2015 (August)
COMMERCE
Paper: 103
(Cost and Management Accounting)
Full Marks – 80
Time – Three Hours
The figures in the margin indicate full marks for the questions.
1. (a) Define
‘Costing’ and ‘Cost accounting’. Describe the importance of cost accounting as
a managerial tool. 2+4+10=16
Ans: Introduction to Cost Accounting
Cost: The
term ‘cost’ has to be studied in relation to its purpose and conditions. As per
the definition by the Chartered Institute of Management Accountants (C.I.M.A.),
London ‘cost’ is the amount of actual expenditure incurred on a given thing.
Costing: The
C.I.M.A., London has defined costing as the ascertainment of costs. “It refers
to the techniques and processes of ascertaining costs and studies the
principles and rules concerning the determination of cost of products and
services”.
Cost
Accounting: It is the method of accounting for cost. The process of
recording and accounting for all the elements of cost is called cost
accounting. I.C.M.A. has defined cost accounting as follows: “The process of
accounting for cost from the point at which expenditure is incurred or
committed to the establishment of its ultimate relationship with cost centers
and cost units. In its widest usage it embraces the preparation of statistical
data, the application of cost control methods and the ascertainment of the
profitability of activities carried out or planned”.
Cost
Accountancy: The term ‘Cost Accountancy’ includes Costing and Cost
accounting. Its purposes are Cost-control and Profitability – ascertainment. It
serves as an essential tool of the management for decision-making.
I.C.M.A., has defined cost accountancy
as follows: “The application of costing and cost accounting principles, methods
and techniques to the science, art and practice of cost control and the
ascertainment of profitability. It includes the presentation of information
derived there from for the purpose of managerial decision making”.
Advantages of Cost Accounting (Aid to
Management)
a)
Helps in Decision Making: Cost accounting
helps in decision making. It provides vital information necessary for decision
making. For instance, cost accounting helps in deciding:
1.
Whether to make a product buy a product?
2.
Whether to accept or reject an export order?
3.
How to utilize the scarce materials
profitably?
b)
Helps in fixing prices: Cost accounting
helps in fixing prices. It provides detailed cost data of each product (both on
the aggregate and unit basis) which enables fixation of selling price. Cost
accounting provides basis information for the preparation of tenders, estimates
and quotations.
c)
Formulation of future plans: Cost
accounting is not a post-mortem examination. It is a system of foresight. On
the basis of past experience, it helps in the formulation of definite future
plans in quantitative terms. Budgets are prepared and they give direction to the
enterprise.
d)
Avoidance of wastage: Cost accounting
reveals the sources of losses or inefficiencies such as spoilage, leakage,
pilferage, inadequate utilization of plant etc. By appropriate control
measures, these wastages can be avoided or minimized.
e)
Highlights causes: The exact cause of an
increase or decrease in profit or loss can be found with the aid of cost
accounting. For instance, it is possible for the management to know whether the
profits have decreased due to an increase in labour cost or material cost or
both.
f)
Reward to efficiency: Cost accounting
introduces bonus plans and incentive wage systems to suit the needs of the
organization. These plans and systems reward efficient workers and improve
productivity as well improve the morale of the work -force.
g)
Prevention of frauds: Cost accounting
envisages sound systems of inventory control, budgetary control and standard
costing. Scope for manipulation and fraud is minimized.
h)
Improvement in profitability: Cost
accounting reveals unprofitable products and activities. Management can drop
those products and eliminate unprofitable activities. The resources released
from unprofitable products can be used to improve the profitability of the
business.
i)
Preparation of final accounts: Cost
accounting provides for perpetual inventory system. It helps in the preparation
of interim profit and loss account and balance sheet without physical stock
verification.
j)
Facilitates control: Cost accounting
includes effective tools such as inventory control, budgetary control and variance
analysis. By adopting them, the management can notice the deviation from the
plans. Remedial action can be taken quickly.
