element of working capital.

4.8 BUDGET AND BUDGETORY CONTROL

4.8.1 INTRODUCTION:- The management in any organization consists of the various functions namely, planning,

controlling, organizing, communicating and motivating. Controlling function implies

implementation of the planning decisions and performance evaluation so that feedback can

be used for attainment of objectives. It involves a comparison of actual performance with

plans so that deviations from plans can be identified and corrective action taken. This

process enables the management to assess whether or not the objectives included in the

long-term plan are likely to be achieved. If these are unlikely to be achieved, the control

process gives warning of potential problems and long term plans to be changed before any

serious damage to the company occurs. For effective running of a business, management

must know: Where it intends to go, i.e. organizational objectives, How it intends to

accomplish its objectives i.e. plans, whether individual plans fit in the overall

organizational objectives, i.e. coordination and, whether operations conform to the plan of

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operations relating to that period i.e. control. Budgetary control is the device that a

company uses for all these purposes.

4.8.2 BUDGET:- A budget is defined in the CIMA terminology as4, "A plan expressed in money. It is

prepared and approved prior to the budget period and may show income, expenditure and

the capital to be employed, may be drawn up showing incremental effects on former

budgeted or actual figures, or be complied by zero based budgeting".

4.8.3 BUDGETARY CONTROL: - The Institute of Cost and Management Accountants of England and Wales defines

Budgetary Control as," The establishment of budgets relating the responsibilities of

executives to the requirements of a policy, and the continuous comparison of actual with

budgeted results either to secure by individual action the objectives of that policy or to

provide a base for its revision". Broadly speaking it is a system of achieving the firm's

objectives with minimum possible cost.

4.8.4 OBJECTIVES OF BUDGETARY CONTROL:- The objectives of a Budgetary Control system are determining the targets of performance

for each section or department of the business. Laying down the responsibility of each of

the executives and other personnel so that every one knows what is expected of him and

how he will be judged. Budgetary control is one of the few ways in which an objective

assessment of executives or department is possible. It provides a basis for the comparison

of actual performance with the predetermined targets and investigation of deviation, if any,

of actual performance and expenses from the budgeted figures. This naturally helps in

adopting corrective measures. It ensures the best use of all available resources to maximize

profit or production, subject to the limiting factors.

4.8.5 WORKING OF A BUDGETARY CONTROL SYSTEM:- The responsibility for successfully introducing and implementation of a Budgetary Control

System rests with the Budget Committee acting through the Budget Officer. The Budget

should be composed of all functional heads and a member from the Board to preside over

and guide the deliberations. The main responsibilities of the Budget Officer are to assist in

the preparation of budgets, to forward the budget to the individuals who are responsible to

adhere them, to guide them in overcoming any practical difficulties in its working; to

prepare the periodical budget reports for circulation to the individual concerned; to follow

up action to be taken on the budget reports; to prepare periodical reports for the Board

meeting and comparing the budgeted profit and loss account and balance sheet with the

actual results.

4. BOS, Cost and Management Accounting, ICWAI, Colkatta .Page No 7.1

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4.8.6 ADVANTAGES OF BUDGETARY CONTROL:- The use of budgetary control system enables the management of business concern to

conduct its business activities in efficient manner. It is a powerful tool used for the control

of expenditure. It provides a yardstick for measuring and evaluating the performance of

individual and department. It reveals the deviations to management from the budgeted

figures. Effective utilization of various resources like men, material, machinery and money

is made possible. It helps in the review of current trends and framing of future polices. It

creates suitable conditions for the implementation of standard costing system in a business

organization. It inculcates the feeling of cost consciousness among the workers.

4.8.7 LIMITATION OF BUDGETARY CONTROL:- Budgets may or may not be true as they are based on estimates. They are considered as

rigid document. Budgets cannot be executed automatically. Staff co-ordination is usually

not available during budgetary control exercise.

4.8.8 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. These

functional budgets are broadly grouped under various heads. These heads are physical

budget, cost budget, profit budgets and financial budgets.

