(Test Bank) Cost & Management Accounting And Financial Management

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INTERMEDIATE : PAPER - 10 INTERMEDIATE STUDY NOTESCOST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT The Institute of Cost Accountants of India CMA Bhawan, 12, Sudder Street, Kolkata - 700 016SYLLABUS - 2016First Edition : August 2016 Reprint : September 2017 Reprint : January 2018 Reprint : June 2018 Reprint : January 2019 Edition : August 2019 Published by : Directorate of StudiesThe Institute of Cost Accountants of India (ICAI)CMA Bhawan, 12, Sudder Street, Kolkata - 700 016www.icmai.in Printed at : M/s. Sap Prints Solutions Pvt. Ltd.28A, Lakshmi Industrial EstateS. N. Path, Lower Parel (W)Mumbai - 400 013, Maharashtra Copyright of these Study Notes is reserved by the Institute of Cost Accountants of India and prior permission from the Institute is necessary for reproduction of the whole or any part thereof.PAPER 10: COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT Syllabus Structure The syllabus comprises the following topics and study weightage: A Cost & Management Accounting 50% B Financial Management 50% ASSESSMENT STRATEGY There will be written examination paper of three hours. OBJECTIVE To rovide an in depth knowledge of the detailed procedures and documentation involved in cost ascertainment systems. To understand the concepts of Financial Management and its application for managerial decision making. Learning AimsThe syllabus aims to test the student’s ability to: Understand the cost and management accounting techniques for evaluation, analysis and application in managerial decision making;  Compare and contrast marginal and absorption costing methods in respect of profit reporting;  Apply marginal and absorption costing approaches in job, batch and process environments;  Prepare and interpret budgets and standard costs and variance statements;  Identify and apply the concepts of Financial Management Skill Set requiredLevel B: Requiring the skill levels of knowledge, comprehension, application and analysis.Note: Subjects related to applicable statutes shall be read with amendments made from time to time. Section A : Cost & Management Accounting 50% 1. Cost and Management Accounting - Introduction 2. Decision Making Tools 3. Budgeting and Budgetary Control 4. Standard Costing and Variance Analysis 5. Learning Curve Section B : Financial Management 50% 6. Introduction to Financial Management 7. Tools for Financial Analysis and Planning 8. Working Capital Management 9. Cost of Capital, Capital Structure Theories, Dividend Decisions and Leverage Analysis 10. Capital Budgeting - Investment Decisions Syllabus - 2016SECTION A: COST & MANAGEMENT ACCOUNTING [50 MARKS] 1. Cost and Management Accounting: Introduction to Management Accounting - Relationship between Management Accounting and Cost Accounting 2. Decision Making Tools: (a) Marginal Costing: Break Even Analysis and Cost - volume - profit analysis; break-even charts and profit charts; differential cost analysis; stock valuation under marginal costing vs. absorption costing; applications of marginal costing in decision making. (b) Transfer Pricing - Determination of Inter-departmental or Inter-company Transfer Price 3. Budgeting and Budgetary Control: (a) Budgetary Control and Preparation of Functional and Master Budgeting. (b) Fixed, Variable, Semi-Variable Budgets (c) Zero Based Budgeting (ZBB) 4. Standard Costing & Variance Analysis: Computation of variances for each of the elements of costs, Sales Variances, Investigation of variances - Valuation of Stock under Standard Costing - Uniform Costing and inter-firm comparison. 5. Learning Curve: Concept of Learning curve and its application. Section B: FINANCIAL MANAGEMENT [50 marks] 6. Introduction to Financial Management: Meaning - Objectives - Scope of Financial Management sources of Finance - Introduction to Financial Markets. 7. Tools for Financial Analysis and Planning: Financial Ratio Analysis - Funds Flow Analysis - Cash Flow Analysis. 8. Wroking Capital Management Working Capital Management - Financing of Working Capital 9. Cost of Capital, Capital Structure Theories, Dividend Decisions and Leverage Analysis Meaning of Cost of Capital - Computation of Cost of Capital - Capital Structure Theories and Dividend Decisions Theories (Walters - MM - Gordon Models) - Leverage Analysis 10. Capital Budgeting - Investment Decisions: Concept of Capital Budgeting - Non-Discounted and Discounted Cash Flow Method - Ranking of Projects.SECTION A - COST & MANAGEMENT ACCOUNTING Study Note 1 : Cost & Management Accounting 1.1 Introduction 1 1.2 Management Accounting - Definition 2 1.3 Significance of Management Accounting 2 1.4 Role of Management Accounting in Management Process 3 1.5 Functions of Management Accounting 4 1.6 Limitations of Management Accounting 5 1.7 Relationship between Management Accounting and Cost Accounting 6 Study