Lecture notes, Accounting and Finance Fundamentals Core PDF

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Chapter – 1 Cost and Managerial Accounting Financial Accounting VS Cost Accounting VS Management Accounting Financial Accounting: Financial Accounting is that part of accounting in which we record the transactions as per accounting cycles and make the financial statements. Financial statements provide information of profitability and financial position to the external parties for decision making. Financial statements include Income statement, stockholders’ equity, balance sheet, and statement of cash flows. External parties include stockholders, suppliers, debtors, banks, government agencies, etc. Purpose of Financial statements The purpose of financial statements is to provide information about the performance of the company over the period, company’s financial position on a particular date, reasons of changes in stockholders’ equity over the period (month, or quarter, or year), and cash flows of an enterprise over the period (month, or quarter, or year) to outsiders for their decision. Cost Accounting Cost accounting is that part of accounting concerned with the determining and accumulating the cost of products or processes, or activities. Example- Standard costs and V/S actual costs of operations or products, Job order wise costs, determination of process costs, establishment of Budget, etc. Purpose of Cost Accounting The purpose of cost accounting is establishing budget and actual cost of operations, processes, departments or products and the analysis of variances. Managers use cost accounting information to support decision making or to reduce a company's costs and improve its profitability. Management Accounting Management accounting is the field of accountancy concerned with the preparing of management reports with the help of financial accounting and cost accounting in order to assist internal management in formulating strategy, future planning and controlling activities.

Management reports are generated monthly or weekly or even on daily basis for organization's internal audiences such as chief executive officer, CFO, departmental managers, etc. Examples- Cash available report at month end, Number of orders in hand, Status of accounts payable and accounts receivable, Outstanding debts, Trend charts, Wastage report, Yield report, break even point, etc. Purpose of Management Accounting The purpose of management accounting is to provide managers with financial and statistical information which will help them to carry out their responsibilities efficiently.

Cycles of Financial Accounting In financial accounting, we pass the journal entries. Then, we make the ledger accounts. Then, we prepare the unadjusted trial balance. Then, we make the adjusted trial balance. Then, we make the final accounts. Then, we make the closing entries. Then, we make the post closing trial balance finally. That will be ready for next year’s entries. Cycles Cost Accounting In cost accounting, we first calculate the raw material cost. Then, we calculate the labor cost. After this, we calculate the overhead cost. All these cost are added. A profit margin is added. An estimated sale price is calculated. Its whole controlling cycle will also control the cost of raw materials, labor, and factory over head. Difference between Financial Accounting & Management Accounting Particulars

Financial Accounting

Management Accounting

• Normal Users

External parities

Internal management

• Freedom of choice

Mandatory

Complete freedom

Past historical data focus

present and forecasted data focus

• Degree of precision

Objectivity principle

More subjective

• Accounting Entity

Normally whole firm

Normally firm’s segments

Main time frame focus

• Reporting frequency

Well defined Time table

As needed - daily, weekly, monthly.

• Rules

Drafted according to GAAP

Drafted according to management suit

Chapter – 2 Cost concepts, Classifications and Financial statements  Costs concepts: An amount that has to be paid or given up in order to get something. In business, cost is usually a monetary valuation of (1) effort, (2) material, (3) resources, (4) time and utilities consumed, (5) risks incurred, and (6) opportunity forgone in production and delivery of a good or service. All expenses are costs, but not all costs (such as those incurred in acquisition of an income-generating asset) are expenses ………………….. • Classification of Costs: The costs are classified on different approaches, these approaches are as under: 1. Classification of cost with respect to general According to this classification, costs may be divided into (i). Manufacturing (ii).Non manufacturing costs (i).Manufacturing costs: All manufacturing costs are product costs. The manufacturing costs include,

• • •

Direct materials, Direct labor, and Manufacturing overheads.

