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Preference Share capital
Types Kind of Shares
1) Equity Share
2) Preference Share
a) Participating & Non Participating
b) Redeemable & Non Redeemable
c) Cumulative & Non Cumulative
d) Convertible and Non Convertible
Types of Preference Shares
1) On the basis of participating rights objectives of finance
management
a) Participating preference shares such as shareholders enjoy the
right to participate in the excess profits made by the unit over
& above fixed percentage.
b) Non Participating preference shares such share holders are
entitled to receive only the fixed % of dividend.
2) On the basis of redemption
a) Redeemable preference shares such share capital shall be
repayed back to the share holder after a specific period
mentioned in the contract
b) Irredeemable preference shares such share capital is payed
back only at the time of winding up of the company.
3) On the Basis of Accumulation
a) Cumulative preference shares such shareholders enjoy the
privilege of accumulating the dividend over the number of

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years. If during a gun year a unit does not enjoy profits, then
the dividend can be carried forward to the next year.
b) Non Cumulative preference shares Such shareholders cannot
accumulate the dividend. If the unit suffers a loss during a year
then they have to forego their dividend for that year.
4) On the basis of convertibility
a) Convertible preference shares such shares enjoy the privilege
of getting converted into equity shares after a specific period,
such an option is left to the discretion of the preference
shareholder.
b) Non convertible shares such shares cannot change their
status & they would remain as preference share capital
throughout their life.

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Reserves & Surplus

(Ploughing back of profits)

Every Company sets aside a certain sum of money as reserves & surplus out of
profits. Such an amount is called Revenue reserve which is meant for
emergency requirements.
Such reserves have a special benefits such as :a)
b)
c)
d)
e)

They are readily available with the company


They do not require any external administrative procedure
They do not involve any external financial cost for acquisition
They do not dilute the control of the company.
Such results act as a cushion to absorb all the foreseen emergencies.

The practise of using the reserves & surplus as a source of finance is


technologically referred to as ploughing back of profits.

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Borrowed Funds

A)
B)
C)
D)
E)

Debenture
Term Loans
Lease Contract
Hire Purchase
Subsidies

A) Debentures
a legal acknowledgement of debentures (borrowing) by a company to a
specific individual or an institution it contains a contract for the
repayment of the principle sum with interest at a stipulated time. It is a
part of a company borrowed funds.

Secured &
Unsecured

Bearer &
Refistered

Debentures

Reedemable
and
Irredeemable

Convertible
and Non
Convertible

Advantages :1)
2)
3)
4)

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They help the company achieve Trading the Equity.


They do not dilute the control of the company.
Enable the company to enjoy tax benefits.
Debenture holder enjoys a definite rate of return on his loan rent.

Types
A) On the Basis of registration
1) Bearer Debenture such debentures are highly negotiable & the holder
of a bearer debenture is entitled to receive the interest.
2) Registered Debentures in this case the company maintains an official
register to record the names of registered debenture holders. Such
debentures cannot be sold by mere delivery they have to follow the
registration procedure. The registered number alone can receive the
interest.
B) On the basis of redemption
1) Redeemable Debentures these are repayable after a short period
2) Irredeemable Debentures these are repaid only at the time of
winding up the company or after a long duration.
C) On the basis of security
1) Secured Debentures certain debentures are specifically issued inorder
to purchase certain properties. Such debentures are secured to the
extent of the value of that property in the event of winding up the m2o
obtained from the sale of that property would be used to repay such
debenture holders.
2) Unsecured Debentures such debenture holders only enjoy a general
claim over the properties (assets) of the company unlike the secure
debenture holders.

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D) On the basis of convertibility
1) Convertible Debentures these debenture holders are gun the option to
convert their debentures into preference shares after a specific period.
2) Non Convertible Debentures such debenture holders cannot enjoy any
ownership status in the company.

