unit 1 accounts notes

7/29/2019 Unit 1 Accounts Notes

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UNIT 1 (INTRODUCTION TO ACCOUNTING INFORMATION)

Scope of Accounting:

Accounting has got a very wide scope and area of application. Its use is not confined to the

business world alone, but spread over in all the spheres of the society and in all professions.

Now-a-days, in any social institution or professional activity, whether that is profit earning or

not, financial transactions must take place. So there arises the need for recording and

summarizing these transactions when they occur and the necessity of finding out the net result of

the same after the expiry of a certain fixed period. Besides, the is also the need for interpretation

and communication of those information to the appropriate persons. Only accounting use can

help overcome these problems. In the modern world, accounting system is practiced no only in

all the business institutions but also in many non-trading institutions like Schools, Colleges,

Hospitals, Charitable Trust Clubs, Co-operative Society etc .and also Government and Local

Self-Government in the form of Municipality, Panchayat. The professional persons like Medical

practitioners, practicing Lawyers, Chartered Accountants etc. also adopt some suitable types of

accounting methods. As a matter of fact, accounting methods are used by all who are involved in

a series of financial transactions. the scopes of accounting are inter-related and it includes:

Recording and classifying financial data. Financial transaction are recorded either through asingle-entry or double-entry bookkeeping system. Additionally, this provides transparency both

in the business and with the government. This is because the book of accounts are also filed with

the necessary government agencies.

Information in accounting is relevant, comprehensive, reliable, complete, objective, timely andrelevant and can be used as basis for comparison.

Measurement of the economic capabilities of the individuals and businesses. This involves:Taxes, wages and salaries, and dividends among others.

Responsible use and management of funds and assets in accordance to its specified uses.


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Communication of accounting data through the financial statements. Thesefinancial statements in return will help in the decision making as to the allocation of financial

resources and meeting the obligations incurred.

SCOPE OF ACCOUNTING

Management Accounting and Cost Accounting

Management or cost accounting is a management information system which analysis data to

provide information as a basis for managerial action. The concern of a management accountant is

to present accounting information in the form most helpful to management.

Financial Accounting

Financial accounting is mainly a method of reporting the results and financial position of a

business. It is not primarily concerned with providing information towards the more efficient

conduct of a business. This is particularly clear in the context of the published accounts of

limited companies. Accounting standards and public law prescribe that a company should

produce accounts to be presented to the shareholders.

Financial Management

The financial manager is responsible for raising finance and controlling financial resources.Including the following decisions:

(a)Should the firm borrow from a bank or raise funds by issuing shares?(b) How much should be paid as a dividend?

(c) Should the firm spend money on new machinery?

(d) How much credit should be given to customers?

(e) How much discount should be given to customers who pay early?

Auditing

The annual accounts of a company must generally be audited by a person independent of a

company. In practice, this often means that the members of the company appoint a firm of

registered auditors to investigate the financial statements and report as to whether or not they


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show a true and fair view of the companies results for the year and its financial position at the

end of the year.

Qualities of Good Accounting Information

Relevance

Comprehensibility

Reliability

Completeness

Objectivity

Timeliness

Comparability

Nature of Accounting:

The basic features of accounting are as follows:

1. Accounting is a process: A process refers to the method of performing any specific job step

by step according to the objectives, or target. Accounting is identified as a process as it performs

the specific task of collecting, processing and communicating financial information. In doing so,

it follows some definite steps like collection of data recording, classification summarization,

finalization and reporting.

2. Accounting is an art: Accounting is an art of recording, classifying, summarizing and

finalizing the financial data. The word art refers to the way of performing something. It is a

behavioral knowledge involving certain creativity and skill that may help us to attain some

specific objectives. Accounting is a systematic method consisting of definite techniques and its

proper application requires applied skill and expertise. So, by nature accounting is an art.

3. Accounting is means and not an end: Accounting finds out the financial results and position

of an entity and the same time, it communicates this information to its users. The users then take

their own decisions on the basis of such information. So, it can be said that mere keeping of

accounts can be the primary objective of any person or entity. On the other hand, the main

objective may be identified as taking decisions on the basis of financial information supplied by

accounting. Thus, accounting itself is not an objective, it helps attaining a specific objective. So

it is said the accounting is a means to an end and it is not an end in itself.


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4. Accounting deals with financial information and transactions; Accounting records the

financial transactions and date after classifying the same and finalizes their result for a definite

period for conveying them to their users. So, from starting to the end, at every stage, accounting

deals with financial information. Only financial information is its subject matter. It does not deal

with non-monetary information of non-financial aspect.

5. Accounting is an information system: Accounting is recognized and characterized as a

storehouse of information. As a service function, it collects processes and communicates

financial information of any entity. This discipline of knowledge has been evolved out to meet

the need of financial information required by different interested groups.

ACCOUNTING PRINCIPLES : Accounting principles are guidelines & standards,

which have been accepted by the accounting profession in preparation and presentation of

accounts of the business. It is approved and normally accepted by the government bodies &

controlling authorities. Accounting principles are uniform in order to understand in the same

sense by those using it. Also they are not rigid (i.e. inflexible) like principle of gravity but they

are flexible. This is because mainly the account principles are social science. Accounting

principles are not universal and permanent as they are not discovered but are developed by man

from time to time. Thus the development of accounting principles is a continuous process.

