Edition 1,Version 1 United Kingdom · · 2016-03-24Job & batch costing 69 - 74 Process costing 75 - 82 Service ... Relationship between cost/management accounting system ... Method

Edition 1,Version 1

ISBN 978-1-84808-288-5

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INDEX Management information requirements

1 - 8

Cost accounting systems 9 - 14 Cost classification 15 - 24 Accounting for materials 25 - 38 Accounting for labour 39 - 44 Accounting for other expenses

45 - 52

Absorption costing 53 - 62 Marginal costing 63 - 68 Job & batch costing 69 - 74

Process costing 75 - 82

Service costing 83 - 76

Cost-volume-profit analysis 87 - 92 Factors affecting short term decision making

93 - 98

Principles of discounted cash flows

99 - 104

Nature of cash & cash flow 105 - 110

Cash management 111 - 114

Cash budgets 115 - 118

Investing & financing 119 - 122

Spreadsheet system overview 123 - 124

Using computer spreadsheets 125 - 128 Presenting information in spreadsheet

129 - 130

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Management Information Requirements 1

Intro: this Study Guide discusses concepts of good information, its attributes & how managerial processes benefit from good information systems.

The purpose of management information

Raw, unprocessed facts & figures Data

Analysis of data to give some meaning comprehensible to user

Information

It is essential for organisation to provide right information in right quantity to right person (decision makers i.e. top management) at right time.

Planning

Purpose of management information

Decision-making Controlling

concerned with defining goals for future organisational

performance & deciding on tasks & resources to be used

to attain these goals

choosing particular course of action out of several alternative

courses to achieve given objective

controlling activities of an organisation & thereby

controlling costs & maintaining quality

Management Information 2

Operational information

Planning is done on basis of

Tactical information Strategic information

facts, data collected internally; used by supervisors or floor managers for day-to-day planning

data & its analysis; used by middle management for medium term plans

Collected from external sources or results of tactical information used by top level management for strategic long term plans

Decisions made on basis of

information in an

organisation include

Product mix decisions to decide which products are profitable & should continue to be offered

Make or buy decisions to determine whether it is profitable to buy a product from outside or produce it in-house

Discontinuation to decide whether an operation or division should be closed down

Pricing decisions to determine if organisation should increase or decrease price of goods or services


Characteristics Description

1. Accuracy It fulfills the purpose for which information is needed.

2. Completeness Incomplete information leads to bad decisions or hinders the decision-making process.

3. Clarity Clearly & easily laid out information is understood by the recipient and ensures its proper use.

4. Relevance Irrelevant information annoys the reader so provider should understand the purpose & accordingly supply information.

5. Reliable Information should be authentic & obtained from reliable & dependable sources.

6. Channel of communication

While choosing the channel, careful consideration should be given to recipients & nature of information

7. Timeliness Time frame for preparation of information should match that of decision making process. Should be given to user at appropriate time.

8. Cost effective Benefits provided by information should outweigh costs incurred to generate that information.

9. Communication to correct person

Information must be communicated to right person in appropriate manner.

10. Volume Recipient should be capable of handling volume of information.

Features of useful management information


Types of information used by management

Financial information

Non-financial information

A mixture of financial & non-

financial information

Financial & non-financial information

Costs, profit , income & expenses

Overall environment in which entity operates (factors such as human resources, market trends)

Monetary value attached to non-financial factors

Source of financial &

non-financial

information

Internal sources

� Finance department � Marketing department � Human resource department � Production department

External sources

� Customer feedback � Trade associations & journals � Newspapers, magazines & television � Internet, market research � External consultant & auditors


Financial & non-financial information is useful at strategic level for setting standards, budgeting & performance evaluation. A combination of both facilitates effective & timely decision–making.

Management responsibilities & their effect on management information & performance measurement

Man

agem

ent

resp

onsi

bilit

ies

for

cost

, pro

fit

& in

vest

men

t

Cost centre Production or service location, function or activity whose costs may be attributed to cost units

Profit centre Part of business accountable for costs & revenues; can be called business centre or business unit

Investment centre A profit centre whose performance is measured by its return on capital employed

Manager is responsible for costs which come within his sphere of influence

Manager responsible for costs as well as revenue to calculate profit

Manager is responsible for profit & capital investment

Performance measured on basis of his ability to identify & reduce controllable costs

Performance measured on basis of his ability to maximise organisation’s profit

Performance measured on basis of his ability to earn higher return on investments


Computerised information systems

designed to collect information regarding actual performance against functional goals; enables management to exercise control & conduct business effectively

Role of information technology in management information

4 types of information systems used by organisation

Transaction processing system (TPS)

Used to record & process routine transactions of organisation. Keeps an official record of transactions & serves as data source for other systems

Management information system (MIS)

A system that provides data & information to managers at all levels in form of reports which require analysis and action & other information to support functions of planning, control & decision making.

Decision support system (DSS)

Helps management make decisions in situations with high level of uncertainty. Comprises of set of tools & techniques that provide potential outcomes for number of different strategies

Office automation system (OAS)

Uses a combination of hardware, software & networks to enable employees to perform traditional paper based tasks electronically. Increases efficiency & productivity amongst employees


Role of Trainee accountant

Trainee Accountant

Variance analysis

Comparison of actual cost with budgeted cost

Future cost of goods & services

� Cost of production � Revenues � Profitability

� Cost of goods old � Price of inventory � Value of inventory

His role also encompasses: � making use of correct information & presenting it to management for decision-making � keeping track of information � providing management reports which meet needs of a specific user group � keeping track of money spent & earned by company


Present management information in suitable format according to purpose

Information is communicated

Orally

in form of reports Numerical

Mix of the two reports

Non-financial (written in essay form)

Report should contain all information that would help user to take decisions while not leaving out any information that would have an adverse effect on user’s final decision

To:

Signature

Subject:

Standard format of report

Name of intended recipient

Report Title

From: Name of sender

Subject

Signature & name

Body of report

Date:

Ref. No.:

Date

Cost Accounting System 9

Intro: this Study Guide discusses the accounting process, the relationship between cost / management accounting and financial accounting, determines cost units, cost of the final output & analyses cost elements for different purposes.

Relationship between cost/management accounting system & financial accounting/management information systems

Cost accounting

An activity of assigning the appropriate costs incurred to a product.

It creates sufficient data for future reference.

Management accounting

Process that identifies, measures, accumulates, analyses & communicates cost information to management.

Facilitates planning, evaluation & control processes.

Aids the preparation of various financial reports.

Financial accounting

Collecting, classifying, recording & summarising financial transactions.

It presents the financial results of an organisation for given periods.


Financial accounts (FA) Cost & management accounts (CA & MA)

Use Ensures all business assets & liabilities are accounted for. Aids decision making.

Detailing Consolidated for the entire organisation.

Prepared into meaningful chunks to aid decision-making.

Type of information Mainly contains monetary value. Contains mainly monetary value & incorporates non-monetary measures.

Format Declared by law & Financial Reporting Standards.

According to management choice & purpose of information.

Time span SOCI usually 1 year & SOFP as on last day of given period.

Period appropriate for purpose.

Statutory Legal requirement

Management choice but cost records are recommended at times.


Interlocking system Integrated system

Number of sets of accounts

2 sets of accounts are maintained. 1 set of accounts is maintained.

Duplication of work

Each transaction processed twice. Single processing to avoid duplication of work.

Time span CA are prepared after a posting is made into FA system.

CA are prepared directly from book of original entry

Reconciliation system

Prepared to discover the causes of discrepancy between the two accounting systems.

No need to prepare a reconciliation statement.

Cost of maintaining accounting system

Comparatively expensive to maintain. Comparatively less expensive to maintain.

Role of CA & MA in organisation’s

MIS

Accurate ascertainment of costs

Analysis factual v/s budgeted costs

Provides required information to management for decision making


Input costs & documentation required for different cost accounting transactions

Input costs

Direct material

Direct labour

Direct expenses

Material used in producing finished product

Wages / salaries paid to workers directly associated with rendering of service / trading activity

Expenses specifically incurred for a particular product / process

Documentation for labour includes

� Workmen time card

� Computation of effective working hours

� Job card

� Computation of per employee cost per project

Documentation for material involves

Materialrequisition slip

Bill of material

Goods received note (GRN)

Materialtransfer note

Material return note


Coding and its importance

Codes System of symbols designed to be applied to a classified set of items to give brief accurate reference, facilitating entry, collation & analysis.

Benefits of coding data

Saves data entry & processing time

Unique code helps easy identification

More precise, reduces ambiguity

Flexible coding systems helps easy classification

Methods of coding data

Sequencecodes

Digital codes

Block codes

Faceted codes

Hierarchical codes

Coding Method of assigning codes to a unique set of items to distinguish it from another unique class of items.

Concept of cost units

Cost unitUnit of product / service in relation to which costs are determined.

It allows for comparisons between actual cost & standard cost.


Method of capturing, processing, storing & outputting cost & management accounting data by computer

Data capturing

meaning

methods

stages

converting data into a readable format

manual entry

origination

optical character recognition (OCR)

imaging & recording

transcription

actual input

Different methods of costing final output

Method of

costing

Job costing

Batch costing

Service costing

Method of cost ascertainment separately for job, contracts, products / work orders

Method used for ascertaining cost where production is done in batches which are similar

Method of ascertaining costs of providing / operating services

Process costing Method of cost ascertainment where output of one process becomes input of next, for conversion into a

final product

Cost Classification 15

Intro: this Study Guide discusses classification of cost by direct / indirect behaviour. Nature of variable, fixed & mixed cost & its cost analysis. Use of the high-low method to separate semi-variable cost and analysis & effects of changing activity levels on unit costs.

