A TEXTBOOK OF FINANCIAL COST AND MANAGEMENT ACCOUNTING

A TEXTBOOK OF FINANCIAL COST AND MANAGEMENT ACCOUNTING Dr. P. PERIASAMY, M.B.A., Ph.D., Reader, Department of Business Management, ' Erode Arts College, Erode - 638 009. Kat GJIimalaya CJlublishingGJIouse MUMBAI DELHI NAGPUR BANGALORE HYDERABAD

AUTHOR No part of this publication should be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical. photocopying, recording' and/or otherwise without the prior written permission of the author and the publisher. ' Revised Edition: 2010 Published by Branch Offices: Delhi Nagpur Bangalore Hyderabad Printed by Mrs. Meena Pandey for HIMALAYA PUBLISHING HOUSE, "Ramdoot", Dr. Bhalerao Marg, Girgaon. Mumbai - 400 004. Phones: 23860170& 23863863, Fax: 022-23877178 Email: himpub@vsni.com Website: www.himpub.com "Pooja Apartments", 4-B, Murari Lal Street, Ansari Road, Darya Ganj, New Delhi - 110 002. Phone: 23270392, Fax: 011-23256286 Kundanlal Chandak Industrial Estate, Ghat Road, Nagpur - 440 018. Phone: 2721216, Telefax: 0712-2721215 No. 16/1 (Old 1211), 1 st Floor, Next to Hotel Highlands, Madhava Nagar, Race Course Road, Bangalore - 560 001. Phones: 22281541 &22385461, Fax: 080-22286611 No. 2-2-1 167!2H, 1st Floor, Near Railway Bridge, Tilak Nagar, Main Road, Hyderabad - 500 044. Phone: 55501745, Fax: 040-27560041 Geetanjali Press Pvt. Ltd. Kundanlal Chandak Industrial Estate, Ghat Road, Nagpur - 440 018.

CONTENTS I (1) ACCOUNTING PRINCIPLES AND CONCEPTS 1-6 Meaning and Scope of Accounting - Definition of Accounting - Steps of Accounting - Functions of Accounting - Objectives of Accounting - Book keeping - Limitations of Accounting; Branches of Accounting; Accounting Principles - Accounting Concepts - Entity Concept - Dual Aspect Concept - Accounting Period Concept - Going Concern Concept - Cost Concept - Money Measurement Concept - Matching Concept - Realization Concept - Accrual Concept - Rupee Value Concept; Accounting Conventions - Conventions of Disclosure - Convention of Conservatism - Convention of Consistency - Convention of Materiality - Questions. (2) DOUBLE ENTRY SYSTEM OF ACCOUNTING 7-12 Meaning - System of Accounting - Cash System - Mercantile System - Mixed System - Single Entry System - Double Entry System - Advantages - Factors Common to Every Business; Types of Accounts - Personal Accounts - Real Accounts - Nominal Accounts; Accounting Rules - Debit Aspect - Credit Aspect - Problems and Solutions and Exercises - Questions. (3) ACCOUNTING BOOKS AND RECORDS 13-89 Introduction - Meaning of Books and Records - Journal - Meaning - Specimen ruling of Journal - Preparation of Journal - Types of Journal - General Journal - Special Journals - Sales Book - Purchase Book - Sales Returns Book - Purchase Returns Book - Preparation Subsidiary Journals - Bills Receivable Book - Bills Payable Book - Cash Book - Types of Cash Book - Preparation of Cash Book - Petty Cash Book - Preparation of Petty Cash Book - Purpose of Subsidiary Books - Illustrations - Solutions - Questions and Practical Problems; Ledger - Meaning - Specimen Ruling of Ledger - Posting of Journal to Ledger - Balancing of Ledger - Difference between Journal and Ledger - Preparation of Ledger - Illustrations - Solutions - Questions and Exercises; Trial Balance - Meaning - Objectives - Errors not disclosed by Trial Balance - Classification of Errors - Errors of Omission - Errors of Commission - Errors of Principles Compensating Errors - Errors Disclosed by Trial Balance - Locating Errors - Suspense Account - Method of Preparation of Trial Balance - Specimen - Problems - Solutions - Questions and Exercises. (4) FINAL ACCOUNTS 90-121 Meaning - Manufacturing Account - Components of Manufacturing Account - Illustration and Solution; Trading, Profit and Loss Account - Meaning - Purpose - Specimen Format - Elements of Trading Account - Equations of Trading Account - Profit and Loss Account - Specimen Format - Preparation of Final Accounts - Operating Expensel'- - Non-operating Expenses - Operating Incomes. - Non-operating Incomes; Balance Sheet - Meaning.~- t.>urpose - Specimen form of Balance Sheet - Assets 'and Liabilities - Classification of Asset~ hl'i :Uabilities - Adjustment Entries - Difference between Profit and Loss Account and Balance S};et:t - Preparation of Profit & Loss and Balance Sheet - Illustrations - Solutions - Questions - Exf:ldses.

