Managerial Accounting Study Notes

 Managerial Accounting Syllabus 2023

Chapter 1: Basic Concepts

Forms of Business Organization refer to the different legal structures under which a business can operate. The four main forms of business organization are:

1. Sole Proprietorship: A sole proprietorship is a business owned and operated by a single person. It is the simplest form of business organization and offers the owner complete control over the business. 
2. Partnership: A partnership is a business owned by two or more people who share profits and losses. Partnerships are governed by a partnership agreement, which outlines the rights and responsibilities of each partner.
3. Corporation: A corporation is a separate legal entity that is owned by shareholders and managed by a board of directors. Corporations offer limited liability protection to their shareholders, meaning that the shareholders are not personally liable for the debts and obligations of the corporation.
4. Limited Liability Company (LLC): A Limited Liability Company (LLC) is a hybrid form of business organization that combines the flexibility of a partnership with the limited liability protection of a corporation. LLCs offer the same limited liability protection as a corporation but are taxed like a partnership, meaning that the profits and losses are passed through to the owners and taxed at their individual tax rates.

Accounting is the process of recording, classifying, summarizing, and interpreting financial transactions of a business. It provides a framework for analyzing, measuring, and communicating financial information about a business to its stakeholders, such as investors, creditors, management, and government agencies.

The importance of accounting:

1. Financial Decision Making: Accounting provides financial information that helps businesses make informed decisions about their operations, investments, and financing. It helps in evaluating the profitability and performance of a business and identifying areas for improvement.
2. Compliance with Laws and Regulations: Accounting helps businesses comply with legal and regulatory requirements by providing accurate financial records and reports.
3. Performance Evaluation: Accounting enables the evaluation of the performance of different departments, projects, and products of a business. It helps in identifying areas of strength and weakness, and developing strategies for improving efficiency and profitability.
4. Stakeholder Communication: Accounting provides financial information to stakeholders, such as investors, creditors, and government agencies, to enable them to make informed decisions. It helps in building trust and credibility with stakeholders, and enhancing the reputation of a business.
5. Taxation: Accounting provides accurate financial records and reports that are required for tax purposes. It helps in calculating the tax liability of a business, and in filing tax returns accurately and on time.

Basic concepts and terms used in accounting:

1. Assets: Assets are economic resources owned or controlled by a business that are expected to provide future economic benefits. Examples include cash, accounts receivable, inventory, and property, plant, and equipment.
2. Liabilities: Liabilities are obligations of a business to pay money or provide goods or services in the future. Examples include accounts payable, loans, and taxes owed.
3. Equity: Equity represents the residual interest in the assets of a business after deducting its liabilities. It represents the ownership interest of shareholders in a corporation.
4. Revenues: Revenues are the inflows of economic resources resulting from the sale of goods or services or from other business activities. Examples include sales revenue, interest income, and rental income.
5. Expenses: Expenses are the outflows of economic resources resulting from the consumption of goods or services or from other business activities. Examples include salaries, rent, and utility bills.
6. Accounts Payable: Accounts payable are amounts owed by a business to its suppliers or creditors for goods or services purchased on credit.
7. Accounts Receivable: Accounts receivable are amounts owed to a business by its customers for goods or services sold on credit.
8. General Ledger: The general ledger is the main accounting record that contains all the accounts used by a business. It is used to record all financial transactions and to prepare financial statements.
9. Double Entry Accounting: Double entry accounting is a system of accounting that requires each financial transaction to be recorded in two or more accounts. This ensures that the accounting equation remains in balance.
10. Trial Balance: A trial balance is a statement that lists all the accounts in the general ledger and their balances. It is used to ensure that the total debits equal the total credits, and that the accounting equation is in balance.

Capital Expenditures: Capital expenditures are expenditures that are incurred to acquire or improve a fixed asset, which is a long-term asset that is used in the production of goods or services for a business. Examples of capital expenditures include the purchase of a new building, the installation of a new machine, or the addition of a new wing to an existing building.