4.8.9 TYPES OF BUDGET:- Budgets may be classified by capacity, coverage they encompass, period for which they

cover and conditions on which they are based. The various type of budgets are fixed

budget, flexible budget, functional budget, master budget, long term budget, short term

budget, basic budgets and current budgets.

4.9 COST CONTROL AND COST REDUCTION

4.9.1 INTRODUCTION:-

Cost control helps executives to guide and regulate the cost of operating an undertaking.

For modern business management, it is not enough to plan for the future. Efforts are

constantly made to scrutinize the results of operations so that out of control situations are

immediately attacked and eliminated. By cost control, executives strive to keep costs at

their planned level.

4.9.2 COST CONTROL:- Cost control is defined as5 the regulation by executive action of the costs of operation of

undertaking. It is achieved by setting targets of performance, collecting actual cost of each

5 Board of Studies, Cost Accounting, Course Material of C.A. PE (II), ICAI, New Delhi, Page No.4.

54

area of responsibility, comparing actual with targets and submitting prompts report to top

management showing deviation from targets.

4.9.3 CHARACTERISTICS OF COST CONTROL:- The important characteristics of cost control includes delineation of centers of

responsibility, delegation of authority, measurement of performance, relevance of

controllable cost, cost reporting, constant efforts, policies and general objectives.

4..9.4 COST REDUCTION:- Cost reduction is not only an ideal couple of two important words made for each other

but it basically a Mol Mantra for not only the growth and prosperity but also for the very

survival and existence in the current economic regime of cut-throat competition.

The amount of profits in any organization can be maximized by either increasing the

amount of sales or reducing costs. However, in the era of liberalization, when the economy

is being opened up to lot of competition from overseas, it may be very difficult to increase

the sales prices of its products or services by any organization. Therefore cost reduction

techniques occupy a prominent position in any organization trying to maximize its profits.

The reduction in per unit of cost of production or service may be effected by either by

reduction in unit cost of production or by increasing productivity. However, both the above

mentioned aspects are very closely inter-linked and therefore generally act together. But

this is possible only when the cooperation and team work forms the basic features of any

planned approach to cost reduction.

4.9.5 MEANING OF COST REDUCTION: - Cost reduction may be defined as," the achievement of real and permanent reduction in the

unit cost of goods manufactured or service rendered without impairing their suitability for

the use intended or diminution in the quality of the product".

The threefold assumption involved in the definition of cost reduction may be summarized

as- (a) There is a saving in unit cost. (b) Such saving is of permanent nature. (c) The utility

and quality of goods and services remains unaffected, if not improved.

4.9.6 DIFFERENCE BETWEEN COST CONTROL AND COST REDUCTION:- Both cost control and cost reduction are efficient tools in the hands of management, but

their concept and procedures are different.

a) Cost control represents the efforts made towards achievements of predetermined targets

or goal. Cost reduction represents the real and permanent reduction in costs.

b) Cost control is very routine exercise and lacks dynamic approach. Cost reduction is

continuous and planned process of analyzing all the factors affecting the costs in an

organization.

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c) Cost control is preventive function, where costs are optimized before these are incurred.

While cost reduction is corrective function, which can operate along with efficient cost

control system also. In other words, there is always a scope for reduction in costs even

under controlled conditions also.

d) Cost control accepts the standards, once they have been fixed. In other words the

standards remain. Cost reduction assumes the existence of concealed potential savings in

the standards or norms unchallenged and therefore aim at improving them by bringing out

more savings.

e) Cost control involves setting up a target, ascertaining the actual performance and doing

the variance analysis followed by remedial actions. Cost reduction is not concerned with

maintenance of performance according to standards.

4.9.7 ADAVNTAGES OF COST REDUCTION:- The cost reduction programs results in profit improvement. The more the profits, the more

the stable company becomes. The Society will be benefited by reduced prices, which may

be possible by savings from cost reduction programs.

