Himachal Pradesh PSC: Management Accounting (Part 2 of 3)

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Responsibitlity Accounting

Some business organisation are now adopting responsibility accounting in their management section, though adopting advance computer and internet facility they are setting each and every person's responsibility.

So you should know about responsibility accounting.

Responsibility accounting is system of control where responsibility is a signed of control on cost. The proper authority is given to person so that they are given to persons so that they are able to keep up their performance.

β€œIn other words, the responsibility accounting is that type of management accounting that collects and reports both planed actual accounting informations in the terms of responsibility centers.”

Types of Responsibility Center

  1. Cost center The cost center relates to that segment in which the managers are responsible for incurring the cost. But there have no responsibility of revenue. It is also known as expenses center.

  2. Profit Center When a responsibility center gets revenue from output then it is known as profit center. The difference between revenue earned and cost incurred will be the amount of profit.

  3. Investment Center An investment centre is an entry segment in which a manager can control not only revenue or cost but also investments. In this, the manager who is given the responsibility of investment center is under obligation for proper utilisation of assets.

Steps of Responsibility Accounting

  1. The organisation should be divide

  2. Making of Responsibility Center

  3. Making of targets or set the targets in different centers

  4. Count actual performance

  5. Analysis of performance

  6. Timely improved action.

Definition of Working Capital and Benefits of Its Analysis

As an accountant, you must know working the working capital and benefits of its analysis. Dear working capital means excess of current asset over current liabilities. In other word. If your current assets are more than your current liabilities. These more current assets are known as working capital. For doing your business with better way, the business must have working capital every time. If you have more current assets than your current Liabilities, it means you can buy your stock of business, you can pay your creditors. All time when your investor or any body who want to give you loan will see you working capital. If your liquid capital is non, nobody will give you any debt or goods on credit. So it is the duty of accountant of business. To make some working capital so that your business will grow with the help of loan and debt. For this I am giving some tips.

Each time when you pass the voucher entry in tally or any other computer accounting software, then see what is the position of your working capital.

If you see that there is no working capital, when current assets are equal to current liabilities, or current liabilities are more than current assets this will be very serious position when working capital is in negative. At this time, you must sell some fixed assets so that you can keep your working capital position in positive.

Never give goods on credit to any body who has not good dealing with you Financial accounting, cost accounting and management accounting are interrelated because without co-ordination and co-operation with each other, we will never succeed in achieving the objectives of business. Financial accounting provides different financial statements. On these statements we calculate different cost, like cost of material, cost of labour, and cost of overheads. On the basis we calculate cost of goods sold and then we include our profit margin in it and the ascertain our product price. In management accounting, financial and cost accounting supply different useful accounting information. On these accounting data manager makes the plans of business. Organize different works. Even standard costing and budgeting is very useful toots for controlling the organization. In a business the requirement of funds has to be carefully estimated. Certain funds are required for long term purpose investment in fixed assets etc. A careful estimation of such funds depends different ratio analysis which tells us that what is rate on capital employed, if this rate is very high then we can get more fund for more production and for more production give more money. Even financial management is also part of management accounting. If system of financial accounting will complete with good way and rules and regulation, then other system of cost accounting and management accounting will gives good result.

Leverage analysis is the part of management accounting. This is the duty of finance manager to use the technique for making ideal structure of capital. Leverage analysis is the best technique of finance manager. With this technique he can make wonderful structure of capital. For doing leverage analysis he has to calculate three leverage

1st Leverage-Operating Leverage

Operational leverage is calculate by following formula

Operational leverage = % change in Earning before interest and tax/% Change in Sales

Analysis of operating leverage of a firm is very useful to the financial manager. It tells the impact of changes in

sales on operating income. A firm having higher Degree of operating leverage can experience a magnified effect on

E B I T for even a small change in sales level. Higher D. O. L. Can dramatically increase the operating profit. But if

there is decline in sales level, E. B. I. T. May be wiped out and a loss may be operated.

2nd Leverage-Financial Leverage

Financial leverage can be calculate with following formula = % change in Earning per share/% change in Earning before interest and tax.

Financial leverage helps the finance manager in designing the appropriate capital structure. One of the objectives of

planning an appropriate capital structure is to maximize the return on equity shareholders'funds or maximize the

earning per share.

Financial leverage is doubled edged sword. On the one hand it increase earning per share and on the other hand it

increase financial risk. A high financial leverage means high fixed financial costs and high financial risk i.e.. As the

debt component in capital structure increases, the financial leverage increases and at the same time the financial

risk also increase.

