Accounts Theory Question

Que 1:

A) Short Note on Target Costing

Target cost management technique is where prices of product are determined by market conditions,
taking into account several factors, such as homogeneous products, level of competition, no/low
switching costs for the end customer, etc. When these factors come into the picture, management
wants to control the costs, as they have little or no control over the selling price.

The difference between the current cost and the target cost is the “cost reduction,” which management
wants to achieve.

Advantages of Target Costing

1. It shows management’s commitment to process improvements and product innovation to gain

competitive advantages.

2. The product is created from the expectation of the customer and, hence, the cost is also based on
similar lines. Thus, the customer feels more value is delivered.

3. With the passage of time, the company’s operations improve drastically, creating economies of scale.

4. The company’s approach to designing and manufacturing products becomes market-driven.

5. New market opportunities can be converted into real savings to achieve the best value for money
rather than to simply realize the lowest cost.

B) Break Even Chart: Break-even chart shows the relationship between cost and sales and indicates
profit and loss on different quantity on the chart for analysis where the horizontal line shows the sales
quantity and the vertical line shows the total costs and total revenue and at the intersection point it is
breakeven point which indicates no profit and no loss at given quantity.

Que:2

A) Standard Costing is a technique for magerial control?

Standard costs are estimates of the actual costs in a company’s production process because actual costs
cannot be known in advance. This helps a business to plan a budget. Later, when the actual costs are
determined, the company can see if it has a favourable budget variance (meaning, actual costs did not
exceed standard costs) or unfavourable budget variance (the standard costs were exceeded)

The standard costs associated with a company’s products allow management to set benchmarks so that
the actual costs can eventually be compared. If the benchmarks are met, that’s great. If not, and there is
an unfavourable variance, then the company can try to determine efficiencies in the production process
to lower those costs in the future.

B) Critically Evaluate variance analysis for stage 0 to 3

Standard Costing and Variance Analysis, Standard Costing System (civilserviceindia.com)

Que5:

A) Explain the concept of relevant range with the help of an example?

 B) How Cost chart flows for a manufacturing Company?

C) Explain and illustrate the value chain analysis. What are key success factors…?

[TBU]

D) What is linear cost function and what type of cost behavior can it represent?

[TBU]

Que 6:all four parts:

Question 7: Skipped

Question 8:

A) Assumption of CVP analysis:

(i) Assumptions in CVP analysis

Here are some assumptions about the use of CVP analysis in business.

CVP analysis costs can be segregated into fixed and variable portions and total fixed costs remain
constant at all output levels.

In CVP, cost linearity is preserved over the relevant range, and revenues are constant per unit.

A business has a constant product mix and produces only one kind of product.

B) Methods for Segregating Semi-Variable Costs into Fixed and Variable

1. High and low points method: - This approach considers the difference in total cost between two
different volumes, and divides the incremental cost by the volume. As the words ‘high’ and ‘low’ imply,
the two levels of volume chosen are the highest and the lowest for the periods under review. The result
of this division is the estimated variable cost per unit.

Then, the average activity level is computed together with the average cost for the periods in the data
base. The fixed cost is estimated by taking the total average cost and subtracting the variable cost for
the average activity level. The variable cost is computed by multiplying the average activity level by the
variable cost per unit as determined above.

2. Scatter graph method :- Another approach to the estimation of the fixed and variable components of
a mixed cost is the scatter-graph method. With this procedure, various costs are plotted on a vertical
line, the y-axis, and measurement figures (activity levels such as direct labour hours, units of output,
percentage of capacity or direct labour cost) are plotted along a horizontal line, the x-axis.
A straight line is fitted to this scatter of points by visual approximation. The slope of the line is used to
estimate the variable costs and the intercept of the line with the vertical axis is considered as the
estimated fixed cost. The following examples illustrates the scatter-graph method.

3. Least squares regression method :- The method of least squares uses the equation for a straight line:
Y = a + bx, with a as the fixed element, and b the degree of variability. For many accounting application,
regression provides an accurate estimate of fixed and variable costs.

4. Accounting or analytical approach :- This approach to cost behaviour analysis is close scrutiny of the
chart of accounts and a classification of costs into their fixed and variable components according to their
basic characteristics determined by the accountant using good judgment, knowledge, and experience.
This approach is simple and inexpensive but in its simplicity lies its inherent weakness.

C) Cost Flows:
 Already covered in question 5.

D) Diff between financial and management accounting:

 Financial Accounting is based on set of  There is no such laws for management

accounting laws
 Prepared for external users
 Key statements are P&L, Balance sheet and
cash flows
 Used in evaluation of the company
 Prepared periodically
accounting
 Prepared for internal users
 Cost Sheet (CVP, Budget, variance analysis)
 Used for internal decision making
 No such requirement
E) Diff between Fixed Budget and Flexible Budget:
 A fixed budget is a budget that doesn't change due to any change in activity level or output
level. A flexible budget is a budget that changes as per the activity level or production of units.
The fixed budget is static and doesn't change at all.