4.9.8 COST REDUCTION PLAN AND PROGRAMME: - The cost reduction program to be effective must be real and permanent. Similarly, cost

reduction approach should embrace all the functions and divisions of a business. The cost

reduction to be successful requires the cooperation at all levels so that a combined action is

taken with the common aim of benefit to the business. The organization for initiation of

cost reduction program may vary from organization to organization depending upon its

size, the nature of business, the availability of information and the individual requirements.

The effective course may be to formulate a committee with representatives from all sectors

of the business i.e. purchase, planning, production, sales, finance, and research and

development etc. The committee drew up a program for cost reduction and decides the area

of potential savings and allots the assignments to the executives responsible. It also fixes

priorities amongst the various areas for cost reduction and review the actual performance

from time to time.

4.9.9 ESSENTIAL FEATURES COST REDUCTION:- Any cost reduction program should be based on various factors. It includes managements

involvement, cooperation and team work, cost reduction committee, priorities in cost

reduction, cost of cost reduction, operational and procedural research and proper follow up.

4.9.10 AREAS OF COST REDUCTION:- Cost reduction can be ideally used in the various areas namely, design, Office organization

and methods, Product / services planning, Factory / office layout and equipment, Utility

services, Marketing, Finance and Overheads. Thus cost reduction does not just mean the

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reduction of expenses one can also achieve greater profits through the more efficient use of

money spent.

Thus it can rightly be said that a rupee saved is a rupee earned.

4.9.11 DANGERS OF COST REDUCTION:- The possible dangers of any cost reduction program include the attempt to bring about cost

reduction may lead to diminished quality. The cost reduction drive may bring about

conflict between individual objective and organizational objective. The participants of cost

reduction team may become so enthusiastic that they may neglect the very basic concept of

cost reduction, i.e. a real and permanent reduction in cost. If cost reductions are not based

on sound reasons, then very quickly cost will grow to the original size. Cost reduction

program may not be very favourably accepted by employees in the beginning. Management

may be tempered by the circumstances to use cost reduction as a crash program. This is

very dangerous and may result in the kick-back for the company.

4.9.12 TECHNIQUES OF COST REDUCTION: - Various techniques of cost reduction are Value analysis, Simplification and

standardization, Rationalization, Organization and methods study, Design analysis,

Operations research and statistical techniques, Mechanization, PERT Analysis, Job

evaluation and merit rating, Technological forecasting, ABC (Always Better Control)

Analysis, Economic Batch Quantity, Capital equipment analysis, Contribution analysis,

Classification and coding, Cost benefit analysis, Cost reduction interviews, Cybernetics,

Ergonomics.

4.10 UNIFORM COSTING AND INTER-FIRM COMPARISON

4.10.1 UNIFORM COSTING:-

Uniform costing is not a distinct method of costing. In fact, when several members of

industry or trade association start using the same costing principles, practices and

procedures they are said to be following uniform costing. It is a technique, which ensures

application of uniform accounting methods in a number of concerns in the same industry or

sometimes in all the units under the same management. It is necessary that every member

unit of an industry should adopt a uniform method of costing. The system is made

operative through Trade Association of Chamber of Commerce or some other central

agency. Its underlying idea is that whatever costing methods are used, all the members of

the industry should apply the same uniformly.

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4.10.2 DEFINITION:- CIMA defines uniform accounting as, a system, using common concepts, principles and

standard accounting practice, adopted by different entities in the same industry to facilitate

inter firm comparison.

4.10.3APPLICATION OF UNIFORM COSTING: - Uniform Costing may be applied in a company having number of branches/ factories or in

a number of companies within the same industry.

4.10.4 OBJECTIVES OF UNIFORM COSTING: - The main objectives of Uniform Costing are to facilitate the comparison of costs and

performance of different units in the same industry. The other objectives are to eliminate

unhealthy competition among the different units of an industry, provide a reliable cost data

for inter-units or inter-firm comparison of costs, compare the operational efficiency of

individual members against industrys overall performance, improve production capacity

level and labour efficiency by comparing the production cost of different units with each

other, provide relevant cost information /data to the Government for fixing and regulating

prices of the products, bring standardization and uniformity in the operation of

participating units and reduce various variable cost and to exercise control on fixed cost.

