MANAGEMENT ACCOUNTANCY
TOPIC - 1
Lecture Notes of Sri K. Ramasubramonia Pillai/SAO/MTP(R)/MS


MANAGEMENT ACCOUNTING

MANAGEMENT REPORTS AND CONTROLS

01. Concept of Management Accounting:

v The techniques termed as 'Management Accounting' first in 1950 by British Team of Accountants (Anglo American Productivity Council).

v Internal administrative aid to business management. A Management tool.

v Two Terms - (1) Management (2) Accounting.

v Management is the substitute of ‘Guess Work' or 'Hit or Miss' method. Objectives - to study the operating problems on the basis of facts and to work out the best use and application of human and material resources.

v 'Accounting' - analysing, interpreting the transactions in terms of time, quantity and money. Financial - cost - Management Accounting.

v Definition of 'Management Accounting' - "The presentation of accounting information in such a way as to assist the management in the creation of the policy and day-to-day operation of an undertaking" - by: Anglo American Productivity Council.

v Objectives:

v Devices employed to achieve the objectives.

Forward looking principle.

Target setting principle.

The principle of exception.

02. Evolution:

v I Stage - Financial recording - Double entry system of Book-Keeping.

v II Stage - Scientific cost ascertainment - Cost Accounting.

v III Stage - Integration of cost and financial Accounts.

v IV Stage - Business forecasting, Budgeting and standard costing.

v V Stage - Budgetary control - not merely knowing the cost of production
but also controlling the costs.

03. Scope of Management Accounting:

v Financial Accounting.
v Cost Accounting.
v Budgetary and forecasting.
v Cost control procedure.
v Statistical methods.
v Legal provisions.
v Organisation and Methods.

04. Functions of Management Accounting:

v Modification of data.
v Analysis and interpretation of data.
v Facilitating Management Control.
v Formulation of Business budgets.
v Use of Qualitative information.
v Satisfaction of information needs of Management.

05. Emphasis of Management Accounting:

v Emphasis on future/use of budget.

v Involve a process selecting and discrimination of data - use of 'costs' in decision making process.

v Emphasis on the behaviour of cost elements - division of costs into - fixed, semi-fixed, variable and semi-variable.

v Establishes relationship between cause and effect of any significant business activity.

06. Advantages:

v Elimination of intuitive management.
v Enables to get maximum return.
v Continuous method of comparing results with standards, etc.

07. Stages:

Re-arrangement
®
Adoption
®
Analysis
®





¯
Mental Revolution
¬
Explanation
¬
Diagnosis
¬


v
Re-arrangement
:
Classifying the financial data etc.
v
Adoption
:
Processing of financial data
v
Analysis
:
Interpreting the financial statement.
v
Diagnosis
:
The causes and the effects i.e., result of the financial statement.
v
Explanation
:
Suggestion i.e., the result of analysis and diagnosis.
v
Mental Revolution
:
The concept of human psychology regarding the introduction of Management Accounting.

08. Tools and Techniques of Management Accounting.

v Management of today is not satisfied with only post-mortem examination of accounts and records; it seeks guidance from accounts in its management functions. It is not an easy job to arrive at any concrete management decision unless it is accentuated on some aids or medias. So certain medias or tools are necessary to reach the target.

v Therefore, Management Accounting employs tools and techniques in order to discharge its duty of helping the management in planning, co-ordination control and appraisal of activities. They are as follows:

v Analysis of financial Statements.

v Ratio Analysis.

v Cash Flow & Fund Flow Analysis.

v Statistical & Graphical Techniques.

v Costing Techniques.

v Standard Costing & Variance Analysis.

v Budgetary Control.

v Total Cost & Marginal Cost Analysis, Break-even and Profit Volume Analysis.

v Inventory Management.

v Financial Planning & Control.

v Evaluation of Capital Project & Returns on Investment.

v Communication & Reporting.

The above analysis may lead to two things viz.

i) Show areas where immediate management action is necessary.

(ii) Serve as the basis for formulation of regular plans for the future.

Ratio Analysis may throw up data for action in spheres or profitability, solvency of the business etc.

Flow of funds Analysis may disclose important features on the basis of which working capital requirements, stock holding, cash requirements cash position, etc, may be modified and revised.

Marginal Cost Analysis assists in policy decisions regarding utilisation of spare capacity, sales mix, cost control etc.

Data from the above analysis are used for establishing budgets and standard cost for future periods.

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TOPIC 2


BUDGET AND BUDGETARY CONTROL

01. Budget:

v A plan of future activities normally expressed in financial terms.

v Not a mere 'forecast', a ‘prediction’ or a ‘guesstimate’ or 'estimate.

v But a well-conceived plan which shows the desired level of profitability of the company as a whole.

v "A financial and/or quantitative statement prepared and approved prior to a defined period of time of the policy to be pursued during that period for the purpose of attaining a given objective" - by Institute of Cost and Works Accountants (UK).

v Briefly - "a predetermined statement of management policy during a given period which provides a standard for comparison with the results actually achieved".

02. Budgetary Control:

Definition -
"the establishment of departmental budgets relating to the responsibilities of executives to the requirements of a policy, and the continuous comparison of actuals with budgeted results either to secure by individual action or through executive direction, the objective of that policy or to provide a basis for its revision." - by The Institute of Cost and Works Accountants (UK).

The Budgetary control system involves -

v Establishment of targets.
v Comparison of actuals with the targets and
v Acting upon results to achieve maximum profitability.

Functions

v Making budget for future activities.

v Using budget to control activities.

v Briefly - it concerns with planning, organising and controlling all the financial and operating activities of the firm in the forthcoming period.

v De Paula illustrates Budgetary Control through an analogy with the navigation of a ship across the seas.

v Log book of Navigating officer - factors that caused misadventure - report by him to captain for correct course of ship.

03. Objectives:

v To plan the allocation of business resources, so as to achieve maximum profitability.

v To communicate plans and targets to executives responsible for their execution.

v To bring about co-ordination between the activities of technique business.
v To motivate executives to achieve targets.
v To provide a yard stick for comparison with targets.
v To show managements where action is needed to remedy a situation.
v To centralise control.
v To decentralise responsibility on to each executive involved.
v To combine the ideas and aspirations of all levels of management.
v To act as a guide and director during unforeseen contingencies.

04. Advantageous:

v Instrument of planning.
v Tool of co-ordination.
v Delegation of authority and responsibility
v Checking tool.
v Control of costs.
v Accounting records
v Controlling the Income and Expenditure

05. Limitations:

v Future is uncertain.
v Inflexible nature
v A costly system.
v Not a substitute for management - only a tool.
v Lot of paper work.
v Lack of co-ordination among departments - negative effect.
v Responsibilities may overlap.
v Resistance to change.

06. Reasons for failure:

v Too much of expectation.
v Poor organisation.
v Inadequate accounting system.
v Failure to obtain co-operation.
v Failure to analyse and ascertain causes of variances.
v Failure to revise the estimates i.e., lack of flexibility.


