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GNDU Question Paper-2025
B.Com 5
th
Sem
Management Accounting
Time Allowed: Three Hours Max. Marks: 100
Note: Attempt Five questions in all, selecting at least One question from each section. The
Fifth question may be attempted from any section. All questions carry equal marks.
SECTIONA
1. Give the nature and scope of Management Accounting.
How is it different from Cost Accounting?
2. (A) From the following information, calculate the Stock Turnover Ratio:
Revenue from operations = Rs. 3,00,000
Gross Profit = 25% on cost of revenue from operations
Opening stock = 1/3rd of the value of closing stock
Closing stock = 30% of revenue from operations
2. (B) Calculate current assets of a company from the following:
(a) Stock turnover = 4 times
(b) Stock at the end is Rs. 20,000 more than stock in the beginning
(c) Sales = Rs. 3,00,000
(d) Gross Profit Ratio = 25%
(e) Current Liabilities = Rs. 40,000
(f) Quick Ratio = 0.75
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SECTIONB
3. Define the terms 'Fund' and 'Flow' in respect of Fund Flow Statement.
How is Fund Flow Statement prepared?
4. Prepare a Cash Flow Statement from the following information:
Equity and Liabilities
Particulars
31-03-2020 (Rs.)
31-03-2021 (Rs.)
Share Capital
1,10,000
1,70,000
General Reserve
4,000
10,000
Statement of Profit & Loss
1,00,000
1,20,000
Creditors
5,000
3,000
Bills Payable
15,000
25,000
Total
2,34,000
3,28,000
Assets
Particulars
31-03-2020 (Rs.)
31-03-2021 (Rs.)
Goodwill
50,000
30,000
Building
40,000
90,000
Machinery
49,000
98,000
Debtors
15,000
20,000
Cash
80,000
90,000
Total
2,34,000
3,28,000
Additional Information: Depreciation provided during the year on machinery was Rs.
10,000.
SECTIONC
5. (A) What is a Break-Even Chart? How is it prepared?
(B) What is a P/V Graph? How is it prepared?
6. A firm having a capacity of 15,000 units per annum produces 10,000 units, which are
consumed in the home market at Rs. 25 per unit.
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The cost per unit is as follows:
Particulars
Rs.
Materials
8.00
Labour
6.00
Fixed Factory Expenses
2.00
Variable Factory Expenses
1.50
Office Expenses
1.00
Fixed Selling Expenses
0.50
Variable Selling Expenses
1.00
Total
20.00
(i)
A foreign customer is interested in the product, but he is willing to buy only 5,000 units at
Rs. 18 per unit.
Do you recommend the firm to accept the order?
(ii) What will be your advice if:
(a) The new customer is not a foreigner.
(b) The price offered is Rs. 15 per unit.
(c) The foreign customer is unwilling to buy less than 8,000 units, the price per unit
being Rs. 22.
SECTIOND
7. What is Transfer Pricing?
Explain various methods of transfer pricing.
8. What is Responsibility Accounting?
Give the features, assumptions and basic principles of responsibility accounting.
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GNDU Answer Paper-2025
B.Com 5
th
Sem
Management Accounting
Time Allowed: Three Hours Max. Marks: 100
Note: Attempt Five questions in all, selecting at least One question from each section. The
Fifth question may be attempted from any section. All questions carry equal marks.
SECTIONA
1. Give the nature and scope of Management Accounting.
How is it different from Cost Accounting?
Ans: Nature and Scope of Management Accounting
Imagine a business owner asks, Are we really making profit? Which product is performing
well? Where are we spending too much money? Should we increase production?
The owner cannot make these decisions simply by looking at a large pile of accounting
records. This is where Management Accounting becomes useful. It takes accounting
information, analyses it, and presents it in a meaningful way so that managers can make
better decisions.
Meaning of Management Accounting
Management Accounting is the process of collecting, analysing, interpreting and presenting
financial and non-financial information to the management for planning, decision-making
and controlling business activities.
In simple words:
Management Accounting = Accounting information + Analysis + Management decisions
For example, suppose a company sells two products, A and B. Both products generate sales,
but after analysing costs, management discovers that Product A gives much higher profit
than Product B. The company may then decide to produce more A and reduce production of
B.
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Nature of Management Accounting
The nature of management accounting means its basic characteristics or features.
1. It is Mainly for Management
Management accounting is prepared mainly for managers and internal users. Unlike
financial accounting, it is not primarily designed for outsiders such as shareholders, creditors
or government authorities.
2. It Helps in Decision-Making
One of its most important purposes is to help managers make decisions.
For example:
Should we manufacture a product or buy it?
Should we increase the selling price?
Should we stop an unprofitable product?
Should we open a new branch?
Management accounting provides information to answer such questions.
3. It Helps in Planning
Managers need to plan the future. Management accounting provides budgets, forecasts and
estimates that help management decide what the business should do in the future.
For example, a company may prepare a sales budget to estimate how much it expects to
sell next year.
4. It Helps in Controlling
Planning alone is not enough. Management must also check whether actual performance
matches the plan.
For example:
Budgeted expenditure = ₹1,00,000
Actual expenditure = ₹1,20,000
Management accounting helps identify the ₹20,000 difference and investigate why it
occurred.
5. It Uses Both Financial and Non-Financial Information
Management accounting does not depend only on money figures. It may also use:
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Number of units produced
Number of employees
Production hours
Customer satisfaction
Sales volume
Machine hours
Therefore, it gives management a broader picture of the business.
6. It is Future-Oriented
Financial accounting mainly records what has already happened. Management accounting,
however, is strongly concerned with future decisions and plans.
Past information is used as a basis for predicting the future.
Scope of Management Accounting
The scope means the areas covered by management accounting.
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The major areas include:
1. Financial Accounting
Management accounting uses financial accounting information such as sales, purchases,
expenses, assets and liabilities.
2. Cost Accounting
Cost accounting provides information about the cost of producing goods or providing
services. Management accounting uses this information for pricing, cost control and
decision-making.
3. Budgeting
Budgets estimate future income and expenditure.
For example:
Expected Sales → Expected Expenses → Expected Profit
This helps management plan its activities.
4. Financial Analysis
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Management accounting analyses financial statements and ratios to understand the
financial position and performance of the business.
5. Decision-Making
It provides information for important decisions such as:
Make or buy
Pricing decisions
Product selection
Expansion
Closing a department
Investment decisions
6. Performance Evaluation
Management accounting compares actual performance with planned performance and
identifies areas where improvement is required.
Management Accounting vs Cost Accounting
These two terms are closely related, but they are not exactly the same.
Think of it this way:
Cost Accounting mainly asks: What does it cost?
Management Accounting asks: What does the information tell management to do?
