1.Ques :- Describe the nature and scope of Management Accounting.

Ans -: Nature of Management Accounting are as follows :-

(i) Selective Nature: - Management accounting is selective in nature. It selects only those
plans or alternatives which seems to be more attractive and profitable. Similarly only those
facts and figures are presented before the management which are useful for managerial
decisions.
(ii)Achieving of Objectives: -In management accounting, the accounting information is
used in such a way s o that organisational objectives and targets may be achieved and
efficiency of business may be improved.
(iii) Integrated System: - Management accounting is an integrated system in which
techniques related to various subjects are used in the process of data collection, analysis and
decision- making. These subjects include cost accounting, financial accounting, statistics,
economics. business laws, industrial psychology, etc.
(iv) Cause and Effect Analysis :- Management accounting lays emphasis on the analysis
of cause and effect of different variables. For example, financial accounting is limited to the
preparation of profit and loss account and finding out the result in the form to profit or loss
but does not account for its causes. But management accounting examines causes of such
results. I f there is a loss, the reasons for the loss are proved. If there is a profit, the factors
directly influencing the profitability are studied.
(v) Both as a Science and an Art:- In management accounting data are collected
systematically and they are analysed with the help of various formulae and techniques and
on this basis it is a science. On the other hand, subjective judgement of management and
various needs of the organisation are also taken into account while taking decisions and on
this basis it is an art. On the whole, management accounting is both, a science as well as an
art.
(vi) More concerned with Future :- Management accounting is more concerned with
future'. No doubt, analysis and interpretation are made on the basis of historical data, but the
important objective of management accounting is to determine policies for future, to make
forecasting and to help management in its task of planning and budgeting.
(vii) Supplies Information and not decision :- An important nature of management
accounting is that its provides requisite information and not decisions. However, decisions
are taken by management with the help of these informations. "The role of management
accounting can be compared to a map. Every wise traveller carries a map with him, but he
does not ask the map where he should go."
(viii) Accounting Service :- Management accounting is a function of accounting service
towards management. Under this service necessary informations are provided to various
levels of management. These informations may be financial as well as non-financial.
Scope of Management Accounting :-
The following are some of the areas of specialisation included within the ambit of
management accounting
(i) Tax Accounting:- In present times, tax accounting has also become a part of
management accounting. It involves preparation of various returns relating to income,
production and sales. calculation of tax liability and timely payment of taxes.
(ii) Office Services :- In some cases office services may also be under t h e control of
management accountant. This responsibility covers data processing and reporting about
the utility o f different office machines.
(iii) Internal Audit: - Internal audit is required to assess the performance of various
departments and to make the system of internal control effective. Moreover, internal audit
helps management in fixing responsibility of different individuals.
(iv) Specific Techniques of Accounting :-These techniques include Decision Accounting,
Control Accounting, Responsibility Accounting, Development Accounting, Revaluation
Accounting, etc.
(v) Financial Accounting:- Financial accounting means
general accounting which pertains to recording of all business transactions in the books of
prime entry, posting them into ledger accounts, balancing them and preparing a trial
balance, from and out of which a Profit and Loss Account showing financial results of the
business and a balance sheet showing assets and liabilities of the business concern are
prepared. Various statements prepared and data collection on the basis of this accounting
provide an useful and meaningful base to management accounting.
(vi) Interpretation of Data :- Interpretation is as important as compiling of financial
statements. Therefore, the management accountant interprets various financial statements
and presents them in simple language to the management.
(vii) Cost Accounting: - Cost accounting is an important part of management accounting.
Various aspects of cost accounting, such as standard costing, marginal costing. budgetary
control, differential costing, etc. are very helpful to the management for planning various
business activities.
(viii) Financial Management: - It is concerned with the planning and controlling of
financial resources of the firm so that the funds at disposal may be utilised effectively.
Though, financial management has developed as a separate subject, management accounting
includes and extends to the functioning of financial management also.
(ix) Inventory Control : - Inventory control is an important technique for cost control and
efficiency of the enterprise. It involves determination of different levels o f stocks s u c h as.
economic order quantity (E,O.Q.), re-order point, mini-mum level, maximum level, etc. and
for all these levels management accountant provides useful guidelines to the management.
(x) Reporting to Management:- Reporting is an important process in management
accounting. It can be performed at two levels-internal reporting to provide information to
management and external reporting to provide information to outsides. Internal reporting
involves continuous availability of information to management relating to various aspect of
business.
(xi) Cost and Statistics.:- Various statistical methods are used for the purpose of cost
control in management accounting. Moreover, supplementary statistics and analytical
services are also provided to various departments of the business concern.

2 Ques. :- Define Management Accounting and discuss its functions.

Ans. - The term ‘Management Accounting' represents a merger of two words 'Management'
and Accounting’. ‘Management' refers to the functions of planning, direction and control
etc. While ‘Accounting’ refers to record compilation, analysis and presentation of various
financial transactions. In this context that form or system of accounting may be called
management accounting which provides all such accounting informations as are required by
management for planning, direction and control of business activities. Some important
definitions of management accounting are as follows :
According to Anglo-American Council on Productivity, "Management Accounting is the
presentation of accounting information in such a way as to assist management in the
creation of policy and the day-to-day operation of an undertaking."
According to Robert N. Anthony, "Management Accounting is concerned with the
accounting information that is useful to management."
According to The American Accounting Association,
"Management Accounting includes the methods and concept necessary for effective
planning, for choosing among alternative. business actions and for control through the
evaluation and interpretation of performances."
On the basis of study and analysis of the above
various definitions the concept of management accounting may be explained as follows :
"Management Accounting is the process of identification, measurement,
presentation, analysis, interpretation and communication of accounting information that
assists the management in planning, decision-making, direction and control within the
framework of fulfilling the organisational objectives. Functions of Management
Accounting: -The functions of management accounting can be divided in two broad
categories : (I) Operating Functions, and (II) Theoretical Functions.
I. Operating Functions:- Management accounting means use of financial and accounting
data for managerial functions. It requires systematic collection and processing of data.
Such processing is termed as operating functions. The main operating functions of
management accounting as follows:
1. Recording of Data :- Recording of business transactions is a basic function of any
accounting system. Initially transactions are recorded in their original form so as to maintain
their basic entity and quality. Later on, these original recorded facts and data are classified
into distinct groups and sub- records and finally analytical reports are drafted on the basis of
these sub-records. These reports provide information base for managerial actions.
2. Validating the Data: -The effectiveness of managerial functions depends up on the
accuracy and adequacy of financial data. Hence, through proper communication and
experience it should be ensured by the management accountant that the data available are
complete and accurate at certain predetermined level of significance.
3. Interpretation of Data:- Interpretation of data is an important function of management
accounting. It involves impartial, objective and concise explanation of data and its analysis.
In other words, financial data is generally collected and presented in a technical way.
Management accountant analyses and interprets financial data in a simple way and presents
it in a non-technical language.
4. Communicating the Data :- The collected and interpreted information in the form of
quantitative expression can give fruitful results only when it is communicated to proper
person and at proper time. To accomplish this function of management accounting several
reports and statements are used by the management accountant.
II. Theoretical Functions:- The theoretical function of management accounting is to help
in effective and successful performance of managerial functions. Incedently this becomes
the objective of management accounting also. The main theoretical functions (objectives) of
management accounting are as follows :-