07. Organisation for budgetary control:
v Creation of budget centres:

v With a budget centre there may be smaller areas to which costs are attributable - called 'a cost centre'.

v 'Cost Centre' - " A location, person, or items of equipment or a group of these, in or connected with an undertaking in relation to which costs may be easily and conveniently ascertained and used for purposes of cost control"

v Good accounting system.
v Better knowledge about the system.
v Organisation chart.
v Establishment of a Budget Committee.
v Preparation of Budget manual
v Budget period.
v Determination of the 'key factor' or limitation factor.
v Laying down 'level of activity'.

08. Budget procedure:
THE BUDGET PROCEDURE

ESTABLISH OBJECTIVES




BUDGET AND PLANS PREPARED BY BUDGET CENTRES




CORDINATED BY BUDGET COMMIITTEE


ACTUAL PERFORMANCE RECORDED
FINAL BUDGETS AGREED




COMPARISONS MADE




FEED BACK FOR FUTURE CONTROL
VARIANCES INVESTIGATED



REMEDIAL ACTION WHERE POSSIBLE

09. Classification of Budget:

v Fixed Budget and flexible budget.
v Fixed budget - “a budget which is designed to remain unchanged irrespective of the level of activity actually attained".
v Flexible budget - “is a budget which is designed to amend the budget figures as the level of output changes".

10. Various Railway Budgets:

v Railway Budget.
v Zero-based budgeting
v Performance budgeting.
v Earnings budget.
v Integrated budget.
v Fuel budget.
v Stores Budget
v Budget of manufacture operations.
v Works, Machinery and Rolling Stock Budget.
v Cash budget.



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TOPIC 3


RATIO ANALYSIS OR ACCOUNTING RATIOS

01. Ratio Analysis:

v A ratio is simply a quotient of two numbers.
v This is an instrument for diagnosis of the financial health of an enterprise.
v It does by evaluating important aspects of the conduct of business like liquidity, solvency, profitability, capital gearing, etc.
v It is an invaluable aid to management in the discharge of basic functions of forecasting, planning, co-ordination, communication, and control.
v The technique used by Accountants to facilitate the discussion of the questions ( a few are listed below) listed below is Ratio analysis -

-
Profitability
-
Are the profits adequate for the capital employed?
-
Solvency
-
Can the concern repay its creditors?
-
Ownership
-
What extent of the business is financed by its creditors?
-
Financial Strength
-
Has it got sufficient resources to enable it to expand?
-
Trend
-
Are the profits on a rising scale or Are they falling away?
-
Gearing
-
How certain are dividends?

02. What they are:

v Pure ratios - (e.g. = 2:1) (Current Assets: Current Liabilities).

v No. of times -(e.g. : Stock Turnover being 6 times a year)

v Percentages - (e.g.: 30% Gross profit on Sales).


03. Handling of Ratios:

v By itself may be meaningless unless it is interpreted against some standard and analysed on a comparative basis.

v Usefulness depends upon the ingenuity and experience of the analyst who employs them.

v Properly used, can assist for improving efficiency. In the wrong hands, may mislead.
04. Why Ratios?

v Absolute figures are often misleading.

v The value of absolute figures increases manifold if they are studied with ratio analysis.

v Ratios enable mass of data to be summarised and simplified for presentation to management for decision making.

v "Time series analysis" - the comparison of ratios of the same company over a period of time for evaluating the CO's financial condition and profitability.

v "Cross Sectional Analysis" an analysis of the future based on projected financial statements. It may also be in comparison with those of similar companies in the same line of business and with an industry average.

v Past ratios indicate trends in costs, sales, profit and other relevant facts. For forecasting likely events, they may be very useful.

v By accounting ratios, the plans made can be 'signposted'.

v To establish the desirable co-ordination or balance they may be used.

v Control of performances (e.g. Sales quotas) as well as control of costs may be materially assisted by the use of ratios.

v Ratios may be used as measures of efficiency for inter-firm and intra-firm comparisons.

v Ratios can play a vital role in informing what has happened.

v If properly selected, correctly calculated, and timely presented, accounting ratios often prove very handy and useful tools for helping the management to have a clear grasp of the trend of the business resulting from the policy followed so far.

05. Limitations

Ratio analysis has a number of pitfalls:

v Ratios are calculated from the data drawn from accounting records. As such, it suffers from the inherent weakness of the accounting system itself which is the source of data.

v Ratios compared from single set of figures will not have much significance. They must be compared with independent standards. But, as ratios share with other statistical concepts the fact that all the limitations of the latter in the determination of a proper standard for comparison can't be ignored

v Ratios are clues, not bases for immediate conclusions. They are only the means to reach conclusions and not conclusion in themselves. They give just a fraction of information needed for decision making.
v Conclusions from analysis of statements are not sure indicators of bad or good management. They give room to suspicion and should be carefully looked into. For example, a high inventory turnover generally considered to be indication of operating efficiency may be temporarily achieved by unwarranted price reduction or failure to maintain stock-in-hand.

v As ratios are simple to calculate and easy to understand, there is a tendency to employ them profusely. When too many ratios are calculated, they are likely to confuse instead of revealing meaningful conclusions.

v Different agencies adopt different definitions, thereby making the ratios non-comparable.

06. Classification of Ratios:

v
Structural point of view
-
Balance sheet ratios,
Profit & Loss Account ratios,
Composite Ratios.
v
Functional point of view
-
Solvency Ratios,
Profitability Ratios,
Efficiency & performance Ratios.

STRUCTURAL POINT OF VIEW

RATIO ANALYSIS
BALANCE SHEET RATIOS
PROFIT & LOSS ACCOUNT RATIOS
COMPOSITE RATIOS
Current (or 2 to 1) Ratio.
Gross Profit Ratio
Return on Proprietor's Fund.
Quick Ratio or Liquid Ratio or Acid Test Ratio.
Net Profit Ratio
Return on Proprietor's Equity.
Proprietory Ratio.
Expense Ratio
Return on Equity Share Capital
Assets Proprietorship Ratio.
Operating Ratio
Return on Capital Employed.
Debt-Equity Ratio.
Stock Turnover Ratio
Return on total Assets
Capital gearing Ratio.

Turnover of Fixed Assets.


Turnover of Total Assets.


Turnover of Working Capital.


Debtors' Turnover


Creditors' Velocity

FUNCTIONAL POINT OF VIEW
RATIO ANALYSIS
SOLVENCY
PROFITABILITY
EFFICIENCY
&
PERFORMANCE
SHORT TERM
IMME-DIATE
LONG TERM
Gross Profit Ratio
Solvency Ratio

Current
Ratio
Quick
Ratio
Proprietory
Ratio
Net Profit Ratio
Capital Gearing Ratio



Dividend Per Share
Ratio
Stock Turn Over Ratio



Return on Capital
Employed
Operating Ratio



Return on Equity
Expense Ratio



Return on total assets etc.
Turnover of Total assets etc.