Note 2 : Decision Making Tools 2.1 Marginal Costing 9 2.2 Tools and Techniques of Marginal Costing 11 2.3 Differential Cost Analysis 21 2.4 Differences between Absorption Costing and Marginal Costing 23 2.5 Application of Marginal Costing in Decision Making 23 2.6 Transfer Pricing 34 2.7 Objectives of Inter Company Transfer Pricing 35 2.8 Methods of Transfer Pricing 35 Study Note 3 : Budgeting and Budgetary Control 3.1 Budgetary Control and Preparation of Functional and Master Budgeting 89 3.2 Fixed, Variable, Semi-Variable Budgets 93 3.3 Zero Based Budgeting (ZBB) 94 Study Note 4 : Standard Costing and Variance Analysis 4.1 Introduction 111 4.2 Computation of variances for each of the Elements of Costs, Sales Variances 113 4.3 Investigation of variances & Reporting of Variances 126 4.4 Valuation of Stock under Standard Costing 127 4.5 Uniform Costing and Inter-Firm Comparison 128ContentsStudy Note 5 : Learning Curve 5.1 Introduction 161 5.2 Phases in Learning Curve 161 5.3 Uses of Learning Curve 163 5.4 Limitations to the usefulness of the Learning Curve 163 5.5 Factors Affecting Learning Curve 164 5.6 The Experience Curve 164 5.7 Reasons for use of Learning Curve 165 5.8 Application of Learning Curve 166 SECTION B - FINANCIAL MANAGEMENT Study Note 6 : Introduction to Financial Management 6.1 Meaning 175 6.2 Objectives 175 6.3 Scope of Financial Management 177 6.4 Sources of Finance 182 6.5 Introduction to Financial Markets 194 Study Note 7 : Tools for Financial Analysis and Planning 7.1 Financial Ratio Analysis 205 7.2 Funds Flow Analysis 229 7.3 Cash Flow Analysis 231 Study Note 8 : Working Capital Management 8.1 Working Capital Management - Financing of Working Capital 265 8.2 Inventory Management 285 8.3 Management of Receivables 286 8.4 Determinant of Credit Policy 288 8.5 Cash Management 295Study Note 9 : Cost of Capital, Capital Structure Theories, Dividend Decisions and Leverage Analysis 9.1 Meaning of Cost of Capital - Computation of Cost of Capital 305 9.2 Capital Structure Theories 319 9.3 Dividend Policy 335 9.4 Leverage Analysis 351 9.5 EBIT - EPS Indifference Point / Level 352 Study Note 10 : Capital Budgeting - Investment Decisions 10.1 Capital Budgeting 367 10.2 Need of Capital Budgeting Decision 367 10.3 Significance of Capital Budgeting Decisions 368 10.4 Process of Capital Budgeting 368 10.5 Investment Criterion - Methods of Appraisal 370Section A Cost & Management Accounting (Syllabus - 2016)The Institute of Cost Accountants of India 1 Cost and Management AccountingThis Study Note includes: 1.1 Introduction 1.2 Management Accounting - Definition 1.3 Significance of Management Accounting 1.4 Role of Management Accounting in Management Process 1.5 Functions of Management Accounting 1.6 Limitations of Management Accounting 1.7 Relationship between Management Accounting and Cost AccountingStudy Note - 1 COST AND MANAGEMENT ACCOUNTING 1.1 INTRODUCTION Accounting involves collection, recording, classification and presentation of financial data. The word ‘Account - ing’ can be classified into three categories: (A) Financial Accounting (B) Management Accounting and (C) Cost Accounting. Branches of Accounting Management Accounting Cost Accounting Financial Accounting FINANCIAL ACCOUNTING: Financial Accounting has come into existence with the development of large-scale business in the form of joint- stock companies. As public money is involved in share capital, Companies Act has provided a legal framework to present the operating results and financial position of the company. Financial Accounting is concerned with the preparation of Profit and Loss Account and Balance Sheet to disclose information to the shareholders. Financial accounting is oriented towards the preparation of financial statements, which summarises the results of operations for select periods of time and show the financial position of the business on a particular date. Financial Accounting is concerned with providing information to the external users. Preparation of financial statements is a statutory obligation. Financial Accounting is required to be prepared in accordance with Generally Accepted Accounting Principles and Practices. In fact, the corporate laws that govern the enterprises not only make it mandatory to prepare such accounts, but also lay down the format and information to be provided in such accounts. In sharp contrast, management accounting is entirely optional and there is no standard format for preparation of the reports. Financial Accounts relate to the business as a whole, while management accounts focuses on parts or segments of the business. CONCEPT OF MANAGEMENT ACCOUNTING: Management Accounting is a new approach to accounting. The term Management Accounting is composed of two words — Management and Accounting. It refers to Accounting for the Management. Management Accounting is a modern tool to management. Management Accounting provides the techniques for interpretation