Management Accounting

Accounting Ratio:
Accounting ratio, also known as the financial ratio, is the comparison of two or more
financial data which are used to evaluate a business condition. It is an effective business tool
that is used by shareholders, creditors, and all kinds of stakeholders to understand the
profitability, strength, and financial status of a business. Accounting ratio are also widely
used to examine business performance and accordingly business decisions can be made.
Different Types of Accounting Ratio
Ratios are classified into two types namely traditional classification and functional
classification. The traditional classification is based on the financial statement to which the
determinants belong. Based on the traditional classification, ratios are classified as:
1. Statement of Profit and Loss Ratio:
A ratio of two variables from the profit and loss statements is termed the statement of
profit and loss ratio. For example, the ratio of gross profit to revenue generated from
business operations is referred to as the gross profit ratio. It is calculated using both
the figures derived from the profit and loss statement.
2. Balance Sheet Ratio:
If both the variables of the ratio are from the balance sheet, then it is classified as the
balance sheet ratio. For example, the ratio of current assets to current liabilities is
termed the current ratio. It is calculated using both the figures derived from the
balance sheet.
3. Composite Ratio:
If the ratios are calculated using one variable from the financial statement and another
variable from the balance sheet, then it is termed composite ratio. For example, the
ratio of credit revenue from business operations to trade receivables is termed the
trade receivable turnover ratio. It is calculated using one variable from the profit and
loss statement (credit revenue from business operations) and another variable (trade
receivables) from the balance sheet statement.
On the Basis of Functional Classification, Ratio Are Classified as:
1. Liquidity Ratio: To meet business commitments, the business needs liquid funds.
The ability of a business to pay the due amount to stakeholders as to when it is due is
known as liquidity; the ratio calculated to measure it are known as liquidity ratio. The
liquidity ratio are short-term in nature. They are calculated to measure the short-term
solvency of the business i.e. the firm's ability to meet its current obligations. The most
common type of liquidity ratio are:
• Current Ratio
• Quick or Liquid Ratio
2. Solvency Ratio: The business solvency is determined by its ability to meet its
contractual obligations towards stakeholders, specifically towards external
stakeholders, and the ratio calculated to measure the business solvency positions are
known as the solvency ratio. The solvency ratios are long-term in nature. The most
common type of solvency ratio for calculating the business solvency are:
• Debt-Equity Ratio
• Debt to Capital Employed Ratio
• Proprietary ratio
• Total Asset to Debt Ratio
• Interest Coverage Ratio
3. Activity or Turnover Ratio: These are the ratios that are calculated for measuring
the efficiency of business operations based on the effective utilization of resources.
Hence, these are also termed efficiency ratios. A higher turnover ratio means better
 utilization of assets and signifies improved business efficiency and profitability. The
most important types of activity ratios are:
• Activity Turnover Ratio
• Trade Receivable Turnover Ratio
• Trade Payable Turnover Ratio
• Net Asset or Capital Employed Turnover Ratio
• Fixed Asset Turnover Ratio, and
• Working Capital Turnover Ratio
4. Profitability Ratio: Profitability ratio are referred to as analysis of business profits in
relation to the revenue generated from the business operations ( or funds) or assets
used in the business and the ratios calculated to meet its objectives are termed as
profitability ratios. The most common types of profitability ratios that are used to
analyse the profitability of the business are:
• Gross Profit Ratio
• Operating Ratio
• Operating Profit Ratio
• Net Profit Ratio
• Return on Investment (ROI) or Return on Capital Employed (ROCE)
• Return on Net Worth (RONW)
• Earnings Per Share
• Book Value Per Share
• Dividend Pay out Ratio
• Price Earning Ratio
Accounting Ratio Formulas
Here, we will list the formulas of all the accounting ratio on the basic functional classification
discussed above:

Liquidity Ratio Formulas

Current Ratio Current Asset/Current Liabilities

Quick Ratio Quick Asset/Current Liabilities

Liquid Ratio Liquid Asset/Current Liabilities

Solvency Ratios

Debt Equity Ratio Long - Term Debts/Shareholders Funds

Debt to Capital Employed Ratio Long - Term Debts/Capital Employed or Net Assets

Proprietary ratio Shareholders Funds/Capital Employed or Net Assets

Total Asset to Debt Ratio Total Assets/Long - Term Debts

Net Profit Before Interest And Tax/Interest on Long -

Interest Coverage Ratio
Term Debts

Activity or Turnover Ratio

 Cost of Revenue From Business Operations/Average
Activity Turnover Ratio
Inventory

Net Credit Revenue From Business Operations

Trade Receivable Turnover Ratio /Average Trade Receivables
Here, Average Credit Receivables =
Opening Debtors and Bill Receivables + Closing
Debtors and Bills Receivables/2

Net Credit Purchase/Average Trade Payables

Trade Payable Ratio Turnover Here, Average Credit Payables =
Ratio Opening Debtors and Bill Payables + Closing Debtors
and Bills Payables/ 2

Net Asset or Capital Employed

Revenue From Business Operations/Capital Employed
Turnover Ratio

Net Revenue From Business Operations/Net Fixed

Fixed Asset Turnover Ratio
Assets

Net Revenue From Business Operations/Working

Working Capital Turnover Ratio
Capital

Profitability Ratio

Gross Profit Ratio Gross Profit/Net Revenue of Business Operations×100

Cost of Revenue From Business Operations + Operating

Operating Ratio
Expense/Net Revenue From Business Operations×100

Operating Profit/Revenue From Business

Operations×100
Operating Profit Ratio
Here, Operating Profit =Revenue From Business
Operations/Operating Cost

Net Profit Ratio Net Profit/Revenue From Business Operations×100

Return on Investment (ROI) or

Return on Capital Employed Profit Before Interest And Tax/Capital Employed×100
(ROCE)

Return on Net Worth (RONW) or

Profit After Tax/Shareholders Fund×100
Return on Shareholder’s Fund

Profit Available For Equity Shareholders/Number of

Earnings Per Share
Equity shares

Book Value Per Share Equity Shareholders Fund/Number of Equity shares

Dividend Payout Ratio Dividend Per Share/Earning Per Share

Price Earning Ratio Market Price of Share/Earning Per Share

Cash Flow Statement
A cash flow statement (CFS) is one of a business’s most important financial reports. Unlike
the income statement and balance sheet, which concentrate on accounting profits, a CFS
deals with the cash component of a business. Since cash provides liquidity, it is decisive for
the survival of a business.
A CFS records a firm’s all cash-based transactions during a particular accounting period. In
other words, it mirrors the availability and usage of business funds to reveal its current state
of liquidity. Thus, it explains how well a corporate unit manages its resources (cash and cash
equivalents) to ensure uninterrupted business functioning and generate profits.
Further, it is essential for corporate planning in the short run as it gauges a company’s
capacity to meet its short-term obligations. Besides, it is also crucial for business forecasting,
determining liquidity status, dividend decision-making, borrowing in case of monetary
shortage, and wisely allocating surplus funds.
Besides, it discloses vital information regarding the solvency of a business. As opposed to
other financial statements, it is more difficult to manipulate and, therefore, more reliable.
Hence it is widely sought after by the stakeholders of a business.
The cash flows in a business from three significant activities: operating, investing, and
financing. Thus, a cash statement presents the cash generated and spent on all these activities
individually and collectively.
Following are the basic steps to preparing a CFS:
1. Take the opening balance of cash and bank available at the beginning of the
respective accounting year.
2. Add to it all the incoming cash from various sources like cash sale of goods or
services, proceeds from the sale of assets or investments, the funds acquired by the
issue of shares or through bank loans, etc.
3. Subtract the cash outflows from payments like salaries, dividends, rent, insurance,
loan repayment, stock repurchase, taxes, etc. Also, deduct the money invested in
business projects or offered as a loan.
Then the net amount so evaluated is the cash in hand remaining with the company.
Cash Flow Statement Format
The CFS is subdivided into three categories:
1 – Cash flow from Operating Activities
Cash Flow from Operating Activities includes cash used in or generated from the daily core
business activities. The operational activities are the principal revenue-generating or expense-
incurring activities of the company. It includes selling goods or services and payment
towards expenses like salaries, taxes, etc. Some operating activities that result in cash inflows
and outflows are listed below.

