MANAGEMENT

2
ACCOUNTING
BMS-III
1
4
0011 0010 1010 1101 0001 0100 1011

Manjiri Dighe

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 Introduction to accounting
0011• 0010 1010
Types of1101 0001 enterprises
business 0100 1011

• Book Keeping & Accounting

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• Profit Vs Non-profit organizations

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• It is the language of business.

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• Basic functions:
– To measure Profit & Loss
– Ascertain financial position
– Cash flows
• Accounting is the process of recording, classifying,
summarizing, analyzing and interpreting the financial
transactions and communicate the results.
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 Types of Accounting
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Accounting

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2
•Management
•Financial Accounting •Cost Accounting

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Accounting
It prepares trial It classifies and
Deals with the
balance, P&L Ac, B/S. Analyses the cost on
processing
It shows the amount of The basis of
If data generated in
Profit earned or loss Functions processes
Financial accounting and
Incurred during Products centers etc.
Cost accounting for
A period It also deals in the
Managerial decision
Cost consumption,
Making. It also deals
Cost saving, cost
With application
Reduction etc
of managerial
Economic concepts for
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Decision making.
 Types / Branches of Accounting
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1. Financial Accounting:

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• process of identifying, measuring, classifying,

1
analyzing, summarizing and communicating
the financial transactions.

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• Purpose is to keep systematic records of
financial position and to communicate the
accounting information to the needy and
interested persons.

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 2. Cost Accounting
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• Process of accounting and controlling the

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cost of a product.

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• Purpose is to ascertain the cost and to

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control the cost so that it may be used in
taking decisions.

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 3. Management Accounting
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• It is the application of accounting techniques for

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providing information to management, so that

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timely decision may be taken by the management.

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• Purpose is to supply all relevant information to the
management so that they may evaluate the impact
of the decisions taking by them.
• E.g. Dividend decision

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 Financial statements
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• These are the statements prepared at the end

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of a period for a business
– Balance sheet

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4
– Manufacturing, Trading & P&L A/c
– Cash flow statement

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 Preparation of Manufacturing A/c
Dr. Manufacturing a/c of … for the year ending …. Cr.
Particulars Amount Particulars Amount

0011 0010 1010

To Opening stock1101 0001 0100 1011 By Sales of scrap
Raw material By closing stock
Work in progress Raw materials

2
To purchases of RM Work in progress

1
Less: Returns By Cost of finished
(direct Expenses) goods transferred to

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Trading A/c (balance fig)
To wages of workers
To salaries of foreman
To carriage/Freight on
RM
To Lighting
To Repairs to P&M
To other factory expenses
etc.

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 Preparation of Trading A/c
Trading a/c of … for the year ending ….
Dr.
0011 0010 1010 1101 0001 0100 1011 Cr.
Particulars Amount Particulars Amount

2
To stock of finished By Sales

1
goods
To manufacturing A/c By stock of finished

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(cost of finished goods) goods (closing)
To purchases of finished By Gross Loss
goods Transferred to P&L (bal
To other factory expenses fig)
etc.
Gross profit tfd to P& L
(bal fig)

9
 Preparation of P&L A/c
Profit and Loss a/c for the year ending …. Cr.
Dr.
0011 0010 1010 1101 0001Amount
Particulars 0100 1011 Particulars Amount

(Indirect expenses) To, By Gross Profit

2
Gross Loss .. By cash discounts received

1
To office salaries By Bad debts recovered
To office rent By interest on deposits

4
To printing By net loss (if any) tfd to
&stationary capital a/c
To Telephone
expenses…etc
To Bad debts
To Carriage outwards
Net profit (transferred to
capital A/c)

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 Balance Sheet
Balance Sheet As on ….
Liabilities Amount Assets Amount
A) Capital A) Fixed assets:
Equity Plant & Machinery
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preference OR, Less: Depreciation
(Proprietor’s funds Building
Less- Drawings) OR Less: depreciation

2
Partner 1’s Capital Goodwill

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Less-Drawings B) Investments

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Partner 2’s capital C) Current assets
Less- Drawings debtors
B) Borrowed funds: Stock
Debentures prepaid expenses
Long term debt D) Miscellaneous
C) Current liabilities: expenditure
creditors
Bills payable
o/s expenses
bank overdraft
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 Components of Balance Sheet
• Fixed Assets
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i) Tangible Assets: Building, Machinery, Plant,

Furniture etc.

