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Contents CHAPTER 1 ............................................................................................................................... 3 Introduction To The Concept Of Variance Analysis ............................................................. 3 Variance Analysis And Management By Exception: ............................................................. 4 CHAPTER 2 ............................................................................................................................... 8 Research Methodology: ............................................................................................................ 8 Types Of Variance In Costing .................................................................................................. 9 CHAPTER 4 .............................................................................................................................. 11 Detail Study On Certain Variances ....................................................................................... 11 In Depth Study Of The Concept Of Fixed Production Overhead Variance. ..................... 12 Practical Example Of All Fixed Manufacturing Variances: ............................................... 14 Fixed Manufacturing Overhead Volume Variance: ............................................................ 18 Illustration Of Fixed Manufacturing Overhead Variances ................................................ 19 Fixed Manufacturing Overhead Analysis For The Year 2010: .......................................... 20 CHAPTER 5 .............................................................................................................................. 21 In Depth Study Of The Concept Of Selling Price Variance And Sales Volume Variance ... 21 Numeric Explanation: ............................................................................................................. 24 CHAPTER: 6 ............................................................................................................................... 27 Importance Of All Variances In Decesion Making: ................................................................ 27 Analysis: ................................................................................................................................... 27 CHAPTER 7 .............................................................................................................................. 31 Case Analysis ............................................................................................................................... 31 Case 1: ...................................................................................................................................... 31 Effect Of Assumed Standard Levels: ................................................................................. 31 Analysis ................................................................................................................................. 32 Case 2: ...................................................................................................................................... 34 Factory Overhead Variance Analysis: ............................................................................... 34 Analysis: ............................................................................................................................... 34 CHAPTER 8 .............................................................................................................................. 36
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Variance Analysis
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CHAPTER 1
INTRODUCTION TO THE CONCEPT OF VARIANCE ANALYSIS
In budgeting (or management accounting in general), a variance is the difference between a budgeted, planned or standard amount and the actual amount incurred/sold. Variances can be computed for both costs and revenues. A variance is the difference between an actual result and an expected result. The process by which the total difference between standard and actual results is analyzed is known as variance analysis. When actual results are better than the expected results, we have a favorable variance (F). If, on the other hand, actual results are worse than expected results, we have an adverse (A).
Types:
Traditional variance analysis it works like this: compare actual amounts at the natural class account level to budget or forecast with a column that computes the dollar or percentage variance. Alight does this for all combinations of time periods month, year to date, full year, etc. Not so traditional variance analysis It should work like this, but usually doesn't: compare actual units, rates and amounts at the line item level to budget or forecast with columns that compute variances for all three data types. Alight does this. Causal analysis Where actual and plan line items include units and rate as well as dollar amount, you may compute a causal analysis variance. This variance type calculates how much of the total dollar variance is due to higher or lower units (the volume impact) or a higher or lower price/cost (the rate impact). Alight automatically computes volume and rate impacts for all revenue, expense, headcount and balance sheet line items that incorporate units and rates
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Project Work on Cost and Management Accounting 2011 Variance Analysis and Management by Exception:
Variance analysis and performance reports are important elements of management by exception. Simply put, management by exception means that the manager's attention should be directed toward those parts of the organization where plans are not working out for reason or another. Time and effort should not be wasted focusing on those parts of the organization where things are going smoothly. The budgets and standards explained in this section of the web site reflect management's plans. If all goes according to plans, there will be little difference between actual results and the results that would be expected according to the budgets and standards. If this happens, managers can concentrate on other issues. However, if actual results do not conform to the budget and to standards, the performance reporting system sends a signal to the management that an "exception" has occurred. This signal is in the form of a variance from the budget or standards. However, are all variances worth investigating? The answer is no. Differences between actual results and what was expected will almost always occur. If every variance were investigated, management would waste a great deal of time tracking down nickel-and-dime differences. Variances may occur for any of a variety of reasons - only some of which are significant and warrant management attention. For example, hotter than normal weather in the summer may result in higher than expected electrical bills for air conditioning. Or, workers may work slightly faster or slower on a particular day. Because of unpredictable random factors, one can expect that virtually every cost category will produce a variance of some kind. How should managers decide which variances are worth investigating? One clue is the size of the variance. A variance of $5 is probably not big enough to warrant attention, whereas a variance of $5000 might well be worth tracking down. Another clue is the size of the variance relative to the amount of spending involved. A variance that is only 0.1% of spending on an item is likely to be well within the bounds one would normally expect due to random factors. On the
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Fav.
Unfav.
