Ans.

1) (Chapter 1)

Management accounting is the process of identification, measurement, accumulation, analysis,

preparation, interpretation and communication of information used by management to plan,
evaluate and control within an entity and to assure appropriate use of and accountability for its
resources. Management accounting also comprises the preparation of financial reports for non
management groups such as shareholders, creditors, regulatory agencies and tax authorities. The
core activities of management accounting include;

 Participation in the planning process at both strategic and operational levels. This
involves the establishment of policies and the formulation of plans and budgets which
will subsequently be expressed in the financial terms.
 The initiation of and the provision of guidance for management decisions. This involves
the generation, analysis, presentation and interpretation of appropriate information.
 Contributing to the monitoring and control performance through the provision of reports
on organizational performance, including comparisons of actual with planned or
budgeted performance, and their analysis and interpretation.

According to the Chartered Institute of Management Accountants (CIMA), Management

Accounting is "the process of identification, measurement, accumulation, analysis, preparation,
interpretation and communication of information used by management to plan, evaluate and
control within an entity and to assure appropriate use of and accountability for its resources.
Management accounting also comprises the preparation of financial reports for non-management
groups such as shareholders, creditors, regulatory agencies and tax authorities" (CIMA Official
Terminology).
The American Institute of Certified Public Accountants(AICPA) states that management
accounting as practice extends to the following three areas:

 Strategic Management—Advancing the role of the management accountant as a strategic partner

in the organization.
 Performance Management—Developing the practice of business decision-making and managing
the performance of the organization.
 Risk Management—Contributing to frameworks and practices for identifying, measuring,
managing and reporting risks to the achievement of the objectives of the organization.

The Institute of Certified Management Accountants(ICMA), states "A management accountant

applies his or her professional knowledge and skill in the preparation and presentation of
financial and other decision oriented information in such a way as to assist management in the
formulation of policies and in the planning and control of the operation of the undertaking."
Management Accountants therefore are seen as the "value-creators" amongst the accountants.
They are much more interested in forward looking and taking decisions that will affect the future
of the organization, than in the historical recording and compliance (scorekeeping) aspects of the
profession. Management accounting knowledge and experience can therefore be obtained from
varied fields and functions within an organization, such as information management, treasury,
efficiency auditing, marketing, valuation, pricing, logistics, etc.

Features of Management Accounting:

 It should be relevant for its purpose.

 It should be complete for its purpose.
 It should be sufficiently accurate for its purpose.
 It should be clear to the manager using it.
 The manager using it should have confidence in it.
 It should be communicated to the appropriate manager.
 Its volume should be manageable.
 It should be timely.
 It should be communicated through appropriate channel of communication.
 It should be provided at a cost which is less than the value of the benefits it provides.

Sr. No. Criterion Management Accounting Cost Accounting

1 Prime Objectives Management Accounting aims at
the presentation of the cost data,
to the extent required, whenever
and wherever they are required
together with other relevant
information to the management
to take decisions.
Cost accounting aims at the
ascertaining the cost of goods and
services. It lays emphasis on the stage
by stage computation of costs. For
cost ascertainment different
techniques and system of costing are
used under different circumstances.
2 Data Coverage Cost data form a part of
managerial report but not the
sole aspects. Report includes
both quantitative and qualitative
information.
3 Use of Reports Management reports are useful
only to the management but not
to the internal and external
parties.
4 Control of Preparation of report as per the
Appropriate rules of the appropriate authority
Authority etc.
No such rigidity is there in
managerial reports. The
procedure, format etc. can be
modified from time to time
depending upon convenience
and requirement.
5 Statutory Management reports are not
Verification subject to statutory audit. There
is management audit but it is
voluntary and it evaluates the
managerial decisions etc.
Managerial reports include both
objective and subjective data.
6 Nature Management Accounting is
mainly concerned with the future
plan policies. Management rely
on past records for formulation
of future plans and hence the
interdependence of cost
accounting and management
accounting cannot be over
emphasized.
7 Subject Matter Management accounting is also
and Scope known as Managerial
Accounting, or Accounting for
management, or Management
oriented accounting etc. It is also
known as internal accounting,
identifies, collects, measures,
classifies, and report information
that is useful to managers in
planning, control and decision-
making.
Cost reports deal mainly with the
cost-incurred or budgeted and
standards, variance, savings, etc. Cost
reporting is a continuous process and
may be daily weekly, monthly etc.
Though cost reports are meant for
management, they are useful even to
the external parties.
Cost accounts and reports are to be
prepared as per certain rules,
principles, procedure etc. as specified
by the appropriate authority to the
industry to which the company
belongs to. It has been made
obligatory to keep cost records under
the Companies Act.
Cost reports and accounts, in many
cases, are subject to statutory audit.
Hence they should be prepared as far
as possible, on objective manner.
Cost accounting is concerned not only
with historical data but also with
predetermined costs. Cost accounting
also helps to improve the
performance of future. Cost
Accounting help in determining the
selling price
Cost Accountancy embraces costing,
cost accounting and even cost control
and cost audit. Cost Accountancy is
used to describe the principles,
conventions, techniques, and systems
which are employed in the business
to plan and control the utilization of
its resources.
Ans. 1) (Chapter 1)

