Industrial Engineering & Accountancy (CS 702)

B.Tech. CS (7 Semester), National Institute of Technology, Jamshedpur 831014

Subject I/C: Dr. S. Tripathy
th

Chapter- I: Time Value of Money: Concepts

One of the most fundamental concepts in finance is that money has a time value. That is to
say that money in hand today is worth more than money that is expected to be received in the
future. The reason is straightforward: A dollar that you receive today can be invested such
that you will have more than a dollar at some future time. This leads to the saying that we
often use to summarize the concept of time value: A rupee today is worth more than a dollar
tomorrow." This core principle of finance holds that, provided money can earn interest, any
amount of money is worth more the sooner it is received. Thus, at the most basic level, the
time value of money demonstrates that, all things being equal, it is better to have money now
rather than later.
Importance
The best planning is useless without a financial goal in mind. Time value of money concepts
allows you, the planner, to translate goals into dollar amounts. Further, these concepts permit
you to determine the dollar input required to achieve the desired results. TVM calculations
require the client and planner to decide upon an estimated investment rate of return and an
inflation rate to be used. Since these are certain to be inaccurate for at least some of the years
of the planning period, some would argue that any rule of thumb is just as useful. This
argument has some merit, but every client has a unique set of circumstances and goals. In
reality, people are more likely to follow a plan that is based on their input rather than a rule of
thumb that may or may not be appropriate. The TVM concept has many applications in
financial planning. For instance, it is used to determine how investment dollars should be
applied to best meet financial objectives. It also is used to help calculate education, survivor,
and retirement needs for a given client and to determine how to best meet those needs.
Additionally, it is used to determine the financial effect of postponing taxes. In insurance
planning, time values of money concepts are used to calculate life insurance needs. Of all the
concepts that are important to a financial planner, a clear understanding of TVM calculations
is imperative. When working through the problems in this module, it is critical that a planner
endeavor to understand the concepts behind, and the relationships between the five basic
TVM factors: present value [PV], future value [FV], payment [PMT], interest [I/YR], and
number of periods [N].
Money has time value because of the following reasons:
1. Risk and Uncertainty: Future is always uncertain and risky. Outflow of cash is in our
control as payments to parties are made by us. There is no certainty for future cash
inflows. A cash inflow is dependent out on our Creditor, Bank etc. As an individual or
firm is not certain about future cash receipts, it prefers receiving cash now.
2. Inflation: In an inflationary economy, the money received today, has more purchasing
power than the money to be received in future. In other words, a rupee today
represents a greater real purchasing power than a rupee a year hence.
3. Consumption: Individuals generally prefer current consumption to future
consumption.
4. Investment opportunities: An investor can profitably employ a rupee received today,
to give him a higher value to be received tomorrow or after a certain period of time.

Thus, the fundamental principle behind the concept of time value of money is that, a sum of
money received today, is worth more than if the same is received after a certain period of
time. For example, if an individual is given an alternative either to receive 10,000 now or
after one year, he will prefer 10,000 now. This is because, today, he may be in a position to
purchase more goods with this money than what he is going to get for the same amount after
one year.
Techniques of Time Value of Money
There are two techniques for adjusting time value of money. They are:
1. Compounding Techniques/Future Value Techniques
2. Discounting/Present Value Techniques
The value of money at a future date with a given interest rate is called future value. Similarly,
the worth of money today that is receivable or payable at a future date is called Present
Value.
Compounding Techniques/Future Value Technique
In this concept, the interest earned on the initial principal amount becomes a part of the
principal at the end of the compounding period.
Multiple Compounding Periods
Interest can be compounded monthly, quarterly and half-yearly. If compounding is quarterly,
annual interest rate is to be divided by 4 and the number of years is to be multiplied by 4.
Similarly, if monthly compounding is to be made, annual interest rate is to be divided by 12
and number of years is to be multiplied by 12.
Future Value of Multiple Cash Flows/ Annuity
The above illustration is an example of multiple cash flows. The transactions in real life are
not limited to one. An investor investing money in instalments may wish to know the value of
his savings after n years.
Effective Rate of Interest (EIR) in Case Of Multi-Period Compounding
Effective interest rate brings all the different bases of compounding such as yearly, halfyearly, quarterly, and monthly on a single platform for comparison to select the beneficial
base. Now, the question is which works out highest interest amount? When interest is
compounded on half-yearly basis, interest amount works out more than the interest calculated
on yearly basis. Quarterly compounding works out more than half-yearly basis. Monthly
compounding works out more than even quarterly compounding. So, if compounding is more
frequent, then the amount of interest per year works out more.
Discounting or Present Value Concept
Present value is the exact opposite of future value. The present value of a future cash inflow
or outflow is the amount of current cash that is of equivalent value to the decision maker. The
process of determining present value of a future payment or receipts or a series of future
payments or receipts is called discounting. The compound interest rate used for discounting
cash flows is also called the discount rate. In the next chapter, we will discuss the net present
value calculations.
(For details, follow your class room notes)
Examples:
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Find the value of $10,000 in 10 years. The investment earns 5% per year.
Today your stock is worth $50,000. You invested $5,000 in the stock 18 years ago.
What average annual rate of return.
What is the future value of a 4-year annuity, if the annual interest is 5%, and the
annual payment is $1,000?
Find the present value of $10,000 to be received at the end of 10 periods at 8% per
period.
What is the present value of a 4-year annuity, if the annual interest is 5%, and the
annual payment is $1,000?

