Presentation

for
BUSINES ECONOMICES AND FINANCIAL ANALYSIS
B.TECH III AND V SEMESTER
(IARE – R18 AND R16)
by
Ms G. Joseph Mary, Assistant Professor, MBA
Ms. B. Tulasi Bai, Assistant Professor, MBA
 UNIT-I

INTRODUCTION TO MANAGERIAL ECONOMICES

2
 INTRODUCTION

The word "economics" is derived from a

Greek word "okionomia", which means "household
management" or "management of house affairs"
however, economics considers how a society provides for its
needs. Its most basic need is survival; which requires food,
clothing and shelter.

Economics is the social science of studying the production,

distribution and consumption of goods and services. ...

3
 Definitions of Managerial Economics

“The integration of economic theory with business

practice for the purpose of facilitating decision-making
and forward planning by management”– Spencer and
Siegelman
“ the study of how to direct scarce resources in a way
that most efficiently achieves a managerial goal”. ---
Michael R.baye

4
 Features of Economics

Unlimited Scarce
wants resources

Alternati
Choice
ve uses

Of all the above alternatives, which one do I choose?

How do I behave in satisfying my unlimited wants with
the scarce resources?
5
 Types of Economics

MICRO ECONOMICS
➢The study of an individual consumer or a firm is called
microeconomics ( also called the Theory of the Firm)
➢It deals with behavior and problems of single individual and micro
organization.
➢It concerns with the application of the concepts such as price theory ,
Law of Demand and theories of market structures and so on.

MACRO ECONOMIC
➢The study of ‘aggregate ‘ or total level of economic activity in a
country is called macroeconomics.
➢ It include national income analysis , balance of payments, theories of
employment, and so on.
➢It provides the necessary framework in term of government policies
etc.,

6
Nature of Managerial Economics

Close to micro
economics

Operate against
Interdisciplinary the backdrop of
micro economics

Offers scope to
evaluate each Normative
statements
alternative

Perspective
Applied in nature
actions
 Scope of Managerial Economics

A professional managerial economist has to integrate

concepts and methods from all these disciplines and
functional areas in order to understand and analyze
practical managerial problems.
Objectives of the firm
▪Demand analysis and Demand forecasting
▪Production and cost
▪Competition
▪Pricing and output
▪Profit
▪Investment and capital budgeting
▪Product policy, sales promotion, and Market Strategy
Relation with other subjects

Traditional
economics

Theory of
Decision Operations
making Managerial Research
Economics

Statistics Mathematics
ELASTICITY OF DEMAND

10
 Demand Analysis

Meaning of Demand: Demand for a commodity refers to

the quantity of the commodity which an individual
consumer or a household is willing to purchase per unit of
time at a particular price.
Dealing with a good demanded by an individual we call it
as Individual demand
If the good is demanded by a household we call it as house
hold demand
If all the individuals/ house holds together demanded we
call it as Market demand (or) Aggregate Demand.
 Nature and Types of Demand

The nature of Demand is better understood when

we see these variations given below
Consumer Goods vs. • Example : Bread, apple / Machinery , cars
Producer Goods
Autonomous Demand vs. • Example : super specialty Hospital/ around
Derived Demand that Hospital
Durable vs. Perishable • Example : Milk, Vegetables / TV, Mobile
Demand Phone
Firm Demand vs. Industry • Example : Cement by firm / cement by
Demand whole industry
Short-run demand vs. • Example: Seasonal products vs. Non-
Long-run Demand Seasonal Products
New demand vs. • Example : New Model car / Washing
Replacement Demand machine
Total market and • Example : Sugar / Sweet making industry-
segment market Demand Sugar
 Determinants of Demand

Number of Buyers Prices of

Price
other goods

Income Determinants of
Demand Quality

Expectations
about future Supply?
Tastes
 Demand Function

Meaning : A mathematical expression of the relationship

between quantity demanded of the commodity and its
determinants is known as the demand function.

When this relationship relates to the demand by an

individual consumer it is known as individual demand
function, while if it relates to the market it is called
market demand function.
 Market Demand Function

Qdx = f ( Px, Y , P1,........Pn − 1, T , A , Ey , Ep , P , D , u )

Where
QDX = Quantity demanded of good X
Px = Price of the product X
Y = Level of Household income
P1…pn-1 = Price of all other related Products in Economy
T = Tastes of the Consumer
A = Advertising
Ey = Consumer expected future income
Ep = consumer’s expectations about future prices
P = Population
D = Distribution of consumers like age, gender,
income
U = refers to all those determinants which are not
covered
 Individual Demand Function

Qdx = f ( Px, Y , P1,........Pn − 1, T , A , Ey , Ep , u )

Where
QDX = Quantity demanded of good X
Px = Price of the product X
Y = Level of Household income
P1…pn-1 = Price of all other related Products in Economy
T = Tastes of the Consumer
A = Advertising
Ey = Consumer expected future income
Ep = consumer’s expectations about future prices
U = refers to all those determinants which are not
covered
Law of Demand

Meaning: Law of demand states that higher the price

lower the quantity demanded, and vice versa, other things
being constant.

Qdx = f ( p)
 The Assumptions of Law of Demand

1. Law of Demand is based on the following assumptions. The Law

will hold good only if the following assumptions are fulfilled.
That the tastes and fashions of the people remain unchanged.
2. That the people’s income remains unchanged / constant.That
the prices of related goods remain unchanged / same.
3. That there are no substitutes for the commodity in the
market.That the commodity is not the one which has prestige
value such as diamonds etc.
4. That the demand for the commodity should be continuous. That
the people should not expect any change in the price of the
commodity.
 Exceptions to the Law of Demand

Where Expectation
there is a s of change Incase of
shortage of is the price ignorance
necessities of the of price
feared commodity changes

Commodities Geffen's
which are paradox
used as status
symbols
 Elasticity of Demand

Most of the times , it is not enough to understand the

increase or decrease in price and its consequential impact of
change in the quantity demanded. It is necessary to find out
the extent of increase or decrease in each variables for taking
certain managerial decisions.

Definition : “ The percentage change in quantity demanded

caused by one percent change in the demand determinant
under consideration , while other determinants are held
constant.”
E= Percentage change in quantity demanded of good X
Percentage change in determinant Z
Symbolically it may be stated as
 Measurement of Elasticity

Perfectly Elastic Demand : When any quantity can be sold at a given

price, and when there is no need to reduce price , the demand is
said to be perfectly elastic. In such cases , even a small increase in
price will lead to complete fall in demand.
 Perfectly Inelastic demand

When a significant degree change in price leads to little or no

change in the quantity demanded then elasticity is said to be
perfectly inelastic.