Basis
Cost Accounting
Management Accounting
Meaning
Determines and analyses the cost of
products/services
Uses accounting information for
management decisions
Main
purpose
Cost determination and cost control
Planning, decision-making and
control
Scope
Relatively narrower
Wider
Information
Mainly cost-related information
Financial + cost + non-financial
information
Focus
Mainly cost of production and
operations
Overall business performance
Time focus
Mainly past and present costs
Past, present and future
Users
Cost managers and management
Top, middle and operational
management
Example
Finding cost of producing one unit
Deciding whether to increase or
reduce production
Simple Example
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Suppose a company manufactures chairs.
Cost accounting may tell management:
Material = ₹500
Labour = ₹200
Other costs = ₹100
Total cost = ₹800 per chair
This is Cost Accounting because it determines and analyses the cost.
Management accounting goes one step further.
It may ask:
Can we reduce the ₹100 other cost?
Should we sell the chair for ₹1,000 or ₹1,100?
Should we manufacture more chairs?
Which chair model gives the highest profit?
Should we buy materials from another supplier?
This is Management Accounting because the information is being used to make managerial
decisions.
Easy Diagram to Remember
ACCOUNTING INFORMATION
│
┌───────────┴───────────┐
↓ ↓
COST ACCOUNTING FINANCIAL ACCOUNTING
│ │
└───────────┬───────────┘
↓
MANAGEMENT ACCOUNTING
│
┌─────────────────┼─────────────────┐
↓ ↓ ↓
Planning Decision-Making Control
│ │ │
└─────────────────┼─────────────────┘
↓
Better Management
& Better Results
In One Line
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Cost Accounting tells management about costs, while Management Accounting uses cost
and other accounting information to help management plan, control and make decisions.
Conclusion
Management accounting is therefore a decision-support system for management. Its
nature is analytical, practical, future-oriented and decision-focused. Its scope is broad
because it includes budgeting, cost accounting, financial analysis, planning, control,
performance evaluation and decision-making.
The easiest way to remember the difference is:
Cost Accounting = Know the Cost.
Management Accounting = Use the Information to Manage.
2. (A) From the following information, calculate the Stock Turnover Ratio:
Revenue from operations = Rs. 3,00,000
Gross Profit = 25% on cost of revenue from operations
Opening stock = 1/3rd of the value of closing stock
Closing stock = 30% of revenue from operations
Ans: Imagine you run a small shop. During the year, you buy goods, sell them, and keep
some goods unsold at the end of the year.
The Stock Turnover Ratio tells us:
How many times the average stock of goods is sold/replaced during the year.
The basic formula is:
And:
So, our job is to find:
1. Cost of Revenue from Operations
2. Opening Stock
3. Closing Stock
4. Average Stock
5. Finally, Stock Turnover Ratio
Step 1: Find Revenue from Operations
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The question gives:
Revenue from Operations = ₹3,00,000
This means the business earned ₹3,00,000 from selling its goods/services during the year.
But remember: Stock Turnover Ratio uses cost of goods sold, not selling revenue.
So we cannot directly put ₹3,00,000 into the numerator.
We first need to find the Cost of Revenue from Operations.
Step 2: Understand Gross Profit
The question says:
Gross Profit = 25% on cost of revenue from operations
This wording is very important.
It means if the cost is ₹100, the business earns ₹25 gross profit.
Therefore:
So the relationship becomes:
Therefore:
Now substitute the revenue:
So:
Cost of Revenue from Operations = ₹2,40,000
Easy way to remember
If profit is 25% on cost, then:
Cost = 100
Profit = 25
Revenue = 125
So:
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Step 3: Find Closing Stock
The question says:
Closing Stock = 30% of Revenue from Operations
Revenue = ₹3,00,000
Therefore:
So our Closing Stock = ₹90,000.
Step 4: Find Opening Stock
Now the question says:
Opening Stock = 1/3rd of the value of Closing Stock
We have already found closing stock:
Therefore:
So:
Opening Stock = ₹30,000
Closing Stock = ₹90,000
Step 5: Calculate Average Stock
Stock Turnover Ratio doesn't use just opening stock or just closing stock.
It uses Average Stock.
The formula is:
Put our values:
So the average stock is ₹60,000.
Step 6: Calculate Stock Turnover Ratio
Now we have everything required.
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Formula:
We found:
Cost of Revenue = ₹2,40,000
Average Stock = ₹60,000
Therefore:
Final Answer
This means that, on average, the business sold and replaced its stock 4 times during the
period.
Let's See the Whole Question as a Flow
REVENUE FROM OPERATIONS
₹3,00,000
│
▼
Gross Profit = 25% on Cost
│
▼
Cost = 100, Profit = 25
Revenue = 125
│
▼
Cost of Revenue = ₹2,40,000
│
│
┌─────────────────┴─────────────────┐
│ │
▼ ▼
Closing Stock Opening Stock
30% of Revenue 1/3 of Closing
│ │
▼ ▼
₹90,000 ₹30,000
│ │
└──────────────┬────────────────────┘
▼
Average Stock
(30,000 + 90,000) ÷ 2
│
▼
₹60,000
│
▼
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Stock Turnover Ratio
2,40,000 ÷ 60,000
│
▼
4 TIMES
Quick Exam Method
When you see a question like this, don't get confused by all the information. Follow this
order:
1. Revenue → Find Cost
2. Revenue → Find Closing Stock
3. Closing Stock → Find Opening Stock
4. Find Average Stock
5. Apply STR Formula
The one thing you must remember
Stock Turnover Ratio = Cost of Goods Sold ÷ Average Stock
Not Revenue ÷ Average Stock.
2. (B) Calculate current assets of a company from the following:
(a) Stock turnover = 4 times
(b) Stock at the end is Rs. 20,000 more than stock in the beginning
(c) Sales = Rs. 3,00,000
(d) Gross Profit Ratio = 25%
(e) Current Liabilities = Rs. 40,000
(f) Quick Ratio = 0.75
Ans: First understand the basic idea
A company's Current Assets are assets that can normally be converted into cash within a
short period.
For this question, we can think of current assets as:
Current Assets = Stock + Quick Assets
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And:
Quick Assets = Current Assets − Stock
So, if we can find Stock and Quick Assets, we can easily find Current Assets.
Step 1: Find Gross Profit
The question gives:
Sales = ₹3,00,000
Gross Profit Ratio = 25%
Gross Profit Ratio means:
So:
Gross Profit = ₹75,000
Step 2: Find Cost of Goods Sold (COGS)
Now we need Cost of Goods Sold, because the stock turnover ratio is calculated using
COGS.
Remember:
Therefore:
So:
Cost of Goods Sold = ₹2,25,000
Step 3: Understand Stock Turnover Ratio
The question says:
Stock Turnover = 4 times
The formula is:
We know:
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Stock Turnover = 4
COGS = ₹2,25,000
Therefore:
So:
Therefore:
Average Stock = ₹56,250
Step 4: Find Opening and Closing Stock
Now comes the slightly tricky part.
