MANagement ACCounting..must read

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<p>Management AccountingSandeep Gokhale Jamnalal Bajaj Institute University of Mumbai1</p> <p>Syllabus Relevance &amp; Scope C-V-P Analysis Cost Classification Marginal Costing Standard Costing Budgeting Balance Score card Learning Curves Profit Center Mgmt Transfer Pricing Over Head Allocations Cost Sheet Analysis Inventory Valuation2</p> <p>References Charles Hongren Khan &amp; Jain S.C.Maheshwari Banerjee Robert Kaplan</p> <p>3</p> <p>FINANCIAL MANAGEMENTObjective: Create share holder value Methodology: Capturing of value at all Levels. Scalability of Operations Business Process restructuring Enterprise resource management. Vertically integrated operations. Customer relationship Management Effectiveness: Proximity of gross profit to net profit Maximisation of EVA EV / EBIDTA multiple4</p> <p>Financial Management an overviewBusiness environment Planning Policies&amp;Decisions (Management Accounting) Restructuring Financial Markets Resource mobilisation Treasury Control&amp;Information ( Audit &amp; Taxation) Valuation Technique5</p> <p>Investor Wish List</p> <p>Financial Decision Areas Investment analysis Working capital management Sources and cost of funds Determination of capital structure Dividend policy Analysis of risks &amp; returns Treasury - interest / exchange rate swaps Restructuring of operations / term debt profile</p> <p> To result in shareholder wealth maximisation6</p> <p>PROFIT AND LOSS ACCOUNTFor the Period 1st April to March 31st</p> <p>Income:</p> <p>Gross sales from Goods &amp; Services Less: Excise Duty Net Sales Other Income Non operating Income Total Income</p> <p>7</p> <p>Expenditure:</p> <p>Raw materials consumed Manufacturing expenses Administrative expenses Selling expenses WIP +FG adjustment PBIDT (Gross Profit) Less: Interest Less Depreciation PBT (Operating Profit) Less: Tax PAT (net profit) Gross cash accruals : PAT + Depn Net cash accruals : GCA - Dividend8</p> <p>THE BALANCE SHEET For the year ended March 31st 200... Liabilities:Equity share capital Reserves &amp; Surplus Term loan Debentures Fixed deposits Other unsecured loans Commercial bank borrowings Creditors Other current liabilities9</p> <p>Assets:</p> <p>Gross fixed assets Less: Acc. Depn Net Block Investments Currents Assets: RM Stock WIP F.G.Stock Debtors Cash in bank Loans &amp; Advances Misc.. expenditure Deferred expenditure10</p> <p>MANAGEMENT ACCOUNTINGIt is the process of Identification, Measurement, Accumulation, Analysis, Preparation, Interpretation and Communication of financial information used by management to plan, evaluate and control an organisation and to ensure appropriate use of and accountability for its resources. It is thus the process of : Identification Measurement Accumulation Analysis Preparation and interpretation Communication11</p> <p>Management accounting is for exercising internal control by the management and hence companies follow different techniques, methodologies to enable them to utilise the results obtained for optimal benefit.</p> <p>Management accounting is used to:</p> <p>Plan Evaluate Control Establish Accountability Short Term Business Decisions12</p> <p>1. Financial accounting serves the interest of external users while management accounting caters to the needs of internal users. 2. Financial accounting is governed by the generally accepted accounting principles while management accounting has no set principles. 3. Financial accounting presents historical information while management accounting represents predetermined as well as past information. 4. Financial accounting is statutory while management accounting is optional.</p> <p>13</p> <p>5. Financial accounting presents annual reports while management accounting reports are of both shorter and longer duration.</p> <p>6. Financial accounting reports cover the entire organization while management accounting reports are prepared for the organization as will as its segments.