Intro Accounting Email

INTRODUCTION TO
FINANCIAL
ACCOUNTING
PRESENTED BY
PROF. (C.A.) SWATI GODBOLE
BACKGROUND AND
MEANING
BUSINESS IS
ALL ABOUT
MONEY
8/20/2018 PROF. (C.A.) SWATI GODBOLE 2

BRANCHES OF
ACCOUNTING
Process of FINANCIAL
Communicating social ACCOUNTING Post mortem of
And environmental impacts Business transactions
Of business actions
SOCIAL COST
ACCOUNTING
ACCOUNTING ACCOUNTING
Cost estimation,
Cost control
Accounting
MANAGEMENT
For ACCOUNTING
management

FINANCIAL ACCOUNTING
BASIC PRINCIPLES
PRINCIPLES
CONCEPTS CONVENTIONS

CONCEPTS
 Means basic rules & regulations

 Different concepts BUSINESS AND OWNERS
ARE SEPARATE
 Business entity BUSINESS = ARTIFICIAL
LEGAL ENTITY
BUSINESS HAS A LONG ,

 Going concern INDEFINITE LIFE
EVERY THING OF BUSINESS HAS TWO

EQUAL SIDES / TWO EQUAL FOLD
 Dual aspect IMPACT

CONTD..
 Accounting period Standard Period of 12 Months at
The end of which evaluation will
Be done
Expenses are recognized in the same

 Matching accounting period when the related
revenue is recognized
Accounts only deal with items

to which a monetary value
 Money measurement can be attributed

CONTD..
 Cost An asset is entered into the

accounting records at the price paid to acquire it.
The idea that income and expense items must

be included in financial statements
 Accrual as they are earned or incurred.
Revenue recognized only when it is

realizable or earned or realized
 Revenue recognition

CONVENTIONS
 Means basic assumptions
to inform both current and potential
 Disclosure investors of the accounting strategies
and methods used when developing
periodic corporate
Be consistent = no change in method

 Consistency Unless forced
Play Safe
 Conservatism
relating to the importance/significance of
 Materiality an amount, transaction, or discrepancy.

 The immediate recognition of loss is
supported by the underlying principle of
 Matching
 Consistency
 Judgment
 Conservatism

 The determination of the expenses for
an accounting period is based largely on
the application in which principle?
 Cost
 Consistency
 Matching
 Time period

 The Business entity concept
 Refers to the name of the company
required in the heading of the financial
statements
 Refers to the owners of the entity, who
must account for their interest in the entity
their personal holdings
 Indicates that the accounting unit on which
the financial reports are based is the
business itself, separate from its owners
 Holds that the business is made up of
many separate components that are
accounted for separately but reported
collectively in the financial statements
 Assigning revenues to the accounting
period in which the goods were delivered
or the services performed and expenses
to the accounting period in which they
were used to produce revenues is known
as the
 Accounting period
 Continuity assumption
 Matching rule
 Revenue recognition

 Generally accepted accounting
principles
 Define accounting practice at a point in
time
 Are similar in nature to the principles of
chemistry or physics
 Are rarely changed
 Are not affected by changes in the way
business operate

ACCOUNT
 Personal  Impersonal
 Accounts of  Accounts of Others
Individuals i.e. those who are
And Artificial persons not individuals and
 E.g. Mr. A , B , C ,
artificial persons.
ABC Ltd. Z Ltd. etc.  Further classified
into two types.
 Real and Nominal

REAL AND NOMINAL
 Real  Nominal
 Accounts of things  Accounts of things
that can be seen, that can only be felt,
touched i.e. which imagined but cannot
are real. be seen or touched.
 E.g. Cash ,  E.g. Wages ,
Furniture , Car , Salary , Electricity
Mobile , charges ,
Machinery etc. Telephone
Charges etc.

 Classify the following into Personal, Real
and Nominal.
 Stationery Account
 Cash Account
 Goodwill Account
 Capital Account
 Freight Account
 Rent Account
 Interest Account
 Account of Govind, a customer
 Bank Loan Account
 Depreciation
THREE GOLDEN RULES FOR
DEBIT AND CREDIT
PERSONAL
Debit Credit
The Receiver The Giver

Example
 Received cash Rs.500 from Mr. A

 Mr. A a Personal account
 A is the giver of the money
 So A’s account will be credited.

Contd.
REAL
Debit Credit
What Comes In What Goes Out

Contd. The same example
 Cash is a real account

 Cash is coming in the business
 Cash will be debited applying the rule.

Contd.
NOMINAL
Debit Credit
All Expenses And Losses All Incomes And Gains

Example
 Received cash from Mr. A as
Commission
 Here commission is a nominal account
 In the given transaction Commission is
Income
 Applying the rule commission will be
credited.

