1.

Management Accounting
Management or managerial accounting is used by managers to make decisions concerning the day-to-day
operations of a business. It is based not on past performance, but on current and future trends, which does not
allow for exact numbers. Because managers often have to make operation decisions in a short period of time in a
fluctuating environment, management accounting relies heavily on forecasting of markets and trends.
According to Anglo American Council on Productivity " Management accounting is the presentation of accounting
information in such a way to assist management in creation of policy and day to day operation of an undertaking."

3. There are 3 basic financial statements that exist in the area of Financial Management.
1. Balance Sheet.
2. Income Statement.
3. Cash Flow Statement.
4. Fund Flow Statement
The first two statements measure one aspect of performance of the business over a period of time. Cash flow statements signify the changes in
the cash and cash equivalents of the business due to the business operations in one time period . Funds flow statements report changes in a
business's working capital from its operations in a single time period, but have largely been superseded by cash flow statements.
A Cash Flow Statement is a statement showing changes in cash position of the firm from one period to another. It explains the inflows
(receipts) and outflows (disbursements) of cash over a period of time. The inflows of cash may occur from sale of goods, sale of assets, receipts
from debtors, interest, dividend, rent, issue of new shares and debentures, raising of loans, short-term borrowing, etc. The cash outflows may
occur on account of purchase of goods, purchase of assets, payment of loans loss on operations, payment of tax and dividend, etc.
A cash flow statement is different from a cash budget. A cash flow statement shows the cash inflows and outflows which have already taken
place during a past time period. On the other hand a cash budget shows cash inflows and outflows which are expected to take place during a
future time period. In other words, a cash budget is a projected cash flow statement.
Funds Flow Statement states the changes in the working capital of the business in relation to the operations in one time period.

The main components of Working Capital are:

Current Assets
1. Cash
2. Receivables
3. Inventory
Current Liabilities
1. Payables
Net working capital is the total change in the business's working capital, calculated as total change in current assets minus total
change in current liabilities.
Net Working Capital = Current Asset Current Liability
FOR EXAMPLE: If the inventory of the business increased from Rs 1,40,000 to Rs 1,60,000, then this increase of Rs 20,000 is the increase in
the working capital for the corresponding period and will be mentioned on the funds flow statement. But the same would not be reflected in the
cash flow statement as it does not involve cash.
So the Fund Flow Statement uses all the above four components and shows the change in them. While a cash flow statement only shows the
change in cash position of the business.
Cash flow statements have largely superseded funds flow statements as measurements of a business's liquidity because cash and cash
equivalents are more liquid than all other current assets included in working capital's calculation.

What is Included in a Cash Flow Statement?

The statement of cash flows uses information from the other two statements (Income Statement and Balance Sheet) to indicate cash inflows and
outflows.

A Cash Flow Statement comprises information on following 3 activities:

1. Operating Activities
2. Investing Activities
3. Financing Activities

1. Operating Activities: Operating activities include cash flows from all standard business
operations. Cash receipts from selling goods and services represent the inflows. The revenues from interest and dividends are also
included here. The operational expenditures are considered as outflows for this section. Although interest expenses fall under this section
but the dividends are not included .Dividends are considered as a part of financing activity in financial accounting terms.
2. Investing Activities: Investing activities include transactions with assets, marketable securities and credit instruments. The sale of property,
plant and equipment or marketable securities is a cash inflow. Purchasing property, plant and equipment or marketable securities are
considered as cash outflows. Loans made to borrowers for long-term use is another cash outflow. Collections from these loans, however,
are cash inflows.
3. Financing Activities: Financing activities on the statement of cash flows are much more defined in nature. The receipts come from
borrowing money or issuing stock. The outflows occur when a company repays loans, purchases treasury stock or pays dividends to
stockholders. As the case with other activities on the statement of cash flows depend on activities rather than actual general ledger
accounts.

Table of Difference between Funds Flow Statement and Cash Flow Statement
Basis of
Difference

Funds Flow Statement

Cash Flow Statement

1.

Basis
Analysis

of Funds flow statement is based on broader Cash flow statement is based on narrow concept i.e.
concept i.e. working capital.
cash, which is only one of the elements of working
capital.