Cash flow from Operating Activities

Cash Inflows Cash Outflows

Sales revenue received from customers Rent paid

The commission, brokerage, royalty, and

Cash payment to suppliers and vendors
other fees received

Receipts from debtors Salary, wages, and commission paid

 Taxes paid

Purchase of stock in cash

Freight and other expenses paid

2 – Cash flow from Investing Activities: Cash flow from Investing Activities represents the
outgoing or incoming cash from acquiring or disposing of a company’s long-term assets and
holdings. Assets include land, property, plant & equipment, investments in other companies,
etc.
Listed below are some of the cash flows through investing activities:
Cash flow from Investing Activities

Cash Inflows Cash Outflows

Proceeds from the sale of fixed asset Purchase of fixed assets

Cash is received from selling investments Buying of shares, debentures, and other
in other companies like bonds, fixed assets, long-term or short-term investment
equity, debentures, etc. instruments issued by other companies

Money received on maturity of shares,

debentures, and bonds.

Dividends and interest received on

investments.

3 – Cash flow from financing activities: Cash Flow from financing activities shows the
capital receipts and payments marked by the transactions with the corporate finance providers
like banks, shareholders, and promoters.
Given below are some the examples of cash flows from financing activities:

Cash flow from Financing Activities

Cash Inflows Cash Outflows

Proceeds from borrowings from banks and Repayment of borrowings or loan

other financial institutions instalments

Proceeds from issuance of the shares and

Buyback of debentures and shares
debentures
 Interest paid on loans and borrowings.

Dividend paid on shares issued.

Preparing Cash Flow Statement
There are two methods for calculating cash flows: direct and indirect. Note that the difference
between the two methods lies in computing cash flows from operating activities. In contrast,
the cash flows from investing and financing activities are treated similarly in direct and
indirect methods.
1 – Direct Method
Only the cash operating items are recorded under the direct method of preparing CFS. This
method is relatively easy to understand as it considers the actual cash transactions. The cash
from operating activities can be straightaway computed by adding all the cash receipts and
deducting all the cash payments. Later the cash from all the three activities, i.e., operating,
investing, and financing, can be summed up to get the closing balance of cash and cash
equivalents.

Cash Flow Statement – Direct Method

Particulars Amount Total amount

Opening Cash Balance XXXX

Cash flow from operating activities:

Receipts from sale of goods and services, royalties, etc. XXXX

Payment to employees, taxes, suppliers, etc. (XXXX)

Net cash from operating activities (A) XXXX

Cash flow from investing activities:

Sale of investments, vehicles, property, etc. XXXX

Purchase of machinery, plant, equipment, etc. (XXXX)

Net cash from investing activities (B) (XXXX)

Cash flow from financing activities:

Proceeds from issuing shares, borrowings from banks, etc. XXXXX

Repayment of loan (XXXX)

Payment of dividends to shareholders (XXX)

Net cash from financing activities (C) XXXX

Add: Net cash flow during the year (A + B + C) XXXX

Ending Cash Balance XXXXX

The Financial Accounting Standards Board (FASB) and International Accounting Standards
Board (IASB) suggest that companies record their cash flows through the direct method. But
it is not a handy method for the organizations since various accrual incomes and outstanding
expenses are equally significant in accounting.
2 – Indirect Method
The CFS prepared through an indirect method requires adjustment of the non-cash items
which are earned but not yet received. These changes are made to the net profit or loss of the
company in the particular accounting year. The non-cash and non-operating expenses are
added back to the net profit/loss, while all the non-operating and accrued incomes are
subtracted. Thus, it is the reverse treatment of the income statement and provides the
operating profit before the working capital changes.