(5) DEPRECIATION 122-148 Introduction - Meaning and Definition of Depreciation, Depletion and Amortization - Purpose - Factors affecting Depreciation - Methods of charging Depreciation - Straight Line Method - Written Down Value Method - Annuity Method - Sinking Fund Method - Revaluation Method. Insurance Policy Method - Depletion Method - Sum of Digits Method - Machine Hour Rate Method - Calculation of Machine Hour Rate - Illustrations - Solutions - Questions - Exercises. (6) FINANCIAL STATEMENTS ANALYSIS AND INTERPRETATION 149-172 Introduction - Meaning of Income Statements, Balance Sheet and Statement of Retained Earnings Nature of Financial Statements - Objectives of Financial Statements - Limitations of Financial Statements; Analysis and Interpretation - Meaning - Types of Analysis and Interpretations - Internal Analysis - External Analysis - Horizontal Analysis - Vertical Analysis - Rearrangement of Income Statements - Income Statement Equations - Rearrangement of Balance Sheet - Balance Sheet Equations - Methods of Analysis and Interpretations - Comparative Financial Statements - Common Size Statements - Trend Analysis - Ratio Analysis - Fund Flow Analysis - Cash Flow Analysis - Illustrations - Solutions - Questions - Exercises. (7) FUND FLOW STATEMENT 173-209 Introduction - Meaning of Fund, Flow of Fund and No Flow of Fund - Statement of changes in Financial Position - Flow of Funds chart - No Flow of Funds Chart - Examples of Flow of Fund - Components of Flow of Funds - Current Assets - Current Liabilities - Non-current Assets - Non-current Liabilities - Fund Flow Statement - Meaning - Difference between Fund Flow Statement and Income Statement - Fund Flow Statement Vs Balance Sheet - Preparation of Fund Flow Statement; Fund From Operations - Statement of Changes in Working Capital - Fund Flow Statement - Meaning - Specimen Format - Purposes - Calculation of Fund From Operations - Illustrations - Solutions - Rules for Preparation of Working Capital Statement - Specimen Form - Illustrations - Sources of Fund and Applications of Fund - Components of Sources of Fund and Applications of Fund - Calculation of Sources and Application of Fund - Illustrations - Solutions - Exercises. (8) CASH FLOW STATEMENT 210-232 Meaning - Purpose of Cash Flow Statement - Difference between Cash Flow Statement and Fund Flow Statement - Limitations - Preparation of Cash Flow Statement - Flow of Cash Under Non-Current Items - Flow of Cash due to Operations - Non-cash Items - Specimen Format - Calculation of Cash Received from Operations - Illustrations - Solutions - Questions - Exercises. (9) RATIO ANALYSIS 233-297 Meaning and Definition of Analysis and Interpretations of Ratios; Principles of Ratio Selection - Advantages - Limitations of Ratio Analysis; Classification of Ratios - Liquidity Ratio; Current Ratio - Quick Ratio - Absolute Liquid Ratio; Profitability Ratio; Gross Profit Ratio - Operating Ratio - Operating Profit Ratio - Net Profit Ratio - Return on Investment Ratio - Return on Capital Employed Ratio - Earning per Share Ratio - Dividend Yield Ratio - Price Earning Ratio - Net Profit to Net Worth Ratio; Turnover Ratio; Stock Turnover Ratio - Debtors Turnover Ratio - Debt Collection Period Ratio - Creditor's Turnover Ratio - Average Payment Period - Working Capital Turnover Ratio - Fixed Assets Turnover Ratio - Capital Turnover Ratio; Solvency Ratios; Debt Equity Ratio - Proprietary Ratio - Capital Gearing Ratio - Debt Service Ratio; Overall Profitability Ratio; Illustrations - Solutions - Questions - Practical Problems. (10) COST ACCOUNTING 298-304 Introduction - Definitions of Important Concepts - Cost - Cost Accounting - Cost Control - Cost Reduction - Cost Allocation - Cost Absorption - Cost Audit - Cost Unit - Cost Centre -