2.

Source

Funds flow statement tells about the various Cash flow statement stars with the opening balance of
sources from where the funds generated with cash and reaches to the closing balance of cash by
various uses to which they are put.
proceeding through sources and uses.

3.

Usage

Funds flow statement is more useful in Cash flow statement is useful in understanding the
assessing the long-range financial strategy.
short-term phenomena affecting the liquidity of the
business.

4.

Schedule
of In funds flow statement changes in current In cash flow statement changes in current assets and
Changes
in assets and current liabilities are shown through current liabilities are shown in the cash flow statement
Working Capital the schedule of changes in working capital.
itself.

5.

End Result

Funds flow statement shows the causes of Cash flow statement shows the causes the changes in

changes in net working capital.

6.

Principal
Accounting

cash.

of Funds flow statement is in alignment with the In cash flow statement data obtained on accrual basis
accrual basis of accounting.
are converted into cash basis.

4. Classification is the process of grouping costs according to their common characteristics or features. There are

various methods of classifying costs on the basis of requirements.The following are the important bases on which
costs are classified :
a) On the basis of Nature (or) Elements.
b) On the basis of Function
c) On the basis of Variability.
d) On the basis of Normality.
e) On the basis of Controllability and Decision Making.

The following chart can explain further the classifications cost:

1) On the basis of Nature or Elements: One of the important classification cost is on the basis of nature or
elements. Based on elements, it is classified into Material Cost, Labour Cost and Other Expenses. They can be
further subdivided into Direct and Indirect Material Cost, Direct and Indirect Labour Cost and Direct and Indirect
Other Expenses.
2) On the basis of Function: The classification of costs on the basis of the various functions of a concern is known
as function-wise classification. Here, there are four important functional divisions in the business organization. viz.
(a) Production Cost (b) Administration Cost (c) Selling Cost and (d) Distribution Cost.
3) On the basis of Variability : On the basis of variability with the volume of production cost is classified into Fixed
Cost, Variable Cost and Semi Variable Cost. Fixed Costs are those costs which remain constant with the volume of
production. Rent and rates of office and factory building are some example of fixed cost.
Variable costs are those costs incurred directly with the volume of output. For example, cost of materials and
wages to workers are the expenses chargeable with direct proportion to the volume of production.
Semi-Variable Costs are those costs incurred partly fixed and partly variable, with the volume of production.
Accordingly, it has both fixed and variable features. For example, depreciations and maintenance cost of plant and
machinery.
4) On the basis of Normality: Costs are classified into normal costs and abnormal costs on the basis of normality
features. Normal costs are those incurred normally within the target output or fixed plan.
5) On the basis of Controllability and Decision Making: Based on the managerial decision making and
controllability the classifications are as follows: (a) Controllable Cost, (b) Uncontrollable Cost, (c) Sunk Cost, (d)
Opportunity Cost, (e) Replacement Cost, (f) Conversion Cost.
a) Controllable Costs : Controllable Costs are the costs which can be influenced by the action of a specified
number of an undertaking. Controllable Costs incurred in a particular responsibility centre which is influenced by
the action of the executive heading. For example, direct materials and indirect materials.