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Term Loans

These are institutional loans provided by financial institution to the corporate


units. Such loans may be borrowed on a short tem (1-3 Years), medium term
(3-5 years), long term (5 and above years). Such loans inject funds into the
capital structure & increase the sources of funds. A term loan involves a
contract between a financial institution & a company. The contract will specify
certain covenants to be observed by the borrower:-

A) Interest covenant: - this would indicate the rate of interest & the
mode of payment (half yearly , annual, etc.) During the borrowing
period.
B) Liability Covenant:- this condition would restrict the borrower from
increasing his liability through additional borrowing from other units.
If the borrower wishes to borrow from other units then he would be
required to get the permission of the original institution which
provided the term loans.

C) Asset Related Covenant this condition would require the borrower


to take the permission of the financial unit before selling any profit of
the unit.
D) Repayment Covenant a term loan may adopt either a balloon
repayment or equated monthly installement method of repayment
(EMI) In India the EMI method is normally being adopted by the
financial institutions.

E) (newly added) Management related Covenant by which a lending


institution can send its member to participate in the proceedings

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Term loans provide long term liquidity they facilitate research & innovation
activities. They support growth & diversification; they enhance the institutional
image in the market. This term loans are considered to be a valuable source of
finance

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Lease Contract

Facilities like lease contracts, hire purchase agreements, deferred credits &
subsidies support the companies to utilize their available funds in the most
profitable manner.
Lease contract would enable a company to use a property without owning the
same. Since the lease rent would be a nominal amount a company can enjoy
the benefit of the property without blocking M2o to buy it. Thus a lease
becomes a source of finance. It is also referred to as off balance sheet
finance.
A lease agreement normally involves two parties namely the
a) lessor owner of the property
b) lessee user of the property
The lessor & the lessee enter into an agreement regarding
A) Type of lease contract
B) Amount of lease contract
C) Duration of lease contract

Types (classified under 2 specific categories)


1) Operating Lease these contracts are for a short duration & they can be
cancelled by either of the 2 parties without prior notice, in such a lease
the lessor cannot recover the value of the properly through a single
lease contract.
2) Financial Lease these are long term agreements of a non cancellable
nature. These inturn may be classified under 3 types :a) Direct Lease in such a contract, the owner of the property gives a long
term lease to the lesser. Eg:- Citco land lease 99 years

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b) Sale & Lease back agreement the owner of a property may enter into a
contract with the buyer in the form of sale & lease back. Wherein the
seller will become the lessee & the buyer will become the lessor. This
enables location benefit of the unit without blocking his funds.

c) Leverage Lease a leasing company may borrow loan from a financial


institution in order to buy lease properties. The lessors banker would
act as a guarantee & provide the support to get the loan. He would also
be a party to the lease contract.
A financial lease will enable the lessor to recover the m20 invested in the
property through a single contract

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Hire Purchases

Hire purchases involves a hirer (potential buyer) & a hire(potential seller) of a


property. Such contracts will involve an initial down payment in cash once it is
payed the ownership title would be transferred in a temporary manner in
favour of the hirer. When the last instalment of the hire charges is paid, the
hirer will become the full fledged owner of such a property. In the event of
default the hiree cannot take back the property hired out without court
permission. The hire would enjoy all the ownership rights however he would
receive a tax budget only for the interested portion of the hire charges.
Lease
1) Right to use an asset
2) No down payment needed
3) Lessor gets salvage benefit
4) Financial lease involves 3
parties
5) Lease rent is tax deductible
6) Involves huge amounts

Hire Purchase
1) Right to own an asset
2) Down Payment needed
3)Hirer gets salvage benefit
4)Interest alone is tax
deductible
5)Interest alone is tax deductible
6)Small amounts

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Subsidies

a)
b)
c)
d)
e)
f)
g)

Subsidy is a welfare measure provided by the government.


Promotes export
Protects agricultural products from market fluctuations in prices
Promotes consumer welfare
Promotes educational facilities
Promotes credit
They are given for merits and non merit goods & services.