The question says:
Stock at the end is ₹20,000 more than stock at the beginning.
Let's call:
Opening Stock = X
Closing Stock = X + ₹20,000
The formula for average stock is:
We already know average stock is ₹56,250.
Therefore:
Multiply both sides by 2:
So:
Opening Stock = ₹46,250
And closing stock:
Therefore:
Closing Stock = ₹66,250
Simple diagram
Opening Stock Closing Stock
₹46,250 ₹66,250
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│ │
└──────────────┬─────────────────────┘
↓
Average Stock
₹56,250
Notice that the closing stock is exactly ₹20,000 higher than the opening stock.
Step 5: Find Quick Assets
Now the question gives:
Current Liabilities = ₹40,000
Quick Ratio = 0.75
The formula is:
We know:
Therefore:
So:
Quick Assets = ₹30,000
Step 6: Finally, Calculate Current Assets
Now we have everything we need.
We know:
Closing Stock = ₹66,250
Quick Assets = ₹30,000
Current Assets consist of stock plus quick assets:
Therefore:
Final Answer
Current Assets = ₹96,250
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Let's understand the entire question in one flow
Think of the question as a 5-step ladder:
SALES
₹3,00,000
│
↓
Gross Profit = 25%
₹75,000
│
↓
COGS = ₹2,25,000
│
↓
Stock Turnover = 4 times
│
↓
Average Stock = ₹56,250
│
┌───────┴───────┐
↓ ↓
Opening Stock Closing Stock
₹46,250 ₹66,250
│
↓
Quick Ratio = 0.75
Current Liabilities
₹40,000
│
↓
Quick Assets = ₹30,000
│
↓
Current Assets = Stock + Quick Assets
₹66,250 + ₹30,000
│
↓
₹96,250
Formulas to remember
Concept
Formula
Gross Profit
Sales × GP Ratio
COGS
Sales − Gross Profit
Stock Turnover
COGS ÷ Average Stock
Average Stock
(Opening Stock + Closing Stock) ÷ 2
Quick Ratio
Quick Assets ÷ Current Liabilities
Current Assets
Stock + Quick Assets
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Exam shortcut
Whenever you see a question like this, don't try to calculate Current Assets directly.
Follow this order:
Sales → Gross Profit → COGS → Average Stock → Closing Stock → Quick Assets → Current
Assets
That sequence is the key to solving the whole problem without getting confused.
Therefore, the required Current Assets of the company are ₹96,250.
SECTIONB
3. Define the terms 'Fund' and 'Flow' in respect of Fund Flow Statement.
How is Fund Flow Statement prepared?
Ans: Fund Flow Statement Simple Explanation
A Fund Flow Statement is a financial statement that explains where the funds
(money/resources) came from and where they were used during a particular period.
Think of it like your personal monthly budget. Suppose you receive ₹30,000 salary, take a
₹10,000 loan, and then spend ₹20,000 on rent, shopping and other expenses. At the end of
the month, you would naturally ask:
Where did my money come from, and where did it go?
A Fund Flow Statement answers exactly this question for a business.
1. Meaning of Fund
In Fund Flow Statement, the term Fund generally means Working Capital.
Working Capital = Current Assets − Current Liabilities
For example:
Current Assets = ₹2,00,000
Current Liabilities = ₹1,20,000
Therefore:
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Working Capital = ₹2,00,000 − ₹1,20,000 = ₹80,000
So, when we talk about the flow of funds, we mainly study the changes in working capital.
2. Meaning of Flow
Flow means movement or change.
In a Fund Flow Statement, flow means the movement of funds from one source to another
use.
There are two types:
A. Inflow of Funds Sources
When funds come into the business, it is called a source of funds.
Examples:
Issue of shares
Issue of debentures
Taking a long-term loan
Sale of fixed assets
Funds generated from business operations
B. Outflow of Funds Applications
When funds are used by the business, it is called an application of funds.
Examples:
Purchase of machinery
Purchase of land/building
Repayment of long-term loan
Redemption of debentures
Payment of dividend
Easy way to remember
Sources → Where did the funds come from?
Applications → Where did the funds go?
You can imagine the business as a water tank:
SOURCES
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(Funds coming IN)
↓
┌───────────────┐
│ BUSINESS │
│ FUND │
└───────────────┘
↓
APPLICATIONS
(Funds going OUT)
3. What is a Fund Flow Statement?
A Fund Flow Statement is a statement showing the sources from which funds were
obtained and the applications for which those funds were used during a particular
accounting period.
In simple words:
Fund Flow Statement tells us from where the money came and where it was spent.
It is useful for understanding the financial changes and movement of working capital
between two balance-sheet dates.
4. How is a Fund Flow Statement Prepared?
The preparation of a Fund Flow Statement is generally done in three major steps.
Balance Sheets
Opening & Closing
↓
1. Schedule of Changes
in Working Capital
↓
2. Funds from Operations
↓
3. Fund Flow Statement
Sources & Applications
Step 1: Prepare Schedule of Changes in Working Capital
First, compare the current assets and current liabilities of the opening and closing balance
sheets.
Current Assets include:
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Cash
Bank balance
Debtors
Bills receivable
Stock
Short-term investments
Prepaid expenses
Current Liabilities include:
Creditors
Bills payable
Outstanding expenses
Short-term loans
Bank overdraft (depending on the treatment in the question)
The basic rule is:
For Current Assets
Increase in Current Asset → Increase in Working Capital
Decrease in Current Asset → Decrease in Working Capital
For Current Liabilities
Increase in Current Liability → Decrease in Working Capital
Decrease in Current Liability → Increase in Working Capital
A simple memory trick:
Current Asset ↑ = Working Capital ↑
Current Liability ↑ = Working Capital ↓
Step 2: Calculate Funds from Operations
The next step is to find out how much fund was generated through the normal operations
of the business.
We start with Net Profit and adjust items that do not involve actual flow of funds.
For example:
Add:
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Depreciation
Goodwill written off
Preliminary expenses written off
Loss on sale of fixed asset
Less:
Profit on sale of fixed asset
Non-operating income, where applicable
The purpose is to find the actual funds generated from business operations.
For example, suppose:
Net Profit = ₹50,000
Depreciation = ₹10,000
Then:
Funds from Operations = ₹50,000 + ₹10,000 = ₹60,000
Why do we add depreciation?
Because depreciation reduces accounting profit, but no cash/fund actually goes out when
depreciation is recorded.
Step 3: Prepare the Fund Flow Statement
Finally, prepare the actual Fund Flow Statement.
