Unit 3: Accountancy

Nair
April 4, 2025

1 Defining Accountancy and Its Operational Scope

Accountancy is the systematic process of identifying, measuring, recording, classifying, sum-
marizing, interpreting, and communicating financial information. It serves as the principal tool
through which the financial health, efficiency, and sustainability of an organization are assessed.
The discipline encompasses a range of functions including financial reporting, cost analysis,
budgeting, internal controls, and performance evaluation.
Accountancy distinguishes between financial accounting which deals with the preparation
of reports for external stakeholders and management accounting, which focuses on internal de-
cision making processes. Both branches are essential in ensuring accountability, transparency,
and rational resource allocation.

1.1 Etymological and Historical Origins

The term accountancy is derived from the Latin computare, meaning to calculate or reckon.
Historically, rudimentary forms of bookkeeping were practiced in Mesopotamia and Egypt.
The formalization of double entry bookkeeping, attributed to Luca Pacioli in the 15th century,
marked the foundational moment for modern accountancy. Over time, as economic systems
grew in complexity, accountancy evolved to incorporate standards, regulatory frameworks, and
professional oversight.

1.2 Core Functions of Accountancy

• Preparation of Balance Sheets: Provides a snapshot of an entity’s financial position by
detailing assets, liabilities, and equity.

• Assessment of Economic Viability: Uses tools such as cost volume profit analysis, net
present value, and internal rate of return to evaluate feasibility.

• Decision Making Support: Supplies accurate and timely financial data for operational and
strategic choices.

• Expected Cost Analysis: Involves forecasting direct and indirect costs associated with
production, marketing, and administration.

• Planning and Production Control: Applies standard costing, budgeting, and variance anal-
ysis to align resources with objectives.

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 • Quality Control Accounting: Monitors financial impact of defective outputs, rework, and
quality assurance systems.
• Marketing and Advertisement Accounting: Evaluates return on promotional expenditure
and allocates budgets effectively.
• Industrial Relations Accounting: Measures cost implications of labor relations, including
wage structures, bonuses, and industrial disputes.
• Sales and Purchase Accounting: Records and monitors inflows and outflows through sales
ledgers and purchase journals.
• Wages and Incentive Accounting: Designs compensation structures and tracks perfor-
mance linked payments.
• Inventory Control and Valuation: Utilizes methods such as FIFO, LIFO, and weighted
average to determine cost of goods sold and closing stock.
• Preparation of Financial Reports: Generates income statements, cash flow statements,
and statements of changes in equity.
• Accounts and Stores Studies: Examines internal systems for tracking, storing, and veri-
fying material and financial records.

1.3 Illustrative Example

A manufacturing unit maintains inventory using the weighted average method. At the beginning
of the month, it holds 1,000 units at 100 each. It purchases another 500 units at 120. The average
cost per unit becomes 106.67. When 800 units are sold, the cost of goods sold is calculated as
800 × 106.67 = 85,336. This approach simplifies valuation and aligns with periodic accounting.

1.4 Systematic Role in Organizational Control

Accountancy enables monitoring by establishing benchmarks and identifying deviations. Bud-
getary control systems allow comparisons between actual and expected performance, while cost
accounting helps identify wastage or inefficiencies. This control function is critical for main-
taining financial discipline and achieving organizational targets.

1.5 Integration with Internal Systems

A well designed accounting system ensures integration with procurement, production, sales,
and human resource functions. Through synchronized data flows, organizations can maintain
real time financial visibility and implement corrective actions promptly.

2 Preparation and Interpretation of Balance Sheets

2.1 Definition and Purpose
A balance sheet is a structured financial statement that presents the financial position of an entity
at a specific point in time. It reflects the accounting equation:
Assets = Liabilities + Equity

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This equation embodies the principle that all resources (assets) are either funded by external
obligations (liabilities) or internal claims (equity). The balance sheet aids in assessing solvency,
liquidity, and capital structure.

2.2 Classification of Balance Sheet Elements

• Assets are economic resources controlled by the entity, expected to generate future ben-
efits. They are classified into:

– Current assets: cash, accounts receivable, inventory (expected to be realized within

one year).
– Non current assets: property, plant, equipment, intangible assets (long term use).

• Liabilities are obligations arising from past events, requiring future outflows:

– Current liabilities: accounts payable, short term loans, wages payable.

– Non current liabilities: long term borrowings, deferred tax liabilities.

• Equity represents the residual interest in assets after deducting liabilities. It includes:

– Owner’s capital, retained earnings, and reserves.