1
2
ii) Intangible Asset: Goodwill, Patent, Copyright,
Trade Marks etc.

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• Current Assets
i) Liquid Asset: Cash, Securities etc.
ii) Circulating Asset: Trade Debtors, Bills Receivable,
Stocks, etc.
iii) Intangible Asset: e.g. Prepaid Expenses,
Outstanding Incomes etc.
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 Continued….
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• Miscellaneous

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i) Unrealizable Assets: like preliminary expenses

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4 13
 Continued….
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• Liabilities:

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i) Fixed Liability: long term loan, debenture

1
ii) Owned funds: equity and preference share

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capital
iii) Current Liability: Sundry Creditors, Bills
Payable, and Outstanding Expenses.
iv) Internal Liability: Profit & Loss A/c,
Reserve, etc.
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 SCHEDULE VI
AS PER COMPANIES ACT, 1956
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• Section 211 requires that every Balance Sheet of a company

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should provide a true and fair view of the state of a

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company as at the end of the financial year and it should be

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sent out in the format prescribed in Part I of Schedule VI of
the Companies Act, 1956.

• The format of Balance Sheet as per schedule VI may of two

types viz. i) Vertical Format and ii) Horizontal Format.

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 Vertical form of P & L A/c
Particulars Rs Rs Rs
A Net Sales
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Sales (gross) **
Less: Returns ** **

2
B. Cost of Goods sold

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Opening stock **

4
Add: Purchases **
Less: returns **
Add: Direct expenses
wages….etc.. **
Cost of goods available for sale **
Less: closing stock ** **
C: Gross profit (A-B) **

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 Particulars Rs Rs Rs

D Operating expenses
• Selling expenses
Carriage outward **
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Discount allowed **
Baddebts **

2
• Office and admin expenses

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salaries and wages **
Rent **

4
Depreciation ** **
E. Net Operating P/L (C-D) **
F: net non-operating result
a) Non operating incomes
interest, discount earned ** **
a) Non-operating expenses
interest allowed etc ** ** **
G. Net profit (E-F) **
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 Vertical form of Balance sheet
Particulars Rs Rs Rs
A Sources of funds
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proprietor’s funds or share capital **
Long term debts etc… **

2
B. Application of funds

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i) net working capital
a) Current assets

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debtors **
Stock
** **
prepaid expenses
b) Less: current liabilities
creditors **
Bills payable **
o/s expenses **
bank o/d
** ** **
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 contd..
Particulars Rs Rs Rs
ii)0010
0011 Investments
1010 1101 0001 0100 1011 **
iii) Fixed assets
Plant & Machinery **

2
Less: Depreciation
** **

1
Building
Less: depreciation **

4
Goodwill ** **
** **
**

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 BALANCE SHEET AS PER
SCHEDULE VI
0011 0010 1010 1101 0001 0100 1011

• ASSETS

2
Fixed Assets
Investments
1
4
Current Assets, Loans and Advances
Miscellaneous Expenditure

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 Continued….
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• LIABILITIES

2
Share Capital
Reserve & Surplus
1
4
Secured Loan
Unsecured Loan
Current Liabilities & Provisions
Contingent Liabilities

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 Analysis of financial statement
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• Steps in financial statement Analysis

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1. Determination of objects and scope of analysis

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2. Study of financial statements

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3. Collection of relevant information
4. Arrangement of data
5. Analysis of data
6. Interpretation, presentation and preparation of
reports

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 Techniques of Analysis
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Techniques of
Techniques of
Analysis

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Analysis

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Comparative
Comparative Fund and cash
Financial
Financial size Fund and cash
Common size
Common
Trend Analysis
Trend Analysis Flow
Flow Ratio Analysis
Ratio Analysis
Statement
Statement Statement
Statement Statements
Statements

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 Comparative statement
• It can be used for “intra-firm” comparison as well
0011 0010 1010 1101 0001 0100 1011
as for “inter-firm” comparison.
• In intra-firm - comparison of the same business

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2
enterprise over the years
• Inter-firm - comparison of two or more business

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enterprises and can be compared over a period of
years.
• They indicate the direction of movement of the
financial position and performance over the years.
• Identification of trouble points or weaknesses
becomes easier.
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 Common size statement
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• It shows the relation of each component to

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the whole.