1.Help in Forecasting and Planning: - One of the important functions of the management
accounting is to help management in the process of forecasting and planning so as to
achieve the objectives of the business concern. It is worthwhile to note that formulation of
policies and plans needs various forecasts
and management accounting adequately provides various tools with the help of which
various forecasts can be made in respect of production, cost, sales, cash receipts, cash
payments and profit, etc.
2. Help in Organising :- Organisation establishes structural relationship among various
individuals and segments in an enterprise, which is achieved through the pro cess of
delegation of authority and fixing of responsibility. Management accounting can help
greatly in this process. The soundness and efficiency of an total organisation as well as of
various departments can easily be judged with the help of the technique of return on capital
employed an important tool of management accounting.
3. Help in Controlling:-Control means to ensure the work performance as per plan and pre-
determined standards. It is possible through standard costing and budgetary control which
are in integral parts of management accounting.
4. Help in Communication:- Management accounting plays an important role in the
process of communication. All operating results and financial data are presented in the form
of various reports and statements. These reports and statements communicate useful
information to internal management as well as to outside parties, such as shareholders,
debenture holders and other institutions. Sometimes some special reports or statements
dealing with specific problems are also prepared for the purpose of conveying it to different
levels.
5. Help in Co-ordination:- Management accounting helps in the over-all coordination of
various operational activities and this purpose is achieved with the help of various
functional budgets.
6. Motivating Employees :- Management accounting presents various schemes of
motivation for employees and does also help in implementation of these schemes.
To sum up it can be said that "Management accounting aims to provide useful accounting
information to management for better decision-making and executing of its policies.

3. Ques.:- Explain meaning and objectives of Cash flow Statement and also distinguish
between cash flow statement fund flow statement.

Ans. :- Cash Flow Statement is a statement that shows inflows and outflows of cash in a
concern during a particular ac- counting period. 'Cash' means cash and cash equivalents,
while 'flow' means movement of cash. Cash Flow Statement may be defined as a summary
of receipts and payments of cash which reconciles the opening cash balance with the closing
balance of a given period on the basis of information of sources (inflow)and application
(outflow) of cash from the items appearing in the Balance Sheet and Profit and Loss
Account of an enterprise,
In brief, Cash Flow Statement explains reasons for the changes
in cash position of an enterprise. Transactions that increase the cash balance of the concern
are known as ‘inflow’ of cash and those which decrease the cash balance as 'outflow" of
cash. According to Accounting Standard-3 (AS-3), cash flow is classified into three main
activities namely Operating Activities, Investing Activities and Financing Activities. It may
also be mentioned that Cash Flow Statement is also known as Statement Accounting for
Variation in Cash' or Statement of Changes in Financial Position
on Cash Basis'
Objectives of cash flow statement: -
 (i) Prediction of Future :- A Cash Flow Statement doubt, forecasts the future cash flows
which helps the management to take various financing decisions since synchronization of
cash is possible.
(ii) Analysis of Cash Position:- Cash flow statement explains the reasons for lower or
higher cash balances with the firm. Sometimes, a firm may have lower cash balance in spite
of higher profits or a higher cash balance inspite of lower net profits.
(iii) Short-term Cash Management and Planning:- Cash flow statement is very useful for
short-term financial planning and management. This statement reveals the position of
surplus or deficiency of cash so that the management may be able to make plan for proper
investment of surplus cash or to tap the sources where from the deficiency is to be met with.
(iv)Helpful in the Formation of Policies:- Cash flow statement helps in formation of
various policies, such as repayment of long-term loans, expansion or replacement of fixed
assets, declaration of dividend, etc.
(v) Assessing Liquidity and Solvency Position: -Both the inflows and outflows of cash
and cash equivalent can be known, and, as such, liquidity and solvency position of a firm
can also be maintained as timing and certainty of cash generation is known, i.e. it helps to
assess the ability of a firm to generate cash.
(vi) Analysis of Cash Flow from Different Activities :- As per AS-3, Cash flow statement
is required to disclose cash flow from operating, investing and financing activities
separately. Thus, it clearly indicates the direction of cash flow and provides guidelines for
maintaining proper flow of cash.
(vii) Comparison of Operating Performance :- Cash flow statement enhances the
comparability of the reporting of operating performance by different enterprises because it
eliminates the effects of using different accounting treatments of the same transaction and
events.
(viii) Supply Necessary Information to the Users :- A Cash Flow Statement supplies
various information relating to inflows and outflows of cash to the external analysts
particularly to the bankers, investors and creditors because they review the financial
position of the concern and such review is greatly facilitated by Cash Flow Statement.
Difference between Cash flow statement and Fund flow statement :-
(1) Concept:- Cash Flow Statement is based on the narrower concept of fund, i.e., cash and
cash equivalents' only while Funds Flow Statement is based on a wider concept of fund, i.e.,
'working capital'
(2) Basis of Accounting :- Cash Flow Statement recognises 'cash basis of accounting"
while Funds Flow Statement is based upon 'accrual basis of accounting'.In other words,
adjustments for outstanding and prepaid items are to be made in case of Cash Flow
Statement in order to convert the data from accrual to cash basis.
(3) Statement of Changes in Working Capital :- A statement or schedule of changes in
working capital is prepared separately, while preparing Funds Flow Statement but no such
statement or schedule is required in case of Cash Flow Statement.
(4) Explanation of Causes :- Cash Flow Statement the causes of changes ni the balance of
cash and cash equivalents while Funds Flow Statement studies causes of change in working
capital.
(5) Cash Balances:- Cash Flow Statement reconciles the opening cash balance with the
closing balance of a given period on the basis of net increase or decrease in cash during that
period, while in Funds Flow Statement cash balances are shown under the head of current
assets in the schedule of changes in working capital.
 (6) Long-term and Short-term Planning :- Cash Flow Statement, as a tool of financial
analysis, is more useful for short- term cash planning. But Funds Flow Statement is more
useful in planning medium-term and long-term financing.
(7) Focus : - Cash Flow Statement summarises the effect of operating, investing and
financing activities of a business on the flow of cash but Funds Flow Statement focuses on
changes in working capital during an accounting period.
(8) Practical Utility:- Institute of Chartered Accountants of India, FASB, America and
SEBI all have accepted cash flow more useful than funds flow particularly from the view of
analysis of liquidity of a business firm.
(9) Prescribed Format :- Cash Flow Statement is compulsorily to be prepared in
prescribed proforma as given in AS-3, where as no such proforma is prescribed for the
preparation of Funds Flow Statement.

4. Ques -: What is fund flow statement ? Explain its objectives and process.

Ans:- In a narrow sense, the term fund means the fund flow statement depicts the cash
receipts and cash disbursements/payments. It highlights the changes in the cash receipts and
payments as a cash flow statement in addition to the cash balances i.e. opening cash balance
and closing cash balance.
Contrary to the earlier, the fund means working capital, i.e. the differences between the
current assets and current liabilities.
The term flow denotes the change. Flow of funds means working cap or in working capital.
The change on the working capital leads to the net changes taken place on the working
capital, i.e. especially due to either increase or decrease in the working capital. Some of the
transactions may lead to increase or decrease the volume of working capital. Some other
transactions register neither an increase nor decrease in the volume of working capital.
According to Foulke, "A statement of source and application of funds is a technical device
designed to analyse the changes to the financial condition of a business enterprise in
between two dates."
Objectives of Fund Flow Statement :-
1. To find out the position of working capital on two dates of Balance Sheets.
2. It reveals clearly the changes in items of financial position between two different balance
sheet dates showing clearly the different sources and applications of funds.
3. To know the changes in working capital during this period.
4. It also reveals how much of the total funds is being collected from normal operational
activities of the business.
5. To understand the main features o f financial operation
and policies.
6. To know the inflow of funds according to their sources.
7. To know the item-wise outflow of funds during this period.
8. To know the changes and its causes in working capital.
Preparation of Fund Flow Statement :-
Funds Flow Statement is prepared usually for the period of
one year and for this purpose following informations are collected :-
(i) Balance Sheet at the beginning of the year (or Last year's Balance Sheet).
(ii) Balance Sheet at the end of the year (or Current year's Balance Sheet).
(iii) Income Statement or Profit and Loss A/c of the current year.
(iv) Any other information which affects the flow of funds. collection of the above
mentioned documents, two statements are prepared in the process of fund flow analysis: (I)
Statement or Schedule of changes in Working Capital (II) Adjusted P/L and (III) Funds
Flow Statement.
I. Statement or Schedule of changes. in Working Capital :-
This statement depicts the amount of working capital at the beginning as well as at the end
of the year and the changes in working capital during the year. This statement is construeted
on the basis of Current Assets - Current Liabilities,