• Direct materials: The materials that go into the final product are called direct materials. The Direct materials are those materials that become an integral part of finished product & whose cost can conveniently be traced or charged to the finished product Thus those costs which can be directly identified with a job, batch, product or service. Examples: Cast iron used in manufacturing the body of Aero plane or Motor Car, Transformer used in UPS, etc. • Direct labor: Direct labor cost consists of labor that can easily (i.e., physically & conveniently) be traced to individual units of product. Direct labor is also called touch labor, as direct labor workers normally touch the product while it is being made. Examples: Assembly line workers of Vehicle assembly, Electricians who install electric wires on an Aero plane, etc. • Manufacturing overhead: Manufacturing overhead is the all costs of manufacturing expenses except Direct material & Direct labor. These costs cannot easily be traced to the individual units of product. Examples: Depreciation, Property tax, Maintenance & repairs, Insurance, etc. (ii).Nonmanufacturing costs: Non manufacturing costs are often divided into three groups, called • Selling and marketing costs, • Administrative costs, • Financial costs. • Selling and Marketing expenses: Selling costs include all costs that are incurred to secure customer’s orders and get the finished products to the customers. These costs are also called order getting & order filling costs. Examples: Advertising, shipping, Sales commission, sales travel, Sales salaries etc. • Administrative expenses: The administrative costs include all costs associated with the general management of an organization rather than manufacturing or selling.

Examples: Administration & office salaries, Legal expenses, auditing expenses, etc. • Financial costs/charges: The financial charges include bank’s interest expenses against long term & short term loans & other miscellaneous charges of banks. 2. Classification of costs with respect to cost behavior Cost behavior refers to how a cost reacts by changes in volume or output. As the activity rises or falls, a particular cost may rise or falls as well - or it may remain constant. According to this classification, costs may be divided into the following: • Fixed costs: The cost, which remains constant regardless of production over a wide range of business activity. • Examples: Depreciation of Plant & Machinery, Factory insurance, Supervisory salaries, etc. • Variable costs: The costs, which tend to vary by the change in volume or out put. • Examples: Direct materials costs, Direct labor costs, Fuel, etc. • Semi variable costs: The costs, which contain both type of characteristics. i.e. . partly variable & partly fixed in nature. • Examples: repair and maintenance of machinery, utility bill, etc. 3. Classification of costs with respect to cost objects A cost object is anything for which for which cost data are required. Any activity for which separate cost data are required for its measurement or valuation. Examples are: Product’s cost, job’s cost, etc. For the purpose of assigning costs to cost objects, costs may be divided into the following: • Direct cost: Those costs, which can easily be identified with a job, batch, product or service. Examples are: direct materials, direct labor, etc. • Indirect costs: Those costs, which cannot be identified with a job, batch, product or service, but have to be charged to jobs, batch, and product on some appropriate basis. Examples: Indirect materials, Indirect labor, indirect expenses, plant insurance, depreciation of plant, etc. 4. Classification of costs with respect to Decision making According to this classification, costs may be divided into following categories:  Differential cost Differential cost is the cost difference between the two alternatives. It is also called the incremental cost. Example: The cost involves in producing one more unit of product.

 Opportunity cost: Opportunity cost is the potential benefit that is given up when one alternative is selected over another .  Sunk cost: Sunk cost is a cost that has already been incurred and that cannot be changed by any decision made now or in future. Example: You bought an automobile that cost Rs 1,000,000 two years ago. The cost Rs 1,000,000 is sunk cost because whether you drive it, park it, trade it or sell it, you cannot change Rs 1,000,000 cost.  Relevant costs: A relevant cost is a future expected cost that will change among the alternative choices. Example: If management decides to purchase alternative Machine & energy consumption changes on this alternative choice, then the energy consumption is the relevant cost on this decision.  Irrelevant costs: The cost that will not vary among the alternative choices. Example: If material consumption on two different alternative choices is the same, then the material consumption on these alternative choices is irrelevant. 5. Classification of costs with respect to product costs versus period costs.  Product costs: Product costs include all costs involved in making the product. In case of manufacturing a product, these costs consist of direct materials, direct labor, and manufacturing overhead. Thus product costs are similar to manufacturing costs.  Period costs: Period costs are all those costs that are not product costs. Thus period costs are similar to non manufacturing costs. 6. Classification of costs with respect to planning and control and other basis. According to this classification, costs may be divided into the following sub groups:  Standard cost: It is defined as, predetermined cost to manufacture a single product or number of products in immediate future.  Budget: It is defined as, future plan expressed in financial/numerical and quantitative terms. Examples are sales budget, production budget, raw materials purchase budget, etc