Chapter- II: Basic Accounting & Financial Statements

Meaning:
Accounting is the process of recording, classifying, summarizing, analyzing and interpreting
the financial transactions of the business for the benefit of management and those parties who
are interested in business such as shareholders, creditors, bankers, customers, employees and
government. Thus, it is concerned with financial reporting and decision making aspects of the
business.
The American Institute of Certified Public Accountants Committee on Terminology proposed
in 1941 that accounting may be defined as, The art of recording, classifying and
summarizing in a significant manner and in terms of money, transactions and events which
are, in part at least, of a financial character and interpreting the results thereof.
Objective of Accounting
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
To keeping systematic record: It is very difficult to remember all the business
transactions that take place. Accounting serves this purpose of record keeping by
promptly recording all the business transactions in the books of account.
To ascertain the results of the operation: Accounting helps in ascertaining result i.e.,
profit earned or loss suffered in business during a particular period. For this purpose, a
business entity prepares either a Trading and Profit and Loss account or a n Income
and Expenditure account which shows the profit or loss of the business by matching
the items of revenue and expenditure of the some period.
To ascertain the financial position of the business: In addition to profit, a businessman
must know his financial position i.e., availability of cash, position of assets and
liabilities etc. This helps the businessman to know his financial strength. Financial
statements are barometers of health of a business entity.
To portray the liquidity position: Financial reporting should provide information
about how an enterprise obtains and spends cash, about its borrowing and repayment
of borrowing, about its capital transactions, cash dividends and other distributions of
resources by the enterprise to owners and about other factors that may affect an
enterprises liquidity and solvency.
To protect business properties: Accounting provides upto date information about the
various assets that the firm possesses and the liabilities the firm owes, so that nobody
can claim a payment which is not due to him.
To facilitate rational decision making: Accounting records and financial statements
provide financial information which help the business in making rational decisions
about the steps to be taken in respect of various aspects of business.
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To satisfy the requirements of law: Entities such as companies, societies, public trusts
are compulsorily required to maintain accounts as per the law governing their
operations such as the Companies Act, Societies Act, and Public Trust Act etc.
Maintenance of accounts is also compulsory under the Sales Tax Act and Income Tax
Act.
Bookkeeping, in business, is the recording of financial transactions, and is part of the process
of accounting. Transactions include purchases, sales, receipts and payments by an individual
or organization. The accountant creates reports from the recorded financial transactions
recorded by the bookkeeper and files forms with government agencies. There are some
common methods of bookkeeping such as the single-entry bookkeeping system and the
double-entry bookkeeping system. But while these systems may be seen as "real"
bookkeeping, any process that involves the recording of financial transactions is a
bookkeeping process.
Bookkeeping is usually performed by a bookkeeper. A bookkeeper, is a person who records
the day-to-day financial transactions of an organization. A bookkeeper is usually responsible
for writing the "daybooks". The daybooks consist of purchases, sales, receipts, and payments.
The bookkeeper is responsible for ensuring all transactions are recorded in the correct day
book, suppliers ledger, customer ledger and general ledger. The bookkeeper brings the books
to the trial balance stage. An accountant may prepare the income statement and balance sheet
using the trial balance and ledgers prepared by the bookkeeper.
Bookkeeping and accounting are both essential business functions required for all businesses.
Bookkeeping is responsible for the recording of financial transactions. Accounting is
responsible for interpreting, classifying, analyzing, reporting and summarizing financial data.
The biggest difference between accounting and bookkeeping is that accounting involves
interpreting and analyzing data and bookkeeping does not.
Book-keeping includes recording of journal, posting in ledgers and balancing of accounts. All
the records before the preparation of trail balance is the whole subject matter of bookkeeping. Thus, book-keeping many be defined as the science and art of recording transactions
in money or moneys worth so accurately and systematically, in a certain set of books,
regularly that the true state of businessmans affairs can be correctly ascertained. Here it is
important to note that only those transactions related to business are recorded which can be
expressed in terms of money.
Objectives of Book-keeping
i)
Book-keeping provides a permanent record of each transactions.
ii)
Soundness of a firm can be assessed from the records of assets and abilities on a
particular date.
iii)
Entries related to incomes and expenditures of a concern facilitate to know the
profit and loss for a given period.
iv)
It enables to prepare a list of customers and suppliers to ascertain the amount to be
received or paid.
v)
It is a method gives opportunities to review the business policies in the light of the
past records.
vi)
Amendment of business laws, provision of licenses, assessment of taxes etc., are
based on records.