b) Uncontrollable Costs: Uncontrollable Costs are those costs which cannot be influenced by the action of a
specified number of an undertaking. In fact, no cost is controllable; it is only in relation to a particular individual
that may specify a particular cost to either controllable or non-controllable. For example, rent and rates.
c) Sunk cost : These are historical costs which were incurred in the past and are not relevant to the particular
decision making problem being considered. While considering the replacement of a plant, the depreciated bookvalue of the old asset is irrelevant as the amount is a sunk cost which is to be written-off at the time of
replacement. Unlike incremental or decremental costs, sunk costs are not affected by increase or decrease of
volume. Examples of sunk cost include dedicated fixed assets, development cost already incurred.
d) Opportunity Cost: Opportunity cost means the cost of forgoing or giving up an opportunity. It is the notional
value of going without the next best use of time, effort and money. These indicate the income or potential
benefits sacrificed because a certain course of action has been taken. An example of opportunity costs is the
market value forgone or sacrificed when an old machine is being used.
e) Replacement Cost: Such expenses may be incurred due to factors like change in method of production, an
addition or alteration in the factory building, change in flow of production etc. All such expenses are treated as
production overheads; when amount of such expenses is large, it may be spread over a period of time.
f) Conversion Cost: Conversion costs are those costs which are incurred while converting materials into semifinished or finished goods. It is the aggregate of direct wages, direct expenses and overhead costs of converting
raw materials into finished products.
5. a. Break-even analysis is a technique widely used by production management and management accountants.
It is based on categorising production costs between those which are "variable" (costs that change when the
production output changes) and those that are "fixed" (costs not directly related to the volume of production).
Total variable and fixed costs are compared with sales revenue in order to determine the level of sales volume,
sales value or production at which the business makes neither a profit nor a loss (the "break-even
point").
The Break-Even Chart
In its simplest form, the break-even chart is a graphical representation of costs at various levels of activity shown
on the same chart as the variation of income (or sales, revenue) with the same variation in activity. The point at
which neither profit nor loss is made is known as the "break-even point" and is represented on the chart below by
the intersection of the two lines:

In the diagram above, the line OA represents the variation of income at varying levels of production activity
("output"). OB represents the total fixed costs in the business. As output increases, variable costs are incurred,
meaning that total costs (fixed + variable) also increase. At low levels of output, Costs are greater than Income. At
the point of intersection, P, costs are exactly equal to income, and hence neither profit nor loss is made.
Fixed Costs
Fixed costs are those business costs that are not directly related to the level of production or output. In other
words, even if the business has a zero output or high output, the level of fixed costs will remain broadly the same.
In the long term fixed costs can alter - perhaps as a result of investment in production capacity (e.g. adding a new
factory unit) or through the growth in overheads required to support a larger, more complex business.
Examples of fixed costs:
- Rent and rates
- Depreciation
- Research and development
- Marketing costs (non- revenue related)
- Administration costs
Variable Costs
Variable costs are those costs which vary directly with the level of output. They represent payment output-related
inputs such as raw materials, direct labour, fuel and revenue-related costs such as commission.
A distinction is often made between "Direct" variable costs and "Indirect" variable costs.
Direct variable costs are those which can be directly attributable to the production of a particular product or
service and allocated to a particular cost centre. Raw materials and the wages those working on the production
line are good examples.
Indirect variable costs cannot be directly attributable to production but they do vary with output. These include
depreciation (where it is calculated related to output - e.g. machine hours), maintenance and certain labour costs.
Semi-Variable Costs
Whilst the distinction between fixed and variable costs is a convenient way of categorising business costs, in
reality there are some costs which are fixed in nature but which increase when output reaches certain levels.
These are largely related to the overall "scale" and/or complexity of the business. For example, when a business
has relatively low levels of output or sales, it may not require costs associated with functions such as human
resource management or a fully-resourced finance department. However, as the scale of the business grows (e.g.
output, number people employed, number and complexity of transactions) then more resources are required. If
production rises suddenly then some short-term increase in warehousing and/or transport may be required. In
these circumstances, we say that part of the cost is variable and part fixed.

b. P/V Ratio: P/V Ratio (Profit Volume Ratio) is the ratio of contribution to sales which indicates the contribution
earned with respect to one rupee of sales. It also measures the rate of change of profit due to change in volume
of sales. Its fundamental property is that if per unit sales price and variable cost are constant then P/V Ratio will
be constant at all the levels of activities. A change is fixed cost does not affect P/V Ratio. It is calculated as under:

(Contribution * 100) / Sales

(Change in profits * 100) / (Change in sales)
A high P/V Ratio indicates that a slight increase in sales without increase in fixed costs will result in higher profits.
A low P/V ratio which indicates low profitability can be improved by increasing selling price, reducing marginal
costs or selling products having high P/V ratio.
Contribution:
It is the difference between sales revenue and variable cost (also known as variable cost). Variable cost is the
important cost in deciding profitability as fixed costs are ignored by marginal costing.
It can be expressed in two ways:
Sales Revenue Variable Cost
Fixed Cost + Profit
The situation generating higher contribution is treated as a profitable situation .