2the-notes for osting

8/13/2019 2the-Notes for Osting

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CLASSIFICATION OF COSTS: Manufacturing

We first classify costs according to the three elements of cost:a) Materials b) Labour c) Expenses

Product and Period Costs: We also classify costs as either1 Product costs: the costs of manufacturing our products; or Period costs: these are the costs other than product costs that are charged to! debited to! or "ritten off to the income statement each period#

$he classification of Product Costs:

%irect costs: %irect costs are generally seen to be &ariable costs and they are calleddirect costs because they are directly associated "ith manufacturing# 'n turn! thedirect costs can include:

%irect materials: ply"ood! "ooden battens! fabric for the seat and the bac(!nails! scre"s! glue#

%irect labour: sa"yers! drillers! assemblers! painters! polishers! upholsterers %irect expense: this is a strange cost that many texts dont include; but

*'nternational +ccounting ,tandard) '+, ! for example! includes it# %irectexpenses can include the costs of special designs for one batch! or run! of a

particular set of tables and-or chairs! the cost of buying or hiring specialmachinery to ma(e a limited edition of a set of chairs#

$otal direct costs are collecti&ely (no"n as Prime Costs and "e can see thatProduct Costs are the sum of Prime costs and .&erheads#

'ndirect Costs: 'ndirect costs are those costs that are incurred in the factory but thatcannot be directly associate "ith manufacture# +gain these costs are classifiedaccording to the three elements of cost! materials labour and o&erheads#

'ndirect materials: ,ome costs that "e ha&e included as direct materials

"ould be included here# 'ndirect labour: Labour costs of people "ho are only indirectly associated"ith manufacture: management of a department or area! super&isors!cleaners! maintenance and repair technicians

'ndirect expenses: $he list in this section could be infinitely long if "e "ereto try to include e&ery possible indirect cost# Essentially! if a cost is a factorycost and it has not been included in any of the other sections! it has to be anindirect expense# /ere are some examples include:

%epreciation of e0uipment! machinery! &ehicles! buildings Electricity! "ater! telephone! rent! Council $ax! insurance

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$otal indirect costs are collecti&ely (no"n as .&erheads#

inally! "ithin Product Costs! "e ha&e Con&ersion Costs: these are the costsincurred in the factory that are incurred in the con&ersion of materials into finishedgoods#

$he classification of Period Costs:

$he scheme sho"s fi&e sub classifications for Period Costs# When "e loo(at different organisations! "e find that they ha&e period costs that might ha&e subclassifications "ith entirely different names# 2nfortunately! this is the nature of theclassification of period costs; it can &ary so much according to the organisation! theindustry and so on# 3e&ertheless! such a scheme is useful in that it gi&es us the basicideas to "or( on#

+dministration Costs: Literally the costs of running the administrati&e aspects of anorganisation# +dministration costs "ill include salaries! rent! Council $ax!electricity! "ater! telephone! depreciation! a potentially infinitely long list# 3oticethat there are costs here such as rent! Council $ax! that appear in se&eral subclassifications; in such cases! it should be clear that "e are paying rent on buildings!for example! that "e use for manufacturing and storage and administration and eacharea of the business must pay for its share of the total cost under re&ie"#

Without "ishing to o&erly extend this listing no"! "e can conclude this

discussion by saying that the costs of ,elling! the costs of %istribution and the costsof 4esearch are all accumulated in a similar "ay to the "ay in "hich +dministrationCosts are accumulated# Conse0uently! our tas( is to loo( at the selling process andclassify the costs of running that process accordingly: ad&ertising! mar(et research!salaries! bonuses! electricity! and so on# $he same applies to all other classificationsof period costs that "e might use#

inance Costs: inance costs are those costs associated "ith pro&iding thepermanent! long term and short term finance# $hat is! "ithin the section headedfinance costs "e "ill find di&idends! interest on long term loans and interest on short

term loans#

inally! "e should say that "e can add any number of subclassifications toour scheme if "e need to do that to clarify the "ays in "hich our organisationoperates# We "ill also add further subclassifications if "e need to refine and furtherrefine out cost analysis#


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COST SHEET FORMAT

Particulars +mount +mount.pening ,toc( of 4a" Material+dd: Purchase of 4a" materials

+dd: Purchase ExpensesLess: Closing stoc( of 4a" Materials4a" Materials Consumed%irect Wages *Labour)%irect Charges

555555

555555555555555

Prime cost *1) 555+dd :6 actory .&er /eads:

actory 4entactory Po"er'ndirect Material

'ndirect Wages,uper&isor ,alary%ra"ing .ffice ,alaryactory 'nsuranceactory +sset %epreciation

555555555

555555555555555

Wor(s cost 'ncurred 555+dd: .pening ,toc( of W'PLess: Closing ,toc( of W'P

555555

Wor(s cost *) 555

+dd:6 +dministration .&er /eads:6.ffice 4ent+sset %epreciation7eneral Charges+udit ees8an( ChargesCounting house ,alary.ther .ffice Expenses

555555555555555555555

Cost of Production *9) 555+dd: .pening stoc( of inished 7oodsLess: Closing stoc( of inished 7oods

555555

Cost of 7oods ,old 555+dd:6 ,elling and %istribution ./:6

,ales man Commission,ales man salary$ra&eling Expenses+d&ertisement%eli&ery man expenses,ales $ax

555555555555555555

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8ad %ebts 555Cost of ,ales *) 555Profit *balancing figure) 555,ales 555

3otes:61) actory .&er /eads are reco&ered as a percentage of direct "ages

) +dministration .&er /eads! ,elling and %istribution .&erheads are reco&ered asa percentage of "or(s cost#


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MATERIAL

1) 4eorder le&el < Maximum usage 5 Maximum lead time *.r) Minimum le&el = *+&erage usage 5 +&erage Lead time)

) Minimum le&el < 4eorder le&el > *+&erage usage 5 +&erage lead time)9) Maximum le&el < 4eorder le&el = 4eorder 0uantity > *Minimum usage 5

Minimum lead time)

) +&erage le&el < Minimum le&el =Maximum le&el *or)

Minimum le&el = ? 4eorder 0uantity

) %anger le&el *or) safety stoc( le&el


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1) safety stoc( < +nnual %emand 5*Maximum lead time 6 +&erage lead time) 9@1@) $otal 'n&entory cost < .rdering cost = Carrying cost of in&entory =Purchase cost

1) 'nput .utput 4atio < Auantity of input of material to production

,tandard material content of actual output4emar(s :6

1) /igh 'n&entory $#. 4atio indicates that the material in the 0uestion is fast mo&ing

) Lo" 'n&entory $#. 4atio indicates o&er in&estment and loc(ing up of "or(ing Capital in in&entories

Pricing of material 'ssues:6

1) Cost price method:6 a) ,pecific price method

b) irst in irst .ut method *'.) c) Last in irst .ut method *L'.) d) 8ase stoc( method

) +&erage price method:6

a) ,imple a&erage price method < $otal unit price$otal 3o# of purchases

b) Weighted a&erage price method < $otal cost $otal 3o# of units

c) Periodic simple a&erage price method < $otal unit price of certain period

$otal 3umber of purchases of that period*$his rate is used for all issues for that period# Period means a month *or) "ee( *or)year)

d) Periodic "eighted a&erage price method < $otal cost of certain period$otal 3umber of units of that period

e) Mo&ing simple a&erage price method < $otal of periodic simple a&erage of certain number of periods

3umber of periods

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f) Mo&ing "eighted a&erage price method< $otal of periodic "eighted a&erage of certain number of periods

3umber of periods

9) Mar(et price method:6

a) 4eplacement price method < 'ssues are &alued as if it "as purchased no" atcurrent mar(et price

b) 4ealiIable price method < 'ssues are &alued at price if it is sold no"

) 3otional price method:6

a) ,tandard price method < Materials are priced at pre determined rate *or),tandard rate

b) 'nflated price method < $he issue price is inflated to co&er the losses incurreddue to natural*or)climatic losses

) 4e use price method < When materials are returned *or) reJected it is &alued atdifferent price# $here is no final procedure for this method#

+8C +nalysis *or) Pareto +nalysis :6 'n this materials are categoriIed into

Particulars Auantity Kalue

+ > 'mportant material 1HD HD8 > 3either important nor unimportant HD HDC > 23 'mportant HD 1HD

3ote:6

1) Material recei&ed as replacement from supplier is treated as fresh supply

) 'f any material is returned from %epartment after issue! it has to be first disposed in the next issue of material

9) loss in the boo( balance of stoc( and actual is to be transferred to 'n&entory adJustment a-c and from there if the loss is normal it is transferred to .&er /ead

control a-c# 'f it is abnormal it is transferred to costing profit and loss a-c#

) C' < Cost 'nsurance and reight *$his consignment is inclusi&e of prepaidinsurance and freight)


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) .8 < ree on 8oard *Materials mo&ing by sea > insurance premium is notpaid)

@) .4 < ree on 4ail *'nsurance and freight is not borne by the supplier but paidby the company or purchase)

) or each receipt of goods < 7oods 4eceipt note

F) or each issue of goods < Materials 4e0uisition note *or) Material 'ssue note

+ccounting $reatment :6

1) 3ormal Wastage < 't should be distributed o&er goods output increasing per unit cost

) +bnormal Wastage< 't "ill be charged to costing profit and loss a-c

9) ,ale &alue of scrap is credited to costing profit and loss a-c as an abnormal gain#

) ,ale proceeds of the scrap can be deducted from material cost or factory.&erheads#

) ,ale proceeds of scrap may be credited to particular Job#

@) 3ormal %efecti&es < cost of rectification of defecti&es should be charged to ,pecific

) +bnormal %efecti&es < this should be charged to costing profit and loss a-c

F) Cost of 3ormal spoilage is to borne by good units

G) +bnormal spoilage should be charged to costing profit and loss a-c

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LABOUR

Method of 4emuneration:

1) $ime 4ate system

a) lat time 4ateb) /igh "age systemc) 7raduated time rate

) Payment by 4esults

a) Piece rate systemi) ,traight piece rateii) %ifferential piece rate

$aylor system Merric( system

b) 7roup 8onus ,ystemi) 8udgeted Expensesii) $o"ne gain sharing schemeiii) Cost efficiency bonusi&) Priest man system

c) Combination of $ime and Piece rate

i) 7antt tas( and 8onus schemeii) Emerson Efficiency systemiii) Point scheme

8edaux system /aynes manit system

d) Premium bonus plansi) /alsey premium planii) /alsey "eir premium plan

iii) 4o"an schemei&) 8arth scheme&) +ccelerating premium bonus scheme

e) .ther incenti&e schemesi) 'ndirect monetary incenti&e

Profit sharing Co6partnership

ii) 3on6Monetary 'ncenti&e

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1) $ime rate system < /ours "or(ed 5 4ate per hour *8asic "ages)

) Piece rate system:

i) ,traight piece rate earnings < 3umber of units produced 5 4ate per unit

ii) %ifferential Piece rate

a) #W#$aylorBs differential rate system N F9D of piece rate "hen belo" standard N 1D of piece rate "hen abo&e or at standard

b) Merric( differential or multiple piece rate system

Efficiency le&el Piece rate

N up to F9D N3ormal piece rateN F9D to 1HHD N 11HD of 3ormal rateN +bo&e 1HHD N 1HD of 3ormal rate

iii) 7antt $as( and 8onus system

.utput Payment N 8elo" standard N $ime rate *guaranteed) N +t standard N HD 8onus of $ime rate

N +bo&e standard N 1HD of ordinary piece rate i&) EmersonBs Efficiency system

Efficiency Payment N 8elo" @@#D N /ourly 4ate N from @@#D N /ourly rate *=) increasing bonus according to degree

to 1HHD of efficiency on the basis of step bonus rates N +bo&e 1HHD N /ourly rate *=) HD 8onus *=) additional bonus of 1D

of hourly rate for e&ery 1D increase in efficiency

&) /alsey Premium Plan < 8asic "ages = HD of time sa&ed 5 /ourly 4ate

&i) /alsey Weir Premium Plan < 8asic "ages = 9HD of time sa&ed 5 /ourly rate

&ii) 4o"an Plan < 8asic "ages = $ime sa&ed 5 8asic Wages $ime allo"ed

&iii) 8edaus Point system < 8asic "ages = D 5 8edaus point-@H 5 4ate-hr

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ix) 8arthBs ,ystem < /ourly rate 5 ,td time 5$ime ta(en

Labour $urno&er:6

1) ,eparation rate method < ,eparation during the period

+&erage 3o# of "or(erBs during the period) 3et labour $#. rate *or) 4eplacement method

< 3umber of replacements +&erage 3o# of "or(erBs during the period

9) Labour flux rate < 3o# of separation = 3o# of replacement +&erage 3o# of "or(erBs during the period

+ccounting $reatment

1) 3ormal 'dle time < Charged to factory o&erheads

) 3ormal but un6controllable < 't should be charged to Job by inflating "age rate#

9) +bnormal < 't should be charged to costing P O L a-c

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OVER HEADS

4eapportionment of ser&ice department expenses o&er production department :6

1) %irect redistribution method:

,er&ice department costs are di&ided o&er production department# 'gnore ser&ice rended by one dept# to another

) ,tep method of secondary distribution *or) 3on reciprocal method: ,er&ice department "hich ser&es largest number of ser&ice department is

di&ided first and go on#

9) 4eciprocal ser&ice method:

i) ,imultaneous e0uation method *or) +lgebraic method E0uation is formed bet"een ser&ice departments and is sol&ed to find the

amount due#

ii) 4epeated distribution method: ,er&ice department cost separated repeatedly till figure of ser&ice dept# is

exhausted or too small#

iii) $rial and Error method: Cost of ser&ice department is apportioned among them repeatedly till the

amount is negligible and the total is di&ided among production department#

$reatment of .&er-2nder absorption of o&erheads:6

i) 'f under absorbed and o&er absorbed o&erheads are of small &alue then it should betransferred to costing profit and loss a-c

ii) 'f under and o&er absorption occurs due to "rong estimates then cost of productmanufactured should be adJusted accordingly#

iii) 'f the same accrued due to same abnormal reasons the same should be transferredto costing profit O loss a-c

+pportionment of o&erhead expenses > 8asis

a) ,tores ser&ice expenses < Kalue of materials consumed

b) actory rent < loor area

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G) $ransport department < Crane hours! truc( hours! truc( mileage!3umber of pac(ages#

1H) Po"er house *electric po"er cost) < /ousing po"er! horse po"er machine hours!

3o# of electric points etc#11) Po"er house < loor area! cubic content#

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RECONCILATION OF COST AND FINANCIAL A/C

Causes of differences:6

1) Purely financial items : i) +ppropriation of profits Q$ransferred to reser&es! good"ill! preliminary expenses! di&idend paid etc# ii) Loss on sale of in&estment! penalties and fines

iii) 'ncome Q 'nterest recei&ed on 8an( deposits! profit on sale of in&estments! fixed assets! transfer fees#

) Purely cost account items: 6 3otional 4ent - 'nterest - ,alary

9) Kaluation of stoc(:6

i) 4a"6material < 'n financial a-cBs stoc( is &alued at cost or mar(et &alue Whiche&er is less! "hile in cost a-cBs it is &alued at L'.! '.etc#

ii) Wor( in progress < 'n financial a-cBs administrati&e expenses are also considered "hile &aluing stoc(! but in cost a-cBs it may be &alued at prime *or) factory cost *or) cost of production

iii) inished 7oods < 'n financial a-cBs it is &alued at cost or mar(et price "hiche&er is less! in cost a-cBs it is &alued at total cost of production#

) .&erheads: 'n financial < +ctual expenses are ta(en 'n cost < Expenses are ta(en at predetermined rate#

) %epreciation: 'n financial < Charged in diminishing or fixed balance method 'n cost < Charged in machine hour rate

@) +bnormal 7ains: 'n financial < $a(en to profit O Loss a-c

'n cost < Excluded to cost a-cBs or charged in costingprofit O Loss a-c

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JOB AND BATCH COSTIN

With Job costing! "e are dealing "ith one off situations# We are dealing "ith

organisations that carry out functions and ser&ices on a one at a time basis# 7oodexamples of Job costing situations include Jobbing builders: the builder "ho "illpro&ide a householder! or a shop o"ner! or a factory o"ner "ith a ser&ice that hepro&ides for no one else# $he Jobbing builder "ill build an extension! or reno&atesome property to a design that "ill probably not be copied any"here else at anytime: it is a one off Job# Rob costing can apply in non manufacturing situations as"ell as in manufacturing situations#

E&en though many Jobbing enterprises are small scale! "e are not suggestingthat all Jobbing enterprises are small scale enterprises# +n engineering shop may be

"or(ing on a Job for a customer that ta(es se&eral months and many man andmachine hours to complete#

/ere are t"o definitions:

+ Job is + customer order or tas( of relati&ely short durationRob costing is + form of specific order costing; the attribution of cost to Jobs

8atch costing is not normally seen as much of an ad&ance on Job costing#

+ batch is + group of similar articles "hich maintains its identity throughoutone or more stages of production and is treated as a cost unit 8atch costing is + formof specific order costing; the attribution of costs to batches#

Economic 8atch Auantity < E8A < +,-CWhere + < +nnual %emand , < ,etting up cost per batch C< Carrying cost - unit of production#

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!ROCESS COSTIN

ormat of process a-c

Particulars 2nit 4ate 4s# Particulars 2nit 4ate 4s#$o %irect material 8y 3ormal Loss$o %irect Labour 8y 2nits transferred

to other process$o 'ndirect material$o .ther Expenses 8y +bnormal loss

*8-)$o +bnormal gain*8-)$otal $otal

ormat of +bnormal loss

Particulars 2nit 4s# Particulars 2nit 4s#$o Process a-c 8y ,ale of "asted

units8y costing P O L a-c

$otal $otal

ormat of +bnormal gain a-c

Particulars 2nits 4s# Particulars 2nits 4s#

$o 3ormal Loss a-c 8y Process a-c *names of differentprocess)$o costing POla-c$otal $otal

1)$o find the cost per unit for &aluation of units to be trans# to next process and alsofor abnormal! loss or gain < $otal process cost > ,al&age &alue of normal spoilage

$otal units introduced > 3ormal loss in units

) $o find abnormal loss *or) gain *all in units): < 2nits from pre&ious process = fresh units introduced > 3ormal loss > units

transferred to next process *'f the result is positi&e then abnormal loss# 'fnegati&e then abnormal gain)

9) 'n case of opening W'P and closing W'P are gi&en then there are differentmethods of &aluation of closing W'P

i) '. Method ii) L'. Methodiii) +&erage Method i&) Weighted +&erage Method

) Karious statements to be prepared "hile W'P is gi&en:

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Loss-gain units and output of the process#

c) ,eparate a-c for both abnormal loss-gain is to be prepared#

JOINT !RODUCT AND B" !RODUCT COSTIN

Methods of apportioning Joint cost o&er Joint products :

1) Physical unit method < Physical base to measure *i#e#) output 0uantity is used to separate Joint cost# Roint cost can be separated on the basis of ratio of output

0uantity# While doing this "astage is also to be added bac( to find total 0uantity#

) +&erage unit cost method < 'n this method Joint cost is di&ided by total unitsProduced of all products and a&erage cost per unit is arri&ed and is multiplied

With number of units produced in each product#

9) ,ur&ey method or point &alue method < Product units are multiplied by points or"eights and the point is di&ide on that basis#

) ,tandard cost method < Roint costs are separated on the basis of standard cost setfor respecti&e Joint products#

) Contribution margin method < Cost are di&ided into t"o categories *i#e#) &ariable

and fixed# Kariable costs are separated on unit produced# ixed on the basis ofcontribution ratios made by different products#

@) Mar(et &alue method:6

a) Mar(et &alue at the point of separation: Roint cost to sales re&enueS percentageis found "hich is called as multiplying factor < Roint cost 5 1HH

,ales 4e&enue Roint cost for each product is apportioned by applying this D on sales re&enue

of each product# ,ales re&enue < ,ales 4e&enue at the point of separation# $his method cannot be done till the sales re&enue at the separation point is

gi&en#

b) Mar(et &alue after processing: Roint cost is apportioned on the basis of total sales Kalue of each product after further processing#

c) 3et 4ealiIable &alue method < orm sales &alue follo"ing items are deductedi) Estimated profit margin