. 1234567 8 9 10 Week 11 12 13 14 15 16 17 18 19
What value of X (standard deviation) should be chosen? The bigger the value of X, the wider the band of acceptable variances that would not be investigated. Thus the bigger the value of X, the less time will be spent tracking down variances, but the more likely it is that a real out of control situation would be overlooked. Ordinarily, if X is selected to be 1.0, roughly 30% of all variances will trigger an investigation even when there is no real problem. If X is set at 105, the
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Variance Analysis
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Variance Analysis
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CHAPTER 2
RESEARCH METHODOLOGY:
The following is a secondary research conducted in the field of Cost Accounting. This is basically a Doctrinal Research wherein the source of Data Collection is mainly Secondary Sources of data. The research mainly aims at gaining in depth knowledge on the subject matter of Standard Costing and Variance Analysis. The project work specifically focuses on three variances that are
Fixed Production overhead total Variance and all sub-variances Selling price variance Sales Volume Variance
The calculations and importance of the above mentioned variance in managerial decisions is studied in depth in the present project work.
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CHAPTER 3
TYPES OF VARIANCE IN COSTING
Material total variance: The direct material total variance is the difference between what the output actually cost and what it should have cost, in terms of material. Material price variance: This is the difference between what the actual quantity of material used did cost and what it should have cost. Material usage variance: This is the difference between how much material should have been used for the number of units actually produced and how much material was used, valued at standard cost Labour total variance: The direct labour total variance is the difference between what the output should have cost and what it did cost, in terms of labour. Labour rate variance: This is the difference between what the actual number of hours worked should have cost and what it did cost. Labour efficiency variance : The is the difference between how many hours should have been worked for the number of units actually produced and how many hours were worked, valued at the standard rate per hour. Variable overhead total variance and all sub- variances: The variable production overhead total variance is the difference between what the output should have cost and what it did cost, in terms of variable production overhead. The variable production overhead expenditure variance: This is the difference between what the variable production overhead did cost and what it should have cost
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Variance Analysis
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CHAPTER 4
DETAIL STUDY ON CERTAIN VARIANCES
This example will be used throughout this learning exercise on variance analysis:
Standard cost of Product A Materials (5kgs x $10 per kg) Labour (4hrs x $5 per hr) Variable o/hds (4 hrs x $2 per hr) Fixed o/hds (4 hrs x $6 per hr)
$ 50 20 8 24 102 Budgeted results Production: Sales: Selling price: 1,200 units 1,000 units $150 per unit
ACTUAL Results Production: Sales: Materials: Labour: Variable o/hds: Fixed o/hds: Selling price: 1,000 units 900 units 4,850 kgs, $46,075 4,200 hrs, $21,210 $9,450 $25,000 $140 per unit $ Actual production at std rate (1,000 x $24) 24,000
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$ Overhead incurred Overhead absorbed (1,000 units x $24) Overhead variance 25,000 24,000 1,000 (A)
Fixed production overhead expenditure variance This is the difference between the budgeted fixed production overhead expenditure and actual fixed production overhead expenditure $ Budgeted overhead (1,200 x $24) Actual overhead Expenditure variance 28,800 25,000 3,800 (F)
Fixed production overhead volume variance This is the difference between actual and budgeted production volume multiplied by the standard absorption rate per unit.
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Fixed production overhead volume efficiency variance This is the difference between the number of hours that actual production should have taken, and the number of hours actually worked (usually the labor efficiency variance), multiplied by the standard absorption rate per hour. Labour efficiency variance in hours Valued @ standard rate per hour Volume efficiency variance 200 hrs (A) x $6 $1,200 (A)
Fixed production overhead volume capacity variance This is the difference between budgeted hours of work and the actual hours worked, multiplied by the standard absorption rate per hour Budgeted hours (1,200 x 4) Actual hours Variance in hrs x standard rate per hour 4,800 hrs 4,200 hrs 600 hrs (A) x $6 $3,600 (A)
POINTS TO NOTE: The fixed overhead volume capacity variance is unlike the other variances in that an excess of actual hours over budgeted hours results in a favorable variance and not an adverse variance as it does when considering labor efficiency, variable overhead efficiency and fixed overhead volume
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Rent for space per month including heat/air Rent for equipment per month
$600 $100
A small amount of these fixed manufacturing costs must be allocated to each apron produced. This is known as absorption costing and it explains why some accountants say that each product must "absorb" a portion of the fixed manufacturing overhead costs. A simple way to assign or allocate the fixed costs is to base it on things such as direct labor hours, machine hours, or pounds of direct material. (Accountants realize that this is simplistic; they know that overhead costs are a result ofor are driven bymany different factors.)
