Management Accounting Oct 2010

8/7/2019 Management Accounting Oct 2010

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Ans.1) (Chapter 1)

Management accounting is the process of identification, measurement, accumulation, analysis,preparation, interpretation and communication of information used by management to plan,evaluate and control within an entity and to assure appropriate use of and accountability for itsresources. Management accounting also comprises the preparation of financial reports for nonmanagement groups such as shareholders, creditors, regulatory agencies and tax authorities. Thecore activities of management accounting include;

y

P articipation in the planning process at both strategic and operational levels. Thisinvolves the establishment of policies and the formulation of plans and budgets whichwill subsequently be expressed in the financial terms.

y

The initiation of and the provision of guidance for management decisions. This involvesthe generation, analysis, presentation and interpretation of appropriate information.

y

C ontributing to the monitoring and control performance through the provision of reportson organizational performance, including comparisons of actual with planned or budgeted performance, and their analysis and interpretation.

According to the Chartered Institute of Management Accountants (CIM A), ManagementAccounting is "the process of identification, measurement, accumulation, analysis, preparation,interpretation and communication of information used by management to plan, evaluate andcontrol within an entity and to assure appropriate use of and accountability for its resources.Management accounting also comprises the preparation of financial reports for non-managementgroups such as shareholders, creditors, regulatory agencies and tax authorities" ( CI MA OfficialTerminology).


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T he American Institute of Certified Public Accountants( AICP A) states that managementaccounting as practice extends to the following three areas:

y

S trategic ManagementAdvancing the role of the management accountant as a strategic partner in the organization.

y

P erformance ManagementDeveloping the practice of business decision-making and managingthe performance of the organization.

y

R isk Management C ontributing to frameworks and practices for identifying, measuring,managing and reporting risks to the achievement of the objectives of the organization.

T he Institute of Certified Management Accountants(ICM A), states "A management accountantapplies his or her professional knowledge and skill in the preparation and presentation of financial and other decision oriented information in such a way as to assist management in theformulation of policies and in the planning and control of the operation of the undertaking."Management Accountants therefore are seen as the "value-creators" amongst the accountants.They are much more interested in forward looking and taking decisions that will affect the futureof the organization, than in the historical recording and compliance (scorekeeping) aspects of theprofession. Management accounting knowledge and experience can therefore be obtained fromvaried fields and functions within an organization, such as information management, treasury,efficiency auditing, marketing, valuation, pricing, logistics, etc.

Features of Management Accounting:

y

I t should be relevant for its purpose.

y

I t should be complete for its purpose.

y

I t should be sufficiently accurate for its purpose.y

I t should be clear to the manager using it.y

The manager using it should have confidence in it.

y

I t should be communicated to the appropriate manager.

y

I ts volume should be manageable.

y

I t should be timely.

y

I t should be communicated through appropriate channel of communication.

y

I t should be provided at a cost which is less than the value of the benefits it provides.

Sr. No. Criterion Management Accounting Cost Accounting

1 Prime Objectives Management Accounting aims atthe presentation of the cost data,to the extent required, wheneverand wherever they are requiredtogether with other relevantinformation to the managementto take decisions.

Cost accounting aims at theascertaining the cost of goods andservices. It lays emphasis on the stageby stage computation of costs. Forcost ascertainment differenttechniques and system of costing areused under different circumstances.

2 Data Coverage Cost data form a part of Cost reports deal mainly with the


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managerial report but not thesole aspects. Report includesboth quantitative and qualitativeinformation.

cost-incurred or budgeted andstandards, variance, savings, etc. Costreporting is a continuous process andmay be daily weekly, monthly etc.

3 Use of Reports Management reports are usefulonly to the management but notto the internal and externalparties.

Though cost reports are meant formanagement, they are useful even tothe external parties.

4 Control of AppropriateAuthority

Preparation of report as per therules of the appropriate authorityetc.No such rigidity is there inmanagerial reports. Theprocedure, format etc. can bemodified from time to timedepending upon convenienceand requirement.

Cost accounts and reports are to beprepared as per certain rules,principles, procedure etc. as specifiedby the appropriate authority to theindustry to which the companybelongs to. It has been madeobligatory to keep cost records underthe Companies Act.

5 StatutoryVerification

Management reports are notsubject to statutory audit. Thereis management audit but it isvoluntary and it evaluates themanagerial decisions etc.Managerial reports include bothobjective and subjective data.

Cost reports and accounts, in manycases, are subject to statutory audit.Hence they should be prepared as faras possible, on objective manner.

6 Nature Management Accounting ismainly concerned with the futureplan policies. Management relyon past records for formulation

of future plans and hence theinterdependence of costaccounting and managementaccounting cannot be overemphasized.