Cash Flow Statement – Indirect Method

Particulars Amount Total amount

Cash flow from operating activities:

Profits before tax XXXX

Add: Non-operating expenses

Depreciation, accounts payable, accrued expenses, etc. XXXX

Less: Non-operating income

Accounts receivable, prepaid expenses, unearned revenue,

(XXXX)
etc.

Operating profits before working capital changes XXXX

Add: Decrease in current assets and increase in current

XXXX
liability

Less: Decrease in current liability and increase in current

(XXXX)
assets

Net Cash from operating activities (A) XXXX

Cash flow from investing activities:

Proceeds from sale of fixed assets XXXX

Purchase of fixed assets (XXXX)

Net cash from investing activities (B) XXXX

Cash flow from financing activities:

Proceeds from issuing shares, borrowings from banks, etc. XXXX

Payment of borrowings, dividends, etc. (XXXX)

Net cash from financing activities (C) XXXX

Net cash flow during the year (A + B + C) XXXX

Add: Opening cash balance XXXX

Ending Cash Balance XXXX

The corporates widely use the indirect method since the books of accounts are on an accrual
basis, thus making it a more practical approach.

Variance Analysis
Marginal Costing
Budgeting
Reference Books:
• Management Accounting – Dr K. L. Gupta(Sahitya Bhawan Publications)
• Management Accounting- R.S.N. Pillai & Bhagavati (S. Chand
Publications)
• Management Accounting – T.S. Reddy & Hari Prasad Reddy (Margham
Publications)

YouTube Video links:

• https://youtube.com/playlist?list=PLLhSIFfDZcUWafSuXeR7wIUG3fSGKhpnl
• https://youtube.com/playlist?list=PLLy_2iUCG87D6w12QCXDGfaEa-r_eVY33

QUESTION BANK
UNIT – 1
1. The term Management accounting refers to accounting for the
Management.

2. Management accounting helps to prepare Budgets covering all functions of a

business.

3. Management accounting analyses Monetary and non – Monetary transactions.

 4. Management accounting is a convenient tool for evaluation of Performance.

5. The officer entrusted with the management accounting functions in an organization is

called Management Accountant.

6. Management accountant is also called as Management Controller.

7. Publications of management accounting statement are not Compulsory.

8. Management accounting is suitable for large industrial and trading concerns.

9. Management accounting depends on financial accounting which is its main

source of information.
10. Management Accounting helps the management in decision making.

11. The Balance sheet and income statements are Traditional financial statements.

12. A Comparative Balance Sheet shows the value of assets and liabilities on two
different dates.

13. The statement which report the figures as a percentage of some common base are
called Common Size statements.

14. The relationship between two figures expressed mathematically is called a Ratio.

15. Ratio analysis is a technique for analysis and interpretation of financial statements.

16. Ratios calculated on the basis of the figures of the balance sheet are called Balance
sheet Ratios.

17. Gross profit ratio express the relationship between gross profit and net sales.

18. The Ideal current ratio is 2:1

19. Quick ratio is also called as Acid – test ratio.

20. Trend analysis is significant for forecasting and budgeting.

UNIT – 2
1. A Fund flow statement is a report on the movement of funds or working capital.
2. The main purpose of fund flow statement is to analyses the Financial operations of
the business.