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Step1. Project/estimate the fixed manufacturing overhead costs for the year 2010.
We indicated above that Denim Works' only fixed manufacturing overhead costs are rents of $700 per month (space and equipment) totaling to $8,400 for the year 2010. Step2. Project/estimate the total number of standard direct labor hours that are needed to manufacture your products during 2010.
We can do that from the information given earlier (and repeated here):
Small Apron
Total
0.3 hr. (18 0.2 hr. (12 min.) 5,000 aprons 1,500 min.) 3,000 aprons 600 2,100
Planned production for the year 2010 Total standard direct labor hours in the planned production for the year 2010
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Step 3. Compute the standard fixed manufacturing overhead rate to be used in 2010. = Expected fixed manufacturing Expected total standard direct labors hours (DLH) for 2010
overhead for 2010 = $8,400 2,100 Standard DLH = $4 per Standard Direct Labor Hour
POINTS TO NOTE: One of the reasons a company develops a predetermined annual rate is so that the rate is uniform throughout the year, even though the number of units manufactured may fluctuate month by month. For example, if the company used monthly rates, the rate would be high in the months when few units are manufactured (monthly fixed costs of $700 100 units produced = $7 per unit) and low when many units are produced (monthly fixed costs of $700 350 units = $2 per unit).
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Total
Standard hours of direct labor hours per apron 0.3 hr. manufactured Total standard hours of direct labor in the good 1,590 aprons manufactured hr.
520 hr.
2,110 hr.
Standard cost per direct labor hour for fixed $4 manufacturing overhead Standard cost of fixed manufacturing overhead in $6,360 (applied to) the good output
$4
$4
$2,080
$8,440
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budget for the volume variance labor that should year 2010 (1 - 2) be in the good output standard x the fixed
manufacturing overhead rate Actual Amount Difference Annual Budget Difference Std Hr x Std Rate 2,110 std hr x $4 $8,700 $300 Unfavorable $8,400 $40 Favorable $8,440
This analysis shows that the actual fixed manufacturing overhead costs are $8,700 and the fixed manufacturing overhead costs applied to the good output are $8,440. This unfavorable difference of $260 agrees to the sum of the two variances: Fixed manufacturing overhead volume variance Fixed manufacturing overhead budget variance Total Fixed Manufacturing Overhead Variance $ 40 Favorable $300 Unfavorable $260 Unfavorable
Actual fixed manufacturing overhead costs are debited to overhead cost accounts. The credits are made to accounts such as Accounts Payable or Cash.
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CHAPTER 5
IN DEPTH STUDY OF THE CONCEPT OF SELLING PRICE VARIANCE AND SALES VOLUME VARIANCE SALE PRICE VARIANCE:
The difference between the amount of money a business expects to sell its products or services for and the amount of money it actually sells its products or services for. Sales price variance means that a business will be more or less profitable than it anticipates over a given time period. As a result, sales price variances are said to be either "favorable" or "unfavorable." Sale price variance = (actual selling price - anticipated price) * # units sold Illustration: Let's say a clothing store has 50 shirts that it expects to sell for $20 each, which would bring in $1,000. Unfortunately, the shirts are sitting on the shelves and are not selling, so the store has to discount them to $15. It does sell all 50 shirts at the $15 price, bringing in $750. The store's sales price variance is $1,000 minus $750, or $250, and the store will earn less profit than it expected to.
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SALES MIX VARIANCE: The difference in the quantity of customer purchases of each product or service compared to the quantities that a business expected to sell. Sales mix variance compares the actual mix of sales to the budgeted mix. The metric can be used for analyzing the company's profitability since some products and services usually have higher profit margins than others. Sales mix variance is the sum of all product line calculations as follows: Sales Mix Variance = (actual sales at the expected mix - expected sales at expected mix) * expected contribution margin per unit. Or Sales Mix Variance = total units actually sold * (actual sales mix % - expected sales mix %) * expected contribution margin per unit Analyzing sales mix variance can help a company detect trends in the popularity of its different offerings and compare the results on profit. For example, If a company expected to sell 600 As and 900 Bs, its expected sales mix would be 40% A (600/1,500) and 60% B (900/1,500). If the company actually sold 1,000 units of product A and 2,000 units of product B, its actual
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We can use the expected mix on the actual sales to get comparable numbers. So A would be 3000 x 0.4 = 1200 and B would be 0.6 x 3000 = 1,800. Now we can see A was under expectations by 200 units and B exceeded by 200 units. Using the
expected contribution margin per unit - lets use $12 per unit for A and $18 for B - you find an unfavorable variance of $2,400 for A and a favorable variance of $3,600 for B, so the total sales mix variance is $1,200. Using the second equation from above: 3,000*(0.33333-.04)*$12 = -$2,400
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Measures the effect of the difference between the standard selling price per unit and the actual selling price.