Objectives of Cost Accounting - Difference between Financial Account and Cost Accounting - Management Accounting - Meaning - Cost Accounting Vs Management Accounting - Advantages of Cost Accounting - Limitations of Cost Accounting - Installation of Cost Accounting System - Practical Difficulties in Installation of Costing System - Steps to Overcome - Questions. (11) COST METHODS, TECHNIQUES OF COST ACCOUNTING AND CLASSIFICATION OF COST 305-309 Introduction - Methods of Cost':" Job Costing - Contract Costing - Cost Plus Contract - Batch Costing - Process Costing: Operation Costing - Output Costing - Multiple Costing - Technique of Costing - Uniform Costing - Marginal Costing - Standard Costing - Historical Costing - Absorption Costing; Classification of Cost; On the basis of Nature - Functions - Variability - Normality - Controllability - Material- - Labour - Expenses - Production Cost - Administrative Cost - Selling Cost - Distribution Cost - Normal Cost - Abnormal Cost - Fixed Cost - Variable Cost - Controllable Cost - Uncontrollable Cost - Sunk Cost - Opportunity Cost - Replacement Cost - Conversion Cost - Questions. (12) COST SHEET ANALYSIS (OR) STATEMENT OF COST 310-325 Introduction - Meaning - Elements of Cost - Direct Cost - Indirect Cost - Overheads - Prime Cost - Works Cost - Cost of Production - Cost of Sales - Importance of Cost Sheet - Specimen Format of Cost Sheet - Preparation of Cost Sheet - Illustrations - Solutions - Questions - Practical Problems. (13) MATERIAL COST CONTROL 326-331 Meaning of Materials - Direct Materials - Indirect Materials - Material Control - Functions of Materials Control - Objectives of Stores Control - Essentials - Advantages; Materials Purchase Control - Organization of Purchasing - Centralized Organization - Advantages - Disadvantages - Decentralized Purchasing - Purchase Manager - Qualities - Duties of Purchase Manager - Functions of Purchase Department - Purchase Procedure - Bills of Materials - Purchase Requisition - Selection of Suppliers - Purchase Orders - Goods Received Note - Inspection of Materials - Questions. (14) MATERIALS - INVENTORY CONTROL 332-351 Introduction - Store and Store keeping - Purpose of Store keeping - Functions of the Store keeper - Stores Layout - Types of Stores - Centralized Stores - Decentralized Stores - Combination of Both; Fixation of Stock levels - Minimum Stock Level - Maximum Stock Level - Danger Level - Reorder Level - Calculations - Economic Order Quantity - Calculation EOQ - Illustrations - Solutions - ABC Analysis - Alphabetical Method - Numerical Alphabetical Method; Inventory System - Periodic Inventory System - Perpetual Inventory System - Continuous Stock Taking - Advantages of Each System - Bin Card - Stores Ledger - Bin Card Vs Stores Ledger - Continuous Stock Taking Vs Periodic Stock Taking - Material Stores Losses - Normal Loss - Abnormal Loss - Inventory Turnover Ratios - Illustrations - Solutions - Questions - Exercises. (15) VALUATION OF MATERIALS ISSUES 352-367 Introduction - Valuation of Total Cost of Material Purchased - Trade Discount - Quantity Discount - Cash Discount - Materials Issue Procedure - Material Requisition - Bill of Materials; Methods of Materials Pricing Issues - First In First Out (FIFO) - Last In First Out (LIFO) - Specific Price Method - Base Stock Method - Highest In First Method (HIFO) - Periodic Simple Average Method - Periodic Weighted Average Method - Standard Price Method - Inflated Price Method - Market Price or Replacement Price Method - Illustrations - Solutions - Questions - Practical Problems.