2.3 Structure of a Balance Sheet

An illustrative format is:
Particulars Amount ()
Assets
Cash and Bank 50,000
Accounts Receivable 70,000
Inventory 1,00,000
Plant and Machinery 3,00,000
Total Assets 5,20,000
Liabilities
Accounts Payable 80,000
Bank Loan (Short term) 70,000
Long term Loan 1,00,000
Total Liabilities 2,50,000
Equity
Owner’s Capital 2,00,000
Retained Earnings 70,000
Total Equity 2,70,000
Total Liabilities + Equity 5,20,000

2.4 Valuation Principles

• Historical Cost: Assets are recorded at purchase price.

• Fair Value: Some assets, like investments, may be revalued based on market conditions.

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 • Going Concern Assumption: Assets are assumed to be used rather than liquidated.

• Accrual Basis: Transactions are recorded when incurred, not when cash changes hands.

2.5 Use in Financial Analysis

The balance sheet enables ratio analysis:

• Current Ratio = Current Assets / Current Liabilities

• Debt to Equity Ratio = Total Liabilities / Total Equity

• Return on Equity = Net Income / Equity (derived using income statement linkage)

These metrics assist in evaluating liquidity, leverage, and profitability.

2.6 Illustrative Scenario

A trading firm maintains 60,000 in inventory, owes 20,000 in accounts payable, and holds
1,00,000 in owner’s capital. It receives a 30,000 loan and purchases a delivery van worth 80,000.
After adjustments:

• Assets = 60,000 (inventory) + 80,000 (van) = 1,40,000

• Liabilities = 20,000 (payable) + 30,000 (loan) = 50,000

• Equity = 1,00,000

Balance: 1,40,000 (Assets) = 50,000 (Liabilities) + 1,00,000 (Equity)

This process ensures adherence to the accounting equation.

3 Assessment of Economic Viability

3.1 Defining Economic Viability
Economic viability refers to the capacity of a project, product, or business to generate sufficient
income to cover its operational and capital costs over time. It is a quantitative estimation of
whether planned activities are financially feasible and sustainable. The assessment is rooted in
cost behavior, expected revenues, and investment returns.

3.2 Components of Viability Analysis

• Fixed Costs: Expenses that remain constant regardless of output volume, such as rent,
salaries, and depreciation.

• Variable Costs: Costs that vary directly with production, including raw materials, direct
labor, and packaging.

• Total Cost (TC): The sum of fixed and variable costs at a given level of output.

• Revenue Projections: Estimations of future sales based on market demand, pricing, and
volume.

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 • Break Even Point (BEP): The output level where total revenue equals total cost; no profit
or loss is incurred.
Fixed Costs
Break Even Point (Units) =
Selling Price per Unit − Variable Cost per Unit

• Contribution Margin: The difference between selling price and variable cost per unit;
used to cover fixed costs and generate profit.

• Profitability Index: Compares the present value of cash inflows to the investment cost.
Present Value of Future Cash Inflows
Profitability Index =
Initial Investment

3.3 Investment Appraisal Techniques

• Net Present Value (NPV): The present value of expected cash flows minus the initial
investment. A positive NPV indicates viability.
𝑛
Õ 𝐶𝐹𝑡
𝑁 𝑃𝑉 = − 𝐶0
𝑡=1
(1 + 𝑟) 𝑡

Where 𝐶𝐹𝑡 is cash inflow at time 𝑡, 𝑟 is the discount rate, and 𝐶0 is the initial cost.

• Internal Rate of Return (IRR): The discount rate at which NPV becomes zero. Higher
IRR relative to the cost of capital indicates attractiveness.

• Payback Period: Time taken to recover the initial investment from net cash inflows. Shorter
periods suggest lower risk.

3.4 Example of Break Even Analysis

An enterprise has fixed costs of 2,00,000. The selling price per unit is 500, and the variable cost
is 300 per unit.
2, 00, 000 2, 00, 000
BEP (Units) = = = 1, 000 units
500 − 300 200
Thus, selling 1,000 units covers all costs; units sold beyond this contribute to profit.

3.5 Scenario: Comparative Project Evaluation

Two proposed projects:
• Project A requires 5,00,000 and yields annual inflows of 1,50,000 for 5 years.

• Project B requires 4,00,000 and yields annual inflows of 1,20,000 for 5 years.
Assuming a discount rate of 10
• NPV(A) = 74,745

• NPV(B) = 76,152
Project B, though smaller, is more economically viable based on return per unit investment.

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3.6 Sensitivity Analysis
Viability assessment often includes stress testing under variable assumptions:

• Increase in input costs

• Decline in selling price

• Delay in cash inflows

This analysis ensures robustness against fluctuations.