Business transactions
 In order to record the business
transactions we follow certain steps
 Identify the nature of transaction i.e. Cash
or Credit
 If Cash transaction then one account
getting affected is Cash or Bank (Cheque)
 Next question WHY?
 If no answer to the previous question then
next question WHOM?

Contd.
 In case of Credit Transaction
 One account getting affected is Personal
account
 Next question WHY?
 Example

Example
 Purchased Furniture from Furniturewala
and Sons Rs.20000
 Credit Transaction as no money coming in
or going out
 So Furniturewala and Sons Account
getting affected
 WHY = Purchase of Furniture
 Second account getting affected is
Furniture

 Point out the accounts which will be
debited and credited for each one of the
following transactions
 Cash received from X
 Cash paid to Y
 Credit sale to Z.
 Salary paid to clerk by means of cheque.
 Payment of cash to Landlord for Rent.

JOURNAL BOOK OF PRIME ENTRY
 Meaning
 “JOUR” = a day
 Recording of transaction on a daily basis
 Specific format in which transactions are
recorded
 Format

Ledger Folio Journal
= Folio
Page no. 120
Date PARTICULARS L.F. DEBIT CREDIT

AMT. AMT.
2010
Cash A/c. Dr 05 1500

1st April To Sales A/c. 10 1500
(Being Goods sold on Cash)
Rent A/c. Dr 15 850

7th April To Cash A/c. 05 850
(Being Rent paid by cash)
NARRATION

Certain Terms
Means Properties , something that the
 Assets
business owns
Means something that does not belongs

 Liabilities to business or something that you owes
Investment made by the owner in the

 Capital
business which can be in cash or kind
Money or any thing withdrawn by owner

 Drawings from business for personal use
Means the product in which the business

 Goods deals

Contd.
 Fixed Assets Assets that remains with us for long
time
Assets the value of which keeps

 Current Assets on changing
Liabilities the value of which

 Current Liabilities keeps on changing
Liabilities that remains with us for

 Fixed Liabilities long time ie. As long as the life of
the business

 Journalize the following transactions for
the month of January 2010
 R started the business with cash Rs.150000
 Deposited Cash Rs.100000 in Bank
 Purchase Goods worth Rs.50000 from C
 Sold goods worth Rs.70000 to D
 Paid Cash Rs.2500 to Rashmi
 Received Cheque from Sawant for Rs.6000 towards
commission
 Issued a cheque for Rs.7500 to Sanjay towards
courier charges
 Received cash from Sudhir as Interest
 Paid by cheque to C Rs.25000
 Received from D by cheque Rs.45000

LEDGER
 Meaning
 Summary of transactions entered into with
one party, one person, one asset, one
expenditure etc.
 Format

CASH ACCOUNT
DR CR
D Particulars J. Amt D Particulars J Amt

at F at F
e e
2010 To Sales A/c. 120 1500 2010 By Rent A/c. 120 850
1/4 5/4
2010 By Balance C/d. 650

30/4
1500 1500

 Refer slide no. 34 and prepare various
ledger account and find out the balance

Subsidiary Books
 Books kept for each type of transaction
 Various types are-
For recording credit purchase

 Purchase Book of goods
For recording credit sales of goods

 Sales Book
For recording returns
 Purchase Return Book outwards or purchase return
 Sales Return Book For recording return inwards

or sales return

Contd.
For recording receipts & payments of
 Cash Book cash and cheque
For recording Bills

 Bills receivable Book receivable received
For recording Bills payable

 Bills payable Book accepted
For recording any other

 Journal Proper Book
transaction which could not
be recorded in any of the
above books

Topics for Today
 Revision
 Certain important terms related to
Subsidiary books
 Depreciation
 Stock And its Valuation
 Bank Reconciliation

Certain terms
 Trade Discount Discount offered at the time of bulk
purchase.
Discount offered in order to receive

 Cash Discount the money quickly from customers
Note which is issued when we debit a

 Debit Note party in our books of accounts
Note which is issued when we credit a

 Credit Note party in our books of accounts

Contd.
Reduction in the value of a Fixed
 Depreciation
assets due to wear and tear or usage
The unsold goods lying with us at any

 Stock given point of time

Depreciation
 Meaning
 What is Original Cost of an Asset?
 Various methods of charging
Depreciation – the popular one are
 Fixed installment method or Straight line
method
 Reducing balance method or Written down

value method

Example
 Fixed Installment
 Original Cost 100
 Less: Depreciation @10% P.a. 10
 Written down value 90
 Less: Depreciation @10% 10
 So on and so forth
 Depreciation is calculated on Original Cost
of the asset till the asset exists.

Example
 Reducing Balance Method
 Original Cost 100
 Less: Depreciation @10% P.a. 10
 Less: Depreciation @10% 9
 So on and so forth

Formula – Original Cost method
 Depreciation = (Original Cost – Salvage)
÷ Life of the asset
 Salvage = Expected realizable Value for

an asset at the end of its life.