It has two sides:
Sources of Funds
Applications of Funds
Funds from operations
Purchase of fixed assets
Issue of shares
Repayment of long-term loan
Issue of debentures
Redemption of debentures
Long-term loans
Purchase of investments
Sale of fixed assets
Payment of dividend
Decrease in working capital
Increase in working capital
The important rule is:
Total Sources of Funds = Total Applications of Funds
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Simple Example
Suppose a business has:
Sources:
Funds from operations = ₹60,000
Issue of shares = ₹40,000
Sale of machinery = ₹20,000
Total Sources:
₹60,000 + ₹40,000 + ₹20,000 = ₹1,20,000
The business uses these funds for:
Applications:
Purchase of machinery = ₹70,000
Repayment of loan = ₹30,000
Increase in working capital = ₹20,000
Total Applications:
₹70,000 + ₹30,000 + ₹20,000 = ₹1,20,000
Therefore:
Total Sources = Total Applications = ₹1,20,000
The statement balances.
Quick Revision
Remember the entire concept using F-S-A:
F → Fund
Fund means Working Capital.
S → Sources
Where did the funds come from?
Examples: shares, loans, sale of assets, funds from operations.
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A → Applications
Where were the funds used?
Examples: purchase of machinery, repayment of loans, purchase of investments.
Preparation Formula
Opening & Closing Balance Sheets
↓
Changes in Working Capital
↓
Funds from Operations
↓
Sources of Funds
+
Applications of Funds
↓
Fund Flow Statement
In one sentence:
A Fund Flow Statement shows the sources from which funds were obtained and the
purposes for which those funds were used during an accounting period, with special focus
on changes in working capital.
4. Prepare a Cash Flow Statement from the following information:
Equity and Liabilities
Particulars
31-03-2020 (Rs.)
31-03-2021 (Rs.)
Share Capital
1,10,000
1,70,000
General Reserve
4,000
10,000
Statement of Profit & Loss
1,00,000
1,20,000
Creditors
5,000
3,000
Bills Payable
15,000
25,000
Total
2,34,000
3,28,000
Assets
Particulars
31-03-2020 (Rs.)
31-03-2021 (Rs.)
Goodwill
50,000
30,000
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Building
40,000
90,000
Machinery
49,000
98,000
Debtors
15,000
20,000
Cash
80,000
90,000
Total
2,34,000
3,28,000
Additional Information: Depreciation provided during the year on machinery was Rs.
10,000.
Ans: We have Balance Sheets for 31 March 2020 and 31 March 2021.
Our job is to prepare a Cash Flow Statement for the year 202021.
First understand the basic idea
A Cash Flow Statement answers only three questions:
CASH FLOW STATEMENT
│
┌───────────────┼───────────────┐
↓ ↓ ↓
Operating Investing Financing
Activities Activities Activities
│ │ │
Daily business Buying/Selling Shares, loans,
operations assets capital etc.
For this question, we will use the Indirect Method.
Step 1: Find the Actual Profit of the Year
Look at:
Particulars
2020
2021
Statement of Profit & Loss
₹1,00,000
₹1,20,000
At first glance:
₹1,20,000 − ₹1,00,000 = ₹20,000
But there is an important point.
The General Reserve increased from ₹4,000 to ₹10,000.
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So:
Increase in General Reserve = ₹10,000 − ₹4,000 = ₹6,000
This ₹6,000 has been transferred out of the year's profit into General Reserve.
Therefore, actual profit earned during the year is:
Increase in P&L + Transfer to General Reserve
= ₹20,000 + ₹6,000
= ₹26,000
Why?
Think of it like your personal bank account.
Suppose your savings increased by ₹20,000, but you also moved ₹6,000 into another savings
account. Your actual earning was not ₹20,000 it was:
₹20,000 + ₹6,000 = ₹26,000
So, Profit = ₹26,000.
Step 2: Adjust Non-Cash Expenses
The question gives:
Depreciation on machinery = ₹10,000
What is depreciation?
Depreciation means the reduction in the book value of an asset because of usage, age, etc.
But remember:
Depreciation does NOT involve actual cash going out.
For example:
You bought a machine for ₹1,00,000.
You record ₹10,000 depreciation.
Your books say:
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Machine value reduced by ₹10,000.
But did you actually pay ₹10,000 to someone this year?
No.
Therefore, while preparing Cash Flow from Operating Activities, depreciation is added back.
So:
Profit = ₹26,000
Add:
Depreciation = ₹10,000
Running total:
₹36,000
Step 3: Understand Goodwill
Goodwill decreased:
₹50,000 → ₹30,000
Decrease =
₹50,000 − ₹30,000 = ₹20,000
The question doesn't give any information about goodwill being sold.
Therefore, the logical treatment in this type of examination question is that goodwill has
been written off.
Writing off goodwill is a non-cash item.
So, just like depreciation, we add it back:
₹36,000 + ₹20,000 = ₹56,000
Step 4: Adjust Current Assets and Current Liabilities
Now we look at Debtors, Creditors and Bills Payable.
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The simple rule is:
Current Assets
Increase in Current Asset → Subtract
Decrease in Current Asset → Add
Current Liabilities
Increase in Current Liability → Add
Decrease in Current Liability → Subtract
Why?
Imagine a student has to receive ₹5,000 from a friend.
If the amount receivable increases, the student has not received that cash yet.
Therefore, increase in debtors reduces cash flow.
A. Debtors
Debtors increased:
₹15,000 → ₹20,000
Increase = ₹5,000
Because debtors increased, subtract ₹5,000.
₹56,000 − ₹5,000
= ₹51,000
B. Creditors
Creditors decreased:
₹5,000 → ₹3,000
Decrease = ₹2,000
When creditors decrease, it means the business has paid some amount to creditors.
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Therefore, cash has gone out.
So subtract ₹2,000.
₹51,000 − ₹2,000
= ₹49,000
C. Bills Payable
Bills Payable increased:
₹15,000 → ₹25,000
Increase = ₹10,000
An increase in current liability is treated as an increase in cash available.
So add ₹10,000.
₹49,000 + ₹10,000
= ₹59,000
Therefore:
Cash Flow from Operating Activities = ₹59,000
Step 5: Calculate Investing Activities
Now we examine fixed assets.
Investing activities mainly involve:
Purchase of building
Purchase of machinery
Sale of fixed assets
Investment in securities, etc.
A. Building
Building:
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₹40,000 → ₹90,000
Increase:
₹90,000 − ₹40,000 = ₹50,000
Assuming no sale is mentioned, this means building was purchased for ₹50,000.
Therefore:
Cash outflow = ₹50,000
B. Machinery
This part is slightly tricky.
Machinery:
₹49,000 → ₹98,000
At first, you may think:
₹98,000 − ₹49,000 = ₹49,000
But the question says:
Depreciation on machinery = ₹10,000
The closing machinery value of ₹98,000 is after depreciation.
Therefore:
Opening Machinery ₹49,000
+ Machinery Purchased ?
− Depreciation ₹10,000
-----------------------------------------------
Closing Machinery ₹98,000
So:
₹49,000 + Purchase − ₹10,000 = ₹98,000
Therefore:
Purchase = ₹98,000 − ₹49,000 + ₹10,000
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= ₹59,000
So machinery purchased for ₹59,000.
