SYMBIOSIS CENTRE FOR DISTANCE LEARNING

CERTIFICATE COURSE IN INSTRUCTIONAL DESIGN (CCID)

PROJECT TOPICS

1. FORECASTING, PLANNING AND DECISION MAKING

2. STRESS MANAGEMENT

3. BASICS OF FINANCIAL ACCOUNTING

Audience for all three topics:

The learners are in the age group of 25 years to 45 years including both males and females. They are all working professionals in private or multinational organizations, with a working experience of at least two years. They are all graduates or post-graduates. Most of them have some supervisory experience also. They come from different parts of India, and some 10% are foreign nationals. The learners have working knowledge of computers.

TOPIC 1

FORECASTING, PLANNING AND DECISION MAKING

Forecasting: Management function begins with forecasting. It is the scientific process of looking forward which is based on past performance, current analysis and future trends. Planning is based on forecasting.

Every company undertakes the process of forecasting, either on its own or takes note of general economic forecasts made by various competent authorities. Some companies also have consultants for this purpose. Confederation of Indian Industries (CII), Centre for Monitoring Indian Economy (CMIE), Reserve Bank of India (RBI) and many other private organizations forecast trends as per the requirements of companies.

Some of the popular forecasts are:

a. Demand Forecasts

b. Sales Forecasts

c. Production Trends Forecasts

d. Specific Industry Forecasts

Apart from this general categorization, forecasts can also be company specific or problem specific, such as manpower forecasts for a particular industry, based on growth prospects. Every forecast must be preceded by authentic research, analyzing of trends, taking into consideration risk factors and even the probability of an error.

What is Planning?

Planning is defined as -

A long look ahead,

Broad look around and

A searching look within

The most popular definition of planning is based on answering the following six questions:

1. What is to be done? (Nature of Business)

2. Why to do it? (Objectives of Business)

3. How to do it? (Technology and Strategies to be adopted)

4. Where to do it? (Place or location)

5. Who will do it? (People)

6. When to do it? (Time Factor)

The above definition signifies that ‘answer these questions and planning is complete’.

Planning is imperative in an uncertain environment. These days the word ‘Strategy’ has taken the place of the word ‘ Planning’. Strategy is ‘competitive planning’ as it takes care of competitors and SWOT model, i.e. Strength – weaknesses – opportunities and threats.

Advantages of Planning

1. Planning makes companies competitive

2. Planning anticipates risk factors and eliminates waste

3. It reduces cost

4. It helps the company to face future challenges

5. Planning helps in controlling

6. Planning gives direction and helps in formulating specific strategies

7. Planning improves efficiency and introduces various systems in the organization

8. Planning can warn about deviations and helps in assessing performance

Limitations of Planning

1. Planning can minimize the risk but cannot eliminate the risk

2. The success of planning depends upon implementation (planning on paper is as good as no planning)

3. It depends on authenticity and reliability of information

4. It depends on internal and external variables which are beyond the control of the planner

Essentials of a good plan

1. Planning must be continuous

2. Planning must be creative

3. Planning process must be communicated to the lowest possible level

4. Planning should be time bound

5. Planning should exist at all levels in the organization

6. Planning must motivate people towards its implementation, so it must have an inbuilt rewards system for effective execution

7. Planning should not be rigid (it must be flexible to respond to sudden changes in internal and external environment)

8. Planning must coordinate the efforts of all departments (must respect the process of unification of efforts)

9. Planning must have an inbuilt controlling process

10. People are the essence of planning (the success of every plan depends upon people, so this factor should be kept in mind while framing plans)

Components of Planning

1. Objectives

2. Policies

3. Procedures

4. Programs

5. Rules

6. Budgets

7. Strategies

Any planning process generally has the above seven components, though its nature and scope depends upon the type of plan, purpose of the plan and the time factor.

1. Objectives: The word “objectives” has changed over a period of time and includes concepts like:

a. VISION – (Category of intensions, broad, all inclusive, forward thinking)

b. MISSION – Mission becomes more tangible when expressed in the form of a mission statement. What is our reason for being, what is unique about our company

c. GOALS – More specific, financial, non-financial issues, range of goals, reached with a stretch

d. Objectives become measurable and they incorporate dimensions of time and hierarchy. Objectives can be classified as:

1. On the basis of time (Short-term, Medium-term and Long-term)

2. On the basis of functions (Marketing, Production, Materials, Human Relations Objectives)

3. On the basis of levels (Top, Middle and Lower level objectives)

2. Policies: Policies are general statement. It can be implicit or explicit. Policies offer general direction to planning and they offer the framework within which an organization must work. For example: HR Policy on recruitment, selection, training.

3. Procedure: Procedure is the step-by-step approach to implement policies. It is more specific in terms of steps. For e.g. Recruitment procedure consists of releasing an advertisement, inviting applications, conducting written tests and interviews.

4. Programs: When time element is introduced in procedures, it becomes a program. As there is an element of time, it is also called as the timetable of planning. For e.g. the dates on which advertisements are to be released for recruitment, the last date of receiving applications, day, date and time of written tests, the scheduling of interviews etc.

5. Rules: They are specific, rigid, and non-flexible. They offer a definite direction to the planning process. For e.g. smoking is to be discouraged is a policy, but ‘No Smoking in the premises of the organisation’ is a rule.

6. Budgets: All financial requirements under the plan by the various departments can be called as ‘Budgets’. Budget-allocation by top management and budget requirements submitted by departmental heads uses the two common terms in the organization at the time of budget formulation. In simple words, expected income and expenditure under different heads can be called as budget in planning.

7. Strategies: Strategies can be called the ‘Action Component’ of planning. As stated earlier it is competitive planning. Indian companies have adopted various strategies for survival and facing the threats from competitors.

Following are the examples of recent corporate strategies:

1. Joint Ventures, Alliances, Tie-Ups

2. Take-over, Acquisitions

3. Reverse mergers, Mergers and Amalgamations

4. Demerger

5. Core Competence

6. Diversification

7. Backward, Forward, Horizontal Integration

8. Hiving – off units/Division

9. Turn Around

10. Harvesting

11. Disinvestments

12. Pricing

13. Brand-Building

14. Employee Stock Option

15. Profit Centres/SBUs (Strategic Business Units)

16. Downsizing/ Rightsizing

17. Benchmarking

18. TQM/Total Quality Management

Functional Level Strategy

a. Production

b. Human Resource

c. Finance

d. Marketing

e. Information Technology

Vision

What is Vision?

A vision is essentially a dream. In the corporate sense, it is a dream with a deadline. A vision statement articulates the long-term goals of the enterprise. It is a look beyond the present to see what the future can be. For an organization a vision statement should assert what an organization can be at its best. It may also define what is unique about the enterprise. For a business a vision statement would be presented as a pen picture in terms of its likely physical appearance, size etc.

A vision statement should have the following components.

An ability to inspire people to work for the organization.

A sense of worthiness, which creates a lasting impact.

It should be precise and objective.

It should be achievable and realizable.

It should be in a clear and understandable detail.

Recent examples of vision statements of Indian Corporations show the vibrate dreams of their leaders. The tractor division of Mahindra and Mahindra has declared its vision to be the world’s largest tractor manufacturers by 2003. Even the Reliance Industries before setting up the refinery at Jamnagar had the vision to be the first among the developing countries to arrive at the global oil scene.

Powerful visions if communicated always produce powerful results. An organization without a vision is like a ship without a rudder.

Mission

It specifies how the organization will achieve its goals. Mission statements explain what you do and why you are in business. A well-formulated mission statement identifies at the minimum the type of business it is in, its markets, customers and financial goals. Mission statements help in

generating the unity that leads to high performance. They basically indicate the purpose of the business. Mission statements are derived from the vision statements.

The various components of the mission statements are:

Elicits an emotional, motivational response.

