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Study Material
Paper Name : Management Accounting
Paper Code : 21UCC13
Batch : 2021-24
Semester : Even Semester
Staff In charge : M. JAYABHARATHI

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 MANAGEMENT ACCOUNTING
UNIT – I

Management Accounting – Meaning – Objectives – Functions – Importance and Scope – Distinguish

between Management Accounting , Cost Accounting and Financial Accounting – Advantages and
Limitations of Management Accounting.

UNIT – II
Ratio Analysis – uses and Limitations of Ratio Analysis - Classification of ratio – Analysis of Liquidity
– Solvency and Profitability.

UNIT – III
Fund Flow Analysis ; Uses, Significance and Importance of fund flow statement - Cash Flow Analysis
(New Format) –Comparison between fund flow analysis and cash flow analysis .

UNIT – IV
Budgets and Budgetary Control – Definition - Importance - Essentials - Classification of Budget-
Master budget- Preparation of Production Budget, Purchase Budget, Sales Budget, Cash Budget,
Material budget and Flexible budget.

UNIT- V
Marginal Costing – Significance and Limitations of Marginal Costing Absorption costing – P/V Ratio –
BEP and Margin of Safety - Practical Application of marginal costing technique to different situations.

Note: Distribution of Marks – Problems 80% and Theory 20%.

TEXT BOOKS:

1.Management Accounting - Dr.Ramachandran, Dr.R.Srinivasan.

2.Management Accounting - Sharma and SasiK.Gupta
3.Magagement Accounting – T.S.Reddy and Y.Hari Prasad Reddy

REFERENCE BOOKS:
1. Management Accounting - S.N.Maheswari, Sultan Chand & Sons, New Delhi

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 QUESTION PAPER PATTERN

MANAGEMENT ACCOUNTING
Time: 3 Hours Max. Marks: 75

PART – A (15 x 1= 15 Marks)

Answer All Questions

PART – B (2 x 5 = 10 Marks)

Answer Any Two Questions

PART – C (5 x 10 = 50 Marks)

Answer Any Five Questions

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 MANAGEMENT ACCOUNTING
UNIT – I
MEANING:
The term management accounting refers to accounting for management. It provides information
to management so that planning, organizing, directing and controlling of business operations can be
done in an orderly manner. Thus management accounting is a system in carrying out its function more
efficiently.

DEFINITION:
1. “Management Accounting is concerned with accounting information that is useful to management”.
- Robert N.Anthony
2. “Management Accounting is accounting for effective management”.-BOSE
NATURE AND CHARACTERISTIC OF MANAGEMENT ACCOUNTING:
Management Accounting is concerned with accounting information which is useful to
management in maximizing profits or minimizing losses. The following are the main characteristics of
Management Accounting.

1. Forecasting:
It helps the management in planning for the future because decisions are always taken for future
course of action.

2. Supply Information:
Management Accounting provides information to the management and not decisions. The way in
which the data is used depends upon the efficiency of the management.

3. Increase in Efficiency:
The purpose of using accounting information is to increase efficiency of the concern. The
efficiency can be achieved by setting up goals for each department.

4. Techniques and Concepts:

Management accounting uses special techniques and concepts to make accounting data more
useful i.e. marginal costing, break even analysis etc. The type of technique to use will be determined
according to the situation.

5. Cause and Effect Analysis:

It attempts to examine the ‘cause’ and ‘effect’ of different variables. For example, if there is a
loss, the reasons for the loss are identified. Similarly, if there is a profit, the factors directly influencing
the profitability are also studied.

6. No fixed Norms:
It has no set of rules and formats like double entry system of book-keeping. The analysis of data
depends upon the person using it.

7. Assists Management:
Management accounting provides all assistance to management in all of its functions. By
providing the accounting information in the required form and at the required time, it enables the
management to perform its functions effectively.

8. Achieving of objectives:
In Management Accounting, the accounting information is used in such a way that it helps in
achieving organizational objectives.

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SCOPE OF MANAGEMENT ACCOUNTING:

(Updated notes)
Management accounting includes various areas of specialization to render effective service to the
management.

 Financial Accounting:
Financial accounting deals with financial aspects by preparation of profit and loss a/c and
balance sheet. Management accounting rearranges and uses financial statements. Thus, management
accounting is dependent on financial accounting.

 Cost Accounting:
Cost Accounting, through its various techniques, reveals efficiency of various divisions,
departments and products. Management Accounting makes use of all this data by focusing it towards
managerial decisions.

 Budgeting and Forecasting:

Budgeting is setting targets by estimating expenditure and revenue for a given set of
circumstances. Both budgeting and forecasting are useful for management in planning various activities.

 Inventory control:
This includes planning, co-coordinating and control of inventory from the time of acquisition to
the stage of disposal. This is done through various techniques of inventory control like stock levels,
ABC & VED analysis etc.

 Statistical Analysis:
In order to make the information more useful, statistical tools are applied. These tools include
charts, graphs, diagrams etc.

 Analysis of Data:
Financial statements are analyzed and compared with past statements compared with other firms
and with standards set. This analysis and interpretation results in drawing reports to the management.

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  Internal Audit:
Internal audit helps the management in fixing individual responsibility for internal control.

 Tax Planning:
Tax planning is done by, following the various tax incentives offered by the central and state
governments, knowledge of tax provisions helps the management in meeting the tax liabilities.

 Methods & Procedures:

It includes keeping of efficient system for data processing and effective reporting of required
data in time.

OBJECTIVES OF MANAGEMENT ACCOUNTING:

The primary objective of management accounting is to enable management to maximize profits
or minimize losses. The following are the important objectives of Management Accounting:

Planning and policy formulation:

The object of management accounting is to supply necessary data to the management for
formulating plans. Management accountant prepares statement of past results and gives information for
the future. The figures supplied and opinion given by the management accountant helps management in
planning and policy formulation.

Helpful in controlling performance:

Management accounting devices like standard costing and budgetary control are helpful in
controlling performance. The work is divided into different units and separate goals are set-up for each
unit. The actual results are compared with pre-determined objectives. The management is able to find
out the deviations and take necessary corrective measures.

Helpful in organizing:
Organization is related to the establishment of relationship among different individuals in the
concern. Management accounting helps in setting up on effective and efficient organizational
framework.

Helpful in interpreting financial information:

Financial information is of a technical nature and managerial personnel may not be able to
understand the uses of various financial statements. Management accountant explains these statements
to the management in a simple language. If necessary, he uses charts, diagrams etc.

Motivating employees:
Targets are laid down for the employees. They feel motivated in achieving their targets and
further incentives may be given for improving their performance.

Helpful in taking decisions:

The management has to take certain important decisions. Management accountant prepares a
report on the feasibility of various alternatives. The information provided by the accountant helps
management in selecting a suitable alternative and take correct decisions.
Reporting to management:
The primary objective of management accounting is to keep the management fully informed
about the latest position of the concern. This helps the management in taking proper and timely
decisions.

Helpful in co-ordination:
Management accounting provides tools which are helpful in co-ordinating the activities of
different departments.

Helpful on tax administration:

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 Management accounting helps in assessing various tax liabilities and depositing correct amount
of taxes with the concerned authorities.

NEED & IMPORTANCE (ADVANTAGES) OF MANAGEMENT:

.
The advantages of management accounting are summarized below:
1. Helps in Decision Making:
Management accounting helps in decision making such as pricing, make or buy, acceptance of
additional orders, selection of suitable product mix etc. These important decisions are taken with the
help of marginal costing.
2. Helps in Planning:
Planning includes profit planning, preparation of budgets, programmes of capital investment and
financing. Management accounting assists in planning through budgetary control, capital budgeting and
cost-volume-profit analysis.
3. Helps in Organizing:
Management accounting uses various tools and techniques like budgeting, responsibility
accounting and standard costing. A sound organizational structure is developed to facilitate the use of
these techniques.
4. Facilitates communication:
Management is provided with up-to-date information through periodical reports. These reports
assist the management in the evaluation of performance and control.
5. Helps in coordinating:
The functional budgets (purchase budget, sales budget, overhead budget etc.) are integrated into
one known as master budget. This facilitates clear definition of departmental goals and co-ordination of
their activities.
6.Evaluation and Control of performance:
Management accounting is a convenient tool for evaluation of performance. With the help of
ratios and variance analysis, the efficiency of departments can be measured. Management accounting
assists the management in the location of weal spots and in taking corrective actions.
7. Interpretation of Financial Information:
Management accounting presents information in a simple and purposeful manner. This facilitates
quick decision-making.
LIMITATIONS OF MANAGEMENT ACCOUNTING:
 Based on accounting information:
Management accounting is based on data supplied by financial and cost accounting. If
financial data is not reliable then management accounting will not provide correct analysis.
 Lack of knowledge:
The use of management accounting requires the knowledge of a numbers of related
subjects such as accounting principles, statistics, economics, and principles of management etc.
inefficiency in knowledge of any of these subjects limits the use of management accounting.
 Intuitive decisions:
Though management accounting provides scientific analysis of various situations, there is
a tendency for the management to make decisions intuitively. Such intuitive decisions limit the
usefulness of management accounting.
 Not an alternative to administration:
Management accounting does not provide an alternative to administration. The tools and
techniques of management accounting provide only information and not decisions. Decisions are
to be taken by the management.
 Top heavy structure (costly):
Introduction of management accounting system is a costly affair and can be used by big
concerns only. Smaller units cannot afford to use this system because of heavy cost. A large
number of rules and regulations are required to make this system effective.
 Evolutionary stage:

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 Management accounting is only in a developmental stage and not yet reached a final
stage. The techniques and tools used by this system give different results.
 Personal bias:
The interpretation of financial information depends upon the capability of interpreter as
one has to make a personal judgement. There is every chance of personal bias in analysis and
interpretation.
 Psychological resistance:
The installation of management accounting involves basic change in organizational set
up. New rules and regulations are to be framed which affect a number of personnel and hence
there a possibility of resistance from employees.
FINANCIAL ACCOUNTING:
Main purpose of financial accounting is to ascertain profit or loss and to indicate financial position of an
enterprise. Two fundamental statement of financial accounting are income and expenditure
statement and balance sheet.
FUNCTIONS OF FINANCIAL ACCOUNTING:
 Book-Keeping Function:
Financial Accounting is helpful to a firm’s management to ascertain the results of its operation
and status of the business.
 Classification of information:
The data of one particular type is classified into one segment. This is done in the form of
ledger accounts.
 Preparation of Financial Statement:
Business transaction relating are summarized by preparing the principal statement of the
business i.e., Profit and loss account and the Balance Sheet.
 Segregating Financial Transactions:
The economic transactions relating to a business are measured in terms of money. Financial
accounting is concerned with transactions which are measurable in monetary terms.
 Interpretation of Financial Data:
The management interprets the financial data for decision making.
 Reporting of information:
Financial Accounting not only records data but also communicates data by way of profit and
loss account and the balance sheet to all concerned at frequent interval.
Cost Accounting:
The term ‘cost’ has to be studied in relation to its purpose and conditions, as per the definition
given by Institutions of Costs and Management Accountants (ICMA).
FUNCTIONS (OR) OBJECTIVES OF COST ACCOUNTING:
Ascertainment of Cost (Cost Finding):The primary objective of cost accounting is ascertainment of
cost. It is done through the methods and techniques of costing. Costing is the process of collection,
classification and analysis of costs or expenses.
Control of Cost:A basic function of cost accounting is control of costs. Cost control refers to, regulate
the cost of production. In simple words, control of cost means maintain the level of cost which means
cost per unit remain constant.
Cost Reduction:Cost reduction is the real and permanent reduction in the unit of goods manufactured or
services. In other words cost reduction means reduce the cost of production, which means reduce the
cost per unit of output.
Fixation of Selling Price:The total cost and the margin requirement determines the price of a product.
Cost accounting provides detailed information regarding total cost in the form of various stages. It is aid
to management for fixation of selling price.
Framing Business Policy:Cost accounting helps the management in formulating business policy and
decision making. For.eg. Break even analysis and Cost volume profit analysis etc.