Revenue Expenditures: Revenue expenditures are expenditures that are incurred to maintain or operate a fixed asset, or to generate revenue in the current accounting period. Revenue expenditures are expected to provide benefits to the business for only one accounting period. Examples of revenue expenditures include repairs and maintenance of buildings and equipment, and expenses related to advertising, marketing, and sales.

Capital Receipts: Capital receipts are receipts that result from the sale of a capital asset, such as land, buildings, or equipment. They may also include money received from the issuance of new shares, or from long-term borrowing. They are usually non-recurring and have a long-term impact on the financial position of the business. Examples of capital receipts include the sale of a company's building or the issuance of new shares to investors.

Revenue Receipts: Revenue receipts are receipts that arise from the normal operations of a business. They are earned by selling goods or services to customers, or by receiving interest or dividends. Revenue receipts are recurring and have a short-term impact on the financial position of the business. Examples of revenue receipts include the sale of goods or services, interest received on bank deposits, and dividends received from investments.

Users of accounting information:

1. Business owners: Business owners rely on accounting information to monitor the financial performance of their business and make decisions related to investments, expansion, and strategic planning.
2. Investors: Investors use accounting information to evaluate the financial health of a company and make investment decisions. They look at financial statements such as income statements, balance sheets, and cash flow statements to assess the company's profitability, liquidity, and solvency.
3. Creditors: Creditors use accounting information to assess the creditworthiness of a company before extending credit. They look at financial statements and other financial ratios to determine the company's ability to repay its debts.
4. Government agencies: Government agencies such as tax authorities and regulatory bodies use accounting information to ensure compliance with laws and regulations, monitor the financial health of companies, and collect taxes.
5. Employees: Employees use accounting information to assess the financial health of their company and determine their own job security. They may also use accounting information to negotiate salaries and benefits.
6. Customers: Customers may use accounting information to assess the financial health of a company before doing business with them, especially for large purchases or long-term commitments.

key accounting concepts and conventions:

1. Accruals concept: This concept states that revenue and expenses should be recorded in the period in which they are earned or incurred, regardless of when the cash is received or paid.
2. Going concern concept: This concept assumes that the business will continue to operate indefinitely unless there is evidence to the contrary. This assumption underlies the preparation of financial statements on a historical cost basis.
3. Consistency concept: This concept states that accounting methods and principles should be applied consistently from one period to another, unless there is a valid reason to change them.
4. Prudence concept: This concept requires that caution should be exercised when making accounting estimates or valuations, so as to avoid overstating assets or understating liabilities.
5. Materiality concept: This concept states that financial information should be reported if it is likely to influence the decisions of the users of the financial statements.
6. Historical cost convention: This convention requires that assets should be recorded at their original cost, rather than their current market value.
7. Matching concept: This concept requires that expenses should be matched with the revenues they help to generate, in order to determine the net income or loss for a given period.
8. Conservatism convention: This convention requires that losses should be recognized as soon as they are anticipated, while gains should be recognized only when they are realized

Fundamental Accounting Equation: The fundamental accounting equation represents the basic relationship between assets, liabilities, and equity. It is expressed as Assets = Liabilities + Equity. This equation is used to ensure that the accounting equation remains balanced, and any change in one element affects the other two elements.

Journal: A journal is a chronological record of all the financial transactions of a business. It records the date of the transaction, the accounts affected, and the amounts involved. The journal is used to ensure that all transactions are recorded accurately and completely.

Ledger: A ledger is a collection of accounts that contains all the information related to a particular type of transaction. For example, the accounts payable ledger contains information related to all the payments made to suppliers. The ledger is used to summarize the information in the journal and provide a detailed record of all transactions.

Trial Balance: A trial balance is a statement that lists all the accounts and their balances at a particular point in time. It is used to ensure that the total debits and credits are equal and the accounting equation is balanced. The trial balance is prepared before the financial statements are prepared, and any errors are corrected before the statements are finalized.

Chapter 2: Financial Statements

Financial statements are reports that provide information about the financial performance, financial position, and cash flows of an organization. These statements are used by various stakeholders, including investors, creditors, management, and government agencies, to evaluate the financial health of a company.