4 Decision Making Support through Accountancy

4.1 Nature of Accounting Information for Decision Making
Accounting serves as the principal source of quantitative data used in organizational decision
making. It provides structured information about costs, revenues, assets, liabilities, and cash
flows. These data are essential for evaluating alternatives, forecasting outcomes, and selecting
optimal courses of action. Effective decisions rely not only on historical records but also on
predictive analysis grounded in accounting principles.

4.2 Types of Decisions Supported by Accounting Data

• Pricing Decisions: Determining the minimum price at which goods or services may be
offered without incurring a loss. Cost based pricing requires knowledge of both fixed and
variable costs.

• Make or Buy Decisions: Evaluating whether to produce a component internally or pur-

chase it externally. This involves comparison of marginal cost versus purchase price.

• Product Mix Decisions: When resources are limited, deciding the optimal combination
of products to maximize profit based on contribution margin per unit of limiting factor.

• Shutdown or Continuation Decisions: Assessing whether a segment or product line should

be discontinued by analyzing avoidable costs and foregone contribution.

• Capital Investment Decisions: Deciding among alternative long term projects using Net
Present Value (NPV), Internal Rate of Return (IRR), and Payback Period.

• Budgeting and Forecasting: Creating financial projections to allocate resources and an-
ticipate performance.

4.3 Relevant Costing and Differential Analysis

Decision relevant costs are future oriented and differ between alternatives. These include:

• Relevant Costs: Directly impacted by the decision (e.g., variable costs, opportunity costs).

• Irrelevant Costs: Sunk costs and costs that remain unchanged regardless of the decision.

• Opportunity Cost: The income foregone by choosing one alternative over another.

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4.4 Illustrative Case: Make or Buy
A company manufactures a component at 150/unit (90 variable + 60 fixed). An external supplier
offers it at 130. If fixed costs are unavoidable, the relevant comparison is 90 vs 130. Hence, in
house production is preferable, even if the supplier’s price is lower than the full cost.

4.5 Marginal Analysis in Decision Contexts

Marginal costing involves analyzing the incremental cost and benefit of an additional unit. De-
cisions regarding additional production, special orders, or temporary pricing rely on:

Contribution Margin = Selling Price − Variable Cost

• Accepting special orders if contribution margin is positive and fixed costs are unaffected.

4.6 Example: Special Order Evaluation

A unit costs 80 to produce (50 variable + 30 fixed). A customer offers to buy at 60. Since
variable cost is 50, the contribution is 10 per unit. If spare capacity exists and no extra fixed
cost is incurred, accepting the order improves total profit.

4.7 Tools for Decision Support

• Variance Analysis: Highlights deviations from standard costs, aiding corrective measures.

• Cash Flow Forecasting: Projects liquidity and assists in short term financing decisions.

• Scenario Planning: Evaluates multiple potential outcomes under different assumptions.

• Ratio Analysis: Assesses financial health to support strategic planning.

5 Expected Cost Analysis and Budgetary Control

5.1 Concept of Expected Costs
Expected costs refer to the forecasted expenditure associated with specific levels of output or
activity. They are projected using historical data, market conditions, input price trends, and
operational plans. Expected costs are fundamental in financial planning, pricing, budgeting,
and risk analysis.

5.2 Classification of Costs for Planning Purposes

• Fixed Costs: Do not vary with production volume (e.g., rent, salaries).

• Variable Costs: Change directly with output (e.g., raw materials, direct labor).

• Semi Variable Costs: Contain both fixed and variable components (e.g., electricity bills).

• Controllable vs. Uncontrollable Costs: Based on managerial influence over cost behavior.

• Standard Costs: Pre determined costs set as benchmarks for efficiency analysis.

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5.3 Budgetary Control: Definition and Objectives
Budgetary control is a systematic approach to planning and controlling income and expenditure.
A budget is a quantitative statement for a defined period, while budgetary control ensures actual
performance aligns with the plan.
Objectives:
• Planning of future operations
• Coordination across departments
• Resource optimization
• Cost control and efficiency improvement
• Performance evaluation

5.4 Types of Budgets

• Operating Budget: Covers revenues and expenses related to core activities.
• Capital Budget: Involves long term investment planning.
• Cash Budget: Projects inflows and outflows to manage liquidity.
• Flexible Budget: Adjusts for varying levels of activity.
• Master Budget: Consolidates all functional budgets into one comprehensive plan.