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DIFFERENCE BETWEEN FINANCIAL ACCOUNTING & MANAGEMENT ACCOUNTING:
Financial Accounting Management Accounting
1. Object:
To know the financial position and to To help the management in formulating
find out profit or loss at the end of the policies and plans.
financial year.
2. Nature:
It records only transactions which It deals with projection of data for the future.
have already taken place.
3. Subject matter:
In Financial accounting, overall In Management accounting, the results of
performance is judged. different departments are evaluated
separately to find out their performance
differently.
4. Compulsion:
The preparation of financial accounts Preparation of management accounting is not
is compulsory. compulsory. The management is free to use
or not to use management accounting.
5. Rules (Procedure):
Particular procedure is to be followed No such procedure in management
for preparing financial accounts. accounting.
6. Figures:
In Financial accounting, only actual The approximate figures are considered more
figures are recorded and no room for useful than exact figures.
approximate figures.
7. Reporting:
[The reports are useful for outsiders Management accounting reports are meant
like bankers, investors, shareholders, for internal use only.
government agencies etc]. The reports
are prepared not only for the benefit
of the concern but also for outsiders.
8. Description:
Only those things which can be Management accounting uses both monetary
measured in monetary terms are and non-monetary events.
recorded.
9. Quickness:
Reporting of financial accounting is Reporting of management accounting is very
slow and time consuming. quick.
10. Accounting principles:
Financial accounts are governed by No set of principles are followed in
generally accepted principles and management accounting.
conventions.
11. Period:
Financial accounts are prepared for a Management accountant supplies
particular period. P&L a/c for one information from time to time during the
year and Balance sheet is prepared on whole year.
a particular date.
12. Publication:
Financial accounts like P&L a/c and Management accounting statements are
Balance sheet are published for the prepared for the benefit of the management
benefit of the public. only and these are not published.
13. Audit:
Financial accounts can be got audited. Management accounts cannot be audited.

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DIFFERENCE BETWEEN COST ACCOUNTING & MANAGEMENT ACCOUNTING:

Cost Accounting Management Accounting

1. Object:
The object of cost accounting is to The purpose of management accounting is to
record the cost of producing a product. provide information to the management for
planning the activities of the business.
2. Scope:
Cost accounting deals primarily with It includes Financial accounting, Cost
cost ascertainment. accounting, Budgeting, Tax planning,
Reporting to management etc.
3. Nature:
Cost accounting uses both past and Management accounting is concerned with the
present figures. projection of figures for future.
4. Data used:
Only quantity aspect is recorded in cost Management accounting uses both quantitative
accounting. and qualitative information.
5. Principles followed:
Certain principles and procedures are No specific rules and procedures are followed
followed for recording costs of in reporting management accounting.
different products.

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 MCQ (Multiple Choice Questions)

PART-A

1) Management accounting can be viewed as .

A. Marketing-oriented Accounting
B. Management-oriented Accounting
C. Accounting-oriented Management
D. Manager-oriented Accounting

2) is the language of Business which used to communicate financial information.

A. Accounting
B. Marketing
C. Profit
D. Pricing

3) The term management accounting was first coined in .

A. 1940
B. 1950
C. 1960
D. 1970

4))Which is the sub-field of accounting?

A. Management accounting
B. Cost accounting
C. Financial accounting
D. All of the above

5) The main objective of management accounting is

A. To maintain the accounting records
B. To know the amount due from customers and suppliers
C. To ascertain analyse and interpret the results of business operations
D. To record all the business transactions

6) is the study of managerial aspects of financial accounting

A. Cost accounting
B. Financial accounting
C. Management accounting
D. Business accounting

7) The purpose of management accounting is to help make decisions

A. managers
B. investors
C. marketers
D. banks
8) Managerial accounting information is generally prepared for
A. managers
B. stakeholders
C. government agencies
D. competitors

9) shows how the accounting function can be represented so as to fit it within the framework
of Management activity.

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A. Management accounting
B. Cost accounting
C. Financial accounting
D. Tax accounting cancer is Management accounting

10) The primary task of management accounting is, therefore, to redesign the entire accounting system so
that it may serve the needs of the firm.
A. Marketing
B. Operational
C. Human resource
D. Production

(PART – B) 5 MARKS

1. Give an outline of the scope and objectives of Management accounting.(nov2018)

2. What are the functions of Management accounting?(nov2018)
3. Explain the importance of Management Accounting as a tool of management decision-making.
4. Differentiate Cost Accounting & Management Accounting.(nov2018)
5. Describe the limitations of Management Accounting.(nov2018)
6. Explain the characteristic feature of Management Accounting..( april2020)

(PART – C) 10 MARKS

7. Define Management Accounting. Distinguish between Financial Accounting & Management

Accounting..( april17)

8 .What are the tools and techniques used in Management Accounting? Explain in detail.(nov2018)

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 I. UNIT ABSTRACT

Name of the Paper: Management Accounting Class: III B.COM

Important Question
Keywords Definition
with marks
It provides information to Management Accounting is 1. What are the functions
management so that planning, concerned with accounting of Management
organizing, directing and information that is useful to accounting?(nov2018)
2. Explain the importance
controlling of business management”.
of Management
operations can be done in an Accounting as a tool of
orderly manner management decision-
making.(Dec-2019)

Management accounting is Management accounting 1. What are the tools and

concerned with the projection reports are meant for internal techniques used in
of figures for future. use only. Management
Accounting? Explain
in detail

Signature of the Subject in charge Head of the Department/Vice Principal

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 UNIT – II
ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS
RATIO ANALYSIS
Meaning:
The relationship between two figures expressed mathematically is called a Ratio. It is a
numerical relationship between two numbers which are related in some manner.
Ratio analysis is a technique of analysis and interpretation of financial statements. It is the
process of determination and interpretation of various ratios for helping in decision making.
Ratio analysis involves 3 steps:
Calculation of appropriate ratio from the financial statements.
Comparison of the ratios with standards or with ratios of the past period. Comparison can also be
made with the ratios of other firms.
Interpretation of ratios.

Financial statements refer to a package of statements such as balance sheet, income statement,
funds flow statement, cash flow statement and statement of retained earnings. The balance sheet and
income statement are traditional financial statements.

DEFINITION:
According to the American Institute of Certified Public Accounts (AICPA), “Financial
statements reflect a combination of recorded facts, accounting principles and personal judgements”.

OBJECTIVES:
* To estimate the earning capacity of the concern.
* To judge the financial position and performance of the concern.
* To decide about the future prospects of the concern.
* To determine the debt capacity of the concern.

NATURE AND FINANCIAL STATEMENTS:

Recorded Facts:
The term recorded facts refers to the data taken out from accounting records. Facts which have
not been recorded in the financial books are not depicted in financial statements, however important they
might be.
Accounting Principles:
In financial statements, certain accounting principles, concepts and conventions are followed.
For ex: the convention of valuing stock at cost or market price, whichever is less is followed.
Personal Judgments:
It has an important bearing on the financial statements. For ex: the selection of a method for
stock valuation depends on the personal judgment of the accountant.

LIMITATIONS OF FINANCIAL STATEMENTS:

Financial statements are relevant and useful for a concern. But they do not present a final picture.
The following are the limitations of financial statements:

 Financial statements are only interim reports.

 Many items in the financial statements are based on the personal judgment of the accountant.
This factor affects the validity of financial statements.
 Non-monetary factors such as credit worthiness, reputation of the management, influence the
financial position of a concern.
 Financial statements ignore the changes in price level. Hence, their use is limited during
inflationary periods.

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  In balance sheet, assets are recorded at their original costs. Replacement cost or realizable value
of the asset is ignored. Hence, it does not reveal the true position of the business.
 Financial statements are records of past events only.
 Financial statements are prepared on the basis of certain accounting concepts and conventions.

ANALYSIS AND INTERPRETATION:

Analysis and interpretation of financial statements is the most important step in accounting. To
have a very clear understanding of the profitability and financial position of a company, the financial
statements have to be analyzed and interpreted.

Analysis:
It refers to the methodical classification of the data given in the financial statements. For ex:
the amount of capital employed is not directly available in the balance sheet.

Interpretation:
It means explaining the meaning and significance of the data so arranged. It is the study of the
relationship between various financial factors. The relationship between profit and capital employed,
current assets, sales etc. have to be explained. Further, to make interpretation more meaningful,
comparisons have to be made.

Analysis and interpretation are closely related. Interpretation is not possible without analysis and
without interpretation analysis has no value. Hence, the term analysis is widely used to refer both
analysis and interpretation.

TOOLS & TECHNIQUES OF FINANCIAL STATEMENTS:

Comparative Statements.
Common size Statements.
Trend Analysis.

1. Comparative Statements:
Financial statements are presented as on a particular date or for a particular period. For ex:
balance sheet indicates the financial position as at the end of the period and also income statement.
But a financial analyst is interested in knowing whether the business is moving in a favorable or
unfavorable direction.

2. Common size Statements:

Financial statements present absolute figures. They are even misleading. For ex: cost of sales in
absolute figures might have gone up but as percentage of sales it might have come down. Hence, for a
better understanding the figures are converted into percentage of some common base.
In income statement, a sale is taken as the common base in the common size statement. In
balance sheet, each item is expressed as a percentage of the total of assets and liabilities.

3. Trend Analysis:
Trend analysis is also an important and useful technique of financial statement analysis. The
calculation of trend ratio involves the ascertainment of arithmetical relationship which each item of
several years to the same item of base year. Thus, one particular year out of many years is taken as base.
The value of one particular item out of several items shown in the financial statements are converted
into ratio or percentage taking of that item in base year as equal to 100.
RATIO ANALYSIS
Meaning:
The relationship between two figures expressed mathematically is called a Ratio. It is a
numerical relationship between two numbers which are related in some manner.
Ratio analysis is a technique of analysis and interpretation of financial statements. It is the
process of determination and interpretation of various ratios for helping in decision making.
15
 Ratio analysis involves 3 steps:
Calculation of appropriate ratio from the financial statements.
Comparison of the ratios with standards or with ratios of the past period. Comparison can also be
made with the ratios of other firms.
Interpretation of ratios.

Significance & Uses:

Ratio analysis is a powerful tool of financial analysis. It used as a device to analyze and interpret
the financial health of the firm. It helps the management in taking decision and control.
It is used for different parties for different purposes to know about the financial position. It helps
in making decisions regarding the granting of credit and making investment in the firm.

