Fmca Unit 3 & 4 Notes
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2005shreyansh2005Fmca Unit 3 & 4 Notes
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2005shreyansh2005 BA-111
M FINANCIAL MANAGEMENT & COST ACCOUNTING
UNIT-3
UE. COST ACCOUNTING
Q
Cost Accountingis the process ofrecording, analyzing,and reporting all of a company’s costs
associated with the production of a product or service. It helps management in budgeting, cost control,
and decision-making.
ost accountingis a branch of accounting that focuseson recording, analyzing, and managing the
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costs of producing goods or services. Its main purposeis to help businesses understand how much
it costs to run operations, so they can make informed decisions about pricing, budgeting, and cost
control.
Objectives of Cost Accounting:-
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1 ost Control:Monitor and reduce unnecessary expenses.
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2. Cost Ascertainment:Determine the actual cost of products/services.
3. Profitability Analysis:Understand which productsor departments are profitable.
4. Decision Making:Provide data to assist in pricing,budgeting, and investment.
5. Inventory Valuation:Help in valuing inventory forfinancial statements.
lements of Cost:-
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Cost accounting breaks down total cost into the following elements:
1. Direct Costs:-
○ Direct Materials:Raw materials used in production.
○ Direct Labor:Labor directly involved in manufacturing.
○ Direct Expenses:Other costs directly traceable toa product.
2. Indirect Costs (Overheads):-
○ Factory/Manufacturing Overheads:Indirect materials,indirect labor, depreciation.
○ Administrative Overheads:Office expenses.
○ Selling and Distribution Overheads:Marketing, advertising,logistics.
Scope of Cost Accounting:-
1. C ost Ascertainment :-Determining the cost of products,services, or processes using various
costing methods such as job costing, process costing, batch costing, etc.
2. Cost Control :-Monitoring and controlling costs throughtechniques like standard costing and
variance analysis. Helps in identifying inefficiencies and wastage.
3. Cost Reduction :-Identifying areas to reduce costswithout compromising on quality. It is a
continuous process aimed at improving efficiency.
4. Cost Allocation and Apportionment :-Distributingcosts among various departments,
products, or processes fairly and logically (e.g., factory rent to departments).
5. Budgeting and Forecasting :-Preparing financial plansand comparing them with actual
performance to control future costs.
6. Decision-Making Support :-Assisting management withdata to make informed decisions,
such as pricing, make-or-buy, cost-volume-profit analysis, etc.
7. Inventory Valuation :-Determining the value of rawmaterials, work-in-progress, and finished
goods for financial reporting and decision-making.
8. Reporting to Management :-Providing internal reportson cost performance, productivity, and
efficiency for strategic planning.
Classifications of Cost Accounting
. By Nature or Element
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This classification divides costs based on what the cost is composed of:
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● aterial Costs: Raw materials and components usedin production.
● Labor Costs: Wages and salaries paid to employees.
● Expenses: All other costs not included in materialor labor (e.g., rent, utilities).
. By Function
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This refers to the purpose or activity for which the cost is incurred:
● anufacturing/Production Cost: Costs involved in makinga product.
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● Administrative Cost: Costs for general management.
● Selling and Distribution Cost: Costs for promoting,selling, and delivering products.
● Research and Development Cost: Costs related to innovationand product development.
. By Behavior
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Based on how costs change with the level of activity:
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● ixed Costs: Do not change with production level (e.g.,rent).
● Variable Costs: Change in proportion to activity level(e.g., raw materials).
● Semi-Variable (Mixed) Costs: Contain both fixed andvariable elements (e.g., electricity bills
with a fixed charge and a usage-based charge).
. By Controllability
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This identifies whether the cost can be controlled by a specific level of management:
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● ontrollable Costs: Can be influenced by a manager(e.g., direct labor).
● Uncontrollable Costs: Cannot be directly controlledby a manager (e.g., depreciation).
. By Traceability
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How directly a cost can be traced to a cost object (product, department, etc.):
Direct Costs: Can be directly traced (e.g., raw materials).
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● Indirect Costs: Cannot be directly traced (e.g., factoryrent).
. By Time
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When the cost is recorded or considered:
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● istorical Costs: Actual costs incurred in the past.
● Predetermined Costs: Estimated or standard costs usedfor planning.
. By Decision-Making Purpose
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Useful for managerial decisions:
● elevant Costs: Future costs that will differ betweenalternatives.
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● Irrelevant Costs: Do not affect the decision.
● Opportunity Costs: Benefit lost when one alternativeis chosen over another.
● Sunk Costs: Already incurred and cannot be recovered.
● Marginal Costs: Extra cost of producing one more unit.
Types of Costs
Type Description
Fixed Costs Do not change with output (e.g., rent).
Variable Costs Change with output (e.g., raw materials).
Semi-variable Costs Have both fixed and variable components (e.g., utility bills).
Controllable Costs Can be influenced by a manager.
Uncontrollable Costs Cannot be influenced in short term.
Opportunity Cost Cost of foregone alternatives.
Sunk Cost Already incurred and cannot be recovered.
Marginal Cost Additional cost to produce one more unit.
Methods of Costing
Method Application
Job Costing Used for customized jobs (e.g., construction).
Batch Costing For producing goods in batches.
Process Costing For continuous production (e.g., chemicals, oil).
Contract Costing For long-term contracts (e.g., infrastructure).
Operation Costing For industries with repetitive operations (e.g., textiles).
Unit/Output Costing For homogeneous products (e.g., bricks).