Investing Cash Flow
Purchase of Building ₹50,000
Purchase of Machinery ₹59,000
--------
Total Cash Outflow ₹1,09,000
Therefore:
Cash Flow from Investing Activities = −₹1,09,000
Step 6: Calculate Financing Activities
Now look at Share Capital.
Share Capital:
₹1,10,000 → ₹1,70,000
Increase:
₹1,70,000 − ₹1,10,000
= ₹60,000
An increase in share capital means the company received money from issuing shares.
Therefore:
Cash inflow from financing activities = ₹60,000
Step 7: Prepare the Final Cash Flow Statement
Now everything comes together.
Cash Flow Statement
Particulars
Amount (₹)
A. Cash Flow from Operating Activities
Profit during the year
26,000
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Add: Depreciation
10,000
Add: Goodwill written off
20,000
Less: Increase in Debtors
(5,000)
Less: Decrease in Creditors
(2,000)
Add: Increase in Bills Payable
10,000
Net Cash from Operating Activities (A)
59,000
B. Cash Flow from Investing Activities
Purchase of Building
(50,000)
Purchase of Machinery
(59,000)
Net Cash used in Investing Activities (B)
(1,09,000)
C. Cash Flow from Financing Activities
Issue of Share Capital
60,000
Net Cash from Financing Activities (C)
60,000
Net Increase in Cash (A+B+C)
10,000
Add: Opening Cash Balance
80,000
Closing Cash Balance
90,000
And this exactly matches the Balance Sheet:
Cash on 31-03-2021 = ₹90,000
The Whole Question in One Diagram
You can remember the entire solution like this:
PROFIT
│
↓
₹26,000
│
┌─────────────┴─────────────┐
↓ ↓
Non-cash items Working Capital
│ │
Depreciation ₹10,000 Debtors − ₹5,000
Goodwill ₹20,000 Creditors − ₹2,000
│ Bills Payable + ₹10,000
└──────────┬────────────────┘
↓
OPERATING CASH
₹59,000
│
┌──────────┴──────────┐
↓ ↓
INVESTING FINANCING
│ │
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Building − ₹50,000 Share Capital + ₹60,000
Machinery − ₹59,000
│ │
↓ ↓
−₹1,09,000 +₹60,000
└──────────┬──────────┘
↓
CASH INCREASE
₹10,000
↓
Opening Cash = ₹80,000
↓
Closing Cash = ₹90,000 ✓
Important Concepts to Remember for Exams
1. Depreciation
Non-cash expense → Add back
It reduces accounting profit but does not actually reduce cash.
2. Goodwill Written Off
Non-cash expense → Add back
The reduction in goodwill does not mean cash was paid.
3. Debtors
Increase → Subtract
Decrease → Add
4. Creditors/Bills Payable
Increase → Add
Decrease → Subtract
5. Purchase of Fixed Assets
Purchase of building/machinery means:
Cash Outflow → Investing Activity
6. Issue of Shares
Money received from issuing shares:
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Cash Inflow → Financing Activity
Final Answer to Remember
Activity
Cash Flow
Operating Activities
₹59,000 Inflow
Investing Activities
₹1,09,000 Outflow
Financing Activities
₹60,000 Inflow
Net Increase in Cash
₹10,000
Opening Cash
₹80,000
Closing Cash
₹90,000
The most important trick in this question
There are three places where students commonly make mistakes:
① Profit is ₹26,000, not ₹20,000
Because ₹6,000 was transferred to General Reserve.
② Machinery purchased = ₹59,000, not ₹49,000
Because ₹10,000 depreciation must be added back when finding the actual purchase.
③ Goodwill ₹20,000 is treated as written off
Since there is no information about its sale, it is treated as a non-cash write-off and added
back.
And finally, the best way to check your answer is:
Opening Cash ₹80,000 + Net Increase ₹10,000 = Closing Cash ₹90,000
SECTIONC
5. (A) What is a Break-Even Chart? How is it prepared?
(B) What is a P/V Graph? How is it prepared?
Ans: Imagine you start a small business selling notebooks. You have some fixed costs, such
as rent and salary, which remain the same whether you sell 10 notebooks or 1,000
notebooks. You also have variable costs, such as paper and printing, which increase when
you produce more notebooks.
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A Break-Even Chart is a graphical presentation that shows the relationship between sales,
total cost and profit/loss. Most importantly, it helps us find the Break-Even Point (BEP).
The Break-Even Point is the point where:
Total Sales = Total Cost
At this point, there is neither profit nor loss.
10203040506050010001500RevenueTotal costQuantity$Q*
𝑄
∗
=
𝐹
𝑝 − 𝑣
=
400
32 − 12
= 20
Q* is the break-even quantity where total revenue matches total cost.
𝐹
$
𝐹
𝑣
$/unit
𝑣
𝑝
$/unit
𝑝
Give feedback
How is a Break-Even Chart prepared?
To prepare a Break-Even Chart, we generally follow these steps:
1. Draw the X-axis and Y-axis
X-axis (horizontal) → shows the volume of production or sales.
Y-axis (vertical) → shows cost and revenue in ₹.
2. Draw the Fixed Cost line
Fixed cost remains constant regardless of production. Therefore, draw a horizontal line
starting from the fixed-cost amount.
3. Draw the Total Cost line
Total Cost consists of:
Total Cost = Fixed Cost + Variable Cost
As production increases, variable cost increases. Therefore, the total-cost line slopes
upward.
4. Draw the Sales/Revenue line
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Sales increase as the number of units sold increases. Therefore, the sales line also slopes
upward, generally starting from zero when there are no sales.
5. Find the Break-Even Point
The point where the Sales line intersects the Total Cost line is called the Break-Even Point.
Cost / Revenue (₹)
│
│ Sales
│ /
│ /
│ / ● ← Break-Even Point
│ / /
│ / / Total Cost
│ / /
│────────────/────/──────── Fixed Cost
│ /
│ /
│ /
└────────────────────────────→ Units Sold
Loss Profit
Before the Break-Even Point, Total Cost is greater than Sales, so there is a loss.
After the Break-Even Point, Sales are greater than Total Cost, so there is a profit.
Thus, a Break-Even Chart gives management a quick visual answer to the question: How
many units must we sell before we start earning profit?
(B) P/V Graph
P/V means Profit/Volume. A P/V Graph (Profit-Volume Graph) is a graph that shows the
relationship between profit or loss and the volume of sales.
In simple words, a P/V graph tells us:
As sales increase, how does our profit change?
It is particularly useful for understanding how much profit a business earns at different
levels of sales.
How is a P/V Graph prepared?
1. Draw the axes
X-axis → represents Sales Volume or Sales value.
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Y-axis → represents Profit and Loss.
2. Mark the zero-profit point
At zero sales, the business normally has a loss equal to its fixed costs because fixed costs still
have to be paid.