5.5 Budget Preparation Process

1. Establish objectives and policies
2. Forecast revenues and costs
3. Set standard costs and quantities
4. Prepare individual functional budgets (sales, production, procurement)
5. Integrate into a master budget
6. Review, approve, and implement

5.6 Illustrative Example of Budget Preparation

A company expects to produce 10,000 units.
• Variable cost per unit = 120
• Fixed overheads = 3,00,000
• Expected revenue per unit = 180
Expected Total Variable Cost = 10,000 units × 120/unit = 12,00,000
Expected Total Cost = Total Variable Cost + Fixed Overheads = 12,00,000 + 3,00,000 = 15,00,000
Expected Total Revenue = 10,000 units × 180/unit = 18,00,000
Expected Profit = Total Revenue - Total Cost = 18,00,000 - 15,00,000 = 3,00,000
This forms the foundation for the operating budget.

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5.7 Variance Analysis and Corrective Measures
Variance is the difference between actual and expected (budgeted) figures.

• Cost Variance = Standard Cost – Actual Cost

• Revenue Variance = Actual Revenue – Budgeted Revenue

Positive variance indicates efficiency or favorable conditions; negative variance signals ineffi-
ciencies or misestimates.

5.8 Example of Variance Analysis

• Budgeted Material Cost = 5,00,000

• Actual Material Cost = 5,40,000

• Material Cost Variance = (–40,000) → Unfavorable

Management must investigate price increases, wastage, or supplier inefficiency.

5.9 Zero Based Budgeting (ZBB)

In ZBB, every budget item requires justification from scratch, not just adjustments from past
figures. It enhances cost discipline and eliminates redundant expenditures.

6 Planning and Production Control

6.1 Definition and Objective
Planning and production control (PPC) refers to the coordination and regulation of manufac-
turing processes to ensure that production occurs efficiently, on time, and within budgeted cost
limits. It links strategic planning with operational execution and resource utilization.

6.2 Functions of Production Planning

• Routing: Determining the optimal sequence of operations.

• Scheduling: Fixing the timing for operations and resource deployment.

• Loading: Assigning work to machines or work centers based on capacity.

• Dispatching: Issuing orders for the start of production activities.

• Follow up: Monitoring progress and resolving bottlenecks.

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6.3 Types of Production Systems and Planning Approaches
• Job Order Production: Custom manufacturing for unique orders; requires flexible plan-
ning.

• Batch Production: Producing in defined lots; planning revolves around batch sizes.

• Mass Production: Standardized, continuous output; requires streamlined PPC for scale
efficiency.

• Process Production: Flow based systems (e.g., chemicals); emphasis on uninterrupted

operation.

6.4 Cost Accounting for Production Planning

Cost data informs decisions regarding material use, labor deployment, and overhead allocation.

• Standard Costing: Sets pre determined costs for materials, labor, and overhead.

• Variance Analysis: Compares actual vs standard costs to identify inefficiencies.

• Job Costing vs Process Costing:

– Job Costing: Used in job order systems; costs are accumulated by individual jobs.
– Process Costing: Used in continuous production; costs are averaged over units.

6.5 Production Budgeting

The production budget forecasts the quantity of goods to be produced based on sales forecasts
and desired inventory levels.

Units to Produce = Expected Sales + Desired Ending Inventory − Opening Inventory

6.6 Illustrative Example

Sales forecast = 8,000 units
Opening inventory = 1,000 units
Desired ending inventory = 1,500 units

Units to Produce = 8, 000 + 1, 500 − 1, 000 = 8, 500 units

This estimate guides procurement, labor planning, and machine scheduling.

6.7 Material Requirement Planning (MRP)

MRP calculates the materials needed for production based on the bill of materials (BOM), pro-
duction schedule, and current inventory. It ensures timely availability of inputs.

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6.8 Capacity Planning
Capacity planning ensures production resources (machinery, labor, time) are sufficient to meet
the output schedule. Types include:

• Short Term: Daily/weekly resource alignment

• Medium Term: Monthly adjustments to shifts, overtime, or outsourcing

• Long Term: Capital investment in new equipment or facilities

6.9 Efficiency and Throughput Metrics

Actual Hours Used
• Machine Utilization Rate = Available Hours × 100

• Throughput = Output per unit of time; measures production flow speed

• Downtime Tracking: Helps identify non productive periods and their causes

6.10 Inventory Linkages

Effective production control is synchronized with inventory levels:

• Overproduction increases holding costs

• Underproduction risks stock outs and lost sales

7 Quality Control and Financial Implications

7.1 Definition and Relevance
Quality control refers to the operational techniques and activities used to fulfill quality require-
ments in products or services. From an accounting perspective, it involves identifying, measur-
ing, and managing the financial impact of quality related efforts, including both preventive and
corrective costs.