Above graph explains that there is no change in the quantity

demanded though there is change in price, say increase or
decrease.
The increase in price from OP to OP1, the quantity demanded has
not fallen down. Similarly there is a fall in the price from OP3 to
OP2 , the quantity demanded remains unchanged.
 Relatively Elastic Demand

The demand is said to be relatively elastic when the change in

demand is more than the change in the price.

The above graph explains that the quantity demanded

increases from OQ1 to OQ2 because of a decrease in price
from OP1 to OP2. the extent of increase in the quantity
demanded is greater than the extent of in the price.
 Relatively Inelastic Demand

The demand is said to be relatively inelastic when the change

in demand is less the change in the price.

The above graph explains that the quantity demanded

increase from OQ1 to OQ2 because of a decrease in price from
OP1 to OP2. The extent of increase in the quantity demanded
is lesser than the extent of fall in the price.
 Unit Elasticity

The elasticity in demand is said to be unity when the

change in demand is equal to the change in price.

From the above graph the quantity demanded increases

from OM1to OM2 because of decrease in price from OP1 to
OP. The extent of increase in the quantity demanded equal
to the extent of fall in the price.
Types of Elasticity of Demand

Price Income
Elasticity Elasticity
of Demand of Demand

Cross Advertising
Elasticity Elasticity of
of Demand Demand
Price Elasticity of Demand
 Types of Price Elasticity

In fact, it is the nature of a commodity which is responsible

for differing elasticity's of demand in case of different
commodities.
1.Perfectly elastic Demand (e=∞) . Where no reduction in
price is needed to cause an increase in quantity demanded.
2. Absolutely inelastic demand : (e=0). Where a change
in price, however large, causes no change in quantity
demanded
3. Unit elasticity of demand (e=1). Where a given
proportionate change in price causes an equally
proportionate change in quantity demanded (in this case
the demanded curves takes the form a rectangular
hyperbola).
4. Relatively elastic Demand (e>1)
Where a change in price causes a more than proportionate
change in quantity demanded.
5. Relatively inelastic Demand (e<1) :
Where a change in price causes a less than proportionate
change in quantity demanded.
Income Elasticity of Demand
 Types of Income Elasticity:

High income elasticity: this is shown in figure. Here

the values of the coefficient E is greater than unity,
which implies that quantity demanded of good X
increases by a larger percentage than the income of
the consumer.
Unitary income elasticity: the figure shows an income-
demand curve having this property. It indicates that the
percentage change in quantity demand is equal to the
percentage change in money income.
Low income elasticity: Income elasticity is elasticity is low
if the relative change in quantity demanded is less than the
relative change in money income is shown in figure.
Zero income elasticity: Here, a change in income will
have no effect on the quantity demanded, like in case
of salt .so; the value of the coefficient is equal to zero
.such a demand curve is shown in figure.
Negative income elasticity: As pointed out above, inferior
goods have negative income elasticity of demand. This is
shown in figure it explains that less is bought at lower
incomes. The value of the coefficient is less than zero or
negative in this case.
CROSS ELASTICITY OF DEMAND:
 Factors Influencing Advertising Elasticity of Demand

Stage of product market: The advertising elasticity is different

for new and old products, and also for products with an
established market and a growing market.
Influence of advertising by rivals
Effect of advertising in terms of time
Factors Governing Elasticity of Demand

Elasticity is governed by a number of factors. Change in

any on of these factors is likely to affect the elasticity of
demand. These factors are:
a) Nature of the Product
b) Time Frame
c) Degree of postponement
d) Number of alternative uses
e) Tastes and preferences of the consumer
f) Availability of close substitutes
g) In case of complementary goods
h) Level of prices
 Cont…,

I) Availability of subsides
J)Expectation of prices
K)Durability of the Product
L)Government Policy
 Significance of Elasticity of Demand

A. Prices of factors of production

B. Price fixation
C. Government Policies
➢ Tax polices
➢ Raising bank deposits
➢ Public utilities
➢ Revaluation or devaluation of
currencies
➢ Formulate government policy

D. Forecasting Demand
E. Planning the levels of output
and price
ARC AND POINT ELASTICITY
ARC ELASTICITY
 Techniques of Demand Forecasting

Subjective (qualitative ) methods :

Rely on human judgment and
opinion.
➢Buyers opinion
➢Sales force Composite
➢Market Stimulation
➢Test marketing
➢Expert’s opinions
➢Group Discussion
➢Delphi Method
 Techniques of Demand Forecasting

Quantitative methods : use mathematical or

simulation models based on historical demand
or relationships between variables.
➢Trend projection
➢Smoothing technique
➢Barometric Techniques
➢Economic Techniques
 Opinion polling Methods

Consumer’s survey (or survey of Buyers’ Intentions) Methods

Consumers are contacted personally to disclose their future
purchase plan . This may be attempted with the help of either a
complete survey of all consumers (called , complete enumeration)
Or
By selecting few concerning unit out of the relevant
population (called, Sample survey).
Advantages:
➢To contact a large number of customers, scattered all
over the market, is a costly proportion.
➢Consumers may be hesitant to divulge their purchase
plans because of personal privacy or commercial secrecy.
➢The consumers may misjudge their own future purchases
or change their intentions due to unexpected changes in
conditions.
Sample survey : The probable demand expressed buy each
selected unit is summed up to get the total demand of
sample units in the forecast period.
A variant of Sample Survey technique is Test marketing. It is
especially useful for forecasting sales of new products or the
potential of existing products in new geographical areas. It
involves selecting a test area which can be regarded as a truly
representative portion of the total market.
Disadvantages:
➢It is exceptionally costly in both time and money
➢Test must be continued long time-otherwise false
predictions may be made.
➢Difficult to select test area which is ‘typical’ of the total
market.
➢ It is not uncommon for a company to test market a product.
Sales –force Opinion (or collective opinion, or
Reaction survey) Method:

A cursory look at this technique also gives an impression that

this is an attractive technique.
The men who are closest to the market (viz., salesmen) are
questioned and their responses (or reactions) aggregated.
Advantages:
It is cheap and very easy
First hand knowledge of the sales–men
It is very use full for new products and is, therefore, known as
reaction survey method.
 Statistical Methods

For forecasting the demand for goods and services in the long-run,
statistical and mathematical methods are used considering the past
data.
Trend Projection Method :
Definition: The Trend Projection Method is the most classical
method of business forecasting, which is concerned with the
movement of variables through time. This method requires a long
time-series data.
In predicting demand for a product, the trend projection
method is applied to the long time-series data.
There are five main techniques of mechanical extrapolation.
In extrapolation, it is assumed that existing trend will maintain all
through.
Fitting Trend Line by Observation (or, Visual me
Series Projection )
This method of forecasting trend is elementary, easy
and quick as it involves merely the plotting the actual sales
data on a chart and then estimating just by observation
where the trend line lies.
The line can be extended towards a future period
and corresponding sales forecast read from the graph.

