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MBA - Financial and Management Accounting
MBA - Financial and Management Accounting
The pedagogy used to design this course is to enable the student to assimilate the concepts
with ease. The course is divided into modules. Each module is categorically divided into units or
chapters. Each unit has the following elements:
Table of Contents: Each unit has a well-defined table of contents. For example: “1.1.1.
(a)” should be read as “Module 1. Unit 1. Topic 1. (Sub-topic a)” and 1.2.3. (iii) should
be read as “Module 1. Unit 2. Topic 3. (Sub-topic iii).
Aim: It refers to the overall goal that can be achieved by going through the unit.
Learning Outcomes: These are demonstrations of the learner’s skills and experience
sequences in learning, and refer to what you will be able to accomplish after going
through the unit.
Did You Know?: You will learn some interesting facts about a topic that will help you
improve your knowledge. A unit can also contain Quiz, Case Study, Critical Learning
Exercises, etc., as metacognitive scaffold for learning.
Summary: This includes brief statements or restatements of the main points of unit and
summing up of the knowledge chunks in the unit.
Activity: It actively involves you through various assignments related to direct application
of the knowledge gained from the unit. Activities can be both online and offline.
e-References: This is a list of online resources, including academic e-Books and journal
articles that provide reliable and accurate information on any topic.
Video Links: It has links to online videos that help you understand concepts from a
variety of online resources.
Author
Dr. K. Hema Divya
Director CDOE
C. Shanath Kumar
Instructional Designer
Nabina Das
Content Editor
M. Mounika
Project Management
K. D. N. Lakshmi
Graphic Designer
B. V. Satyanarayana
Dr. K. Hema Divya, MBA, Mphil, PhD, is currently Deputy Head of the Department and Associate
Professor in Department of MBA, K L Business School, KL University. She has specialised in
the areas of Accounting, Finance and Analytics with 15 years of experience. She has published
11 Scopus-indexed papers and 10 papers in UGC Care-indexed journals. She has organised
various Faculty development programmes and workshops in the area of Finance and also
attended various national and international conferences. She also obtained a patent from Govt
of India Intellectual Property Rights in 2021.
She is a member of World Economic Association and International Society of Research and
Development. She is a reviewer for various international Journals. One PhD has also been
awarded under her guidance in the area of Finance in the year 2021. She has published one
textbook titled “Determinants of Equity share prices of companies listed in Sensex”.
Course Description
Financial and Management Accounting is a basic level course in accounting. It lays foundation to
other courses of accounting. This course begins with the basic concepts of accounting, process
of accounting, types of accounting and preparation of financial statements by a sole trading
concern and as well as a company form of organisation. This course explains the various tools
required to analyse the financial statements of a company and provides an analytical way of
analysing the performance of the company. It covers financial accounting and management
accounting required by management students which helps them to grasp and analyse the
financial statements of the company. Through this course, students will be able to explain the
books required to be maintained, procedure for recording and classifying of transactions into
various accounts, preparation of income statement and balance sheet and how to analyse the
financial statements for evaluating the performance of a company during a financial period.
The purpose of accounting is to accumulate and report financial information about the performance,
financial position, and cash flows of a business. This information is then used to reach decisions
about how to manage the business, or invest in it, or lend money to it. Financial statements, the
result of financial accounting, will help the investors in making decisions about whether to invest
or not to invest in a particular company. Break-even point and cost volume profit analysis can be
prepared which helps in management decision-making.
Put another way, accounting is the lifeblood of a business. All types of businesses have basic
information that is recorded to get that job done. Accounting is a way to communicate the
financial health of a business or an organisation to any interested parties, and is also a method
of assessing the assets, liabilities, and cash flow – or the future of an entity for all current and
future investors. So, even though accounting is not business, it is a vital part of the contemporary
business environment. The role of accounting in the current economy is an important one, as is
the role of management accounting in modern business.
By the end of this course, Students will be able to analyse the financial performance through
ratios and can advise the management on key areas where more focus is required in the near
future. This course lays down the foundation for any accounting course and provides a framework
for understanding the language of business.
Trading and Profit & Loss Account - Balance Sheet with Adjustments (problems) - Methods of
Depreciation. - Ratio Analysis (problems).
Issue of shares (entries) Companies Financial Accounts as per schedule 6 part I & Part II. For-
mats: Banking Accounts, Insurance Accounts and Electricity Accounts.
MODULE 2
PREPARARTION OF FINANCIAL STATEMENTS
Unit 2.1 Financial Statements
Unit 2.2 Ratio Analysis
MODULE 3
COMPANY ACCOUNTS
Unit 3.1 Adjustments in Financial Statements
Unit 3.2 Issue of Shares
Unit 3.3 Company Final Accounts
MODULE 4
MANAGEMENT ACCOUNTING
Unit 4.1 Marginal Costing
Unit 4.2 Break-Even Analysis
MODULE 1
UNIT 1
INTRODUCTION TO
ACCOUNTING
INTRODUCTION TO ACCOUNTING
Module Description
Accounting is regarded as language of Business. It plays a key role in business to keep track of
incomes and expenses, ensure statutory compliance, and provide financial information about the
performance of business to external parties like prospective investors, management and to the
government. Business trends and projections are based on historical financial data to keep your
operations profitable. This financial data is most appropriate when provided by well-structured
accounting processes.
By the end of this module, the students will be able to summarise accounting concepts and
principles followed in reporting of financial statements and able to summarise the process of
accounting from recording of transactions, posting of entries to preparation of Trial balance.
Unit 1.1
Aim -------------------------------------------------------------------------------------------------------------- 7
Instructional Objectives ------------------------------------------------------------------------------------ 7
Learning Outcomes ----------------------------------------------------------------------------------------- 7
Summary ------------------------------------------------------------------------------------------------------- 21
Terminal Questions ------------------------------------------------------------------------------------------ 21
Answer Keys -------------------------------------------------------------------------------------------------- 22
Bibliography --------------------------------------------------------------------------------------------------- 22
e-References ------------------------------------------------------------------------------------------------- 23
Video Links ---------------------------------------------------------------------------------------------------- 23
Keywords ------------------------------------------------------------------------------------------------------ 23
Instructional Objectives
In this unit, students will be able to:
1. Define accounting
2. Differentiate Accounting from Book-keeping
3. Summarise Accounting Information
4. Identify distinct types of accounting
Learning Outcomes
At the end of the unit, students are expected to:
1. Illustrate the meaning of accounting
2. Compare and contrast the features of Accounting and Book-keeping
3. Analyse to whom accounting information is useful
4. Differentiate between Financial Cost and Management Accounting
The above definition of accounting brings out the following attributes of accounting:
2. Identifying: Accounting records only those transactions and events which are of financial
character, therefore it is necessary to identify the recordable transactions. If an event cannot be
expressed in terms of money, then it is not considered for recording.
Example: manager’s honesty cannot be expressed in terms of money, hence not recorded in
books.
3. Recording: It is concerned with recording of identified events and transactions in the book of
original entry, i.e., in journal.
7. Communicating: It involves presenting the analysed data in the form of financial reports or
statements, to the end users of the financial information, i.e., insiders and outsiders like officers,
staff members, shareholders, creditors, government, etc.
(a) Ledger
(b) Journal
(c) Report
(d) Entry
(a) Ledger
(b) Journal
(c) Report
(d) Entry
(a) Ledger
(b) Journal
(c) accounting records
(d) Entry
(a) Ledger
(b) Journal
(c) Report
(d) Trial Balance
(a) Past
(b) Future
(c) Present
(d) None
1 To keep a systematic record of the financial activities: The first important function of
accounting is to keep a systematic record of the financial transactions of the business.
In accounting only those business transactions are recorded which can be expressed in
terms of money. Business transactions are properly recorded, classified into appropriate
accounts and summarised into financial statements.
3 To communicate the financial results: Accounting communicates the financial results and
other valuable financial information to the various interested groups such as officers,
creditors, employees, government, consumers.
4 To prevent and detect errors and frauds: The most important function of accounting is that
it helps in detecting errors and frauds, if any take place by maintaining proper records.
1. Based on accounting concepts and conventions: The results disclosed by financial state-
ments are not realistic as they are based on various accounting concepts and conventions. For
instance, fixed assets are shown at their historical cost and not at their market price.
2. Accounting can lead to window dressing: The management of the business can present
financial statements to meet their own needs by showing more profit or less profit than the
actual value. This is done by window dressing, i.e., showing the items at the convenience of the
management. For example, closing stock may be over or under valued than the true value.
3. Accounting ignores the effect of changes in price level: Accounting statements are
prepared at historical cost. Assets are shown in the books of account at the original cost. Thus,
assets do not disclose a true and fair view and the balance sheet does not reflect the true
financial position of the entity.
5. Based on Unrealistic information: Actual profit of the business can be known only when the
business is shut down and closing stock is valued at realisable value. For example, assets are
recorded at historical cost and accounts are prepared on a going concern basis, which provide
unrealistic financial information.
(a) Yes
(b) No
(a) Yes
(b) No
(a) Yes
(b) No
(a) Yes
(b) No
9. Accounting statements reflect the true and fair value of financial information.
(a) Yes
(b) No
According to Kohler, “Accountancy refers to the entire body of the theory and practice of
accounting.”
1.1.2.2 Difference between book-keeping and accounting
S.no Basis of Difference Book-Keeping Accounting
It is concerned with identi-
It is concerned with summaris-
fying financial transactions;
ing the recorded transactions,
1 Nature measuring them in mone-
interpreting them and commu-
tary terms; recording and
nicating the results.
classifying them.
It aims at ascertaining business
It is to maintain systematic income and financial position
2 Objective records of financial by maintaining records of busi-
transactions. ness transactions.
It is recording, classifying,
It is to record business summarising, interpreting
3 Function transactions. So, its scope business transactions and
is limited. communicating the results.
Thus, its scope is wide.
(a) Book-keeping
(b) Journal
(c) Accounting records
(d) Entry
12. Book-keeping records only those transactions which can be measured in money.
(a) Yes
(b) No
(a) Yes
(b) No
(a) Yes
(b) No
(a) Yes
(b) No
Accounting is an information system which identifies records and communicates this information
to the interest users in the form of financial statements. These financial reports are transferred to
the users in two forms -- internal and external. Internal financial reports are used by an individual
who runs, manages, and operates the daily activities of an inside area of an organisation. Manager,
supervisor, financial director are the most featured examples of internal users. External financial
reports are used by individuals and organisations who want financial accounting information.
External users are not part of the management of the company.
1. Creditors: Creditors are focused on that information which are related to the borrower before
making a large loan such as the Bank will want information about the borrower to repay the loan,
the amount of assets and liabilities of the borrower, evidence of income, tax policies, and so on.
2. Investors: Investors provide money to individuals or organisations to start a business. Before
investing money investors want to know whether they should invest or not or if they would invest
to start a business now then how much return they will get from their investment.
3. Government regulatory agencies: Government regulatory agencies like State government
agencies and security and exchange commission want financial accounting information which
is related to the investors, business organisations or any individuals. These regulatory agencies
want information to know whether the business organisations are following the business rules
and regulations or not or whether the investors are able to invest or make decisions or not.
4. Taxing authority: Taxing authority wants financial accounting information relating to the tax
policies, tax laws, amount of payable tax, etc. from the individual or organisation. The taxing
authority wants financial accounting information to know whether the business organisations are
following tax rules or not and their ability to pay income tax because income tax is based on the
financial accounting reports.
5. Suppliers and customers: Customers also want to know about company issues like warranty,
product development, etc. Suppliers want to know about the company’s future goals so that they
can serve the best material in coming days.
6. Employers and labour unions: Employers use accounting information for their own benefit.
Accounting information helps the employee to ensure their future benefit from the company like
pension, health provision, retirement benefit, etc. The Labour union wants accounting information
to know their future salary.
Cost and management accounting is for finance professionals and business managers or owners
whose role it is to maintain records to identify where to cut costs for increased profitability.
Purpose: Ascertain business costs for day-to-day planning, cost control, and internal decision
making.
Financial accounting is for accountants whose role it is to record all transactions and accurately
report the entire financial picture and performance of a business.
Purpose: Secure overall business financial information and report on performance and position.
2. Recording systems
Cost management professionals book actual transactions and compare them to estimates. They
then base reports on the estimation of cost and on the recording of actual transactions.
Purpose: Cost of sale of product(s), addition of a profit margin and determination of selling price
of the product.
Financial accounting professionals evaluate actual transactions only and do not use estimation
in recording financial transactions.
Purpose: Journal entries, ledger accounts, trial balance, cash flow and financial statements.
3. Target audience
Cost accounting involves the preparation of a broad range of reports that management needs to
run a business.
Purpose: The readers are exclusively internal management.
Financial accounting involves the preparation of a standard set of reports for an outside audience.
Purpose: The readers may include investors, creditors, credit rating agencies, and regulatory
agencies.
4. Period of profit
Cost management accounting is used as per the requirement of management or on an
as-and-when-required basis.
Purpose: Profit is determined related to a particular product, job, or process.
Financial accounting is required during the report period at the end of the fiscal year.
Purpose: Profit is determined for the whole organisation made during a particular period only.
5. Regulatory framework
Cost accounting involves creating reports that can be in any format specified by management.
There are no regulatory framework governing cost accounting reports so they can be tailored to
suit a
certain costing need or managerial demand.
Purpose: Cost accounting reports are voluntary and created with the intention of including only
that information pertinent to a specific decision or situation.
6. Measurement
Cost accounting compiles the costs of raw materials, work-in-process, and finished goods
inventory.
Purpose: Record the details for each product, process, job, or contract.
Financial accounting incorporates this information into its financial reports, primarily into the
balance sheet.
Purpose: To show overall costs and profit gains or losses.
7. Reporting
Cost accounting usually results in reports at a much higher level of detail within the company.
Purpose: Record internal and external transactions for present and future, such as for individual
products, product lines, geographical areas, customers, or subsidiaries.
Financial accounting’s primary focus is on reporting the results and financial position of an entire
business entity.
Purpose: Record external transactions only, with a focus on historical data. One way of doing
this would be to translate an annual accounting cycle from a source document into financial
statements.