Managerial uses of Ratio Analysis:

 Simplifies Financial Statements.
 Helps measuring performance and position.
 Facilitates intra-firm comparison.
 Facilitates inter-firm comparison.
 Helps in forecasting and planning:
 Helps in co-ordination.
 Helps in control.

CLASSIFICATION OF RATIOS:
A. Traditional Approach.
B. Functional Approach.
A. Traditional Approach:
(a) Profit & Loss a/c Ratios:
These are calculated on the basis of items of the profit and loss account only. For ex: gross profit
ratio.

(b) Balance Sheet Ratios:

Ratios calculated on the basis of figures of the balance sheet only. For ex: current ratio.

(c) Composite Ratios:

These are based on figures of profit and loss account as well as balance sheet. For ex: Return on
Investment ratio.

B. Functional Approach:
 Solvency Ratio:
Long-term and Short-term solvency ratios can be calculated. For ex: debt-equity ratio.
 Profitability Ratio:
The following ratios are ascertain return on investment, gross profit ratio etc.
 Turnover / Activity Ratio:
Fixed asset turnover ratio, working capital turnover ratio, stock turnover ratio can be ascertained.
 Capital Structure Ratio:
Capital gearing ratio express the relationship between fixed interest bearing security [preference
share capital and debentures] and equity shareholders fund.
The fixed interest bearing security is more than equity shareholders fund, the ratio is high gear.
The equity shareholders fund is more than fixed interest bearing security the ratio is low gear.

LIMITATIONS OF RATIO ANALYSIS:

16
Ratio analysis suffers from certain limitations. They are discussed below:
 Inadequacy of standards:
Ratios are useful only if they are compared with some standards. But, adequate standards like
industry averages are not easily available.

 Difficulty in comparison:
In practice, it is difficult to have similar companies for comparison. Even if it is possible, their
accounting periods may differ. This makes inter-firm comparison difficult.

 Limitations of financial statements:

Ratios are based on the information recorded in the financial statements. If there is any mistake
in financial statements it affects the ratios also.

 Ratios alone are not adequate:

Ratios are only indicators. They cannot be taken as final regarding good or bad financial position
of the firm.
 Problems of price level changes:
Ratio analysis does not take into account the effect of changes in price level. Because of this,
interpretation of ratios becomes invalid.

 No fixed standards:
No fixed standards can be laid down. For ex: ideal ratio is said to be 2:1. However for firms
which have adequate credit arrangement with their bankers, it may be perfectly ideal to have a ratio of
1:1.

 Personal bias:
Ratios are only a means of financial analysis. They have to be interpreted and different people
may interpret the same ratio in different ways.

 Window dressing:
Financial statements can easily be window-dressed to present a better picture of the financial and
profitability positions. Hence, one has to be very careful in making a decision on the basis of ratios
calculated from such financial statements. But, it is very difficult for an outsider to know about the
window-dressing made by a company.

STEPS RATIO ANALYSIS:

(1) Selection of relevant information:

The first step in ratio analysis is to select relevant information from financial statement and calculate
appropriate ratios required for decision under consideration.
(2) Comparison of Calculated Ratios:

17
 In order to assess the relative meaning the ratios calculated are compared with the past ratios and
industry ratios.
(3) Interpretation and Reporting:
The third step in ratio analysis is to interpret the significance of various ratios, draw inference and to
write a report.

I. PROFITABILITY RATIO:
1. RETURN ON INVESTMENT OR OVER ALL PROFITABLE RATIO

Operating profit
R.O.I= x 100
Capital employed

(a) RETURN ON SHAREHOLDER FUND

Net profit after interest and tax
= x 100
Shareholders fund
(b).RETURN ON TOTAL ASSETS

Net profit after tax

= x100
Total assets

Net profit after tax + interest

= x100
Total assets excluding fictious assets
2. GROSS PROFIT RATIO:
Gross profit
= ----------------- 100
Net sales
3. OPERATING RATIO:
Cost of sales+ operating expenses
= x100
Net sales
4. OPERATING PROFIT RATIO:

=------------------------------

PROBLEMS:
1. From the following details of a trader you are required to calculate stock turnover ratio.
Sales Rs. 39,984
Sales returns Rs.380
Opening stock Rs. 1,378
Closing stock Rs. 1,814
Total Cross Profit for the year Rs. 8,068

Solution: Cost of Sales

Stock Turnover Ratio = --------------------------------
Average Stock
= Sales – Gross Profit
= (39,984-380) – 8,068
= 39,604-8,068
= 31,536
18
 Opening stock + Closing Stock
Average Stock =
2
1,378-1,814 3,193
= =
2 2
= 1,596

31,536
Stock Turnover Ratio = -------------- = 19.76 times
1,596

2.From the following information make out a statement of proprietors funds with as many detail as
possible:

a. Current ratio 2.5

b. Liquidity ratio 1.5
c. Proprietary ratio 0.75
d. Working capital Rs. 60,000
e. Reserves & Surplus Rs. 40,000
f. Bank Overdraft Rs. 10,000
g. There is no long- term loan or fictitious asset.

Sol:

Particulars Rs. Rs.

Proprietors Fund:
Share Capital 2,00,000
Reserves & Surplus 40,000 2,40,000

Proprietors Fund represented by:

Fixed assets(A) 1,80,000
Current Assets:
Stock 40,000
Other current asset 60,000 1,00,000
Less: Current liabilities:
Bank Overdraft 10,000
Other current liabilities 30,000 40,000
Working Capital (B) 60,000
Capital employed = A+B 2,40,000
Less: Long- term debt Nil
Proprietors Funds
2,40,000

Note: If liquid liabilities are used in liquid ratio formula, the only change in the above statement is:
Stock Rs. 55,000; Other Current assets: Rs: 45,000. No other figure or total is affected.
Workings:
1. Calculation of CA & CL:
Current ratio given = 2.5
Current asset
Current ratio = -----------------------

19
 Current liabilities

If current assets are 2.5, current liabilities are 1.

Working capital = CA-CL
= 2.5-1
Working capital given = Rs. 60,000
1.5 = Rs. 60,000
2.5
Current asset = 60,000 X ------ = Rs. 40,000
1.5
2. Calculation of liquid assets and stocks:
Liquidity ratio given = 1.5

Current asset
Current ratio =
Current liabilities
Liquid Assets
1.5 =
40,000
Liquid assets = 40,000 X 1.5 = Rs. 60,000
Liquid assets = Current asset – Stocks
60,000 = 1,00,000-60,000 = Rs. 40,000

2. Calculation of Fixed assets and Capital:

Proprietary ratio given = 1.5

Fixed assets
Proprietary Ratio= ------------------------
Proprietors Fund
It is given that there is no long-term or fictitious assets.
Balance sheet equation = Total assets - Total liabilities
(or) Proprietor’s funds + CL = Fixed assets + CA

If proprietor’s funds are assumed as X,

X + CL = 0.75X + Current assets
X + 40,000 = 0.75X + 1,00,000
X – 0.75X = 1,00,000 – 40,000
0.25X = 60,000
= 60,000/ 0.25 = Rs. 2,40,000
Proprietors funds = Rs. 2,40,000
Less: Reserves & Surplus = 40,000

Rs. 2,00,000
Fixed Assets = Rs. 2,40,000 X 0.75
= Rs. 1,80,000
Note:
Liquid assets
Some experts on ratio analysis use the formula for liquid ratio as ----------------------
Liquid liabilities
Liquid liabilities = Current liabilities – Bank Overdraft
Liquid assets
1.5 = -------------------------
40,000-10,000
Liquid assets = 1.5 X 30,000 = Rs.45,000

20
 MCQ (Multiple Choice Questions)
PART-A

1. Funds flow statement is prepared on the basis of .

a. Profit and loss account of the current year
b. The balance sheet of the previous and current year
c. Both a and b
d. None of the above (Answer: c)
2. Which of the following are sources of funds for an organisation?
a. Conversion of debentures into shares
b. Conversion of loans into shares
c. Issue of shares against the purchase of fixed assets
d. None of the above (Answer: d)
3. Funds flow statement is also known as .
a. Statement of sources and uses of funds
b. Statement of sources and application of funds
c. Statement of funds flow
d. All of the above (Answer: d)
4. The statement prepared while conducting funds flow analysis is called .
a. Funds flow statement
b. Schedule of changes in working capital
c. Both a and b
d. None of the above (Answer: c)
5. Funds flow statement is prepared to .
a. Ascertain the item-wise outflow of funds in a given period
b. Identify changes in working capital
c. Identify reasons behind changes in working capital
d. All of the above (Answer: d)

6. The statement of cash flow clarifies cash flows according to

A) Operating and Non-operating Flows
B) Inflow and Outflow
C) Investing and Non-operating Flows
D) Operating, Investing, and Financing Activities
Answer: D
7. Cash flow example from a financing activity is
A) Payment of Dividends

21
 B) Receipt of Dividend on Investment
C) Cash Received from Customers
D) Purchase of Fixed Asset
Answer: A
8. Cash flow example from an investing activity is
A) Issue of Debenture
B) Repayment of Long-term Loan
C) Purchase of Raw Materials for Cash
D) Sale of Investment by Non-Financial Enterprise
Answer: D
9. Cash flow example from an operating activity is
A) Purchase of Own Debenture
B) Sale of Fixed Assets
C) Interest Paid on Term-deposits by a Bank
D) Issue of Equity Share Capital
Answer: C
10. Which item comes under financial activities in cash flow?
A) Redemption of Preference Share
B) Issue of Preference Share
C) Interest Paid
D) All the above
Answer: D

(PART – B) 5 MARKS
1. Explain the nature of financial statements.(nov2017)
2. What are the limitations of financial statements?.(nov2018)
3. List out the limitations of Ratio Analysis..(nov2018)
4. Explain – Comparative Statements..(april2017)
5. Discuss about common size statements..(april2020)
6. Give short notes on Trend Analysis..(nov2018)
7. Compute the debtors turnover ratio from the following:.(nov2018)
Rs.
Gross Sales 1,42,000
Cash Sales 28,000
Sales Returns 14,000
Opening Debtors 15,000
Opening Bills Receivable 5,000
Closing Debtors 26,000
Closing Bills Receivable 4,000

22
 (PART – C) 10 MARKS
8. Discuss some of the important ratios usually worked from financial statements showing how they
would be useful to higher management.

23
 II. UNIT ABSTRACT

Name of the Paper: Management Accounting Class: III B.COM

Important Question
Keywords Definition
with marks
Financial statements refer to a package of According to the American 1. Explain the nature of
statements such as balance sheet, income Institute of Certified Public financial statements.
statement, funds flow statement, cash flow Accounts (AICPA), “Financial
2. What are the
statement and statement of retained statements reflect a
limitations of financial
earnings. combination of recorded facts,
accounting principles and statements?
personal judgements”.

Financial statements are 1. Discuss some of the

a. Comparative Statements. presented as on a particular important ratios usually
b. Common size Statements. date or for a particular period. worked from financial
c. Trend Analysis statements showing
For ex: balance sheet indicates
how they would be
the financial position as at the useful to higher
end of the period and also management.
income statement.