Is easily understood and can be transformed into individual action.

Has a major able, attainable goal.

Is simple, honest and frank.

Is fully believed.

Mission is an action-oriented and enduring expression of how a company wants to accomplish its visions.

A corporate example of a mission statement is Pepsi Co’s mission statement.

“Pepsi Co’s mission is to increase the value of our share holders investment. We do this through sales growth, cost controls and wise investment of resources”.

Hence the mission statements can help a company to end up at its final destination–SUCCESS.

The Purpose Of Vision and Mission Statements

Can unleash boundless constructive energy among workers.

Determining and visualizing goals focuses the attention of workers.

Inspires them to perform better by providing yardsticks of performance.

Creates a sense of urgency.

Gives the sense of belonging as they feel they are partners in achieving the organizational goals.

Enhances commitment as there is something real and genuine they can commit to.

Statements of vision and mission are not just elements of future planning. They also provide benchmarks for a historic review. Managers will find it difficult to develop a future strategy for a business without correctly articulating its vision and mission. Vision and mission must be combined with corporate values so as to have true realization of the organizational goals.

Vision without mission is incomplete and mission without vision is meaningless.

Management by Objectives

MBO

Management by objectives is a very popular tool in today’s organizational setup. Peter Drucker is the first management thinker who wrote about it. He acted as a catalyst by emphasizing that

objectives must be set in all areas where performance affects the health of the enterprise. He laid down a philosophy that emphasizes self-control and self-direction.

Why MBO?

1. To clearly set objectives/goals/targets.

2. For performance evaluation.

3. For participation by managers in decision-making process.

4. For monitoring the performance from time to time.

5. For self-control, assessment and self-direction.

6. For effective control.

7. It is a tool of training and development.

The above points are dealt in detail in following pages under the heading of benefits of MBO.

The process of MBO

As in all planning, one of the critical needs in MBO is the consistent planning premise. No manager can set or establish plans and budgets without guidelines. The steps included in the process of MBO are:

1. Preliminary setting of goals at the top: Given appropriate planning premises, the first step-in setting objectives is for the top manager concerned to determine what he or she perceives to be the purpose and the more important goals for the enterprise to achieve in the given period of time ahead. These can be set for any period of time–a quarter, a year or five years or whatever is appropriate in the circumstances. Certain goals should be scheduled for the accomplishment of a much shorter period and others for a longer period. Also as one proceeds down the organizational hierarchy, the length of time set for accomplishing the goals, tends to get shorter. The goals set by the superiors are preliminary, are based on the analysis and judgment of what can and should be accomplished by the organization in a given period of time. This requires to take into account the company’s strengths and weaknesses in the light of available opportunities and threats. It is also not advisable to force objectives on subordinates, since people seldom feel committed to goals that are pressed upon them. Most of the managers find that the process of working out goals with subordinates reveals both problems to be dealt with and opportunities they would not have previously known.

2. Clarification of organisational goals: Ideally every goal and sub-goal should be some person’s clear responsibility. By analysing an organizational structure we often find vagueness where we need the organizational clarification or even reorganization. Sometimes it is impossible to structure an organization so that a given objective is one person’s clear responsibility. For e.g. For launching a new product, the managers of research, marketing and production must carefully co-ordinate their activities. The specific part of each co-ordinating manager to the programmed goal can and should be clearly identified.

3. Setting of Subordinate Objective: After making sure that subordinate managers have been informed of pertinent general objectives, strategies and planning premises, the superior can then proceed to work with subordinates in setting their objectives. The superior role at this point of time becomes extremely important. He asks various questions to his subordinates such are:

a. What can you contribute?

b. How can we improve our operations?

c. What stands in the way or what are the problems?

d. What changes can be made?

e. How can I help?

The things that create an obstruction in the performance are identified and many constructive ideas are dredged from the experience and knowledge of the subordinates. In this step, the superiors must also be patient counsellors, helping their subordinates develop consistent and supportive objectives and being careful not to set impossible targets. The superior’s final judgment and approval must be based upon what is reasonably attainable.

Another advantage of setting up a careful network of verifying goals is tying in the need for capital, material and human resources to the goals themselves. The superior can see the most effective and economical way of allocating them.

4. Recycling of Objectives: Objectives can hardly be set by starting at the top and dividing them among the subordinates nor should they be started from the bottom. A degree of recycling is required. Recycling suggest discussion, interaction with the managers concerned and accepting suggestions from all levels. Thus the objective setting is not only a joint process but is also one of interaction, For e.g. A sales manager may realistically set a goal to achieve a much higher sales of a product than what the top management has believed to be possible. In this event the goals of the manufacturing and finance departments will surely get affected.

From here on we will be talking to you about:

Guidelines for setting objectives

Quantitative and Qualitative objectives

Verifiable and non-verifiable objectives

Benefits and Weaknesses of management by objectives

Now without clear objectives, managing is haphazard. No individual and no group can expect to perform effectively and efficiently unless there is a clear aim. Therefore this gives rise to guidelines for setting objectives, which is indeed a difficult task. It requires intelligent coaching by the superiors and extensive practice by the subordinates. The list of objectives prepared must not be too long and yet it should cover the main features of the job.

The objectives should be…..

Verifiable and should state what is to be accomplished and when. If possible the quality desired and the projected cost of achieving the objectives should be indicated.

The objectives should present a challenge, indicate priorities and promote professional growth and development.

Therefore these criteria would help in setting objectives.

Now to be measurable, objectives must be verifiable. This means that one must be able to answer questions such as…..

At the end of the period, how do I know if the objectives have been accomplished?

How much has been accomplished?

What has been accomplished?

When was it accomplished?

Thus, these falls under quantitative and qualitative objectives, but at times it is more difficult to state results in verifiable terms. This is especially true for staff personnel. For e.g. Installing a new computer system is an important task but is not a verifiable goal. On the other hand, the objective is to install a computerized control system in the production department by December 1999 with expenditure not more than 500 working hours. Then this would be a verifiable objective. Here the goal accomplishment can be measured.

Other examples would be such as to make a reasonable profit would be a non-verifiable objective, but to achieve a return on investment of 12% at the end of the current fiscal year would be a verifiable objective.

Benefits of Management by Objectives

There is considerable evidence much from laboratory studies that shows the motivational aspects of real goals. But there are other benefits as well.

1. Improvement in Management: Management by objectives results in greatly improved management. Objectives cannot be set without planning and result-oriented planning is the only one that makes sense. Management by objectives therefore forces managers to think about planning for results rather than merely planning activities or work.

2. Clarification of Organization: Another benefit of MBO is that it forces managers to clarify organizational roles and structures even to the extent where positions could be built around the key results expected areas, of the people occupying them. Companies that have effectively embarked on the MBO program, have discovered deficiencies in the organization such as lack of delegation of authority according to results expected, decentralization management etc. Here MBO helps in activating the fulfilment process for these deficiencies.

3. Encouragement of Personal Commitment: One of the great advantages of MBO is that it encourages the people to commit themselves to their goals. No longer people are just doing work, following instructions and waiting for guidance and decisions, they are now individuals with clearly defined purposes. They have had a part in actually setting the objectives, they have had an opportunity to put their ideas in planning programs. They

understand their areas of discretion; their authority and they have got their help from their superiors to ensure that they can accomplish their goals. These are the elements that make for a teaching for commitment.

4. Development of Effective Control: MBO also aids in developing effective controls. Now, control involves measuring results and taking actions to correct deviations from plans to ensure goals are reached. But one of the major problems is knowing where one has deviated i.e. knowing what to watch out for. Thus, here a clear set of verifiable goals is the best guide for having effective controls.