When a more detailed estimate is needed, a

time series analysis using least squares equation in used.
Time Series Analysis employing LeastSquares
Method :
The trend line is the basis to extrapolate the line for future
demand for the given product or service in a graph..
Here it is assumed that there is proportional (linear) change in
sales over a period of time.
In such case , the trend line equation is in linear form. Where this
assumption does not hold good, the evaluation can be in non-linear form.
The estimating linear trend equation of sales is written as:
S = x + y (T)
Where x and y have been calculated from the past data S is sales and T is
the year number for which the forecast is made. To find the values of x and
y, the following normal equations have to be stated and solved:
ES = Nx + y E T
EST = xET+ y E T2
Where S is the sales; T is the year number, n= number of years
TIME SERIES ANALYSIS :

Where the surveys or market tests are costly and time-consuming,

statistical and mathematical analysis of past sales data offers
another method to prepare the forecasts, that is , time series
analysis.
The following are the four major components analyzed from
time series while forecasting the demand.

Trend (T) , also called the long-term trend, is the result of

basic developments in the population, capital formation of
technology. These developments relate to over a period of long time
say five to ten years, not definitely overnight.

Cyclic Trend (c ) is seen in the wave like movement of sales.

The sales data is quite often affected by swings in the levels of
general economic activity, which tend to be somewhat periodic.
Cont…
Seasonal Trend (s) refers to a consistent pattern of sales
movements within the year. More goods are sold during the
festival seasons. The seasonal components may be related to
weather factors, holidays, and so on.
Erratic Trend (E) results from the sporadic occurrence of strikes,
riots, and so on. These erratic components can even damage the
impact of more systematic components, and thus make the
forecasting process much more complex.
Models- Time series analysis:
Y= T+C+S=E ,
Y= TX CX SX E.
Y is the product of all these components
 MOVING AVERAGE METHOD

This method considers that the average of past events

determine the future events. In other words, this method
provides consistent results when the past events are
consistent and unaffected by wide changes.
BAROMETRIC TECHNIQUES : In this method one set of
data is used to predict another set. In other words, to
forecast demand for a particular product or service, use
some other relevant indicator (which is known as
Barometer ) of future demand.
in this method difficult to determine the time lag
between the change in one variable and change in the
forecast variable.
Ex: Number of scooters vs. Income level
 Simultaneous Equation Method :

in this method all variables are simultaneously considered , with the

conviction that every variable influences the other variables in an
economic environment. hence, the set of equations equal the
number of dependent (controllable) variable which is also called
endogenous variables.
Correlation and Regression Methods : Correlation describes the
degree of association between two variables such as sales and
advertisement expenditure. When two variables tend to change
together , then they are said to be correlated.
Regression Analysis : It is estimated which best fits in the sets of
observation of dependent variables and independent variables. The
best estimate of the true underlying relationship between these
variables is thus generated.
 OTHER METHODS

Expert Opinion : An expert is good at forecasting and analyzing the

future trends in a given product or service at a given level of
technology.
Advantages :
results would be more reliable
Forecast can be made relatively quickly and cheaply
Differences can be sorting out by using Delphi technique
TEST MARKETING :
The term ‘test marketing’ is also some- times called ‘field-testing’.
The word ‘test’ means examination or trial. Test marketing, thus,
means testing the product in the market before the product is
commercialized on a large scale.
This is done with a view to understand the market and the
marketing considerations like nature of competition, nature of
demand, and the consumers’ needs, etc.
CONTROLLED EXPERMINTS :

it refers to such exercises where some of the major determinants

of demand are manipulated to suit the customers with different
tastes and preferences, income groups, and such others.
It is used to gauge the effect of a change in some
demand determinant like price, product, design, advertisement,
packaging, and so on.
JUDGMENTAL APPROACH :
Judgmental forecasting methods incorporate
intuitive judgment, opinions and subjective probability
estimates. Judgmental forecasting is used in cases where
there is lack of historical data or during completely new and
unique market conditions
 UNIT -II

THEORY OF PRODUCTION FUNCTION AND COST

ANALYSIS

62
THEORY OF PRODUCTION AND COST ANALYSIS

WHAT IS PRODUCTION

It’s an activity that transforms input into output.

Production

63
 Production Function

Inputs Process output

land
Product or
service
labour
generated
– value added

Capital

64
 Production Function

Mathematical representation
of the relationship:
Q = f (K, L, La)
Output (Q) is dependent upon the
amount of capital (K), Land (L) and
Labour (La) used

65
 Uses of Production Function

• How to obtain Maximum output

• Helps the producers to determine whether

employing variable inputs /costs are
profitable

• Highly useful in longrun decisions

• Least cost combination of inputs and to

produce an output

66
TYPES OF PRODUCTION FUNCTION

Types

Short –Run
(Inputs kept constant Long – Run
(Varying all inputs)
One input (Labour) is varied)

Law of variable Law of returns to

proportion scale
Production factor with one variable input

The Law of returns state that

when at least one factor of
production is fixed and when all
other factors are varied, the
output in the initial stage will
increase at an increasing rate and
after reaching certain level of
output the total output will
increase at declining stage

68
Production function with two variable input

Normally both capital and labour are required to

produce a product. To some extent, these two inputs
can be substituted for each other . Hence the producer
may choose any combination of labour and capital to
give the required output

69
 ISOQUANTS

A isoquant is a firm's counterpart of

the consumer's indifference curve.
An isoquant is a curve that shows all
the combinations of inputs that yield
the same level of output. 'Iso' means
equal and 'quant' means quantity.
Therefore, an isoquant represents a
constant quantity of output.

70
 Features of isoquant

1.Downward sloping
2.Convex to origin
3.Do not intersect
4.Do not touch axes

71
MARGINAL RATE OF TECHNICAL SUBSTIITUTION

The MRTS refers to the rate at which one input

factor is substituted with the other to attain a
given level of output. in other words the lesser
units of input must be compensated by
increasing amount of other input to produce
the same level of output
MRTS= Change in one input, say, CAPITAL
Change in another input, say LABOUR

72
 ISOCOSTS

In economics an isocost line

shows all combinations of
inputs which cost the same
total amount. ... The slope is:
The isocost line is combined
with the isoquant map to
determine the optimal
production point at any given
level of output..