 Controllable costs: Cost which can be adjusted & controlled at a given level of activity during a specified period of time. Example: The manager of producing department can control abnormal production losses.  Uncontrollable costs: Cost, which cannot be adjusted & controlled at a given level of activity during a specified period of time. Example: The depreciation on a particular machine is uncontrollable by the department once the machine has been purchased.  Prime costs: Direct materials consumption + Direct labor  Conversion costs: Direct labor + Manufacturing overhead ………………..  Financial statements Financial statements, include, income statement, statement of Owners’ or stockholders’ equity, Balance sheet, & cash flow statement. These financial statements are prepared from the analysis of business transactions during the period/year. We will discuss here only Income statement in detail. Income statement: The income statement measures the performance of the firm over some period of time, usually a month or a quarter or a year. The first thing reported in income statement is revenue .i.e. sales and then expenses relating to the firm’s principal operations .i.e. Cost of goods sold, operating expenses [Administration and marketing & selling expenses]). Subsequent parts include financial charges, such as interest expenses and other revenue and expenses, such as interest income earned, gain or loss on sale of fixed assets, etc. Taxes are reported separately. The last item is net income. The general format of income statement is as under: XYZ Company Income statement For the year ended December31,2013

Rs

Rs xx

Net Sales Less: Cost of goods sold (see schedule) xx Gross profit xx Less: Operating expenses: Marketing and selling expenses : xx : xx xx Administrative expenses : xx : xx xx Total operating expenses xx Operating profit xx Less: Financial charges (if any) xx Profit before other revenue & expenses items (if any) xx Add: other revenue items (If any and to be indicated) xx Less: other expenses items (If any and to be indicated) -xx Net addition or deduction ± xx Profit/ (Loss) before taxation ± xx Less: provision for taxation xx Net profit (after tax) xx ===== The general format of Cost of goods Sold is as under: XYZ Company Cost of Goods Sold Statement For the year ended December31, 2013 Direct raw material consumption: Opening inventory Purchases Add freight in Gross purchases Less: purchases returns Purchases discount Net purchases Raw materials available for production Less Ending Inventory of raw materials Direct raw materials consumed

Rs.

Rs. XX

XX XX XX -XX -XX

- XX XX XX - XX XX

Direct Labor Manufacturing overhead: Indirect labor Depreciation on plant & machinery Electricity charges plant .. .. Total manufacturing cost for the period Add WIP Opening Total WIP Less WIP closing Cost of goods manufactured

XX XX XX XX XX XX

Add cost of Opening finished goods inventory Total cost of goods available for sale Less cost of closing finished goods inventory Cost of Goods Sold

………………………..

XX XX XX XX - XX XX

XX XX -XX XX ====

Chapter 3

Contribution margin: The contribution margin is defined as, the amount left after deducting the variable expenses from the revenue.

Sales, Variable expenses, and Contribution margin are expressed on a per unit basis and as well as in total. Contribution margin is used first to cover fixed expenses and then whatever, remains goes towards profit. If contribution margin is not sufficient to cover fixed expenses, then a loss occurs for the period.

Break-even point/Sales: It is the sales units or sales in rupees at which company neither gets a profit nor suffers a loss.i.e.zero level of profit.

Margin of safety point/Sales: The Margin of safety point indicates/depicts that how much sales may decrease before the company will reach at a break even point.i.e.before the company will suffer a loss.

Following topics are covered in this Chapter.