7.2 Classification of Quality Costs

Quality costs are typically categorized into four components under the Cost of Quality (CoQ)
framework:

• Prevention Costs: Incurred to avoid defects before they occur. Examples: Staff training,
quality audits, equipment calibration.

• Appraisal Costs: Associated with measuring and monitoring quality. Examples: Inspec-
tion, product testing, process control.

• Internal Failure Costs: Arising from defects detected before delivery. Examples: Scrap,
rework, downtime due to quality issues.

• External Failure Costs: Costs resulting from defective goods reaching customers. Exam-
ples: Warranty claims, returns, reputation damage, legal disputes.

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7.3 Accounting Treatment of Quality Costs
• Prevention and appraisal costs are treated as period expenses and charged to the income
statement.

• Failure costs may affect cost of goods sold or be recognized as liabilities if future obliga-
tions (e.g., warranties) exist.

• Proper classification ensures accurate reflection of operational efficiency.

7.4 Illustrative Example: Cost of Quality Calculation

A firm incurs the following monthly expenses:

• Prevention Costs: 30,000

• Appraisal Costs: 20,000

• Internal Failure Costs: 50,000

• External Failure Costs: 70,000

Total Cost of Quality (CoQ) = 30,000 + 20,000 + 50,000 + 70,000 = 1,70,000

This total provides a baseline for quality cost control and improvement strategies.

7.5 Impact on Financial Performance

• High failure costs reduce profitability and may lead to cash flow issues.

• Preventive investments, although increasing short term expenses, often yield long term
savings.

• Lowering external failure costs improves customer satisfaction and reduces liabilities.

7.6 Quality Improvement and Return on Investment (ROI)

Investment in quality initiatives must be evaluated using financial tools:

(Savings from reduced defects − Investment in quality)

ROI on Quality Programs =
Investment in quality
Improved process efficiency and reduced wastage translate into higher margins.

7.7 Benchmarking and Performance Indicators

Defective Units
• Defect Rate (%) = Total Units Produced × 100
Total CoQ
• Cost of Quality as % of Sales = Total Sales × 100
Warranty Claims
• Warranty Expense Ratio = Total Sales

These ratios support ongoing monitoring and decision making.

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7.8 Integration with Budgetary Systems
Quality related expenses should be integrated into the budgeting process. Setting allowable
failure cost limits and allocating prevention budgets ensures resource prioritization.

8 Marketing and Advertisement Accounting

8.1 Definition and Purpose
Marketing and advertisement accounting involves the systematic tracking, classification, and
evaluation of expenditures related to promotional activities. These costs are incurred to enhance
visibility, attract customers, and ultimately increase revenue. Accounting treatment ensures
these expenses are allocated appropriately, their impact evaluated, and future budgets optimized.

8.2 Types of Marketing and Advertising Expenditures

• Direct Advertising Costs: Print, digital, television, radio campaigns.

• Sales Promotion Costs: Discounts, coupons, loyalty programs.

• Public Relations Expenses: Sponsorships, press releases, brand events.

• Digital Marketing Costs: Social media ads, influencer fees, pay per click campaigns.

• Market Research Costs: Surveys, focus groups, consumer analytics.

8.3 Accounting Treatment of Advertising Costs

• Revenue Expenditure: Most advertising costs are treated as revenue expenditures and
charged to the income statement in the period incurred.

• Deferred Revenue Expenditure: If the benefit of the advertisement extends beyond the
current period (e.g., launch campaigns), the cost may be amortized over multiple periods.

• Capitalization Restriction: Advertising is generally not capitalized as an asset, except in

rare cases where it meets strict criteria of future economic benefit.

8.4 Budgeting for Marketing Activities

Marketing budgets are typically set as a percentage of projected sales or based on prior perfor-
mance.

• Methods: Percentage of Sales, Objective and Task Method, Competitive Parity

• Budget allocations must balance visibility goals with cost efficiency.

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8.5 Illustrative Example: Annual Marketing Budget
Projected Annual Sales = 50,00,000
Marketing Budget @ 6Allocation:

• Digital Campaigns: 1,50,000

• Print Media: 50,000

• Events and PR: 60,000

• Research and Analytics: 40,000

This allocation becomes part of the operating budget and is tracked through cost centers.

8.6 Evaluating Effectiveness of Advertising Spend

Revenue Attributed to Ads
• Return on Advertising Spend (ROAS) = Advertising Cost

Total Marketing Cost

• Customer Acquisition Cost (CAC) = Number of New Customers
Leads Converted to Sales
• Conversion Rate = Total Leads × 100

These metrics assist in justifying marketing investments and optimizing future strategies.