73
 COBB DOUGLAS PRODUCTION FUNCTION

P=bLaC1-a
Where p= total output
L=the index of employment of labour in manufacturing
C= the index of fixed capital in manufacturing
The function estimated for the USA by Cobb Douglas is
p=1.01L0.75C0.25
The production Function shows that one percent change in
labour input, capital remains the same, is associates with a 0.75
percentage change in out put, similarly one percent change in
capital labour remaining same is associated with 0.25
percentage change in output

74
 Returns to sale & returns to factors

Returns to scale refer to returns enjoyed by the firm as a result of

change in all the inputs. It explain the behavior of the returns
when the inputs are changed simultaneously

Law of returns to sale

There are three laws of returns governing production function
(a)Law of increasing Returns to scale
(b)Law of constant Returns to scale
(c)Law of Decreasing Returns to scale

75
 Returns to Factor

Returns to Factor is also called factor productivities. Productivity

is the ratio of output to inpute. Factor productivity refers to the
short run relationship of input and output
Return to factor refer to the output or return
generated as a result of change in one or more factors keeping
the other factors unchanged

The Change in productivity can be measured in terms of

(a)Total Productivity
(b)Average productivity
(c)Marginal Productivity

76
ECONOMIES AND DISECONOMICS OF SCALE

The economics of scale results because of increase in the scale of production

ALFRED MARSHEL divides the economics of scale into two groups
1. Internal
2. External

Internal Economies
Refers to the economies in production cost which accrue to firm alone
when it expand its output
Types of Internal Economies
(a)Managerial Economics
(b) Commercial Economics
(c) Financial Economics
(d)Technical Economics
(e)Marketing Economics
(f) Risk-bearing Economics
(g)Individual and Automated Machinery
(h)Economies of Larger Dimension
(i)Economies of Research And development

77
 EXTERNAL ECONOMIES

External Economics Refers to all the firms in the industry as the

industry expands

External economics can be grouped under three types

1) Economies of concentration
2) Economies of R&D
3) Economies of welfare

78
 DISECONOMIES OF SCALE

Diseconomies are mostly managerial in nature.

Problem of planning, coordination,
communication and control may become
increasingly complex as firm grows in size
resulting in average cost per unit. Sometimes the
firm may also collapse

79
 What is cost?

In producing a commodity a firm has to employ an

aggregate of various factors of production such as
land, labour, capital and entrepreneurship.
• These factors are to be compensated by the firm
for their contribution in producing the commodity.
• This compensation (factor price) is the cost.

80
 COST CONCEPT & TYPES

OPPORTUNITY COST –

• Opportunity cost of a product is value

of the next best alternative forgone (that
is not chosen).
• It can also defined as the revenue
forgone for not making the best
alternative use.
• The concept of opportunity cost is
useful for manager in decision making

81
 ECONOMIC COST

This cost includes explicit and implicit cost both. In other words,
economic cost includes both recorded and unrecorded cost.
❖ EXPLICIT COST is the actual money expenditure on inputs or
payments made to the outsiders for hiring the factor services.
Example – wages paid to employees, payment for raw materials
etc.
❖IMPLICIT COST is the cost of self supplied factors . Example-
Interest on own capital ,Rent of own land etc.
❖The sum of explicit cost and implicit cost is the total cost of
production of a commodity.

82
 ACCOUNTING COST

• Accounting cost is the cost based upon accounting records in

the book of accounts.
• They are recorded in the book of accounts when they are
actually incurred . Its based on Accrual concept.
• Accounting costs are explicit cost and must be paid

83
 Incremental and Sunk Costs

• Incremental costs are closely related to marginal

costs, incremental costs refers to the total additional
cost associated with the expand in output.
• Sunk Costs are those which cannot be altered,
increased or decreased by varying the rate of output.

84
 Short Run and long run costs

Short run costs are costs that vary with variation in

output. Short run costs are the same as variable costs

Long run costs are costs that are incurred on fixed

assets like plant, machinery, etc

85
 TOTAL COST

Total cost is the actual money spends to produce a particular

quantity of output.
It is the summation of fixed and variable costs
TC = TFC+ TVC

➢ TFC(Total Fixed Cost):

Total fixed costs, i.e the cost of plant,
building, equipment etc. remain fixed with a change in
output.

➢ TVC(Total Variable Cost):

The total variable cost i.e the cost of
labour,raw material etc varies with the variation in
output.
86
 AVERAGE COST

Average cost is the total cost of producing per unit of

commodity. It can be found out as follows
AC= AFC +AVC
AC= Total cost/no.of units produced

➢AFC (Average fixed Cost)-

Fixed cost of producing per unit of the commodity.
AFC= total fixed cost / no. of units produced.

➢AVC (Average Variable Cost)

Variable cost of producing per unit of the commodity.
AVC= total fixed cost / no. of units produced.

87
 MARGINAL COST

• Marginal cost is the additional to total cost when

one more unit of output is produced .

• It can be arrived by dividing the change in total cost

by the change in total output

88
 Cost-output Relationship

Cost-output relationship has 2 aspects

▪Cost-output relationship in the short run,
▪Cost-output relationship in the long run

▪The SHORT RUN is a period which doesn’t permit

alterations in the fixed equipment (machinery ,
building etc.) & in the size of the org.

▪The LONG RUN is a period in which there is sufficient

time to alter the equipment (machinery, building, land
etc.) & the size of the org. output can be increased
without any limits being placed by the fixed factors of
production

89
Cost-output Relationship In The
Short Run

90
Short Run can be studied in terms of

Short Run may be studied in terms of

▪ Average Fixed Cost

▪ Average Variable Cost

▪ Average Total cost

91
BEHAVIOUR OF COST IN THE SHORT- RUN
 ▪Total, average & marginal cost

▪ Total, average & marginal cost

TC) = TFC + TVC, rise as output
rises

1.Total cost (TC) = TFC +TVC, rise

as output rises
2.Average cost (AC) = TC/output
3. Marginal cost (MC) = change in
TC as a result of changing output
by one unit

93
 Fixed cost & variable cost

1.Total fixed cost (TFC) = cost of using fixed factors =

cost that does not change when output is changed,
e.g.

2.Total variable cost (TVC) = cost of using variable

factors = cost that changes w

94
 Average Fixed Cost and Output

▪The greater the output, the lower the fixed cost per
unit, i.e. the average fixed cost.

▪Total fixed costs remain the same & do not change

with a change in output.

95
 The Break Even Analysis

The Break Even Analysis (BEA) is a useful tool to study

the relation between fixed costs and variable costs and
revenue. It's inextricably linked to the Break Even Point
(BEP), which indicates at what moment an investment
will start generating a positive return.

96
KEY TERM USED IN BREAK EVEN ANALYSIS

➢FIXED COST
➢VARIABLE COST
➢TOTAL COST
➢CONTRIBUTION MARGINE
➢PROFIT
➢CONTRIBUTION MARGINAL RATIO
➢MARGIN OF SAFETY IN UNITS
➢MARGINAL OF SALES IN SALES VOLUME
➢ANGLE OF INCIDENCE
➢P/V RATIO

97
DETERMINATION OF BREAK EVEN POINT

Selling price = Fixed cost+ Profit

Selling price- Variable cost =Fixed cost+profit
= Contribution
Contribution per unit = Selling price-Variable cost

98
DETERMINATION OF BREAK EVEN POINT IN
UNITS

Break even point = Fixed cost /Contribution margin per

unit

Determination of BEP in value

BEP= Fixed cost/ Contribution Margin ratio

99
DIFFERENT FORMULAS USED UNDER BEA AND
THERE APPLICATIONS

Profit volume Ratio=Contribution/sales

Margina of safety=profit/p/v ratio

Volume of sales to attain profit =FC+Targete Profit

Contribution margin

100
 CONTRIBUTION RATIO

Contribution Ratio= Selling price-Variable cost* %sales

Selling price

101
 UNIT-III

MARKET &
NEW ECONOMIC
ENVIRONMENT
 MARKET STRUCTURE

• Market: A regular gathering of people for the

purchase and sale of provisions, livestock, and
other commodities.