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ii) ,elling and distribution expenses if any included#iii) Post split off cost

$he resultant amount is net realiIable &alue# Roint cost is apportioned on thisbasis#

8i6product T Method of accounting

$reat as other income in profit and loss a-c

3et 4ealiIable &alue of 8i6product is reduced from cost of main product#

'nstead of standard process! ,tandard cost or comparati&e price or re6useprice is credited to Joint process a-c#

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O!ERATION COSTIN

,er&ice costing is + cost accounting method concerned "ith establishing the costsof ser&ices rendered# ,er&ice costing is also applied "ithin a manufacturing setting#

$he %ifferences 8et"een Product Costing and ,er&ice CostingU $here may be &ery fe"! if any! materials to "orry about .&erheads "ill comprise the most significant portion of any costs of "hich!

labour costs may "ell comprise as much as HD

3o# Enterprise Cost per unit1# 4ail"ays or bus companies Per passenger6(ilometer# /ospital Per patient-day! per bed-day9# Canteen Meals ser&ed ! cups of tea# Water supply ser&ice Per 1HHH gallons# 8oiler /ouse 1HHH (g of steam@# 7oods $ransport Per tonne (m! 0uintal (m# Electricity 8oards Per (ilo"att > hoursF# 4oad maintenance department Per mile or road maintenanceG# 8ric(s .ne thousand

1H# /otel Per room-day

'n this &arious terms such as passenger (m! 0uintal (m! tonne (m! these areall (no"n as composite units and are computed in "ays:

a) +bsolute *"eighted a&erage): *e#g#) tones (m 6 Multiplying total distance byrespecti&e load 0uantity#

b) Commercial *simple a&erage): *e#g#) tonne m>Multiplying total distance bya&erage load 0uantity

+ll accumulated cost is classified into 9 categories:

1) ,tanding charges *or) fixed cost) 4unning cost *or) &ariable cost9) Maintenance charges *or) semi &ariable cost

4unning charges < uel! %ri&er Wages! %epreciation! oil etc#

Maintenance charges < ,uper&ision salary! 4epairs and Maintenance

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3ote:6 D of factory o&erheads on direct "ages

D of administration o&erheads on "or(s cost D of selling O distribution o&erheads on "or(s cost D of profit on sales

.perating cost sheet :6

Particulars $otal cost Cost per (m+ ,tanding charges :6

License fees

'nsurance Premium 4oad tax 7arage rent %ri&erBs "ages +ttendant6cum6cleanerBs "ages ,alaries and "ages of other staff

$otal8 4unning charges :6

4epairs and maintenance Cost of fuel *diesel! petrol etc#)

Lubricants! grease and oil Cost of tires! tubes and other spare parts %epreciation

$otalC $otal charges V *+) = *8)


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CONTRACT COSTIN

Contract costing is + form of specific order costing; attribution of costs toindi&idual contracts#

+ contract cost is +ggregated costs of a single contract; usually applies to maJorlong term contracts rather than short term Jobs#

eatures of long term contracts:

8y contract costing situations! "e tend to mean long term and large contracts:such as ci&il engineering contracts for building houses! roads! bridges and so

on# We could also include contracts for building ships! and for pro&idinggoods and ser&ices under a long term contractual agreement#

With contract costing! e&ery contract and each de&elopment "ill beaccounted for separately; and does! in many respects! contain the features of a

Job costing situation# Wor( is fre0uently site based#

We might ha&e problems "ith contract costing in the follo"ing areas

'dentifying direct costs Lo" le&els of indirect costs %ifficulties of cost control Profit and multi period proJects

$he source of the follo"ing has eluded me: my sincere gratitude for "hoe&er theauthor might be#

XContract Costing such Jobs ta(e a long time to complete O may spread o&er t"o or

more of the contractors accounting years#

F#atur#$ %f a C%ntract

$he end product $he period of the contract $he specification $he location of the "or( $he price

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Completion by a stipulated date $he performance of the product

C%&cti%n %f C%$t$ :

%esirable to open up one or more internal Job accounts for the collection ofcosts# 'f the contract not obtained! preliminary costs be "ritten off as aborti&econtract costs in POL 'n some cases a series of Job accounts for the contract "ill benecessary:

to collect the cost of different aspects to identify different stages in the contract

S'#cia& f#atur#$

Materials deli&ered direct to site# %irect expenses ,tores transactions# 2se of plant on site

T(% '%$$i) acc%unting *#t+%,$:

Where a plant is purchased for a particular contract O has little further &alue to thebusiness at the end of the contract

Where a plant is bought for or used on a contract! but on completion of the contract ithas further useful life to the business+lternati&ely the plant may be capitalised "ith Maintenance and running costscharged to the contract#X

ormat:6

Particulars 4s# Particulars 4s#$o Materials a# Purchased directly

b# 'ssue from sitec# ,upplied by contractee

55

5555

8y materials returned 558y Material sold *cost

price) 55

$o Wages and salaries 55 8y W'P Wor( certified Wor( 2ncertified

5555

$o .ther direct Expenses 55$o ,ub6contractor fees 55$o Plant O Machinery *purchase price-8oo( &alue) 55

8y Materials at site 55

$o 'ndirect expenditure *apportioned shareof o&erheads)

55 8y Plant andmachinery*W%K) 55


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$o 3otional profit *,urplus) 55$otal $otal 55

Profit of 'ncomplete contract :6

1) When D of completion is less than or e0ual to D then full 3otional profit is transferred to reser&e#

) When D of completion is abo&e D but less than HD follo"ing amount should be credited to profit O loss a-c < 1-9 5 3otional Profit 5 YCash recei&ed - Wor(

certifiedZ

9) When D of completion is more than or e0ual to HD then the amount transferred

to profit is < -9 5 3otional Profit 5 YCash recei&ed - Wor( certifiedZV8alance is transferred to reser&e a-c

D of completion < YWor( certified-Contract priceZ 5 1HH

) When the contract is almost complete the amount credited to profit O loss a-c is

a) Estimated total profit 5 YWor( certified - Contract priceZ b) Estimated total profit 5 YCash recei&ed - Contract priceZ c) Estimated total profit 5 YCost of "or( done - Estimated total profitZ

d) Estimated total profit5YCost of "or( done5Cash recei&ed Estimated total cost 5 Wor( certifiedZ

) Wor(6'n6Progress is sho"n in 8alance ,heet as follo"s:6

,(eleton 8alance sheet

Liabilities *4,) +sset *4s)Profit O loss a-c *"ill include) Profit on contract *,pecify

the contract number) Less : Loss on contract*,pecify the contract number)

,undry creditors *"ill include) Wages accrued %irect expenses accrued +ny other expenses

*,pecify)

Wor(6in6progressKalue or "or( certified

Cost of "or( uncertifiedLess :6 4eser&e for unrealiIed profitLess :6 +mount recei&ed fromcontractee

@) Escalation Clause < $his is to safeguard against li(ely change in price of cost elements rise by and certain D o&er the prices pre&ailing at the time tendering the


26/84

contractee has to bear the cost#

MARINAL COSTIN

,tatement of profit:6

Particulars +mount,ales 555Less:6Kariable cost 555

Contribution 555Less:6 ixed cost 555

Profit 555

1) ,ales < $otal cost = Profit < Kariable cost = ixed cost = Profit

) $otal Cost < Kariable cost = ixed cost

9) Kariable cost < 't changes directly in proportion "ith &olume

) Kariable cost 4atio < YKariable cost - ,alesZ 5 1HH

) ,ales > Kariable cost < ixed cost = Profit

@) Contribution < ,ales 5 P-K 4atio

) Profit Kolume 4atio VP-K 4atio:6 YContribution - ,alesZ 5 1HH YContribution per unit - ,ales per unitZ 5 1HH YChange in profit - Change in salesZ 5 1HH YChange in contribution - Change in salesZ 5 1HH

F) 8rea( E&en Point V8EP:6 ixed cost - Contribution per unit Vin units ixed cost - P-K 4atio Vin &alue *or) ixed Cost 5 ,ales &alue per unit

*,ales > Kariable cost per unit)G) Margin of safety VM.P

+ctual sales > 8rea( e&en sales 3et profit - P-K 4atio Profit - Contribution per unit V'n units

@


27/84


28/84

STANDARD COSTIN

Method one of reading:6Material:6

,P 5 ,A ,P 5 +A ,P 5 4,A +P 5 +A *1) (2) (3) (4)

a) Material cost &ariance < *1) > *)b) Material price &ariance < (2) (4)c) Material usage &ariance < *1) > *)d) Material mix &ariance < *9) > *)e) Material yield &ariance < *1) >*9)

Labour :6,45,$ ,45+$ *paid) ,454,$ +45+$ ,45+$*"or(ed)(1) (2) (3) (4) (5)

a) Labour Cost &ariance < *1) > *)b) Labour 4ate &ariance < *) > *)

c) Labour Efficiency &ariance < *1) > *)d) Labour mix &ariance < *9) > *)e) Labour 'dle time &ariance < *) > *)

Kariable .&erheads cost &ariance :6,4 5 ,$ ,4 5 +$ +4 5 +$

(1) (2) (3)

a) Kariable .&erheads Cost Kariance < *1) > *9)

b) Kariable .&erheads Expenditure Kariance < *) > *9)c) Kariable .&erheads Efficiency Kariance < *1) > *)

[Where: ,4


29/84

a) ixed .&erheads Cost Kariance < *1) > *)b) ixed .&erheads 8udgeted Kariance < *) > *)c) ixed .&erheads Efficiency Kariance < *1) > *)d) ixed .&erheads Kolume Kariance < *1) > *)e) ixed .&erheads Capacity Kariance < *) > *9)

f) ixed .&erheads Calendar Kariance < *9) > *),ales &alue &ariance:68udgeted Price58A 8P5+A 8P58udgeted mix +P5+A (1) (2) (3) (4)

a) ,ales &alue &ariance < *4) (1)b) ,ales price &ariance < *) > *)c) ,ales &olume &ariance < *) > *1)d) ,ales mix &ariance < *) > *9)e) ,ales 0uantity &ariance < *9) > *1)