07. Operating Ratio - in Management Accounting:-

v This is obtained by dividing the total of the cost of goods sold plus operating expenses by the amount of sales. Lower the ratio the better it is! The ratio is calculated as

Cost of goods Sold + Manufacturing, Administrative, Selling Expenses and financial Expenses
X
100
Net Sales

v A comparison of operating ratio would indicate whether the cost content is higher or low in the figure of sales.

v A rise in the operating ratio indicates decline in efficiency;

Net Profit Ratio + Operating Ratio = 100

v This is the most general measure of operating efficiency and is important to managements in judging its operations.

v In general, for manufacturing concerns, operating ratio is expected to touch a percentage of 75 to 85.

v The difference between the operating ratio and 100 is the ratio of operating profit to net sales. Lower the operating ratio, higher the margin of profit.

v While this ratio serves as an index of overall efficiency, its usefulness is limited by its vulnerability to changes resulting from management decisions.

08. Inventory Turnover Ratio (or Stock turnover Ratio or Inventory Ratio). (in Management Accounting).

v It shows the number of times the stock is turned over during the accounting period. It is the ratio between the average stock (i.e. Closing Stock + Opening Stock divided by 2) held and the cost of sales (Opening Stock + Purchases - Closing Stock).

v For Example, the opening stock, purchases and closing stock of a company are Rs.18, 000/-, Rs.3, 44,000/-, Rs.20, 000/- respectively. The Stock turnover ratio is worked out as
X
= 18 timesCost of Goods Sold 3, 42,000
Average Stock 19,000

v High inventory turnover indicates that more sales are being produced by a unit of investment in stocks and thus reflects an effective inventory management.

v A low turnover ratio may indicate that the concern has accumulated unsaleable goods or may be the inventories are over valued.

v It affords useful information whether capital is being locked-up in slow moving stocks or whether Gross Profit may be increased by reducing prices in order to induce a rapid rate of turnover. Therefore, an increase in the ratio may indicate expansion of the business and a decrease the opposite.

v This ratio can be improved in one of the three ways.

By keeping sales at the same level, while reducing the stock of finished goods.

By increasing sales, while keeping the stock of finished goods at the same level.

By increasing sales, while at the same time reducing the stock of finished goods.

v This ratio also shows whether the concern is indulging in overtrading or undertrading. A sharp increase in this ratio along with sharp increase in the ratio of inventory to working capital may indicate over trading, and a sharp fall in this ratio may indicate undertrading.

09. Return on Capital Employed [or on investment (ROR)]
Ratio - 1
v
Return of Capital Employed
=
Profits
X
100
Capital Employed

Ratio - 2
v Return on Capital Employed
=
Profit
X
Sales
X
100
Sales
Capital Employed

v Ratio 1 -reveals the efficiency of trading operation of the business. It is a profitability ratio.

v Ratio 2 -reveals the degree, of success in the utilization of capital used in the business. It is a capital-turnover ratio

v A business might be efficient in trading operations, showing a high profitability ratio. But this may be accompanied by excessive employment of capital in relation to the value of sales achieved by the business.

10. Common standards:

v Ratios in themselves are meaningless unless they are compared to some appropriate standard.

v What is an appropriate standard? It is very difficult to answer. It is only mental generalisation of what is adequate and normal. There are four common standards used in this connection. They are as follows:

1. Absolute Standards.
2. Historical Standards
3. Horizontal Standards.
4. Budgetted Standards.

v 1. Absolute Standards are those which become generally recognised as being desirable regardless of type of company. However, there can hardly be an independent absolute standard which is desirable in all cases.

v 2. Historical Standards (also known as Internal Standards) involve comparing a company's own past performance as a standard for the present or future. It simply shows that the current period is better or worse than the past. However, it does not provide a sound basis for judgement, as historical standard may not have represented an acceptable standard.

v 3. Horizontal Standards (also known as External Standards) compared one company with another company or companies of the same nature. We know that no two companies are similar variations in accounting methods lead to significant differences in ratios. Such industry standards are periodically published in the Reserve Bank of India Bulletin and other financial dailies.

v 4. Budgeted Standard is arrived at after preparing the budget for a period. Such standards may be set by management as goals. They can be very useful because they are evolved after taking into account the prevailing conditions and the specific company situation. In fixing the budgeted standards, the management has to pay due attention to historical as well as horizontal standards.

11. Railway Financial Ratios:

v Financial Ratios: - The financial efficiency of operating an enterprise can best be seen from the 'financial ratios' which are worked out from the Statement of Profit and Loss for the year and the Balance Sheet (of Assets and Liabilities) as at the end of the year. The glossary of terms which should be used in Railway Estimates and Financial statements is given in para 308-F.
v The important financial ratios, applicable to Indian Railways, may now be described as shown below: -

(a) Operating Rate, i.e., percentage of gross working expenses [item (xiii) of para 308-F] to gross earnings [item (vi)] of para 308-F).

(b) Return on Capital -
(i) Percentage of (revenue) surplus (item xxi of Para 308-F) to Capital-at-charge (item xxii of para 308-F).

(ii) Percentage of net receipts (item xix of para 308-F_ to Capital-at-charge.

(c) Current Assets/Liabilities -
(i) Stores in stock in terms of month's consumption.
(ii) Work-in-progress (workshops) as a percentage of the value of workshop outturn.
(iii) Stores Inventory (stores, 'purchases', 'sales', and miscellaneous advance, capital, etc.,) as percentage the total issue of stores.
(iv) Unrealised earnings at the year-end in terms of number of days, earnings.

v The above ratios, compared from year to year, provide useful information for judging the financial performance of the Railways.

v Glossary of terms used

(i) Coaching Earnings (less refunds)

(ii) Goods Earnings (less refund)

(iii) Traffic Earnings = (i) + (ii)

(iv) Sundry Other Earnings (Less refunds) = Other than Traffic Earnings.

(v) Gross Earnings = (iii) +) iv) = true or accrued earnings in an accounting period whether or not actually realised.

(vi) Suspense.

(vii) Gross Receipts = (v) + (vi) = Earnings actually realised during an accounting period.

(viii) Miscellaneous Receipts = Guarantee recoverable from State governments + Other Miscellaneous Receipts, such as Government share of surplus profits, sale of land of subsidized companies, receipts from surcharge on Passenger fares, etc.

(ix) Total Revenue receipts = (vii) + (viii)

(x) Ordinary Working Expenses = Expenses booked under final heads, excluding appropriation to Depreciation Reserve Fund, and Pension Fund. (Payments on account of accident compensation and Pensionary payments should also be excluded).
(xi) Appropriation to Depreciation Reserve Fund.

(xii) Appropriation to Pension Fund.

(xiii) Gross Working Expenses = (x) + (xi) + (xii) = True expenses in an accounting period whether or not actually disbursed.