The most commonly used financial statements include:

1. Balance Sheet: A balance sheet provides a snapshot of a company's financial position at a particular point in time. It shows the company's assets, liabilities, and equity, and is used to assess the company's solvency, liquidity, and financial health.
2. Income Statement: An income statement, also known as a profit and loss statement, shows a company's revenues and expenses over a specific period of time. It is used to determine the company's profitability and to assess its ability to generate profits.
3. Cash Flow Statement: A cash flow statement provides information about a company's inflows and outflows of cash over a specific period of time. It is used to assess the company's ability to generate cash and to meet its cash obligations.
4. Statement of Retained Earnings: A statement of retained earnings shows changes in the company's retained earnings over a specific period of time. It is used to assess the company's dividend policy and to determine the amount of profits that are reinvested in the business.

The importance and objectives of financial statements :

1. Provide information for decision-making: Financial statements provide valuable information that is used by various stakeholders, including investors, creditors, and management, to make informed decisions about the company. 
2. Assess the financial health of a company: Financial statements provide a snapshot of a company's financial position, performance, and cash flows. They are used to assess the company's solvency, liquidity, and financial health.
3. Facilitate financial analysis: Financial statements provide a basis for financial analysis, which is used to evaluate the company's financial performance relative to industry benchmarks and competitors. Financial analysis helps identify trends and areas for improvement, which can guide strategic decision-making.
4. Meet legal and regulatory requirements: Companies are required by law to prepare and publish financial statements that comply with generally accepted accounting principles (GAAP) and other regulatory requirements. Financial statements are used to meet these legal and regulatory requirements.
5. Provide accountability and transparency: Financial statements provide accountability and transparency by showing how the company has used its resources and managed its finances. They provide stakeholders with a clear understanding of the company's financial performance and help build trust and confidence in the company.

Different Particulars in Balance Sheets, P&L and Trading Account

How to prepare Financial Statements

Practical Example:

Chapter 3: Cost Accounting

Cost accounting is a branch of accounting that deals with the measurement, analysis, and reporting of costs associated with a product or service. It provides management with the information needed to make informed decisions regarding pricing, production, and cost control. Here are some basic concepts of cost accounting:

1. Cost: This is the monetary value of resources used or sacrificed to achieve a specific objective. In cost accounting, costs can be classified into various categories such as direct costs, indirect costs, fixed costs, and variable costs.
2. Cost object: This is the item or activity for which costs are being calculated. Cost objects can be products, services, departments, projects, or even customers.
3. Cost center: This is a department, process, or activity within a company that incurs costs but does not generate revenue. Examples include the accounting department, human resources, and maintenance.
4. Cost allocation: This is the process of assigning indirect costs to cost objects. This is done to determine the total cost of producing a product or service.
5. Cost driver: This is the activity that causes costs to be incurred. For example, in a manufacturing company, the cost driver for machine maintenance costs could be the number of hours machines are in operation.
6. Standard cost: This is the predetermined cost of producing a product or service. It includes direct materials, direct labor, and overhead costs.
7. Variance analysis: This is the process of comparing actual costs with standard costs to determine the reasons for any differences. This helps management identify areas for cost reduction and performance improvement.

Cost Centre: This is a department or function within a company that incurs costs but does not generate revenue. Examples include the accounting department, human resources, and maintenance.

Cost Unit: This is the item or activity for which costs are being calculated. Cost units can be products, services, departments, projects, or even customers.

Elements of Cost: The elements of cost include direct material, direct labor, and manufacturing overhead. Direct material refers to the raw materials used in the production process. Direct labor refers to the wages paid to workers who are directly involved in the production process. Manufacturing overhead includes indirect labor, rent, utilities, depreciation, and other indirect costs.

Classification and Analysis of Costs: Costs can be classified into direct costs and indirect costs. Direct costs are costs that can be traced directly to a cost object, while indirect costs are costs that cannot be traced directly to a cost object. Cost analysis involves breaking down costs into their constituent parts and analyzing the factors that contribute to cost variations.