Weaknesses of MBO

With all its advantages, a system of MBO has a number of weaknesses most of which are due to shortcomings in applying MBO concepts. They are:

1. Failure to teach the philosophy of MBO: Managers who understand the concept of MBO, who have put into practice and appreciate a good deal about it must in turn explain to the subordinates what it is all about, how it works, why is it being done, what part will it play in appraising the performance and how the participants can benefit from it. The philosophy is based upon the concepts of self-control and self-direction that are aimed at making managing professionals. Therefore, failure to teach the philosophy could pose to be a major weakness of MBO.

2. Failure to give guidelines to goal setters: Here we would like to mention that managers must know their corporate goals and how their own activity fits in them. Failure to fill certain needs such as: some assumptions as to future, knowledge of major company policies, understanding the policies affecting their areas of operation etc. could result in a total vacuum in planning.

3. Difficulty in setting goals: Truly verifiable goals are difficult to set. It takes more study to work. It is more difficult to establish verifiable goals that are formidable but attainable than to develop many other plans which tend only to lay out work to be done in the future.

4. Emphasis on short run goals: This could become a danger at the expense of long run goals. Therefore, managers should see that short run plans are designed to some longer range goals.

5. Danger of Inflexibility: Now managers often hesitate to change objectives. Sometimes goals may cease to be meaningful if they are changed too often and do not represent a well thought out and well planned out result. Nevertheless it is foolish to expect the manager to strive for a goal that has been made absolute by revised corporate objectives, changed premises or modified policies. Therefore hesitation to change objective could result in major weakness of MBO.

Finally to conclude, we would like to state that just if a goal-oriented management approach is to produce results, then it has to be adopted to the specific situation.

Decision Making

Planning and decision making are closely interlinked. As we have seen in the earlier chapters on planning, decision making is an integral part of planning. Decision making as a process and function of management is very vital as many critical aspects of management depend upon the right decision at the right time. The following general observations will tell us how complicated and at the same time how challenging decision making is:

Every decision is right when it is taken

Not to take a decision is also a decision

The manager is as good as the decision he takes

Decision making is the most creative activity in the life of a manager

Rationality in decision making is subjective

Decision making is a conflict resolving process

Decision making exists at all levels, but it is so perceptive that people in the middle and lower levels never get an opportunity to take the decisions

Right decisions at the wrong time are disastrous

Decision making is also influenced by a gut feeling or intuition (Very difficult to define these words, but it is said that no explanation is necessary if you believe in them and no explanation is possible if you don’t)

So decision making is often a function of ‘sixth sense’

What is Decision Making?

Decision making is a process of making a choice out of best alternatives. It is an intellectual process involving the following steps:

Identify the problem (Need for action is felt)

Collect information from all possible sources

Develop alternatives

Compare and evaluate these alternatives

Decision making stage of making a choice among alternatives

Implementation and communication of decisions

Follow up and review

Factors affecting the Decision Making Process:

1. Information (It must be available, authentic, adequate, reliable, must be available at the right time. It must be analysed and presented in the right manner).

2. Time Factor: Decision must be taken at the right time. Some products are introduced ahead of time. For e.g. Dish washers introduced in India. Decisions are also time bound. In business, context, introduction of air-conditioners, coolers and refrigerators in summer and woollen clothing in winter also suggests the influence of time in decision making.

3. External Environmental Factors: As decision making is always interactive with the environment, various environmental factors influence decision making such as economic, political, social, cultural, technical, ethical, legal, global factors.

4. Internal Factors: Rules, regulations, procedures within the organization or administrative restrictions also affect decision making.

5. Personality of the Decision Maker or Subjectivity: The decision making process has a lot to do with who is the decision maker, his attitudes, perceptions, values, style of functioning, the nature of personality and overall way of thinking.

6. Participation, Acceptance and Implimentation: Elements of how decisions are taken, how far they are accepted and how they are to be implemented also contribute in the decision making process.

7. Precedent: In a bureaueratic set up this becomes a ruling factor as questions like “Have we done this before?”, “Is there a precedent of taking such decisions?” are often asked before taking a decision.

8. Experience of a Decision Maker: As it is said that experience is the best teacher, maturity in business experience of a manager go a long way in taking effective decisions.

9. Power to Decide: Many times, people know what is wrong in the organisation, but often they do not have the power to decide and act. That is how the concept of empowerment is evolved which talks about decision making to the lowest possible level.

10. Escalation of Commitment (Point of No-return): After a decision has been taken, it is often felt that the decision is going in a wrong way, but more than half of the work is completed. Therefore, there comes a point of no return and the decision has to be completed in spite of negative feedback.

11. Bounded Rationality: Constructing simplified models that extract the essential features from the problems without capturing all their complexities. The decision maker settles for the early solution that is good enough. In layman’s language, the decision maker finds out the earliest available alternatives, takes certain things for granted and acts on it. The decision maker takes generalised judgemental shortcuts which are also called Heuristics. For e.g. if two students from a particular management institute show exemplary performance in the job, the judgemental shortcut is “every student from this institute is good”, and vice versa.

12. Problem Perception: Problems that are visible catch a decision makers decision. These problems become the first to be acted upon, or a priority. For e.g. if at the time of the chief executive officers (CEO) visit, workers start agitating, then this agitation becomes the main problem for the CEO because it is visible for him.

TOPIC 2

STRESS MANAGEMENT

The existence and importance of stress in industry was first recognised in America in 1956. A machine operator named James Carter cracked up while working on the General Motors production line in Detroit. Mr. Carter had what is now commonly known as a nervous breakdown and he sued General Motors, claiming that the stresses of his job had contributed to his condition. It was an important lawsuit. Carter won and from that day onwards most executives and all lawyers and the physicians in America took the relationship between stress and industry very seriously indeed. However, executives around the rest of the world have been slow to recognise the importance of stress in Industry.

Indeed, in some ways it is difficult to blame company executives for failing to understand the importance of ‘stress’ as a trivial problem and laugh at any suggestion that there could be a link between problems in the mind and problems affecting the body.

In the last few years evidence has accumulated from around the world to show that the most common cause of destructive ill health is stress at work. Researchers have not only built up evidence showing links between industrial stresses in general and ill health but have even accumulated evidence showing that it is possible to link specific occupations with specific types of stress induced disease. No one is immune. The man or women on the shop floor is just as vulnerable as the man or women on the board of directors.

In India, the statistics show, the rate of people suffering from the heart-related problems has gone up nine times within the last four decades.

Although there is absolutely no doubt that stress is killing many people, disabling many more and costing industry crores of rupees every year, there is one important question that has to be asked. Why are we so susceptible to stress these days?

The answer to this apparently unanswerable paradox is quite simple. Our bodies were designed a long, long time ago. We were not designed for the sort of world in which we live today. We were designed for a world in which fighting and or running were useful practical solutions to everyday problems. We were designed to cope with physical conformations with sharp-toothed tigers.

The problem is that our environment has changed far more rapidly than we have evolved. We have changed our world far faster than our bodies have been able to adapt. At no other time in the history of the world has there been such a constant progression of ideas and technology. Fashions, themes and attitudes have never changed as rapidly as they have in the last hundred years or so. Never before have expectations and pressures been so great. Revolutionary changes in agriculture, navigation, medicine, military tactics, design, transport, communications and industrial methods have all transformed our world. But our bodies are still the same as they were tens of thousands of years ago. It takes millennia for the human body to adapt. We have moved far too quickly to be good for our bodies.

It is these environmental changes that have made stress more pronounced. These days stress is ubiquitous. None can escape stress. As a matter of fact stress has its origin in the body chemistry which has remained unchanged since the man came on the earth.

Let us take example of the cave man. For him to survive was either a fight or a flight. Whenever there was any life threatening event any action off light or fight, pituitary would give appropriate signals for secreting adrenaline in the blood stream. This resulted in creation of additional energy for the body either to fight or fly. This is known as ‘fight or flight mechanism’.