Cost accounting is concerned not onlywith historical data but also withpredetermined costs. Cost accountingalso helps to improve the

performance of future. CostAccounting help in determining theselling price

7 Subject Matterand Scope

Management accounting is alsoknown as ManagerialAccounting, or Accounting formanagement, or Managementoriented accounting etc. It is alsoknown as internal accounting,identifies, collects, measures,classifies, and report informationthat is useful to managers inplanning, control and decision-making.

Cost Accountancy embraces costing,cost accounting and even cost controland cost audit. Cost Accountancy isused to describe the principles,conventions, techniques, and systemswhich are employed in the businessto plan and control the utilization of its resources.


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business cost standards, expense budgets, sales forecasts, profit planning, and programmefor capital investment and financing, together with necessary procedures to effectuate theplan.

y

To compare performance with operating plan and standards and to report and interpretthe results of operation to all levels of management, and to the owners of the business.

This function includes the formulation and administration of accounting policy and thecompilations of statistical records and special reposts as required.y

To consult withal segments of management responsible for policy or action conservingany phase of the operations of business as it relates to the attainment of objective, and theeffectiveness of policies, organization strictures, procedures.

y

To administer tax policies and procedures.

y

To supervise and coordinate preparation of reports to Government agencies.

y

The assured fiscal protection for the assets of the business through adequate internal;control and proper insurance coverage.

y

To continuously appraise economic and social forces and government influences, andinterpret their effect upon business.

Duties and R esponsibilities of Management Accountant

The primary duty of Management Accountant is to help management in taking correct policy-decisions and improving the efficiency of operations. He performs a staff function and also hasline authority over the accountants. I f management accountant feels that a decision likely to betaken by the management based on the information tendered by him shall be detrimental to theinterest of the concern, he should point out this fact to the concerned management, of course,with tact, patience, firmness and politeness. On the other hand, if the decision taken happens tobe wrong one on account t of inaccuracy, biased and fabricated data furnished by themanagement accountant, he shall be held responsible for wrong decision taken by themanagement. C ontrollers I nstitute of America has defined the following duties of ManagementAccountant or controller:

y

The installation and interpretation of all accounting records of the corporative.

y

The preparation and interpretation of the financial statements and reports of thecorporation.

y

C ontinuous audit of all accounts and records of the corporation wherever located.

y

The compilation of costs of distribution.

y

The compilation of production costs.

y

The taking and costing of all physical inventories.

y

The preparation and filing of tax returns and to the supervision of all matters relating totaxes.

y

The preparation and interpretation of all statistical records and reports of the corporation.

y

The preparation as budget director, in conjunction with other officers and departmentheads, of an annual budget covering all activities of the corporation of submission to theBoard of Directors prior to the beginning of the fiscal year. The authority of theC ontroller, with respect to the veto of commitments of expenditures not authorized by thebudget shall, from time to time, be fixed by the board of Directors.


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y

The ascertainment currently that the properties of the corporation are properly andadequately insured.

y

The initiation, preparation and issuance of standard practices relating to all accounting,matters and procedures and the co-ordination of system throughout the corporationincluding clerical and office methods, records, reports and procedures.

y

The maintenance of adequate records of authorized appropriations and the determinationthat all sums expended pursuant there into are properly accounted for.y

The ascertainment currently that financial transactions covered by minutes of the Boardof Directors and/ or the Executive committee are properly executed and recorded.

y

The maintenance of adequate records of all contracts and leases.

y

The approval for payment(and / or countersigning ) of all cheques, promissory notes andother negotiable instruments of the corporation which have been signed by the treasurer or such other officers as shall have been authorized by the by-laws of the corporation or form time to time designated by the Board of Directors.

y

The examination of all warrants for the withdrawal of securities from the vaults of thecorporation and the determination that such withdrawals are made in conformity with the

by-laws and /or regulations established from time by the Board of Directors.y

The preparation or approval of the regulations or standard practices, required to assurecompliance with orders of regulations issued by duly constituted governmental agencies.


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Ans. 2) (Chapter 4)

PARTICULARS Amount (Rs)Current Assets

CashRaw Material ( 45,000 *52*1)

12Work-in-progress

Raw Material ( 45,000 *52*0.5)12

Labor ( 45,000 *26*0.5)12

Overhead ( 45,000 *32*0.5)12

Debtors ( 45,000 *130*2) * (3)12 4

Current LiabilitiesCreditors ( 45,000 *52*1)

12Wages( 45,000 *26*0.35)

12Overheads( 45,000 *32*1)

12

1,20,0001,95,000

97,500

48,750

60,000

7,31,25012,52,500

1,95,000

34,125

1,20,0003,49,125


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Net Working Capital Required =Current Asset- Current Liabilities