3ote :6

i) +ctual margin per unit *+MP2) < +ctual sale price > selling cost per unit

ii) 8udgeted margin per unit *8MP2) < 8udgeted sale price > selling price per unit

,ales margin &ariance :6

8MP258A 8MP25+A 8MP258udgeted mix +MP25+A (1) (2) (3) (4)

a) ,ales margin &ariance < *) > *1)b) ,ales margin price &ariance < *) > *)c) ,ales margin &olume &ariance < *) > *1)d) ,ales margin mix &ariance < *) > *9)e) ,ales margin 0uantity &ariance < *9) > *1)

Control 4atio :6

1) Efficiency 4atio < ,tandard hours for actual output 5 1HH+ctual hours "or(ed

) Capacity 4atio < +ctual /ours Wor(ed 5 1HH8udgeted /ours

9) +cti&ity 4atio < +ctual hours "or(ed 5 1HH8udgeted /ours

G


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Kerification: +cti&ity 4atio < Efficiency 5 Capacity 4atio

STANDARD COSTIN

Method t"o of reading:6Material:6

a) Material cost &ariance < ,C > +C < *,A5+A) > *+A5+P)

b) Material price &ariance < +A *,P > +P)

c) Material usage &ariance < ,P *,A > +A)

d) Material mix &ariance < ,P *4,A > +A)

e) Material yield &ariance < *+\ > ,\ for actual input) ,tandard material cost perunit of output

f) Material re&ised usage &ariance *calculated instead of material yield &ariance)

< Vstandard 0uantity > 4e&ised standard for actual output 0uantity 5 ,tandard price

Labour :6

a) Labour Cost &ariance < ,C > +C < *,/5,4) > *+/5+4)

b) Labour 4ate &ariance < +/ *,4 6 +4)

c) Labour Efficiency or time &ariance < ,4 *,/ >+/)

d) Labour Mix or gang composition Kariance < ,4*4,/6+/)

e) Labour 'dle $ime Kariance < 'dle hours 5 ,4

f) Labour \ield Kariance < V+ctual .utput > ,tandard output for actual input5 ,tandard labour cost-unit of output

g) Labour 4e&ised Efficiency Kariance *instead of L\K) 4e&ised standard hours 5 ,tandard rate

3otes :6 i) LCK < L4K = LMK = '$K = L\Kii) LCK < L4K = LEK = '$Kiii) LEK < LMK! L\K *or) L4EK

.&erhead &ariance :6 *general for both &ariable and fixed)

a) ,tandard o&erhead rate *per hour) < 8udgeted .&erheads 8udgeted /ours

b) ,tandard hours for actual output < 8udgeted hours 5 +ctual .utput 8udgeted output

c) ,tandard ./ < ,tandard hrs for actual output 5 ,tandard ./ rate per hour

d) +bsorbed ./ < +ctual hrs 5 ,tandard ./ rate per hour

e) 8udgeted ./ < 8udgeted hrs 5 ,tandard ./ rate per hour

f) +ctual ./ < +ctual hrs 5 +ctual ./ rate per hour

g) ./ cost &ariance < +bsorbed ./ > +ctual ./

Kariable .&erheads &ariance :6

a) Kariable ./ Cost Kariance < ,tandard ./ > +ctual ./

b) Kariable ./ Exp# Kariance < +bsorbed ./ > +ctual Kariable ./

c) Kariable ./ Efficiency Kariance < ,tandard ./ > +bsorbed ./ < V,tandard hours for > +ctual 5 ,tandard rate

actual output hours for &ariable ./

ixed .&erheads &ariance :6

a) ixed ./ Cost Kariance < ,tandard ./ > +ctual ./

b) ixed ./ expenditure &ariance < 8udgeted ./ > +ctual ./

c) ixed ./ Efficiency Kariance < ,tandard ./ *units based) > +bsorbed ./*/ours based)

91


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d) ixed ./ Kolume Kariance < ,tandard ./ > 8udgeted ./ < V,tandard hrs for > 8udgeted 5 standard rate

actual output hours

e) ixed ./ capacity &ariance < +bsorbed ./>8udgeted ./

f) ixed ./ Calendar Kariance < V4e&ised budgeted hrs > 8udgeted hrs5 ,tandard rate-hrs

3ote:6 When there is calendar &ariance capacity &ariance is calculated as follo"s :6 Capacity &ariance < V+ctual hours > 4e&ised 5 ,tandard

*4e&ised) 8udgeted hrs rate-hour

Kerification :6

i) &ariable ./ cost &ariance < Kariable ./ Expenditure &ariance= Kariable ./ Efficiency &ariance

ii) ixed ./ cost &ariance < ixed ./ Expenditure &ariance = ixed ./ &olume &ariance

iii) ixed ./ &olume &ariance < ixed ./ Efficiency &ariance = Capacity &ariance = Calander &ariance

,ales &ariances :6

$urno&er method *or) sales &alue method :6

a) ,ales &alue &ariance < +ctual ,ales > 8udgeted ,ales

b) ,ales price &ariance < V+ctual Price > ,tandard price 5 +ctual 0uantity < +ctual sales > standard sales

c) ,ales &olume &ariance < V+ctual68udgeted 0uantity 5,tandard price < ,tandard sales > 8udgeted sales

d) ,ales mix &ariance < V+ctual 0uantity > 4e&ised standard 0uantity 5 ,tandardprice

< ,tandard sales > 4e&ised sales

e) ,ales 0uantity &ariance < V4e&ised standard &ariance > 8udgeted 0uantity5 ,tandard price

9


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< 4e&ised ,tandard sales > 8udgeted sales

Profit method:6

a) $otal sales margin &ariance < *+ctual Profit>8udgeted price)

< Y+ctual 0uantity 5 +ctual profit per unitZ6Y8udgeted 0uantity 5 ,tandard profit per unitZb) ,ales margin price &ariance,tandard profit < Y+ctual Profit per unit > ,tandard profit per unitZ 5 +ctual 0uantity of sales

c) ,ales margin &olume &ariance < ,tandard profit > 8udgeted Profit< Y+ctual 0uantity > 8udgeted 0uantityZ 5 ,tandard profit per unit

d) ,ales margin mix &ariance < ,tandard profit > 4e&ised ,tandard profit< Y+ctual 0uantity > 4e&ised standard 0uantityZ 5 ,tandard profit per unit

e) ,ales margin 0uantity &ariance < 4e&ised standard profit 6 8udgeted profit < Y4e&ised standard 0uantity > 8udgeted 0uantityZ 5 ,tandard profit per unit

99


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STANDARD COSTIN

%iagrammatic 4epresentation: 6Material Kariance: 6

Material cost &ariance < ,C > +C < *,A5+A) > *+A5+P)

Labour Kariances:6

Labour Cost &ariance < ,C > +C < *,/5,4) > *+/5+4)

ixed .&erhead Kariance : 6a) ,tandard ./ < ,tandard hrs for actual output 5 ,tandard ./ rate per hour

b) +bsorbed ./ < +ctual hrs 5 ,tandard ./ rate per hour

c) 8udgeted ./ < 8udgeted hrs 5 ,tandard ./ rate per hour

9


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d) +ctual ./ < +ctual hrs 5 +ctual ./ rate per hour

e) 4e&ised 8udgeted /our < +ctual %ays 5 8udgeted /ours per day *Expected hours for actual days "or(ed)

When Calendar &ariance is as(ed then for capacity &ariance 8udgeted.&erhead is *8udgeted days 5 ,tandard ./ rate per day)

4e&ised 8udgeted /our *8udgeted hours for actual days) < +ctual days 5 8udgeted

hours per day

Kariable .&erhead Kariance : 6

9


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,ales Kalue Kariances : 6

,ales &alue &ariance < +ctual ,ales > 8udgeted ,ales

,ales Margin Kariances : 6

$otal sales margin &ariance < *+ctual Profit>8udgeted price) < Y+ctual 0uantity 5 +ctual profit per unitZ6

Y8udgeted 0uantity 5 ,tandard profit per unitZ

VWhere :6

,C < ,tandard Cost! +C < +ctual Cost ,P < ,tandard Price! ,A < ,tandard Auantity +P < +ctual Price! +A < +ctual Auantity +\ < +ctual \ield! ,\ < ,tandard \ield 4,A < 4e&ised ,tandard Auantity! ,4 < ,tandard 4ate!

9@


37/84

,$ < ,tandard $ime +4 < +ctual 4ate!+$ < +ctual $ime 4,$ < 4e&ised ,tandard $ime!8P < 8udgeted Price! 8A < 8udgeted Auantity

48$ < 4e&ised 8udgeted $ime8MP2 < 8udgeted Margin per 2nit

+MP2 < +ctual Margin per 2nit4econciliation:6

4econciliation statement is prepared to reconcile the actual profit "ith thebudgeted profit

Particulars a&orable 2nfa&orable *4s)8udgeted Profit : +dd a&orable &ariances

Less 2nfa&orable &ariances,ales Kariances : ,ales price &ariance ,ales mix &ariance ,ales 0uantity &arianceC%$t -arianc# :.