Relevant and Irrelevant Costs: Relevant costs are costs that will be affected by a specific decision, while irrelevant costs are costs that will not be affected by the decision. For example, the cost of raw materials is a relevant cost for a manufacturer considering a new production process, while the company's sunk costs are irrelevant costs.

Differential Costs: Differential costs are the costs that differ between two alternative courses of action. For example, the differential cost of producing a product in-house versus outsourcing it to a third-party supplier would be the difference in cost between the two options.

Sunk Costs: Sunk costs are costs that have already been incurred and cannot be recovered. Sunk costs are irrelevant to future decision-making since they cannot be changed.

Opportunity Cost: Opportunity cost is the value of the next best alternative that is forgone when a decision is made. It represents the cost of choosing one option over another. For example, the opportunity cost of investing in a new project might be the revenue that could have been generated by investing in a different project instead.

Preparation of Cost Sheet:

Example of Cost Sheet:

Chapter 4: Marginal Costing

Marginal costing is a method of costing in which only the variable costs are considered in the calculation of the cost of a product or service. Fixed costs are treated as period costs and are not allocated to the product or service. This method is also known as variable costing or direct costing.

The principles of marginal costing:

1. Only variable costs are considered in the calculation of the cost of a product or service.
2. Fixed costs are treated as period costs and are not allocated to the product or service.
3. The contribution margin is used to cover fixed costs and to generate a profit.
4. The cost-volume-profit (CVP) relationship is used to analyze the impact of changes in volume on profits.

Advantages of marginal costing:

1. Marginal costing provides a better understanding of the cost behavior of a product or service.
2. Marginal costing helps in decision-making, as it provides a clear picture of the contribution margin and the impact of changes in volume on profits.
3. Marginal costing helps in pricing decisions, as it provides a better understanding of the cost structure of a product or service.
4. Marginal costing helps in cost control, as it separates fixed costs from variable costs, making it easier to identify and control costs.

Limitations of marginal costing:

1. Marginal costing does not provide a complete picture of the cost of a product or service, as it ignores fixed costs.
2. Marginal costing may not be suitable for long-term decision-making, as fixed costs are an important part of the cost structure of a product or service.
3. Marginal costing may lead to underutilization of capacity, as it does not allocate fixed costs to the product or service.
4. Marginal costing assumes that the variable cost per unit remains constant, which may not be the case in the long run

Contribution is the difference between the sales revenue and the variable costs of a product or service. It represents the amount available to cover the fixed costs and to generate a profit. Contribution can be calculated per unit or as a total amount.

P/V Ratio stands for Profit-Volume Ratio. It is the ratio of contribution to sales revenue. It represents the percentage of sales revenue that contributes towards covering the fixed costs and generating a profit. The P/V ratio is used to calculate the break-even point and to analyze the impact of changes in volume on profits.

Break-Even Point is the level of sales at which the total revenue equals the total cost, i.e., the point at which there is no profit or loss. It can be calculated in units or in sales revenue. The break-even point is an important tool for analyzing the profitability of a product or service and for making pricing and volume decisions

CVP Analysis is a method of analyzing the relationship between costs, volume, and profits. It involves the calculation of the break-even point, the contribution margin, and the P/V ratio. CVP analysis is used to analyze the impact of changes in volume, price, and cost on profits and to make short-term business decisions.

Short-term business decisions are those decisions that are made to address specific short-term issues or opportunities. Some examples of short-term business decisions are:

1. Product Mix Decisions: Decisions about the mix of products to produce and sell based on the contribution margin, P/V ratio, and demand.
2. Make or Buy (Outsourcing) Decisions: Decisions about whether to produce a component or service in-house or to outsource it based on the cost and quality.
3. Accept or Reject Special Order Decisions: Decisions about whether to accept a special order that is different from the regular orders based on the contribution margin and the impact on capacity.
4. Shutting Down Decisions: Decisions about whether to shut down a product or service line based on the contribution margin and the fixed costs.