• Market structure: It is the interconnected

characteristics of a market, such as the number
and relative strength of buyers and sellers, degree
of freedom in determining the price, level and
forms of competition, extent of product
differentiation and ease of entry into and exit from
the market
TYPES OF MARKET STRUCTURE
 PERFECT COMPETITION

1. All firms sell an identical product.

2. All firms are price takers.
3. All firms have a relatively small market share.
4. Buyers know the nature of the product being
sold and the prices charged by each firm.
5. The industry is characterized by freedom of
entry and exit.
It is also referred as “PURE COMPETITION”.
 PERFECT COMPETITION

1. Large no. of sellers

2. Large no. of buyer
3. Homogeneous products
4. Free entry and exit
5. Perfect knowledge
6. Perfect mobility of factors of production
7. Seller is the price-taker
 PERFECT COMPETITION

• Potatoes • Potatoes are sold in

markets where all
vendors sell
homogenous products
at homogeneous
prices.
•Example- Potato is
sold at markets etc.
where all vendors sell
homogenous
products, i.e. potato.
MONOPOLY

• A Monopoly is a market structure in which there is

only one producer/seller for a product. In other
words, the single business is the industry.
• Entry into such a market is restricted due to high
costs or other impediments, which may be
economic, social or political.
 MONOPOLISTIC COMPETITION

• Monopolistic competition is a type of imperfect

competition such that one or two producers sell
products that are differentiated from one another
as goods but not perfect substitutes .
(such as from branding, quality, or location).
• In monopolistic competition, a firm takes the
prices charged by its rivals as given and ignores the
impact of its own prices on the prices of other
firms.
• Consumers may like some special thing in the
particular brand.
MONOPOLISTIC COMPETITION
DUOPOLY

• A situation in which two companies own all or

nearly all of the market for a given product or
service.
• It is a specific type of oligopoly where
only two producers exist in one market.
In reality, this definition is generally used where
only two firms have dominant control over a
market.
• In the field of industrial organization, it is the most
commonly studied form of oligopoly due to its
simplicity.
OLIGOPOLY

• It is a situation in which a particular market is

controlled by a small group of firms.
• An oligopoly is a market form in
which a market or industry is
dominated by a small number of sellers
(oligopolists). Because there are few sellers, each
oligopolist is likely to be aware of the actions of the
others.
• The decisions of one firm influence, and are
influenced by, the decisions of other firms.
PRICE & OUTPUT DETERMINATION

Perfect Competition for Short run

❑Under perfect competition Price determined
by the market
❑In short run one can make any changes in
variable factors but it does not allow any
change in fixed factors.
❑Every firm under perfect competition
produces same cost curve.
❑Under perfect competition for short run
always the demand curve and average
revenue curve will be one and a same.
PERFECT COMPETITION FOR SHORT RUN

❑Firm sales additional units at the same price so that

average revenue curve and marginal revenue
curve will be one and a same.
❑Avg. cost curve and Marginal cost curve as usual
found
normally as “U” shaped.
❑In short run there are three possibilities as below
to earn profit:Super Normal Profit,Normal
Profit,Sub Normal Profit
❑After attaining the equilibrium the firm will not
increase or decrease its output.
Equilibrium = MR = MC
PERFECT COMPETITION FOR
SHORT RUN
PERFECT COMPETITION FOR
LONG RUN

bep
PRICE DETERMINATION UNDER MONOPOLY
FOR SHORT RUN

Short run period allows change in variable factors

only. In Monopoly the firm will achieve its
equilibrium . where MR = MC
In short run there are three possibilities as below
to earn profit:
• Super Normal Profit
• Normal Profit
• Sub Normal Profit
But generally thefirm will earn supernormal
profit because there is no direct competition.
PRICE DETERMINATION UNDER MONOPOLY
FOR SHORT RUN
PRICE DETERMINATION UNDER MONOPOLY
FOR LONG RUN
PRICE DETERMINATION UNDER MONOPOLISTIC
FOR SHORT RUN

• Long run is that period which allows the firm to

change the factors of production that is fixed and
variable.
• If the existing firms are earning super normal profit
then there will be new entry in the market this will
be resuled in the firm will only earn Normal profit.
• But compared to supply demand not increased so
that the firm will start selling at a lower price.
• Same would be done by the other firms to
maintain their sales. Thus, price will increase and
super normal profit will disappear.
PRICE DETERMINATION UNDER MONOPOLISTIC
FOR LONG RUN

• Long run is that period which allows the firm to

change ll the factors of production that is fixed and
variable.
• If the existing firms are earning super normal profit
then there will be new entry in the market this will
be resuled in the firm will only earn Normal profit.
• Thus, total supply of the group will increase.
• But compared to supply demand not increased so
that the firm will start selling at a lower price.
NEW ECONOMIC ENVIRONMENT

The term "business organization" refers to how a

business is structured.
It refers to a commercial or industrial enterprise and
the people who constitute it.
TYPES OF BUSINESS ORGANISATIONS

• Sole Proprietorship
• Joint Hindu Family Business
• Partnership Firm
• Joint Stock Company
• 1.) Private Limited
2.) Public Limited
• Co-operative Society
SOLE PROPRIETERSHIPc

When the ownership and management of a business are

in control of one individual the form of business is called
sole proprietorship.
 SOLE PROPRIETERSHIP

Characteristics:
• The business enterprise is owned
by one single individual (i.e. both
profit and risk belong to him)
• Owner is the Manager
• Owner is the only source of
Capital
• The proprietor and business
enterprise are same in the eyes of
the law.
ADVANTAGES OF SOLE PROPREITORSHIP

• Easy formation
• Better Control
(Prompt decision
making and
Flexibility in Operations)
• Subject to fewer regulations
• Not subject to corporate income tax
• Ownership of all profits
DISADVANTAGES OF SOLO ROPREITORSHIP

• Owner has unlimited

liability
• Difficult to raise
capital
• Business has a
limited life
• Difficult to do
business beyond a
certain size
PARTNERSHIP FIRM