So the finance manager therefore is required to trade off i.e.. Has to bring a balance between risk and return for

determining the appropriate amount of debt in the capital structure of a firm. Thus the analysis of financial leverage

is most important tool in the hands of finance managers who are engaged in financing the capital structure of business

firms, keeping in view the objectives of their firm.

3rd Leverage Combined Leverage

The combined leverage measures the effect of a % change in sales on % change in Earning per share.

Combined leverage = operating leverage X financial leverage


Combined leverage = % change in E. B. I. T. x % change in E. P. S./% change in sales x % change in E. B. I. T.

The ratio of contribution to earning before tax, given by combined leverage shows the combined effect of financial and

operating leverage. A high operating and high financial leverage combination is very risky. If the company is

producing and selling at a high level, it will make extremely high profit for its shareholders. But even a small fall

in the level of operations would result in a tremendous fall in earning per share. A company must, therefore maintain

a proper balance between these two leverage.

Comparative Financial Statement

This is main tool of financial analysis. This type of analysis is useful when the accounting data of two periods is given. Generally two statements are prepared

  1. Comparative balance sheet

  2. Comparative income statement The figures of two periods are taken in their respective columns and increase or decrease after which percentage is taking into account previous year as base year. After showing the increase or decrease the interpretation in form of comment is also to be specified. However the various comparative statements are to be prepared as follow.

Comparative Balance Sheet

To analysis the financial statement as per the technique of comparative statement analysis the first one is the comparative balance sheet for preparation comparative balance sheet with following steps

  1. Ist step: Take the given balance sheet of two period in years

  2. 2nd step: Make the difference of each item of balance sheet in the vertical or horizontal form determining the increase or decrease (in absolute figure)

  3. 3rd Step: Make the % of increasing or decreasing (Previous year as base year)

  4. 4th step: Interpretation (Comments)

    1. Long term financial position

    2. Working capital position

    3. profitability position

    4. Overall financial position

Comparative Income Statements

The income statement shows results of operation of business. The comparative income statement indicate the variation with different item which are to be recorded in income statement. Over a particular period of time that is one year. It shows the amount of gross profit, operating profit and net profit. However a comparative income statement is to be prepared in following form.

Interpretation or Comments can be given

  1. On the increasing sale or cost of sale increasing or decreasing

  2. Operating expenses and incomes affecting the amount of profit or loss

  3. Overall profitability position

Making of Cash Flow Statement with Both Direct and Indirect Methods

In good question of making cash flow statement, the examiner must give you two year balance sheet of company, a profit and loss account and some additional information for making cash flow statement. With above three basic information you can easily make cash flow statement with direct or indirect method.

Here we are taking one practical question, then we solve it both direct method and indirect method. This question ca be asked in CA, ICWA, MCA, MCOM and MBA exams

The following is the abstract of balance sheet of Software securities ltd for the year 2005 and 2006


  • Provision for depreciation 2005 Rs. 108000 and 2006 RS. 396000
  • Retained earning 244800 370800
  • 9% debenture 270000 198000
  • Account payable 72000 41400
  • Expense payable 0 18000


  • Land 2005-Rs. 126000 and 2006-Rs. 81000
  • building 360000 360000
  • Accumulated depreciation
  • on building 19800 37800
  • Equipment 122400 347400
  • Accumulated depreciation on
  • equipement 18000 50400
  • stock in hand 10800 97200
  • Account receivable 36000 122400
  • cash in hand 66600 97200
  • Preliminary expenses 10800 7200

Question gives you also income statememtn of software securities ltd

  • Sales 1602000
  • less cost of sale 837000
  • less operating exp. 397800
  • less interest exp. 21600
  • loss on sale of equipments 3600
  • 126000
  • Net income before tax 342000
  • provision of tax 117000
  • Net Income after tax 225000

Additional Information

  1. Operating expenses include depreciation of rs. 59400 and charges from preliminary expenses of rs. 3600

  2. Land was sold at its book value

  3. cash dividend paid for the year 2006 amounted to rs. 27000 and fully paid bonus shares were given in the ratio of 2 shares for every 3shares held.

  4. Interest expenses was paid in cash.

  5. Equipment with a cost of rs. 298800 was purchased for cash. Equipment with a cost of rs. 73800 (book value rs. 64800) was sold for rs. 61200

  6. Debenture for rs. 18000 were redeemed for cash and for rs. 54000 were redeemed by converting into equity shares at par value.