(Form Of Statement of Changes in Working Capital)

Particulars Previous Current Effect on working capital
year year Increase Decrease
Current Assets Rs. Rs. Rs. Rs.
cash in hand
cash at Bank
Bill Receivables
Debtors
Temporary Investments
Stocks
Prepaid Expenses
Accrued Incomes
Total
Current Liabilities :
Creditors
B/P
O/s Expenses
Bank overdraft
Temporary Advance
Dividend Payable
Proposed Dividend
Provision for Taxation
Total
WC=CA-CL
Net increase/decrease in
Working capital

The Statement is prepared in such away or form as to indicate the amount of working capital
at the end of two years
as well as increase or decrease in the individual items of cur- rent assets and current
liabilities. While ascertaining the in- crease or decrease in individual items of current assets
and current liabilities and its impact on working capital, the following rules are followed :-
(a) An increase in current assets increases working capital;
(b) A decrease in current assets decreases working capital;
(c) An increase in current liabilities decreases working capital;
(d) A decrease in current liabilities increases working capital.
(Il) Adjusted (Profit & Loss Account) P/LA/c :-
Funds from Operations:- It refers to increase in working capital resulting from operating
activities of business. It can be computed by preparing Adjusted Profit & Loss A/c as shown
below :-
Adjusted Profit and Loss Account
To Depreciation Rs. By Balance b/d (Balance of P & Rs To
Loss on Sale of Fixed L at the end of previous year)
Assets By Profit on Sale of Fixed Assets
To Loss on Sale of Long- By Profit on Long-term Inv.
term Investment. By Refund of Tax By Dividend
To Preliminary Expenses on Investment
written off By Funds from Operations
To Goodwill written off (Balancing figure)
To Discount on Debentures
written off
To Provision for Taxation
To Dividend/Interim
Dividend
To Proposed Dividend
To Transfer to General
Reserve
To Transfer to Sinking
Fund
To Balance/d(Balance of
P&L A/c at the end of
current year)

The balancing figure, if it is on the credit side, represents as funds from operations. If the
balancing figure comes in debit side, it is known as funds lost in operations.
IlI. Funds Flow Statement
Funds Flow Statement is known by a variety of names.
These are :-
(a) Statement of Funds Flow,
(b) Statement of Sources & Application of Funds,
(c) Statement of Sources & Uses of Funds.
This statement consists of two parts: (a) Sources of Funds, and (b) Uses of Funds. There is
no prescribed format for this statement, but it can be prepared either in account form or in
statement form. Specimen of these two formats are a s follows:-
Statement Form (Fund flow Statement)
Sources of funds :
1. Funds from operation
2. Issue of share capital
3. Issue of debentures
4. Raising long-term loans
5. Sale of fixed assets
6. Non-trading received (such as dividend)
7. Sale of long term investments
8. Decrease in Working Capital
Total
Application of funds :
1. Funds lost in operation
2. Redemption of Preference share capital
3. Redemption of debentures
4. Repayment of Long-term Loans
5. Purchase of Fixed Assets
6. Purchase of long-term investments
7. Non-trading payments
8. Payment of Dividends
9. Payment of Tax
10. Increase in Working Capital
Total

Accounting Form
Sources and Application of Funds
(for the year ending………….)
Sources of Funds. Amount Application of Fund Amount
1. Funds lost in operation 1.Funds from operation
2. Issue of share capital 2. Redemption of Preference
3. Issue of debenture share capital 4. Raising
long-term loans 3. Redemption of debentures
5. Sale of fixed assets 4 Repayment of Long-term Loans
6. Non-trading received 5 Purchase of Fixed Assets (such as
dividend). 6. Purchase of long-term
7. Sale of long-term investments investments.
7. Non-trading payments
8. Decrease in Working 8. Payment of Dividends
Capital 9. Payment of Tax
10. Increase in Working Capital

4.Ques: - Explain meaning, objectives and importance of Analysis and interpretation

of financial statements.
Ans :- Analysis of financial statements i s a systematic process of critical evaluation of the
financial information given in financial statements so that these informations may be
understood properly. For the purpose of analysis individual items are studied, their
relationship with other relevant figures is established and the data is sometimes re-arranged
to have better understanding of the information with the help of various techniques or tools
for the purpose. Some of its definitions are as follows : -
According to John N Myer, "Financial statement analysis is largely a study of relationships
among the various financial factors in a business, as disclosed by a single set of statements
and a study of trends of these factors as shown in a series of statements."
According to Belverd Needles, "Financial statement analysis comprises al the techniques
employed by users of financial statements to show important relationship in the financial
statements."
Thus, financial statement analysis involves segregating the important facts of these
statements into simple and valuable elements and putting them into easily understandable
form. In short, it is a technique of X-raying the financial position and the performance of the
enterprise.
It is important that the process of" analysis' is followed by “interpretation’.
Though in practical usage the terms 'analysis' and ‘interpretation’ may be used in the same
meaning but technically there is difference between these two. Analysis is the first step
while interpretations is a step thereafter. Analysis is a process of dividing complex data into
simple and understandable group, while interpretation is a system of drawing conclusions
on the basis of available data and their analysis. However, analysis and interpretation are
closely related.
Interpretation is not possible without analysis and without interpretation analysis has no
value. Some combined definitions of analysis and interpretation are as follows:-
According to Kennedy and Midler,”The analysis and interpretation of financial statements
are an attempt to determine the significance and meaning of financial statements data so that
the forecast may be made of the prospects for future earnings, ability to pay interest and
debts maturities and profitability of a sound dividend policy.”
According to Spicer and peglar, "Interpretation of accounts may be defined as the art and
science of translating the figures therein in such a way as to reveal the financial strength and
weakness of a business and the causes which have contributed thereto.”
Objectives of Analysis and Interpretation of Financial statements :-
Though every user of financial statements has a distinct objective for which he attempts to
analyse and interpret, some common but important objectives of this process are as follows
:-
1. Earning Capacity: To determine and examine the current earning capacity and to
estimate future prospects.
2. Managerial Efficiency: To estimate overall as well as segment-wise performance
efficiency and managerial ability in a business concern.
3. Solvency: To determine long-term as well as short-term solvency, which
decides credit worthiness of the firm also.
4. Forecasts and Budgets: To forecast the future results and prepare the budgets.
5. Inter-firm Comparison: To make inter-firm comparison on the basis of operational
efficiency and financial position of various firms engaged in the same industry.
6. Financial Weakness: To identify financial weaknesses of the firm and to suggest remedial
measures.,
7. Growth Prospects: To determine the growth prospects of different divisions as well as of
the firm as a whole.

5.Ques. -: Explain nature, objects and limitation of Financial Statement.