Signature of the Subject in charge Head of the Department/Vice Principal

24
 UNIT - III
FUND FLOW ANALYSIS
MEANING:
The funds flow statement is a report on the movement of funds or working capital. It explains
how working capital is raised and used during an accounting period.

DEFINITION:
“A statement of sources and application of funds is technical device designed to analyze the
changes in the financial condition of a business enterprise between two dates.”
- Foulke

OBJECTIVES OF FUND FLOW STATEMENT:

* To show how the resources have been obtained and used.

* To indicate the results of current financial management.
* To know the changes in working capital during a specific period.
* To show how the general expansion of the business has been financed.
* To have an assessment of the working capital position of the concern.

CONCEPT OF FLOW OF FUNDS:

The term ‘fund’ has been defined in a number of ways. Generally it means cash. The term fund
refers to all financial resources. However, the concept of funds as working capital is the most popular
and widely accepted.

Working capital is the excess of current assets over current liabilities.

The term ‘flow’ means change and flow of funds means change in funds or change in working
capital. In other words, flow of funds means any increase or decrease in working capital. If the
transaction results in the increase of funds it is called a source of funds; if it results in the decrease of
funds it is known as an application of funds. If the transaction does not affect the working capital there is
not flow of funds.

25
MANAGERIAL USES / ADVANTAGES OF FUNDS FLOW STATEMENT:
The fund flow statement is of primary importance to the financial management. It is an essential
tool for financial analysis. The following are the significance of funds flow statement:
Analysis of Financial operations:
The main purpose of funds flow statement is to analyze the financial operations of the business.
The statement explains the causes for changes in the assets and liabilities during a period.
Evaluation of the firm’s financing:
The analysis of sources of funds reveals how the firm has financed its development projects in
the past i.e. internal from external sources. It reveals the rate of growth of the firm.

Allocation of scarce resources:

A projected funds flow statement is an instrument for allocation of resources. It lays down the
plan for efficient use of scarce resources in future.

Helps in working capital management:

Funds flow statement indicates the adequacy or inadequacy of working capital. The management
can take steps for effective use of surplus working capital.
Acts as guide to future:
With the help of projected funds flow statement, the management can plan for meeting future
financial requirements.

Helps in financial institutions:

The funds flow statement is also useful to lending institutions like banks, IDBI, ICICI, IFCI,
HDFC and others. It helps them to assess the credit worthiness and repaying capacity of the borrowing
company.

LIMITATIONS OF FUNDS FLOW STATEMENT:

The following are the limitations of funds flow statement:
 Funds flow statement is not a substitute for an income statement or balance sheet. It provides
only some additional information regarding changes in working capital.
 It gives more important for Changes in working capital only.
 It is not an original statement. It is only a rearrangement of data given in financial statements.
 Funds flow statement is essentially historic in nature.
 It cannot reveal continuous changes.

DISTINCTION BETWEEN FUNDS FLOW STATEMENT & INCOME STATEMENT:

Funds Flow Statement Income Statement

1. It is prepared to know the sources It is prepared bto know the profit or loss
and uses of working capital. of the business activities.

2. It matches the funds raised with It matches cost of goods sold with sales to
funds applied. No distinction ascertain profit or loss. It deals with
between capital and revenue items. revenue items only.

DISTINCTION BETWEEN FUNDS FLOW STATEMENT & BALANCE SHEET:

Funds Flow Statement Balance Sheet

1. It is dynamic in nature. It is static in nature.
2. It shows changes in working It shows the position of assets and liabilities
capital between two balance sheet on a specific date

26
 3. It shows only those items which It shows the real and personal accounts of a
causes change in working capital. business, reflected in the assets and liabilities.
4. It aims at presenting flow of funds It aims depicting the financial position of a
over a period. business.
5. It is prepared after the financial It is prepared after the income statement is
accounts are completed. completed.

FACTORS INFLUENCING THE WORKING CAPITAL IN A BUSINESS:

Working capital refers to the capital required for the day-to-day operations of a business. It is the
excess of current assets over current liabilities. Adequate working capital is necessary for the successful
running of any organization.
The requirements of working capital depend on the following factors:

Nature of business:
In the case of public utility concerns like railways, electricity etc. most of the transactions are on
cash basis. Further they do not require large inventories. Hence their working capital requirements are
low. For the manufacturing concerns, they have to invest high.

Size of the business:

Generally large business concerns are required to maintain large inventories for the flow of
business. So larger will be the working capital requirement..

Seasonal fluctuations:
A number of industries manufacture and sell goods only during certain seasons. For ex: Sugar
industry produces only December onwards.

Fluctuations in supply:
If the supply of raw materials is irregular, companies are forced to maintain huge stocks to avoid
stoppage of production.

Speed of turnover:
A concern which affects sales quickly needs comparatively low working capital. This is because
of the quick conversion of stock into cash.

Time consumed in manufacture:

To run a long production process more inventories is required. Hence the longer the period of
manufacture, the higher will be their requirements of working capital and vice versa.

Terms of sales:
More credit sales will result in locking up of funds in sundry debtors. Hence, a company which
allows more credit will need more working capital.

Terms of purchase:
Working capital requirements are also affected by the credit facilities enjoyed by the company. A
company enjoying liberal credit facilities from its suppliers will need lower amount of working capital.

Growth and expansion of business:

A growing concern needs more working capital to finance its increasing activities and expansion.
But working capital requirements are low in the case of static concerns.

CASH FLOW ANALYSIS

Introduction:
Cash plays an important role in the economic life of a business. A firm needs cash to make
payments to its suppliers, to incur day-to-day expenses and to pay salaries, rent, interest, dividends etc.
27
Thus, in a firm, there is constant inflow and outflow of cash. Cash flow statement is an important tool of
cash planning and control.

MEANING:
A statement prepared from the historical data showing sources and uses of cash is called cash
flow statement. It reveals the inflow and outflow of cash during a particular period.

OBJECTIVES:
◊ To show the causes of changes in cash balance between two balance sheet periods.
◊ To indicate the factors contributing to the reduction of cash balance in spite of increase in profits
and vice versa.

SIGNIFICANCE & USES OF CASH FLOW STATEMENT:

 The cash flow statement explains the reasons for low cash balance in spite of huge profits and vice
versa.
 It helps in short-term financial decisions relating to liquidity.
 It helps the management in planning the repayment of loans, replacement of assets, credit
arrangements etc.
 It shows the major sources and uses of cash. The management with the help of projected cash flow
statement can know
(a) How much cash will be needed?
(b) From which sources it can be obtained.
(c) How much can be generated internally?
(d) How much could be obtained from outside?
 On the basis of past years cash flow statements projections can be made for the future. The projected
cash flow statement helps in planning for the investment of surplus or meeting the deficit.
 The comparison of actual and projected cash flow statement helps in understanding the variations
and control of cash expenditure.

DISTINCTION BETWEEN FUNDS FLOW STATEMENT & CASH FLOW STATEMENT:

Funds Flow Statement Cash Flow Statement

1. Here, increase or decrease in Here, only cash receipts and payments are
working capital is recorded. recorded.
2. It shows the causes of changes in It indicates the causes for changes in cash
working capital. position.
3. It is appropriate for long range It is appropriate for short range planning.
planning.
4. Inflow of funds does not necessarily Whenever there is inflow of cash there will
mean inflow of cash. definitely be inflow of funds.
5. Here, there is no opening and Cash flow statement starts with opening
closing balances in funds flow cash balance and closes with the closing
statement. cash balance.

PROBLEM:

Calculation of funds from operations:

1. Calculate funds from operations from the following P&L A/c.
Particular Rs Particular Rs
To Expenses paid 30,000 By Gross Profit 4,50,000
To Depreciation 70,000 By Gain on sale of Land 60,000
To Loss on sale of machine 4,000
To Discount 200
To Goodwill 20,000

28
 To Net profit 1,15,800
5,10,000 5,10,000

Calculation of Funds Flow Statement:

2. Following are the summarized Balance sheet of X Ltd., as on 31-12-98 & 31-12-99.
Liabilities Rs. Rs. Assets Rs. Rs.
Share capital 2,00,000 2,50,000 Land & Buildings 2,00,000 1,90,000
General Reserve 50,000 60,000 Machinery 1,50,000 1,69,000
P&L A/c 30,500 30,600 Stock 1,00,000 74,000
Bank Loan (Long 70,000 - Sundry Debtors
80,000 64,200
Term)
Sundry Creditors 1,50,000 1,35,200 Cash 500 600
Provision for Tax 30,000 35,000 Bank - 8,000
Goodwill - 5,000
5,30,500 5,10,800 5,30,500 5,10,800
Additional Information:
During the year ended 31-12-99.
(a) Dividend of Rs. 23,000 was paid
(b) Assets of another company were purchased for consideration of Rs. 50,000, payable in share. The
following assets were purchased. Stock Rs. 20,000, Machinery Rs. 25,000
(c) Machinery was further purchased for Rs. 8,000
(d) Depreciation written off machinery Rs. 12,000
(e) Income tax provided during the year Rs. 33,000
(f) Loss on sale of machine Rs.200 was Written off to general reserve.
Prepare a Funds Flow Statement.
Sol:
Step:1
Schedule of Changes in Working Capital
Particulars 31-12-98 31-12-99
Rs. Rs. Change in working Capital
Increase Rs. Decrease Rs
Current Assets:
Stock 1,00,000 74,000 - 26,000
Debtors 80,000 64,200 - 15,800
Cash 500 600 100 -
Bank - 800 8,000 -
Total Current Assets (A) 1,80,500 1,46,800
Current Liabilities:
Sundry Creditors 1,50,000 1,35,200 14,800 -
Total Current Liabilities(B) 1,50,000 1,35,200
Working Capital (A-B) 30,500 11,600 22,900 41,800
Decrease in Working Capital - 18,900 18,900 -
TOTAL 30,500 30,500 41,800 41,800

Step: 2
Machinery A/c
Particulars Rs. Particulars Rs.
To Balance b/d 1,50,000 By General Reserve (loss on sale) 200
To Share Capital 25,000 By Adjusted P&L A/c(Depn.) 12,000
To Cash (purchase) 8,000 By Cash (sales) (bf) 1,800
By Balance c/d 1,69,000
1,83,000 1,83,000
29
 Share Capital A/c
Particulars Rs. Particulars Rs.
By Balance b/d 2,00,000
By Stock (sources of funds) 20,000
By Machinery 25,000
To Balance c/d 2,50,000 By Goodwill 5,000
2,50,000 2,50,000

Note:

1. Share issued for = Rs. 50,000

value of assets acquired = Rs.20,000+25,000 = Rs. 45,000

Goodwill (Balance) Rs. 5,000

2. Issue of shares in consideration for machinery and goodwill does not affect the flow of funds
(working capital).
Provision for Taxation
Particulars Rs. Particulars Rs.
To Cash (Tax paid) 33,000 By Balance b/d 30,000
By Adjusted P & L A/c 38,000
(Current year Provision)
To Balance c/d 35,000
68,000 68,000

General Reserve
Particulars Rs. Particulars Rs.
To Machinery (loss on sale) 200 By Balance b/d 50,000
By Adjusted P & L A/c 10,200
To Balance c/d 60,000
60,200 60,200

Step: 3
Adjusted P L A/c
Particulars Rs. Particulars Rs.
To Depn. On Machinery 12,000 By Balance b/d 30,500
To Prov. For Taxation 38,000 By Funds from operations 93,300
To General Reserve 10,200
To Deprn. On L&B 10,000
To Dividend 23,000
To Balance c/d 30,600
1,23,800 1,23,800

Step: 4
FUNDS FLOW STATEMENT

Particulars Rs. Particulars Rs.

