Ipcc Capsule PDF

Intermediate Course
Intermediate Course
Paper: 1
Accounting
ISBN : 978-81-8441-885-9
Accounting
Module - 1
Board of Studies
The Institute of Chartered Accountants of India
A- 29, ICAI Bhawan, Sector-62, Noida-201309 The Institute of Chartered Accountants of India
Phone : 0120 - 3045930 (Set up by an Act of Parliament)
E-mail : bosnoida@icai.in
Website : http://www.icai.org July/2017/P2118(New) New Delhi
ACCOUNTING
Accounting - A Capsule for Quick Revision
Accounting constitutes a significant area of core competence for Chartered Accountancy students. The
significance of this subject can be judged from the fact that we have a paper on Accounting at every level of
CA course. Accounting papers at Intermediate level under Chartered Accountancy curriculum concentrate on
conceptual understanding of the crucial aspects of accounting and acquaint students with the basic concepts,
theories and accounting techniques followed by different entities. The objective of Paper 1 “Accounting” at
Intermediate level is to acquire the ability to apply specific accounting standards and legislations to different
transactions and events and in preparation and presentation of financial statements of various business entities.
It has always been the endeavour of Board of Studies to provide quality academic inputs to the students.
Keeping in mind this objective, it has been decided to bring forth a crisp and concise capsule for Intermediate
Paper 1 ‘Accounting’. Chapter overview has been provided to present a broad outline of the topic coverage in each
chapter. The significant points of the topics have been presented through pictorial presentations in this capsule
which will help the students in grasping the intricate practical aspects of each topic. This will facilitate the
students to recapitulate the whole concepts within minimum time and efforts in the later stages of preparation.
Although, the capsule has been prepared keeping in view the new and revised scheme of Education and Training
of ICAI, the students of earlier scheme may also be benefitted from it.
This capsule, though, facilitates the students in undergoing quick revision, under no circumstances, such
revisions can substitute the detailed study of the material provided by the BoS.
CHAPTER 1: INTRODUCTION TO ACCOUNTING STANDARDS

Chapter Overview
Concepts & Benefits Accounting Significance of

of Accounting Standards setting List of Accounting
Global Standards
Standards process Standards
International Financial International

Concept of Ind AS Convergence to Reporting Standards as Financial Reporting
Carve Outs IFRS in India global standards Standards (IFRS)
Issuance of Accounting Standards

Standardisation of
Accounting Standards are written alternative accounting
policy documents issued by treatments
Government
ICAI
e.g. (MCA) for corporate
for non corporate entities
entities in consultation
with NACAS Benefits
Comparability of Enhanced
of financial Accounting disclosures
statements Standards
Accounting Standards - Benefits
Recognition Measurement Presentation

of events and of of Disclosures
transactions transactions transactions
and events and events
The Chartered Accountant Student October 2017

ACCOUNTING
Accounting Standards Setting Process Significance of Global Standards

Identification of area
Constitution of study group

Cross
border flow
Preparation of draft and its circulation Lower risk of money
of errors of Global listing
judgment in different
Ascertainment of views of different bodies on draft stock
markets
Finalisation of exposure draft (E.D.)
Reduced
Comments received on exposure draft (E.D.) operational Significance Comparability
challenges of Global of financial
Standards statements
Modification of the draft
Issuance of AS
Greater Elimination
transparency of costly
requirements
List of Accounting Standards Enhanced
1 Disclosure of Accounting Policies
accountability
2 Valuation of Inventories
3 Cash Flow Statement
4 Contingencies and Events Occurring after the Balance Sheet Date
5 Net Profit or Loss for the Period, Prior Period Items and
Changes in Accounting Policies
International Financial Reporting
7 Construction Contracts Standards (IFRS)
9 Revenue Recognition
10 Property, Plant and Equipment
11 The Effects of Changes in Foreign Exchange Rates IFRS issued by Interpretations on IAS/IFRS
IASB issued by IFRS Interpretations
12 Accounting for Government Grants Committee
13 Accounting for Investments
14 Accounting for Amalgamations
15 Employee Benefits IAS issued Interpretations
16 Borrowing Costs by IASC and on IAS issued
adopted by IASB
17 Segment Reporting IFRS by SIC
18 Related Party Disclosures
19 Leases
20 Earnings Per Share
21 Consolidated Financial Statements
22 Accounting for Taxes on Income
23 Accounting for Investments in Associates in Consolidated
Financial Statements
24 Discontinuing Operations International Financial Reporting
25 Interim Financial Reporting
Standards (IFRSs) as Global Standards
26 Intangible Assets
Enhanced
27 Financial Reporting of Interests in Joint Ventures Principle transparency Emergence
IFRSs based set of and as Global
28 Impairment of Assets comparability of
standards Standards
29 Provisions, Contingent Liabilities and Contingent Assets financial
statements
Effectively, there are now only 27 Accounting Standards.
October 2017 The Chartered Accountant Student

ACCOUNTING
Convergence to IFRS in India
Deviation from
corresponding IFRS, if
Indian Accounting
Application of IFRS in required
Convergence Standards (Ind AS)
to IFRS; India considering legal
ICAI
not adoption and other conditions
prevailing in India Decision to have two
sets of Accounting Accounting Standards
standards (AS)
Ind AS Indian Accounting Standards - Benefits

Ind AS are IFRS converged standards issued by
the Central Government with certain carve outs. Globalization Transparency Comparability Enhanced
and of financial of financial Disclosure
Steps for notification Liberalization statements statements requirements
Objectives and Concepts of Carve Outs
Sent to Formulation of Ind AS

Central
Govt. for
Sent to NACAS Notification Departures
for deliberation
Resulting into carve-outs Not resulting into carve-outs

Formulation by
ASB of ICAI
Removal of options in
Deviation from the
accounting principles and
accounting principles
practices in Ind AS vis-a-
stated in IFRS
vis IFRS
Implementation of Ind AS
Voluntary w.e.f.
Corporate 1/4/15
entities
Mandatory w.e.f.
1/4/16
MCA NBFC
1/4/2018
Roadmap by
respective RBI Earlier adoption
Regulators Banking Co 1/4/2018 not allowed
Earlier Ind AS to be implemented from

IRDA Insurance Co. 1.4.2018. However after issuance of IFRS 17,
implementation of Ind AS will be from F.Y.
2020-21

ACCOUNTING
CHAPTER 4: FINANCIAL STATEMENTS OF COMPANIES
Unit 1: Preparation of Financial Statements of Companies
Unit Overview
Meaning of Company
and maintenance of Preparation of Requisites of financial Managerial remuneration
books of accounts financial statements statements of managers
Accounting for Transfer to Declaration

Dividend Divisible profits
Taxes on Income Reserves and payment of
Distribution Tax
dividend
Meaning of Company and Maintenance of Books of Accounts of a Company

As per Section 128 of the Companies Act, 2013
Company as per Section 2(20) of
Every company should prepare and keep
the Companies Act, 2013
at its registered office
books of accounts, relevant books and financial statements
Company Under any Different types on accrual basis and according to double entry system
incorporated previous company of companies as of accounting
under the law (e.g., the defined in the
Companies Act, Companies Act, Companies Act, for every financial year
2013 1956) 2013
giving a true and fair view of the state of the affairs.
Preparation of Financial Statements Requisites of Financial Statements
Schedule
III to the
Statement
Companies
of Profit and
Act, 2013
loss
Cash Flow
Balance Statement
sheet Accounting
Financial
Statements Statutory Financial Standards
as per Section requirements Statements notified by
2(40) MCA
Statement
of changes
in Equity (if
Notes applicable)
and other
statements Guidance
Notes

ACCOUNTING
Managerial Remuneration Schedule V
Managerial
Remuneration (MR) Part I Part II Part III Part IV
Adequacy of profits
Lays down Deals with Specifies the Deals with
conditions to remuneration provisions Central
Calculated as Total MR* < 11% Total MR > 11% of be fulfilled payable to applicable Government’s
Profit % as per of the net profits the net profits as for the managerial to parts 1 power to
Sec. 198 as per Sec. 198 per Sec. 198 appointment person by and 2 of this relax any
of a companies schedule requirements
As per Schedule managing or having profits in this
with the whole-time and also by Schedule.
V and sections As per approval of
under the Section 197 director or companies
the Central a manager having no
Companies Act, Govt.
2013. without the profits or
approval of inadequate
the Central profits.
*Total managerial remuneration payable Subject to Govt.
includes payable to Directors + Managing Schedule V.
director + Whole-time director+ Manager
Remuneration Payable by Companies having no Profit or Inadequate Profit without Central

Government Approval
Where the effective capital is Limit of yearly remuneration payable should not exceed (Rupees)
(i) Negative or less than 5 crores 60 Lakh
(ii) 5 crores and above but less than 100 crores 84 Lakh
(iii) 100 crores and above but less than 250 crores 120 Lakh
(iv) 250 crores and above 120 lakh plus 0.01% of the effective capital in excess of ` 250 crore.
Distribution of
Divisible Profits divisible profit as per
number of shares
The availability of Divisible Profits (available held by share holder
A r m ea s
for distribution) depends on a number of
di ay e o
o rel
st n f
rib ot as
d
factors, e.g., their composition, the amount of

en
ut en set
id
io ta s
iv
provisions and appropriations that must be
n il
D
m a
ay
made out of them in priority, etc.
Declaration of a dividend presupposes that there is a trading profit or a surplus available for distribution,
arrived at after providing for depreciation on assets, not only for the year in which the profits were earned
but also for any arrears of depreciation of the past years. Board of Directors of a company may declare
interim dividend during any financial year out of the surplus in the profit and loss account and out of profits
of the financial year in which such interim dividend is sought to be declared.
Declaration and Payment of Dividend
No Dividend can be declared except out of
Trading profits after Money provided (in pursuance

providing for depreciation of guarantee) by
(a) Current (b) Previous financial Both (a) and Central State
financial year years (b) Government Government
Capital cannot be returned to the shareholders by way of dividend.

No dividend should be declared or paid by a company from its reserves other than free reserves.
ACCOUNTING
Conditions as per Companies (Declaration and Payment of Dividend) Rules, 2014
Should not exceed Average This rule does not apply to a company,
Rate of Dividend rates of dividend in the 3 years which has not declared any dividend in
immediately preceding that year each of the three preceding financial year.
Total amount drawn from

accumulated profits should not as appearing in the latest audited Financial
Amount exceed 1/10 of Paid-up share capital Statements
+ free reserves
Drawn amount should first incurred in the FY in which dividend is

Utilization declared.
be used to set off the losses
After such withdrawal should

not fall below 15% of paid up as appearing in the latest audited
Balance of reserves Financial Statements
share capital
No company should declare dividend

unless carried over previous losses and
Loss or depreciation, whichever is less, in previous years is set off
depreciation not provided in previous year
against the profit of the company for the year for which dividend is
are set off against profit of the company of declared or paid.
the current year.
Transfer to Reserves Disclosure and Presentation of DDT in

Financial Statements
Appropriation of a part of Profit
● Dividend on shares is shown as an appropriation of profit in
the ‘Notes to Accounts’ of the ‘Reserves and Surplus’ item of
the Balance sheet.
● DDT liability relates to distribution of profits as dividends
As per section 123 (1)of As required under law. which are disclosed as appropriation /allocation of profit
the Companies Act, 2013.
in the ‘Notes to Accounts’ of ‘Reserves and Surplus’, it is
appropriate that the liability in respect of DDT should also
be disclosed therein.
Dividend Distribution Tax (DDT)

AS 22 Accounting for Taxes on Income *
Meaning Income
Accounting income as per Taxable income as per

Leviable on books of accounts Income Tax Act
gross dividend /
income
DDT paid Differences between accounting income &

treated as the taxable income that originate in one period
final payment of Addition to the
tax on dividends. income-tax Are they capable of reversal in one or
more subsequent periods?
DDT
No Yes
DDT should be Chargeable in
payable even if respect of the
no income-tax is total income Permanent differences Timing differences
payable of a domestic
The rate is 15% company.
Results in a DTA or a
(excluding 12% No accounting
surcharge* + 3% DTL in B/S and
adjustments form part of the tax
secondary and
higher expenses in P& L A/c
education cess).
*Accounting for Taxes on Income is not covered in syllabus of Paper
1 under earlier scheme.
* In specified cases

ACCOUNTING
Unit 2: Cash Flow Statement
Unit Overview Cash and Cash Equivalents for the Purpose
of Cash Flow Statement
‘Cash’ include: Cash, Bank balances
Meaning of Difference
Definition &
Cash & cash between Preparation
Significance
equivalents operating, of cash flow
of cash flow
and Cash investing and statement as
statement
flow financing per AS 3.
activities.
Definition of Cash Flow Statement
Cash flow statement is a summary of

+
cash receipts and cash payments for
accounting period.
and
Cash equivalents
Significance of Cash Flow Statement
Historical Short term highly liquid

Securities with
changes & Future investments that are
short maturity
requirement readily convertible
period of, say, three
of cash & cash into known amounts
months or less from
equivalents. of cash and subject to
Accuracy date of acquisition
Ability to an insignificant risk of
of past changes in value
assessments generate cash &
of future cash cash equivalents.
flows.
Cash flow
statement Meaning of term Cash Flow
depicts
Indicator
of amount, Operational Cash Flow
timing and efficiency
certainty of of different
future cash enterprises.
flows. Insolvency
and liquidity Inflow from Activities Outflow of Activities
position of an
enterprise.
Cash increase Cash decrease

ACCOUNTING
Classification of Cash Flow Activities
Classification of Cash Flow Activities
Investing activities Financing activities

Operating activities
(acquisition and disposal of long-term (changes in the size and composition of
(principle revenue generating)
assets and other investments) the owner’s equity and borrowings)
Methods (Operating Cash flow)
Direct method Indirect method
Gross cash receipts and gross cash payments Net profit or loss is adjusted instead of
individual items of P & L A/c
Proforma of Cash Flow Statement prescribed by AS 3

Direct Method Indirect Method
Particulars Particulars
Operating Activities: Operating Activities:
Cash received from sale of goods xxx Closing balance of Profit & Loss Account xxx
Cash received from Trade receivables xxx Less: Opening balance of Profit & Loss Account xxx
Cash received from sale of services xxx xxx xxx
Less: Payment for Cash Purchases xxx Reversal of the effects of Profit & Loss Appropriation xxx
Account
Payment to Trade payables xxx
Net Profit after tax xxx
Payment for Operating Expenses xxx
Add: Provision for Income Tax xxx
e.g. power, rent, electricity
Payment for wages & salaries xxx Net Profit Before Tax and Extraordinary Items xxx
Payment for Income Tax xxx xxx Reversal of the effects of non-cash and non-operating items xxx
xxx Effects for changes in Working Capital except cash & xxx
cash equivalent
Adjustment for Extraordinary Items xxx
xxx
Net Cash Flow from Operating Activities xxx
Less : Payment of Income Tax xxx xxx
Net Cash Flow from Operating Activities xxx

ACCOUNTING
CHAPTER 5: PROFIT OR LOSS PRE AND POST INCORPORATION
Chapter Overview Methods for Computation
Apportionment of Close off old books and

Meaning of profit items of incomes and open new books with the
or loss prior to Methods for expenses in pre and assets and liabilities as
incorporation computation post incorporation they existed at the date of
periods incorporation
Meaning of Profit or Loss prior to Incorporation Methods

for computation
Split up the profit Time basis (i)

referred as of the year in which
Pre-Incorporation Such profits or the business has
Profit or loss of Turnover basis (ii)
Profits or Losses losses are of been transferred,
a business
capital nature between ‘pre’ and
‘post’ incorporation Combination
Company came of both (i+ii)
periods
prior to the date into existence disclose them
separately
Apportionment of Items of Incomes and Expenses in Pre and Post Incorporation Periods
Item Basis of Apportionment between Audit Fees Types of Audit

pre and Post incorporation period
Gross Profit or Gross Loss Sales Ratio or Cost of goods (i)For Company’s Audit under Charge to Post-incorporation
sold Ratio or Time Ratio the Companies Act period
Variable expenses linked with (ii)For Tax Audit under the

On the basis of turnover in the
Turnover [e.g. Selling and Sales Ratio Income-tax Act, 1961
respective periods
distribution expenses, etc.]
Fixed Common charges [e.g., Interest on purchase

Salaries, Office etc.] Time Ratio consideration to vendor Time basis
Expenses exclusively relating to (i) For the period from the date
Charge to Pre-incorporation Charge to Pre-incorporation
pre-Incorporation period [e.g. of acquisition of, business to
period period
Interest on Vendor’s Capital] date of incorporation
Expenses exclusively relating to (ii) From the date of

Charge to Post-incorporation Charge to Post-incorporation
post-incorporation period [e.g. incorporation
period period
interest on debentures etc.]

ACCOUNTING
CHAPTER 6: ACCOUNTING FOR BONUS ISSUE AND RIGHT ISSUE*
Chapter Overview
Accounting
Value of treatment
Right
Right Issue
& its Effects
Provisions of the
Companies Act,
2013
Definition of Bonus
Shares & its Effects
Authorised
by its articles
Partly paid-up
shares, if any Authorised
Definition of Bonus issue outstanding in the general
meeting of the
are made fully
paid-up company
Issue of shares Conditions
at no cost Based upon That the for issue of
to current the number shareholder bonus shares
shareholders in of shares already owns
a company Company not
Company not defaulted in
defaulted for payment of interest
payment of / principal of fixed
statutory dues of deposits/ debt
Provisions of the Companies Act the employees securities issued
by it
Section 63 allows companies to issue

fully paid-up bonus shares from
Free reserves
Effects of Bonus Issue
Securities premium
Increase in share capital
Capital redemption reserve Reduction in EPS and other
per share values
Favourable act considered by
markets
Adjustment in market price
Out of
Can’t be reserves in lieu of
Bonus shares Reduction in accumulated
issued created by dividend
profits
revaluation
of assets
*Right Issue is not covered in the syllabus of Paper 1 under the

earlier scheme.
ACCOUNTING
Accounting Entries Effects of Right Issue
Upon the sanction of an issue of bonus shares Maintenance of existing
Dilution in the value of share.
shareholders’ proportional
● Debit Capital Redemption Reserve Account holding in company and retain
● Debit Securities Premium Account their financial and governance
rights
● Debit General Reserve Account
● Debit Profit & Loss Account Effects
● Credit Bonus to Shareholders Account. of Right
issue
Upon issue of bonus shares
Image enhancement Convenience in handling
● Debit Bonus to Shareholders Account issue
● Credit Share Capital Account.
Upon the sanction of bonus by converting partly paid shares
into fully paid shares
Conditions for right issue as per the
● Debit General Reserve Account Companies Act
● Debit Profit & Loss Account
● Credit Bonus to Shareholders Account.
On making the final call due After the expiry of
the time specified
● Debit Share Final Call Account Notice specifying Offer to include a in notice or on
● Credit Share Capital Account. the number of right exercisable receipt of earlier
shares offered and by the person intimation from
On adjustment of final call
limiting a time not concerned to person that he
● Debit Bonus to Shareholders Account being < 15 days and renounce the declines to accept the
● Credit Share Final Call Account. not > 30 days from shares offered to shares offered, BoD
the date of the offer him unless articles may dispose of them
provide otherwise in a manner which is
not disadvantageous
to shareholders and
Definition of Right Issue; Value of Right and company
Right of Renunciation
The existing shareholders have a right to subscribe to any
fresh issue of shares by the company in proportion to their
existing holding for shares.
Situations when Right shares are offered
Employees under a scheme Any persons, either for cash or

of ESOP for a consideration other than
Cum-right Ex-right
Value of cash, if the price of such shares is
value of Less value of determined by registered valuer
right = share share
Situations when shares can be offered,
without being offered to the existing
shareholders, provided the company
has passed a special resolution and
shares are offered to
When companies borrow money When loan has been obtained from
through debentures / loans and the government, and government
give their creditor an option to buy in public interest, directs the
[Cum-right (Existing equity shares of a company. debentures / loan to be converted
value of the Number into equity shares.
Ex-right existing shares Divided by
of shares +
value of the + (Rights shares Number of
shares = X Issue Price)] right shares)
Accounting treatment
Right of renunciation refers to the right of the sharehold-

Same as Bank A/c Equity share
er to surrender his right to buy the securities and transfer
ordinary debited capital A/c
such right to any other person. share credited

ACCOUNTING
CHAPTER 9: INVESTMENT ACCOUNTS
Chapter Overview Categories of Investments
Categories of
Investment on the
Definition basis of Income
Cost &
Disposal Carrying
amount
Fixed income Variable income
bearing scrips bearing scrips
Investment
Accounts
Classification Accounting
Securities having Securities having
& for
fixed return of variable return of
Reclassification purchase
income income
and sale
Accounting
for Right
& Bonus e.g. Government
securities; debentures e.g. Equity shares
Shares
or bonds
Definition of Investments Cost of Investments

Investments are assets held
by an enterprise Type of acquisition Cost
for earning income for capital appreciation or Payment Cash price including charges such as
for other benefits in Cash/ bank brokerages, fees and duties
Dividend
By Issue of shares/ Fair value of securities issued
other securities
Assets held as Stock-in-
Interest trade are not ‘Investments’.
Fair value of asset given up or
In exchange for fair value of investment acquired,
another asset whichever is more clearly evident
Rentals
Classification and Carrying Amount of Investments
Current Investments
(readily realisable and intended Carried at lower of cost and
to be held for not more than fair value
Classification of one year)
Investments as per
AS 13
Long Term Investments Carried at cost

(other than Current)

ACCOUNTING
Accounting in the Books at the Time of Accounting for Income on Investments
Purchase and Sale of Investments
Particulars Value in ‘capital’ column of Investment Accounting of
Account Interest accrued/Dividend Declared
Purchase Sale
Transaction Purchase price of Entire sale proceeds i.e.,
on ex-interest investment, i.e., no no impact of accrued
basis impact of interest interest (from the date Pre-acquisition period Post-acquisition period
accrued up to the date of last payment to the
of transaction date of sale)
Transaction Purchase price of Sale proceeds, net of
Deducted Recognized as
on cum- investment less accrued interest (from from cost of an income
interest basis accrued interest up to the date of last payment investment
the date of transaction to the date of sale)
Accounting for Right Shares and Bonus Reclassification of Investments

Shares
Accounting for
Reclassification
of Investments
Right shares Bonus
Long-term to Current to
Subscribed Not subscribed, No amount is Current Long-term
Cost of shares but sold entered in the
added to carrying Sale proceeds capital column of
amount taken to P&L A/c investment account.
Transfer at lower Transfer at Lower

If acquired on cum-right basis & the market value of of cost & carrying of cost & fair
amount at the date value on the date
investments immediately after their becoming ex-right of transfer
is lower than the cost for which they were acquired, the of transfer
sale proceeds of rights is applied to reduce the carrying
amount of such investments to the market value.
Disposal of Investments
Part of investment is Investments held as

Difference between the disposed: stock-in-trade:
carrying amount and
the disposal proceeds, Carrying amount is
net of expenses is allocated to that part Cost of stocks
recognised in the on the basis of average disposed = formula as
P & L statement. carrying amount of per AS 2.
total investment.

ACCOUNTING
CHAPTER 10: INSURANCE CLAIMS FOR LOSS OF STOCK AND LOSS OF PROFIT
Chapter Overview Claim for Loss of Stock

Amount of claim in case goods are
fully insured
Significance Meaning of Claim for loss Important

of insurance Fire of stock and terms
Loss of profit Total Loss Partial Loss
policy
Actual loss
Significance of Insurance Policy Amount of claim

in case of Under
insurance
Loss
Contract of
of stock indemnity
Total Loss Partial Loss
Insurance
claims
Restricted Without With Average
Loss of Loss due to the policy Average clause Clause
profit to fire, amount
flood, theft, Loss of stock x
earthquake Actual loss Or
Sum insured sum insured /
etc. Insurable amount
whichever is lower
(Total cost)
Important Points
Meaning of Fire
Spontaneous fomentation Stock records are  Value of the stock as at the date of the fire
or heating or any process maintained can be easily arrived.
involving application
Fire not occasioned of heat
or happening through Stock records are  Trading Account is prepared. After allowing
not available or are for the usual gross profit, closing stock
Earthquake, riot, civil destroyed by fire ascertained as balancing item.
commotion, war, etc.
 Trading Account preparation is difficult.
Books of account Information is obtained from the customers
Lightning
are destroyed and suppliers to ascertain the amount of sales
Fire
and purchases.
Boilers used for domestic
purposes only  Damaged stocks are subrogated to the
Insurance company insurance company. Subrogation is the right
makes payment of an insurer to legally pursue a third party
Any other boilers on the
Explosion not that caused an insurance loss to the insured.
premises
occasioned or
happening through
In a building, not being  Cost of such stock credited to the Trading
any gas works or gas Salvaged stock is Account and debited to a salvaged stock
for domestic purposes made saleable after account. The expenses on reconditioning
or used for lighting or it is reconditioned debited and sales credited to this account, final
heating balance being transferred to the P & L A/c

ACCOUNTING
Loss of Stock Important Terms
Particulars Amount Claim for Loss The Loss of Profit Policy normally covers
of Profit the following items:
Value of stock on the date of fire xxx (1) Loss of net profit
Less:- Value of Salvaged stock xxx (2) Any increased cost of working
Amount of loss of stock xxx Gross Profit Net profit +Insured Standing charges
OR
Insured Standing charges – [Net Trading
Particulars Amount Loss (If any) X Insured Standing charges/
All standing charges of business]
Value of salvaged stock xxx
Add: Expenses on re-conditioning xxx Net Profit The net trading profit (exclusive of all
capital receipts and accretion and all
Less: Sales xxx outlay properly chargeable to capital)
resulting from the business of the Insured
Profit/(loss) xxx
at the premises after due provision has
been made for all standing and other
charges including depreciation.
Claim for Loss of Profit Insured Interest on Debentures, Mortgage Loans

Standing and Bank Overdrafts, Rent, Rates and
Loss of Profit (consequential loss) Policy Charges Taxes (other than taxes which form part
of net profit) Salaries of Permanent
Staff and Wages to Skilled Employees,
Boarding and Lodging of resident
Directors and/or Manager, Directors’
Fees, Unspecified Standing Charges.
Any increased cost of
Loss of net profit
working
Rate of Gross The rate of Gross Profit earned on
Profit turnover during the financial year
immediately before the date of damage.
Business is interrupted e.g., Renting of temporary Annual The turnover during the twelve months
due to damage of premises premises Turnover immediately before the damage.
(adjusted)
Standard The turnover during that period (in the
(i)Reduction in Turnover twelve months immediately before the
turnover, and date of damage) which corresponds with
loss of the Indemnity Period.
Insurance limited gross
for Loss of to profit due
Profit to Indemnity The period beginning with the occurrence
Period of the damage and ending not later than
(ii) Increase
in the cost of twelve months.
working

ACCOUNTING
CHAPTER 11: HIRE PURCHASE AND INSTALMENT SALE TRANSACTIONS
Chapter Overview Important Terms Used in Hire Purchase

Arrangements and Instalment Payment System
Accounting for sales Distinction
between sales Hire Person who delivers the goods along with its possession
Meaning under Instalment Vendor to the hire purchaser under a hire purchase agreement.
payment system under Hire
purchase and
Instalment Hire Person who obtains the goods and rights to use the same
payment Purchaser from hire vendor under a hire purchase agreement.
system
Amount to be paid by the buyer on outright purchase in
Cash Price cash.
Repossession and
Important Recording the value of Initial payment made to the hire vendor by the hire
Down purchaser at the time of entering into a hire purchase
terms repossessed goods Payment agreement.
Amount which the hire purchaser has to pay after

Hire a regular interval upto certain period as per the
agreement to obtain the ownership of the asset
Purchase purchased (on payment of the last Instalment). It
Accounting for hire Instalment
Ascertainment comprises of principal amount and the interest on the
purchase transactions unpaid amount.
of Cash price in books of Hire
and Interest Purchaser and Hire
vendor Total sum payable by the hire purchaser to obtain the
Hire ownership of the asset purchased under hire purchase
purchase agreement. It comprises of cash price and interest on
price outstanding balances.
Sales under Hire Purchase and Instalment
Payment System If the hire purchaser fails to pay any of the instalments,
Repossession the hire vendor takes the asset back in its actual form.
Sales This act of recovery of possession of the asset is termed
as repossession.
Ascertainment of Cash Price

On full On Instalment
payment
(in Cash or Calculation of cash
Credit) price and Interest
Hire Instalment
Purchase
Without using annuity table With the help of annuity table

Transfer of
Ownership (Interest included in each (Cash price = Down
at the time of Agreement Agreement instalment is calculated from payment + Present value of
sale of Hiring of Sale
an appropriate formula) instalments)
Ownership Ownership Accounting for Hire Purchase Transactions

transfer on transfer on
payment payment
of first
Books of Hire Purchaser
of last
Instalment Instalment
Methods
Cash Price Method Interest Suspense Method

Parties Parties
At the time of transfer of

Full cash price of possession of asset, total interest
asset is debited to unaccrued is transferred to
Hire Hire Asset Account and interest suspense account.
Purchaser Vendor Buyer Seller
credited to Hire
Vendor Account At later years, as and when
interest becomes due, interest
account is debited and interest
suspense account is credited.

ACCOUNTING
Journal Entries To Asset Account
Cash Price Method For closing interest and depreciation account
Profit and Loss Account Dr.
At the time of entering into the agreement
To Interest Account
Asset Account Dr. [Full cash price]
To Depreciation Account
To Hire Vendor Account
When down payment is made
Hire Vendor Account Dr. [Down payment] Books of Hire Vendor
To Cash/Bank Account
When an instalment becomes due
Interest Account Dr. [Interest on outstanding balance]
Accounting for
When an instalment is paid Hire-Purchase
in the books
Hire Vendor Account Dr. [Amount of instalment] of Hire Vendor
(Seller)
To Bank Account
When depreciation is charged on the asset
Methods
Depreciation Account Dr. [Calculated on cash price]
To Asset Account
For closing interest and depreciation account Interest Suspense
Sales Method Method
Profit and Loss Account Dr.
To Interest Account
To Depreciation Account Hire purchase sale is Hire purchaser is
treated as a credit sale, debited with full cash
subject to payment in price and total interest
instalments included in the selling
price.
Interest Suspense Method
When the asset is acquired on hire purchase Journal Entries
Asset Account Dr. [Full cash price] Sales Method
To Hire Vendor Account When Goods are sold and delivered
For total interest payment Hire Purchaser Account Dr. [Full cash price]
H.P. Interest Suspense Account Dr. [Total interest] To H.P. Sales Account
When the down payment is received
Bank Account Dr.
When down payment is made
To Hire Purchaser Account
Hire Vendor Account Dr. When an instalment becomes due
To Bank Account Hire Purchaser Account Dr.
For Interest of the relevant period To Interest Account
When the amount of instalment is received
Interest Account Dr. [Interest of the relevant
period] Bank Account Dr.
To H.P. Interest Suspense Account To Hire Purchaser Account

For closing interest Account
When an instalment is paid
Interest Account Dr.
Hire Vendor Account Dr.
To Profit and Loss Account
To Bank Account For closing Hire Purchase Sales Account
When depreciation is charged on the asset H.P. Sales Account Dr.
Depreciation Account Dr. [Calculated on cash price] To Trading Account

ACCOUNTING
Interest Suspense Method
When Goods are sold and delivered For interest of the relevant accounting period
Hire Purchaser Account Dr. [Full cash price Interest Suspense Account Dr.
+ total interest] To Interest Account
For closing interest Account
To H.P. Sales Account [Full cash price] Interest Account Dr.
To Interest Suspense Account [Total Interest] To Profit and Loss Account
When down payment/instalment is received For closing Hire Purchase Sales Account
H.P. Sales Account Dr.
Bank Account Dr.
To Trading Account
To Hire Purchaser Account
REPOSSESSION
I COULDN’T PAY
THE INSTALMENT THEY
REPOSSESSED
MY ASSET
Repossession
Books of Hire Purchaser Books of Hire vendor
Hire Vendor A/c Dr.

To Asset A/c Goods Repossessed A/c Dr.
To Hire Purchaser
Complete Partial Vendor may incur further

expenses and sell at profit or loss
Hire vendor repossesses Hire vendor repossesses part of

all the goods the goods & Balance of goods
remains with the purchaser.
Loss on surrender
If the repossessed value For remaining portion of asset
is < book value
Application of usual rate

of depreciation
Asset in books af W.D.V
Accounting Treatment of Sales Under Instalment Payment System

Books of buyer Books of Seller
Asset A/c Dr. Full cash price Purchaser Dr. Full Instalment price
Interest Suspense A/c Dr. Full Instalment price less cash price To Sales A/c cash price
To Vendor Full Instalment price To Interest Suspense A/c Full Instalment price less cash price

ACCOUNTING
Differences Between Sales Under Hire Purchase And Instalment System
Basis of Distinction Hire Purchase Instalment System
Governing Act It is governed by Hire Purchase Act,1972. It is governed by the Sale of Goods Act, 1930.
Nature of Contract It is an agreement of hiring. It is an agreement of sale.
Passing of Title (ownership) The title to goods passes on last payment. The title to goods passes immediately as in the
case of usual sales.
Right to Return goods The hirer may return goods without further payment Unless seller defaults, goods are not returnable.
except for accrued instalments.
Seller’s right to repossess The seller may take possession of the goods if hirer The seller can sue for price if the buyer is in
is in default. default. He cannot take possession of the goods.
Right of Disposal Hirer cannot hire out, sell, pledge or assign entitling The buyer may dispose of the goods and give
transferee to retain possession as against the hire vendor. good title to the purchaser.
Responsibility for Risk of Loss. The hirer is not responsible for risk of loss of goods The buyer is responsible for risk of loss of goods
if he has taken reasonable precaution because the because ownership has transferred.
ownership has not yet transferred.
Name of Parties involved The parties involved are called Hirer and Hire vendor. The parties involved are called buyer and seller.
Component other than cash price. Component other than Cash Price included in Component other than Cash Price included in
instalment is called Hire charges. Instalment is called Interest.
CHAPTER 14: ACCOUNTS FROM INCOMPLETE RECORDS
Chapter overview Features

Definition of Single Entry System and its features
Inaccurate,
unscientific and
Types of Single entry system unsystematic
Cash book
mixes up business No record of
Determination of profit by comparing capitals at different points
and personal real and personal
of time
transactions accounts
of the owners
Features of
Statement of Affairs and its comparison with Balance sheet Single Entry
System
Technique of obtaining complete information for
preparation of financial statements No uniformity in Record is kept for
maintaining the cash transactions
records
Estimate of
Definition of Single Entry System profits and financial
position based on
The term “Single Entry System” is popularly used to describe available
the problems of accounts from incomplete records. information
Types of Single Entry System

Types of single entry system
Ignores con-
Single Entry
cept of duality
System
Simple single Quasi single
Pure single entry
entry entry
» Followed by Personal accounts,

Only personal Personal accounts
Sole trading con- cash book and
accounts are and cash book are
cerns or Partner- subsidiary books
maintained maintained
ship firms are maintained

ACCOUNTING
Ascertainment of Profit by Capital Comparison at Different Points of Time
Closing
Capital
Net Worth
method or Less
Statement
Profit/ Loss
of Affairs
Method. Opening
Capital
Particulars ` Design of statement of affairs

Capital at the end (a) ………. Statement of affairs as on...........
Add: Drawings …………. Liabilities ` Assets `
Capital (Bal. Fig.) xx Building xx
Less: Fresh capital introduced ………….
Loans, Bank overdraft xx Machinery xx
Capital at the beginning (b) ……….. Sundry creditors xx Furniture xx
Profit/Loss (a-b) …………. Bills payable xx Inventory xx
Outstanding expenses Sundry debtors xx
Bills receivable xx
Loans and advances xx
Preparation of Statement of Affairs Cash and bank xx
Prepaid expenses xx
xx xx
Bank pass
book for Distinction between Statement of Affairs
bank and Balance Sheet
balance
Basis Statement of affairs Balance sheet
It is prepared on the basis of It is based on
List of fixed transactions partly recorded transactions recorded
assets for
statement of Personal Reliability on the basis of double entry strictly on the basis
Sources ledger for book keeping and partly on of double entry book
affairs utilized by debtors, the basis of single entry. keeping.
accountant creditors In this statement, capital is Capital is derived from
merely a balancing figure the capital account in
being excess of assets over the ledger and total of
Capital
capital. Hence assets need assets side will always
not be equal to liabilities. be equal to the total of
Cash book Inventory liabilities side.
for cash by actual Since this statement is All items are properly
balance counting, prepared on basis of recorded. It is easy to
valuation. incomplete records, it is locate missing items
Omission
difficult to locate assets and since the balance sheet
liabilities, if they are omitted will not agree.
from the books.
The valuation of assets is The valuation of assets
{
Sources utilized by Basis of generally done in an arbitrary is done on scientific
Collection of necessary Valuation manner; no method of basis. Method of
Accountant information about assets and
liabilities valuation is disclosed. valuation is disclosed.
The object of preparing this The object of preparing
statement in the calculation the balance sheet is to
Derivation of
opening and
closing capitals
{ Statement of Affairs
different points of time
at Objective of capital figures in beginning
and at end of accounting
period respectively.
ascertain the financial
position on a date.

