Cost and Management Accounting

UNIT – IV COST AND MANAGEMENT ACCOUNTING

Fund Flow Analysis – Cash Flow Analysis – Problems

FUND FLOW ANALYSIS

The study and control of this funds flow process is the main objective of financial
management to assess the soundness and the solvency of a firm. The traditional
statements – Balance Sheet and Profit and Loss Account of a business tell little about
its flow of funds, i.e. financing and investing activities over the related period.

Meaning and Definition of Funds Flow Statement

The statement of changes in financial position, prepared to determine only Sources
and Uses of working capital between dates of two balance sheets, is known as „Funds
Flow Statement‟. Fund Flow Statement indicates the changes in the firm‟s working
capital position. It discloses the total financial resources.

According to Anthony, “The funds flow statement describes the sources from which
additional funds were derived and the use to which these sources were put”

The fund flow statement is also termed as:

 Statement of Sources and Application of funds
 Statement of Sources and Uses of Funds
 Statement of changes in Financial Position
 Statement of Inflow and Outflow of Funds

Parties Interested in Funds Flow Statement

1) Management
2) Banks and Financial Institutions
3) Shareholders and other Investors
4) Debenture holders
5) Trade Creditors

Advantages of Funds Flow Statement

 Helps in the analysis of financial operations
 Throws light on many confusing questions of general interest
 Helps in the formation of a realistic dividend policy
 Helps in the proper allocation of resources
 Acts as a future guide

Disadvantages of Funds Flow Statement

o Fails to cover sufficient information
o Secondary nature
o Doubtful statement
o Crude device
o Fails to reveal continuous changes

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 Cost and Management Accounting

Procedure of Preparing Funds Flow Statement

 Statement of changes in Working Capital
 Statement of Sources and Application/Uses of Funds

STATEMENT OF CHANGES IN WORKING CAPITAL

The working capital does change due to various transactions. The working capital
position at the beginning of the period is changed to a different position at the end of
that period.

A specimen of statement is given below.

STATEMENT OF CHANGES IN WORKING CAPITAL

Effect on Working
Amount of Amount of
Capital
Particulars Previous year Current year
Rs. Rs. Increase Decrease
(Dr.) Rs. (Cr.) Rs.
Current Assets:
Cash in hand
Cash at bank
Bills receivable
Sundry debtors
Temporary Investments
Stocks / Inventories
Prepaid Expenses
Accrued Incomes
Total Current Assets (A)
Current Liabilities:
Bills payable
Sundry creditors
Outstanding expenses
Bank overdraft
Short-term advances
Dividends payable
Total Current Liabilities (B)

Working Capital (A – B)
Net Increase/Decrease in
Working Capital
TOTAL

The following rules may be noted:

(a) Increase in a current asset item increases working capital
(b) Decrease in a current asset item decreases working capital
(c) Increase in a current liability item decreases working capital
(d) Decrease in a current liability item increases working capital

The increase or decrease in the Working Capital should be equal to that shown in the
Statement of Sources and Applications of Funds.
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 Cost and Management Accounting

Problem:
You are given the following Balance Sheet of a Company:
31st December
2009 2010
Assets: Rs. Rs.
Cash 3000 4700
Accounts receivable 12000 11500
Land 5000 6600
Stock 8000 9000

28000 31800
Liabilities:
Account payable 7000 4500
Capital 20000 25000
Retained earnings 1000 2300
28000 31800

Prepare a statement showing the changes in working capital.