A Partnership consists of two or more

individuals in business together
 ADVANTAGES OF PARTNERSHIP

• Easy Formation
• Larger Resources
• Sharing Of Risk
• Better Management and
Flexibility of Operation
• No corporate income tax
• Subject to fewer regulations as
compared to companies
DISADVANTAGES OF PARTNERSHIPS

• Unlimited Liability
• Limited Life
• Difficult to raise
capital
• Chances of Dispute
JOINT STOCK COMPANY

A joint stock company is a voluntary

association of people who contribute money to
carry on business
CHARACTERISTICS OF A CORPORATION

• It is considered as a separate legal entity

• It comes into formation after all formalities
under the Indian Companies Act 1956 are
completed
• Management and ownership is completely
separate
• Capital is raised through shares which are
transferable
 ADVANTAGES OF A CORPORATION

• Limited liability of the

shareholders
&promoter
• Can easily raise capital
• Have unlimited life
• Ease of transfer of
ownership
 DISADVANTAGES OF A CORPORATION

• Formation is not easy

• Excessive Government Regulation
• Subject to Corporate Tax and Dividend
Tax (Double Taxation)
• Delay in Policy Decisions
• Control by a Group
 TWO TYPES OF CORPORATIONS

1. PRIVATE COMPANY
•Closely held by a few people
•Minimum 2 and maximum 50 shareholders
•Stocks cannot be traded on exchanges and private
equity cannot be raised
•Less regulations as compared to Public Companies
2. PUBLIC COMPANY
•Stocks are held by a large
number of people
•Minimum 7 shareholders
and no limit for maximum
•Can be listed on stock
exchange and can go public
•Have to follow many laws
with regards to the board
composition and AGM.
CO-OPERATIVE SOCIETY

It is a voluntary
association of
people or
business to
achieve a an
economic goal
with a social
perspective
ADVANTAGES OF CO-OPERATIVE

• Easy Formation
• Limited Liability
• Stability
• Democratic
Management
• State Assistance
DISADVANTAGES OFA COOPERATIVE

• Possibility of conflict
• Long decision making
process
• Not enough capital
 UNIT - IV

CAPITAL BUDGETING
 Definition of capital

• "Capital is a necessary factor of production and, like any

other factor, it has a cost,"
- Eugene F. Brigham
• "Firms with the most profitable investment opportunities
are willing and able to pay the most for capital, so they
tend to attract it away from inefficient firms or from
those whose products are not in demand,“
- Brigham
• Capital is the money or wealth needed to produce goods
and services. In the most basic terms, it is money. All
businesses must have capital in order to purchase
assets and maintain their operations.
 Need for capital

▪ To promote a business
▪ To conduct business operations smoothly
▪ To expand and diversify
▪ To meet contingencies
▪ To pay taxes
▪ To pay dividends and interests
▪ To replace the assets
▪ To support welfare programmes
▪ To wind up
 Types of capital

Capital

Working
Fixed capital
capital
 Features of fixed capital

Permanent in nature
Profit generation
Low liquidity
Amount of fixed capital
Utilised for promotion and expansion
 Types of fixed assets

❖Tangible fixed assets

❖Intangible fixed assets
❖Financial fixed assets
 Working capital

Definition:
Working capital is money available to a company for
day-to-day operations. It is also called as circulating
capital.
Simply put, working capital measures a
company's liquidity, efficiency, and overall health of
business.
 Features of working capital

Short life span

Smooth flow of operations
Liquidity
Amount of working capital
Utilized for payment of current expenses
Components of working capital
Working capital cycle
 Methods and sources of finance

Method of finance is the type of finance used

such as loan or mortgage
Source of finance would be where the money was
obtained from
- a loan may be obtained from a bank while the
mortgage may be obtained from a credit soceity.
 Methods of finance

The following are the common methods of finance :

Long - term finance
Medium - term finance
Short - term finance
 Sources of finance

Long – term finance

Own capital
Share capital
Preference share capital
Equity share capital
Retained profits
Long term loans
Debentures
Government grants and loans
 Sources of finance

Medium - term finance

Bank loans
Hire purchase
Leasing or renting
Venture capital
 Sources of finance

Short - term finance

Commercial paper
Bank overdraft
Trade credit
Debt factoring or credit factoring
Advance from customers
Short – term deposits from the customers, sister
companies and outsiders
Internal funds
 Capital Budgeting

Definition of Budget:
Budgeting is a management toolfor planning and
controlling future activity.
Financial Buzz Words: A plan for saving, borrowing and
spending.
Budget is a financial plan and a
list of all planned expenses and revenues.
 Capital Budgeting

An Investment Decision Method

 Capital Budgeting

Capital: Operating assets used for production.

Budget: A plan that details projected cash flows during
some period.
Capital Budgeting: Process of analyzing projects and
deciding which ones to include in capital
budget.
 Significance of Capital Budgeting

Substantial capital outlays

Long term implications
Strategic in nature
Irreversible
 Non discounting: Pay-Back Period

Pay-Back Period Method- It is defined as the number

of years required to recover original cost invested in a
project. It has two conditions
➢When cash inflow is constant every year
PBP= Cash outflow/cash inflow (p.a.)

➢When cash inflow are not constant every year

PBP = Completed years + required inflow * 12
inflow of next year
 Non discounting: Annual Rate of Return

Average Rate of Return Method - ARR means the

average annual earning on the project. Under this
method, profit after tax and depreciation is considered.
The average rate of return can be calculated in the
following two ways.
ARR on average investment = Average profit after tax
*100
Average investment
ARR on initial investment = Average profit after tax *100
Initial investment
 Discounting Criteria: Pay-Back Period

Discounted Pay-Back Period Method - In discounted

pay- back period method, the cash inflows are
discounted by applying the present value factors for
different time periods. For this, discounted cash
inflows are calculated by multiplying the P.V. factors
into cashinflows.

Discounted = completed years + Required inflow *12

pay back Inflow of next year
Discounting Criteria: Net Present Value

Net Present Value Method:- It is the best method for

evaluation of investment proposal. This method takes
account time value of money.
NPV= PV of inflows- PV of outflows
➢Evaluation of Net Present Value Method:-Project
with the higher NPV should be selected.
Accept NPV>0
if Reject NPV<0
May or may not accept NPV=0
 Discounting Criteria: Profitability Index

Profitability Index Method - As the NPV method it is

also shows that project is accepted or not. If
Profitability index is higher than 1, the proposal can be
accepted.
Accepted PI > 1
Rejected PI < 1

Profitability index = Total Cash Inflows /Total

Cash
Outflows
 Discounting Criteria: Internal Rate of Return

Internal Rate of Return Method:- IRR is the rate of

return that a project earns. The rate of discount
calculated by trial and error , where the present value
of future cash flows is equal to the present value of
outflows, is known as the Internal Rate of Return.