Following are some of the changes that occur in the body to protect itself from the danger within a few microseconds. These responses of the body to a situation are known as fight or flight mechanism with, interalia, the following bodily responses:

Release of Adrenaline and conversion of glycogen into glucose;

Raised Pulse;

Raised Blood Pressure;

Rapid Breathing;

Dilated Pupils;

Digestion slowed because of diversion of blood supply from stomach to the extremities of the body;

Over million of years the lifestyle has changed; however, the body chemistry has not changed. With the change in the lifestyle, stressors have multiplied and diversified in different forms. However, the body chemistry response has remained the same.

The theory of ‘General Adaptation Syndrome’ states that when an organism is confronted with a threat, the general physiological response occurs in three stages viz. alarm reaction, resistance reaction and state of exhaustion.

Alarm Reaction

The first stage includes an initial “shock phase” in which resistance is lowered, and a “countershock phase” in which defensive mechanism become active. Alarm Reaction is characterised by autonomous excitability; and adrenaline discharge; increased heart rate; muscle tone, and blood content; and gastro-intestinal ulceration. Depending on the nature and intensity of threat and the conditions of the organism the severity of the symptoms may differ from a mild invigoration to disease of adaptation.

Stage of Resistance

Maximum adaptation occurs during this stage. The bodily signs characteristic of the alarm reaction disappear. Resistance increases to levels above normal. If the stress persists, or the defensive reaction proves ineffective, the organism deteriorates to the next stage.

iii) State of Exhaustion: Adaptation energy is exhausted, signs of alarm reaction reappear, and resistance level begins to decline irreversibly the organism collapses.

A diagrammatic view of these stages is shown in the figure below

One of the major shortcomings of this theory is that the related research was carried out on animals where the stressors are usually physical or environmental–and this is not always the case in relation to human organisms. The concept of General Adaptation Syndrome is, therefore, not given weightage in the present days.

Present day human is being compressed by stresses from various sources such as his own psychological and physical make up; the familial demands, the social demands, the demands of the job etc. etc.

Whenever a superior scolds a subordinate, the latter’s body chemistry acts in the same way it did in the cave man when he was threatened by a tiger. Even all his body functions race up to meet the emergency. However, physical emergency there is none. This additional burst of energy is not only useless for him but is harmful. He can neither fight physically with the superior nor leave the place of work. The adrenaline is metabolised. These metabolic changes act on various balancing and self-correcting mechanisms of the body. The result is the psychosomatic diseases.

STRESS DEFINITIONS

Different definitions of stress occur. Dr. Seyles, an expert in stress management, gives the best definition in stress management. According to him “stress is a non-specific response of the body to situation”.

It is important to remember that the body chemistry does not distinguish between the anxiety causing, pleasant or unpleasant situations. In any of these situations, the body response is the same, resulting in fight or fly mechanism.

The other definitions of stress are :

“Stress is a physiological abnormality at the structural or bio-chemical level caused by overloading experiences.”

“Stress is an adaptive response to an external situation that results in physical, psychological and or behavioural deviations.”

According to Dr. Pestonji of I.I.M. Ahmedabad, the stress can be categorised as under:

Eustress

This stress is because of the sudden overjoy. Fortunately this type of stress is not long- lasting. Furthermore it is a state of happiness. Eustress, therefore, is not harmful, being occasional and fleeting.

Distress

This is anti-thesis of eustress. Distress is caused whenever a person is suddenly very sad or angry. Distress is caused because of the demands of the modern life and anxiety to cope with them. This results in feelings of inadequacy, anxiety, nervousness, loss etc. This type of stress is harmful. It is this stress that has caused more havoc in the executive life. It is this stress that justifies the saying “Ulcer is the surest sight of executive success”.

Since it is distress that takes a heavy toll of executive efficiency, the organisations should try to alleviate it. An atmosphere of objectivity and mutual trust would go a long way in reducing distress.

Hyper Work Stress

This type of stress is caused because of the hyper activity and travails of life to meet dead- lines etc. Target mindedness and the eleventh hour rush or continuous overwork cause hyper stress. The key therefore, to deal with hyper stress lies in good planning.

Hypo Stress

This type of stress is the opposite of the hyper stress. This stress is caused by less than optimum activity. The effects of hypo stress are slower than other types but are more penetrating and longer lasting. There are examples when the Organisations have deliberately created hypo stress by denying legitimate work to their employees. Such situations, beyond creating stress, deprive a person of the fulfillment of self-esteem needs. More often the retired persons experience this stress. For them it is a transition from hyper to hypo stress. This underlines the necessity of planning the post-retirement period, doing proper time management by planning activities so that an individual remains optimally busy.

The above discussion shows that whatever an individual does or does not so, there is always some sort and some amount of stress on him. This is why stress is known as “non-specific response of the body to the situation.

There are three broad categories of stressors. They are :

a) Organizational stressors;

b) Life stressors; and

c) Personal stressors.

Organisational stressors

Organisational membership is a dominant source of stress. The concept of organisational stress was first evolved in the classic work of Kahn et al. They were the earliest to draw attention to organisational stress in general and role stress in particular.

Some of the organisational stressors are intrinsic to the job. They are boredom, time pressures and deadliness, exorbitant work demands and technical problems.

Some organisational stressors relate to the role in the Organisation. They are role ambiguity, role conflict, role overload etc.

Some organisational stressors relate to the organizational structure and the climate. They are lack of participation in the decision-making, lack of responsiveness and appreciation, pressers towards conformity etc.

Life stressors

Life stressors can be catagorised in three classes. They are :

a) Life changes,

b) Daily stressors

c) Life trauma

Life change

Human has tendency to maintain equilibrium. Any change occurring in the life is a reason to get stressed. The research shows that even the minor or the trivial occurrences in the life create stress. Various life changes are attached weightages that are shown below.

Death of Spouse – 100

Divorce – 73

Jail Term – 63

Death of a close family member – 63

Major personal injury or illness – 53

Marriage – 50

Fired from work – 47

Retirement – 45

Business Re-adjustment – 39

Change in responsibilities at work – 29

Trouble with boss – 23

Vacation – 13

Festivals – 12

Minor violations of law – 11

Personal stressors

Personal stressors relate to the personal health and the familial life of an individual. They are like menopause or male menopause, commuting problems, reduced self-confidence as a result of aging etc.

While the Western world has started thinking about the stress only lately, the Indians have thought about stress centuries before. According to Yoga ignorance, ego i.e. attachment to self, temptations, envy or hate, or jealousy and a state of helplessness are the main personal stressors. If one applies one’s mind to the reasons one will find that it is impossible to be away from the stress.

The individual consequences of stress result in an individual finding it difficult to adjust with others. In extreme cases it results in divorce too. Stress at the individual level also results in medical problems. Most of all it affects an individual’s decision making capacity.

At the organisational level the stress of the employees may have negative effect on the job satisfaction, morale, motivation to perform at high levels.

Even though stress has multifarious deleterious effects on individual and the Organisation, stress cannot be done away with. Every success has its roots in stress. Stress propels a man to do something that ultimately results in success. Stress is like the voltage on an electric bulb. High voltage fuses the bulb; at the same time less voltage dims the bulb. Stress is necessary evil. But it has bad effects. Therefore the only thing a man can do is to keep the stress from harming him. One must manage stress.

Management of Stress

Since the stress affects an individual in his body and mind, it is that individual who is to do something about his stress. The diagram below gives the strategies that can be adopted by an individual to cope with stress.

Stress: Personal coping strategies

Know your personality type

Recognition is half the solution.

Know your personality type

Stress can affect different people in different ways. The most fully developed individual relating specifically to stress is the distinction between type A and type B personality profiles.

Type A people are the people who create unnecessary stress for themselves. On the contrary type B people are the ones who are mild mannered and take the life as it comes. Type B persons are not stress prone individuals. However people are not purely type A or type B; instead people tend toward one or the other type. Also the relationship between personality and health problems (such as heart disease) is unclear.