30
 Sale of Machinery 1,800 Repayment of Bank loan 70,000
Issue of Share for stock 20,000 Payment of Tax 33,000
Funds from operations 93,300 Purchase of Machinery 8,000
Decrease in working capital 18,900 Dividend paid 23,000
1,34,000 1,34,000

3. Calculate cash from operations from the following.

Selvi Ltd., earned profit of Rs. 2,00,000 after charging or crediting the following items to its
P&L A/c during 31-03-2005.

Particulars Rs.
a) Profit on sale of investment 4,000
b) Loss on sale of Building 9,000
c) Depreciation on Fixed assets 7,000
d) Amortization of goodwill 2,000

(ii) The following is the position of current assets and current liabilities.

I year II year
Rs. Rs.
Bills payable 5,000 8,000
Creditors 12,000 16,000
Outstanding expenses 2,000 1,000
Bills receivable 20,000 18,000
Debtors 40,000 60,000
Prepaid expenses 2,000 3,000
Accrued incomes 5,000 8,000
Income received in advance 2,000 1,000

Sol:
Statement showing cash from operations for the year ending 31-03-2005
Particulars Rs. Rs.
Net profit as per P&L A/c 2,00,000
Add: Non cash & Non trading expenses:
Loss on sale on buildings 9,000
Depreciation on Fixed assets 7,000
Amortization of goodwill 2,000 18,000
2,18,000
Less: Non trading incomes:
Profit on sale of investment 4,000 2,14,000
Funds from Operations
Add: Increase in Current Liabilities:
Bills payable (8,000-5,000) 3,000
Creditors (16,000-12,000) 4,000
Decrease in Current Assets:
Bills Receivables(20,000-18,000) 2,000 9,000
2,23,000
Less: Decrease in Current Liabilities:
Outstanding expenses (2,000-1,000) 1,000
Income received in advance (2,000-1,000) 1,000
Increase in Current Assets:
Debtors (60,000-40,00) 20,000
Prepaid expenses (3,000-2,000) 1,000
Accrued incomes (8,000-5,000) 3,000 26,000
31
 Cash from Operations 1,97,000

4. Balance Sheet of M/s. Black and White as on 1.1.99 and 31.12.1999 was as follows.
Liabilities 1.1.99 31.12.99 Assets 1.1.99 31.12.99
Creditors 40,000 44,000 Cash 10,000 7,000
Mrs. White’s loans 25,000 ------ Debtors 30,000 50,000
Loan from PNB 40,000 50,000 Stock 35,000 25,000
Capital 1,25,000 53,000 Machinery 80,000 55,000
Land 40,000 50,000
Buildings 35,000 60,000
2,30,000 2,47,000 2,30,000 2,47,000

During the year a machine costing Rs. 10,000 (accumulated depreciation Rs. 3,000) was sold
for Rs. 5,000. The provision for depreciation against machinery as on 1.1.99 was Rs. 25,000 and
31.12.1999 Rs. 40,000. Net profit for the year 1999 amounted to Rs. 45,000.

Sol:
Step: 1
Machinery A/c
Particulars Rs. Particulars Rs.
To Balance b/d 80,000 By Cash (sale) 5,000
By P&L A/c (loss on sale) 2,000
By Depreciation (b/f) 18,000
By Balance c/d 55,000
80,000

Share Capital A/c

Particulars Rs. Particulars Rs.
To Drawings 17,000 By Balance b/d 1,25,000
By Net profit 45,000
To Balance c/d 1,53,000
1,70,000 1,70,000

Step: 2
Adjusted P&L A/c
Particulars Rs. Particulars Rs.
To Depr. On Machinery 18,000 By Balance b/d -
To Loss on sale of Machinery 2,000 By Funds from operations 65,000
To Balance c/d 45,000
65,000 65,000

Step: 3
Statement showing Cash from Operation
Particulars Rs. Rs.
Funds From Operations 65,000
Add: Increase in CL & Decrease in CA:
Increase in Creditors 4,000
Decrease in Stock 10,000 14,000
79,000
Less: Increase in CA & Decrease in CL:
Increase in debtors 20,000
Cash from Operation 59,000
32
Step: 4

CASH FLOW STATEMENT

INFLOW Rs. OUTFLOW Rs.

Opening balance of cash 10,000 Mrs. White’s Loan repaid 25,000
Cash from operations 59,000 Drawing 17,000
Loan from Bank 10,000 Purchase of Land 10,000
Sale of machinery 5,000 Purchase of Building 25,000
Closing balance of cash 7,000
84,000 84,000

MCQ (Multiple Choice Questions)

PART-A

UNIT:3 Fund flow and cash flow

1. Funds flow statement is prepared on the basis of .

a. Profit and loss account of the current year
b. The balance sheet of the previous and current year
c. Both a and b
d. None of the above (Answer: c)
2. Which of the following are sources of funds for an organisation?
a. Conversion of debentures into shares
b. Conversion of loans into shares
c. Issue of shares against the purchase of fixed assets
d. None of the above (Answer: d)
3. Funds flow statement is also known as .
a. Statement of sources and uses of funds
b. Statement of sources and application of funds
c. Statement of funds flow
d. All of the above (Answer: d)
4. The statement prepared while conducting funds flow analysis is called .
a. Funds flow statement
b. Schedule of changes in working capital
c. Both a and b
d. None of the above (Answer: c)
5. Funds flow statement is prepared to .
a. Ascertain the item-wise outflow of funds in a given period
b. Identify changes in working capital
c. Identify reasons behind changes in working capital
d. All of the above (Answer: d)

6. The statement of cash flow clarifies cash flows according to

A) Operating and Non-operating Flows
B) Inflow and Outflow
C) Investing and Non-operating Flows
D) Operating, Investing, and Financing Activities

33
Answer: D
7. Cash flow example from a financing activity is
A) Payment of Dividends
B) Receipt of Dividend on Investment
C) Cash Received from Customers
D) Purchase of Fixed Asset
Answer: A
8. Cash flow example from an investing activity is
A) Issue of Debenture
B) Repayment of Long-term Loan
C) Purchase of Raw Materials for Cash
D) Sale of Investment by Non-Financial Enterprise
Answer: D
9. Cash flow example from an operating activity is
A) Purchase of Own Debenture
B) Sale of Fixed Assets
C) Interest Paid on Term-deposits by a Bank
D) Issue of Equity Share Capital
Answer: C
10. Which item comes under financial activities in cash flow?
A) Redemption of Preference Share
B) Issue of Preference Share
C) Interest Paid
D) All the above
Answer: d

(PART – B) 5 MARKS
1. Explain the concept of Flow of funds.(nov2016)
2. List out the limitations of funds flow statement.(nov2017)
3. Distinction between Funds flow statement & Income Statement.(april2016)
4. Distinction between Funds flow statement & Balance Sheet,(april2020)
5. Point out the importance of cash flow statement.(nov2017)

(PART – C) 10 MARKS
6. Define FFS & CFS. Describe about the difference between Funds flow statement and Cash
flow statement(nov2016).
7. What are the managerial utility of the funds flow statement? Explain in detail. (nov2017)

34
 III. UNIT ABSTRACT

Name of the Paper: Management Accounting Class: III B.COM

Important Question
Keywords Definition
with marks
“A statement of sources and
application of funds is
The funds flow statement is a 1. Distinction between Funds
technical device designed to
report on the movement of flow statement & Balance
analyze the changes in the Sheet,(april2020)
funds or working capital.
financial condition of a 2. Point out the importance of
business enterprise between cash flow statement.(nov2017)
two dates.”

The term ‘fund’ has been Working capital is the excess 1. Define FFS & CFS.
defined in a number of ways. of current assets over Describe about the
Generally it means cash. The current liabilities. difference between
Funds flow statement
term fund refers to all
The term ‘flow’ means change and Cash flow
financial resources. statement(nov2019).
and flow of funds means
change in funds or change in 2. What are the
working capital. managerial utility of
the funds flow
statement? Explain in
detail. (nov2017)

Signature of the Subject in charge Head of the Department/Vice Principal

35
 UNIT – IV
BUDGET & BUDGETARY CONTROL
INTRODUCTION:
A budget is a detailed plan of operation for some specific future period. The word ‘budget’ is derived
from a French term “bougette” which means leather pouch in which funds are appropriated for meeting
anticipated expenses.
Meaning:
A budget is a plan of action expressed in financial terms or non-financial terms. It is prepared for a
definite period of time. It is a planned estimate of future business conditions such as the sales, cost and
profit.
A budget is a tool, which helps the management in planning and control of business activities.
DEFINITION:
1. According to ICMA, England, a budget is, “a financial and /or quantitative statement, prepared and
approved prior to a defined period of time, of the policy to be pursued during the period for the purpose
of attaining a given objective.”
2. “Budget is an estimate of future needs arranged according to an orderly basis, covering some or all of
the activities of an enterprises for definite period of time”- George R.Terry.
BUDGETARY CONTROL:
1. According to ICMA, England, budgetary control is “the establishment of budgets relating the
responsibilities of executives to the requirements of a policy and the continuous comparison of actual
with budgeted results, either to secure by individual action the objectives of that policy or to provide a
basis for its revision.”
2. According to J Batty “ budgetary control is a system which uses budgets as a means of planning and
controlling all aspects of producing and / or selling commodities and services”.
STEPS IN BUDGETARY CONTROL:

1. Establishment of budgets for each section of the organisation.

2. Recording of actual performance.
3. Continuous comparison of the actual performance with the budget.

36
 4. In case there is a difference between actual and budgeted performance, taking suitable remedial
action.
5. Revision of budgets if necessary.
OBJECTIVES OF BUDGETARY CONTROL:
1. To define the goal of the enterprise.
2. To provide long and short period plans for attaining these goals.
3. To co-ordinate the activities of different departments.
4. To operate various cost centres and departments with efficiency and economy.
5. To eliminate waste and increase the profitability.
6. To estimate capital expenditure requirements of the future.
7. To centralize the control system.
8. To correct deviations from established standards.
9. To fix the responsibility of various individuals in the organization.
10. To ensure that adequate working capital is available for the efficient operation of the business.
11. To indicate to the management as to where action is needed to solve problems without delay.

FUNCTION OF BUDGETARY CONTROLLER:

Budget controller is also called budget officer or budget director. He is a top executive
responsible for the efficient working of budgetary control system. He should possess sound knowledge
of accounting, budgetary control and technical aspects of the business. His main functions are:
1. Arranging for all the meetings of the budget committee.
2. Issuing instructions to various departments.
3. Receiving and checking the budget estimates.
4. Suggesting revisions
5. Preparing the summary budget and place all budgets before the committee.
6. Ensuring that management prepares their budget in time.
7. Coordinating all budget work.