QUE. ABSORPTION COSTING
bsorption costing, also known asfull costing, is a method of accounting for all the costs associated
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with manufacturing a product. Under this method,bothfixed and variable manufacturing costsare
allocated to the cost of each unit produced. This includes:
bsorption costingis a costing method whereall manufacturingcosts—both fixed and
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variable—are assigned to units of product. This means that each unit of product "absorbs" a portion of
direct materials,direct labor, andboth variable and fixed manufacturing overheads.
Components of Absorption Costing:
1. Direct Costs(easily traceable to products):
○ Direct Materials: Raw materials used in the production.
○ Direct Labor: Wages for workers directly involvedin production.
2. Indirect Manufacturing Costs (Overheads):
○ Variable Manufacturing Overheads: Costs that varywith production volume, e.g.,
utilities, indirect materials.
○ Fixed Manufacturing Overheads: Costs that do not changewith production volume,
e.g., rent, salaries of permanent staff, depreciation of factory equipment.
In absorption costing,all these costs are “absorbed”by the units produced, meaning
each unit carries a portion of all production costs, including fixed overheads.
How Absorption Costing Works (Step-by-Step):
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1 alculate per-unit cost of direct materials, labor, and variable overheads.
2. Allocate fixed manufacturing overheads to each unitbased on a predetermined overhead
rate (often based on machine hours or labor hours).
3. Sum up all these coststo get the full cost per unit.
xample:
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Suppose you produce 1,000 units of a product in a month, and the costs are:
● irect Materials: $5 per unit
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● Direct Labor: $4 per unit
● Variable Overhead: $3 per unit
● Fixed Overhead: $8,000 total per month
Fixed Overhead per unit= $8,000 / 1,000 = $8
Total Absorption Cost per unit= $5 + $4 + $3 + $8 =$20
Key Features
Feature Description
Used for External financial reporting, income statements, inventory valuation
GAAP compliance Required under GAAP and IFRS
Inventory Inventory includes a share of fixed overhead
Valuation
Profit Impact rofit is affected by production volume (producing more can defer
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fixed costs to inventory)
Advantages of Absorption Costing
● omplies with accounting standards (GAAP/IFRS)
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● More accurate product costing for long-term decisions
● Reflects all manufacturing costs in inventory
● Useful for full cost recovery and pricing decisions
QUE. MARGINAL COSTING
arginal costing, also known asvariable costing, is a costing technique in managerial accounting
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where only variable costs are considered when calculating the cost of a product or decision. Fixed costs
are treated as period costs and are not included in product cost.
🔹 Key Concepts of Marginal Costing
1. Marginal Cost
hemarginal costis the additional cost incurredby producing one more unit of a product. It includes
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onlyvariable costs, such as:
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● irect materials
● Direct labor
● Variable overheads
Formula:Marginal Cost=Change in Total Cost÷Changein Output
🔹 Features of Marginal Costing
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1 lassification of Costs: Costs are divided intofixedandvariablecomponents.
2. Product Costing: Onlyvariable costsare assignedto the product. Fixed costs are excluded.
3. Profit Calculation: Profit is determined by subtractingtotal fixed costs fromcontribution(sales
minus variable costs).
4. Inventory Valuation: Inventories are valued at variablecost only.
🔹 Key Terms
1. Contribution
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● ontribution=Sales Revenue−Variable Costs
● Contribution helps in covering fixed costs and generating profit.
2. Break-even Point (BEP)
● The level of sales at which total revenue equals total costs (no profit, no loss).
𝐹𝑖𝑥𝑒𝑑𝐶𝑜𝑠𝑡𝑠
● BEP (units)=
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛𝑝𝑒𝑟𝑈𝑛𝑖𝑡
3. Profit
● Profit=Total Contribution−Fixed Costs
🔹 Example
Assume:
● elling price per unit = $50
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● Variable cost per unit = $30
● Fixed costs = $10,000
● Units sold = 1,000
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● ontribution per unit = $50 - $30 = $20
● Total Contribution = $20 × 1,000 = $20,000
● Profit = $20,000 - $10,000 = $10,000
🔹 Advantages of Marginal Costing
● implifies decision-making(e.g., pricing, make orbuy decisions)
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● Easier cost controldue to separation of fixed andvariable costs
● Useful forbreak-even analysis
● Avoids arbitrary allocation of fixed costs
🔹 Limitations
Ignores fixed costsin product costing, which maymislead long-term pricing strategies
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● Not accepted underGAAP/IFRSfor external reporting
● Mayunderestimate inventory value, leading to understatedprofit
🔹 Applications in Decision Making
Marginal costing is widely used in:
● ricing decisions(especially for special orders)
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● Make or buy decisions
● Product mix optimization
● Shut-down or continue decisions
● Break-even and profitability analysis
UE. METHODS OF VALUING MATERIAL ISSUES
Q
Valuing material issues -especially in contexts likesustainability reporting; ESG(Environmental,
Social, Governance) analysis. or corporate risk management involves identil\ing and assessing issues
that significantly impact a company's performance. stakeholders. and long-tenn value. I lerc arc key
methods used to value material issues:
l. Monetary Valuation
Assigning a financial value to material issues based on their impact
● C ost-Benefit Analysis (CBA) :-Weighs the costs ofaddressing a material issue (e.g.. installing
pollution controls) against the benefits (e.g., avoiding fines. improved public perception).
● Shadow Pricing :-Assigns monetary values to intangibleimpacts (like carbon emissions)
based on societal costs.
● Natural Capital Valuation :-Assigns value to ecosystemservices (e.g.. Clean air, water) that a
business relies on.
. Qualitative Assessment
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Evaluates the significance of material issues based on expert judgment, stakeholder feedback, or
strategic importance.
● S takeholder Interviews & Surveys :-Capture the perceptions and priorities of internal and
external stakeholders.