Cost classification

Cost

means expenditure incurred on resources

used to achieve particular objectives

Costs classification by

� Function

� Behaviour

� Direct (DC)/ indirect cost (IC)

� Responsibility

Fun

ctio

nal

cla

ssif

icat

ion

of

Cos

t

Non-production

costs

Production costs

Selling costs

Primecosts

Productionoverheads

Administrative costs

Research costs

Distribution costs

Finance costs

Directmaterial (DM)

Direct labour (DL)

Direct expenses (DE) + +

Costs incurred in relation to the manufacturing process

Production costs (PC)

Costs of goods used in producing a productDM costs

Costs of labour engaged in production activityDL costs

Specifically incurred for particular product / process other than DM & DL DE


Indirect expenses incurred in factory & forming a part of PC

Production overheads

Cost that cannot be specifically identified with a product / service

IC / overheads

Also known as period costs Non-

production cost

Are not incurred in relation to the actual production

Are essential for the entire organisational activity

Administrative costs� Costs incurred for management / administration of business

� example- Office rent

� Examples-Rent, insurance for factory

� Depreciation-, building, machinery

Costs incurred for transportation of goods

Distribution costs

Costs incurred for maintaining channel of distribution

Fuel, depreciation, repairs & maintenance charges for vehicles used by distribution department

incurred for exploration of new / to improve existing products / processes

Research cost (RC)

costs incurred on the implementation of the research work

Development cost (DC)

Selling costs

� Costs incurred in relation to sale of a product / rendering services

� Sales promotion, showroom expenses


Classification by responsibility

Type

s of

res

pon

sibi

lity

cen

tres

Cost centre

Profit centre

Investment centre

Revenue centre

Cost control

Main objective

Profit maximisation

Optimisation of return on investment

Revenuemaximisation

Cost centre (CC)

� production / service department, function, activity, person / item of equipment for which costs are accumulated

� generally split into production CC & service CC

� direct costs incurred in production CC

� indirect costs incurred in service CC

costs incurred in relation to provision of finance to the business Finance costs

a unit of product / service in relation to which costs are ascertained Cost unit

product, service, item of equipment / geographical location for which a separate cost determination is required Cost object (CO)

Classification by behaviour

Fixed cost

Variable costs

Semi-variable cost


Nature of variable, fixed & mixed (semi-variable, stepped fixed) cost

also known as period cost / stand-by-cost Fixed costs

(FC)do not vary in total, irrespective of changes in volume of activity

unit cost as production volume & vice-versa

Tim runs a saw mill. He pays $6,000 (i.e. $500 per month) as annual rent. His other monthly expenses change each month except the rent.

Example

The above diagram shows that total annual rent cost remains constant throughout the budget period of one year

The above diagram shows how the per unit fixed cost decreases as the volume of production increases.


costs that are fixed for a given level of activity Stepped fixed

cost / Semi fixed cost but in due course change

by constant amount at some point

Matrix Plc pays office rental of $10,000. which rises every two years by $5,000 & again remains constant at $15,000 until the end of the fourth year & again rises by $5,000.

Example

costs that are composed of a mixture of fixed & variable components

Semi variable cost

Example

An electricity bill is generally divided into two components - a fixed charge payable per billing period and a variable per unit usage charge (depends on the number of units of electricity consumed).


Variable cost (VC): the portion of total cost that varies with a change in the volume of activity.

VC per unit

Cos

t /

un

it (

$)

Activity Level (Units)0 X

Y

VC per unit remains the same at different levels of activity

Total variable cost increases as activity levels increase

Cos

t ($

)

Activity Level (Units)0 X

Y

Examples � Direct material & labour cost � Power & fuel� Products purchased for resale


The total cost line consisting of FC & VC The average total cost i.e. per unit cost consisting of the fixed and variable elements, decreases with an increase in the volume of production


Cost type with examples Explanation

A) Fixed cost Insurance

Cost incurred to protect against events that could damage business property. No relationship to activity of production & therefore does not vary with the volume of units manufactured.

Depreciation on buildings Accounting convention to reflect the reduction in value of assets due to wear & tear. No relationship to activity.

B) Stepped fixed cost Depreciation on company-owned vehicles

If the company operates a fleet of vehicles to reduce the delivery time, the depreciation cost on the vehicles will step up each time the number of vehicles increases.

C) Variable costs DM, DL, DE

The cost of direct material labour or expenses per unit of production is constant & as the units of production increase so does the cost. A direct relationship with activity.

Sales commission The cost of rewarding sales persons according to their sales volumes has a direct relationship with sales activity.

D) Semi-variable costs Monthly electricity costs

Electricity charges consist of fixed & variable components. Fixed components remain unchanged for any quantum of usage & variable components vary with a change in usage level.

Cost type with examples


High-low method to separate semi-variable costs

High / low analysis

Fixed cost = Total cost (at highest / lowest level of activity) – (Total units (at highest / lowest level) x Variable cost per unit (as calculated above) )

Hence changes in the total costs at two different levels of activity can be attributed solely to the variable elements

Fixed element of the total cost remains unchanged during different levels of activity

volumeinDifferenceproductionofvolumedifferent at cost inDifference

unitpercost Variable =


VC, FC & Semi VC analysis & effect of changing activity levels on unit costsproducedunitsofnumber unit x per cost variable+cost fixed=cost Total

Fixed cost, as the name suggests remain fixed irrespective of any change in volume. Per unit fixed cost however reduces with an increase in volume.

� the total fixed cost remains unchanged irrespective of the changes in the number of units produced � the total variable cost increases directly in proportion to the increase in the number of units produced � the total cost increases with the increase in production

Total variable cost changes with the changes in volume of output. However, variable cost per unit of production remains unchanged irrespective of increase or decrease in volume.

� Per unit fixed cost decreases with the increase in production because the cost remains unchanged while the number of units produced increase. The same amount of fixed costs get distributed between the increasing number of units. Every additional unit produced helps to reduce the per unit fixed cost. � Per unit variable costs remain unchanged with the changes in the level of production. Every new unit produced increases the total cost. � Per unit total cost (fixed + variable) decreases with the increase in the level of production.

Accounting for Materials 25

Types of material classification

Intro: this Study Guide discusses recording, ordering and issuing material from inventory

Stages in production

process

raw material (RM)

work-in-progress (WIP)

Role in production

process

direct material (DM)

indirect material (IM)

finished goods (FG) Classification of material

according to

purchased goods that form basis of final product

RM for which a portion of work is performed but not completed

goods which are ready for sale

part of material specifically attributed to a unit of production / job / service

cannot be directly attributed to a specific unit of production

Ways in which material can be classified

Substance: Wood, plastic, metal, wool, glass

Measurement: Litre, meter, kilogram, bags, packets, numbers

Physical properties: Color, shape, flexibility, quality, fire / water resistant

Cost Recording 26

Procedure & documentation required to ensure correct authorisation, coding, analysis & recording of DM & IM cost

Purchase requisition

� a formal request for purchase of material � issued by stores to purchase department � issued when level of inventory slips down / storekeeper feels

requirement� usually storekeeper fills out request & works manager / plant

superintendent signs it

Purchase order (PO)

� issued by purchase manager to vendor � written request for supplying goods according to contract � binds both, the organisation issuing it & the supplier, in a contractual

agreement

Goods receipt note (GRN)

� prepared & authorised by receiving department � acknowledges formal receipt of inspected goods

Material procurement procedure

Selection of vendor � quotations & tenders will be requested from prospective suppliers � supplier who offers the best term is selected


Material return note

� contains details of output quantity & RM required

� authorised by production manager

� sent to stores

� exchanged for RM from stores

Material issue procedure

Material requisition note

Material outward note

� accompanies material returned to supplier

� issued by despatch department to vendor, authorised by stores manager

� released when returning unwanted / faulty goods

� usually done before preparation of GRN, hence not debited in store

ledger

� accompanies material returned from production

� sent to stores manager

� given out when returning material to the stores

� authorised by department head of the department returning the material

Cost Recording 28

Methods of valuation of

closing inventory

First In First Out (FIFO): material received first is assumed to be consumed first & material received later is assumed to be consumed later

Weighted Average (WA) Cost: materials issued at average purchase price

Cumulative WA

Periodic WA

� dividing the value of inventory in stock by its quantities in stock

� dividing the total cost of inventory received by total units of inventory received during the period

FIFO, LIFO & weighted average methods

Last In First Out (LIFO): material received last is assumed to be consumed first & material received first is assumed to be consumed later

Role of accounts department

Purchase of materials: � compares GRN with suppliers invoice & PO to process invoice for payment � verifies documents & pays the vendor � make a receipt entry in the priced stores ledger

Issue of materials: � check authenticity & mathematical accuracy of supplier’s invoice � check quantity & price with reference to GRN & PO � certifies & passes the invoice for payment


FIFO LIFO WA

Situation used in perishable goods, lower volume of transaction

� time of inflation � heavy price fluctuation

heavy price fluctuation

Assumption issues made in order of purchase

� issues made in reverse order of purchase

----

Major benefit closing valuation closest to current prices

� production cost closest match with input current prices

� lower tax burden

issue price kept stable

Major disadvantage

variations in cost of one job, over time, when prices fluctuate

� unrealistic view of closing inventory � disallowed by major accounting

frameworks

actual material cost not reflected

Calculation of unit issue price of material

Sum of prices of all the batches of material purchased during a period (including opening balance) Unit issue

price of material

= Total quantity of material purchased during the period (including opening

balance)

Periodic WA

Cumulative WA store in material ofquantity Total

issue of date till purchased material of batches the all of price of Sum material of price issueUnit =

Cost Recording 30

Transaction Entry

Receipt of material Dr Stores control a/c (asset) Cr Sundry suppliers a/c Being material purchased & received in stores

XX

Issue of direct material to production

Dr Work in process control account (asset) Cr Stores control account (asset) Being raw material issued to production

XX

Return of DM to stores Dr Stores control account (asset) Cr Work in process control account (asset) Being raw material returned to stores

XX

RM are returned to suppliers Dr Sundry suppliers account Cr Stores control account

XX

When indirect RM are purchased Dr Stores control account (assets) Cr Sundry suppliers account (liability)

XX

Issue of IM to production Dr Factory overhead control account (asset) Cr Stores control account (asset) Being indirect material issued to production

XX

Return of IM to stores Dr Stores control account (asset) Cr Factory overhead control account (asset) Being indirect material returned to stores

XX


Material input requirement, control measures where wastage occurs, procedure required to monitor inventory & to minimize discrepancies & loss

Input loss

occurrence of visible wastage i.e. loss / evaporation, shrinkage of material, smoke Physical

Wastage Discarded substances having no realisable value

to avoid scarcity of resources

Economiclabour, overheads / other resources that are used / unused without the organisation obtaining the desired output

Material input requirement

organisations purchase a margin of extra material over the normal material requirement

usually charged to production by inflating unit price of good units produced

Accounting for waste

Normal waste

basic RM lost in / before production process

Abnormal waste

Loss occurs during production & acceptable to management

excess loss over normal losses transferred to costing profit & loss a/c to avoid fluctuations in cost of production

Cost Recording 32

normal allowances for yield & waste

should be made from past experience, technical factors & special features of the material process & product

assign responsibilities

to purchase, storage, production, maintenance & inspection staff to maintain records

systematic feedback process

should be established for the feedback of achievements against standards laid down

Control of waste

appropriate action should be taken wherever necessary by comparing the actual yield & waste of material with anticipated features at regular intervals

duty of management to take necessary

stepsmethods

proper storage should be established for the feedback of achievements against standards laid down

waste

how to control it ?