(xiv) Suspense.

(xv) Gross Expenditure = (xiii) + (xiv) = Working, Expenses actually disbursed during an accounting period.

(xvi) Miscellaneous expenditure = surveys + Land for subsidized companies; subsidy + other Miscellaneous Railway Expenditure. Appropriations to Pension Fund relating to Railway Board and Miscellaneous establishments booked under grants 1 & 2 and Accident Compensation, Safety and Passenger Amenities fund and Open Line Works (Revenue_ expenditure, and payments to worked lines.

(xvii) Total Revenue Expenditure = (xv) + (xvi)

(xviii) Net earnings = (v) - (xiii)

(xix) Net Receipts = (ix) - (xvii)

(xx) Payments to General Revenues.

(xxi) Surplus/Shortfall = (xix) - (xx).

Note: The "Surplus or Shortfall" shown in item (xxi) differs from the "gain or loss" given in Account No.110 of the Finance and Revenue Accounts of the Government of India, as besides dividend, the former takes into account all the Miscellaneous Receipts (viii) and Expenditure (xvi) attributable to a Railway, whereas the latter does not.

(xxii) Capital-at-charge represents the Central Government's investment in the Railways by way of Loan Capital and value of the assets created therefrom.

12. Railway Operating Ratio: (Time series analysis)
Year @
Indian Railways
Southern Railway
1991-92
89.5%
117.81 %
1992-93
87.4%
118.51 %
1993-94
82.9%
110.60 %
1994-95
82.6%
109.47 %
1995-96
82.5%
105.62%
1996-97
86.2%
106.98 %
1997-98
90.9%
111.81 %
1998-99
93.3%
114.29 %
1999-2000
93.3%
114.29%
2000-01(RE)
98.5%
-
2001-02 (BE)
98.8%
-

v Cross Sectional Analysis

RAILWAYS
INDIAN ZONAL RAILWAYS
1992-93
1993-94
1994-95
1995-96
1996-97
Central
76.51
74.33
77.97
80.79
84.38
Eastern
98.40
93.49
91.79
95.83
97.71
Northern
86.51
81.65
83.25
80.45
83.56
North Eastern
182.67
174.06
177.39
158.21
164.74
North East Frontier
187.88
186.70
186.51
196.01
210.74
Southern
118.51
110.60
109.47
105.62
106.98
South Central
85.76
81.98
84.03
78.98
80.96
South Eastern
69.00
65.18
62.75
63.93
68.73
Western
70.87
67.83
64.90
64.66
69.52
Total Indian Rlys.
*87.36
*82.93
*82.64
*82.45
*86.22



13. Ratio of net revenue to capital-at-charge:
(Please see annexure enclosed)


14. Railway inventory turnover ration (Excl. Fuel)

Year
Indian Railways
Southern Railway
Central Railway
1991-92
20.97 % (RE)
24.19 %
-
1992-93
21.93 % (BE)
36.53 %
-
1993-94
-
22.34 %
28.15 %
1994-95
-
16.81
22.54 %
1995-96
-
12.80 %
17.77 %
1996-97
12.00 %
9.69 %
16.00 %
1997-98
11.00 %
10.58 %
13.35 %
1998-99
-
13.12 %
-
1999-2000
11.00 %
14.33 %
-
2000-2001(RE)
14.00 %
-
-
2001-2002 (BE)
14.00 %
-
-




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TOPIC 4


B R E A K- E V E N A N A L Y S I S


1. What is?

Profit maximization the ultimate objective of all business concerns. Profit is the resultant of the interplay of costs, price and volume.

v By a study of break-even-analysis, the managements knows how much sales, both in units and in value should be effected to avoid loss at the least.

v Cost-Volume-profit analysis (known otherwise) is an attempt at systematic study of the relationship existing among these variable factors and it analysis the effect of a change or changes in these factors on profits.

v It is an integral part of profit planning.

2. Breakeven Point (BEP)

v Total costs incurred total value of sales made = No loss or profit

i.e. Sale proceeds = Total costs (Fixed & variable = BEP

If sales go up beyond BEP = Profit

If sales come down = Loss

v A sale at Break-even point is the minimum amount of sales to be effected to avoid loss.

v BEP is an extension of the principles of marginal costing

v Break-even chart is a primary form of profit graph, which is a useful device to the management to inform the effects of changes in costs, volume and revenue.


Let us now construct a break-even chart on the basis of the following information (illustrativey)

Selling price - Re.0.40 per unit
Variable cost - Re.0.20 per unit
Fixed costs - Rs.2, 000
(Maximum)

From these data we can derive the following table to construct the chart

1
Sales units

2
Fixed cost
Rs.

3
Variable cost
Re.0.20 p.u.
Rs.

4
Total Cost
Rs.

5
Sales value
Re.0.40 p.u.
Rs.

5,000

2,000

1,000

3,000

2,000

10,000

2,000

2,000

4,000

4,000

15,000

2,000

3,000

5,000

6,000

20,000

2,000

4,000

6,000

8,000

25,000

2,000

5,000

7,000

10,000

BREAK -EVEN CHART
Profit
Variable costs
MARGIN OF SAFETY

(In terms of Sales units)
BREAK-EVEN POINT
X
Fixed costs
5000 10000 15000 20000 25000
Y
10, 0000
8,000
6,000
4,000
2,000
0
Sales (Units)
3. Margin of Safety (M.S)

v The excess of actual sales over the break-even sales is the margin of safety

v Higher the margin of safety more will be the profits for the organization, because only after reaching the BEP, sales bring forth profits.

v This concept is useful in times of depression when the sales are gradually declining

v M-S = Actual sales – Break-even sales x 100
Actual sales

4. Angle of incidence (Profit angle or profit path)

v It indicates rate at which profit is earned in an organization after crossing the BEP.

v A wide angle represents a higher rate of profit earning and a narrow angle implies relatively a low rate of return.

v The consideration of the angle of incidence arises only after meeting the entire amount of fixed costs. Therefore the nature of angle depends upon the incidence of variable costs.

v A narrow angle indicates that variable costs form relatively a large part of the cost of the product and vice-versa

5. Profit-Volume-Ratio (P.V.R.)

v It indicates the relation between the sales value and its corresponding contribution.

v It explains the rate at which sales are contributing towards the recovery of fixed costs and profits.

v A high ratio means that the BEP is achieved sooner after which profit is earned at a higher rate and a low ratio implies the opposite.

v PVR = Sales – Variable costs (i.e. contribution) x 100
Sales
(Profit here means contribution)

Formulae:

v
P.V.R.
=
S-V x 100
S
Where
S = Sales Value
V = Variable cost
S-V = C (Contribution)

v

M.S.