For example, if fixed cost is ₹20,000, then at zero sales the business has a ₹20,000 loss.
3. Draw the P/V line
As sales increase, contribution increases. Therefore, the loss gradually decreases and
eventually becomes zero.
The point where the P/V line crosses the zero-profit line is the Break-Even Point.
After this point, the line moves upward, showing increasing profit.
Profit / Loss (₹)
│
Profit │ /
│ / ← Profit
│ /
│ ● ← Break-Even Point
────────┼──────────────────/──────── Zero Profit
│ /
│ /
Loss │●────────────
│ ← Fixed Loss
└──────────────────────────→ Sales Volume
Loss Profit
Simple example
Suppose a company has:
Fixed Cost = ₹20,000
Selling Price per unit = ₹100
Variable Cost per unit = ₹60
Contribution per unit:
₹100 − ₹60 = ₹40
Therefore, the company must sell:
₹20,000 ÷ ₹40 = 500 units
So, 500 units is the Break-Even Point.
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At 500 units, there is no profit and no loss. If the company sells more than 500 units, it
starts earning profit. If it sells fewer than 500 units, it suffers a loss.
Break-Even Chart vs P/V Graph
Basis
Break-Even Chart
P/V Graph
Shows
Sales, cost and profit/loss
Profit or loss and sales volume
Main purpose
Find Break-Even Point
Study profit at different sales levels
Lines
Fixed cost, total cost and sales
Mainly profit-volume line
Starting point
Based on cost and sales
Usually starts with fixed loss
Main use
Cost-volume-profit analysis
Profit planning and decision-making
In short
A Break-Even Chart answers: At what level of sales will there be no profit and no loss?
A P/V Graph answers: How will profit or loss change when sales volume changes?
6. A firm having a capacity of 15,000 units per annum produces 10,000 units, which are
consumed in the home market at Rs. 25 per unit.
The cost per unit is as follows:
Particulars
Rs.
Materials
8.00
Labour
6.00
Fixed Factory Expenses
2.00
Variable Factory Expenses
1.50
Office Expenses
1.00
Fixed Selling Expenses
0.50
Variable Selling Expenses
1.00
Total
20.00
(i)
A foreign customer is interested in the product, but he is willing to buy only 5,000 units at
Rs. 18 per unit.
Do you recommend the firm to accept the order?
(ii) What will be your advice if:
(a) The new customer is not a foreigner.
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(b) The price offered is Rs. 15 per unit.
(c) The foreign customer is unwilling to buy less than 8,000 units, the price per unit
being Rs. 22.
Ans: First understand the costs
The cost per unit is:
Particulars
₹ per unit
Nature
Materials
8.00
Variable
Labour
6.00
Variable
Fixed Factory Expenses
2.00
Fixed
Variable Factory Expenses
1.50
Variable
Office Expenses
1.00
Fixed
Fixed Selling Expenses
0.50
Fixed
Variable Selling Expenses
1.00
Variable
Total Cost
20.00
What is variable cost?
Variable costs increase when we produce more units.
Here:
Materials = ₹8
Labour = ₹6
Variable factory expenses = ₹1.50
Variable selling expenses = ₹1
Therefore:
Variable Cost = 8 + 6 + 1.50 + 1
Variable Cost = ₹16 per unit
The remaining:
₹20 − ₹16 = ₹4
is fixed cost per unit at the present production level.
The most important concept
For a special order, don't compare the offered price with the total cost of ₹20.
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Why?
Because the firm already has fixed expenses such as:
Fixed factory expenses
Office expenses
Fixed selling expenses
These expenses will continue whether we accept the order or reject it.
Therefore, for the additional order, we mainly look at the additional/variable cost.
Decision Rule
If Special Order Price > Variable Cost → Accept
If Special Order Price < Variable Cost → Reject
This is the basic principle of marginal costing.
(i) Foreign customer offers 5,000 units @ ₹18
The foreign customer wants:
5,000 units × ₹18 = ₹90,000
Now calculate the variable cost:
5,000 × ₹16 = ₹80,000
Therefore:
Additional Contribution
₹90,000 − ₹80,000
= ₹10,000
Or per unit:
₹18 − ₹16 = ₹2 contribution
For 5,000 units:
5,000 × ₹2 = ₹10,000
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Decision: ACCEPT
Why?
Because the company has exactly 5,000 units of idle capacity, and the order gives an
additional contribution of ₹10,000.
The fixed expenses are already being incurred, so they don't change.
Simple picture:
Maximum Capacity 15,000 units
↓
Currently producing 10,000 units
↓
Idle capacity 5,000 units
↓
Foreign order 5,000 units
↓
Extra contribution ₹10,000
↓
ACCEPT ORDER
So the answer is:
Yes, the firm should accept the foreign order.
(ii) What happens in the following situations?
(a) New customer is NOT a foreigner
This is an important conceptual point.
The order is attractive because the firm has idle capacity. However, if the customer is a
domestic/home-market customer, selling the product to him at ₹18 could create a
problem.
The firm's normal home-market selling price is:
₹25 per unit
Suppose other domestic customers discover that the company is selling the same product
for ₹18.
They may demand the same lower price.
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That could reduce the firm's normal selling price of ₹25.
Why is this dangerous?
Normal domestic contribution:
₹25 − ₹16 = ₹9 per unit
Special-order contribution:
₹18 − ₹16 = ₹2 per unit
So the company normally earns:
₹9 contribution
but would earn only:
₹2 contribution
at ₹18.
Therefore, if accepting the order causes the normal market price to fall, the company could
lose much more than the ₹10,000 gained from the special order.
Advice: Normally REJECT
If the domestic order would affect the existing home-market price, it should be rejected.
The reason is that an export customer at a lower price can often be treated separately
without disturbing the domestic market, whereas a local customer may create price-
cutting/market-price problems.
(b) Price offered is ₹15 per unit
Now suppose the foreign customer offers:
₹15 per unit
Remember:
Variable cost = ₹16 per unit
So:
Selling price = ₹15
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Variable cost = ₹16
Therefore:
₹15 − ₹16 = ₹1 loss per unit
For 5,000 units:
5,000 × ₹1 = ₹5,000 loss
The company would actually lose ₹5,000 on the additional order.
Decision: REJECT
Because:
Offer price ₹15
Less: Variable cost (₹16)
----
Loss per unit ₹1
The company should never accept an additional order when the price doesn't even cover its
additional variable cost, assuming there is no other strategic benefit.
(c) Foreign customer wants 8,000 units @ ₹22
This is the most interesting part.
Remember:
Idle capacity = only 5,000 units
But the foreign customer wants:
8,000 units
Therefore, the company cannot produce all 8,000 extra units without affecting its existing
home-market production.
This means we have an opportunity cost.
Step 1: What happens to home-market sales?