ACCOUNTING
Techniques of Obtaining Complete Accounting Information
Incomplete Completion Preparation Preparation

books of of double Accounting of Trial of
accounts entry in all process Balance Financial
transactions Statements
General
Techniques
Fresh
Investment
by
proprietors/
partners
Techniques Derivation of
of obtaining Information
complete from Cash
accounting Book
information
Distinction
between
Business
Expenses and
Drawings Analysis of
Sales Ledger,
Purchase Ledger
and Nominal
accounts

Intermediate Course
Intermediate Course
Paper: 3
Cost and Management Accounting

Cost and
ISBN : 978-81-8441-881-1
Management
Accounting
Module - 1
Board of Studies
COST AND MANAGEMENT ACCOUNTING
Cost and Management Accounting - A Capsule for Quick Revision
In contemporary business environment, existence of an entity depends on the way it tackles the challenges
posed by the competitive market conditions. Cost leadership being one of the competitive strategies, gives
an added advantage to the entity. Cost being an important aspect for survival and growth in business,
requires a mandatory awareness about the cost control and cost reduction. Fourth industrial revolution,
also known as Industry 4.0, puts more emphasis on the digitization of information for effective decision-
making, which enables an entity in keeping ahead in competition. Cost and Management accounting, a
discipline of accounting, capacitates an entity in taking timely decisions by provisions of cost, profitability
and other relevant information.
Chartered Accountants, as a global business solution provider, play an important role in business, have
an onus by helping an entity to achieve its long-term objectives. In this direction, Cost and Management
Accounting helps Chartered Accountants in taking timely and informed business decisions. In view of
nobility of the objective to provide quality academic inputs to the students of CA course, the Board of
Studies (BoS) of ICAI has decided to bring forth a capsule module of Cost and Management Accounting.
Although, the capsule has been prepared keeping in view the new and revised Scheme of Education and
Training of ICAI, the students of earlier Scheme may also be benefitted from it.
In the beginning, a chapter overview has been provided to present a holistic viewpoint on the topic’s coverage.
This capsule, though, facilitates the students in undergoing quick revision, under no circumstances; such
revisions can substitute the detailed study of the material provided by the BoS.
Remember, “The expert in anything was once a beginner”. Now, let us begin.
Introduction to Cost and Management Accounting

Chapter Overview
Objectives of Cost Scope of Cost Role & Functions of Users of Cost

and Management and Management Cost and Management and Management
Accounting Accounting Accounting Accounting
Cost Relationship of Cost and

Cost Responsibility Cost
Accounting Management Accounting with
Classification Centres Object
using IT other accounting disciplines
Meaning of Terms used in Cost and Management Accounting

First of all, let us discuss the meaning of various terminologies used in Cost and Management Accounting to have
a clear understanding about the subject.
Cost Cost Management Cost

Cost Costing Accounting Accountancy Accounting Management
Cost It is an
The amount Costing is Accountancy has Management application of
of expenditure defined as the been defined as accounting is management
It is the the application accounting
incurred on or technique and the application
process of of costing and concepts,
attributable to a process of of the principles
accounting for cost accounting methods of
specified article, ascertaining of accounting
cost. principles, collections,
product or costs. and financial
activity. methods and management. analysis and
techniques. presentation of
data.
The Chartered Accountant Student September 2017

Objectives of Cost Accounting
There are many objectives of cost accounting. The main objectives are explained as below. We also need to keep
our focus on understanding the difference between Cost Control and Cost Reduction.
Ascertainment of Cost: The main objective of cost and management accounting is accumulation
and ascertainment of cost. Costs are accumulated, assigned and ascertained for each cost object.
Objectives of Cost Accounting
Determination of Selling Price and Profitability: The cost and management accounting system
helps in determination of selling price and thus profitability of a cost object.
Cost Control: Maintaining discipline in expenditure is one of the main objectives of a good cost and
management accounting system. It ensures that expenditures are in consonance with predetermined
set standard and any variation from these set standards is noted and reported on continuous basis.
Cost Reduction: It may be defined “as the achievement of real and permanent reduction in the
unit cost of goods manufactured or services rendered without impairing their suitability for the use
intended or diminution in the quality of the product.”
Assisting management in decision making: Cost and Management accounting by providing

relevant information, assist management in planning, implementing, measuring, controlling and
evaluation of various activities.
Scope of Cost Accounting Role and Functions of Cost and

We also need to know various scopes of cost accounting. Management Accounting
Cost ascertainment and the process of cost accounting
are the major scopes. The other scopes are presented. Role of a Cost and Functions of Cost and
Management Accounting Management Accounting
system System
Provide relevant Collection and

information to management accumulation of cost for
for decision making each element of cost
Cost Analysis
Assigning costs to cost
Assist management for objects to ascertain cost.
planning, measurement,
Sets budget and standards
evaluation and controlling of
for a particular period
business activities or activity beforehand
Statutory and these are compared
Cost
Compliances Scope with the assigned and
Comparisons
of Cost Help in allocation of cost ascertained cost.
Accounting
to products and inventories
for both external and Provision of relevant
internal users. information to the
management for decision
making.
Cost Cost
Control To gather data like time
Reports taken, wastages, process
idleness etc., analyse the
data, prepare reports and
take necessary actions
September 2017 The Chartered Accountant Student

Users of Cost and Management Accounting Relationship of Cost Accounting,
Cost and Management Accounting information
Management Accounting, Financial
which are generated or collected are used by various
Accounting and Financial Management
stakeholders. The users of the information can be There is a close relationship between various disciplines
broadly categorized as below: like Cost Accounting, Management Accounting,
Financial Accounting and Financial Management.
Sometimes these disciplines are interrelated and
Internal External dependent on each other also.
Users Users
Managers Regulatory
Authorities
Operational Auditors
level staffs
Employees Shareholders
Creditors and
Lenders
Essentials of a good Cost Accounting System

The essential features which a cost accounting system should possess are depicted as below:
Informative and Accurate and Uniformity and Integrated and Flexible and Trust on the
simple authentic consistency inclusive adaptive system
Cost Accounting using Information Cost Objects

Technology It is very important to understand the meaning of
With the use of information technology, the cost cost object, cost unit and cost driver. Their meaning
accounting system gets integrated and automated. The alongwith examples are illustrated below.
basic features are depicted as below:
Cost Object: Cost object is anything for which
a separate measurement of cost is required. Cost
object may be a product (book), a service (airline),
a project, a customer, a brand category etc.
Enterprise Resource Internet (including intranet
Planning (ERP) and extranet)
Cost Accounting
using IT Cost Units: It is a unit of Cost Drivers: A Cost driver
product, service or time (or is a factor or variable which
combination of these) in effect level of cost. Example
relation to which costs may for a purchase department is
Paperless Environment Just-in-Time (JIT)
be ascertained or expressed. number of purchase orders.
Example for power industry is
kilo Watt hour (kWh).

Responsibility Centres
To have a better control over the organisation, management delegates its responsibilities and authorities to various
departments or persons, which are known as responsibility centres. There are four types of responsibility centres
as discussed below:
Responsibility Centres
Cost Centres: Revenue Centres: Profit Centres: Investment Centres:

The responsibility centre Which are accountable for Which have both Which are not only
which is held accountable generation of revenue for responsibility of generation responsible for profitability
for incurrence of costs the entity. Example- Sales of revenue and incurrence but also has the authority
which are under its control. Department. of expenditures. Example- to make capital investment
Decentralised branches of decisions. Example-
an organisation. Maharatna, Navratna and
Miniratna.
Standard Cost Centre: Discretionary Cost

Cost Centre where output Centre:
is measurable and input The cost centre whose
required for the output can output cannot be measured
be specified. in financial terms.
Classification of Cost
Classification of cost basically means grouping of cost according to their common features. The important ways of
classification of cost are illustrated as below:
Classification of Cost
By Nature By Variability By By Costs for

or Element By Functions By Normality Managerial
or Behaviour Controllability
Decision Making
(i) By Nature or Element

ELEMENTS OF COST
Material Cost Labour Cost Other Expenses
Direct Indirect Direct Indirect Direct Indirect

Material Cost Material Cost Labour Cost Labour Cost Expenses Expenses
Overheads
Production Administration Selling and Distribution

Overheads Overheads Overheads

(ii) By Functions (iv) By Controllability
Direct Materials
Direct Employees Controllable Costs: Cost that can be controlled
Prime Cost
(Labours)
Direct Expenses Uncontrollable Costs: Costs which cannot be influenced
Indirect Factory Overheads or controlled
Material Factory Cost or Works Cost
Administration
Indirect Overheads Cost of Goods Sold
Labour (v) By Normality
Selling and Distribution
Indirect Overheads
Expenses Cost of Sales
Normal Cost - It is the cost which is normally incurred
(iii) By Variability or Behaviour

Abnormal Cost - It is the cost which is not normally incurred
Fixed Cost Variable Cost Semi-variable Cost
(vi) By Cost for Managerial Decision Making
(j) Out-of- It is that portion of total cost, which involves

(a) Pre A cost which is computed in advance before pocket Cost cash outflow
determined production or operations start
Cost
Those costs, which continue to be incurred

(k) Shut down even when a plant is temporarily shut-down
A pre-determined cost, which is calculated
(b) Standard Costs e.g. rent, rates, depreciation, etc
from managements ‘expected standard of
Cost efficient operation’ and the relevant necessary
expenditure
Historical costs incurred in the past are
(l) Sunk Costs known as sunk costs. They play no role in
The amount at any given volume of output decision making in the current period.
(c) Marginal by which aggregate costs are changed if the
Cost volume of output is increased or decreased by
one unit
(m) Absolute These costs refer to the cost of any product,
Cost process or unit in its totality.
The expected cost of manufacture, or
(d) Estimated acquisition, often in terms of a unit of product
Cost computed on the basis of information
available in advance of actual production or Such costs are not tied to a clear cause
purchase (n) Discretionary
and effect relationship between inputs and
Costs
outputs.
It represents the change (increase or decrease)
(e) Differential
in total cost (variable as well as fixed) due to
Cost
change in activity level, technology, process or
method of production, etc. These are the costs, which are not assigned
(o) Period Costs to the products but are charged as expenses
against the revenue of the period in which
they are incurred.
(f) Imputed These costs are notional costs which do not
Costs involve any cash outlay
These are costs that result specifically from
(p) Engineered a clear cause and effect relationship between
Costs inputs and outputs.
(g) Capitalised These are costs which are initially recorded as
Costs assets and subsequently treated as expenses.
These costs are also known as out of pocket
(q) Explicit costs and refer to costs involving immediate
These are the costs which are associated with payment of cash. Salaries, wages, postage and
(h) Product the purchase and sale of goods (in the case of Costs
Costs telegram, printing and stationery, interest on
merchandise inventory). loan etc.
This cost refers to the value of sacrifice (r) Implicit

(i) Opportunity made or benefit of opportunity foregone in These costs do not involve any immediate
Cost Costs cash payment.
accepting an alternative course of action

Material Cost
Chapter Overview How Material is Procured?
Material requirement procedure can be understood
Material Procurement: Valuation of Materials with the help of the following diagram. We should
• Bill of Materials Received focus on various documents in general required and
• Material Requisition Note also should keep in mind the departments who initiate
• Purchase Requisition these documents.
• Goods Received Note Material Storage & Records:
• Material Returned Note etc. • Bin Cards Bill of Materials- It is the Material Requisition
• Stores Ledger basic document which Note- It is prepared by
is prepared by experts the department which
• Stock Control Cards etc. specifying the quality and require materials for
quantity of materials required processing.
Inventory Control: to make final goods.
• Setting of various stock
levels
Valuation of Material
• Economic Order Quantity Issues:
(EOQ)
• Cost Price methods (FIFO,
• Techniques of Inventory LIFO etc)
Control etc. Purchase Order- After Purchase Requisition
• Average Price methods selection of vendor Note- It is the document
• Market Price methods for the materials, the which authorise purchase
• Notional Price methods purchase department department to purchase
initiates purchase order the requisitioned materials.
Accounting & Control of: for the required quality Based on this document the
• Waste, Scrap, Spoilage, and quantity. purchase department invites
Defectives etc. proposals or quotations
Consumption of from the vendors.
Materials
Goods Received Note Material Returned Note-

(GRN)- This document This document is prepared
Value at Which Materials are Recorded in is evidence of the receipt when all or any materials
Stores Ledger of goods from the are returned back to
vendor.
vendor.
From the following table we can understand the
procedure of calculating total value at which materials
are to be recorded in stores ledger.
Invoice- This is the bill charged by vendor for the materials.
Invoice also shows the duties and taxes to be paid for the purchase
Particulars Amount Amount of materials. The invoice is the basis for valuation of material in
store ledger and books of account.
Purchase Price XXX
Additions/ Inclusions:
Insurance charges XXX
Commission or brokerage XXX
How Inventory is Controlled?
Freight inward XXX Inventory control is the function of ensuring that
sufficient inventory is retained to meet all requirements.
Cost of containers XXX
In inventory control, it is essential to balance between
Wastage due to normal reasons XXX overstock and understock. Various techniques of
Duties and Taxes for which no XXX XXX inventory control are illustrated below:
credit or refund is available
Deduction/ Exclusions: Inventory Control
Discount, Rebate and Subsidy XXX
Duties and Taxes for which credit XXX
or refund is available
Penalties and charges XXX By Setting On the basis Using Ratio Physical
Other expenses not borne XXX (XXX) Quantitative of Relative Analysis Control
Levels Classification
XXX

(a) Inventory Control- By Setting Quantitative
Levels
Re-order Stock Level When to Order

(v) Average Inventory Level:
Average Stock Level = Minimum Stock Level
+ 1/2 Re-order Quantity
Re-order Quantiy/ EOQ How Much to Order Or
Average Stock Level =
Maximum Stock Level Upto How much to stock Maximum Stock Level + Minimum Stock Level
2
Minimum Stock Level Atleast How much to keep (b) On the basis of Relative Classification
Average Stock Level Stock normally kept ABC Analysis On the basis of value and
frequency of inventory
Danger Stock Level Kept for emergency requirement

Fast, Slow and Non On the basis of inventory
Moving (FSN) turnover
Buffer Stock To meet sudden demand
Vital, Essential and On the basis of importance of

Desirable (VED) inventory
(i)
Re-order Stock Level (ROL): Maximum
Consumption × Maximum Re-order Period
Or, ROL = Minimum Stock Level + (Average Rate of High, Medium and Low On the basis of price of an item
Consumption × Average Re-order period) (HML) of inventory
(ii) Re-Order Quantity/ Economic Order Quantity

(EOQ): (c) Using Ratio Analysis
(i) Input Output Ratio: Input-output ratio is the ratio
of the quantity of input of material to production and
2x Annual Requirement (A) x Cost per order (O) the standard material content of the actual output.
EOQ =
Carrying Cost per unit per annum (C)
(ii) Inventory Turnover Ratio:
Inventory Turnover Ratio =
Just in Time (JIT) Inventory Management Cost of materials consumed during the period
JIT is a system of inventory management with
Cost of average stock held during the period
an approach to have a zero inventories in stores.
According to this approach material should only be (d) Physical Control
purchased when it is actually required for production. (i) Two Bin System: Two Bin System is supplemental
Production Material Order Supplier
to the record of respective quantities on the bin
Demand starts to Requirement for raw sent the card and the stores ledger card.
for final process the is sent to materials material
product for
demad for
product
Purchase
department
sent to
supplier production
(ii) Establishment of system of budgets: Based on this,
inventories requirement budget can be prepared.
Such a budget will discourage the unnecessary
investment in inventories.
(iii) Minimum Stock Level:
Minimum Stock Level = Re-order Stock Level - (iii)
Perpetual inventory records and continuous
(Average Consumption Rate × Average Re-order stock verification :
Period) Perpetual inventory represents a system of records
maintained by the stores department in the form of
(iv) Maximum Stock Level: Bin cards and Stores ledger.
Maximum Stock Level = Re-order Level + Re-
order Quantity - (Minimum Consumption Rate × (iv) Continuous Stock Verification:
Minimum Re-order Period) The system of continuous stock-taking consists of
physical verification of items of inventory.

Valuation of Material Issue
Cost Price Methods Average Price Methods Market Price Methods Notional Price Methods
• Specific Price Method • Simple Average Price • Replacement Price • Standard Price Method
• First-in First-out (FIFO) Method Method • Inflated Price Method
method • Weighted Average Price • Realisable Price Method • Re-use Price Method
• Last-in-First-out (LIFO) Method
method
• Base Stock Method
Some of the techniques are discussed as follows: Treatment of Loss of Material

(i) First-in First-out method (FIFO): The materials
(i) Treatment of Waste
received first are to be issued first when material
Normal- Cost of normal waste is absorbed by good
requisition is received. Materials left as closing
production units.
stock will be at the price of latest purchases.
Abnormal- The cost of abnormal loss is transferred to
(ii) Last-in First-out method (LIFO): The materials Costing Profit and loss account.
purchased last are to be issued first when material
requisition is received. Closing stock is valued at (ii) Treatment of Scrap
the oldest stock price. Normal- The cost of scrap is borne by good units and
(Accounting Standard- 2 and Ind AS-2 do not allow income arises on account realisable value is deducted
LIFO method for inventory valuation, however, for from the cost.
academic knowledge it may be studied).
Abnormal- The scrap account should be charged
(iii) Simple Average Method: Material Issue Price= with full cost. The credit is given to the job or process
concerned. The profit or loss in the scrap account, on
Total of unit price of each purchase
realisation, will be transferred to the Costing Profit and
Total Nos of Purchases Loss Account.
(iv) Weighted Average Price Method: This method
gives due weightage to quantities purchased and (iii) Treatment of Spoilage
the purchase price to determine the issue price. Normal- Normal spoilage (i.e., which is inherent in the
Weighted Average Price = operation) costs are included in costs either charging
the loss due to spoilage to the production order or by
Total cost of materials in stock charging it to production overhead so that it is spread
Total quantity of materials over all products.
Abnormal- The cost of abnormal spoilage (i.e., arising

Normal and Abnormal Loss of Materials out of causes not inherent in manufacturing process) is
Waste: Portion of basic raw material lost in
charged to the Costing Profit and Loss Account.
processing having no recoverable value
(iv) Treatment of Defectives:
Scrap: The incidental material residue coming Normal- The cost less realisable value on sale of
out of certain manufacturing operations defectives are charged to material cost of good
having low recoverable value. production.
Loss of Material
Spoilage: Goods damaged beyond Abnormal- The material cost of abnormal loss is
rectification to be sold without further transferred to costing profit and loss account.
processing.
(v) Treatment of Obsolescence:

Defectives: Goods which can be rectified and The value of the obsolete material held in stock is a total
turned out as good units by the application of
additional labour or other services. loss and immediate steps should be taken to dispose it
off at the best available price. The loss arising out of
obsolete materials on abnormal loss does not form part
Obsolescence: It is the loss in the intrinsic
value of an asset due to its supersession. of the cost of manufacture.

Overheads
Chapter Overview Steps for Distribution of Overheads
OVERHEADS Estimation of Overheads
Selling and Allocation of Overheads: Apportionment of

Production Administrative Distribution Overheads: Allotment
Overheads Overheads Direct assignment of cost
Overheads to a cost object which can of proportions of items
be traced directly of cost to cost centres or
departments on some basis.
Accounting and Control of Overheads

Production Production Service Service
Department-I Department-II Department-I Department-II
Concepts
Distribution of Overhead related with
Overheads Rates Capacity Re-apportionment of Overheads: The process of assigning
service department overheads to production departments
is called reassignment or re-apportionment. Methods of re-
apportionment are:
Classification of Overheads (i) Direct re-distribution method
Overheads are the expenditure which can not be (ii) Step method of secondary distribution or non-reciprocal
identified with a particular cost unit. Overheads can be method
classified as under. (iii) Reciprocal Service method.
By Function By Nature By Element By Control
• Factory or • Fixed • Indirect • Controllable Total Overheads: The sum of allocated, apportioned and re-
Manufacturing Overhead materials costs apportioned overhead is called total overheads for a cost object.
or Production • Variable • Indirect • Uncontrollable
Overhead Overhead employee cost costs
• Office and • Semi-Variable • Indirect Absorption of Overheads: Total overheads calculated as above
Administrative Overheads expenses is distributed over the actual quantity of goods produced. The
Overheads distribution of total estimated overheads to units of production
• Selling and is called absorption of overheads.
Distribution
Overheads
Methods for Re-apportionment of
Overheads
Functional Classification of Overheads
One of the most important ways of classifying overheads The re-apportionment of service department expenses
is as per their function. As per this classification over the production departments may be carried out by
overheads are classified as under. using any one of the following methods:
Indirect cost incurred for manufacturing or Methods for
Factory or production activity in a factory. Manufacturing
Manufacturing Re-apportionment
overhead includes all expenditures incurred
or Production from the procurement of materials to the
Overhead completion of finished product.
Expenditures incurred on all activities relating

to general management and administration Direct Step method or Reciprocal
of an organisation. It includes formulating re-distribution non-reciprocal Service
Office and the policy, directing the organisation and method method. method.
Administrative controlling the operations of an undertaking
Overheads which is not related directly to production,
selling, distribution, research or development
activity or function.
(i) Selling overhead: expenses related to sale of

Simultaneous Trial and Repeated
Selling and products and include all indirect expenses in
Equation error distribution
Distribution sales management for the organisation.
method method method
Overheads (ii) Distribution overhead: cost incurred on
making product available for sale in the market.

Methods of Absorbing Overheads to various Products or Jobs

Several methods are commonly employed either individually or jointly for computing the appropriate overhead
rate. The more common of these are:
Percentage of Percentage of Percentage of direct Labour hour Machine hour Rate per unit of
direct materials prime cost labour cost rate rate Output
Machine hour rate Treatment of Under-absorption and Over-

absorption of overheads in Cost Accounting
Machine hour rate implies, cost of running a machine
for an hour to produce goods.
Is there any under/
The steps involved in determining of Machine hour over absorption of
rate is as follows: overheads?
Step1: Calculate total of overheads apportioned to a production

department. Yes
Step 2: Apportion further these overheads to machines or group

of machines in the department. Amount of under/ Yes
over absorption is
small
Step 3: Allocate machine specific costs (directly identifiable with
the machine)
No
Costing
P&L A/c
Step 4: Estimate total productive hours for the machine
Due to wrong
estimation Yes
Step 5: Aggregate overheads as apportioned in step-2 and and abnormal
allocated in step-3 and divide it by Estimated total productive reasons
hours
No
The resultant figure is machine hour rate
Calculate Supplementary Rate and Charge to Cost of Sales
A/c, Finished Goods A/c and W-I-P A/c
Types of Overhead Rates Concepts related with Capacity

Installed/ The maximum capacity of producing goods
Normal Rate: This rate is calculated by dividing Rated or providing services. It is also known as
the actual overheads by actual base. It is also capacity theoretical capacity.
known as actual rate.
Practical It is defined as actually utilised capacity of a

Pre-determined Overhead Rate: This rate capacity plant. It is also known as operating capacity.
is determined in advance by estimating the
amount of the overhead for the period in
which it is to be used.
The volume of production or services
Normal achieved or achievable on an average over a
capacity period under normal circumstances taking
Blanket Overhead Rate: Blanket overhead into account the reduction in capacity
rate refers to the computation of one single resulting from planned maintenance.
overhead rate for the whole factory.
Actual Capacity actually achieved during a given
capacity period.
Departmental Overhead Rate: It refers to the
computation of one single overhead rate for a
particular production unit or department. Idle It is that part of the capacity of a plant,
capacity machine or equipment which cannot be
effectively utilised in production.

Treatment of Certain Items in Cost Accounting
Interest and financing It includes any payment in nature of interest for use of non- equity funds and incidental cost that an entity
charges incurs in arranging those funds. Interest and financing charges shall be presented in the cost statement as a
separate item of cost of sales.
Cost of primary packing necessary for protecting the product or for convenient handling, should become a
Packing expenses part of cost of production. The cost of packing to facilitate the transportation of the product from the factory
to the customer should become a part of the distribution cost.
These indirect benefits stand to improve the morale, loyalty and stability of employees towards the
Fringe benefits organisation. If the amount of fringe benefit is considerably large, it may be recovered as direct charge by
means of a supplementary wage or labour rate; otherwise these may be collected as part of production
overheads.
If research is conducted in the methods of production, the research expenses should be charged to the
production overhead; while the expenditure becomes a part of the administration overhead if research relates
Research and to administration. Similarly, market research expenses are charged to the selling and distribution overhead.
Development
Expenses Development costs incurred in connection with a particular product should be charged directly to that
product. Such expenses are usually treated as “deferred revenue expenses,” and recovered as a cost per unit of
the product when production is fully established.
Process and Operation Costing

Chapter Overview Meaning of Process Costing
Process Costing is a method of costing used in
industries where the material has to pass through two
or more processes for being converted into a final
Meaning
product. It is defined as “a method of Cost Accounting
whereby costs are charged to processes or operations
and averaged over units produced”.
Costing
Procedure
Normal
This can be understood with the help of the following
diagram:
Process & Operation Costing
Treatment of
Process loss/ gain Raw Process Process Process Finished
Abnormal Material -I -II -III Goods
Costing Procedure in Process Costing

Process Costing
Methods Materials: Each process for which the materials are used, are
debited with the cost of materials consumed on the basis of the
information received from the Cost Accounting department.
Valuation of WIP
Equivalent Units
Employee Cost (Labour) - Each process account should
Inter-process be debited with the labour cost or wages paid to labour for
Profit carrying out the processing activities. Sometimes the wages
paid are apportioned over the different processes after selecting
appropriate basis.
Operation Costing
Direct expenses - Each process account should be debited with
direct expenses like depreciation, repairs, maintenance, insur
ance etc. associated with it.
Production Overheads- These expenses cannot be allocated to a

process. The suitable way out to recover them is to apportion them
over different processes by using suitable basis.

Steps in Process Costing Treatment of Normal, Abnormal Loss and
Abnormal Gain
Step-1: Analyse the Physical Flow of Production Units Normal Process Abnormal Abnormal Process
Loss Process Loss Gain/ Yield
Step-2: Calculate Equivalent Units for each Cost Elements •

The cost of • The cost of • The process account
normal process an abnormal under which
loss in practice process loss unit
is equal to the abnormal gain
is absorbed
cost of a good arises is debited
Step-3: Determine Total Cost for each Cost Element by good units unit. The total
produced under with the abnormal
cost of abnormal
the process. The process loss is gain and credited
amount realised credited to the to abnormal gain
Step-4: Compute Cost Per Equivalent Unit for each Cost Element by the sale of process account
from which it account which
normal process
loss units should arises. will be closed by
be credited to • Total cost transferring to the
of abnormal
Step-5: Assign Total Costs to Units Completed and Ending WIP the process Costing Profit and
process loss
account. is debited to Loss account.
costing profit
and loss account.
Valuation of Work-in-process
The valuation of work-in-process presents a good deal of difficulty because it has units under different stages of
completion from those in which work has just begun to those which are only a step short of completion.
(i) Equivalent Units
Equivalent units or equivalent production units, means converting the incomplete production units into
their equivalent completed units. Under each process, an estimate is made of the percentage completion of
work-in-process with regard to different elements of costs, viz., material, labour and overheads.
The formula for computing equivalent completed units is:
Equivalent completed units = Actual number of units in Percentage of

X
the process of manufacture Work completed
Input Details Units Output Units Equivalent Units

Particulars
Material Labour Overhead
% Units % Units % Units
a b c= a×b d e=a×d f g=a×f
Opening xxx Opening W-I-P* xxx xxx xxx xxx xxx xxx xxx
W-I-P
Unit xxx Finished xxx xxx xxx xxx xxx xxx xxx
Introduced output**
Normal loss*** xxx - - - - - -
Abnormal loss/ xxx xxx xxx xxx xxx xxx xxx

Gain****
Total Closing W-I-P xxx xxx xxx xxx xxx xxx xxx
xxx Total xxx xxx xxx xxx
* Equivalent units for Opening W-I-P is calculated only under FIFO method. Under the Average method, it is not shown separately.
**Under the FIFO method, Finished Output = Units completed and transferred to next process less Opening WIP. Under Average
method, Finished Output = Units completed and transferred.
***For normal loss, no equivalent unit is calculated.
****Abnormal Gain/ Yield is treated as 100% complete in respect of all cost elements irrespective of percentage of completion.