Management Accountant is an officer who is entrusted with Management Accounting function of

an organization. He plays a significant role in the decision making process of an organization.
The organizational position of Management Accountant varies from concern to concern
depending upon the pattern of management system. He may be an executive in some concern,
while a member of Board of Directors in case of some other concern. However, he occupies a
key position in the organization. In large concerns, he is responsible for the installation,
development and efficient functioning of the management accounting system. He designs the
frame work of the financial and cost control reports that provide with the most useful data at the
most appropriate time. The Management Accountant sometimes described as Chief Intelligence
Officer because apart from top management, no one in the organization perhaps knows more
about various functions of the organization than him. Tandon has explained the position of
Management Accountant as follows:

“The management accountant is exactly like the spokes in a wheel, connecting the rim of the
wheel and the hub receiving the information. He processes the information and then returns the
processed information back to where it came from”.

Role of Management Accountant

The role of the management accountant is to perform a series of tasks to ensure their
company's financial security, handling essentially all financial matters and thus helping to drive
the business's overall management and strategy.

A management accountant's responsibilities can range widely. Depending on the company, your
level of experience, the time of year and the type of industry, you could find yourself doing
anything from budgeting, handling taxes and managing assets to helping determine
compensation and benefits packages and aiding in strategic planning.

Management accountants are essentially key figures in determining the status and success of a
company. Some management accountants choose to become a Certified Management Accountant
(CMA), a similar credential to CPA, but with a greater focus on cost accounting, financial
planning, and management issues.

Management Accountant, otherwise called Controller, is considered to be a part of the

management team since he has the responsibility for collecting vital information, both from
within and outside the company. The functions of the controller have been laid down by the
Controller’s Institute of America. These functions are:

 To establish, coordinate and administer, as an integral part of management, an adequate

plan for the control of operations. Such a plan would provide, to the extent required in the
 business cost standards, expense budgets, sales forecasts, profit planning, and programme
for capital investment and financing, together with necessary procedures to effectuate the
plan.
 To compare performance with operating plan and standards and to report and interpret
the results of operation to all levels of management, and to the owners of the business.
This function includes the formulation and administration of accounting policy and the
compilations of statistical records and special reposts as required.
 To consult withal segments of management responsible for policy or action conserving
any phase of the operations of business as it relates to the attainment of objective, and the
effectiveness of policies, organization strictures, procedures.
 To administer tax policies and procedures.
 To supervise and coordinate preparation of reports to Government agencies.
 The assured fiscal protection for the assets of the business through adequate internal;
control and proper insurance coverage.
 To continuously appraise economic and social forces and government influences, and
interpret their effect upon business.

Duties and Responsibilities of Management Accountant

The primary duty of Management Accountant is to help management in taking correct policy-
decisions and improving the efficiency of operations. He performs a staff function and also has
line authority over the accountants. If management accountant feels that a decision likely to be
taken by the management based on the information tendered by him shall be detrimental to the
interest of the concern, he should point out this fact to the concerned management, of course,
with tact, patience, firmness and politeness. On the other hand, if the decision taken happens to
be wrong one on account t of inaccuracy, biased and fabricated data furnished by the
management accountant, he shall be held responsible for wrong decision taken by the
management. Controllers Institute of America has defined the following duties of Management
Accountant or controller:

 The installation and interpretation of all accounting records of the corporative.

 The preparation and interpretation of the financial statements and reports of the
corporation.
 Continuous audit of all accounts and records of the corporation wherever located.
 The compilation of costs of distribution.
 The compilation of production costs.
 The taking and costing of all physical inventories.
 The preparation and filing of tax returns and to the supervision of all matters relating to
taxes.
 The preparation and interpretation of all statistical records and reports of the corporation.
 The preparation as budget director, in conjunction with other officers and department
heads, of an annual budget covering all activities of the corporation of submission to the
Board of Directors prior to the beginning of the fiscal year. The authority of the
Controller, with respect to the veto of commitments of expenditures not authorized by the
budget shall, from time to time, be fixed by the board of Directors.
 The ascertainment currently that the properties of the corporation are properly and
adequately insured.
 The initiation, preparation and issuance of standard practices relating to all accounting,
matters and procedures and the co-ordination of system throughout the corporation
including clerical and office methods, records, reports and procedures.
 The maintenance of adequate records of authorized appropriations and the determination
that all sums expended pursuant there into are properly accounted for.
 The ascertainment currently that financial transactions covered by minutes of the Board
of Directors and/ or the Executive committee are properly executed and recorded.
 The maintenance of adequate records of all contracts and leases.
 The approval for payment(and / or countersigning ) of all cheques, promissory notes and
other negotiable instruments of the corporation which have been signed by the treasurer
or such other officers as shall have been authorized by the by-laws of the corporation or
form time to time designated by the Board of Directors.
 The examination of all warrants for the withdrawal of securities from the vaults of the
corporation and the determination that such withdrawals are made in conformity with the
by-laws and /or regulations established from time by the Board of Directors.
 The preparation or approval of the regulations or standard practices, required to assure
compliance with orders of regulations issued by duly constituted governmental agencies.
Ans. 2) (Chapter 4)

