ANSWER 8(a)

Master Budget Definition

The master budget is the aggregation of all lower-level budgets produced by a company's various
functional areas, and also includes budgeted financial statements, a cash forecast, and a financing
plan. The master budget is typically presented in either a monthly or quarterly format, and
usually covers a company's entire fiscal year. An explanatory text may be included with the
master budget, which explains the company's strategic direction, how the master budget will
assist in accomplishing specific goals, and the management actions needed to achieve the budget.
There may also be a discussion of the headcount changes that are required to achieve the budget.
A master budget is the central planning tool that a management team uses to direct the activities
of a corporation, as well as to judge the performance of its various responsibility center. It is
customary for the senior management team to review a number of iterations of the master budget
and incorporate modifications until it arrives at a budget that allocates funds to achieve the
desired results. Hopefully, a company uses participative budgeting to arrive at this final budget,
but it may also be imposed on the organization by senior management, with little input from
other employees.
The budgets that roll up into the master budget include:

Direct labour budget

Direct material budget

Closing finished goods budget

Manufacturing overhead budget

Production budget

Sales budget

Sales and administration budget

The selling and administrative expense budget may be further subdivided into budgets for
individual departments, such as the accounting, engineering, facilities, and marketing
departments.

Once the master budget has been finalized, the accounting staff may enter it into the company's
accounting software, so that the software can issue financial reports comparing budgeted and
actual results.
Smaller organizations usually construct their master budgets using electronic spreadsheets.
However, spreadsheets may contain formula errors, and also have a difficult time constructing a
budgeted balance sheet. Larger organizations use budget-specific software, which does not have
these two problems

Master budget vs. cash budget

1. Master budget is aggregation of all lower-level budgets produced by a company, whereas
cash budget is only single part of lower level budget.
2. Master budget is central planning tool that a management team uses to direct the
activities of a corporation, whereas cash budget is used to control the cash activities of
corporation.
3. Master budget is imposed on the organization by senior management, with little input
from other employees , whereas cash budget is maintained by the lower level employees.
4. Master budget includes direct labor, Direct material, Closing finished goods,
Manufacturing overhead, Production, Sales, Sales and administration expense etc.,
whereas cash budget deals only with the cash transaction.

ANSWER 8(b)

Methods of inventory valuation

Inventory is a quantity of goods and materials on hand. Usually, inventory is called stock. A
stock includes finished goods held for sale, goods in the process of production, raw materials,
and items that will be consumed in the process of producing salable goods. Inventories are
considered assets on a companys balance sheet. Inventories are priced on financial statements
either at cost value or market value.

Inventory values change according to price fluctuations. The valuation of an inventory directly
affects the inventory, total current asset, and total asset balances. There are different methods of
valuing inventories used by public and private companies. Such methods include:

Specific Identification method: it is the simplest method of valuing inventories. When an

inventory item is sold, the inventory account should be reduced or credited, and cost of
goods sold should be increased or debited for the amount paid for each inventory item.
This method works only when a company knows the cost of every individual item that is
sold. Specific identification method works well when the quantity of inventory a
company has is limited and each inventory item is unique. The specific identification
method can be practiced in businesses such as car dealerships, jewelers, and art galleries.

First-In, First-Out (FIFO) method: FIFO is a method of valuing the cost of goods sold
that uses the cost of the oldest items in inventory first. This method is based on the
assumption that goods that are sold or used first are those goods that are bought first.
Therefore, the cost of goods bought first (first-in) is the cost of goods sold first (firstout). According to FIFO, at the end of a year an inventory would consist of goods most
recently placed in inventory. If there is inflation, the cost of goods sold will be at its
lowest possible amount. This would help in maximizing net income within an
inflationary environment. The downside of that effect is that income taxes will be at their
greatest.

Last-In, First-Out (LIFO) method: LIFO is an inventory valuing method that assumes that
the last items placed in inventory are the first sold during an accounting year. Therefore,
when the LIFO method is applied, the inventory at the end of a year consists of the goods
placed in inventory at the beginning of the year, rather than at the end[i]. During
inflation, when prices are rising, the LIFO method yields a lower ending inventory, a
higher cost of goods sold, a lower gross profit, and a lower taxable income. The LIFO
Method is preferred by many companies because it has the effect of reducing a
companys taxes and therefore increasing cash flow.

Average Cost method: the average cost method takes the average of all units available for
sale during the accounting period. The average cost method uses the average cost to
determine the value of the cost of goods sold and ending inventory.

Impact of inventory valuation on profit during inflation

Inventory includes raw materials, partially finished goods and finished goods. A retail business
may have finished goods awaiting shipment, while a manufacturing business may have raw
materials and partially completed products that require further processing before sale. The choice
of an inventory valuation method affects the calculation for cost of goods, which affects gross
profit and net income.

Basics
The perpetual system tracks each purchase and sale, which continually updates the inventory
balance and cost of goods. The periodic system relies on physical inventory counts and cost of
goods estimates for inventory balances because it does not track inventory continually. The
common inventory valuation methods are first-in first-out (FIFO), last-in first-out (LIFO),
weighted average and specific identification. Inventory costs include acquisition, shipping and
direct labor costs.