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• In case of income statement –base is sales

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• In case of balance sheet- total funds
employed or total net assets is the base.

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 Trend analysis
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• It is used for the purpose of comparative

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study of financial statements over a number
of years.
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4
• Minimum of 3 years financial data is a must
• One year is taken as base and items are
considered as 100, then % increase or
decrease is calculated

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 Ratio Analysis
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• Indicated quotient of two mathematical

2
expressions and the relationship between two or

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more things

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• It is used as an index for evaluating the financial
position of the concern
• It involves comparison for a useful interpretation
of financial statements. E.g. current ratio to be
compared with past , or ratio of one firm can be
compared with the other.
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 Types of ratios
0011 0010 1010 1101 0001 0100 1011

2
Types of

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Ratios

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Leverage
Ratio / Profitability
Liquidity Ratio Activity Ratio
structural Ratio
Ratios

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 Classification
of Ratios

Revenue
Balance Combined
Statement
Sheet Ratios Ratios
Ratios
Return on cap employed
0011 0010 1010
Current Ratio1101 0001 0100
Gross1011
profit ratio (including long term
borrowing)

Return on proprietor’s fund

2
Liquid Ratio Expenses ratio
(SH fund+pref capital)

1
4
Stock to working capital Operating ratio Return on equity capital

Proprietary ratio Net profit ratio Dividend payout ratio

Debt equity ratio Net operating profit ratio Debt service ratio

Capital gearning ratio Stock turnover ratio Debtors turnover

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Creditors turnover
0011 0010 1010 1101 0001 0100 1011
Modes of
expression

2
of ratios

1
4
Number of
Number of Amount in
Pure ratio Percentages days/
times Rupees
weeks/months

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 Balance sheet ratios
1. Current Ratio:
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– = current assets / Current liabilities
• Standard is 2:1

2
• Applied to find out:

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• Solvency of the company

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• Short term financial strength
• Current strength of business
• Adequacy of working capital

1. Liquid ratio: (Acid test / Quick ratio):

– =(current assets-stock-prepaid expenses) / (current
liabilities-bank overdraft )
– Standard is 1:1
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 Contd…
3. Stock to working capital ratio
0011 0010 1010 1101 0001 0100 1011
– Stock / working capital
–

2
Working capital= CA-CL

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– It reflects important or weightage of stock in the
current assets

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– Higher the ratio, greater is the weakness of working
capital
3. Proprietary ratio
– Proprietor’s funds / Total assets
– High ratio- company is less dependent on outside
funds for the working
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 Contd..
5. Debt equity ratio
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– Debt / equity ratio
– Debt= all long term and short term liabilities

2
– Equity= equity share capital + reserves & surplus +

1
preference share capital

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– Higher the ratio, less secured are the creditors.
5. Capital gearing ratio:
– (Pref share capital + debentures + Term loans) /
(equity share capital + Reserves & Surplus)
– Explains the relationship between fixed term capital
to capital not having fixed rate.
– Ratio >1 highly geared
– Ratio<1 very lowly geared. 33
 Revenue statement ratios
• 1010
0011 0010 Gross profit
1101 0001Margin=
0100 1011(GP / Sales)*100
• Net profit Margin = (NP/ Sales)*100

2
• Operating expense Ratio: Operating Expenses / Sales

1
• Net operating profit Ratio: (Operating profit /

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Sales)*100
• Stock turnover ratio:
– Cost of sales / Average stock (in times) ((op stock + closing
stock) / 2)
– Stock velocity (in period)=(Average stock / cost of sales)*365

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 Combined ratios
1. Return on capital employed
 1101
0011 0010 1010 (EBIT/0001
capital0100
employed)*100
1011
2. Return on proprietor’s funds
 (NPAT / Shareholders funds)*100