=

P
PVR


Where P = Profit


v

Volume of Sales

=

F+P
PVR

Where
F = Fixed Costs
P= Profit


v

BEP (In value)

=

F
PVR

Where F = Fixed costs

v

BEP (In Units)

=

F
P-V

Where
F = Fixed costs
P = Price
V = Variable costs



Illustration:

The accountant of ABC Company Ltd. provides the following data for the year 1978:

Sales 15,000 units @ Rs.4 per unit = Rs.60, 000

Variable cost @ Rs.2 per unit = Rs.30, 000 (50%)

-------------
Contribution = Rs.30, 000

Less Fixed Costs = Rs.18, 000
-------------
Profit = Rs.12, 000
------------
You are required to find out the following:

a) Profit = Volume Ratio

b) Break-even Point and

c) Margin of safety


Workings:

a) Profit – Volu me Ratio = S – V x 100
S

P.V.R. = 60,000 - 30,000 x 100 = 50%
60,000

b) Break-even Point = Fixed costs
P/V Ratio

= 18,000 = 18,000 x 100 = Rs.36000
50% 50

c) Margin of Safety = Profit
P/V Ratio

Ms = 12,000 = 12000 x 100 = Rs.24000
50% 50

The results can be verified as follows:

Break-even Point Sales = Rs.36, 000

At this level the total costs are –

Fixed costs = Rs, 18,000
Variable costs = Rs.18, 000 (50% of sales)
------------
Total cost = Rs.36, 000
------------

Margin of Safety = Rs.24, 000

Sales beyond break-even point constitute the Margin:
.
. . Ms = Actual sales – BEP

= 60,000 – 36,000
= Rs.24, 000


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******TOPIC 5



M A R G I N A L C O S T I N G


1. Other names:

Direct costing, Variable costing, Differential costing, Incremental costing, Out of pocket costing

2. Marginal cost means -

v The amount by which the total cost varies as a direct result of the change in the volume of production by one unit.

v When used in the plural as ‘marginal costs’ – it means the total of all variable costs.

v Marginal Cost is the amount at any given volume of output by which aggregate costs are changed of the volume of output is increased or decreased by one unit. In practice this is measured by the total variable cost attributable to one unit.

By the Institute of Costs and Works Accountants, London


v Marginal costing is defined as “the ascertainment of marginal costs and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs”.

v Thus, all the costs attributable to a product are broadly classified into two viz. fixed costs and variable costs.

v Fixed costs are those elements of the cost of production which are not affected by variation in the volume of output – i.e. under normal conditions; fixed costs remain constant irrespective of the volume of output.

v On the other hand variable costs are those elements of cost which tend to vary directly with the volume of output. The total of all such variable elements of the cost of a product is called the marginal cost of that product.

v The difference between the selling price and the marginal cost of a product is called “contribution” which is the most significant aspect of marginal costing. All the decisions made with the help of marginal costing are based on this concept. It is also called “gross margin”. All the products are expected to “contribute” towards a fund from which the total of all fixed costs is deducted, the surplus being the profit.

v Thus, the contributions of all products (or all units of the product) represent (a) Sales less variable cost or (b) fixed costs plus profit (or fixed cost less)

v Since much emphasis is placed on this concept of contribution, we can frame an equation as follows:

Marginal Cost Equation:

Sales – Variable Costs = Fixed Costs + Profit = S-V = F+P

v The following specimen of cost statement will show the components of marginal cost and total cost (i.e. the different types of variable costs and the fixed costs)

Cost Statement Rs.

Direct Materials XXX
Direct Labour (Wages) XXX
Direct Expenses XXX
-----
Prime Cost XXX
Variable overheads XXX
Marginal cost of Production XXX
Fixed Overhead XXX


3. Special features of marginal costing method:

v Separation of fixed costs and variable costs. Marginal costs (variable) above are considered to be the cost of the product in marginal costing unlike in the orthodox system – vi. Absorption or total costs costing.

v Valuation of stock-in-trade

v Like the cost determination, calculation of the profit, also done in a special manner in marginal costing method. First the marginal cost of production will be deducted from the sales; the remaining proceeds are known as “contribution”. The Contributions of all the products are brought into a pool from which the total of fixed costs will be deducted. If there is any surplus after meeting the fixed costs, it forms the profit.

v Fixed costs are not apportioned to the individual products under marginal costing. This is the basic and salient principle of marginal costing.

v The profitability of each department or product will be determined by its contribution. From the sum total of these contributions, total fixed costs will be deducted to arrive at the profit.

v The significance of the concept of contribution is well explained in this method (marginal costing method). When fixed costs are apportioned to the cost centres individually certain products may show a loss.

4. Illustration of cost statements:

1. ABSORPTION COSTING 2. MARGINAL COSTING

Particulars
Cost per 100 units
Cost per 120 units


Particulars
Cost per 100 units
Cost per 120 units

Variable Expenses :

Direct Materials


Rs.


1,500

Rs.


1,800


Variable Expenses :

Direct Materials


Rs.


1,500

Rs.


1,800

Direct Labour

1,000

1,200


Direct Labour

1,000

1,200

Variable overheads

600

720


Variable overheads

600

720

Fixed Expenses

1,500

1,500


Marginal costs

3,100

3,720

Total Cost

4,600

5,220


Marginal cost per unit

31

31

Cost per Unit
46
4,350





5. Uses of Marginal Costing Method:


v Fixing the price of the product :

- Pricing under Trade depressions
(operate or shut down decisions)

- Pricing in a special market

- Pricing in a special job (accepting a special order)

v Effect of changing the prices on profits

With the help of marginal costing technique, the following questions can be answered:

1. What is the effect of a change in price on the present profits?

2. What should be the volume of sales in order to earn a given profit?

3. What will be the profit for a given volume of sales?

4. Which is the most profitable product?

When management plans to expand output, normally the cost per unit will be reduced, enabling a price reduction. Again to attract a wider market, the selling price may be reduced. Therefore, the management is willing to know the effect of such a price change on the profits.

v Make or Buy decision

v Product Mix or Sales Mix

v Planning the volume of production (or level of activity)

6. Advantages:

v Marginal costing method clearly explains the nature and behaviour of the various costs incurred in the production of a particular product.

v Marginal cost statements provide for the data regarding the cost-volume profit factors that are required by the management for profit – planning.

v Marginal cost statements and reports give a more clear picture regarding cost of production and they are easier for the management to understand. For example, the impact of fixed costs on the volume of profit is well depicted by summarizing the fixed costs in the profit statements.

v The concept of contribution facilitates the relative appraisal of the profitability of the various products, product mixes sales territories etc. This is feasible because under the marginal costing technique, costs are classified as variable and fixed and the incidence of fixed costs is considered separately.

v Marginal costing is contributing to cost control plans such as standard costing and flexible budgeting.

v As illustrated earlier, marginal costing method is of immense use to the management in its area of decision making as in fixing the prices, determining the sales mix, closing down a business venture, planning the level of activities buying a component from outside etc.