Stock or Inventory
 Various methods of inventory verification
Under this method the stock verification is
done by keeping continual track of
 Perpetual additions or deletions in materials
 Periodic
Under this method physical stock taking is
done periodically

Methods of stock valuation
 Various methods of stock valuation –
popular ones are
First in First Out
 FIFO
Last In First Out

 LIFO
 Weighted or Moving Average Method
Weighted average is taken as a

base for valuation

Example - FIFO
Date Receipt Issue (Units) Balance
(Units) (Units)
01/04/2010 500 @ Rs. 21

02/04/2010 1200 @ Rs. 500 @ Rs.21
20.25 1200 @ Rs.
20.25
03/04/2010 500 @ Rs.21 950 @ Rs.
250 @ 20.25
Rs.20.25
04/04/2010 600 @ 950 @
Rs.21.75 Rs.20.25
600 @ Rs.
21.75
05/04/2010 700 @ 250 @ Rs.
Rs.20.25 20.25
600 @
8/20/2018 PROF. (C.A.) SWATI GODBOLE Rs.21.75 51
Example - LIFO
(Units) (Units)
01/04/2010 500 @ Rs. 21

02/04/2010 1200 @ Rs. 500 @ Rs.21
20.25 1200 @ Rs.
20.25
03/04/2010 750 @ 500 @ Rs.21
Rs.20.25 450 @ Rs.
20.25
04/04/2010 600 @ 500 @ Rs.21
Rs.21.75 450 @
Rs.20.25
600 @ Rs.
21.75
05/04/2010 600 @ 500 @ Rs.21
Rs.21.75 350 @ Rs.
8/20/2018 100 @
PROF. (C.A.) SWATI GODBOLE 20.25 52
PROF. (C.A.) SWATI GODBOLE
Rs.20.25
Example – weighted average
(Units) (Units)
01/04/2010 500 @ Rs. 21

02/04/2010 1200 @ Rs. 1700
20.25 Rs.34800
03/04/2010 750 @ 950 Rs.19447

Rs.20.47
04/04/2010 600 @ 1550 @

Rs.21.75 Rs.32497
05/04/2010 700 @ 850 Rs.17820

Rs.20.9658

Bank Reconciliation statement
 A statement which is prepared to tally
the bank balance as per Cash book and
Bank book or Bank Statement
 Various reasons due to which there is
difference between two books such as
 Cheque issued not presented for payment
 Cheque deposited but not yet clear
 Interest , Commission , Bank charges
charged by bank not recorded in cash
book
 Human Errors
Topics for Today
 Revision
 Trial Balance – Meaning, Format,
Preparation etc.
 Financial Statements – Meaning, Parts
etc.

TRIAL BALANCE
 Meaning
 Is a list of balances of various ledger
accounts
 Prepared at the end of the year.
 Only ledger accounts with balances are
reflected in the trial balance
 Format

TRIAL BALANCE
Particulars L.F Debit Credit
Cash Account 12 2500
Plant and machinery 15 10700
Bank Loan 25 11600
Creditors 32 1600
Total 13200 13200

Backbone of Trail Balance
 All expenses and losses
Debit Balance
 All Income and gains

Credit Balance
 All assets Debit Balance
Credit balance
 All Liabilities & Capital
Prepare a Trial Balance
Capital 125000 Rent & taxes 12500
Furniture 45000 Purchases 85000
Return inward 1250 Return Outward 1465
Courier Charges 1485 Opening stock 20355
Cash in hand 12879 Debtors 35121
Creditors 10265 Sales 110000
Bank Overdraft 12850 Salaries 27410
Bills receivable 20000 Bills Payable 1420

Answer
Particulars LF Debit Credit

Capital 125000
Furniture 45000
Return Inward 1250
Courier charges 1485
Cash In hand 12879
Creditors 10265
Bank Overdraft 12850
Bills Receivable 20000
Contd.
Particulars LF Debit Credit
Rent & taxes 12500
Purchases 85000
Return Outward 1465
Opening Stock 20355
Debtors 35121
Sales 110000
Salaries 27410
Bills Payable 1420
Total 261000 261000
FINANCIAL STATMENTS
 INCOME STATEMENT
 BALANCESHEET
POSITION REVENUE
STATEMENT STATEMENT
STATEMENT STATEMENT
SHOWING ASSETS SHOWS A
AND LIABILITIES COMPARISON
POSITION BETWEEN
INCOME &
EXPENSES

PARTS OF INCOME
STATEMENT
HIGHLIGHTS THE NET RESULT
HIGHLIGHTS THE OF AN ORGANISATION AT THE
TRADING RESULTS OF END OF A YEAR CALLED
AN ORGANISATION NET PROFIT OR NET LOSS
CALLED
GROSS PROFIT OR
GROSS LOSS
 PROFIT & LOSS ACCOUNT