Example of marginal costing:

Chapter 5: Budgetary Control & Standard Costing

A budget is a financial plan that outlines the expected income and expenses for a specific period, typically a year. Budgeting is the process of creating and implementing a budget. It involves estimating future revenue and expenses, allocating resources, and monitoring actual performance against the budget.

Advantages of Budgeting:

1. Control of Resources: Budgeting helps to control the use of financial resources by identifying priorities and allocating resources accordingly.
2. Goal Setting: Budgeting helps to set goals and objectives for the organization and to track progress towards achieving them.
3. Planning: Budgeting helps to plan and coordinate activities across different departments and functions.
4. Decision Making: Budgeting provides information that is needed to make informed decisions about resource allocation, pricing, and other key business decisions.

Disadvantages of Budgeting:

1. Time-Consuming: Budgeting can be time-consuming and requires the participation of several people in the organization.
2. Inflexibility: Budgets can be inflexible and may not account for unexpected changes in the business environment.
3. Unrealistic Expectations: Budgets can create unrealistic expectations and put pressure on employees to meet targets that are unattainable.

A cash budget is a budget that focuses on cash inflows and outflows. It is used to forecast cash balances and to ensure that the organization has enough cash on hand to meet its obligations. Cash budgets are important for managing working capital and for making short-term financing decisions.

A flexible budget is a budget that can be adjusted based on changes in volume or other factors. It is useful for analyzing the impact of changes in volume on costs and profits. Flexible budgets are used to provide a more accurate picture of the cost structure of a business and to help make better decisions.

Functional budgets are budgets that focus on specific functions or departments within an organization. Examples of functional budgets include sales budgets, production budgets, and marketing budgets. Functional budgets help to align activities with the overall goals of the organization and to ensure that resources are used efficiently.

Standard costing is a cost accounting system that uses pre-determined standard costs to determine the costs of products or services. Standard costs are estimated costs of materials, labor, and overhead, and they are used to establish a benchmark against which actual costs can be compared.

Advantages of Standard Costing

1. Cost Control
2. Performance Evaluation
3. Pricing Decisions
4. Inventory Valuation

Disadvantages of Standard Costing:

1. Time-Consuming
2. Rigidity
3. Inaccuracies
4. Misleading Information

Cost variance analysis is a tool used by managers to identify and understand the reasons for differences between actual and expected costs. By analyzing these variances, managers can take appropriate corrective actions to improve the efficiency and profitability of the business.

Material variances are the differences between the actual costs of materials used and the expected or standard costs. There are several types of material variances:

1. Material Cost Variance: This is the difference between the actual cost of materials used and the standard cost of materials. It is calculated as Actual Quantity x (Actual Price - Standard Price).
2. Material Rate Variance: This is the difference between the actual price paid for materials and the standard price. It is calculated as Actual Quantity x (Actual Price - Standard Price).
3. Material Usage Variance: This is the difference between the actual quantity of materials used and the standard quantity of materials. It is calculated as (Actual Quantity - Standard Quantity) x Standard Price.
4. Material Mix Variance: This is the difference between the actual mix of materials used and the standard mix of materials. It is calculated as (Actual Mix Percentage - Standard Mix Percentage) x Total Quantity x Standard Price.
5. Material Yield Variance: This is the difference between the actual yield of materials and the expected yield of materials. It is calculated as (Actual Yield - Expected Yield) x Standard Price.

Labour variances are the differences between actual labour costs and the standard labour costs. Labour variances help managers to identify the causes of cost differences and take corrective action

1. Labour Cost Variance: The difference between the actual cost of labour and the standard cost of labour.
2. Labour Rate Variance: The difference between the actual rate paid for labour and the standard rate of labour.
3. Labour Efficiency Variance: The difference between the actual hours worked and the standard hours allowed for the work done.
4. Labour Mix Variance: The difference between the actual mix of labour used and the standard mix of labour allowed.
5. Labour Idle Time Variance: The difference between the actual hours of idle time and the standard hours of idle time allowed.
6. Labour Yield Variance: The difference between the actual output of labour and the standard output of labour allowed.