Ans.:- The following points are important in relation to nature of financial statements:
(1) Summarised Reviews :- These statements present the summarised or conclusive
reviews about the performance, achievements and weaknesses of the business unit.
(2) Presentation at the end of Accounting Period : - Financial Statements are, generally,
prepared at the end of the accounting period so that the various parties may obtain proper
information about the position of business and may take decisions accordingly.
(3) Based on Recorded Facts: - The figures appearing in the financial statements are based
only on those facts which have been recorded in the books of accounts. There m a y be
certain developments and factors which may be very important for the business but are not
taken into account as these are n o t the part of accounting records. For example, a business
enterprise may receive an award for excellent export performance and it is an important
achievement but being a non-financial factor it will not be a part of financial statements.
Similarly, fixed assets are shown at historical value which is on record while there may be
significant difference in their market value.
(4) Level of Reliability:- The reliability of financial statement depends on the reliability of
accounting data. If there are frauds and defalcations in accounting records, financial
statements cannot be said to be true and fair representatives of financial results and position.
(5) Accounting Concepts and Conventions: - Financial statements are prepared as per
accounting concepts and conventions.
(6) Influence of Personal Judgements :- Even though certain standard accounting
conventions and various legal is ions are followed in preparing financial statements but still
personal judgements of the accountant plays an important role. These judgements may
relate to valuation of stock, method of depreciation of fixed assets, distinction of
expenditure as capital and revenue. In the end it is worthwhile to quote the opinion of
AICPA (American Institute of Certified Public Accountants) that "Financial statements are
prepared for the purpose of presenting a periodical review or report by the management and
deal with the states of the investment in the business and the results achieved during the
period under review. They reflect a combination of recorded facts, accounting conventions
and personal judgement."
Objectives of financial statements:- The objectives of financial statements, in general, are
as follows :
1. Source of Financial Information:- The primary objective of financial statement is to
provide various reliable financial information related to business unit.
2. Information of Earning Capacity :- Financial statements provide such information that
assists in estimating the earnings capacity o f the enterprise.
3. Information o f Financial Position:- An important objective of financial statements is to
provide detailed and reliable information about economic resources (assets) and obligations
of a business unit.
4. Information of Changes in Financial Position :- Financial statements also provide
information about changes in financial resources and obligations during a specified period.
5. Help in Financial Forecasting:- One of the objectives is to provide all such necessary
facts and figures which may assist in making reliable financial forecasting.
6. Information to meet user's needs :- It is also an objective of financial statements that
they should disclose, to some possible extent, various other information which may meet the
needs of its users such as investors, creditors, financial institutions, stock exchanges,
research, etc.
limitations of financial statements :- Generally, the
following limitations should be taken into account while analysing the financial statements :
(1) Lack of Preciseness:- The information furnished by the financial state-ments are not
precise. Since the construction of these statements is based on practical methods and rules
used and propounded on the basis of experiences of several years o f accountancy
profession, therefore, the information emanating from them can not be precisely measured.
(2) Based only on Financial Factors:- Financial Statements don't disclose the correct
financial position of the business concern. The financial position of a business concern is
affected by several factors (economic, social and financial); but only financial factors are
being recorded in financial statements; social and economic factors are not incorporated in
these statements.
(3) Static Picture:- Balance Sheet is considered to be a static document; and it reflects the
position of the concern at a moment of time. The real position of the concern may be
changing day-to-day. As a result of this limitation, there is possibility of window dressing in
the Balance Sheet.
(4) Values shown are not real values :- Balance Sheet is not a valuation statements. In
other words, the values shown in it are not real values of assets or values for which these
can b e sold. It is thus clear that the exact position of the business cannot be gauged form the
Balance Sheet.
(5) Estimated Profit :- Profit disclosed by the Profit and Loss Account is also not a real
profit. The Profit and Loss Account for a particular year exhibits a profit, which is never
accurate and correct mathematically or from economic point of view, because a number of
items shown in the Profit and Loss Account are just estimated.
(6) Problem of Interpretation:- Data contained in the financial statements are dumb; they
do not speak themselves. It is also worth while to note that human judgment is always
involved in the interpretation of financial statements. It is the user who provides tongue to
these data and make them to speak.

6.Ques : - Explain meaning, definition and characteristics of Responsibility

Accounting. Also discuss advantages and limitations.
Ans:- Responsibility accounting is a specific technique of managerial control wherein
responsibilities of various individuals or groups are identified in terms of work, revenue or
cost so that the concerned person or group may be held responsible for cost variances, if
any.
According to Robert N Anthony, "Responsibility Accounting is that type of Management
Accounting that collects and reports. both planned and actual accounting information in
terms of responsibility centres.”
According to Anderson "This concept (i.e.
responsibility accounting) encompasses an accounting system in which the information and
data are gathered and reported in a manner closely related to the responsibility structure of
the enterprise." According to Kohler, "It is (Responsibility Accounting) classification,
management, maintenance, review and appraisal of accounts serving the purpose of
providing information on the quality, quantity and standards of performance attained by
persons to whom authority has been assigned.”
The main features or characteristics of responsibility accounting are as follows :
(1) Determination of Functional Areas:- The initial point of responsibility accounting is
the preparation of organisation chart which explains the functional areas of each executive,
so that they may be held responsible for their work performance.
(2) Classification of Costs on the basis of Cost Centres :- In responsibility accounting all
costs are classified on the basis of cost centres. Moreover, only those costs are considered at
each responsibility centre over which the executive of that centre has control.
(3) Separate Collection of Non-controllable Costs :- There is no cost like non-controllable
cost in.the system of responsibility accounting because each cost is controllable by-one or
other executive. However, if there are some non-controllable costs at a particular cost centre
these costs are kept separately.
(4) Proper Classification of Controllable Costs :- All controllable costs of each centre are
classified in such a way in various categories, os that it may provide suitable base for
analysis from the view of responsibility.
(5) Reporting of Work Performance :- Under responsibility accounting system, each
executive of responsibility center makes a comparison of actual performa or result with
predeter-mined targets or goals. There after he presents a report before the top management
indicated his success or failure.
Advantages of Responsibility Accounting :-
The main advantage of responsibility accounting are as follows :-
(1) Assignment of Responsibility :- Each and every individual in the organisation is
assigned a definite responsibility and on this basis they are accountable for their
performance. Moreover, every individual knows what is expected to him. Thus,
the responsibility of each person for his satisfactory or unsatisfactory performance can
easily be identified and nobody can shift his responsibility fi something goes wrong.
(2) Improvement in Performance:- The assigning of responsibility to, specific persons
acts as a motivational catalyst also. Every person knows that if there will be some
deficiencies in not his performance, they will be reported to top management and he will
have to explain his performance.
(3) Helpful in Cost Planning :- Under the system of responsibility accounting complete
information is collected in respect costs and revenues. These informations help in planning
for future costs and revenues, fixing of standards and preparing of budgets.
(4) Delegation and Control:- Responsibility accounting enables management to delegate
authority while retaining overall control. The work goes on smoothly because responsibility
is also with delegation on authority. If there is any deficiency, that is regularly reported to
the top management.
(5) Helpful in Decision-Making :- This system is very helpful to management in the
process of decision-making because it enables the regular collection of data related to
revenues, costs, profits and variances.
(6) Cost Control:- Responsibility accounting lays special emphasis on cost control, so this
system motivates the management for effective cost control.
(7) Basis of Appraisal of Managers:- Responsibility ting provides base for the appraisal of
success or failures of managers which makes it easier to take decisions related to their
transfer, promotion, training, etc.
(8) Awareness among Supervisory Staff:- It increases interests and awareness among the
supervisory staff as they are called upon to explain about the deviations for which they are
responsible.
Shortcomings or Limitations of Responsibility Accounting :-
It is true that responsibility accounting is an important tool for cost planning and control but
it has following limitations also :-
(1) Problem of Classification of Costs:- It is necessary to divide costs as controllable and
non-controllable from the view- of effectiveness of responsibility accounting. However ,
many times it becomes a question of debate that which costs should be controllable and
which are non-controllable?
(2) Delay in Reporting :- If there is delay in preparation of responsibility reporting and its
communication, the system may not prove to be effective
(3) Inter-departmental Conflicts :- Under responsibility accounting, manager of each
department gives specific attention towards the performance of his department which may
become a cause of conflict and competition among various individuals and departments.
In the end, it should be noted that the effectiveness of responsibility accounting rests upon
certain pre-requisites, such as well-defined organisational structure, proper delegation of
work and responsibility, proper allocation of costs, proper system of reporting, etc.