� records every transaction that takes place (receipt & issue) � constant checks on physical inventory & book inventory & identifies

discrepancies � maintains bin cards, stores ledger � maintains all necessary documents supporting transactions � continuous inventory counting

Monitoring inventory under the perpetual inventory control system

Perpetual inventory control system

Bin card (BC)

� physical records kept to monitor the movement of stores item

� record movement of material in terms of quantity immediately

� separate for each item of material in order to make efficient stores management

Stores ledger (SL)

� record movement of material in terms of quantity as well as cost

� maintained by cost accounting department

� periodically reconciles with BC

� records monetary value of issues / receipts & inter-departmental transfers

� arithmetical errors in calculating balances � mistake in posting data

Difference between these two arise due

to:

Cost Recording 34

Continuous physical

inventory verification

� physical counting is required even when BC & SL present a real picture of balance

� present real picture of material in hand

Perpetual inventory system

Periodic inventory system

� inventory continuously verified � entire stock is verified at least once a year, hence discrepancies identified

� inventory verified only once a year (usually end of the year) � discrepancies sorted out at year end, often a long period has passed

since they originally occured

Just-in-time (JIT)

� technique originated in Japan, pioneered in Toyota plant in 1970 � emphasis on elimination on waste � prevents holding up funds in inventory & reduces carrying costs � minimises inventory level by manufacturing exact quantities at exact time (leads to

reduction in set-up time, storage cost)

Necessary points to make JIT

work

� Reliable suppliers in terms of delivery times, quality and quantity of material. � Accurate production planning taking into account defects and waste. � Factory layout should ensure there is a minimum movement and handling of

material, quick & easy work flow between work centres. � Minimal finished goods stock should be held. � Suppliers are connected to the network and have up-to-date information on

the plans of the company.


Cost of holding inventory & of being without inventory

Reason for holding

inventory

� to meet future shortages � to hold sufficient inventory to produce the goods to meet expected demand � to take advantage of bulk purchases � to allow a smooth & efficient production process � to meet seasonal fluctuations & variations in availability of material

Holding cost (HC)

amount required for purchase is borrowed from bank / lender then interest payable is the cost of investment in inventory Interest cost

Storage cost

Other cost

costs relating to renting / insurance of premises & insurance of inventory

includes risk of obsolescence, deterioration, theft, outdated / useless material & damage

=

+

+

� material procured at higher price � inferior quality material procured � penalty for late deliveries � loss of sales & future sales � idle resources

Stock-out Cost of stock-out

arises when inventory is at zero

level

Cost Recording 36

� where demand and lead time is constant � when a fresh order for inventory should

be placed for replenishment or

Maximum usage x Maximum lead time

Minimum level + (Average usage x Average lead time)

Minimum level RL - (Average usage x Average lead time) Can wait no more!

Re-order level (RL)

Assumptions � material requirements are pre-defined � rate of issue of material is fixed in a

time interval

Reorder level =

=

2

dimum periomin+riodMaximum pe =

Average delivery period (lead time)

for each item

indicates the lowest level of inventory which must be maintained at all times for production to be continuous

Maximum inventory level

if level exceeds this, leads to over stocking

indicates the maximum level of inventory held at any time

= reorder level – (minimum usage X minimum lead time) + reorder quantity

Inventory control levels (minimum, maximum, re-order)


Optimal order quantities

Optimal / economic order quantity (EOQ)

size of order for which total cost of ordering & carrying

inventory is minimal

Co = cost of ordering per order / consignment from supplier

Ch = cost of holding per unit of inventory per annum / time period

D = total demand during the period

hCo x D x C2

EOQ =

Cost Recording 38

Relationship between material costing system & inventory control system

provides essential data for the material costing system

� availability of reliable information for all material

� proper production planning � detection of loss

� no interruptions in production

� minimised obsolescence & deterioration

facilitates material costing through records such as BC & SL

Speeds up material costing process since errors can be avoided

Proper inventory control

Accounting For Labour 39

Distinction between direct & indirect labour costs

Intro: this Study Guide discusses labour costs and their classification.

Direct labour cost Indirect labour cost

Definitionspecifically incurred for / can be readily charged to / identified with a product / service

not directly incurred / cannot be readily chargeable / identifiable with a product / service

Allocation, apportionment or absorption

directly charged to: � specific job or � contract work or � any other cost object.

cost is assigned to a product / service / job on a suitable basis, such as number of machines set-up, number of labour hours, number of inspections, etc.

Direct / indirect is a relative term

Labour that is direct in one industry may be indirect in another industry, due to different methods / process of work.

Labour that is indirect in one industry may be direct in another industry, due to different methods or process of work.

Recorded in the cost sheet part of prime cost part of factory overheads eventually

become a part of “cost of production”

Labour remuneration methods

Labour remuneration methods

Time based systems

Piecework systems

payment on the basis of time spent on work

payment on the basis of quantity of work done

Cost Recording

To overcome

40

Wages = Hours worked x Wage rate per hour

� basic time wages paid up to certain level of efficiency

� hourly wage rate rises as efficiency increases

Straight time rate systems

Differential time rate systems

Time-based systems (TS) guaranteed minimum wages

Wages = N0. of units produced x Piece rate per unit

� Workers are given a chance to earn a bonus / incentive as their productivity increases

� Hourly wage rate rises as the efficiency increases

Straight piece rate systems

Differential piece rate systems

Piecework system (PS) payment based on productivity

Combination of time & piece

rate

Deficiencies of � TS do not motivate worker to put in best efforts � No minimum wage guarantee in PS

Individual incentive plans

� reward employees individually according to their performance � basic wages + incentives (calculated separately for each worker) � effective factor in motivating the workers

Overtime premium

� wages paid in addition to normal wages for overtime work done

� paid at higher rate than normal wages � treated as indirect labour charge

Idle time

� wages paid for unproductive labour time caused due to unavoidable circumstances e.g. machine breakdowns, material shortage etc.


Incentive schemes / Bonus plans

� incentive based upon individual performance of worker

� high wage rate system (pays higher than normal wage rate)

incentive based upon individual performance of worker & divided amongst individual members

Group incentive schemes Individual incentive schemes

encourage more efficiency Individual & group bonus schemes

Procedure & documentation required to ensure correct coding, analysis & recording of direct & indirect labour

Tasks of personnel dept. � engagement, transfer & discharge of employee � remuneration schemes � maintenance of personal records � issuing reports regarding employees’

performance, timekeeping, turnover etc.

Tasks of production planning dept.scheduling work � monitoring any jobs running behind

schedule � issuing job orders

Different information from different sources: employee no., department, pay rate, job/batch no., client no.

Source documents for recording costs � Payroll� Pay slips

Cost Recording 42

Documents for recording labour costs

Job card

Operation card

prepared by employees for each job, contains details of time spent on each job, reduces errors & saves time as opposed to manual record keeping

known as piece work ticket,, shows details about the total production, rejected units & good production, wages paid only for good production

Authorisation procedure1.Authorisation of calculations before the actual payment 2. Verification of calculation of gross pay & deductions 3. Ensure that all deductions are paid to the Govt & other agencies on or

before the due dates (all these approvals need to be properly documented)

Accounting for labour costs

Accounting for labour costs Transaction Accounting Entry

1. Total salary & wages paid Dr Wages control account Cr Cash / bank account

2. Direct labour cost charged to production Dr Work in progress account Cr Wages control account

3. Indirect labour cost charged to production Dr Production Overhead control account Cr Wages control account


Accounting for payroll

1. Provision made for the salary payable

Dr Basic salary Dr Allowances

Cr Deductions Cr Net salary payable

2. Salary paid Dr Net salary payable

Cr cash / bank

Labour turnover

Ratio of the number of persons leaving the organisation in the

given period to the average number employed

Cause & costs of, & calculate labour turnover

100 x workersofnumberAverage

tsreplacemenofNumber=turnoverLabour

can be eliminated by taking

proper action

Unavoidable � Retirement � Business has moved to a location where the employee cannot

move� Disciplinary action � Any disability acquired by a worker � Lack of career structure, better prospects, marriage, pregnancy � Dissatisfaction over the pay, hours or working conditions

Avoidable � Lack of job satisfaction � Poor working conditions � No scope for further

development � Strained relationship � No scope for recreation � No medical benefits

Causes

Cost Recording 44

Cost associated

with labour

turnover

Preventive costs

Replacement cost

for reducing labour turnover e.g. retirement benefit / welfare schemes, medical services / benefits

costs which arise due to labour turnover e.g. extra cost incurred in training, cost of replacement, cost of break down, cost of greater scraps & waste generated, accidents

Measurement of labour efficiency & utilisation

100 x workedhours A ctua l

output actua l of hours Standard = ratio e fficiencyLabour

Labour ratios helps to compare actual performance with budgeted standard performance

to know the efficient utilisation of available labour resources

100 x input of hours Budgeted

workedhours A ctua l = ratiocapacity Labour productivity of workers compared with the

standards to measure their efficiency

Accounting for Other Expenses 45

Nature of expenses by function

Intro: this Study Guide discusses the costing of other expenses

Production/ manufacturing costs

incurred in relation to the operation of a manufacturing process

can be sub classified as: � direct material � direct labour � production overhead

Administrative

costs incurred from conceptualisation to sale of a product, other than production expenses

e.g. office rent , staff salary

Distribution Finance

e.g. sales promotion cost

e.g. interest paid on loan , debenture

Selling

e.g. transportation cost

Non-production costs

Research& development

Cost Recording 46

Capital expenditure (CE) & revenue expenditure (RE) & relevant accounting treatment

Capitalexpenses

(CE)

Revenueexpenses

(RE)

� which have a direct effect on thr SOFP (balance sheet) � improves the earning capacity of assets � increases value of non-current assets � provides benefits for the long term i.e. for more than one accounting period

� incurred to maintain the existing capacity of an asset � is a part of regular income � decreases current assets � provides current benefits i.e. lasting for one

accounting period

Classification of expenses on the

basis of the relationship with accounting period

Differences between CE & RE � not a regular business expense � benefits for the long term � e.g. machinery purchased

� a regular business expense � benefits for the short term � e.g. repairs to machinery

Capitalisation of expenditure

when expenses are recorded in the books of account as an increase in non-current assets

Accounting for Other Expenses

SOFP $

Assets Non-current assets X

Total X Capital & liability X

Total X

Income statement$

Income X

Less: Expenses (X)

RE will appear here

CE will appear here

Disclosure of CE & RE in financial statements

Procedure & documentation required to ensure correct authorisation, coding, analysis & recording of direct & indirect expenses

Source documents

(SD) for recording

costs

� invoices� payment slips

� cash payment - remittance adviceaccompanying the actual cash

� cheque payment - remittance adviceaccompanying the actual cheque

� expense vouchers� petty cash vouchers

47

Cost Recording

Authorisation procedure

1.Expenses are approved by an authorised person in the department incurringthe expense before making a payment.