Book Keeping Vs Accounting:

Similarities
Bookkeeping and accounting can appear to be the same profession to the untrained eye. Both
bookkeepers and accountants work with financial data. To enter either profession, you must
have basic accounting knowledge. Bookkeepers in smaller companies often handle more of
the accounting process than simply recording transactions. They also classify and generate
reports using the financial transactions. They may not have the education required to handle
these tasks, but this is possible because most accounting software automates reports and
memorizes transactions making transaction classification easier. Sometimes, an accountant
records the financial transactions for a company, handling the bookkeeping portion of the
accounting process.
Differences
Taking a few accounting courses and developing a basic understanding of accounting will
qualify you for a job in bookkeeping. To work in accounting, you must have at least a
bachelor's degree to become an accountant or, for a higher level of expertise, you can become
a certified public accountant. Accountants are qualified to handle the entire accounting
process, while bookkeepers are qualified to handle recording financial transactions. To ensure
accuracy, accountants often serve as advisers for bookkeepers and review their work.
Bookkeepers record and classify financial transactions, laying the groundwork for
accountants to analyze the financial data.
Bookkeeping- is the tedious part of the financial affairs of a business. It involves the
systematic recording of the amounts, dates and sources of each revenue and expense
transaction. Bookkeeping is concerned with the systems that enable the financial information
to be extracted in the transactions that generate revenue and incur expense in the business.
Accounting - is the bigger picture. It is the system that keeps track of the data, including
people, and records the transactions history, as well as taking the information that is obtained
through the bookkeeping process and using that information to analyse the results of the
business. Accounting is the system that provides the reports and information needed for
management to make decisions as to the direction of the business, as well as issues such as
taxation, Sales Tax etc.
Accounting Terminology
Accounting Equation - assets = liabilities + equity
Accounts Payable - Accounts Payable is an amount owed by the business for delivered
goods or completed services. Accounts Payable is a liability. Money owed to creditors,
vendors, etc.
Accounts Receivable - Account Receivable is an amount owed to the business from a
completed transaction of sales or services rendered. Accounts Receivable is an asset. Money
owed to a business, i.e. credit sales.
Asset - Tangible or intangible items of value owned by a business e.g. cash, stock, buildings
& vehicles, etc. Or property with a cash value that is owned by a business or individual
Balance Sheet A summary of a company's financial status, including assets, liabilities, and
equity. It shows a snapshot at a given point in time of the net worth of the business. It details
the assets, liabilities and owners equity.
Credit - an account entry with a negative value for assets, and positive value for liabilities
and equity.
Debit - an account entry with a positive value for assets, and negative value for liabilities and
equity.
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Dividends amounts paid to shareholders out of current or retained earnings

