Unit 1: Introduction & ratio analysis
Cost and Management Accounting notes · PTU syllabus (BBA 303-18)
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Unit summary
Managers need accounting information to plan, control and decide — not just to report. This unit covers the nature and scope of management accounting, its difference from cost accounting, cost control versus cost reduction, and the computation of liquidity, solvency, profitability and turnover ratios.
After this unit you can
- Explain the meaning, objectives and scope of management accounting
- Distinguish cost accounting from management accounting and cost control from cost reduction
- Compute and interpret liquidity and solvency ratios
- Compute and interpret profitability and turnover ratios
PTU syllabus topics
- Meaning
- objectives
- nature and scope of management accounting
- difference between cost and management accounting
- cost control and cost reduction
- computation of liquidity
- solvency
- profitability and turnover ratios
Current ratio
Current assets / current liabilities
Ideal about 2:1
Quick ratio
Quick assets / current liabilities
Ideal about 1:1
Debt-equity ratio
Long-term debt / shareholders' funds
Net profit ratio
Net profit / sales × 100
Inventory turnover
Cost of goods sold / average inventory
Topic 1
Meaning, objectives and scope of management accounting
Management accounting is the presentation of accounting information to help management in planning, decision-making and control (Anglo-American Council on Productivity). Objectives: help in planning and policy formulation, interpret financial information, aid decision-making, control performance, motivate employees and communicate information. Scope: financial accounting, cost accounting, budgeting, standard costing, marginal costing, financial analysis, reporting to management and tax planning.
Topic 2
Cost vs management accounting; cost control vs cost reduction
Focus
Ascertaining and controlling cost
Information for all management decisions
Data
Mainly cost data
Cost, financial and non-financial data
Scope
Narrow
Wide
Orientation
Past and present
Present and future
Aim
Keep costs within set standards
Lower costs permanently
Nature
Preventive, routine
Corrective, continuous improvement
Standards
Accepts existing standards
Challenges standards
Topic 3
Liquidity and solvency ratios
Ratio analysis expresses the relationship between two related accounting figures.
Current ratio
Current assets / current liabilities
Ideal about 2:1
Quick (acid-test) ratio
Quick assets / current liabilities
Quick assets = current assets − stock − prepaid; ideal 1:1
Debt-equity ratio
Long-term debt / shareholders' funds
Ideal about 2:1 or lower
Proprietary ratio
Shareholders' funds / total assets
Interest coverage ratio
EBIT / interest
Example
Current assets ₹4,00,000, stock ₹1,00,000, current liabilities ₹2,00,000. Current ratio = 2:1; quick ratio = 3,00,000 / 2,00,000 = 1.5:1.
Topic 4
Profitability and turnover ratios
Gross profit ratio
Gross profit / net sales × 100
Net profit ratio
Net profit / net sales × 100
Operating ratio
(COGS + operating expenses) / net sales × 100
Return on capital employed
EBIT / capital employed × 100
Earnings per share
(Net profit − preference dividend) / number of equity shares
Inventory turnover
Cost of goods sold / average inventory
Debtors turnover
Net credit sales / average debtors
Average collection period
365 / debtors turnover
Creditors turnover
Net credit purchases / average creditors
Fixed assets turnover
Net sales / net fixed assets
Exam tip
Always interpret a ratio: compare it with the ideal, past years or industry average, and state what it means for the business.
Key terms
- Management accounting
- Accounting information for management decisions
- Cost reduction
- A permanent fall in unit cost without lowering quality
- Current ratio
- Current assets divided by current liabilities
- ROCE
- Return on capital employed
- Inventory turnover
- How many times stock is sold in a year
Quick revision
- Management accounting is wider and future-oriented.
- Cost control keeps to standards; cost reduction challenges them.
- Current 2:1, quick 1:1 ideals.
- Profitability: GP, NP, operating, ROCE, EPS; turnover: stock, debtors, creditors.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.Define management accounting.
- Q2.Differentiate between cost control and cost reduction.
- Q3.What is the quick ratio and its ideal value?
- Q4.How is the debt-equity ratio calculated?
- Q5.Define return on capital employed.
Long-answer questions
- Q1.Explain the nature, scope and objectives of management accounting.
- Q2.Compare cost accounting and management accounting.
- Q3.Calculate liquidity, solvency, profitability and turnover ratios from given financial statements and interpret them.
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