(16) LABOUR COST CONTROL 368-381 Meaning - Types of Labour Cost - Direct Labour Cost - Indirect Labour Cost - Control of Labour Cost - Technique - Organization for Control of Labour Cost - Personnel Department - Engineering and Works Study Department - Method Study - Motion Study - Time Study - Job Analysis - Job Evaluation - Merit Rating - Job Evaluation Vs Merit Rating; Time Keeping Department - Time Keeping - Objectives - Methods of Time Keeping - Manual Method - Disc Method - Mechanical Method - Time Keeping Clocks - Dial Time Records - Key Record System; Time Booking - Objectives - Methods of Time Booking - Daily Time Sheet - Weekly Time Sheet - Job Cards - Combined Time and Job Card; Piece Work Card - Idle Time - Types - Normal Idle Time and Abnormal Idle Time - Accounting Treatment of Idle Time; Overtime - Meaning - Effect of Overtime - Accounting Treatment of Over Time - Control of Overtime - Casual Workers - System of Control - Out Workers; Pay Roll Department - Labour Turnover - Methods of Labour Tum over - Separation Method - Replacement Method - Flux Method - Illustrations - Solutions - Questions - Practical Problems. (17) LABOUR COST ACCOUNTING 382-401 Introduction - Meaning - Objectives of an Ideal Wage System - Principles - Methods of Remuneration - Time Rate System - At Ordinary Levels - At High Wage Levels - Guaranteed Time Rates - Piece Rate System - Straight Piece Rate - Piece Rate With Guaranteed Time Rate; Differential Piece Rates - Taylor Differential Piece Rate System - Merrick Differential Piece Rate System - Gantt Task and Bonus Plan - Bonus System or Incentive System; Individual Bonus Plan - Halsey Premium Plan - Halsey - Wire Premium Plan - Rowan Plan - Barth Variable Sharing Plan - Emerson Efficiency Plan - Bedaux Point Premium System - Accelerating Premium Plan; Group Incentive Plan - Indirect Monetary Incentives - Non-Monetary Incentives - Illustrations - Solutions - Questions - Practical Problems. (18) OVERHEADS 402-424 Meaning and Definitions of Overheads - Importance of Overheads - Classification of Overheads - Indirect Materials Cost - Indirect Labour Cost - Indirect Expenses - Production Overhead - Administration Overhead - Selling Overhead - Distribution Overhead - Fixed Overhead - Variable Overhead - Useful of Overhead Classification; Codification of Overhead - Advantages of Codification - Procedure or Steps in Overhead - Collection of Overhead - Overhead Expenses - Sources and Documents Used - Overhead Analysis - Allocation and Absorption - Apportionment of Overhead - Basis of Apportionment - Illustrations - Solutions - Reapportionment or Redistribution of Overhead - Method of Re-apportionment - Direct Re-distribution Method - Step Distribution Method - Reciprocal Service Method - Step Repeated Distribution Method - Simultaneous Equitation Method - Trial and Error Method - Illustrations of Each Methods - Solutions - Questions - Practical Problems. (19) ABSORPTION OF OVE~HEAD 425-446 Meaning - Overhead Rate - Actual Overhead Rate - Pre-Determined Overhead Rate - Blanket Overhead Rate - MUltjple Overhead Rate - Normal Overhead Rate - Supplementary Overhead Rate; Methods of Absorption of Overhead - Direct Material Cost Method - Direct Labour Cost Method - Direct Labour Hours Method - Prime Cost Method - Unit Output Method - Machine Hour Rate; Calculation of Machine Hour Rate - Fixed or Standing Charges - Variable Machine Expenses - Basis for Apportionment of Machine Expenses - Advantages - Disadvantages - Illustrations - Solutions -- Questions - Practical Problems.