● Materiality Matrices :-Plot issues by importance to stakeholders and potential impact on the
business.
● Scenario Analysis :-Qualitatively explores how tilture scenarios (e.g.. regulatory changes,
climate events) could affect material issues.
. Quantitative Scoring and Ranking
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Uses scores or indices to evaluate and compare issues.
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● isk Scoring Models :-Combine likelihood and severityof impact to prioritize risks.
● ESG Ratings Frameworks :-Uses structured indicators (e.g., (iRI. SASB, MSCI) to assess and
compare ESG performance.
● KPI Tracking :-Ties key performance indicators tomaterial issues and tracks over time.
. Benchmarking
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Compares material issues and perfOrmance metrics against peers, industry standards, or best
practices.
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● eer Benchmarking :-Understand how competitors addresssimilar issues.
● Standard Frameworks :-Use established frameworks(like GRI, SASB, TCFD) to identify and
benchmark material issues.
. Integrated Reporting and Impact Valuation
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Consider how material issues affect the broader value creation process.
● Integrated Reporting (<IR>) :-Links material issuesto financial, manufactured, human, social,
and natural capital.
● Impact Valuation Models :-Measure positive and negativeimpacts on society/environment
alongside financial performance.
QUE. BREAK-EVEN ANALYSIS
reak-even analysisis a financial tool used to determinethe point at which a business’s revenues
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equal its costs, meaning there isno profit or loss.This point is known as thebreak-even point (BEP).
It's a crucial concept in cost accounting, budgeting, and decision-making.
Key Concepts in Break-even Analysis
1. Fixed Costs (FC):
○ Costs that do not change with production or sales volume (e.g., rent, salaries, insurance
Depreciation).
2. Variable Costs (VC):
○ Costs that vary directly with the level of production (e.g., raw materials, direct labor,
packaging, Utilities tied to production).
3. Total Costs (TC):
Total Costs=Fixed Costs+Variable Costs
4. Revenue:
○ The income from selling products or services:
○ Revenue=Selling Price per Unit×Quantity Sold
5. Contribution Margin (CM):
CM per unit=Selling Price per Unit−Variable Cost per Unit
○ This shows how much money is available to cover fixed costs and generate profit.
6. Break-even Point (in Units):
𝐹𝑖𝑥𝑒𝑑𝑐𝑜𝑠𝑡𝑠
BEP (units)=
𝑆𝑎𝑙𝑒𝑠𝑃𝑟𝑖𝑐𝑒𝑝𝑒𝑟𝑈𝑛𝑖𝑡−𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝐶𝑜𝑠𝑡𝑝𝑒𝑟𝑈𝑛𝑖𝑡
7. Break-even Point (in Sales Value):
𝐹𝑖𝑥𝑒𝑑𝐶𝑜𝑠𝑡𝑠
BEP (sales)=
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛𝑀𝑎𝑟𝑔𝑖𝑛𝑅𝑎𝑡𝑖𝑜
Where:
𝐶𝑀𝑝𝑒𝑟𝑈𝑛𝑖𝑡
CM Ratio=
𝑆𝑒𝑙𝑙𝑖𝑛𝑔𝑃𝑟𝑖𝑐𝑒𝑝𝑒𝑟𝑈𝑛𝑖𝑡
Example
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● ixed Costs: $10,000
● Selling Price per Unit: $50
● Variable Cost per Unit: $30
ontribution Margin per Unit= $50 - $30 = $20
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Break-even Point (units)= $10,000 / $20 =500 units
This means you must sell500 unitsto cover all costs.
Uses of Break-even Analysis
● ricing decisions
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● Cost control and efficiency planning
● Financial forecasting and budgeting
● Investment feasibility
● Determining the safety margin (i.e., how much sales can drop before incurring a loss)
Limitations
● ssumes constant selling price and costs
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● Only applies to a single product (or a constant product mix)
● Doesn't account for inventory changes or capacity constraints
● Ignores time value of money
UE. USE OF COST-DATA IN MANAGERIAL DECISION-MAKINGWITH SPECIAL REFERENCE
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TO PRICING AND MAKE OR BUY DECISION.
heuse of cost data in managerial decision-makingis critical for ensuring that business decisions
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are economically sound and strategically aligned. Two common areas where cost data plays a pivotal
role are inpricing decisionsandmake-or-buy decisions.Let's break these down:
. Pricing Decisions
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Cost data helps managers determine appropriate prices for products or services by analyzing various
cost components. Key approaches include:
A. Cost-Plus Pricing
● Definition :-Adds a fixed markup to the cost of producinga product.
● Formula :-Selling Price = Cost + Markup
● Use :- Common in contract-based businesses or whencost recovery is critical.
B. Break-Even Analysis
● Definition :-Determines the sales volume at whichtotal revenue equals total cost.
● Use :-Helps set minimum pricing to avoid losses and understand the margin of safety.
C. Target Costing
● Definition :- Starts with a target selling price based on market conditions and subtracts desired
profit to arrive at allowable cost.
● Use :-Common in competitive markets with price-sensitivecustomers.
D. Marginal Costing (Variable Costing)
● Definition :-Uses only variable costs to determinethe contribution margin, which aids in
short-term pricing decisions.
● Use :-Useful in special orders or during excess capacityscenarios.
Example:
● If a company receives a one-time export order, it may price the product just above
variable costs to utilize spare capacity and increase contribution, even if below full cost.
. Make-or-Buy Decisions
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This involves deciding whether to produce internally or purchase from an external supplier.
Key Cost Data Considered:
Relevant Costs :-Only those costs that differ betweenmaking and buying are considered.
● Direct Costs :-Raw materials, direct labor, etc.