</p> <p>7. Financial accounting emphasises accuracy of facts while management accounting requires prompt and timely reporting of facts even if they are less precise.</p> <p>14</p> <p>DI</p> <p>I I</p> <p>I D</p> <p>W I</p> <p>II I I</p> <p>II</p> <p>1.</p> <p>I</p> <p>Y I</p> <p>I</p> <p>TI T . T I T T T I</p> <p>T I T , T I T T T - T X , T .</p> <p>I T.,</p> <p>2. I I IT I T T</p> <p>Y</p> <p>TI</p> <p>T I I 3. I I I TI W T T I I I I .15</p> <p>T</p> <p>I T I I</p> <p>I Y. Y J TI I TI .</p> <p>WI</p> <p>4.</p> <p>TI</p> <p>T I T TI XI W Y Y, Y. / I Y, Y T Y,</p> <p>T</p> <p>I</p> <p>T TI</p> <p>5.</p> <p>TI</p> <p>XI Y.</p> <p>6.</p> <p>T</p> <p>T I T I II TITY, T T T</p> <p>Y T I T T, W T. I T Y .</p> <p>T WIT</p> <p>7.</p> <p>I</p> <p>T</p> <p>T</p> <p>16</p> <p>EXTRACT OF FACTORY COST SHEETA. Direct materials consumed = Opening Stock + Purchases - Closing Stock =________ B. Direct labour A+B = ________ = ________ (prime cost)</p> <p>C. Factory overheads: 1. Indirect materials 2. Indirect labour 3. Factory rent, insurance etc 4. Depreciation for factory 5. Salaries &amp; wages of supervisory staff =_______17</p> <p>D. = Opening WIP E . = A+B+C+D = Factory cost of goods available for manufacturing. F. = Closing WIP G. H. I. J. K. = E -F Factory cost of goods manufactured.</p> <p>= Finished goods opening stock. = G + H = cost of goods available for sale. = Closing finished goods. = I - J = factory cost of goods sold.18</p> <p>INCOME STATEMENTGross sales ......................... Less : Excise duty Net sales .................... Less : Factory cost of goods sold ............................. Gross manufacturing profit ......................................... Less : Selling &amp; distribution expenses. Add : Income other than sales. PBIDT Less : Depreciation Less : Interest Less : Tax Profit after tax19</p> <p>METHODS OF COSTING1. Job costing - Batch costing - Contract costing</p> <p>2. Process costing</p> <p>3 .Multiple costing20</p> <p>TECHNIQUES OF COSTING Marginal costing Absorption costing Standard costing Joint product costing By-product costing Activity based costing</p> <p>21</p> <p>CLASSIFICATION OF COSTS</p> <p>Elements</p> <p>Functional</p> <p>Behavioural</p> <p>22</p> <p>CLASSIFICATION OF COSTS BY ELEMENTS</p> <p> Direct materials Indirect materials Direct labour Indirect labour Factory overheads (variable) Factory overheads (fixed) Selling and distribution General administration Interest Depreciation23</p> <p>CLASSIFICATION OF COSTS BY FUNCTIONS</p> <p> Sales Marketing Production Research &amp; development Personnel Administration Staff welfare</p> <p>24</p> <p>CLASSIFICATION OF COSTS BEHAVIOURALLYVariable costs : When costs change in direct proportion to changes in volume, it is called variable costs. Variable cost vary in proportionate with volume. Mathematically, a linear relationship could exist between variable costs and volume. Fixed costs : When costs remain non-variable (fixed) to changes in volume, it is called a fixed cost. Fixed costs remain at the same level irrespective of changes in volume. Semi fixed /semi-variable costs : Costs which are partially fixed and partially variable.</p> <p>25</p> <p>BREAK EVEN ANALYSIS</p> <p>Cost-volume-profit (CVP) analysis : The technique to study the behaviour of profit in response to the changes in volume, costs and prices is called CVP analysis. Break even analysis is the most widely known form of CVP analysis.</p> <p>Break even point : It is that point of sales at which total revenue is equal to total costs. It is a no-profit, no-loss point.</p> <p>26</p> <p>BREAK EVEN FORMULAF = Total fixed cost V = Total variable cost T = Total cost S = Total sales Total fixed cost --------------------Unit contribution where unit contribution = Unit sales - Unit variable cost. BEP(Units) = BEP(Rs) = Total fixed cost ---------------------- x Unit selling price. Unit contribution27</p> <p>Margin of safety : The excess of actual or budgeted sales over break even sales is called margin of safety.