IRR = LDR + NPV @LDR * (HDR –LDR)

NPV@LDR –NPV @ HDR
 UNIT – V

Introduction to Financial Accounting

and Analysis

168
Accounting

Process of identifying, recording, summarizing, and

reporting economic information to decision makers in
the form of financial statements

169
Definitions of Accounting

“The process of identifying, measuring, and

communicating economic information to permit
informed judgments and decisions by users of the
information.”—American Accounting Association (AAA)

• “A service activity whose function is to provide

quantitative information, primarily financial in nature,
about economic entities that is intended to be useful in
making economic decisions.” —American Institute of
Certified Public Accountants
(AICPA)

170
Accounting Concepts, Conventions, Bases &
Policies
The basic ideas, the theories on how and why certain
categories of transactions should be treated in a
particular manner. Once the theories have been
established and tested and proved to be acceptable,
the task of the Conventions is to set out the limit of
their applications.

171
FUNCTIONS / SCOPE OF FINANCIAL
ACCOUNTING
➢Recording
➢Classifying

➢Summarizing

➢Deal with financial

transactions

➢Interpretation

➢Communicating

172
1. Deals with financial transactions : Accounting records only
those transactions and events, which are of a financial
character.
2. Recording : This is the basic function of Accounting. It is
essentially concerned with not only ensuring that all business
transaction of financial character are in fact recorded but also
that they are recorded in an orderly manner. Recording is
done in the book called “Journal”
3. Classifying : Classification is concerned with the systematic
analysis of the recorded data, with view to group transactions
or entries of one nature at one place .The work of
classification is done in the book called “Ledger

173
4. Summarizing : This involves presenting the classified data
in a manner, which is understandable and useful to the
internal as well as external end –users of accounting
statements. This process leads to the preparation of the
following statement :- Trial Balance Trading Account
Profit and Loss Account Balance Sheet
5. Analysis and Interpretation : This is the final function of
accounting. The recorded financial data is analyzed and
interpreted in a manner that the end-users can make a
meaningful judgment about the financial condition and
profitability of the business operations.

174
OBJECTIVES OF FINANCIAL ACCOUNTING

1. Maintaining proper/systematic record of

Business Transactions
2. To ascertain the financial results of the
enterprise
3. To ascertain financial position or financial
health of the business
4. To help in decision making: Accounting serves
as an information system
5. Providing Effective Control over the Business
6. Making Information to various groups

175
PROCESS OF ACCOUNTING

Recording Journal

Classifying Ledger

Summarizing Trail Balance

Preparation of financial Status

176
Users of Accounting Information

➢Security analysts &

Investors
➢Creditors/suppliers
External Users ➢Government & regulatory
authorities
➢customers
➢ Competitors Researchers
➢Taxing authorities

➢Owners
Internal Users ➢managers
➢employees
177
ADVANTAGES/ SIGNIFICANCE
OF FINANCIAL ACCOUNTING:
1. Replacement of memory
2. Evidence in court
3. Settlement of taxation liability
4. Comparative study
5. Sale of the business
6. Assistance to the insolvent person
7. Assistance to various interested parties
8. Preparation of Financial Statements
9. Decision Making
10.Planning and Control of Operations
11.Value of Business

178
LIMITATIONS/DISADVANTAGES OF
ACCOUNTING

1. Records only monetary transactions

2. Effect of price level changes not considered
3. No realistic information
4. No real test of managerial performance
5. Historical in nature
6. Personal bias / judgment of Accountant affects the
accounting Statements
7. Permits alternative treatments

179
DOUBLE ENTRY SYSTEM

MEANING:

Double entry system is a scientific way of presenting

accounts. As such all the business concerns feel it convenient
to prepare the accounts under double entry system. The
taxation authorities also compel the businessmen to prepare
the accounts under Double Entry System. Under dual aspect
the Account deals with the two aspects of business
transaction i.e.,

(1) Receiving Aspect and

(2) Giving Aspect.

180
PRINCIPLE OF DOUBLE ENTRY SYSTEM

Every business transaction has got two accounts, where one

account is debited and the other account is credited. If one
account receives a benefit, there should be another account to
impart/give the benefit.
➢The principle of Double Entry is based on the fact that there
can be no giving without receiving nor can there be receiving
without something giving. The receiving account is debited (i.e.,
entered on the debit side of the account) and the giving account
is credited (i.e., entered on the credit side of the account).
➢The principle under which both debit and credit aspects are
recorded is known as the principle of double entry. According to
this principle every debit must necessarily have a corresponding
credit and vice versa.

181
ADVANTAGES OF DOUBLE ENTRY SYSTEM

1. Scientific system:
Double entry system records, classifies and
summarizes business transactions in a systematic
manner and, thus, produces useful information for
decision makers. It is more scientific as compared to
single entry of book-keeping.
2. Full Information:
Full and authentic information can be had about all
transactions as the trader maintains the ledger with
all types of accounts.
3. Assessment of Profit and Loss:
The businessman/trader will be able to know
correctly whether he had earned profit or sustained loss.

182
4. Knowledge of Creditors:
The trader is also knows the exact amounts owed by the firm
to others and he will be able to arrange prompt payment to
obtain cash discount.
5. Assessment of Financial Position:
The trader will be able to prepare the Balance Sheet which will
help the interested parties to know fully about the financial
position of the firm.
6. Comparison of Results:
It facilitates the comparison of current year results with those
of previous years.
7. Maintenance according to Income Tax Rules:
Proper maintenance of books will satisfy the tax authorities
and facilitates accurate assessment. In India Joint stock
companies should maintain accounts under double entry
system. 183
LIMITATIONS / DISADVANTAGES OF DOUBLE ENTRY
SYSTEM:
The Double Entry System however may not provide any
solution to the following errors.
1. Not Practical to All Concerns: This system requires
the maintenance of a number of books of accounts
which is not practical in small concerns.
2. Costly system: This system is costly because of a
number of records are to be maintained.
3. No guarantee of Absolute Accuracy of the Books of
Account: There is no guarantee of absolute
accuracy of the books of account inspite of
agreement of the trial balance because of there are
some errors like errors of principles, errors of
omission, compensating errors etc., which remain
understand inspite of agreement of trial balance.
184
4. Errors of Omission: In case the entire transaction is not
recorded in the books of accounts, the mistake cannot
be detected by accounting. The Trial Balance will tally
inspite of the mistakes.
5. Errors of Principle: Double entry is based upon the fact
that every debit has its corresponding credit and vice
versa. It will not be able to detect the mistake such as
debiting Ram‟s account instead of Rao‟s account or
Building account in place of Repairs account.
6. Compensating Errors: If Rahim‟s account is by mistake
debited with Rs. 15 lesser and Mohan‟s account is also
by mistake credited with Rs.15 lesser, the Trial Balance
will tally but mistake will remain in accounts.