12,52,500 3,49,125=9,03,375

y

Assumed 12 months = 52 weeks

Or 52 weeks = 12 months1 week = 12 month

52Therefore 1.5 week = 1.5 * 12 month

52

Ans.3) (Chapter 5)

(a)

P/V Ratio = Change in Profit *100

Change in Sales

*Profit = Sales Cost

P/V Ratio = 8, 00,000 * 100

20, 00,000


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= 40%

(b) Fixed Cost = Contribution Profit = (Sales * P/V Ratio) Profit

= (60,000* 40) 4,00,000100

= 24,00,000 - 4,00,000 = 20,00,000

(c) Sales required to BEPBE P(Sales) = Fixed Cost = 20,00,000 *100

P/V Ratio 40= 50, 00,000

(d) Sale for Profit = 10,00,000F.C. = 20, 00,000

P/V Ratio = 40%

Sales = F.C. + Desired ProfitP/V Ratio

= (20, 00,000 + 10, 00,000)*10040

= 75,00,000

Ans.3) (Chapter 4)

Working capital management involves the relationship between a firm's short-term assets andits short-term liabilities. The goal of working capital management is to ensure that a firm is able

to continue its operations and that it has sufficient ability to satisfy both maturing short-term debtand upcoming operational expenses. The management of working capital involves managinginventories, accounts receivable and payable, and cash.

Working capital has two components: C urrent assets and C urrent liabilities. Current assetscomprise several items. The typical items are:

Cash to meet expenses as and when they occur.


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Accounts Receivables or sundry trade debtors

I nventory of:

1.

R aw materials, stores, supplies and spares,2.

Work-in-process, and

3.

Finished goods

Advance payments towards expenses or purchases, and other short-term advances which arerecoverable.

Temporary investment of surplus funds which could be converted into cash whenever needed.

A part of the need for funds to finance the current assets may be met from supply of goods oncredit, and deferment, on account of custom, usage or arrangement, of payment for expenses.The remaining part of the need for working capital may be met from short-term borrowing fromfinanciers like banks. These items are collectively called current liabilities. Typical items of current liabilities are:

Goods purchased on credit

Expenses incurred in the course of the business of the organisation (e.g., wages or salaries, rent, electricity bills, interest etc.) which are not yet paid for.

Temporary or short term borrowings from banks, financial institutions or other parties

Advances received from parties against goods to be sold or delivered, or as short termdeposits.

Other current liabilities such as tax and dividends payable. S ome of the major components of current assets are explained here in brief:

Current Assets:Cash: C ash is initially required for acquiring fixed assets like plants and machinery whichenables a firm to produce products and generate cash by selling them. C ash is also required andinvested in working capital. I nvestments in working capital is required, as firms have to storecertain quantity of raw materials and finished goods and also for providing credit terms to thecustomers.

A minimum level of cash helps in the conduct of everyday ordinary business such as making of purchases and sales as well as for meeting the unexpected payments, developments and other contingencies. As discussed earlier cash invested at the beginning of-the operating cycle gets

released at the end of the cycle to fund fresh investments. However, additional cash is requiredby the firm when it needs to buy more fixed assets, increase the level of operations or for bringing out change in working capital cycle such as extending credit period to the customers.

The demand for cash is affected by several factors, some of them are within the control of themanagers and some are outside their control. I t is not possible to operate the business withoutholding cash but at the same time holding it without a purpose also costs a firm either directly inthe form of interest or loss of income that could be earned out of the cash.


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I n the context of working capital management, cash management refers to optimizing the benefitand cost associated with holding cash. The objective of cash management is best achieved byspeeding up the working capital cycle, particularly the collection process and investing surpluscash in short term assets in most profitable avenues.

Accounts Receivable: Firms rather prefer to sell for cash than on credit, but competitivepressures force most firms to offer credit. Today the use of credit in the purchase of goods andservices is so common that it is taken for granted. S elling goods or providing services on creditbasis leads to accounts receivable. When consumers expect credit, business units in turn expectcredit from their suppliers to match their investment in credit extended to consumers. Thegranting of credit from one business firm to another for purchase of goods and services ispopularly known as trade credit. Though commercial banks provide a significant part of requirements for working capital, trade credit continues to be a major source of funds for firms

and accounts receivable that result from granting trade credit are major investment for the firm.

Both direct and indirect costs are associated with carrying receivables, but it has an importantbenefit for increasing sales. Excessive levels of accounts receivables result in decline of cashflows and many result in bad debts which in turn may reduce the profit of the firm. Therefore, itis very important to monitor and manage receivables carefully and regularly.

Inventory: Three things will come to your mind when you think of a manufacturing unit -machines, men and materials. Men using machines and tools convert the materials into finishedgoods. The success of any business unit depends on the extent to which these are efficientlymanaged. I nventory is an asset to the organisation like other components of current assets.