</p> <p>Budgeted sales - Break even sales Margin of safety ratio = -----------------------------------------Budgeted sales Break even point is a function of fixed cost, unit selling price and unit variable cost.</p> <p>28</p> <p>PROFIT VOLUME RATIO (P/V RATIO)It represents the rate at which the company is generating surplus in the financial system. Contribution ----------------Sales</p> <p>P/V</p> <p>=</p> <p>Break even analysis: Scenario 1 : Company having a high P/V ratio but also having high BEP. Reason : Fixed cost is high.29</p> <p>Scenario 2 : Company having high selling prices but low P/V ratio, high BEP and a low M.O.S. Reason : High variable cost.</p> <p>Scenario 3 : Company having high selling price, low variable cost, low M.O.S. Reason : Low volumes.</p> <p>30</p> <p>PROFIT ANALYSISImpact of changing factors Profits may be affected by the changes in the following factors. 1. Selling price 2. Volume 3. Variable costs 4. Fixed costs 5. A combination of all or any of the above factors.31</p> <p>UTILITY OF CVP ANALYSIS1. Understanding accounting data.</p> <p>2. Diagnostic tool</p> <p>3. Provides basic information for profit improvement</p> <p>4. Risk implications for alternative action.32</p> <p>LIMITATIONS OF CVP - ANALYSIS1. Difficulty in segregation of fixed and variable costs. 2. The assumption that total fixed costs would remain unchanged over the entire range of volume is not valid. 3. The assumption of constant selling prices and variable costs is not valid. 4. Difficult to use in a multi-product company. 5. It is a short run concept with a limited use in long range planning. 6. It is a static tool.33</p> <p>MARGINAL COSTINGMarginal costing is also called as direct costing.</p> <p>It is a system of segregating costs between fixed and variable components and charging the product only the variable cost. It comprises of the prime cost and variable overheads. It highlights the concept of contribution margin, which is the excess of sales over variable costs.</p> <p>Contribution = U.S.P - U.V.C34</p> <p>ABSORPTION COSTINGGenerally accepted conventional system of product costing and external reporting. The basic premise on which this system rests is that all costs, direct and indirect, should be charged to the cost of goods in a given period.</p> <p>35</p> <p>DIRECT COSTING VS. ABSORPTION COSTING</p> <p>1. Sales equals production PA = PD</p> <p>2. Production exceeds sales PA &gt; PD</p> <p>3. Sales exceeds production, PD &gt; PA36</p> <p>RECONCILIATION Fixed cost Fixed cost allocable to - allocable closing to opening inventory inventory</p> <p>PD</p> <p>+</p> <p>=</p> <p>PA</p> <p>VALUATION OF INVENTORY Direct costing : Only variable cost. Absorption costing : Full cost</p> <p>37</p> <p>APPLICATIONS OF MARGINAL COSTING1. Segregation of fixed and variable costs 2. Emphasis on c-v-p relationship 3. Highlights contribution 4. Avoids allocation of fixed cost 5. Profit planning</p> <p>38</p> <p>6. Decision making Pricing special orders Product mix decision Make or buy Sell or process further Closing of operations</p> <p>39</p> <p>SHORT RUN DECISION MAKING PROCESS USING MARGINAL COSTINGThe following steps/ elements need to be analysed :</p> <p>1. Identify and define the problem 2. Identify alternatives as possible solutions to the problem 3. Eliminate alternatives that are clearly not feasible</p> <p>40</p> <p>LIMITATIONS OF MARGINAL COSTING</p> <p>1. Difficulty in segregation of fixed and variable costs 2. Improper to exclude fixed manufacturing overheads from inventories 3. Wide fluctuations in profits 4. Only a short run profit planning and decision making technique 5. Non-acceptable for external reporting41</p> <p>STANDARD COSTINGStandard costs are scientifically predetermined costs. They are an estimate prepared in advance, co-relating to a technical specification of materials and labour. VARIANCE ANALYSIS : It is the difference between standard costs and actual costs. Variances are of two types : a. Favourable variance b. Unfavourable variance42</p> <p>STEPS IN STANDARD COSTING &amp; VARIANCE ANALYSIS1. Establish scientific standards for each element of cost. 2. Communicate these standards through budgets. 