185
PROFARMA FOR DOUBLE ENTRY SYSTEM

An account contains the following columns on the following

columns on either side. 1) Date column 2) Particulars column
3) Journal Folio column 4) Amount column. The format or
ruling of an account is as follows:

Date Particulars J.F Amount Date Particulars J.F Amount

Rs Rs

To By
Particulars Particulars
of benefits xxxxx of benefits xxxxx
received given

186
Classification of Accounts

Broadly speaking accounts are classified into two types

Types of
Accounts

Personal Impersonal
Accounts Accounts

Real Nominal
Account Account

187
Personal Accounts

Personal Accounts are those which are opened in the names

of persons. These are accounts of persons and institutions
with whom the business deals. A separate account is kept for
each person.
Personal accounts can be also sub classified into three
categories:
They are
i) Natural personal accounts: Natural Personal Accounts:
The term Natural Persons means who are creations of
Gods. For example Ravi Account, Rani Account, Raghu
account Nagarjuna Account etc., are called as Natural
Personal Accounts.

188
Artificial Personal accounts: Artificial Personal Accounts: These
accounts include accounts of corporate bodies or institutions
which are recognized as persons in business dealings. The
account of a Limited Company, the accounts of co-operative
society, the accounts of clubs, the account of Government, the
account of insurance company, the account of Colleges, Schools,
Universities and Hotels etc., are examples of Artificial Personal
Accounts.

189
iii)Representative Personal accounts: Representative Personal
Accounts: These are accounts which represent a certain person
or group of persons. For example, Outstanding expenses A/c,
Prepaid expenses A/c, Income Receivable A/c and Income
received in advance A/c, Drawings A/c and Capital A/c are
termed as Representative Accounts

190
Principle/ Rule of Personal Account

1. Debit the receiver and

2. Credit the giver.

Example:
If cash has been paid to Raja, the account of Raja will
have to be debited since Raja is the receiver of cash.
Similarly, if cash received from Krishna, the account
of Krishna will have to be credited since Krishna is
the giver of cash.

191
 Real Account

Real Accounts are those which are relating to Properties and

Assets of the business concern. Accounts relating to properties or
assets or possessions of the firm are called Real Accounts. Every
business firm needs Fixed Assets such as Land and Buildings,
Plant and Machinery, Furniture and Fixtures etc for running its
business.

There are Four types of Assets.

Fixed Assets: Those assets which are acquired for long term use
by the business concern are known as Fixed assets. For example
Land and Buildings, Plant and Machinery, Furniture and Fixtures
etc are called as Fixed Assets.

192
Current Assets: Those assets which are possible to convert into
cash are known as known as Current assets. For example cash
in hand, cash at Bank, Stock in trade, Debtors, Bills Receivable
etc., are called as current assets
Tangible Assets: Tangible assets are those which relate to such
things which can be touched, felt, measured etc., Tangible
assets have physical existence. Hence these assets may be
transferred from one place to another place. Fixed assets and
Current assets are the examples of Tangible assets.
Intangible Assets: These accounts represent such things which
cannot be touched. Of course, they can be measured interms of
money. Intangible assets haven't any physical existence.
Goodwill, copy rights, patents and trademarks are the
examples of Intangible assets
193
 Principle/Rule of Real Account:

1. Debit what comes into the business and

2. Credit what goes out of the business.

Example:
If machinery has been purchased for cash, is coming into
the business, while machinery account should be debited
since Machinery h account should be credited since cash is
going out of the business. If furniture is sold for cash, cash
account should be debited since cash is coming into the
business, while Furniture account should be credited since
furniture is going out of the business.

194
 Nominal Accounts

Nominal accounts include accounts of all Expenses, Losses,

Incomes and Profits or Gains.
➢The examples of Expenses and Losses are salaries,
wages, rent, taxes, lighting charges, transport charges,
travelling charges, coolie charges, warehouse rent,
insurance, advertisement paid, Bad debts, commission
paid, Discount allowed, interest paid, interest paid on
capital.
➢The examples of Incomes and Profits are rent received,
interest received, commission received, discount
received, dividend received, interest on investment
received, bad debts recovered etc.,

195
These accounts are opened in the books to simply explain
the nature of the transactions. They do not really exist.
For example, in a business when salary is paid to the
manager, commission is paid to the salesmen, rent is paid
to landlord, cash goes out of the business and it is
something real, while salary, commission, or rent as such
does not exist.
The accounts of these items are opened simply to explain
how the cash has been spent. In the absence of such
information, it may be difficult for the cashier to explain
how the cash at his disposal was utilized. Nominal
accounts are also called Fictitious Accounts.

196
Principle or Rule of Nominal Account

1. Debit all Expenses and Losses and

2. Credit all Incomes and Profits/Gains.
1. Debit all Expenses and Losses and
2. Credit all Incomes and Profits/Gains.
Example:
When salaries
Example: paid in cash, salaries account
When salaries paid in cash, salaries
should beaccount debited since
should be debited Salaries is
since Salaries
expenditureisaccount
expenditure to the business, while cash
to should
the bebusiness, while cash
credited since cash is
account should beofcredited
going out the business.since cash is going
out of the business.

197
 The Accounting Cycle

1. Analyze the transaction

2. Journalize the transaction
3. Post the transaction to accounts
in ledger
4. Prepare the trial balance
5. Prepare financial statements

198
 The Recording Process

The sequence of steps in recording transactions

Transaction
Documentation Journal

Financial Ledger
Trial Balance
Statements

199
 Journal

What is a journal?
• It is a list in chronological order of all the transactions
for a business.
1 Identify transaction from source documents.
2 Specify accounts affected.
3 Apply debit/credit rules.
4 Record transaction with description.
Journalizing
• Journalizing –
It is the process of entering transactions into the
journal

200
Journal entry
•Journal entry - an analysis of the effects of
a transaction on the accounts, usually
accompanied by an explanation of the
transaction
–This analysis identifies the accounts to be
debited and credited.

• What does a journal entry include?

– date of the transaction
– title of the account debited
– title of the account credited
– amount of the debit and credit
– description of the transaction (narration)
201
PROFARMA FOR JOURNAL ENTRIES

202
LEDGER

A book containing all accounts of a business enterprise is known

as ledger and transferring transactions from the books of original
entries to their respective ledger accounts is known as posting.
Ledger serves as the main book for an effective and result oriented
accounting system.

Date
Dr. Particulars F Amount Date Particulars F Amount Cr.
Rs Rs

To Rs. By Rs.
The Name Name of
of Credit debit
Account Account

203
 TRAIL BALANCE

What is a Trial balance?

• It is an internal document.
• It is a listing of all the accounts with their
related balances.
• It provide a check on accuracy by showing
whether total debits equal total credits.

A listing of all accounts with balances at the

end of the accounting period after all
transactions have journalized and posted
• Purpose
– to determine that debits = credits
– to identify accounts to be adjusted

204
205