Or
(b) Describe the benefits and
limitations of Activity-based costing. 8+8=16
2. (a) (i)
Distinguish between Job costing and Process costing 8
Ans: Difference
between Job costing and Process Costing
Basis of distinction
|
Job Costing
|
Process Costing
|
Basic
|
Job
costing is used when the cost object is an individual (or a lot/batch) unit
or a distinct product or service.
|
Process
Costing is generally used for a mass of identical product or service.
|
Accumulation
of Cost
|
Costs
can be accumulated by each individual product or service.
|
The
Costs are accumulated in a period. The total costs in a period are divided
over the number of units to get an average unit cost.
|
Cost
Determination
|
Job
costing is done against a specific order being produced.
|
Costs
are compiled for each process over a period of time.
|
Cost
Calculation
|
Costs
are calculated when a job is over.
|
Costs
are calculated at the end of a cost period like an accounting year.
|
Transfer
|
There
are usually no transfers of costs from one job to another.
|
Transfer
of costs from one process to another is made as the product moves from one
process to the other.
|
Forms
and Details
|
There is
more paper work.
|
It has
lesser paper work.
|
Inventory
|
There is
little or no inventory.
|
There is
regular and significant inventory.
|
Mechanization
|
It is
less amenable to mechanization & automation.
|
It is
more amenable to mechanization & automation.
|
(ii) The following data relate to
a manufacturing concern:
Production
Cost of production
Normal loss
Actual loss
Scrap value
|
= 1,000 units
= Rs. 1,850
= 10% of production
= 150 units
= Re. 0.50 per unit
|
Prepare
Process Account and Abnormal Loss Account 8
(b) Why it is
necessary for reconciliation of cost and financial accounts? State the reasons
for differences between profits shown by both the sets of accounts. 6+10=16
Ans: Meaning
of Reconciliation of Cost and Financial Accounts
When
cost accounts and financial accounts are maintained in two different sets of
books, there will be prepared two profit and loss accounts - one for costing
books and the other for financial books. The profit or loss shown by costing
books may not agree with that shown by financial books. Such a system is termed
as, ‘Non-Integral System’ whereas under the integral system of accounting,
there are no separate cost and financial accounts. Consequently, the problem of
reconciliation does not arise under the integral system.
However,
where two sets of accounting systems, namely, financial accounting and cost accounting
are being maintained, the profit shown by the two sets of accounts may not
agree with each other. Although both deal with the same basic transactions like
purchases consumption of materials, wages and other expenses, the difference of
purpose leads to a difference in approach in a collection, analysis and
presentation of data to meet the objective of the individual system.
Financial
accounts are concerned with the ascertainment of profit or loss for the whole operation
of the organisation for a relatively long period, usually a year, without being
too much concerned with cost computation, whereas cost accounts are concerned
with the ascertainment of profit or loss made by manufacturing divisions or
products for cost comparison and preparation and use of a variety of cost
statements. The difference in purpose and approach generally results in a
different profit figure from what is disclosed by the financial accounts and
thus arises the need for the reconciliation of profit figures given by the cost
accounts and financial accounts.
The reconciliation of the profit
figures of the two sets of books is necessary due to the following reasons
a)
It helps to identity the reasons for the
difference in the profit or loss shown by cost and financial accounts.
b)
It ensures the arithmetical accuracy and
reliability of cost accounts.
c)
It contributes to the standardization of
policies regarding stock valuation, depreciation and overheads.
d)
Reconciliation helps the management in
exercising a more effective internal control.
Reasons
for disagreement between Profits as per financial accounting and Profits as per
cost accounting:
The difference in the profitability of cost and financial records
may be due to the following reasons.
1)
Items included in the financial accounts but
not in cost accounts.
Ø
Purely financial income- such as interest
received on bank deposits, interest and dividend on investments, rent
receivables, transfer fee received, profit on the sale of assets etc.
Ø
Purely financial charges – such as losses due
to scraping of machinery, losses on the sale of investments and assets,
interest paid on the bank loans, mortgages, debentures etc., expenses of
company’s transfer office, damages payable at law etc.
Ø
Appropriation of profit – the appropriation of
profit is again a matter which concerns only financial accounts. Items like
payment of income tax and dividends transfer to reserve, heavy donations,
writing off of preliminary expenses, goodwill and patents appear only in profit
and loss appropriation account and the costing profit and loss a/c is not
affected.
2)
Items included in cost accounts only: There
are certain items which are included in cost accounts but not in financial accounts.