3. Cost comparison. 4. Variance analysis. 5. Corrective action.</p> <p>43</p> <p>BENEFITS OF STANDARD COSTING</p> <p>- Performance evaluation. - Management by exception. - Cost reduction. - Planning and decision making. - Optimal resource utilisation. - Pricing decisions.44</p> <p>ANALYSIS OF COST VARIANCES BY CAUSESMATERIALS PRICE VARIANCE</p> <p>1. Recent changes in purchase of materials.</p> <p>2. Failure to purchase anticipated quantities when standards were established resulting in higher prices owing to nonavailability of quantity purchase discounts.</p> <p>45</p> <p>3. Not obtaining cash discounts anticipated at the time of setting standards resulting in higher prices.</p> <p>4. Substituting raw material differing from original material specifications.</p> <p>5. Freight cost changes and changes in purchasing and storekeeping costs if these are debited to the materials cost.46</p> <p>MATERIALS QUANTITY VARIANCE 1. Poor material handling 2. Inferior workmanship by machine operators. 3. Faulty equipment 4. Cheaper, defective raw material causing excessive scrap 5. Inferior quality control inspection 6. Pilferage 7. Wastage due to inefficient production method47</p> <p>LABOUR RATE VARIANCE 1.Recent labour rate changes within industry 2. Employing a worker of a grade different from the one laid down in the standard 3. Labour strike leading to utilisation of unskilled help 4. Retaining skilled labour at higher rates, so as to prevent resignations and job switching 5. Employee absenteeism 6. Paying a higher overtime allowance than provided for in the standard48</p> <p>LABOUR EFFICIENCY VARIANCE</p> <p>1. Machine breakdown, use of defective machinery and equipment. 2. Inferior raw materials. 3. Poor supervision. 4. Lack of timely material handling. 5. Poor employee performance.</p> <p>49</p> <p>6. Inefficient production scheduling delays in routing work, materials, tools and instructions. 7. Inferior engineering specifications. 8. New inexperienced employees. 9. Insufficient training of workers. 10. Poor working conditions inadequate or excessive heating, lighting, ventilation etc.</p> <p>50</p> <p>OVERHEAD VOLUME VARIANCE</p> <p>1. Failure to utilise normal capacity 2. Lack of orders 3. Excess installed capacity 4. Inefficient utilisation of existing capacity 5. Machine breakdown 6. Defective materials 7. Labour inefficiencies51</p> <p>BUDGETINGDefinition : A budget is a quantified expression of the intentions of the management and operates in a fashion that enables attainment of orgainsational goals. Elements of a budget are : 1. It is a comprehensive and co-ordinated plan. 2. It is expressed in financial terms. 3. It is a plan for the companys operations and resources. 4. It is a future plan for a specified period.52</p> <p>THE MAJOR PURPOSES OF BUDGETING ARE</p> <p>1. To state the companys goals. 2. To communicate expectations to all concerned. 3. To provide detailed plan of action for reducing uncertainty. 4. To co-ordinate activities and efforts in such a way so as to maximise resources. 5. Measure for controlling performance.</p> <p>53</p> <p>TYPES OF BUDGETSComprehensive budgeting involves the preparation of a master budget. The three important components of master budget are : i) Operational / functional budgets. ii) Financial budgets iii) Capital budgets Budgeting concepts : - Budget period - Fixed time / rolling - A-priori Vs. Posteriori budgeting - Key factors.</p> <p>54</p> <p>Facets ofame of getSales</p> <p>getsy ase o lassificatio</p> <p>W at it s o s Pre are</p>...