(20) JOB, BATCH AND PROCESS COSTING 447-470 Introduction - Meaning - Features of Job Order Costing - Objectives of Job Order Costing - Prerequisite for Job Order Costing - Advantages and Disadvantages of Job Order Costing - Procedure for Job Order Cost System; Batch Costing - Meaning - Features - Determeniation - Diffemece between Job Costing and Batch Costing - Advantages and Disadvantages - Problems and Solutions; Process Costing - Meaning - Application of Process Costing - Job Costing Vs Process Costing - Calculation of Normal Process Loss and Abnormal Process Loss - Procedure for Preparation of Process Costing - Illustrations - Solutions - Questions - Practical Problems. (21) JOINT PRODUCT AND BY -PRODUCT 471-490 Introduction - Joint Products - Me<lning - Features of Joint Products - Objectives of Joint Product Costing - Methods of Apportionment of Joint Products - Average Unit Cost Method - Physical Unit Method - Survey Method _. Contribution Margin Method - Standard Cost Method - Market Value Method - Market Value at Point of Separation - Market Value After Further Processing - Net Realisable Value or Reverse Cost Method - By-Products - Meaning - Methods of Valuation of By Products - Non Cost or Sales Value Method - Other Income Method - Cost Methods - Replacement Cost Methods - Standard Cost Method - Apportionment on Suitable Basis - Inter Process Profits - Equivalent Units - Steps Involved for Calculation of Equivalent Units - Illustrations - Solutions - Questions - Multiple Choice - Questions - Answers - Practical Problems. (22) CONTRACT COSTING 491-508 Meaning - Special Features of Contract Costing -- Costing Procedure - Accounting Treatment of Materials, Labour, Direct Expenses, Overhead C05t, Plant and Machinery - Sub-Contracts - Work Certified - Work Uncertified - Work in Progress - Accounting Treatment of Profit or Loss of Contract - Escalation Clause - Cost-Plus Contract - Profit or Loss on Completed Contract - Cost of Uncertified Work - Problems and Solutions - Questions - Choose the Correct Answers - Practical Problems. (23) UNIFORM COSTING 509-511 Uniform Costing - Meaning - Objectives - Essential Requisites for Installation of Uniform Costing - Advantages of Uniform Costing - Limitations - Requisites of Inter - Firm Comparison - Advantages - Disadvantages - Questions. (24) ACTIVITY-BASED COSTING 512-521 Meaning - Different Stages in Activity Based Costing - ABC and Cost Drivers - Examples of Cost Drivers - Classification of Activities - Unit Level Activities - Batch Level Activity - Product Level Activities - Facility - Level Activities - Difference Between Activity - Based Costing and Conventional Costing - Advantages of Activity - Based Costing - Essential Factors.)f a Good Activity - Based Costing System - Illustrations - Solutions - Questions. (25) RECONCILIATION OF COST AND FINANCIAL ACCOUNTS 522-535 Reconciliation of Cost Financial Accounts - Meaning - Reasons for the difference - Items shown only in Financial Accounts - Income - Expenditure - Items shown only in Cost Accounts - Absorption of Overheads - Methods of stock valuation - Abnormal losses and gains - Methods of Reconciliation - Treatment of causes for differences - Types of problems - I\Iustrations - Solutions - Questions - Practical Problems. (26) MARGINAL COSTING AND COST VOLUME PROFIT ANALYSIS 536-560 Meaning of Marginal Cost and Marginal Costing - Features of Marginal Costing - Absorption Costing - Absorption Costing Vs Marginal Costing - Differential Costing - Meaning - Marginal Costing Vs Differential Costing - Advantages of Marginal Costing - Limitations of Marginal