7. Limitations of Marginal Costing:

v It is always difficult to bifurcate all the elements of costs rigidly into fixed and variable ones. Very often, arbitrary classifications are made to segregate the fixed and variable costs.

v In the long run, all the costs are variable i.e. even the fixed costs will vary at different stages in the long term. Therefore long range pricing and other policy decisions cannot rely much on the marginal cost analysis.

v Valuation of inventories and profit estimations on marginal costing basis are objected to by Tax Authorities.

8. Areas of application in the Railways

v Make or Buy decisions - in various Railways Workshops

v Fixing the tariff - Station to Station rates

v Pricing in a special job - Deposit Works.




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MISCLASSIFICATION IN ACCOUNTS

"Accounting classification is a managerial necessity and not merely an accounting nicety"
Functions of the Accounts Department among other things include:
(Ref: Para 101A)

Keeping the accounts of the Railway in accordance with the prescribed rules.

Compile budget and monitor budgetary control procedures.

Discharging management accounting functions such as providing financial data for management reporting, assisting inventory management etc.

Seeing that there are no financial irregularities in the transactions of the Railways.

II. Purpose of detailed classification in Administrative Accounts:
(Ref: Para 216A)
A careful and well-planned analysis of all items of receipt and expenditure is a condition precedent to an effective financial control and is the primary object of any accounting classification.

Such a classification will secure the requisite degree of uniformity of accounting-

Amid the volume and variety of the financial transactions of railways,

so as to render the accounts of different railways comparable over the same time periods and

to enable preparation of budget or forecasts of receipts and payments.

III. Allocation of receipts and expenditure:
(Ref: Para 217A)
The primary responsibility for the allocation of all receipts and payments rests with the departmental officer concerned.

Each bill or voucher should show the correct allocation of the receipt/expenditure in the fullest detail.

The Accounts Department is responsible for seeing to the extent it is possible, that the allocation shown on the initial document is not prima facie incorrect.

Correct classification should be followed in recording the expenditure in Accounts.

Irrespective of whether provision in the budget has been made under correct budget head.

Changes in Accounting classification will not ordinarily be introduced during the course of the year in order to avoid under variation between the Budget and Accounts figures.

Such changes are to be made after ensuring provision in the Budget Estimate stage or at the revised estimate stage to cover the expenditure for the entire year including the write-back of the expenditure incurred from the commencement of the work to the end of the previous year.

Structure of Railway Accounts:
(Ref: Chapter II AI)
IV. Commercial and Government Accounts:
(Ref: Para 201A)
The financial transactions of a commercial concern should be recorded in such a way as to show how its capital has been utilized, how it stands in relation to its debtors and creditors, whether it is gaining or losing, what the sources of its gains or losses are and whether it is solvent or insolvent.

The main requirement of Government accounting on the other hand, is that a systematic record of all receipts and expenditure classified under certain appropriate headings, should be available

Railway Accounts should, therefore, not only secure the essential requirements of commercial accounting but also conform to the practices of Government accounting.

This objective is achieved by keeping the accounts of the railways on a commercial basis outside the regular Government account and by maintaining a link between the two to show how much is coming into Government revenues through the railways and how much is spent by the Government, whether as capital or revenue expenditure, in carrying on the activities of the railways. Link Account heads such as Demands Payable, traffic Accounts and Labour are operated in the Railway Books.

V. Capital and Revenue Accounts:
(Ref: Para 202 - 204A)
The accounts of a railway presented in such a form as to facilitate a review of the finances of the railway as a commercial undertaking are known as “Capital and Revenue Accounts”.

The Capital Revenue Accounts of a railway are compiled every year and included in the Annual Report of the Railway. The various processes of accounting followed in Railway Accounts Offices lead-up to these accounts.

The financial results of the working of a railway cannot be adequately gauged unless separate accounts are maintained of its Capital transactions as distinguished from its revenue transactions.



Capital transactions may be broadly described as those which pertain to the acquisition of concrete assets while Revenue transactions are those which relate to the working of the Railways, comprising both earnings and working expenses.

The expenditure incurred on acquiring concrete assets in connection with Unremunerative projects, Amenities to passengers and other railway users Amenities to staff, and Safety works, financed from the Development Fund, the Accident Compensation, Safety and Passenger Amenities Fund and Revenue (Open Line works-revenue) is accounted for separately.

The expenditure on renewals and replacements of railway assets is financed from the Depreciation Reserve Fund and is accounted for accordingly.

Rules for allocation:

1. Detailed rules regulating the classifications of transactions under Capital, Revenue, Depreciation Reserve Fund, Development fund, accident Compensation, Safety and Passenger Amenities Fund and Revenue (Open Line Works - Revenue) are prescribed in chapter VII of the Indian Railway Financial Code, Volume-I.

2. Expenditure of capital nature incurred on railway assets is classified under five heads viz. Capital, Depreciation Reserve Fund, Development fund, Accident Compensation, Safety and Passenger Amenities fund and Revenue (Open Line Works-Revenue). ACSPF is at present not being operated in addition to Capital, a Capital Fund is being operated.

To give an overall picture of the expenditure of a capital nature incurred by the Railways as distinguished from the expenditure actually charged to Capital (loan account) a separate account is compiled namely, a Block Account which exhibits the entire expenditure of a capital nature irrespective of the head of account to which it has actually been charged. The Loan Account will give only the extent of expenditure actually charged to capital. Dividend to the General Revenues payable by the Railway on this learned Capital

4. General Principles of Allocation: (Chapter VII - FI).

Allocation of expenditure implies identifying its source of finance and should be distinguished from classification which deals with the detailed heads of account under which expenditure is recorded in the accounting books of the Railway

5. Sources of Railway Finance:

Loan capital provided by the General Revenues.
Railway funds and
3) Current revenues.


VII. Government Accounts:
(Ref: Para 205A)
The Accounts maintained in accordance with the requirements of Government accounts are collectively termed as the "Finance Accounts”, The Finance Accounts of a railway are compiled annually, for the purpose of presenting in a condensed form, the various transactions brought to account in the books of the railway duly classified in accordance with the heads of account prescribed for Government accounting.

According to Article 266 of the Constitution of India, the Central Government have a consolidated fund entitled the “Consolidated fund of India” into which flow all the revenues (for the railways traffic earnings are the main source of income) received by the Central Government, loans raised by the government by the issue of treasury bills, loans or ways and means advances, and moneys received by the government in repayment of loans and from which all expenditure of the Central Government is met when so authorized by the Parliament in accordance with law.

The Central Government have also a public account entitled the “Public account of India” into which all other public moneys received by or on behalf of Government are credited and from which disbursements are made in accordance with the prescribed rules.

The procedure to be followed for the payment into and the withdrawal, transfer or disbursement of moneys from, the Consolidated Fund and the Public Account and for the custody of moneys standing in that Fund and Account, is regulated by law made by Parliament and pending such legislation, by the rules made by the President under Article 283 of the Constitution.