They are: Charges in lieu of rent where premises are owned, interest on capital
employed in production but upon which no interest is actually paid.
3)
Under/Over absorption of overhead expenses: In
cost accounts, overheads are absorbed at predetermined rates which are based on
past data. In the financial accounts the actual amount incurred is taken into
account. There arise a difference between the actual expenses and the
predetermined overheads charged to product or job.
If overheads are not fully recovered, which means that the amount
of overheads absorbed in cost accounts is less than the actual amount, the
shortfall is called as under recovery or under absorption. If overhead expenses
recovered in cost accounts are more than that of the actually incurred, it is
called over absorption. Thus, both the over and under recovery may cause the
difference in the profits of both the records.
4)
Different basis of stock valuation: In cost
accounts, the stock of finished goods is valued at cost by FIFO, LIFO, average
rate, etc. But, in financial accounts stocks are valued either at cost or
market price, whichever is less.
The valuation of work-in-progress may also lead to variation. In
financial books only prime cost may be taken into account for this purpose
whereas in cost accounts, it may be valued at prime cost plus factory overhead.
5)
Different basis of depreciation adopted: The
rates and methods of charging depreciation may be different in two sets of
accounts.
3. (a) Prepare a comparative Balance Sheet of X Co. Ltd. from the
following data and show the trend percentages:
16
2010
|
2011
|
2012
|
2013
|
2014
|
|
Liabilities and owners’ Equity:
Reserves
Long term liabilities
Current liabilities
|
100
73
304
213
|
100
78
316
183
|
135
125
332
235
|
135
125
425
264
|
170
96
478
307
|
Total Liabilities
|
690
|
677
|
827
|
949
|
1,051
|
Assets
|
2010
|
2011
|
2012
|
2013
|
2014
|
Fixed Assets
Current Assets
Investments
|
154
524
12
|
182
482
13
|
221
591
15
|
270
631
48
|
309
689
53
|
Total Assets
|
690
|
677
|
827
|
949
|
1,051
|
Or
(b) What is
Common-size Statement? What are its objectives? Describe the utility of such a
statement. 4+6+6=16
Ans: Common Size Statements: These are
the statements which indicate the relationship of different items of a
financial statement with a common item by expressing each item as a percentage
of that common item. The percentage thus calculated can be easily compared with
the results of corresponding percentages of the previous year or of some other
firms, as the numbers are brought to common base. Such statements also allow an
analyst to compare the operating and financing characteristics of two companies
of different sizes in the same industry. Thus, common size statements are
useful, both, in intra-firm comparisons over different years and also in making
inter-firm comparisons for the same year or for several years. This analysis is
also known as ‘Vertical analysis’.
Characteristics/Essentials of Common Size Statements
Common Size statements are regarded as
indices of an enterprise‘s performance and position. As such, extreme care and
caution should be exercised while preparing these statements. Common Size statements
generally reflect the following observable characteristics:
a)
Internal Audience: Common
Size statements are intended for those who have an interest in a given business
enterprise. They have to be prepared on the assumption that the user is
generally familiar with business practices as well as the meaning and
implication of the terms used in that business.
b)
Articulation: The basic Common
Size statements are interrelated and therefore are said to be articulated‘. Example: Profit and Loss account shows
the Common Size results of operations and represents an increase or decrease in
resources that is reflected in the various balances in the balance sheet.
c)
Historical Nature: Common
Size statements generally report what has happened in the past. Though they are
used increasingly as the basis for the future by prospective investors and
creditors, they are not intended to provide estimates of future economic
activities and their effect on income and equity.
d)
Legal and economic
consequences: Common Size statements reflect elements of both economics and law.
They are conceptually oriented towards economics, but many of the concepts and
conventions have their origin in law. Example:
Conventions of disclosure and materiality
e)
Technical
Terminology: Since Common Size statements are products of a technical process
called accounting‖, they involve the use of technical terms. It is, therefore,
important that the users of these statements should be familiar with the
different terms used therein and conversant with their interpretations and meanings.
f)
Summarization and
Classification: The volume of business transaction affecting the business
operations are so vast that summarization and classification of business events
and items alone will enable the reader to draw out useful conclusions.
g)
Money Terms: All
business transactions are quantified, measured and related in monetary terms.