Costing - Cost - Volume Profit Analysis - Meaning - Objectives - Marginal Cost Equations - Contribution - Break Even Analysis - Profit Volume Ratio (PN Ratio) - Margin of Safety - Break Even Chart - Cash Break Even Point - Advantages - Limitations - Illustrations - Solutions - Questions - Practical Problems. (27) BUDGETING AND BUDGETARY CONTROL 561-596 Introduction - Definition of Budget - Essentials of Budget - Difference between Forecast and Budgets - Budgetary Control- Objectives of Budgetary Control- Scope and Techniques of Standard Costing and Budgetary Control - Requisites for effective Budgetary Control - Organization for Budgetary Control - Organization Chart - Budget Centre - Budget Officer - Budget Committee - Budget Manual - Budget Period - Key Factors - Advantages of Budgetary Control - Limitations of Budgetary Control; Types of Budgets Control Ratios - Capacity Ratio - Activity Ratio - Efficiency Ratio - Calendar Ratio; Some Important Budgets - Sales Budgets - Production Budget - Material Purchase Budget - Cash Budget - Master Budget - Fixed Budget - Flexible Budget - Advantages - Fixed Budgets Vs Flexible Budgets - Methods of Preparing Flexible Budget - Multi - Activity Method - Ratio Method - Charting Method - Illustrations - Solutions - Zero Base Budgeting - Questions - Practical Problems. (28) STANDARD COSTING AND VARIANCE ANALYSIS 597-641 Introduction - Standard Cost and Standard Costing - Meaning - Standard Costing and Budgetary Control - Preliminaries to the establishment of Standard Costs: Advantages and Disadvantages of Standard Costing, Analysis of Variances - Material Variances - Calculation of Material Price Variances, Material Usage Variances, Material Mix Variance; Labour Variance; Overhead Variance - Overhead Cost Variance - Fixed Overhead Variances - Sales Variances - Illustrations - Solutions - Questions - Practical Problems. (29) CAPITAL BUDGETING 642-669 Capital Budging - Meaning - Definition - Importance - Objectives - Principles or Factors of Capital Budgeting Decisions - Capital Budgeting Process - Types of Capital Expenditure - Types of Capital Budgeting Proposals - Methods of Evaluating Capital Investment Proposals - Traditional Methods - Pay-back Period Method - Post Pay - Back Period - Discounted Pay-back Period - Reciprocal Pay Back Period - Accounting Rate of Return Method - Time Adjusted Method - Net Present Value Method - Internal Rate of Return Method - Profitability Index Method - JIIustrations - Solutions - Questions - Multiple Choice Question and Answers - Practical Problems. (30) COST AUDIT 670-674 Cost Audit - Meaning and Definition - Difference between Financial Audit and Cost Audit Purposes or Objectives of Cost Audit - Protective Purpose - Constructive Purpose - Circumstances Under Which Cost Audit is Desirable - Types of Cost Audit - Efficiency Audit - Propriety Audit - Statutory Audit - Advantages or Usefulness of Cost Audit - Usefulness to the Management - To the Government - To the Shareholders; Cost Audit Programme - Areas of Cost Audit Programme is carried out - Advantages - Disadvantages - Cost Accounts Records Questions. (31) REPORTING TO MANAGEMENT 675-681 Introduction - Definition of Management Reporting - Objectives of Management Reporting - Essentials of Good Reporting System - Classification of Management Reporting - According to Objectives, Period, Functions - Report Meant for the Top Level of Management, Middle Level Management and Junior Level Management - Questions. DOD