 TRADING ACCOUNT

Format Trading Account for the year ending
31.03.2010
Particulars Amount Particulars Amount
To Opening Stock ****** By Net Sales ******
To Net Purchases ****** By Closing stock ******
To Wages ******
To Carriage ******
Inward
To Gross Profit ******
C/d.
Total ******* Total *******

Question
 From the following details prepare Trading Account.
Sales Return 200 Purchases 240000

Opening 25000 Wages 21000
Stock
Sales 300200 Carriage 900
Inward
Insurance 3000 Bad debts 800
recovered
CLOSING STOCK COST PRICE Rs.20000, MARKET VALUE RS.22000

Answer
To Opening Stock 25000 By Sales 300000

Less: Returns
To Purchase 240000 By Closing stock 20000
Less: Returns
To Wages 21000
To Carriage 900
Inward
To Gross Profit 33100
c/d.
Total 320000 Total 320000

Profit & Loss account for the
Format year ending 31.03.2010
To Indirect By Gross Profit ******

Expenses - B/d.
Salaries ***** By Discount *****
Received
Advertisement ***** By Dividend *****
Recd.
Postage & Courier *****
Printing & *****

Stationery
Depreciation *****
To Net Profit C/d. *****
Total ***** Total *****

Question
Rent & Taxes 4000 Insurance 3000
Bad debts 800 Commission 4000

recovered received
Interest 1500 Salaries 7500
received
Advertisement 3500 Postage, 2250
Courier
Internet 2450 Discount 225
expenses Allowed
PROVIDE DEPRECIATION ON MACHINERY RS.25000 @ 10% P.A.

Answer
To Rent & Taxes 4000 By Gross Profit 33100
To Insurance 3000 By Bad Debts 800

Recovered
To Salaries 7500 By Commission 4000
To Advertisement 3500 By Interest Recd. 1500
To Postage & 2250
courier
To Internet Exp. 2450
To Discount 225
allowed
To Depreciation 2500
To Net Profit c/d. 13975


Format
Liabilities Amount Assets Amount
Capital Account **** Fixed Assets - ****
Bank Loan or **** Plant & machinery ****
overdraft Less – Depreciation
Sundry Creditors **** Furniture & fixture ****
Less – Depreciation
Bills payable **** Land & Building ****
Less – Depreciation
Outstanding **** Investments ****
Expenses
Current assets - ****
Sundry Debtors ****
Cash & Bank ****
balance
Total ***** Total *****

Question
Cash in Hand 4975 Capital 200000
Sundry 110000 Bills payable 40000

Debtors
Plant & 25000 Sundry 48000
Machinery Creditors
Furniture 40000 Bank Overdraft 22500
Bills 30000
Receivable
Advance Tax 95500

Answer
Capital 200000 Plant & Machinery 25000

Add: Net Profit 12475 Less: Depreciation
(2500)
Bank Overdraft 22500 Furniture 40000
Sundry Creditors 48000 Sundry Debtors 110000
Bills Payable 40000 Bills Receivable 30000
Cash In Hand 4975
Closing Stock 20000
Advance Tax 95500

Certain Terms
 Shares , Debentures, Bonds
 Equity & Preference Shares
 Authorized Capital, Paid Up Capital etc
 Partly Paid up Shares, Fully Paid up etc
 Bonus Share
 Reserves & Surplus
 Secured & Unsecured Loan

A Typical Manufacturing Company
Starts Operation
Two promoters deposit Rs 5 lakhs in the company account as
equity
XYZ Private Limited

Balance Sheet at April 1, 2006
Equity 5,00,000 Cash 5,00,000

Total 5,00,000 Total 5,00,000

A Machine is bought on cash basis
Owner pays Rs 3 lakhs from the bank acount
Equity 5,00,000 Cash 2,00,000
Plant 3,00,000
Total 5,00,000 Total 5,00,000

Raw material worth Rs 80,000
bought on a 60 day credit basis
No payment is done so cash position does not change
Equity 5,00,000 Cash 2,00,000
Plant 3,00,000
Account 80,000 Inventory 80,000
Payable
Total 5,80,000 Total 5,80,000

Raw material worth Rs 40,000 processed and sold
for Rs 50,000 with a 30 day credit
No payment is done so cash position does not

change, but inventory is reduced
Equity 5,00,000 Cash 2,00,000

Accounts Payable 80,000 Plant 3,00,000
Inventory 40,000
Retained Earnings 10,000 Accounts 50,000
receivable
Total 5,90,000 Total 5,90,000
Customer pays up after 20 days
Payment deposited in bank so cash position changes
Equity 5,00,000 Cash 2,50,000

Retained Earnings 10,000 Inventory 40,000
Accounts 00,000
receivable
Total 5,90,000 Total 5,90,000

Supplier credit period is over and raw material is paid
for after 60 days
Payment done from bank so cash balance reduces
Equity 5,00,000 Cash 1,70,000