ACCOUNTING CONCEPTS AND CONVENSIONS.

Accounting concepts: - An accounting concepts is a basic assumption concerning the economic

environment in which accounting exists.

Characteristics of Accounting Concepts:-

1. Accounting concepts are continuously changing and evolving: In the event of rapidly changing

economic activities, accounting concepts also undergo frequent changes. This is a healthy signfor the accounting fields. This is because of the following two main reasons.

i. It is relatively a new field and hence it is developing with time.ii. Some aspects tend to change with the changes in social, economic and

commercial conditions.


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2. Another important feature of accounting concepts is the interrelationship among thedifferent concepts. Most of the concepts do not stand by themselves; they depend on the

other concepts to a large extent.

ACCOUNTING CONVENTIONS

The term "conventions" includes those customs or traditions which guide the accountants while

preparing the accounting statements. The following are the important accountingconventions.

1. Convention of Disclosure2. Convention of Materiality3. Convention of Consistency4. Convention of Conservatism

Convention of Disclosure:

The disclosure of all significant information is one of the important accountingconventions. It

implies that accounts should be prepared in such a way that all material information is clearly

disclosed to the reader. The term disclosure does not imply that all information that any one

could desire is to be included in accounting statements. The term only implies that there is to a

sufficient disclosure of information which is of material in trust to proprietors, present and

potential creditors and investors. The idea behind this convention is that any body who want to

study the financial statements should not be mislead. He should be able to make a free judgment.

The disclosures can be in the way of foot notes. Within the body of financial statements, in the

minutes of meeting of directors etc.

Convention of Materiality:

It refers to the relative importance of an item or even. According to this convention only those

events or items should be recorded which have a significant bearing and insignificant things

should be ignored. This is because otherwise accounting will be unnecessarily over burden with

minute details. There is noformulain making a distinction between material and immaterial
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events. It is a matter of judgment and it is left to theaccountantfor taking a decision. It should be

noted that an item material for one concern may be immaterial for another. Similarly, an item

material in one year may not be material in the next year.

Convention of Consistency:

This convention means that accounting practices should remain uncharged from one period to

another. For example, if stock is valued at cost or marketpricewhichever is less; this principle

should be followed year after year. Similarly, if depreciation is charged onfixed assetsaccording

to diminishing balance method, it should be done year after year. This is necessary for the

purpose of comparison. However, consistency does not mean inflexibility. It does not forbid

introduction of improved accounting techniques. If a change becomes necessary, the change and

its effect should be stated clearly.

Convention of Conservatism:

This convention means a caution approach or policy of "play safe". This convention ensures that

uncertainties and risks inherent in business transactions should be given a proper consideration.

If there is a possibility of loss, it should be taken into account at the earliest. On the other hand, a

prospect of profit should be ignored up to the time it does not materialise. On account of this

reason, the accountants follow the rule 'anticipate no profit but provide for all possible losses'.

On account of this convention, the inventory is valued 'at cost or marketpricewhichever is less.'

The effect of the above is that in case marketpricehas gone down then provide for the 'anticipated

loss' but if the marketpricehas gone up then ignore the 'anticipated profits.' Similarly a provision

is made for possible bad and doubtful debt out of current year's profits. Critics point out that

conservatism to an excess degree will result in the creation of secrets reserves. This will be quite

contrary to the doctrine of disclosure.


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ACCOUNTING CONCEPTS

The term concepts includes those basic assumptions or conditions upon which accounting is

based. The following are the important accounting concepts:

Business Entity Concept: This concept assumes that, for accounting purposes, the business

enterprise and its owners are two separate independent entities. Thus, the business and personal

transactions of its owner are separate. For example, when the owner invests money in the

business, it is recorded as liability of the business to the owner. Similarly, when the owner takes

away from the business cash/goods for his/her personal use, it is not treated as business expense.

Thus, the accounting records are made in the books of accounts from the point of view of the

business unit and not the person owning the business. Let us take an example. Suppose Mr.

Sahoo started business investing Rs100000. He purchased goods for Rs40000, Furniture forRs20000 and plant and machinery of Rs30000. Rs10000 remains in hand. These are the assets of

the business and not of the owner. According to the business entity concept Rs100000 will be

treated by business as capital i.e. a liability of business towards the owner of the business.

Significance:

This concept helps in ascertaining the profit of the business as only the business expensesand revenues are recorded and all the private and personal expenses are ignored.

This concept restraints accountants from recording of owners private / personaltransactions.

It also facilitates the recording and reporting of business transactions from the businesspoint of view

It is the very basis of accounting concepts, conventions and principles.Going Concern Concept: This concept states that a business firm will continue to carry on its

activities for an indefinite period of time. Simply stated, it means that every business entity has

continuity of life. Thus, it will not be dissolved in the near future. This is an important

assumption of accounting, as it provides a basis for showing the value of assets in the balance

sheet; For example, a company purchases a plant and machinery of Rs.100000 and its life span is

10 years. According to this concept every year some amount will be shown as expenses and the

balance amount as an asset. Thus, if an amount is spent on an item which will be used in

business for many years, it will not be proper to charge the amount from the revenues of the year


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in which the item is acquired. Only a part of the value is shown as expense in the year of

purchase and the remaining balance is shown as an asset.