ADVANTAGES:
Maximization of profits:
Budgetary control aims at increasing the overall profits of organization. This is achieved through
planning , coordination and economical.
Effective coordination:
Performance and working of various activities is effectively coordinated through budgetry control.
Emphasis on co – ordination and cooperation helps in achieving the predetermined targets and goals.
Evaluation of executive performance:
Goals are set for each department. Actual performance is compared with standards and deviations are
reported to top management for action against unfavourale deviations.
Economy in operations;
Expenses are properly planned and financial resoureces are put to optimum use.
Correction of ineffectiveness:
Comparison of actual performance with budgeted performance reveals week spots so that attention is
focused on them to improve the performance.
LIMITATIONS:
Prediction ofuncertain future:
Budgeting is a process of forecasting and estimation. Forecasting may not e accurate.
Changes of conditions:
Budgets are prepared on the basis of certain prevailing conditions. If the conditions change budget Are
also to be revised.
Complacence:
General tendancy of employees is to achieve the targets as budgeting fixes the targets. Some of the
employees who are highly skillful may also be satisfied in performing up to the goals set without
showing full potential which will be a loss to the enterprise as well as the employee in terms of
productivity.
37
Difficulty in coordination:
Effective implementation of budgetary control depends upon proper coordination among various
departments ass the performance of a departments depends on the work of other departments and vice
versa.
CLASSIFICATION OF BUDGETS:
Budgets are classified according to their nature. The following are the different classifications of
budgets.
A. Classification according to time:
1. Long-term budgets
2. Short-term budgets
3. Current Budgets.
B. Classification according to functions:
1. Functional or subsidiary budgets
2. Master budget.
C. Classification on the basis of flexibility:
1. Fixed budget
2. Flexible budget

A. Classification according to time:

1. Long-term Budgets:
Long-term budgets are prepared to reflect long-term planning of the business. Generally, the
long-term period varies between five to ten years. E.g. capital expenditure, research and development,
long-term finances, etc.
2. Short-term budgets:
These budgets are generally for duration of one year and are expressed in monetary terms. E.g.
Cash, Material budget, etc.
3. Current Budgets:
The duration of current budgets is generally in months and weeks. These budgets are prepared
for the current operations of the business.
B. Functional Budgets:
These budgets relate to various functions of the concern. Following are the commonly prepared
functional budgets:
a) Purchase budget
b) Cash budget.
c) Production budget.
d) Sales budget.
e) Materials budget.
f) Overhead budget
g) Labour budget.
h) Research and development budget.
i) Capital expenditure budget.
2. Master budget:
This budget is a summary of various functional budgets. In encompasses the activities of
the whole organization.
1. Sales budget:
A sales budget is an estimate of expected sales during the budget period. It may be stated
in terms of money or quantity or both.
2. Production Budget:
The preparation of production budget is dependent on the sales budget. Production
budget is an estimate of quantity of goods that must be produced during the budget period.
3. Materials Budget:
Materials may be direct or indirect. The materials budget deals with only the direct
materials. Indirect materials are included in the factory overhead budget.
38
4. Direct Labour Budget:
This indicates detailed requirements of direct labour and its cost to achieve the
production target.
5. Cash budget:
This budget gives an estimate of receipts and payments of cash during the budget period.
It is prepared by the chief accountant. It shows the cash available and needed from time to meet
the capital requirement of the organization.
6. Overhead Budget:
a. Production overhead budget:
It is a budget of indirect costs in the form of indirect material and indirect expenses to be
incurred in the factory.
b. Administration overhead budget:
This budget is prepared to estimate the expenditure to be incurred for planning,
organizing, direction and control functions of the management.
c. Selling and distribution overhead budget:
This budget is prepared to estimate expenditure to be incurred to sell the product and its
distribution. It is based on sales budget.
7. Research and development budget:
This budget is prepared to estimate the research and development expenditure to be
incurred during a specific period.
8. Capital Expenditure budget:
This budget is prepared to estimate the capital expenditure on fixed assets – Buildings,
machinery, plant, furniture etc.
C. Classification on the basis of flexibility:
1. Fixed Budget:
It is prepared for a given level of activity and remains same irrespective of change of activity.
2. Flexible Budget:
It is a budget prepared for various levels of activity by classification of expenditure under fixed,
variable and semi fixed categories.

PROBLEMS:
I. Production Budget:
a. You are required to prepare a production budget for the half year ending June 2000 from the
following information.
Product Budgeted sales Actual stock on Desired stock on
quantity (Units) 31.12.1999 (Units) 30.06.2000 (Units)
S 20,000 4,000 5,000
T 50,000 6,000 10,000

Sol:
Production Budget for the half year ending 30.06.2000
Products

Particular S (Units) T (Units) Total (Units)

Sales (Budgeted) 20,000 50,000 70,000

+ Desired closing 5,000 10,000 15,000
stock
25,000 60,000 85,000
- Opening stock 4,000 6,000 10,000
Quantity to be 21,000 54,000 75,000
produced

39
II Cash Budget:
1. From the following data forecast the cash position at the end of April, May and June 2008.
Month Sales Purchase (Rs) Wages (Rs) Sales
(Rs) Expenses(Rs)
February 1,20,000 80,000 10,000 7,000
March 1,30,000 98,000 12,000 9,000
April 70,000 1,00,000 8,000 5,000
May 1,16,000 1,03,000 10,000 10,000
June 85,000 80,000 8,000 6,000

Further Information:

 Sales at 10% realized in the month of sales. Balance equally realized in two subsequent months.
 Purchase: Creditors are paid in the month following the month of supply.
 Wages: 20% paid in arrears in the following month.
 Sundry expenses paid in the month itself.
 Income tax Rs. 20,000 payable in June.
 Dividend Rs. 12,000 payable in June.
 Income from investment Rs. 2,000 received half-yearly in March and September.
 Cash balance on hand as on 1.04.2008 Rs. 40,000.

Sol:
Cash budget for 3 months ending June 2008
Particular April (Rs) May (Rs) June (Rs)
Opening balance of cash 40,000 47,700 29,700
+ Receipts: Cash Sales 7,000 11,600 8,500
Cash from debtors:
1st month 58,500 31,500 52,200
nd
2 month 54,000 58,500 31,500
Total Receipts(A) 1,59,500 1,49,300 1,21,900
- Payments: Cash from Purchase 98,000 1,00,000 1,03,000
Wages: Current 6,400 8,000 6,400
Arrear 2,400 1,600 2,000
Sundry Expenses 5,000 10,000 6,000
Income Tax - - 20,000
Dividend - - 12,000
Total Payments (B) 1,11,800 1,19,600 1,49,400
Closing balance of cash (A-B) 47,700 29,700 -27,500(O.D)

III Flexible Budget:

1. Draw up a flexible budget for production at 75% and 100% capacity on the basis of the following
data for a 50% activity.
Particulars Per Unit (Rs.)
Material 100
Labour 50
Variable expenses (Direct) 10
Administrative expenses (50% fixed) 40,000
Selling and Distribution expenses (60% fixed) 50,000
Present production (50% activity) 1,000 Units

Sol:
Cash Budget for 3 months ending June 2008
Capital Levels

40
 50% 75% 1,500 Units 100% 2,000 Units
Particular 1,000Units
Per Total Per Total Per Total
unit(Rs) (Rs) unit(Rs) (Rs) unit(Rs) (Rs)
Material 100 1,00,000 100.00 1,50,000 100 2,00,000
Labour 50 50,000 50.00 75,000 50 1,00,000
Variable expenses 10 10,000 10.00 15,000 10 20,000
Prime Cost 160 1,60,000 160.00 2,40,000 160 3,20,000
Administrative expenses:
Variable (50%) 20 20,000 20.33 30,000 20 40,000
Fixed (50%) 20 20,000 13.33 20,000 10 20,000
Cost of Production 200 2,00,000 193.33 2,90,000 190 3,80,000
Selling & Distribution
Expenses:

Variable (40%) 20 20,000 20.00 30,000 20 40,000

Fixed (60%) 30 30,000 20.00 30,000 15 30,000
Total Cost 250 2,50,000 233.33 3,50,000 225 4,50,000

MCQ (Multiple Choice Questions)

PART-A

1) In a month, payment for salary was Rs. 5,750 when the lag in payment of salary is 1/8 month. If total sala
of current month are Rs 6,000, determine the salaries of previous month.

a. Rs 4,800
b. Rs 4,250
c. Rs 4,000
d. Rs 4,750
2) In a firm, the forecast of wages for month of December, January, February and March are Rs 4,800, Rs 6
Rs 6,400 and Rs 6,800. The time-lag in payment of wages is 1/8 month. Determine the amount of wages payab
each month January to March.

a. Rs 6,750, Rs 6,350 and Rs 5,850

b. Rs 5,850, Rs 6,350 and Rs 6,750
c. Rs 5,850, Rs 6,750 and Rs 6,350
d. None of the above

3) Cash budget deals with historical data whereas Cash Flow Statement deals with future data.

a. True
b. False

41
4) In cash flow method for preparing cash budget, payment of dividends and prepaid payments are

a. Deducted from opening balance of cash

b. Added to opening balance of cash
c. Not included in cash budget
d. None of the above
5) As per Cash flow method Increase in current liabilities and decrease in current assets are

a. Deducted from opening balance of cash

b. Added to opening balance of cash
c. Not included in cash budget
d. None of the above

6) As per Cash flow method, the amount of expected net operating cash profit during the fiscal is

a. Added to the opening balance of cash

b. Deducted from the opening balance of cash
c. Not included in cash budget
d. None of the above

7) Which of the following method is based on technique of cash flow statement?

a. Cash Accounting Period

b. Projected Balance Sheet Method
c. Project forecast method
d. None of the above

8) Which of the following statements are not true about Projected Balance Sheet Method?

a. It is good for long-term

b. It is appropriate for annual cash forecast
c. It is of extreme use for planning and control
d. None of the above
9) A budgeted balance sheet is prepared in Projected Balance sheet method and an estimate is made of the v
of all assets including bank overdraft, cash balance and bank.

a. True
b. False

10) Given estimated sales in February, March, April, May and June are Rs 90,000, Rs 96,000, Rs 54,000, Rs
87,000 and Rs 63,000. In case 50% of sales are realized in the next month and balance in the next of next mo
42
determine cash collection from sales in April and May.

a. Rs 93,000 and Rs 75,000

b. Rs 93,000 and Rs 70,500
c. Rs 75,000 and Rs 70,500
d. None of the above

(PART- B) 5 MARKS

1. State the objectives of budgetary control.(nov2016)

2. How cash budgets are prepared?(aprl 2016)
3. Discuss about the advantages and disadvantages of budgetary control.(april2016)
4. Write short notes on Overhead Budgets.(nov2018)
5. Explain about (a) Budget committee & (b) Budget centre.(nov2017)

(PART-C) 10 MARKS
6. Discuss about the steps in installation of budgetary control system in detail.(april2016)
7. What is budget? Explain its types.(aprl 2020)

43
 IV. UNIT ABSTRACT

Name of the Paper: Management Accounting Class: III B.COM

Important Question
Keywords Definition
with marks
“Budget is an estimate of
future needs arranged
A budget is a detailed plan of operation according to an orderly basis, 1. Write short notes
for some specific future period. covering some or all of the on Overhead
activities of an enterprises Budgets.(nov2018)
A budget is a plan of action expressed for definite period of time”- 2. Explain about (a)
in financial terms or non-financial George R.Terry. Budget committee
terms. It is prepared for a definite & (b) Budget
centre.(nov2017)
period of time.