(a) Yes
(b) No
(a) Yes
(b) No
(a) Financial
(b) Management
(c) Cost
(d) Inflation
(a) Financial
(b) Management
(c) Cost
(d) Inflation
20. Financial accounting is required during the report period at the end of the fiscal year.
(a) Yes
(b) No
2. Accounting information is widely used by both internal and external parties to know the
performance of the company.
4. Cost and management accounting is for finance professionals and business managers or
owners whose role it is to maintain records to identify where to cut costs for increased prof
itability.
5. Financial accounting’s primary focus is on reporting the results and financial position of
an entire business entity.
Terminal Questions
1 B
2 A
3 C
4 D
5 A
6 A
7 A
8 B
9 B
10 A
11 A
12 A
13 A
14 A
15 A
16 A
17 A
18 B
19 C
20 A
Text Books
1. Libby, R., Libby, P., & Hodge, F. Financial Accounting (6th ed.). Tata McGraw-Hill.
2. Horngren, C. T., & Harrison, Jr. O. Financial & Management Accounting. PHI.
3. Drury, C. Cost & Management Accounting. Cengage Publishing.
4. Horngren, C. T., & Harrison Jr. O. Financial & Management Accounting. PHI.
e-References
1. https://www.accountingcoach.com/bookkeeping/explanation
2. https://www.toppr.com/guides/accounting-and-auditing/theoretical-framework-of-
accounting/merits-and-demerits-of-accounting/
3. https://web.ung.edu/media/university-press/Principles-of-Financial-Accounting.
pdf?t=1542408454385
Video Links
Topic Link
Keywords
• Journal
• Accounting records
• Inflation
MODULE 1
UNIT 2
ACCOUNTING CONCEPTS
AND CONVENTIONS
Aim --------------------------------------------------------------------------------------------------------------- 26
Instructional Objectives ------------------------------------------------------------------------------------- 26
Learning Outcomes ------------------------------------------------------------------------------------------ 26
Summary -------------------------------------------------------------------------------------------------------- 35
Case lets -------------------------------------------------------------------------------------------------------- 36
Terminal Questions ------------------------------------------------------------------------------------------- 36
Answer Keys -------------------------------------------------------------------------------------------------- 37
Glossary --------------------------------------------------------------------------------------------------------- 38
Bibliography ---------------------------------------------------------------------------------------------------- 38
e-References -------------------------------------------------------------------------------------------------- 38
Video links ------------------------------------------------------------------------------------------------------ 38
Keywords ------------------------------------------------------------------------------------------------------- 39
Instructional Objectives
This unit intends to:
• Elaborate concepts of accounting
• Examine accounting conventions
Learning Outcomes
After the completion of this unit, students will be able to:
• Apply the accounting concepts
• Analyse the range of accounting conventions
Accounting concepts are the assumptions upon which financial statements of a business
organisation are prepared. These are the fundamental assumptions and terms that act as the
foundation for accounting. The same will help to maintain consistency and regularity in the
process of preparation of accounting reports. They help us to understand the business rules and
regulations that are required to be adopted by all types of business entities. Hence, they simplify
detailed and comparable financial information.
The main concept of accounting refers to basic assumptions, rules, and principles that an
accountant needs to follow and serves as a basis for recording business transactions and
preparation of accounts. This concept of accounting brings to light those commercial enterprises
and their owners as two separate and independent accounting entities.
1. Separate business entity concept: This concept explains that the owner is different
from the business. An owner and a business are two different entities. A business is a
separate entity which has its own assets and liabilities. Business has its own signature in
the form of a common seal. Business can sue anyone, and anyone can sue business. It
is a separate legal entity. For example. When business is started by the owner, business
sees the owner as separate entity and taking this concept, capital contributed by owner
is shown as liability which indicates that business must repay back to its owner.
2. Double entry concept: This concept says that for every debit there will be corresponding
credit with an equal amount. In business, every transaction will have two aspects, one is
debit and another one is credit. Every transaction must be recorded twice in the books
of accounts, such recording of debit and credit is termed as double entry concept.
Accounting equation coins the above rule as Assets = Liabilities + Owners Equity. For
example, purchased goods Rs 5000. This transaction involves two aspects. one is
purchasing of goods and second one is cash. The balance in the purchase account
must be increased and the balance in the cash account needs to be decreased. For
this, purchase accounts must be debited and cash accounts to be credited.
3. The concept of ongoing concern: It states that the business activity will be carried
out for the indefinite future. It means that while maintaining books of accounts an
assumption is that business will be carried out for an extended period, that means
business entity is immortal.
4. Matching concept: It states that the incomes and expenses of a business entity which
is recorded in the books should belong to the same accounting period. It means that It
facilitates comparison of revenue with expenses related to the same accounting period.
Using this concept expenses and incomes are adjusted in the books of accounts.
1. Which concept explains that financial accounting purposes, the business enterprise,
and its owners are two separate independent entities:
2. If all the business transactions are expressed in monetary terms, it will be easy to
understand the accounts prepared by the business enterprise.
3. This concept states that a business firm will continue to carry on its activities for an
indefinite period.
4. This concept requires assets to be shown at the price that has been acquired, which
can be verified from the supporting documents.
5. It helps in knowing actual expenses and actual income during a particular time.
8. Accounting period concept: Accounting period concept states that every business
organisation has to main books of accounts for certain period to determine whether it
has derived profit /loss during that period. Maintaining accounting records for a specific
period helps the organisations to trace and analyse the overall performance of each
company during a specific time. When there are two different periods, various financial
parameters can be used to analyse and compare, and suggestions can be drawn up
for the growth or the downfall of the company. It serves as a reference to such a report
and is extremely useful for the stakeholders.
1. Calendar Year: Accounting books are opened on 1st January and closed on 31st
December of the same year.
2. Fiscal Year: Accounting books are opened on the first day of any month other than
January and are closed at the end of the same month of next year.
6. ‘For every debit, there should be corresponding credit with equal amount’ is stated by
___ concept.
8. ‘Organisation must record all probable losses than probable gains’ are stated by:
9. __________ concept states that ‘every business organisation has to maintain books
of accounts for certain period’
10. ________ is a concept that states that the ‘income or revenue is recognised or
recorded only when it is earned’.
Accounting, when an investor examines the financial accounts of a company, conventions are
formed to assure uniformity, consistency, and the same interpretation. Conventions are long-
standing customs, traditions, or practices that organisations do follow. The organisation will be
guided in the creation of financial statements by conventions. Principles are another name for
these conventional practices. Let us have a look at some of the most essential traditions that
businesses adhere to.
1. Convention of Disclosure
This convention underlines that the corporation must offer information to the
stakeholders for whom it will be responsible for all material and key facts of financial
performance and operational results.
There may be a time gap between the date of production of the balance sheet and
its publication, during that time, certain events such as bad debts, plant damage,
and debt recovery may occur, all of which must be disclosed to stakeholders. In
financial statements, the corporation is obligated to produce and disclose all relevant
information to all stakeholders. As a result, full disclosure becomes a healthy principle
and is regarded as crucial.
2. Convention of Consistency
The term “consistency” refers to the consistency of norms and practices. It does not
rule out the possibility of change. It states that any valuation strategies, methods, or
techniques used must be consistent over a period of time for the management to draw
conclusions about the company’s activities. It is necessary to guarantee that practices
and procedures do not change frequently, and that consistency is maintained. It will
be tough to compare if practices and approaches change frequently. Consistency aids
in the elimination of personal prejudice. Any changes in techniques and processes
must be clearly documented in the financial statements’ footnotes. This standard
improves the accuracy and comparability of accounting data for better forecasting and
decision-making. Changes are not prohibited by this convention. If a change occurs, its
implications must be understood and presented or indicated in the financial accounts.
11. “Anticipate no profit and provide for all possible losses” is the essence of __________
convention.
12. ________implies that the economic significance of an item will affect its accounting
treatment.
13. It states that any practices and methods or technique followed in valuation need
to be consistent for a certain number of years, which helps the management to draw
conclusions about the operations of the company.
14. The purpose of this convention is to communicate all material and relevant facts
concerning financial position and results of operations to the users.
15. As per this concept, all accounting must be based on objective evidence. In other
words, the transactions recorded should be supported by verifiable documents.
This principle states that, if a business records transactions in its books, it should
always “anticipate no profit and provide for all conceivable losses.” Because the future
is unclear and unpredictable, changes and uncertainties are common. As a result,
this notion emphasises the ability to record potential losses rather than anticipated
earnings.
Closing shares, for example, should be valued at either the cost or market price,
depending on which is lower. This convention can be used as a precaution or a safe
bet while preparing financial statements.
If followed, this conservatism tends to produce true and fair value information in
financial accounts.
4. Convention of Materiality
Purchasing tiny products such as a pen, stapler, printer and stationery, envelopes,
stamps, and other similar items, for example, can be classified as an asset based
on the asset’s durability and nature. Separating accounts is not essential; all can be
pooled and regarded as expenses for the accounting period.
As a result, minor and insignificant items can be overlooked or mixed with other items.
The quantity of their amount determines their materiality. When the numbers are in
the thousands, the omission of a paisa is inconsequential. In summary, all material
information that is required to make the financial statements clear and understandable
should be published.
(a) yes
(b) No
17. It is helpful for the investors/shareholders to know the exact amount of profit or loss
of the business.
18. It takes into consideration all prospective losses but leaves all prospective profits
19. According to this convention the accounting practices should remain unchanged
from one period to another.
20. It is because of this concept that fixed assets are recorded at their original cost and
depreciation in a systematic manner without reference to their current realisable
value.
Separate Business entity accounting concept makes a clear distinction between the
business and the owner. The going concern assumes that business activities will
continue to operate for a longer period in future.
The concept of correspondence states that income and expenses must be recorded
at the same time as they are incurred.
Money measurement states that business transactions which are expressed in terms
of money will only be recorded in books of accounts.
Conservatism states that the business has to identify all possible losses rather than
anticipated profits.
The Principle of Materiality implies that the economic importance of an item will affect
its accounting treatment.
In the below cases, wherever possible apply concepts and analyse its recording.
1. At the conclusion of each month, a firm pays a 10% commission to sales leaders. If
the company makes Rs 50,000 in sales in March, it will pay a commission of Rs 5,000
the following June. Examine the numerous ideas that should be considered while
recording transactions in books of accounts.
2. A supplier invoice for Rs 20,000 will arrive a few days after the end of the month, but
the accountant prefers to close the accounts at the end of the fiscal year. As a result,
it makes a Rs 20,000 reverse entry to account for the charges this month. The entry
reverses the following month, resulting in a negative Rs 20,000 charge offset by the
arrival and recording of a supplier invoice.
Terminal Questions
Question No Answers
1 c
2 c
3 c
4 a
5 a
6 c
7 a
8 b
9 b
10 d
11 b
12 a
13 c
14 b
15 c
16 a
17 b
18 a
19 a
20 c
• Entity: Something that exists apart from other things, having its own independent
existence
• Cost concept: It refers to the amount of payment made to acquire any goods and
services.
Bibliography
Textbooks
1. Libby, R., Libby, P. A., & Hodge, F. (2020). Financial Accounting. McGraw-Hill
Education.
2. Horngren, C. T., Harrison, W., & Oliver, M. S. (2011). Financial & Managerial
Accounting. Pearson College Div.
e-References
1. https://corporatefinanceinstitute.com/resources/knowledge/accounting/
2. https://www.tutor2u.net/business/reference/accounting-concepts-and-conventions
3. https://www.vedantu.com/commerce/accounting-concepts
Video Links
Topic Link
MODULE 1
UNIT 3
ACCOUNTING CYCLE
Aim ------------------------------------------------------------------------------------------------------- 42
Instructional Objectives ------------------------------------------------------------------------------ 42
Learning Outcomes ---------------------------------------------------------------------------------- 42
Instructional Objectives
This unit intends to:
• Examine the process of preparing accounts
• Identify various books to be maintained for accounting
Learning Outcomes
At the end of the unit, students are expected to:
• Enumerate the accounting process/cycle
• Apply the accounting process
• Analyse various books of accounts at each process
The accounting cycle is the process of a company’s accounting events being identified, analysed,
and recorded. It’s an eight-step process that starts when a transaction occurs and finishes when
the transaction is recorded in the financial statements.
1 - Financial
Transaction
5 - Financial 2 - General
Statements Journal
4 - Trail 3 - General
Balance Ledger
Financial transactions are the transactions that take place in the monetary aspect in the process of
running the business. All these transactions are initially recorded in bookkeeping in chronological
order and later they are recorded in various books. Accounting cycle speaks about various stages
of recording the transactions, classifying them, and summarising them to prepare the financial
statements of the firm.
1.3.1 Journal
It is the practice of recording transactions in the form of entries in a book called a Journal.
Journalising is the process of recording entries in a book journal. Book of Original Entry is
the name of the journal. A formal record that documents a transaction is an accounting entry.
There are two types of accounting entry systems. The income and expenses for transactions
are recorded in a cash register in single-entry bookkeeping, whereas the double-entry system
begins with a journal, then a ledger, a trial balance, and finally financial statements. The double-
entry system is the most often used accounting system due to its various advantages over the
single-entry system. In the double-entry system, every financial transaction is recorded in at least
two independent accounts, with equal and opposite impacts on the appropriate accounts. In a
double-entry system, the entries are made in the system to satisfy the equation:
In this system, every credit is counterbalanced by debits, either in the general ledger or in a
T-account. To put it another way, every transaction has two separate accounts with credit and
debit entries.
Let us look at an example to better grasp the method steps. The accounts that will be affected in
this example are your office supply account and your cash account.
1. Office supplies and cash are two accounts that have been recognised.
2. The cash account is a genuine account, but the office supplies account is an expense
account.
3. All expenses will be deducted from the account, and cash will be credited.
(a) Ledger
(b) Book
(c) Journal
(d) Bookkeeping
(a) Journalising
(b) Ledge rising
(c) Entering
(d) Recording
3. The income and expenses for transactions are recorded in a cash register is
__________ system of Bookkeeping.
(a) Single
(b) Dual
(c) Double
(d) Empty
(a) Single
(b) Dual
(c) Double
(d) Empty
5. In a double-entry system, the entries are made in the system to satisfy the equation:
It’s also known as the book of last entries. All transactions recorded in the journal will be placed into
distinct accounts in this book. For various transactions, various accounts are opened throughout
the year and after posting all the transactions, accounts will be closed at the end of the year and
balances will be finalised and carry forward for next year which will become opening balance of
the account. In accounting there are three types of accounts. An organisation may handle varies
transactions, but all these transactions are classified into these accounts and posting entries will
be as per the rules specified for various accounts.