7.Ques: - Define Budget. Also describe its objectives, importance and limitations.
Ans: -A budget is the monetary or quantitative presentation of business plans and policies to
be pursued in the future period of time. Some of its definitions are as follows :
According to I.C.M.A London, "A Budget is a financial statement prepared prior to a
predetermined period of time of the policy to be persued during that period for the purpose
of attaining a given objective."
According to Brown and Howard,”A Budget is a pre- determined statement of management
policy during a given period which provides a standard for comparison with the results
actually achieved."
Objectives Of Budgeting :-
The main objective of budgeting is to assist the management in its main functions of
planning, co-ordination and control. In fact budget is an important instrument of
communication through, which management communicates its policies and targets t o the
persons doing work. The objectives of budgeting may b e classified into three groups :-
I. Policy relating Objectives
(1) To express the policies and objectives of the firm in quantitative terms.
(2) To prepare base for appraisal of work-performance.
(3) To co-ordinate administrative, managerial and organisational units of the firm.
(4) To develop a system of regular appraisal o f policies and objectives of the firm.
II. Administrative Objectives
(1) To determine responsibilities of various departments and sub-departments of the firm.
(2) To establish balance between available funds and estimated expenditures.
(3) To develop a system of internal control so as to ensure efficiency and economy,
(4) To establish the system of decentralisation of authority.
Importance of Budget :-
There are three important functions of top management- Planning,Co-ordination and
Control. Budgeting helps in all these functions and in this context the advantages of
budgeting may be studied under following three heads :
I. Budgeting and Planning
A budget is a plan of the policy to be pursued during the defined period of time to attain a
given objective. In other words, planning and budgeting are closely related with each other
and in this context following advantages may be mentioned :
(1) Action on the basis of Well Decided Plan :- Under budgeting al actions are guided by
well thought out plan because a budget is prepared after a careful study and research.
(2) Mechanism for Policy Implementation :- Budgeting provides a mechanism through
which the policies of management can be implemented effectively.
(3) Work on the basis of Best Option:- Various available options are considered,
while preparing budgets and efforts are made to select the best option. It improves the
effectiveness of planning.
(4) Communication :- Budget is an important media of communication which establishes
link between the top management and the operatives. Thus, the actual operators can
understand the policy of top management more precisely and clearly.
(5) Objectivity -: Budgeting expresses all business activities in numerical terms and it
develops the quality of objectivity in planning.
II. Budgeting and Co-ordination
Co-ordination is the essence of management and budgeting makes the work of co-
ordination simple and sure. Budgeting is useful in co-ordination in following manner:
(1) Co-ordination in Budget Preparation : - While preparing budgets, individual goal,
problem and potentiality of all departments are given due considerations and each
departmental aspects and views are co-or-dinated in the budget.
(2) Co-ordination in Working :- Budgeting promotes co-ordination among policies, plans
and actual working.
(3) Communication and Co-ordination :- Budget is a media of communication and on the
basis of it each member of management is having perfect and clear-cut knowledge as 'what
is the plan' and liow, when and by whom it can be implemented.' Thus, budgetary control
helps in maintaining continuous co- ordination among administration, management and
organisation.
Ill. Budgeting and Control
(1) Control on Cost of Production:- Budgeting helps in controlling cost of production by
determining budgets of different budget centres.
(2) Control on Liquidity:- The liquidity position of the firm can easily be controlled
according to need by the technique of cash budgeting.
(3) Control on Capital Expenditure:- Capital budgeting helps in making control on capital
expenditure and having best use of available resources of capital.
(4) EffectiveUtilisation of Resources :- It ensures effective utilisation of men, materials,
machines and money because production is planned according to the availability of these
resources.
(5) Standards for Measuring Performance :- Budget provides standards of expected
perfor-mance, against which actual performance of departments and employees can be
compared.
(6) Feeling of Cost Consciousness:- Budgetary control helps in developing a feeling of
cost consciousness and in restricting expenditure to the minimum.
Limitations of Budgeting :-
Though budgeting is an important device of management control, it suffers from the
following limitations
(1) Budgets are based on Plan Estimates :-Budgets are based on estimates made for
planning. Naturally the success or failure of budget depends to a large extent upon the
accuracy of these estimates. Though, it is not possible to have cent-percent accuracy in these
estimates but if they are very far from reality, the entire system of budgeting will be a futile
exercise. This aspect of budgeting should always be kept in mind while interpreting the
results thereof.
(2) Budgeting is not a Substitute of Management :- Budget is not a substitute of
management, it is only a tool of management for achieving the objectives of the concern.
Hence, the success of budgeting depends on the ability and efficiency of those persons who
are responsible for budgetary system.
(3) Operation of the Budget Plan is not Automatic :- Mere preparation of budget cannot
ensure the advantages of budgeting. The execution of budget is as important as its
preparation. However, its operation is not automatic. In this context it is required that each
executive must feel his responsibility and should make necessary efforts to attain the
budgeted goals.
(4) Time Effect:- It takes some time in preparing budgets and during this period many such
changes may occur due to which it becomes difficult to maintain the accuracy of budget.
(5) Prohibitive Cost:- The installation of budgeting system involves too much time and
costs. Normally, small concerns can not afford it. Therefore, there should be proper balance
between expected profits from budgetary system and cost of its operation.
(6) Effects of Changing Conditions:- In rapidly changing conditions it may not be possible
to achieve the budgeted targets. Budget may have to be revised from time to time but
frequent revision of targets reduces the importance of budget involves additional
expenditure too.
(7) Constraints on Managerial Initiative:- Budgeting may serve as constraints on
managerial initiative because every executive tries to achieve the budgeted targets only.
There may be some efficient persons who can exceed the targets but they will also feel
contended by reaching the targets.