Material : Cost &ariance 2sage &ariance

Mix &arianceLabour : 4ate &ariance Mix &ariance Efficiency &ariance 'dle time &arianceixed o&erhead &ariance : Expenditure &ariance Efficiency &arianceixed o&erhead &ariance : Expenditure &ariance Efficiency &ariance Capacity &ariance Calendar &ariance

9


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39/84

i) Material issued from stores for repairsManufacturing o&erhead a-c %r $o ,tores ledger control a-c

Labour:

a) %irect "ages paidi) Wage control a-c %r $o Cost ledger control a-c

ii) Wor(6in6progress a-c %r $o Wage control a-c

b) 'ndirect "ages paid to "or(ers in Production!+dministration! ,elling and %istribution departments

i) Wage control a-c %r $o Cost ledger control a-c

ii) Production .&erhead a-c %r +dministrati&e .&erhead a-c %r ,elling O %istribution .&erhead a-c %r

$o Wage control a-cc) %irect Expenses on a particular Job

Rob a-c %r $o Cost ledger control a-c

.&erheads:6

a) .&erhead expenses incurredProduction o&erhead a-c %r

+dministrati&e .&erhead a-c %r ,elling O %istribution .&erhead a-c %r

$o cost ledger control a-c

b) Carriage in"ardManufacturing .&erhead a-c %r

$o Cost ledger control a-c

c) Production .&erheads reco&ered

9G


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Wor(6in6progress control a-c %r $o Production .&erhead a-c

d) +dministrati&e .&erhead reco&ered from finished goodsinished goods ledger control a-c %r

$o +dministrati&e .&erhead a-ce) ,elling and %istribution .&erhead reco&ered from sales

Cost of sales a-c %r $o ,elling O %istribution a-c

f) 'f o&er-under absorbed amounts are carried for"ard to subse0uent year! thebalance of each .&erhead account "ill ha&e to be transferred to respecti&e.&erhead suspense *or reser&e) +ccounts as follo"s:

i) or o&er reco&ery : Production .&erhead a-c %r $o Production o&erhead suspense a-c

ii) or under reco&ery : +dministrati&e .&erhead ,uspense a-c %r $o +dministrati&e .&erhead a-c

,elling O %istribution .&erhead ,uspense a-c %r$o ,elling O %istribution .&erhead a-c

g) 'n case the 2nder-.&er absorbed o&erheads are transferred to costing profit O lossa-c then the rele&ant entries are: i) or .&er reco&ery: Production .&erhead a-c %r

$o Costing Profit O Loss a-c

ii) or 2nder reco&ery: Costing Profit O Loss a-c %r $o +dministration .&erhead a-c

,ales:6

or sales effected: Cost ledger control a-c %r $o Costing Profit O Loss a-c

Profit - Loss:

a) 'n case of profit the entry is as follo"sCosting Profit O Loss a-c %r

$o Cost ledger control a-c

H


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b) 4e&erse the entry in case of loss

$he main accounts "hich are usually prepared "hen a separate cost ledger ismaintained is as follo"s:6

i) Cost ledger control a-cii) ,tores ledger control a-ciii) Wor(6in6progress control a-ci&) inished goods control a-c&) Wage control a-c&i) Manufacturing-Production-Wor(s .&erheads a-c

&ii) +dministrati&e .&erhead a-cKiii) ,elling O %istribution .&erhead a-cix) Cost of sales a-cx) Costing profit O loss a-c

1


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Tran$f#r !ricing

+ transfer price is the amount of money that one unit of an organisationcharges for goods and ser&ices to another unit of an organisation#

.ne of the (ey aspects here is that a transfer price is e0ui&alent to an ordinaryselling price and that any department or di&ision that sets a transfer price iseffecti&ely selling its goods and ser&ices at a profit or a loss to another department ordi&ision "ithin its organisation# +ny part of an organisation using transfer pricing

"ill be classed as a profit centre: since it is operating "ith a &ie" to ma(ing a profit*"hether positi&e! profit! or negati&e! loss)# 'f goods and ser&ices are transferred

bet"een departments and di&isions at cost! then no profit or loss arises and the issueof transfer pricing does not! or should not! arise#

.rganisations ha&e a system of transfer pricing! therefore! in order to assessthe efficiency and effecti&eness of its department and di&isional managers# $hismaybe in spite of the fact that transfer prices may be artificial in the sense that it isfelt that there is no rationale for selling bet"een departments and di&isions#

Criteria for fixing $ransfer Pricing:6

i) External Capacity not fully utiliIed < Kariable Cost

ii) Capacity fully 2tiliIeda) 'f single product :6

,elling Price *>) ,elling Expenses

b) 'f multiple product

Kariable cost = .pportunity cost *measured on the basis of Productactually sacrificed)

iii) 'f no mar(et for 'ntermediate productCost of supplying di&ision of optimum le&el

*6) Cost of the supplying di&ision at pre&ious output le&el# %ifference in .utput

*$his "ould be e0ual to Kariable cost "hen ixed Cost is same at all le&els)


43/84

3ote:6

i) 'gnore Kariable ,elling expenses on 'nter %epartment $ransferii) 'n case of *ii) abo&e 'f selling expenses is not gi&en "e ha&e to assume some

D as selling Expenses but it should not exceed D #Bu,g#tar C%ntr%&

8udget 4atios:6

1) Capacity usage 4atio< # 8udgeted /ours # 5 1HH

Maximum possible "or(ing hours in budget period

) ,tandard Capacity Employed 4atio

< +ctual /ours Wor(ed 5 1HH 8udgeted hours

9) Le&el of +cti&ity 4atio< ,tandard /ours for +ctual Production 5 1HH

,tandard /ours for 8udgeted Production

) Efficiency 4atio< ,tandard /ours for +ctual Production 5 1HH

+ctual /ours) Calendar 4atio

< +ctual Wor(ing days 5 1HH 8udgeted "or(ing days

]ero 8ase 8udgeting:

$he name Iero base budgeting deri&es from the idea that such budgets arede&eloped from a Iero base: that is! at the beginning of the budget de&elopment

process! all budget headings ha&e a &alue of ]E4.# $his is in sharp contrast to theincremental budgeting system in "hich in general a ne" budget tends to start "ith a

balance at least e0ual to last years total balance! or an estimate of it#

%efinition of ]ero 8ase 8udgeting *]88)

+ method of budgeting "hereby all acti&ities are ree&aluated each time abudget is set# %iscrete le&els of each acti&ity are &alued and a combination chosen to

9


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match funds a&ailable#

.bJecti&es and 8enefits of ]88

What Iero base budgeting tries to achie&e is an optimal allocation ofresources that incremental and other budgeting systems probably cannot achie&e#]88 starts by as(ing managers to identify and Justify their area*s) of "or( in termsof decision pac(ages *0&)#

+n effecti&e Iero base budgeting system benefits organisations in se&eral

"ays# 't "ill

ocus the budget process on a comprehensi&e analysis of obJecti&es andneeds

Combine planning and budgeting into a single process Cause managers to e&aluate in detail the cost effecti&eness of their operations Expand management participation in planning and budgeting at all le&els of

the organisation


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Acti-it Ba$#, c%$ting

'n $raditional Method "e split the .&er /ead incurred in production! basedon machine hours "hich are not acceptable for many reasons#

'n +8C method .&er /ead are splited according to the related acti&ity! foreach type of .&er /ead# .&erhead are apportioned among &arious Production costcenters on the basis of +cti&ity cost dri&ers#

Relevant C%$ting . $%*# t+#%r

'ntroduction: 6

+ management decision in&ol&es predictions of costs O re&enues# .nly thecosts and re&enues that "ill differ among alternati&e actions are rele&ant to thedecision# $he role of historical data is to aid the prediction of future data# 8uthistorical data may not be rele&ant to the management decision itself# Aualitati&e

factors may be decisi&e in many cases! but to reduce the number of such factors to beJudged! accountants usually try to express many decision factors as possible in0uantitati&e terms#

Meaning of 4ele&ant Costs: 6

4ele&ant costs represent those future costs that "ill be changed by aparticular decision# While irrele&ant costs are those costs that "ill not be affected bya decision# 'n the short run! if the rele&ant re&enues exceed the rele&ant costs then it"ill be "orth"hile accepting the decision# $herefore rele&ant costs playa maJor rolein the decision6ma(ing process of an organiIation# + particular cost can be rele&antin one situation but irrele&ant in another! the important point to note is that rele&antcosts represent those future costs that "ill be changed by a particular decision! "hileirrele&ant costs are those costs that "ill not be affected by that decision# We shallno" see "hat are rele&ant costs and re&enues for decision6ma(ing process# 'nsummary rele&ant information concerns:

.ther 'mportant $erminologies : 6


46/84

4ele&ant costs are costs appropriate to aiding the ma(ing of specificmanagement decisions# +ctually! to affect a decision a cost must be:

uture: Past costs are irrele&ant as they are not affected them by future decisions Odecisions should be made as to "hat is best no"#

'ncremental: $his refers to additional re&enue or expenditure! "hich may appear as aresult of our decision6ma(ing#*+ cash flo" 6 ,uch charges as depreciation may be future but do not represent cashflo"s and! as such! are not rele&ant#)

,un( costs: Past costs! not rele&ant for decision ma(ing

Committed costs: $his is future in nature but "hich arise from past decisions!

perhaps as the result of a contract#

4ele&ant Costs: Problem areas:

1 Problems in determining the rele&ant costs of materials:

When considering &arious decisions! if the any materials re0uired is not ta(enfrom existing stoc(s but "ould be purchased on a later date! then the estimated

purchase price "ould be the rele&ant material cost# + more difficult problem arises

"hen materials are ta(en from existing stoc(# 'n this situation the rele&ant cost ofmaterials for a particular Job *say Job ^) depends on

Material is in regular use of the companyMaterial is not in regular use of the companyMaterial is in short supply#

'f the material is in regular use of the company then the material ta(en fromexisting stoc( re0uires replacement for the purpose of regular use therefore therele&ant cost of material "ill be the 4eplacement cost#

'f the material is not in regular use of the company the rele&ant cost of thematerials depends on their alternati&e use# $he alternati&e use of the materials "ill beeither to sell them or to use them on other Jobs# /ence the cost of using the materialsresults in an opportunity cost consisting of either

$he net sales re&enue if the materials "ere sold *or) $he expense that "ould bea&oided if the materials "ere used on some other Job Whiche&er is greater#

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'f the material is in short supply the only "ay material for the Job underconsideration can be obtained is by reducing production of some other product - Job#This would release material for the order. but the reduced production "ill result inloss of contribution "hich should be ta(en in to account "hen ascertaining therele&ant costs for the specific order# $herefore the rele&ant cost "ill be Contribution

lost *before the material cost since the material cost "ill be incurred in any case) "illbe the rele&ant cost#labour: %etermining the direct labour that are rele&ant to short 6 term decision depends onthe circumstances#

Where a company has temporary sparse capacity and the labour force is to bemaintained in the short 6 term! the direct labour cost incurred "ill remain same for allalternati&e decisions# $he direct labour cost "ill therefore be irrele&ant for short 6term decision 6 ma(ing purposes#