3. Fund flow statement is a Post balance sheet exercise.

4. Transactions that increase the working capital are called Sources of funds.
5. Transactions that decrease the working capital are called Applications of funds.
6. Working capital is the difference between current assets and current liabilities.
 7. The Adjusted Profit and loss account is prepared to ascertain the funds from
operation.
8. Increase in working capital will appear on the Application side of fund flow statement.
9. Decrease in working capital will appear on the Source side of fund flow statement.
10. A projected fund flow statement is an instrument of allocation of resources.
11. The Cash flow statement shows the inflow and outflow of cash.
12. Cash flow statement helps in short – term financial decisions relating to Liquidity.
13. Increase in the amount of creditors results in increase in cash
14. The cash flow statement starts with opening cash balance and ends with closing cash
balance.
15. Cash flow statement is prepared for One year.
16. Cash flow statement is significant for Capital Budgeting decisions.
17. In cash flow statement only Cash receipts and Cash payments are recorded.
18. Increase in current assets increase working capital.
19. Cash from operation is a source of cash.
20.Cash form operation is the result of cash from business activities and changes in
current assets and current liabilities.
UNIT – 3
1.Standard costing is a technique which aims at Controlling and Reducing Costs.
2. Standard Costs are predetermined cost.
3. Standard costing is an expensive technique for Small concern.
4. If the actual cost is less than the standard cost it is termed as Favourable variance.
5. If the actual cost is more than the standard cost is known as Adverse (or)
Unfavourable variance.
6. The difference between the standard wages and actual wages is called Labour cost
variance.
7. Labour rate variances arises due to Unscheduled overtime.
8. Material cost variance = (SQ*SP) – AQ*AP.
9. Material cost variance arises due to Change in the price of the materials.
10. Labour yield variance is a part of the Labour efficiency variance.
11. Material Price Variance is a part of material cost variance.
12. Labour efficiency variance = (SH-AH)*SR.
 13.Material yield variance is a sub – variance of Material usage variance.
14.Variance are transferred to Reserve Account.
15. If the variance are favourable they are shown on Liability side of balance sheet.
16. If the variances are unfavourable they are shown on Asset side of balance sheet.
17.Standard costing is a cost control technique.
18.Standard hours represents output of different kinds expressed in terms of hours.
19. Variance is the difference between standard cost and actual cost.
20. Idle time variance represents the cost of abnormal wastage of time.
UNIT – 4
1.The excess of sales over the break even sales is known as Margin of safety.
2.The profit volume ratio is usually called as P.V Ratio.
3.Key factor is also known as liming factor.
4.The difference between sales and cost of sales is known as Profit.
5.Expenses that do not vary with the volume of production are known as Fixed expenses.
6. Expenses that vary with the volume of production are called Variable expenses.
7. Contribution is also known as Gross Margin.
8. At break-even point the profits is Zero.
9. At break-even point the total cost is equal to Total Revenue.
10. The fixed and variable costs are charged to products in case of Absorption costing.
11. Under marginal costing, fixed cost is ignored for decision making.
12. Fixed cost is reduced from contribution is to find profit.
13. Contribution is excess of sales over variable cost.
14. Large angle of incidence indicates a high profit.
15. Angle of incidence is angle between sales and total cost lines.
16. Break Even Point is a point at which there is no profit or loss.
17. Marginal cost is alternatively called as variable cost.
18.Break Even Chart is a graphical representation of marginal costing.
19.Marginal costing is based on the principle of variability of costs.
20. Make or buy decision ignores fixed cost.
UNIT -5
1. A Budget is a detailed plan of operation for specific future period.
2. Budgeting refers to the management action of formulating budgets.
3. Budgetary control enables the management to decentralize responsibility without
losing control.
4. Budget manual lays down the objectives of the organization, responsibilities of all
executives and the procedure to be followed for budgetary control.
5. Master budget is also called summary budget.
6. Budgets are blue print of the desired plan of action.
7. Sales budget is a budget of output to be sold.
8. A Master budget is a budget for operations of the entire organization.
9. Expand ZBB: Zero Base Budget.
10. Budgeting system integrates key managerial functions.
11. Budgetary control helps the management to plan and control.
12. Cash budget is a short - term budget.
13. Sales budget is a functional budget.
14. Flexible budget is prepared to know the costs at different levels of activity.
15. A budget period is the length of time for which a budget is prepared.
16. A budget which is prepared for more than one year is called Long - term budget.
17. Control Ratios are calculated for comparison of actual performance with budgets.
18. Efficiency Ratio shows the level of efficiency attained during a period.
19. Budgetary control is helpful in setting targets for the whole concern and
achievement of the targets.
20. Budget centres are the specific segments of the organization for which budgets are
prepared.