8.7 Control Mechanisms

• Expense monitoring via dedicated marketing cost centers

• Periodic variance analysis between budgeted and actual spend

• Pre authorization protocols for large campaigns

8.8 Integrated Reporting

Marketing effectiveness can be linked to financial performance through integrated dashboards
combining sales, profit margins, and campaign costs. This linkage supports strategic decision
making.

9 Sales and Purchase Accounting

9.1 Fundamental Concepts
Sales and purchase accounting deals with the systematic recording, classification, and analysis
of transactions related to goods or services sold and acquired. These entries directly impact
revenue recognition, cost of goods sold, inventory valuation, and cash flow.

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9.2 Sales Accounting: Scope and Recording
Sales transactions are recorded when ownership is transferred and revenue is earned. Sales can
be:

• Cash Sales: Immediate payment received; enhances liquidity.

• Credit Sales: Payment deferred; creates accounts receivable.

Sales Entry (on credit):

Accounts Receivable Dr.

To Sales Cr.

Upon Payment:

Cash/Bank Dr.
To Accounts Receivable Cr.

Key Sales Documents:

• Invoice

• Delivery Challan

• Sales Return Note

9.3 Purchase Accounting: Scope and Recording

Purchases are recorded when goods or services are received, and liability arises. Purchases may
also be:

• Cash Purchases: Paid immediately.

• Credit Purchases: Payment delayed; creates accounts payable.

Purchase Entry (on credit):

Purchases/Inventory Dr.
To Accounts Payable Cr.

Upon Payment:

Accounts Payable Dr.

To Cash/Bank Cr.

Key Purchase Documents:

• Purchase Order

• Goods Received Note (GRN)

• Purchase Invoice

• Debit Note (for returns)

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9.4 Purchase Returns and Sales Returns
Returns are separately tracked to adjust the gross amount of sales or purchases.
Sales Return Entry:
Sales Returns Dr.
To Accounts Receivable Cr.
Purchase Return Entry:
Accounts Payable Dr.
To Purchase Returns/Inventory Cr.

9.5 Discounts and Allowances

• Trade Discounts: Deducted before recording; not entered in books.
• Cash Discounts: Recorded as income or expense based on payment terms.
Example: Sales with Cash Discount
Invoice value: 10,000 with 2
Cash/Bank Dr. 9,800
Discount Allowed Dr. 200
To Accounts Receivable Cr. 10,000

9.6 Inventory Linkage

Every purchase and sale transaction affects inventory:
• Inventory decreases with each sale
• Inventory increases with each purchase
These are tracked through:
• Perpetual System: Real time inventory updates
• Periodic System: Updates at defined intervals

9.7 Impact on Financial Statements

• Sales are reported in the income statement under revenue.
• Purchases and Cost of Goods Sold are recorded as expenses.
• Accounts Receivable and Accounts Payable appear in the balance sheet.

10 Inventory Control and Valuation

10.1 Concept and Importance
Inventory control refers to the systematic management of raw materials, work in progress, and
finished goods to ensure optimal stock levels. It aims to prevent overstocking, stockouts, and
obsolescence. Inventory valuation determines the monetary worth of goods held, directly influ-
encing cost of goods sold (COGS) and reported profit.

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10.2 Classification of Inventory
• Raw Materials: Inputs used in production

• Work in Progress (WIP): Partially completed goods

• Finished Goods: Ready for sale

• Maintenance, Repair, and Operating Supplies (MRO): Indirect materials

10.3 Inventory Control Techniques

• Economic Order Quantity (EOQ): Determines the optimal order quantity to minimize
total inventory cost. r
2𝐷𝑆
𝐸𝑂𝑄 =
𝐻
Where: 𝐷 = Annual demand, 𝑆 = Ordering cost per order, 𝐻 = Holding cost per unit

• ABC Analysis: Classifies inventory by value:

– A: High value, low quantity

– B: Moderate value
– C: Low value, high quantity

• Just in Time (JIT): Minimizes inventory by ordering exactly when needed

• Reorder Level System: Orders are placed when inventory falls to a predefined level

10.4 Inventory Valuation Methods

• First In, First Out (FIFO):

– Oldest inventory is used/sold first

– In rising price scenarios, results in lower COGS and higher profits

• Last In, First Out (LIFO):

– Latest inventory is used/sold first

– In inflationary periods, leads to higher COGS and lower profits
– Not permitted under some accounting standards (e.g., IFRS)

• Weighted Average Cost (WAC):

– Average cost of all items calculated for valuation

Total Cost of Goods Available for Sale
WAC =
Total Units Available for Sale
• Specific Identification:

– Individual items tracked for cost; used for unique or high value items

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10.5 Illustrative Example
Opening Inventory: 100 units @ 10 = 1,000
Purchase: 200 units @ 12 = 2,400
COGS for sale of 150 units:

• FIFO: (100 × 10) + (50 × 12) = 1,000 + 600 = 1,600

• LIFO: (150 × 12) = 1,800

• WAC: Total cost = 3,400; Total units = 300

WAC per unit = 11.33; COGS = 150 × 11.33 ≈ 1,700

10.6 Inventory Records and Systems

• Perpetual Inventory System:

– Real time updates through each transaction

– Requires continuous stock verification

• Periodic Inventory System:

– Inventory assessed at set intervals

COGS = Opening Inventory + Purchases − Closing Inventory

• Storekeeping Documents:

– Bin Cards
– Material Requisition Slips
– Stock Registers

10.7 Financial Statement Impact

• Inventory is a current asset on the balance sheet

• Valuation method affects:

– COGS (income statement)

– Gross Profit and Net Income

11 Preparation of Financial Reports

11.1 Objective and Scope
Financial reporting involves the structured presentation of financial data to communicate an en-
tity’s economic performance and position to internal and external stakeholders. The primary re-
ports include the income statement, balance sheet, cash flow statement, and statement of changes
in equity. These reports are prepared in compliance with applicable accounting standards and
legal frameworks.

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11.2 Key Financial Statements
• Income Statement (Profit or Loss Account): Reports revenues, expenses, and resulting
profit or loss over a specific period. Structure:

– Revenue - Cost of Goods Sold = Gross Profit

– Gross Profit - Operating Expenses = Operating Profit
– Operating Profit +/- Non Operating Items - Taxes = Net Profit

• Balance Sheet: Shows assets, liabilities, and equity at a specific date. Ensures the ac-
counting equation is balanced:

Assets = Liabilities + Equity

• Cash Flow Statement: Tracks cash inflows and outflows categorized into:

– Operating Activities
– Investing Activities
– Financing Activities

Provides insight into liquidity and cash management.

• Statement of Changes in Equity: Reconciles opening and closing balances of equity com-
ponents. Reflects retained earnings, share capital, reserves, and dividends.

11.3 Steps in Financial Report Preparation

1. Record Transactions: Use journals and ledgers to chronologically capture all financial
activity.

2. Adjust Entries: Include accruals, deferrals, depreciation, and provisions.

3. Prepare Trial Balance: Ensure total debits equal total credits.

4. Draft Financial Statements: Compile structured financial reports using adjusted balances.

5. Review and Finalize: Verify accuracy, perform reconciliations, and ensure compliance.

11.4 Illustrative Example: Income Statement Format

Particulars Amount ()
Revenue 8,00,000
Less: COGS 5,00,000
Gross Profit 3,00,000
Operating Expenses 1,20,000
Operating Profit 1,80,000
Interest and Taxes 30,000
Net Profit 1,50,000

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11.5 Qualitative Characteristics of Reports
• Relevance: Includes information that influences decisions

• Reliability: Free from material error and bias

• Comparability: Across periods and with other entities

• Understandability: Clear and logically structured

11.6 Regulatory Compliance and Standards

• Financial reports must conform to national standards (e.g., Indian Accounting Standards
Ind AS)

• Companies Act and Income Tax Act dictate reporting formats and disclosure requirements

• Audited reports ensure accuracy and enhance credibility

11.7 Internal vs External Reporting

• Internal Reports: Used for management control, often detailed and frequent (e.g., monthly
MIS)

• External Reports: Annual or quarterly disclosures for shareholders, lenders, regulators

12 Accounts and Stores Studies

12.1 Overview and Integration
Accounts and stores studies focus on the systematic coordination between accounting records
and physical inventory controls. This integration ensures accurate valuation, timely replenish-
ment, and secure management of materials and financial resources. It bridges the operational
and financial domains of enterprise functioning.

12.2 Accounting Perspective

The accounting system records all financial transactions related to procurement, usage, and
disposal of inventory. Key objectives include:

• Verification of purchase costs

• Tracking of material consumption

• Allocation of direct and indirect costs

• Preparation of audit trails and reconciliation reports

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12.3 Stores Management Functions
• Receipt of Materials: Supported by documents such as Goods Received Notes (GRN).
Inspected and recorded in the stores ledger.

• Storage and Classification: Organized by SKU (Stock Keeping Unit), material code, or
usage type. Requires secured and labeled storage areas.

• Issue of Materials: Materials Requisition Note (MRN) or Bill of Materials (BOM) used
for authorization. Entries posted in both bin cards and accounting ledgers.