  7. Equity shares of rs. 162000 were issued for cash at par.

  8. Income tax paid during the year amounted to rs. 117000

Prepare Cash Flow Statement

with direct method & indirect method

Cash Flow Statement with Direct Method

  • Particulars Amount Amount
  • A-catagory
  • Cash flow from operating
  • activity
  • Inflow of cash
  • Cash sale & amount from debtors
  • calculation
  • = sale + opening bal. Of debtors-
  • closing balance of debtors
  • = 1602000 + 36000 βˆ’ 122400 = ( + ) 1515600
  • Any other operating income ( + ) nil
  • Less
  • Cash outflow
  • 1. Cash purchase and amount paid to creditors
  • Calculation
  • = Cost of goods sold + opening creditors
  • closing creditors =
  • = 837000 + 72000 βˆ’ 41400 = (-) 867600
  • 2. Cash operating Expenses
  • Operating expenses as per profit
  • Loss account-depreciation-preliminary exp.
  • Outstanding expense closing
  • = 397800 βˆ’ 59400 βˆ’ 3600 βˆ’ 18000 = (-) 316800
  • Out flow of stock
  • + opening stock (-) 86400
  • closing stock = 10800 βˆ’ 97200
  • 244800
  • Less income tax paid (-) 117000
  • 127800 127800
  • B-Category
  • Cash flow from investing activity
  • Inflow of cash
  • 1. Sale of equipment ( + ) 298800
  • 2. Sale of land ( + ) 45000
  • Less Cash outflow
  • 1 cash paid for purchase of equipment (-) 298800
  • 192600 192600
  • C-catagory
  • Cash flow of financing activity
  • Cash inflow
  • 1. Issue of new shares ( + ) 162000
  • Less Cash outflow
  • 1. Cash paid for redemption of deb (-). 18000
  • 2. Dividend paid (-) 27000
  • 3. Interest Paid (-) 21600
  • 95400 95400
  • Add opening cash balance + 66600
  • Closing balance of cash 97200

Cash Flow Statement with Indirect Method

  • Particularv Amount Amount
  • A-category
  • Cash flow of operating activity
  • 1st Point
  • Net Profit before taxation and extraordinary
  • Items 342000
  • 2nd Point
  • Add for non cash and non operating expenses
  • And losses
  • Depreciation 59400
  • Preliminary expenses written off 3600
  • Discount on issue of shares and deb. w/o nil
  • Goodwill written off nil
  • Patent and trade marks written off nil
  • Interest on borrowing and deb. 3600
  • Loss on sale of fixed assets 21600
  • 430200
  • 3rd Point
  • Less non cash and non operating incomes (-) nil
  • Dividend income (For non financial co.)
  • Rental income
  • Profit on sale of fixed asset
  • 4th point (Ist point + 2nd Point-3rd Point) 430200
  • Adjustment of working capital changes
  • 5th point
  • Add Decrease in current assets and increase in
  • Current liabilities ( + ) nil
  • Decrease in stock
  • Decrease in debtors
  • Decrease in accrued income
  • Decrease in prepaid expenses
  • Increase in creditors
  • Increase in bill payables
  • increase in outstanding expenses ( + ) 18000
  • Increase in advance incomes
  • Increase in provision for doubtfull debts
  • 448200
  • 6th Point
  • Less increase in current assets and decrease in (-)
  • Current liabilities
  • Increase in stock 86400
  • Increase in debtors 86400
  • increase in accrued incomes nil
  • increase in prepaid expenses nil
  • decrease in creditors 30600
  • Decrease in bill payables nil
  • decrease in outstanding expenses nil
  • decrease in advance incomes nil
  • Decrease in provision for d/d nil
  • 244800
  • Less income tax paid (-) 117000
  • 127800 127800
  • B-Category
  • Cash flow from investing activity
  • Inflow of cash
  • 1. Sale of equipment ( + ) 298800
  • 2. Sale of land ( + ) 45000
  • Less Cash outflow
  • 1 cash paid for purchase of equipment (-) 298800
  • 192600 192600
  • C-catagory
  • Cash flow of financing activity
  • Cash inflow
  • 1. Issue of new shares ( + ) 162000
  • Less Cash outflow
  • 1. Cash paid for redemption of deb (-). 18000
  • 2. Dividend paid (-) 27000
  • 3. Interest Paid (-) 21600
  • 95400 95400
  • Add opening cash balance + 66600
  • Closing balance of cash 97200