Types
1) Cash subsidies the government support the farmers by paying a cash
subsidy & thus enable them to receive a fair price for their products.
2) Intrest Subsidies these are being paid to framers & small scale units to
enable them to get institutional loans.
3) Tax Subsidies these encourage the exports to earn more foreign
exchange & enjoy the benefit of lower rate taxation
4) Regulatory Subsidies these are associated with petroleum, cement &
power supply facilities. These ensure the availability of such products &
services to the weaker sections of the society
5) Procurement Subsidies such subsidies encourage import substitution &
the subsidy will enable the manufacturer to import material equipment
or technology to support import substitution activity.
These subsidies act as an internal source of finance to the general public.

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Sources of Finance

1) Borrowed
2) Owned
a) Reserves and Surplus
b) Shared
1) Equity
2) Preference
Sources of finance refer to broad sources from where funds can be procured
by the financer manger.
1) Owned Sources
2) Borrowed Sources
Owned Sources comprise of a distinct elements
a) Share Capital
b) Reserves & surplus (ploughing back of profits)

A) Share Capital
As per companies act of 1956 a share means a share in the share capital
of a company & includes stock except where a distinction between stock
and share is expressed or implied.
- Share Capital is broadly classified into 2 categories
- Equity Share capital and Preference share capital
- Authorized, issued, subscribed, and called-up, paid-up classes of
share capital.

Classification of Share Capital

1) Authorized Share capital refers to maximum amount of share capital


which a company is legally permitted to raise from the market during its
lifetime

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2) Issued share Capital refers to value of shares issued to the public by


the company at a given point of time.
3) Subscribed Share Capital refers to the amount of share capital which
the public is willingly to take up from the company. In the case of highly
reputed promoters, an oversubscription may be experienced. New
companies promoted by unknown individuals will experience under
subscription.
4) Called-up share capital the Board of Director of a company may
require the subscribers to pay a certain sum of the share capital within
specific time. Such an amount to be paid by the shareholders is referred
to as called-up share capital.
5) Paid-up Share Capital the public would respond to the call made by the
Board & make payments towards share capital. The total amount
actually paid towards share capital is referred to as paid-up share
capital. For all practical purposes, this amount represents the actual
funds available.
If certain individuals default the payment, their shares will be forfeited &
reissued to others.

Equity Share Capital a full fledged ownership document of a company.


Rights of Equity Share holders:1) Right to vote : an equity shareholder can cast a vote in proportion to the
number of shares held by him
2) Right to receive dividend shareholder enjoys the right to receive a share
in the profits of the unit in proportion to the amount of share capital
contributed by him.
3) Right to pre-emption: when an existing company issues additional shares
to raise more share capital, the existing shareholder has the right to buy
those shares before they are offered to outsiders. Thus the existing
shareholders can previously empty such new issue before they are
offered to outsiders.

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4) Right to share assets at the time of winding up of the company, the


equity share holder has the right ti share the assets in exchange of share
capital contributed by him.

Advantages of Equity Share Capital


1) Equity share capital is a permanent source of finance for the company.
2) Dividend payment is made depending on the availability of funds for
such distribution. It is not a legal compulsion
3) Holding a large amount of equity capital promotes the credibility of the
unit in the market.
4) It facilitates the shareholders to retain control over the unit.

Disadvantages of Equity Share Capital


1)
2)
3)
4)

The source of equity share capital involves many procedures


Such an issue is a time consuming process
Often the cost of raising such capital is high
New companies may not get which contribution from the public in the
form of equity share capital.
5) Excessive issue of equity share capital will dilute control of the unit.