Solution:
STATEMENT OF CHANGES IN WORKING CAPITAL
31st December Changes in Working Capital
Particulars Increase Decrease
2009 2010
(Dr.) (Cr.)
Rs. Rs. Rs. Rs.
Current Assets:
Cash 3000 4700 1700 --
Accounts receivabl 12000 11500 -- 500
Stock 8000 9000 1000 --
Total (A) 23000 25200

Current Liabilities:
Accounts payable 7000 4500 2500 --
Total (B)
7000 4500
Working Capital (A – B) 16000 20700
Net Increase/Decrease in
Working Capital 4700 4700
TOTAL 20700 20700 5200 5200

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 Cost and Management Accounting

Problem:
The summarized balance sheet of Sugee Ltd. as on 31st March is given below:
Liabilities 2009 2010 Assets 2009 2010
(Rs) (Rs) (Rs) (Rs)
Share capital 2,00,000 2,50,000 Land & Building 2,00,000 1,90,000
Debentures 50,000 90,000 Machinery 1,50,000 1,74,000
Profit & Loss A/c 30,500 30,600 Inventory 1,00,000 74,000
Bank loan 70,000 -- Sundry Debtors 80,000 94,200
Creditors 1,50,000 1,35,200 Cash 500 8,600
Provision for tax 30,000 35,000

Prepare a statement showing the changes in working capital.

Solution:
STATEMENT OF CHANGES IN WORKING CAPITAL
Changes in Working
31st March
Capital
Particulars
2009 2010 Increase Decrease
(Rs) (Rs) (Dr.) (Cr.)
Current Assets:
Inventory 1,00,000 74,000 26,000
Sundry debtors 80,000 94,200 14,200
Cash 500 8,600 8,100
Total Current Assets (A) 1,80,500 1,76,800
Current Liabilities:
Creditors 1,50,000 1,35,200 14,800
Provision for tax 30,000 35,000 5,000
Total Current Liabilities (B) 1,80,000 1,70,200
Working Capital (A – B)
500 6,600 6,100
Increase in Working Capital
180,500 1,76,800 37,100 37,100

STATEMENT OF SOURCES AND APPLICATION/USES OF FUNDS

Funds flow statement is a statement which indicates various sources from which funds
(working capital) have been obtained during a certain period and the uses or
applications to which these funds have been put during that period.

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 Cost and Management Accounting

Sources of Funds Uses/Application of Funds

Funds from Operation / Operational Funds Lost in Operations / Operational

Profit Loss
Issue of Shares Redemption of Preference Share Capital

Issue of Debentures Redemption of Debentures

Raising Long-term Loans Repayment of Long-term Loans

Sale of Fixed Assets / Trade Investments Purchase of Fixed Assets

Sale of Non-current /Trade Investments Purchase of Non-current Assets

Net Decrease in Working Capital Payment of Tax and Dividends

FUNDS FROM OPERATIONS

The term „operation‟ means the day-to-day affairs of the business. It refers to those
activities which are trading. Non-trading items, such as depreciation, loss on sale of
assets, writing off of fictitious assets as goodwill, preliminary expenses, discount or
loss on issue of share and debentures are taken as non-operational.

Problem
M/s. Anand & Company reported that the current profit is Rs.70,000 after
incorporating the following particulars:
Rs. Rs.
Loss on sale of Equipment 10000 Gain from sale of non-
Premium on Redemption of current assets 40000
Debentures 1500 Excess Provision for
Discount on Issue of Debentures 2000 Taxation 22000
Dividend income on
Depreciation on Machinery and Investments 4000
Buildings 20000 Transfer to General Reserve 5000
Depletion of natural resources 10000 Preliminary Expenses 1000
Amortization of Goodwill 30000 Profit on Revaluation of
Interim Dividend 25000 Investments 2500

You are required to calculate funds from the operations.

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 Cost and Management Accounting

Solution
CALCULATION OF FUND FROM OPERATIONS
Rs. Rs.
Net Profit for the current year 70000
Add: Non-fund or Non-Operating debits:
Loss on sale of Equipment 10000
Premium on Redemption of Debentures 1500
Discount on issue of Debentures 2000
Depreciation on Machinery and Buildings 20000
Depletion of Natural Resources 10000
Amortization of Goodwill 30000
Interim Dividend 25000
Excess provision for Taxation 22000
Transfer to General Reserve 5000
Preliminary Expenses 1000 126500
196500

Less: Non-fund or Non-Operating Credits:

Gain from Sale of non-current Assets 40000
Dividend Income on Investments 4000
Profit on Revaluation 2500 46500
Net Inflow of funds from Operations 150000

Problem
Balance sheets of M/s. Ceat Company Ltd. as at 31st March 2008 and 2009 are given
below:
Liabilities 2008 2009 Assets 2008 2009
(Rs) (Rs) (Rs) (Rs)
Equity Capital 10,00,000 15,00,000 Buildings 16,50,000 26,00,000
Reserve & Surplu 8,10,000 10,15,000 Depreciation 4,00,000 7,00,000
10% Debentures 4,00,000 6,00,000 12,50,000 19,00,000
Accounts Payable 3,20,000 2,90,000 Land 9,00,000 11,00,000
Outstanding Exp 20,000 65,000 Inventory 2,10,000 2,15,000
Provision for tax 20,000 30,000 A/c Receivable 1,70,000 1,85,000
Cash in hand 25,000 90,000
Preliminary Exp 15,000 10,000
25,70,000 35,00,000 25,70,000 35,00,000
Additional Information
1) A building costing Rs.9,50,000 and Land Rs.2,00,000 was purchased for cash.
2) Equity share and debenture were issued for cash at par.
3) Dividend paid during the year were Rs.3,00,000

You are required to prepare schedule of changes in working capital, compute funds
from operation, and fund flow statement.

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 Cost and Management Accounting

Solution
Statement of Changes in Working Capital
Changes in Working
31st March
Capital
Particulars
2008 2009 Increase Decrease
(Rs) (Rs) (Dr.) (Cr.)
Current Assets:
Inventory 2,10,000 2,15,000 5,000
Accounts Receivable 1,70,000 1,85,000 15,000
Cash 25,000 90,000 65,000
Total Current Assets (A) 4,05,000 4,90,000
Current Liabilities:
Accounts Payable 3,20,000 2,90,000 30,000
Outstanding Expenses 20,000 65,000 45,000
Provision for Taxation 20,000 30,000 10,000
Total Current Liabilities (B) 3,60,000 3,85,000
Working Capital (A – B) 45,000 1,05,000
Increase in Working Capital 60,000
4,05,000 4,90,000 1,15,000 1,15,000

Calculation of Fund from Operations

Particulars Amount Rs.
Increase in Reserve and Surplus (10,15,000 – 8,10,000) 2,05,000
Dividends paid 3,00,000
Preliminary Expenses written off (15,000 – 10,000) 5,000
Depreciation charged (4,00,000 – 7,00,000) 3,00,000
Funds from Operations 8,10,000

Fund Flow Statement (or)

Statement of Sources and Uses of Funds
Sources of Funds Rs. Uses of Funds Rs.
Funds from Operations 8,10,000 Dividends paid 3,00,000
Issue of Shares 5,00,000 Purchase of land 2,00,000
Issue of Debenture 2,00,000 Purchase of buildings 9,50,000
Increase in Working Capital 60,000
Total 15,10,000 15,10,000

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 Cost and Management Accounting

CASH FLOW ANALYSIS

A statement of changes in the financial position of firm on cash basis is called a cash
flow statement. Such a statement enumerates net effects of the various business
transactions on cash and takes into account receipts and disbursements of cash. A cash
flow statement summarizes the causes of changes in cash position of a business
enterprise between dates of two balance sheets. The term cash here stands for cash and
bank balances.

Advantages of Cash Flow Statement

 Helps in Efficient Cash Management
 Helps in Internal Financial Management
 Disclose the movement of Cash
 Discloses Success or Failure of Cash Planning
 Helpful in Declaring Dividends etc.