Double-Entry Bookkeeping - Double-entry accounting is a method of recording financial
transactions in which each transaction is entered in two or more accounts and involves twoway, self-balancing posting. Total debits must equal total credits. Or it is a system of
bookkeeping where all transactions have 2 entries, a debit and a credit, which net to zero.
Drawings- An accounting record maintained to track money withdrawn from a business by
its owners. A drawing account is used primarily for businesses that are taxed as sole
proprietorships or partnerships. Owner withdrawals from businesses that are taxed as separate
entities must generally be accounted for as either compensation or dividends.
Financial Statement - It represents a formal record of financial activities containing the
balance sheet and the income statement: trading account, profit & loss account.
Fixed Asset - long-term tangible property; building, land, computers, etc.
Goodwill an intangible asset reflecting the value of an entity in excess of its tangible assets
Income Statement - A summary of income and expenses. For trading account, income and
expenses are gross profit or gross loss; and for profit & loss account, income and expenses
are net profit or net loss.
Journal - A record where transactions are recorded for the first time, also known as an
"account"
Liability - Amounts owed to entities outside of the business e.g. bank loan, supplier
payments & overdrafts. Or money owed to creditors, vendors, etc
Liquid Asset - cash or other property that can be easily converted to cash within one
accounting period.
Non Cash Expense - recognizing the decrease in the value of an asset; i.e. depreciation and
amortization
Posting The process of entering then permanently saving or archiving accounting data,
also known as ledger.
Retained Earnings the amount of net profit retained and not paid out to shareholders over
the life of the business
Financial Statements:
Trading Account; Profit & Loss Account; Balance Sheet (Details Attached)

Chapter- III: Depreciation

The term depreciation refers to fall in the value or utility of fixed assets which are used in
operations over the definite period of years. In other words, depreciation is the process of
spreading the cost of fixed assets over the number of years during which benefit of the asset
is received. The fall in value or utility of fixed assets due to so many causes like wear and
tear, decay, effluxion of time or obsolescence, replacement, breakdown, fall in market value
etc.
Depreciation, Depletion and Amortization
In order to correct measuring of depreciation it is essential to know the conceptual meaning
of depreciation, depletion and amortization.
Depreciation: Depreciation is treated as a revenue loss which is recorded when expired utility
fixed assets such as plant and machinery, building and equipment etc.
Depletion: The term depletion refers to measure the rate of exhaustion of the natural
resources or assets such as mines, iron ore, oil wells, quarries etc. While comparing with
depreciation, depletion is generally applied in the case of natural resources to ascertllin the

rate of physical shrinkage but in the case of depreciation is used to measure the fall in the
value or utility of fixed assets such as plant and machinery and other general assets.
Amortization: The term Amortization is applied in the case of intangible assets such as
patents, copyrights, goodwill, trade marks etc., Amortization is used to measure the reduction
in value of intangible assets.
Obsolescence: Obsolescence means a reduction of usefulness of assets due to technological
changes, improved production methods, change in market demand for the product or service
output of the asset or legal or other restrictions.
Purpose of Charging Depreciation
The following are the purpose of charging depreciation of fixed assets:
(1) To ascertain in the true profit of the business.
(2) To show the true presentation of financial position.
(3) To provide fund for replacement of assets.
(4) To show the assets at its reasonable value in the balance sheet.
Factors Affecting the Amount of Depreciation
The following factors are to be considered while charging the amount of depreciation :
(1) The original cost of the asset.
(2) The useful life of the asset.
(3) Estimated scrap or residual value of the asset at the end of its life.
(4) Selecting an appropriate method of depreciation.
Methods of Charging Depreciation
The following are the various methods applied for measuring allocation of depreciation cost:
Straight Line Method
Written Down Value Method
Annuity Method
Sinking Fund Method
Insurance Policy Method
Machine Hour Rate Method
Straight Line Method
This method assumes that the useful life of an asset is evenly distributed to its life, so results
in a constant depreciation charge per year provided the estimated residual value remains
constant over the life of the asset. This method is also termed as Constant Charge Method.
Under this method, depreciation is charged for every year will be the constant amount
throughout the life of the asset. According to this method, depreciation is a function of time,
which does not consider the magnitude of use of the asset. Accordingly depreciation is
calculated by deducting the scrap value from the original cost of an asset and the balance is
divided by the number of years estimated as the life of the asset. The following formula for
calculating the periodic depreciation charge is:
Depreciation = (Original Cost of Asset - Scrap Value) / Estimated Life of Asset
Example: From the following information you are required to calculate depreciation rate:
Cost of the Machine = Rs. 20 000
Erection Charges = Rs 4000
Estimated useful life = 10 Years
Estimated Scarp Value = Rs 2000
Merits
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(1) Simple and easy to calculate.