Significance:

This concept facilitates preparation of financial statements. On the basis of this concept, depreciation is charged on the fixed asset. It is of great help to the investors, because, it assures them that they will continue to get

income on their investments.

In the absence of this concept, the cost of a fixed asset will be treated as an expense in theyear of its purchase.

A business is judged for its capacity to earn profits in future.Money Measurement Concept:

Accounting to records only those transactions which can be expressed in terms of money.

Transactions or events which cannot be expressed in money do not find place inthe booksof

accounts though they may be very useful for the business. For example, if a business has got a

team of dedicated and trusted employees, it is definitely an asset tothe business, but since their

monetary measurement is not possible, they are not shown inthe booksof business. It should be

remembered that money enables various things of diverse nature to be added up together and

dealt with. The use of a building and the use of clerical service can be aggregated only through

money values and not otherwise.

Significance:

:

This concept guides accountants what to record and what not to record. It helps in recording business transactions uniformly. If all the business transactions are expressed in monetary terms, it will

be easy to understand the accounts prepared by the business enterprise.

It facilitates comparison of business performance of two differentperiods of the same firm or of the two different firms for the same period.


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Cost Concept: Accounting cost concept states that all assets are recorded in the books of

accounts at their purchase price, which includes cost of acquisition, transportation and

installation and not at its market price. It means that fixed assets like building, plant and

machinery, furniture, etc are recorded in the books of accounts at a price paid for them. For

example, a machine was purchased by XYZ Limited for Rs.500000, for manufacturing shoes. An

amount of Rs.1,000 were spent on transporting the machine to the factory site. In addition,

Rs.2000 were spent on its installation. The total amount at which the machine will be recorded in

the books of accounts would be the sum of all these items i.e. Rs.503000. This cost is also known

as historical cost. Suppose the market price of the same is now Rs 90000 it will not be shown at

this value. Further, it may be clarified that cost means original or acquisition cost only for newassets and for the used ones, cost means original cost less depreciation. The cost concept is also

known as historical cost concept. The effect of cost concept is that if the business entity does not

pay anything for acquiring an asset this item would not appear in the books of accounts. Thus,

goodwill appears in the accounts only if the entity has purchased this intangible asset for a price.

Significance:

This concept requires asset to be shown at the price it has been acquired,which can be verified from the supporting documents.

It helps in calculating depreciation on fixed assets. The effect of cost concept is that if the business entity does not pay

anything for an asset, this item will not be shown in the books of accounts.

Dual Aspect Concept:

This is the basic concept of accounting. Modern accounting system is based on dual aspect

concept. Dual concept may be stated as "for every debit, there is a credit". Every transaction

should have two sided effect to the extent of same amount. For example, if A starts a business

with a capital of $10,000. There are two aspects of the transaction. On the one hand the business

has assets of $10,000 while on the other hand the business has to pay to the proprietor a sum of

$10,000 which is taken as proprietor's capital.


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Capital (Equities) = Costs (Assets)

10,000 = 10,000

Equities = Assets

OR Liabilities + Capital = Assets

Thus the accounting Equation states that at any point of time the assets of any entity must be

equal (in monetary terms) to the total of owner's equity and outsider's liabilities. As a mater of

fact the entire system of double entry accounting is based on this concept.

Significance: This concept helps accountant in detecting error. It encourages the accountant to post each entry in opposite sides of two affected accounts

Accounting period concept:

According tothis concept, the life ofthe businessis divided into appropriate segments for studying

the results shown bythe businessafter each segment. Since the life ofthe businessis considered to

be indefinite (according togoing concern concept) the measurement of income and studying

financial position ofthe businessaccording tothe above concept, after a very long period would

not be helpful in taking proper corrective steps at the appropriate time. It is, therefore, absolutely

necessary that after each segment or time interval the businessman must stop and see, how things

are going on. In accounting such a segment or time interval is called accounting period.

Significance:

It helps in predicting the future prospects of the business.

It helps in calculating tax on business income calculated for a particular time period. It also helps banks, financial institutions, creditors, etc to assess and analyse the

performance of business for a particular period.

It also helps the business firms to distribute their income at regularintervals as dividends.


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Matching concept: The matching concept states that the revenue and the expenses incurred to

earn the revenues must belong to the same accounting period. So once the revenue is realised, the

next step is to allocate it to the relevant accounting period. This can be done with the help of

accrual concept.

Significance:

It guides how the expenses should be matched with revenue fordetermining exact profit or loss for a particular period.

It is very helpful for the investors/shareholders to know the exactamount of profit or loss of the business.

(v) matching (vi) matching

Realization Concept: This concept states that revenue from any business transaction should be

included in the accounting records only when it is realised. The term realisation means creation

of legal right to receive money. Selling good is realisation, receiving order is not. In other words,

it can be said that : Revenue is said to have been realised when cash has been received or right to

receive cash on the sale of goods or services or both has been created.