4.10.5 ADVANTAGES OF UNIFORM COSTING:- In uniform costing member-companies adopt best method of cost accounting system

known to the industry. It develops a sense of awareness for production efficiencies within

the industry for controlling costs. It provides standard guidelines for pricing of products. It

is beneficial to all the companies for filling tenders and quotations and consequently ill

effects of competition are avoided. In case of cost plus contracts, uniform costing

facilitates preparation of cost sheets on commonly accepted standard, principles and

practices. It helps the Chambers of Commerce and Industry to present their case to

Government on matters such as tariffs, relaxation, price fixation, incentives etc. It

encourages research and development work at comparatively low cost to the member-

companies. The small units can share the benefits of research and development carried by

large-scale organized units. Services of cost consultants or experts may be available jointly

to each firm in the industry by sharing experiences and expenses. It enables the member-

companies to receive the services of cost experts jointly with the minimum expenditure. It

facilitates the introduction of uniform wage structure for the industry as a whole. It serves

as a pre-requisite to cost audit and inter-firm comparison. The management of each firm

will be saved form the exercise of developing and introducing a costing system of its own.

A costing system devised by mutual consultation is readily adopted and successfully

implemented. It facilitates comparison of cost figures of various firms to enable the firms

to identify their weak and strong points besides controlling costs. It helps Trade

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Associations in negotiating with the Government for any assistance or concession in the

matters of taxation, exports, subsidies, duties and prices determination etc. Prices fixed on

the basis of uniform costing are representatives of the whole industry and thus reliable.

Uniform costing provide a basis for the comparative assessment for the performance of two

firms in the same industry but in different sectors. Introduction of Uniform Costing helps

the business organizations to submit reliable cost data to price fixing bodies or Government

departments to determine the average cost and fixing the fair selling prices of various

products or services.

4.10.6 LIMITATIONS OF UNIFORM COSTING:- The various member-units in an industry differ widely with regards to location, age,

financial conditions and degree of mechanization. This difference is sometime so wide that

it does not permit efficient use of uniform costing system. For smaller units, this system

becomes too expensive to operate. Uniform costing system may promote a monopolistic

tendency. Thus, it may prove harmful to the consumers. The member companies may not

understand the standard terminology used in the uniform costing system properly. However

this objective can be overcome by introduction of Uniform Costing Manual. Some times it

is not possible to adopt uniform standards, methods and procedures of costing in different

firms due to different circumstances in which they operate. Disclosures of cost information

and other data are essential requirements of a uniform costing system. Many firms do not

wish to share such information with their competitors in the same industry.

4.10.7 ESSENTIAL REQUISITES FOR THE INSTALLATION OF UNIFORM COSTING SYSTEM:- A successful system of uniform costing has the various requirements. This includes

willingness to share/furnish relevant data/information, cooperation and mutual trust, mutual

exchange of ideas, methods used, special achievements made, research and know-how etc.

Initiative by big firms towards sharing their experience and know-how with the smaller

firms. Uniformity on size of unit, various definition, production methods, must be

established. Treatment of Research and Development in costs and methods of allocations

of R & D to each cost center / cost units. Methods of payment of remunerations, treatment

of items like interest on own capital, rent of premises owned etc. Methods of working out

depreciation on fixed assets. Treatment of under / over absorbed overhead, e.g. applying

supplementary rate or write off to profit and loss account. System of classification and

codification of cost accounts Method of valuation of work in progress. The method of

presentation of data and reporting to management.

4.10.8 UNIFORM COST MANUAL:- The characteristics of a good uniform cost manual includes that it should present a strong

case for the desirability of using uniform cost accounting methods. It should serve as a

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comprehensive reference book on cost accounting procedures. It should be useful to the

executives / cost accountants for solving all problems in installation and execution of

recommended uniform costing methods.