● Variable Overheads
● Avoidable Fixed Costs
pportunity Costs :-E.g., if making the product in-houseprevents using the facility for a more
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profitable product.
Qualitative Factors:- Reliability of suppliers, qualityconcerns. confidentiality. etc.
UE. INTRODUCTION TO STANDARD COSTING INCLUDING VARIANCEANALYSIS —
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MATERIALS AND LABOUR VARIANCE
standard Costing is a cost accounting technique that involves assigning predetermined (standard) costs
to products or services, and then comparing them to actual costs incurred. The goal is to identify and
analyze variances (differences) to improve cost control and decision-making.
Key Features:
● Used for budgeting, cost control, and performance evaluation.
● Standards are set for materials, labour, and overheads.
● Variances are calculated to understand efficiency and cost deviations.
Variance Analysis Overview :-
Variance Analysis is the process of computing the difference between standard cost and actual
cost, and then investigating the reasons behind those differences.
Types of Variances :-
● Favorable (F) :-Actual costs are less than standardcosts.
● Unfavorable (U) :-Actual costs are more than standardcosts.
Materials Variances :-
. Material Cost Variance (MCV)
1
Overall difference between standard and actual material cost.
● MCV = (Standard Price x Standard Quantity) — (Actual Price x Actual Quantity)
. Material Price Variance (MP V)
2
Difference due to change in material price.
● MP V = (Standard Price — Actual Price) x Actual Quantity
. Material Usage Variance (MUV)
3
Difference due to change in material quantity used.
● MUV = (Standard Quantity — Actual Quantity) x Standard Price Labour Variances
. Labour Cost Variance (LCV)
1
Total difference in labour cost.
● LCV = (.Standard Rate x Standard Hours) - (Actual Rate x Actual
. Labour Rate Variance (LRV)
2
Variance caused by change in wage rate.
● LRV = (.Standard Rate — Actual Rate) x Actual Hours
. Labour Efficiency Variance (LEV)
3
Variance due to difference in time taken.
● LEV = (Standard Hours — Actual Hours) x Standard Rate
Numericals of Material Variance and Labour Variance
❖ Numerical Example —- Material Variance
Standard quantity of materialper unit = 5 kg
Standard priceper kg = $4
Actual quantity used= 520 kg
Actual price per kg= $4.50
Units produced= 100
Step I: Standard Quantity for Actual Output
● Standard Quantity = 100 units x 5 kg =500 kg
Step 2: Material Price Variance (MP V)
● MP V = (Standard Price — Actual Price) x Actual Quantity
● MPV = ($4.00 - $4.50) x 520 =-$260 (Unfavorable)
Step 3: Material Usage Variance (MUV)
● MUV = (Standard Quantity – Actual Quantity) x Standard Price
● MUV = (500 – 520) =– $80 (Unfavorable)
Step 4: Material Cost Variance (MCV)
● MCV = MPV - MUV = – $260 + (-$80) =– $340 (Unfavorable)
❖ Material Variance – Numerical Example
Standard hoursper unit = 2 hours
Standard rateper hour = $10
Actual hours Worked= 220 hours
Actual rate per hour= $12
Units produced= 100
Step I: Standard Hours for Actual Output
● Standard Hours = 100 units 2 hours =200 hours
Step 2: Labour Rate Variance (LRV)
● LRV = (Standard Rate — Actual Rate) x Actual Hours
● LRV = ($10 – $12) x 220 =$440 (Unfavorable)
Step 3: Labour Efficiency Variance (LEV)
● LEV = (Standard Hours — Actual Hours) x Standard Rate
● LEV = (200 – 220) x $10 =– $200 (Unfavorable)
Step 4: Labour Cost Variance (LCV)
● LCV = LRV + LEV = –$440 + (--$200) =–$640 (Unfavorable)
UE. COST CONTROL TECHNIQUES
Q
Cost control techniques are essential tools for managing expenses and ensuring that a project,
business, or department stays within its budget. Here are some of the most commonly used and
effective cost control techniques:
1. Budgeting
● Definition:Creating a detailed financial plan thatestimates revenues and expenses over a
specific period.
● Purpose:Serves as a benchmark to compare actual performanceagainst planned targets.
2. Standard Costing
● Definition:Using predetermined costs for productsor services as a benchmark.
● Purpose:Helps identify variances between standardand actual costs to address inefficiencies.
3. Variance Analysis
● Definition:Analyzing the differences between budgeted/standardcosts and actual costs.
● Purpose:Pinpoints areas where performance deviatedfrom the plan and identifies causes.
4. Activity-Based Costing (ABC)
● Definition:Allocating overhead costs more accurately based on activities that drive costs.
● Purpose:Provides better insight into what activitiescontribute to overhead and how they can
be optimized.
5. Break-Even Analysis
● Definition:Calculates the point at which revenuesequal costs.
● Purpose:Helps determine minimum sales volume neededto avoid losses.
6. Forecasting
● Definition:Predicting future financial outcomes basedon historical data and market trends.
● Purpose:Assists in proactive planning and adjustingresource allocation.
7. Cost–Benefit Analysis
● Definition:Comparing the benefits of a decision orproject against the costs involved.
● Purpose:Ensures that decisions provide value formoney and resources are used effectively.
8. Zero–Based Budgeting (ZBB)
● Definition:Every expense must be justified for eachnew period, starting from a "zero base."
● Purpose:Prevents unnecessary costs and encouragesefficient resource allocation.
9. Inventory Management
● Techniques:Just-in-Time (JIT), Economic Order Quantity (EOQ), ABC Analysis.
● Purpose:Reduces holding costs and avoids overstockingor stockouts.