Retained Earnings 10,000 Inventory 40,000
Accounts 00,000
receivable
Total 5,10,000 Total 5,10,000

A new promoter buys 10,000 shares of Rs 10 face value
at a premium of Rs 20
Payment done to bank so cash balance increases

Equity 6,00,000 Cash 4,70,000
Retained 10,000 Accounts receivable 00,000
Earnings
Share Premium 2,00,000 Plant 3,00,000
a/c
Accounts payable 00,000 Inventory 40,000
Total 8,10,000 Total 8,10,000
Topics for Today
 Introduction to financial Management
 Financial Analysis
 Ratio Analysis
 Cash Flow

MEANING
 “CASH IS KING”
 F.M- MANAGEMENT OF CASH
 WHY ONE SHOULD MANAGE CASH?
 HOW ONE SHOULD DO SO?
 WHAT AMOUNT OF FINANCING IS
REQUIRED FOR THE FIRM?
 HOW SHOULD THE REQUIRED
FINANCING BE RAISED?

CONTD..
 WHAT INVESTMENTS SHOULD THE FIRM

MAKE?
 HOW CAN THE FINANCIAL DECESIONS
HELP TO ADD VALUE TO THE FIRM AND
ITS SHAREHOLDERS?

KEY CONCEPTS RELATED
TO F.M
 ASSESSMENT OF CURRENT
BUSINESS – FINANCIAL ANALYSIS
 ASSESSMENT OF FUTURE
FINANCING REQUIREMENTS –
FINANCIAL PROJECTIONS

CONTD..
 ISSUES RELATED TO LONG TERM

FINANCING DECISION – COST OF
CAPITAL , CAPITAL BUDGETING
AND STRUCTURE DECISIONS
 ISSUED RELATED TO
INVESTMENTS

Financial Statement Analysis
 Meaning
 Is the process of evaluating the
relationship between components/ parts of
financial statements
 Objective is to obtain a better
understanding of the firm’s position and
performance.

DIFFERENT TOOLS USED FOR
FINANACIAL ANALYSIS
 RATIO ANALYSIS
 CASH FLOW & FUND FLOW

ANALYSIS

RATIO ANALYSIS
 It is a systematic use of ratios to interpret/

assess the performance and status of the firm

MEANING - RATIO
 Ratio is a comparison between two

variable
 It may be presented in the form of % or

times or :

TYPES OF RATIOS
 Liquidity ratios
 Capital Structure ratios
 Profitability ratios
 Activity ratios

LIQUIDITY RATIOS
 Is the ability of a firm  Types

to satisfy its short  Current ratio
term obligations as  Quick Ratio/ Acid
they become due. Test

CURRENT RATIO
 Is a measure of liquidity calculated by

dividing current assets by current
liabilities
 Formula : Current Assets / Current

Liabilities

QUICK / ACID TEST RATIO
 Is a measure of liquidity calculated

dividing current assets minus inventory
and prepaid expenses by current
liabilities
 Formula: C. assets- Stock & prepaid

exp./ C. Liabilities

CAPITAL STRUCTURE
RATIOS
 Ratios that throws light on the long term
solvency of the firm
 is reflected in its ability to assure the
long term lenders with regard to payment
of the interest and repayment of principal
on maturity.
 Two types-
 For ability to repay the principal
 For regular repayment of interest

Contd.
 Ability to repay  Regular repayment

principal of interest- Coverage
ratio
 Debt Equity Ratio  Interest coverage
ratio
 Proprietary Ratio  Dividend coverage
ratio
 Debt service
capacity

DEBT-EQUITY RATIO
 Measures the ratio of long term or total
debt to shareholders equity.
 Formula: Long term debt / Shareholder’s
Equity or Total debts / Shareholder’s
equity
 Total debts = long term debts + current
liabilities
 Shareholder’s equity = Equity,
Preference Share Capital & Reserves
less Miscellaneous Expenses.
Contd.
 Imp. From the point of view of creditors,

owners and the firm
 High ratio= more share of financing by
the creditors
 Low ratio = less share of financing by the
creditors
 Ratio say is 1:2 means for every rupee
of the creditors the firm has two rupees
of owners.

Contd.
 For firm a high ratio is not good as that may

lead to interference from the creditors in
management due to high stake
 For the shareholders a high ratio is good or a
gain as
 Their investment is low or limited but they can
retain the control
 The returns to them can be magnified. (trading
on equity)

PROPRIETORY RATIO
 Indicates the extent to which assets are

financed by owners funds.
 Formula: Proprietor’s fund / Total assets
*100
 Proprietor’s fund = Equity capital +
Preference capital + Reserves & surplus

COVERAGE RATIO
 Measure the firm’s ability to pay certain

fixed charges.