4.10.9 CONTAINS OF COST MANUAL:- A typical uniform cost manual may contain the introduction part, organization of system,

Accounting & Cost System to be followed and reporting system.

4.10.10 INTER-FIRM COMPARISON MEANING:- When production methods, technology, product characteristics and general operating

figures of ones own company are compared with other company within the same industry

it is known as inter firm comparison.

An inter-firm comparison is not possible unless the like is compared with the like. Thus,

a Uniform Costing is prerequisite for an inter-firm comparison. Inter-firm comparison

enables the management of a company to compare its performance with the efficient

companies.

4.10.11 PURPOSE OF INTER-FIRM COMPARISON: - The main purpose of inter-firm comparison is the improvement of efficiency by showing

management the present achievements and possible weaknesses. Many problems can be

overcome by use of inter-firm comparison. Some of these special problems include

improvement in the profitability, efficiency in selling product or providing services and

production efficiency.

4.10.12 PROCEDURE OF INTER FIRM COMPARISON: - The procedure adopted for inter-firm comparison is that data are collected from

participating organizations by a central agency like trade association or chamber of

commerce. This data are analyzed and presented in such a manner (by use of code number

and ratios) that the data furnished by an individual company are kept secret. Then the

management of a company is provided with information, which will enable them to

determine its efficiency by comparing the performance of other companies within the

industry. At the end to highlight weakness, an attempt is made to show why the efficiency

of an organization is less than that of other organizations.

4.10.13 REQUISITES OF INTER-FIRM COMPARISON: - Requisites for installing system of inter-firm comparison include the nature and extent of

information required by the management, responsibility for collection and presentation of

information which lies on Associations/Chamber of Commerce, existence of Central body

for doing a comparative study, dissemination of the results to members and taking

membership of Association by firms.

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4.10.14 ADVANTAGES INTER-FIRM COMPARISON: - The inter-firm comparison provides an overall view of the industry as a whole, present

position of the industry, progress made during the past and the future of the industry. It also

helps a concern in knowing its strengths or weakness in relation to others so that remedial

measures may be taken. It also ensures an unbiased specialized reporting on particular

problems of the concern. It develops cost consciousness among members of the industry.

Inter-firm comparison helps Government in effecting price regulation. It helps to improve

the quality of products manufactured and to reduce the cost of production. It is thus

advantageous to the industry as well as to the society.

4.10.15 LIMITATIONS OF INTER-FIRM COMPARISON: - The difficulties in the implementation of a scheme of inter-firm comparison includes

reluctance by the member to share the data relating to their performance, unwillingness in

active participation, practice of different cost accounting system, fear of losing secrecy of

data, resistance from Middle management, absence of a suitable basis for comparison etc.

4.11 CAPITAL STRUCTURE AND COST OF CAPITAL

4.11.1 INTRODUCTION: - Basic task of finance manager is the procurement of funds. The basic objective of financial

management is wealth maximization. The finance manager for the procurement of funds is

therefore required to select such a finance mix or capital structure, which maximizes

shareholders wealth. For designing the optimum capital structure he is required to select

such a mix of sources of finance so that overall cost of capital is minimum.

4.11.2 MEANING OF CAPITAL STRUCTURE: - It refers to The make up of a firms capitalization. Capital structure refers to the mix of

sources from where the long-term funds required in the business may be raised.

In other words what should be the proportion / mix of long term funds such as equity share

capital, preference share capital, internal sources, debenture, and other sources of funds in

the total amount of capital, which an undertaking may raise for establishing its business?

There is no standard model of capital structure, which can be applied to all business

undertakings. No single approach or formula is available to decide about the debt equity

mix. One has to plan the capital structure in a model complied from past experiences of the

business house. The choice of an appropriate capital structure depends on number of factors,

as the nature of the companys business, regularity of earnings, conditions of the money

market, attitude of the investors etc.