Recognition is half the solution

One must remember an important facet of stress. Most of the time a person does not understand that he is under stress. How do you recognise that you are under stress? Self report measure provide clear indication that people who know us closely and observe us frequently can say with certain degree of accuracy, whether we are under stress or not. To the question “Did anyone tell you that you are under stress?” Most of the executives reported that it is their wives who told them that they are under stress. A relatively less number said it was their friends and collagues who could correctly detect that they are under stress. Correct detection is possible by these people because of some specific symptoms when stress still operates at behavioural and psychosomatic level. Awareness of these symptoms will help us to recognise when we are under stress.

Some Behavioural Symptoms of Stress are:

Low productivity, decreased work performance;

Tendency to remain absent from work;

Much of interpersonal conflict;

LOVE THYSELF

BODYHave regular medical exam.Exercise regularlyDon’t touch tobaccoDo mind what you:DrinkEat

SOUL – MIND

Mediate regularlyLearn to relaxDevelop some hobby

Tendency to remain isolated;

Sudden change in habit (clothing, eating, drinking);

Talking around a subject;

Poor eye contact while talking;

Making others look ridiculous;

Brooding; feeling worthless;

Frequent references to death, suicide etc.

Some Psychosomatic Symptoms of Stress are:

Sleep disturbance;

High blood pressure;

Stress diabetes;

Bowel irritation;

Back ache;

High blood pressure;

Sexual dysfunction.

Love your body

Our body is the vehicle that enables to perceive, understand the world. It is because of our body that we are known in this world. It is through our body that we experience the world. It is only when we love our body that we will take proper care of it. Loving is not pampering. The following are some tips to deal with stress by making our body strong.

Have a regular medical checkup

Unfortunately we Indians are not health conscious. A regular medical check is a preventive measure, especially when one is beyond forties. It is advisable that if a person is below 40 he must have a medical checkup at least once a year. Beyond 45th year of age the health checkup should be at least twice a year.

Do exercise regularly

To effectively cope with stress a healthy body is a must. One can raise defenses against stress by regular exercises. One may take any type of exercise. The exercise of walking is the best for all the ages. Walking as an exercise should be minimally five to six kilometres at a stretch at the speed not less than one and a half kilometres per minute. For a person beyond thirty-five strenuous exercise is contra indicated.

Don’t touch tobacco

The medical research has amply demonstrated that tobacco is carcinogenic substance. The research also tells that passive smoking is more harmful than active smoking.

Do mind what you

a) Eat : One must be careful about what one eats. What we are largely depends on what we eat. As far as possible oily and pungent food be avoided. This has tendency to cause more secretion of digestive acids, which erode the mucus membrane of the stomach. This results in ulceration. It is also better if one avoids eating non-vegetarian food which is rich in calories and cholesterol and lack fiber.

b) Drink : Drink minimally three to four litres of water daily. Avoid alcoholic beverages. Alcohol contains calories but has no food value. Especially the use of tobacco with alcohol is injurious to health.

Love your mind

We have already said that the happy as well as unhappy situations cause secretion of adrenaline. The remedy is to keep the mind tranquil. It is realised that keeping the mind tranquil is easily said than done. The Indian tradition has always been stressing importance of meditation. The idea is that in meditation a person takes away his mind for some time from the usual surroundings, which serves as a respite.

In the modern times many new therapies of meditation have come. Transcendental Meditation, Sidha Samadhi Yog, Sahaj Marg etc. to name a few. Are all intended to initiate a person into the art of meditation which results in a peaceful and strong mind.

The Western countries are so-much convinced of the utility of meditation as a way of keeping the mind tranquil that some firms have reserved separate rooms for meditation for their executives. In India the organisations are slow to catch up with this. None-the-less it can be practised at the individual levels.

Organisational Strategies for managing employee stress

Create supportive organisational climate;

Convince employees that their contributions are significant;

Rotate employees out of potentially stressful positions and do not allow them to overwork;

Organise training programs to help employees cope with stress provide employee counselling.

Remember one who ‘dares’ stress conquers it: D –DietA –ActivityR –RelaxationE –EmpathyS- Spirituality

TOPIC 3

BASICS OF FINANCIAL ACCOUNTING

As stated earlier, financial accounting is the process of recording the past financial business transactions and calculating the net result of these transactions with the intention to communicate the same to the various persons dealing with the business in the external capacity. However, financial accounting is the technical process. Before we consider the technicalities of financial accounting, let us consider some of the fundamental issues relating to the financial accounting.

Accounting Principles

In order to bring the uniformity in recording the business transactions, the accountants follow certain basic procedures universally. These are referred to as the Accounting Principles. The Accounting Principles can be classified in two categories –

a. Accounting Concepts

b. Accounting Conventions

Accounting Concepts

Accounting Concepts indicate those basic assumptions upon which the basic process of accounting is based. Following are the important Accounting Concepts :

Business Entity Concept

This accounting concept propose that the business is assumed to be a distinct entity than the person who owns the business. The accounting process is carried out for the business and not for the person who owns the business. E.g. If there is a partnership concern carrying on the business in the name of M/s. XYZ & Co., where Mr. A and Mr. B are the equal partners, M/s. XYZ & Co. is supposed to be a separate entity from Mr. A and Mr. B. The financial statements prepared on the basis of accounting records are of M/s. XYZ & Co. and not of Mr. A or Mr. B individually. It should be noted in this connection that the business entity concept has nothing to do with the legal entity of the business. It applies to both corporate organization(which by itself is a separate legal entity from the owners) as well as non-corporate organization (which is not a legal entity separate from the owners).

Dual Aspect Concept

This concept proposes that every business transaction has two aspects. However, basic relationship between assets and liabilities i.e. assets are equal to liabilities, remains the same. E.g. If Mr. A starts the business by introducing the capital of Rs. 50,000, the assets and liabilities structure will be as below -

Liabilities AssetsCapital 50,000 Cash 50,000

Now, if Mr. A uses the cash to purchase the material worth Rs. 40,000, the assets and liabilities structure will change as below –

Liabilities AssetsCapital 50,000 Cash 10,000

Stock in Trade 40,000

50,000 50,000

If Mr. A sells the above material worth Rs. 40,000 for Rs. 45,000 on credit basis, the assets and liabilities structure will change as below –

Liabilities AssetsCapital 55,000 Cash 10,000

Receivables 45,000

55,000 55,000

Going Concern Concept

This concept proposes that the business organization is going to be in existence for an indefinitely longer period of time and is not likely to close down the business in the shorter period of time. This affects the valuation of assets and liabilities. As such, the assets are disclosed in the Balance Sheet at cost less depreciation and not at the current market price. If the assets are to be disclosed in the Balance Sheet at correct value, the current market price will be most suitable. However, as the business is likely to exist for an indefinitely longer period of time and as the assets are not likely to be sold off in the market in the near future, the market price becomes immaterial.

Accounting Period Concept

Even if the Going Concern Concept proposes that the business is going to be in existence for an indefinitely longer period of time, in order to facilitate the preparation of financial statements on periodical basis, the indefinitely longer life span on the business is divided into shorter timesegments, each one being in the form of Accounting Period. Profitability is computed for this accounting period (by preparing the profitability statement) and the finanial position is assesseed at the end of this accounting period (by preparing the balance sheet). It should be noted that the selection of accounting period may depend upon the various factors like characteristics of the business organization, tax considerations, statutory requirements etc.

Cost Concept

This concept proposes that the assets acquired by the organization are recorded at their cost of acquisition and this cost is considered for all the subsequent accounting purposes say charging of depreciation. This concept does not take into consideration current market prices of the various assets.