(Authorisation includes a full signature / printed name below the signature / itshould not be illegible, only initials / “okay” without a signature does notrepresent proper authorisation of an expense voucher).

2. Expense voucher should be prepared.

In case, this kind of voucher is not prepared, an alternate form such as a note,letter / memo should be attached to a payment request, it must include:

� name of person / vendor to be paid� account number to be charged� amount of payment being approved� purpose of payment being approved� signature authorisation

Importance of coding

� every item should be coded in order to identify it

� all required SD should be sequentially coded / pre-numbered, it helps the

accounts department to verify whether every invoice has been accounted for.

48


Expenditure Procedure, documentation and accounting

Directors’ remuneration

� director should disclose his interest in the board meeting � directors are not automatically entitled to remuneration � paid either according to terms of articles of association / a resolution made in

general meeting � company should keep minutes of the meeting in which remuneration is decided

Rent

� normally decided with tenancy agreement & payable quarterly in advance � may be fixed / renewable annually depending upon the terms of tenancy � tenancy agreement, voucher of rent paid containing details of expenditure, & should

be authenticated

Insurance � cost comprises of the premiums paid to insurance company to cover various risk

against the office assets � an annual sum payable either on renewal date / in instalments

Professional fees

� fees paid to professionals ( legal advisors, auditors) for services rendered � usually accounted for on the basis of time spent attending to the client’s business

Telephone, electricity

� normally has two elements (fixed & variable) � basic rent is fixed & variable amount is based on usage

49

Cost Recording

Purpose of depreciation

to comply with accrual & matching principle

to charge cost of asset to revenue over useful life of assets

asset generates revenue for many years therefore

incorrect to charge the entire cost in the first year

This car costs $20,500

The same car after 5 years from the date of its purchase with a carrying value of $500.

Depreciation charges using straight-line, reducing balance & machine hour rate methods

Depreciation systematic allocation of the depreciable amount of an asset over its useful life

Residual value (RV)

is the value which the entity expects to realise from disposal of the asset at the end of its useful life

Useful life (UL)

the period over which the asset is expected to be available for an entity’s use

50


Reducing balance method(RBM)

Different methods of depreciation

Straight line method (SLM) Units of production method

Fixed amount / percentage on

the original cost every year

(constant charge)

Depreciation is charged as a

percentage on the written down

/ book value of the asset

(decreasing charge)

Depreciation is charged based

on the expected use / output of

asset

asset UL of theEstimated

RVEstimated e asset - Cost of th

also called the Diminishing balance

method

ratepreciationtion) x Ded depreciaAccumulate(Cost

hours workingEffective

valueScrap - machine the ofCost

Depreciation =

Depreciation =

Machine hour rate =

51

Cost Recording

Straight-line method Reducing balance method

Fixed amount each year to SOCI (IS).

Higher amount during initial years when machine is new and efficient & lower amount in later years.

Suitable for assets which give the same efficiency year after year e.g. a building which is used equally over the years.

Suitable for assets which give a higher efficiency in earlier years and a lower efficiency in later years.

If repairs increase in later years, the charge of depreciation plus repairs increases each year (since the depreciation is constant).

the charge of depreciation plus repairs is expected to be the same over the years. In the initial years when repairs are low depreciation is high, and in later years when repairs are high depreciation is low.

Simple to understand and operate. Relatively difficult to understand and operate.

Comparison between

Relationship between expense costing system & expense accounting system

Expense accounting system helps

expense costing system in the

following ways

� Estimation & collection of manufacturing overheads

� Cost allocation, cost apportionment & re-apportionment

� Absorption

� Treatment of over & under absorption of overheads

Compliment each other

52

Absorption Costing 53

Rationale for absorption costing

Intro: this Study Guide discusses allocation, apportionment & absorption of overheads

Absorption costing (AC)

process by which total overheads (o/h) are absorbed into production

cost of an item of a product / service provided, is calculated as the sum of direct costs and its share

of indirect costs

objectives

� to include appropriate share of total overheads in the total cost of a product / service � provides basis for preparing all financial accounting statements � identifies direct costs & indirect costs involved in production � enables management to decide appropriate profit margins & selling price

Nature of production & service cost centres & their significance for production overhead allocation, apportionment & absorption

cost centre that is essentially involved in the

production of products

Production cost centre (PCC)

cost centre that is involved in providing support

services to production department

Service cost centre (SCC)

Costing Techniques 54

Process of applying production costs to products

Total overheads

P

P

S Individual product

allocated / apportioned

Stage 1 Stage 2

P – Production departments S – Service department


Determining production o/h Absorption Rates (OAR)

classification of o/h

codification of o/h

re-apportionment of o/h of SCC to PCC

on the basis of function / variability

NO

apportionment of cost to PCC or SCC

accumulation of o/h

allocation / apportionment of

o/h to cost centres

is there a clear basis to assign o/h to a cost

centre? YES

allocate the costs to the cost centres using the appropriate basis

All overheads allocated / apprtioned to PCC

calculate separate o/h rates for each PCC

assign o/h to each product selectedbasisofquantum

centrecost too/hdapportioneallocated/

OAR x units of allocation basis consumed into categories according to internal

system of coding

unreasonable basis leads to over/under assignment of o/h


Overhead cost Basis of distribution

1All labour related expenses e.g. time keeping, expenses, staff welfare expenses, canteen expenses and indirect labour.

Number of employees / wages paid for each department, direct labour hours are used as a basis for indirect labour.

2 Heat & light costs Number of light points, floor space area occupied.

3 Supervising costs Time spent in each department / number of employees in the department.

4 Rent, rates & property taxes, heat, light, air conditioning. Area occupied

5 Depreciation of plant & machinery. Capital value / book value of the machinery / plant will form the basis to apportion depreciation to the machine.

6 Advertisement Apportioned to products as a percentage of sales value as these expenses are incurred for the purpose of sale of the product.

7 Insurance of equipment book value of equipment


Re-apportion SCC o/h to PCC using direct & step down methods

apportioning cost of each SCC to PCC

Direct method of re-apportionment

� re-apportionment order is not relevant for the direct method

apportioningcost of each

SCC to another SCC

Step down / non-reciprocal method of re-apportionment

� more complex than the first method, because a sequence of apportionments have to be selected

� distribution begins with the department which rendered the maximum number of service etc.

� re-apportionment order is relevant for the step down method

PCC OAR using labour & machine hour method

Absorption of o/h

process of charging the o/h to the units of output

basis allocation of Total

dApportioneallocated/ o/h Total=OAR

Process of setting OAR

� estimating total amount of o/h for a department

� selecting appropriate allocation basis � dividing the total o/h by the total of the allocation

basis to arrive at OAR � multiply OAR arrived at above with the actual labour

hours / machine hours worked


Direct labour hour (DLH) rate

� basis for charging o/h is DLH consumed in the department � perfect method for labour-driven industries � most overhead expenses are generally incurred on this resource � scientific method as a majority of the overhead expenses are related to the labour time � includes welfare expenses, canteen expenses etc. � method qualifies as the most logical basis for computation of the overhead rate

Machine hour (MH) rate

� allocation basis for assigning overheads is machine hours consumed for production

� labour is used very carefully in these industries

� more logical to use this basis, as most of the overheads such as depreciation, insurance,

repairs, power etc. are machine-related overheads

workedDLHed/apportion allocated o/h Total

= ratehour Labour

department the in consumed MHo/h ofAmount

= rate MH


Relative merits of actual & pre-determined OAR

Actual OAR

� rates are calculated on the basis of o/h actually incurred � rate does provide an accurate data for overhead costs incurred on each activity / product � to calculate rates on the basis of the actual figures one has to wait until the end of the activity period

period the in produced units ofnumber Actualperiod thefor overheads Actual

=OAR Actual

Pre-determined OAR (POAR)

� normally preferred over the actual absorption rate method � the budgeted figures, estimated before the start of the period, are used for this purpose � the overheads are added to the actual cost of product

hours budgeted / period the in produced units ofnumber Budgetedperiod thefor overheads Budgeted

= POAR

Actual cost of production = Direct material + Direct labour + Direct expenses (actual figure) + Production overheads (on the basis of pre-determined budgeted figure)


Major considerations behind using

POAR

to reduce the effect of fluctuations

� in the level of activity on unit cost

� in the total level of o/h costs incurred every month

Accounting for production o/h, analysis & interpretation of over/under absorption

O/h absorbed Actual O/h

incurred>

=Over-absorption

of O/h

Dr Manufacturing o/h control a/c Cr Over-absorbed o/h a/c Being over-absorption of o/h quantified

Dr Over-absorbed o/h a/c Cr Costing profit & loss a/c Being over-absorption of o/h charged to the costing profit & loss account

O/h actually incurred

O/h recovered/absorbed

Dr Manufacturing O/h control a/c Cr Cash / General ledger adjustment a/c Being manufacturing o/h incurred

Dr Work-in-progress control a/c Cr Manufacturing O/h control a/c Being manufacturing o/h absorbed by production

in case of works o/h


Methods of attributing non-production o/h to cost units

Non-production o/h

Research & development

costs

� incurred for exploration/improvement of new/existing products & processes

� consumer cost / added value is basis of apportionment

Administrative costs

Selling & distribution costs

� incurred in the administrative division � consumer cost / added value is basis of apportionment

� incurred for the purpose of selling products � sales value is basis of apportionment

Methods of allocating non-production o/h

� select an appropriate basis of OAR for non-production o/h � allocate non-production costs to products on basis of production costs

costs production Budgetedo/h production non Budgeted

=OAR

Actual o/h incurred

o/h absorbed >

=Under-absorption

of o/h

Dr Under-absorbed o/h a/c Cr Manufacturing o/h control a/c Being under-absorption of o/h quantified

Dr Costing profit & loss a/c Cr Under-absorbed o/h a/c Being under-absorption of o/h charged to the costing profit & loss account


Transaction Journal entry

Non-manufacturing o/h incurred Dr Non-manufacturing o/h control account

Cr Expenses payables control account Being non-manufacturing overheads incurred

Non-manufacturing o/h absorbed by final products

Dr Cost of sales accountCr Non-manufacturing o/h control account

Being non-manufacturing overheads absorbed by production

Journal entries relating to non-production o/h

Cost Sheet $Direct materials x Direct labour x Direct expenses x Total direct / prime cost xxProduction overhead x Full production cost xxAdministration overhead x Selling and distribution overhead x Full cost of sale xx

Format of the product cost calculation

Marginal Costing 63

Intro:- this Study Guide discusses marginal & absorption costing, explaining the situations where profit is derived under these two methods, the reasons behind the differences in profit under the two methods & the usefulness of profit & contribution information.