I nventory constitutes a very significant part of working capital or current assets in manufacturingorganisation. I t is essential to control inventories (physical/quantity control and value control) asthese are significant elements in the costing process constituting sometimes more than 60% of the current assets. I nventory holding is desirable because it meets several objectives and needsbut an excessive inventory is undesirable because it costs a lot to firms.

I nventory which consists of raw material components and other consumables, work in process

and finished goods, is an important component of `current assets'. There are several factors likenature of industry, availability of material, technology, business practices, price fluctuation, etc.that determines the amount of inventory holding. Holding inventory ensures smooth productionprocess, price stability and immediate delivery to customers. S ince inventory is like any other form of assets, holding inventory has a cost. The cost includes opportunity cost of funds blockedin inventory, storage cost, stock out cost, etc. The benefits that come from holding inventoryshould exceed the cost to justify a particular level of inventory.


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Marketable Securities: C ash and marketable securities are normally treated as one item in anyanalysis of current assets although these are not the same as cash they can be converted to cash ata very short notice. Holding cash in excess of immediate requirement means the firm is missing

out an opportunity income. Excess cash is normally invested in marketable securities, whichserves two purposes namely, provide liquidity and, also earn a return.

Marketable securities are a way of holding cash but with the attribute of earning interest. Marketsecurities have three characteristics:

1.

S hort-term maturity (less than one year, or money market instruments2.

High marketability

3.

Virtually no risk of default

S everal types of marketable securities exist, the major ones being

y

Anticipation notes

Anticipation notes are issued by municipalities and school districts. S ince their revenues come from tax sources, the notes are in anticipation of future taxreceipts.

y

C ommercial paper

C ommercial paper is the promissory notes of a major national firms. Most of thefirms that issue commercial paper sell it directly to investors (insurancecompanies, money market funds, pension funds) although sometimes it will besold through investment bankers. C ommercial paper is a substitute for bank debt,but at a rate of interest that is one-fourth to on-half of a percent higher than t-billsbut significantly less than what banks would charge.

y

Bankers Acceptances

A bankers acceptance is a time draft that evolves from internationalexport/import financing. An exporter is paid by a time draft issued by a foreignbank. S ince the draft is not payable until some future date (1-3 months, typically)the company that receives it will often sell it to its local bank at a discount. The


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local bank bundles the discounted drafts (bankers acceptances) and then resellsthem in the money markets.

Current Liabilities

Short-term Financing

T rade Credit: The major source of short-term financing for firms is that of trade credit. Whileit is an account payable on our balance sheet, it is an account receivable on the balance sheet of our supplier.

The terms of credit can vary quite a bit:

1.

C ash on Delivery (i.e., no credit)2.

Net amount due within a certain period of time

3.

Net amount with a discount if paid within a certain period of time, net amount within

another period.

Commercial BanksThe second major source of short-term financing for firms is commercial banks. A firm wants toestablish a close relationship with its bank and obtain a line of credit. I n order to get a creditline, you will want to show them your income statements, balance sheets, financial ratios, etc.The bank will then allow a certain amount of credit with a set rate of interest (usually primeplus). This can be renegotiated every year. I n fact, commercial banks bread and butter is their business accounts and they are very competitive with one another in trying to attract corporate

clients. The amount of the credit line is typically tied to the amount of accounts receivable thatthe firm has and sometimes to the amount of inventories that it holds.

Another type of credit line is referred to as a revolving line of credit . With a revolvingline of credit, the bank provides a written agreement guaranteeing loans up to a certain amount.The firm will pay a normal rate of interest on the amounts of funds that it borrows plus acommitment fee of one-half to one percent on any unborrowed funds. Unlike a regular line of credit which can be changed, a revolving line of credit guarantees that the bank will always makethe amount available if needed. Additionally, a revolving line of credit will often be extendedjointly by several banks when the amounts used are larger than a single bank can (or wants to)handle alone.


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Ty pes of Loans

Loans come in a variety of shapes. A simple loan requires that the firm maintain a non-interest-bearing account at the bank. While compensating balances are not used as much as they

have been in the past, they are still encountered frequently.

S ecurit y for Bank Loans

Banks like some sort of collateral for loans to ensure repayment of the loan, at least inpart. The preferred collateral for bank loans is accounts receivable. The reason, of course, isthat collecting money is what banks do. There are two ways to obtain financing with

receivables:

P ledging of Accounts R eceivable This is the most common form. A lender will loan upto 80% of the amount of the invoice. Upon payment, the borrower has pledged to use theproceeds to reduce the amount of the loan. I f the customer does not pay the invoice, theborrower is still obligated to repay the loan.