(ii) Methods for valuation of work-in-process
First-in-first-out (FIFO) method Weighted Average (Average) Method
Under this method the units completed and transferred include Under this method, the cost of opening work-in-process and cost
completed units of opening work-in-process and subsequently of the current period are aggregated and the aggregate cost is
introduced units. Proportionate cost to complete the opening divided by output in terms of completed units.
work-in-process and that to process the completely processed
units during the period are derived separately.
Inter Process Profit Operation Costing

In some process industries the output of one process is This product costing system is used when an entity produces
transferred to the next process not at cost but at market more than one variant of final product using different
value or cost plus a percentage of profit. The difference materials but with similar conversion activities. Which
between cost and the transfer price is known as inter- means conversion activities are similar for all the product
process profits. variants but materials differ significantly. Operation
Costing method is also known as Hybrid product costing
system as materials costs are accumulated by job order or
batch wise but conversion costs i.e. labour and overheads
costs are accumulated by department, and process costing
methods are used to assign these costs to products.
Standard Costing
Chapter Overview Types of standards
There are various types of standard which are illustrated
Meaning of below:
Advantages Standard cost
and Standard
and Criticism
Costing Types of Ideal Standards: The
of Standard Standards level of performance
Costing
attainable when
prices for material
and labour are most
favourable, when Normal Standards:
Computation Standard
The Process the highest output These are standards
of Standard is achieved with the that may be achieved
of Variance Costing Costing
best equipment and under normal
layout and when the operating conditions.
maximum efficiency
in utilisation of
Setting-up of resources results in
Classification of
Standard Cost maximum output
Variances
Types of with minimum cost.
Standards
Basic or Bogey Current Standards:

Standards: These These standards reflect
What is a Standard or Standard Cost? standards are used the management’s
Standard cost is defined in the CIMA Official Terminology only when they are anticipation of what
as “‘the planned unit cost of the product, component likely to remain actual costs will be for
or service produced in a period. The standard cost may constant or unaltered the current period.
be determined on a number of bases. The main use of over a long period.
standard costs is in performance measurement, control,
stock valuation and in the establishment of selling prices.”
Process followed in Standard Costing
Setting of Ascertainment of Comparison of Investigate the Disposition of

Standards actual costs actual cost with reasons for variances
standard cost variances
Variances at a Glance
Total Cost Variance
Material Cost Variance Labour Cost Variance Overhead Cost Variance
Usage Idle Time Efficiency Variable Overheads Fixed Overhead

Price Variance Variance Rate Variance Variance Variance Variance Variance
Expenditure
Mix Variance Mix Variance Expenditure Volume
Variance Variance Variance
Efficiency Efficiency
Yield Variance Yield Variance Variance Variance
Capacity
Variance
Calendar
Variance
Variance Analysis
(i) Material Cost Variance
Material Cost Variance
[Standard Cost – Actual Cost]
(The difference between the Standard Material Cost of the actual production volume and the Actual Cost of Material)
[(SQ × SP) – (AQ × AP)]
Material Price Variance Material Usage Variance

[Standard Cost of Actual Quantity – Actual Cost] [Standard Cost of Standard Quantity for Actual Production –
Standard Cost of Actual Quantity]
(The difference between the Standard Price and Actual Price for
the Actual Quantity Purchased) (The difference between the Standard Quantity specified for actual
production and the Actual Quantity used, at Standard Price)
[(SP – AP) × AQ] [(SQ – AQ) × SP]
Or Or
[(SP × AQ) – (AP × AQ)] [(SQ × SP) – (AQ × SP)]
Material Mix Variance Material Yield Variance

[Standard Cost of Actual Quantity in Standard Proportion – [Standard Cost of Standard Quantity for Actual Production –
Standard Cost of Actual Quantity] Standard Cost of Actual Quantity in Standard Proportion]
(The difference between the Actual Quantity in standard (The difference between the Standard Quantity specified for
proportion and Actual Quantity in actual proportion, at Standard actual production and Actual Quantity in standard proportion, at
Price) Standard Purchase Price)
[(RSQ – AQ) × SP] [(SQ – RSQ) × SP]
Or Or
[(RSQ × SP) – (AQ × SP)] [(SQ × SP) – (RSQ × SP)]

(ii) Labour Cost Variances
Labour Cost Variance
[Standard Cost – Actual Cost]
(The difference between the Standard Labour Cost and the Actual Labour Cost incurred for the production achieved)
[(SH × SR) – (AH* × AR)]
Labour Rate Variance Labour Idle Time Variance Labour Efficiency Variance
[Standard Cost of Actual Time – Actual Cost] [Standard Rate per Hour x Actual Idle Hours] [Standard Cost of Standard Time for Actual
(The difference between the Standard Rate (The difference between the Actual Production – Standard Cost of Actual Time]
per hour and Actual Rate per hour for the Hours paid and Actual Hours worked at (The difference between the Standard Hours
Actual Hours paid) Standard Rate) specified for actual production and Actual
Hours worked at Standard Rate)
[(SR – AR) × AH*] Or [(AH* – AH#) × SR] Or [(SH – AH#) × SR] Or
[(SR × AH*) – (AR × AH*)] [(AH* × SR) – (AH# × SR)] [(SH × SR) – (AH# × SR)]
Labour Mix Variance Or Gang Variance Labour Yield Variance Or Sub-Efficiency Variance
[Standard Cost of Actual Time Worked in Standard [Standard Cost of Standard Time for Actual Production
Proportion – Standard Cost of Actual Time Worked] – Standard Cost of Actual Time Worked in Standard
(The difference between the Actual Hours worked in Proportion]
standard proportion and Actual Hours worked in actual (The difference between the Standard Hours specified
proportion, at Standard Rate) for actual production and Actual Hours worked in
standard proportion, at Standard Rate)
[(RSH – AH#) × SR] Or (SH – RSH) × SR Or
[(RSH × SR) – (AH# × SR)] (SH × SR) – (RSH × SR)
(iii) Variable Overhead Variances

Variable Overhead Cost Variance
(Standard Variable Overheads for Production – Actual Variable Overheads)
Variable Overhead Expenditure Variable Overhead Efficiency Variance

(Spending) Variance
(Standard Variable Overheads for Actual Hours#) (Standard Variable Overheads for Production)
Less Less
(Actual Variable Overheads) (Standard Variable Overheads for Actual Hours#)
[(SR – AR) × AH#] [(SH – AH#) × SR]
Or Or
[(SR × AH#) – (AR × AH#)] [(SH × SR) – (AH# × SR)]
(iv) Fixed Overhead Variances

Fixed Overhead Cost Variance
(Absorbed Fixed Overheads) Less (Actual Fixed Overheads)
Fixed Overhead Expenditure Variance Fixed Overhead Volume Variance

(Budgeted Fixed Overheads) (Absorbed Fixed Overheads)
Less Less
(Actual Fixed Overheads) (Budgeted Fixed Overheads)
Or Or
(BH × SR) – (AH × AR) (SH × SR) – (BH × SR)
Fixed Overhead Capacity Variance Fixed Overhead Calendar Variance Fixed Overhead Efficiency Variance
SR (AH – BH) Std. Fixed Overhead rate per day (Actual no. SR (AH – SH)
Or of Working days – Budgeted Working days) Or
(AH × SR) – (BH × SR) (AH × SR) – (SH × SR)
AH* - Actual Hours paid
AH# - Actual Hours worked
Marginal Costing
Chapter Overview Characteristics of Marginal Costing
Meaning of All elements of cost are classified into fixed and variable
Marginal Cost components. Semi-variable costs are also analyzed into fixed
and Marginal and variable elements.
Costing
The marginal or variable costs (as direct material, direct

Characteristics Break-even labour and variable factory overheads) are treated as the cost
Characteristics of Marginal Costing

of Marginal Analysis of product
Marginal Costing
Costing
Under marginal costing, the value of finished goods and
Cost-Volume- Margin of Safety work–in–progress is also comprised only of marginal costs.
Profit (CVP) Variable selling and distribution overheads are excluded for
Analysis valuing these inventories.
Angle
of Incidence Fixed costs are treated as period costs and are charged to profit
Short-term
and loss account for the period for which they are incurred
Decision making
Contribution
Prices are determined with reference to marginal costs and
Ratio
contribution margin
Profitability of departments and products is determined with

reference to their contribution margin
Meaning of Terms
In order to understand the concept of marginal costing,
let us first define various terminology associated with Computation of Contribution and Profit
marginal costing. under Marginal Costing
For the determination of cost of a product/ service under
marginal costing, costs are classified under variable and
Differential
Marginal Cost fixed. All the variable costs are part of product and fixed
Marginal Cost Direct Costing
Costing costs are charged against contribution margin.
Cost and Profit Statement under Marginal Costing

Marginal It is a costing Direct costing Differential
cost as system where and Marginal cost is Amount Amount
understood products or Costing difference (Rs) (Rs)
in economics services and is used between the Revenue xxx
is the inventories synonymously costs of two Product Cost:
incremental are valued at at various different - Direct Materials xxx
cost of variable costs places and it production - Direct employee (labour) xxx
production only. is so also. levels. - Direct expenses xxx
which arises - Variable manufacturing overheads xxx
due to
Product (Inventoriable) Costs xxx (xxx)
one-unit
Product Contribution Margin xxx
increase
- Variable Administration overheads xxx
in the
- Variable Selling & Distribution overheads xxx (xxx)
production
Contribution Margin xxx
quantity.
Period Cost:
Fixed Manufacturing expenses xxx
Fixed non-manufacturing expenses xxx (xxx)
Profit/ (loss) xxx

Advantages of Marginal Costing Break-Even Analysis

There are many advantages of marginal costing, some Break-even analysis is a generally used method to study
of them are discussed below. the CVP analysis. This technique can be explained in
two ways.
(i) In narrow sense it is concerned with computing the
Simplified break-even point.
Pricing
Policy
(ii) In broad sense this technique is used to determine
Short term
profit
Proper the possible profit/loss at any given level of
recovery of
planning production or sales.
Overheads
= Fixed Cost /
Break-even Point Contribution per unit
Advantages
Helps in of Marginal Shows
Decision Costing Realistic
Making Profit
Break even
Cash Break-even = Cash Fixed Cost /
point Contribution per unit
More How
control over much to
expenditure produce
The contribution is
Multi-Product calculated by taking
Break-even Analysis weights (sales quantity/
value) for the products
Cost-Volume-Profit (CVP) Analysis Angle of Incidence

It is a managerial tool showing the relationship between This angle is formed by the intersection of sales line and
various ingredients of profit planning viz., cost, selling total cost line at the break-even point. This angle shows
price and volume of activity. the rate at which profit is earned once the break-even
point is reached. The wider the angle the greater is the rate
Marginal Cost Equation of earning profits. A large angle of incidence with a high
Marginal Cost Equation = S -V = C = F ± P margin of safety indicates extremely favourable position
Marginal Cost Statement Margin of Safety

This is the difference between the expected level of sales
(r) and break even sales (no profit, no loss). The larger is
Sales (S) xxxx the margin of safety higher is the profit and vice versa.
Less: Variable Cost (V) xxxx
Variations of Basic Marginal Cost Equation and
Contribution (C) xxxx other formulae
Less: Fixed Cost (F) xxxx
Profit/ Loss (P) xxxx i. Sales – Variable cost = Fixed cost + Profit / Loss
By multiplying and dividing L.H.S. by S

Profit Volume Ratio or P/V ratio ii. S (S – V)
=F+P
This ratio shows the proportion of sales required to S
cover fixed cost and profit. P/V ratio is calculated as S- V
below: iii. S x P/V Ratio = F + P or Contribution (P / V Ratio = X 100)
S
Contribution ( ... at BEP Profit is zero )
(a) P/V Ratio= ×100 iv. BES x P/V Ratio = F
Sales v.
Fixed cost
BES =
(b) When two years’ data is given, P/V Ratio P/V Ratio
vi.
Fixed cost
Change in contribution/ Profit P/V Ratio =
×100 BES
Change in sales vii S × P/V Ratio = Contribution (Refer to iii)

viii. xiv.
Contribution Contribution
P/V Ratio = X 100
Sale Profitability =
Key factor
ix. (BES + MS) × P/V Ratio = Contribution (Total sales = BES + MS)
xv. Profit
Margin of Safety = Total Sales – BES or
x. (BES × P/V Ratio) + (MS × P/V Ratio) = F + P P/V Ratio
By deducting (BES × P/V Ratio) from L.H.S. and F from R.H.S. xvi. BES = Total Sales – MS
in (x) above, we get:
xvii.
xi. M.S. × P/V Ratio = P Margin of Safety Ratio = Total sales – BES
Total Sales
xii.
Change in profit
P/V Ratio = X 100
Change in sales
xiii.
Change in contribution
P/V Ratio = X 100
Change in sales
Budget & Budgetary Control

Chapter Overview Definition and Terminology
Let us first define various important terminologies
Essentials of used in budget and budgetary control.
Budget
Budget Budgeting Budgetary control

Objectives of Capacity-wise
Budgeting
Budget & Budgetary Control
Quantitative Coordinating The establishment

expression of a the combined of budgets
Types of plan for a defined intelligence of an relating to the
Budgets Functions-wise period of time entire organisation responsibilities
into a plan of of executives
action based on of a policy and
past performance the continuous
Zero-based
Budgeting (ZBB) comparison of the
Period-wise
actual with the
budgeted results,
either to secure by
Performance individual action
Budgeting
Master Budget the objective of
the policy or to
provide a basis for
Budget Ratio its revision
Essentials of Budget
Essential elements of budget are illustrated below:
Essential elements of a budget
Organisational Setting of clear Budgets are Budgets are Budgets should be Budgetary
structure must objectives and prepared for updated for the quantifiable and master performance
be clearly reasonable the future events that were budget should be broken needs to be linked
defined targets periods based on not kept into down into various effectively to the
expected course the mind while functional budgets. reward system
of actions establishing Budgets should be
budgets monitored periodically

Characteristics of Budget Objectives of Budgeting

Main characteristics of budget are as below: The objective of budgeting begins with planning and
ends with controlling. Once the planning is done, they
can be used for directing and controlling operations so
It is concerned that the stated targets in planning are achieved.
for a definite
future period
Budget is usually
prepared in the light It is a written Planning
of past experiences document
Characteristics
of Budget
Budget helps
in planning, It is a detailed
plan of all Dir
coordination and
the economic Co ectin
control g ord g a
activities of a llin ina nd
tro tin
Budget is a business n g
means to achieve Co
business and it
is not an end in
itself
Advantages of Budgetary Control System

There are many advantages of budgetary control system, and some of the them are illustrated below:
Control on Finding Effective Revision of Implementation Cost

Efficiency utilisation of of Standard Credit Rating
expenditure deviations plans Consciousness
resources Costing system
Classification of Budget
BUDGET
Capacity wise Functions wise Master Budget Period wise
Sales budget Long-term

Fixed Budget Production budget Budgets
Plant utilisation budget
Direct-material usage budget
Flexible Direct-material purchase budget Short-term
Budget Direct-labour (personnel) budget Budgets
Factory overhead budget
Production cost budget
Current
Ending-inventory budget Budgets
Cost of goods-sold budget
Selling and distribution cost budget
Administration expenses budget
Research and development cost budget
Capital expenditure budget
Cash budget
Definition of different types of Budget

Functional Budgets Budgets which relate to the individual functions in an organisation are known as Functional Budgets. For
example, purchase budget; sales budget; production budget; plant-utilisation budget and cash budget.
Master Budget It is a consolidated summary of the various functional budgets. It serves as the basis upon which budgeted
P & L A/c and forecasted Balance Sheet are built up.
Long-term Budgets The budgets which are prepared for periods longer than a year are called long-term budgets. Such budgets
are helpful in business forecasting and forward planning. Capital expenditure budget and Research and
Development budget are examples of long-term budgets.
Short-term Budgets Budgets which are prepared for periods less than a year are known as short-term budgets. Cash budget is
an example of short-term budget. Such types of budgets are prepared in cases where a specific action has
to be immediately taken to bring any variation under control, as in cash budgets.
Basic Budgets A budget which remains unaltered over a long period of time is called basic budget.
Current Budgets A budget which is established for use over a short period of time and is related to the current conditions
is called current budget.
Fixed Budget According to CIMA official terminology, “a fixed budget, is a budget designed to remain unchanged
irrespective of the level of activity actually attained”.
Flexible Budget According to CIMA official terminology, “a flexible budget is defined as a budget which, by recognizing
the difference between fixed, semi-variable and variable costs is designed to change in relation to the level
of activity attained.”
Differences between Fixed Budget and Flexible Budget

Sl. no. Fixed Budget Flexible Budget
1. It does not change with actual volume of activity achieved. Thus it is It can be re-casted on the basis of activity level to be
known as rigid or inflexible budget achieved. Thus it is not rigid.
2. It operates on one level of activity and under one set of conditions. It It consists of various budgets for different levels of
assumes that there will be no change in the prevailing conditions, which activity.
is unrealistic.
3. Here as all costs like - fixed, variable and semi-variable are related to only Here, analysis of variance provides useful information
one level of activity, so variance analysis does not give useful information. as each cost is analysed according to its behaviour.
4. If the budgeted and actual activity levels differ significantly, then the Flexible budgeting at different levels of activity
aspects like cost ascertainment and price fixation do not give a correct facilitates the ascertainment of cost, fixation of
picture. selling price and tendering of quotations.
5. Comparison of actual performance with budgeted targets will be It provides a meaningful basis of comparison of the
meaningless specially when there is a difference between the two actual performance with the budgeted targets.
activity levels.
Zero- Based Budgeting (ZBB) Performance Budgeting

It is defined as ‘a method of budgeting which requires A performance budget is one which presents the
each cost element to be specifically justified, although purposes and objectives for which funds are required,
the activities to which the budget relates are being the costs of the programmes proposed for achieving
undertaken for the first time, without approval, the those objectives, and quantitative data measuring the
budget allowance is zero’. accomplishments and work performed under each
programme.
Stages in Zero-based budgeting
Steps in Performance Budgeting
Identification and description of Decision packages
Establishing Evolving suitable

Bring the norms, yardsticks,
a meaningful system of
Evaluation of Decision packages functional work units of
accounting performance
programme and financial
and activity and units costs,
management wherever possible
classification in accord
Ranking (Prioritisation) of the Decision packages of under each
with this programme and
government classification
operations activity for their
reporting and
Allocation of resources evaluation

Budget Ratio
Budget ratios provide information about the performance level, i.e., the extent of deviation of actual performance
from the budgeted performance and whether the actual performance is favourable or unfavourable.
The following ratios are usually used by the management to measure development from budget
Efficiency Ratio Standard Capacity Employed Ratio
This ratio may be defined as standard hours equivalent of work
produced expressed as a percentage of the actual hours spent in This ratio indicates the extent to which facilities were actually
producing the work. utilized during the budget period.
Level of Activity Ratio Capacity Usage Ratio

This may be defined as the number of standard hours equivalent This is the relationship between the budgeted number of working
to work produced expressed as a percentage of the budget of hours and the maximum possible number of working hours in a
standard hours. budget period.
Calendar Ratio
This ratio may be defined as the relationship between the number
of working days in a period and the number of working days as in
the relative budget period.
Budget Ratios:
(i) Efficiency Ratio = S tandard Hours (iv) Standard Capacity = Budgeted Hours
× 100 × 100
Actual Hours Usage Ratio Max. possible hours in the budgeted period
S tandard Hours (v) Actual Capacity Actual Hours worked

(ii) Activity Ratio = × 100 Usage Ratio = × 100
Budgeted Hours Max. possible working hours in a period
Available working days (vi) Actual Usage of

(iii) Calendar Ratio = × 100 Actual working Hours
Budgeted working days Budgeted Capacity Ratio = × 100
Budgeted Hours

Intermediate Course
Intermediate Course
Paper: 5
Advanced Accounting
Advanced
ISBN : 978-81-8441-882-8
Accounting
Module - 1
Board of Studies
ADVANCED ACCOUNTING
A CAPSULE ON ACCOUNTING STANDARDS FOR QUICK RECAP

It has always been the endeavour of Board of Studies to provide quality academic inputs to the students. Considering this
objective in mind, it has been decided to bring forth a crisp and concise capsule for the topic on Accounting Standards covered
in Intermediate Paper 5 “Advanced Accounting”. The significant provisions of AS 7, AS 9, AS 14, AS 18, AS 19, AS 20, AS 24, AS
26 and AS 29 have been gathered and presented through pictorial presentations in this capsule which will help the students in
grasping the intricate practical aspects of each Accounting Standard. Although, the capsule has been prepared keeping in view
the new and revised scheme of Education and Training of ICAI, the students of earlier scheme may also be benefitted from it. This
capsule, though, facilitates the students in undergoing quick revision, under no circumstances, such revisions can substitute the
detailed study of the material provided by the Board of Studies.
AS 7 “CONSTRUCTION CONTRACTS”
AS 7 prescribes the principles of accounting for construction contracts in the financial statements of contractors. The focus of the
standard is on allocation of contract revenue and contract costs to the accounting periods in which construction work is performed.
What are Construction Contracts? AS 7 prescribes conditions under which the outcome of a
contract can be estimated reliably.
Contracts
specifically Contracts for Contracts for
negotiated for rendering of destruction or Total contract revenue can be
the construction services related restoration of measured reliably.
of an asset or to construction of assets. In fixed
combination assets.
of assets that price
are closely contract It is probable that the economic
interrelated. benefits associated with the
contract will flow to the
enterprise.
Construction contracts can be classified into two
categories. Both contract costs to complete
Outcome the contract and the stage of
Types of construction of contract completion at the
contracts contracts reporting date can be measured
can be reliably.
estimated
reliably
Fixed price contract Cost plus contract Contract costs attributable
when to contract can be clearly
identified and measured reliably
so that actual contract costs
incurred can be compared with
Contractor agrees to a Contractor is prior estimates.
fixed contract price or reimbursed for
fixed rate per unit of allowable or otherwise
output, which in some defined costs, plus It is probable that the
cases is subject to cost percentage of these economic benefits associated
escalation. costs or a fixed fee. with the contract will flow to
the enterprise.
If the final outcome of the contract

In cost plus Contract costs attributable
contract to the contract, whether or
not specifically reimbursable,
Can be estimated reliably Cannot be estimated can be clearly identified and
reliably measured reliably.
Revenue Revenue should Contract costs

and costs be recognized should be
recognized as only to the extent recognised as Methods for Determination of Stage of
per percantage of contract costs an expense in Completion of Contracts
of completion incurred, of the period in
method which recovery is which they are Determination of Stage of Completion
considering probable. incurred. (Method to be chosen depending on the nature of the contract)
the stage of
completion
of contract at Proportion that Surveys of work Completion
reporting date. contract performed of a physical
costs incurred for proportion of
work performed upto the contract
Note: Any expected loss (when contract cost > contract the reporting date work
revenue) on the construction contract should be recognised bear to the estimated
total contract costs
as an expense immediately in both the situations.
May 2018 The Chartered Accountant Student

ADVANCED ACCOUNTING
As per the standard, Contract revenue and Contract costs A contract may provide for the construction of an additional
comprise of the following: asset at the option of the customer or may be amended to include
the construction of an additional asset.
Contract Revenue
Variations in contract work, Construction of the additional asset should be

claims and incentive payments if treated as a separate construction contract when
Initial amount of revenue (i) it is probable that they will
agreed in the contract. result in revenue.
(ii) they are capable of being Asset differs significantly in design, technology or
reliably measured. function from the asset or assets covered by the
original contract
Contract Costs Price of the asset is negotiated without regard to the

original contract price.
Costs Costs that are Such other costs
that relate attributable to as are specifically
directly to contract activity chargeable to the
the specific in general and customer under Disclosures in Financial Statements
contract. can be allocated the terms of the
General Specific for contracts in progress
to the contract. contract.
Amount of contract revenue
recognised as revenue in the Amount of advances received
period
• Application of percentage of
completion on a cumulative basis in Methods used to determine the
each accounting period to the current stage of completion of contracts Amount of retentions
estimates of contract revenue and in progress
contract costs.
• Effect of a change in the estimate Retentions are the amounts of progress billings which are
of contract revenue or contract
Changes costs, or the effect of a change in the
not paid until the satisfaction of conditions specified in the
in estimate of the outcome of a contract, contract for the payment of such amounts or until defects
Estimates is accounted for as a change in have been rectified.
accounting estimate.
• The changed estimates are used
in determination of the amount of
revenue and expenses recognised in An enterprise
the statement of profit and loss in the should present Due from customers As an asset
gross amount
period in which the change is made for contract
and in subsequent periods. work in the
financial
statements Due to customers As a liability
When a contract covers a number

of assets, each contract should be
treated as separate contract if
Separate proposals Each asset has been

subject to separate Costs and
have been negotiation and revenues of each
submitted for each contractor and asset can be
asset. customers are able identified.
to accept or reject
that part of the
contract relating to
each asset.
A group of Group of contracts is negotiated as a

contracts, single package.
whether with a
single customer
or with several Contracts are performed concurrently
customers, or in a continuous sequence.
should be treated
as a single
construction Contracts are so closely interrelated
contract when that they are, in effect, part of a single
project with an overall profit margin.
The Chartered Accountant Student May 2018

ADVANCED ACCOUNTING
AS 9 “REVENUE RECOGNITION”
AS 9 explains the timing for recognition of revenue in the Sale of Goods
financial statements and also state the circumstances under Revenue from sale of goods should be recognised when the
which revenue recognition should be postponed. requirements as to performance as set out in the standard are
satisfied.
Bases for recognition In the statement of

of revenue arising profit and loss of In sale of goods, performance should be regarded as
AS 9 deals with in the course of the an enterprise. being achieved when
ordinary activities
Revenue is the gross inflow of cash, receivables

or other consideration arising from
Use by others of
Rendering of enterprise resources Seller of goods has
Sale of goods services yielding interest,
royalties and dividends transferred to the buyer the
No significant uncertainty
property in the goods for a
exists regarding the amount
price or all significant risks
of the consideration that
and rewards of ownership
AS 9 does not deal with revenue arising from will be derived from the
have been transferred to the
sale of the goods.
buyer and the seller retains
no effective control of the
Construction contracts goods transferred.
Hire-purchase, lease agreements

Rendering of Services
Revenue from service transactions is usually recognised as the
service is performed.
Government grants and other similar subsidies
Methods of recognition of Revenue

Insurance contracts of insurance companies
Proportionate Completed service

completion method contract method
Realised gains
resulting from
the disposal of (i) Recognition of revenue in (i) Recognition of revenue
non-current
assets the statement of profit and in the statement of profit
Unrealised gains Unrealised gains loss proportionately with and loss only when the
resulting from resulting from
the holding of the degree of completion rendering of services
the restatement non-current of services under a under a contract is
of the carrying assets e.g.
amount of an contract. completed or substantially
obligation appreciation in (ii) Performance consists of completed.
Items not the value of fixed
assets the execution of more (ii) Services become
included than one act.
within the chargeable.
definition of (iii) Revenue is recognised (iii) Performance consists of
“revenue” Unrealised proportionately the execution of a single
Realised gains holding gains
resulting from resulting from by reference to the act.
the discharge the change in performance of each act.
of an obligation value of current
at less than its assets, and the
carrying amount Realised or natural increases
unrealised gains in herds and Note: Revenue from Sale of goods “for consideration” and Service
resulting from agricultural and
changes in foreign forest products transactions should be recognized only when no significant
exchange rates uncertainty exists regarding amount of consideration.
and adjustments
due to translation
of foreign
currency financial
statements

ADVANCED ACCOUNTING
Use of Enterprise Resources by Other Parties Effect of Uncertainties on Revenue Recognition
Use of enterprise resources by others may yield revenue in the Where the ability to assess the ultimate collection with reasonable
form of Interest, Royalties and Dividends. certainty is lacking at the time of raising any claim, revenue
recognition is postponed to the extent of uncertainty involved.
Recognition of Revenue when enterprise When the uncertainty relating to collectability arises subsequent
resources are used by others to the time of sale or the rendering of the service, it is more
appropriate to make a separate provision to reflect the uncertainty
rather than to adjust the amount of revenue originally recorded.
Disclosures
Royalties - Dividends -
In addition to the disclosures required by AS 1 “Disclosure
Interest - Accrual basis When right to
of Accounting Policies”, an enterprise should disclose the
Time basis depending upon the receive the payment
circumstances in which revenue recognition has been postponed
terms of agreement. is established.
pending the resolution of significant uncertainties.
AS 14 “ACCOUNTING FOR AMALGAMATIONS”

AS 14 (Revised) deals with the accounting to be made in the Transferor company Company which is amalgamated into another
books of Transferee company in the case of amalgamation and company.
the treatment of any resultant goodwill or reserve. Transferee company Company into which a transferor company is
amalgamated.
Reserve Portion of earnings, receipts or other surplus
Objective of an enterprise (whether capital or revenue)
appropriated by the management for a general
Accounting for amalgamations or a specific purpose other than a provision for
depreciation or diminution in the value of assets
or for a known liability.
Consideration for the Aggregate of the shares and other securities
Treatment of any resultant goodwill or reserves amalgamation issued and the payment made in the form of cash
or other assets by the transferee company to the
shareholders of the transferor company.
Disclosures Fair value Amount for which an asset could be exchanged
between a knowledgeable, willing buyer and a
knowledgeable, willing seller in an arm’s length
transaction.
Scope
This standard deals The standard does not deal Types of Amalgamations and Methods of Accounting
with Accounting for with cases of acquisitions
Amalgamation i.e. where one entity is acquired Amalgamation may be either
acquisition of one entity by by the other and the in the nature of
the other and the acquired acquired entity continues
entity ceased to exist to exist.
Merger Purchase
Key Terms
Meaning of Amalgamations
In an amalgamation,
two or more companies Amalgamations which are in
are combined into one effect a mode by which one
by merger or by one Amalgamations where there is company acquires another
taking over the other. a genuine pooling not merely of company and as a consequence,
Amalgamation means an the assets and liabilities of the the shareholders of the company
amalgamating companies but which is acquired normally
amalgamation
also of the shareholders’ interests do not continue to have a
and of the businesses of these proportionate share in the equity
companies are amalgamations in of the combined company, or the
pursuant to the nature of merger. business of the company which
the relevant includes is acquired is not intended to be
provisions “merger” continued.
of the
Companies
Act Method of Accounting - Method of Accounting -
Pooling of Interest method Purchase method

ADVANCED ACCOUNTING
The standard specifies the conditions to be satisfied by an Treatment of Reserves of the Transferor
amalgamation to be considered as amalgamation in nature of Company on Amalgamation
merger or purchase.
Conditions for Amalgamation in the nature Treatment of Reserves

of Merger and Purchase
Amalgamation in the nature of merger is an amalgamation which
satisfies all the following conditions:
Amalgamation in Amalgamation in the
(i)
All the assets and liabilities of the transferor company nature of merger nature of purchase
become, after amalgamation, the assets and liabilities of the
transferee company.
Identity of the reserves, other
(ii) Shareholders holding not less than 90% of the face value Identity of the
than the statutory reserves is
of the equity shares of the transferor company (other than reserves is preserved
the equity shares already held therein, immediately before not preserved. The amount
and they appear in the
amalgamation, by the transferee company or its subsidiaries of the consideration is
financial statements
or their nominees) become equity shareholders of the deducted from the value of
of the transferee
transferee company by virtue of the amalgamation. the net assets of the transferor
company in the
company acquired by the
same form in which
transferee company. If the
(iii)Consideration for the amalgamation receivable by those they appeared in the
result of the computation
equity shareholders of the transferor company who agree financial statements
is negative, the difference is
to become equity shareholders of the transferee company of the transferor
debited to goodwill arising on
is discharged by the transferee company wholly by the company.
issue of equity shares in the transferee company, except amalgamation and if the result
that cash may be paid in respect of any fractional shares. of the computation is positive,
the difference is credited to
(iv)The business of the transferor company is intended to Capital Reserve.
be carried on, after the amalgamation, by the transferee
company.
(v) No adjustment is intended to be made to the book values

of the assets and liabilities of the transferor company
when they are incorporated in the financial statements
of the transferee company except to ensure uniformity of Statutory Reserves
accounting policies.
Statutory reserves retain their identity in the financial statements of
Amalgamation in the nature of purchase is an amalgamation which the transferee company in the same form in which they appeared in the
financial statements of the transferor company, so long as their identity is
does not satisfy any one or more of the conditions specified above. required to be maintained to comply with the relevant statute.
Methods of Accounting
Purchase Method Statutory reserves are recorded in the financial statements of the transferee
company by a corresponding debit to a suitable account head (e.g.
‘Amalgamation Adjustment Reserve’) which is presented as a separate line
Under the purchase method, the transferee company accounts for item under the head “Reserves and Surplus”.
the amalgamation either
• By incorporating the assets and liabilities at their existing
carrying amounts or When the identity of the statutory reserves is no longer required to be
• By allocating the consideration to individual identifiable maintained, both the reserves and the aforesaid account are reversed.
assets and liabilities of the transferor company on the basis of
their fair values at the date of amalgamation.
Balance of Profit and Loss Account

Pooling of Interests Method
1 Assets, liabilities and reserves of the Balance of the Profit and Loss Account appearing in
transferor company to be recorded the financial statements of the transferor company
Pooling of interests by the transferee company at existing
is a method of carrying amounts and in the same form
accounting for as at the date of the amalgamation.
amalgamations, the Amalgamation in nature Amalgamation in the
object of which is 2 If the transferor and the transferee of merger nature of purchase
to account for the companies have conflicting accounting
amalgamation as if the policies, a uniform set of accounting
separate businesses policies should be adopted following the Is aggregated with the Debit or credit
of the amalgamating amalgamation. corresponding balance appearing balance loses its
companies were
in the financial statements of the identity.
intended to be 3 The difference between the amount of
continued by the transferee company.
share capital issued (plus any additional
transferee company. consideration in the form of cash or
other assets) and the amount of share Alternatively, it is transferred to
capital of the transferor company the General Reserve, if any.
should be adjusted in reserves.

ADVANCED ACCOUNTING
Treatment of Goodwill For amalgamations accounted for under the pooling of interests
method, the following additional disclosures are considered
Goodwill arising on amalgamation represents a payment made appropriate in the first financial statements following the
in anticipation of future income and it is appropriate to treat it as amalgamation:
an asset to be amortised on a systematic basis over its useful life.
Description and number of shares issued, together
Due to the nature of goodwill, it is frequently difficult to estimate with the percentage of each company’s equity shares
its useful life with reasonable certainty. exchanged to effect the amalgamation; and
It is considered appropriate to amortise goodwill over a period

not exceeding 5 years unless a longer period can be justified. Amount of any difference between the consideration
and the value of net identifiable assets acquired, and the
treatment thereof.
Disclosure Requirements
For all amalgamations, the following disclosures are considered
appropriate in the first financial statements following the For amalgamations accounted for under the purchase method,
amalgamation: the following additional disclosures are considered appropriate
in the first financial statements following the amalgamation:
Names and general nature of business of the amalgamating
companies; Consideration for the amalgamation and a description of the
consideration paid or contingently payable; and
Effective date of amalgamation for accounting purposes;
Amount of any difference between the consideration
Method of accounting used to reflect the amalgamation; and and the value of net identifiable assets acquired, and the
treatment thereof including the period of amortisation of
any goodwill arising on amalgamation.
Particulars of the scheme sanctioned under a statute.
AS 18 “RELATED PARTY DISCLOSURES”

AS 18 prescribes the requirements for disclosure of related party relationship and transactions between the reporting enterprise
and its related parties. The requirements of the standard apply to the financial statements of each reporting enterprise as also to
consolidated financial statements presented by a holding company.
Related Parties and Related Party Relationships

in making financial
or exercise significant and/or operating
one party has the influence over the decisions.
if at any time during ability to control the other party
Parties are considered the reporting period other party
to be related
(e)
(a)
(b) (c) (d) Enterprises
Enterprises over which any
that directly, Individuals person described
Associates and Key in (c) or (d) is
or indirectly owning, directly
joint ventures management able to exercise
through or indirectly, an
AS 18 deals of the reporting personnel and significant
one or more interest in the influence.
only with enterprise and relatives of such
intermediaries, voting power of This includes
related party the investing
control, or are the reporting personnel enterprises
relationships party or
controlled by, enterprise owned by
in situations venturer in directors
or are under that gives
when: respect of which or major
common them control
the reporting shareholders of
control with, or significant
enterprise is an the reporting
the reporting influence over enterprise and
associate or a
enterprise (this the enterprise, enterprises
joint venture.
includes holding and relatives that have a
companies, of any such member of key
subsidiaries individual. management in
and fellow common with
the reporting
subsidiaries). enterprise.