Money Measurement Concept

This concept proposes that only those transactions and facts find the place in accounting which can be expressed in terms of money. As such, all those transactions and facts which can not be expressed in terms of money (E.g. Morale and motivation of the workers, credibility of the business organization in the market etc.) do not find any place in accounting and that is why in financial statements, though they may be having direct or indirect bearing on the business. This concept imposes severe restrictions on the kind of information available from the financial

statements. In fact, this is one of the major drawbacks of financial accounting and financial statements.

Matching Concept

This concept proposes that while calculating profit for the accounting period in a correct manner, the expenses and costs incurred during the period, whether paid or not, should be matched with the revenues generated during the period. E.g. If the accounting period ends on 31st March, the salaries for the month of March should be considered as cost for the year ending on 31st March, even if they are actually paid for in the month of April. Otherwise, calculation of the profits for the year ending on 31st March will go wrong as the income will be for 12 months while the expenses will be for 11 months only.

Accounting Conventions

Accounting Conventions indicate those customs and traditions that are followed by the accountants while preparing the financial statements. Following are the important Accounting Conventions.

Convention of Conservation

This convention is usually expressed as “anticipate all the future losses and expenses, however do not consider the future incomes and profits unless they are actually realized.” This convention generally applies to the valuation of current assets and as such, the current assets are valuedat cost or market price whichever is lower. The valuation of non-curret assets is done at cost (as per the cost concept).

Convention of Materiality

This convention proposes that while accounting for the various transactions, only those transactions will be considered which have material impact on profitability or financial status of the organization and other insignificant transactions will be ignored. E.g. If the organization purchases some postal stamps, some of which remain unused at the end of the accounting period. According to matching concept, the cost of such non-used postal stamps should not be considered as the item of cost. However as its impact on the overall profitability is likely to be negligible, the cost of non-used postal stamps may be ignored treating the cost of purchases as the expenditure. Which transactions should be treated as material ones is a subjective concept and depends upon the judgment and knowledge of the accountant.

Convention of Consistency

This convention proposes that the accounting polices and procedures should be followed consistently on period-to -period basis so as to facilitiate the comparison of finanacial statements on period to period - to - period basis. if there is any change in the accounting policies and procedures, this fact coupled with its effect on profitabity should be disclosed explicitly while preparing the financial statements.

Systems of Accounting

a. Cash System of Accounting

In this system of accounting, expenses are considered to be the expenses only when they are paid for and the incomes are considered to be incomes only when they are actually received. This system of accounting is mainly used by the organizations established not for earning the profits. This system of accounting is considered to be defective in nature, as it may not represent the true picture of the profitability as well as of the state of affairs.

b. Mercantile or Accrual System of Accounting

In this system of accounting, expenses are considered as expenses during the period to which they pertain. Similarly, incomes are considered to be incomes during the period to which they pertain. When the expenses are actually paid for or when the incomes are actually received is not significant in case of Mercantile or Accrual system of accounting. This system of accounting is considered to be more ideal, generally preferred by the accountants. However, as the time of physical receipt of cash is immaterial in this system of accounting, Accrual System of Accounting may result into the unrealized profits beingreflected in the books of accounts on which the organization may be required to pay the taxes also.

It will not be out of place to mention here that as per the provisions of Section 209 of the Companies Act, 1956, all the company form of organizations are legally required to follow Mercantile or Accrual system of accounting. Other organizations have a choice to select either of the systems of accounting.

Types of Expenditure

For the purpose of accounting, the amount of money that is paid for is classified in three ways –

a. Capital Expenditure

Capital Expenditure indicates the amount of funds paid for acquiring the infrastructural properties required for doing the business that are technically referred to as Fixed Assets. Fixed Assets do not give the returns during the same period during which they are paid for. As such, benefits available from capital expenditure are long-term benefits. Hence, it will be wrong to consider the capital expenditure as expenses while calculating the profitability during a certain period. In technical words, capital expenditure never affects the Profitability Statement, except in case of Depreciation, which in simple words indicates that part of capital expenditure returns equivalent to which are received during the corresponding period.

b. Revenue Expenditure

Revenue Expenditure indicates the amount of funds paid during a certain period with the intention to receive the return during the same period. As such, the benefits available from revenue expenditure are received during the same period during which they are paid for. The entire amount of revenue expenditure affects the Profitability Statement.

c. Deferred Revenue Expenditure

Deferred Revenue Expenditure indicates the amount of funds paid which does not result into the acquisition of any fixed asset. However, at the same time benefits from this expenditure

are not received during the same period during which they are paid for. The examples of Deferred Revenue Expenditure are –

a. Initial Advertisement Expenditure

b. Research and Development Expenditure

c. In case of company form of organization, Preliminary Expenses or Company Formation Expenses.

Principally, Deferred Revenue Expenditure is not transferred to Profitability Statement during the period during which they are paid for. As such, deferred revenue expenditure does not affect the profitability of the period during which it is paid for. It is transferred to Profitability Statement (in technical words “written off to Profitability Statement”) over the period over which benefits are received, by passing the adjustment entry. As such, deferred revenue expenditure affects the profitability only when they are written off to Profitability Statement. Till they are written off to Profitability Statement, they are shown on the Asset side of Balance Sheet.

GLOSSARY OF TERMS USED IN FINANCIAL ACCOUNTING

1. Account – Account is the record of all the transactions pertaining to a person, asset, liability, income or expenditure which have taken place during a specified period and shows the net effect of all these transactions finally.

2. Debit Side – Debit Side of the account is left hand side of the account.

3. Credit Side – Credit Side of the account is right hand side of the account.

4. Voucher – Voucher is any documentary evidence to justify that a particular transaction has taken place. The voucher can be internal voucher or external voucher.

5. Entry – Entry means the record of a financial transaction in the books of accounts.

6. To debit – To debit an account means to make the entry on debit side of the account.

7. To credit – To credit an account means to make the entry on credit side of the account.

8. Journal – Journal is the Book of Original Entry or the Book of Prime Entry where the financial transactions are recorded in the chronological order as and when they take place.

9. Ledger – Ledger is the book where the transactions of the similar nature are pooled together under one Ledger Account. Ledger or General Ledger as it is referred to in practical circumstances, maintains all types of accounts i.e. Personal, Real and Nominal. Whichever transactions are recorded in the Journal or Subsidiary Books in chronological order, the same transactions are posted in the Ledger, account wise.

10. Narration – Narration is the summarized explanation or description of the financial transaction recorded in the books of accounts.

11. Casting – Casting refers to totalling of the books of accounts.

12. Posting – Posting refers to the process of transferring the transaction entered into the book or original entry or subsidiary book to the ledger account.

13. Folio – Folio refers to the page number of the book of original entry or the ledger.

14. Brought Forward – When the balances in the ledger account or cash/bank book of the previous year or previous period are entered in the current year’s books of accounts, the balances are said to be Brought Forward.

15. Carried Forward – When the balances in the ledger account or cash/bank book of the current year or current period are to be transferred to the next year’s books of accounts, the balances are said to be Carried Forward.

16. Assets – All the properties owned by the business are collectively referred to as the assets of the business.

17. Liabilities – All the amounts owed by the business to various providers of funds or services are collectively referred to as liabilities.

18. Capital – Capital indicates the amount of funds invested by the owner of the business in the business.

19. Drawings – Drawings indicates the amount of funds or goods withdrawn by the owner of the business for the personal use.

20. Debtor – A Debtor is a customer who owes the money to the business for the goods or services supplied to him on credit basis.

21. Creditor – A Creditor is a supplier to whom the business owes the money for the goods or services bought from him on credit basis.

22. Debit Note – Debit Note is an intimation sent to a person dealing with the business that his account is being debited for the purpose indicated therein.

23. Credit Note – Credit Note is an intimation sent to a person dealing with the business that his account is being credited for the purpose indicated therein.