In the absence of this monetary unit of measurement, Common Size statements
will be meaningless.
h)
Various Valuation
Methods: The valuation methods are not uniform for all items found in a
Balance Sheet. Example: Cash is
stated at current exchange value; Accounts receivable at net realizable value;
inventories at cost or market price whichever is lower; fixed assets at cost
less depreciation.
i)
Accrual Basis: Most Common
Size statements are prepared on accrual basis rather than on cash basis i.e.,
taking into account all incomes due but not received and all expenses due but
not paid.
j)
Need for Estimates
and judgement: Under more than one circumstance, the facts and figures to be
presented through Common Size statements are to be based on estimates, personal
opinions and judgements. Example: Rate
of depreciation, the useful economic life of a fixed asset, provision for
doubtful debts are all instances where estimates and personal judgements are
involved.
k)
Verifiability: it is
essential that the facts presented through Common Size statements are
susceptible to objective verification, so that the reliability of these
statements can be improved.
l)
Conservatism: Wherever
and whenever estimates and personal judgements become essential during the
course of preparation of Common Size statements, such estimates, should be
based moderately on a conservative basis to avoid any possibility of
overstating the assets and incomes.
m)
Understandability: Common Size statements
should be prepared following the accepted accounting principles for better
understanding of the users.
n)
Comparable: Common Size statements should
disclose the information in such a manner that they are conformable for inter-firm
and intra-firm comparison.
Merits of Common Size Statements:
a)
A common size statement facilitates both types
of analysis, horizontal as well as vertical. It allows both comparisons across
the years and also each individual item as shown in financial statements.
b)
Comparison of the performance and financial
condition in respect of different units of the same industry can also be done.
c)
These statements help the management in making
forecasts for the future.
Demerits of Common Size Statements:
a)
If there is no identical head of accounts,
then inter-firm comparison will be difficult.
b)
Inter-firm comparison may be misleading if the
firms are not of the same age and size, follow different accounting policies.
c)
Inter-period comparison will also be
misleading if there is frequent changes in accounting policies.
4. (a) “Ratios are
mechanical and incomplete.” Comment on this statement giving justifications in
support of your answer. 16
Ans: Meaning of Ratio Analysis
A ratio is one figure expressed in
terms of another figure. It is mathematical yardstick of measuring relationship
of two figures or items or group of items, which are related, is each other and
mutually inter-dependent. It is simply the quotient of two numbers. It can be
expressed in fraction or in decimal point or in pure number. Accounting ratio
is an expression relating to two figures or two accounts or two set accounting
heads or group of items stated in financial statement.
Ratio analysis is the method or
process of expressing relationship between items or group of items in the
financial statement are computed, determined and presented. It is an attempt to
draw quantitative measures or guides concerning the financial health and
profitability of an enterprise. It can be used in trend and static analysis. It
is the process of comparison of one figure or item or group of items with
another, which make a ratio, and the appraisal of the ratios to make proper
analysis of the strengths and weakness of the operations of an enterprise.
According to Myers, “Ratio analysis of
financial statements is a study of relationship among various financial factors
in a business as disclosed by a single set of statements and a study of trend
of these factors as shown in a series of statements."
Objectives of Ratio analysis
a)
To know the area of the business which need
more attention.
b)
To know about the potential areas which can be
improved with the effort in the desired direction.
c)
To provide a deeper analysis of the
profitability, liquidity, solvency and efficiency levels in the business.
d)
To provide information for decision making.
e)
To Judge Operational efficiency
f)
Structural analysis of the company
g)
Proper Utilization of resources and
h)
Leverage or external financing
Advantages and Uses of Ratio Analysis
There are various groups of people who
are interested in analysis of financial position of a company used the ratio
analysis to workout a particular financial characteristic of the company in
which they are interested. Ratio analysis helps the various groups in the
following manner:
a)
To workout the profitability: Accounting ratio
help to measure the profitability of the business by calculating the various
profitability ratios. It helps the management to know about the earning
capacity of the business concern.
b)
Helpful in analysis of financial statement:
Ratio analysis help the outsiders just like creditors, shareholders,
debenture-holders, bankers to know about the profitability and ability of the
company to pay them interest and dividend etc.