PARTICULARS Amount (Rs)

Current Assets
Cash 1,20,000
Raw Material ( 45,000 *52*1) 1,95,000
12
Work-in-progress
Raw Material ( 45,000 *52*0.5) 97,500
12
Labor ( 45,000 *26*0.5) 48,750
12
Overhead ( 45,000 *32*0.5) 60,000
12
Debtors ( 45,000 *130*2) * (3) 7,31,250
12 4 12,52,500

Current Liabilities
Creditors ( 45,000 *52*1) 1,95,000
12
Wages( 45,000 *26*0.35) 34,125
12
Overheads( 45,000 *32*1) 1,20,000
12 3,49,125
 Net Working Capital Required = 12,52,500 – 3,49,125
Current Asset- Current Liabilities =9,03,375

 Assumed 12 months = 52 weeks

Or 52 weeks = 12 months
1 week = 12 month
52
Therefore 1.5 week = 1.5 * 12 month
52

Ans.3) (Chapter 5)

(a) P/V Ratio = Change in Profit *100

Change in Sales

*Profit = Sales – Cost

P/V Ratio = 8, 00,000 * 100

20, 00,000
 = 40%

(b) Fixed Cost = Contribution – Profit

= (Sales * P/V Ratio) – Profit

= (60,000* 40) – 4,00,000

100
= 24,00,000 - 4,00,000 = 20,00,000

(c) Sales required to BEP

BEP(Sales) = Fixed Cost = 20,00,000 *100
P/V Ratio 40
= 50, 00,000
(d) Sale for Profit = 10,00,000
F.C. = 20, 00,000
P/V Ratio = 40%

Sales = F.C. + Desired Profit

P/V Ratio
= (20, 00,000 + 10, 00,000)*100
40
= 75,00,000

Ans.3) (Chapter 4)

Working capital management involves the relationship between a firm's short-term assets and
its short-term liabilities. The goal of working capital management is to ensure that a firm is able
to continue its operations and that it has sufficient ability to satisfy both maturing short-term debt
and upcoming operational expenses. The management of working capital involves managing
inventories, accounts receivable and payable, and cash.

Working capital has two components: Current assets and Current liabilities. Current assets
comprise several items. The typical items are:

 Cash to meet expenses as and when they occur.

 Accounts Receivables or sundry trade debtors
 Inventory of:
1. Raw materials, stores, supplies and spares,
2. Work-in-process, and
3. Finished goods
 Advance payments towards expenses or purchases, and other short-term advances which are
recoverable.
 Temporary investment of surplus funds which could be converted into cash whenever
needed.

A part of the need for funds to finance the current assets may be met from supply of goods on
credit, and deferment, on account of custom, usage or arrangement, of payment for expenses.
The remaining part of the need for working capital may be met from short-term borrowing from
financiers like banks. These items are collectively called current liabilities. Typical items of
current liabilities are:

 Goods purchased on credit

 Expenses incurred in the course of the business of the organisation (e.g., wages or
salaries, rent, electricity bills, interest etc.) which are not yet paid for.
 Temporary or short term borrowings from banks, financial institutions or other parties
 Advances received from parties against goods to be sold or delivered, or as short term
deposits.
 Other current liabilities such as tax and dividends payable. Some of the major
components of current assets are explained here in brief:

Current Assets:
Cash: Cash is initially required for acquiring fixed assets like plants and machinery which
enables a firm to produce products and generate cash by selling them. Cash is also required and
invested in working capital. Investments in working capital is required, as firms have to store
certain quantity of raw materials and finished goods and also for providing credit terms to the
customers.

A minimum level of cash helps in the conduct of everyday ordinary business such as making of
purchases and sales as well as for meeting the unexpected payments, developments and other
contingencies. As discussed earlier cash invested at the beginning of-the operating cycle gets
released at the end of the cycle to fund fresh investments. However, additional cash is required
by the firm when it needs to buy more fixed assets, increase the level of operations or for
bringing out change in working capital cycle such as extending credit period to the customers.

The demand for cash is affected by several factors, some of them are within the control of the
managers and some are outside their control. It is not possible to operate the business without
holding cash but at the same time holding it without a purpose also costs a firm either directly in
the form of interest or loss of income that could be earned out of the cash.
In the context of working capital management, cash management refers to optimizing the benefit
and cost associated with holding cash. The objective of cash management is best achieved by
speeding up the working capital cycle, particularly the collection process and investing surplus
cash in short term assets in most profitable avenues.