Significance:

It helps in making the accounting information more objective. It provides that the transactions should be recorded only when goods are delivered to the

buyer.

Defining bookkeeping

Bookkeeping is an indispensable subset of accounting. Bookkeepingrefers to the process of

accumulating, organizing, storing, and accessing the financial information base of an entity,

which is needed for two basic purposes:

Facilitating the day-to-day operations of the entity Preparing financial statements, tax returns, and internal reports to managersBookkeeping (also called recordkeeping) can be thought of as the financial information

infrastructure of an entity. The financial information base should be complete, accurate, and


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timely. Every recordkeeping system needs quality controls built into it, which are called internal

controls.

Defining accounting

The term accountingis much broader, going into the realm of designing the bookkeeping system,

establishing controls to make sure the system is working well, and analyzing and verifying the

recorded information. Accountants give orders; bookkeepers follow them.

Accounting encompasses the problems in measuring the financial effects of economic activity.

Furthermore, accounting includes the function offinancial reportingof values and performance

measures to those that need the information. Business managers, investors, and many others

depend on financial reports for information about the performance and condition of the entity.

Accountants design the internal controls for the bookkeeping system, which serve to minimize

errors in recording the large number of activities that an entity engages in over the period. The

internal controls that accountants design are also relied on to detect and deter theft,

embezzlement, fraud, and dishonest behavior of all kinds.

Accountants prepare reports based on the information accumulated by the bookkeeping process:

financial statements, tax returns, and various confidential reports to managers. Measuring profit

is a critical task that accountants perform a task that depends on the accuracy of the

information recorded by the bookkeeper. The accountant decides how to measure

sales revenue and expenses to determine the profit or loss for the period.

CapitalExpenditures Revenue Expenditures
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1 Its effect is long term i.e., it is not

exhausted within the current account

year. Its benefit is enjoyed in future year

or years also. In a word, its effect is

reduces gradually.

1 Its effect is temporary, i.e., it is

exhausted within the current accounting

year.

2 An asset is acquired or the value of an

asset is increased as a result result of

this expenditure.

2 Neither an asset is acquired nor the

value of an asset is increased.

3 It does not occur again and again - it is

non-recurring and irregular.

3 It occurs repeatedly - It is recurring and

regular.

4 Generally, it has physical existence i.e.,

it can be seen with eyes.

4 It has no physical existence, i.e., it

cannot be seen with eyes.

5 This expenditure improves the position

of the concern

5 This expenditure helps to maintain the

concern

6 A portion of this expenditure is shown

in the trading and profit and loss

account or income and expenditure

account asdepreciation.

6 The whole amount of this expenditure is

shown in trading and profit and loss

account or income and expense account.

But deferred revenueexpenditures and

prepaid expenses are not shown.7 It appears inbalance sheet until its

benefit is fully exhausted.

7 It does not appear inbalance

sheet.Deferred revenueexpenditure,

outstanding expenditure, outstanding

expenses and prepaid expenses,

however, temporarily shown in

the balance sheet.

8 It does not reduce the revenue of the

concern. Purchase offixed assetsdoes

not effect revenue.

8 It reduces revenue. Payment of salaries

to employees decreases revenue.


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Expenditure means the amount spent. Any expenditure incurred for the following purposes is

capital expenditure:

1. For acquiringfixed assetssuch as land, building, plant and machinery, furniture and fittingand motor vehicles. These assets should not be acquired with a view toresellthem at a

profit but to retain in the business. The cost offixed assetwould include all expenditure up

to the asset becomes ready for use.

2. For making improvement and extensions to thefixed assete.g., additions to buildings.3. For increasing the earning capacity of a business or for reducing the cost of manufacture,

administration or distribution in a business e.g., expenditure incurred in removing the

business to a central locality or compensation paid to retrenched employee.

4.

For raising capital monies for the business such as brokerage paid for arranging loans,discount on issue of shares and debentures, underwriting commission etc.

All capital expenditures represent either an asset or liability and are shown in thebalance sheet.

Examples of Capital Expenditures):

The following is a list of the usual items ofcapital expenditures:

Cost of goodwill. Cost of freehold land and building and the legal charges incurred in this connection. Cost of lease. Cost of machineries, plants, tools, fixtures, etc. Cost oftrade marks, patents, copy rights, designs, etc. Cost of car, lorry etc. Cost of installation of lights and fans. Cost of any other assets acquired by way of equipment. Erection cost of plant and machinery. Cost of addition to existing assets. Structural improvements and alteration in the existing assets. Expenses for developments in case of mines and plantations.


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Expenses for administration incurred during construction and equipment of any industrialenterprise.

Expenses incurred in experimenting which finally result in the acquisition ofa patentorother rights.

Expenditures will be treated as revenue expenditures if it is incurred for the following purposes:

1. Expenditure for purchasing floating assets i.e., assets meant for resale at a profit or forbeing converted into saleable goods, such as the cost of goods, raw materials and stores.

2. Expenditures incurred by maintaining assets in proper working order e.g., repairs to plantand machinery, building furniture and fittings etc.

3. Expenditures incurred for meeting day to day expenses of carrying on a business e.g.,salaries, rent, rates, taxes, stationery, postage etc.