Formula: [Standard selling price per unit-Actual selling price per unit] x Actual quantity of units sold
budgeted level of sales. difference between the actual and budgeted sales is multiplied by the standard contribution per unit.
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[ Budgeted Sales level-Actual Sales level]x Standard Contribution or profit per unit Illustration: Company A budgeted sales are 3,500 Product A per month at a standard price of $70 each against their unit cost of $35. At the end of the third month, the actual sales revenue was $780,000 and 12,000 Product A had been sold. Further details: Volume Unit selling price Profit per unit Budget 10,500 70 Actual 12,000 65 30 Required: Compute: (a) the sales VOLUME profit variance; (b) The sales PRICE variance. Solution: (a) The Sales VOLUME variance is: [Actual units sold-budgeted units sold]x Standard profit per unit =(12,000-10,500]x$35 35
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CHAPTER: 6
IMPORTANCE OF ALL VARIANCES IN DECESION MAKING: ANALYSIS:
1. If the variance amount is very small (insignificant relative to the company's net income), simply put the entire amount on the income statement. If the variance amount is unfavorable, increase the cost of goods soldthereby reducing net income. If the variance amount is favorable, decrease the cost of goods soldthereby increasing net income. 2. If the variance is unfavorable, significant in amount, and results from mistakes or inefficiencies, the variance amount can never be added to any inventory or asset account. These unfavorable variance amounts go directly to the income statement and reduce the company's net income. 3. If the variance is unfavorable, significant in amount, and results from standard costs not being realistic, allocate the variance to the company's inventory accounts and cost of goods sold. The allocation should follow the standard costs of the inputs from which the variances arose. 4. If the variance amount is favorable and significant in amount, allocate the variance to the company's inventories and its cost of goods sold. 5. The following table can also serve as a guide:
concerned Put
insignificant, amounts on the income statement without allocating any amount to inventories.
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direct materials than called for inefficiencies, expense the entire by the company's standards. amount. If variance results from unrealistic standards, allocate the variance to inventories and cost of goods sold.
Direct Labor Rate Company paid less than its Allocate to inventories and cost of Favorable standard cost for the direct goods sold based on where the labor it used. related standard costs are residing. (Will reduce the standard cost amount.) Direct Labor Rate - Company paid more than its Allocate to inventories and cost of Unfavorable standard cost for the direct goods sold based on where the labor it used.
Variance Analysis
direct labor than called for by inefficiencies, expense the entire the company's standards. amount. If variance results from unrealistic standards, allocate the variance to inventories and cost of goods sold.
Var.
Mfg.
Spending - Favorable manufacturing overhead costs goods sold based on where the (assume the overhead is were less than the amount related standard costs are residing. applied hours) Var. Mfg. on machine expected for the actual machine (Will reduce the standard cost hours used. amount.)
Spending - Unfavorable manufacturing overhead costs goods sold based on where the (assume the overhead is were more than the amount related standard costs are residing. applied hours) Var. Mfg. on machine expected for the actual machine (Inventory amounts are subject to hours used. lower of cost or market.)
O/H The company's actual machine Allocate to inventories and cost of were less than the goods sold based on where the
(assume the overhead is standard machine hours for the related standard costs are residing. applied hours) Var. Mfg. on machine good output. (Will reduce the standard cost amount.) O/H The company's actual machine If variance results from
Efficiency
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Fixed Mfg O/H Volume The company applied more Allocate to inventories and cost of fixed manufacturing overhead goods sold based on where the to the good output than the related standard costs are residing. budgeted amount of fixed (Will reduce the standard cost amount.)
Fixed Mfg O/H Volume The company applied less fixed Put the entire unfavorable amount manufacturing overhead to the on the income statement. good output than the budgeted amount of fixed manufacturing overhead.