INTEREST COVERAGE ( TIME
INTEREST EARNED ) RATIO
 Measures the firm’s ability to make

contractual interest payments.
 Interest is a charge on profits
 Formula: EBIT / Interest

DIVIDEND COVERAGE
RATIO
 The ability of the firm to pay dividend on
preference shares
 Preference dividend = appropriation of
profits
 Formula: EAT / Preference Dividend

DEBT SERVICE CAPACITY
 Is the ability of a firm to make the

contractual payments required on a
scheduled basis over the life of the debt
 Formula: EAT+ Interest+ Depreciation+
other non- cash expenditure / installment

PROFITABILITY RATIOS
 Are designed to provide answers to questions

such as
 Is the profit earned by the firm adequate?
 What rate of return does it represent?
 What is the rate of profit for the various segments
of the firm?
 What are the earnings per share?
 What was the amount paid in dividends?
 What is the rate of return to equity- holders?

GROSS PROFIT MARGIN
 Measures the percentage of each sales

rupee remaining after the firm has paid
for its goods
 Formula: Gross profit / Net sales * 100

NET PROFIT MARGIN
 Measures the percentage of each sales

rupee remaining after all costs and
expenses including interest and taxes
have been deducted
 Three Types
 Operating profit ratio
 Pre tax profit ratio
 Net profit ratio

Contd.
 Formula:
 Operating profit ratio = EBIDT/ Net Sales
 Pre tax profit ratio = EBT / Net Sales
 Net Profit ratio = EAT / Net Sales

RETURN ON INVESTMENTS
(ROI)
 Measures the overall effectiveness of
management in generating profits with
its available assets.
 Three types
 Return on assets (ROA)
 Return on capital employed (ROCE)
 Return on shareholder’s Equity

RETURN ON ASSETS
 Relationship between net profits and

assets.
 Profit to asset ratio
 Formula: EAT + (Interest- tax on interest)
/ average total assets
 Interest is considered as the assets are
financed by both owner’s fund as well as
borrower’s fund.

RETURN ON CAPITAL
EMPLOYED
 Profits are related to capital employed
and not with assets.
 Capital employed is equal to owner’s
fund and borrowed funds (long term
funds supplied by lenders)
 Formula: EBIDT / Total capital employed
* 100

RETURN ON SHARHOLDER’S
EQUITY
 Measures the return on the owners (both
pref. and equity shareholders)
investment in the firm.
 Two types
 Return on shareholder’s equity
 Return on ordinary shareholder’s equity

Contd.
 Return on total shareholder’s equity reveals

how profitably the owner’s fund have been
utilized by the firm.
 Formula: Net profit after taxes / shareholder’s
equity * 100
 Shareholder’s equity = Entire share capital +
reserves and surplus – accumulated losses

RETURN ON ORDINARY
SHARHOLDER’S EQUITY
 Ordinary shareholders = Equity
shareholders
 Indicates whether the firm has earned a
satisfactory return for its equity holder’s
or not.
 Formula: (NPAT – Pref. Dividend) /
ordinary shareholder’s equity

EARNINGS PER SHARE
(EPS)
 Measures the profit available to the
equity shareholders on a per share
basis.
 Formula: Net profit available to equity-
holders / no. of equity shares
outstanding

DIVIDEND PER SHARE
 Dividend paid to the equity shareholders

per share
 Formula: dividend paid to ordinary
shareholders / no. of shares outstanding

DIVIDEND PAYOUT RATIO
(D/P)
 Measure the proportion of dividends paid
to earning available to shareholders
 Formula : dividend paid to holders / total

net profit belonging to equity-holders

PRICE/EARNINGS RATIO
(P/E)
 Measures the amount investors are
willing to pay for each rupee of earnings;
the higher the ratio , the larger the
investors confidence in the firm’s future.

ACTIVITY RATIOS
 Measure the speed with which various

accounts/assets are converted into sales
or cash

INVENTORY/ STOCK
TURNOVER
 Measures the activity/liquidity of
inventory of a firm; the speed with which
inventory is sold.
 Formula: COGS / Average inventory

DEBTOR’S TURNOVEER
RATIO
 Is the average amount of time needed to
collect accounts receivable
 Shows how quickly debtors are
converted into cash.
 Two ways of calculation
 Debtors turnover = Credit Sales / (Debtors
+ B.R.)
 Average collection period = days / months
in a year / debtors turnover ratio

CREDITOR’S TURNOVER
RATIO
 Is the average amount of time needed to
pay accounts payable
 Creditor’s Turnover ratio = Credit
Purchase / (Creditors + Bills payable)

Topics for Today
 Introduction to Cost Accounting
 Meaning
 Different Elements of Cost
 Classification of Cost
 Cost Sheet

INTRODUCTION
Financial Management
Accounting Accounting
Cost Accounting

MEANING & OBJECTS
 The Amount of Expenditure attributable to

a given thing.
 To Know the cost of a product , to

evaluate the cost of a product , to control
the cost and to determine the selling price
or profit of a product.