10. Project Management Tools
● Examples:Gantt charts, Critical Path Method (CPM),Earned Value Management (EVM).
● Purpose:Helps monitor project progress and controlproject costs.
11. Outsourcing and Automation
● Definition:Delegating non-core activities to thirdparties or automating repetitive tasks.
● Purpose:Reduces labor costs and increases efficiency.
Preparation of Budgets and Their Control
Thepreparation of budgets and their controlis afundamental part of financial planning and
cost management in any organization. Here's a breakdown of thesteps involved in preparing
budgetsandhow budgetary controlis exercised:
Preparation of Budgets
1. Identify Objectives and Goals
● Define the overall financial and operational goals of the organization.
● Align departmental objectives with strategic goals.
2. Gather Historical Data
● Analyze previous years' financial data to identify trends and patterns.
● Consider past income, expenditures, seasonal variations, and market conditions.
3. Forecast Revenues
● Estimate expected income from sales, services, investments, etc.
● Base projections on market analysis, economic indicators, and sales forecasts.
4. Estimate Costs and Expenses
● List fixed costs (e.g., rent, salaries) and variable costs (e.g., raw materials, commissions).
● Include expected costs for new projects or expansion plans.
. Classify Budget Types
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Organizations may prepare different types of budgets:
● Operating Budget:Day-to-day revenue and expenses
● Capital Budget:Long-term investments in assets.
● Cash Budget:Expected cash inflows and outflows.
● Master Budget:Comprehensive summary of all individualbudgets.
6. Coordinate with Departments
● Involve all departments in budget preparation to ensure realism and accountability.
● Encourage input from department heads for better accuracy.
7. Draft and Review the Budget
● Compile and consolidate departmental budgets.
● Review for consistency, accuracy, and alignment with goals.
8. Approval and Implementation
● Submit the final budget to senior management for approval.
● Communicate the approved budget to all departments and implement it.
.
Budgetary Control
Budgetary control involves monitoring actual performance against the budget, identifying variances, and
taking corrective action. Key components include:
1. Monitoring and Reporting
● Regularly track actual revenues and expenses.
● Generate variance reports (Actual vs Budgeted figures).
2. Variance Analysis
● Investigate significant deviations.
● Determine reasons: e.g., price increases, lower sales, inefficiencies.
3. Corrective Actions
● Adjust operations or spending where necessary.
● Reallocate resources if required to stay within budget.
4. Performance Evaluation
● Use budget comparisons to assess departmental or managerial performance.
● Reward departments or teams that perform efficiently.
5. Revisions and Updates
● Modify the budget if significant changes occur (e.g., economic shifts, new opportunities).
● Ensure the budget remains relevant and practical throughout the period.
Benefits of Budget Preparation and Control
● Enhances financial discipline.
● Helps in setting and achieving goals.
● Improves resource allocation.
● Supports strategic planning.
● Encourages accountability and efficiency.
UE. ZERO BASED BUDGETING
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ZERO-BASED BUDGETING (ZBB)is a modern and strategicbudgeting technique whereevery
expense must be justified from scratchfor each newperiod, starting from a "zero base." Unlike
traditional budgeting, where the previous year's budget is simply adjusted, ZBB requires managers to
build the budget as if no money has been allocated yet.
ey Features of Zero-Based Budgeting
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Feature Description
Start from Zero Every function is analyzed and justified regardless of past spending
Decision Packages Activities are grouped into “decision packages” ranked by importance and
value.
Resource Allocation Resources are allocated based on need and priority, not history.
Cost–Effectiveness Emphasis on outcomes, ROI and efficiency.
teps in Zero-Based Budgeting
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1. Define Organizational Goals
● Clearly understand the overall mission and short/long-term goals.
2. Identify and Break Down Activities
● List all activities and operations in each department.
● Create "decision units" (e.g., marketing campaign, training program).
3. Develop Decision Packages
Each package should include:
● Purpose and objectives.
● Cost of implementation.
● Consequences of not funding.
● Alternatives and cost-benefit analysis.
4. Evaluate and Rank Decision Packages
● Rank based on priority, contribution to goals, and cost-effectiveness.
● Use techniques like cost-benefit or scoring models.
5. Allocate Resources
● Fund the highest-priority decision packages first.
● Continue until available resources are fully allocated.
6. Monitor and Review
● Continuously track performance and actual spending.
● Adjust or re-evaluate priorities as needed.
Advantages of Zero—Based Budgeting
● Improved Efficiency:Eliminates redundant or Iow-valueactivities.
● Cost Savings:Identifies and cuts unnecessary spending.
● Strategic Focus:Ensures alignment with business goals.
● Greater Accountability:Managers must justify everydollar spent.
Challenges of ZBB
● Time-Consuming:Requires detailed analysis and justification.
● Complexity:May be hard to implement in large organizations.
● Resistance to Change:Managers used to incrementalbudgets might push back.
Where ZBB is Commonly Used
● Government agencies
● Nonprofits
● Startups and growing businesses
● Large corporations looking to streamline operations.
UE. STANDARD COSTING AND VARIANCE ANALYSIS
Q
Standard Costing and Variance Analysis—two essential tools for cost control and performance
evaluation in accounting and management.
tandard Costing :-
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Standard costing involves assigning predetermined (standard) costs to products or services. These
costs are established based on:
● Historical data,
● Expected efficiency levels,
● Industry benchmarks,
● Engineering estimates.