ADVANCED ACCOUNTING
In the context of AS 18, following are deemed not to be the consent or concurrence of any other person, to appoint or
related parties: remove all or a majority of directors/members of the governing
body of that company/enterprise.
Two companies simply because they have a director in
common (unless the director is able to affect the policies of
both companies in their mutual dealings). An enterprise is deemed to have the power to appoint
a director/ member of the governing body, if any of the
A single customer, supplier, franchiser, distributor or general
agent with whom an enterprise transacts a significant volume following conditions are satisfied:
of business.
A person’s The director/

Providers of finance, Trade unions, Govt. agencies and A person cannot appointment as member of the
public utilities in the course of their normal dealings with be appointed as director/member governing body is
an enterprise. director/member of governing nominated by that
of the governing body follows enterprise; in case
body without the necessarily from that enterprise
exercise, in his his appointment is a company,
favour, by that to a position the director is
enterprise of held by him in nominated by
such a power or that enterprise that company/
No disclosure is required in consolidated financial or subsidiary thereof.
statements in respect of intra-group transactions.
Substantial Interest
Key Terms
An enterprise/individual is considered to have a
substantial interest in another enterprise if
Related Party Transaction
That enterprise or That individual owns, directly

individual owns, directly or indirectly, 20% or more
or indirectly, 20% or more interest in the voting power of
interest in the voting power the enterprise.
of the other enterprise
regardless of
whether or
between not a price is Associate
related charged.
or parties
obligations
resources
in which nor a
A Associate an and
has which is joint
transfer is an investing significant venture
enterprise reporting neither a
of influence subsidiary of that
party party.
Control
Control includes
Significant Influence
Significant influence is participation in the financial and/or operating
Control of the policy decisions of an enterprise, but not control of those policies.
composition
Ownership, Substantial
of the board Significant influence may be gained by share ownership, statute
directly or interest in voting
of directors in or agreement.
indirectly, of more power and the
the case of a
than one half of power to direct,
company or of the
the voting power by statute or As regards share ownership, if an investing party holds, directly
composition of
of an enterprise agreement, the or indirectly, through intermediaries, 20% or more of the
the corresponding financial and/or voting power of the enterprise, it is presumed that the investing
governing body in operating policies party does have significant influence, unless it can be clearly
case of any other of the enterprise. demonstrated that this is not the case.
enterprise
A substantial or majority ownership by another investing party

For the purpose of AS 18, an enterprise is considered to control does not necessarily preclude an investing party from having
the composition of the board of directors of a company or significant influence.
governing body of an enterprise, if it has the power, without

ADVANCED ACCOUNTING
Key Management Personnels are The Related Party Issue

Related party relationships are a normal feature of commerce
Those persons who have the authority and responsibility
for planning, directing and controlling the activities of the and business.
reporting enterprise.
In relation to an individual, Relative means Without related party disclosures, there is a general
presumption that transactions reflected in financial
statements are consummated on an arm’s-length basis
between independent parties.
Any person or be The operating results and financial position of an enterprise

Spouse, son, who may be influenced by, in his/her may be affected by a related party relationship even if related
daughter, expected to that individual dealings with
brother, sister, and which the reporting party transactions do not occur.
influence
father and is neither a enterprise.
mother subsidiary
Sometimes, transactions would not have taken place if the
related party relationship had not existed.
Joint Venture and Joint Control Disclosure

Name of the related party and nature of the related party relationship
Undertake Which is where control exists should be disclosed irrespective of whether or
Joint A Whereby
contractual two or an subject not there have been transactions between the related parties.
Venture economic to joint
is arrangement more
activity control.
parties If there have been transactions between related parties, during
the existence of a related party relationship, the reporting
enterprise should disclose the following:
To govern The name of the transacting related party;

Contractually Sharing of the Of an
Joint agreed power financial economic
Control and activity.
is operating A description of the relationship between the parties;
policies
A description of the nature of transactions;

Holding Company
A company having one or more subsidiaries is a holding company.
Volume of the transactions either as an amount or as an
Subsidiary Company appropriate proportion;
A company is Subsidiary Any other elements of the related party transactions necessary for
an understanding of the financial statements;
Amounts or appropriate proportions of outstanding items

in which another company
of which another company pertaining to related parties at balance sheet date and provisions
(the holding company) for doubtful debts due from such parties at that date;
holds, either by itself and/ (the holding company)
or through one or more controls, either by itself and/
subsidiaries, more than or through one or more
one-half, in nominal value subsidiaries, the composition Amounts written off or written back in the period in respect of
of its equity share capital; of its board of directors. debts due from or to related parties.
or
Items of a similar nature may be disclosed in aggregate by type of
related party except when separate disclosure is necessary for an
Fellow Subsidiary understanding of the effects of related party transactions on the
financial statements of the reporting enterprise.
Company is if both are same
fellow of another holding No disclosure is required in the financial statements of state-
considered to subsidiaries
subsidiary company company. controlled enterprises as regards related party relationships with
be a of the
other state-controlled enterprises and transactions with such
enterprises.

ADVANCED ACCOUNTING
AS 19 “LEASES”
The objective of AS 19 is to prescribe, for lessees and lessors, the Minimum Lease Payments
appropriate accounting policies and disclosures in relation to finance
leases and operating leases. Minimum lease payments are
the payments over the lease term

series of
periodic
in return payments that the lessee is
for a (Lease rents).
payment
conveys to the or
Lessee (another to make excluding contingent rent,
party)
whereby the
Lessor (legal
owner of an
asset) costs for services and
A Lease
is an
agreement
taxes to be paid by and
Scope
reimbursed to the lessor,
Lease agreements to explore for or use of
natural resources such as oil, gas, timber
metals and other mineral rights.
together with:
(a) in the case of the lessee, any residual value guaranteed
by or on behalf of the lessee; or
Licensing agreements for items such as (b) in the case of the lessor, any residual value guaranteed
motion picture films, video recordings, to the lessor:
plays, manuscripts, patents and (i) by or on behalf of the lessee; or
AS 19 applies to copyrights. (ii) by an independent third party financially capable of
all leases other meeting this guarantee.
than:
Lease agreements to use lands.
However, if the lessee has an option to purchase the asset at a
price which is expected to be sufficiently lower than the fair value
at the date the option becomes exercisable that, at the inception of
Agreements that are contracts for the lease, is reasonably certain to be exercised, the minimum lease
services, that do not transfer right to use payments comprise minimum payments payable over the lease term
assets from one contracting party to the and the payment required to exercise this purchase option.
other.
Fair Value
Key Terms Fair value
Non-cancellable lease is a lease that is cancellable
in an arm’s length
Upon the occurrence of With the permission of the transaction. is the amount
some remote contingency; lessor; or
or
Upon payment by the lessee of knowledgeable,

If the lessee enters into a
new lease for the same or an additional amount such that, willing parties for which an asset
an equivalent asset with the at inception, continuation of
same lessor; or the lease is reasonably certain.
a liability settled
The lease term is the non-cancellable period for which the lessee between could be exchanged
has agreed to take on lease the asset together with any further periods or
for which the lessee has the option to continue the lease of the asset,
with or without further payment, which option at the inception of the
lease it is reasonably certain that the lessee will exercise.

ADVANCED ACCOUNTING
Economic Life Unearned Finance Income
the number of Difference between:

the period over which an production or
Economic asset is expected to be similar units
or expected to be
life is either: economically usable by obtained from
one or more users; the asset by one
or more users. Gross investment in the lease; and
Useful Life Present value of
(i) Minimum lease payments under a finance lease from the

Number of standpoint of the lessor; and
Period over production or
Useful life of a which the leased similar units (ii) Any unguaranteed residual value accruing to the lessor, at
leased asset is asset is expected OR expected to be
either: the interest rate implicit in the lease.
to be used by the obtained from the
lessee; use of the asset by
the lessee.
Net investment in the lease is the gross investment in the lease less
unearned finance income.
Residual Value
Interest rate implicit in the lease
Residual is the at the end

value estimated fair of the lease Discount rate Any unguaranteed
value term.
that, at the Minimum lease residual value
inception of the payments under a accruing to the
lease, causes finance lease from lessor, to be equal
the aggregate the standpoint of to the fair value of
present value of the lessor; and the leased asset.
Guaranteed Residual Value
Guaranteed residual value is:

in the case of the lessee,
that part of the residual value
which is guaranteed by the
lessee or by a party on behalf in the case of the lessor, that
of the lessee (the amount of the part of the residual value which Lessee’s Incremental Borrowing Rate of Interest
guarantee being the maximum is guaranteed by or on behalf of
amount that could, in any the lessee, or by an independent
event, become payable). third party who is financially
capable of discharging
the obligations under the
guarantee. is the rate of interest
the lessee would have to pay on a similar lease or,
if that is not determinable,

Unguaranteed Residual Value the rate that, at the inception of the lease,
the lessee would incur to borrow over a similar term
Its and with a similar security, the funds necessary to

Amount of the Exceeds
by which guaranteed purchase the asset.
asset residual
the
residual value.
value
Contingent Rent
Contingent rent is that portion of the lease payment

Gross Investment
that is not fixed in amount but is based on a factor

Aggregate Minimum Under a From the
of lease finance standpoint
payments lease of the lessor.
other than just the passage of time

ADVANCED ACCOUNTING
Types of Leases
For accounting purposes, leases are classified as
Finance leases Operating leases
A lease that transfers substantially, all the risks and rewards incident to A lease is classified as an Operating Lease, if it does not transfer substantially
ownership of an asset. Title may or may not be eventually transferred. all the risk and rewards incident to ownership.
Indicators of Finance Lease
Lessee has
the option to
purchase the asset At the inception
at a price which of the lease,
is expected to be present value of
Lease term is for Leased asset is
Situations, which Lease transfers sufficiently lower the minimum
the major part of a specialised
would normally ownership of than the fair value lease payment
of the economic nature such
lead to a lease the asset to the at the date the amounts
life of the asset that only the
being classified lessee by the end option becomes to at least lessee can use it
even if title is not
as a finance lease of the lease term. exercisable substantially all without major
transferred.
are: such that, at of the fair value modifications
the inception of of the leased being made.
the lease, it is asset.
reasonably certain
that the option
will be exercised.
Indicators of situations which individually or in combination could A finance lease gives rise to a depreciation expense for the asset
also lead to a lease being classified as a finance lease are: as well as a finance expense for each accounting period. The
depreciation policy for a leased asset should be consistent with
If the lessee can If gains or losses from If the lessee that for depreciable assets which are owned, and the depreciation
cancel the lease and the fluctuations in the can continue
the lessor’s losses recognised should be calculated on the basis set out in AS 10
residual value accrue the lease for a
associated with the secondary period (Revised), Property, Plant and Equipment. If there is no reasonable
to the lessee certainty that the lessee will obtain ownership by the end of the
cancellation are at a rent, which is
borne by the lessee. substantially lower lease term, the asset should be fully depreciated over the lease
than market rent. term or its useful life, whichever is shorter.
Lease classification is made at the inception of the lease. If at any

Initial direct costs are often incurred in connection with
time the lessee and the lessor agree to change the provisions of the specific leasing activities, as in negotiating and securing leasing
lease, other than by renewing the lease, in a manner that would have arrangements. The costs identified as directly attributable to
resulted in a different classification of the lease had the changed terms activities performed by the lessee for a finance lease are included
been in effect at the inception of the lease, the revised agreement is as part of the amount recognised as an asset under the lease.
considered as a new agreement over its revised term.
Accounting for Finance Leases (Books of Computation of Interest Rate implicit on
Lessee) Lease (IRR)
On the date of inception of lease, lessee should show it as an Minimum
asset and corresponding liability at lower of: lease payments
under a finance
(i) Fair value of leased asset at the inception of the lease lease from the
standpoint of the
(ii) Present value of minimum lease payments from the standpoint lessor; and
of the lessee (present value to be calculated with discount rate The interest rate
implicit in the lease
equal to interest rate implicit in the lease, if this is practicable to is the discount rate
determine; if not, the lessee’s incremental borrowing rate should that, at the inception
be used). Lease payments to be apportioned between the finance of the lease, causes
charge and the reduction of the outstanding liability. the aggregate present Any
value of unguaranteed
residual value
accruing to the
Finance charges to be allocated to periods during the lease term so lessor, to be equal
as to produce a constant rate of interest on the remaining balance to the fair value
of liability for each period. of the leased
asset.

ADVANCED ACCOUNTING
Disclosures made by the Lessee in case of Review of Unguaranteed Residual Value by

Finance Lease Lessor
The lessee should, in addition to the requirements of AS 10 (Revised)
AS 19 requires a lessor to review unguaranteed residual value
and the governing statute, make the following disclosures for finance
leases: used in computing the gross investment in lease regularly. In case
any reduction in the estimated unguaranteed residual value is
(a) Assets acquired under finance lease as segregated from the identified, the income allocation over the remaining lease term is to
assets owned;
be revised. An upward adjustment of the estimated residual value
is not made.
(b) For each class of assets, the net carrying amount at the
balance sheet date;
Manufacturer or Dealer Lessor
The manufacturer or dealer lessor should recognise the
(c)
Reconciliation between the total of minimum lease transaction of sale in the statement of profit and loss for
payments at the balance sheet date and their present the period, in accordance with the policy followed by the
value. In addition, an enterprise should disclose the total enterprise for outright sales.
of minimum lease payments at the balance sheet date, and
their present value, for each of the following periods:
Initial direct costs should be recognised as an expense in the
(i) not later than one year;
(ii) later than one year and not later than five years; statement of profit and loss at the inception of the lease.
(iii) later than five years;
Disclosures
(d) Contingent rents recognised as expense in the statement of
The lessor should make the following disclosures for
profit and loss for the period;
finance leases:
(e) Total of future minimum sublease payments expected to (a) Reconciliation between the total gross investment in the lease at
be received under non-cancelable subleases at the balance the balance sheet date, and the present value of minimum lease
sheet date; and payments receivable at the balance sheet date. In addition, an
enterprise should disclose the total gross investment in the lease
and the present value of minimum lease payments receivable at
the balance sheet date, for each of the following periods:
(f )
General description of the lessee’s significant leasing (i) not later than one year;
arrangements including, but not limited to, the following: (ii) later than one year and not later than five years;
(i)
the basis on which contingent rent payments are (iii) later than five years;
determined;
(ii)
the existence and terms of renewal or purchase
options and escalation clauses; and
(iii) restrictions imposed by lease arrangements, such (b) Unearned finance income;
as those concerning dividends, additional debt, and
further leasing.
(c) Unguaranteed residual values accruing to the benefit of the

Accounting for Finance Leases (Books of lessor;
Lessor)
The lessor should recognise assets given under a finance lease in its
balance sheet as a receivable at an amount equal to the net investment (d)
Accumulated provision for uncollectible minimum lease
in the lease. payments receivable;
In a finance lease, the lessor recognises the net investment in lease
which is usually equal to fair value as receivable by debiting the
Lessee A/c.
(e) Contingent rents recognised in the statement of profit and loss
Recognition of Finance Income for the period;
The unearned finance income is recognised over the lease term
based on a pattern reflecting a constant periodic return on the net
investment in lease outstanding.
(f ) General description of the significant leasing arrangements of
the lessor;
Initial Direct Costs
For finance leases, initial direct costs incurred to produce finance
income are either recognised immediately in the statement of (g) Accounting policy adopted in respect of initial direct costs.
profit and loss or allocated against the finance income over the
lease term.

ADVANCED ACCOUNTING
Accounting for Operating Leases Disclosures by Lessors
Accounting treatment in the Books of lessee As per AS 19, the lessor should, in addition to the requirements
Lease payments under an operating lease should be recognised as an of AS 10 (Revised)* and the governing statute, make the following
expense in the statement of profit and loss of a lessee on a straight disclosures for operating leases:
line basis over the lease term unless another systematic basis is more
representative of the time pattern of the user’s benefit.
(a)
For each class of assets, the gross carrying amount, the
accumulated depreciation and accumulated impairment losses
Disclosures by Lessees at the balance sheet date; and
Lessees are required to make following disclosures for operating (i) the depreciation recognised in the statement of profit and
leases: loss for the period;
(ii) impairment losses recognised in the statement of profit and
loss for the period;
(a) Total of future minimum lease payments under non-cancelable (iii) impairment losses reversed in the statement of profit and
operating leases for each of the following periods: loss for the period;
(i) not later than one year;
(ii) later than one year and not later than five years;
(iii) later than five years; (b) Future minimum lease payments under non-cancelable
operating leases in the aggregate and for each of the following
(b) Total of future minimum sublease payments expected to periods:
be received under non-cancelable subleases at the balance (i) not later than one year;
sheet date; (ii) later than one year and not later than five years;
(iii) later than five years;
(c)
Lease payments recognised in the statement of profit and
loss for the period, with separate amounts for minimum lease
(c) Total contingent rents recognised as income in the statement of
payments and contingent rents;
profit and loss for the period;
(d) Sub-lease payments received (or receivable) recognised in the

statement of profit and loss for the period; (d)
General description of the lessor’s significant leasing
arrangements; and
(e)
General description of the lessee’s significant leasing
arrangements including, but not limited to, the following:
(e) Accounting policy adopted in respect of initial direct costs.
(i) the basis on which contingent rent payments are determined;
(ii) the existence and terms of renewal or purchase options and
escalation clauses; and
(iii) restrictions imposed by lease arrangements, such as those
concerning dividends, additional debt, and further leasing.
Sale and Leaseback

Accounting Treatment in the books of Lessor
Lease income from operating

leases should be recognised
The lessor should in the statement of profit and One vendor Lessee or seller
present an asset given loss on a straight line basis sells an asset receives cash
under operating lease over the lease term, unless for cash and immediately and
as fixed assets in its another systematic basis is then takes it makes periodic
balance sheets. more representative of the back from the payment in the
time pattern in which benefit buyer on lease. form of lease rents
derived from the use of the for right to use the
leased asset is diminished. property.
Accounting Lease payments

treatment of a sale and the sale price
Depreciation of leased assets The impairment losses are generally
should be charged in books on assets given on and lease back
depends upon interdependent as
of lessor on a basis consistent operating leases are they are negotiated
with the normal depreciation the type of lease
determined and treated involved. as a package.
policy of the lessor for similar
assets. as per AS 28*.
* AS 10 and AS 28 are not covered in the syllabus of Paper 5.

ADVANCED ACCOUNTING
Where sale and leaseback results in finance lease Sale price Carrying Carrying Carrying
The excess or deficiency of sales proceeds over the carrying amount established at amount equal amount less amount above
should not be recognised immediately but deferred and amortised fair value to fair value than fair value fair value
over the lease term in proportion to the depreciation of the leased Profit No profit Recognise No profit
asset. profit (note 1)
Where sale and leaseback results in operating lease immediately
Case 1: Sale price = Fair Value
Profit or loss should be recognised immediately. Loss not Recognise loss Recognise loss (note 1)
compensated immediately immediately
by future lease
Case 2: Sale Price < Fair Value payments at
Profit should be recognised immediately. The loss should also be below market
recognised immediately except that, if the loss is compensated by price
future lease payments at below market price, it should be deferred
and amortised in proportion to the lease payments over the period Loss Defer and Defer and (note 1)
compensated amortise loss amortise loss
for which the asset is expected to be used. by future lease
payments at
Case 3: Sale Price > Fair Value below market
The excess over fair value should be deferred and amortised over the price
period for which the asset is expected to be used. Sale price above fair value (paragraph 50)
If the fair value at the time of a sale and leaseback transaction is less
than the carrying amount of the asset, a loss equal to the amount of Profit Defer and Defer and Defer and
the difference between the carrying amount and fair value should be amortise amortise amortise
profit profit profit (note
recognised immediately.
2)
Sale price Carrying Carrying Carrying Loss No loss No loss (note 1)

established at amount equal amount less amount above
fair value to fair value than fair value fair value
Profit No profit Recognise profit Not applicable Note 1: Circumstances that require the carrying amount of an asset
immediately to be written down to fair value where it is subject to a sale and
Loss No loss Not applicable Recognise loss leaseback.
immediately Note 2: Profit would be the difference between fair value and sale
price as the carrying amount would have been written down to fair
Sale price below fair value (paragraph 50) value in accordance with AS 19.
AS 20 “EARNINGS PER SHARE”
The objective of AS 20 Earnings per share (EPS) is a financial ratio indicating the amount
of profit or loss for the period attributable to each equity share and
AS 20 gives computational methodology for determination and
is to describe principles presentation of basic and diluted earnings per share.
for determination and presentation
of earnings per share

This Accounting Standard is mandatory for all companies.
However, disclosure of diluted earnings per share (both including
which will improve comparison of performance and excluding extraordinary items) is not mandatory for SMCs.
among different enterprises
for the same period and

In consolidated financial statements, the information required by
among different accounting periods AS 20 should be presented on the basis of consolidated
information.
for the same enterprise.

ADVANCED ACCOUNTING
Key Terms Potential Equity Share

Equity Shares A financial That
Other entitles, Its holder
instrument
An equity share a preference share. contract or may to equity
or
entitle, shares.
is a share other than
Preference Share Share Warrants or Options
Financial instruments
Preference Carrying to dividends
share preferential and that give the holder
rights repayment
of capital. right to acquire equity shares.
Fair Value
A Financial Instrument
Fair value is
the amount
Any contract that
gives rise to both

for which an
in an arm’s
asset could be
length
exchanged,
transaction.
a financial asset of
one enterprise and
a financial liability between or a liability

or equity shares knowledgeable, settled,
willing parties
of another
enterprise.
Financial Asset Basic Earnings Per Share

A financial asset is any asset that is
Basic earnings per share is calculated as
Cash
A contractual right to receive cash or another financial asset from

Net profit (loss) attributable to equity shareholders
another enterprise
Weighted average number of equity shares outstanding during the period
A contractual right to exchange financial instruments with another
enterprise under conditions that are potentially favourable; or
An equity share of another enterprise. For calculating basic earnings per share, the net profit or
loss for the period attributable to equity shareholders
Financial Liability
should be the net profit or loss after deducting preference
Any liability that is a dividends and any attributable tax thereto for the period.
Contractual obligation to deliver cash or another financial All items of income and expense which are recognised in a
asset period, including tax expense and extraordinary items, are
included in the determination of the net profit or loss for
To another enterprise or to exchange financial instruments the period.
With another enterprise under conditions that are

potentially unfavourable.

ADVANCED ACCOUNTING
Amount of any preference dividends In calculating diluted earnings per share, effect is given to all
Amount of on non-cumulative preference shares dilutive potential equity shares that were outstanding during
preference provided for in respect of the period; and the period, that is:
dividends for the
period that is Full amount of the required preference
deducted from the dividends for cumulative preference
net profit for the shares for the period, whether or not the The weighted average number of equity
period is: dividends have been provided for. shares outstanding during the period
The net profit for the is increased by the weighted average
period attributable to number of additional equity shares
equity shares is: which would have been outstanding
If an enterprise has more than one class of equity shares, net profit or
loss for the period is apportioned over the different classes of shares assuming the conversion of all dilutive
in accordance with their dividend rights. potential equity shares.
Earnings Per Share

Increased by the Increased by the Adjusted for the
The number of shares used in the denominator for basic amount of dividends amount of interest after-tax amount of
EPS should be the weighted average number of equity shares recognised in the recognised in the any other changes in
outstanding during the period. period in respect period in respect expenses or income
of the dilutive of the dilutive that would result
potential equity potential equity from the conversion
The weighted average number of equity shares outstanding shares as adjusted shares as adjusted of the dilutive
during the period is the number of shares outstanding at the for any attributable for any attributable potential equity
beginning of the period, adjusted by the number of equity change in tax change in tax shares.
shares bought back or issued during the period multiplied by expense for the expense for the
a time-weighting factor. period; period; and
For the purpose of calculating diluted earnings per share, an

(i) Are treated as a fraction of (ii) to the extent that they were
enterprise should assume the exercise of dilutive options and other
an equity share entitled
dilutive potential equity shares of the enterprise. The assumed
Partly paid proceeds from these issues should be considered to have been
equity shares
received from the issue of shares at fair value. The difference between
(iii) to participate in dividends (iv) relative to a fully paid the number of shares issuable and the number of shares that would
equity share have been issued at fair value should be treated as an issue of equity
shares for no consideration.
Where an enterprise has equity shares of different nominal values but Options and other share purchase arrangements are dilutive when they
with the same dividend rights, the number of equity shares is calculated would result in the issue of equity shares for less than fair value. The
by converting all such equity shares into equivalent number of shares of amount of the dilution is fair value less the issue price. Therefore, in order
the same nominal value. to calculate diluted earnings per share, each such arrangement is treated
as consisting of:
Equity shares may be issued, or the number of shares outstanding may
be reduced, without a corresponding change in resources. Examples
include: bonus issue or share splits. (a) A contract to issue a certain number of equity shares at their average
fair value during the period. The shares to be so issued are fairly
In a rights issue, the exercise price is often less than the fair value of the priced and are assumed to be neither dilutive nor anti-dilutive.
shares. A rights issue usually includes a bonus element. (b) A contract to issue the remaining equity shares for no consideration.
Such equity shares generate no proceeds and have no effect on the
net profit attributable to equity shares outstanding.
The number of equity shares to be used in calculating basic earnings per

share for all periods prior to the rights issue is the number of equity shares
outstanding prior to the issue, multiplied by the following adjustment
factor: Dilutive Potential Equity Shares
Fair value per share immediately prior to the exercise of rights
Theoretical ex -rights fair value per share Potential equity shares are anti-dilutive when their conversion to equity
shares would increase earnings per share from continuing ordinary
activities or decrease loss per share from continuing ordinary activities.
The theoretical ex-rights fair value per share is calculated by adding the
aggregate fair value of the shares immediately prior to the exercise of the
rights to the proceeds from the exercise of the rights, and dividing by the
number of shares outstanding after the exercise of the rights. In considering whether potential equity shares are dilutive or anti-
dilutive, each issue or series of potential equity shares is considered
separately rather than in aggregate.
Diluted Earnings per Share
Where an enterprise has equity shares of different nominal values
but with the same dividend rights, the number of equity shares is Potential equity shares are weighted for the period they were
calculated by converting all such equity shares into equivalent outstanding.
number of shares of the same nominal value.

ADVANCED ACCOUNTING
Restatement Disclosure
If the number of equity or potential equity shares outstanding
increases as a result of a bonus issue or share split or decreases Where the statement of profit and The amounts used as the
as a result of a reverse share split (consolidation of shares), the loss includes extraordinary items numerators in calculating basic and
calculation of basic and diluted earnings per share should be basic and diluted EPS computed diluted earnings per share, and a
adjusted for all the periods presented. on the basis of earnings excluding reconciliation of those amounts to
extraordinary items (net of tax the net profit or loss for the period.
If these changes occur after the balance sheet date but before expense).
An enterprise should
the date on which the financial statements are approved by disclose
the board of directors, the per share calculations for those
financial statements and any prior period financial statements The weighted average number
presented should be based on the new number of shares. of equity shares used as the The nominal value of shares along
denominator in calculating basic with the earnings per share figures.
and diluted earnings per share
and a reconciliation of these
Presentation denominators to each other.
An enterprise should present AS 20 requires an enterprise

basic and diluted earnings to present basic and diluted
per share on the face of the earnings per share, even if If an enterprise discloses, in addition to basic and diluted earnings per
statement of profit and loss for the amounts disclosed are share, per share amounts using a reported component of net profit other
each class of equity shares that negative . than net profit or loss for the period attributable to equity shareholders,
has a different right to share in such amounts should be calculated using the weighted average number of
the net profit for the period. equity shares determined in accordance with AS 20.
AS 24 “DISCONTINUING OPERATIONS”
The objective of AS 24 is to establish principles for reporting Assets, liabilities, revenue, and expenses are directly attributable
information about discontinuing operations, thereby enhancing to a component if they would be eliminated when the component
the ability of users of financial statements to make projections of an is sold, abandoned or otherwise disposed of. If debt is attributable
enterprise's cash flows, earnings-generating capacity, and financial to a component, the related interest and other financing costs are
position by segregating information about discontinuing operations similarly attributed to it.
from information about continuing operations.
Discontinuing Operation Discontinuing operations are infrequent events, but this does
not mean that all infrequent events are discontinuing operations.
A discontinuing operation is a component of an enterprise
That represents That can be

Initial Disclosure Event
That the a separate major distinguished
enterprise, line of business operationally Enterprise has entered into
pursuant to a or geographical and for financial With respect to a binding sale agreement
single plan* area of operations reporting a discontinuing for substantially all of
purposes. operation, the the assets attributable to
initial disclosure discontinuing operation or Approved a
event is the detailed, formal
occurrence plan for the
*(i) Disposing of substantially in its entirety, such as by selling the of one of discontinuance
component in a single transaction or by demerger or spin-off of the events, and
ownership or whichever
occurs earlier:
(ii) Disposing of piecemeal, such as by selling off the component’s
Enterprise’s board of Made an
assets and settling its liabilities individually or directors or similar announcement
(iii) Terminating through abandonment. governing body has of the plan.
To qualify as a discontinuing operation, the disposal must be

pursuant to a single coordinated plan.
Recognition and Measurement
A component can • Operating assets and liabilities of the component can be
be distinguished directly attributed to it. This AS does not provide any guidelines
operationally and for • Its revenue can be directly attributed to it.
financial reporting • For recognizing and measuring,
• Majority of its operating expenses can be directly
purposes if these attributed to it. • Effect of discontinuing operations,
conditions are met: • Relevant Accounting Standards should be referred.

ADVANCED ACCOUNTING
Presentation and Disclosure Separate disclosure for each discontinuing

Initial Disclosure
operation
An enterprise should include the following information relating to Any disclosures required by AS 24 should be presented separately
a discontinuing operation in its financial statements beginning with for each discontinuing operation.
the financial statements for the period in which the initial disclosure
event occurs:
Presentation of the Required Disclosures
A description of The amounts of net cash flows attributable
the discontinuing to the operating, investing, and financing
activities of the discontinuing operation The amount of pre-tax profit or loss
operation(s). during the current financial reporting period. from ordinary activities attributable
All disclosures
to the discontinuing operation
should be presented
during the current financial
in the notes to the
The amount of pre-tax profit or loss from reporting period, and the income
The business financial statements
ordinary activities attributable to the tax expense related thereto
or geographical except these
segment(s) in which it discontinuing operation during the current disclosures which
financial reporting period, and the income
is reported. tax expense related thereto. should be shown
The amount of the pre-tax gain or
on the face of the
loss recognized on the disposal of
statement of profit
assets or settlement of liabilities
and loss:
attributable to the discontinuing
The date and The amounts of revenue and expenses in operation.
nature of the initial respect of the ordinary activities attributable
disclosure event. to the discontinuing operation during the
current financial reporting period.
Restatement of Prior Periods
Comparative information for prior periods that is presented in financial
The date or period in statements prepared after the initial disclosure event should be restated
which the discontinuance The carrying amounts, as of the balance to segregate assets, liabilities, revenue, expenses, and cash flows of
sheet date, of the total assets to be continuing and discontinuing operations.
is expected to be disposed of and the total liabilities to be
completed if known or settled.
determinable. Disclosure in Interim Financial Reports
Other Disclosures • Any significant activities or events

Disclosures in an since the end of the most recent
interim financial annual reporting period relating
When an enterprise disposes of assets or settles liabilities
report in respect to a discontinuing operation and
attributable to a discontinuing operation or enters into • Any significant changes in
of a discontinuing
binding agreements for the sale of such assets or the the amount or timing of cash
operation
settlement of such liabilities, it should include, in its financial flows relating to the assets to
statements, the following information when the events occur: be disposed or liabilities to be
• For any gain or loss that is recognised on the disposal of settled.
assets or settlement of liabilities attributable to the discontinuing
operation:
(i) the amount of the pre-tax gain or loss
(ii) income tax expense relating to the gain or loss
• The net selling price or range of prices (which is after

deducting expected disposal costs) of those net assets for
which the enterprise has entered into one or more binding
sale agreements, the expected timing of receipt of those
cash flows and the carrying amount of those net assets on
the balance sheet date.
The disclosures should continue in financial statements for periods

up to and including the period in which the discontinuance
is completed. Discontinuance is completed when the plan is
substantially completed or abandoned, though full payments from
the buyer(s) may not yet have been received.
If an enterprise abandons or withdraws from a plan that was
previously reported as a discontinuing operation, that fact, reasons
therefore and its effect should be disclosed.

ADVANCED ACCOUNTING
AS 26 “INTANGIBLE ASSETS”
The objective of AS 26 is to prescribe the accounting treatment for intangible assets that are not dealt with specifically in another Accounting
Standard. AS 26 also specifies how to measure the carrying amount of intangible assets and requires certain disclosures about intangible assets.
Scope Amortisation
• Intangible assets that are covered by another
Accounting Standard.
AS 26 should • Financial assets.
be applied by all • Mineral rights and expenditure on the of the of an
enterprises in The systematic over its useful
exploration for, or development and extraction depreciable intangible
accounting for of, minerals, oil, natural gas and similar non- allocation life.
intangible assets, amount asset
except regenerative resources.
• Intangible assets arising in insurance
enterprises from contracts with policyholders.
• Other intangible assets used (such as

computer software), and other expenditure Depreciable Amount
AS 26 applies to (such as start-up costs), in extractive industries
or by insurance enterprises.
Expenditure The cost of an its residual

Less
on advertising, asset value.
training, start - up
cost.
Research and
Goodwill. development
activities.
Useful Life
AS 26 also
applies to Useful life is either
Right under (a) Period of time over

licensing which an asset is
agreements for
Trademarks. items such as expected to be used by
motion picture the enterprise; or
films, video
recordings.
(b) Number of production
Patents, or similar units expected
copyrights.
to be obtained from the
asset by the enterprise.
Key Terms
Asset Controlled by an Fair Value
enterprise as a result
Fr ono pec erp
of past events and

ec e ex ent
om m te ris
ar the
a
Fair
rce is
to
wh c
amount for could be knowledgeable, in an arm’s

ou set
value of
ich ben flow
exchanged length
i
:
which that willing parties

res n as
an asset between transaction.

asset
fu efits
is the
d
A
tu
to e.
re
An Active Market
Monetary Assets
or determinable Willing buyers

amounts of A market Items traded Prices are
assets to be where all the within the and sellers can
received in fixed money. normally be available to
are money held conditions market are the public.
Monetary assets and exist homogeneous. found.
Non-monetary assets are assets other than monetary assets.

ADVANCED ACCOUNTING
Impairment Loss Control
An enterprise controls an
carrying its asset if the enterprise has
Amount by amount of an exceeds recoverable the power to obtain the
which asset Future economic benefit is
amount. future economic benefits
flowing from the underlying also flown from the skill of
resource and also can restrict labour and customer loyalty
the access of others to those but usually this flow of
benefits. benefits cannot be controlled
Carrying Amount by the enterprise. Hence,
these items don’t even
Amount at which an asset is recognised in the balance sheet, qualify as intangible asset.
net of any accumulated amortisation and accumulated

impairment losses thereon.
Future Economic Benefits
Financial Asset
The future economic benefits flowing from an intangible asset may
A contractual right to receive include revenue from the sale of products or services, cost savings,
cash or another financial asset or other benefits resulting from the use of the asset by the enterprise.
Cash. from another enterprise. Use of intellectual property in a production process may reduce
future production costs rather than increase future revenues.
A financial asset
is any asset that is
Recognition and Initial Measurement of an
A contractual right to exchange
Intangible Asset
financial instruments with An ownership interest in another
another enterprise under enterprise. The recognition of an item as an intangible asset requires an
conditions that are potentially
favourable. enterprise to demonstrate
Intangible Assets It is probable that the future

economic benefits that are The cost of the asset can be
attributable to the asset will measured reliably.
An intangible asset is flow to the enterprise
An intangible asset should be measured initially at cost.

An identifiable Non-monetary asset
Separate Acquisition
If an intangible asset is acquired separately; cost of the intangible
Without physical substance asset can usually be measured reliably.
Cost of an intangible asset comprises its purchase price
Held for use in the production or supply of goods or services, for rental including any import duties and other taxes (other than those
to others, or for administrative purposes. subsequently recoverable by the enterprise from the taxing
authorities) and any directly attributable expenditure on
making the asset ready for its intended use.
If an item covered by AS 26 does not meet the definition of an
intangible asset, expenditure to acquire it or generate it internally If an intangible asset is acquired in exchange for shares or other
is recognised as an expense when it is incurred. securities of the reporting enterprise: asset is recorded at its fair
value or the fair value of the securities issued whichever is more
Identifiability clearly evident.
The definition of an intangible asset requires that an intangible Acquisition as part of an Amalgamation
asset be identifiable. To be identifiable, it is necessary that the
intangible asset is clearly distinguished from goodwill.
Intangible asset A transferee If the cost (i.e. fair
An intangible asset can be clearly distinguished from goodwill recognises an value) of an intangible
acquired in an
if the asset is separable. An asset is separable if the enterprise intangible asset that asset acquired as part
amalgamation in the
could rent, sell, exchange or distribute the specific future meets the recognition of an amalgamation in
nature of purchase
economic benefits attributable to the asset without disposing criteria, even if that the nature of purchase
is accounted for in
of future economic benefits that flow from other assets used in intangible asset had cannot be measured
accordance with AS
the same revenue earning activity. not been recognised reliably, that asset is
14 (Revised).
If an asset generates future economic benefits only in in the financial not recognised as a
combination with other assets, the asset is identifiable if the statements of the separate intangible
enterprise can identify the future economic benefits that will transferor and asset but is included
flow from the asset. in goodwill.