Differences between Fixed and Flexible Budget:

 A fixed budget is a budget that doesn’t change due to any change in activity level or output
level. A flexible budget is a budget that changes as per the activity level or production of units.
 The fixed budget is static and doesn’t change at all. On the other hand, a flexible budget is
adjustable as per the necessity of the business.
 A fixed budget is always fixed. That means it is the same for any activity level. A flexible budget,
on the other hand, is semi-variable. One part of it is fixed, and another changed as per the
activity level.
 The fixed budget is very simplistic. A flexible budget is pretty complicated.
 The fixed budget takes comparatively little time to prepare. On the other hand, a flexible budget
takes a lot more time.
 A fixed budget is estimated on the past data and management’s anticipation regarding future
events. On the other hand, a flexible budget is estimated based on realistic situations.
  A fixed budget isn’t advantageous to medium and large enterprises but only suitable for micro-
organizations. A flexible budget is suitable for all kinds of organizations – from micro to large
F) Master Budget:

 A master budget is a comprehensive financial planning document that includes all of the lower-
level budgets, cash flow forecasts, budgeted financial statements, and financial plans of an
organization.
 It's usually developed by a firm's budget committee and guided by the budget director.
 A master budget usually incorporates many elements, which may include the budgets for sales,
production, administration, direct materials, labor, and overhead.
 The master budget is a comprehensive financial planning document. It usually includes all of the
lower-level budgets within the operating budget and the financial budget.
 The operating budget shows the income-generating activities of the firm, including revenues and
expenses. The result is a budgeted income statement.
 The financial budget shows the inflows and outflows of cash and other elements of the firm's
financial position. The inflows and outflows of cash come from the cash budget. As such, the
result of the financial budget is the budgeted balance sheet.

Question 9:

A) What are the financial statements? How they are used by different parties?
 Financial statements are written records that convey the business activities and the financial
performance of a company.
 Financial statements are often audited by government agencies, accountants, firms, etc. to ensure
accuracy and for tax, financing, or investing purposes.
 They include Income Statement, Balance Sheet and Cash Flow Statements
o BALANCE SHEET – reports the amount of assets, liabilities, and stockholders’ equity of an
accounting entity at a point in time.
o INCOME STATEMENT – reports the revenues less the expenses of the accounting period.
o STATEMENT OF STOCKHOLDERS’ EQUITY – reports the changes in each of the company’s
stockholders’ equity accounts, including the change in the retained earnings balance caused
by net income and dividends during the reporting period.
o STATEMENT OF CASH FLOWS – reports inflows and outflows of cash during the accounting
period in the categories of operating, investing, and financing.

 They are used by Investors, creditors to assess the profitability, solvency and financial position of the
company.

B) Is cash flow statement a substitute for income statement? Explain

 Income statement is not a substitute of income statement due to following reasons:
 o Income statement shows the profitability level whereas cash flows shows the changes in
cash position
o Income statement is prepared on accrual basis whereas cash flow statement is prepared on
cash basis
 A cash flow statement is generally divided into three main parts:

1. Operating activities analyze a company’s cash flow from net income or losses by reconciling

the net income to the actual cash the company received from or used in its operating activities.
2. Investing activities show the cash flow from all investing activities, which generally include
purchases or sales of long-term assets, such as property, plant, and equipment  (PP&E), as well
as investment securities.
3. Financing activities show the cash flow from all financing activities, such as cash raised by
selling stocks and bonds, or borrowing from banks. 

 The most common financial statement is the income statement, which shows a company's revenue
and total expenses, including noncash accounting such as depreciation, traditionally either
monthly, quarterly, or annually. An income statement is used to determine the performance of a
company, specifically how much revenue it generated, the expenses it incurred, and the resulting
profit or loss from the revenue and expenses
 The cash flow statement cannot exist without the income statement, as it begins with the net
income or loss derived from the income statement, and goes onto show how well a company
manages its cash position

C) Diff between capital expenditure and revenue capture?

Capital expenditure Revenue Expenditure

 Expenditure incurred for long term  Expenditure incurred for short-term
 Shown in the balance sheet  Shown in the income statement
 Purchase of machinery  Rent expenses

D) Increase in assets and increase in liabilities

 Increase in assets in debited and increase in liabilities is credited
 Example: Purchase of machinery on credit

E) Increase in one liability and decrease in other liability

 Increase in liability is credited
 Paid to supplier from the loan proceeds

F) Increase in assets and increase in Capital

• Increase in assets in debited and increase in capital is credited

• Example: Sale of goods for cash

G) Concept of conservatism

Conservatism Principle is a concept in accounting under GAAP that recognizes and records expenses and
liabilities- uncertain, as soon as possible but recognizes revenues and assets when they are assured of
being received. It gives clear guidance in documenting cases of uncertainty and estimates.

Suppose an asset owned by an entity like inventory was bought for $120 but can now be bought for $50.
Then the company must immediately write down

The value of the asset to $50, i.e., the lower the market cost. But if the inventory was bought for $120
and now costs the company $150, it must still be shown as $120 on the books. The gain is only recorded
when the inventory or the asset is sold.

The conservative accounting principle always says that one should always err on the most conservative
side of any financial transaction.

It is done by minimizing profits by stating uncertain losses or expenses and not mentioning unknown or
estimated gains. It always indicates that a more conservative estimate should always be followed.

Q10:

A) Discuss the flow of cost:

Already covered in question no 5

B) Direct and Indirect cost:

 Direct costs are expenses that can be connected to a specific product, while indirect costs are
expenses involved with maintaining and running a company
C) Master Budgeting:

Already covered

Que 11:

Part 2: Accounting is an art of recording, classifying and summarizing data? Explain.

Que 12:

A) Difference between accrual and cash basis

B) Assumption of CVP analysis
[Already covered]
C) Concept of fixed and variable cost with diagram