An account will be in T shape having debit and credit. Debit refers to left side and credit refers to
right side of an account. What is posted on debit and credit side of an account depends on nature
or type of account and then rule of that account will be applied.
1. Personal accounts
2. Real accounts
3. Nominal accounts
2. Real accounts: Real accounts deal with all forms of transactions involving an
organisation’s assets. It represents all asset accounts that involve transactions such
as asset purchases, asset sales, and so on. These are assets that can be touched and
have a tangible existence. Building a/c, cash a/c, stationery a/c, inventory a/c, and so
on.
3. Nominal accounts: These account types are related to income or gains and expenses
or losses. For example: – Rent A/c, commission received A/c, salary A/c, wages A/c,
conveyance A/c, etc.,
There are a few other accounts in accounting that you should be aware of:
• Cash account: Keep track of all cash payments, withdrawals, and deposits in this
account.
• Income account: This account is used to maintain track of the business’s revenue
sources.
• Expense account: This account keeps track of the company’s expenses.
• Liabilities: If there is any debt or loan, it is classified as a liability.
• Equities: If the account owner has made an investment in common stocks or retained
earnings, these are considered equities.
QUIZ
Write the accounts affected and applicable rules in the below-mentioned transactions.
1. Bought goods for cash.
2. Sold goods for cash
3. Paid expenses.
Answer
1. Debit purchase account and credit cash account.
2. Debit cash account and credit sales account.
3. Debit expenses account and credit cash/bank account.
(a) Personal
(b) Real
(c) Nominal
(d) Other
7. Copyright is ___________asset.
(a) Tangible
(b) Intangible
(c) Traceable
(d) Perishable
(a) Nominal
(b) Personal
(c) Real
(d) Other
(a) Journal
(b) Ledger
(c) Bookkeeping
(d) None of the above
(a) Yes
(b) No
DID Amatino Manucci, a Florentine trader around the end of the 13th century, kept
YOU the first existing accounting records in Europe that used the contemporary
KNOW double-entry system. The Farolfi firm employed Manucci, and the firm’s
ledger from 1299 to 1300 shows full double-entry bookkeeping.
Subsidiary Books are books that preserve a systematic record of similar transactions. Daybooks
and Special Journals are other names for them. It is difficult to record all transactions in one
journal and post them to numerous accounts in large corporations. As a result, the journal is
separated into multiple subsidiary books for quick and accurate recording of all transactions.
There is a separate book for each sort of transaction.
There are 8 types of subsidiary books that are used for recording several types of transactions.
The 8 Subsidiary books are as follows:
1. Cash Book
2. Purchase Book
3. Sales Book
4. Purchase Return Book
5. Sales Return Book
6. Bills Receivable Book
7. Bills Payable Books
8. Journal Proper
1. Cash Book
The cash book is the most essential and initial subsidiary book. It keeps track of all revenues
and payments made in cash and by bank. The cash books of a company are separated into
three sections. They are:
Single column cash book: A ledger account is similar to a cash book with only one column.
It has a debit and credit side to it. The debit side of the cash book records all cash receipts,
while the credit side records all cash payments.
Double column cash book: A discount column is added to both the debit and credit sides of
the cash book, which is the fundamental difference between a Double Column Cash Book
and a Single Column Cash Book. It keeps track of the discounts that have been given on
the debit side of the cash book as well as the discounts that have been acquired on the
credit side.
Triple column cash book: A triple column cash book contains all of the columns found in a
double column cash book, plus an additional bank column.
2. Purchase Book
The Purchase Book is a sub-book in which all credit-related transactions are recorded. The
assets are never bought or registered in the buy book.
Purchase Book
Date Particulars Inward Invoice No. L.F. Amount
3. Sales Book
All credit sales transactions are recorded in the Sales Book. Asset sales aren’t allowed to
be reported in the sales book. The sales book format is given below.
Sales Book
Date Particulars Outward Invoice No. L.F. Amount
The purchase return book, also known as the return outward book, is used to track all
supplier returns. A debit note is issued for each return, which is recorded in the Purchase
Return Book.
All incoming returns transactions are recorded in the sales return book. It’s also known as a
return inward book. A credit note is sent and recorded in the Sales Return Book every time
a consumer returns merchandise.
All transactions involving bills drawn in the company’s favour are recorded in the Bills
Receivable Book. The total of the bills receivable book is posted on the debit side of the
Bills Receivable account. The Format of Bills Receivable Book is as follows.
Bills Receivable Book
Date of Bill Bill No. Acceptor From Terms Due Date Amount
The Bills Payable Book records all the transactions related to bills that are drawn on the
business and are payable by the business. The Bills Payable Books Format is as follows.
Bills Payable Book
Date of Bill Bill No. Drawee Payee Terms Date of Maturity Amount
8. Journal Proper
A few solved examples are given to make the content on subsidiary books clearer to the
students.
3. Depreciation of buildings.
Journal Proper is the book.
Accounts are settled once all of the accounts are opened and all transactions are posted to them
during the year, and only a few will be closed at the conclusion of the fiscal year by determining
the amounts remaining in each account. Accounts showing debit balances will be entered in the
debit column of trial balance and credit balances on credit column in trial balance.
The main objective of preparation of trial balance statement is to check the accuracy of accounts
at the end of the year. Accuracy can be ensured only when the sum of the debit column is equal
to the sum of the credit column. If there is any difference, transactions are to be checked where
there may be some error in recording and posting of transactions in accounts. Debit column and
credit column totals equal implies that there is accuracy, and it happens because of dual aspect
concept of accounting which states for every debit there will be a corresponding credit with equal
amount.
Total
Once trial balance is prepared, observe the following points to get clarity on nature of accounts
and balance they represent always in the account:
Particulars Balances
Furniture 640
Buildings 7500
Machinery 6250
Capital 12500
Bad debts 125
Debtors 3800
Creditors 2500
Stock on 1-4-2011 3460
Purchases 5475
Sales 15450
Bank OD 2850
Sales returns 200
purchase returns 145
Advertisement 450
Interest 650
Cash 118
Commission 375
Tax and Insurance 1250
General Expenses 782
Salary 3300
Bills Payable 200
Total 34,000
DID Trial Balance is thought to have originated and developed in Italy in the
YOU thirteenth and fourteenth centuries, while the precise date, style, and
KNOW
location are unknown.
Solved Problems
In Ledger, several accounts are opened throughout the year, and after posting all
transactions, accounts are closed at the end of the year, and balances are finalised
and carried forward for the following year, which becomes the account’s opening
balance.
Special journals or Daybooks are other names for subsidiary books. It is difficult to
record all transactions in one journal and post them to numerous accounts in large
corporations.
All cash receipts are recorded on the debit side of a single column cash book, while
all cash payments are entered on the credit side.
A Double Column Cash Book is similar to a Single Column Cash Book, except that it
has an additional discount column on both the debit and credit sides.
A triple column cash book features all of the columns of a double column cash book
plus an extra bank column.
At the end of the year, the trial balance statement is used to verify the accuracy of the
accounting.
Accounts with debit balances will be recorded in the debit column of the trial balance,
and accounts with credit balances will be entered in the credit column.
Terminal Questions
Question No Answers
1 A
2 B
3 A
4 A
5 A
6 B
7 A
8 A
9 C
10 D
11 A
12 B
13 A
14 B
15 A
Glossary
• Liabilities: Any kind of financial obligation that a business has to pay at the end of
an accounting period to a person or a business.
Bibliography
Textbooks
1. Libby, R., Libby, P. A., & Hodge, F. (2020). Financial Accounting. McGraw-Hill
Education.
2. Horngren, C. T., Harrison, W., & Oliver, M. S. (2011). Financial & Managerial
Accounting. Pearson College Div.
e-References
1. https://www.toppr.com/guides/principles-and-practice-of-accounting/subsidiary-books/in-
troduction-to-subsidiary-books/
Video Links
Topic Link
Keywords
• Ledger
• Expense Account
• Tangible
• Perishable
MODULE 2
UNIT 1
FINANCIAL STATEMENTS
Module Description
Financial statements prepared at the end of the accounting period helps to identify and analyse
the performance of the company. Preparation of financial statements is one of the crucial steps
and is the main objective of financial accounting. Every firm at the end of the year would like
the know whether it has made profit or loss . These statements also help in understanding the
sustainability of the business.
It furnishes a snapshot of a company’s financial performance which gives an insight into its
performance, operations, and cash flow. These statements are necessary for every firm as since
they provide information about a company’s revenue, expenses, profitability, and debt.
At the end of this module, students will be able to understand various financial statements and
their preparation and various ratios to analyse the performance of company.
Aim --------------------------------------------------------------------------------------------------------- 68
Instructional Objectives ------------------------------------------------------------------------------- 68
Learning Outcomes ------------------------------------------------------------------------------- 68
Instructional Objectives
This unit intends to encourage students to:
• Demonstrate and prepare financial statements
• Define the financial statements with adjustments
Learning Outcomes
At the end of the unit, students are expected to:
• Apply accounting concepts and prepare financial statements
• Summarise the financial statements with adjustments
For a given fiscal year, a standalone trading firm will produce and keep books of accounts.
All transactions for the fiscal year must be recorded in books that must be closed at the end
of the accounting period. The fundamental goal of financial accounting is to prepare financial
statements at the conclusion of the fiscal year. Three major financial statements make up these
financial statements:
1. Income statement
2. Statement of retained earnings
3. Balance sheet
Income statement, termed as Profit and Loss Account, is a financial statement that is prepared at
the conclusion of each fiscal year to show how much profit the company made during that period.
The Income Statement aids in determining a company’s performance over time. Revenue minus
expenses is referred to as income. If revenues exceed expenses, it is referred to as profit, and if
revenues fall short of expenses, it is referred to as a loss.
Revenues are the goods received by the company throughout a given fiscal year.
The income gained from the selling of goods or services is referred to as revenues. It’s important
to note that revenues are earned when a sale is made. It’s possible that the payment was
received, but it’s also possible that it wasn’t. Sales for products and service fees for service firms
are examples of revenue. When a company receives goods and services, it incurs expenses.
Payment may or may not been earned, just like revenues. Salary expense, utility expense, and
interest expense are all examples of expenses.
The cost of goods sold is the cost incurred by a company to purchase or manufacture a product
for resale. A bookstore, for example, buys a book for Rs 25 and then sells it for Rs 32. The
selling price of the goods is Rs 7/-. The expenses incurred in running a business are known as
operating expenses. Salary, utility, and depreciation expenses are examples of such accounts.
Revenue, expenses, gains, and losses that are not related to the company’s principal operations
are referred to as non-operating items. Interest expenses, as well as gains and losses from the
sale of equipment and assets, are recorded in these accounts.
5. Revenue and expenses, gains and losses which arise out of non-business activities
are called ______.
Solved Problem
1. KP Limited’s trial balance for the year ending 31.3.2020 is shown below. Prepare the
trading and profit and loss account, as well as the balance sheet, for the year ended
31.3.2020.
Dr. Trading &P&L Account for the year ended 31.3.2020 Cr.
Particulars Rs/- Particulars Rs/-
To opening stock 3460 By sales 15450
To Purchases 5475
To Gross Profit 6515
To Rent 5000 By Gross Profit 6515
To insurance 1050
T0 net Profit 465
The Statement of Retained Earnings shows how a company’s financial condition was affected by
net income and dividends during the period.
Solved Problem
Solution
A balance sheet is a financial statement that shows a company’s assets and liabilities. A balance
sheet’s purpose is to report an accounting firm’s financial situation at a specific point in time.
The balance sheet’s goal is to report an accounting entity’s financial situation at a specific point
in time.
Assets
Any resource or good utilised to produce cash flow, reduce expenses, or give future economic
benefits to an individual, government, or business is referred to as an asset. Assets have economic
value and can help a company’s operations, enhance a company’s value, or boost a person’s net
worth. The classification of assets can be done in a variety of ways. Assets are classed based on
how quickly they can be changed into cash, whether they are physically present or not, and their
usage and/or purpose. The following is a list of the various categories of assets.
Current assets: These are highly liquid assets that can be sold and turned into currency very
fast. Cash, bonds, mutual funds, stocks, and other marketable securities are regarded as the
most liquid current assets, which means they can be sold easily and rapidly without impacting
their value. Cash, accounts receivable, inventory, and prepaid expenses are examples of current
assets for firms.
Intangible assets: Items or goods that exist in theory rather than in their physical form. Permits,
intellectual property, patents, brand reputation, and trademarks are examples of intangible assets
that increase in value as a result of successful use.
Liabilities
A liability is a phrase used in accounting to indicate any type of financial obligation that a company
has to pay to a person or a company at the conclusion of an accounting period. The distribution
of economic rewards such as money, products, or services is used to settle liabilities.
Liabilities, which include various types of loans, creditors, lenders, and suppliers, are recorded
on the right-hand side of the balance sheet.
Short-term and long-term liabilities are both possible. Short-term liabilities must be paid within
an accounting period (12 months), while long-term liabilities must be paid over a longer period
of time.
1. Current Obligations
2. Fixed Liabilities/Long-term obligations
Current liabilities: Obligations that are due and must be paid within an accounting period are
referred to as current liabilities (which is usually a year or 12 months). Because of the quick
turnaround period, current liabilities are also known as short-term liabilities.
Current liabilities have a direct impact on working capital as well as the business’s liquidity.
1. Interest to be paid
2. Accounts receivables
3. Short-term financing
4. Expenses that have accumulated
5. Overdraft at the bank
By supplying the necessary capital, these liabilities assist enterprises in acquiring capital assets.
Businesses can also use funds earned through long-term debts or liabilities to invest in new
capital projects.
Long-term liabilities are a key measure of a company’s ability to stay afloat. A corporation’s
inability to pay off long-term liabilities when they become due suggests a problem with the
company’s solvency or a crisis within the company.