All revenue expenditure shave to be deducted from the income earned by the firm. That is to say,

all revenue items will be taken to the profit and loss account.

List of Revenue Expenditures - (Examples of Revenue Expenditures):

Expenses incurred for the ordinary administration and carrying on the business. Expenses for repairs,renewalsand replacement of permanentassets. Cost of goods for resale. Cost of raw materials and stores acquired for consumption in course of manufacturing. Wages paid for manufacture of products for sales. Expenses for the manufacture and distribution of the finished goods. Loss from wear and tear and obsolescence ofassets. Depreciationof lease. Intereston loansborrowed for business. Loss from sale of fixedassets. Fees for renewal of patent rights, etc. Up-keep and maintenance of motor car and van. Maintenance of fan and lights. Book value ofassetsdiscarded or totally damaged or destroyed by fire or other reasons.


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Meaning of Under-absorption of overheads

Under-absorption of overheads means that the amount of overheads absorbed in the production is

less than the amount of actual overheads-Incurred. For example if the overheads absorbed on a

predetermined basis are Rs : 1, 00,000 and the actual overheads incurred are Rs. 1, 20,000, there

is under-absorption to the extent of Rs.20, 000.

It represents under stating the costs as the overheads incurred are not fully recovered in the cost

of jobs or processes, etc. Under-absorption is also termed as 'under recovery',

Meaning of over-absorption of overheads

Over-absorption of overheads means the excess of overheads absorbed over the actual amount of

overheads incurred. In other words when the amount absorbed is more than the expenditure

incurred due to expenses being less than the estimates it would mean over-absorption of

overheads. Usually over-absorption inflates the cost. Over- absorption is also formed as 'over

recovery'.

For example the overheads recovered are Rs.3, 00,000 and the actual production overheads are

Rs.2, 75,000 then there will be over-absorption of Rs.25, 000. (Rs.3, 00,000 - Rs.2, 75,000).


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UNIT 2 (COST ACCOUNTING )

The word Costing refers to the technique and process of ascertaining costs. There have beencertain rules and principles in the field of costing developed over years by our forefathers. These

rules and principles help us to ascertain the cost of products produced. The term 'Cost

Accounting refers to the recording of all incomes and expenditures and ends with the

preparation of periodical statements and reports for ascertaining and controlling costs.

Definitions of Cost Accounting.

According to the Terminology used by the Institute of Cost and

Management Accountants, Cost accounting is the part of management

accounting which establishes budgets and standard costs and actual costs

of operations, processes, departments or products and the analysis of

variances, profitability or social use of funds.

Cost Accounting Financial Accounting

1) It helps us to ascertain the cost ofgoods produced.

It helps us to know operational

results and financial position of

business.

2) It provides required information tothe management.

It provides information parties

involved in business internally and

externally.

3) It need not be followed by a systemof external audit

Audit is a statutory obligation

4) It classifies the costs into material, Transactions are divided into debit


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labour, fixed overhead and variable

overhead.

and credit terms.

5) Cost sheet is main format of costaccounting

Trading and Profit & Loss Account

and Balance Sheet are two

consolidated financial statements.

6) It does not form a basis for taxassessment.

It forms a basis for deciding the tax

liabilities of the business.

7) Variance analysis is to identify thefavourable and adverse difference

between standard cost and actual

cost.

It records only actual transactions

occurring in the course of business

operations

8) Cost accounting facilitates thepresentation of cost information at

regular intervals.

Financial statements are annually

presented.

9) Profit or loss is estimated onspecific product, branch,

department or job.

It presents operational results of the

entire business.

10)It is an effective control device Financial accounting is not acontrol device. Rather, accounting

ratios can be computed with

financial accounting.

11)Unit wise accounting is alsoprepared.

Monetary units alone are yardstick

of financial accounting.


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There are two broad types of accounting information:

Financial Accounts: It is geared toward external users of accounting information

Management accounts: It aims more at internal users of accounting information

Although there is a difference in the type of information presented in financial and management

accounts, the underlying objective is the same - to satisfy the information needs of the user.

Financial Accounts Management Accounts

Financial accounts describe the

performance of a business over a

specific period and the state of affairs

at the end of that period. The specific

period is often referred to as the

Trading Period and is usually one

year long. The period-end date as the

Balance Sheet Date

Management accounts are used to

help management record, plan and

control the activities of a business

and to assist in the decision-making

process. They can be prepared for

any period.

Companies that are incorporated

under the Companies Act 1956 are

required by law to prepare and

publish financial accounts. The level

of detail required in these accounts

reflects the size of the business with

smaller companies being required to

prepare only brief accounts.

There is no legal requirement to

prepare management accounts.

The format of published financial

accounts is determined by several

different regulatory elements:

Company Law

Accounting Standards

Stock Exchange

There is no pre-determined format for

management accounts. They can be

as detailed or brief as management

wishes.


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advantag

es of costaccountin

g.

a. Providing

information to

the insiders and

outsiders with

respect to

production,

cost, materials,

labour, stores,

plant capacity

etc., which assist out planning

b.