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4.11.3 OPTIMUM CAPITAL STRUCTURE / BALANCED CAPITAL STRUCTURE: - The capital structure is said to be optimum capital structure when the firm has selected such

a combination of equity and debt so that the wealth of firm is maximize. At this capital

structure the cost of capital is minimum and the market price per share is maximum. It is

however, difficult to find out optimum debt and equity mix where the capital structure

would be optimum because it is difficult to measure a fall in the market value of equity

share on account of increase in risk due to high debt content in the capital structure. In

theory one can speak about the optimum capital structure but in practice appropriate capital

structure is more realistic term than the former. Hence the planning the capital expenditure

is of crucial importance, as it has long-term financial implication.

A capital structure will be considered to be appropriate if it improve profitability, solvency,

control and confirm flexibility.

4.11.4 MAJOR CONSIDERATIONS IN CAPITAL STRUCTURE PLANNING: - There are three major considerations, i.e. risk, cost of capital and control, which should be

bear in mind while determining the proportion in which the firm can raise funds from

various resources. In addition to this various other factors need to be considered in capital

structure. These factors include nature of enterprise, size of the company, purpose of

financing, period of financing, trading on equity, timing, corporation taxation, government

policies, legal requirements, marketability, maneuverability, flexibility, requirement of

investors, and provision for future.

4.11.5 CAPITAL STRUCTURE THEORIES: - The objective of a firm should be directed towards the maximization of the value of the

firm. The capital structure, or leverage decision should be examined from the point of view

of its impact on the value of the firm. If capital structure or financing decision affects the

value of the firm, a firm should like to have a capital structure, which maximizes the market

value of the firm.

There are broadly four approaches namely Net Income Approach (NI Approach), Net

Operating Income Approach (NOI Approach), Traditional Theory, Modigliani and Miller

Approach (M&M Approach). These approaches analyses relationship between the leverage,

cost of capital and the value of the firm in different ways. However, these approaches are

based on certain assumptions which need to understand before selecting it.

4.11.6 MEASUREMENT OF COST OF CAPITAL: - Measurement of cost of capital includes measurement of each source of capital namely cost

of debt, cost of preference share, cost of irredeemable preference share, cost of ordinary or

equity Shares, cost of reserves and cost of depreciated funds.

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The cost of capital is an important factor in designing the capital structure of an

undertaking. The basic reason behind running a business undertaking is to earn a return at

least equal to its cost of capital. Therefore, cost of capital constitutes an important factor in

various business decisions.

4.11.7 WEIGHTED AVERAGE COST OF CAPITAL: - The composite or overall cost of capital of a firm is the weighted average of the costs of

various sources of funds. Weights are taken to be the proportion of each source of funds in

the capital structure. The weights to be used can be either book value weights or a market

value weights. While making financial decisions this overall or weighted cost is used. Each

investment is financed from a pool of funds which represents the various sources from

which funds have been raised. Any decision of investment therefore has to be made with

reference to the overall cost of capital and not with reference to cost of a specific source of

fund used in that investment.

4.12 PRICING OF SERVICES

4.12.1 INTRODUCTION:-

Pricing of services is one of the most crucial and difficult of all areas of decision-making.

Such a decision affects the long term of any profit-oriented enterprise. Accounting

information is often an important input to pricing decisions. In pricing decision the

management must first decide on it pricing goal and then set the base price for its products or

services. After this the firm may design its pricing strategies. 4.12.2 FACTORS AFFECTING PRICES:-

There are many factors involved in the establishment of prices. They are costs, customers,

competitors and ccompetition.

4.12.3 METHODS OF PRICING:- Various methods of pricing are Cost-plus pricing, Marginal Pricing / Variable Cost Pricing,

Non Cost Method. Competitive Pricing Going rate pricing Sealed bid pricing Incremental

Pricing. Various methods of the pricing of new services are skimming pricing and

penetration pricing.