24. Trade Discount – Trade Discount is the discount received on purchases or discount allowed on sales which is an adjustment with the basic purchase or sales price. Trade discount is not accounted for in the books of accounts. Purchase value or sales value is accounted for net of trade discount.

25. Cash Discount – Cash discount is the discount received from the suppliers or allowed to customers for making the early payment of dues. Cash discount is accounted for in the books of accounts. Cash discount received from the suppliers is revenue income and cash discount allowed to the customers is revenue expenditure.

26. Balance Sheet – Balance Sheet is the summarized statement of what the businessowns i.e. assets and what the business owes i.e. liabilities at any given point of time.

27. Bills Payable – Bills Payable indicates the amount payable to the suppliers for which the negotiable instrument in the form of Bill of Exchange is given to the suppliers.

28. Bills Receivable – Bills Receivable indicates the amount receivable from the customers for which the negotiable instrument in the form of Bill of Exchange is given by the customer.

29. Depreciation – The term Depreciation applies to fixed assets like Land, Buildings, Machinery, Furniture, Vehicles etc. The term indicates reduction in the value of fixed assets which can arise either due to time factor or use factor or both. A detailed note on Depreciation Accounting is enclosed in the Annexure.

Double Entry System of Accounting

The basic presumption made by the Double Entry System of Accounting is that every business transaction has two elements i.e. when the business receives something, it has to pay something. Eg. If the business pays the telephone bill in cash, it gets the benefit of using the telephone, but at the same time cash goes out. Similarly, if goods are sold to the customer for cash, goods of the business go out, but it receives the corresponding amount of cash. Accordingly, if Double Entry System of Accounting is followed, every business transaction affects two accounts. One account is debited, while another account is credited by the similar amount. Thus, Double Entry System of Accounting follows the principle of “every debit has a corresponding credit” and hence, total of all debits has to be equal to the total of all credits.

Double Entry System of Accounting proves to be advantageous due to certain reasons –

a. It takes into consideration both the aspects of each business transaction.

b. Arithmetical accuracy of the accounting records can be verified by preparing

the Trial Balance.

c. The correct result of operations can be ascertained by preparing the final accounts periodically.

d. Correct valuation of assets and liabilities is possible at any given point of time by preparing the Balance Sheet.

Types of Accounts

The various accounts for the purpose of Financial Accounting get classified under the following categories –

1. Personal Accounts - These are the accounts of persons with whom the organization deals in various capacities. In practical circumstances, personal accounts may consistof the following types of accounts –

Accounts of the suppliers

Accounts of the customers

Bank / Financial Institutions

Capital Account

2. Real Accounts – These are the accounts of assets and liabilities. In practical circumstances, real accounts may consist of the following types of accounts –

Land Account

Building Account

Machinery Account

Furniture Account

Vehicles Account

Real Accounts may also consist of the accounts of some intangible assets like –

Goodwill Account

Patents and Trade Marks Account

3. Nominal Accounts – These are the accounts of incomes or expenses. In practical circumstances, nominal accounts may consist of following types of accounts –

Salary Account

Wages Account

Printing & Stationary Account

Insurance Account

Telephone Expenses Account

Interest paid or Received Account

Commission paid or Received Account

Rules of Double Entry Book Keeping

While entering into various financial transactions in the records maintained by the organization, following basic rules for accounting are followed –

a. In case of Personal Accounts – Debit the Receiver, Credit the Giver

b. In case of Real Accounts – Debit What Comes in, Credit What Goes out

c. In case of Nominal Accounts – Debit all the expenses, Credit all the incomes

Depreciation Accounting

Depreciation can be defined as a permanent, continuous and gradual reduction in the book value of a fixed asset. Normally, all the fixed assets except land depreciate, in value rendering the asset useless after the end of certain specific period. Following may be stated as the main causes of depreciation.

(1) Use factor : The fixed assets depreciate because they are used for the purpose they are meant for. It is applicable in case of tangible assets like machinery, furniture, office equipments etc.

(2) Time factor : The fixed assets depreciate due to the passage of time.

(3) Obsolescence : It is the reduction in the value of fixed assets, say a machine, due to its supersession at a date before it is completely worn out. It may take place due to new inventions, modifications or improvements.

Need for Depreciation Accounting :

According to the nature of fixed assets, these are those assets which may be used for the business purposes over a certain number of future accounting periods and the benefit received from them is spread over the said number of future accounting periods. According to the matching principle of accounting, the costs incurred during an accounting period are required to be matched with the benefits or revenues earned daring that period. Hence, it is necessary to distribute the cost of a fixed asset less the scrap or salvage or realisable value after the useful life of the fixed asset is over, in such a way as to allocate it as equitably as possible to the periods during which the benefits are received from the use of fixed assets. This system or procedure is called depreciation accounting. Thus the depreciation accounting is necessary for two main purposes.

(a) To ascertain due profits by correctly matching the various costs and expenses incurred with various incomes and revenues earned during various accounting periods.

(b) To represent the value of a fixed asset on the Balance Sheet at its unexpired cost i.e. at book value less depreciation. If depreciation is not provided, the asset may appear in the Balance Sheet at an overstated amount.

It may also be noted in this connection that the depreciation forms a part of cost for arriving at the profits which can be distributed to the owners of the business in the form of dividend. By providing the depreciation, the amount of distributable profits is reduced and retained in the business, which can be utilized for the replacement of the asset at the end of its economic life.

Methods for Calculating Depreciation :

There may be various methods available for calculating the amount of depreciation to be charged to Profit and Loss Account. Amount of depreciation is a function of various factors.

(1) Time, (2) Usage, (3) Time and Usage, (4) Time and Cost of maintaining the fixed asset, (5) Provision of funds for replacing the assets.

As such the various methods available for charging the depreciation can be described as below.

(1) Straight Line Method :

According to this method, the amount of yearly depreciation is calculated as below.

Cost of asset - Estimated scrap value

Estimated life in years

Eg. C = Cost of Asset. Rs. 1,10,000

Estimated scrap value(At the end of life of the asset) Rs. 10,000

Estimated life 10 years

Yearly depreciation = Rs. 1,10,000 - Rs. 10,000

10 years

= Rs. 10,000

The benefit of this method is that equal amount of depreciation is charged every year throughout the life of the asset, making the calculation of depreciation and cost comparison easy. The main drawback of this method is that the amount of depreciation in later years is high when the utility of the asset is reduced.

(2) Written Down Value (Reducing Balance) Method :

According to this method, the depreciation is provided at a predetermined percentage, on the balance of cost of asset after deducting the depreciation previously charged (usually termed as written down value).

Eg. Cost of asset Rs. 1,10,000

Estimated scrap value Rs. 10,000

Cost of asset subjected to depreciation Rs. 1,00,000

Rate of depreciation 10%

The amount of depreciation is calculated as shown below.

Year Balance Cost Depreciation Written Downof Assets Value - WDV

Rs. Rs. Rs.

1 1,00,000 10,000 90,000

2 90,000 9,000 81,000

3 81,000 8,100 72,900

4 72,900 7,290 65,610

5 65,610 6,561 59,049

The rate of depreciation to be charged is calculated according to the following formula.

D = 1 - n R Cwhere n = number of years

R = Residual / Scrap Value

C = Cost of the asset

The main benefit of this method is that it recognizes the fact that in the initial years of life of the asset, the repairs and maintenance cost is less which goes on increasing gradually with the progressing life of asset. According to this method, the higher amount of depreciation in the initial years and a gradual decrease therein is counterbalanced by the lower amount of repairs and maintenance cost in the initial years and a gradual increase therein. It should be noted here that the written down value can never become zero.

(3) Production Unit Method :

According to this method, depreciation is provided at a predetermined rate per unit which in turn is calculated on the basis of total number of units lo be produced during the life of the asset.