of accounting data. Here, accounting should serve the needs of management. Management is concerned with decision-making. So, the role of management accounting is to facilitate the process of decision-making by the management. Managers in all types of organizations need information about business activities to plan, accurately, 2 The Institute of Cost Accountants of India Cost and Management Accounting and Financial Management for the future and make decisions for achieving the goals of the enterprise. Uncertainty is the characteristic of the decision-making process. Uncertainty cannot be eliminated, altogether, but can be reduced. The function of Management Accounting is to reduce the uncertainty and help the management in the decision making process. Management accounting is that field of accounting, which deals with providing information including financial accounting information to managers for their use in planning, decision-making, performance evaluation, control, management of costs and cost determination for financial reporting. Managerial accounting contains reports prepared to fulfil the needs of managements. 1.2 MANAGEMENT ACCOUNTING - DEFINITION Different authorities have provided different definitions for the term ‘Management Accounting’. Some of them are as under: “Management Accounting is concerned with accounting information, which is useful to the management”. — Robert N. Anthony “Management Accounting is concerned with the efficient management of a business through the presentation to management of such information that will facilitate efficient planning and control”. —Brown and Howard “Any form of Accounting which enables a business to be conducted more efficiently can be regarded as Management Accounting” —The Institute of Chartered Accountants of England and Wales The Certified Institute of Management Accountants (CIMA) of UK defines the term ‘Management Accounting’ in the following manner: “Management Accounting is an integral part of management concerned with identifying, presenting and interpreting information for: 1. Formulating strategy 2. Planning and controlling activities 3. Decision taking 4. Optimizing the use of resources 5. disclosure to shareholders and others, external to the entity 6. disclosure to employees 7. safeguarding assets From the above definitions, it is clear that the management accounting is concerned with that accounting information, which is useful to the management. The accounting information is rearranged in such a manner and provided to the top management for effective control to achieve the goals of business. Thus, management accounting is concerned with data collection from internal and external sources, analyzing, processing, interpreting and communicating information for use, within the organization, so that management can more effectively plan, make decisions and control operations. The information to be collected and analysed has been extended to its competitors in the industry. This provides more meaningful clues for proper decision-making in the right direction. The information in the management accounting system is used for three different purposes: 1. Measurement 2. Control and 3. Decision-making 1.3 SIGNIFICANCE OF MANAGEMENT ACCOUNTING 1.3 SIGNIFICANCE OF MANAGEMENT ACCOUNTING The various advantages that accrue out of management accounting are enumerated below: (1) Delegation of Authority: Now a day the function of management is no longer personal, management accounting helps the organisation in proper delegation of authority for the attainment of the vision and mission of the business. The Institute of Cost Accountants of India 3 Cost and Management Accounting(2) Need of the Management : Management Accounting plays the role in meeting the need of the management (3) Qualitative Information : Management Accounting accumulates the qualitative information so that management would concentrate on the actual issue to deliberate and attain the specific conclusion even for the complex problem. (4) Objective of the Business : Management Accounting provides measure and reports to the management thereby facilitating in attainment of the objective of the business. 1.4 ROLE OF MANAGEMENT ACCOUNTING IN MANAGEMENT PROCESS An enterprise would operate, successfully, if it directs all its resources and efforts to accomplish its specified objective in a planner manner, rather than reacting to events. Organisation has to be both efficient and effective. Organisation is effective when the planned objective is achieved. However, the firm is efficient only when the objective is achieved, with minimum cost and resources, both in physical and monetary terms. The role of Management Accounting is significant in making the firm both efficient and effective. Management Accounting has brought out clear shift in the objective of accounting. From mere recording of transactions, the emphasis is on analyzing and interpreting to help the