Factoring of Accounts R eceivable The receivable is sold to a factoring institution.Typically, this is used prior to making a sale on credit. The seller will go to a factor who will runa credit check on the potential buyer. I f the buyer has a good credit rating, the factor will givethe go-ahead to sell on credit and then buy the receivable (at a discount) from the seller. Thebuyer is notified in writing to pay the factor directly for the receivable. Then, if the invoice isnot paid, it is up to the factor to collect from the buyer and the factor takes the risk of bad debt.S ometimes, the factor may withhold 10% from the seller to make them share in the risk of non-payment. Then, when payment is received, the 10% reserve will be refunded to the seller.

The use of factoring is considerably more expensive than the pledging of accountsreceivable. This is due to the fact that, in addition to lending money for a period of 30-90 days,the factor also must run a credit check, incur the cost of collection, and undertake the risk of nonpayment.

Banks will also use inventories as collateral for short-term loans. A blanket lien (or floating lien) is one that covers all inventories. Even then, the lender will only loan 40-50% of the cost of those goods. This is because, if default occurs, the lender will have to hire someoneto sell the inventories as well as substantially discounting them in order to liquidate theinventories.


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A warehouse receipts loan is where a third party holds the inventory as collateral for thelender. A warehouse receipts loan is most commonly used in the canning industry or whereproduction of inventory is seasonal. For example, the cotton season runs from June to October.Denim jeans, on the other hand, are purchased year-round. Thus, a denim manufacturer mightbuy cotton in June and produce denim but not have enough for the estimated annual demand.

The producer could then go to a bank and borrow against the bolts of denim that have beenproduced. These bolts of denim would then be stored in a public warehouse as collateral andfunds would be made available for the producer to purchase more cotton and produce moredenim. As inventories are sold, the loan could be paid down, in which case the lender wouldnotify the public warehousing company to release X number of bolts of denim to the producer and the process reverses itself.

I f the inventories are too bulky to transport to a public warehouse, a field warehousearrangement may be set up where the public warehousing company goes to the producers placeof business and physically segregates the inventories that are being held as collateral for thelender. Only the public warehousing company would have access to the collateral and would

only release it upon notification by the lender.S ecurities Loans

A borrower can pledge their inventories of securities of another company (bonds, notespayable) as collateral for a loan as well. Thus, if you hold a note payable from a creditworthyfirm, many lenders will loan money against it. (This is similar, in a sense, to what happens witha margin purchase.)

I n short, if a firm has assets of virtually any kind, it can use them as collateral for short-term loans to meet its short-term cash needs.


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Ans. 4) (Chapter 2)

(a)

G ross profit Ratio = Gross Profit * 100 = 6,00,000 *100 = 25% Net Sales 24, 00,000

(b) Net Profit Ratio = Net Profit * 100 = 3,60,000 *100 = 15 Net Sales 24, 00,000

(c) Return on Assets = Net Income = Net Profit B efore Taxes = 3,60,000 = 0.12:1Total Assets Total Asset 30, 00,000

(d) Inventory Turnover Ratio = Net Sales = 24,00,000 = 3 timesInventory 8, 00,000

(e)

W orking Turnover = Sales = 24,00,000 = 2.5: 1 Net Working Capital 9, 60,000

(f)

Net W orth to Debt = Net Worth = 15,00,000 = 1.67 Debt 9,00,000

Ans.4) (Chapter 3)

FUND FLOW S T ATE M ENT

An analysis of the fluctuations of current assets and current liabilities i.e. working capital tells us how theworking capital has increased or decreased. The profit and loss account gives some indication of theresults of operations and its impact on the funds position. Integrate the impact of operations reported inthe profit and loss account and balance sheet by preparing a statement of changes in financial position. I tdescribes the sources from which fluids were received and the uses to which funds were put. Thisstatement of changes in financial position is usually referred to as fund flow state ment or statement of sources and application funds. As the title indicates fund flow statement traces the flow of funds throughthe organisation. In other words, it shows the sources from where the funds were raised , and the uses towhich they were put.

The statement of funds flow is usually bifurcated into two logical divisions: sources of funds or inflowsduring the periods and uses of funds or applications of funds during the period. The division showingsources of funds summarises all those transactions which had the net effect of increasing the workingC apital. Uses of funds on the other hand deal with all those transactions which had the effect of decreasing the working capital.


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The flow of funds statement gives a summary of the impacts of managerial decisions. As such itreflects the policies of financing, investment, acquisition and retirement of fixed assets,distribution of profits, and the success of operations.

Definition of Funds flow statement.

T he funds flow statement describes the sources from which additional funds were derivedand the use to which these funds were put.

I t indicates various methods by which funds are obtained during a particular period and theways in which these funds are employed. I n simple words, it is a statement of sources andapplication of funds.

A statement of sources and application of funds is a technical device designed to analyse thechanges in the financial condition of a business enterprise between two dates.