Eg. Cost of the machine Rs. 1,10,000

Estimated scrap value Rs. 10,000

Estimated number of units to be produced 50,000

Rate of depreciation per unit = Rs. 1,10,000 - Rs. 10,000 50,000 units

= Rs. 2

If in a particular year, 7,000 units are produced, the depreciation to be charged will be :

7,000 units x Rs. 2 per unit = Rs. 14,000.

This method gives more stress on usage factor rather than time factor. Higher the number of units produced, higher is the amount of depreciation and vice versa.

(4) Production Hour Method :

This method is similar to the production unit method except that instead of number of units to be produced during the life of asset, number of hours for which the asset is expected to work are taken into consideration.

Eg. Cost of the machine Rs. 1,10,000

Estimated scrap value Rs.10,000

Estimated number of hours 25,000

Rs. 1,10,000 - Rs. 10,000Rate of depreciation per hour = 25,000 hours

= Rs. 4

If in a particular year, the machine works for 2,500 hours, the depreciation to be charged will be :

2,500 hours x Rs. 4 per hour = Rs. 10,000

(5) Joint Factor Rate Method :

According to this method, the depreciation is provided partly at a fixed rate on time basis and partly at a variable rate on usage basis.

Eg. Cost of the machine Rs. 1,00,000

To be depreciated on time basis over life of the machine i.e. 10 year Rs. 50,000

Estimated number of units to be produced 50,000

Depreciation :

(a) On time basis - Rs. 50,000 = Rs. 5,000 per year10 years

(b) On usage basis - Rs. 50,000 = Re. 1 per unit50,000 units

If in a particular year, the machine produces 6,000 units, the depreciation to be charged will be :

Time basis Rs. 5,000

Usage basis 6,000 units x Re. 1 Rs. 6,000

Rs. 11,000

(6) Annuity Method :

This method assumes that the amount of capital invested in the fixed assets would have earned interest had it been invested otherwise. The depreciation to be charged under this method is a constant proportion of the aggregate of the cost of the asset depreciated and interest at the specific rate on written down value of the asset at the beginning of each period.

Eg. Cost of the asset (c ) Rs. 1,00,000

Life of the asset (n) 5 years

Rate of interest ( r ) 10%

Depreciation to be charged is calculated as below.

D = C x r = 1,00,000 x 0.10 = Rs. 26,380

1 1

1 - (1 + r)n -1 1 - (1.10)5 -1

Year Cost/WDV Interest Total Depreciation WDV C/fd

Rs. Rs. Rs. Rs.

1 1,00,000 10,000 1,10,000 26,380 83,620

2 83,620 8,362 91,982 26,380 65,602

3 65,602 6,560 72,162 26,380 45,782

4 45,782 4,578 50,360 26,380 23,980

5 23,980 2,400 26,380 26,380 Nil

The amount of depreciation is very high under this method and covers the opportunity cost of non-investment of the capital anywhere else.

(7) Sinking Fund Method :Unlike any other method, this method attempts to make available funds equivalent to the original cost of asset, at the end of useful life of the asset. According to this method, depreciation to be charged is the fixed period charge which is invested at a compound rate and the amount of investmen with the compounded interest earned over the life of the asset equals to the original cost of the asset.

Eg. Cost of the asset (c) Rs. 1,00,000

Life of the asset (n) 5 years

Rate of interest (r) 10%

Depreciation to be charged is calculated as below :

D = C x r = 1,00,000 x 0.10 = Rs. 26,380

(1 + r)n - 1 (1.10)5 - 1

Year Bal. B/fd Interest Annual Annual Bal.c/fdProvision Investment

Rs. Rs. Rs. Rs. Rs.

1 – – 16,380 16,380 16,380

2 16,380 1,638 16,380 18,018 34,398

3 34,398 3,440 16,380 19,820 54,218

4 54,218 5,422 16,380 21,802 76,020

5 76,020 7,600 16,380 23,980 1,00,000

(8) Endowment Policy Method :

This method is similar to sinking fund method. Under this method, an insurance policy is taken out for the amount required to replace the asset at the end of life of the asset. The amount of depreciation to be charged is equal to the annual premium payable on the insurance policy, which is decided by the insurance company.

(9) Revaluation Method :

According to this method, the asset is revalued periodically. The amount of depreciation for that period is the difference between the cost of the asset at the beginning of the period and the amount of revaluation at the end of the period.

This method of charging the depreciation is extensively used for the assets like livestock, patterns etc.

(10) Renewal Method :

According to this method, the full cost of the asset is charged as depreciation during the period in which asset is renewed. No depreciation is charged in between the period. This method of charging can be used if the asset is of small value and is renewed frequently.

Practical considerations relating to depreciation

1. In spite of the fact that there are various methods available for calculating the depreciation, the final choice of the method depends upon the individual organization. It should be noted that Income Tax Act, 1961 which is a very important piece of legislation applicable to all types of business organizations, recognizes only one method for calculating the depreciation i.e. Written Down Value method. The rates at which the depreciation is to be calculated are also specified in the Income Tax Act, 1961. If the organization wants to calculate the depreciation on some different basis or at some different rates, it can do so for financial accounting purposes. However, for calculating the tax liability, the depreciation has to be calculated on Written Down Value basis and that too at the specified rates.

2. The company form of organizations to whom the provision of Companies Act, 1956 apply are required to calculate the depreciation as per the provisions of Schedule XIV of the

Companies Act, 1956. The salient features of Schedule XIV of the Companies Act, 1956 can be stated as below -

a. Schedule XIV of the Companies Act, 1956 provides that the company can calculate the depreciation by using either Written Down Value method or Straight Line method. The companies are given the choice to select between these two methods. The actual choice of the method may depend upon the effect on the profitability of the company. If the company wants to change the method of calculating the depreciation, it amounts to the change in accounting policy. Any change in the method of calculating the depreciation has to be effected with retrospective effect from the date of incorporation of the company. The company is required to disclose the fact of change in the method of calculating the depreciation while preparing its financial statements along with the effect of change in the method of calculating the depreciation.

b. The rates at which the companies are required to calculate the depreciation are also specified in Schedule XIV. For this purpose, the fixed assets are classified in various categories. The broad categorization of the fixed assets is as below -

Buildings - Factory Building as well as Administration Buildings

Plant and Machinery

Furniture

Vehicles

Computer Installations

The rates for calculation of depreciation are as below -

Nature of the Fixed Assets WDV SLMBuildings - Factory 10% 3.63%

Buildings - Administrative 5% 1.63%

Plant and Machinery 15% 4.75%

Furniture 10% 6.33%

Vehicles 20% 9.5%

Computer Installations 40% 16.21%

c. If during the financial year, any addition has been made to any asset or any asset has been sold, the depreciation on such asset will be calculated on a pro rata basis from the date of such addition or upto the date on which such asset has been sold.

There are some of the questions which are normally raised in respect of the nature of depreciation.

(1) Is Depreciation a cost?

Yes, depreciation is a cost because of the obvious reasons that it reduces the profitability and it is a charge against the profit. At the same time, it should also be noted that it is a non-cash cost as it is never paid or incurred in cash.

(2) Does Depreciation generate funds for replacement of assets?

If the depreciation is provided under the Sinking Fund Method or Endowment Policy Method, sufficient funds may be available, at the end of life of the asset, equivalent to the original cost of the asset. As such, it can be said that these two methods make available the funds equivalent to the original cost of the asset at the end of life of the asset. However these funds may not be sufficient to replace the asset due to the increased price of the same. Other methods of charging the depreciation do not directly generate the funds required for replacing the assets. The fact that the assets are depreciated to the extent of almost entire of the original cost of the same, does not indicate that the funds are available for the replacement purpose. However, depreciation may be viewed from one more angle. It is a charge to profits which reduces the profits which can be distributed among the shareholders by way of dividends, thus conserving the business funds in the business itself. This may be considered to be a very very indirect way of interpretation that the depreciation involves a source of funds.