Concept of contribution, profit statement under marginal costing & usefulness of profit & contribution information

Concept of contribution

Signifies an alternative measure of profit

It contributes towards fixed costs & profit

Contribution = Sales – Variable costs (VC)

Sales -= Contribution

Variable cost

Fixed cost

- = Profit


Features of contribution

� provides pool for fixed costs (FC) for a period, & surplus, if any, constitutes profit

� Contribution > FC then business starts making profit

� Contribution = FC then no profit no loss � Contribution < FC then business incurs losses

� Profit per unit changes along with a change in the level of activity

� Contribution per unit remains unaltered over accounting periods

� Contribution of a product helps planning for future

� Changes with the number of units sold & remains constant per unit

� Useful for identifying break-even point, margin of safety & other cost-volume-profit analysis

� Changes in contribution affect profits

Usefulness of profit & contribution information

Profit information

� does not lead to manipulation

� calculation of profit becomes easy

Contribution information

� Even though there is an increase / decrease in sales, calculation of profit is easier

� calculation of profit / loss possible when total contribution is compared with fixed overheads

Marginal Costing 65

Marginal costing

(MC)

Accounting system where variable costs are charged to cost units

Fixed costs of a period are written-off in full against aggregate contribution

It helps in recognising cost behaviour & assists in decision making

Marginal costing is a better tool for profit ascertainment

FC does not ever undergo a change

Sales volume never affects amount of FC

Profit calculation should be based on contribution analysis

When additional units are produced

When sales units are reduced

Closing inventory

FC always relates to activity period

Final profit = Total contribution – Fixed costs

VC increase

FC remain same

FC remain same

VC decreases

Valuation should be based on variable costs


Profit statements using absorption costing method

Absorption costing (AC)

� Basis of preparing all financial accounting

� All costs are absorbed into production and hence no distinction between FC & VC

� Entire costs of production (VC / FC) are considered as product costs

� Non- manufacturing costs (VC & FC) are considered as period costs

Situation 1 When opening & closing inventories are same, then there is no difference in the profits

Situation 2 Production exceeds sales – AC profit > MC profit (AC rewards production)

Situation 3 Sales exceeds production – MC profit > AC profit (MC rewards sales)

Profit reported by AC & MC

Marginal Costing 67

Profit statement under absorption costing

$ $ $Sales X

Less: Production costs

Direct material X

Direct Labour X

Direct expenses X

Prime cost X

Variable production overheads X

Fixed production overheads X

Factory costs or production cost X

Difference in opening and closing inventory X

Cost of goods sold (X)

Gross margin X

Less: Non-manufacturing costs

Administration overheads X

Selling and distribution overheads X (X)

Net profit X


Reconcile profit / loss

under AC & MC

Calculate difference in opening & closing inventory for the period

Adjust cost difference arising due to difference in valuation of inventory

Absorption costing (AC) Marginal costing (MC)

For valuation of inventory, both variable & fixed manufacturing costs are considered.

For valuation of inventory, only variable manufacturing costs are considered.

Non-manufacturing costs are considered to be period costs and written off in the period in which they are incurred.

Fixed manufacturing costs and non-manufacturing costs (both variable and fixed) are written off in the period in which they are incurred.

Emphasis on profit. Emphasis on contribution.

Basis for preparing all financial accounting statements and is suitable for external reporting purpose.

Basis for various managerial decisions taken by management, and is suitable for internal reporting purposes.

Per unit cost changes from period to period depending upon the volume of activity.

Useful for product pricing because per unit cost is constant.

Not useful for control purposes since costs are divided only on functional basis and not based on behaviour.

Useful for control purposes since costs are classified into fixed and variable.

Distinguish between AC & MC methods & reconcile profit/ loss

Job and Batch Costing 69

Characteristics of job & batch costing & appropriate situations for use

Intro: This Study Guide discusses the concepts of job and batch costing, where they can be used and the method of preparing cost records under each of these systems.

Job costing (JC)

Costs are attributed to individual jobs undertaken according to customers’

requirements Characteristics

Batch costing (BC)

applies to industries where identical articles

are manufactured together in batches Characteristics

Production / services are rendered for specific job orders

Clear identification of job throughout production process

Jobs are unique & non-repetitive

Each job becomes separate cost centre

Cost directly charged to individual job orders

Job order may extend to several accounting periods

Cost can be computed only after completion of each job

Production / services are rendered for specific batch orders

Clear identification of job throughout production process is not possible

Jobs / batches are repetitive

Each batch becomes separate cost centre

Costs are charged to each batch order

Batch order may extend to several accounting periods

Cost can be computed only after completion of each batch

Costing techniques 70

Situations where JC & BC is applied

Job costing

Each job consumes different materials, labour resources & indirect facilities dissimilar to other jobs

Production is non repetitive & not continuous

Each job maintains its separate identity

Batch costing

Customer orders for specific / similar items

Where necessary, features of product sold need to be uniform

Production department requires identical items for replenishment

batch a in produced units of No.batch afor incurredcost Total

= batch a inunit per Cost


Unit costs using JC & BC & pricing in JC & BC

Calculation of unit cost under

job costing

Calculated by aggregating all costs related to the job – materials, labour & overheads

Dr Job Account Cr

$ $

Direct materials (issued)

X Materials (returned to stores)

X

Direct labour X Cost of sales

(finished jobs) (Bal fig)

X

Direct expenses X X

Productionoverheads

X X

Other overheads X X

XX XX

Calculation of unit cost under batch costing

Calculated by dividing the total batch cost by the number of units in a batch

$

Direct material X

Direct labour X

Direct expenses X

Prime cost X

Add: Overheads X

Total cost X

Cost per unit (Total cost/ units)

X


Cost-plus pricing Selling price Cost of product + % of profit

Cost-plus pricing of jobs

$

Total costs X

Add: 10% margin X

Selling price X

Cost-plus pricing of batch

$ per unit

Factory cost X

Add: selling & distribution expenses X

Total cost X

Add: % profit margin X

Selling price X

=


Accounting for costs under job and batch costing

Accounting for cost

Material cost

Labour cost Calculated by determining the time spent on each job

Direct expenses Calculated by identifying amount incurred for specific job

Overheads Calculated on basis of overhead rates as applicable

Ascertained from material requisition slips

Control of cost in job and batch costing

� Job cost sheet contains all the costs incurred on a job � Every job is different & hence a separate cost sheet needs to be prepared for each job

Helps to analyse cost which reveal related discrepancies

Essential part of every cost system

Costs need to be recorded properly at each stage they are incurred

Cont

rol o

f Co

st


Computerisation of job costing

job codes are allotted for each job -accordingly entries are recorded

Inbuilt entry system identifies job numbers & cost incurred

System provides detailed analysis report where user can identify variances & make comparison

Accounting and recording of batch costs

It is similar to job costs

Cost per unit is calculated by dividing the total cost of a batch by number of units produced in a batch

Process Costing 75

Intro:- this Study Guide elaborates on the concepts of process costing, joint & by-product costing and the intricacies of the accounting procedures followed. It also explains the concepts of normal & abnormal losses and gains.

Characteristics of process costing (PC)

Process costing

Applicable to industries involving continuous &

mass production of identical parts

Aims to determine cost of each

operation / process

Characteristics of PC

Costsaccumulated (CA) for a

period

CA for clearly defined

processes

Output of one process, input of next

Cost of normal loss units borne

by good units

WIP, treated as

equivalent finished goods

Apply costs accumulated at the end of each

process directly to the products

CA into process, & not directly

intoproducts

Definedproceduresfor division

of costs amongst the

jointproducts

Unit costs & Process accounts (PA) where losses occur in process

quantity loss Normal-quantity input Totalloss normal of valueScrap-cost Total

=unit per Cost � Labour costs & other expenses are debited as & when they are incurred � Overhead expenditure is allocated to the process on a suitable basis, according to the given information


Nature of normal & abnormal losses / gains & account for scrap

Normal loss (NL)

Losses are inherent & unavoidable in production process

Calculated at fixed % of output & includes waste & scrap

Caused by factors such as evaporation, chemical change, test / sampling, unavoidable spoilage

Process loss Difference between the input quantity of raw material & the output

Waste Discarded substances that have no realisable value

Scrap

Discarded material, that has some recovery value

Usually disposed of without further treatment or

Re-introduced into production process in place of raw material

Abnormal process loss

(AL)

Waste arising in excess of the normal amounts

Cause by unexpected / abnormal factors e.g. fire, machine breakdown, power failure, strike etc.