ADVANCED ACCOUNTING
Acquisition by way of a Government Grant An intangible asset arising from development (or from the
development phase of an internal project) should be recognised if, and
only if, an enterprise can demonstrate all of the following:
a. The technical feasibility of completing the intangible asset so that it

will be available for use or sale.
If an intangible
or for nominal b. Its intention to complete the intangible asset and use or sell it.
asset is acquired
consideration,
free of charge,
c. Its ability to use or sell the intangible asset.
d. How the intangible asset will generate probable future

economic benefits.
it should be by way of a
accounted for on government
the basis of their e. The availability of adequate technical, financial and other resources
grant,
acquisition cost to complete the development and to use or sell the intangible asset and
or for nominal
consideration. f. Its ability to measure the expenditure attributable to the intangible
asset during its development reliably.
Expenditure on internally generated brands, mastheads, publishing

Internally Generated Goodwill titles, customer lists and items similar in substance cannot be
distinguished from the cost of developing the business as a whole.
Internally generated goodwill Therefore, such items are not recognised as intangible assets.
is not recognised as an asset Cost of an Internally Generated Intangible

because it is not an identifiable resource Asset
controlled by the enterprise
that can be measured reliably at cost. Expenditure on materials and services used
The cost of an internally or consumed in generating the intangible
generated intangible asset.
asset comprises all
Internally Generated Intangible Assets expenditure that can be Salaries, wages and other employment
directly attributed, or related costs of personnel directly engaged
allocated on a reasonable in generating asset.
To assess whether an internally generated intangible asset and consistent basis,
meets the criteria for recognition, an enterprise classifies the for creating, producing Any expenditure that is directly attributable
generation of the asset into and making the asset to generating the asset.
ready for its intended
use from the time when Overheads that are necessary to generate
the intangible asset first the asset and that can be allocated on a
meets the recognition reasonable and consistent basis to the asset.
criteria. The cost includes
Research Phase Development Phase
If an enterprise cannot distinguish the research phase from the

development phase of an internal project to create an intangible
The costs Selling, administrative and other general
asset, the enterprise treats the expenditure on that project as if it overhead expenditure unless this
which are not expenditure can be directly attributed to
were incurred in the research phase only. components making the asset ready for use.
of the cost of
an internally Clearly identified inefficiencies and initial
Research Phase generated
operating losses incurred before an asset
achieves planned performance and
intangible
Expenditure on training the staff to operate
Research is original and planned investigation undertaken with asset: the asset.
the prospect of gaining new scientific or technical knowledge and
understanding.
No intangible asset arising from research or from the research phase

should be recognised. Expenditure on research or on the research
phase should be recognised as an expense when it is incurred. Recognition of an Expense
Expenditure on an intangible item should be recognised
Development Phase as an expense when it is incurred unless:
Development is the application of research findings or other
knowledge to a plan or design for the production of new or The item is acquired in an
substantially improved materials, devices, products, processes, It forms part of the cost of an amalgamation in the nature
systems or services prior to the commencement of commercial intangible asset that meets the of purchase and cannot be
production or use. recognition criteria. recognized as an intangible
asset.

ADVANCED ACCOUNTING
In some cases, expenditure is incurred to provide future
economic benefits to an enterprise, but no intangible asset In some cases, there may be persuasive evidence that the
or other asset is acquired or created that can be recognised. useful life of an intangible asset will be a specific period longer
In these cases, the expenditure is recognised as an than ten years. In these cases, the presumption that the useful
expense when it is incurred. Expenditure on research life generally does not exceed ten years is rebutted and the
is always recognised as an expense when it is incurred. enterprise:
Expenses recognised as expenses cannot be reclassified as cost of

intangible asset in later years.
Amortises the intangible asset over the best
Nature of Expenditure Accounting treatment estimate of its useful life.
Planning Expense when incurred
Application and
Infrastructure Estimates the recoverable amount of the intangible
Apply the requirements of AS 10 asset at least annually in order to identify any
Development
impairment loss and
Graphical Design and If a separate asset is not identifiable,
Content Development then expense when incurred, unless it
meets the recognition criteria
Operating Discloses the reasons why the presumption is

Expense when incurred, unless in rare
circumstances it meets the criteria, in rebutted and the factors that played a significant
which case the expenditure is included role in determining the useful life of the asset.
in the cost of the web site
Other Expense when incurred Amortisation Method

A variety of amortisation methods can be used to allocate the
depreciable amount of an asset on a systematic basis over its
Subsequent Expenditure useful life. These methods include the straight-line method, the
diminishing balance method and the unit of production method.
Subsequent expenditure on an intangible asset after its The method used for an asset is selected based on the expected
purchase or its completion should be recognised as an pattern of consumption of economic benefits and is consistently
expense when it is incurred unless applied from period to period.
It is probable that the

Residual Value
expenditure will enable the Expenditure can be measured Residual value is the amount, which an enterprise expects to obtain
asset to generate future and attributed to the asset for an asset at the end of its useful life after deducting the expected
economic benefits in excess of reliably. costs of disposal.
its originally assessed standard
of performance and There is a i. Residual value
commitment by can be determined
a third party to by reference to
If these conditions are met, the subsequent expenditure should be purchase the asset that market and
The residual at the end of its
added to the cost of the intangible asset. value of an useful life.
intangible
Subsequent expenditure on brands, mastheads, publishing titles, asset should be
customer lists and items similar in substance is always recognised as assumed to be
zero unless ii. It is probable
an expense to avoid the recognition of internally generated goodwill. that such a market
There is an active will exist at the
end of the asset’s
Measurement Subsequent to Initial market for the
useful life.
asset and:
Recognition
After initial recognition, an intangible asset should be carried at
its cost less any accumulated amortisation and any accumulated
impairment losses.
Review of Amortisation Period and
Amortisation Period Amortisation Method
The depreciable amount of an intangible asset should be allocated on The amortisation period and the amortisation method should be
a systematic basis over the best estimate of its useful life. Amortisation reviewed at least at each financial year end.
should commence when the asset is available for use.
If there has been a significant change in the expected pattern of
AS 26 adopts a presumption that the useful life of intangible assets economic benefits from the asset, the amortisation method should
is unlikely to exceed ten years. be changed to reflect the changed pattern.

ADVANCED ACCOUNTING
Retirements and Disposals Disclosure

I. Additions, indicating
An intangible asset should be derecognised (eliminated Useful lives or the separately those from
from the balance sheet) if amortisation rates used. internal development and
through amalgamation.
Amortisation methods
used. II. Retirements and
disposals.
The financial statements
should disclose for each
class of intangible assets,
distinguishing between Gross carrying amount III. Impairment losses
When no future economic internally generated and the accumulated recognised in the
Disposed benefits are expected from its intangible assets and other amortisation (aggregated statement of profit and
intangible assets with accumulated loss.
use and subsequent disposal. impairment losses) at the
beginning and end of the
period.
IV. Impairment losses
Gains or losses arising from the retirement or disposal of an reversed in the statement
of profit and loss.
intangible asset should be determined as the difference between A reconciliation of the
carrying amount at the
the net disposal proceeds and the carrying amount of the asset and beginning and end of the
period showing:
should be recognised as income or expense in the statement of profit
and loss. V. Amortisation recognised
during the period and
VI. Other changes in the

carrying amount during
the period.
Other Disclosure
The financial statements should also disclose:
a. If an intangible asset is amortised over more than ten years, the reasons why it is presumed that the useful life of an intangible asset will
exceed ten years from the date when the asset is available for use.
b. A description, the carrying amount and remaining amortisation period of any individual intangible asset that is material to the financial
statements of the enterprise as a whole.
c. The existence and carrying amounts of intangible assets whose title is restricted and the carrying amounts of intangible assets pledged as
security for liabilities and
d. The amount of commitments for the acquisition of intangible assets.
AS 29 “PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS”

AS 29 lays down appropriate accounting for contingent assets. The objective of AS 29 is to ensure appropriate recognition criteria and
measurement bases are applied to provisions and contingent liabilities.
Scope Key Terms

Executory contracts are contracts under which neither party has
performed any of its obligations or both parties have partially performed
their obligations to an equal extent.
AS 29 should be Those resulting from financial
applied in accounting instruments that are carried at fair value;
for provisions and Those resulting from executory contracts
except where the contract is onerous*; A Provision is a liability which can be measured only by using a substantial
contingent liabilities degree of estimation.
Those arising in insurance enterprises
and in dealing with from contracts with policy-holders; and
contingent assets, Those covered by another Accounting
other than Standard. A Liability is a present obligation of the enterprise arising from past
events, the settlement of which is expected to result in an outflow from the
enterprise of resources embodying economic benefits.
* An ‘onerous contract’ is a contract in which the unavoidable costs of meeting

An Obligating event is an event that creates an obligation that results in an
the obligations under the contract exceed the economic benefits expected to be enterprise having no realistic alternative to settling that obligation.
received under it.

ADVANCED ACCOUNTING
(a)A possible obligation that Past Event

arises from past events and
the existence of which will A past event that leads to a present obligation is called an obligating
be confirmed only by the event. For an event to be an obligating event, it is necessary that
occurrence or non-occurrence the enterprise has no realistic alternative to settling the obligation
of one or more uncertain future
created by the event.
events not wholly within the
control of the enterprise; or (i)
It is not probable that
A Contingent an outflow of resources No provision is recognised for costs that need to be incurred
liability is: embodying economic to operate in the future. The only liabilities recognised in an
(b) A present obligation that benefits will be required to
arises from past events but settle the obligation; or
enterprise’s balance sheet are those that exist at the balance sheet
is not recognised because date.
(ii)A reliable estimate of the
amount of the obligation It is only those obligations arising from past events existing
cannot be made.
independently of an enterprise’s future actions that are recognised
as provisions.
A Contingent asset is a possible asset that arises from past events the
existence of which will be confirmed only by the occurrence or non-
occurrence of one or more uncertain future events not wholly within the An event that does not give rise to an obligation immediately may
control of the enterprise. do so at a later date, because of changes in the law. However, the
causing of the damage will become an obligating event when a
new law requires the existing damage to be rectified.
Present obligation - an obligation is a present obligation if, based on the
evidence available, its existence at the balance sheet date is considered
probable, i.e., more likely than not Probable Outflow of Resources Embodying
Economic Benefits
Possible obligation - an obligation is a possible obligation if, based on the
evidence available, its existence at the balance sheet date is considered not For a liability to qualify for recognition there must be
probable. not only a present obligation but also the probability of
an outflow of resources embodying economic benefits
to settle that obligation. An outflow of resources or
A Restructuring is a programme that is planned and controlled by other event is regarded as probable if the probability
management, and materially changes either:
that the event will occur is greater than the probability
(a) The scope of a business undertaken by an enterprise; or
that it will not. Where it is not probable that a present
(b) The manner in which that business is conducted.
obligation exists, an enterprise discloses a contingent
liability, unless the possibility of an outflow of resources
embodying economic benefits is remote.
Provisions
Where there are a number of similar obligations (e.g.,
A provision should be recognised when:
product warranties or similar contracts) the probability
that an outflow will be required in settlement is
determined by considering the class of obligations as a
whole. Although the likelihood of outflow for any one
item may be small, it may well be probable that some
(b)It is probable outflow of resources will be needed to settle the class of
(a)An enterprise that an outflow (c)A reliable estimate
has a present can be made of obligations as a whole. If that is the case, a provision is
of resources
obligation as a embodying the amount of the recognised (if the other recognition criteria are met).
result of a past economic benefits obligation.
event; will be required to
settle the obligation;
and
Reliable Estimate of the Obligation
Present Obligation The use of estimates is an

inherent part of preparing In the extremely rare case
financial statements and does where no reliable estimate
An enterprise should Where it is more likely Where it is more can be made, a liability exists
determine whether likely that no present not undermine their reliability.
than not that a present Provisions require a greater that cannot be recognised.
a present obligation obligation exists at the obligation exists at the degree of estimation than most That liability will, instead,
exists at the balance balance sheet date, the balance sheet date, the other items, but it should not be disclosed as a contingent
sheet date by taking enterprise recognises enterprise discloses be impossible to determine a liability.
account of all available a provision (if the a contingent liability, range of possible outcomes.
evidence. recognition criteria are unless the possibility of
met); and an outflow of resources
embodying economic
benefits is remote.

ADVANCED ACCOUNTING
Contingent Liabilities Future Events

An enterprise should not recognise a contingent liability but should be
disclosed. A contingent liability is disclosed, unless the possibility of an It is only those Future events that The effect of possible
outflow of resources embodying economic benefits is remote. obligations arising may affect the amount new legislation is taken
from past events that required to settle an into consideration in
Where an enterprise is jointly and severally liable for an obligation, the part exist independently obligation should be measuring an existing
of the obligation that is expected to be met by other parties is treated as a of the enterprise’s reflected in the amount
contingent liability. The enterprise recognises a provision for the part of the obligation when
obligation for which an outflow of resources embodying economic benefits future actions that are of a provision where sufficient objective
is probable, except in the extremely rare circumstances where no reliable recognised as provisions. there is sufficient evidence exists that the
estimate can be made. objective evidence that legislation is virtually
they will occur. certain to be enacted.
Contingent Assets Expected Disposal of Assets

Contingent
assets usually An enterprise
A contingent asset
Gains on the expected disposal of assets are not taken into
arise from should not Contingent assets
recognise a is not disclosed are assessed account in measuring a provision, even if the expected disposal
unplanned in the financial
or other contingent asset, continually and is closely linked to the event giving rise to the provision. Instead,
since this may statements. It is if it has become
unexpected usually disclosed virtually certain
an enterprise recognises gains on expected disposals of assets at
events that result in the
recognition of in the report of the that an inflow the time specified by the Accounting Standard dealing with the
give rise to approving authority
the possibility income that may of economic assets concerned.
never be realised. where an inflow of benefits will arise,
of an inflow economic benefits
of economic the asset and the
is probable. related income are
benefits to the
recognised.
enterprise.
Reimbursements
Where some or all of the expenditure required to settle a provision
is expected to be reimbursed by another party, the reimbursement
Table- Provisions and contingent liabilities should be recognised when, and only when, it is virtually certain
Where, as a result of past events, there may be an outflow of that reimbursement will be received if the enterprise settles the
resources embodying future economic benefits in settlement of: obligation.
(a) a present obligation the one whose existence at the balance sheet
date is considered probable; or
(b) a possible obligation the existence of which at the balance sheet
Some or all of the expenditure required to settle a provision is
date is considered not probable.
expected to be reimbursed by another party.
There is a present There is a possible There is a possible
obligation that obligation or a present obligation or a
probably requires an obligation that may, present obligation The enterprise The obligation for the The obligation
outflow of resources but probably will not, where the likelihood has no obligation amount expected to be for the amount
and a reliable require an outflow of of an outflow of for the part of the reimbursed remains expected to be
estimate can be made resources. resources is remote. expenditure to be with the enterprise and reimbursed
of the amount of
obligation. reimbursed by the it is virtually certain that remains with the
other party. reimbursement will be enterprise and the
A provision is No provision is No provision is received if the enterprise r e im b ur s e m e n t
recognised. recognised. recognised.
settles the provision. is not virtually
Disclosures are Disclosures are No disclosure is
required for the required for the required. certain if the
provision. contingent liability. enterprise settles
the provision.
Measurement- Best Estimate The enterprise The reimbursement is The expected
has no liability for recognised as a separate reimbursement is
The estimates of the amount to be asset in the balance not recognised as
The amount outcome and financial
recognised as a effect are determined reimbursed. sheet and may be offset an asset.
provision should be by the judgment of the against the expense
the best estimate management of the
of the expenditure enterprise, supplemented in the statement of
required to settle the by experience of similar profit and loss. The
present obligation at transactions and, in amount recognised
the balance sheet date. some cases, reports from
independent experts. for the expected
reimbursement does not
exceed the liability.
Risks and Uncertainties No disclosure is The reimbursement is The expected

required. disclosed together with reimbursement is
The risks and uncertainties that inevitably surround many events the amount recognised disclosed.
and circumstances should be taken into account in reaching the for the reimbursement.
best estimate of a provision.

ADVANCED ACCOUNTING
Decision Tree A provision for restructuring costs is recognised only when the
recognition criteria for provisions are met. No obligation arises
Start for the sale of an operation until the enterprise is committed to
the sale, i.e., there is a binding sale agreement.
Present obligation No No (a) Necessarily entailed by the

as a result of an A restructuring provision restructuring; and
Possible obligation?
obligating event? should include only the direct
Yes expenditures arising from the
Yes restructuring, which are those
that are both: (b) Not associated with the
No Yes ongoing activities of the enterprise
Possible obligation? Remote?
Yes
No ( rare) No Identifiable future operating losses up to the date of a
Reliable estimate?
restructuring are not included in a provision.
Yes
Gains on the expected disposal of assets are not taken into
Provide account in measuring a restructuring provision, even if the sale
of assets is envisaged as part of the restructuring.
Disclose contingent
liability
Do nothing Disclosure
For each class of provision, an enterprise
Changes in Provisions should disclose:
Provisions should be reviewed at each balance sheet date and
adjusted to reflect the current best estimate. If it is no longer
probable that an outflow of resources embodying economic
benefits will be required to settle the obligation, the provision
should be reversed. Carrying Additional Amounts used Unused amounts
amount at provisions made (i.e. incurred and reversed during
the beginning in the period, charged against the period.
Note: As per the amendment made in AS 29 (Revised) and end of the including the provision)
period; increases during the
pursuant to MCA notification dated 30 March 2016, to existing period; and
effective from financial year 2016-17, all the existing provisions;
provisions for decommissioning, restoration and similar
liabilities should be discounted prospectively, with the
corresponding effect to the related item of property, plant
and equipment. (a) A brief description of the
nature of the obligation
and the expected timing of
any resulting outflows of
Use of Provisions An enterprise economic benefits;
b) An indication of the
A provision should be used only for expenditures for which the should disclose uncertainties about those
provision was originally recognised. Only expenditures that outflows. Where necessary
relate to the original provision are adjusted against it. for each class of to provide adequate
information, an enterprise
provision: should disclose the
Application of the Recognition and major assumptions made
concerning future events, and
Measurement Rules
(c) The amount of any expected
Future Operating Losses reimbursement, stating the
amount of any asset that
Future operating losses do not meet the definition of a liability has been recognised for that
and the general recognition criteria, therefore provisions should expected reimbursement.
not be recognised for future operating losses. Note: SMCs are exempt from the above disclosure requirements.
Restructuring
The following are examples of events Unless the possibility
of any outflow in (a) An estimate of its financial effect,
that may fall under the definition of
restructuring: settlement is remote, (b) An indication of the uncertainties
an enterprise should
disclose for each class of relating to any outflow; and
contingent liability at the (c) The possibility of any
balance sheet date a brief
description of the nature reimbursement.
Closure of Fundamental of the contingent liability
Sale or business re-organisations and, where practicable:
termination of a locations in that have a
line of business a country or Changes in material effect
region or the management on the nature
relocation structure. and focus of
Where any of the information required by the standard is not
of business the enterprise’s disclosed because it is not practicable to do so, that fact should
activities. operations. be stated.

Advanced Accounting
ISBN : 978-81-8441-882-8
Board of Studies
A- 29, ICAI Bhawan, Sector-62, Noida-201309
Phone : 0120 - 3045930
Website : http://www.icai.org July/2017/P2118(New)
Intermediate Course
Paper: 6
Auditing
and Assurance
AUDITING AND ASSURANCE
AUDITING AND ASSURANCE : A Capsule for Quick Revision
It has always been the endeavour of Board of Studies to provide quality academic inputs to the students of Chartered Accountancy Course.
Keeping in mind this objective, BoS has decided to come out with a Crisp & Concise Capsule of each subject to facilitate students for quick revision
before examination.
The third in the series of capsules is on Paper 6: Auditing & Assurance of Intermediate (IPC) Course. It may be mentioned that this capsule is a tool
for quick revision of some significant areas of Auditing & Assurance & this should not be taken as a substitute for the detailed study of the subject.
Students are advised to refer to the relevant Study Material, Practice Manual and RTP for comprehensive study & revision.
CHAPTER 1 : NATURE OF AUDITING

What is an Audit
“An audit is independent SCOPE OF AUDIT
examination of financial
information of any entity,
To form an opinion, ensure that the accounting
whether profit oriented information is reliable and sufficient i.e. basis for the
or not, and irrespective preparation of the financial statements
of its size or legal form,
when such an examination
is conducted with a view All aspects relating to Accounting and Finance of the
to expressing an opinion enterprise to be covered
thereon.”
Ensure whether the relevant information is properly

disclosed in the financial statements
To obtain reasonable To ensure the F.S. as
assurance a whole are free from
material misstatement Not to perform duties which fall outside the
scope of his competence.
Overall objective
of the auditor
Constraints on the scope of the audit that impair
To report on the financial To communicate as the auditor’s ability to express an unqualified
statements required by the SAs opinion should be set out in his report
Aspects to Be Covered In Audit Safeguards the

interest of persons
not associated with
the management
Reporting to
the appropriate
person/body An examination
Government may Acts as a moral
Checking the of the system require audited and check on the
result shown by the of accounting certified statement employees
profit and loss and
internal control
Verification of the
Advantages of Audit
Verification of
liabilities the authenticity
and validity of
transaction Helps in the Helpful in settling
Verification Comparison detection of liability for taxes
of the title, of wastages and losses
existence and the Items of
value of FS with the
the assets underlying record
Useful for settling
trade disputes
The Chartered Accountant Student June 2017

Inherent Limitations of Audit (SA 200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Standards on Auditing”): The auditor is not expected to, and cannot, reduce audit risk to zero because there
are inherent limitations of an audit. The inherent limitations of an audit arise from:
The Nature of Financial Reporting: The preparation of financial statements involves judgment by management.
The Nature of Audit Procedures: There are practical and legal limitations on the auditor’s ability to obtain audit evidence such as:
Possibility that management or others may not provide, Fraud may involve An audit is not an official investigation into
intentionally or unintentionally, the complete information sophisticated and carefully alleged wrongdoing.
relevant for preparation and presentation of FS. organised schemes.
Timeliness of Financial Reporting and the Balance between Benefit and Cost: Relevance of information, and thereby its value, tends
to diminish over time, and there is a balance to be struck between the reliability of information and its cost.
Other Matters that Affect the Limitations of an Audit: Certain assertions or subject matters are particularly significant, such
assertions or subject matters include:
• Fraud, particularly involving senior management or collusion. • The occurrence of non-compliance with laws and regulations.
• The existence and completeness of related party • Future events or conditions that may cause an entity to cease to
relationships and transactions. continue as a going concern.
Relationship of Auditing With Other Disciplines

Types of Audit
Audit required under law: The organisations which require
audit under law are the following:
Accounting (a) companies governed by the Companies Act, 2013;
Production Law (b ) banking companies;
(c) electricity supply companies;
(d) co-operative societies;

Financial
Auditing Economics
Management (e) public and charitable trusts;
(g) corporations set up under an Act of Parliament or State

Legislature.
Data Behavioural (h) Specified entities under various sections of the Income-
Processing Science tax Act, 1961.
Statistics
& In the voluntary category are the audits of the accounts
Mathematics of proprietary entities, partnership firms, Hindu undivided
families, etc.
Applicability of Engagement and Quality Control Standards Preconditions for an Audit (SA 210 “Agreeing the Terms of
Audit Engagements”):
apply in the audit of historical financial
SAs
information.
the use by and the

apply in the review of historical financial management in the agreement of
SREs of an preparation management
information
acceptable of the to the premise
financial financial on which
reporting statements an audit is
apply in assurance engagements, dealing with framework conducted.
SAEs subject matters other than historical financial
information
apply to engagements to apply agreed upon

SRSs procedures to information and other related
services engagements such as compilation
engagements
June 2017 The Chartered Accountant Student

International Auditing and Assurance Standards Board (IAASB): The IFAC Board has established
the IAASB to develop and issue, in the public interest and under its own authority, high quality auditing
standards for use around the world. The IAASB functions as an independent standard-setting body
under the auspices of IFAC.
Auditing and Assurance Standards Board: ICAI is a member of the IFAC and is committed to work
towards the implementation of the guidelines issued by the IFAC. ICAI constituted the AASB (erstwhile
Auditing Practices Committee) to review the existing auditing practices in India and to develop
Engagement and Quality Control Standards (erstwhile Statements on Standard Auditing Practices) so
that these may be issued by the Council of the Institute.
Diagrammatic Representation of the Structure

of Standards Under the New Preface
AUDITING STANDARDS - AN OVERVIEW
Auditing and Assurance STRUCTURE OF

Standard Board - (AASB)- PRONOUNCEMENTS
Scope / Objective ISSUED BY AASB
FRAMEWORK FOR AUDIT & ASSURANCE & OTHER

SERVICES ENGAGEMENTS –
Scope/ Objective/ Definitions/ Requirements
Standard
Standards on
for Quality Standards on Standard on
Related
Control Review Assurance
Services
(SQC 01 Engagements Engagements
SRS- 4000 &
- 99) (SRE 2000 SAE (3000-
4699
-2699) 3699)
Standards on Auditing (SA 100-999) aspects covered in series:

Introductory Matters SA100 - 199
General Principles and Responsibilities SA200 - 299
Risk Assessment and Response to Assessed Risk SA300 - 499
Audit Evidence SA500 - 599
Using Work of Others SA600 - 699
Audit Conclusions and Reporting SA700 - 799
Specialised Areas SA800 - 899

CHAPTER 2 : BASIC CONCEPTS IN AUDITING
Auditor's Independence is the keystone upon which the respect and dignity of a profession is based. Independence implies that
Independence the judgement of a person is not subordinate to the wishes or directions of another person who might have engaged
him or to his own self interest.
Integrity
Technical
Objectivity
Standards
Fundamental
Principles
Professional
Professional
Competence
Behaviour
and Due Care
Confidentiality
True and Fair The phrase “true and fair” in the auditor’s report signifies that the auditor is required to express his opinion as to
whether the state of affairs and the results of the entity as ascertained by him in the course of his audit are truly and
fairly represented in the accounts under audit.
Accounting Accounting policies refers to the specific accounting principles and the methods of applying those principles adopted
policies by the enterprise in the preparation and presentation of financial statements.
Fundamental AS 1 states that fundamental accounting assumptions are usually not specifically stated because their acceptance and
Accounting use are assumed. Disclosure is necessary if they are not followed.
Assumptions
Going Concern Consistency Accrual
Audit Procedures
Risk Assessment Other Procedures

Procedures
Test of Controls Substantive Procedures
Test of Details Analytical Procedures
Test of Transactions i.e. Test of Balances i.e.

Vouching Verification

AUDIT EVIDENCE is information used by the auditor in arriving at the conclusions on which the auditor’s opinion is
based. Audit Evidence includes both information contained in the accounting records underlying the financial statements
and other information.
Information contained in
the accounting
records
Audit Evidence
Other information that
authenticates
the accounting records and also
supports the auditor’s rationale
behind the true and fair
presentation of the financial
statements.
Sufficient
Property of the Auditor Written
Representations
Consideration of
Audit
Audit Documentation Specific Items
Evidence
External
Confirmations
Audit File Completion
Memorandum Appropriate
Auditor should obtain sufficient and appropriate audit evidence.

Sufficiency of audit evidence : Sufficiency is the measure of quantity of audit evidence. Auditor's judgment as to sufficiency
may be affected by the factors such as :
(i) Materiality (ii) Risk of material misstatement (iii) Size and characteristics of the population.
Appropriateness of Audit Evidence: Appropriateness is the measure of the quality of audit evidence; that is, its relevance
and its reliability in providing support for the conclusions on which the auditor’s opinion is based.
Audit Procedures to Obtain Audit Evidence: Audit evidence to draw reasonable conclusions on which to base the
auditor’s opinion is obtained by performing:
Audit Procedures to obtain

Audit Evidence
Inspection Observation External Recalculation Reperformance Analytical Inquiry

Confirmation Procedure

Types of Audit Evidence Reliability of Audit

Evidence
Increases when
Depending upon nature Depending upon source
Visual Internal
Obtained Related Obtained Obtained in Provided
from Controls are directly by documentary by Original
independent effective the auditor form Documents
Documentary sources
External
Oral
CHAPTER 3 : PREPARATION FOR AN AUDIT

Agreement on Audit Engagement Terms {(SA 210) agreed terms of the audit engagement shall be recorded in an audit
engagement letter or other suitable form of written agreement)} shall include:
Objective and Responsibilities of Applicable financial Expected form and

scope of the audit management and reporting framework content of any
auditor reports
DEVELOPMENT OF AN OVERALL PLAN:

 The terms of his engagement and statutory  Possible rotation of emphasis on specific audit
responsibilities. areas.
 Nature and timing of reports.  The nature and extent of audit evidence to be
 Applicable legal or statutory requirements. obtained.
 Accounting policies adopted by the client.  The work of internal auditors and the extent of
their involvement.
 Effect of new accounting or auditing
pronouncements on the audit.  The involvement of other auditors.
 Identification of significant audit areas.  The involvement of experts.
 Setting of materiality levels for audit purposes.  The allocation of work between joint auditors.
 The degree of reliance on accounting system and  Establishing and coordinating staffing
internal control. requirements.
In establishing the overall audit strategy, the auditor shall:
Ascertain Consideration of Consider the Ascertain the

Identify the the reporting significant factors results of nature, timing and
scope of the objectives in directing the preliminary extent of resources
engagement; of the engagement team’s engagement required for the
engagement; efforts; activities; engagement.

AN AUDIT PROGRAMME is a detailed
 Special instructions
plan and consists of a series of verification based on past
 Audit objective experience of the
procedures to be applied to the financial
auditee
statements and accounts of a given
company for the purpose of obtaining
sufficient evidence to enable the auditor  Audit procedure to  Allocation of work
be applied amongst the team
to express an informed opinion on members
such statements. For framing an audit
programme, some points should be kept
in view:
 Extent of check  Timing of check
Audit Techniques: For collection and accumulation of audit evidence, certain methods and means are
available and these are known as audit techniques
The two terms, procedure and

Posting Casting techniques, are often used
checking checking interchangeably. However, a
distinction does exist. Procedure
Bank may comprise a number of
Reconciliation
Physical techniques and represents the
examination broad frame of the manner
and count
of handling the audit work;
techniques stand for the methods
Audit employed for carrying out
Tracing in
subsequent Techniques the procedure.
period
Confirmation
For example, procedure
requires an examination of the
documentary evidence. This job
Re- is performed by the procedure
computation
known as vouching which would
Inquiry
Year-end involve techniques of inspection
scrutiny and checking computation of
documentary evidence.
AUDIT DOCUMENTATION (SA 230) refers to the record of audit procedures performed, relevant
audit evidence obtained, and conclusions the auditor reached (term such as “working papers” is also
sometimes used).

Examples of Audit Documentation.

Form and Content of Working Papers depend on
factors such as:
Audit programmes. • Size and complexity of the entity.
• Nature of the audit procedures to be performed.
Letter of confirmation and • Identified risks of material misstatement.
representation. • Significance of the audit evidence obtained.
• Nature and extent of exceptions identified.
Correspondence (including e-mail) • Need to document a conclusion not determinable
concerning significant matters.
from audit evidence.
• The audit methodology and tools used.
Checklists.
Audit documentation
serves a number
of purposes:
 Assists team
Assists the members to  Quality  External
engagement  Accountability control
discharge of  Record of inspections
team to plan their review future audits. reviews and as per legal
and perform engagement's inspections
responsibilities team. requirements.
the audit. as per SA 220. as per SQC 1.
AUDIT SAMPLING (SA530) refers to the application of audit procedures to less than 100% of items within
a population of audit relevance such that all sampling units have a chance of selection in order to provide
the auditor with a reasonable basis on which to draw conclusions about the entire population.
Statistical Sampling is more scientific than
testing, based entirely on the auditor’s own
judgment as it involves use of mathematical laws
Approaches to Sampling of probability in determining the appropriate
sample size in varying circumstances.
In Non-statistical Sampling approach auditor’s

opinion determines the sample size but it cannot
Statistical be measured how far the sample size would fulfill
Non-Statistical
Sampling Sampling the audit objective.