Accounts Receivable: Firms rather prefer to sell for cash than on credit, but competitive
pressures force most firms to offer credit. Today the use of credit in the purchase of goods and
services is so common that it is taken for granted. Selling goods or providing services on credit
basis leads to accounts receivable. When consumers expect credit, business units in turn expect
credit from their suppliers to match their investment in credit extended to consumers. The
granting of credit from one business firm to another for purchase of goods and services is
popularly known as trade credit. Though commercial banks provide a significant part of
requirements for working capital, trade credit continues to be a major source of funds for firms
and accounts receivable that result from granting trade credit are major investment for the firm.

Both direct and indirect costs are associated with carrying receivables, but it has an important
benefit for increasing sales. Excessive levels of accounts receivables result in decline of cash
flows and many result in bad debts which in turn may reduce the profit of the firm. Therefore, it
is very important to monitor and manage receivables carefully and regularly.

Inventory: Three things will come to your mind when you think of a manufacturing unit -
machines, men and materials. Men using machines and tools convert the materials into finished
goods. The success of any business unit depends on the extent to which these are efficiently
managed. Inventory is an asset to the organisation like other components of current assets.

Inventory constitutes a very significant part of working capital or current assets in manufacturing
organisation. It is essential to control inventories (physical/quantity control and value control) as
these are significant elements in the costing process constituting sometimes more than 60% of
the current assets. Inventory holding is desirable because it meets several objectives and needs
but an excessive inventory is undesirable because it costs a lot to firms.

Inventory which consists of raw material components and other consumables, work in process
and finished goods, is an important component of `current assets'. There are several factors like
nature of industry, availability of material, technology, business practices, price fluctuation, etc.
that determines the amount of inventory holding. Holding inventory ensures smooth production
process, price stability and immediate delivery to customers. Since inventory is like any other
form of assets, holding inventory has a cost. The cost includes opportunity cost of funds blocked
in inventory, storage cost, stock out cost, etc. The benefits that come from holding inventory
should exceed the cost to justify a particular level of inventory.
Marketable Securities: Cash and marketable securities are normally treated as one item in any
analysis of current assets although these are not the same as cash they can be converted to cash at
a very short notice. Holding cash in excess of immediate requirement means the firm is missing
out an opportunity income. Excess cash is normally invested in marketable securities, which
serves two purposes namely, provide liquidity and, also earn a return.

Marketable securities are a way of holding cash but with the attribute of earning interest. Market
securities have three characteristics:

1. Short-term maturity (less than one year, or “money market instruments”

2. High marketability
3. Virtually no risk of default

Several types of marketable securities exist, the major ones being

 Anticipation notes
Anticipation notes are issued by municipalities and school districts. Since their
revenues come from tax sources, the notes are “in anticipation” of future tax
receipts.

 Commercial paper
Commercial paper is the promissory notes of a major national firms. Most of the
firms that issue commercial paper sell it directly to investors (insurance
companies, money market funds, pension funds) although sometimes it will be
sold through investment bankers. Commercial paper is a substitute for bank debt,
but at a rate of interest that is one-fourth to on-half of a percent higher than t-bills
but significantly less than what banks would charge.

 Banker’s Acceptances
A banker’s acceptance is a time draft that evolves from international
export/import financing. An exporter is paid by a time draft issued by a foreign
bank. Since the draft is not payable until some future date (1-3 months, typically)
the company that receives it will often sell it to its local bank at a discount. The
 local bank bundles the discounted drafts (banker’s acceptances) and then resells
them in the money markets.

Current Liabilities

Short-term Financing

Trade Credit: The major source of short-term financing for firms is that of trade credit. While
it is an account payable on our balance sheet, it is an account receivable on the balance sheet of
our supplier.
The terms of credit can vary quite a bit:

1. Cash on Delivery (i.e., no credit)

2. Net amount due within a certain period of time
3. Net amount with a discount if paid within a certain period of time, net amount within
another period.

Commercial Banks
The second major source of short-term financing for firms is commercial banks. A firm wants to
establish a close relationship with its bank and obtain a line of credit. In order to get a credit
line, you will want to show them your income statements, balance sheets, financial ratios, etc.
The bank will then allow a certain amount of credit with a set rate of interest (usually prime
plus). This can be renegotiated every year. In fact, commercial banks’ bread and butter is their
business accounts and they are very competitive with one another in trying to attract corporate
clients. The amount of the credit line is typically tied to the amount of accounts receivable that
the firm has and sometimes to the amount of inventories that it holds.

Another type of credit line is referred to as a revolving line of credit. With a revolving
line of credit, the bank provides a written agreement guaranteeing loans up to a certain amount.
The firm will pay a normal rate of interest on the amounts of funds that it borrows plus a
commitment fee of one-half to one percent on any unborrowed funds. Unlike a regular line of
credit which can be changed, a revolving line of credit guarantees that the bank will always make
the amount available if needed. Additionally, a revolving line of credit will often be extended
jointly by several banks when the amounts used are larger than a single bank can (or wants to)
handle alone.
Types of Loans

Loans come in a variety of shapes. A simple loan requires that the firm maintain a non-
interest-bearing account at the bank. While compensating balances are not used as much as they
have been in the past, they are still encountered frequently.