/o"e&er "here casual labour is used and "here "or(ers can be hired on adaily basis; a company may then adJust the employment of labour to exactly theamount re0uired to meet the production re0uirements# $he labour cost "ill increaseif the company accepts additional "or(! and "ill decrease if production is reduced#'n this situation the labour cost be a rele&ant cost for decision 6 ma(ing purposes#

'n a situation "here full capacity exists and additional labour supplies areuna&ailable in the short 6 term! and "here no further o&ertime "or(ing is possible!the only "ay that labour resources could then be obtained for a specific order "ould

be to reduce existing production# This would release labour for the order. but thereduced production "ill result in loss of contribution! "hich should be ta(en in toaccount "hen ascertaining the rele&ant costs for the specific order# $herefore therele&ant cost "ill be Contribution lost *before the labour cost) "ill be the rele&antcost#

P4.8LEM,

1# 'n a firm! material + has no alternati&e uses and HH units of "hich lie in stoc(#$he information belo" has been collected# \ou are re0uired to find the rele&ant price

of 1H units and H units respecti&ely#8oo( &alueCurrent price,ale price obtainable

4s# per (g 4s#9 per (g 4s##FH per (g

# +ssume in the abo&e problem the material is in regular use of the company


48/84

9# +ssume in the abo&e problem the material is in short _supply and it is not possibleto obtain the stoc( of material for some more time# +t present the material is used inanother product on "hich a contribution at the rate of 4s#1 .-unit is earned *aftermeeting the material cost)# Each unit of the product re0uires 1 7 of 4a" material+#

Ca$+ an, fun, f&%( $tat#*#nt

4ules for preparing schedule of changes in "or(ing capital :6

'ncrease in a current asset! results in increase in "or(ing capital > so +dd%ecrease in current asset! results in decrease in "or(ing capital > so %ecrease'ncrease in current liability! results in decrease in "or(ing capital > so %ecrease

%ecrease in current liability results in increase in "or(ing capital > so +dd

unds from operations > ormat

Particulars 4s# 4s#3et profit 555+dd : %epreciation 7ood"ill "ritten off Preliminary Exp# Written off

%iscount on share "ritten off $ransfer to 7eneral 4eser&e Pro&ision for $axation Pro&ision for %i&idend Loss on sale of asset Loss on re&aluation of asset

55555

555555555555555

5555555

555

555Less : Profit on sale of asset Profit on 4e&aluation of asset

55555

555

F


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5und flo" statement 555

und flo" statement

Particulars 4s#,ources of funds : 6 'ssue of shares 'ssue of %ebentures Long term borro"ings ,ale of fixed assets .perating profit

555555555555555555

$otal ,ources 555+pplication of funds : 6 4edumption of 4edeemable preference shares 4edumption of %ebentures Payment of other long term loans Purchase of ixed assets .perating Loss Payment of di&idends! tax etc

555555555555555555555

$otal 2ses 5553et 'ncrease - %ecrease in "or(ing capital

*$otal sources > $otal uses) 555

Cash flo" statement

Cash rom .peration : 6< 3et profit = %ecrease in Current +sset

= 'ncrease in Current Liability6 'ncrease in Current +sset6 %ecrease in Current Liability

Cash flo" statement

,ources 4s# +pplication 4s#.pening cash and ban(

balance'ssue of shares4aising of long term loans,ales of fixed assets,hort term 8orro"ingsCash 'nflo"Closing 8an( .-%

55555555555555

.pening 8an( .-%4edumption of Preference ,hares4edumption of Long term loansPurchase of fixed assets%ecrease in %eferred payment LiabilityCash .utflo"$ax paid%i&idend paid

5555555555555555

G


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%ecrease in 2nsecured loans! %epositsClosing cash and ban( balance

5555

55 55

Rati% Ana&$i$

+) Cash Position 4atio : 6

1) +bsolute Cash 4atio < Cash 4eser&oir

Current Liabilities) Cash Position to $otal asset 4atio < Cash 4eser&oir 5 1HH *Measure li0uid layer of assets) $otal +ssets

9) 'nter&al measure < Cash 4eser&oir *ability of cash reser&oir to meet cash expenses) +&erage daily cash expenses * +ns"er in days)

3otes : 6 Cash 4eser&oir < Cash in hand = 8an( = Mar(etable 3on trade in&estment at

mar(et &alue# Current liabilities < Creditors = 8ills Payable = .utstanding Expenses =

Pro&ision for tax *3et of ad&ance tax) = Proposed di&idend = .therpro&isions#

$otal assets < $otal in asset side > Miscellaneous expenses > Preliminaryexpenses = +ny increase in &alue of mar(etable non trading 'n&estments#

+&erage cash expenses 3on cashitem such as depreciation! good"ill! preliminary expenses "ritten off! loss on

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sale of in&estments! fixed assets "ritten off = ad&ance tax *'gnore pro&isionfor tax) # $he net amount is di&ided by 9@ to arri&e a&erage expenses#

4emar(s : 6 'n Comparison When absolute cash ratio is lo"er then current liability is higher

When cash position to $otal +sset ratio is lo"er then the total asset isrelati&ely higher# When cash inter&al is lo"er the company maintain lo" cash position# 't is not

good to maintain too lo" cash position or too high cash position#

8) Li0uidity 4atio : 6

1) Current ratio < Current asset Current Liability

) Auic( ratio or +cid $est ratio < Auic( +ssetAuic( liability

3otes : 6 Auic( +sset < Current +sset > ,toc( Auic( Liability < Current liability > Cash credit! 8an( borro"ings! .% and

other ,hort term 8orro"ings# ,ecured loan is a current liability and also come under cash credit ,undry debtors considered doubtful should not be ta(en as 0uic( asset# Creditors for capital W'P is to be excluded from current liability# Current asset can include only mar(etable securities# Loans to employees in asset side are long term in nature and are not part of

current assets# Pro&ision for gratuity is not a current liability# 7ratuity fund in&estment is not a part of mar(etable securities# $rade in&estments are not part of mar(etable securities#

4emar(s : 6 /igher the current ratios better the li0uidity position#

C) Capital structure ratios : 6

1) %ebt e0uity ratio < %ebt < External E0uity *or) Le&erage ratio E0uity 'nternal E0uity < Long term debt < ,hare holders fund

1


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Long term fund Long term fund

) Proprietary ratio < Proprietary fund $otal +ssets

9) $otal Liability to 3et "orth ratio < $otal Liabilities 3et "orth

) Capital gearing ratio < Preference share capital = %ebt E0uity > Preference share capital

3otes : 6 ,hare holders fund *or) E0uity *or) Proprietary fund *or) ."ners fund *or)

3et "orth < E0uity share = Preference share = 4eser&es and surplus > P O La-c > Preliminary Expenses#

%ebt *or) Long term liability *or) Long term loan fund < ,ecured loan*excluding cash credit) = unsecured loan = %ebentures#

$otal asset < $otal assets as per 8alance sheet > Preliminary expenses# $otal liability < Long term liability = Current liability *or) short term liability Long term fund < $otal asset > Current liability < ,hare holders fund = long

term loan fund#

4emar(s : 6 'n debt e0uity ratio higher the debt fund used in capital structure! greater is

the ris(# 'n debt e0uity ratio! operates fa&orable "hen if rate of interest is lo"er than

the return on capital employed# 'n total liability to 3et "orth 4atio < Lo"er the ratio! better is sol&ency

position of business! /igher the ratio lo"er is its sol&ency position# 'f debt e0uity ratio is comparati&ely higher then the financial strength is

better#

%) Profitability 4atio : 6

1) 7ross Profit 4atio < 7ross Profit 5 1HH ,ales

) 3et Profit 4atio < 3et Profit 5 1HH,ales

9) .perating Profit ratio < .perating profit 5 1HH ,ales


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) 4eturn to shareholders < 3et profit after interest and tax ,hare holders fund

) 4eturn on 3et Worth < 4eturn on 3et "orth 5 1HH

3et "orth@) 4eturn on capital employed *or) 4eturn on in&estment < 4eturn *E8'$)

Capital Employed

) Expenses 4atios :6

a) %irect expenses 4atios : 6 i) 4a" material consumed 5 1HH ,ales

ii) Wages 5 1HH ,ales iii) Production Expenses 5 1HH ,ales

b) 'ndirect expenses 4atios : 6 i) +dministrati&e Expenses 5 1HH ,ales ii) ,elling Expenses 5 1HH

,ales iii) %istribution Expenses 5 1HH ,ales i&) inance Charge 5 1HH ,ales

3otes : 6 'n the abo&e the term term is used for business engaged in sale of goods!

for other enterprises the "ord re&enue can be used# 7ross profit < ,ales > Cost of goods sold .perating profit < ,ales > Cost of sales < Profit after operating expenses but before 'nterest and tax# .perating Expenses < +dministration Expenses = ,elling and distribution

expenses! 'nterest on short term loans etc# 4eturn < Earning before 'nterest and $ax < .perating profit < 3et profit = 3on operating expenses > 3on operating 'ncome Capital employed < ,hare holders fund = Long term borro"ings < ixed assets = Wor(ing capital

9


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Credit Purchases

) 'n&entory $urno&er *for W'P) < Cost of production +&erage 'n&entory *for W'P)

F) 'n&entory $urno&er *for 4a" material) < 4a" material consumed +&erage in&entory *for ra" material)

1H) 'n&entory /olding Period < 9@ # 'n&entory turno&er ratio

11) Capital $urno&er ratio < Cost of sales Capital employed

3ote : 6 Wor(ing capital < Current asset > Current liability < H# 5 Proprietary ratio +ccounts 4ecei&able < %ebtors = 8ills recei&able +ccounts payable < Creditors = 8ills Payable

4emar(s : 6 'f assets turno&er ratio is more than 1! then profitability based on capital

employed is profitability based on sales# /igher in&entory turno&er is an indicator of efficient in&entory mo&ement# 't

is an indicator of in&entory management policies# Lo" in&entory holding period lo"er "or(ing capital loc(ing! but too lo" is

not safe# /igher the debtors turno&er! lo"er the credit period offered to customers# 't is

an indicator of credit management policies# /igher the creditors turno&er! lo"er the credit period offered by suppliers#