Meaning of important terms


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Funds

I n funds flow statement funds means working capital i.e. current assets current liabilities.

F low of funds

I t means changes in funds or change in working capital

S ource of fund

I t is any transaction that results in an increase in working capital (inflow of funds)

Application of funds

I t is any transaction that results in a decrease in working capital (outflow of funds)

Importance of Funds F low S tatement.

1. Helps in analysis of financial operations.

2. Helps in formulation of realistic dividend policy.

3. Helps in proper allocation of resources.

4. I t acts as a future guide.

5. Helps in appraising the use of working capital.

6. I t helps knowing the overall creditworthiness of a firm.

7. I t throws light on many questions of general interest.

. Why were the net C A lesser in spite of profits.

. Why dividend could not be declared in spite of available profits.

. What are the sources of repayment of debts.

Identification of flow of funds: general rules

1. There will be a flow of funds if a transaction involves a current account and a non-current

account i.e. involves

a. C urrent assets and fixed assets eg purchase of building for cash

b. C urrents asset and capital eg issue of share for cash

c. C urrent assets and fixed liabilities eg redemption of debentures in cash or repayment of long term loan in cash


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d. C urrent liabilities and fixed liabilities eg creditors paid off in debentures

e. C urrent liabilities and capital eg creditors paid off in shares

f. C urrent liabilities and fixed assets eg building transferred to creditors in satisfaction of their claims/

2. There will be NO flow of funds if a transaction involves 2 current accounts or 2 non-currentaccounts ie involves:

a. C urrent assets and current liabilities eg payment of creditors in cash

b. Fixed assets and fixed liabilities eg building purchased and payments made in debentures

c. Fixed assets and capital eg. Building purchased and payment made in shares.


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S IG NIF ICA NC E O F FUND FLOW S T ATE M ENT

The utility of this statement can be measured on the basis of its contributions to the financial

management. I t generally serves the following purposes:-

(1) Anal ysis of F inancial Position. The basic purpose of preparing the statement is to have arich into the financial operations of the concern. I t analyses how the funds were obtained andused in the past. I n this sens, it is a valuable tool for the finance manager for analyzing the pastand future plans of the firm and their impact on the liquidity. He can deduce the reasons for theimbalances in uses of funds in the past an take necessary corrective actions. I n analyzing thefinancial position of the firm, the Funds Flow S tatement answers to such questions as-

1. Why were the net current assets of the firm down, though the net income was up or viceversa?

2. How was it possible to distribute dividends in absence of or in excess of current income for the period ?3. How was the sale proceeds of plant and machinery used ?4. How was the sale proceeds of plant and machinery used ?5. How were the debts retired ?6. What became to the proceeds of share issue or debenture issue ?7. How was the increase in working capital financed ?8. Where did the profits go?

Though it is not an easy job to find the definite answerers to such questions because fundsderived from a particular source re rarely used for a particular purpose. However, certain useful

assumptions can often be made and reasonable conclusions are usually not difficult to arrive at.

(2) E valuation of the F irm's F inancing. One important use of the statement is that it evaluatesthe firm' financing capacity. The analysis of sources of funds reveals how the firm's financed itsdevelopment projects in the past i.e., from internal sources or from external sources. I t alsoreveals the rate of growth of the firm.

(3) An Instrument for Allocation of R esources. I n modern large scale business, available fundsare always short for expansion programmes and there is always a problem of allocation of resources. I t is, therefore, a need of evolving an order of priorities for putting through their expansion programmes which are phased accordingly, and funds have to be arranged as different

phases of programmes get into their stride. The amount of funds to be available for these projectsshall be estimated by the finance with the help of Funds Flow S tatement. This prevents thebusiness from becoming a helpless victim of unplanned act ion.

(4) A T ool of Communication to Outside World. Funds Flow S tatement helps in gathering thefinancial states of Business. I t gives an insight into the evolution of the present financial positionand gives answer to the problem 'where have our resources been moving'? I n the present worldof credit financing, it provides a useful information to bankers, creditors, financial, it provides a


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useful informations and government etc. regarding amount of loan required, its proposes, theterms of repayment an sources for repayment of loan etc. the financial manager gains aconfidence born out of a study of Funds Flow S tatement. I n fact, it carries information regardingfirm's financial policies to the outside world.

(5) Future Guide. An analysis of Funds FlowS

tatements of several years reveals certainvaluable information for the financial manager for planning the future financial requirements of the firm and their nature too i.e. S hort term, long-term or mid term. The management canformulate its financial policies based on information gathered from the analysis of suchstatements. Financial manager can rearrange the firm's financing more effectively on the basis of such information along with the expected changes in trade p payables and the various accruals.I n this way, it guides the management in arranging its financing more effectively.