8.Ques:- Define Budgetary control. Also describe its objectives, importance and
limitations.
Ans:- Budgetary control is an important technique of control on business activities by
management, in which business activities are operated on the basis of pre-prepared budget
and thereafter actual results are evaluated in the light of budget estimates.
According to W. Bigg, “The term 'Budgetary Control' is applied to a system of management
and accounting control by which all operations and output are forecasted as far as ahead
possible and the actual results, when known, are compared with the budget estimates."
According to Brown and Howard, "Budgetary control is a system of controlling costs which
includes the preparation of budgets, co-ordinating the departments and establishing
responsibilities, comparing actual performance with the budgeted and acting upon results to
achieve maximum profitability.”
Objectives of Budgetary Control :-
Budgetary control is essential for policy planning and control.It also acts as an instrument of
co-ordination. The mani objectives of budgetary control are as follows :-
1. To assist in policy formulation no ht e basis of proper and reliable data.
2. To ensure planning for future by setting up various budgets.
3. To determine short-term and long-term financial and physical targets.
4. To operate various cost centres and departments with efficiency and economy.
5. To classify expenses according to their nature such as direct and indirect expenses; fixed,
variable and semi-variable expenses etc.
6. To help administration as under this system, executives perform their functions accord-
ing to predetermined budgets.
7. To anticipate capital requirements and to make necessary arrangement for it
8. To make cost accounting more reliable and systematic.
9. To eliminate wastes and increase in profitability.
10. To correct the variations from the established standards.
11. To fix the responsibility of various individuals in the organisation
Characteristics of Budgetary Control :-
(1) Planning: - nI the system of budgetary control, first of all a plan is prepared in respect
of various business activities for a definite period. This plan is prepared on the basis of
available resources and targets of the business concern.
(2) Co-ordination :- Co-ordination among various departments of a business is an
important pre-requisite for budgetary control. Heads of various departments prepare budgets
in respect of their departments and a master budget is prepared on the basis of these
departmental budgets.
(3) Proper Recording :- In budgetary control every activity is recorded properly and on
that basis necessary data are collected.
(4) Assignment of Responsibility :- After the approval of budgets, they are divided for
various departments and sub- departments and responsibility of relevant authorities are
assigned on that basis.
(5) Review :- Budgeted data and actual data are compared from time to time. If the position
is favourable, arrangements are made to maintain and motivate such situation.
(6) Follow-up :- If actual data are adverse, necessary corrective actions are decided and
follow-up measures are undertaken for their effective implementation.
Importance of Budgetary Control:-
(i) A Tool for Improvement i n Planning : - As a result of continuous use of Budgetary
Control System, management's ability and power to foresee or think ahead is greatly
enhanced. This enables them to forecast future operational problems and difficulties and to
arrange for suitable and corrective actions quite in advance. This certainly brings an
improvement in planning process and it becomes more clear, precise, attainable and
effective. Management also finds opportunity to modify and to revise policy and such
revised policy may be used as a base for next plan and budget and so on.
(ii) As an aid in Co-ordination:- As pointed out earlier, budgets of various departments are
prepared in such a way as to lead co-ordinated efforts t o achieve common goal . Since
departmental budgets are related to each other, balanced operations in the business are
encouraged and co-operative feelings are promoted and developed. All segments of the
business participate actively in the budget preparations and therefore mutual co- operation,
team-spirit and mutual exchange of thoughts, etc., are born in them and all these contribute
to effective coordination. Thus, Budgetary Control System provides for a co-ordinated
effort and ensures harmony between the overall objectives and objectives of its various parts
(departments). It acts as a coordinating machinery between different departmental heads.
(iii) A Vehicle of Comprehensive Control : - The foremost benefit of Budgetary Control
System lies in the fact that it can have comprehensive control over various functions of the
business concern. This is given effect in two ways. First, it limits the chance of wastages
and thus control production function. It also keep under control the expenses and cost by
limiting the allowable expenses for various departmental heads. It also facilitates centralised
control, even if decentralised function is essential. Secondly, control is also effected through
the comparison of actual performance with budget targets and locating the variances. Thus,
unfavourable variances or trends may be arrested at the earliest opportunity.
(iv) An Instrument of Motivation:- Budgetary Control System provides a scientific basis
for making appraisal of personal efficiency and inefficiency and in this way it acts as
incentives to all personnel. Everybody in the concern becomes conscious and responsible to
his duty and strives to contribute his maximum to the common goal and in turn gets
personal awards/appraisal.
(V) A Media of Communication: - Budgets translate the goals and targets of the business
concern in terms of quantities both physical and monetary, Thus, the overall goal and
departmental targets are easily communicated to all persons concerned.
Limitations of Budgetary Control :-
(1) Changing Situations :- Business situations do not remain static. They go on changing
on account of trade cycle, inflation, economic recession and government policies. nI this
context it becomes difficult to prepare a perfect budget.
(2) Effect of Unclarified Facts :- Various unclarified and undisclosed facts are not
considered in the preparation of budgets, while these facts have their significant effects on
actual operations.
(3) Dictatorial Attitude:- Sometimes budgetary control may develop dictatorial attitude
and authorities may be extremely strict in order to follow-up the budgetary limits.
(4) Limited Freedom for Accountants :- Budgetary control restricts the freedom of
account-ants. They can do work within the limits and targets determined by budgets and do
not remain free to do work according to situations.
(5) Formal Arrangement: - Sometime budgets become merely a paper formality and
efforts are not made for their proper implementation.
(6) Efforts to Hide Variations :- If there are adverse variances, departmental officers may
hide the correct and real facts in order to cover their weaknesses.
9.Ques: - What is Marginal Costing ? Discuss some of the important implications of
marginal costing for managerial decisions. Also distinguish between marginal costing
and Absorption Costing.
Ans:- Marginal costing is a method of costing that is concerned with changes in costs
resulting from changes in the volume or range of output and sales
An increase or decrease in total costs that is caused by an increase or decrease in the volume
of production and sales is known as marginal cost, differential cost, or incremental cost.
Thus, marginal costs relate to future costs and can be determined by subtracting the total at
one level of output or sale from that at another level.
It should be noted that marginal costs refer to the
increase or decrease in costs on account of the block of units produced or
sold. The marginal costs per unit remain the same.
Marginal costing is a very useful technique in solving various managerial
problems and contributing in various areas of decisions. In this chapter, the uses of marginal
costing in following important areas have been discussed :-
(I) Make or Buy Decision,
(Il) Change in Product Mix.
(III) Pricing Decisions,
(IV) Exploring a New Market,
(V) Shut-down Decisions.
I. MAKE OR BUY DECISION :- 'Make or Buy Decision' is a problem in respect of which
management has to take decisions continuously. In this context, the management has to
decide whether a certain product or a component should be made in the factory itself or
bought from outside suppliers.
The nature of decision regarding make or buy may be of the following types :-
(a) Stopping the production of the part and buying it from the market.
(b) Stopping the purchase of a component and to produce it in own factory. II.Change in
Product Mix -: (1) Introducing a
New Line or Department :- The problem of introducing a new product or line involves
decision in two respects (i) Whether a new product or line should be added to the
existing production or not, and ii) If it should be introduced, then what should be the
model or design or shape of the new product. In other words, if new product can be
produced in more than one model, which model should be introduced?
A decision like above should not only be based on contribution but other relevant
factors should also b e considered. The marginal cost of new production all its possible
models should be considered. It is also possible that a portion of the cost of facilities
 relating to the original production may be used for the purpose of producing new
product. Some additional investments i n the form of additional plant and machinery
may be desired. This will likely increase the fixed overheads, which should also be
considered along with marginal costs.
(2) Selecting Optimum Product-Mix :- When a company is engaged in a number of
lines or products, there may arise a problem of selecting most optimum product-mix
which would maximise the earnings. This problem becomes complicated, when one of
the factors happens to be limiting or key factors. Under such a situation, profitability
will be improved only by economising the scarce resources (key factors). As pointed out
earlier, contribution per unit of key factor is the real index of profitability under such a
case. Thus, while deciding a profitable mix of products, Contribution per unit of Key
Factor should be considered. The product giving highest contribution per unit of key
factor should be considered as most desirable product and in this way all products may
be assigned ranks in order of priority. Selection of products in this way will offer an
optimum product-mix at which the profit will be maximum.
Thus, guiding principles for taking a decision in respect of product-mix are :- (i)
Calculate contribution per unit of key factor.
(ii) Assign ranks on the basis of highest contribution per
unit of key factor.
(iii) Available key factor should be utilised in the manufacture of that product which has
been assigned first rank; then in the production of product having second rank and so on.
III. PRICING DECISIONS
It is generally contended that price, in the long-run should
be such as to cover total cost (Marginal Costs + Fixed Costs) as well as desired profit. In
such a case, marginal costing will not play
any significant role. Again, in a competitive market, price is not determined by the
individual concern but is governed b y the market forces. Thus, costing (particularly
Marginal Costing) i s helpful
in price determination only i n short-term a n d monopoly conditions. Here we shall confine
our discussion only to the short- term price policy. The various aspects of price policy may
be enumerated as under :-
( 1 ) Normal Price,
( 2 )Minimum Price,
(3) Depression Price
(4) Special Price including dumping,
( 5 ) Price-changes.
IV. EXPLORING A NEW MARKET
Schemes of sales promotion as discussed earlier would aim at increasing the sales volume
within the usual sales territories Sales volume can also be increased by taping new
territories. This can be done either by extending its own marketing organisation (such as
opening a Branch/Depot/Shop) or through local distributors.
It is also significant to note that some initial expenses will have to be incurred in organising
sates-channels in the new territories. A sort of competition may also be there due to the
attachment of customers of that area to some other brand, removal of which will involve
higher selling and distribution costs. Again, Marginal Costing will be helpful in providing
adequate and relevant data for taking a • decision in this regard.
V. Shutdown Decisions: - Shutdown decisions may be of two types - (a) (a) Closure of
entire business, (b) Dropping a Line or Product or Department.
(a) Closure of entire Business (Suspension of Activities) :- Sometimes, a business
concern may not be in a position to cary out its trading activities (i.e., production and
selling) in an adequate volume due to trade recession/depression or cut- throat
competition. As such, the management of such business concern may be faced with a
problem of suspending the trading activities. Such suspension may be of the following
nature :- (i) Temporary closure or shut-down for a
short period; (ii) Permanent closure.
(b) Dropping a Line or Product or Department:- Basically this problem is very much
related to the profitability of a product or department. The best possible and maximum
profitable utilisation o f limited resources of a business concern clearly
demands the continuance of the production of that product/line/ department, which will
ensure the maximisation of profit. This requires o n the part of management to fi x priorities
for various products/lines. Management will also have to decide whether the production of
one or more products/lines should be dropped or curtailed. Such decision may be effective
and judicious only, when it is based on the comparative study of contributions made by each
product/line or department. Here comes the role of marginal costing with the help of which
Marginal Cost and Contribution Statement is prepared and decision data are made available.
While preparing this statement, the following points must be kept into account:
(i) If a product/line is dropped, there will be some disengaged capacity, which may be left
unused or may be used to increase the production of products/lines selected to be continued,
(ii) If any factor of production is Key Factor (i.e., available in restricted quantity or supply
is short), then contribution should be expressed in terms of per unit of Key Factor.
Difference between Marginal Costing and Absorption Costing :-
The basic differences between Absorption Costing and Marginal Costing are as follows :-
(1) Classification and Sequence of Presentation of Costs:- In absorption costing, cost is
divided into three major parts-manufacturing (factory), administrative and selling. First all,
gross profit is calculated by of deducting cost of sales from the amount of sales and
thereafter, net profit is obtained by deducting administrative and selling expenses from
gross profit. In marginal costing, total cost is divided into two parts, i.e., fixed cost and
variable cost. First of all, marginal contribution is obtained by deducting marginal cost from
sales and thereafter the amount of net profit is calculated by deducting fixed costs from
contributions.
(2) Period Vs. Product:- In absorption costing ‘period' is important and al expenses related
to a particular period are included in total cost, while in marginal costing product is
important and those expenses of the period are not taken into account which have no
relationship with the level of output. Thus, fixed costs form the part of total cost under
absorption costing but they do not form the part of cost of production under marginal
costing.
(3) Under or Over-recovery of Fixed Coat:- Under or over-recovery of fixed cost is
adjusted in Profit &Loss Account, while determining profit under absorption costing but it
is not done in marginal costing.
(4) Valuation of Stock:- In absorption costing, the stock of finished goods and work-in-
progress is valued at total cost (fixed +variable) while in marginal costing, such stocks are
valued at marginal or variable cost only. It results in following two important differences:
(i) Higher valuation of stock in absorption costing as compared to marginal costing and (ii)
Carry over of elements o f fixed cost in valuation of stock.
(5) Net Operating Profit:- hi this context these methods have following differences:
(i) If all costs are variable, the amount of profit obtained in both methods will be same, ii) If
the volume of output and sales are equal in a period, then also profit will be same in both the
methods of costing, (iii) If the volume of output is more than volume of sales, the amount of
profit obtained in absorption costing will be greater than profit in marginal costing, (iv) If
the volume of output is less than volume of sales, the amount of profit obtained in
absorption costing will be less as compared to profit in marginal costing.
(6) Basis of Managerial Decisions :- Under absorption costing managerial decisions are
based on profit, i.e., surplus of sales revenue over total cost, while in marginal costing
managerial decisions are directed by contribution or profit- volume ratio.
(7) Application :- Absorption costing is well suited for determining long-term cost and
long-term pricing policy, while marginal costing si used for solving various managerial
decisions, planning and control.