Security for Bank Loans

Banks like some sort of collateral for loans to ensure repayment of the loan, at least in
part. The preferred collateral for bank loans is accounts receivable. The reason, of course, is
that collecting money is what banks do. There are two ways to obtain financing with
receivables:

Pledging of Accounts Receivable – This is the most common form. A lender will loan up
to 80% of the amount of the invoice. Upon payment, the borrower has “pledged” to use the
proceeds to reduce the amount of the loan. If the customer does not pay the invoice, the
borrower is still obligated to repay the loan.

Factoring of Accounts Receivable – The receivable is sold to a factoring institution.

Typically, this is used prior to making a sale on credit. The seller will go to a factor who will run
a credit check on the potential buyer. If the buyer has a good credit rating, the factor will give
the go-ahead to sell on credit and then buy the receivable (at a discount) from the seller. The
buyer is notified in writing to pay the factor directly for the receivable. Then, if the invoice is
not paid, it is up to the factor to collect from the buyer and the factor takes the risk of bad debt.
Sometimes, the factor may withhold 10% from the seller to make them share in the risk of non-
payment. Then, when payment is received, the 10% reserve will be refunded to the seller.

The use of factoring is considerably more expensive than the pledging of accounts
receivable. This is due to the fact that, in addition to lending money for a period of 30-90 days,
the factor also must run a credit check, incur the cost of collection, and undertake the risk of
nonpayment.

Banks will also use inventories as collateral for short-term loans. A blanket lien (or
floating lien) is one that covers all inventories. Even then, the lender will only loan 40-50% of
the cost of those goods. This is because, if default occurs, the lender will have to hire someone
to sell the inventories as well as substantially discounting them in order to liquidate the
inventories.
 A warehouse receipts loan is where a third party holds the inventory as collateral for the
lender. A warehouse receipts loan is most commonly used in the canning industry or where
production of inventory is seasonal. For example, the cotton season runs from June to October.
Denim jeans, on the other hand, are purchased year-round. Thus, a denim manufacturer might
buy cotton in June and produce denim but not have enough for the estimated annual demand.
The producer could then go to a bank and borrow against the bolts of denim that have been
produced. These bolts of denim would then be stored in a public warehouse as collateral and
funds would be made available for the producer to purchase more cotton and produce more
denim. As inventories are sold, the loan could be paid down, in which case the lender would
notify the public warehousing company to release X number of bolts of denim to the producer
and the process reverses itself.

If the inventories are too bulky to transport to a public warehouse, a field warehouse
arrangement may be set up where the public warehousing company goes to the producer’s place
of business and physically segregates the inventories that are being held as collateral for the
lender. Only the public warehousing company would have access to the collateral and would
only release it upon notification by the lender.

Securities Loans

A borrower can pledge their inventories of securities of another company (bonds, notes
payable) as collateral for a loan as well. Thus, if you hold a note payable from a creditworthy
firm, many lenders will loan money against it. (This is similar, in a sense, to what happens with
a margin purchase.)

In short, if a firm has assets of virtually any kind, it can use them as collateral for short-
term loans to meet its short-term cash needs.
Ans. 4) (Chapter 2)

(a) Gross profit Ratio = Gross Profit * 100 = 6,00,000 *100 = 25%
Net Sales 24, 00,000

(b) Net Profit Ratio = Net Profit * 100 = 3,60,000 *100 = 15

Net Sales 24, 00,000
(c) Return on Assets = Net Income = Net Profit Before Taxes = 3,60,000 = 0.12:1
Total Assets Total Asset 30, 00,000
(d) Inventory Turnover Ratio= Net Sales = 24,00,000 = 3 times
Inventory 8, 00,000
(e) Working Turnover = Sales = 24,00,000 = 2.5: 1
Net Working Capital 9, 60,000
(f) Net Worth to Debt = Net Worth = 15,00,000 = 1.67
Debt 9,00,000

Ans.4) (Chapter 3)

FUND FLOW STATEMENT

An analysis of the fluctuations of current assets and current liabilities i.e. working capital tells us how the
working capital has increased or decreased. The profit and loss account gives some indication of the
results of operations and its impact on the funds position. Integrate the impact of operations reported in
the profit and loss account and balance sheet by preparing a statement of changes in financial position. It
describes the sources from which fluids were received and the uses to which funds were put. This
statement of changes in financial position is usually referred to as fund flow statement or statement of
sources and application funds. As the title indicates fund flow statement traces the flow of funds through
the organisation. In other words, it shows the sources from where the funds were raised , and the uses to
which they were put.