Ans.5)

(a) F lexible Budget

Ans a) (Chapter 6)

A flexible budget is a budget that adjusts or flexes for changes in the volume of activity. Theflexible budget is more sophisticated and useful than a static budget, which remains at oneamount regardless of the volume of activity. The flexible budget responds to changes inactivity, and may provide a better tool for performance evaluation. I t is driven by the expectedcost behavior. Fixed factory overhead is the same no matter the activity level, and variable costsare a direct function of observed act ivity. When performance evaluation is based on a staticbudget, there is little incentive to drive sales and production above anticipated levels becauseincreases in volume tend to produce more costs and unfavorable variances.

The flexible budget is a performance evaluation tool. I t cannot be prepared before the end of theperiod. A flexible budget adjusts the static budget for the actual level of output. The flexiblebudget asks the question: If I had known at the beginning of the period what my output volume


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(units produced or units sold) would be, what would my budget have looked like? Themotivation for the flexible budget is to compare apples to apples. I f the factory actually produced10,000 units, then management should compare actual factory costs for 10,000 units to what thefactory should have spent to make 10,000 units, not to what the factory should have spent tomake 9,000 units or 11,000 units or any other production level.

The flexible budget variance is the difference between any line-item in the flexible budget andthe corresponding line-item from the statement of actual results.

The following steps are used to prepare a flexible budget:

1. Determine the budgeted variable cost per unit of output. Also determine the budgetedsales price per unit of output, if the entity to which the budget applies generatesrevenue (e.g., the retailer or the hospital).

2. Determine the budgeted level of fixed costs.

3. Determine the actual volume of output achieved (e.g., units produced for a factory,units sold for a retailer, patient days for a hospital).

4. Build the flexible budget based on the budgeted cost information from steps 1 and 2,and the actual volume of output from step 3

Flexible budgets are prepared at the end of the period, when actual output is known.

Preparation of a F lexible Budget

The flexible budget uses the same selling price and cost assumptions as the original budget.Variable and fixed costs do not change categories. The variable amounts are recalculated usingthe actual level of activity, which in the case of the income statement is sales units. Each flexiblebudget line will be discussed separately.

S ales . The original budget assumed 17,000 P ickup Trucks would be sold at R s 15 each. Toprepare the flexible budget, the units will change to 17,500 trucks, and the actual sales level and

the selling price will remain the same. TheR

s 2,62,500 is 17,500 trucks timesR

s 15 per truck.The variance that exists now is simply due to price. Given that the variance is unfavorable,management knows the trucks were sold at a price below the R s15 budgeted selling price.

Cost of Goods S old . Using the cost data from the budgeted income statement, the expected totalcost to produce one truck was R s 11.25. The flexible budget cost of goods sold of R s 1,96,875 isR s 11.25 per pick-up truck times the 17,500 trucks sold. The lack of a variance indicates thatcosts in total (materials, labor, and overhead) were the same as planned.


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S elling E xpenses . The original budget for selling expenses included variable and fixed expenses.To determine the flexible budget amount, the two variable costs need to be updated. The newbudget for sales commissions is R s 10,500 ( R s 2, 62,500 sales times 4%), and the new budget for delivery expense is R s 1,750 (17,500 units times 10%). These are added to the fixed costs of R s12,500 to get the flexible budget amount of R s 24,750.

General and Administrative E xpenses . This flexible budget is unchanged from the original(static budget) because it consists only of fixed costs which, by definition, do not change if theactivity level changes.

Income T axes . I ncome taxes are budgeted as 40% of income before income taxes. The flexiblebudget for income before income taxes is R s 20,625, and 40% of that balance is R s 8,250. Actualexpenses are lower because the income before income taxes was lower. The actual tax rate isalso 40%.

Net Income . Total net income changes as the amount for each line on the income statement

changes. The net variance in this example is mainly due to lower revenues.

The important thing to remember in preparing a flexible budget is that if an amount, cost or revenue, was variable when the original budget was prepared, that amount is still variable andwill need to be recalculated when preparing a flexible budget. I f, however, the cost wasidentified as a fixed cost, no changes are made in the budgeted amount when the flexible budgetis prepared. Differences may occur in fixed expenses, but they are not related to changes inactivity within the relevant range.

(b) Objectives of Budgetar y Control

Ans. b) (Chapter 6)

Budgets are simply exercises in calculation unless they are used. When we use a budget, we doso as part of a system of budgetary control. That is, we have some basic ideas of what we want todo, we prepare budgets to help us achieve those ideas; and then once we have done whatever it is

that we wanted to do, we check to see if we kept to our budget.

Budgetary control relates to the establishment of budgets relating the responsibilities of budgetholders the needs of a policy. Budgetary control also relates to the continuous comparison of actual with budgeted results, it does this to try to ensure that the objectives of that policy areachieved; or to provide a basis for the change of those objectives.