Types of Standard Costs:-
● Direct Material Cost
● Direct Labor Cost
● Manufacturing Overhead Cost
These are used to measure how efficiently resources are being used.
ariance Analysis :-
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Variance Analysis standard costs actual costs and identifies variances. I.e,. differences. It helps
managers understand why performance differs from expectations.
ypes of Variances
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I. Material Variances
● Material Price Variance (MPV)= (Standard Price -Actual Price) x Actual Quantity
● Material Usage Variance (MUV)= (Standard Quantity- Actual Quantity) x Standard Price
2. Labor Variances
L
● abor Rate Variance (LRV)= (Standard Rate - Actual Rate) x Actual Hours
● Labor Efficiency Variance (LEV)= (Standard Hours - Actual Hours) x Standard Rate
3. Overhead Variances
● Variable Overhead Variances
● Fixed Overhead Variances
4. Sales Variances
● Sales Price Variance= (Actual Price - Standard Price)x Actual Quantity Sold
● Sales Volume Variance= (Actual Quantity - BudgetedQuantity) x Standard Price
Benefits of Standard Costing and Variance Analysis
● Cost Control:Helps track where costs deviate andwhy.
● Performance Evaluation:Measures efficiency of departmentsor indr.i"31s
● Planning and Budgeting:Assists in setting realisticbudgets.
● Decision Making:Informs corrective action and strategicdecisions.
Limitations
● Outdated Standards:Must be regularly updated to reflectcurrent market conditions.
● Focus on Cost Only:Might ignore quality or innovationaspects.
● Time-Consuming:Detailed analysis can be complex inlarge organizations.
UE. RESPONSIBILITY ACCOUNTING
Q
Responsibility Accounting is a management accounting system that assigns the responsibility of
financial results to specific individuals or departments within an organization. The core idea is to track
performance by responsibility centers so that managers are held accountable only for the elements they
can control.
Key Concepts of Responsibility Accounting
. Responsibility Centers
1
These are segments of an organization for which managers are held accountable:
ype
T escription
D xample
E
Cost Center Responsible for controlling costs only Manufacturing dept, HR
Revenue Center Responsible for generating revenues Sales dept, Marketing
Profit Center Responsible for both revenues and costs Product division, branch office
Investment Center Responsible for revenues, costsand Strategic business unit, regional
capital investments. headquarters.
. Controllability Principle
2
Only hold managers accountable for items they can control. For example:
● A factory manager is accountable for production costs, not for sales performance.
. Performance Reports
3
Regular reports compare actual performance with budgeted targets. These reports include:
● Variances (favorable/unfavorable),
● Explanations or analysis of variances,
● Action items for correction.
. Budgeting by Responsibility Center
4
Budgets are developed per department or unit, aligning with each manager's area of control.
Let's say your organization has three departments:
epartment
D ype
T anager Responsible For
M
Manufacturing Cost Minimizing production costs
Sales Revenue Center Maximizing sales revenue
Regional Office A Profit Center Managing both revenues and costs
Each manager is assessed based on how well they handle their specific area, not the whole business.
Benefits of Responsibility Accounting
● Improvesaccountabilityandtransparency.
● Encouragesdecentralized decision-making.
● Enhancesmotivation and performancethrough clearownership.
● Facilitates betterperformance evaluationandcostcontrol.
Challenges
● Defining clear lines of responsibility in complex organizations.
● May lead tointernal competitionorgoal misalignment.
● Requires accurate and timely data for effectiveness.
BA-111
M FINANCIAL MANAGEMENT & COST ACCOUNTING
UNIT-4
UE. INTRODUCTION TO RECENT DEVELOPMENTS IN COSTMANAGEMENT
Q
In the face of globalization, digital transformation, and increasing economic uncertainty, cost
management has become a critical area of focus for organizations seeking to remain competitive and
financially sustainable. Traditional approaches. which often emphasized static budgeting and cost-
cutting, are no longer sufficient in an era that demands agility, precision, and strategic foresight.
ecent developments in cost management reflect a shift fromconventional cost control to strategic
R
cost optimization, where the goal is not merely toreduce expenses but to enhance the value
generated from every unit of cost. This transtörmation has been driven by several key innovations and
emerging practices:
1. Digital Technologies and Automation
he use of technologies such asRobotic Process Automation(RPA), cloud computing, and
T
Enterprise Resource Planning (ERP)systems has significantlyimproved the accuracy and efficiency
of cost data collection and analysis. Automation reduces manual errors and administrative overhead,
allowing finance teams to focus on value-added activities.
2. Advanced Analytics and AI
odern cost management leverages predictive analytics and artificial intelligence (AI) to forecast
M
cost trends, identify inefficiencies, and support data-driven decision-making. These tools enable
businesses to simulate different cost scenarios, optimize pricing, and manage risks proactively.
3. Activity-Based Costing (ABC)
BC continues to gain popularity as it allocates overhead costs more precisely based on actual
A
activities and resource consumption. This method provides clearer insight into the true cost of products,
services, and customers, supporting better strategic decisions.
4. Lean and Agile Cost Management
Inspired by lean manufacturing, lean accounting focuses on eliminating non-value-added costs and
aligning financial management with lean principles. Similarly, agile cost management supports
iterative planning and rapid response to market changes, which is especially valuable in dynamic
industries like technology and retail.
5. Sustainability and ESG Integration
nvironmental, Social, and Governance (ESG) factors are becoming central to cost considerations.
E
Companies are increasingly adopting life-cycle costing, which accounts for the total cost of
ownership—including environmental and disposal costs—to support sustainable decision-making.
6. Real-Time Cost Monitoring
loud-based dashboards and IoT-enabled systems provide real-time visibility into cost performance.
C
This enhances responsiveness and enables more accurate, timely interventions.