The Central Government have also as authorized in Article 267 of the Constitution a Contingency Fund entitled the ‘Contingency Fund of India”. This fund will be at the disposal of the President to enable advances to be made by him for meeting unforeseen expenditure, pending authorization of such expenditure by Parliament under Article 115 of Article 116.

The procedure to be followed for the custody of the payment of moneys into and the withdrawal of moneys from, the Fund is regulated by law made by Parliament. The procedure for granting advances to meet unforeseen expenditure of railways is laid down in paragraph 382 F. Application for such advances required by the Railways shall be made to the Financial Commissioner for Railways.

VIII. Classification in Government Accounts:
(Ref: Para 208A)
The Government accounts are thus kept in the following three parts:-

Part - I Consolidated Fund of India
Part - II Contingency Fund of India
Part - III Public Accounts of India

1. Part - I Consolidated Fund of India:
In this part of the Account there are three main divisions namely:-
(1) Revenue; (2) Capital and (3) Debt (Comprising public Debt and Loans and Advances)

The first division deals with the proceeds of taxation and other receipts, classed as revenue and the expenditure therefrom in the case of the Railways, the traffic earnings are the main source of revenues.

The Second division deals with expenditure incurred with the object of increasing assets of a material character and also receipts intended to be applied as a set-off to capital expenditure.

The third division comprises, so far as Railway Accounts are concerned, of loans and advances made by Government together with the repayments of the former and recoveries of the latter.

2. Part - II Contingency Fund of India:
In this part are recorded transactions connected with the Contingency Fund set up by the Government of India under Article 267 of the Constitution.

3. Part - III Public Accounts of India:
Here there are two main divisions, namely - (1) Debt (other than those included in Part-I) and Deposits; and (2) Remittances.

The first division comprises receipts and payments other than those falling under “Debt” heads pertaining to Part-I, in respect of which Government incurs a liability to repay the moneys received or has a claim to recover the amounts paid, together with repayments of the former and the recoveries of the latter such as Contributory/Non-contributory Provident fund Accounts, Staff Benefit Fund, and all Railway Funds like the Development fund, the Depreciation reserve Fund etc.

The second division comprises all adjusting heads, such as transfers between different accounting circles (for transactions appearing in the first instance in the books of one accounts Officer but finally transferred to those of another).

IX. List of major and minor heads of account of railway revenues, capital, and Debt and Remittance transactions adjusted in Railway Books:

This is given in Appendix IV of the Railway Accounts Code Vol-I.

X. Detailed Classification of:

Expenditure chargeable to ordinary revenue is given in Appx. I of F-II
Capital and other works expenditure chargeable to DRF, DF, and OLW(R) is given in Appx.II of F-II

Earnings . . . . . is given in Appx.III of F-II

Re-structured demands for grants and Revised Accounting Classification of Revenue and Capital Expenditure was introduced w.e.f. 01-04-79 as per the recommendations of Task Force which was constituted in 1973 in pursuance of the recommendations of the Railway Convention Committee 1971and as accepted by the Govt. in consultation with the Comptroller and Auditor General of India.

XI. Annexure J to appropriation Accounts:

One of the subsidiary statements accompanying “Appropriation Accounts” is Annexure- J which deals with important misclassifications detected (by statutory Audit).

The statements which are prepared for presentation to the PAC are called the ‘Appropriation Accounts’. (for detailed reading refer Chapter IV/F-I)

XII. Common items of misclassification.

Some of the aspects - often reported by C&AG - while scrutinising the Appropriation accounts are:

Revenue transactions getting booked under Demand No.6 and vice-versa.
Transactions chargeable to Railway Funds getting accounted for under capital and vice-versa within Demand No.16.
Transactions to be accounted for under Deposit works wrongly charged to revenue and vice-versa.
'Charged' expenditure wrongly booked as 'Voted'.
Non-adjustment/delayed adjustment of transactions from suspense Heads; MAR(E) and MAR(X) to Revenue/Demand No.16, resulting in undercasting of expenditure under both Revenue/Demand No.16.
Non-adjustment of cost of staff between Open Line and Construction Organisation.
Belated adjustments; adjustments pertaining to previous years under Revenue, being adjusted during the current year.
Non-adjustment of ballast train (BT) charges.
Non-carrying out of write-back adjustments for condemnation/sale of Rolling stock and dismantling of assets resulting in dividend liability being overstated.
Adjustments, not supported by physical transfers, particularly in accountal of stores.
Non-carrying out of inter-demand adjustments in respect of transactions such as Electrical energy charges, water charges, expenditure in regard to track machine; where the expenditure is initially booked to one demand and later is required to be distributed among other demands based on pre-determined norms.

XV. Broad categories of misclassification:

The following are the broad categories under which the misclassifications/Mistakes normally occur:

Misclassification between Voted and Charged expenditure;
Misclassification/Mistake between one Grant & another;
Misclassification/Mistake arising from lack of vigilance at various levels;
Misclassification/mistake arising from a differing perception as regards the interpretation of Allocation Rules or procedures.

Of these, the misclassifications/mistakes at (i), (ii) & (iii) should be deemed to be avoidable.

XIV. List of adjustment transactions between accounting units to be kept in view to avoid misclassification:

I. Inter-Railway:

Inter-Railway financial adjustments in respect of hire charges for Locos and Bogie vehicle days (rake links, introduction of new trains, and increase in frequency of trains etc. to be kept in view).

Debits from Northern Railway towards

Fuel supplies
IRCA towards wagon hire charges received through Northern Rly. and
Catering debits/credits from Northern, Central, South-Central and other Railways for pick-up meals and pantry-car sales remittances made at destination.

iii. a) Credits receivable by Madras division towards Open heart surgery done on behalf of other railways

Credits from N.Rly. towards passenger earnings, towards issue of freedom fighters' passes as also for MPs and other remittances made on our behalf.

iv. Inter-Railway debits towards POH and rebuilding of locos.

TWFA adjustments in respect of Rolling Stock, transferred from other Railways and vice versa.
Bulk order debits to be received from Board towards Rolling Stock manufactured and allotted to Southern Railway
Debits transferable to Railway Board/Other Railways/Others towards manufacture of Rolling Stock by our Workshops.
Adjustments to earnings in the wake of diversion of goods traffic by a longer route on our system.
Debits from DLW, CLW & DCW/PTA towards supply of Rolling Stock Spares
Credits from other Railways for recoveries effected from GRP payments on behalf.
Credits to be passed on to other Railways in respect of recoveries made on behalf of other Railways from GRP payments made by us.
Traction debits from other Railways.


2. Intra-Railway:

Inter-demand adjustments for deployment of track machines.
Inter-demand adjustments for water, electricity charges, deployment of track machines, ballast train charges etc.
Stores debits for both Stock and Non-stock items, workshop debits.
Write-back adjustments towards condemnation of Rolling Stock/dismantling of assets
Stock Adjustment Account clearances (Scrap Sales credit)
Credits for released materials.
Adjustment to Demand No.12K for missing coal/HSD oil wagons on receipt of sanction from Railway Board.
Adjustments with Construction Units towards

Supply of P.Way materials including ballast.
Staff spared (in respect of which AM's are to be initiated and got accepted by the recipient units to facilitate financial adjustment).
Track machines deployed from Open Line.
Traction debits from other Accounting units.