10.Ques -: Define Standard costing. Discuss its objects, advantages and limitations.
Ans :- Standard costing is a process and technique of accounting in which actual costs
incurred are compared with pre- determined costs. On the basis of comparison efficiency of
operation is determined and necessary corrective measures are taken if there are some
variances. Some important definitions of standard costing are as follows-:
According to H.J Wheldon, Standard costing is a method of ascertaining the costs whereby
statistics are prepared to show :
(a) the standard costs; (b) the actual costs; (c) the difference between these costs; which is
termed as variance"
According to Brown and Howard, "Standard costing is a technique of accounting which
compares the standard cost of each product or service with the actual costs, to determine the
efficiency of the operations so that any remedial action may be taken immediately."
Objectives of Standard Costing:-
1. Increase in Efficiency and Productivity :- The first objective of standard costing is to
improve the quality and minimise the cost so as to face competition effectively. In fact
standard
costing is a tool of management control with the help of which efficiency and productivity
can be improved and these objectives can be achieved.
2. Cost Control:- The purpose of determining standard cost and then to compare it with
actual cost is to make effective
control on cost.
3. Determination of Responsibility :- One important objective of standard costing is to
identify the persons or centres responsible for variances, so that may be controlled properly.
4. Supplement to Budgetary Control :- Standard costing is also adopted to make
budgetary control a success. In. fact management control becomes more effective if
budgetary control and standard costing are introduced simultaneously.
5. Information to the Management:- To provide important information to management is
also an objective of standard costing. This costing provides all such information due to
which the production work could not be completed as per pre-determined plan and
standards so that necessary corrective action may be taken at appropriate time.
6. Progressiveness of Management:- One objective of standard costing is to develop the
feeling of looking forward among managerial personnel and to make management dynamic
and progressive continuously.
Advantages of Standard Costing:-
Standard costing is useful not only for cost control but it is also helpful in production
planning and policy formulation. The main advantages of standard costing may be studied
under following heads :-
I. Advantages from the view of CostAccounting
1. Elimination of the Weaknesses o f Historical Costing :- In historical costing actual
costs are recorded after they have been incurred and thus they are not of much use in price
determination, cost control, etc. Standard costing eliminates such limitations, because under
this system cost data are compiled before production is commenced, are readily available
and are in themselves a valuable guide to management.
2. Simple and Economic :- Standard costing involves a great deal of preliminary work for
setting standards, but once the standards are fixed, the clerical work of costing is
considerably reduced. Thus, it provides a simple and economical means of costing.
3. Cost Control :- Standard costing helps in cost control also. Once the standards are fixed,
they are followed and analysed constantly. Whenever, a variance occurs, the reasons are
studied and immediate corrective measures are undertaken.
Il. Motivational Advantages
1. Cost Consciousness: - Standard costing develops an environment of cost consciousness
among employees, executives and top management, because actual cost is compared with ,
standard cost. If there are variances, the person or group responsible for that is identified.
2. Measurement of and Increase in Efficiency :- Standards set in standard costing provide
yardsticks against which actual costs are compared and efficiency in the use of material,
labour and machine can easily be ascertained. If there are certain deficiencies, necessary
corrective measures may be taken.
3. Basts of Incentive Wage System:- All incentive wage plans are based on certain
standards. Hence, incentive wage payment. systems can easily be operated on the basis of
standard costing.
IlI. Managerial Effectiveness Advantages
1. Facility in Production Planning:- While adopting standard costing, standards are fi x e
d in respect of material, labour, use of machine, etc. These standards help in formulating
production plan and policies according to capacity and need of the firm.
2. Management by Exception:- The introduction of standard costing system helps in the
application of the principle of' Management by Exception'Variance analysis may point out
the areas which are below standard and management can concentrate more on these areas
for bringing further improvement.
3. Effective Delegation of Authority: -Standard costing makes the delegation of authority
easier and more effective because the standard work expected from each person is clearly
stated while delegating authority to him.
Limitations of Standard Costing :-
Though standard costing is an important tool of cost control, it has certain practical
limitations also. These limitations are as follows :-
1.Unsuitable for Concerns Dealing in Non- standardised Products: -Standard costing is
not much useful in those concerns where non-standardised products are produced or
production is undertaken according to customer's specification. In such a case ti becomes
difficult to set up standard for each job separately. 2. Difficulties in Setting up
Standards:- The process of setting up standards is a complicated task as it requires
technical skill and expertise competence. The time and motion studies are required to be
undertaken for this purpose, which require a lot of time and money. Moreover, if wrong
standards are determined, the whole purpose of the system would fail.
3. Not Suitable for Small Firms:- The system o f standard costing may not be suitable for
small concerns keeping in view the cost of high degree of skill required in it.
4. Difficulty in Fixing Responsibility:- The responsibility for variances is fixed in the
process of standard costing but it is not an easy task. Under many circumstances variances
may arise due to various reasons when it becomes difficult to fix the specific responsibility.
For example, in the case of unfavourable labour efficiency variance, it is not necessary that
workers are inefficient. This situation may also arise due to inferior quality of raw material
or defect in machines.
5. Changing Business Conditions:- In standard costing standards are fixed under specified
conditions. In case these conditions change, then either standards loose their suitability or
they have to be modified. Thus, standard costing is not suitable in those concerns where
frequent technological changes take place or prices of materials fluctuate frequently
6. Need of Budgetary Control: -This system can be effective only when budgetary control
is also adopted in the concern.