4.12.4 PARETO ANALYSIS:- Pereto Analysis is based on the rule of 80:20 that was a phenomenon first observed by

Vilfredo Pareto, a nineteenth century Italian economist. He noticed that 80% of the wealth of

Milan was owned by 20% of the its citizens. This phenomenon or some kind of

approximation can be observed in many different business situations. In pricing, a small

number of products offer provide the bulk of the contribution to profits and overheads. Hence

a premium business should concentrate on those few goods and services which are important

and leave the large reminder to look after them selves.

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Table 4.1: Clasiffication of financial Ratios

A) PROFITABILITY RATIOS B) OPERATIONAL RATIOS C) SOLVENCY RATIOS D) PRODUCTIVITY RATIOSa) Interest Earned Ratio a) Ratio of Net Profit to Total Income (Profit Margin) a) Short Term solvency / liquidity Ratio a) Based on per employeeb) Interest Paid Ratios b) Ratio of Interest Earned to Total Income i.Credit-Deposit Ratio (C-D Ratio) i.Per Employee Depositsc) Spread Ratio c) Ratio of Non-Interest Income to Total Income ii.Cash Assets to Deposit Ratio (Cash Ratio) ii.Per Employee Advancesd) NonInterest Expenses Ratio d) Ratio of Total Expenses to Total Income iii.Liquid Assets to Deposit Ratio iii.Per Employee Income i) Man Power Expenses Ratio i.Ratio of Interest paid to Total Income b) Long Term solvency Ratio iv.Per Employee Expenses ii) Other Expenses Ratio ii.Ratio of Manpower Expenses to Total Income i.Owned Funds to Borrowed Funds Ratio v.Per Employee Establishment Expendituree) Non-Interest Income Ratio iii.Ratio of other Establishment Expenses to Total Inco ii.Fixed Assets to Owned Funds Ratio vi.Per Employee Spreadf) Burden Ratio iii.Debt to Total Assets Ratio vii.Per Employee Profitg) Profitability Ratio iv.Ratio of Investments to Deposit viii.Business per employeeh) Net Interest Income Ratio or ix.Voucher per employee Ratio of Interest Income to Interest Cost x. Business per rupee of staff cost.i) Interest Paid to Interest Earned Ratio b) Based on per Branch Productivity Indicatorsj) Ratio of Return on Assets i.Business per Branchk) Return on Equity ii.Net profit per Branchl) Gross Profit Ratio (GPR) iii.Advance per Branch m)Net Profit Ratio (NPR) iv.Deposit per branch

v. Net revenue per branch vi.Working fund per branchvii.Transaction cost per branchc) Based on per Account Indicatorsd) Based on Operating Expenses i.Operating Expenses to Total Business Ratio ii.Operating Expenses to Total Income Ratioe) Other Productivity Ratio i.Over Dues Demand Ratio ii.Yield on Advances Ratioiii.Credit Deposit Ratioiv.Cost Of Deposit Ratiov. Other Income Ratiovi.Return on Total Assets Ratio

FINANCIAL RATIOS

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Page NoContainsSr. No.343537414345485052545761634.4 RATIO ANALYSISPricing of services is one of the most crucial and difficult of all areas of decision-making. Such a decision affects the long term of any profit-oriented enterprise. Accounting information is often an important input to pricing decisions. In pricing ...There are many factors involved in the establishment of prices. They are costs, customers, competitors and ccompetition.METHODS OF PRICING:-Various methods of pricing are Cost-plus pricing, Marginal Pricing / Variable Cost Pricing, Non Cost Method. Competitive Pricing Going rate pricing Sealed bid pricing Incremental Pricing. Various methods of the pricing of new services are skimming ...PARETO ANALYSIS:-Pereto Analysis is based on the rule of 80:20 that was a phenomenon first observed by Vilfredo Pareto, a nineteenth century Italian economist. He noticed that 80% of the wealth of Milan was owned by 20% of the its citizens. This phenomenon or some kin...Ch_ 04A- Chart of Ratios.pdfSheet1