Revealing profitable and unprofitable activities which help the management toreduce or eliminate wasteages and inefficiencies such as under utilization, idle

time, spoilage of material etc.,

c. Systematic management of cost which will lead to effective product pricing.d. Maintaining perpetual inventory system, this ensures preparation of interim profit

and loss account.

Financial accounts concentrate on the

business as a whole rather than

analysing the component parts of the

business. For example, sales are

aggregated to provide a figure for

total sales rather than publish a

detailed analysis of sales by product,

market etc.

Management accounts can focus on

specific areas of a business

activities. For example, they can

provide insights into performance of:

Products

Separate business locations (e.g.

shops)

Departments / divisions

Most financial accounting

information is of a monetary nature

Management accounts usually

include a variety of non-financial

information. For example,

management accounts often include

analysis of:

- Employees (number, costs,

productivity etc.)

- Sales volumes (units sold etc.)

Customer transactions (e.g.

number of calls received into a call

centre)By definition, financial accounts

present a historic perspective on the

financial performance of the business

Management accounts largely focus

on analysing historical performance.

However, they also usually include

some forward-looking elementse.g.

a sales budget; cash-flow forecast


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e. Aiding in formulation of policies related to product, price etc.,f. Comparison of cost between different periods, products, departments or firms.g. Revealing idle capacity, this would help the management to deal bottlenecks.h. Ascertainment of cost and profit more frequently and examination of their causes

in details.

i. Taking decisions based on facts and formulation of suitable polices for variousmatters. (Level of output, make or buy decision, replacement of old equipment,

shut down or continue, introduction of new products or elimination, acceptance of

a special order and replacement of labour with machinery.)

The use of cost accounting is no more restricted to manufacturing organisations. It is

used by other organisatios too banks, educational institutions, hospitals, local

governments so on.

COST : The terms Cost and expenditure are used interchangeably to mention same

thing in the field of business. Cost means the amount of expenditure incurred on, or

attributable to, a given thing.

It may be an actual cost or estimated expenditure. It also indicates a direct or indirect

expenditure. It is also related to job, process, product or service. Examples of costs are

material, labour, factory overhead, administrative overheads, and selling and distribution

overheads.

Cost Ascertainment:

According to the committee on Cost Concepts and Standards of the

American Accounting Association, Cost is foregoing, measured in

monetary terms, incurred or potential to be incurred to achieve a

specific objective


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Cost ascertainment is related to computation of actual costs incurred. It means the methods and

process employed in ascertaining costs. Different methods are employed for ascertaining cost in

different organisations. Job costing, contract costing, batch costing, process costing, unit costing

and multiple costing are some methods. (Refer the method of costing). Each method is chosen

according to its suitability with the organisation concerned. The ascertainment of actual cost has

a small impact because of the following possible reasons:

a. Actual cost cannot be used for the purpose of price quotations and filing tenders.b. Actual cost has practically no utility for control purposes.c. Actual cost is ineffective as means of measuring performance efficiency.

Ascertainment of actual costs proves to be important though there are limitations as shown

above. Ascertainment of actual costs tells us unprofitable activities and losses and inefficiencies

occurring in the form idle time, excessive scrap etc.,

Uses of Cost Estimation:

Cost estimation is the process of predetermined costs of products or services. The costs are

prepared in advance of production and precede the operations. Estimated costs are definitely the

future costs. They are based on the average of the past actual costs adjusted for anticipated

changes in future. The following are the uses of cost estimation:

i. Cost estimates are used in making price quotations and bidding for contractsii. they are used in the preparations of budgets

iii. it helps in evaluating performanceiv. Projected financial statements are prepared with the help of such estimationsv. It serves as targets in contoling costs

There are three elements of Cost


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Materials: The word Materials refers to those commodities, which are used as raw materials,

components, or consumables for manufacturing product. Materials can be direct or indirect.

Direct materials: All materials used as raw-materials or components for a finished product are

known as direct materials. Cotton for textiles, tyres for car are few examples of direct material.

It also includes package material.

Indirect Materials: Consumable like lubricating oil, spare parts for machinery are called as

indirect materials. Such commodities do not form part of the finished product.

Labour

The workers are involved in converting raw material into finished goods. Such involvement of

workers forms the word labour. The reward given to them for their involvement is called

wages. Wages can be direct or indirect.

Direct Labour: The workers who are directly involved in the production of goods are known as

direct labour. The reward paid to them is called direct wages.

Indirect Labour: The workers employed for carrying out tasks incidental to production of goods

or those engaged for office work and selling and distribution activities are known as indirect

labour. The reward given to them is called indirect wages.

Expenses

All expenditures other than material and labour are termed as expenses. Expenses can also be

direct or indirect.

Direct Expenses: Other expenses, which are incurred specifically for a particular product, job or

processes are termed as direct expenses. Some examples are given below:

Indirect Expenses: All expenses other than indirect materials and labour which cannot be directly

attributed to a particular product, job or service are termed as indirect expenses. Some

examples are given below:


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Concept of Overhead: All material, labour and expenses, which cannot be identified as direct

costs, are termed as indirect costs. The three elements of indirect costs namely indirect

materials, indirect labour and indirect expenses are collectively known as Overheads or On

costs. Overheads are grouped into three categories:

a. factory (or manufacturing) overheads,b. office (or administrative) overheads, andc. selling and distribution overheads

Conversion Cost: The cost of converting raw materials into finished goods is termed as

conversion cost. It includes direct wages, direct expenses and factory overheads.