1. Discuss about the

steps in installation
1. Establishment of budgets According to J Batty “ of budgetary
for each section of the budgetary control is a system control system in
organisation. which uses budgets as a detail.(april2016)
2. Recording of actual 2. What is budget?
means of planning and
performance. Explain its
3. Continuous comparison controlling all aspects of
types.(April 2020)
of the actual producing and / or selling
performance with the commodities and services”.
budget.

Signature of the Subject in charge Head of the Department/Vice Principal

44
 UNIT – V
MARGINAL COSTING
MEANING:
Marginal costing is helpful in determining the profitability of products, departments, processes and cost
centres. While analyzing the profitability, marginal costing interprets the cost on the basis of nature of
cost.
DEFINITION:
Marginal cost defined by I.C.M.A, “ The amount at any given volume of output by which aggregate
costs are changed if the volume of output a increased or decreased by one unit. In practice this is
measured by the total variable costs attributable to one unit.”
FEATURES OF MARGINAL COSTING:
* Marginal costing is a technique of control or decision making.
* Under marginal costing the total cost is classified as fixed and variable costs.
* Contribution is ascertained by reducing the marginal cost or variable cost from the selling price.
* The profitability of products, departments or process is determined on the basis of contribution.
* Profit is ascertained by reducing the fixed cost from the contribution of all the products or
departments Or processes or divisions, etc.,
ADVANTAGES OF MARGINAL COSTING:
The statement prepared under marginal costing can be easily followed as it breaks up the cost as variable
and fixed.
Stock valuation can be easily done and understood as it includes only the variable cost.
Marginal costing serves as a good basis for reporting to management.
The fixed costs are treated as period costs and are charged to P& L A/C directly.
Marginal costing technique is helpful in preparation of flexible budgets as the costs are split into fixed
and variable portions.
Marginal costing is immensely helpful in determined of selling prices under different situations like
recession, depression, introduction of new products, etc.
Marginal costing is helpful to management in exercising decision regarding make or buy, exporting, key
factor and numerous other aspects of business operations.

LIMITATIONS OF MARGINAL COSTING:

Break up of cost into variable and fixed portion is a difficult problem.
Since fixed cost is not included in total cost, full costis not available to outsiders to judge the efficiency.
Marginal costing is more suitable for decision making in the short – term.
Under marginal costing only variable costs are considered and the output as well as stocks are
undervalued and profits is distorted.
In these days of automation and technical advancement, huge investments are made in heavy machinery
which result in heavy amount of fixed cost.
In contract type of business and job order business, full cost of the job or the contract is to be charged.

DIFFERENCE BETWEEN MARGINAL COSTING AND ABSORBTION COSTING:

Absorption Costing Marginal Costing
Charging of Fixed costs form part of total costs of Variable costs alone form part of cost of
costs production and distribution. production, and sales whereas fixed costs
are charged against contribution for
determined of profit.
Valuable of Stocks and work in progress are Stocks are valued at variable cost only.
stock valued at both fixed and variable cost.
Variation in When there is no sales the entire stock If ther is no sales, the fixed overhead will
profits is carried forward and there is no be treated as loss in the absence of
trading profit or loss. contribution.
Purpose Absorption costing is more suitable Marginal costing is more useful for short
for long term decision making and for term managerial decision making.
pricing policy over long term.

45
Emphasis Absorption costing lays emphasis on Marginal costing emphasizes selling and
production. pricing aspects.

Profit-Volume Ratio.

The Profit/volume ratio, which is also called the ‘contribution ratio’ or ‘marginal ratio’, expresses the
relation of contribution to sales and can be expressed as under:

P/V Ratio = Contribution/Sales

Since Contribution = Sales – Variable Cost = Fixed Cost + Profit, P/V ratio can also be expressed as:

P/V Ratio = Sales – Variable cost/Sales i.e. S – V/S

or, P/V Ratio = Fixed Cost + Profit/Sales i.e. F + P/S

or, P/V Ratio = Change in profit or Contribution/Change in Sales

The formula to calculate P/V ratio is:

A high P/V ratio indicates high profitability so that a slight increase in volume, without increase in fixed
cost, would result in high profits. A low P/V ratio, on the other hand, is a sign of low profitability so that
efforts should be made to improve P/V ratio.

Uses of P/V Ratio:

(i) It helps in the determination of Break-even-point [BEP = Fixed cost ÷ P/V ratio]

(ii) It helps in the determination of profit at any volume of sales

[Sales x P/V ratio = Contribution, Profit = Contribution – Fixed Cost]

(iii) It helps in the determination of sales to earn a desired amount of profit

The ratio can be increased by increasing the contribution. This can be done by:

(i) Increasing the selling price per unit

46
(ii) Reducing the variable or marginal cost.

(iii) Changing the sales mixture and selling more profitable products for which the P/V ratio is higher.

The concept of P/V ratio is also useful to calculate the break-even point, the profit at a given volume of
sales, the sales volume required to earn a given (or desired) profit and the volume of sales required to
maintain the present profits if the selling price is reduced by a specified percentage.

The formula for the sales volumes required to earn a given profit is:

P/V Ratio = Contribution/Sales

or, P/V Ratio = Fixed Cost + Profit/Sales

or, Sales = Fixed Cost + Profit/P/V ratio = F + P/P/V ratio

BREAK –EVEN POINT

Definition of Break-Even Analysis:

Break-even analysis refers to ‘ascertainment of level of operations where total revenue equals to total
costs’. It is an analysis used to determine the probable profit or loss at any level of operations. Break-
even analysis is a method of studying the relationship among sales revenue, variable cost and fixed cost
to determine the level of operation at which all the costs are equal to its sales revenue and it is the no
profit no loss situation.

Formulae for Break-Even Analysis:

Assumptions and Limitations of Break-Even Analysis:

The following assumptions and limitations are important considerations in break-even analysis:

47
(a) The break-even analysis requires that all costs should be segregated into fixed and variable
components. There is difficulty in segregation of semi-variable expenses into variable and fixed
elements of costs accurately.

(b) It is assumed that all fixed costs remain constant at various levels of activity. But in practice, it may
not be fixed in the long-run.

(c) Another assumption is that variable costs are really variable and changes in direct proportion to the
volume of output. It means that variable cost per unit of product remains constant. In practice variable
costs are not necessarily strictly variable with output.

(d) In break-even analysis, it is assumed that production units and sales units are equal and no inventory
exists in the beginning or at the end of the period for which analysis is made. In practice there will
always be existence of inventory.

(e) There will be no change in selling price and it remains constant at all levels of output and further
assumed that there is no change in sales mix. In the real world situation, to increase the sales, it may
necessitate to frequently change the selling prices and sales mix of the products.

(f) It is assumed that productivity, operating efficiency, product specifications and methods of
manufacture and sale will not undergo any change. In actual situation, the operating efficiency and
productivity depends upon the manpower, it is impractical to assume that these factors remain constant.

(g) A break-even chart can depict the position of only one product and fails to present various products
in the sales mix in one chart and different charts are required to be drawn for different products.

(h) Break-even analysis ignores the capital employed in business, which is one of the important facts in
determination of profitability of the company and its products.

(i) The break-even charts assumes that total cost and total revenue can be represented in straight lines. In
practice, the function of costs and revenue are curvilinear in nature.

Margin of Safety:

The margin of safety refers to sales in excess of the break-even volume. It represents the difference
between sales at a given activity level and sales at break-even point. It is important that there should be a
reasonable margin of safety to run the operations of the company in profitable position.

A low margin of safety usually indicates high fixed overheads so that profits are not made until there is a
high level of activity to absorb the fixed costs. A margin of safety provides strength and stability to a
concern.

The margin of safety is an important measure, especially in times of receding sales, to know the real
position to operate without incurring losses and to take steps to increase the margin of safety to improve
the profitability.

Margin of safety is calculated by using the following formulae:

48
How to Improve Margin of Safety?

The higher the margin of safety, the better profitability of the product/product line.

The margin of safety can be improved by adopting any of the following steps:

(a) Keeping the break-even point at lowest level and try to maintain actual sales at highest level.

(b) Increase in sales volume.

(c) Increase in selling price.

(d) Change in product mix increasing contribution.

(e) Lowering fixed cost.

(f) Lowering variable cost.

(g) Discontinuance of unprofitable products in sales mix.

The following points highlight the ten techniques of application of marginal costing.

Technique of Application # 1. Profit Planning:

Profit planning is the planning of future operations to attain maximum profit.

Under the technique of marginal costing, the contribution ratio, i.e., the ratio of marginal contribution to
sales, indicates the relative profitability of the different products of the business whenever there is any
change in volume of sales, marginal cost per unit, total fixed costs, selling price, and sales-mix etc.

Hence marginal costing is an useful tool in planning profits as it ensures sufficient return on capital
employed.

Example 1:

A company manufactures a single product having a marginal cost of Re. 0.75 per unit. Fixed costs are
Rs. 12,000. The market is such that up to 40,000 units can be sold at Rs. 1.50 per unit, but any additional
sales must be made at Re. 1.00 per unit. There is a planned profit of Rs. 20,000.

How many units must be made and sold?

Solution:

Contribution desired = Fixed Cost + Desired Profit

= Rs. 12,000 + Rs. 20,000 = Rs. 32,000

49
Contribution from 40,000 units = 40,000 x Rs. (1.50 – 0.75) = Rs. 30,000

Additional units to be produced and sold at Re. 1.00 per unit after 40,000 units:

Contribution to be earned after 40,000 units = Rs. (32,000 – 30,000) = Rs. 2,000

New contribution per unit = Re. (1.00 – 0.75) = Re 0.25

Additional units to be produced for contribution of Rs. 2,000

= Rs. 2,000 x 100/25 = 8,000 units.

Total units to be produced to earn planned profit of Rs. 20,000

= 40,000 units + 8,000 units = 48,000 units.

Technique of Application # 2. Pricing of Products:

Sometimes pricing decisions have to be taken to cater to a recessionary market or to utilise spare
capacity where only marginal cost is recovered. For export market, sometimes full cost is loaded to the
sale price to remain competitive. Sometimes special prices are to be offered with expansion in mind,
fixation of price below cost can be made on a short-term basis.

It may be advisable to fix prices equal to or below marginal cost under the following cases:

(i) To maintain production and employees occupied.

(ii) To keep plant in use in readiness to go ‘full team ahead’.

(iii) To prevent loss of future orders.

(iv) To dispose of perishable product.

(v) To eliminate competition of nearer rivals.

(vi) To popularize a new product.

(vii) To keep the sales of a conjoined product which is making a considerable amount of profit.

(viii) Where prices have fallen considerably or a loss has already been made.