(a) Yes
(b) No
(a) Yes
(b) No
(a) Account
(b) Report
(c) Statement
(d) Lesson
1. KP Limited’s trial balance for the year ending 31.3.2020 is shown below. Prepare the
trading and profit and loss account, as well as the balance sheet, for the year ended
31.3.2020.
Dr. Trading &P&L Account for the year ended 31.3.2020 Cr.
Particulars Rs/- Particulars Rs/-
To opening stock 3460 By sales 15450
To Purchases 5475
To Gross Profit 6515
To Rent 5000 By Gross Profit 6515
To insurance 1050
T0 net Profit 465
The income statement demonstrates how much profit the company made during that
time period.
A balance sheet is a financial statement that shows a company’s assets and liabilities.
The statement of retained earnings shows how a company’s financial condition was
affected by net income and dividends during the period.
Terminal Questions
Question No Answers
1 A
2 C
3 A
4 D
5 D
6 A
7 A
8 B
9 C
10 B
Glossary
• Balance Sheet: A financial statement that reports a company’s assets, liabilities, and
shareholder equity at a specific point in time.
• Net Income: Sales minus cost of goods sold, general expenses, taxes, and interest.
Bibliography
Textbooks
1. Libby, R., Libby, P. A., & Hodge, F. (2020). Financial Accounting. McGraw-Hill
Education.
2. Horngren, C. T., Harrison, W., & Oliver, M. S. (2011). Financial & Managerial
Accounting. Pearson College Div.
1. https://www.investopedia.com/ask/answers/031815/how-are-three-major-finan-
cial-statements-related-eachother.asp#:~:text=Also%20referred%20to%20as%20the,in-
volved%20in%20its%20operating%20activities.
2.
https://www.schwab.com/resource-center/insights/content/3-financial-state-
ments-to-measure-companys-strength
3. https://online.hbs.edu/blog/post/how-managers-use-financial-statements
Image Credits
• Fig. 1
http://accountingcorner.org/multiple-step-income-statement-example-tem-
plate-and-single-step-income-statement-sample-format/
• Fig. 2
http://www.svtuition.org/2015/10/statement-of-retained-earnings.html
• Fig. 3
https://slideplayer.com/slide/8687215/
Video Links
Topic Link
The KEY to Understanding Financial
https://www.youtube.com/watch?v=_
Statements F6a0ddbjtI
How To Read & Analyze the Balance
https://www.youtube.com/watch?v=DM-
Sheet Like a CFO v9JC_K37Y
Understanding a P&L https://www.youtube.com/watch?v=02h-
kI7RcFeM
How to Read a Balance Sheet https://www.youtube.com/watch?v=NU-
w4d3Z7cc8
The INCOME STATEMENT for BEGIN- https://www.youtube.com/
NERS watch?v=0--AvwZabIQ
• Income statement
• Retained earnings
• Trial balance
MODULE 2
UNIT 2
RATIO ANALYSIS
Aim -------------------------------------------------------------------------------------------------------- 89
Instructional Objectives ------------------------------------------------------------------------------ 89
Learning Outcomes ----------------------------------------------------------------------------------- 89
Instructional Objectives
This unit intends to help students to:
• Describe several types of ratios
• Analyse the Interpretation of Ratios
Learning Outcomes
At the end of the unit, students are expected to:
• Illustrate the ratios on financial data
• Demonstrate and interpret the ratio in meaningful way
A ratio is a mathematical expression that describes the relationship between two variables. It can
be stated as a percentage, a ratio, or a rate. It is a useful financial analysis tool. Ratio analysis is
a quantitative method for analysing a company’s strengths and flaws. It aids investors in making
critical investment decisions by identifying the firm’s financial performance.
Ratio analysis attempts to explain the link between various components in the profit and loss
account and balance sheet by analysing their significance. This type of study aids investors in
drawing conclusions and forecasting the company’s future success.
A ratio analysis can be performed on a single company using data from the previous year or the
previous five years. It can also be done for certain years or for intra-firm analysis for organisations
in similar industries. This type of study gives information to both the company and potential
investors.
(a) Quantitative
(b) Metric
(c) Measurement
(d) Qualitative
5. Ratio Analysis can be used for comparing the performance between two firms.
(a) Yes
(b) No
There are the four types of ratios that can be found as here:
Liquidity ratios are used to measure short-term solvency of a business Liquidity ratios are a
measure of how liquid something is. These figures represent the company’s liquidity. It determines
whether or not the company will be able to repay its present creditors with current assets within
a year. If a company can pay off its debts, it is described as solvent; if it is unable to do so, it is
described as insolvent.
The Quick ratio is the ratio of current assets which are of highly liquid to current liabilities.
Quick Ratio = Quick assets/Quick Liabilities
In most circumstances, a quick ratio of 1:1 is considered sufficient.
Quick assets are current assets that do not include prepaid expenses or inventories.
Quick liabilities are current liabilities minus bank overdrafts and money received in
advance.
These ratios demonstrate a business’s long-term solvency and ability to satisfy its long-term
obligations which implies Principal payments at maturity or in fixed instalments on predetermined
due date’s periodic interest payment during the loan’s term.
Debt equity ratio, proprietary ratio, debt to total capital ratio, interest coverage ratio, and debt
service coverage ratio are the various ratios of leverage ratios.
The proportion of debt and equity used to fund a company’s assets is depicted in this graph. To
arrive at this ratio, long-term debt is split by shareholder money.
Financial organisations prefer a 2:1 ratio in general. However, this criterion should be applied in
light of the firm’s size, type, and character, as well as the level of risk involved.
Shareholder’s Funds = Equity share capital + Preference share capital + Reserves and
surplus - (Preliminary expenses +Past accumulated losses+ Discount on
issue of shares).
Proprietary ratio
This ratio reflects both the company’s overall financial strength and its long-term solvency. The
proprietor’s funds are divided by total funds to arrive at this percentage. The proprietor’s funds
are equal to the proprietor’s ratio; total assets/funds.
Outside liabilities are compared to the firm’s entire capitalisation in this ratio. It displays how
much of the firm’s permanent capital is made up of long-term debt.
Long-term debt to total capital ratio = Total capital = Long-term debt + Shareholder funds
This ratio evaluates a company’s debt servicing capacity in terms of long-term loans with set
interest rates. It shows how many times EBIT will cover interest charges before they’re paid.
Interest coverage ratio (EBIT/Interest coverage ratio) = Interest Coverage Ratio (EBIT/
Interest Coverage Ratio)
A ratio of 6–7 times is deemed satisfactory. The better the company’s ability to pay interest out
of profits, the higher the ratio. A high ratio, on the other hand, may suggest a lower use of debt
and/or highly efficient operations.
This approach of calculating a company’s debt payment capacity is more comprehensive. It shows
how much total operational funds after tax payments satisfy overall debt service obligations,
which comprise interest and principal repayment in instalments.
Debt service coverage ratio = (EAT+ Interest + Depreciation + Other non-cash exp) /
(Interest + Principal instalment)
(a) 5:1
(b) 2:1
(c) 0.98:1
(d) 1:1
(a) 5:1
(b) 2:1
(c) 0.98:1
(d) 1:1
(a) 5:1
(b) 2:1
(c) 0.98:1
(d) 1:1
9. __________ratio shows how many times EBIT will cover interest charges before
they’re paid.
These ratios assess a company’s operational efficiency and its capacity to provide
acceptable returns to its owners.
Profitability ratios can be used to assess a company’s profitability.
Profitability ratios can also be calculated I in terms of sales and (ii) in terms of investments.
Net profit margin (NPM), Gross profit margin (GPM) and Expenses-to-income ratio
Earnings per share (EPS) Dividend per share (DPS) Dividend pay-out ratio (D/P) Price earnings
ratio (P/E) Return on assets (ROA) Return on capital employed (ROCE) Return on shareholder’s
equity (ROE) Earnings per share (EPS) Dividend pay-out ratio (D/P) Price earnings ratio (P/E).
Divide gross profit by sales to get the gross profit to sales ratio. It is expressed as a percentage.
Gross profit is determined by the relationship between prices, sales volume, and costs.
A business should have a reasonable gross profit margin to cover its operating costs and provide
a reasonable return to its shareholders, or the company’s owners.
The ratio should be compared to the firm’s past ratios, as well as the ratios of similar companies
in the same industry or the industry average, to see if it is satisfactory.
These ratios are calculated by dividing the various expenses by sales. The variants of expenses
ratios are:
(a). Material consumed ratio = Material consumed to Net sales
(b). Manufacturing expenses ratio = Manufacturing expenses to Net sales
(c). Administration expenses ratio = Administration expenses to Net sales
(d). Selling expenses ratio = Selling expenses to Net sales.
(e). Operating ratio = Cost of goods sold plus operating expenses to Net sales
(f). Financial expense ratio = Financial expenses to Net sales
The expense ratios should be compared over time to the industry average as well as to the ratios
of similar businesses. A low expense ratio is advantageous.
A high ratio means that only a tiny percentage of sales is available to cover financial obligations
such as interest, tax, and dividends.
This ratio determines the profitability of a company’s total funds. It’s a metric for determining
the relationship between net income and total assets. The purpose is to see how successfully
management has used the assets as a whole.
Return on Assets = (Net profit after taxes + Interest multiplied) / Total assets
Total assets do not include fictitious assets. The denominator could be average total assets
because total assets at the beginning and end of the year may not be the same.
This ratio measures the relationship between net profit and capital employed. It demonstrates
how well long-term funds held by owners and creditors are used.
Total Shareholder Equity = Preference share capital+ Equity share capital + Reserves,
and surplus - Accumulated losses and fictitious assets
To get a fair depiction of total shareholders’ funds, the denominator might be average total
shareholders’ funds.
On a per share basis, this ratio quantifies the profit accessible to equity stockholders. The net
profit available to equity shareholders is divided by the number of equity shares to arrive at this
ratio.
Earnings per share = (Net profit after tax – Preference dividend) / Number of outstanding
equity shares
On a per-share basis, this ratio depicts the dividend paid to the shareholder. This is a stronger
measure than EPS since it displays the amount of dividend paid to regular shareholders, whereas
EPS only shows how much belongs to ordinary shareholders theoretically.
The link between ordinary shareholders’ earnings and the dividend paid to them is measured by
this ratio.
The price-to-earnings ratio (P/E) is a measure of how much return per rupee is earned by no of
times of investment.
Price earnings ratio = market price per share / Earnings per share
It is expressed in No of times.
12._________Ratio measures the relationship between net profit and capital employed.
13. Divide net profit by total sales to get the net profit to sales ratio.
14. _______determined by the relationship between prices, sales volume, and costs.
Activity ratios
These ratios are referred to as efficiency ratios, asset utilisation ratios, and turnover ratios. The
relationship between a company’s sales and its various assets is depicted by these ratios. The
following are some of the many ratios that can be found in this category:
The inventory/stock turnover ratio, the debtor turnover ratio, and the average collection period,
asset turnover ratio, creditor turnover ratio, average credit period are all ratios to be considered.
The number of times inventory is replaced during the year is represented by this ratio. It calculates
the correlation between the cost of products sold and the amount of inventory on hand. This ratio
can be calculated using one of two methods:
The inventory turnover ratio of a business should be neither too high nor too low. A high ratio
could indicate a low inventory level, putting you at danger of running out of goods and incurring a
significant ‘stock out cost.’ A low ratio, on the other hand, shows that there is too much inventory,
resulting in a high carrying cost.
This ratio is used to assess a company’s debtors’ liquidity. It depicts the link between debtors and
credit sales.
Credit sales / Average debtor turnover ratio Debtors and accounts receivable are two types of
receivables.
The effectiveness of trade credit management is shown by these ratios. A high turnover rate and
short collection duration indicate that the debtor is making timely payments. A low turnover rate
and a long collection period, on the other hand, indicate that the debtor is delaying payments. In
general, a high debtor turnover percentage and a short collection period are favoured.
Depending on the different concepts of assets employed, there are many variants of this ratio.
These ratios measure the efficiency of a firm in managing and utilising its assets.
This ratio represents the speed with which payments are made to suppliers for purchases
made from them. It shows how average creditors and credit purchases are linked.
Creditors turnover ratio= Credit Purchases / Average Creditors & Bills Payables.
Months or days in a year/ Creditor’s turnover ratio = average credit period.
The creditor turnover ratio is a measure of how often a creditor changes hands.
Higher creditor turnover ratios and shorter credit periods indicate that creditors are paid
on time, which improves the firm’s creditworthiness.
17. _________calculates the correlation between the cost of products sold and the
amount of inventory on hand.
18. This ratio represents the speed with which payments are made to suppliers for
purchases made from them.
20. These ratios measure the efficiency of a firm in managing and utilising its assets.
Ratio analysis attempts to explain the link between various components in the profit
and loss account and balance sheet by analysing their significance.
This type of study aids investors in drawing conclusions and forecasting the company’s
future success.
Terminal Questions
1. Write about significance of ratio analysis.
6. What is the difference between Debt equity ratio and shareholders’ funds.
9. Write the meaning and formula of return on equity and its relevance.
12. Bring out difference between creditors’ turnover ratio and average credit period.
Question No Answers
1 B
2 D
3 B
4 B
5 A
6 A
7 D
8 A
9 B
10 B
11 B
12 A
13 C
14 C
15 D
16 B
17 A
18 D
19 C
20 B
Calculate:
3. From the following particulars extracted from the books of Ashok & Co. Ltd., compute
the following ratios and comment:
(a) Current ratio, (b) Acid Test Ratio, (c) Stock-Turnover Ratio, (d) Debtors Turnover
Ratio, (e) Creditors’ Turnover Ratio, and Average Debt Collection period.
1-1-2002 31-12-2002
Particulars
Rs. Rs.
Bills Receivable 30,000 60,000
Bills Payable 60,000 30,000
Sundry Debtors 1,20,000 1,50,000
Sundry Creditors 75,000 1,05,000
Stock-in-trade 96,000 1,44,000
Additional information:
On 31-12-2002, there were assets: Building Rs. 2,00,000, Cash Rs. 1,20,000 and Cash
at Bank Rs. 96,000.
Cash purchases Rs. 1,38,000 and Purchases Returns were Rs. 18,000.