Classification of costs based on functions

This is a traditional classification. The cost may have to be ascertained according to the functions

carried out by the organisation. The functions generally are manufacturing, administration,

selling, distribution and research.

Manufacturing Costs refer to all expenditure incurred in the course of production from

purchasing of materials to packing of the finished goods.

Administration Costs are incurred for general administration of the organisation and for the

operational control.

Manufacturing Costs

Material

Labour

Factory Rent

Depreciation

Power & Lighting

Insurance


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Administration Costs

Accounts office expenses

Legal charges

Audit charges

Office Rent

Remuneration to Director

Postage Expenses

Selling Costs are incurred to create and stimulate the demand and to secure the demand

Selling Costs

Salaries

Commission to Salesmen

Advertising and promotion Expenses

Samples

Travelling Expenses

Distribution Costs are incurred on dispatch of the finished goods to customer including

transportation.

Distribution Costs

Packaging costs

Warehousing Costs

Carriage outwards

Insurance

Upkeep of Vans


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Classification based on Variability or behaviour

Costs have a definite relationship with the volume of production. They behave differently when

volume of production rises or falls. On this basis, costs are classified into fixed cost, variable

costs and semi-variable (semi-fixed) costs.

Fixed Cost: Costs, which remain unaffected by changes in volume of production, are called as

fixed Costs. For example, the rent and managers salary will not change when you increase the

units of production from 1000 to 1200.

Fixed Costs

Rent lease

Salary to Managers

Building Insurance

Salary and Wages

Taxes to local authority

Variable Cost: The cost that tends to vary in direct proportion to the volume of production is

called variable cost. Forexample, for 1000 units of output, cost of raw materials consumed

comes to Rs. 10,000. If the production is increased to 1200 units (20%) the cost of material will

increase to Rs.12,000 (increase of 20%).

Variable costs

Direct Material

Direct Labour

PowerCommission of Salesmen

Royalties


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Semi-variable Costs: Costs, which increase or decrease with a change in volume of production

but not in the same proportion as the change in the volume of production are called semi-

variable costs.

Semi-variable Costs

Supervision

Repairs

Maintenance

Telephone Charges

Light and Power

Depreciation

Classification according to their identifiability with Cost units:

Costs are classified into direct and indirect based on their identifiability with cost units and jobs

or processes:

Direct Cost: It refers to expenses, which can be directly identified with the product, job or

process. For example, in case of materials used and labour employed we can easily ascertain as

to which product or job or process they relate.

Indirect Cost: It refers to those expenses, which cannot be easily identified with a particular

product, job or process. These are general, common or collective nature, which are to be

allocated to various products manufactured in the factory. Few examples are: wages paid to night

watchman, salary to the production manager.

Classification based on their association with product or period.

Product Costs: These are those costs, which are necessary for production and which will not be

incurred if there is no production. Direct material, direct wages and some of the factory

overheads are examples of this kind.


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Period Costs: Costs, which are not necessary for production and are written off as expenses in

the period in which these are incurred are called period costs. Rent, salaries of company

executives, travelling expenses are some examples of period costs.

Classification based on their controllability :

Controllable Costs: These are the costs, which may be directly regulated at a given level of

authority. Variable costs are generally controllable by department heads.

Uncontrollable Costs: Costs, which cannot be influenced by the action of a specified member of

an organisation, are called uncontrollable costs. Factory rent is a good example.

Cost Accounting limitations.

i) There is not standard set of rules and regulations of cost accounting applicable toall industries and even the firms in the same industry.

ii) The cost accounting principles themselves keep on changing.iii) There are widely recognised cost concepts but understood and applied differently

by different concerns.

iv) Cost accounting is not an exact science and its postulates cannot be verified byv) controlled experiment, but only by application in actual practice.

METHODS OF COSTING :

It should be noted that two basic methods of costing are (1) Job costing, and (2) Process Costing.

The other methods discussed below are simply variants of these two methods.

Job Costing: Under this method, costs are ascertained for each job separately. According to

I.C.M.A London

The method of job order costing applies where work is

undertaken to be a job or work

It is suitable for industries like car repairs, printing, foundries, painting and interior designing,

where each job has its own specification.


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Contract Costing: This method is used in case of big jobs described as contracts. Since this is

a variation of job costing, the principles of job costing are in general applied. The contract work

usually involves heavy expenditure, spreaded over a long period. Each contract is treated as a

separate unit for the purpose of cost ascertainment. Shipbuilding, construction of premises, roads

and bridges are few examples suitable for contract costing.

Batch Costing: This is also another version of job costing. The cost of batch or group of uniform

products is ascertained under this method. Each batch of products is a unit of cost for which costs

are accumulated. It is generally used in industries like pharmaceuticals, readymade garments,

shoes, toys, bicycle parts, bakery, etc.

Process costing: A product passes through various stages of production called process in some

industries. Each process is different and well defined. The output of one process is used as a raw

material for the next process. Costs are accumulated for each process. To arrive at the unit cost,

the total cost of the process is divided by the number of units. Textile mills, chemical works,

sugar mills and food products may be cited as examples of industries which use this method.