1. Determination of Contribution margin per unit & Contribution margin ratio – single products.

2. Determination of Contribution margin per unit & Contribution margin ratio – Multiple products.

3. Determination of Break- even point/sales- Single products

4. Determination of Break- even point/sales- Multiple products.

5. Determination of Margin of safety point/ Sales.

6. Determination of sales level at Projected Profit (Before tax).

7. Determination of sales level at Projected Profit (After tax).

8. Operating Leverage ratio

Now we will discuss each above one by one on next pages

1. Determination of Contribution margin per unit & Contribution margin ratio – single products. We know that Contribution margin-Rs. = Total Sales – Total Variable costs. (a). Contribution margin per unit - Rs = sales price/unit – Variable cost/unit

(b). Contribution margin Ratio = Selling price per unit – variable Cost per unit Sales Price per unit Or, it can also be determined by

Contribution margin Ratio = Total sales – Total variable costs Total sales

2. Contribution margin per unit & contribution margin ratio – Multiple products: For finding out the contribution margin ratio of multiple products, we have to calculate the weighted average Contribution margin ratio of multiple products. It can be explained & calculated by the following illustration:

Suppose there are three products, A, B, C A Sales= 8000 units@ Rs80, B Sales= 7000 units@ Rs90, C Sales= 5000 units@ Rs95 A variable cost = Rs50/unit, B variable cost = Rs52/unit, C variable cost = Rs55/unit

Solution: Products -A Total sales – units

8,000

Product -B 7,000

Products -C 5,000

Selling price per unit -Rs Total sales value –Rs

80 640,000

Variable cost per unit-Rs

50

Contribution margin per unit -Rs

90 630,000

95 475,000

52

30

55

38

40

Therefore, weighted average Contribution Margin ratio of multiple products:

8,000 x 30 + 7,000 x 38 x 5,000 x 40 8,000 x 80 + 7,000 x 90 + 5,000 x 95

706,000

= 0.4046

1,745,000

3.Break- even point/ Sales- single products:

(a).Break even point/sales(units)-Single products

=

Total fixed cost ………………

Sales price per unit - Variable cost per unit

(b). Break –even point/Sales- (Rs)-Single products = Total Fixed costs Contribution margin ratio

4. Break even point/Sales - Multiple products :

Most companies have many products, and often these products are not equally profitable. For finding out the break-even point of each product, we first have to calculate the Breakeven point/ sales in units or in rupees of multiple products (on overall basis). The formula for calculating BEP is given below: Total Fixed costs

(a).Break-even pt/ Sales (units)-multiple products = (Over all) Wt.Average. Contribution Margin ratio of multiple products*

*Calculation of it we have already discussed above (see serial # 2 above) Now we may find out the Break-even point (Product wise) in Rs from the above figure obtained by just multiplying the Sales proportion (based on sales units) of each product respectively.

Further the above product wise Break-even point (in Rs) will just be divided by their respective unit price to get the “Break- even point in units (product wise). Moreover, if we add up Break-even point of product wise (rupees), then we will get Breakeven point sales (in total) in rupees.

5. Margin of Safety Sales:

(a). Margin of safety Sales – Rs. = Total Budgeted or total given sales figure (Rs) – Break even sales figure (Rs)

(b). Margin of safety sales -Units =Total Budgeted or total given sales (in units) – Break even sales (in units)

(c). Margin of safety Ratio:

Budgeted sales Figure – Break-even sales figure Budgeted Sales figure

6. Determination of sales figure at Projected profit(before tax):

(a) Sales figure at Projected profit (Before tax) -Rs (before tax)

= Fixed Costs +Projected profit

Contribution Margin ratio

►Note: 1: if, there is a projected loss, this loss will just be deducted in above formula

►Note: 2: In case of multiple products, we will take weighted average Contribution Margin ratio of multiple products.

7. Sales figure at Projected profit (after tax) - Sales:

Fixed Costs + Projected profit (after tax) (1- Tax rate) Sales figure at Projected profit (after tax)- Rs = Contribution Margin ratio

Note: In case of multiple products, see above note: 2 (of serial # 6).

8. Operating Leverage ratio

It can be defined as; a quant...