Disadvantages of Cash Flow Statement

o Ignores Basic Principle of Accounting
o Not Suitable for Judging Profitability
o Cannot be equated with Income Statement
o May not Represent Real Liquid Position

DISTINCTION BETWEEN FUND FLOW AND CASH FLOW STATEMENT

Basis of
Funds Flow Statement Cash Flow Statement
Difference
Its object is to help in providing
Its object is to provide the
information relating to firm‟s
1) Object firm‟s ability to meet its short
ability to meet its long term
term liabilities.
liabilities.
Cash flow statement is
prepared only when schedule
Funds flow statement can be
of changes in working capital
2) Dependence prepared if cash flow statement
along with funds flow
is there.
statement is there. Thus, it is
dependent.
3) Nature of It deals with the changes in It deals with the changes in
Statement working capital. cash position only.
There is always cash opening
4) Opening balance (or) it is prepared with
There is no such balance.
Balance the opening balance of cash in
hand.
Fund flow is helpful in long Cash flow is useful in short
7) Planning
term planning. term planning.
It is prepared for shorter
8) Period It is prepared for longer period.
period.

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 Cost and Management Accounting

Cash Flow Statement as per Accounting Standard 3 (Revised)

The Institute of Chartered Accountants of India has issued in 1997 the Accounting
Standard AS-3 (revised) relating to cash flow statement which has superseded AS-3
issued earlier. As per recent proposed format issued by the SEBI it is mandatory for
each company to give a copy of its cash flow statement along with a copy of its final
accounts.
The cash flow statement can be classified into following activities:
1) Operating Activities
2) Investing Activities
3) Financing Activities

Preparation Cash Flow Statement

There are two methods of preparing cash flow statement:
1) Traditional Method: The traditional method does not have any standard format.
There is no classification of inflow and outflow under operation, investment
and finance activities, separately.
2) Preparing Under AS-3: The basic difference from traditional method is
presentation of cash flow statement. There are two methods of reporting cash
flow from operating activities: (i) Direct Method and (ii) Indirect Method

Problem (Traditional Method)

Balance Sheets of A and B are as follows:
BALANCE SHEETS
1.1.2008 31.12.2008 1.1.2008 31.12.2008
LIABILITIES ASSETS
Rs. Rs. Rs. Rs.
Creditors 40,000 44,000 Cash 10,000 7,000
Mrs. A‟s Loan 25,000 --- Debtors 30,000 50,000
Loan form Bank 40,000 50,000 Stock 35,000 25,000
Capital 1,25,000 1,53,000 Machinery 80,000 55,000
Land 40,000 50,000
Building 35,000 60,000
2,30,000 2,47,000 2,30,000 2,47,000
During the year a machine costing Rs.10,000 (accumulated depreciation Rs.3,000)
was sold for Rs.5,000. The provision for depreciation against machinery as on
1.1.2008 was Rs.25,000 and on31.12.2008 Rs.40,000. Net profit for the year 2008
amount to Rs.45,000. You are required to prepare Cash Flow Statement.

Solution
CASH FLOW STATEMENT (Traditional Method)
Rs. Rs.
Cash Balance as on 1.1.2008 10,000
Add: SOURCES
Cash from Operations 59,000
Loan from Bank 10,000
Sale of Machinery 5,000 74,000
Less: APPLICATIONS 84,000
Purchase of Land 10,000

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 Cost and Management Accounting

Purchase of Building 25,000

Mrs.A‟s Loan repaid 25,000
Drawings 17,000 77,000
Cash Balance as on 31.12.2008 7,000

Direct Method [As per AS-3 (revised)]

Under the direct method, cash receipts (inflows) from operating revenues and cash
payments (outflows) for operating expenses are calculated to arrive at cash flows from
operating activities. The difference between the cash receipts and cash payments is the
net cash flow provided by (or used in) operating activities. The listed companies
should present the cash flow statement only under the direct method as prescribed in
AS-3.