7. Strategic Procurement and Supplier Management
rganizations are also focusing on cost optimization through better procurement practices, supplier
O
collaboration, and risk-sharing arrangements, which help manage input costs and improve supply chain
resilience
hese developments collectively signify a paradigm shift in cost management—from a backward-
T
looking, compliance-focused function to a tot-ward-looking, strategic enabler of business pertörmance.
As companies continue to face margin pressures and global disruptions, the ability to manage costs
intelligently and proactively will be a key differentiator.
QUE. INTRODUCTION TO CONCEPT OF PRICE LEVEL OF ACCOUNTING
rice Level Accounting, also known asInflation Accounting, is a method of accounting that adjusts
P
financial statements to reflect changes in the purchasing power of money due to inflation or deflation.
Traditional historical cost accounting assumes a stable monetary unit and does not consider changes in
the general price level, which can distort financial performance and position, especially during periods
of significant inflation.
Purpose:
he main goal of price level accounting is to provide more accurate and realistic financial information by
T
adjusting the values of assets, liabilities, income, and expenses according to a price index (e.g.,
Consumer Price Index or CPI). This ensures that financial statements reflect the real value of money
and help stakeholders make better decisions.
Key Features:
1. A djustment for Inflation: Prices in the financial statements are restated using a general price
index.
2. Realistic Valuation: It presents a more accurate viewof a company’s financial health in
inflationary environments.
3. Two Main Methods:
○ Current Purchasing Power (CPP) Method: Adjusts all non-monetary items based on a
general price index.
○ Current Cost Accounting (CCA) Method: Replaces historical costs with current costs.
Benefits:
Improves comparability of financial data over time.
●
● Protects investors and creditors from inflationary distortions.
● Enhances the relevance and reliability of financial reports.
Limitations:
R
● equires additional effort and data (such as appropriate price indices).
● May introduce subjectivity in estimating current costs.
● Not widely adopted under standard GAAP or IFRS, though it is used in high-inflation economies.
UE. HUMAN RESOURCE ACCOUNTING
Q
Human Resource Accounting (HRA): An Introduction
Human Resource Accounting (HRA) is the process of identifying, measuring, and reporting the value
of human resources as organizational assets. Traditionally, accounting systems focus on physical and
financial assets, often overlooking the value that employees bring to an organization. HRA attempts to
bridge this gap by quantifying the economic value of human capital and incorporating It Into financial
statements and management reports.
Key Concepts of Human Resource Accounting:
. Valuation of Human Resources :-HRA involves estimatingthe cost-and value of employees,
1
including recruitment, training, development and the future economic benefits they are expected to
provide.
2. Measurement Approaches:
● Cost-based Approaches:These include historical cost,replacement cost, and opportunity cost
models, focusing on the cost incurred to acquire and devgJoø employees.
● Value-based Approaches:These models, such as thepresent value of future earnings, assess
the expected value employees will generate over time
Objectives of HRA:
● To improve management's decision-making related to workforce planning, training, and
development.
● To communicate the value of human assets to stakeholders.
● To assist in monitoring the effectiveness of human resource policies.
Benefits of HRA:
● Enhance organizational transparency.
● Encourages strategic investment in employee development.
● Helps in performånce evaluation and cost control.
Challenges of HRA:
● Lack of standardized methods for valuation.
● Difficulties in quantifying intangible qualities like creativity or leadership.
UE. TARGET COSTING
Q
Target Costing is a strategic cost management technique used primarily during the product planning
and design stages. It focuses on controlling costs by setting a predetermined cost target based on
market conditions and desired profit margin, and then designing the product to meet that] cost.
Key Concepts of Target Costing:
● Market-Driven Approach:Target costing starts with the market price—the price customers are
willing to pay. From this, the company subtracts its desired profit to determine the target cost.
● Cost Control from the Start:Unlike traditional costing, where costs are estimated after the
product is designed, target costing emphasizes cost management early in the development
process. This helps avoid costly redesigns later.
● C
ross-Functional Teams:The process involves collaborationbetween marketing, engineering,
production, and accounting departments to ensure the product meets customer expectations at
the target cost.
● C
ustomer Focus:It ensures that product design andfunctionality are aligned with what the
customer values, without compromising on quality or innovation.
Benefits of Target Costing:
● Enhances cost efficiency and profitability.
● Encourages innovation in product design and production methods.
● Improves market competitiveness by aligning product offerings with customer needs and price
sensitivity.
Challenges:
● May limit design flexibility.
● Requires accurate market data and strong interdepartmental coordination.
● Can be time-consuming during the development phase.
UE. KAIZEN COSTING
Q
Kaizen Costingis a cost management approach thatfocuses on continuous. incremental cost
reduction throughout the production process. Rooted ili the Japanese philosophy of "Kaizen"
This technique emphasizes making small, ongoing changes which means -Continuous improvement,"
changes to improve efficiency and reduce waste without compre_nysing quality.
Key Features of Kaizen Costing:
● Post-Production Cost Management:Unlike target costing,which is applied during product
planning and design, Kaizen costing is used after the product is in production, focusing on
reducing actual costs over time.
● E
mployee Involvement:Kaizen encourages all employees—fromtop management to
Shop-floor workers—to contribute ideas for cost reduction and process improvement.
● Incremental Cost Reduction Goals:Rather than settingmajor cost-reduction targets, Kaizen
costing sets small, achievable cost reduction goals on a continuous basis.
● F
ocus on Processes:Improvements are often made inareas like production methods,
material usage, supply chain management, and workflow efficiency.
Benefits of Kaizen Costing:
● Promotes a culture of continuous improvement.
● Engages employees at all levels.
● Leads to cumulative and sustainable cost savings.
● Enhances operational efficiency and competitiveness.