management to secure better results. In this way, Management Accounting eliminates intuition, which is not at all dependable, from the field of business management to the cause and effect approach. It is well known the basic functions of management are: 1. Planning, 2. Organising, 3. Controlling, 4. Decision-making and 5. Staffing Function of Management Controlling Organising Planning Staffing Decision Making Management accounting plays a vital role in the managerial functions performed by the managers. (1) Planning: Planning is the real beginning of any activity. Planning establishes the objectives of the firm and decides the course of action to achieve it. It is concerned with formulating short-term and long-term plans to achieve a particular end. Planning is a statement of what should be done, how it should be done and when it should be done. While planning, management accountant uses various techniques such as budgeting, standard costing, marginal costing etc for fixing targets. For example, if a firm determines to achieve a particular level of profit, it has to plan how to reach the target. What products are to be sold and at what prices? The Management Accountant develops the data that helps managers to identify more profitable products. What are the different ways to improve the existing profits by 25%? Management Accounting throws various alternatives to achieve the goal. (2) Organising: Organising is a process of establishing the organizational framework and assigning responsibility to people working in the organization for achieving business goals and objectives. The organizational structure may not be the same in all organizations, some may have centralized, while others may be decentralized structures. The management accountant may prepare reports on product lines, based on which managers can decide whether to add or eliminate a product line in the current product mix.4 The Institute of Cost Accountants of India Cost and Management Accounting and Financial Management (3) Controlling: Control is the process of monitoring, measuring, evaluating and correcting actual results to ensure that a firm’s goals and plans are achieved. Control is achieved through the process of feedback. Feedback allows the managers to allow the operations continue as they are or take corrective action, by some rearranging or correcting at midstream. The use of performance and control reports serve the function of controlling. For example, a production supervisor may receive weekly or daily performance reports, comparing actual material cost with planed costs. Significant variances can be isolated for corrective action. In the normal course, periodical reports are submitted, appraising the performance against the targets set. Reports for action are given to the top management, following the principle of management by exception. Performance and control reports do not tell managers what to do. These feedback reports identify, where attention is needed to help managers to determine the required course of action. (4) Decision-making: Decision-making is a process of choosing among competing alternatives. Decision-making is inherent in all the above three functions of management-planning, organizing and controlling. There may be different methods or objectives. The manager can plan or choose only one of the competing plans. Similarly, in organizing, decision can be made whether the organizational structure should be centralized or decentralized. In control function, manager can decide whether variance is worthy to investigate or not. (5) Staffing: Staffing is the process of recruitment, selection, development, training, compensation and overseeing employee in an organisation. Staffing, like all other managerial functions, is the duty which is vest on the management to perform. The role of the management accounting in this regard is manning the entity structure through proper and effective selection, appraisal, and development of the personnel to fill the role assigned to the employer. Moreover, the management accountants have to reduce the labour turnover and to control the overall employee cost. 1.5 FUNCTIONS OF MANAGEMENT ACCOUNTING The primary objective of Management Accounting is to maximize profits or minimize losses. This is done through the presentation of statements in such a way that the management is able to take corrective policy or decision. The manner in which the Management Accountant satisfies the various needs of management is described as follows: (1) Storehouse of Reliable Data: Management wants reliable data for Planning, Forecasting and Decision-making. Management accounting collects the data from various sources and stores the information for appropriate use, as and when needed. Though the main source of data is financial statements, Management Accounting is not restricted to the use of monetary data only. While preparing a sales budget, the management accountant uses the