Cash sales Rs. 1,50,000 and Sales returns were Rs. 6,000. Rate of gross profit 25% on
sales and actual gross profit was Rs. 1,50,000.
Particulars Rs.
Sales (25% Cash sales) 80,00,000
Less: Cost of goods sold 56,00,000
Gross Profit 24,00,000
Net profit (Before interest and tax 50%) 9,00,000
Calculate the following ratios:
Proprietary Ratio
Debt-Equity
Glossary
• Liquidity Ratios: A measure of the ability of a company to pay off its short-term
liabilities.
• Leverage Ratios: Any one of several financial measurements that assesses the
ability of a company to meet its financial obligations.
Bibliography
Textbooks
1. Libby, R., Libby, P. A., & Hodge, F. (2020). Financial Accounting. McGraw-Hill
Education.
2. Horngren, C. T., Harrison, W., & Oliver, M. S. (2011). Financial & Managerial Accounting.
Pearson College Div.
e-references
1. https://corporatefinanceinstitute.com/resources/knowledge/finance/ratio-analysis/
2. https://online.hbs.edu/blog/post/financial-performance-measures
3. https://www.investopedia.com/articles/stocks/06/ratios.asp
Video Links
Topic Link
https://www.youtube.com/watch?v=-
Learn Ratio Analysis
zl5YcY37MnY
https://www.youtube.com/
Profitability Ratios Explained
watch?v=ROqkmlVuXKU
https://www.youtube.com/
Financial Ratio Analysis
watch?v=SHAaBeVKak4
Keywords
• Ratio analysis
• Rational methods
• Critical investment
MODULE 3
UNIT 1
ADJUSTMENTS IN
FINANCIAL STATEMENTS
COMPANY ACCOUNTS
Module Description
When the final accounts of a firm are being finalised, necessary adjustment entries need to
be incorporated at the close of the year, in order to prepare correct accounts. Without passing
such adjustment entries, the correct value of the profit and loss for the year cannot be correctly
determined.To obtain a record of the transactions excluded from the record book. To correct the
errors made in the books of account. To record such incomes that have accrued but not have
been received. To provide for depreciation and other provision.
An accounting adjustment is a business transaction that has not yet been included in the
accounting records of a business as of a specific date. Most transactions are eventually recorded
through the recordation of (for example) a supplier invoice, a customer billing, or the receipt of
cash.
Instructional Objectives
In this unit, students will be able to:
• Apply adjustments in preparation of financial statements
• Identify depreciation and its various methods
Learning Outcomes
At the end of the unit, students are expected to:
• Apply adjustments in financial statements using a Trial Balance
• Examine various methods of depreciation vis-a-vis Fixed Asset
Financial statements produced using such a Trial balance will not accurately reflect
the genuine state of the business. The amount of net profit or loss on the income
statement will be incorrect. Similarly, the balance sheet will not accurately reflect
the company’s genuine financial status.
3.1.1 Adjustments
1. Closing stock: Closing stock is the unsold stock of products at the end of the
accounting year. Normally, this item isn’t shown in the Trial balance. It shows
supplementary data outside of the trial balance.
Treatment:
Treatment:
a. Trading Account: Display on the Debit side of the ledger (subtract from the
respective direct expense.)
b. Profit & Loss Account: Display the Debit side of the ledger (subtract from
the respective indirect expense).
c. Assets side of the balance sheet (usually under the head current assets).
4. Outstanding income vs. Accrued income: Expenses like this are also known as
income generated but not yet received. Accrued income refers to revenue that has
already been earned but has not yet been received by the company. Rent that has
not been paid, commission that has not been received, and so on.
Treatment:
a. Profit & Loss Account: Display on the Credit side of the ledger (Add to
respective income).
b. Balance Sheet: Display the Assets side of the balance sheet (usually under
the head current assets).
Treatment:
a. Profit & Loss Account: Display on the Credit side of the ledger (Subtract
from the respective income)
b. Show on the Liability side of the balance sheet (usually under the head current
liabilities)
2. If a business pays only 11 months’ rent during a financial year, what accounting term
is given to the outstanding one month’s rent?
(a) Repayment
(b) Prepayment
(c) Underpayment
(d) Payable
(a) An asset
(b) Expenses
(c) A liability
(d) Revenue
5. A liability account that reports amounts received in advance of providing goods and
services:
It’s a non-cash expense, which means it’s not paid in cash or currency equivalents. The cost of a
fixed asset is allocated over its anticipated useful life through depreciation. Because fixed assets
are used to generate revenue, a reduction in their value is considered an expense incurred in
order to generate that revenue.
Treatment:
Profit & Loss Account: Display on the debit side of the ledger (calculate as per
percent & method given).
Asset side of the balance sheet: (subtract depreciation from the fixed asset).
Bad debts
Not all of a company’s creditors will be able to pay 100 percent of their bills all of the time. This
can result in a loss for the receiving company, which is referred to as bad debt.
Treatment:
Situation 1: When bad debts are included in the trial balance, they are only reported
in the P&L.
Situation 2: When bad debts are presented as an adjustment outside the trial balance,
they are referred to as further bad debts, and final accounts adjustments are recorded.
Profit & Loss Account: Display on the debit side of the ledger (add to bad debts
already written off)
Asset side of the balance sheet: (subtract from sundry debtors)
Prudence and conservatism, an accounting principle, warns that each company should be
prepared to bear all expected losses. As a result, all firms set aside money in the form of provision
for dubious debts to cover the possibility of bad debts originating from non-payment by debtors.
Debtors are given a monetary discount as an incentive for making timely payments. Because the
payment may be received in the following accounting year in some situations, such discounts
should be treated as a cost in the current year under the accrual approach of accounting. A
provision for discount on debtors is generated when such a provision is made.
Treatment:
Profit & Loss Account: Show on the debit side (compute on good debtors, i.e.,
after adjusting bad debts & provision for doubtful debts).
Balance Sheet: Show on the asset side (calculate on good debtors, i.e., after
adjusting bad debts & provision for doubtful debts) (subtract from sundry debtors).
Capital refers to the amount of money invested in a business by the owner. It is usual for a
company to pay some type of (pre-determined) interest on its capital. Interest paid is recognised
as an expense and is deducted before calculating a company’s net profit or loss.
Treatment:
Show the Debit side of the profit and loss account.
Show on the Liabilities side of the balance sheet (add to the owner’s capital).
A business owner may opt to withdraw cash or items from their own company; this is a regular
practice. It’s known as drawings, and it lowers a company’s total purchases.
Treatment:
Debit Side Trading Account (Subtract from purchases).
Balance Sheet: Show on the Liabilities side (subtract from owner’s capital).
Profit & Loss Account: No effect.
(a) Liabilities
(b) Assets
(c) Income
(d) Expense
(a) Liabilities
(b) Assets
(c) Income
(d) Expense
(a) Liabilities
(b) Assets
(c) Income
(d) Expense
(a) Liabilities
(b) Assets
(c) Income
(d) Expense
(a) Liabilities
(b) Assets
(c) Income
(d) Expense
Buildings, furniture, office equipment, machinery, and other fixed assets are
examples. Because the value of land increases with time, it is the sole exception
that cannot be depreciated. Depreciation permits a portion of the cost of a fixed
asset to be applied to the revenue provided by the fixed asset. Revenues are
recorded with their corresponding expenses in the accounting period when the
asset is in use, hence this is required by the matching principle. This makes it
easier to acquire a full view of the revenue generation transaction.
Depreciation Example: If a firm buys a delivery truck for Rs.100,000 and expects
to use it for 5 years, the company may depreciate the asset at a rate of Rs.
20,000 per year for 5 years.
Depreciation causes
1. Wear and tear: As a result of normal use, some assets deteriorate physically.
When an asset is used for production on a regular basis, it wears out. The more
an asset is used, the more wear and tear it will suffer. Movement, pressure,
friction, erosion, and other factors contribute to the physical deterioration of an
asset. Buildings, machinery, furniture, automobiles, and plants, for example.
Wear and tear are a common yet important cause of depreciation.
2. Time lapse: Certain assets, such as leasehold property, patents, and copyright,
are purchased for a specific period of time. They are rendered useless after the
period has expired, i.e., their value has vanished. As a result, their expenses are
written off over the course of their legal careers.
3. Obsolescence: When new and improved machines are introduced, old machines
are phased out. As a result, new inventions, changes in fashion and taste, market
conditions, government legislation, and other factors might cause an asset’s value
to be discarded. However, this is neither the cause nor the effect of depreciation
in the true sense.
A new machine performs the same work faster and is more affordable than the
old one. As a result, existing machines may become obsolete or out of date.
4. Exhaustion: Some assets are inherently wasteful. For example, quarries, mines,
and oil wells. It’s the diminishing worth of natural deposits as resources are
removed year after year. As a result, these assets are referred to as “wasting
assets.” The removal of its contents physically exhausts the coalmine or oil well.
7. Market trend: In the case of some assets, such as gilt-edged securities, the
market price may change. When prices fall, the value of the asset in question
may decrease. Accidents can depreciate the value of assets in some instances.
2. To expose the true financial situation: Fixed assets are charged depreciation,
which helps to indicate the asset’s current value. As a result, it aids in displaying
the genuine financial situation (assets and liabilities) of the company.
4. Calculating true profit: Depreciation (the decrease in the book value of fixed
assets) is charged to revenue in the same way that other operating expenses
are. As a result, it aids in determining the firm’s genuine profit.
5. Calculate the cost of production: In order to ascertain the true or actual cost
of production, depreciation should be applied to fixed assets such as machinery
and plants.
(a) An asset’s whole cost of purchase and installation can be discounted less its
salvage value.
(b) The value of the components of a physical asset when the item itself is no
longer usable
(c) Indicates how much a firm is worth on the stock market
(d) An asset’s expected resale value at the end of its useful life
(a) An asset’s whole cost of purchase and installation can be discounted less its
salvage value
(b) The value of the components of a physical asset when the item itself is no
longer usable
(c) Indicates how much a firm is worth on the stock market
(d) An asset’s expected resale value at the end of its useful life
For Example,
Mine = Rs 20,000/-, mineral in mine = 40,000 tonnes
Rate of depreciation per tonne = 20,000/40,000 =0.50 Per tonne
If output in a year =1,000 tonnes = 1,000*0.50 =5,000 as Depreciation
For Example,
The rate of Depreciation = 10%, Machinery =200000/-
Depreciation for I year = 20000/-, II year = 180000*10/100=18000/-
III yr =162000*10/100 =16200 and so on.
Depreciation = (Remaining life of asset /Sum of all digits of life of the assets)
* original cost
For Example,
Cost of Machine -10000/-, Life=5 years
Dep I yr = (5/1+2+3+4+5) *10000 = 3333/-
II yr = (4/1+2+3+4+5) *10000=2,666/-
III yr = (3/1+2+3+4+5) *10000 = 1,333/-
3. Other methods
Those assets which are of small values such as loose tools or where the life
of the asset cannot be ascertained.
Cost of asset at Beginning ****
+ Cost of Asset purchased ***
Cost of asset at the end ***
Dep= ***
c. Annuity method
16. The systematic reduction of the recorded cost of a fixed asset until the asset’s value
reaches zero or inconsequential.
(a) Depreciation
(b) Amortisation
(c) Intangible
(d) Tangible
18. Depreciation is charged for the group total not item by item.
20. _______is used provide for replacement of asset at the end of its useful life.
In the same way, part or all the expenses listed in the Trial balance may be for the
following year. Financial statements produced using such a Trial balance will not
accurately reflect the genuine state of the business.
The amount of net profit or loss on the income statement will be incorrect. Similarly,
the balance sheet will not accurately reflect the company’s genuine financial status.
Terminal Questions
1. Explain adjustment treatment for provision for bad and doubtful debts.
2. Write about objectives of Depreciation.
3. Explain various depreciation methods.
4. Explain adjustment treatment for
a. Closing stock
b. Prepaid expense
c. Income received in advance
d. Outstanding expense
5. Explain the adjustment treatment for bad debts.
Question No Answers
1 C
2 C
3 A
4 C
5 A
6 B
7 C
8 A
9 D
10 A
11 B
12 D
13 D
14 D
15 D
16 A
17 A
18 C
19 D
20 B
Adjustments:
i. Closing Stock Rs 3,250/-
ii. Depreciate Buildings by 5%, Furniture 10%, Motor by 20%
iii. 85/- is due for interest on Bank OD
iv. Salaries Rs 300/- and taxes Rs 120/- are Outstanding
v. Prepaid Insurance Rs 100/-
vi. Write off further Bad debts Rs 100/-
vii. Provision for Bad and doubtful debts is to be made equal to 5% on debtors
viii. 1/3rd of the commission is received in advance.
2. From the following Trial balance and additional information, Prepare a trading and
profit and Loss account and balance sheet.
Particulars Debit Credit
Capital 20,000
Sundry Debtors 5,400
Drawings 1,800
Machinery 7,000
Sundry Creditors 2,800
Wages 10,000
Purchases 19,000
Opening stock 4,000
Bank 3,000
Carriage inwards 300
Salaries 400
Sales 29,000
Rent and taxes 900
Total 51,800 51,800
3. From the following details, prepare trading and profit and loss account for the year
ended 31.3.2014 and balance sheet as on that date.
Particulars Debit Credit
Drawings 14,000
Capital 85,000
Machinery 19,200
Stock 29,200
Purchases & Sales 2,07,240 2,38,120
Returns 4,200 5,820
Sundry Expenses 15,200
Apprentice Premium 2,400
Bank OD 4,000
Bad debts 3,440
Debtors & Creditors 64,000 20,000
Bills Receivable 4,800
Bills Payable 3,600
Provision for Bad and doubtful debts 3,300
Cash 960
Total 3,62,240 3,62,240
Adjustments:
i. Closing stock Rs 40,000/-
ii. Maintain provision for doubtful debts at 2% on debtors.
iii. Depreciate Machinery at 20%.