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A budget is a statement setting out the monetary, numerical or non quantitative aspects of anorganisation's plans for the coming week or month or year. Budgetary control is the analysis of what happened when those plans came to be put into practice, and what the organisation did or did not do to correct for any variations from these plans.

y

Efficiency.In budget terms this is expressed as the profit after tax to sales, or productivity figures relating to direct labour, machinery performance or a combination of

these things.y

P rofit target. To ensure an adequate financial reward for the owners. This may equate topercentage level or dividend amount for the members of the ownership.

y

Dividend. A suitable return on investment for shareholders or the owners.

y

Budget provides the yardstick against which future results can be compared.

y

With the establishment of the budget, action(s) can be taken by management if there areany material variances against budget.

y

Budgets enable management to plan and anticipate in areas of adequacy in workingcapital and scarce or type of availability of resources;

y

Budgets are able to direct capital expenditure in the most profitable direction;y

Assist to plan and control earnings and expenditure so that maximum profitability can beachieved;

y

I t act as a guide for management decisions when unforeseeable conditions affect thebudget;

y

Assist in decentralizing responsibility on to each manager involved. With the setting of budgets, the managers involved will better understand what the company expects fromthem. Therefore there is a congruence of goals between the company and the employees

(c) Cash F low S tatement (Chapter 3):

Cash flow refers to the movement of cash into or out of a business, a project, or a financialproduct. I t is usually measured during a specified, finite period of time. Measurement of cashflow can be used

y

to determine a project's rate of return or value. The time of cash flows into and out of projects are used as inputs in financial models such as internal rate of return, and netpresent value.

y

to determine problems with a business's liquidity. Being profitable does not necessarilymean being liquid. A company can fail because of a shortage of cash, even whileprofitable.

y

as an alternate measure of a business's profits when it is believed that accrual accountingconcepts do not represent economic realities. For example, a company may be notionallyprofitable but generating little operational cash (as may be the case for a company thatbarters its products rather than selling for cash). I n such a case, the company may bederiving additional operating cash by issuing shares, or raising additional debt finance.

y

cash flow can be used to evaluate the 'quality' of I ncome generated by accrual accounting.When Net I ncome is composed of large non-cash items it is considered low quality.


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y

to evaluate the risks within a financial product. E.g. matching cash requirements,evaluating default risk, re-investment requirements, etc.

C ash flow is a generic term used differently depending on the context. I t may be defined by usersfor their own purposes. I t can refer to actual past flows, or to projected future flows. I t can refer

to the total of all the flows involved or to only a subset of those flows.S

ubset terms include 'netcash flow', operating cash flow and free cash flow

C ash flow statement is produced to show how the enterprise generates and uses cash and cashequivalents. A cash flow statement, when used in conjunction with the rest of the financialstatements, provides information that enables users to evaluate the changes in net assets of anenterprise, its financial structure and its ability to affect the amounts and timing of cash flows inorder to adapt to changing circumstances and opportunities.

C ash flow statement should report cash flows during the period classified by operating, investingand financing activities.

Operating Activities

C ash flow from operating activities relates to cash generated or paid out through the normal cashgenerating activities of the enterprise. The enterprise need to generate enough cash flow fromthese activities as they are the main sources of cash for the business. C ash flow from operatingactivities will be used to repay loans, maintain the operating capabilities of the enterprise andmake new investments.

C ash flow from operating activities includes:

a) cash received from sale of goods or provision of services;b) cash received from royalties, fees, commission and other revenues;c) cash payments to suppliers;d) cash payments to or on behalf of employeese) cash payments or refund of income tax.

Investing Activities

These are cash flow on capital expenditure incurred which will generate future operating cashflows. Examples of cash flows arising from investment activities are:

a) C ash payments to acquire property plant and equipment or cash received from disposal of these assets.b) C ash payment to acquire equity or debt instruments of other enterprises.c) C ash received from sale of equity or debt instrument of another enterprise.d) C ash advances and loans made to other parties.e) C ash received from the repayments of advances and loans made to other parties;

F inancing Activities


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C ash flow from financing activities relates to cash flow received from or repaid to outsideproviders of finance. Examples include:

a) C ash proceeds from issuing of shares or other equity instrument;b) C ash payments to owners to acquire or redeem the enterprise shares.

c)C

ash repayment of amounts borrowed.d) C ash payments in finance leasee) Dividend paid to ordinary share holders

C ash flow statement can be produced used direct or indirect method. Direct method discloses themajor classes of cash receipts and gross payments. While indirect method begins with net profitwhich is adjusted with non cash transactions, accrued income or expenses and items of income or expenses associated with investing or financing activities.

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Management Accounting Oct 2010

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