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Functions of Finance Manger


1) Procurement Function a finance manager procures both long and short
term finance for his unit. Such procurement comprises of both owned
and borrowed funds.
2) Investment function this requires the finance manager to take capital
budgeting decisions and portfolio management. Decisions in a judicious
manner.
3) Dividend Distribution decision the finance manager decides the
manner in which the earnings & profits of a unit is to be distributed. This
involves the determination of volume and types of reserves to be
maintained by the unit, the volumes of such reserve & the percentage of
dividend to be declared for various types of shareholders as well as the
mode of dividend distribution.
Investment Function Decisions
1) Fixed Asset Investment decisions long term assets such as land,
buildings, etc are called fixed assets. The types of such investments &
the amount to be invested in them are to be decided by the finance
manger.
2) Current Asset Investment decision short term assets like stock, cash,
etc are called current or liquid assets. Their volume & value should be
decided by the finance manger.
3) Capital Budgeting Decision a finance manager has to be exercise his
choice among alternative investment options to invest the funds of the
company. Such is called a capital budgeting.
4) Portfolio management Decision a finance manager invests the funds of
his company in various financial investment which are collectively called
as portfolio. He should exercise risk return trade off in such decision.

Dividend Distribution Decisions


1) Reserve funds decisions all units keep aside a certain portion of their
profits as a reserve to meet emergencies its volume is to be decided.

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2) Dividend % decision the percentage of dividend to be declared on


equity shares has to be decided by the finance manager in consultation
with board of directors.
3) Mode of Dividend distribution the finance manager has to decide the
form, in which the dividend should be distributed, some companies may
distribute it in the form of dividend warrants which are liquid assets
while others may issue a part of the dividend in the form of company
shares.
Non Commercial decisions
Decisions regarding CSR- globalisation have inculcated the CSR culture in the
corporate world. The finance manager decides about the specific projects to be
undertaken in this connection.

Scope of Financial management


The term scope refers to the impact & influence of financial management in
various areas of operation
1) Impact on accounting financial management provides the basic data
model to determine the various cost elements.
2) Impact on management decisions financial management is the basics
for the field of management accounting which aids management
decision making.
3) Influence investor decision potential investors read & analyse the
financial statement in order to evaluate the strength & weakness of the
unit.
4) Basis for corporate rating credit rating institutions & financial rating
institutions use financial information as a tool to determine the credit
worthiness & solvency of a unit.

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5) Basics for taxation financial data is used by the government for levying
corporate taxes.
6) Profit & wealth maximisation precedent financial management ensure
maximisation of profits in the short run & maximisation of wealth in the
long-run.

Inter relationship with other financial areas:A) Financial production management production as a field of activity
involves the purchase of raw materials. It also requires the acquisition of
equipments, recruitment of skilled workforce & the creation of adequate
infrastructure. Each one of these factors would require financial support.
Subsequently the production unit may have to dispose of the scrap
material or recycle the waste. This would again involve a financial
allocation. Activities like quality control, safety procedures, pollution
control measures & storage facilities would also require funds. Thus
every aspect of production is closely related with a financial
commitment. Besides the control of production cost can be achieved
only through efficient financial management.
B) Finance and Marketing The field of marketing covers a variety of
activities such as research, transportation, warehousing, insurance,
channel distribution, promotional activities. It includes research &
innovation, production improvement & withstanding competition. Each
one of the above activities would require a financial commitment.
Certain related activities like the appointment of agents, legal experts,
and financial consultants for global trade could also require a huge
financial commitment. Each one of the promotional techniques would
require a separate budgeting allocation. Thus sales promotion measures
may involve expenditure on gift items. Advertising would involve the
payment on creative & media charges. Direct marketing may require
extensive sales force training. Thus successful marketing would be the
outcome of sufficient funds allocated for marketing processes.
C) Finance and Advertising The term advertising is being popularly
referred to as any paid form of non personal communication & this
implies a financial commitment for promotional purposes. The two