Process Costing 77

Abnormal gain Actual loss < Normal loss

Normal output = Units input – Normal loss in units

Abnormal loss = Actual output - Normal output


Dr Costing profit & loss account Cr Abnormal loss account Being loss transferred to costing profit & loss account

To close the AL a/c

Dr Cash account Cr Abnormal loss account Being sale value realised on sale of AL units

If any amount is received from sale of scrap

Dr Abnormal loss account Cr Process account Being abnormal loss charged to process

To value AL & set up AL a/c

Accounting treatment of

abnormal loss

Value of AL = Normal cost of normal output x Units of AL/Normal output

Cost per unit of process outputs and process accounts

Dr Cash account Cr Normal loss account Being cash realised on sale of scrap units

For sale of scrap, if any

Dr Normal loss account Cr Process account Being normal loss charged to process

NormallossAccounting

treatment of normal

loss

Normal cost = Normal cost of process - Realisable value of NL if any

Process Costing 79

Ascertain the work completed on the WIP units with regards to material and conversion costs

Multiply % of work completed by number of units of WIP

Once the number of EU are ascertained, the cost per EU is calculated

Calculate total cost for WIP units & finished units, by multiplying units for each by the costs, per EU, as computed

Concept of Equivalent Units (EU), allocation of cost between finished output & work in progress (WIP), unit cost for WIP & process accounts where closing WIP exists

EUUnits that represent units of production as equivalent to fully complete units of production

Helps split process costs into complete units & WIP units

EU of WIP = Actual number of units in process x % of work completed

60 units complete as to materials

75 units of total labour & overheads complete

60% complete as regards materials

75% complete as regards labour & overheads

WIP – 100 Units

WIP – 100 Units

Equivalent units

Equivalent units

=

=

1

2

3

4


Joint products By-products

Importance All are of equal importance, as they all are the main products.

A by-product is generally less important than the main product.

Value Each joint product has a high commercial value.

The commercial value of a BP is lower compared to the main product.

Status Always remains the same with regards to their importance and value.

By-products can become main products & vice-versa.

Joint products (JP) & by products (BP)

Example : Butter & cheese> joint products – Butter milk> bi-product

By- products

Output of some value produced incidentally while manufacturing something else

Has less importance than main product

Joint products

Two / more products separated in processing

Each product merits recognition as a main product

Example – Oil refining – petrol, diesel, kerosene etc

Process Costing 81

Valuation of by-products - alternatives

NRV of by-products is deducted from the total cost of production up to the point of separation.

Value of by-products + sales value of the main products = total. Production costs upto point of separation deducted

The sale value of the by-products is recognised as incidental income in the statement of comprehensive income.

By-products produced in a large volume are treated as joint products and valued accordingly.

Total production costs up to the point of separation are deducted from these to arrive at the profits.

Treatment of JP & BP at point of separation & joint process costs using net realisable values (NRV) & weight / volume of output

Valuation of joint products

Allocate joint costs in the ratio of the volume / weight of the products produced

Allocate the costs on the basis of the relative sales value (NRV) of the products

Estimated Sales Value at point of sale - Estimated Cost of Completion & disposal

These costs do not include any further procession costs


Benefit of further processing

Further processing of joint products Decision taken by companies is based on whether further processing generates incremental revenue / loss

Usefulness of product cost / profit data from a joint process

Advantages Limitations

Provides information on cost allocation between various joint products

Basis of split not reliable, and hence does not show true division of costs

Helps management to decide the sales mix and price of the products that are making a loss

Despite one joint product making a loss, it still has to be produced, as the other joint product has to be produced. Data may become useless.

Service Costing 83

Intro:- this Study Guide discusses the situations where the use of service costing is appropriate & the unit cost measures that may be used. It also explains service cost analysis in simple service industry situations.

Characteristics of service costing (SC) & situations where it applies

Service costingCharge for providing a facility / service

Characteristics of SC

Service output is intangible

Services are provided internal / external customers

Services are heterogeneous

Service provided is always produced & consumed at the same time

Services cannot be stored

Cost of labour & direct expenses > material costs

Procedure applied for determing the cost of the service provided

Situations where service costing applies

Consultancy

Transportservices

Leisure services

Canteens & hotels

Communicationservices

Electricity board

Hospitals

Technical services

Internal service cost centres


Practical problems relating to the costing of services

Example Department Units

Out patients department Per out patient

Casualty or emergency Per patient

Wards Per Patient, per bed

Medical service departments Per course of treatment per day or per person

General service department Per 100 articles laundered

Income received = average of each patient x total number of patients

Expert doctor’s fees

Salaries of permanent staff

Charges of caretaker and other services for patients to be a variable cost, as they are related to the number of patients

The treatment of the patient, for e.g. cost of other medical services such as X-rays, etc are treated as fixed costs.

Hospital

Service Costing 85

Suitable unit cost for variety of services & situations

Calculation of the per unit cost of service provided

provided service of units ofNumber service a providing in incurredcost variableTotal

=cost bleunit variaper of nCalculatio

provided service of units ofNumber service a providing in incurredcost fixed Total

=cost fixedunit per of nCalculatio

provided service of units ofNumber service a providing in incurredcost variable- semi Total

=cost variable- semiunit per of nCalculatio

1

2

3

Total unit cost

+

+

=

Nature of industry Cost measures

Tour operator, railway, bus companies Cost per passenger-mile

Hospital Cost per patient per day, per bed per day

Canteen Cost per meal served per person

Cargo transport Cost per tonne per mile

Electricity supply Cost per kilowatt-hours

Hotel Cost per room per day

Telecommunication Cost per unit time (e.g. per minute / second)


Variable costs Fixed Costs Semi-variable costs

Transport service charges

Fuel costs Salaries & wages Hire charges for vehicles

Lubricants Administrative costs

Additional supervisory costs

Maintenance & depreciation (if based on distance)

Annual maintenance charges & depreciation (if based on time)

-

Insurance costs -

Canteen costs

Provisions – Fish, poultry, vegetables, flour

Rent -

Services –Gas, electricity, power, lighting Depreciation -

Consumable stores – cutlery, cloths, glass wares

Other annual fixed charges

Administrative costs -

Cost/Volume/Profit Analysis 87

Contribution per unit (CPU), contribution/sales (C/S) ratio

Intro: this Study Guide explains & illustrates the concepts of contribution, break-even point (BEP), margin of safety & the effects on them due to changes in the selling price & cost

Sales -

= Contribution

Variable Cost (VC)

FC- = Profit

Marginal cost

equations

If any three factors are known, can easily calculate the fourth factor

An alternative measure of

profit

Cost-volume-profit (CVP) analysis: study the effects on future profit of changes in fixed cost, variable cost, sales price, quantity and mix

Objective of CVP Analysis to know the effect of fluctuation in activity volume on the financial results

Fixed cost

Decision Making 88

100 x Sales

nontributioTotal=C/S ratio

value

cCan use per unit value to calculate C/S ratio

Contribution to sales ratio

known as C/S ratio or profit-volume (PV) ratio

indicates profitability of business

High C/S ratio = High profitability

Remains constant if selling price (SP) and variable cost remain constant

Break-even & margin of safety (MOS), calculation of Break-even point (BEP) & MOS using CPU & C/S ratio

Break-even point (BEP)

� situation of no gains no losses

� total contribution = total FC

unitper onContributi

FC Total = units in sales BEP

ratioC/SFCBEP sales

in value SP x unitsinBEPOR=


MOS

difference between budgeted sales & BEP

MOS in absolute terms

= (Budgeted / Expected sales) – Sales at BEP

= MOS in absolute terms/Sales x 100

Margin of safety %measures soundness of business

slight fall in sales

Higher MOS

may not affect business

Lower MOS

slight fall in sales

may have adverse effect

on profit

Movement in price / cost

Effect on BEP

Selling PriceIncreases Decreases Decreases Increases

Variable CostsDecreases Decreases Increases Increases

Fixed CostsDecreases Decreases Increases Increases

expressed in value / as percentage

Effect on BEP & MOS of changes in SP & costs

Decision Making 90

Selling price is reduced

Other things remain

constant

Effect on MOS

Increased BEP

results in

Reduced MOS

Decreased BEP

Other things remain

constant

Selling price is

increased results

in

Increased MOS

Calculation of sales required to achieve target profit using CPU & C/S ratio

Target profit (TP): profit that the business expects to earn under the given circumstances in a budget period

CPU

TP)+(FC=volumesalesTarget

Target revenue = Target sales volume x expected selling price


0

BEP

Volume

FC V

C

Margin of safety Expected

sales

Rev

enu

e /

cost

Break-even & profit/volume charts for single product / business

The traditional break-even chart (TBC)

0

BEP

Volume

Con

trib

uti

on

Rev

enu

e /

cost

FC

The contribution break-even chart (CBC)

The only difference between TBC & CBC: CBC shows the VC line instead of the FC line

Advantage of CBC: contribution at the different levels of production is clearly understood

VC

Decision Making 92

0

BEP

Profit

Loss Volume

Pro

fit

Loss

Profit / volume (P/V) chart

OR contribution-volume graph

The basic feature: the vertical axis indicates profit and loss and the horizontal axis is drawn at zero profit / loss

Limitations of the break-even analysis

� Time consuming to prepare break-even chart

� Analysis can only be applied to single product / group of single mix of products

� Inventory is not taken into consideration � At all levels of output, it assumes: FCs are fixed / constant, VCs are same / fixed per unit SPs are fixed / constant

Advantages of P/V chart

Effect on profit & BEP, of any changes in VC, FC & SP can be clearly shown on P/V chart

Factors Affecting Short Term Decision Making 93

Importance of the limiting factor (LF) concept, LF in given situations

Intro: this Study Guide explains the importance of the limiting factor concept, optimal production solution, solving make / buy-in problems and the concept of relevant cost

Resources / Factors of production

Tangible / intangible inputs in the production process that are essential for production / rendering of product / service

resource which limits & restricts volume of production / factor which is in short supply

it might be raw material, labour, labour time / labour hours, machine hours

LM restricts indefinite expansion of production / service activity leads to restriction on earning, and limits infinite profits

Decision Making 94

Factors on which LF can be identified

� Supply of skilled labour, material � Factory space � Finance – working capital availability � Plant capacity � Market demand

If organisation is able to identify LF correctly from

these factors, it will be able to utilise the available

resources in an optimal way

Manufacturing single product

resources will be used for production of single product

Manufacturing multiple products

needs to decide on optimal product mix which will yield maximum profit

CPU of LF helps to set priority amongst products & identify quantity based on their contribution generating capacity

Importance of LM:

helps arriving at product mix that will lead to an optimal utilisation of resources


Optimal production plan

1. Calculate CPU of LF

2. Rank products in order of highest contribution

3. Draw schedule of production

4. Use balance hours in order of ranking

by using number of hours available for

maximum demand of first ranked product

Optimal production solution when there is a single resource constraint

Basic factors taken into consideration while

calculating product mix

� contribution each product makes to the profit � market demand for the product � units of LF consumed by each unit of product

The product which has the highest CPU is not necessarily the product with the highest contribution per LF