The statement of funds flow is usually bifurcated into two logical divisions: sources of funds or inflows
during the periods and uses of funds or applications of funds during the period. The division showing
sources of funds summarises all those transactions which had the net effect of increasing the working
Capital. Uses of funds on the other hand deal with all those transactions which had the effect of
decreasing the working capital.
The flow of funds statement gives a summary of the impacts of managerial decisions. As such it
reflects the policies of financing, investment, acquisition and retirement of fixed assets,
distribution of profits, and the success of operations.

Definition of Funds flow statement.

“The funds flow statement describes the sources from which additional funds were derived
and the use to which these funds were put.”

It indicates various methods by which funds are obtained during a particular period and the
ways in which these funds are employed. In simple words, it is a statement of sources and
application of funds.

“A statement of sources and application of funds is a technical device designed to analyse the
changes in the financial condition of a business enterprise between two dates.”

Meaning of important terms

Funds

In funds flow statement funds means working capital i.e. current assets – current liabilities.

Flow of funds

It means changes in funds or change in working capital

Source of fund

It is any transaction that results in an increase in working capital (inflow of funds)

Application of funds

It is any transaction that results in a decrease in working capital (outflow of funds)

Importance of Funds Flow Statement.

1. Helps in analysis of financial operations.

2. Helps in formulation of realistic dividend policy.

3. Helps in proper allocation of resources.

4. It acts as a future guide.

5. Helps in appraising the use of working capital.

6. It helps knowing the overall creditworthiness of a firm.

7. It throws light on many questions of general interest.

. Why were the net CA lesser in spite of profits.

. Why dividend could not be declared in spite of available profits.

. What are the sources of repayment of debts.

Identification of flow of funds: general rules

1. There will be a flow of funds if a transaction involves a current account and a non-current
account i.e. involves

a. Current assets and fixed assets eg purchase of building for cash

b. Currents asset and capital eg issue of share for cash

c. Current assets and fixed liabilities eg redemption of debentures in cash or repayment of

long term loan in cash
 d. Current liabilities and fixed liabilities eg creditors paid off in debentures

e. Current liabilities and capital eg creditors paid off in shares

f. Current liabilities and fixed assets eg building transferred to creditors in satisfaction of their
claims/

2. There will be NO flow of funds if a transaction involves 2 current accounts or 2 non-current

accounts ie involves:

a. Current assets and current liabilities eg payment of creditors in cash

b. Fixed assets and fixed liabilities eg building purchased and payments made in debentures

c. Fixed assets and capital eg. Building purchased and payment made in shares.
SIGNIFICANCE OF FUND FLOW STATEMENT

The utility of this statement can be measured on the basis of its contributions to the financial
management. It generally serves the following purposes:-

(1) Analysis of Financial Position. The basic purpose of preparing the statement is to have a
rich into the financial operations of the concern. It analyses how the funds were obtained and
used in the past. In this sens, it is a valuable tool for the finance manager for analyzing the past
and future plans of the firm and their impact on the liquidity. He can deduce the reasons for the
imbalances in uses of funds in the past an take necessary corrective actions. In analyzing the
financial position of the firm, the Funds Flow Statement answers to such questions as-

1. Why were the net current assets of the firm down, though the net income was up or vice
versa?
2. How was it possible to distribute dividends in absence of or in excess of current income for
the period ?
3. How was the sale proceeds of plant and machinery used ?
4. How was the sale proceeds of plant and machinery used ?
5. How were the debts retired ?
6. What became to the proceeds of share issue or debenture issue ?
7. How was the increase in working capital financed ?
8. Where did the profits go?

Though it is not an easy job to find the definite answerers to such questions because funds
derived from a particular source re rarely used for a particular purpose. However, certain useful
assumptions can often be made and reasonable conclusions are usually not difficult to arrive at.

(2) Evaluation of the Firm's Financing. One important use of the statement is that it evaluates
the firm' financing capacity. The analysis of sources of funds reveals how the firm's financed its
development projects in the past i.e., from internal sources or from external sources. It also
reveals the rate of growth of the firm.

(3) An Instrument for Allocation of Resources. In modern large scale business, available funds
are always short for expansion programmes and there is always a problem of allocation of
resources. It is, therefore, a need of evolving an order of priorities for putting through their
expansion programmes which are phased accordingly, and funds have to be arranged as different
phases of programmes get into their stride. The amount of funds to be available for these projects
shall be estimated by the finance with the help of Funds Flow Statement. This prevents the
business from becoming a helpless victim of unplanned action.

(4) A Tool of Communication to Outside World. Funds Flow Statement helps in gathering the
financial states of Business. It gives an insight into the evolution of the present financial position
and gives answer to the problem 'where have our resources been moving'? In the present world
of credit financing, it provides a useful information to bankers, creditors, financial, it provides a
useful informations and government etc. regarding amount of loan required, its proposes, the
terms of repayment an sources for repayment of loan etc. the financial manager gains a
confidence born out of a study of Funds Flow Statement. In fact, it carries information regarding
firm's financial policies to the outside world.