• Return and Disposal: Surplus or rejected items returned to stores. Obsolete inventory
written off through approval based procedures.

12.4 Stores Documentation and Records

• Bin Cards: Physical stock tracking at item level

• Stores Ledger: Value based tracking maintained by accounts department

• Stock Register: Consolidated record of all receipts and issues

• Material Requisition Slips: Internal authorization for material withdrawal

• Inspection and Rejection Reports: Quality control feedback

12.5 Reconciliation Between Accounts and Stores

Regular reconciliation is essential to ensure consistency between physical stock and financial
books. Common causes of discrepancies include:

• Recording delays

• Unauthorized issues

• Data entry errors

• Loss, theft, or damage

12.6 Stock Verification

• Periodic Stock Taking: Scheduled physical verification

• Perpetual Inventory System: Continuous monitoring

• Surprise Checks: Random audits to prevent fraud

12.7 Valuation and Consumption Accounting

Materials issued to production are recorded as expenses and affect cost of goods sold.

• Pricing methods used: FIFO, LIFO, Weighted Average

• Closing stock valuation affects the balance sheet and income statement

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12.8 Example of Store Ledger Entry

Date Receipts (Qty @ Rate) Issues (Qty) Balance (Qty @ Rate)

01 Apr 100 @ 10 – 100 @ 10
05 Apr – 40 60 @ 10
10 Apr 50 @ 12 – 60 @ 10, 50 @ 12

12.9 Internal Controls in Stores and Accounting

• Segregation of duties: Receiving, issuing, and recording by different personnel

• Pre numbered forms for requisitions and receipts

• Regular audit trails and managerial approvals for adjustments

13 Industrial Relations and Wage Accounting

13.1 Conceptual Overview
Industrial relations concern the structured interaction between employers, employees, and their
representative bodies. These relations affect labor policies, wage negotiations, grievance re-
dressal mechanisms, and the overall working environment. Wage accounting, in this context,
provides the financial framework for administering compensation and statutory benefits.

13.2 Structure of Wages and Related Payments

Wage components include:

• Basic Pay: The fixed remuneration linked to grade, rank, or skill.

• Allowances: Dearness Allowance (DA), House Rent Allowance (HRA), travel or shift
based payments.

• Incentives and Bonuses: Performance based earnings in addition to fixed salary.

• Overtime Pay: Compensation for hours worked beyond the standard schedule.

• Statutory Contributions: Employer and employee shares towards Provident Fund (PF),
Employee State Insurance (ESI), and Gratuity.

13.3 Payroll Accounting Procedure

Gross Wage Calculation:

Gross Wage = Basic Pay + Allowances + Incentives + Overtime

Deductions:

• Statutory (PF, ESI, Professional Tax)

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 • Voluntary (loan repayments, advance settlements)
Net Pay:
Net Pay = Gross Wage − Total Deductions
Employer Liability Recognition:
Employer contributions to PF, ESI, and gratuity are recorded as separate expenses and liabilities.

13.4 Illustrative Journal Entries

For wage accrual:
Wages Expense Dr.
To Wages Payable Cr.
To PF Payable (Employee Share) Cr.
To ESI Payable (Employee Share) Cr.
To Professional Tax Payable Cr.
For payment:
Wages Payable Dr.
To Cash/Bank Cr.
For statutory contributions (Employer share):
Employer PF Contribution Expense Dr.
Employer ESI Contribution Expense Dr.
To PF Payable (Employer Share) Cr.
To ESI Payable (Employer Share) Cr.

13.5 Wage Budgeting and Variance Analysis

Labor costs are forecasted department wise using standard hours and rates. Variances are ana-
lyzed monthly to assess efficiency.
• Labor Cost Variance = (Standard Cost – Actual Cost)
• Rate Variance = (Standard Rate – Actual Rate) × Actual Hours
• Efficiency Variance = (Standard Hours – Actual Hours) × Standard Rate

13.6 Incentive Schemes and Their Accounting Implications

• Piece rate Systems: Wages vary with output; treated as direct labor cost.
• Bonus and Commission: Accrued as part of wage expense.
• Profit sharing Plans: Provisioned periodically based on performance.

13.7 Statutory Compliance and Financial Reporting

• Timely remittance of PF, ESI, and TDS
• Maintenance of payroll registers, salary slips, and employment ledgers
• Compliance with labor laws (Payment of Wages Act, Minimum Wages Act)

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13.8 Cost of Industrial Disputes
• Work stoppages result in idle time, captured under indirect labor cost

• Legal settlements and back wages may require provisions

• Unrest may trigger reputational losses and affect future wage negotiations

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