Problem (Direct Method)

The following data are provided for Z Ltd. You are required to prepare the statement
of Cash Flows using the Direct Method [AS-3 (revised)].
Income Statement Data
Particulars Rs.
Revenues 84,000
Cost of goods sold (48,000)
Depreciation expenses (4,000)
Interest expenses (6,000)
Other expenses (22,000)
Net Income 4,000

Comparative Balance Sheet Data

2008 (Rs) 2009 (Rs)
Current Assets
Cash 16,000 20,000
Debtors (net) 7,000 12,000
Stock in hand 14,000 16,000
Non-current Assets
Plant and Machinery 20,000 24,000
Less: Accumulated Depreciation (4,000) (8,000)
Total Assets 53,000 64,000
Liabilities
Creditors 14,000 12,000
Non-current notes payable 20,000 20,000
Less: Discount on notes (2,000) (1,600)
32,000 30,400
Owner’s Equity
Equity Share Capital 14,000 24,000
Retained Earnings 7,000 9,600
21,000 33,600

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 Cost and Management Accounting

Solution: Direct Method

Z Ltd.
Cash Flow Statement for the year ended 31st December 2009 [AS-3 (revised)]
Rs Rs
Cash Flows from Operating Activities
Cash receipts from customers 79,000
Cash paid to suppliers and employees (73,600)
Net Cash from Operating Activities 5,400
Cash Flows from Investing Activities
Purchase of Plant and Machinery (4,000)
Net Cash used in Investing Activities (4,000)
Cash Flows from Financing Activities
Proceeds from issue of share capital 10,000
Interest paid (6,000)
Dividends paid (1,400)
Net Cash from Financing Activities 2,600
Net Increase in Cash and Cash Equivalents 4,000
Cash and Cash Equivalents at the beginning of the period 16,000
Cash and Cash Equivalents at the end of the period
20,000

Indirect Method: [As per AS-3 (revised)]

Under the indirect method, net profit is taken as base and is adjusted instead of
individual items appearing in the profit and loss account to arrive at cash from
operations.

Problem
From the following Balance Sheets of Vivek Limited, Prepare Cash Flow Statement.
BALANCE SHEETS
LIABILITIES 2008 2009 ASSETS 2008 2009
Equity share capital 2,00,000 2,50,000 Goodwill 30,000 20,000
12% Preference Building 1,00,000 80,000
share capital 50,000 40,000 Plant 40,000 70,000
General reserve 35,000 55,000 Debtors 1,20,000 1,60,000
P&L A/c 15,000 17,000 Stock 18,000 20,000
Creditors 23,000 5,000 Cash 15,000 17,000
3,23,000 3,67,000 3,23,000 3,67,000

Depreciation charged on Plant was Rs.30,000 and on Building Rs.50,000.

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 Cost and Management Accounting

Solution:
CASH FLOW STATEMENT [As per AS-3 (Revised)]
Rs. Rs.
1. Cash Flows from Operating Activities:
Net Profit as per P&L A/c 2,000
Depreciation on Plant 30,000
Depreciation on Building 50,000
Goodwill Written off 10,000
Transfer to General Reserve 20,000
Decrease in Creditors (18,000)
Increase in Debtors (40,000)
Increase in Stock (2,000)
Net Cash Flow from Operating Activities 52,000

2. Cash Flows from Investing Activities:

Purchase of Building (30,000)
Purchase of Plant (60,000)
Net Cash Flow from Investing Activities (90,000)

3. Cash Flows from Financing Activities:

Issue of Shares (Equity) 50,000
Redemption of Preference Shares (10,000)
Net Cash Flow from Financing Activities 40,000
Net Increase cash and cash equivalent 2,000
Cash and Cash equivalent at the beginning of the
15,000
year
Cash and Cash equivalent at the end of the year 17,000

Text Books & References

1. S.P.Jain and K.L.Narang, “Cost Accounting Principles and Practice”, Sultan
Chand and Sons,New Delhi, 5th Edition, 2001.
2. Shashi K Gupta and Sharma R.K., “Cost and Management Accounting, Kalyani
Publishers, New Delhi, __ Edition, 2003
3. S.N.Maheswari, “Cost and Management Accounting”, Sultan Chand and Sons,
New Delhi, 9th Edition, 2000.

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