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broad categories of advertising are above the line & below the line
they have their own explicit & implicit cause. Normally, mass
communication through mass media involves a very heavy budget in
addition to media cost. Creative expenditure should also be incurred for
advertising purposes. Off late, the field of advertising has emerrged its
scope & has included consultancy & creative services. Such consultancy
may have to be paid a highly large salary. Thus finance has a direct
impact on advertising expenditure and advertising impact.
Finance
Finance is the provision of money at the time it is needed F.W. Paish
finance function is associated with the optimal administration of cash
& credit inflows & outflows of a unit during any given period of time
Howard Upton
1) Profit Maximization this is a commercial goal achieved through the
maximisation of the revenues by increasing sales of the unit.
2) Shareholders wealth maximisation if a company earns huge profits
then its reputation in the market increases. This goodwill increases
the market value of its shares. Such an increase in the market value
maximizes the wealth of its shareholders
3) Risk return trade off every financial decision involves a certain
degree of risk as well as a return. The finance manager has to achieve
a delicate balance between risk & return. He should achieve
maximum return with minimum risk.
4) Safety & Solvency the term safety refers to the investment of
companys funds in a judicious manner. Solvency refers to the ability
of a unit to meet its financial commitments to outsiders on time.
5) Economy finance manager should manage to procure borrowed
funds at low interest. Rates & thus reduce the cost of funds. He
should also ensure optimum usage of funds & avoid wasteful
expenditure.

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6) Liquidity refers to availability of ready cash to meet day to day


expenses. The finance manager should ensure the availability of such
liquid cash.
7) Corporate Social Responsibility every year the finance manager
expected to allocate a certain sum towards the discharge of social
service activities of the unit.
8) Institutional image building the finance manager has a great role to
play in building the image of the company in the market. This enables
a unit to attract both FDI foreign direct investment & FII - foreign
institutional investments.

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Financial Decisions

1) Commercial
A) Procurement function
B) Investment
C) Dividend Distribution
2) Non Commercial
A) CSR

1) Commercial Decision
A) Procurement function decisions
1) Capitalisation decision the finance manger has to decide about
the volume of long term funds to be invested in the business.
2) Capital Gearing Decisions the ratio owned & borrowed funds
is also to be decided by the finance manager this ratio is referred
to as gearing ratio
3) Types of financial instruments decision the finance manager has
to decide about the difference types of shares & debentures to be
issued by the company & the terms & conditions of their issue.

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Ratio Analysis

Financial Statements
Every unit records the financial transaction either in a horizontal format or in a
vertical format

Horizontal Format
The horizontal format also knows as the T shaped format. It comprises of 2
statements namely:1) Trading and Profit & loss account
2) Balance sheet
The trading & profit & loss account indicates the profit or loss made by the unit
during a given year.
The balance sheet indicates the financial status of the unit during a gun year
The balance sheet comprises of liabilities & assets Liabilities = what the firm
owes to share holders & outsiders.
Assets = what the firm owns over a period of time.
The Basic accounting equation is expressed as liabilities = assets

Vertical Format
This is the most modern way of presenting financial statements, it comprises of
income statement which indicates the profit or loss made during a given year.
A position statement indicates financial status of a unit as of a gun date.
Sources = methods through which funds have been raised.
Applications = methods in which funds have been used.

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Format of balance sheet ofas on..


Liabilities Rs.
Share Capital
Reserve & Surplus
Long Term Loans
Current liabilities &
provisions
Total

Assets Rs.
Fixed Assets
Investment
(Current assets loan and
advances)
Total

Income statement of-for the year ended


Rs

Net sales
Less cost of goods sold
Less operating expenses
Add operating income +
Operating Profit
Less non operating expenses
Add non- operating income
Net profit before taxation & reserves
Less tax
Net Profit after tax before reserves
Less reserves
Net profit (net income of the year)

Position statement of as on
Rs
Sources of funds
Owned Funds
A) Share Capital
B) Reserves & surplus