(5) Future Guide. An analysis of Funds Flow Statements of several years reveals certain
valuable information for the financial manager for planning the future financial requirements of
the firm and their nature too i.e. Short term, long-term or mid term. The management can
formulate its financial policies based on information gathered from the analysis of such
statements. Financial manager can rearrange the firm's financing more effectively on the basis of
such information along with the expected changes in trade p payables and the various accruals.
In this way, it guides the management in arranging its financing more effectively.

Ans.5)

(a) Flexible Budget

Ans a) (Chapter 6)

A flexible budget is a budget that adjusts or flexes for changes in the volume of activity. The
flexible budget is more sophisticated and useful than a static budget, which remains at one
amount regardless of the volume of activity.   The flexible budget responds to changes in
activity, and may provide a better tool for performance evaluation. It is driven by the expected
cost behavior. Fixed factory overhead is the same no matter the activity level, and variable costs
are a direct function of observed activity. When performance evaluation is based on a static
budget, there is little incentive to drive sales and production above anticipated levels because
increases in volume tend to produce more costs and unfavorable variances.

The flexible budget is a performance evaluation tool. It cannot be prepared before the end of the
period. A flexible budget adjusts the static budget for the actual level of output. The flexible
budget asks the question: “If I had known at the beginning of the period what my output volume
(units produced or units sold) would be, what would my budget have looked like?” The
motivation for the flexible budget is to compare apples to apples. If the factory actually produced
10,000 units, then management should compare actual factory costs for 10,000 units to what the
factory should have spent to make 10,000 units, not to what the factory should have spent to
make 9,000 units or 11,000 units or any other production level.  

The flexible budget variance is the difference between any line-item in the flexible budget and
the corresponding line-item from the statement of actual results.

The following steps are used to prepare a flexible budget:

1.                 Determine the budgeted variable cost per unit of output. Also determine the budgeted
sales price per unit of output, if the entity to which the budget applies generates
revenue (e.g., the retailer or the hospital).  

2.                  Determine the budgeted level of fixed costs. 

3.                  Determine the actual volume of output achieved (e.g., units produced for a factory,
units sold for a retailer, patient days for a hospital).

4.                  Build the flexible budget based on the budgeted cost information from steps 1 and 2,
and the actual volume of output from step 3 

Flexible budgets are prepared at the end of the period, when actual output is known.

Preparation of a Flexible Budget

The flexible budget uses the same selling price and cost assumptions as the original budget.
Variable and fixed costs do not change categories. The variable amounts are recalculated using
the actual level of activity, which in the case of the income statement is sales units. Each flexible
budget line will be discussed separately.

Sales. The original budget assumed 17,000 Pickup Trucks would be sold at Rs 15 each. To
prepare the flexible budget, the units will change to 17,500 trucks, and the actual sales level and
the selling price will remain the same. The Rs 2,62,500 is 17,500 trucks times Rs 15 per truck.
The variance that exists now is simply due to price. Given that the variance is unfavorable,
management knows the trucks were sold at a price below the Rs15 budgeted selling price.

Cost of Goods Sold. Using the cost data from the budgeted income statement, the expected total
cost to produce one truck was Rs 11.25. The flexible budget cost of goods sold of Rs 1,96,875 is
Rs 11.25 per pick-up truck times the 17,500 trucks sold. The lack of a variance indicates that
costs in total (materials, labor, and overhead) were the same as planned.
Selling Expenses. The original budget for selling expenses included variable and fixed expenses.
To determine the flexible budget amount, the two variable costs need to be updated. The new
budget for sales commissions is Rs 10,500 (Rs 2, 62,500 sales times 4%), and the new budget for
delivery expense is Rs 1,750 (17,500 units times 10%). These are added to the fixed costs of Rs
12,500 to get the flexible budget amount of Rs 24,750.

General and Administrative Expenses. This flexible budget is unchanged from the original
(static budget) because it consists only of fixed costs which, by definition, do not change if the
activity level changes.

Income Taxes. Income taxes are budgeted as 40% of income before income taxes. The flexible
budget for income before income taxes is Rs 20,625, and 40% of that balance is Rs 8,250. Actual
expenses are lower because the income before income taxes was lower. The actual tax rate is
also 40%.

Net Income. Total net income changes as the amount for each line on the income statement
changes. The net variance in this example is mainly due to lower revenues.

The important thing to remember in preparing a flexible budget is that if an amount, cost or
revenue, was variable when the original budget was prepared, that amount is still variable and
will need to be recalculated when preparing a flexible budget. If, however, the cost was
identified as a fixed cost, no changes are made in the budgeted amount when the flexible budget
is prepared. Differences may occur in fixed expenses, but they are not related to changes in
activity within the relevant range.

(b) Objectives of Budgetary Control

Ans. b) (Chapter 6)

Budgets are simply exercises in calculation unless they are used. When we use a budget, we do
so as part of a system of budgetary control. That is, we have some basic ideas of what we want to
do, we prepare budgets to help us achieve those ideas; and then once we have done whatever it is
that we wanted to do, we check to see if we kept to our budget.