3. With public Sector Units under Railway Ministry

Expenditure adjustment by PGT/TVC/TPJ & XC/HQ with Konkan Railway Corporation Ltd. Towards:

(a) Hire charges for Rolling Stock to be debited to Misc. Suspense duly getting acceptance by KRCL
(b) Other claims: Settlement by payment

Earnings adjustment with KRCL & CONCOR (Payment by Cheques)
Cash settlement of hire charges towards locos leased to Malaysian & Tanzanian Railways through IRCON, RITES respectively (TPJ & XC/HQ).
Cash settlement towards sale of locos/wagons to Myanmar/Malaysia & Bangladesh through M/s. RITES & IRCON respectively (Workshop Accounts/PER and GOC and the associated write-back adjustment between Capital & DRF as also the adjustment of sale proceeds.

4. Inter-Government Adjustments.

Receipt and expenditure with other Departments/Ministries through RBI/CAS/NGP to be advised to the Central Books section on or before 1st April to facilitate them being paid through in March accounts (e.g. Transaction with Defence, Postal & P&AO's DGS & D).

Pension debits received through Banks/Post Offices, To be monitored and reconciled concurrently by HQ/Pension section in order to bring the balances under "Reserve Bank Suspense" to NIL at the end of March accounts.


XV. Team work:

Accounting nicety depends upon proper input. The accounts to be purposeful, it should adhere to the accounting principles.

Close and concurrent review at all levels for correct and meticulous allocation and classification of expenditure is essential.

Test check at all levels of allocations recorded on the bills and Vouchers is necessary.

Processing of Adjustment means correctly and promptly and Signing of Journal Vouchers on the basis of value of adjustments are to be made.

Prompt reconciliation of the Subsidiary Books with the General Books has to be ensured. Review of suspense balances and comparison of actual with Budget Allotments are to be undertaken concurrently.

Prompt supply of Journal Vouchers/Records, on demands by Audit (for timely rectification of misclassification that may be detected by them) has to be ensured.

Potential grey areas within the domain of everybody have to be identified and the efforts are to be bestowed to help minimising, if not totally eliminating the chances of their appearing as part of Annexure J items.

XVI. Rectification of mistakes in Accounts:

The inaccuracy in the accounts compiled by the Accounts Office has to be rectified keeping in view the rules contained in Para 922 F.

XVII. Rectification of mistakes in Accounts disclosed by Audit.

If the audit scrutiny discloses any inaccuracy in the accounts compiled by the Accounts Officer the following procedure, which is equally applicable to mistakes detected in internal check, should be adopted:-

(1) If the accounts of the year have not been finally closed the mistake should be rectified through the accounts of the month in hand.

(2) Mistakes and misclassifications noticed after the March accounts have been closed should be rectified before the Capital & Revenue accounts and Finance accounts are prepared and intimated to the Railway Board by the first week of August either through a revised account or through corrections to accounts already submitted.

(3) Mistakes and misclassifications noticed after the submission of the Capital Revenue and Finance Accounts should be dealt with in accordance with the following rules:-

(a) No correction need be made, if the item properly belongs to one revenue or service head but is wrongly classified under another, a suitable note against the original entry being sufficient. If, however, the error affects the revenue or expenditure of another Railway, or a Branch line company or another Government department or a Capital head outside the Revenue Account or a debt or remittance head, it must be corrected.

(b) If the corrections or transfers affect Capital Major heads, unless they affect the accounts of different Governments or represent readjustment of less important misclassifications of a previous year, they should usually be effected by altering the progressive figure of capital outlay without financial adjustment. i.e., without passing the debit and credit entries through the accounts of the year's financial transactions. This would prevent unnecessary inflation of the current year's accounts and the voting of grants which the inclusion of the correcting entries in the current accounts would otherwise involve.

(c) If the error affects a debt or remittance head, the procedure should be as follows:-

(i) Item taken to one debt or remittance had instead of another - The correction should be made by transferring it from the one to the other. Such corrections affecting the heads for which grants are obtained should be made as plus credit or minus credit under the heads concerned, instead of as minus debit or plus debit.

(ii) Item credited to a debt or remittance head instead of a revenue head, or debited to a debt or remittance head instead of to a service head. - the correction should be made by transferring it to the head under which it should originally appear.

(iii) Item credited or debited to a revenue head instead of to a debt or remittance head. - the correction should be made by minus crediting or minus debiting the revenue head and crediting or debiting the proper head.

(4) If the rectification of a mistake would lead to an excess over a grant or grants voted by the Parliament or an appropriation sanctioned by the President or to a considerable change in the dividend payable during the year to General Revenues, the orders of the Financial Commissioner, Railways must be first obtained.



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RISK ANALYSIS
- Study of risk/uncertainty factor of any investment proposal
Factors of uncertainty
1. process or product becoming obsolete
2. decline in demand
3. change in Govt policy in business
4. price fluctuation
5. foreign exchange restriction
6. inflationary tendencies

Techniques
I. Conservative: 1. Short Pay Back Period
2. Risk Adjusted Discount Rate
3. Conservative Forecasts of Certainty
Equivalent
Ii. Modern Methods:1. Sensitivity Analysis
2. Probability Analysis
3. Decision Tree Analysis

I. 1. Short Pay Back Period: Projects with short pay back period are normally preferred to those with longer pay back period. It would be effective when it combined with a cut off period. The cut off period denotes the risk tolerance level of the firm.

I. 2. Risk adjusted discount rate: Under this method, the cut off rate or minimum required rate of return is raised by adding what is greater.

I. 3. Conservative forecasts of certainty equivalent: It deals with the uncertainty in cash flow. Under this method, the estimated risks from cash flows are reduced by employing initiative corrective factors or certainty equivalent coefficient, which is calculated by the decision maker subjectively or objectively. Normally, this coefficient reflects the decision maker’s confidence in obtaining a particular cash flow in a particular period.

II.1. Sensitivity analysis:SENANA.DOC

II.2. probability analysis: The measure of some one’s opinion about the likelihood that an event (cash flow) will occur. The range of probability is 1 to 0. That is 100 % certain to 100% uncertain. The measure can be classified into 1. Optimistic 2. Pessimistic 3. Most likely based objective or subjective factors.
II. 3. Decision tree: In this analysis alternative course of action are charted into a form of branches left to right. The nodes represents either the chance event (denoted by a circle) and a decision point (denoted by a square). The process starts from the extreme right hand decisions and travel stage by stage along the branches that maximize interest. This process is known as Roll Back Method.

CE
CE
CE
DP
DP
DP










CE:Chance event DP: Decision point
DP
CE
DP
CE









DECISION TREE