Simple Random Sampling: Random selection ensures
Random that all items in the population or within each
Random Sampling stratum have a known chance of selection. It may
Sampling involve use of random number tables.
Stratified
Sampling Systematic sampling: It involves selecting items
using a constant interval between selections, the
first interval having a random start.
Sample Systematic Block
Selection Sampling Sampling Monetary Unit Sampling: It is a type of value-
Methods weighted selection in which sample size, selection
Monetary Cluster and evaluation results in a conclusion in monetary
Unit Sampling amounts.
Sampling Haphazard sampling: Auditor selects the sample
Haphazard without following a structured technique.
Sampling
ADVANTAGES OF STATISTICAL SAMPLING IN AUDITING:

(1) The amount of testing (sample size) does not increase in proportion to the increase in the size of
the area (universe) tested.
(2) The sample selection is more objective and thereby more defensible.
(3) The method provides a means of estimating the minimum sample size associated with a specified
risk and precision.
(4) It provides a means for deriving a “calculated risk” and corresponding precision (sampling error).
(5) It may provide a better description of a large mass of data than a complete examination of all the data.
AUDIT RISK means the risk that the auditor gives an inappropriate audit opinion when the financial statement
are materially misstated. SA 315 establishes requirements and provides guidance on identifying and assessing
the risks of material misstatement at the financial statement and assertion levels.
Risk of material misstatement may be defined as the risk that the
financial statements are materially misstated prior to audit. This
consists of two components, described as follows at the assertion level:
(A) Inherent risk—The susceptibility of an assertion about a class
of transaction, account balance or disclosure to a misstatement
that could be material, either individually or when aggregated
with other misstatements, before consideration of any related
controls.
Audit risk is a function of the risks of material (B) Control risk—The risk that a misstatement that could occur in an
misstatement and detection risk assertion about a class of transaction, account balance or disclosure
Audit Risk = Risk of Material Misstatement x and that could be material, either individually or when aggregated
Detection Risk------(1) with other misstatements, will not be prevented, or detected and
Risk of Material Misstatement= Inherent Risk corrected, on a timely basis by the entity’s internal control.
x Control Risk------(2) (C) Detection Risk: The risk that the procedures performed by
From (1) and (2), we arrive at- the auditor to reduce audit risk to an acceptably low level will not
detect a misstatement that exists and that could be material, either
Audit Risk = Inherent Risk x Control Risk x individually or when aggregated with other misstatements.
Detection Risk
Assessment of Risks - Matter of Professional Judgement
Surprise Checks: are a part of normal audit procedures. An element of surprise can significantly improve the
audit effectiveness. Wherever practical, an element of surprise should be incorporated in the audit procedures.
The element of surprise in an audit may be, both in regard to the time of audit, i.e. selection of date, when the
auditor will visit the client’s office for audit and selection of areas of audit.
Areas where Surprise Checks can Significantly Improve the Effectiveness of an Audit: Surprise checks
constitute an important part of normal audit procedure. An element of surprise both with regard to the time of
checking and selection of items, significantly improves the effectiveness of an audit. Normally, areas over which
surprise check can be employed are-
(i) Verification of cash and investments.
(ii) Inventory.
(iii) Internal control and internal checks.
(iv) Books of prime entries and statutory registers, etc.
CHAPTER 4 : INTERNAL CONTROL
CONCEPT OF INTERNAL CONTROL: “The process designed, implemented and maintained by those charged with governance,
management and other personnel to provide reasonable assurance about the achievement of an entity’s objectives with regard to
reliability of financial reporting, effectiveness and efficiency of operations, safeguarding of assets, and compliance with applicable
laws and regulations. The term “controls” refers to any aspects of one or more of the components of internal control.”
Human
Judgement
Reliable
Financial
Reporting
Limitations Ineffective
of Small Operation of
Entities Inherent Control
Purpose
Safeguarding The Effective
of Assets of Internal Limitations
and Efficient
Control of Internal
Operations
Control
Laws and Judgement

Regulations- by Collusion
Compliance Management among
Employees
Benefits of IT in an Entity’s Internal Control
● Processing of large volumes of transactions or data becomes simple

 Enhances the timeliness, availability, and accuracy of information
● Facilitates the additional analysis of information

 Enhances the ability to monitor the performance of the entity’s activities and its policies and procedures
● Reduces the risk that controls will be circumvented; and
 Effective segregation of duties through security controls
IT poses Specific Risks to an Entity’s Internal Control
● Reliance on systems or programs processing inaccurate data

● Unauthorised access to data that may result in destruction of data
● Breaking down segregation of duties through access privileges

● Unauthorised changes to data in master files
● Unauthorised changes to systems or programs
● Failure to make necessary changes to systems or programs

● Inappropriate manual intervention
● Potential loss of data or inability to access data as required

Review of Internal Control

with the help of
Narrative Record- Check List-series Questionnaire- Flow Chart-

complete and of instructions and/ comprehensive graphic
exhaustive or questions series of questions presentation
description
of the system
INTERNAL AUDIT
Monitoring
of Internal “Internal Audit is an independent management function, which
Control
involves a continuous and critical appraisal of the functioning of
Examination
of Financial an entity with a view to suggest improvements thereto and add
Governance
and Operating value to and strengthen the overall governance mechanism of
Information
the entity, including the entity’s risk management and internal
Activities of
the Internal control system.”
Audit Function
Risk Review of
Management Operating
Activities
Review of
Compliance
with Laws and
Regulations
The auditor shall include significant
deficiencies in internal control
in written communication
Applicability of Provisions of Internal Audit: (section 138 of
the Companies Act, 2013 & Rule 13 of Companies (Accounts)
Rules, 2014) :
A description Sufficient
(a) every listed company; of the information to
(b) every unlisted public (iii) outstanding loans or borrowings deficiencies TCWG and
company having- from banks or public financial and their management in
(i) paid up share capital institutions exceeding one effects; this regard:
of fifty crore rupees hundred crore rupees or more and
or more during the at any point of time during the
preceding financial preceding financial year; or
year; or
(ii)turnover of two hundred (iv) outstanding deposits of twenty Deficiencies
crore rupees or more five crore rupees or more at reported and
Purpose of audit Consideration of concluded are
during the preceding any point of time during the
internal control of sufficient
financial year; or preceding financial year; and
importance
(c) every private company (ii) outstanding loans or borrowings
to merit being
having- from banks or public financial
reported to
(i) turnover of two hundred institutions exceeding one
TCWG
crore rupees or more hundred crore rupees or more
during the preceding at any point of time during the
financial year; or preceding financial year:

CHAPTER 5 : VOUCHING
VOUCHING
The act of examining vouchers to establish the authenticity of the transactions with the relevant documentary evidence
and the authority and to ensure the amount of voucher posting to an appropriate account which would disclose the nature
of the transaction on its inclusion in the final statements of account.
On these considerations, the essential points to be borne in mind while examining a voucher are that the :
(i) date of the voucher falls within the accounting period;
(ii) voucher is made out in the client’s name;
(iii) voucher is duly authorised;
(iv) voucher comprised all the relevant documents, i.e., the voucher is complete in all respects; and
(v) account adjusted as per voucher is disclosing the character of the receipts or payments posted
thereto on its inclusion in the final accounts.
After the examination is over, each voucher should be either impressed with a rubber stamp or initialed so that it may not be
presented again in support of another entry.
SALE OF SCRAP: PURCHASE RETURN:

• Review the internal control as regards generation, storage and • Examine debit note issued to the supplier which in turn may be
disposal of scrap. confirmed by corresponding credit note issued by the supplier
• Check whether the organization is maintaining reasonable acknowledging the same.
record for generation of scrap.
• Analyze the raw material used, production and generation • Verify by reference to relevant corresponding record in good
pattern of scrap and compare the same with figures of earlier outward book or the stores records. Compare the figures in
year. documentary evidence with the supplier’s original invoices for
• Check the rates at which scrap has been sold and compare the rates and other charges and calculation should also be checked.
rate with previous year. • Examine in depth to eliminate the possibility of fictitious
• Vouch sales, with invoices raised, advertisement for tender, rate purchase returns for covering bogus purchases recorded earlier
contract with scrap dealers. when such returns outwards are in substantial figure either at
• Ensure the existence of proper control procedure to identify the beginning or end of the accounting year.
scrap and good units and they are not mixed up and sold as
scrap. • Cross-check with reference to original invoices any rebates in
• Make an overall assessment of the value of realization from price or allowances if any given by suppliers on strength of their
scrap as to its reasonableness Credit Notes.
BAD DEBTS: RENTAL RECEIPTS:

• Check that amount of bad debts should be traced to the schedule • Check copies of rent receipt issued to the tenant and bills of
of bad debts written off during the year. charges paid by the landlord on behalf of tenants.
• Major amount of bad debts in the schedule be taken for scrutiny. • The entries in the rental register for accrued rent be traced with
• Check that the amount considered in write off had been overdue reference to rental bills copies.
for long and scrutinize the correspondence files. • Scrutinize the account of collecting agent when the rent is
• Check the authority for write off and the level of authority is collected by such agent.
sufficiently higher than the executive involved in collection. • Vouch the entries for rent received in advance and ensure
proper adjustment is made.
• The bad debts should be properly disclosed in Statement of
• Investigate into abnormal rent outstanding. Reconcile the
Profit and Loss according to its materiality.
outstanding rent and see that proper provision is made if
• If provision had already been created for bad debts, see that
unrecoverable.
to the extent of actual bad debts written off, the provision is • If rent is received net of TDS, see that rent income is shown at
released. gross and TDS is shown in Balance Sheet as advance Tax.
AUDIT OF CASH TRANSACTIONS

General Considerations Casting or Totalling: Bank Reconciliation Statement
(i) Internal Control System. Where totals of the cash book or the Important accounting control. A copy of the
(ii) Correctness of book-keeping records. ledger are found to have been made statement duly signed by the accountant of
in pencil, the book keeper should be the client after it has been checked, should
(iii) Observance of accounting principles. asked to ink the totals before their be kept in record by the auditor along with
(iv) Evidence of Transactions. verification has commenced. other working papers, for future reference.
(v) Validity of Transactions.
(vi) Disclosure in the Final Accounts.
General Consideration while Vouching Trading Transactions are:
(i) Correctness of book-keeping record
(ii) Observance of accounting principles
(iii) Checking of inventory and records
Cut-off Arrangement: It is the arrangement where the transactions of one period would be separated from those in the ensuing
period so that the results of the working of each period can be correctly ascertained.
Balance Sheet Audit: A Balance Sheet Audit consists of the verification of all includible Balance Sheet items, together with the
examination of expense and income accounts which are so closely related to these items that it cannot be properly verified without
such analysis and test.
CHAPTER 6 : VERIFICATION OF ASSETS AND LIABILITIES
VERIFICATION: is a process to verify the ownership, valuation, possession and existence of a particular Asset or Liability.
Verification relates to the assets and liabilities appearing in the balance sheet.
Verification is generally carried out at the end of year.

To confirm the following for items relating to balance sheet.
Existence Ownership Possession Completeness Valuation Disclosure
Verification is based on observation as well as documentary examination.

Verification requires experienced people and done by the senior staff. Verification includes valuation.
TRADE PAYABLES
(i) Check the adequacy of cut off procedure to ensure that transactions of next period are not accounted and all transactions at year-end are
accounted.
(ii) Check posting in the bought ledger from books of prime entry.
(iii) Compare the balances in the schedule of trade payables with balances in bought ledger.
(iv)
Compare the balances with the confirmation or statement of account received from trade payables.
(v) Pay special attention to long outstanding items and enquire about the reason thereof.
(vi) Verify subsequent payments and reversal entries in the bought ledger of year-end entries.
(vii) See that trade payables are classified and shown in the balance sheet as per requirement of Schedule III to the Companies Act, 2013.
BANK BALANCES
Verify bank balance by reference to bank statements
Examine the BRS and verify whether cheques issued but not presented for payment, and cheques deposited for collection but not credited in the
bank account, have been duly debited/credited in the subsequent period
Pay attention to outstanding items in the reconciliation statements for an unduly long period and required adjustment done for the same
Examine relevant certificates for fixed or other type of deposits duly supported by bank advices
Check the disclosure requirement in the form of Balance Sheet as per Part I of Schedule III

CHAPTER 7 : COMPANY AUDIT - I
Appointment of Auditor
Appointment of Auditor
(Section 139)
First Auditor Subsequent Auditor
Other than Government Goverment Company defined Other than Government Goverment Company defined
Company [Section 139(6)] u/s 2 (45) [Section 139(7)] Company [Section 139(1)] u/s 2 (45) [Section 139(5)]
Appointment by BOD - within 30 Appointment by C&AG within 60 Appointment by Appointment by C & AG

days from DOR days from the DOR Members in GM within 180 days from the
commencement of year
in case of failure: in case of failure
Members in EGM within 90 days. BOD within 30 days Hold the office from
1st AGM to 6th AGM Hold the office till
Hold the office till the conclusion in case of failure subject the conclusion of
of the first AGM Members in EGM within 60 days to fulfillment of the AGM
certain conditions
Hold the office till the conclusion
of the first AGM
Eligibility, Qualifications and Disqualifications of an Auditor (Section 141 of The Companies Act, 2013)
Who can be appointed as an Auditor?
A person shall be eligible for appointment as an auditor of a company only if he is a chartered accountant: In case of a firm, whereof majority of
partners practising in India are qualified for appointment as aforesaid may be appointed by its firm name to be auditor of a company.
Where a firm including a limited liability partnership is appointed as an auditor of a company, partners who are chartered accountants shall be
authorised to act and sign on behalf of the firm.
DISQUALIFICATIONS OF AN AUDITOR :
Under sub-section (3) of section 141 along with Rule 10 of the Companies (Audit and Auditors) Rules, 2014 following persons shall not be eligible
for appointment as an auditor of a company
(a) a body corporate other than a limited liability partnership registered under the LLP Act, 2008 Accounting and book keeping services;
(b) an officer or employee of the company;
Internal audit;
(c) a person who is a partner, or who is in the employment, of an officer or employee of the
company;
(d) a person who, or his relative or partner - Design and implementation of any
financial information system;
(i) is holding any security of or interest (ii) is indebted to the (iii) has given a guarantee or
in the company or its subsidiary, or company, or its provided any security
of its holding or associate company subsidiary, or in connection with the Actuarial services;
or a subsidiary of such holding its holding or indebtedness of any third
company;(relative may hold security associate company person to the Company
or interest in the company of face or a subsidiary or its Subsidiary, or its Investment advisory services;
value not exceeding rupees one lakh of such holding Holding or Associate
the condition of rupees one lakh company, in excess Company or a Subsidiary
Investment banking services;
shall, wherever relevant, be also of rupees five lakh; of such Holding Company,
applicable in the case of a company or in excess of one lakh
not having share capital or other rupees. Rendering of outsourced financial
securities. services;
Student may note that the corrective
action to maintain the limits as
specified above shall be taken by Management services; and
the auditor within 60 days of such
acquisition or interest. Any other kind of services as may be
(e) a person or a firm who, whether directly or indirectly has business relationship with the prescribed.
Company, or its Subsidiary, or its Holding or Associate Company or Subsidiary of such holding
company or associate company, of such nature as may be prescribed; Certain services not to be rendered by
the Auditor as per section 144 of the
(f ) a person whose relative is a Director or is in the employment of the Company as a director or Companies Act 2013
Key Managerial Personnel.
(g) a person who is in full time employment elsewhere or a person or a partner of a firm holding
appointment as its auditor, if such person or partner is at the date of such appointment or Where a person appointed as an
reappointment holding appointment as auditor of more than twenty companies auditor of a company incurs any of the
(h) a person who has been convicted by a Court of an offence involving fraud and a period of ten disqualifications mentioned above,
years has not elapsed from the date of such conviction. after his appointment, he shall vacate
his office as such auditor and such
(i) any person whose subsidiary or associate company or any other form of entity, is engaged as on vacation shall be deemed to be a casual
the date of appointment in consulting and specialized services as provided in section 144. vacancy in the office of the auditor.

Filling of casual vacancy {u/s 139 (8)}
Rotation of Auditor (SECTION 139(2) ROTATION

Other Companies Govt Companies OF AUDITOR)
As per rules prescribed in Companies (Audit and Auditors) Rules, 2014,
To be filled by BOD To be filled by C&AG within for applicability of section 139(2) the class of companies shall mean the
within 30 days 30 days following classes of companies:-
In case of failure in above,
In case of resignation, BOD shall fill within 30 days Class of Companies for Rotation of Auditor
appointment by BOD
should be approved including Listed Companies
by Co. at GM +
excluding OPC (One Person Company) and Small Companies
CEILING ON NUMBER OF AUDITS (Section 141(3)(G) of the

Companies Act, 2013)
All unlisted All private All companies having
A person who is in full time employment In the case of a firm of public limited paid up share capital of
elsewhere or a person or a partner of a firm auditors, it has been companies companies below threshold limit
holding appointment as its auditor, if such further provided that having having mentioned,
person or partner is at the date of such ‘specified number paid up share paid up share but
appointment or reappointment holding of companies’ shall capital ≥ ` 10 capital ≥ ` 20 having public borrowings
appointment as auditor of more than be construed as the crore crore from financial
twenty companies, other than one person number of companies institutions, banks or
companies, dormant companies, small specified for every public deposits ≥ ` 50
companies and private companies having partner of the firm crore
paid-up share capital less than rupees 100 who is not in full
crore, shall not be eligible for appointment as time employment
an Auditor of a Company. elsewhere.
The specified number of tax audit assignments that an auditor, as an
individual or as a partner of a firm, can accept is 60 numbers.
Fraud Reporting
[Section 143(12) of Companies Act, 2013 & Rule 13 of CAAR, 2014]
Fraud involving amount of Fraud involving amount of

less than ` 1 crore ` 1 crore or above
Auditor to Report Board/ Auditor to Report Central Government

Audit Committee Company bound to disclose in following manner:
certain specified details in
Board's Report as:
Within 2 days of (a) Nature of Fraud with Within 2 days of knowledge
knowledge of fraud, description; of fraud,
(b) Approximate amount
Report the following involved; Report to Board/
matters: (c) Parties involved, if Audit Committee
(a) Nature of Fraud remedial action not
with description; taken; and
(b) Approximate (d) Remedial actions taken.
amount involved; Seeking reply
and within 45 days
(c) Parties involved.
Reply/observations Reply/observations not

received within stipulated time received within stipulated time
Forward Forward
Report+Reply/ Report+Note containing
observations+Comments details of report for
to CG which failed to receive
within 15 days of receipt of any reply/observations
such reply/observations to CG

Rights of Auditor Duties of Auditor
Duty to Inquire on certain matters

Right of access to books, etc.
Duty to Sign the Audit Report
Right to obtain information and explanation
from officers Duty to comply with Auditing Standards
Right to receive notices and to attend Duty to report on S.S.
general meeting
Duty to report on frauds
Right to report to the members of the
company on the accounts examined by him Duty to report on any other matter
specified by Central Government
Right to Lien Duty to state the reason for qualification
or negative report
Basic Elements of the Auditor’s Report: As per SA 700 “Forming an opinion and reporting on financial statements”:
Title
Types of Modified Opinions (SA 705)
Addressee
Introductory Paragraph Qualified Opinion Adverse Opinion Disclaimer of Opinion
Management’s Responsibility for the Financial Statements
Auditor’s Report is considered to be

Auditor’s Responsibility Modified when it includes
Auditor’s Opinion
Other Reporting Responsibilities

Matters That Do Not Affect Matters That Do Affect the
the Auditor’s Opinion Auditor’s Opinion
Signature of the Auditor
Date of the Auditor’s Report

Emphasis Other Emphasis Adverse Disclaimer
Place of Signature of matter matter of matter opinion of opinion
As per section 143 (3) of the Companies Act, 2013, the auditor’s report shall state the matters relating to–
(a) obtained all the information and (d) balance sheet and profit and loss account (g) any director is disqualified to be
explanations to the best of his are in agreement with the books of appointed as director;
knowledge and if not, the details account and returns;
thereof;
(b) proper books of account as required by (e) financial statements comply with the (h) any qualification, reservation or adverse
law have been kept by the company; accounting standards; remark relating to maintenance of
accounts;
(c) whether the branch auditor’s report has (f ) the observations or comments on matters (i) adequate internal financial controls
been sent to him and manner of dealing which have any adverse effect on the system is in place and the operating
with that ; functioning of the company; effectiveness of such controls;
(j) such other matters prescribed in Rule 11 of the CAAR 2014 namely:-
(i) disclosed the impact of pending (ii) provided for material foreseeable losses (iii) delay in transferring the amounts to
litigations; IEPF Account

Reporting under Companies (Auditor’s Report) Order, 2016 (CARO, 2016)

Applicability: CARO specifically exempts, a banking company, an insurance company, a company licensed
to operate under section 8 of the Companies Act; a One Person Company and a small company and a private
limited company, not being a subsidiary or holding company of a public company, having a paid up capital and
reserves and surplus not more than rupees one crore as on the balance sheet date and which does not have total
borrowings exceeding rupees one crore from any bank or financial institution at any point of time during the
financial year and which does not have a total revenue as disclosed in Schedule III to the Companies Act, 2013
(including revenue from discontinuing operations) exceeding rupees ten crore during the financial year as per
the financial statements.
Matters To Be Included In The Auditor's Report

Clause (i) (a) whether the company is maintaining b) whether these fixed assets are (c) whether the title deeds of immovable
proper records of fixed assets; physically verified; whether any properties are held in the name of the
material discrepancies, if any, company. If not, provide the details
have been properly dealt with; thereof;
Clause (ii) whether physical verification of inventory has been conducted at reasonable intervals by the management and whether any
material discrepancies, if any have been properly dealt with;
Clause (iii) whether the company has granted any loans to parties covered in the register maintained under section 189 of the Companies
Act, 2013. If so,
(a) whether the terms and conditions of the grant of (b) whether the schedule of repayment (c) if the amount is overdue,
such loans are not prejudicial to the company’s of principal and payment of interest state the total amount
interest; has been stipulated and whether the overdue for more than
repayments or receipts are regular; ninety days, and whether
reasonable steps have been
taken by the company for
recovery of the principal and
interest;
Clause (iv) in respect of loans, investments, guarantees, and security whether provisions of section 185 and 186 of the Companies Act,
2013 have been complied with. If not, provide the details thereof.
Clause (v) in case, the company has accepted deposits, whether the directives issued by the Reserve Bank of India and the provisions of the
Companies Act, 2013 in this regard and the rules have been complied with? If not, the nature of such contraventions be stated; If an
order has been passed by Company Law Board or National Company Law Tribunal or Reserve Bank of India or any court or any other
tribunal, whether the same has been complied with or not?
Clause (vi) whether maintenance of cost records has been specified by the Central Government under section 148(1) of the Companies
Act, 2013 and whether such accounts and records have been so made and maintained.
Clause(vii) (a)whether the company is regular in depositing undisputed (b) where dues of income tax or sales tax or service tax or duty
statutory dues to the appropriate authorities and if not, the of customs or duty of excise or value added tax have not been
extent of the arrears of outstanding statutory dues as on deposited on account of any dispute, then the amounts involved
the last day of the financial year concerned for a period of and the forum where dispute is pending shall be mentioned.
more than six months from the date they became payable,
shall be indicated;
Clause (viii) whether the company has defaulted in repayment of loans or borrowing to a financial institution, bank, Government or dues to
debenture holders? If yes, the period and the amount of default to be reported.
Clause (ix) whether moneys raised by way of initial public offer or further public offer (including debt instruments) and term loans were
applied for the purposes for which those are raised. If not, the details together with delays or default and subsequent rectification,
if any, as may be applicable, be reported;
Clause (x) whether any fraud by the company or any fraud on the Company by its officers or employees has been noticed or reported
during the year; If yes, the nature and the amount involved is to be indicated;
Clause (xi) whether managerial remuneration has been paid or provided in accordance with the provisions of section 197 read with
Schedule V to the Companies Act? If not, state the amount involved and steps taken by the company for securing refund of the
same;
Clause (xii) whether the Nidhi Company has complied with the Net Owned Funds to Deposits in the ratio of 1: 20 to meet out the liability
and whether the Nidhi Company is maintaining ten per cent unencumbered term deposits as specified in the Nidhi Rules, 2014
to meet out the liability;
Clause (xiii) whether all transactions with the related parties are in compliance with sections 177 and 188 of the Companies Act, 2013 where
applicable and the details have been disclosed in the F.S., as required by the applicable accounting standards;

Clause (xiv) whether the company has made any preferential allotment or private placement of shares or fully or partly convertible
debentures during the year under review and if so, as to whether the requirement of section 42 of the Companies Act, 2013 have
been complied with and the amount raised have been used for the purposes for which the funds were raised. If not, provide the
details in respect of the amount involved and nature of non-compliance;
Clause (xv) whether the company has entered into any non-cash transactions with directors or persons connected with him and if so,
whether the provisions of section 192 of the Companies Act, 2013 have been complied with;
Clause (xvi) whether the company is required to be registered under section 45-IA of the Reserve Bank of India Act, 1934 and if so, whether
the registration has been obtained.
CHAPTER 8 : COMPANY AUDIT - II

Financial Statements as per section 2(40) of the Companies Act, 2013, includes
a) a balance sheet as (b) a profit and loss (c) cash flow statement (d)
a statement of (e) any explanatory
at the end of the account, or in the for the financial changes in equity, if note annexed to, or
financial year; case of a company year; applicable; and forming part of, any
carrying on any document referred
activity not for above.
profit, an income
and expenditure
account for the
financial year;
However, the financial statement, with respect to One Person Company, small company and dormant company, may not include the cash
flow statement.
Section 129 prescribes norms for financial statements which are as under:
(i) Form of Financial statements [Section 129(1)]:The financial statements shall-
(a) give a true and fair view of the state of affairs of the company or companies
(b) comply with the accounting standards notified under section 133 and
(c) be in the form or forms as may be provided for different class or classes of companies in Schedule III
(ii) Consolidated Financial Statements: According to Section 129(3), where a company has one or more subsidiaries (including associate
company and joint venture), it shall, in addition to its own financial statements prepare a consolidated financial statement of the
company and of all the subsidiaries in the same form and manner as that of its own.
Authentication of Financial Statements, {Section 134(1)} shall be approved by the board of directors before they are signed on behalf of
the board at least by the following-
(a) The chairperson of the company where he is authorised by the Board; or

(b) By two directors out of which one shall be managing director and
(c) The Chief Executive Officer, if he is a director in the company,
(d) The Chief Financial Officer, wherever he is appointed; and
(e) The company secretary of the company, wherever he is appointed.
Verification of the Constitution and Powers - A company can function within the limits prescribed by the documents on the basis of
which it has been registered. It is essential that the auditor, prior to starting the audit of a company, shall examine:
The Memorandum of Association; The Articles of Association; Contracts with vendors and other persons
for purchase of property, payment of
commission, etc.

CHAPTER 9 : AUDIT OF DIFFERENT TYPE OF ENTITIES
AUDIT OF GOVERNMENT EXPENDITURE is one of the major components of government audit conducted by the office of
C&AG. The basic standards set for audit of expenditure are to ensure that there is provision of funds authorised by competent
authority fixing the limits within which expenditure can be incurred. Briefly, these standards are explained below:
Audit against Rules Audit of Sanctions: The Audit against Provision Propriety Audit: To Performance Audit: This
& Orders: The auditor auditor has to ensure that of Funds: It contemplates ensure compliance with involves that the various
has to see that the each item of expenditure that there is a provision general principles of programmes, schemes
expenditure incurred is covered by a sanction, of funds out of which financial propriety and and projects where large
conforms to the relevant either general or special, expenditure can be to bring out cases of financial expenditure
provisions of the incurred and the amount improper, avoidable, or has been incurred are
accorded by the competent infructuous expenditure
statutory enactment and authority, authorising such of such expenditure being run economically
is in accordance with even though the
expenditure. does not exceed the expenditure has been and are yielding results
the financial rules and appropriations made. incurred in conformity expected of them.
regulations framed by with the existing rules
the competent authority. and regulations.
Role of C&AG in the Audit of a Government company:
Audit of Government Companies

Role of C&AG is prescribed under sub-section (5), (6) and (7) of section 143 of the Companies Act, 2013.)
Section 143(5)
Section 143(6) Section 143(7)
↓
Appointment of auditor by C&AG as per section ↓ ↓
139(5) or 139(7) C&AG's right to- C&AG may, by an order,
+ * Conduct supplementary audit cause test audit
Directions by C&AG, the manner in which accounts * Comment upon or
shall be audited supplement such audit report
+
Submission of Auditor's Report to C&AG including-
* Directions issued, if any
* Action taken thereon
* Impact on Accounts
Audit of Different Entities

(major points that must be kept in mind while performing the audit of Educational
Institution, Charitable Institutions, Cinema, Hospital etc., are:)
Constitution of the Evaluate Check the Verification

organisation Examine Check the
the internal the various various of assets and
Control accounting receipts expenditures liabilities.
System in the policies of the of the
organisation. followed organisation organisation
Examine the Examine the Examine the Examine the
and the in the form like to staff,
constitution bye laws or powers of minute books
accounting of fees, rent, common
of the rules and the members of managing
records income on expenses.
organisation. regulations of the committee
or trust management and of maintained. investment,
deed. and other members' donations
officers. general and grants.
meeting as the
case may be.

Special Points in Audit of a Partnership Firm:
Confirming that the letter of appointment signed by a partner duly authorised clearly states the nature and scope of audit contemplated by
the partners, specially the limitation, if any, under which the auditor shall have to function.
Examine the partnership deed signed by all partners and its registration with the registrar of firms. Also ascertain from the partnership
deed about capital contribution, profit sharing ratios, interest on capital contribution, powers and responsibilities of the partners, etc.
Studying the minute book, if any, maintained to record the policy decision taken by partners specially the minutes relating to authorisation
of extraordinary and capital expenditure, raising of loans, purchase of assets, extraordinary contracts entered into and other such matters
which are not of a routine nature.
Verifying that the business in which the partnership is engaged is authorised by the partnership agreement.
Examining whether books of account appear to be reasonable and are considered adequate in relation to the nature of the business of the
partnership.
Verifying generally that the interest of no partner has suffered prejudicially by an activity engaged in by the partnership which, it was not
authorised to do under the partnership deed or by any violation of a provision in the partnership agreement.
Confirming that a provision for the firm’s tax payable by the partnership has been made in the accounts before arriving at the amount of
profit divisible among the partners. Also see various requirements of legislations applicable to the partnership firm like Section 44AB of
the Income-tax Act, 1961 have been complied with.
Verifying that the profits and losses have been divided among the partners in their agreed profit-sharing ratio.
While planning the Audit of a Non-Governmental Organisation (NGO), the auditor may
concentrate on the following-
(i) Knowledge of the NGO’s work
NGO
Non Governmental (ii) Reviewing the legal form of the organisation
Organization
(iii) Reviewing the NGO’s Organisation chart, Manuals, Guidelines, etc
(iv) Examine minutes of the Board/Managing Committee/Governing Body/Management
(v) Study the accounting system, procedures, internal controls and internal checks
Corpus fund
Establishment Reserves
Expenses Contribution
and Grants for
projects and
programmes
Programme and Ear-marked
Project Expenses Funds
Interest and
Audit programme Dividends
of NGO should Receipt of Receipts from
Inventory in include all assets, Project/Agency income Fund raising
Hand liabilities, income Balances programmes
of NGO
and expenditure
Bank Balance Loans

Subscription
Membership
Fees
Cash in Hand Fixed Assets
Investments

Advanced Accounting
>E<W'
ISBN : 978-81-8441-882-8
Board of Studies
Phone : 0120 - 3045930
Intermediate Course
Intermediate Course
Paper: 7A
Enterprise Information Systems

Enterprise
ISBN : 978-81-8441-887-3 Information
Systems
Board of Studies
ENTERPRISE INFORMATION SYSTEMS
ENTERPRISE INFORMATION SYSTEMS – A CAPSULE FOR QUICK REVISION
The capsule on Intermediate Paper 7A: Enterprise Information Systems that covers the entire syllabus of the subject
is another step of Board of Studies in its endeavour to provide quality academic inputs to the Intermediate students
of Chartered Accountancy Course. This concise capsule of the subject intends to assist students in their quick
revision of the subject and should not be taken as a substitute for the detailed study of the subject. Students are
advised to refer to the relevant Study Material and Revision Test Paper for comprehensive study and revision.
CHAPTER 1: AUTOMATED BUSINESS PROCESSES

This chapter deals with the basic concepts of Business Process, its automation and implementation; risks and controls
associated with various business processes and provides comprehensive knowledge about the specific Regulatory and
Compliance requirements of The Companies Act and The IT Act.
An Enterprise Information System (EIS) may be defined as any kind of information system which improves the functions of an
enterprise business processes by integration. This means classically offering high quality services, dealing with large volumes of data
and capable of supporting some huge and possibly complex organization or enterprise. All parts of EIS should be usable at all levels
of an enterprise as relevant. A Business Process is an activity or set of activities that will accomplish a specific organizational goal.
Categories of Business Processes IMPROVED OPERATIONAL EFFICIENCY

Operational Supporting Management • Automation reduces the time it takes to achieve a task, the
Processes Processes Processes effort required to undertake it and the cost of completing it
Operational or Supporting Management successfully.
Primary Processes Processes back core Processes measure, • Automation not only ensures systems run smoothly and
deal with the core processes and func- monitor and control efficiently, but that errors are eliminated and that best practices
business and value tions within an organ- activities related to are constantly leveraged.
chain. These pro- ization. Examples of business procedures
cesses deliver value supporting or man- and systems. Exam-
to the customer by agement processes ples of management GOVERNANCE & RELIABILITY
helping to produce include Accounting, processes include • The consistency of automated processes means stakeholders can
a product or service. Human Resource internal communi- rely on business processes to operate and offer reliable processes
Operational process- (HR) Management cations, governance, to customers, maintaining a competitive advantage.
es represent essential and workplace safety. strategic planning,
business activities that budgeting and infra-
accomplish business structure or capacity REDUCED TURNAROUND TIMES
objectives. management.
Example - Order to Example- HR Process Example - Budgeting
• Eliminate unnecessary tasks and realign process steps to
optimize the flow of information throughout production,
Cash (O2C) cycle. service, billing and collection.
BUSINESS PROCESS AUTOMATION (BPA) • This adjustment of processes distills operational performance
and reduces the turnaround times for both staff and external
customers.
Business Process Automation (BPA) is the tactic a business uses
to automate processes to operate efficiently and effectively. REDUCED COSTS
CONFIDENTIALITY INTEGRITY • Manual tasks, given that they are performed one-at-a-time
To ensure that data is only To ensure that no and at a slower rate than an automated task, will cost more.
available to persons who Automation allows us to accomplish more by utilizing fewer
unauthorized amendments resources.
have right to see the same. can be made in data.
BPA Objectives
Steps involved in the Implementation of BPA
AVAILABILITY TIMELINESS
To ensure that data is To ensure that data is made Step 1: Define
available when asked for. available at the right time. The answer to this question will provide
why we plan to
justification for implementing BPA.
implement BPA?
Benefits of Automating Business Processes Step 2: Understand
The underlying issue is that any BPA
rules/regulation
QUALITY & CONSISTENCY created needs to comply with applicable
under which it needs
laws and regulations.
• Ensures that every action is performed identically - resulting to comply with?
in high quality, reliable results and stakeholders consistently Step 3: Document The current processes which are planned
experience the same level of service.
the process, we wish to be automated need to be correctly and
TIME SAVING to automate. completely documented at this step.
• Automation reduces the number of tasks employees would Step 4: Define the This enables the developer and user to
otherwise need to do manually, thus allowing innovation and o b j e c t i v e s / g o a l s understand the reasons for going for BPA.
increasing employees’ levels of motivation. to be achieved by The goals need to be precise and clear.
implementing BPA.
VISIBILITY
• Automated processes are controlled and consistently operate Once the entity has been able to define
Step 5: Engage
accurately within the defined timeline. It gives visibility of the the above, the entity needs to appoint
business process
process status to the organization. an expert, who can implement it for the
consultant.
entity.