11.Ques :- What do you understand by variances ? Describe its significance and their
different types.
Ans: - Variance analysis is an important central point in the system of standard costing. In
fact it is variance analysis which completes the process of standard costing and helps in
achieving the objectives of standard costing i.e., cost control and profit planning.
In standard costing variance means difference between standard level and actual
performance. The term variance analysis refers to "the systematic evaluation of variances in
an attempt to provide managers with useful information for measuring efficiency and
improving performance." The process of analysis of variance involves following three
steps:-
1. Computation of Variances :- First of all, variances are computed on the basis of various
formulae. In this context total cost variances are divided into material variances, labour
variances and overhead variances and again these variances are segregated into several sub-
variances.
2. Determination of the Causes of Variances :- After computation of variances, causes
responsible for each variance are determined. In fact variances by themselves are not t h e
end unless the causes responsible for them are identifted. Hence, variance analysis includes
detailed study of the causes of variances and their effects.
3 . Disposition of Variances :- In this step, causes are identified as controllable and
uncontrollable Thereafter, a report is prepared for necessary actions to deal controllable
variances, so that management may take necessary corrective measures.
Classification of Variances:- Normally, the basis of classification and their classified
forms may be as under:-
I. On Functional Basis
On functional basis, variances may broadly be classified into two groups, viz. Cost
Variances and Sales Variances.
1 Cost Variances: Cost variances refer to differences between standard level and actual
performance in respect of various elements of cost. This is the most important type of
variance and includes the calculation of following.-
(i) Direct Material Variance ( i ) Direct Labour Variance (iii) Overhead Variance:
(a) Variable Overhead Variance, (b) Fixed Overhead Variance.
2. Sales Variances : A sales variance reveals the ce between actual sales and budgeted sales
during a budget period. This variance may arise due to change in sales price, sales volume
and sales mix.
II. On Result Basis
On the basis of result, the variances may be of the following two types:
1. Favourable Variance :- If the actual cost is less than the standard cost the difference is
known as favourable or credit variance. Generally, a favourable variance is considered as a
good indicator o f business efficiency.
2. Unfavourable or Adverse Variance :- If the actual • cost exceeds the standard cost, the
difference si known as an. unfavourable or adverse or debit variance. Normally, these
variances indicate the inefficiency and hence, these variances require closer and deeper
analysis
Ill. On Measurement Basis
On this basis also, variances may of the following two types.
1. Absolute Variances:- The variances calculated on the basis of monetary amount of
standard cost and actual cost are known as absolute variance and generally variances are
calculated in this form.
2. Relative Variances:- If variances are expressed as percentage of standard cost, they are
known as relative variances.
IV. On Controllability Basis
The basis of controllability is of much significance from the view of managerial decisions.
On this basis variances may be controllable or uncontrollable:-
1. Controllable Variances:- Controllable variances are those which can be controlled by
the, management o r necessary steps can be taken to control these variances. It is possible
only when any specified person or department may be held responsible for the variance.
2. Uncontrollable Variances :- Variances, for which a particular person or a specific
department cannot be held responsible, are known as uncontrollable variances.
V. On the basis of Nature 1. Basic
Variances:- Basic variances are those variances which arise on account of monetary rates
fi.e., price of raw materials or rate of labour) and also on account of non- monetary factors
{i.e., physical units in quantity or time). Basic variances due to monetary factors are
Material Price Variance, Labour Rate Variance and Expenditure Variance, while basic
variances due to non-monetary factors are Material Quantity Variance, Labour Efficiency
Variance and Volume Variance. 2. Sub-Variances:- Basic variances arising due to
non- monetary factors are further analysed and classified into sub- variances taking into
account the factors responsible for them. Thus, Material Quantity. Variance may be divided
into Material Mix Variance, Material Revised Usage Variance, Material Yield Variance, etc.
Similarly Labour Efficiency Variance can be divided into several sub-variances.
Importance/Significance of Variance Analysis :-
1. Measurement of Operational Efficiency:- Efficiency of business activities can easily be
measured on the basis of variances. If variances are favourable, the activity is considered
efficient. If it is otherwise the activity is considered inefficient. 2.Technique of Cost
Control:- Variance analysis is a useful managerial technique from the view of cost control
because necessary corrective measures may be taken after analysing the cause of
unfavourable variances.
3. Knowledge ofVariance Centres:- Variance analysis helps in identifying the level,
activity or departments where variances are occurring so that special attention may be
focussed to these activities or departments.
4 Determination of Responsibility :- On the basis of variance analysis the persons or
departments responsible for variances can be identified which helps in taking corrective
measures.
5. Measurement of Accuracy of Standards:- If there is no variance or variances are very
limited, it is an indication of accuracy of standards. On the contrary permanent existence of
variances indicate the inaccuracy of standards.
6. Relative Measurement of Performance:- The performance of different departments of
an enterprise can easily be evaluated in relative terms on the basis of variance analysis.
7. Basis of Future Action and Planning :- Analysis of causes of variances, identification
of responsible persons and suggestions of corrective measures provide a useful base for
future action and planning by management.