CLASSIFICATION
 Element-wise classification
 Functional classification
 Classification based on Cost Behavior

Cost Sheet
 Prime Cost
 Factory Cost
 Cost of Production
 Cost of goods sold
 Cost of Sales
Format
Particulars Amount Amount
Opening Stock – Raw ****
Material
Add: Purchase of Raw ****
Material
Less: closing Stock – ****
Raw Material
Total Raw Material ****
Add: Direct labour ****
Add: Direct Expenses ****
Prime Cost ****
Contd.
Add: Factory Overheads ****
Add: opening Stock - ****

WIP
Less: Closing stock - ****
WIP
Factory Cost ****
Add: Office & ****
Administration O/H.
Cost Of Production ****

Contd.
Add: Opening Stock – ****
Finished Goods
Less: Closing stock – ****
Finished Goods
Cost of Goods Sold *****
Add: Selling & *****

distribution O/H.
Cost of Sales *****
Add: Profit *****
Sales *****
Topics for Today
 Marginal Costing

Marginal Costing
 Marginal Costing is an important tool for decision

making.
 Definition
 Marginal cost is the change in total cost for the
change in activity by one unit.
 In actual cost, Marginal cost = Variable cost.
 Therefore, Marginal Costing is a decision making

technique by use of calculation of marginal costs.

Contd.
 Marginal costing involves ascertaining marginal costs.

Since marginal costs are direct cost, this costing
technique is also known as direct costing;
 In marginal costing, fixed costs are never charged to
production.
 Once marginal cost is ascertained contribution can be
computed. Contribution is the excess of revenue over
marginal costs.
 The marginal cost statement is the basic
document/format to capture the marginal costs.

Contd.
 Features of Marginal Costing System:

 It is a method of recording costs and reporting profits;
 All operating costs are differentiated into fixed and
variable costs;
 Variable cost are charged to product and treated as a
product cost while
 Fixed cost treated as period cost and written off to the
profit and loss account

Contd.
 Advantages of Marginal Costing:

 It is simple to understand re: variable versus fixed cost
concept;
 A useful short term survival costing technique particularly
in very competitive environment or recessions where
orders are accepted as long as it covers the marginal
cost of the business and the excess over the marginal
cost contributes toward fixed costs so that losses are
kept to a minimum;
 Its shows the relationship between cost, price and
volume;

Contd.
 Under or over absorption do not arise in marginal

costing;
 Stock valuations are not distorted with present years
fixed costs;
 Its provide better information hence is a useful
managerial decision making tool;
 It concentrates on the controllable aspects of business
by separating fixed and variable costs
 The effect of production and sales policies is more
clearly seen and understood.

Contd.
 Disadvantages Of Marginal Costing

 Marginal cost has its limitation since it makes use of
historical data while decisions by management relates
to future events;
 It ignores fixed costs to products as if they are not
important to production;
 Stock valuation under this type of costing is not
accepted by the Inland Revenue as it ignore the fixed
cost element;
 It fails to recognize that in the long run, fixed costs may
become variable;

Contd.
 Its oversimplified costs into fixed and variable as if it

is so simply to demarcate them;
 Its not a good costing technique in the long run for
pricing decision as it ignores fixed cost. In the long
run, management must consider the total costs not
only the variable portion;
 Difficulty to classify properly variable and fixed cost
perfectly, hence stock valuation can be distorted if
fixed cost is classify as variable.

Contd
 Marginal Cost Table

 Total Sales X XX
(-) Variable Cost X XX
Contribution X XX
(-) Fixed Costs X XX
Profits/Loss X XX
 Total Sales 100000
(-) Variable Cost 60000
Contribution 40000
(-) Fixed Costs 30000
Profits/Loss 10000
Contd.
 Contribution = Difference in sales and

variable cost at any level.
= Sales – variable cost
= Qty x (SP) – Qty (Variable cost per unit)
= Qty x (SP – variable cost per unit)
 PV Ratio = Profit Volume Ratio
= Contribution/Sales *100
Note – Contribution and sales should always
be taken for the same activity level.

Contd.
 PV Ratio does not change due to

(a) Qty
(b) Fixed Costs
(c) Change in both in same proportion
 PV Ratio changes when
(a) Selling Price is Changed (Sales are affected due
to change in SP. Thus denominator in the ratio
changes)
(b) Variable Cost changes (Numerator changes due
to change in Variable cost)
(c) Change in both at differential proportion.