The answer to this question can be used a. Internal

Step 6: Calculate the for convincing top management to say h. Monitoring Environment b. Objective
RoI for project. ‘yes’ to the BPA exercise. Setting
Once the top management grant their g. Information & c. Event

Communication ERM Identification
approval, the right business solution
Step 7: Development has to be procured and implemented or COMPONENTS
of BPA. developed and implemented covering d. Risk
f. Control
necessary BPA. Activities Assessment
e. Risk Response
Step 8: Testing the Before making the process live, the BPA
BPA. solutions should be fully tested.
ENTERPRISE RISK MANAGEMENT (ERM) Encompasses the tone of an organization,

and sets the basis for how risk is viewed and
a. Internal addressed by an entity’s people, including risk
May be defined as a process, effected by an entity’s Board of Environment management philosophy and risk appetite,
Directors, management and other personnel, applied in strategy integrity and ethical values, and the environment
setting and across the enterprise, designed to identify potential in which they operate.
events that may affect the entity, and manage risk to be within
its risk appetite, to provide reasonable assurance regarding the
achievement of entity objectives. ERM ensures that management has a process
in place to set objectives and that the chosen
b. Objective objectives support and align with the entity’s
Benefits of Enterprise Risk Management (ERM) Setting mission/vision and are consistent with the
entity’s risk appetite.
Risk appetite is degree of risk, on a broad-based
level that an enterprise is willing to accept in Event identification includes identifying
Align risk pursuit of its goals. Management considers the c. Event factors - internal and external - that influence
appetite and entity’s risk appetite first in evaluating strategic Identification how potential events may affect strategy
strategy alternatives, then in setting objectives aligned implementation and achievement of objectives.
with the selected strategy and in developing
mechanisms to manage the related risks. Identified risks are analyzed to form a basis for
Entities accept risk as part of value creation d. Risk determining how they should be managed. Risks
Link growth, Assessment are associated with related objectives that may
risk and and preservation, and they expect return
commensurate with the risk. ERM provides an be affected.
return enhanced ability to identify and assess risks,
and establish acceptable levels of risk relative to Management selects an approach or set of
growth and return objectives. e. Risk actions to align assessed risks with the entity’s
Response risk tolerance and risk appetite, in the context of
ERM provides the rigor to identify and strategy and objectives.
Enhance risk select among alternative risk responses - risk
response avoidance, reduction, sharing and acceptance.
decisions ERM provides methodologies and techniques for f. Control Policies and procedures are established and
making these decisions. Activities executed to help ensure that the risk responses
management selected, are effectively carried out.
Minimize Entities have enhanced capability to identify
operational potential events, assess risk and establish Relevant information is identified, captured and
g. Information communicated in a form and time frame that
surprises and responses, thereby reducing the occurrence of and
surprises and related costs or losses. enable people to carry out their responsibilities.
losses Communication
Identify Monitoring is accomplished through ongoing

and manage Every entity faces a myriad of risks affecting h. Monitoring management activities, separate evaluations of
cross- different parts of the enterprise. Management the ERM processes or a combination of the both.
enterprise needs to not only manage individual risks, but
also understand interrelated impacts.
risks
RISKS AND CONTROLS
Provide Business processes carry many inherent risks,
integrated and ERM enables integrated solutions for Risk is any event that may result in a significant deviation from a
responses to managing the risks. planned objective resulting in an unwanted negative consequence.
multiple risks Risks of Business Process Types of Business Risks
Automation
Management considers potential events, rather All input transaction Risk that would prevent
Strategic
File & Data Input &
Seize than just risks, and by considering a full range of data may not be accurate, an organisation from
Transmission Access
opportunities events, management gains an understanding of complete and authorised. accomplishing its
how certain events represent opportunities. objectives.
All files and data Risk that could result in a
Financial
More robust information on an entity’s total transmitted may not be negative financial impact
Rationalize risk allows management to more effectively processed accurately to the organisation.
capital assess overall capital needs and improve capital and completely, due to
allocation. network error.

Risks of Business Process Types of Business Risks Masters

Automation • Refers to the way various parameters are set up for all modules of
Is not complete Risk that could expose the software like Purchase, Sales, Inventory, Finance etc.
Reputational
and accurate due to organisation to negative • Set up first time during installation and these are changed
Output
program error or bugs publicity. whenever the business process rules or parameters are changed.
and is distributed to • Examples are Vendor Master, Customer Master, Material Master,
unauthorised personnel Accounts Master, Employee Master etc.
due to weak access control.
Valid input data may Risk that could expose Transactions
(Compliance)
Regulatory
Processing
not have been processed the organization to fines

• Refers to the actual transactions entered through menus and func-
accurately and completely and penalties from a
tions in the application software, through which all transactions for
due to program error or regulatory agency due to
specific modules are initiated, authorized or approved.
bugs. non-compliance with laws
• For example: Sales transactions, Purchase transactions, Stock
and regulations.
transfer transactions, Journal entries and Payment transactions.
Master data and Risk that could prevent
transaction data may be the organisation from
BUSINESS PROCESSES - DIAGRAMMATIC
Data
changed by unauthorised operating in the most

personnel due to weak effective and efficient REPRESENTATION
Operational
access control. manner or be disruptive

to other operations. Are used in designing and documenting simple
All data & programs processes or programs. Like other types of
Infrastructure
could be lost if there is diagrams, they help visualize what is going on

Flowcharts
no proper backup in the and thereby help understand a process, and
event of a disaster and the perhaps also find flaws, bottlenecks, and other
business could come to a less-obvious features within it.
standstill.
DFD basically provides an overview of:
Data Flow (a) What data a system processes;
Defined as policies, procedures, practices and (b) What transformations are performed;
Diagrams
organisation structure that are designed to provide (c) What data are stored; and
(DFDs)
Control reasonable assurance that business objectives are (d) What results are produced and where they
achieved and undesired events are prevented or flow.
detected and corrected.
• These are a system consisting of specific policies REGULATORY AND COMPLIANCE
Internal and procedures;
• Designed to provide management with reasonable
REQUIREMENTS
Controls assurance that the goals and objectives it
believes important to the entity, will be met. Section 134 of the Companies
Act, 2013 on “Financial statement,
• Facilitates the effectiveness and efficiency of Board’s report”, etc.
operations. The
Regulatory and Compliance Requirements
• Helps ensure the reliability of internal and Companies

An Internal Act, 2013
external financial reporting. Section 143 of the Companies Act
Control 2013, on “Powers and duties of
• Assists compliance with applicable laws and
System regulations. auditors and auditing standards”
• Helps safeguarding the assets of the entity.
Components Of Internal Control Advantages of Cyber Laws

Control Set of standards, processes, and structures that
Environment provide the basis for carrying out internal control Computer Related Offences - Email
across the organisation. A/c Hacking, Credit Card fraud,
Information web defacement etc.
Risk This forms the basis for determining how risks will be Technology Act
Assessment managed. A precondition to risk assessment is estab- (IT Act)
Privacy
lishment of objectives, linked at different levels of entity.
Control Actions established through policies and procedures that Cyber Crime - Hacking, Traditional
Activities ensure management’s directives to mitigate risks to the Theft etc.
achievement of objectives are carried out.
Information and Communication is the continual, iterative process of Sensitive Personal Data Information
Communication providing, sharing & obtaining necessary information. (SPDI)
Monitoring of Ongoing evaluations, separate evaluations, or some Section 134 of the Companies Act, 2013 on “Financial statement,
Controls combination of two are used to ascertain whether Board’s report, etc.” states inter alia: The Directors’ Responsibility
each of five components of internal control, including Statement referred to in clause (c) of sub-section (3) shall state
controls are present and functioning. that:
The Directors had taken proper and sufficient care for the
Controls should be checked at the following three levels maintenance of adequate accounting records in accordance with
the provisions of this Act for safeguarding the assets of the company
Configuration and for preventing and detecting fraud and other irregularities;
The Directors, in the case of a listed company, had laid down
• Refers to the methodical process of defining options that are internal financial controls to be followed by the company and that
provided. such internal financial controls are adequate and were operating
• Defines how software functions and what menu options are
displayed. effectively.

CHAPTER 2: FINANCIAL AND ACCOUNTING SYSTEMS
This chapter provides an in-depth knowledge about the concept of Financial and Accounting Systems, Integrated
and Non-integrated Systems and further acquaint the students about Regulatory and Compliance requirements
with Financial and Accounting systems.
In accounting language, a Voucher is a documentary evidence of From a business perspective, a Process is a coordinated
a transaction. There may be different documentary evidences for and standardized flow of activities performed by people or
different types of transactions. machines, which can traverse functional or departmental
Voucher Types boundaries to achieve a business objective and creates value
1 Contra For recording of four types of for internal or external customers.
transactions as under :
• Cash deposit in bank
• Cash withdrawal from bank
DATA TYPES
• Cash transfer from one location to
another.
• Fund transfer from our one bank MASTER DATA NON - MASTER DATA
account to our own another bank (Relatively permanent) (Expected to change frequently)
account.
2 Payment For recording of all types of payments.
Whenever the money is going out of Accounting Inventory Payroll Statutory
business by any mode (cash/bank).
3 Receipt For recording of all types of receipts.
Whenever money is being received into Steps involved in the Accounting Flow
business from outside by any mode
Accounting
(cash/bank) Transactions
4 Journal For recording of all non-cash/bank HUMANS
transactions. E.g. Depreciation, Provision,
Voucher Entry
Write-off, Write-back, discount given/
received, Purchase/Sale of fixed assets on
credit, etc. Posting
5 Sales For recording all types of trading sales by
any mode (cash/bank/credit). SOFTWARE
Balancing
6 Purchase For recording all types of trading pur-
chase by any mode (cash/bank/credit).
7 Credit For making changes / corrections Trial Balance
Note in already recorded sales / purchase
transactions.
8 Debit For making changes/corrections Profit & Loss Account Balance Sheet
Note in already recorded sales/purchase
transactions.
9 Memo- For recording of transaction which will
randum be in the system but will not affect the
trial balance. Types of Ledgers
10 Purchase For recording of a purchase order raised
Order on a vendor.
11 Sales For recording of a sales order received Debit Balance Credit Balance
Order from a customer.
12 Stock For recording of physical movement of
Inventory
Journal stock from one location to another. Asset Expense Income Liability
13 Physical For making corrections in stock after
Stock physical counting.
Profit & Loss Account
14 Delivery For recording of physical delivery of
Note goods sold to a customer.
15 Receipt For recording of physical receipt of
Balance Sheet
Note goods purchased from a vendor.
16 Attend- For recording of attendance of
Payroll
ance employees.
17 Payroll For salary calculations.

Installed Applications Vs. Web Applications Features of an Ideal ERP System

Par- Installed Application Web Application
ticulars • Manufacturing: Some of the functions include
As software is installed on As s/w is installed on only engineering, capacity, workflow management, quali-
hard disc of the computer one computer. Hence, ty control, bills of material, manufacturing process, etc.
• Financials: Accounts payable, accounts receivable,
Installation &
Maintenance
used by user, it needs maintenance/updating of s/w

to be installed on every becomes extremely easy. fixed assets, general ledger and cash management, etc.
computer one by one. • Human Resources: Benefits, train-
Maintenance & updating ing, payroll, time and attendance, etc.
of s/w may take lot time • Supply Chain Management: Inventory, sup-
and efforts. ply chain planning, supplier scheduling, claim
As software is installed on As software is not installed on processing, order entry, purchasing, etc.
• Projects: Costing, billing, activi-
Accessibility
the hard disc of the user’s the hard disc of user’s comput-
computer, user needs to er and its used through brows- ty management, time and expense, etc.
go to the computer only. er and internet, it can be used • Customer Relationship Management (CRM): CRM
It cannot be used from any from any computer in the world software is used to support processes, such as sales,
computer. 24 x 7. marketing, customer service, training, professional
Using the software through Using mobile applica- development, performance management, HR
Mobile
App.
mobile application is tion becomes very easy Development, and compensation etc., storing
difficult in this case. as data is available 24 x 7. information on current and prospective customers.
Data is physically stored in Data is not stored in the user’s • Data Warehouse: Data warehouse is a repository of
Data Storage
the premises of the user, server computer. It is stored an organization’s electronically stored data. These are
i.e. on the hard disc of the on a web server. Hence user designed to facilitate reporting and analysis. The
user’s server computer.
Thus user has full control will not have any control over process of transforming data into information and
over data. the data. making it available to the user in a timely enough man-
As the data is in physical Data security is a big ner to make a difference is known as data warehousing.
Data Security
control of the user, user challenge in case of web

shall have the full physical
control over the data and application as the data is Risks and Controls associated with ERP
he/she can ensure that it is not in control of the user or
not accessed without prop- owner of data. It is Aspect Risk Associated Control Required
er access. maintained on a web server. Data is stored centrally and Access rights need to be
Data Access
A well written installed As data is picked from web all the departments access defined very carefully.
Perfor-
central data. This creates Access to be given on

mance
application shall always be server using internet, speed

faster than web applica- of operation may be slower. a possibility of access to “Need to know” and
tion. non-relevant data. Need to do” basis only.
Installed applications shall Web applications do As there is only one set Back up arrangement
Flexibility
Safety
have more flexibility and not even compare to the of data, if this data is lost, needs to be very strong.
Data
controls as compared to flexibility of desktop whole business may come Also, strict physical control
web application. applications. to stand still. is needed for data.
As data is maintained This can be controlled by
centrally, gradually the removing redundant data,
Operation
ENTERPRISE RESOURCE PLANNING (ERP)

Speed of
data size becomes more using techniques like data

An ERP System is based on a common database and a mod- and more and it may warehousing and updating
ular software design. The common database can allow every reduce the speed of hardware on a continuous
department of a business to store and retrieve information in operation. basis.
real-time. The information should be reliable, accessible, and As the overall system All the processes must be
is integrated, a small documents carefully in
Change in
easily shared. An ERP system supports most of the business

process
system that maintains in a single database the data needed for change in process for one beginning of
a variety of business functions such as Manufacturing, Supply department may require implementation
Chain Management, Financials, Projects, Human Resources lot of efforts and money. itself to avoid any
and Customer Relationship Management. discomfort in future.
As the overall system is This can be controlled
Staff Turnover
Advantages of an ERP System integrated & connected and minimized with help
with each other of proper staff training
• Ability to customize an organization’s requirements; department, it becomes system, having help
• Integrate business operations with accounting & financial complicated and difficult manuals, having backup
reporting function; to understand. plans for staff turnover, etc.
• Increased data security and application controls; As everybody is connected This can be controlled
System Failure
• Build strong access and segregation of duties controls; to a single system and and minimized by having
• Automate many manual processes thus eliminating errors; central database, in case of proper and updated
• Process huge volumes of data within short time frames; failure of system, the whole back up of data as well
and business may come to as alternate hardware /
• Strong reporting capabilities which aids management and stand still, may get affected internet arrangements.
other stakeholders in appropriate decision making. badly.

a. Financial Management Information Systems (MIS) Report

Accounting IT is a tool that Type of Information in an MIS Report
k. CRM managers use to An MIS report for this would likely contain data
b. Controlling
evaluate business such as:
j. Supply processes and • The number of calls your staff takes;
Chain c. Sales and operations. • The number of emails that come in each day;
Distribution
• The average amount of time it takes to answer
a phone call or email; and
i. Project ERP d. Human • The number of questions that your staff
Systems MODULES Resource answers correctly vs. the number that are
incorrect.
h. Plant
Maintenance e. Production The information must meet following criteria to become
Planning useful for the user:
g. Quality f. Material Relevant Timely Accurate Structured
Management Management MIS reports need Managers It’s critical Try to break
to be specific to need to know that numbers long passag-
a. Financial This module is the most important module of the business area what’s hap- add up and es of infor-
Accounting the overall ERP System and it connects all the they address. pening now that dates and mation into
Module modules to each other. This is important or in the re- times are cor- more reada-
because a report cent past to rect. Financial ble blocks or
that includes make deci- information is chunks and
b. Controlling This module facilitates coordinating, monitoring, unnecessary sions about often required give these
Module and optimizing all the processes in an information might the future. to be accurate chunks mean-
organization. be ignored. to the dollar. ingful head-
ings.
This is used by organizations to support sales and
c. Sales and
distribution activities of products and services, Data Analytics is the process of examining
Distribution
Module starting from enquiry to order and then ending data sets to draw conclusions about the
with delivery. Data
Analytics information they contain, increasingly with
the aid of specialized systems and software.
d. Human
This module enhances the work process and
Resource data management within HR department of
Module enterprises.
BI encompasses a wide variety of tools,
e. Production PP module is another important module that applications and methodologies that enable
Planning (PP) includes software designed specifically for organizations to collect data from internal
Module Business systems and external sources, prepare it for
production planning and management.
Intelligence analysis, develop and run queries against the
f. Material
(BI) data, and create reports, dashboards and data
MM module as the term suggests manages
Management visualizations to make the analytical results
(MM)
materials required, processed and produced in
enterprises.
available to corporate decision makers as well
Module
as operational workers.
g. Quality Quality Management module helps in
Management management of quality in productions across • It is the public reporting of operating and
Module processes in an organization financial data by a business enterprise, or
the regular provision of information to
This is a functional module which handles
h. Plant decision-makers within an organization to
the maintaining of equipment and enables
Maintenance support them in their work.
Module efficient planning of production and generation
• XBRL (eXtensible Business Reporting
schedules.
Language) is a freely available and
global standard for exchanging business
i. Project Project systems are used for planning and Business information. XBRL allows the expression
Systems managing projects. Reporting of semantic meaning commonly required
in business reporting.
• Who uses XBRL?
This module provides extensive functionality Regulators; Companies; Governments;
j. Supply Chain
Module for logistics, manufacturing, planning, and Data Providers; Analysts and investors and
analytics. Accountants.
• Important features of XBRL
Customer Relationship Management is a system  Clear Definitions
k. Customer
Relationship which aims at improving the relationship with  Testable Business Rules
Management existing customers, finding new prospective  Multi-lingual Support
(CRM)  Strong Software Support
customers, and winning back former customers.

CHAPTER 3: INFORMATION SYSTEMS AND ITS COMPONENTS
This chapter provides a deep understanding about various components of an Information system and its working,
types of threats and their mitigating controls and audit aspects of various components of Information Systems.
An Information System is a combination of people, hardware, software, communicating devices, network and data
resources that processes can be storing, retrieving, transforming information) data and information for a specific purpose.
INPUT PROCESSING OUTPUT Data are the raw bits and pieces of information with
(Business problems (Software, (Solution to no context. Data can either be quantitative which is
Data
in form of data, Programs, people, problems in numeric (the result of a measurement, count, or some
information, equipment, the form of other mathematical calculation) or Qualitative data which
instructions, storage) reports, graphics,
opportunities) calculations, voices) is descriptive.
These consist of both physical devices and
and Communi-
cation Systems
Networking
software, links the various pieces of hardware and
CONTROL FEEDBACK transfers the data from one physical location to another.
Computers and communications equipment can be con-
(Decision Makers, nected in networks for sharing voice, data, images, sound
Auto Control)
and video.
USER
Functions of an Information System Computer System

Input Data is collected from an organization or from external
environments and converted into suitable format
required for processing. Software Hardware
Process A process is a series of steps undertaken to achieve
desired outcome or goal.
Output Then information is stored for future use or communi- Application Operating
cated to user after application of respective procedure Software System
on it. Software
Three basic activities of an Information System that are defined
above, helps enterprise in making decisions, control operations,
analyze problems and create new products or services as an output. Input Processing Data Storage Output
Apart from these activities, information systems also need feed- Devices Devices Devices Devices
back that is returned to appropriate members of the enterprises to
help them to evaluate at the input stage.
Control Unit Internal Memory
Components of Information System
ALU Primary Memory

People Computer Data Network &
System Communication
System Registers Secondary Memory
Hardware Software
Virtual Memory
Operating Systems Application

Software Software
Classification of Information Systems’ Controls
The people involved include users of the system and
People
information systems personnel, including all the people Objective of Controls

who manage, run, program, and maintain the system. • Preventive
Hardware: Information Systems hardware is the part • Detective
of Information Systems that we can touch-the physical • Corrective
components of technology. Computers, keyboards, hard
drives, iPads and flash drives are all examples of Information
Computer System
Systems hardware. Nature of IS Resource

Software: Software is a set of instructions that tells the • Environmental
hardware what to do. Software is not tangible it cannot be • Physical Access
touched. • Logical Access
• An Operating System (OS) is a set of computer programs
that manages computer hardware resources and acts as an
interface with computer applications programs.
• Application software includes all that computer software Audit Functions
that cause a computer to perform useful tasks beyond the • Managerial
running of the computer itself. • Application

Objectives of Controls These are the controls relating to logical access to
Prevent errors, omissions, or security incidents from information resources such as operating systems
occurring. Examples include simple data-entry edits controls, application software boundary controls,
Logical Access Controls

Preventive
Controls
that block alphabetic characters from being entered in networking controls, access to database
numeric fields, access controls that protect sensitive objects, encryption controls etc. The key
data/ system resources from unauthorised people, and factors considered in designing logical access
complex and dynamic technical controls such as antivirus
controls include confidentiality and privacy
software, firewalls, and intrusion prevention systems.
requirements, authorization, authentication and
These controls are designed to detect errors, omis- incident handling, reporting and follow-up, virus
sions or malicious acts that occur and report the
Detective
Controls
prevention and detection, firewalls, centralized secu-

occurrence. For example, a detective control may
identify account numbers of inactive accounts or ac- rity administration, user training and tools for mon-
counts that have been flagged for monitoring of sus- itoring compliance, intrusion testing and reporting.
picious activities. Audit Functions
These controls correct errors, omissions, or incidents The controls over the managerial functions that
once they have been detected. They vary from simple must be performed to ensure the development,
Corrective
Controls
Managerial
Controls
correction of data-entry errors, to identifying and re- implementation, operation and maintenance of informa-
moving unauthorised users or software from systems tion systems in a planned and controlled manner in an
or networks, to recovery from incidents, disruptions, organization. The controls at this level provide a
or disasters. stable infrastructure in which information systems can
Nature of Information Systems’ Resources be built, operated and maintained on a day-to-day basis.
These are the controls relating to IT environment These include the programmatic routines
Environ-
Controls
Application Controls
mental
such as power, air-conditioning, Un-interrupted within the application program code. The objective of
Power Supply (UPS), smoke detection, fire-extin- application controls is to ensure that data remains
guishers, dehumidifiers etc. complete, accurate and valid during its input, update and
These are the controls relating to physical security of the storage. The specific controls could include form
design, source document controls, input, processing and
Controls
Physical
tangible IS resources and intangible resources stored on

Access
tangible media etc. These include Access control doors, output controls, media identification, movement and
Security guards, door alarms, restricted entry to secure library management, data back-up and recovery, authen-
areas, visitor logged access, CCTV monitoring etc. tication and integrity, legal and regulatory requirements.
MANAGERIAL CONTROLS
I. Top Mgt. & IS Mgt. Controls II. Programming Mgt. Controls IV. Data Resource Mgt. Controls V. Security Mgt. Controls
Functions performed by a Senior To acquire and implement high- Data must be available to users Information security
Manager quality programs when it is needed, in location administrators are
where it is needed, and in form in responsible for ensuring that
which it is needed. information systems assets
are secure.
• Planning: determining III. System Development Management
goals of information systems Controls
function and means of Has responsibility for functions • Definition Controls: To
achieving these goals; concerned with analyzing, designing, ensure that database always
• Organizing: gathering, building, implementing & maintaining IS corresponds and comply VI. Quality Assurance
allocating, & coordinating with its definition standards. Mgt. Controls
resources needed to • Existence Controls: To To achieve certain quality
accomplish goals; ensure existence of database goals and standards.
• Leading: motivating, • System Authorization Activities: by establishing backup
guiding, and communicating Systems must be properly recovery procedures.
with personnel; authorized to ensure their economic • Access Controls: Access
• Controlling: Comparing justification and feasibility. controls are designed to
actual performance with • User Specification Activities: The prevent unauthorized
VII. Operations Mgt.
planned performance user can create a detailed written individual from viewing,
Controls
description of the logical needs that retrieving, computing/
Responsible for the daily
must be satisfied by the system. destroying entity’s data.
• Planning: Using WBS,
• Update Controls: Restrict
running of hardware
Gantt Charts, PERT; • Technical Design Activities: These and software facilities.
translate user specifications into a set update of database
• Control: Over software
to authorized users.
development, acquisition, of detailed technical specifications
and implementation tasks; of system that meets user’s needs. • Concurrency Controls:
• Design: Systematic • Internal Auditor’s Participation: Provide solutions, agreed- • Computer operation;
approach to program design Auditor’s involvement should upon schedules and • Network operation;
• Coding: Using Top-down be continued throughout all strategies to overcome the • Data Preparation & Entry;
or bottom-up approach; phases of development process data integrity problems. • Production Control;
• Testing: Could be Unit and into maintenance phase. • Quality Controls: These • File Library;
Testing, Integration • Program Testing: All modules must controls ensure the • Documentation &
be tested before they are implemented. accuracy, completeness Program Library;
Testing and Whole- • Help Desk & Technical support;
• User Test and Acceptance Procedures: and consistency of data
of-Program Testing • Capacity Planning
Just before implementation, maintained in database.
• Operation and & Performance;
Maintenance: Could be individual modules of the system
must be tested as a unified whole. • Management of
Repair Maintenance, Adaptive outsourced operations.
and Perfective Maintenance

APPLICATION CONTROLS
I. Boundary Controls II. Communication III. Processing Controls V. Database Controls VI. Output Controls
An Access control mechanism Controls Responsible for computing, Protects integrity Ensure that data
having three steps - Responsible for sorting, classifying, of a database when delivered to users is
Identification, Authentication transporting data and summarizing data. application s/w act as presented, formatted and
and Authorization. among all other an interface between delivered in a consistent
subsystems. user and the database. and secured manner.
IV. Input Controls • P r o c e s s o r Update Controls and

• Cryptographic Controls: Report Controls: To
Transforming data into codes Responsible for ensuring the Controls: Used to
accuracy and completeness reduce expected protect the integrity
that are meaningless for a of a database when
non-authenticated person. of data that are input into losses from errors
an application system. and irregularities application s/w acts as
• Passwords: User identification an interface to interact
by an authentication associated with
Central processors. between user and database.
mechanism with personal
characteristics like birth date etc. • Real Memory
• PIN: Assigned to a user Controls: Seek to
by institution based on detect and correct
the user characteristics. • Source Document errors that occur in
• Identification Cards: Used Control: Can be memory cells and • Storage and Logging of
used to remove assets to protect areas of Sensitive and Critical Forms:
to store information required
from the enterprise. memory assigned Access of pre-printed stationery
in an authentication process.
• Biometric Devices: • Data Coding Control: to a program from to only authorized persons.
Identification like thumb/ These are put in place illegal access by • Logging of output program
to reduce user error another program. executions: Output programs
finger impression.
during data feeding. • Virtual Memory to be logged and monitored.
• Batch Control: Put Controls: Maps • Spooling/Queuing: To ensure
in place at locations virtual memory that the user can continue
• Physical Component Controls: Involve
addresses into real working, while the print
where batch processing
Transmission Media - Guided or Unguided
is being used to memory addresses. operation is getting completed.
Media; Communication Lines; Port Protection
Devices; Multiplexors and Concentrators etc.
ensure accuracy • Data Processing • Controls over Printing:
and completeness Control: Perform Unauthorized disclosure
• Line Error Controls: Include Error
validation checks of info. is not printed.
of the content.
Detection & Error Correction Techniques.
• Flow Controls: Uses Stop - and
• Validation Control: to identify • Report distribution and
Used to validate the errors during Collection Controls: Deals
- Wait Flow Control mechanism.
accuracy of input processing of data. with secure way to avoid
• Link Controls: Uses protocols - HDLC and SDLC.
unauthorized disclosure of data.
data at different
• Channel Access Controls: Uses
• Retention Controls: Duration
levels like – Field and
Polling and Contention Method.
Record interrogation. for which outputs to be retained
• Internetworking Controls: Uses mainly
before being destroyed.
three devices - Bridge, Router & Gateway.
INFORMATION SYSTEM’S AUDITING
It is defined as the process of attesting objectives (those of the external auditor) that focus on asset safeguarding, data integrity
and management objectives (those of the internal auditor) that include effectiveness and efficiency both.
Cost of computer abuse

Value of hardware, software personnel Controlled evolution of computer use
Organizational costs of data loss High costs of computer error

ORGANIZATION
Costs of incorrect decision making Maintenance of privacy
Control and Audit of Computer-based Information Systems

Information Systems Auditing
Improved Safeguarding of assets ORGANIZATION Improved System efficiency
Improved Data Integrity Improved System effectiveness
Impact of Controls and Audit influencing an organization

Need and Control of Information Systems’ Audit Continuous and Intermittent Simulation (CIS)
Organisation- Data is a critical resource of an organisation for This is a variation of the SCARF continuous audit technique.
al Costs of its present and future process and its ability to This technique can be used to trap exceptions whenever the
Data Loss adapt and survive in a changing environment. application system uses a database management system.
Cost of Management and operational controls taken by Audit Hooks
Incorrect De- managers involve detection, investigations and
cision Making correction of the processes. There are audit routines that flag suspicious transactions.
For example, internal auditors at Insurance Company
Value of These are critical resources of an organisation, determined that their policyholder system was vulnerable
Computer which has a credible impact on its infrastructure to fraud every time a policyholder changed his or her name
Hardware, and business competitiveness. or address and then subsequently withdrew funds from the
Software and policy.
Personnel
Costs of Unauthorised access to computer systems, mal-
AUDIT TRAILS
Computer wares, unauthorised physical access to comput- Audit Trails are logs that can be designed to record activity
Abuse er facilities and unauthorised copies of sensitive at the system, application, and user level. When properly
data can lead to destruction of assets. implemented, audit trails provide an important detective control
Controlled Use of Technology and reliability of complex to help accomplish security policy objectives.
evolution of computer systems cannot be guaranteed and the • The Accounting Audit Trail shows the source and nature of
Computer Use consequences of using unreliable systems can be data and processes that update the database.
destructive. • The Operations Audit Trail maintains a record of attempted
or actual resource consumption within a system.
High Costs In a computerised enterprise environment where
of Computer many critical business processes are performed, Managerial Controls and their Audit Trails
Error a data error during entry or process would cause
great damage. Managerial Scope Audit Trails
Controls
Maintenance Data collected in a business process contains pri-
of Privacy vate information about an individual that needs Discusses the top • Planning: Auditors need
to be maintained. management’s role in to evaluate whether top
planning, organizing, management has formulated
Top Management and Information Systems
Information Systems’ Audit Objectives leading and controlling a high-quality IS’s plan that is
the information appropriate to the needs of an
Asset The information system assets (hardware, soft- systems function. organization or not.
Safeguarding ware, data information etc.) must be protected by Also, provides advice • Organizing: Auditors should
Management Controls
Objectives a system of internal controls from unauthorised to top management in be concerned about how well
access. relation to long-run top management acquires and
Data Integrity Data integrity important from the business per- policy. manages staff resources.
Objectives spective of the decision maker, competition and • Leading: Auditors examine
the market environment. variables that often indicate
when motivation problems
System Effectiveness of a system is evaluated by auditing exist or suggest poor
Effectiveness the characteristics and objective of the system to leadership.
Objectives meet business and user requirements. • Controlling: Auditors
must evaluate whether top
System To optimize the use of various information sys- management’s choice to the
Efficiency tem resources along with the impact on its com- means of control over the
Objectives puting environment. users of IS services is likely to
be effective or not.
TYPES OF AUDIT TOOLS Provides a contingency • Concurrent Audit: Auditors
Snapshots perspective on models assist the team in improving
System Development Management Controls
of the information the quality of systems

Tracing a transaction is a computerized system that can systems development development for the specific
be performed with the help of snapshots or extended process that auditors system they are building and
records. The snapshot software is built into the system can use as a basis for implementing.
at those points where material processing occurs which evidence collection • P o s t - i m p l e m e n t a t i o n
takes images of the flow of any transaction as it moves and evaluation. Audit: Auditors seek to
through the application. These images can be utilized to help an organization learn
assess the authenticity, accuracy, and completeness of the from its experiences in the
processing carried out on the transaction. development of a specific
application system.
Integrated Test Facility (ITF) • General Audit: Auditors seek
to determine whether they can
The ITF technique involves the creation of a dummy reduce extent of substantive
entity in the application system files and the processing testing needed to form an audit
of audit test data against the entity as a means of verifying opinion about management’s
processing authenticity, accuracy, and completeness. This assertions relating to financial
test data would be included with the normal production statements for systems
data used as input to the application system. effectiveness and efficiency.
Discusses the • Planning: Auditors must
System Control Audit Review File (SCARF) major phases in the evaluate how well the planning
program life cycle work is being undertaken.
Programming
The SCARF technique involves embedding audit software

Management
and the important • Control:

Controls
modules within a host application system to provide Auditors must

continuous monitoring of the system’s transactions. The controls that should evaluate whether the nature of
information collected is written onto a special audit be exercised in each and extent of control activities
file- the SCARF master files. Auditors then examine the phase. undertaken are appropriate
information contained on this file to see if some aspect of for different types of s/w that
the application system needs follow-up. are developed or acquired.

Managerial Scope Audit Trails Application Controls Accounting Audit Trail Operations Audit
Controls Trail
• Design: Auditors should find INPUT CONTROLS • The identity of the • Time to key in a
out whether programmers person (organisation) source document
use some type of systematic This maintains the who was the source of or an instrument
approach to design. chronology of events the data; at a terminal;
• Coding: Auditors should from the time data • The identity of the • Number of read
seek evidence to check and instructions person (organisation) errors made by an
whether programmers employ are captured and who entered the data optical scanning
automated facilities to assist entered into an into the system; device;
them with their coding work. application system • The time and date when • Number of
• Testing: Auditor’s primary until the time they the data was captured; keying errors
concern is to see that unit
are deemed valid and • The identifier of the identified during
testing; integration testing of
the system testing has been passed onto other physical device used to verification;
undertaken appropriately. subsystems within enter the data into the • F r e q u e n c y
• Operation & Maintenance: the application system; with which an
Auditors need to ensure system. • The account or record instruction in
effectively & timely to be updated by the a command
reporting of maintenance transaction; language is used;
needs that occur & • The standing data to and
maintenance is carried out be updated by the • Time taken
in a well-controlled manner. transaction; to invoke an
Discusses the role of Auditors should determine • The details of the instruction using
Data Resource
Management
database administrator what controls are exercised to transaction; and a light pen versus
Controls
and the controls that maintain data integrity. They • The number of the a mouse.
should be exercises in might employ test data to physical or logical batch
each phase. evaluate whether access controls to which the transaction
and update controls are working. belongs.
Discusses major Auditors might use interviews, COMMUNICATION • Unique identifier of the • Number of
functions that observations and reviews of CONTROLS source/sink node; messages that
Management Controls
quality assurance documentation to evaluate • Unique identifier of each have traversed

Quality Assurance
management should how well Quality Assurance This maintains a node in the network that each link and
perform to ensure (QA) personnel perform chronology of the traverses the message; each node;
that development, their monitoring role. events from the time Unique identifier of • Queue lengths
implementation, a sender dispatches a the person or process at each node;
operation, and message to the time authorizing dispatch Number of errors
maintenance of a receiver obtains the of the message; Time occurring on each
information systems message. and date at which the link or at each
conform to quality
message was dispatched; node; Number of
standards.
• Time and date at retransmissions
Discusses major Auditors must evaluate whether which the message was that have
Security Management Controls
functions performed security administrators are received by the sink occurred across
by operations conducting ongoing, high- node; each link; Log of
by security quality security reviews or not. • Time and date at which errors to identify
administrators to
node in the network locations and
identify major threats
to IS functions and to was traversed by the patterns of errors;
design, implement, message; and • Log of system
operate, and maintain • Message sequence restarts; and
controls that reduce number; and the image • Message transit
expected losses from of the message received times between
these threats to an at each node traversed in nodes and at
acceptable level. the network. nodes.
Discusses the major Auditors should pay PROCESSING • To trace and replicate the • A comprehensive
functions performed concern to see whether the CONTROLS processing performed on log on hardware
Management
Operations
by operations a data item. consumption

Controls
documentation is maintained
management to securely and that it is issued The audit trail • To follow triggered – CPU time
ensure the day-to- maintains the used, secondary
day operations of the only to authorized personnel. transactions from end to
IS function are well chronology of end by monitoring input storage space
controlled. events from the data entry, intermediate used, and
time data is received results and output data communication
Application Controls And Their Audit Trails from the input or values. facilities used.
Application Controls Accounting Operations communication • To check for existence of • A comprehensive
Audit Trail Audit Trail subsystem to any data flow diagrams log on software
BOUNDARY CONTROLS Action • Resource the time data is or flowcharts that consumption
This maintains the chronology privileges usage from dispatched to describe data flow in – compilers
of events that occur when a user allowed/ log-on to log- the database, the transaction, and used, subroutine
attempts to gain access to and denied. out time. communication, or whether such diagrams libraries used,
employ systems resources. This • Log of output subsystems. or flowcharts correctly file management
includes Identity of the would-be Resource identify the flow of data. f a c i l i t i e s
user of the system; Authentication consumption. • To check whether audit used, and
information supplied; Resources log entries recorded the communication
requested; Action privileges changes made in the software used.
requested; Terminal Identifier; Start data items at any time
and Finish Time; Number of Sign-on
including who made
attempts; and Resources provided/
denied. them.