7) .ther 4atios: 6

1) .perating profit ratio < 3et profit ratio = 3on operating loss - ,ales ratio

) 7ross profit ratio < .perating profit ratio = 'ndirect expenses ratio

9) Cost of goods sold - ,ales ratio < 1HHD 6 7ross profit ratio

) Earnings per share < 3et profit after interest and tax 3umber of e0uity shares


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) Price earning ratio < Mar(et price per e0uity share Earning per share

@) Pay out ratio < %i&idend per e0uity share 5 1HH Earning per e0uity shares

) %i&idend yield ratio < %i&idend per share 5 1HH Mar(et price per share

F) ixed charges co&erage ratio < 3et profit before interest and tax'nterest charges

G) 'nterest co&erage ratio < Earning before interest and tax 'nterest charges

1H) ixed di&idend co&erage ratio < 3et profit # +nnual Preference di&idend

11) .&er all profitability ratio < .perating profit 5 1HH Capital employed

1) Producti&ity of assets employed < 3et profit # $otal tangible asset

19) 4etained earning ratio < 4etained earnings 5 1HH $otal earnings

/) 7eneral 4emar(s: 6 all in 0uic( ratio "hen compared "ith last year or other company is due to

huge stoc( pilling up# 'f current ratio and li0uidity ratio increases then the li0uidity position of the

company has been increased# 'f debt e0uity ratio increases o&er a period of time or is greater "hen

comparing t"o ratios! then the dependence of the company in borro"edfunds has increased#

%irect expenses ratio increases in comparison then the profitability decreases# 'f there is "ages - ,ales ratio increases! then this is to &erified

a) Wage rateb) .utput - Labour rate

'ncrement in "age rate may be due to increased rate or fall in labourefficiency#

@


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+gain there are many reasons for fall in labour producti&ity namely abnormalidle time due to machine failure! po"er cut etc#

4eduction in 4a" material consumed - sales ratio may be due to reduction in"astage or fall in material price#

'ncrease in production expenses ratio may also be due to price raise# ,toc( turno&er ratio denotes ho" many days "e are holding stoc(# 'n stoc( turno&er ratio greater the number of days! the mo&ement of goods

"ill be on the lo"er side# inancial ratios are Current ratio! Auic( ratio! %ebt e0uity ratio! Proprietary

ratio! ixed asset ratio# ,hort term sol&ency ratios are current ratio! Li0uidity ratio Long term sol&ency or testing sol&ency of the company ratios are %ebt e0uity

ratio! fixed asset ratio! fixed charges co&erage ratio *or) 'nterest co&erageratio#

$o compute financial position of the business ratios to be calculated are >current ratio! %ebt e0uity ratio! Proprietary ratio! fixed asset ratio#

ictitious asset are Preliminary expenses! %iscount on issue of shares anddebentures! Profit and loss account debit balance#

A$$ign*#nt

1) 8asis of $echni0ue used is minimiIation $echni0ue

) 't can also be done in maximation $echni0ue

9) Karious steps in +ssignment Problem are

,tep 1: Chec( "hether the problem is balanced or unbalanced by chec(ing"hether ro" is e0ual to column! if unbalanced add dummy column orro" to balance the problem

,tep : 'dentify Least 3umber in each ro" and subtract "ith all number in that 4o"#

,tep 9: 'dentify least number of each column and subtract "ith all number in that column#

,tep : Chec( "hether solution is reached "ith Iero selection in one ro" and column! ie# Co&er all the Iero "ith minimum number of lines! solution is

reached only "hen selected Ieros is e0ual to number of ro"s or columns


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or number of lines is e0ual to order of matrix#

,tep : 'f solution is not reached so maximum stic(ing

,tep @: ,elect the least element in "ithin the unstri(ed Element

,tep : $he element selected abo&e isi) ,ubtracted "ith all the unstri(ed elementii) +dded to all the double stri(ed element *'ntersection of t"o

lines)

,tep F: Chec( the solution

,tep G: 'f solution is not reached continue "ith the process from step #

Lin#ar !r%gra**ing

,implex Method:6,teps:6

1# %etermine the obJecti&e function ]# .bJecti&e may be maximiIation orminimiIation#

# or maximation problem the constraints "ould be < sign#or minimiIation problem the constraints "ould be [ sign#

9# 'ntroduce slac( &ariableor ` sign > add the slac( &ariable ie# +dd ,1

or [ sign > subtract the slac( &ariable and add artificial &ariableie# ,ubtract ,1! add +1#

# Change the .bJecti&e functionor ,1 > +dd _H,1Bor +1 > +dd _M+1B

F


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# ,implex table format:6

@# ]J is arri&ed by summation of constant column "ith ^!\!] columns

# Criteria for selecting the (ey column :6or Maxima ion Problem > /ighest &alue of CJ > ]J

or MinimiIation Problem > Lo"est Kalue of CJ > ]J

F# %i&ide the Auantity Column "ith ey column to arri&e at 44

G# Criteria for ,electing the ey ro" :6or Maximation O MinimiIation Problem > Lo"est Positi&e 44 is selected

1H# $he Meeting Point is (ey Element

11# Criteria for deciding the optimal solutionor Maximation Problem > +ll elements in CJ > ]J ro" is negati&e or Iero#or MinimiIation Problem > +ll elements in CJ > ]J ro" is positi&e or Iero

3ote > or finding "hether all the elements in CJ > ]J ro" is positi&e or Iero for minimiIation problem substitute all the _MB "ith highest &alue#

1# 'f solution is not reached next table is formed#

19# 'nput for next table isirst (ey ro" in the next table is filled by di&iding all the numbers in the (eyro" of the pre&ious table "ith the (ey element#4emaining all the ro"s is arri&ed as follo"s: 6Corresponding pre&ious *Kalue relating to that 5 Corresponding

$able ro" element ro" in the (ey column element in (ey ro" in the ndtable as

filled in pre&iousstep)

CJAuantity Kariable Const# ^ \ ] ,1 , 44

,1,

]JCJ 6]J

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1# Chec( the optimal solution! if not reached form the third table#

1# 'f solution is reached then ans"er is amount in 0uantity columncorresponding to the &ariable#

.ther Points : 6 We can con&ert the MinimiIation Problem into Maximation Problem# $his is

(no"n as duality#

We can change the [ sign to ` sign to match the problemE#g# ^ = \ ` 1HH is con&erted into 6^ 6 \ [ 61HH

Tran$'%rtati%n

$he procedure follo"ed is MinimiIation Procedure

Problem is generally sol&ed in KogelBs +pproximation Method*K+M)

,teps for the problem is : 61# Con&ert profit matrix into loss matrix#

# 8alance the problem#9# +rri&e at 4o" penalty and column penalty

4o" penalty and column penalty is calculated at *ndleast > 1stleast) in thecorresponding ro" or column#

# ,elect from the entire 4o" penalty and column penalty maximum number#

# rom the entire 4o" or Column minimum is selected#

@H


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@# ,tri(e the ro" or column "hich gets eliminated#

# Continue until the entire item in the table is stri(e#

F# Write separately 'nitial solution table#

G# Chec( for %egeneracy# %egeneracy occurs "hen all the elements in the initialsolution is e0ual to *4o" = column > 1)

1H# 'f degeneracy occurs introduce efcilon > _eB# _eB is introduced in leastindependent cell#

11# orm 2K Matrix# 't is formed by the element in the original solutioncorresponding to the element in the 'nitial solution#

1# ind unalloted elements in the 2K Matrix

19# ind 'J i#e#*.riginal Matrix element > 2nalloted element found abo&e)

1# Chec( for optimal solution ie# +ll items must be Iero or positi&e#

1# 'f not reached select the maximum negati&e in 'J matrix#

1@# orm a loop and reallocate the solution#

1# 4epeat from step G#3otes: 6

1# 'f there is Iero in 'J matrix "hile arri&ing at optimal solution then there isanother solution for the problem#

# %ummy column can be introduced in profit or loss matrix#

9# 'f there is penalty-redundancy payment for unsatisfying demand etc# is gi&en

then fills the dummy ro" or column "ith that amount or fill it "ith Ieros## 'f there is constraint in the problem first satisfy the constraint and then sol&e#

# &arious other methods for sol&ing the problem is Least cost method 3orth "est corner rule

@# 7enerally K+M method is used

@1


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N#t(%r0 Ana&$i$ 1C!M/!ERT2

C!M

$otal float < L, > E, *or) L > E

ree float < $otal float > /ead e&ent slac(

'ndependent float < ree float > $ail e&ent slac(

'n the diagram Es < Lf in the critical path Critical path is the longest duration

$o find the minimum time associated cost *i#e# +dditional cost incurred perunit of time sa&ed) follo"ing formula is used :6Crash cost per day *or) +cti&ity cost supply < Crash cost > 3ormal cost 3ormal time > Crash time

@


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'nterfacing float < 't is the part of the total float "hich causes reduction in thefloat of the succession acti&ities# 'n other "ords it is the portion of acti&ityfloat "hich cannot be continued "ithout affecting ad&ersely the float of thesubse0uent acti&ity or acti&ities#

,teps in proceeding the problem : 6

# irst find and fill the E, and L column from the diagram#

9# $hen find L, and E as follo"s :6Ls < Lf > %urationEf < Es = %uration

# ind total float

# ind free float# Where&er total float column has Iero free float column is alsota(en has Iero and remaining elements is filled as said abo&e

@# ind 'ndependent float# Where&er free float column has Iero 'ndependentfloat column is also ta(en has Iero and remaining elements is filled as saidabo&e

3otes: 61# E, < Earliest ,tart# 'ndicates earliest time that the gi&en acti&ity can bescheduled

# E < Earliest inish# $ime by "hich the acti&ity can be completed at theearliest#

9# L < Latest inish# Latest allo"able occurrence time of the head e&ent of theacti&ity#

# L, < Latest ,tart#

# $otal duration of the critical path is the maximum time-amount consumed forthe acti&ity# $his should be crashed "ith respect to crashing days andcrashing cost# $his crashing should not change the critical path#

!ERT: 6

Expected *or) +&erage time is found by assigning "eights as follo"s : 6 1 for optimistic

@9


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for Most li(ely 1 for pessimistic