(2) Original cost of asset reduced up to Scrap Value at the end of estimated life.
(3) Estimated useful life of the asset can be estimated under this method.
Demerits
(1) It does not consider intensity of use of assets.
(2) It ignores any additions or opportunity cost while calculating depreciations.
(3) It ignores effective utilization of fixed assets; it becomes difficult to calculate correct
depreciation rate.
(4) Under the assumption of constant charges of maintenance of assets it is impossible to
calculate true depreciation.
Written-Down Value Method
This method assumes that the asset is more useful on the early days and less useful in the
later days, so it results in more depreciation charge in the early years and the charge
decreases as the asset becomes old. This method is also known as Fixed Percentage on
Declining Base Method (or) Reducing Installment Method. Under this method depreciation is
charged at fixed rate on the reducing balance (i.e., Cost less depreciation) every year.
Accordingly the amount of depreciation gradually reducing every year. The depreciation
charge in the initial period is high depreciation charge in the initial period is high and
negligible amount in the later period of the asset. The following formula used for computing
depreciation rate under Written-Down Value Method.
Amount of depreciation = Rate (%) of depreciation (Value of asset - Depreciation value of
previous year)
Rate of depreciation = 1 Nth root (S / C)
Where: N = Estimated life of Asset; S = Scrap Value of Asset; C = Cost of Asset
Example:
From the following information you are required to calculate depreciation rate under WDV
Method.
Cost of the Machine = Rs 10000
Estimated Useful Life = 3 years
Estimated Scrap or Salvage Value = Rs 1000
Merits
(1) This method is accepted by Income Tax Authorities.
(2) Impact of obsolescence will be reduced at minimum level.
(3) Fresh calculation is not required when additions are made.
(4) Under this method the depreciation amount is gradually decreasing and it will affect the
smoothing out of periodic profit.
Demerits
(1) Residual Value of the asset cannot be correctly estimated.
(2) It ignores interest on investment on opportunity cost which will lead to difficulty while
determining the rate of depreciation.
(3) It is difficult to ascertain the true profit because revenue contributions of the assets are not
constant.
(4) The original cost of the asset cannot be brought down to zero.
Annuity Method
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This method is most suitable for a firm where capital is invested in the least hold properties.
Under this method, while calculating the amount of depreciation, a fixed amount of
depreciation is charged for every year of the estimated useful life of the asset in such a way
that at a fixed rate of interest is calculated on the same amount had been invested in some
other form of capital investment. In other words, depreciation is charged for every year refers
to interest losing or reduction in the original cost of the fixed assets. Under the annuity
method where the loss of interest is due to the investment made in the form of an asset is
considered while calculating the depreciation. The amount of depreciation is calculated with
the help of an Annuity Table.
Sinking Fund Method
Like the Annuity Method, the amount of depreciation is charged with the help of Sinking
Fund Table. Under this method an amount equal to the amount written off as depreciation is
invested in outside securities in order to facilitate to replace the asset at the expiry useful life
of the asset. In other words, the amount of depreciation charged is debited to depreciation
account and an equal amount is credited to Sinking Fund Account. At the estimated expiry
useful life of the asset, the amount of depreciation each year is invested in easily realizable
securities which can be readily available for the replacement of the asset.
Insurance Policy Method
Under this method an asset to be replaced by taking required amount of insurance policy
from an insurance Company. A fixed premium is paid which is equal to the amount of
depreciation for every year. At the end of the agreed sum, i.e., on the maturity of the policy,
the amount will be used for replacing the existing assets.
Machine Hour Rate Method
This method is similar to the Depletion Method but instead of taking estimated available
quantities in advance, the working life of the machine is estimated in terms of hours. The
hourly rate of depreciation is determined by dividing the cost of the machine minus scrap
value of the machine by the estimated total number of hours utilized every year.