Particulars Rs
Capital 10,000
Drawings 2,000
Purchases 20,800
Opening stock 6,900
Sales 27,500
Creditors 8,100
Rent 1,000
Discount received 270
Furniture 900
Machinery 5,000
Travelling Expenses 650
Bad debts 120
Debtors 7,500
Returns inwards 300
Returns Outwards 580
Carriage inwards 400
Wages 325
Salaries 900
Interest 480
Carriage Outwards 705
Insurance 900
Bank loan 3,000
Cash in hand 700
Outstanding Expenses 130
Adjustments:
i. Closing stock was valued at Rs 8,900/-
ii. Insurance Prepaid Rs 250/-
iii. Outstanding Salaries Rs 100/-
iv. Outstanding Rent Rs 200/-
v. Interest on Bank loan Rs 150/-
vi. Depreciation Machinery and Furniture at 10%
vii. Provide for doubtful debts at 5% on debtors.
Adjustments:
i. Closing Stock was valued at Rs 25,000/-
ii. Depreciate Buildings by 10% and furniture by 5%
iii. Provide a reserve for Bad debts @5%
iv. Outstanding bank OD Rs 2,000/-
Glossary
• Repayment: The period from the starting point of credit to the final maturity of a
transaction.
• Trial Balance: A financial report showing the closing balances of all accounts in the
general ledger at a point in time.
Textbooks
1. Libby, R., Libby, P. A., & Hodge, F. (2020). Financial Accounting. McGraw-Hill
Education.
2. Horngren, C. T., Harrison, W., & Oliver, M. S. (2011). Financial & Managerial
Accounting. Pearson College Div.
e-References
1. https://nios.ac.in/media/documents/Seccour224New/ch_15.pdf
2. https://www.accountingcapital.com/india/adjustments-in-final-accounts/
3. https://www.accaglobal.com/in/en/student/exam-support-resources/fundamentals-ex-
ams-study-resources/f3/technical-articles/adjustments-financial-statements.html
Video Links
Topic Link
https://www.youtube.com/
Final Accounts
watch?v=z1dNEz0zO4U
https://www.youtube.com/
Depreciation Methods
watch?v=isqop9h22XY
• Outstanding expenses
• Prepayment
• Underpayment
• Payable
MODULE 3
UNIT 2
ISSUE OF SHARES
Instructional Objectives
In this unit, students will be able to:
• Elaborate upon the concept of share and its types
• Describe the procedure for the issue of shares
• Explain entries and posting of accounts for issue of shares
Learning Outcomes
At the end of the unit, students are expected to:
• Conceptualise shares and its types
• Examine the procedure for the issue of shares in a business
• Summarise the entries and posting of accounts for issue of shares
It is evident from the first unit that an individual can run a business in a variety of ways, such as
a sole trader, a partnership, or a joint stock company. There is a distinction between ownership
and management in the company form of business that does not exist in the sole trading concern
or partnership form of business. Owners in a company type of business are shareholders who
supply capital to the company by subscribing to the company’s shares. Because all of these
shareholders are spread out across the country, they must appoint a Board of Directors to oversee
the company’s activities. To be clear, the company capital is provided by shareholders and
managed by the Board of Directors, which is referred to as the Principle and Agent relationship.
A share is a unit of ownership in the company’s capital. Any individual or institution who purchases
stock in the company becomes a shareholder. He has the right to receive notices and agendas,
as well as voting rights at annual general meetings. A vote is equal to one share. Both public
and private companies can issue shares. Public firms can issue shares to the general public, but
private corporations can only obtain funds from their own friends, relatives, or directors.
Types of shares:
1. Equity shares
2. Preference Shares
Issue of Shares
The term “issue of shares” refers to the distribution of an enterprise’s or any financial asset’s
shares among shareholders who choose to purchase them. Individuals or corporations can be
shareholders if they participate in the purchase of shares at a set price. Let’s look at an example
to better understand the notion of share allocation. XYZ is a firm with a total capital of Rs. 6
lakhs. The capital has been divided into 6000 units of shares, each worth Rs. 100. As a result,
The process of issuing shares is separated into three major parts, which are as follows:
each unit or share of the corporation is valued at Rs. 100. At this price, individuals or businesses
can purchase the stock. As a result, owning a share in a company is frequently seen as partial
ownership. Anyone who owns a share is referred to as a shareholder for the same reason.
The process of issuing shares is separated into three major parts, which are as follows:
Issue of Prospectus
Application of shares
calls in advance
1. The prospectus: This is the first phase in the Issue of Shares process, in which an
organisation distributes a prospectus to the general public. It informs the public that
a new business has been established and that it will require public funding to run, for
which the public can purchase shares in the business.
The prospectus contains all of the relevant information about the share issuing
authority, as well as information about how they will collect money from investors.
They must also put the money down against the shares they want to buy. Along with
the application, the money must be deposited at any designated bank.
3. Allocation of resources: This is the final phase in the issue of shares, in which the
firm issues the shares to the investors after the investor’s formalities are completed.
Because there is a minimum subscription limit, one must wait till it is met.
The shares will be allotted to those investors who have subscribed for the capital
shares after that limit has been reached. Those who have been assigned shares
receive a letter of allotment as well.
The primary motive for the corporation issuing new shares is to raise funds to finance
the business. The following are some scenarios in which a share allotment might be
considered:
When a corporation is formed, a number of shares are normally issued. The company
will be able to trade with the help of a share offering, as well as any money it may
borrow.
Shares might be issued in order to repay all or part of the company’s debt.
Shares can be issued to fund the acquisition of another firm, which entails obtaining
money through a share offering and then using that money to buy the new company.
Shares can also be issued to keep a company trading after a particularly tough period,
to restore a damaged balance sheet, or in the event of widespread issues in an industry
or as part of a larger economic slump.
The company may acquire shares if a director or employee of the company exercises
a share option after being granted permission by the company.
(a) Private
(b) Public
(c) Government
(d) None
(a) Fixed
(b) Variable
(c) Profit
(d) None
(a) 3
(b) 2
(c) 1
(d) None
FOR CONSIDERATION
OTHER THAN CASH
A corporation can issue shares at face value or at a price that is different from the face value.
Shares issued at par are those that are issued at the same price as their face value. Shares
issued at a premium are those whose issue price is higher than their face value. Shares issued
at a discount are those whose issue price is less than their face value. A share’s issue price is
usually collected in stages: with the application, on allotment, and afterwards by making one or
two calls. Only when all of the money payable on the shares is received does it become fully paid
up.
2. On allotment of shares:
(a) 80%
(b) 10%
(c) 90%
(d) None of these
7. Which of the following groups not included a company could issues shares for
consideration other than cash?
(a) Owners
(b) Creditors
(c) Suppliers
(d) Customers
(a) 15%
(b) 10%
(c) 25%
(d) 30%
10. The net gain made by the company on the reissue of shares will be credited to:
The sale of shares at a price higher than the share’s face value is referred to as a “premium issue.”
The premium, in other words, is the amount paid for a share over and beyond its face value.
Companies that are financially sound, well-managed, and have a positive market reputation
typically issue stock at a premium. For example, if a firm issues a ten-dollar share at eleven
dollars, it is releasing it at a 10% premium. Applicants or shareholders may be required to pay the
premium at any time, including during the application process, allotment, and calls. A company,
on the other hand, normally calls the amount of Premium at the time of allotment.
11. When a corporation issue shares at a premium, the company may get the following
amount of premium:
13. Where does the securities premium appear on the Balance Sheet?
15. Which side of the balance sheet does the premium on share issuance appear on?
(a) Assets
(b) Liabilities
(c) Both (a) Assets (b) Liabilities
(d) None of these are true
Shares issued at a discount are priced less than the face value. It is lawful for a company to issue
shares at a discount if several conditions are met.
On receipt of applications:
On allotment of shares:
If shares are issued at a discount to the promoters in consideration of their services, the
entries should look like the following:
(a) Calls-in-advance
(b) Calls-in-arrear
(c) Share Capital
(d) Suspense Account
17. The difference between subscribed capital and called up capital is called _______.
(a) Calls-in-arear
(b) Calls-in-advance
(c) Uncalled capital
(d) None of these
(a) Prospectus
(b) Articles of association
(c) Memorandum of association
(d) All of these
1. Sahni Ltd. issues a total of 10,000 equity shares worth $100 each at a 25% premium. At
the time of allotment, the premium is due. The following is the sum due:
On the 1st and 3rd of March 2018, Rs 30 will be charged on the first and last call.
Journal Entries in the books of Sahni Ltd.
Date Amount
Description
2018 Dr. Cr.
1 Jan Bank A/c 2,00,000
To Share Application A/c 2,00,000
(Being application money received on 10000
shares @20 per share)
1 Feb Share Application A/c 2,00,000
To Share Capital A/c 2,00,000
(Being share application money transferred to
share capital)
1 Feb Share Allotment A/c 7,50,000
To Share Capital A/c 5,00,000
To Securities Premium A/c 2,50,000
(Being share allotment due on 10000 shares
@50 per share)
1 Feb Bank A/c 7,50,000
To Share Allotment A/c 7,50,000
(Being share allotment money received)
1 Mar Share First and Final Call A/c 3,00,000
To Share Capital A/c 3,00,000
(Being money on share call due on 10000
shares @30 per share)
1 Mar Bank A/c 3,00,000
To Share First and Final Call A/c 3,00,000
(Being share call amount received)
Date Amount
Description
2018 Dr. Cr.
25 March Bank A/c 22,500
Discount on shares 2,500
Share capital 25,000
(Issued 500 shares to directors at a discount)
01 April Bank 90,000
Share application 90,000
(Received applications for 2,000 shares)
10 April Shares application 90,000
Discount on shares 10,000
Share capital 1,00,000
(Allotted 2,000 shares to public)
Equity share is one who is the real owner of the company received no fixed rate of
dividend but participates in the decision-making process through vote and determines
the future of the company.
Preference shareholders receive fixed rate of dividend and were paid fixed rate of
dividend, but don does not have a right to participate in AGM and vote.
Shares are issued to public-by-public companies who in turn subscribe to the shares.
It is a three-step process of issuing prospectus, share application and share allotment.
Terminal Questions
1. Explain various types of shares.
Question No Answers
1 B
2 A
3 A
4 A
5 B
6 C
7 A
8 A
9 C
10 B
11 A
12 A
13 B
14 A
15 B
16 B
17 C
18 A
19 D
20 D
2. On March 1st, X Ltd. issues 20,000 equity shares of Rs.10 each at a price of Rs.11,
payable as follows: Rs. 2 for the application, Rs. 3 for the allotment, and Rs. 6 for the
First and Last Call. All of the shares have been purchased. transfer the necessary
journal entries.
Glossary
Bibliography
Textbooks
1. Libby, R., Libby, P. A., & Hodge, F. (2020). Financial Accounting. McGraw-Hill
Education.
2. Horngren, C. T., Harrison, W., & Oliver, M. S. (2011). Financial & Managerial
Accounting. Pearson College Div.
e-references
1. https://www.edudel.nic.in//upload_2015_16/accunts_12_eng_2015.pdf
2. https://blog.ipleaders.in/allotment-shares-appropriation-share-inappropriate-share-com-
pany/
3. https://www.toppr.com/guides/principles-and-practices-of-accounting/issue-forfeiture-re-
issue-of-shares/issue-of-shares-at-premium/
• Fig. 2
https://www.toppr.com/guides/accounting-and-auditing/introduction-to-company-ac-
counts/basic-concepts-of-company-accounts/
Video Links
Topic Link
https://www.youtube.com/
Issue of Shares
watch?v=GtUKPCMA0xY
Keywords
• Posting of entries
• Equity shares
• Preference shares
MODULE 3
UNIT 3
COMPANY FINAL
ACCOUNTS
3.3.1 Format and Components of P&L and Balance Sheet ----------------------------- 161
Self-Assessment Questions -------------------------------------------------------------- 168
3.3.2 Format and Components of Banking Accounts ------------------------------------- 169
Self-Assessment Questions -------------------------------------------------------------- 171
3.3.3 Format and Components of Insurance Accounts ----------------------------------- 172
Self-Assessment Questions -------------------------------------------------------------- 177
3.3.4 Final Accounts of Electricity Companies ---------------------------------------------- 178
Self-Assessment Questions ------------------------------------------------------------- 182
Instructional Objectives
This unit will help students to:
• Elaborate the financial statements of companies
• Describe the components of banking, insurance, and electricity company’s
financial statements
• Differentiate between the components of banking, insurance, and electricity
company’s financial statements
Learning Outcomes
At the end of the unit, students are expected to:
• Examine the components of financial statements for various types of companies
• Analyse the components using ratios for various types of companies
The primary goal of any business activity is to make a profit. In the course of normal business
operations, there will be a greater number of transactions. All these operations are recorded in
books of accounts on a daily basis so that the company may disclose the amount of profit loss
derived at the end of the fiscal year.
There is no conventional format for preserving final accounts in the event of a sole trading
business, except reflecting the profit or loss at the conclusion of the financial year. Organisations
registered as companies under Schedule III of the Companies Act of 2013 must follow the format
and guidelines set forth in the act in maintaining their accounts and preparing their profit and loss
statements and balance sheets.
The Companies Act of 2013 establishes prescribed guidelines for the preparation of financial
statements in Section 129. Balance sheet, profit and loss account/income statement, cash flow
statement, statement of changes in equity, and any accompanying explanatory note are all
included in Section 2(40).
The following is a profit and loss statement prepared in accordance with the Companies Act of
2013.
Statement
Balance Cash Flow
of Profit and
Sheet Statement
Loss
Statement Notes to
of Changes Financial
in Equity Statement
The figures in the Financial Statements may be rounded off depending on the company’s turnover,
as seen below:
The balance sheet is a statement which reports the financial position or situation at the end of a
financial period, such as March 31 at midnight.
Balance Sheet
For the period Ended ______________
Assets Liabilities
Current Assets Current Liabilities
Cash xxx Accounts payable xxx
Short-Term Investments xxx Salaries Payable xxx
Accounts Receivables xxx Accrued Interest xxx
Inventories xxx Taxes Payable xxx
Prepaid Insurance xxx Current Portion of Notes xxx xxx
Others xxx xxx
Other Assets
Receivables from xxx
Employees
1. Calls in arrears: This refers to the amount that shareholders have not paid on the
company’s calls. In most cases, this item is included in the trial balance. To calculate
paid up capital, subtract call in arrears from the called-up capital in balance sheet. If the
trial balance reflects only the paid-up capital and the adjustment only shows the calls
in arrears, the amount is to be first added to the paid-up capital to reflect the called-up
capital, then deducted to show the paid-up capital in the outer column.