Challenges:
● Requires a cultural shift and long-term commitment.
● Improvement may be slow and gradual.
● Success depends on consistent employee participation and management support.
ifference from Target Costing:
D
Features Target Costing aizen Costing
K
Applied When Product design stage During production
Focus Achieving target cost before launch Reducing actual cost continuously
Goal Meet cost before production Improve efficiency and reduce cost
QUE. ACTIVITY BASED COSTING
ctivity-Based Costing (ABC)is a costing method thatassigns overhead and indirect costs to specific
A
activities, which are then allocated to products or services based on their use of those activities. It's
designed to provide a more accurate reflection of the true costs involved in producing a product or
delivering a service.
Key Concepts of Activity-Based Costing:
1. A ctivities: These are the tasks or operations thatconsume resources (e.g., machine setup,
quality inspection, customer service).
2. Cost Pools: Costs are grouped by activity rather thanby department. Each activity has its own
cost pool.
3. Cost Drivers: These are factors that cause a costto be incurred (e.g., number of setups,
machine hours, number of orders processed). Cost drivers are used to assign costs from each
activity to products/services.
4. Cost Allocation: ABC assigns costs to products based on the extent to which each product
uses the activities. This helps identify high-overhead products or customers.
Steps in Activity-Based Costing:
.
1 Identify major activitiesinvolved in the productionprocess.
2. Assign coststo activity cost pools.
3. Determine cost driversfor each activity.
4. Calculate cost driver rates(total cost for each activity÷ total cost driver units).
5. Assign costs to products/servicesbased on the numberof cost driver units consumed.
Example:
Activity Total Cost Cost Driver roduct A
P roduct B
P
Usage Usage
Machine Setup $30,000 Number of Setups 10 20
Quality Inspection $20,000 Number of Inspections 5 15
1. S
etup rate = $30,000 / (10 + 20) = $1,000 per setup
Product A: 10 × $1,000 = $10,000
Product B: 20 × $1,000 = $20,000
2. Inspection rate = $20,000 / (5 + 15) = $1,000 per inspection
Product A: 5 × $1,000 = $5,000
Product B: 15 × $1,000 = $15,000
Total Overhead Assigned:
P
● roduct A: $10,000 + $5,000 = $15,000
● Product B: $20,000 + $15,000 = $35,000
Benefits of ABC:
● ore accurate product costing.
M
● Better understanding of overheads.
● Informed pricing and product decisions.
● Helps identify wasteful activities.
Drawbacks:
M
● ore complex and costly to implement.
● Requires detailed data collection.
UE. LIFE CYCLE COSTING (LCC)
Q
Life Cycle Costingis a cost management techniquethat evaluates thetotal cost of ownershipof a
product, asset, or system over its entire life span—from initial planning and acquisition through
operation, maintenance, and disposal. The goal is to make more informed financial decisions by
considering all costs associated with a product or investment, not just the upfront expenses.
Key Elements of Life Cycle Costing:
Total Cost Perspective:
LCC includes:
● Acquisition Costs(design, development, procurement)
● Operating Costs(utilities, labor, consumables)
● Maintenance Costs(repairs, servicing, upgrades)
● Disposal Costs(decommissioning, recycling, disposalfees)
ong-Term Decision-Making:
L
LCC supports decisions that might involve higher initial investments but lower operating or
maintenance costs, leading to cost savings over time.
sed Across Industries:
U
Common in construction, manufacturing, IT, and defense industries—anywhere long-Term cost
efficiency is critical.
Benefits of Life Cycle Costing
● Promotes cost-effective decision-making.
● Encourages investment in durable and energy-efficient options.
● Helps identify hidden costs early.
● Supports sustainable practices by factoring in environmental and end-of-life costs.
Challenges:
● Requires accurate forecasting of future costs and usage patterns.
● Data-intensive and may involve complex modeling.
● Some costs, like environmental impact, may be hard to quantify.
UE. INTRODUCTION TO TALLY SOFTWARE PACKAGE IN ACCOUNTING
Q
Tally(short forTransactions Allowed in a Linear Line Yards) is one Of the most widely used
accounting software packages in India and other countries forbusiness accounting and inventory
management. Developed byTally Solutions Pvt. Ltd.,the software is known for its simplicity, speed,
and robustness in handling financial data, making it suitable for small to large enterprises.
Key Features of Tally Software
● Accounting Management:Tally supports all accounting activities including journal entries,
ledgers, trial balance, profit & loss account, and balance sheets.
● Inventory Management:It allows tracking and managingstock, including inventory
categorization, stock valuation, and movement.
● GST Compliance:Tally is GST-ready, enabling automatic calculation and reporting of GST,
including e-filing.
● Multi-Language and Multi-Currency Support:It allows users to operate in different languages
and transact in multiple currencies.
● Payroll Management:Tally can manage employee records,salaries, provident fund, ESI, and
● income tax deductions.
● Banking Integration:Enables digital payments, chequeprinting, bank reconciliation, and other
banking functions.
● User Security and Audit Trail:Tally provides userroles, password protection, and audit trails
to ensure data integrity and control.
Versions:
● Tally.ERP 9:A widely used version that supportedcore accounting, inventory, payroll, and
statutory compliance.
● TallyPrime:The latest version, offering a more intuitiveinterface and improved navigation,
reporting, and customization features.
Advantages of Tally:
● Easy to learn and use.
● Highly customizable for different business needs.
● Scalable from small businesses to large enterprises.
● Real-time processing and reports.
● Supports remote access and data synchronization.
Applications of Tally
● Financial accounting and Reporting
● Taxation (GST. TDS. etc)
● Budgeting and forecasting
● Asset and liability management
● Compliance management
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