Contd.
 Break Even Point – The production level at

which there is no profit or loss.
 Contribution at BEP = Fixed Costs
 Break Even Qty = Fixed cost/Contribution per

unit
 Margin of Safety = Actual level – BEP

Contd.
 Q1. X ltd sells product P having SP of Rs 150 and

variable cost/per unit of Rs 60. The fixed cost for year
is 3,60,000 and the total sales Rs 12 lakhs.
(a) Calculate
(i) PV Ratio
(ii) BEP (in Qty and Sales Value)
(iii) Margin of Safety
(iv) Profit at present level
 (b) Calculate profit or loss if activity is 950 units
 (c) Find out how the activity for
(i) How many units to be sold for a profit of Rs. 90000

Contd.
 Sol: - (a)
Sales = 1200000/150 = 8000 Units
Fixed Cost per unit = 360000/8000 = 45
Contribution = SP – Variable Cost
= 150 – 60 = 90
Table
Per Unit Total
 Sales 150 1200000
(-) Variable cost 60 480000
Contribution 90 720000
(-) Fixed Costs 45 360000
Profits 45 360000
 (i) PV Ratio = Contribution /Sales
= 90/150
= 0.60

Contd.
 (ii) BEP à Contribution = Fixed Cost
(90 x BEP) = 360000
BEP = 360000/90
BEP = 4000 units
= 150x4000 = Rs 600000
 (iii) Margin of Safety à Actual Level – BEP
8000 – 4000 = 4000
1200000 – 600000 = 600000
 (iv) Profit at present level à Profit = (SP-Fixed Cost –
Var Costs)x Qty
= (150 – 45 – 60) x 8000
= 45 x 8000
= 360000

Contd.
 (b) Profit or loss if activity is 950 units

Contribution per unit = 90
Total contribution = Contribution per unit x total units
90 x 950 = 85000
Loss = Fixed cost – contribution
= 360000 – 85000= 274000
 Profit or loss for sales of Rs 450000
Total Contribution = PV Ratio x Sales
= 0.60 x 450000
= 270000
Loss = Fixed cost – contribution
Loss = 360000 – 270000
= 90000

Contd.
 (c) (i) Activity for profit of Rs 90000

Total Contribution = Profit + Fixed Costs
= 90000 + 360000
= 450000
Total contribution = No of units x contribution per
unit
450000 = 90 x X
X = 5000

Contd.
 Q.The management is expecting an

increase of Rs 60000 in fixed costs with
the decrease in selling price by 20% and
decrease in Variable cost/unit by 10%.
Calculate what would be change in
profit/loss. ( Consider the basic data from
the sum above)

 Sol: -
Sales (unit SP) = 120
(-) Var Costs = 54
Contribution = 66 528000
(-) Fixed Costs= 420000
Profit (New) 108000
Profit (Old) 360000
Change in profit 252000
 The new Selling Price = 150 –30 = 120

The new Variable Cost = Rs 60 – 6 = Rs 54

Contd.
 New contribution per unit = New SP – New Variable

Cost
= 120 – 54 = 66
No of units sold earlier = Earlier Sales/Earlier SP
= 1200000/150 = 8000
Total Contribution = 8000 x 66 = 528000
New fixed cost = 360000 +60000 = 420000
New profit = New cost – New Fixed Cost
= 528000 – 420000
= 108000
Reduction in profit = Earlier profit – new profit
= 360000 – 108000
= 252000

Contd.
 Q. Under the new circumstances the

management wants to achieve same sales
value. How much would be the effect on
profits?

Answer
 Sol. Sales Qty = Sales Value/SP per unit
= 1200000/120 = 10000 Units
Total Contribution = Contribution per unit x no
of units
= 66 x 10000
= 660000
New Profit = New Contribution – New fixed
costs
= 660000 – 420000
= 240000
Reduction in profits = Old Profit – New Profit
= 360000 – 240000
= 120000

Contd.
 Q. How much should be the sales level under the

changed circumstances to earn the same profit as
before?
 Desired Contribution = Desired Profit + New fixed cost

= 360000 + 420000
= 780000
No of units = 780000/66
= 11819
Sales Value = No of units x SP
= 11810 x 120
= 1418280

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INTRODUCTION TO

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 Means basic rules & regulations

BUSINESS HAS A LONG ,

EVERY THING OF BUSINESS HAS TWO

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Expenses are recognized in the same

Accounts only deal with items

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 Cost An asset is entered into the

The idea that income and expense items must

Revenue recognized only when it is

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Be consistent = no change in method

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 Received cash Rs.500 from Mr. A

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 Cash is a real account

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Date PARTICULARS L.F. DEBIT CREDIT

Cash A/c. Dr 05 1500

Rent A/c. Dr 15 850

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Means something that does not belongs

Investment made by the owner in the

Money or any thing withdrawn by owner

Means the product in which the business

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Assets the value of which keeps

Liabilities the value of which

Liabilities that remains with us for

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D Particulars J. Amt D Particulars J Amt

2010 By Balance C/d. 650

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For recording credit purchase

For recording credit sales of goods

 Sales Return Book For recording return inwards

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For recording Bills

For recording Bills payable

For recording any other

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To Opening Stock By Net Sales

To Net Purchases By Closing stock

Total * Total *