Current production:
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10,000 units
Additional foreign order:
8,000 units
Total required:
10,000 + 8,000 = 18,000 units
But capacity is only:
15,000 units
So the company is short by:
18,000 − 15,000 = 3,000 units
Therefore, the company must sacrifice 3,000 home-market units.
So after accepting the order:
Home market = 7,000 units
Foreign market = 8,000 units
Total:
7,000 + 8,000 = 15,000 units
The factory is now operating at full capacity.
Step 2: Contribution from foreign order
Foreign selling price:
₹22
Variable cost:
₹16
Therefore:
₹22 − ₹16 = ₹6 contribution per foreign unit
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For 8,000 units:
8,000 × ₹6
= ₹48,000
Step 3: Contribution lost from home market
Normal home-market selling price:
₹25
Variable cost:
₹16
Normal contribution:
₹25 − ₹16 = ₹9 per unit
But we have to sacrifice 3,000 home-market units.
Therefore, contribution lost:
3,000 × ₹9
= ₹27,000
This ₹27,000 is called the opportunity cost of accepting the larger order.
Step 4: Compare the two
Foreign order gives:
₹48,000 contribution
But we lose:
₹27,000 home-market contribution
Therefore:
₹48,000 − ₹27,000
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= ₹21,000 additional profit
Decision: ACCEPT
The company will be better off by ₹21,000.
Complete Answer
Situation
Calculation
Result
Decision
(i) 5,000 @ ₹18
5,000 × (18−16)
₹10,000 gain
Accept
(a) Customer is
domestic
Risk of affecting ₹25 home price
Market-price
problem
Reject if normal
price is affected
(b) Price ₹15
5,000 × (15−16)
₹5,000 loss
Reject
(c) 8,000 @ ₹22
Foreign contribution ₹48,000 −
lost home contribution ₹27,000
₹21,000 gain
Accept
Why don't we use ₹20 total cost?
This is the biggest thing students usually get confused about.
You may think:
"The total cost is ₹20 and the foreign customer offers ₹18. So ₹18 < ₹20, therefore reject."
That would be wrong in this situation.
Why?
Because ₹20 contains fixed costs.
For example:
Fixed Factory Expenses = ₹2
Office Expenses = ₹1
Fixed Selling Expenses = ₹0.50
These costs will continue even if the special order is rejected.
The company has already committed to these expenses.
Therefore, for a short-term special-order decision, we concentrate on the
relevant/incremental cost.
Relevant cost:
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₹16 per unit
Therefore, an offer of ₹18 is actually profitable.
A simple real-life example
Imagine you own a bakery.
Your bakery can make 100 cakes per day, but you normally make only 70 cakes.
So you have space for another 30 cakes.
Someone comes and says:
"I'll buy 20 cakes, but I'll pay ₹180 per cake."
Your additional cost of making one cake is ₹150.
You don't need to build another bakery or hire permanent staff because you already have
spare capacity.
So:
₹180 − ₹150 = ₹30 extra contribution per cake
20 cakes × ₹30 = ₹600 extra contribution
Even if your complete accounting cost is ₹200 per cake, the order may still be worth
accepting because much of that ₹200 is fixed cost that you're paying anyway.
That's exactly what is happening in this question.
The Three Concepts You Must Remember
1. Idle Capacity
Unused production capacity.
Here:
15,000 − 10,000 = 5,000 units
This allows the company to accept a special order without sacrificing existing sales.
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2. Marginal/Variable Cost
The additional cost of producing and selling one more unit.
Here:
₹8 + ₹6 + ₹1.50 + ₹1 = ₹16
This is the key figure for the special order.
3. Opportunity Cost
When capacity is insufficient, accepting one order means sacrificing another opportunity.
In part (c), the company sacrifices 3,000 home-market units.
Lost contribution:
3,000 × (₹25 − ₹16) = ₹27,000
That is the opportunity cost.
Final Exam-Style Conclusion
(i) The foreign order of 5,000 units at ₹18 should be accepted, because the firm has 5,000
units of idle capacity and the order gives an additional contribution of ₹10,000.
(ii)(a) If the customer is a domestic customer, the order should generally be rejected if it
adversely affects the existing home-market selling price of ₹25, because it may cause a
reduction in normal-market contribution.
(ii)(b) At ₹15 per unit, the order should be rejected, because the variable cost itself is ₹16
per unit, resulting in a loss of ₹1 per unit.
(ii)(c) The order of 8,000 units at ₹22 should be accepted. Since only 5,000 units of capacity
are idle, 3,000 home-market units must be sacrificed. The foreign order provides ₹48,000
contribution, while the lost home-market contribution is ₹27,000. Thus, there is a net
additional contribution/profit of ₹21,000.
Golden Rule:
Spare capacity → compare special-order price with variable cost.
No spare capacity → also consider opportunity cost.
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SECTIOND
7. What is Transfer Pricing?
Explain various methods of transfer pricing.
Ans: Meaning of Transfer Pricing
Imagine a large company has two departments or branches. One department produces a
product, while another department sells that product. When the first department supplies
the product to the second department, they need to decide a price for that internal
transaction.
This price is called Transfer Price, and the process of deciding this price is known as Transfer
Pricing.
In simple words:
Transfer pricing means determining the price at which goods, services, or resources are
transferred from one department, branch, or associated company to another.
For example, suppose ABC Ltd. has two divisions:
Production Division → manufactures a product
Sales Division → sells the product
If the Production Division transfers one product to the Sales Division for ₹500, then ₹500 is
the transfer price.
Simple Diagram
ABC COMPANY
│
┌──────┴──────┐
↓ ↓
Production Sales
Division Division
│ │
│ Product │
└──────→───────┘
₹500
Transfer Price
The main purpose of transfer pricing is to decide a fair and reasonable price for transactions
between different parts of the same organization.
Why is Transfer Pricing Important?
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Transfer pricing is important because different divisions of a company may have separate
costs, revenues and profits.
For example, if the Production Division transfers goods at a very low price, its profit will look
low while the Sales Division may show a very high profit. If the transfer price is very high,
the opposite may happen.
Therefore, a proper transfer price helps management:
Measure the performance of different divisions.
Calculate the profit of each division.
Encourage managers to control costs.
Make better business decisions.
Ensure that transactions between related units are made fairly.
Methods of Transfer Pricing
There are several methods used to determine the transfer price. The important methods are
explained below.
1. Cost-Based Transfer Pricing
Under this method, the transfer price is based on the cost incurred by the supplying
division.
For example, if the Production Division spends ₹400 to manufacture a product, the company
may transfer it to another division at ₹400 or at ₹400 plus some profit.
Example:
Cost of product = ₹400
Profit margin = ₹50
Transfer Price = ₹450
This method is simple and easy to calculate.
2. Market-Based Transfer Pricing
Under this method, the transfer price is based on the market price of the product.