2
1. Debtors Turnover Ratio:

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4
a) (Debtors + Bills Receivables) / credit sales* period factor i.e. 365 – in
terms of days or
b) Credit sales / Average Debtors- in times
2. Creditors Turnover Ratio:
a) (creditors + Bills payable) / credit purchases* period factor
i.e. 365 or
b) Credit purchases / Average creditors – in times

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0011 0010 1010 1101 0001 0100 1011

2
1
4 36
 Profitability Ratios
– Return on shareholder’s equity: PAT- div on
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pref shs / net worth
– Return on assets: PAT / Average total assets

1
2
4 37
 Profitability Ratios
– Earning Per Share = PAT / No. of shares
0011 0010 1010 1101 0001 0100 1011

– Dividend Per Share: proposed dividend/ no. of

2
equity shares

1
– Dividend Payout Ratio : Dividend per share /

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Earnings Per share
– Price earning Ratio: Market Value per share /
Earning per share

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 Cash flow Analysis
• It portrays exactly where the money of a business
0011 0010 1010 1101 0001 0100 1011
goes over a particular period of time and where
the money flowed into the business from during

2
the same period of time.

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• The cash flow statement is divided into three

4
parts:
– Cash from operations: cash generated through day-to-
day business
– Cash from investing: cash used for investing in assets
as well as the proceeds from the sale of other business,
equipment or other long term assets
– Cash from financing: cash in the form of income
received from investments and borrowing of funds.
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 Statements to prepare
1. Cash from operations
0011 0010 1010 1101 0001 0100 1011
– Non cash transactions to be adjusted
1. Cash flow statement

2
• Sources of cash:

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1. Issue of capital/debentures, debt
2. Cash from operations

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3. Increase in current liabilities
4. Sale of assets
5. Decrease in current assets
• Application of cash:
1. Repayment of long term debt, redemption of capital
2. Cash lost in operations
3. Decrease in current liabilities
4. Purchase of fixed assets
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5. Increase in current assets
 Changes in Balance sheet Impact on cash
0011 0010 1010 1101 0001 0100 1011
Decrease in long term liabilities Outflow of cash
Increase in long term liabilities inflow of cash

1
2
Decrease in current liabilities Outflow of cash

4
Increase in current liabilities inflow of cash
Decrease in non-current assets inflow of cash
Increase in non-current assets Outflow of cash
Decrease in current assets inflow of cash
Increase in current assets Outflow of cash
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 Cash from operations
0011 0010 1010 1101 0001 0100 1011
Amount Amount

a) Decrease in current Net profit

2
assets: a) Increase in current assets:

1
b) Increase in current b) Decrease in current
liability liability

4
c) Non-fund items c) Non-fund items already
already debited to credited to P&L a/c
P&L a/c • Profit on sale of assets
• Depreciation • Cash from operations
• Prel exps w/off
• g/w w/o

42
 Cash Flow Statement
0011 0010 1010 1101 0001 0100 1011
Sources Amount Application Amount

2
Balance at the beginning Cash outflows:

1
Cash in hand
Cash at bank

4
Add: cash inflows Cash lost in operation

Cash from operations Balance at the end:

Cash in hand
Cash at bank

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 Techniques of costing
0011 0010 1010 1101 0001 0100 1011

1. Standard costing

2
– Standard cost is predetermined as target of

1
performance and actual performance is

4
measured against the standard.
– The difference between the standard and
actual costs are analyzed to know the reasons
for the difference so that corrective actions
may be taken.

44
 Contd..
0011 0010 1010 1101 0001 0100 1011

2. Budgetary control

2
– Applied to the control of total expenditure on

1
materials, wages and overhead by comparing

4
actual performance with planned
performance.
– In addition to its use in planning, the budget
is used for control and co-ordination of
business operations.

45
 Contd..
0011 0010 1010 1101 0001 0100 1011

3 Marginal costing

2
– Separation of costs into fixed and variable.