2. Unclaimed dividend: This is the amount of dividend that has not been collected by the
company’s shareholders. This item is always shown on the trial balance’s credit side. It’s
listed under the heading - current liabilities in the balance sheet.
3. Forfeited shares account: This item is shown on the credit side in the trial balance and
is added to the paid-up capital on the liabilities side of the balance sheet.
4. Securities premium account: This is displayed under Reserves and surplus on the
liabilities side of the balance sheet.
The profit and loss account details an organisation’s income and costs that result in a net profit
or loss. It assists in evaluating an organisation’s performance and providing a foundation for
anticipating future success. It also gives important information that the banker while approving
a loan. The profit and loss account are used to describe various business activities such as
revenues and expenses and is especially useful in determining the risk of not meeting a certain
level of income in the future.
Accounts are listed from top to bottom in the assets segment in order of liquidity. They are divided
into two types: current assets, which can be converted to cash in less than a year, and non-
current or long-term assets, which are held for a longer period of time.
Assets Classification
Assets
Diferred Tax
Assets (Net) Trade Recievables
Capital WIP
LT Loans and Cash and Cash
Advances Equivalents
Intangible Assets
Other Non Under Development ST Loans and
Current Assets Advances
Other Current
Assets
Fig. 4: Assets classification
Securities that will not or cannot be liquidated in the following year are classified as long-term
investments.
Land, machinery, equipment, buildings, and other long-term, capital-intensive assets are
examples of fixed assets.
Non-physical (but nonetheless valuable) assets such as intellectual property and goodwill are
examples of intangible assets. Intangible assets are often only recorded on the balance sheet if they
are purchased rather than produced in-house. Their worth could thus be grossly underestimated
– for example, by omitting a globally recognisable brand – or grossly exaggerated.
Liabilities
Taxes that have accrued but will not be paid for another year are referred to as deferred tax
liabilities.
(In addition to time, this figure reconciles discrepancies in financial reporting standards and tax
assessment methods, such as depreciation computations.)
Equity and
Liablities
Some liabilities are deemed off-balance sheet, which means they won’t show up on the balance
sheet.
The net earnings that a firm either reinvests in the business or uses to pay off debt are known as
retained earnings, and the rest is given to shareholders in the form of dividends.
Treasury stock is a stock that has been repurchased or never issued in the first place by a firm.
It can be sold later to raise cash or kept in reserve to fend off a hostile takeover. Preferred stock
is issued by some firms and is listed separately from common stock under shareholders’ equity.
Preferred stock, like common stock in some situations, is given an arbitrary par value that has no
influence on the market value of the shares. The par value is multiplied by the number of shares
issued to determine the “common stock” and “preferred stock” accounts.
The amount invested in excess of the “common stock” or “preferred stock” accounts, which
are based on par value rather than market price, is referred to as additional paid-in capital or
capital surplus. Shareholders’ equity is unrelated to a company’s market capitalisation, which is
based on the stock’s current price, whereas paid-in capital represents the total amount of equity
purchased at any price.
(a) Car
(b) Debtors
(c) Stock
(d) Prepaid expenses
5. The premium paid on the issuance of shares cannot be used for ______.
A banking firm must create its profit and loss account in accordance with Form B under
the Banking Regulation Act of 1949’s Third Schedule. The following is Form B:
Form ‘B’
Form of Profit & Loss Account
for the year ended 31st March
Fig. 8: Form B; Form of profit & loss account for the year ended 31st March
Following is the balance sheet of a Banking company given under section 29 of the
Banking regulation Act.
The formats are given below as specified in Banking Regulation Act in Form A of
Balance Sheet, Form B of Profit and Loss Account and eighteen other schedules of
which the last two relates to Notes and Accounting Policies.
(a) Accrual
(b) Cash
(c) Credit
(d) None
8. Substandard assets are certain loan assets of a bank which are classified as______
assets for a period not exceeding two years.
(a) Non-performing
(b) Performing
(c) Current
(d) Fluctuating
(a) Private
(b) Public
(c) Banking
(d) Capital marketing
10. Every banking company should prepare a balance sheet and profit and loss accounts
as on______ each year.
The provisions of the Insurance Act of 1938, as well as its required forms, must be followed while
preparing final accounts. Although Life Insurance is administered by the LIC (Life Insurance
Corporation) Act of 1956, the Insurance Act of 1938 applies to both General and Life Insurance.
The accounts are prepared for the calendar year, which means that an insurance company’s
accounts must be made up to the 31st of December each year.
These are the forms of final accounts required by the Insurance Act of 1938:
(i) FORM A: For both life and general insurance, this is the form of the balance sheet.
(ii) FORM B: Profit and Loss Account (for both Life and General Insurance).
A life insurance company’s final accounts include (a) Revenue Account, (b) P&L Account,
and (c) Balance Sheet.
(iii) FORM C: Profit and Loss Appropriation Form—for both Life and General Insurance.
(iv) FORM D: Revenue Account Form—only for Life Insurance.
(v) FORM F: Revenue Account Form—only for General Insurance.
(vi) FORM I: Balance Sheet of Valuation.
a. Revenue account
Form ‘D’ of the First Schedule to the Insurance Act of 1938 must be used to produce this
account. It just shows the balance of the Life Insurance Fund at the end of the year, not the
profit or loss for the year. The opening balance of Life Insurance Fund (Cr.) is combined
with all revenue incomes/receipts on the credit side, while all revenue expenditures show
on the debit side. The balance is carried forward as Life Insurance Fund.
c. Balance sheet
(a) Liabilities
(b) Assets
(c) None
(d) Both
12. Premium which has become due but not yet received by the insurance company.
(a) Liabilities
(b) Assets
(c) None
(d) Both
(a) Claims
(b) Premiums
(c) Surrender
(d) Matured policies
Revenue account
It’s the same as a trade company’s profit and loss appropriation account. In the balance
sheet, the balance of the net revenue account is indicated. Below is the statutory form
of a net revenue account.
The goal of this account is to track the total amount of cash raised and how it was used
to buy fixed assets for the company. Each side has three columns, as required by the
Indian Electricity Act of 1910:
In balance sheet all receipts are shown on liabilities side and total expenditure on
Assets side of balance sheet.
Banking companies are required to prepare profit and loss account and balance sheet
for every bank.
Insurance companies have to report revenue accounts, net revenue account, receipt
and expenditures account and balance sheet at the end of fiscal year.
Electricity companies prepare financial statements under the Electricity (Supply) Act,
1948.
Terminal Questions
Question No Answers
1 A
2 C
3 A
4 D
5 D
6 D
7 A
8 A
9 C
10 A
11 A
12 A
13 B
14 A
15 A
16 B
17 A
18 B
19 D
20 A
1. Collect the financial statements of any bank from annual reports of banking company
and analyse its components with the help of ratio analysis.
2. Obtain an insurance company financial statement and its components with the help of
ratio analysis.
3. Take a financial statement of Last 2 years of electricity company and analyse its com
ponents with the help of ratio analysis.
Glossary
Bibliography
Textbooks
1. Libby, R., Libby, P. A., & Hodge, F. (2020). Financial Accounting. McGraw-Hill
Education.
2. Horngren, C. T., Harrison, W., & Oliver, M. S. (2011). Financial & Managerial Accounting.
Pearson College Div.
e-References
1. https://www.irdai.gov.in
2. https://rbidocs.rbi.org.in/rdocs/content/pdfs/83MD01092021_A1.pdf
3. http://kb.icai.org/pdfs/PDFFile5b277ee88fc1b0.09627304.pdf
• Fig. 4: http://kb.icai.org/pdfs/PDFFile5b277ee88fc1b0.09627304.pdf
• Fig. 5: https://www.investopedia.com/
• Fig. 6: http://kb.icai.org/pdfs/PDFFile5b277ee88fc1b0.09627304.pdf
• Fig. 7: https://www.wallstreetmojo.com/shareholders-equity-formula/
• Fig. 8: RBI (Reserve Bank of India)
• Fig. 9: https://commercelecturer.wordpress.com/2020/07/23/form-a-of-balance-
sheet-of-banking-companies/
Topic Link
Keywords
MODULE 4
UNIT 1
MARGINAL COSTING
MANAGEMENT ACCOUNTING
Module Description
Marginal cost is concept from economics which has a significant role in business management
which helps businesses to optimise their production levels. Marginal costing is a valuable
decision-making technique. It helps management to set prices, compare alternative production
methods, set production activity levels, close production lines, and choose which of a range of
potential products to manufacture.
The break-even point is essential for business owners because it represents the minimum level
of sales that must be achieved to generate a profit. If a business owner knows the break-even
point, they can make informed decisions about pricing, production levels, and other factors that
impact the bottom line.
Instructional Objectives
This unit will help students to:
• Elaborate upon the concept of marginal costing
• Differentiate marginal costing from absorption costing
• Examine the application of marginal costing in business.
Learning Outcomes
At the end of the unit, students are expected to:
• Examine marginal costing and its significance
• Analyse how marginal costing plays a key role in business decisions
Marginal cost, also called variable cost, is calculated as per unit cost whereas fixed cost is taken
as lump sum and deducted from the contribution. The change in total cost with a change in
quantity produced is increased by one unit which is known as marginal cost. Marginal cost is the
difference in total cost when the amount produced is raised by one. It is the cost of producing one
more unit of a product. The variable cost per unit remains the same; any change in production
affects the total cost of output. Given a particular level of production, total fixed cost remains
constant and does not fluctuate as production increases or decreases. In terms of total cost, this
means that the fixed cost remains constant.
For example,
3. The contribution of each product or department acts as a foundation for determining the
product’s or department’s profitability.
5. Marginal costing is the basis for valuing finished goods and work-in-progress inventories.
6. Contribution is used to recoup fixed costs, whereas variable costs are charged to
production.
7. Fixed and variable costs are the only costs that are classified. Semi-fixed prices can be
turned into either fixed or variable costs.
3. It helps in determining the selling price, deciding whether to export, and deciding
whether to create or buy.
4. Marginal costing techniques such as break-even analysis and P/V ratio are useful.
6. It gives you control over variable costs by avoiding arbitrary fixed cost allocation.
8. Inventory is valued at marginal cost under marginal costing. As a result, irrational fixed
overheads cannot be carried forward from one accounting period to another.
9. Because fixed costs are difficult to control in the short term, it is easier to focus on
variable costs.
1. If the total cost of 1,000 units is Rs. 60,000 and the total cost of 1,001 units is
Rs. 60,400, the increase in total cost of Rs. 400 is __________.
3. In marginal costing:
5. Which of the following costing approaches distinguishes fixed and variable costs?
(a) Marginal
(b) Standard
(c) Absorption
(d) None of the above
Marginal costing, termed as variable costing, is a costing approach for determining total cost
or determining fixed and variable costs in order to choose the optimal process and product for
manufacturing, among other things. It determines the Marginal Cost of Production and shows
how it affects profit as output units change. The shift in total cost owing to the manufacturing of
an additional unit of output is referred to as marginal cost.
Absorption Costing is a strategy for valuing inventory that involves allocating all manufacturing
expenses to cost centres in order to recognise the whole cost of production. All fixed and variable
costs are included in these manufacturing charges. It is also known as the classic approach of
cost estimation.
(a) Method in which variable costs are considered product costs and fixed costs
are considered period costs
(b) Method in which both fixed and variable costs are considered product costs
(c) The distinction between selling price and variable costs
(d) The distinction between selling price and fixed costs
Marginal costing is a strategy for determining cost that may be used to any costing approach.
Variable expenses are charged to cost units, and the fixed cost corresponding to the relevant
period is written off in full against the contribution for that period, according to this technique. The
gap between sales value and variable cost is known as contribution.
One of the most important factors that affects the market for a product as well
as the amount of profit made by an organisation is the price. Under typical
conditions, a product’s price must cover the product’s total costs plus a profit
margin. However, in some instances, the price must be set even lower than the
entire cost. While there is a general trade depression (or) when identifying new
markets (or) taking further orders, for example, the producer is forced to decrease
the price even lower than the total costs of the product in question. The concept
of marginal cost is usefully employed to suit the prices in these unique conditions.
Some bulk orders may be received from local (or foreign) merchants who are
requesting a lower price than the market pricing. This raises the decision of
whether to accept or not to accept the offer. The order from a local dealer should
not be accepted at a price below the market price because it will have an adverse
effect on the company’s normal market and goodwill. On the other hand, the
order from a foreign dealer should be accepted because it will provide additional
contribution after the fixed costs have been met.
5. Important factor
It’s also referred to as a limiting factor, controlling factor, or scarce factor. A crucial
element is one that limits a company’s production and profit. It may occur as a
result of a scarcity of materials, labour, capital, plant capacity, or sales. In most
cases, when there is no limiting factor, the product with the highest profit volume
ratio will be chosen. When there are limiting constraints, the product will be
chosen based on the main factor’s largest contribution per unit.
Marginal costs are useful for evaluating different production processes, such as
machine work (or) hand work. The strategy that provides the most contribution
should be used while keeping the limiting factor in mind.
The marginal costing technique is used to explain how each product contributes
to fixed expenses and profit. If an organisation, department, or a product
contributes the least, it may be closed (or) the manufacturing of the product may
be suspended. It means that the product that makes the most contribution should
be chosen, while the others are phased out.
May be improved in four ways: (a) by increasing volume; (b) by increasing selling
price; (c) by lowering variable costs; and (d) by lowering fixed costs.
Every executive wants to produce items in the most cost-effective manner possible.
For this, marginal costs is a helpful guide as to the goods at various phases of
Under typical circumstances, the price cannot be less than the overall cost.
Marginal costing functions as a price fixer, and a large margin contributes to the
fixed cost and profit. However, this idea cannot always be followed. The price
should be equal to marginal cost plus an acceptable amount, which is determined
by demand and supply, competition, pricing policy, and other factors.
There is a loss equal to fixed costs if the price is equal to marginal cost. When a
businessman suffers a loss, it can be difficult to recover.
Let’s assume the Punjab government has issued a tender for 20,000 units.