Operating Costing: This method is used in undertakings, which provide services instead of

manufacturing products. The unit cost is a service unit e.g., in case of buses, the unit of cost is

passenger kilometer, and in case of nursing home, it is per bed per day. It is also called service

costing.

Multiple costing: This method is an application of more than one method of cost ascertainment

in respect of the same product. Where a produce comprises many assembled parts as in case of

motor car, typewriter etc., costs have to be ascertained for each component as well as for the

finished product. This may involve use of different methods of costing for different component.

It is, therefore, called multiple or composite costing.

Single, output or unit costing: This method of cost ascertainment is used when production isuniform and consists of a single or two or three varieties of the same product. Where the product

is produced in different grades, costs are ascertained grade wise. Since the units of output are

identical, the cost per unit is found by dividing the total cost by the number of units produced.

This method is used in mines, brick-kilns, steel production, floor mills, etc.


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TYPES OF COSTING

Method of costing refers to the process and practice of ascertaining costs of product and services.

The type of costing refers to the technique of analysing and presenting costs for the purpose of

control and managerial decisions. The types of costing also known as techniques of costing

generally used are as follows:

Marginal costing: Separation of costs into fixed and variable (marginal) is of special interest

and importance. Under marginal costing, cost of a product is estimated with out considering

fixed cost. This method allocates only variable costs (direct material, direct labour, direct

expenses, and variable overheads) to production. It is also known as variable costing.

Absorption costing: It refers to the conventional technique of costing under which the total

costs (fixed and variable) are charged to products. It is considered to have only a limited

application today.

Historical Costing: It refers to a system of cost accounting under which costs are ascertained

only after they have been incurred. The accounting is done in terms of actual costs and not in

terms of predetermined costs. It is widely applied by many organisations today.

Standard Costing: This technique connotes the setting up of definite standards of performance

in advance. These standards are expressed in monetary terms. Actual performance is measured

against these standards. The differences are helping the management to initiate corrective

actions. This is believed to be a valuable tool in cost control.

Budgetary Control: A budget is an estimated results expressed in numerical numbers.

Budgetary control is a technique applied to the control of total expenditure on materials, wages

and overhead by comparing actual performance with planned performance. This technique is

also believed to be another valuable aid in cost control and coordination.

Economic Order Quantity (EOQ)

An Economic Order Quantity (EOQ) is an inventory-related evaluation to determine the

optimum order quantity which a company should use to ensure that Inventory is not overstocked


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whilst at the same time maintaining sufficient stock to prevent a stock-out. The objective

therefore is to minimise the combined costs of acquiring and carrying inventory.:

The EOQ calculation takes into account both the Ordering Cost and the Holding Cost to arrive at

the EOQ for the Item. This then provides information to recommend an economic and realistic

Suggested Order Quantity.

A = Average weekly usage taken from all issue movements over the previous year. C = Carry factor expressed as a percentage O = Ordering cost, as entered U= Current Average Cost of the Item.

________________

Then EOQ = / 2 * (52 * A) * O

/ -------------------

\/ C * U

Annual Usage -(52 * A) in the above formula

The quantity of the item used in the past year. In the above formula this is expressed as

Average Weekly Usage * 52 weeks. This allows us to calculate instances where the Item

has existed for less than one year. Our formula determines the actual weekly usage from

the time it was created.

Order Cost - 'O' in the above formula


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This is the sum of the fixed costs that are incurred each time an item is ordered. These

costs are not associated with the quantity ordered but primarily with physical activities

required to process the order such as the cost to enter the purchase order and/or

requisition, any approval steps, the cost to process the receipt, incoming inspection,

invoice processing and Supplier payment.

Carrying Cost - (C * U) in the above formula

This is primarily made up of the costs associated with the inventory investment and

storage cost and can include Cost of putting away stock receipts and moving material

within the warehouse, Rent and utilities for the portion of your warehouse used to store

stock inventory, Insurance and taxes on inventory, Physical inventory and cycle counting,

Inventory shrinkage and obsolescence, etc. The Carry Factor cost percentage is calculated

by dividing the sum of the above Carrying Costs by the average inventory value.

Assumptions of the Basic EOQ Model

1. The estimate of usage (demand or consumption) of the item of inventory for a given period(usually one year) is known accurately.

2. The usage (demand or consumption of the various items of inventory) is equal (even),throughout the period.

3. There is no lead time involved. That is, the item of inventory can be suppliedimmediately on the receipt of the order itself; there being virtually no time lag between

placing of an order and the receipt of the goods. Consequently, there is no likelihood of

stock out, at any stage. Therefore, the shortage cost (or stock out cost) is not being taken

into account, as if it is nil.

4. Thus, there remain only two distinct costs involved in computing the total costs,pertaining to inventory, viz., a) Ordering cost, and (b) Inventory carrying cost.

5. Further, the cost of every order remains uniformly the same, irrespective of the size of theorder.

6. And, finally, that the inventory carrying cost is a fixed percentage of the average value ofinventory.

unit 1 accounts notes

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