1
– This regards only variable costs as the cost of the

4
products, whereas for fixed cost no attempt is made
to allocate or apportion this cost to individual cost
units.
– It is transferred to costing P&L A/c of the period.
– This technique is used to study the effect on profit
of changes in volume or type of output.

46
 Contd..
0011 0010 1010 1101 0001 0100 1011

4. Total absorption costing

2
– Total costs are charged to products.

1
4. Uniform costing

4
– Not a separate technique
– It simply denotes a situation in which a number of
firms adopt a uniform set of costing principles.
– This helps to compare the performance of one firm
with that of other firms and thus, to derive the
benefit of anyone’s better experience and
performance.

47
 Cost sheet for the month…..

Direct Material ****

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Direct Wages ****
Prime cost ****

1
2
Factory overhead ****
Factory cost ****

4
Office & administration OH ****
Cost of production ****
Selling & distribution OH ****
Total cost (cost of sales) ****
PROFIT ****
Sales ****
48
 Working capital
• It is a financial metric which represents operating liquidity
available
0011 0010 to a business.
1010 1101 0001 0100Along
1011 with fixed assets such as plant and
equipment, working capital is considered a part of operating
capital.

2
• Working Capital = Current Assets − Current Liabilities

1
• If current assets < current liabilities, an entity has a working
capital deficiency, also called a working capital deficit.

4
• It measures how much in liquid assets a company has available to build
its business.
• Positive working capital is required to ensure that a firm is able to
continue its operations and that it has sufficient funds to satisfy
both maturing short-term debt and upcoming operational
expenses.
• The management of working capital involves managing
inventories, accounts receivable and payable and cash.
49
 Contd..
0011 0010 1010 1101 0001 0100 1011

• An increase in working capital indicates

2
that the business has either increased

1
current assets (that is received cash, or other

4
current assets) or has decreased current
liabilities, for example has paid off some
short-term creditors.

50
 Working capital management
0011 0010 1010 1101 0001 0100 1011

Net Working Capital

2
Current Assets - Current Liabilities.

Gross Working Capital

1
4
The firm’s investment in current assets.

Working Capital Management

The administration of the firm’s current assets and the
financing needed to support current assets.

51
 Working capital Items

0011 0010 1010 1101 0001 0100 1011

1
2
4
Non-Working capital Items
52
 Working capital Management
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• Management of Working capital refers to

2
management of CA as well as CL.

1
• The goal of working capital management is

4
to ensure that the firm is able to continue its
operations and that it has sufficient cash
flow to satisfy both maturing short-term
debt and upcoming operational expenses.

53
 Characteristics of Current Assets
• Short Life Span
0011 0010 1010 1101 0001 0100 1011

I.e. cash balances may be held idle for a week or

two , thus a/c may have a life span of 30-60 days

1
2
etc.
• Swift Transformation into other Asset forms

4
i.e. each CA is swiftly transformed into other asset
forms like cash is used for acquiring raw
materials, raw materials are transformed into
finished goods and these sold on credit are
convertible into Accounts Receivable & finally
into cash.
54
 Need for Working Capital
• As profits earned depend upon magnitude of sales
0011 0010 1010 1101 0001 0100 1011
and they do not convert into cash instantly, thus there
is a need for working capital in the form of CA so as

2
to deal with the problem arising from lack of

1
immediate realization of cash against goods sold.

4
• This is referred to as “Operating or Cash Cycle” .
• It is defined as “The continuing flow from cash to
suppliers, to inventory , to accounts receivable &
back into cash “.
• Thus needs for working capital arises from cash or
operating cycle of a firm.
55
 Contd..
• Which refers to length of time required to
0011 0010 1010 1101 0001 0100 1011

complete the sequence of events.

2
• Thus operating cycle creates the need for

1
working capital & its length in terms of

4
time span required to complete the cycle is
the major determinant of the firm’s working
capital needs.
• Working capital management affects the
company’s risk, return, and share price.
56
 Factors influencing working capital
requirements
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1. Nature of business

2
• A service firm, like an electricity undertaking or a

1
transport corporation which has a short operating cycle
and which sells predominantly on cash basis, has a

4
modest working capital requirement.
• On the other hand, a manufacturing concern likes a
machine tools unit, which has a long operating cycle
and which sells largely on credit, has a very substantial
working capital requirement.