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CHAPTER 7
CASE ANALYSIS
Case 1: Effect of Assumed Standard Levels:
Harden Company has experienced increased production costs. The primary area of concern identified by management is direct labor. The company is considering adopting a standard cost system to help control labor and other costs. Useful historical data are not available because detailed production records have not been maintained. To establish labor standards, Harden Company has retained an engineering consulting firm. After a complete study of the work process, the consultants recommended a labor standard of one unit of production every 30 minutes, or 16 units per day for each worker. The consultants further advised that Harden's wage rates were below the prevailing rate of $ per hour. Harden's production vice-president thought that this labor standard was too tight, and from experience with the labor force, believed that a labor standard of 40 minutes per unit or 12 units per day for each worker would be more reasonable. The president of Harden Company believed the standard should be set at a high level to motivate the workers and to provide adequate information for control and reasonable cost comparison. After much discussion, management decided to use a dual standard. The labor standard of one unit every 30 minutes, recommended by the consulting firm, would be employed in the plant as a motivation device, while a cost standard of 40 minutes per unit would be used in reporting. Management also concluded that the workers would not be informed of the cost standard used for reporting purposes. The production vice-president conducted several sessions prior to implementation in the plant, informing the workers of the new standard cost system and answering questions. The new standards were not related to incentive pay but were introduced when wages were increased to $7 per hour.
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labor standard (one U* unit each 30 minutes) Variance cost based on $2,800 (one F
$933U $1,167 U
standard
unit each 40 minutes) *U = Unfavorable; F = Favorable Materials quality, labor mix, and plant facilities and conditions have not changed to any great extent during the six month period. Required: 1. A discussion of the impact of different types of standards on motivations, and specifically the likely effect on motivation of adopting the labor standard recommended for Harden Company by the engineering firm. 2. An evaluation of Harden Company's decision to employ dual standards in its standard cost system. ANALYSIS 1. Standards are often classified into three types - theoretical (tight), normal (reasonable), or expected actual (loose). Standards which are too loose or too tight will generally have a negative impact on workers motivation. If too loose, workers will tend to set their goals at this low rate, thus reducing productivity below what is obtainable; if too tight, workers
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If executive management imposes standards, workers and plant management will tend to react negatively because they feel threatened. If workers and plant management participate in setting the standard, they can more readily identify with it and it could become one of their personal goals.
In Harden's case, it appears that the standard was imposed on the workers by management. In addition, management used an ideal standard to measure performance. Both of these actions appear to have had a negative impact on output over the first six months. 2. Harden made a poor decision to use dual standards. If the workers learn of the dual standards, the company's entire measurement system may become suspect and credibility will be lost. Company morale could suffer because the workers would not know for sure how the company evaluates their performance. as a result, disregard for the present and any future cost control system may develop.
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The 19-- budgeted sales level was the normal capacity level used in calculating the factory overhead predetermined standard cost rate per direct labor hour. At the end of 19--, Strayer Company reported production and sales of 19,200 units. Total factory overhead incurred was exactly equal to budgeted factory overhead for the year and there was under-applied total factory overhead of $2,000 at December 31. Factory overhead is applied to the work in process inventory on the basis of standard direct labor hours allowed for units produced. Although there was a favorable labor efficiency variance, there was neither a labor rate variance nor materials variances for the year. Require: An explanation of the under-applied factory overhead of $2,000, being as specific as the data permit and indicating the overhead variances affected. Strayer uses a three variance method to analyze the total factory overhead. ANALYSIS: Under-applied factory overhead will arise when actual factory overhead incurred is larger than the standard amount of factory overhead applied to work in process. The standard amount of factory overhead applied to work in process is based on actual rather than on budgeted units of output.
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CHAPTER 8
REFERENCES:
BOOKS REFERED:
Cost and Management Accounting by Ducan Willamson Ed 1996 by pretice hall Europe,hemel 7EZ,England.Re-printed in India. hempsterd,herts HP2
Costing An Introduction by Colin Drury Ed third 1993 by best-set typesetter Lyd.,Hongkong.Catalouge of British Library. Advanced cost accounting and cost systems by ravi M. Kishore Ed 2000 september by taxmann allied services pvt. Ltd. Cost Accounting by S.P.Gupta, Ajay Sharma and Satish Ahuja Ed 2006-07 published by Rahul Jain(Delhi) Logistics and Distribution Management by Alan Rushton,John Oxley and Phil Croucher Ed 2000 reprinted in 2004 by Kogan Page Ltd(UK) Managerial Accounting by Garrison Noreen Brewer Ed eleventh by TATA McGrew HILL EDTION (New Delhi) Management Accounting by M.Y.Khan and P.K.Jain Ed fifth (2010) by TATA McGrew HILL Education Pvt. Ltd. (New Delhi)
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WEBSITES REFERRED:
www.svtuition.org www.valuecreationgroup.com www.accountlearning.blogspot.com www.publishyourarticles.org www.lontra.com www.managementparadise.com www.infor.com www.knol.google.com www.sildeworld.com www.scribd.com
JOURNALS REFERRED
Emerald Ensight
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