The units taken by the government are not expected to have an impact on
the company’s current sales of 80,000 units, and the company also wants
to submit the lowest feasible quotation. Because it will provide an additional
marginal contribution and thus profit, the corporation may quote any amount
above marginal cost.
11. The fixed costs are Rs 2,00,000 for a production of 100,000 units. The selling price
per unit is Rs 10 and the variable cost is Rs 6. Marginal costing is a technique for
calculating profit.
(a) Rs 2, 00,000
(b) Rs 8, 00,000
(c) Rs 6, 00,000
(d) None of the above
12. In make or buy decision, marginal costs as well as additional fixed costs are the
factors to be considered.
(a) True
(b) False
13. A machine is being used to create a component. At a cost of Rs 10 per unit, 10,000
units are produced (of which Rs 9 are variable). The market price for the same
component is Rs 9.50 per unit. The owner, on the other hand, plans to rent the
machine for Rs 6,000 and then purchase components from the market. What will
the consequences be if he does so?
The Profit Volume (P/V) Ratio is one which takes the rate of change in profit as a function of sales
volume. It shows the contribution made in relation to sales. The PV ratio, often known as the P/V
ratio, is calculated using the formula below.
If a cup’s sale price is Rs.80 and its variable cost is Rs.60, then the PV ratio is (80-60)
100/80=2010080=25 percent.
(Fixed cost + Desired Profit) / Contribution Per Unit = Sales (in Units)
(Fixed cost + Desired Profit) / PV Ratio = Sales (in Rs/-)
Solved Problems
Fixed cost =Rs 12,000 Selling price =Rs 12 per unit Variable cost= Rs 9 per unit
1). What will be the profit when sales are a) Rs 60,000 b) Rs 1,00,000?
2). What will be the amount of sales desired to earn a profit of c) 6,000;
d) 15,000?
Solution
2. The Bansi firm produces a single item with a marginal cost of Rs. 1.50 per unit.
The annual fixed cost is Rs. 30,000. Up to 40,000 units can be sold at Rs. 3.00
per unit in the current market, but any extra sales must be done at Rs. 2.00 per
unit. The company expects to make a profit of Rs. 50,000. What is the minimum
number of units that must be manufactured and sold?
Solution
14. If management decides to produce an in-house product, the focus should be on:
15. If the raw material is a crucial consideration in making a selection, then a product
that provides the following benefits should be preferred:
Making or buying decisions, accepting bulk orders (or) foreign market orders, selecting
a good product mix, identifying critical factors, and maintaining a desired level of profit
can all be done with marginal costing.
The Profit Volume (P/V) ratio measures the rate of change in profit as a result of
changes in sales volume.
Terminal Questions
Question No Answers
1 C
2 D
3 A
4 C
5 A
6 B
7 B
8 D
9 C
10 C
11 A
12 A
13 A
14 A
15 C
• Prime cost: The total direct costs of production, including raw materials and labor.
Bibliography
Textbooks
1. Libby, R., Libby, P. A., & Hodge, F. (2020). Financial Accounting. McGraw-Hill
Education.
2. Horngren, C. T., Harrison, W., & Oliver, M. S. (2011). Financial & Managerial
Accounting. Pearson College Div.
e-References
1. http://www.bhagininiveditacollege.in/pdf/2020/Dr-Rachna-Mahalwala-%20B.com-III-yr-
Management-accounting-problems-solutions-of-Unit-IV-Management-Accounting.pdf
2. http://tumkuruniversity.ac.in/oc_ug/comm/notes/cost%20accounting%20II_2.pdf
3. https://www.economicsdiscussion.net/cost-accounting/applications-of-marginal-cost-
ing/31695
4. https://commerceiets.com/applications-of-marginal-costing/#gsc.tab=0
Video Links
Topic Link
https://www.youtube.com/watch?v=aE4Jn-
Marginal Costing (Introduction)
jAx2Qc
https://www.youtube.com/watch?v=wVe-
Marginal Costing
HtQ3k2X0
https://www.youtube.com/watch?v=T-
Marginal Costing Technique
0Gdvq7th64
https://www.youtube.com/
Marginal costing
watch?v=i_7dxah6h3w
• Marginal costing
• Net profit
• Gross profit
• Marginal profit
MODULE 4
UNIT 2
BREAK-EVEN ANALYSIS
Instructional Objectives
This unit intends to:
• Elaborate upon the concept of Break-even point
• Apply the Break-even point concept and its role in decision-making
Learning Outcomes
At the end of the unit, students are expected to:
• Analyse the Break-even point and sales
• Apply Break-even point in business decisions
Break-even analysis determines how many units of a product must be sold in order to pay fixed
and variable production expenses. The break-even point is a metric for determining the margin of
safety. Break-even analysis plays a significant role from product planning to receiving profitability
on the product, covering a wide range of decisions.
In economics and business, break-even analysis is described as the point where total cost and
total revenue are equal. A break-even point analysis is used to assess the number of units or
rupees of revenue required to be earned to cover all costs (fixed and variable costs) incurred on
a product or service.
Variable Costs
or +
# of Units Revenue
Fixed Costs
a. Specifies the sales to be made to cover the variable cost and fixed cost and determine
the selling price of each individual product, as well as the total cost.
b. Breakeven Analysis helps to determine the amount of sales to be a goal and helps
in creating a budget for the business.
c. The break-even analysis assists the company in determining the minimum number
of sales required to break even. The management can make a high-level business
judgment based on the margin of safety reports.
d. Fixed and variable costs can have an impact on a company’s profit margin. As a
result, management can use break-even analysis to analyse the impact of changing
costs.
e. Any change in a product’s pricing can impact on the break-even point. If the selling
price is increased, the amount of the product that must be sold to break even is
reduced. Similarly, if a company’s selling price is cut, it must sell more to break even.
It helps in determining the price of a product.
1. Overhead costs
These are also known as fixed costs. Once a business’ financial activity begins,
these costs become apparent. Taxes, salaries, rentals, depreciation costs, labour
costs, interest costs, energy costs, and so on are all included in the fixed prices.
2. Variable costs
These expenses change with the volume of production and will drop or grow. These
expenses include packaging, raw material costs, fuel, and other production-related
components.
(a) A Profit
(b) A Loss
(c) No profit or loss
(d) None of these
4. Break-even point does not follow one assumption among the given.
A break-even chart depicts the amount of sales volume where total costs equal sales. Below this
amount, losses will be incurred, while gains will be earned above this point. Revenue, fixed costs,
and variable costs are plotted on the vertical axis, while volume is plotted on the horizontal axis.
Break-even analysis plays a significant role from product planning to receiving profitability on the
product, covering a wide range of decisions. A break-even point analysis is used to assess the
number of units or rupees of revenue required to be earned to cover all costs (fixed and variable
costs) incurred on a product or service.
Any change in a product’s pricing can impact on the break-even point. If the selling price is
increased, the amount of the product that must be sold to break even is reduced. Similarly, if a
company’s selling price is cut, it must sell more to break even.
Graphic representation of costs at various levels of activity displayed alongside the change in
income in terms of sales or revenue with the same variation in activity.
nue
ve
200000 Break-even Point Re
180000
ed)
160000 Variab le + Fix
Total Costs (
140000
120000
Fixed Costs
100000
80000
60000
40000
20000
0
2000 4000 6000 8000 10000 12000 14000 16000 18000
Number of Units
1. The X-axis represents the number of units, while the Y-axis represents the amount.
3. The revenue per unit sold is represented by the blue line. Sales of 10,000 units, for
example, would result in an income of 10,000 x Rs 12 = Rs 120,000.
4. Total costs are represented by the yellow line which covers fixed cost and variable
cost.
For example, if the company sells 0 units, it will incur Rs 0 in variable costs and Rs
100,000 in fixed costs, totalling Rs 100,000 in total costs. If the company sells 10,000
units, the variable expenses will be 10,000 x Rs 2 = Rs 20,000, and the fixed costs will
be Rs 100,000, for a total cost of Rs 120,000.
5. In the above chart, it clearly depicts that at 10,000 units, the break-even point is reached.
Revenue would be 10,000 x Rs 12 = Rs 120,000 at this point, with expenditure being
10,000 x 2 = Rs 20,000 in variable costs and Rs 100,000 in fixed costs.
6. The company will make a profit on the units sold whenever the total number of units
sold hits 10,000. After 10,000 items are manufactured, the blue revenue line exceeds
the yellow total costs line. Similarly, if the number of units sold is less than 10,000, the
corporation will lose money. The total costs line lies above the revenue line from 0 to
9,999 units. The term “margin of safety” refers to when actual sales exceed BEP sales.
6. Margin of safety =
Examples
1. Raja is a watch salesman. The following items are included in the price of each watch:
The selling price is Rs 1,000, with Rs 400 in variable cost. Raja’s total fixed costs are
Rs 90,000.
b). Calculate the total profit when 200 watches are sold?
c). Specify how many watches the company needs to sell in order to break even
d). In order to get a profit of Rs 60,000 specify how many watches are to be sold by
the company.
N = Break-even in phones
Rs 100N - Rs 50N - Rs 10N - Rs 1,250 - Rs 2,500 = 0
Rs 40N - Rs 3,750 = 0
N = Rs 3,750 / Rs 40 = 93.75 phones
Break-even Point = 94 phones
c). To earn a targeted profit of Rs 7,500, determine how many phones need to be
sold.
N = Phones to be sold
Rs 100N - Rs 50N - Rs 10N - Rs 1,250 - Rs 2,500 = Rs 7,500
Rs 40N = Rs 11,250
N = Rs 11,250 / Rs 40 = 281.25 phones
To achieve target profit: Must sell 282 phones
11. If the selling price is Rs 10 per unit, the variable cost is Rs 6 per unit, and the fixed
cost is Rs 5,000, the total cost is Rs 10,000 then break-even point is:
12. If the selling price is Rs 20 per unit and the variable cost is Rs 16, the contribution is:
13. Selling price of a product is Rs 10/-. Fixed cost of Rs. 40,000 and a variable cost of
Rs. 6 per unit. How many units are to be sold in order to break even?
14. Fixed costs = Rs. 20,000, Price per unit sold = Rs. 8 Variable cost = 60,000,
Contribution = Rs. 12,000. The sales volume is:
15. Determine the BEP in units and rupees if the number of units produced is 10,000,
the fixed cost is 40,000, the selling price is 50 per unit, and the variable cost is 30
per unit.
A business that isn’t profitable could go out of existence at any time. Therefore, every
business should concentrate on its profit centre. Consider the following questions:
2. Calculating a break-even point will help you price your products more effectively. It
helps to set margins for the product to generate the right amount of revenue to break
even.
3. Break-even analysis helps the firm to devise future strategy. A business’ profitability is
driven by the break-even point for each product, which provides a timeline that helps
in building an overall financial plan that meets the projected earnings and can cover
the costs.
4. Cost-benefit analysis examines all fixed costs on a regular basis to determine if any
can be cut. Examine variable costs to see whether they can be reduced or eliminated,
as this enhances margins and lowers the break-even point.
5. Examine the margins. Keep an eye on product margins and push sales of the highest-
margin items to lower the break-even point.
7. Technology: Implement any technologies that can help the company become more
efficient, allowing it to expand capacity without increasing costs.
1. Break-even analysis assumes that all expenses and expenditures can be clearly
split into fixed and variable components. In practice, however, it may be difficult to
distinguish between fixed and variable expenses.
2. At all levels of activity, fixed costs are believed to be constant. It should be noted that
fixed costs tend to fluctuate after a certain level of activity.
3. Variable costs are considered to fluctuate according to output volume. In actuality, they
move in lockstep with production volume, but not always in direct proportions.
5. It’s uncommon to see the assumption that just one product will be produced or that the
product mix will remain steady in practice.
8. It assumes that production and sales quantities are identical, and that the opening and
closing stock of finished goods are unchanged; nevertheless, both assumptions are
incorrect.
9. In the break-even analysis, the amount of capital used in the business is not taken
into account. In truth, a company’s profitability is mostly determined by the amount of
capital it employs.
(a) True
(b) False
(a) True
(b) False
(a) True
(b) False
19. Break-even analysis assumes that fixed costs do not remain constant at all levels
of activity.
(a) True
(b) False
20. Break-even analysis assumes that variable costs vary with the volume of output.
(a) True
(b) False
If the selling price is increased, the amount of the product that must be sold to break
even is reduced. Similarly, if a company’s selling price is cut, it must sell more to break
even.
Caselet
The entire fixed cost of OGE Professional Services Ltd is $300,000, and the average variable
cost (variable cost per unit of production) is $2.00. Furthermore, the corporation sells the
product for #5.00 per unit. The corporation is trying to figure out where it will break even.
In this context you are required to analyse and advise the management.
Terminal Questions
1. Explain the significance of Break-even point.
Question No Answers
1 C
2 A
3 D
4 B
5 A
6 A
7 A
8 B
9 C
10 A
11 C
12 B
13 D
14 A
15 B
16 A
17 B
18 A
19 B
20 A
1. A business plans to manufacture 150,000 units. The variable unit cost is Rs. 14 and
the fixed unit cost is Rs. 2. The corporation sets its selling price to make a 15 percent
profit on cost.
Glossary
• Break-even Analysis: A financial calculation that weighs the costs of a new busi-
ness, service or product against the unit sell price to determine the point at which
you will break even.
• Cost analysis: The act of breaking down a cost summary into its constituents and
studying and reporting on each factor.
Bibliography
Textbooks
1. Libby, R., Libby, P. A., & Hodge, F. (2020). Financial Accounting. McGraw-Hill
Education.
2. Horngren, C. T., Harrison, W., & Oliver, M. S. (2011). Financial & Managerial Accounting.
Pearson College Div.
1. https://hrcak.srce.hr/file/239680
2. https://doi.org/10.2307/1349300
Image Credits
• Fig. 1
https://corporatefinanceinstitute.com/resources/accounting/break-even-analysis/
• Fig. 2
https://corporatefinanceinstitute.com/resources/accounting/break-even-analysis/
Video Links
Topic Link
https://www.youtube.com/watch?v=r-
Break-even analysis
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https://www.youtube.com/
Break-Even Analysis Explained
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Keywords
• Break-even point
• Cost of production
• Production output