Suppose the same product can be purchased from outside suppliers for ₹600. The company
may use ₹600 as the transfer price between its divisions.
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Example:
Market price = ₹600
Transfer price = ₹600
This method is useful when a competitive market price is easily available.
3. Negotiated Transfer Pricing
Sometimes the buying and selling divisions negotiate with each other and agree on a
transfer price.
For example:
Production Division wants ₹550.
Sales Division is willing to pay ₹500.
After discussion, both agree on ₹525.
Therefore:
Negotiated Transfer Price = ₹525
This method gives managers freedom to decide a price that is acceptable to both divisions.
4. Cost Plus Transfer Pricing
In this method, the transfer price is calculated by adding a fixed profit margin to the cost.
For example:
Cost of production = ₹400
Profit margin = 20% of ₹400 = ₹80
Therefore:
Transfer Price = ₹400 + ₹80 = ₹480
This method ensures that the supplying division receives its cost plus a reasonable profit.
5. Marginal Cost-Based Transfer Pricing
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Under this method, the transfer price is based on the additional or variable cost of
producing one more unit.
For example, if producing an additional product costs ₹300, the transfer price may be based
on ₹300.
This method can be useful when the company has unused production capacity and wants to
encourage internal transfers.
Easy Way to Remember the Methods
TRANSFER PRICING
│
┌───────────────┼───────────────┐
↓ ↓ ↓
Cost-Based Market-Based Negotiated
│ │ │
Cost + Market Agreed
margin price price
│
↓
Cost Plus
│
↓
Marginal Cost
In short:
Method
Basic Idea
Cost-Based
Price is based on cost
Market-Based
Price is based on market price
Negotiated
Divisions mutually negotiate the price
Cost Plus
Cost + predetermined profit
Marginal Cost
Price based on additional/variable cost
Conclusion
Transfer pricing is basically a way of deciding At what price should one part of a company
sell something to another part of the same company? It is important because the transfer
price affects the cost, revenue and profit shown by different divisions.
The simplest way to remember it for an exam is:
Transfer Pricing = Price charged for the transfer of goods, services or resources between
different divisions or related units of an organization.
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8. What is Responsibility Accounting?
Give the features, assumptions and basic principles of responsibility accounting.
Ans: Imagine a large company has different departments, such as Production, Sales,
Purchase, and Finance. If the company simply looks at the total profit, it becomes difficult to
know which department is performing well and which department is responsible for extra
costs.
This is where Responsibility Accounting comes in.
1. What is Responsibility Accounting?
Responsibility Accounting is a system of accounting in which the activities and results of a
business are divided among different responsibility centres, and each manager is held
responsible for the items that are under their control.
In simple words:
Give a manager responsibility for a particular area, measure its performance, and hold
the manager accountable for the results that he or she can control.
For example, suppose a company has a Sales Department. The Sales Manager can control
sales targets, sales expenses and sales staff performance. Therefore, the Sales Manager
should be evaluated mainly on these thingsnot on the company's electricity bill or factory
machinery cost, because those may not be under the Sales Manager's control.
Simple Diagram
COMPANY
│
┌────────────┼────────────┐
↓ ↓ ↓
Production Sales Finance
Department Department Department
│ │ │
Production Sales Financial
Manager Manager Manager
│ │ │
↓ ↓ ↓
Performance Performance Performance
Report Report Report
│ │ │
└────────────┼────────────┘
↓
Overall Performance
2. Features of Responsibility Accounting
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The major features are:
1. Division into Responsibility Centres
The business is divided into different units called responsibility centres.
Examples:
Production Department
Sales Department
Purchase Department
Finance Department
Each centre has a responsible manager.
2. Responsibility is Assigned
A particular manager is made responsible for the performance of his/her department.
For example, the Sales Manager is responsible for achieving the sales target.
3. Performance is Measured
Actual performance is compared with the planned or budgeted performance.
Example:
Budgeted sales = ₹10 lakh
Actual sales = ₹12 lakh
The department has performed better than the target.
4. Controllable and Uncontrollable Costs
Responsibility accounting separates costs into:
Controllable costs: Costs that the manager can influence or control.
Uncontrollable costs: Costs that the manager cannot reasonably control.
A manager should primarily be judged on controllable items.
5. Performance Reports
Each responsibility centre receives a report showing its performance.
The report may contain:
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Budget → Actual Result → Difference (Variance)
This helps management identify problems quickly.
6. Management by Exception
Managers do not need to investigate every small difference. They mainly focus on large or
unusual variances.
3. Assumptions of Responsibility Accounting
The system of responsibility accounting works on some basic assumptions:
1. Managers Can Control Certain Activities
It assumes that managers have some authority over the activities for which they are
responsible.
2. Responsibility Can Be Clearly Defined
The responsibilities of each manager or department can be clearly identified.
3. Performance Can Be Measured
The performance of each responsibility centre can be measured using suitable financial and
non-financial information.
4. Costs and Revenues Can Be Identified
Costs and revenues can be assigned to the appropriate responsibility centre.
5. Managers Should Be Judged Fairly
A manager should be evaluated mainly on factors that are within his or her control.
4. Basic Principles of Responsibility Accounting
The main principles are:
Principle 1: Clear Responsibility
Every responsibility centre should have a clearly identified manager.
One department → One responsible manager
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This makes accountability clear.
Principle 2: Controllability
A manager should be held responsible mainly for controllable costs, revenues and
activities.
For example, if the Sales Manager cannot control factory rent, it would be unfair to blame
the Sales Manager for an increase in factory rent.
Principle 3: Authority and Responsibility Should Go Together
If a manager is given responsibility, he/she should also have enough authority to perform
that responsibility.
For example:
Responsibility: Increase sales
Authority: Manage sales staff, promotions and customer discounts within approved limits.
Giving responsibility without authority is unfair.
Principle 4: Performance Should Be Compared with Standards
Actual results should be compared with:
Budget
Target
Standard
Previous performance
This helps determine whether performance is satisfactory.
Principle 5: Report Important Variances
Large differences between actual and budgeted results should be reported to management.
This is called management by exception.
Principle 6: Timely Reporting
Performance reports should be prepared and provided quickly so that managers can take
corrective action.
Easy Example to Remember
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Suppose a company gives the Sales Manager a target of ₹10 lakh sales.
At the end of the month:
Particular
Amount
Target Sales
₹10 lakh
Actual Sales
₹12 lakh
Difference
₹2 lakh favourable
The Sales Manager has achieved ₹2 lakh more than the target.
Now imagine sales expenses were also ₹50,000 higher than the budget. Management can
investigate why the expense increased and whether that expense was controllable by the
Sales Manager.
This is the basic idea behind responsibility accounting:
Set responsibility → Give authority → Set targets → Measure actual performance →
Compare with target → Analyse variances → Take corrective action.
This paper has been carefully prepared for educational purposes. If you notice any mistakes or
have suggestions, feel free to share your feedback.