FIFO
The FIFO valuation method assumes that the first inventory item purchased is the first one used
in production or sold. For example, if a small business has 10 items in stock worth $10 each and
it purchases 10 additional items for $12 each, the FIFO method would assume that items in the
first sales transaction come from the $10 lot. In an inflationary environment, the cost of goods
includes the less expensive items while ending inventory includes the more expensive items.
This means that the net income and ending inventory amounts are higher under the FIFO
method. However, in a deflationary environment, the FIFO method is likely to generate lower net
income.

LIFO
The LIFO valuation method assumes that the last inventory item purchased is the first one used
in production or sale. Continuing with the earlier example, the LIFO method would assume that
items in the first sales transaction come from the latter $12 lot. In an inflationary environment,
the cost of goods includes the more expensive items while ending inventory includes the less
expensive items. This means that the net income and ending balance amounts are lower under the
LIFO method. However, when prices are falling, the LIFO method is likely to generate higher
net income.

Weighted Average
The weighted-average method divides the total purchase costs by the number of units in
inventory to compute the average unit cost. For example, the average unit cost for purchases of
10 units at $100 each and 20 units at $50 each is 10 multiplied by $100 plus 20 multiplied by $50
-- which is $2,000 -- divided by 10 plus 20, or about $67. The weighted-average costs are
directly proportional to the purchase costs. Therefore, in a rising price environment, the average
unit costs are higher and net income is lower, while the opposite is true in a falling price
environment.

Specific Identification
The specific identification method tracks the exact cost of each inventory item. The effect on net
income depends on changes in the acquisition costs of the inventory items. However, this method
is not practical for businesses with hundreds of different items in stock.

Accounting standard 2 of inventory valuation

This accounting standard is formulated for valuation of the inventory with the enterprise in the
course of business. It explains about the different methods of accounting the inventory or closing
stock. This valuation part of inventory is very important as it affects both revenue of the business
and the asset. Because if valuation will be done at higher than actual, it will be shown in the
trading account as closing stock and resulting in to increase in gross profit and the same value
will also be shown in the balance sheet as current asset so it will increase value of asset.

Inventory
As per the definition of inventory or closing stock it includes following things;
Items which are held for sale in the normal course of business that is finished
stock of goods.
Work-in-progress (WIP) for such sale. Goods which are not yet finished or ready
to sale.
Raw material which is not even issued for production while valuation of closing
stock or inventory. It also includes consumable stores item.
Applicability
AS-2 is not applicable to following cases.
Work in process in the construction contract business including, directly related
to service contract.
Any financial instruments held as stock in trade which includes shares,
debentures, bonds etc.
Other inventories like livestock, agricultural product and forest product, natural
gases and mineral oils etc.
Work in progress in the business of banking, consulting and service business.
That means it includes incomplete consulting service, merchant banking service and
medical service in process.
All of above are not cover under the definition of inventory/ closing stock that's
why this accounting standard if not become applicable to above cases or in the
course of business.

Cost of inventory
Valuation of inventory is made at cost or market/ net realisable value whichever is
lower. So that for the purpose of valuation cost of inventory is required to obtain.
There can be three types of cost are included in the inventory which are as follow.
Purchase cost

1. Invoice price at which goods are purchased

2. Duties and taxes paid

3. Freight inward

4. Any other expenditure directly relating to acquiring goods

Above cost should be reduced by following

1. Duties and taxes received or receivable back from the tax authority

2. Trade discount

3. Rebate

4. Duty drawback

Cost of conversion
After purchasing the raw material or goods during the production time whatever
cost is paid or payable will be considered as conversion cost. It includes direct

labour, material and other direct expense plus allocation of fixed and variable
production overhead incurred for conversion or raw material in to finished goods.
Following things should be considered for conversion cost of the inventory.
1. Fixed production overhead it includes indirect cost for production which
remains constant without relating to numbers of units produced. For example
depreciation and maintenance of factory building.

2. Variable overhead indirect cost of production which depends on the number

of units are produced such as packing material and other supporting material
to finished product.

3. Allocation of fixed expense should be made on the bases of normal capacity

and allocation of variable cost will be done on the basis of actual numbers of
units are produced.

Other cost
It includes any other expenditure incurred to bring inventory or stock in the present
location and condition.
All three are the major part of the cost which required to be considered for valuation
of the inventory. But it should not include abnormal wastage relating to material and
labour, storage cost, administrative expenses & selling and distribution expenses.
Methods of valuation of inventory
There are numbers of method for valuation of the inventory in the normal course of
business which includes FIFO, LIFO, weighted average cost, standard cost and retail
method. But practically following two methods only used.
FIFO (first in first out)
Weighted average
Net realisable value
Net realisable value means normal selling price of the goods less estimated
expenditure to sale such goods. It is estimated value on the basis of reliable
evidence at time of valuation. Estimation of net realisable value can be done on the
following basis.

 If the finished goods in which raw material and supply is used is sold at cost or
above the cost, then the estimated realisable value of raw material and supplies is
considered more than cost.
It the finished goods in which raw material and supply are used is sold at below
cost then the estimated realisable value of raw material or supply is equal to
replacement price of raw material or supply.
Disclosure in financial statement
Valuation of inventory is made on comparison of cost and net realisable value
whichever is lower. This value should be disclosed in the financial statements. Other
things relating to inventory to be disclosed in accordance with Accounting Standard1 are accounting policies adopted in measuring inventory, cost formula and
classification of inventory such as finished goods, raw material & WIP and stores
and spares etc.