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Borrowed Funds
A) Debentures
B) Term Loans
C) A B other Borrowings
Total sources of funds

---

Application of funds
1)
2)
3)
4)

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Fixed assets less depreciation


Investment
Working capital (current current liabilities)
Miscellaneous expenditure

Rs

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Financial Statement Analysis

Ratios
In Ratios involved the comparison of 2 details presented in the financial
statements in order to access various assets, liquidity etc. Such ratios maybe
prepared in pure as well as % form. Ratios are broadly classified into 3
categories:a) Balance sheet ratios
b) Profitability or income statement ratios
c) Inter statement ratios

Uses of ratio analysis

It indicates the liquidity of unit


It reveals solvency of the unit
It shows how effectively the firm is using its fixed & current assets
It indicates overall efficiency of unit
It is very useful tool for investors & lending institutions to evaluate a
unit.

Limitations of ratio analysis


Since the ratios consider 2 elements at a gun time, their accuracy is
dependent on the correctness & reliability of the data. eg:- Satyam Scam
Different companies interpret ratio formula in a different manner. Lack
of uniformity makes inter firm comparison very difficult in practise.
Ratios do not reveal intangible factors like customer satisfaction,
employee motivation, institutional goodwill which are crucial to Access
Company. Hence ratios can be used as a supplementary device to
evaluate company over a period of time.
Profitability Ratios
1) Gross Profit Ratio Gross profit/net sales

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Gross profit = net sales cost of goods sold

2) Net profit ratio = net profit after tax/net sales


Net sales = sales sales returns
3) Operating ratio = (cost of goods sold + operating expenses) / Net sales
Cost of goods sold = net sales gross profit
Operating expenses = administration + selling + financial expenses
Net sales = sales sales return

Inter Statement ratios


1) Stock to working capital ratio = closing stock/working capital
Working capital = current assets current liabilities
In case opening stock & closing stock details are given then value of
average stock should be considered to calculate the ratio.
Average stock = opening + closing stock/2

2) Debtors turn over ratio = Credit sales/ (debtors + bills receivable)


Credit sales = total sales cash sales
In case opening balances of debtors & bills receivable are also
available then to calculate the ratios average, debtors average bills
receivable should be considered.

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Debtors collection period = 365/debtors turn over

3) Creditors turn over ratio = Credit purchases / (creditors + bills


payable)
Credit purchases= total purchases cash purchases
In case opening creditors & bills payable are given then average
creditors & average bills payable should be considered.

Creditors payment period = 365/creditors turn over

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Costing

Definition
Cost refers to the amount of expenditure incurred in the production
of a product or creation of a service or completion of a contract. It
comprises of direct & indirect cost.
Incremental Cost cost centre means a location (factory), person
(mason), or equipment (computer) for which cost is ascertained.
Cost unit means the unit in which a production or service is measured
or expressed for commercial purposes. Eg- cloth in metres, paper in
ream, transport cost/ passenger
Indirect costs are the costs which cannot be identified with and
allocated to specific cost centres & hence it is apportioned to the cost
centres on a suitable basis.
Direct costs are costs which can be identified & allocated to specific
cost centres
Functions of costing / 5 As
1) Ascertain cost collect & determine the details of all expenses
relating to a particular production.
2) Analyse Costs classify the expenses under various heads such as
material, labour, etc.
3) Allocate costs: Charge the direct expenses to the production or
process or contract.
4) Apportion costs : distribute the indirect expenses to all products /
processes / contracts on a suitable basis
5) Absorb cost : The expenses of a department area absorbed by its
products

Advantages of costing
1) Costing benefits the owners/ managers through cost control

2)
3)
4)
5)

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It facilitates production mix decisions.