Budgetary control relates to the establishment of budgets relating the responsibilities of budget
holders the needs of a policy. Budgetary control also relates to the continuous comparison of
actual with budgeted results, it does this to try to ensure that the objectives of that policy are
achieved; or to provide a basis for the change of those objectives.
A budget is a statement setting out the monetary, numerical or non quantitative aspects of an
organisation's plans for the coming week or month or year. Budgetary control is the analysis of
what happened when those plans came to be put into practice, and what the organisation did or
did not do to correct for any variations from these plans.

 Efficiency. In budget terms this is expressed as the profit after tax to sales, or
productivity figures relating to direct labour, machinery performance or a combination of
these things.
 Profit target. To ensure an adequate financial reward for the owners. This may equate to
percentage level or dividend amount for the members of the ownership.
 Dividend. A suitable return on investment for shareholders or the owners.
 Budget provides the yardstick against which future results can be compared.
 With the establishment of the budget, action(s) can be taken by management if there are
any material variances against budget.
 Budgets enable management to plan and anticipate in areas of adequacy in working
capital and scarce or type of availability of resources;
 Budgets are able to direct capital expenditure in the most profitable direction;
 Assist to plan and control earnings and expenditure so that maximum profitability can be
achieved;
 It act as a guide for management decisions when unforeseeable conditions affect the
budget;
 Assist in decentralizing responsibility on to each manager involved. With the setting of
budgets, the managers involved will better understand what the company expects from
them. Therefore there is a congruence of goals between the company and the employees

(c) Cash Flow Statement (Chapter 3):

Cash flow refers to the movement of cash into or out of a business, a project, or a financial
product. It is usually measured during a specified, finite period of time. Measurement of cash
flow can be used

 to determine a project's rate of return or value. The time of cash flows into and out of
projects are used as inputs in financial models such as internal rate of return, and net
present value.
 to determine problems with a business's liquidity. Being profitable does not necessarily
mean being liquid. A company can fail because of a shortage of cash, even while
profitable.
 as an alternate measure of a business's profits when it is believed that accrual accounting
concepts do not represent economic realities. For example, a company may be notionally
profitable but generating little operational cash (as may be the case for a company that
barters its products rather than selling for cash). In such a case, the company may be
deriving additional operating cash by issuing shares, or raising additional debt finance.
 cash flow can be used to evaluate the 'quality' of Income generated by accrual accounting.
When Net Income is composed of large non-cash items it is considered low quality.
  to evaluate the risks within a financial product. E.g. matching cash requirements,
evaluating default risk, re-investment requirements, etc.

Cash flow is a generic term used differently depending on the context. It may be defined by users
for their own purposes. It can refer to actual past flows, or to projected future flows. It can refer
to the total of all the flows involved or to only a subset of those flows. Subset terms include 'net
cash flow', operating cash flow and free cash flow

Cash flow statement is produced to show how the enterprise generates and uses cash and cash
equivalents. A cash flow statement, when used in conjunction with the rest of the financial
statements, provides information that enables users to evaluate the changes in net assets of an
enterprise, its financial structure and its ability to affect the amounts and timing of cash flows in
order to adapt to changing circumstances and opportunities.

Cash flow statement should report cash flows during the period classified by operating, investing
and financing activities.

Operating Activities

Cash flow from operating activities relates to cash generated or paid out through the normal cash
generating activities of the enterprise. The enterprise need to generate enough cash flow from
these activities as they are the main sources of cash for the business. Cash flow from operating
activities will be used to repay loans, maintain the operating capabilities of the enterprise and
make new investments.

Cash flow from operating activities includes:

a) cash received from sale of goods or provision of services;

b) cash received from royalties, fees, commission and other revenues;
c) cash payments to suppliers;
d) cash payments to or on behalf of employees
e) cash payments or refund of income tax.

Investing Activities

These are cash flow on capital expenditure incurred which will generate future operating cash
flows. Examples of cash flows arising from investment activities are:

a) Cash payments to acquire property plant and equipment or cash received from disposal of
these assets.
b) Cash payment to acquire equity or debt instruments of other enterprises.
c) Cash received from sale of equity or debt instrument of another enterprise.
d) Cash advances and loans made to other parties.
e) Cash received from the repayments of advances and loans made to other parties;

Financing Activities
Cash flow from financing activities relates to cash flow received from or repaid to outside
providers of finance. Examples include:

a) Cash proceeds from issuing of shares or other equity instrument;

b) Cash payments to owners to acquire or redeem the enterprise shares.
c) Cash repayment of amounts borrowed.
d) Cash payments in finance lease
e) Dividend paid to ordinary share holders

Cash flow statement can be produced used direct or indirect method. Direct method discloses the
major classes of cash receipts and gross payments. While indirect method begins with net profit
which is adjusted with non cash transactions, accrued income or expenses and items of income or
expenses associated with investing or financing activities.

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