c)
Helpful in comparative analysis of the
performance: With the help of ratio analysis a company may have comparative
study of its performance to the previous years. In this way company comes to
know about its weak point and be able to improve them.
d)
To simplify the accounting information:
Accounting ratios are very useful as they briefly summaries the result of
detailed and complicated computations.
e)
To workout the operating efficiency: Ratio
analysis helps to workout the operating efficiency of the company with the help
of various turnover ratios. All turnover ratios are worked out to evaluate the
performance of the business in utilising the resources.
f)
To workout short-term financial position:
Ratio analysis helps to workout the short-term financial position of the
company with the help of liquidity ratios. In case short-term financial
position is not healthy efforts are made to improve it.
g)
Helpful for forecasting purposes: Accounting
ratios indicate the trend of the business. The trend is useful for estimating
future. With the help of previous years’ ratios, estimates for future can be
made.
Limitations of Ratio Analysis
In spite of many advantages, there are
certain limitations of the ratio analysis techniques. The following are the
main limitations of accounting ratios:
a)
Limited Comparability: Different firms apply
different accounting policies. Therefore the ratio of one firm can not always
be compared with the ratio of other firm.
b)
False Results: Accounting ratios are based on
data drawn from accounting records. In case that data is correct, then only the
ratios will be correct. For example, valuation of stock is based on very high
price, the profits of the concern will be inflated and it will indicate a wrong
financial position. The data therefore must be absolutely correct.
c)
Effect of Price Level Changes: Price level
changes often make the comparison of figures difficult over a period of time. Changes
in price affect the cost of production, sales and also the value of assets.
Therefore, it is necessary to make proper adjustment for price-level changes
before any comparison.
d)
Qualitative factors are ignored: Ratio
analysis is a technique of quantitative analysis and thus, ignores qualitative
factors, which may be important in decision making. For example, average
collection period may be equal to standard credit period, but some debtors may
be in the list of doubtful debts, which is not disclosed by ratio analysis.
e)
Effect of window-dressing: In order to cover
up their bad financial position some companies resort to window dressing. They
may record the accounting data according to the convenience to show the
financial position of the company in a better way.
f)
Costly Technique: Ratio analysis is a costly
technique and can be used by big business houses. Small business units are not
able to afford it.
g)
Misleading Results: In the absence of absolute
data, the result may be misleading. For example, the gross profit of two firms
is 25%. Whereas the profit earned by one is just Rs. 5,000 and sales are Rs.
20,000 and profit earned by the other one is Rs. 10, 00,000 and sales are Rs.
40, 00,000. Even the profitability of the two firms is same but the magnitude
of their business is quite different.
Or
(b) From the following Balance Sheet of a company, you are required to
calculate the ratios as given below –
1)
Debt-Equity Ratio.
2)
Equity Ratio.
3)
External Equities to Total
Assets Ratio.
4)
Fixed Assets or Net Worth Ratio.
5)
Current Assets to Net Worth
Ratio. 4+(3x4)=16
Balance Sheet
As at ………………
Liabilities
|
Rs.
|
Assets
|
Rs.
|
3,000 Equity shares @ Rs. 100 each
7% Debentures
Reserve & Surplus
Sundry Creditors
Bills Payable
|
3,00,000
1,50,000
80,000
30,000
50,000
|
Buildings
Furniture
Machinery
Stock
Debtors
Cash balances
|
2,50,000
40,000
2,10,000
60,000
30,000
20,000
|
6,10,000
|
6,10,000
|
5. (a) Explain the
meaning of working capital. Describe the factors that affect the amount of
working capital requirement. 6+10=16
Ans: Meaning and definition of Working Capital
The
capital required for a business is of two types. These are fixed capital and
working capital. Fixed capital is required for
the purchase of fixed assets like building, land, machinery, furniture etc.
Fixed capital is invested for long period, therefore it is known as long-term
capital. Similarly, the capital, which is needed for investing in current
assets, is called working capital. The
capital which is needed for the regular operation of business is called working
capital. Working capital is also called circulating capital or revolving
capital or short-term capital.
In the words of John. J Harpton “Working capital may
be defined as all the short term assets used in daily operation”.