It is the basis of pricing decisions
It is used for the preparation of budgets.
It is used for accessing labour performance to determine bonus &
incentives
6) It helps the government in the fixation of price & taxes.
7) Costing reduces the expenditure & enables price reduction. This benefits
the consumers at large.
Cost Classification
Elements
Material Cost
Labour cost

Behaviour
Fixed Cost
Variable Cost

Overheads

Semi variable
cost

Time
Historical Cost
Pred
determined cost
Standard Cost

Genera
Marginal Cost
Replacement Cost

Budgeted Cost

Notional imputed
cost
Sunk Cost
Controllable Cost
Uncontollable
cost
Relevant Cost
Irrelevant Cost
Discretionary Cost
Diffrential Cost
Shut Down cost

Classification on the basis of elements :Elements are broadly classified under 3 categories
1) Material
2) Labour
3) Overheads ( expenses)

Oppurtunity Cost

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These 3 elements are further classified under 2 broad categories namely


direct cost & indirect cost based on their traceability into products.
Direct material cost refers to expenditure incurred on the cost of raw
material & primary packing material which facilitates production
Indirect material Cost refers to expenditure incurred on certain
facilitating items such as spare parts, lubricants etc. They also include
secondary material used for sale such as cotton waste, thermocol, etc.
Direct labour Cost is associated with the wages paid to the labourers
directly associated with manufacturing operation.
Indirect labour cost this expenditure is incurred in the form of the
wages & salaries paid to the support staff who facilitate production such
as sweepers / watchmans salary, etc.
Direct overheads also called direct expenses these comprise of
expenses such as carriage expenses on raw material custom duty/ octroi
on raw material, patent charges, design charges, royalty on production,
etc.
Indirect expenses / overheads comprises of factory expenses such as
A) Factory rent, lighting, depreciation, factory managers salary, factory
repairs, etc.
B) Office administrative overheads office rent, stationary, fees,
printing, insurance, lighting, etc.
C) Selling & administrative overheads ads, carriage outwards,
warehouse charges, packing & forwarding charges, royalty on sale,
salesmans commission, etc.

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Classification on basis of Behaviour

Cost can be classified on the basis of behaviour in 3 broad categories


1) Fixed Cost
2) Variable Cost
3) Semi- variable cost
Fixed Cost these are otherwise referred to as period costs or time costs. They
remain stable & fixed over a period of time. They do not change with change in
volume of activity. All indirect cost items are fixed cost items rent, insurance,
salary, etc.
Variable Cost refers to the expenditure incurred on certain items which
changes with the volume of activity thus any increase in production will
automatically involve an increase in direct material labour & expenses thus
variable cost are associated with the prime cost elements.
Semi variable cost certain expenses comprise of a fixed cost element as
well as a variable component eg:- electricity, phone charges, etc.
Such expenses which partially vary in amount are referred to as semi variable
cost.

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Classification on the basis of time:-

On the basis of time costs are classified under 2 broad categories mainly
historical costs & pre determine cost
Historical costs refers to expenditure incurred on the acquit ion of an asset
whose benefits are not expired in full. Eg : cost of machinery, furniture etc
which are still in use.
Pre determined cost also called future costs it is an estimation of the
expenditure to be incurred in future. Such an estimate can be classified into 2
categories:1) Standard cost refers to the ideal cost which can be incurred for
acquiring an asset procuring a service.
2) Budget Cost it refers to the cost which a unit can afford to spend in
procuring a service or purchasing an asset based on the available funds.

- General Classification
Marginal refers to expenditure incurred on the creation of an additional
(marginal) unit of production.
Opportunity Cost this refers to the cost & benefit incurred on account of
spending the m20 in the purchase of a specific asset or service by comparing
the cost & benefit of various options the management chooses a specific
investment. It is very useful in corporate decision making.
Replacement Cost refers to the expenditure incurred on replacing an asset
on a service at the prevailing market rates.
Notional/ imputed cost refers to expenses which exist merely for record
purpose. They are not recorded for the sake of tax concession & similar
benefits. Eg:- rent paid for running office from ones own house, etc.
Sunk Cost refers to expenditure incurred on an asset whose benefit has fully
expired eg:- cost of unused obsolete machinery, depreciation expenses, etc