+&erage time < 1 optimistic = most li(ely = 1 pessimistic @

,tandard %e&iation < *Pessimistic time > .ptimistic time)

@ Kariance < *,tandard %e&iation)

Probability of completing the proJect in 3 days< 4e0uired time*3) *6) Expected time *critical path duration)

,tandard %e&iation V3othing but ] < *^ 6 Mean) - ,tandard de&iation < \ *say) < ind ]*y)

< Probability D6 'f re0uired time [ Expected time then < H# = ]*\)6 'f re0uired time ` Expected time then < H# > ]*\)

L#arning Cur-#

Learning is the process of ac0uiring s(ill! no"ledge! and ability by anindi&idual# +ccording to learning cur&e theory the producti&ity of the "or(erincreases "ith increase in experience due to learning effect# $he learning theorysuggests that the best "ay to master a tas( is to learn by doing# 'n other "ords! as

people gain experience "ith a particular Job or proJect they can produce each unitmore efficiently than the preceding one#

$he speeding up of a Job "ith repeated performance is (no"n as the learningeffect or learning cur&e effect#

$he cumulati&e a&erage time per unit produced is assumed to fall by aconstant percentage e&ery time the total output is doubled# ,o generally learningeffect is found in the multiples of # 'f learning cur&e effect is as(ed bet"een t"oe&en numbers then Learning cur&e e0uation is formed ie# Learning cur&e effect isexpressed mathematically as follo"s:

Learning cur&e e0uation ,pot 4ate 5 9@ 5 1HH *in days) ,pot 4ate n

'f the 0uote is direct or 'ndirect is to be found and the relation is "ith *pound) both direct and 'ndirect 0uote is to be said#

Maturity Kalue < P *1=r)n

'nterest 4ate Parity:i) %omestic 4ate oreign 4ate = or"ard Premium - %iscount*'n this case in&est in foreign currency)

ii) %omestic 4ate [ oreign 4ate = or"ard Premium - %iscount*'n this case in&est in %omestic Currency)

or"ard 4ate: 't is rate negotiated for the deli&ery to be made - ta(en on a futuredate for present transaction#

uture spot rate: 't is actual rate pre&ailing on the agreed future date#

.ther points:6 Currency country "hich has less 'nterest rate "ill ha&e for"ard rate at

premium and &ice &ersa 'f t"o rates ie#H#9 - 9 is gi&en then highest rate is offer rate! lo"est

rate is bid rate# 'f '34 - %7 is gi&en and "e ha&e to %7 - '34 then it is 1 - *'34 - %7) 1 - *8id 4ate) < .ffer 4ate#

@@


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1 - *.ffer 4ate) < 8id 4ate#

'nterest rate s"ap: 6 7enerally interest rate differs from company to companybecause of their grade *reputation) and rates can be fixed rates or floting rate# 'f thereis company under different grade and different fixed - floating rate can gin

ad&antage by reducing their interest rate by 'nterest rate s"ap#

'n this if _Company +B "ants to borro" at floating rate and _Company 8B"ants to borro" and fixed rate! then interest rate s"ap is applied by "hich company+ borro"s at floating 4ate of company 8 and company 8 borro"s at fixed rate ofcompany +# 8y this s"ap one company gains and other company losses# 3et gain issplited bet"een t"o companies so that the t"o companies benefits by paying lo"erinterest rate for their barro"ing#

$o loo( at the problem 0uic(ly the theory follo"ed in %ifference in fixed

rate interest of t"o companies is profit and %ifference in floating rate interest oft"o companies is loss# $hen net gain - loss are found#

Ca'ita& Bu,g#ting

Process of Capital 8udgeting:

/uge cash outlay# %ecision ta(en is irressable# 'n&est in lumsum the receipt is piecemeal Wrong decision "ill affect the &ery base of the company#

Capital 8udgeting 4ules:

'gnore accounting profit and ta(e only cash flo"s# $ry only incremental basis ignore +&erage calculation# Consider all incidental effects# 'gnore sun( cost *ie# Cost remain unaltered for &arious alternati&es a&ailable

is sun( cost) Consider opportunity cost *.pportunity Loss is .pportunity cost)

@


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%iscounted C' *Probability less than ]ero)

&i) Probability that 3PK "ithin the range ^ and \]1< > 3PK ]< \ > 3PK

&ii) 'f in the 4is( adJusted %iscount approach both cost of control and 4is(adJusted discount rate is gi&en or the C of the years apply 4is( adJusted discount rate to find

%iscounted C# or the ,crap &alue of the machine after the end of the life the C on

sale is discounted at cost of capital D to find %iscounted C#&iii) 'f probability *or) Certainty e0ui&alence is gi&en then find the +dJusted

C *C 5 Probability) and then use the 4is( less 4ate of return to find %iscountedC#

ix) 4is( is ,tandard de&iation

,ummary:6i) 4is( +dJusted %iscount 4ate +pproach

< 3PK for C+$ at 4is( +dJusted %iscount 4ateii) Certainty E0ui&alent +pproach

< 3PK for *CE coefficient 5 C+$) at 4is( less interest rateiii) Probability %iscount +pproach

< 3PK for *C) at 4is( less 'nterest 4ate


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D#ri-ati-#$

Call .ption: 6 7i&es buyer 4ight but not the obligation to buy the share#Put .ption: 6 7i&es buyer 4ight but not the obligation to sell the share#

Kalue of the Call .ption:6i) 8lac( ,choles Model:6

Kalue of the call option < K. < V, 5 3 *d1) > V*x) 5 *e6t5rf) 5 *3 *d))

Where d1< ln*s-x) = *rf= Y - Z) 5 tt

ln< 3atural logd< d16 ts < Present spot ratex < uture stri(e *excise) pricerf< 4is( free rate

,e&en step to sol&e the problem:6i) ind log *s-x)ii) ind d1iii) ind d

i&) ind 3 *d1)&) ind 3 *d)i&) ind 3 *d1) 3ormal $able

Kalue = H#

&) ind 3 *d)

&i) ind _eB &alue&ii) +pply 8lac( ,chools Model#


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,ub step to step 1:6a) Log *s-x) < Log s > Log x

H#99b) 'f x and s are digit figure the &alue shall be *1 = Log table &alue)#c) 'f x and s are 9 digit then the &alue shall be * = Log table &alue)#

,ub step to step @:6a) 't is to find the po"er &alue of _eB#

b) e6t5rf< 1 *or) 1 # 1 = r-9@ 5 3o# of days *t) 1 = r-9@ 5 3o# of Months *t)

Kalue of Put option: 6< V*x) 5 *e6t5rf) 5 *3 *6d)) 6 V, 5 3 *6d1)

Excise price:6

't is the price at "hich the person "rites the prices on a share to buy after aperiod#Expected Kalue of the share:6

't is the total of estimate mar(et price of the share multiplied "ith therespecti&e probability#

Expiration &alue: 6 Excise price > Expected Kalue

Expected *or) $heoretical &alue of the call option price at expiration *Pay off of Call

option) :6< *Estimated mar(et price > Excise Price) 5 Probability *or)< VMax *s > x)! H 5 Probability

Pay off of call option

Expected *or) $heoretical &alue of the put option price at expiration *Pay of putoption):6< *Excise Price 6 Estimated mar(et price) 5 Probability *or)< VMax *x > s)! H 5 Probability

Pay off of Put option

Where *Estimated mar(et price > Excise Price) is called pay off# 'f it is negati&e it ista(en as Iero#

s < Estimated Mar(et Price#

Put call parity < Put call parity e0uation is*Kalue of call option = Present &alue of excise price) < *&alue of put option =

@


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,pot rate)

3ote:6

i) Changes to be made in computation of 8lac( ,choles model for di&idend stoc(s:6

,ubstitute in all the places of s "ith s > PK of di&idendii)'n the abo&e all PK is found at 4is( free rate#

B#ta

8eta means! it measures the &olatility of securities to the changes in themar(et#

*le&el of ris() < s5 Cor *s!m) "here s< ,% of return on securities m m< ,% of return on mar(et portfolio

*or) Co&ariance*s!m) - m should al"ays be applied on ris( premium and not to the entire return#

rs< rf= *rm> rf ) 5 Where r f< 4is( free raters< Expected return on securities *or) VCapital +ppreciation = %i&idend of thecompanyrm< Expected return on mar(et portfolio *or)

VMar(et index YMar(et rateZ appreciation = Mar(et di&idend yieldD

Portfolio $heory *P$):6

rp*expected return under CML) < rf = *rm> rf) 5 * p- m)$he abo&e formula is based on total ris(#Where p< ,% of efficient portfolio#

When expected return under efficient portfolio is as(ed thenrp*expected return under efficient portfolio) < Capital mar(et line*CML) >

Express e0uilibrium price relationship bet"een expected return and %,

Capital +sset Pricing Model *C+PM):6


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rs*expected return portfolio in C+PM) < rf= *rm> rf) 5 V* s- m) 5cor*s!m)

*or) rf= V*rm> rf) 5

Where rm< rf= Mar(et premium

8eta of the portfolio < * a5 Pa) = * b5 Pb)

Where Pa! Pb< Proportion of in&estment in Company + and Company 8#

3ote:6i) *rm> rf) < Mar(et ris( premium *or) Compensation per unit of ris(#ii) Cor*s!m) is =1 under CMLiii) rf= *rm> rf) 5 V* s- m) 5 cor*s!m) < $his portion in C+PM formula is

ris( premium

i&) *rm> rf) - m< Mar(et ris( return trade off *slope)#

3otes:6$o find the in&estment to be made in ris( free in&estments to get a certain is

of expected portfolio < *W1 5 1) =*W5 )*or) < *W15 1) = *16W1)

Where W1 is "eitage gi&en to existing securities#

W is "eitage gi&en to ris( free securities#'n this case 1is of existing securities and

is of rfsecurities *ie#H)$his can also be use to find in&estment in other then rfsecurities# 'n that case

that is substituted in #

$he "eitage *W1!W) is multiplied "ith mar(et &alue of existing portfolio tofind the proportion of in&estment#

F


79/84

H%&,ing C%*'ani#$

'ndex of Main Points:6

1# 'f there is a %ebit balance in Minority 'nterest first it is adJusted ag

2the-notes for osting

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