Steps

Decision Making 96

Factors that may alter the outsourcing decision:� Delivery lead time & quality of the outsourced company should match with the company standards � Outside supplier should be reliable enough to supply the correct quantity at the best price � Outsourcing will lead to resources being available for alternate use & these should lead to cost saving / incremental revenue � Outsourcing should not lead to client / customer / employee dissatisfaction since it will mean that company is not using its own expertise in making product

Make / buy-in decisions when there is single resource constraint

Make / buy-in decision

Based on comparison of � Purchase cost of the product

to be bought-in with � VC of the product to be

manufactured in-house

If purchased externally there will be savings in terms of FC, hence the decision is generally based on VC to a greater extent

Importance of LF in make / buy-in

decisions � analysis gives the best possible utilisation of the key resources � assists in identifying the products that will best be outsourced

generally taken when the business has fully utilised its capacity & the demand is still unfulfilled


If obsolete

If already purchased not relevant

current realisable value (RV)

RC for materials

If there is alternative use (AU) higher of their current RV & the value fetched from AU

If no RV & no other AU RC is nil

Relevant costs (RC), RC in business decision

Future cost costs pertinent to the making of a specific managerial decision

differ amongst the possible alternative courses of action

RC

FeaturesFuture cost: direct outcomes

of a decision Differential cost: difference in total cost between alternatives

Cash cost: reflect cash expenditure

Sunk cost: cost that has been incurred & cannot be reversed

Irrecoverable past expenditures hence

irrelevant indecision making

Decision Making 98

variable overheads (usually relevant)

fixed overheads (usually irrelevant)

� depreciation is never relevant even in situation where it

might have been charged on activity basis & classified as VC

� committed costs e.g. indirect labour

� if any FC is stepped up, increase in FC is relevant

� if part of FC can be avoided, reduction in FC is relevant

RC for overhead

RC for labour If existing workforce idle not relevant

relevant

If outside labour is hired

to the extent of higher of:

(i) amount payable to the workforce if engaged in other jobs &

(ii) amount payable if labourers are hired

If hired out for specific job

amount is contribution loss when labour is scarce & cannot be hired out &

overtime is not possible

Principles of Discounted Cash Flow 99

Difference between simple & compound interest (SI & CI) rates & nominal & effective interest (NI & EI) rates, compounding & discounting, annuity & perpetuity

Intro: this Study Guide explains interest rates, net present value and internal rate of return methods to discount cash flows

Interest � amount of money earned / payable during the period of

investments made / money borrowed � money charged by a lender to a borrower � compensates the lender for the risk that the borrower may

not return the money

� the value at a future date

� calculated for an amount invested today

� calculated at simple or compound interest

Simple Compound

interest payable / earned on fixed amount in equal amount of money every year FV = PV + nrPV

interest earned / payable on capital amount inclusive of interest earned every year

FV = PV (1 + r)n

PV = Principal amount invested r = rate of interest n = no. of years FV = future value

Difference between SI & CI

Calculated on original principal

lower returns

Calculated on original principal + interest accumulated

higher returns

FV

Decision Making 100

EI

rate

NI

rate

� does not take inflation into account � also called the real interest rate

� takes inflation & EI into account � also called the money rate of return

Both can be calculated by the following formula: (1 + m) = (1 + r) (1 + i) Where: m = money rate r = real / EI rate i = inflation rate

Compounding

PV

Where, FV = Future value PV = Present value r = rate of interest n = term in periods Discounting

FV nr)(1

1FV X =PV

proceeds from PV to calculate FV

proceeds from FV to calculate PV

Opposite terms

Where, A = fixed amount invested annually r = rate of interest n = term, number of periods

Annuity

Constant cash flow that occurs annually

Ar

1)r)((1A x FV

1n

formula gives FV for each year separately, which are then added together


Perpetuity Annuity that is to be received / paid indefinitely into future, i.e. forever

rA

perpetuityofPV

Where, A = amount of perpetuity r = rate of discounting (expressed as a decimal)

Distinction between cash flow & profit, relevance of cash flow to capital investment (CI) appraisal

inflow & outflow of money from operating, financing & investing activities

cash flow statements are prepared on cash accounting basis

residual amount that remains after all the expenses are subtracted from the sales revenue

SOCI is prepared on accrual basis

Difference between cash flow & profit

CI decision � taken in view of expecting more funds back in the future � should be based on relevant cash flows for decision making

If the project’s cash returns are positive, it is financially viable & should be accepted

Decision Making 102

Net present value (NPV) & internal rate of return (IRR) methods of discounted cash flow (DCF), payback (discounted & non-discounted) & their results

NPV � difference between amount of initial investment (II) & sum of discounted cash flows

� calculated to make the cash flows at different dates comparable

NPV = PV of cash inflows – PV of cash outflows

� can accept all the independent projects with positive NPV / competing projects with

highest NPV

� target rate of return should be more than / equal to the cost of capital

Projects that have a positive & maximum NPV & IRR should be selected

Timing assumptions /

conventions relating to

NPV calculations

� initial cash outlay incurred = zero � all transactions during a period as occuring at the end of the

period � transactions occuring at the beginning of the year

considered as occurred in the previous year


IRR � required rate of return / cost of capital which produces an NPV of zero when used to

discount the projects cash flow � when used, the present value of outflow & present value of inflow will be equal

When projects are identical:table of cumulative present value factors can be used

methods When projects are not identical: interpolation method is to be used (NPV at two discount rates)

a = lower of two rates of return used b = higher of two rates used A = NPV obtained using rate a B = NPV obtained using rate b

a)%(b x B-A

Aa=IRR

Decision rule

NPV

IRR

Accept projects with positive NPV or the project with the highest NPV in case of competing projects

Accept projects where IRR is greater than company’s cost of capital or target rate of return

All other projects are rejected

Decision Making 104

Payback period

� Expected amount of time a project will take to pay back the initial investment

� Initial investment/Annual cash inflow

calculated by identifying the point at which net cash inflows = cost of initial investment

Advantages Disadvantages

simple to understand & easy to calculate doesn’t take time value of money into consideration

quick cash flow returns on initial investment help in maximising liquidity & minimising risk

ignores profitability

Superiority of DCF methods

over Non-DCF methods

� give appropriate importance to timing of cash flows, uncertainty factor

� use appropriate discount to consider time value of money

� consider all relevant cash flows of a project

DCF Non-DCF

� ignore timing of cash flows � ignore time value of money � in payback method some cash flows

are ignored

Decision rule

Simple & discounted payback

amount of time expected to make cash inflows from II = cash outflows should be accepted

Nature of Cash and Cash flow

Intro: this Study Guide discusses the sources and applications of cash inflows and cash outflows

105

Cash and cash flows

Cash It is the money available in the form of currency notes & coins with the entity.

Cash Flow It is the amount of money received and paid by an entity during a period of time.

Reasons Examples of cash receipts

Examples of cash payment

Operating activities Sales, receipt from insurance claim.

Payment to suppliers & employees

Investing activities Sale of property, plant & equipment

Purchase of property, plant & equipment

Financing activities Sale of shares, debentures & bonds

Buyback of company shares

Cash Management 106

Various sources of cash receipts & payments (including regular/exceptional revenue revenue/capital receipt & payments, & drawings)

Capital receipt These are the long term funds in the business

These receipts takes place when, � Sells its long term securities � The sole traders & partners

decide to increase the capital � Sells its non current assets These payments takes place

when,� Purchase of non-current

assets� Increase in the capacity or

life of non-current assets owned by the business

These are the long term funds in the business

Capital payments

Exceptional receipts & payments are the cash transactions that do not occur at regular interval. It significantly affects the cash flow of the business e.g. legal fees for defending intellectual property & cash received against claim for fire in the factory.

Drawings : it refers to the withdrawal of funds from the business by the sole trader or partner

Nature of Cash and Cash flow 107

Relation between cash flow accounting and accruals accountingAccrual system of accounting

recognises the effects of transactions and other events as and when they occur

Cash accounting system

recognises income when it is actually received as cash and expenses when they are actually paid

Cash accounting system Accruals accounting system

Income is recognised when it is received. Income is recognised when it is earned.

Expense is recognised when they are paid. Expenses are recognised when they incur.

Is based upon the cash flow of the business. Does not consider cash flow of business. Does not treat capital and revenue items differently. Capital and revenue items are treated differently.

Ignores non-cash items e.g. depreciation. Considers non-cash items e.g. depreciation

Does not follow matching principle of accounting. Follows the matching principle of accounting.

Cash book is the principal book of accounts Business has to maintain journal and ledger

not accepted as good accounting practice considered as a good accounting practice

Cash Management 108

Cash flow pattern of different types of organisationca

sh fl

ow p

atte

rn o

f diff

eren

t typ

es o

f or

gani

satio

n

Construction

Education

Woolen wear

Electronic games

Grocerystores

This type of company usually has to spend huge amount of cash at the time of bidding to win contract & the cash inflow is linked to the progress of the project.

The college pays salary to its lecturers and staff at regular intervals. Hence, the college has a huge cash surplus at the beginning of the course / academic semester and the cash surplus reduces gradually as the course / academic semester progresses.

Most of the sales for such a business will take place at the beginning of the winter season. Hence, for a woollen wear manufacturer most of its cash inflow will take place between the middle and the end of the winter season.

Such business incur heavy cash outflow at the development stage of the product & cash inflow takes place when product is sold

These businesses have cash inflow every day on which they are open and payment for goods are made the end of credit period.

Nature of Cash and Cash flow 109

Importance of cash flow management & its impact on liquidity & companysurvival

Impact of cash flow management on the liquidity

Impact of cash flow management on the survival of company

� Cash is needed regularly for all activities. If adequate cash is not available on time, the day-to-day operations may be hampered.

� Payables and banks are interested in cash flow figures. The management has to remember that their performance will be judged from this angle also, and ensure good cash flow management

� The survival of an entity depends upon its ability to generate cash fromoperations.

Cash Management 110

Cash Management

Intro: this Study Guide discusses the cash management for business as well as public organisation.

111

Basic treasury function

Treasury function ensures that the organisation has sufficient capital to fund its operations and place any excess money into viable investment options

Rol

e of

tre

asur

y de

part

men

t

Corporate finance

Risk management

Foreign currency management

Insurance

Liaison with bank

Cashmanagement

Fundingmanagement The treasury function of an entity includes:

� managing the cash flow � arranging working capital � arranging funds for lowest possible cost � Investing surplus cash to get return

Cash Management 112

Cash handling procedure

Cash handling includes the receipt, storage, payment and banking of entity’s cash

Methods of handling & storing money (cash or cheque)

� Controlling cash received from cash sales

� Controlling cash received in the mail

� Separation of the duties

Other security aspects of handling & storing money

General security measures

Keeping cash on site

Moving cash around

Cash Management 113

Management of cash balances in public sector organisation

Investment guidelines for public sector organisation suggest the ways through which a public sector organisation must invest its surplus funds.