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Controllable costs this deals with certain items of expenditure which can be
totally influenced by the decision of a single individual eg: raw material cost
decided by production manager.
Uncontrollable costs these are general expenses over which no single
individual can exercise control. Eg : office rent, telephone charges, etc.
Relevant Costs these refer to the expenses which are highly essential &
crucial for taking a specific decision eg :- cost of sugarcane in sugar
manufacturing industry.
Irrelevant Cost refers to certain expenses which are relatively insignificant for
decision making purposes. Eg: type of lighting expenses incurred for sugar
manufacturer unit.
Discretionary Cost these are expenses of a secondary significance their
mostly luxuries 7 not necessities for running a unit. Eg: interior decoration, AC
etc. for running a factory, etc.
Differential Cost this refers to any increase or decrease in overall expenditure
on account of changing volume of operation. All variable costs are differential.
Shutdown Cost the expenditure which a unit has to incur even when no
productive activity is being carried out such as rent, security, maintenance, etc.

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Classify the following transactions on the basis of traceability to product


1) Legal Expenses indirect cost
2) Overtime wages indirect cost
3) Cost of buttons & thread in garment manufacturing factory indirect
cost
4) Depreciation of office furniture indirect cost
5) Cost of speakers used in radio direct cost
6) News print cost in newspaper direct cost
7) Bottles and containers used for soft drink manufacturing direct cost
8) Freight inward charges direct cost
9) Factory supervision charges - indirect cost
10)
Import duty on raw materials direct cost
11)
Oil used for lubrication indirect cost
12)
Cost of wire for electric motors direct cost
13)
Gunny bags for filling sugar direct cost
14)
Salary paid to sweepers indirect cost

On the basis of behaviour to change in volume of activity


1)
2)
3)
4)
5)

Purchase commission at 1% per kg


Office rent
Cost of milk used in ice cream variable cost
Managers salary / directors fees fixed cost
Repairs & maintenance semi variable cost

On the basis of function


1)
2)
3)
4)

Dealers commission selling & distribution overhead


Sales stationary expenses selling & distribution overhead
Legal expenses office administration
Rent of warehouse selling & distribution

Nature of capital Budgeting

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Capital budgeting involvers long term, irreversible, investment decision


of a unit.
It involves the selection of long term investments by a unit each
investment would involve a huge outflow of cash at present & a regular
inflow of cash in future years.
Selection is done by comprising & the actual cash inflows earned out of
various investments.
A variety of investment appraisal techniques are being used for such a
selection

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True value of money

Capital budgeting decisions are normally made targeting into account the
concept of time value of m2o. In a general sense m2o experience an increment
in value when it is invested I an asset. Such an increment in value occurs on
account of the interest factor earned by the investment. This increase in value
is referred to as the compounding value of m2o. However on account of
information over a period of time. Monet suffers a decrease in purchasing
power & gets discounted In real terms. Thus the present value of money may
be much more than future value of the same amount. Since any investment is
bound to result in future cash inflows(incomes). Their present value is
calculated & the purpose of evaluating investment proposals. Such an
evaluation is done with the help of annuity factor/discount factor which is
provided corresponding to greater rate of interest.

Investment appraisal Techniques:1) Technique which recognizes pay back of capital employed :- Pay back
period method
2) Technique which considers accounting profit:- Accounting rate of return
3) Technique which recognize time value of money :- Net present value of
method, Profitability index method internal rate of return method.
Discounted pay back method

Pay back method


Initial outlay = cost of an investment an asset
Yearly cash flow = profit after taxation + depreciation
This amount can be uniform year after year or it may vary from year to
year.
Cumulative CFAT = CFAT of precious years added to current years CFAT
Pay back period number of years in which the CFAT covers the cost of
investment asset.

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