57
 Factors influencing working capital
requirements
0011 0010 1010 1101 0001 0100 1011
2. Seasonality of operations
• Firms which have marked seasonality in their operations

2
usually have highly fluctuating working capital requirements.

1
• E.g. a firm manufacturing ceiling fans. The sale of ceiling

4
fans reaches a peak during the summer months and drops
sharply during the winter period. The working capital need of
such firm is likely to increase considerably in summer
months and decrease significantly during the winter period.
• On the other hand, a firm manufacturing product like lamps,
which have even sales round the year, tends to have stable
working capital needs.
58
 Factors influencing working capital
requirements
0011 0010 1010 1101 0001 0100 1011
3. Production policy
• A firm marked by pronounced seasonal fluctuation in

2
its sales may pursue a production policy which may

1
reduce the sharp variations in working capital
requirements.

4
• For example, a manufacturer of ceiling fans may
maintain a steady production throughout the year rather
than intensify the production activity during the peak
business season. Such a production policy may dampen
the fluctuations in working capital requirements.

59
 Factors influencing working capital
requirements
0011 0010
4. 1010 1101
Market 0001 0100 1011
conditions
• The degree of competition prevailing in the market - competition is
keen, a larger inventory of finished goods is required to promptly

2
serve customers who may not be inclined to wait because other

1
manufacturers are ready to meet their needs.
• Further, generous credit terms may have to be offered to attract

4
customers in a highly competitive market. Thus, working capital
needs tend to be high because of greater investment in finished
goods inventory and accounts receivable.
• If the market is strong and is competition weak, a firm can manage
with a smaller inventory of finished goods because customers can
be served with some delay.
• Further, in such a situation the firm can insist on cash payment and
avoid lock-ups of funds in accounts receivable –it can even ask for
advance payment, partial or total
60
 Factors influencing working capital
requirements
5. 1010
0011 0010 Conditions of supply
1101 0001 0100 1011

• The inventory of raw materials, spares, and stores on the

conditions of supply.

1
2
• If the supply is prompt and adequate, the firm can manage with
small inventory. However, if the supply is unpredictable and

4
negligible, then the firm, to ensure continuity of production,
would have to acquire stocks as and when they are available
and carry large inventory on an average.
• A similar policy may have to be followed when the raw
material is available only seasonally and production operations
are carried out round the year.

61
 Classifications of Working
Capital
0011 0010 1010 1101 0001 0100 1011

2
• On the basis of Time
– Permanent

1
4
– Temporary

62
 Permanent Working Capital
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• There is always a minimum level of CA which is

2
continuously required by a firm to carry on its

1
business operations.

4
• Thus , the minimum level of investment in current
assets that is required to continue the business
without interruption is referred as permanent
working capital.

63
 Permanent Working
Capital
0011 0010 1010 1101 0001 0100 1011
The amount of current assets required to meet a firm’s long-
term minimum needs.

1
2
DOLLAR AMOUNT

TIME 4
Permanent current assets

64
 Variable Working Capital
0011 0010 1010 1101 0001 0100 1011

• This is the amount of investment required to take care of

2
fluctuations in business activity or needed to meet

1
fluctuations in demand consequent upon changes in

4
production & sales as a result of seasonal changes.

65
 Temporary Working
Capital
0011 0010 1010 1101 0001 0100 1011
The amount of current assets that varies with seasonal
requirements.

1
2
Temporary current assets
DOLLAR AMOUNT

TIME 4
Permanent current assets

66
 Distinction
• Permanent is stable over time whereas variable is
0011 0010 1010 1101 0001 0100 1011
fluctuating according to seasonal demands.
• Investment in permanent portion can be predicted with

2
some profitability whereas investment in variable cannot

1
be predicted easily.

4
• While permanent is minimum investment in various CA,
Variable is expected to take care for peak in business
activity.
• While permanent component reflects the need for a
certain irreducible level of current assets on a continuous
and uninterrupted basis , the temporary portion is needed
to meet seasonal & other temporary requirements.
67