� A public sector organisation must not take huge risks with the surplus money available with it because the surplus money available with it is ‘public money’.

� Taxes are the major source of receipt for local authorities. These funds collected by local authorities are held in short term securities and are spent when needed.

Legal restrictions on local authorities for making investments

Borrowing funds: section 43 of the Local Government and Housing Act empowers local councils to borrow money. Lending funds: according to section 111 of the Local Government Act 1972, to carry out their duties, the local authorities are empowered to lend their surplus funds.

Cash Management 114

Impact of economic & financial environment on management of cash balances Ec

onom

ic &

Fin

anci

al f

acto

rs

Interest rate

Exchange rate

Level of taxation

Inflation

Firms that borrow funds are obliged to pay interest on their debts which would fall due within one year. Thus, a change in the interest rates of borrowing or investing will effect on cash management

Cash flows of organisations involved in export / import trade or operations in international arena would be affected by movements in exchange rates of the domestic country or of the other trading nation.

A higher tax rate would mean that firms would have to maintain higher cash balances to fund the same. When tax rates go down, firms can hold lower amount of cash.

Periods of inflation reduces the real value of money held by an organisation

Cash Budgets

Intro: this Study Guide talks about the general principles of cash budget & help the organisation to prepare cash budgets for different scenario.

115

Objectives of cash budgeting

A detailed forecast of the anticipated cash inflows and outflows over a period of time is known as cash budget.

Objectives of cash budget

� To maximise income from other sources � For managing its liquidity position � To minimise the cost of funds � To manage foreign currency risk � To implement financial controls � To prepare and monitor long term plans � For appraising projects � To manage working capital � To identify weakness in cash management

Cash budget / forecast

A cleared fund forecast shows the expected amount of actual funds that may be available with an organisation in the short term.

Clear fund forecast allow the organisation to effectively predict & manage its cash surplus & cash deficit

Cash Management 116

Use of cash budget as mechanism for monitory & control

Monitoring cash flows

The management can compare the forecasted cash flows with the actual cash flows over a several time scale say weekly, monthly & quarterly. The duration for which the review dependent upon: � Timing of cash inflows & outflows � The nature of industry � the assumptions that the organisation has made

for raising finances to satisfy its cash deficit

Cash flows control

Control over receipts Control over payments

� Payment from trade receivables � Income from investments

� Routine payments not related with activity level e.g. office rent, interest charges, salaries of senior managers etc.

� Routine payments related with activity level e.g. payment for raw material, wages to labourers, sales commission etc.

Cash Budgets 117

Statistical techniques used in cash forecasting including moving averages & allowance for inflation

A cleared fund forecast shows the expected amount of actual funds that may be available with an organisation in the short term.

Obtain information from various sources

Fill in various information collected in Step 1.

Make the various calculations to find the daily book balance.

Prepare the pro forma of cleared fund forecast

1

2

4

3

Steps to prepare cleared fund forecast

Cash Management 118

Investing and Financing

Intro: This Study Guide will help you to understand the various sources of surplus and different ways in which it can be profitably, but safely parked till it is finally used for its intended purpose

119

Type of short term investment and the associated risks/ returns

Types of short term investment

Bank deposits

money-markets deposits

local authority short term loans

certificates of deposit

government stocks

Cash Management 120

Different ways of raising finance from a bank

Categories of bank loans

Type of credit

Borrowing Frequency

Amount Disbursement Maturity Example

Short term financing Short term loans

One time or occasional

Face value of note

One time for the full amount of loan given

Decided at the time of approving loan, Maximum one year

90-day note

Uncommitted line of credit

Seasonal or periodic

Various amounts up to the line limit

Restricted to one draw or may permit borrowing,repayment and re-borrowing.

Repayable on demand

Foreignexchangelines are usuallyuncommitted

Committed line of credit


Various amounts up to the line limit, some sub-limits may apply

Permits borrowings, repayment and re-borrowing

Amountoutstanding is repayable on maturity date

Accountsreceivables

Investing and Financing 121

Long term financing Revolving credit


Variousamounts up to the line limit, some sub-limits may apply

Permits borrowings, repayment and re-borrowing

Outstanding amounts due on maturity date, more than one year from effective date

Accountsreceivable, Inventory financing

Term loan One time or occasional

Face value of notes or increasing in increments up to the face value of the note or commitment

One time for the full amount of loan or periodically, as agreed

Specific maturity with set repayment schedule, longer than one year

Mortgage term loan

Ways to categorise bank loans: � On the basis of the need to obtain the loan e.g. operating term loans and interim loans. � On the basis of payment terms e.g. instalment loans and bullet loans � On the basis of period-of-payment-terms e.g. short term loans and long term loans � On the basis of security e.g. secured loans and unsecured loans � On the basis of interest payment terms e.g. simple interest loans and balloon loans

Cash Management 122

Spreadsheet system Overview

Into software defined columns

Intro: this Study Guide helps you understand the various applications & uses of spreadsheets in management accounting & data processing

123

Spreadsheet system

Spreadsheet: a worksheet, contains rows & columns & is used to record & compare numerical or financial data

Role of spreadsheet system

Summaries

Recording, analysing,manipulating etc.

From many sources in one place

Presents

In a collective form

Organises Simplifies

Role of Spreadsheets in Management Accounting

� Budgeting, forecasting and planning are some of the functions that the cost and management accountants have to perform.

� In fulfilling all these functions they have to prepare complex reports calculating costs, sales values, profitability, trend analysis, past statistics etc.

Spreadsheet 124

Preparation of monthly MIS report showing various calculations for the salaries paid to the staff, components, deductions etc.

Application of computer spreadsheet in management accounting

Budgets Financial statements

Internet calculation Consolidation Cash flow

projection

Advantages and limitations of spreadsheets

Advantages Disadvantages

Its makes performing calculation & editing data very slow & eliminates any errors in calculation

Some critics of spreadsheet have found that some large models contained errors of a critical nature

It makes analysis, reporting and sharing of financial information information easy

Formulae are not visible immediately under the figure for which the formula is given

The Excel program can be mastered very easily Spreadsheet are only suitable and feasible if there is large amount of data

Spreadsheet reports looks very complicated

Using Computer Spreadsheet 125

Intro: this Study Guide, we will dig further deep into the useful functions that can propel computer spreadsheets as versatile business application software

Numerical & other information is needed in spreadsheets & its structure

Data or information within one or more cells can be structured in various ways, including numerical calculations, sorting, filtering, formatting, etc.

Agenda

Spreadsheet templates

Books

Memos

Reports

Reciepts

Timesheet

Budgets

Calenders

Inventories

Invoices

Projects

Entering & Editing Information in an Excel

Entering Data

Excel Comments

Coping & Pasting

Using auto Complete

Using Autofill

Excel formula Error Checker

Editing Data

The process of entering and editing information

Spreadsheet 126

Formatting tools

Formatting is useful for helping the reader to read & understand the data in workbook

The format cells dialog box contains tabs to control formatting for Number, Alignment, Font, Border, Patterns and Protection.

Wide range of formulae to meet calculations

� A formula in a spreadsheet is defined as how a content of one cell is calculated with the contents of another cell or with multiple cells in a sheet the formula itself and the resulting value

� Formulae is one of the most commonly used features of spreadsheets.

Arithmetical Functions

AdditionMultiplication Subtraction Division Average

Formula starts with TWO steps

Select the cell where you want the formula's result to be

displayed

Type an equal sign ( = ) in that cell to let Spreadsheet know you

are creating a formula

Using Computer Spreadsheet

Errors in formulae

#DIV/0!#NULL!#REF! #NAME?#VALUE!

When a spreadsheet

formula contains

incorrect cell references

When the two or more cell

references are not separated correctly in a

formula.

if formula includes cells that contain

different data types.

When Excel does not

recognise text in a formula

when a formula

attempts to divide any

figure by cell containing zero or a blank cell.

Describe how data from different sources are linked and combined

Different data of spreadsheets can be linked to other worksheets, PowerPoint & WORD. The main purpose of linking data is to summarise & report results from separate worksheets into a master worksheet

Multiple worksheets data consolidation in a master worksheet can be consolidated by formula

127

Spreadsheet

Describe how spreadsheet files are stored & retrieved

When the data is entered in the spreadsheet, one may require the same for use in future or may just need it as a reference in future. It is, therefore, necessary that the spreadsheet is saved as a soft file & retrieved as & when required in future.

The storing of a spreadsheet file is called as “file saving” process. The steps are as follows:

The steps are as follows

Choose the place/folder where you want to save the file

Click ‘save’ or ‘save as’ button

Choose the version of the file format you want to save the file in.

Click ‘file’ from the menu bar

Click Save

Methods of inserting and linking Excel object Word � Copying and pasting from an Excel into Word � Linking an Excel sheet into Word

128

Presenting Information in Spreadsheet

Intro: this Study Guide explains how the spreadsheet software like Excel is filled with a lot of tools which enable the user to quickly understanding the data and decision making

129

Methods of summarising and analysing spreadsheet data

Methods

Sorting: data can be sorted by text numbers, and dates and times in one or more columns.

Ranking: this function returns the rank of a number within a set of numbers for eg. (number, array, and order)

Filter: to show just what you want to see and hide the rest e.g. information about customers, products, sales revenues, etc.

Describe and interpret charts and graphs

Graphs Line graph usually used to demonstrate trends over a period of

time

Scatter graph

usually used to demonstrate how two variables relate to one another

Spreadsheet 130

Charts Bar Chart a graphic representation of a set of values shown as a

series of rectangles

Pie chartusually used to compare a segment with the whole pie rather than comparing various segments among themselves.

Print information including page layout

Points to be considered while printingBefore giving print command to a worksheet containing large quantities of data or charts, one can quickly fine-tune the worksheet in the Page Layout view to achieve professional-looking results.

Additional properties:� Preview worksheet pages before printing � Print a worksheet in landscape or portrait orientation � Insert, move, or delete manual page breaks in a worksheet � Use headers and footers in worksheet printouts