According
to “Hoagland”, “Working Capital is descriptive of that capital which is not
fixed. But, the more common use of Working Capital is to consider it as the
difference between the book value of the current assets and the current
liabilities.
From
the above definitions, Working Capital means the excess of Current Assets over
Current Liabilities. Working Capital is the amount of net Current Assets. It is
the investments made by a business organisation in short term Current Assets
like Cash, Debtors, Bills receivable etc.
Factors Affecting Working
Capital Requirement
The level of working capital is influenced by several factors
which are given below:
a)
Nature of Business: Nature of business is one of the factors. Usually in trading
businesses the working capital needs are higher as most of their investment is
found concentrated in stock. On the other hand, manufacturing/processing business
needs a relatively lower level of working capital.
b)
Size of Business: Size of business is also an influencing factor. As size
increases, an absolute increase in working capital is imminent and vice versa.
c)
Production Policies: Production
policies of a business organisation exert considerable influence on the
requirement of Working Capital. But production policies depend on the nature of
product. The level of production, decides the investment in current assets
which in turn decides the quantum of working capital required.
d)
Terms of Purchase and Sale: A business
organisation making purchases of goods on credit and selling the goods on cash
terms would require less Working Capital whereas an organisation selling the
goods on credit basis would require more Working Capital. If the payment is to
be made in advance to suppliers, then large amount of Working Capital would be
required. 286
e)
Production Process: If
the production process requires a long period of time, greater amount of
Working Capital will be required. But, simple and short production process requires
less amount of Working Capital. If production process in an industry entails
high cost because of its complex nature, more Working Capital will be required
to finance that process and also for other expenses which vary with the cost of
production whereas if production process is simple requiring less cost, less
Working Capital will be required.
f)
Turnover of Circulating Capital: Turnover
of circulating capital plays an important and decisive role in judging the
adequacy of Working Capital. The speed with which circulating capital completes
its cycle i.e. conversion of cash into inventory of raw materials, raw
materials into finished goods, finished goods into debts and debts into cash
decides the Working Capital requirements of an organization. Slow movement of
Working Capital cycle requires large provision of Working Capital.
g)
Dividend Policies: Dividend
policies of a business organisation also influence the requirement of Working
Capital. If a business is following a liberal dividend policy, it requires high
Working Capital to pay cash dividends where as a firm following a conservative
dividend policy will require less amount of Working Capital.
h)
Seasonal Variations: In
case of seasonal industries like Sugar, Oil mills etc. More Working Capital is
required during peak seasons as compared to slack seasons.
i)
Business Cycle: Business
expands during the period of prosperity and declines during the period of
depression. More Working Capital is required during the period of prosperity
and less Working Capital is required during the period of depression.
j)
Change in Technology: Changes
in Technology as regards production have impact on the need of Working Capital.
A firm using labour oriented technology will require more Working Capital to
pay labour wages regularly.
k)
Inflation: During
inflation a business concern requires more Working Capital to pay for raw
materials, labour and other expenses. This may be compensated to some extent
later due to possible rise in the selling price. 287
l)
Turnover of Inventories: A
business organisation having low inventory turnover would require more Working
Capital where as a business having high inventory turnover would require
limited or less Working Capital.
m)
Taxation Policies: Government
taxation policy affects the quantum of Working Capital requirements. High tax
rate demands more amount of Working Capital.
n)
Degree of Co-ordination: Co-ordination
between production and distribution policies is important in determining
Working Capital requirements. In the absence of co-ordination between
production and distribution policies more Working Capital may be required.
Or
(b) Prepare a statement showing
the working capital needed to finance a level of activity of 3,00,000 units of
output for the year. The cost structure for the company’s product for the above
mentioned activity level is detailed below –
Elements of Cost
|
Cost per unit
|
Raw materials
Direct labour
Overheads
|
Rs.
20
5
15
|
Total cost
Profit
|
40
10
|
Selling price
|
50
|
Raw materials are held in stock,
on an average for two months. Work-in-progress will approximate to
half-a-month’s production. Finished goods remain in warehouse, on an average,
for a month. Suppliers of materials extend one month’s credit. Two months
credit is normally allowed to debtors. A minimum cash balance of Rs. 25,000 is
expected to be maintained. The production pattern is assumed to be uniform
during the year. 16
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