PROBLEM – 1
Vasanth ltd. Presents the following results for one year. Calculate the P/V Ratio, BEP and Margin of
Safety.
Rs.
Sales 2,00,000
Variable costs 1,20,000
Fixed costs 50,000
Net profit 30,000
Sol:
Particulars Rs.
Sales 2,00,000
Less : Margin / Variable cost 1,20,000

50
 Contribution 80,000
Less : Fixed cost 50,000
Profit 30,000

(1) P/V Ratio = Contribution X 100

Sales
= 80000 X 100 = 40 %
2,00,000

(2) Break Even Point = Fixed expenses

P/V Ratio

= 50,000 X 100
40
(3) Margin Of Safety = Sales – Break even sales
= 2,00,000 – 1,25,000
= Rs. 75,000
PROBLEM – 2
From the following information relating to Prakash Bros. Ltd., you are required to find out

(1) P/V Ratio (2) Break even point (3) Profit (4) Margin of safety (5) Volume of sales to earn profit of
Rs. 6,000

Rs.

Total fixed costs 4,500

Total variable 7,500

Total sales 15,000

Sol:

Particulars Rs.
Sales 15,000
Less : Margin / Variable cost 7,500
Contribution 7500
Less : Fixed cost 4,500
Profit 30,00

(1) P/V Ratio = Contribution X 100

Sales

51
 = 7,500 X 100 = 50 %
15,000

(2) Break Even Point = Fixed expenses

P/V Ratio

= 5,500 X 100
40

` = Rs. 9,000

(3) Profit = Rs. 3,000

(4) Margin of safety = Sales – Break even sales

= 15,000 - 9,000 = Rs. 6,000

(5) Sales to earn profit of Rs. 6,000

Required Sales = Fixed cost + Required profit

P/V Ratio

= 4,500 + 6,000

50 %

= Rs. 21,000

52
 MCQ ( Multiple Choice Questions)
PART-A

1. Fixed expenses decrease per unit with the increases in production and increases per unit
with the decrease in production.
a) True
b) False

2. Marginal costs is taken as equal to

a) Prime Cost plus all variable overheads
b) Prime Cost minus all variable overheads
c) Variable overheads
d) None of the above

3. If total cost of 100 units is Rs 5000 and those of 101 units is Rs 5030 then increase of Rs 30 in
total cost is
a) Marginal cost
b) Prime cost
c) All variable overheads
d) None of the above

4. Marginal cost is computed as

a) Prime cost + All Variable overheads
b) Direct material + Direct labor + Direct Expenses + All variable overheads
c) Total costs – All fixed overheads
d) All of the above

5. Marginal costing is also known as

a) Direct costing
b) Variable costing
c) Both a and b
d) None of the above

6. Which of the following statements are true?

A) Marginal costing is not an independent system of costing.

B) In marginal costing all elements of cost are divided into fixed and variable components.

C) In marginal costing fixed costs are treated as product cost.

D) Marginal costing is not a technique of cost analysis.

7. While computation of profit in marginal costing

a) Total marginal cost is deducted from total sales revenues
b) Total marginal cost is added to total sales revenues

53
 c) Fixed cost is added to contribution
d) None of the above

8. Which of the following are the assumptions of marginal costing?

A) All the elements of cost can be divided into fixed and variable components.

B) Total fixed cost remains constant at all levels of output.

C) Total variable costs varies in proportion to the volume of output.

D) Per unit selling price remain unchanged at all levels of operating activity.

9. In two periods total costs amounts to Rs 50000 and Rs 40000 against production of 20000 and
15000 units respectively. Determine marginal cost per unit and fixed cost.

a) Rs 2 and Rs 10,000
b) Rs 4 and Rs 5000
c) Rs 10 and Rs 8000
d) None of the above

10. Under High and Low Point method, the output at two different levels is compared with the
amount of incurred at these two points.

a) Total fixed costs

b) Total costs
c) Total fixed costs
d) None of the above

Management Accounting MCQ With Answers

1. Management accounting concentrates on _______

A. preparation of PL account

B. creation of balance sheet

C. providing accounting details to the macro environment

D. control of business operations

Answer: control of business operations

2. In management accounting, an emphasis and focus must be _____ oriented.

A. bank

B. communication

C. future

D. past

Answer: future
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3. Salaries, wages, depreciation, rent & utilities are used to calculate ________

A. marginal costs

B. output cost

C. operating costs

D. fixed costs

Answer: operating costs

4. ______ is responsible for the financial operations of the organization.

A. CEO

B. CMO

C. CFO

D. CA

Answer: CFO (Chief Financial Officer)

5. The primary objective of management accounting is to ______

A. furnish management with complete and true information

B. supply profit and loss details to stakeholders

C. manage company accounts and improve sales

D. cut the operation cost to provide more savings

Answer: furnish management with complete and true information

6. The use of management accounting is ______

A. mandatory

B. compulsory

C. most essential

D. optional

Answer: optional

7. ____ is the type of accounting.

A. cost accounting

B. management accounting

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C. financial accounting

D. all of the above

Answer: all of the above

8. Management accounting helps ______ to make decisions.

A. Customers

B. Investors

C. Managers

D. Banks

Answer: Managers

9. Management accounting can be viewed as __________.

A. Marketing-oriented Accounting

B. Management-oriented Accounting

C. Accounting-oriented Management

D. Manager-oriented Accounting

Answer: Management-oriented Accounting

10. ________ is the language of Business which is used to communicate financial information.

A. Accounting

B. Marketing

C. Profit

D. Pricing

Answer: Accounting

11. The term management accounting was first coined in ____.

A. 1940

B. 1950

C. 1960

D. 1970

Answer: 1950

12. Which is the sub-field of accounting?

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A. Management accounting

B. Cost accounting

C. Financial accounting

D. All of the above

Answer: All of the above

13. The main objective of management accounting is _________

A. To maintain the accounting records

B. To know the amount due from customers and suppliers

C. To ascertain analyse and interpret the results of business operations

D. To record all the business transactions

Answer: To ascertain analyse and interpret the results of business operations

14. ____________ is the study of managerial aspects of financial accounting

A. Cost accounting

B. Financial accounting

C. Management accounting

D. Business accounting

Answer: Management accounting

15. The purpose of management accounting is to help ______ make decisions

A. managers

B. investors

C. marketers

D. banks

Answer: managers

16. Managerial accounting information is generally prepared for _______

A. managers

B. stakeholders

C. government agencies

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D. competitors

Answer: managers

17. _________shows how the accounting function can be represented so as to fit it within the framework of
Management activity.

A. Management accounting

B. Cost accounting

C. Financial accounting

D. Tax accounting cancer is Management accounting

Answer: Management accounting

18. The primary task of management accounting is, therefore, to redesign the entire accounting system so that it
may serve the ___________ needs of the firm.

A. Marketing

B. Operational

C. Human resource

D. Production

Answer: Operational

19. Management accounting provides information to management so that planning organizing directing and
controlling of business operations can be done in an orderly manner.

A. Organising controlling planning and directing

B. Planning controlling organising directing

C. Planning organising directing controlling

D. Organising planning directing controlling

Answer: Planning organising directing controlling

20. Which is the main characteristic of Management accounting?

A. Cause and effect analysis

B. providing accounting information

C. Helping to achieve organisational goals

D. All of the above

Answer: All of the above

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21. Management accounting assists the management in_______

A. planning

B. directing

C. Controling

D. All of the above

Answer: All of the above

22. Management accounting is mainly applicable to _______entities.

A. nonprofit

B. service

C. manufacturing

D. All of the above

Answer: All of the above

23. The scope of Management accounting includes _______

A. Budgeting and forecasting

B. Internal audit and tax accounting

C. Financial and cost accounting

D. All of the above

Answer: All of the above

24. The origin of the term Management Accounting goes back to the year _______

A. 1950

B. 1939

C. 1929

D. 1896

Answer: 1950

25. Which is NOT a limitation of Management accounting?

A. Management accounting is only a tool

B. Personal prejudice and bias

C. Evaluation and control of performance

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D. Psychological resistance

Answer: Evaluation and control of performance

26. Which is NOT an advantage of Management accounting?

A. Economic appraisal

B. Helps in decision making

C. Influenced by personal bias

D. Facilitates communication

Answer: Influenced by personal bias

27. Goodwill is one of the _______

A. Current assets

B. Tangible assets

C. Intangible assets

D. Liquid assets

Answer: Intangible assets

28. The concept of management accounting was introduced by ______

A. Arthur Andersen

B. James H. Bliss

C. William Beaver

D. Herman Bevis

Answer: James H. Bliss

29. The term Management Accounting is mainly related to _______

A. presentation of account data

B. planning of account data

C. accurate recording of data

D. sharing the most reliable cost data with agencies

Answer: presentation of account data

30. Salary is one of the ________

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A. Direct expenses

B. Non cash expenses

C. Capital expenses

D. Revenue expenses

Answer: Revenue expenses

31. Wealth maximization is a _________

A. short term concept

B. temporary concept

C. long term concept

D. outdated concept

Answer: long term concept

32. Management Accounting provides invaluable services to management in performing___________

A. planning and controlling management principles

B. analysis and interpretation of financial data

C. supply of regular funds

D. all management functions

Answer: all management functions

33. _______ mainly deals with the accounting & reporting of information to management regarding the detailed
information.

A. cost accounting

B. financial accounting

C. management accounting

D. traditional accounting

Answer: management accounting

34. Management accounting is mainly _____

A. Future oriented

B. Past oriented

C. Customer oriented

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D. Bank oriented

Answer: Future oriented

PART – B (5 MARKS)

6. Define Marginal costing and its Features. (nov 2019)

7. Describe the objectives of marginal costing. (nov 2018)

8. What are the limitations of breakeven point? (aprl 2017)

9. What is ‘Key Factor ‘? Explain its significance? (nov 2019)

PART – C (10 MARKS )

10. Explain the importance of marginal costing in decision making. (nov 2019)

11. What is marginal costing? What are the Characteristics?

Marginal Costing – Absorption costing – P/V Ratio – BEP and Margin of Safety - Practical Application
of marginal costing technique to different situations. (nov 2018)

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 V. UNIT ABSTRACT

Name of the Paper: Management Accounting Class: III B.COM CA

Important Question
Keywords Definition
with marks
Marginal cost defined by
I.C.M.A, “ The amount at any
Marginal costing is helpful in Define Marginal costing and
given volume of output by
determining the profitability its Features. (nov 2019)
of products, departments, which aggregate costs are
processes and cost centres. changed if the volume of Describe the objectives of
While analyzing the output a increased or marginal costing. (nov 2018)
profitability, marginal costing decreased by one unit.
interprets the cost on the basis What are the limitations of
of nature of cost. breakeven point? (aprl 2017)

1. Stock valuation can be

easily done and .1. Explain the importance of
understood as it Definition of Break-Even marginal costing in decision
includes only the Analysis: making. (nov 2019)
variable cost.
2. Marginal costing Break-even analysis refers to 2.What is marginal costing?
serves as a good basis ‘ascertainment of level of What are the
for reporting to operations where total revenue Characteristics?(Dec-2020)
management. equals to total costs’.
3. The fixed costs are
treated as period costs
and are charged to P&
L A/C directly.

https://livemcqs.com/2022/05/18/management-accounting-mcq-with-answers-pdf/

--------- All the Best ----------

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