past data of the products sold from the financial records and makes projections based on the consumer surveys, population figures and other reliable information to estimate the sales budget. So, management accounting uses qualitative information, unlike financial accounting, for preparing its reports, collecting and modifying the data for the specific purpose. (2) Modification and Presentation of Data : Data collected from financial statements and other sources is not readily understandable to the management. The data is modified and presented to the management in such a way that it is useful to the management. If sales data is required, it can be classified according to product, geographical area, season-wise, type of customers and time taken by them for making payments. Similarly, if production figures are needed, these can be classified according to product, quality, and time taken for manufacturing process. Management Accountant modifies the data according to the requirements of the management for each specific issue to be resolved. (3) Communication and Coordination: Targets are communicated to the different departments for their achievement. Coordination among the different departments is essential for the success of the organisation. The targets and performances of different departments are communicated to the concerned departments to increase the efficiency of the various sections, thereby increasing the profitability of the firm. Variance analysis is an important tool to bring the necessary matters to the attention of the concerned to exercise control and achieve the desired results. (4) Financial Analysis and Interpretation: Management accounting helps in strategic decision making. Top managerial executives may lack technical knowledge. For example, there are various alternatives to produce. There is always a choice for the sales mix. Management 344 Accounting for Managers Accountant gives facts and figures about various policies and evaluates them in monetary terms. He interprets the data and gives his opinion about various alternative courses of action so that it becomes easier to the management to take a decision.The Institute of Cost Accountants of India 5 Cost and Management Accounting(5) Control: It is absolutely essential that there should be a system of monitoring the performance of all divisions and departments so that deviations from the desired path are brought to light, without delay and are corrected then and there. This process is termed as control. The aim of this function ‘control’ is to facilitate accomplishment of the goals in an efficient manner. For the discharge of this important function, management accounting provides meaningful information in a systematic and effective manner. However, the role of accountant is misunderstood. Many consider the accountant as a controller of their performance. Many accountants themselves misunderstand their own role as controllers. The real role of control is effective communication and assists the managers in achieving their goals, as efficiently as possible. (6) Supplying Information to Various Levels of Management : Every level of management requires information for decision-making and policy execution. Top-level management takes broad policy decisions, leaving day-to-day decisions to lower management for execution. Supply of right information, at proper time, increases efficiency at all levels. (7) Reporting to Management: Reporting is an important function of management accounting to achieve the targets. The reports are presented in the form of graphs, diagrams and other statistical techniques so as to make them easily understandable. These reports may be monthly, quarterly, and half-yearly. These reports are helpful in giving constant review of the working of the business. Storehouse of Reliable Data Modification and Presentation of Data Financial Analysis and Interpre tation Communication and Coordination Control Reporting to Management Supplyi ng Information to Various Levels of Management 1.6 LIMITATIONS OF MANAGEMENT ACCOUNTING Despite the development of Management Accounting as an effective discipline to improve the managerial performance, some of the limitations are as under: (1) Accuracy is not Ensured: Management Accounting is largely based on estimates. It does not deal with actual, alone, and thus total accuracy is not ensured under Management Accounting. (2) A Tool in the Hands of Management: Management Accounting is definitely a tool in the hands of management, but cannot replace management. (3) Strength and Weakness: Management Accounting derives information from Financial Accounting, Cost Accounting and other records. The strength and weakness of these basic information providers become the strength and weakness of Management Accounting too. (4) Costly Affair: The installation of Management Accounting is a costly affair so all the organizations, in particular, small firms cannot afford.