Application Controls Accounting Audit Trail Operations Audit Application Controls Accounting Audit Trail Operations Audit
Trail Trail
DATABASE • To confirm whether an • To maintain OUTPUT • What output was • To maintain
CONTROLS application properly a chronology CONTROLS presented to users; the record
accepts, processes, and of resource • Who received the of resources
The audit trail stores information. consumption The audit trail output; consumed –
maintains the • To attach a unique time events that affects maintains the • When the output was graphs, images,
chronology of events stamp to all transactions. the database chronology of events received; and report pages,
that occur either • To attach before-images definition or that occur from the • What actions were taken printing time
to the database and after-images of the the database. time the content with the output? and display rate
definition or the data item on which a of the output is to produce the
database itself. transaction is applied to determined until the various outputs.
the audit trail. time users complete
• Any Modifications or their disposal of
corrections to audit output because it
trail transactions no longer should be
accommodating the retained.
changes that occur
within an application Segregation of Duties (SoD) ensures that single individuals do
system. not possess excess privileges that could result in unauthorized
• To not only test the activities such as fraud or the manipulation or exposure of
stated input, calculation, sensitive data. Segregation of Duties (SoD) Controls are
and output rules for data Preventive and Detective controls that should be put into place
integrity, but also should to manage segregation of duties matters. Some examples of SoD
assess the efficacy of the Controls are Transaction Authorization, Split custody of high-
rules themselves. value assets, workflow and periodic reviews.
CHAPTER 4: E-COMMERCE, M-COMMERCE AND EMERGING TECHNOLOGIES
This chapter provides an insight about meaning, components and architecture of E-Commerce, various risks and controls
associated with e-commerce and applicable laws and guidance governing e-commerce. The chapter further deals with the
emerging technologies like Cloud Computing, Mobile Computing, Green Computing etc. and their perspectives.
TRADITIONAL COMMERCE Vs. E-COMMERCE

Base For Traditional E-Commerce Base For Traditional E-Commerce
Comparison Commerce Comparison Commerce
Definition Includes all those Means carrying out Marketing One way marketing One-to-one marketing
activities which encourage commercial transactions or
exchange, in some way exchange of information, Payment Cash, cheque, credit Credit card, fund transfer,
or the other of goods / electronically on the card, etc. Cash in Delivery, Payment
services which are manual internet. Wallets, UPCI application
and non-electronic. etc.
Transaction Manual Electronically Delivery of Instantly Takes time, but now

Processing goods e-commerce websites have
created options of same day
Availability For limited time. This 24 × 7 × 365 delivery, or delivery within
for time may be defined by 4 hours.
commercial law. Like special stores
transactions which may run 24 hours, Layers of Reduced layers (i) I n c r e a s e s
but in general available Delivery of delivery from profit margin of
for limited time. (Profit manufacturer to manufacturers.
Impact) customers. (ii) Above (i) allow
Nature of Goods can be inspected Goods cannot be inspected manufacturers to
purchase physically before physically before purchase. give discounts to
purchase. customers.
(iii) Customers get better
Customer Face-to-face. Screen-to-face. prices.
interaction
Layers of Reduced layers (i) This helps customers get
Business Limited to particular Worldwide reach Delivery of delivery from faster product deliveries.
Scope area. (Time manufacturer to (ii) Manufacturers can
Impact) customers. have better inventory
Information No uniform platform Provides a uniform management. As they will
exchange for exchange of platform for information always know what products
information. exchange. customers are buying. They
Resource Supply side Demand side shall be able to maintain
focus inventory on JIT (Just in
Time) basis.

Illustration of E-Commerce Transaction Benefits of E-Commerce
Step 2: Select Step 3: Select the Benefits to Customer / Individual / User

Step 1: Go to
Product type you desired product from • Convenience • Time saving
the website.
wish to buy. product list. • Various Options • Easy to find reviews
• Coupon and Deals • Anytime Access
Step 5: Review the Step 4: Make final

Benefits to Business / Sellers
final price and confirm choice and make
the payment. payment online. • Increased Customer Base • Recurring payments made easy
• Instant Transaction • Provides a dynamic market
• Reduction in costs • Efficiency improvement
Step 6: Payment options can Step 7: Select the payment • Creation of new markets • Easier entry into new markets
be done through COD, Net option and get directed to • Better quality of goods • Elimination of Time Delays
banking, credit card etc. the payment gateway.
Benefits to Government
Step 8: Based on delivery • Instrument to fight corruption
terms, the product is • Reduction in use of ecologically damaging materials
delivered to you.
ARCHITECTURE OF NETWORKED SYSTEMS

Architecture is a term to define the style of design and method of construction used in generally for buildings and other physical
structures. In e-commerce, it denotes the way network architectures are built.
Advantages Two-Tier Architecture Disadvantages
• The system • P e r f o r m a n c e
performance is deteriorates
higher because if number of
business logic users increases.
and database are • There is restricted
physically close. flexibility and
• More users could choice of DBMS
interact with system. since data language
• It is easy to setup used in the server
and maintain entire • Presentation Tier (Client Application/Client Tier): This is the interface is proprietary
system smoothly. that allows user to interact with the e-commerce / m-commerce vendor. to each vendor.
• Database Tier (Data Tier): The product data / price data / customer
data and other related data are kept here.
Advantages Three Tier Architecture Disadvantages
• Clear separation • Increased need

of user-interface- for network traffic
control and data management,
presentation from server load
application-log ic . balancing, and
• Dynamic load fault tolerance.
balancing possible • Current tools
if bottlenecks r e l a t i v e l y
in terms of immature and
performance occurs. more complex.
• Change management • M a i n t e n a n c e
is easy and faster. • Presentation Tier: Occupies the top level and displays information tools currently
related to services available on a website. inadequate.
• Application Tier: Also, called the Middle Tier, Logic Tier, Business
Logic or Logic Tier; it controls application functionality by performing
detailed processing.
• Database Tier: This tier houses the database servers where information
is stored and retrieved.

E-Commerce Architecture Vide Internet E-Commerce Architecture Vide Mobile Apps
M-Commerce (Mobile Commerce): M-commerce is the
buying and selling of goods and services through wireless
handheld devices such as cellular telephone and personal digital
assistants (PDAs). M-commerce enables users to access the
Internet without needing to find a place to plug in.
• Client / User Interface: This layer e-commerce connects to

help the customer and e-commerce merchant.
• Application Layer: Through these application’s customer
logs to merchant systems. This layer allows customer to
check the products available on merchant’s website.
• Database Layer: This layer is accessible to user through Digital Payment (contd..)
application layer. All the transactions in digital payments are completed
online. It is an instant and convenient way to make payment;
Risks and Controls resulting in absolute trasparency and involvement of minimal
processes.
Risk is possibility of loss. The same may be result of intentional
or un-intentional action by individuals. Risks associated with New Methods of Traditional Methods of
e-commerce transactions are high compared to general internet Digital Payment Digital Payment
activities. These include the following: • Unified Payment • E-Wallet
Interface (UPI) Apps • Cards - Credit Cards,
Delay in goods and
• Immediate Payment Debits Cards
Infrastructure Quality issues Service (IMPS) • Net Banking
Hidden Costs
• Mobile Apps -
Repudiation of Security and Problem of BHIM (Bharat
contract credit card issues anonymity Interface for Money)
• Mobile Wallets
Lack of Needs Access to • Aadhar Enabled
Data Loss or theft
authenticity of internet and lack of Payment Service(AEPS)
or duplication
transactions personal touch • U n - s t r u c t u r e
Non-recognition Supplementary
Attack from Denial of Service Data (USSD)
of electronic
hackers Service
transactions
Lack of audit Problem of Privacy and

trails piracy Security
n Mobile Cloud
atio
ali z Computing Computing
Digital Payment Vir
tu
Digital Payment is a way of payment which is made through

digital modes. In digital payments, payer and payee both use Grid
digital modes to send and receive money. It is also called Computing
COMPUTING
electronic payment. No hard cash is involved in the digital TECHNOLOGIES Machine
Learning
payments.
Advantages of Drawbacks of Digital Web 3.0
Digital Payments Payments
• Easy and convenient • Difficult for a Non- Art Bring Your Own
ific Device (BYOD)
• Pay or send money technical person Int ial
elli Green
from anywhere • Risk of data theft gen uting
ce Comp
• Discounts from taxes • Overspending
• Written record
• Less Risk

I. Virtualization
Virtualization means to create a virtual version of a device or resource, such Application Areas
as a server, storage device, network or even an operating system where the • Server Consolidation
framework divides the resource into one or more execution environments. • Disaster Recovery
This refers to technologies designed to provide a layer of abstraction between • Testing and Training
computer hardware systems and the software running on them. • Portable Applications
• Portable Workspaces
Types of Virtualization
Hardware Virtualization Network Virtualization Storage Virtualization
This refers to the creation of a virtual It is a method of combining the available It is the apparent pooling of data
machine that acts like a real computer with an resources in a network by splitting up the from multiple storage devices, even
operating system. The basic idea of Hardware available bandwidth into channels, each different types of storage devices,
virtualization is to consolidate many small of which is independent from the others, into what appears to be a single
physical servers into one large physical server and each of which can be assigned device that is managed from a
so that the processor can be used more (or reassigned) to a particular server central console. It helps the storage
effectively. For example, a computer that is or device in real time. It is intended to administrator perform the tasks
running Microsoft Windows may host a virtual optimize network speed, reliability, of backup, archiving, and recovery
machine that looks like a computer with the flexibility, scalability, and security. more easily and in less time by
Linux operating system; based software that disguising the actual complexity of a
can be run on the virtual machine. Storage Area Network (SAN).
II. Grid Computing: It is a computer network in which each computer’s resources are shared with every other computer in the
system. It is a distributed architecture of large numbers of computers connected to solve a complex problem. In the grid computing
model, servers or personal computers run independent tasks and are loosely linked by the Internet or low-speed networks.
Benefits Types of Resources Security
 Making use of Underutilized  Computation.  Single Sign-on.
Resources.  Storage.  Protection of Credentials.
 Resource Balancing.  Communications.  Interoperability with local security
 Parallel CPU Capacity.  Software and Licenses. solutions.
 Access to additional resources.  Special equipment, capacities,  Exportability
 Virtual resources and virtual architectures, and policies.  Support for secure group
organizations for collaboration. communication.
 Reliability.  Support for multiple implementations.
 Management.
III. Cloud Computing: Cloud Computing is both, a combination of software and hardware based computing resources delivered
as a networked service. This model of IT enabled services enables anytime access to a shared pool of applications and resources.
These applications and resources can be accessed using a simple front-end interface such as a Web browser, and thus enabling users
to access the resources from any client device including notebooks, desktops and mobile devices.
Characteristics Advantages
 Elasticity & Scalability  Achieve economies of scale
 Pay-Per-Use  Reduce spending on technology infrastructure
 On-demand  Globalize the workforce
 Resiliency  Streamline business processes
 Multi-Tenancy  Reduce capital costs
 Workload Movement  Pervasive accessibility
 Monitor projects more effectively
 Less personnel training is needed
 Minimize maintenance & licensing software
 Improved flexibility

Types of Cloud
Private Cloud Public Cloud Community Cloud Hybrid Cloud
It resides within the It is the cloud infrastructure It is the cloud infrastructure This is a combination of both, at
boundaries of an that is provisioned for open that is provisioned for least one private (internal) and
organization and is use by the general public. It exclusive use by a specific at least one public (external)
used exclusively for the may be owned, managed, community of consumers from cloud computing environments
organization’s benefits. and operated by a business, organizations that have shared - usually, consisting of
Private Clouds can either be academic, or government concerns (eg. mission security infrastructure, platforms and
private to the organization organizations, or some requirements, policy, and applications. The usual method
and managed by the combination of them. compliance considerations). of using the hybrid cloud is to
single organization (On- Typically, public clouds It may be owned, managed, have a private cloud initially, and
Premise Private Cloud) or are administrated by third and operated by one or more then for additional resources, the
can be managed by third parties or vendors over the of the organizations in the public cloud is used.
party (Outsourced Private Internet, and the services are community, a third party or
Cloud). offered on pay-per-use basis. some combination of them, and
it may exist on or off premises.
Characteristics of Cloud Computing
 Secure  Highly Scalable  Collaborative &  Scalable
 Central Control  Affordable Distributive maintenance  Partially Secure
 Weak Service Level  Less Secure  Partially secure  Stringent SLAs
Agreements (SLAs)  Highly available  Cost effective  Complex Cloud Management
 Stringent SLAs
Cloud Computing Service Models
Infrastructure as a Service (IaaS) Platform as a Service (PaaS) Software as a Service (SaaS)
IaaS, a hardware-level service, provides PaaS provides the users the ability to SaaS provides ability to the end users
computing resources such as processing power, develop and deploy an application on the to access an application over the
memory, storage, and networks for cloud users development platform provided by the Internet that is hosted and managed
to run their application on-demand. service provider. by the service provider.
This allows users to maximize the utilization of PaaS changes the application development SaaS is delivered as an on-demand
computing capacities without having to own and from local machine to online. service over the Internet, there is no
manage their own resources. need to install the software to the end-
user’s devices.
Different instances are - Network as a Service PaaS providers may provide programming Different instances of SaaS include
(NaaS), Storage as a Service (STaaS), Database as languages, application frameworks, Testing as a Service (TaaS), API as a
a Service (DBaaS), Backend as a Service (BaaS), databases, and testing tools apart from Service (APIaaS), Email as a Service
and Desktop as a Service (DTaaS). some build tools, deployment tools and (EaaS), Communication as a Service
software load balancers as a service in (CaaS), Data as a Service (DaaS),
some cases. Security as a Service (SECaaS), and
Identity as a Service (IDaaS).
IV. Mobile Computing: This refers to technology that allows transmission of data via a computer without having to be connected
to a fixed physical link.
Components Limitations Benefits
 Mobile Communication: Refers to  Insufficient Bandwidth  Mobile workforce with remote access
infrastructure put in place to ensure that  Security Standards to work order details.
seamless and reliable communication goes  Power consumption  Enables mobile sales personnel to
on.  Transmission interferences update work order status in real-time.
 Mobile Hardware: This includes mobile  Potential health hazards  Facilitates access to corporate services
devices/device components that range from  Human interface with and information at any time.
Portable laptops, Smart Phones, Tablet PCs, device.  Provides remote access to the corporate
and Personal Digital Assistants (PDA). knowledge base at job location.
 Mobile Software: It is the actual programme  Enables to improve management
that runs on the mobile hardware and deals effectiveness by enhancing information
with the characteristics and requirements of quality, information flow, and ability to
mobile applications. control a mobile workforce.

IV. Green Computing: Green Computing or Green IT refers to the study and practice of environmentally sustainable computing
or IT. In other words, it is the study and practice of establishing / using computers and IT resources in a more efficient and
environmentally friendly and responsible way.
Best Practices  Develop a sustainable Green Computing plan
 Recycle
 Make environmentally sound purchase decisions
 Reduce Paper Consumption
 Conserve Energy
V. BYOD (Bring Your Own Device): This refers to business policy that allows employees to use their preferred computing
devices, like smart phones and laptops for business purposes. It means employees are welcome to use personal devices (laptops,
smart phones, tablets etc.) to connect to the corporate network to access information and application.
Advantages Emerging BYOD Threats
 Network Risks: It is normally exemplified and hidden in ‘Lack of Device Visibility’. As BYOD
 Happy Employees permits employees to carry their own devices (smart phones, laptops for business use), the IT practice
 Lower IT budgets team is unaware about the number of devices being connected to the network. As network visibility
 IT reduces is of high importance, this lack of visibility can be hazardous.
s u p p o r t  Device Risks: It is normally exemplified and hidden in ‘Loss of Devices’. A lost or stolen device can
requirement result in an enormous financial and reputational embarrassment to an organization as the device may
 Early adoption of hold sensitive corporate information.
new Technologies  Application Risks: It is normally exemplified and hidden in ‘Application Viruses and Malware’.
 I n c r e a s e d Organizations are not clear in deciding that ‘who is responsible for device security – the organization
e m p l o y e e or the user’.
efficiency  Implementation Risks: It is normally exemplified and hidden in ‘Weak BYOD Policy’. The effective
implementation of the BYOD program should not only cover technical issues mentioned above but
also mandate the development of a robust implementation policy.
VI. Web 3.0 Technology
 Known as the Semantic Web, this describes sites wherein the computers will generate raw data on their own without direct
user interaction.
 Web 3.0 standard uses semantic web technology, drag and drop mash-ups, widgets, user behaviour, user engagement, and
consolidation of dynamic web contents depending on the interest of the individual users.
 Web 3.0 Technology uses the “Data Web” Technology, which features the data records that are publishable and reusable on
the web through query-able formats. The Web 3.0 standard also incorporates the latest researches in the field of artificial
intelligence.
Web 3.0 Components
Semantic Web Web Services

This provides the web user a common framework that It is a software system that supports computer -
could be used to share and reuse the data across various to - computer interaction over the Internet. For
example – photo sharing website.
applications, enterprises, and community boundaries.
Example: The application that uses content management systems along with artificial intelligence. This helps to achieve a more
connected open and intelligent web applications using concepts of natural language processing machine learning, machine
reasoning and autonomous agents.
System of interrelated computing devices,

mechanical and digital machines, objects, animals
or people that are provided with unique identifiers
Risks
VII. Internet of Ability to transfer data over a network
To product manufacturer
Things (IoT) without requiring human-to-human or
To user of these products human-to-computer interaction.
Technology Risk
Environmental Risk Application Areas
Home Appliances
Office Machines

VIII. Artificial Intelligence may be defined as the ability to use memory, knowledge, experience, understanding, reasoning,
imagination and judgement to solve problems and adapt to new situations. Applications Areas include Medical diagnosis; in
cancer research; Predicting the chances of an individual getting ill by a disease; Creating art such as poetry; Proving mathematical
theorems; Playing games (such as Chess or Go) and predicting the outcomes etc.
IX. Machine Learning is a type of Artificial Intelligence (AI) that provides computers with the ability to learn without being
explicitly programmed. Machine learning focuses on the development of computer programs that can change when exposed to
new data. The process of machine learning is similar to that of data mining. For example: Machine learning has been used for
image, video, and text recognition, as well as serving as the power behind recommendation engines.
CHAPTER 5: CORE BANKING SYSTEMS

This chapter deals with components and architecture of Core Banking Systems (CBS) and impact of related risks and
controls, discusses the functioning of core module of banking and business process flow. The chapter also provides
a detailed understanding on the regulatory and compliance requirements applicable to CBS such as Banking
Regulations Act, RBI regulations, Prevention of Money Laundering Act and Information Technology Act.
Banking is the engine of economic growth specifically

in a rapidly developing country like India with its diverse IV. Collections
background, practices, cultures and large geographic
Collections involve collecting proceeds on behalf of the
dispersion of citizens. The core of banking functions is customer. Customers can lodge various instruments such as
acceptance of deposits and lending of money. Further, specific cheques, drafts, pay orders, travelers’ cheques, dividend and
services such as demand drafts, bank guarantees, letter of interest warrants, tax refund orders, etc.
credits, etc. are also provided. The key features of a banking
V. Clearing
business are as follows:
• The custody of large volumes of monetary items, including This involves collecting instruments on behalf of customers of
cash and negotiable instruments, whose physical security bank.
should be ensured.
• Dealing in large volume (in number, value and variety) of VI. Letters of Credit (LC)
transactions.
It is an undertaking by a bank to the payee to pay to him, on
• Operating through a wide network of branches and behalf of the applicant any amount up to the limit specified in
departments, which are geographically dispersed. the LC, provided the terms and conditions mentioned in the LC
• Increased possibility of frauds as banks directly deal are complied with.
with money making it mandatory for banks to provide
VII. Guarantees
multi-point authentication checks and the highest level
of information security. These are required by the customers of banks for submission
to the buyers of their goods/services to guarantee performance
PRODUCTS & SERVICES RENDERED BY of contractual obligations undertaken by them or satisfactory
COMMERCIAL BANKS performance of goods supplied by them, or for submission to
certain departments like excise and customs, electricity boards,
I. Acceptance of Deposits or to suppliers of goods, etc. in lieu of the stipulated security
deposit.
Commercial banks accept deposits in various forms such as
term deposits, savings bank deposits, current account deposits, VIII. Credit Cards
recurring deposit, saving-cum-term deposit and various others
innovative products. Most credit cards issued by banks are linked to one of the
international credit card networks like VISA, Master etc.
II. Granting of Advances
Advances constitute a major source of lending by commercial

IX. Debit Cards
banks. The type of advances granted by commercial banks
Debit Cards facilitates customers to pay at any authorized outlet
take various forms such as cash credit, overdrafts, purchase/
as well as to withdraw money from an ATM from their account.
discounting of bills, term loans, etc.
III. Remittances X. Other Banking Services
Involves transfer of funds from one place to another. Two of These include Back operations, Retail Banking, High Net-worth
most common modes of remittance of funds are demand drafts Individuals (HNI), Risk Management and Specialized Services
& Telegraphic/ Mail Transfers (TT/ MT). such as insurance broking, claims, underwriting, life insurance,
non-life insurance, etc.

The business processes and standards adapted by Banks should
consider these new set of IT risks and challenges: Control refers to the policies, procedures, practices and
organization structures that are designed to provide
Frequent changes External threats Higher impact due
to intentional or reasonable assurance that business objectives are achieved
or obsolescence of leading to cyber
technology frauds/ crime unintentional acts of and undesired events are prevented, detected or corrected.
internal employees
General Controls: Also, Application Controls:

New social eng.
Multiplicity and techniques known as Infrastructure These are implemented in
complexity of Segregation of Duties employed to
(SoD) Controls, these are pervasive an application to prevent or
systems acquire confidential
credentials
controls and apply to all detect and correct errors.
systems components, Application controls ensure
processes, and data for a that all transactions are
Different types Need for governance given enterprise or systems authorized, complete and
of controls for Vendor related processes to
different types concentration risk adequately manage environment. accurate.
of technologies/ technology and
systems information security General Controls include, Some examples of
but are not limited to: Application controls are as
• Information Security follows:
Proper alignment Need to ensure Policy • Data edits (editing of
with business Dependence on continuity of
vendors due to • Administration, Access, data is allowed only for
objectives and business processes
legal/ regulatory outsourcing of IT in the event of and Authentication; permissible fields);
services major exigencies
requirements • Separation of key IT • Separation of business
functions; functions (e.g.,
Key Modules of Core Banking System (CBS) • Management of Systems transaction initiation
Acquisition and versus authorization);
Mobile Implementation; • Balancing of processing
Banking • Change Management; totals (debit and credit
Internet ATM
Banking Switch • Backup, Recovery & of all transactions are
Business Continuity; tallied);
• Proper Development • Transaction logging
and Implementation of (all transactions are
Phone Back Application S/w; identified with unique id
Banking Central Office
• Confidentiality, Integrity and logged);
Server
& Availability of Software • Error reporting (errors in
& data files; and processing are reported);
Credit • Incident response and and
Card
System Branch management. • Exception Reporting (all
Data
Warehouse exceptions are reported).
RISKS AND CONTROLS Planning
• Risk can be defined as “the potential harm caused if a Approval

Audit
threat exploits a particular vulnerability to cause damage
to an asset.”
• Risk Analysis is defined as the process of identifying
security risks and determining their magnitude and Updation Selection
impact on an organization.
CBS
IT Risk Management is as follows: Support WORKING Design and
Develop/Procure
• Avoid: Eliminate the risk by not taking up or avoiding
the specific business process which involves risk.
• Mitigate: Implement controls (e.g. acquire and deploy
security technology to protect the IT infrastructure). Maintenance
Testing
• Transfer: Share risk with partners or transfer to
insurance coverage.
• Accept: Formally acknowledge that the risk exists and
monitor it. Implementation

Planning CBS SERVERS FUNCTIONING
Implementation of CBS should be done as per strategic and Application The application software, resides in the
business objectives of bank. Server application server and is always the latest
version as accepted after adequate testing.
Approval
Database The Database Server of Bank contains
The decision to implement CBS must be approved by the Server entire data of Bank which would consist
Board of Directors as high investment and recurring costs are of various accounts of customers & master
involved. data.
Selection ATM Channel This server contains the details of ATM
Server account holders. Soon after the facility of
Bank should select the right solution considering various using the ATM is created by the Bank, the
parameters as defined by the bank to meet their specific details of such customers are loaded on to
requirements and business objectives. the ATM server.
Design/Develop or Procured Internet IBCS software stores the name and

Banking password of the entire internet banking
Currently, most of the CBS deployment are procured. Channel customers. IBCS server also contains the
Server (IBCS) details about the branch to which the
There should be appropriate controls covering the design or customer belongs.
development or procurement of CBS for the bank.
Internet The Internet Banking Software which is
Testing Banking stored in IBAS authenticates customer
Application with the login details stored in IBCS.
The testing is to be done at different phases at procurement Server (IBAS)
stage to test suitability to data migration to ensure all existing
data is correctly migrated and testing to confirm processing Web Server The Web Server is used to host all web
of various types of transactions of all modules produces the services and internet related software
Web server is a program that uses HTTP
correct results. (Hypertext Transfer Protocol) to serve
Implementation the files that form Web pages to users,
in response to their requests, which are
CBS must be implemented as per pre-defined and agreed forwarded by their computers’ HTTP clients.
plan with specific project milestones to ensure successful
Proxy Server A Proxy Server is a computer that offers a
implementation.
computer network service to allow clients
to make indirect network connections to
Maintenance other network services.
CBS must be maintained as required. E.g. program bugs Anti-Virus The Anti-Virus Server is used to host anti-
fixed, version changes implemented, etc. Software virus s/w which is deployed for ensuring
Server all the s/w deployed are first scanned to
ensure that appropriate virus/ malware
Support scans are performed.
CBS must be supported to ensure that it is working effectively.
Updation
Current
CBS modules must be updated based on requirements of & Savings
business processes, technology updates and regulatory Account
requirements. (CASA)
Internet Credit
Audit Cards
Banking
Audit of CBS must be done internally and externally as
required to ensure that controls are working as envisaged. Core
Business
Process Flow
CBS IT ENVIRONMENT
The CBS facilities providing banking services for branches Loans
and Trade Mortgages
of a bank which are networked and connected to common
data center. This facilitates staff to process transactions Finance
of customers of any branch. The Server is a sophisticated
computer that accepts service requests from different Treasury
machines called clients. The requests are processed by the
server and sent back to the clients. There are different types of
servers used in deploying CBS which are as follows:

e-Commerce Transaction flow for approval of payments
RISKS ASSOCIATED WITH CBS IT Related Risks

From a business perspective, the risks that can be classified based
Ownership of Data/ Process on following Information criteria are as follows:
Data resides at the Data Centre. Establish clear ownership. Efficiency
Authorization Process Response is delayed resulting in dissatisfied stakeholder.

Anybody with access to the CBS, including the customer himself,
can enter data directly. What is the authorization process? Effectiveness
Process is ineffective and multiple runs consume time.
Authentication Procedures
These may be inadequate and hence the user entering the Reliability
transaction may not be determinable or traceable. Users lose confidence in information system.
Several software interfaces across diverse networks Confidentiality

A Data Centre can have as many as 75-100 different interface and Due to loss of critical data.
application software.
Integrity
Maintaining Response Time Incomplete or inaccurate data due to errors in input or
Maintaining the interfacing software and ensuring optimum processing.
response time and up time can be challenging
Availability
User Identity Management Information system is not available when required.
This could be a serious issue. Some Banks may have more than
5000 users interacting with the CBS at once. Compliance
The information system does not comply with legal, regulatory,
Access Controls contractual or internal compliance requirements.
Designing and monitoring access control is an extremely
challenging task.
Applicable Regulatory and Compliance
Requirements
Incident handling procedures
These may not be adequate considering the need for real-time Negotiable Instruments Act-1881 (NI Act) Under NI Act,
risk management. Cheque includes electronic image of truncated cheque and a
cheque in the electronic form. The truncation of cheques in
Change Management clearing has been given effect to and appropriate safeguards
in this regard have been set forth in the guidelines issued by
At application level and data level – Master files, Transaction files
and Reporting software. RBI from time to time.

Information Technology (IT) Act
I. The Reserve Bank of India (RBI) was established on April
1, 1935 in accordance with the provisions of the Reserve
The Information Technology Act was passed in 2000,
Bank of India Act, 1934. The basic functions of the Reserve amended in 2008 and the Rules were passed in 2011.
Bank as: “to regulate the issue of Bank Notes and keeping of
reserves with a view to securing monetary stability in India ♦ The Act provides legal recognition for transactions
and generally to operate the currency and credit system of the carried out by means of electronic data interchange and
country to its advantage.” other means of electronic communication, commonly
referred to as “electronic commerce”, which involve
II. Money Laundering is the process by which the proceeds
the use of alternatives to paper-based methods of
of the crime and the true ownership of those proceeds are
communication and storage of information, to facilitate
concealed or made opaque so that the proceeds appear to
electronic filing of documents with the Government.
come from a legitimate source.
♦ The Act provides the legal framework for electronic
• Prevention of Money Laundering Act (PMLA) governance by giving recognition to electronic records
and digital signatures. It also deals with cybercrime
• Three stages of Money Laundering
and facilitates electronic commerce. It also defined
 Placement: Involves the Placement of proceeds derived
cyber-crimes and prescribed penalties for them.
from illegal activities – the movement of proceeds, ♦ The Amendment Act 2008 provides stronger privacy
frequently currency, from the scene of the crime to a data protection measures as well as implementing
place, or into a form, less suspicious and more convenient reasonable information security by implementing ISO
for the criminal. 27001 or equivalent certifiable standards to protect
 Layering: Involves the separation of proceeds from against cyber-crimes.
illegal source using complex transactions designed to ♦ Cyber Crimes: Also known as computer crime, it
obscure the audit trail and hide the proceeds. is defined as: “Offences that are committed against
 Integration: Involves conversion of illegal proceeds into individuals or groups of individuals with a criminal
apparently legitimate business earnings through normal motive to intentionally harm the reputation of the
victim or cause physical or mental harm, or loss,
financial or commercial operations.
to the victim directly or indirectly, using modern
• Anti-Money Laundering (AML) using Technology
telecommunication networks such as Internet (Chat
• Financing of Terrorism rooms, emails, notice boards and groups) and mobile
phones”.
Some examples of offences in IT Act which could impact Banks
Section 43 Section 65: Section 66: Section 66-B: Section 66-C: Section 66-D: Section 66-E:
provides Tampering Computer Punishment Punishment for Punishment Punishment
for Penalty with Related for dishonestly identity theft for cheating by for violation of
and Computer Offences receiving stolen personation by privacy
compensation Source computer using computer
for damage Documents resource or resource
to computer, communication
computer device
system, etc.
Sensitive Personal Data Information (SPDI)

The IT Act has a specific category, “Sensitive Personal Data or Information,” which consists of password, financial information
(including bank account, credit card, debit card or other payment details), physical, physiological and mental health conditions,
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Advanced Accounting
>E<W'
ISBN : 978-81-8441-882-8
Board of Studies
Phone : 0120 - 3045930
Intermediate Course
+
+
Paper: 78
Strategic
Management
STRATEGIC MANAGEMENT
Strategic Management - A Capsule for Quick Revision
It is been the endeavour of the Board of Studies to provide holistic education to the students of Chartered
Accountancy course. The education pedagogy adopted is mix of traditional methods and use of modern
technology to make education convenient to the students and they have better assimilation of concepts.
Covering vast subjects is a time consuming exercise. Keeping this in mind the Board of Studies is
releasing capsules in the Students’ Journal that will help the students to quickly revise the subjects. At
the same time, it may be kept in mind that these are not replacement of the study material. Reading
of Study Material is absolute essential. This capsule on strategic management, first in the series, cover
chapters 1, 2 and 3 under the new syllabus of Intermediate Examination. Students of earlier scheme may
also refer to the relevant portions in the write-up.
Chapter 1 : Introduction to Strategic Management

Business Policy Concept of Strategy
• Origin of business policy can be traced back to early • The common thread among the organization’s
twentieth century. activities and product-markets that defines the
• Harvard Business School introduced an integrative essential nature of business that the organization
course in management aimed at the creation of has or planned to be in future. - Igor H. Ansoff
general management capability among business • A unified, comprehensive and integrated plan
executives. designed to assure that the basic objectives of the
• The study of the functions and responsibilities enterprise are achieved. - William F. Glueck
of senior management, the crucial problems
that affect success in the total enterprise,
and the decisions that determine the Respond to
direction of the organization and shape its dynamic and
future. - Christensen hostile external
• Business Policy presents a framework for forces Unravel
Bring a sense complexity
understanding strategic decision making. Such a of dynamic
framework enables a person to make preparations and to reduce
direction, uncertainty
for handling general management responsibilities focus and Strategy is
effectively. consciously of the
cohesiveness environment
considered and
flexibly designed
What is Management? scheme of
Long range corporate intent Exploit
Management as Management blueprint of and action opportunities
Management set of functions desired image, and meet
as key group Management direction and potential
The is an influence destination Pursuit of threats
In-charge of functions process to mission,
organisational include make things objectives to
affairs. Planning, happen, to
achieve goals
Making Organising, gain
organisation Directing, command
a purposeful Staffing and over
and Control. phenomena, Strategy - Partly proactive and partly reactive
productive Determine to induce and
entity. goals and direct events
Brings activities and people in
together/ Helps in a particular Proactive actions on Reactions to
integrates the allocation manner. the part of managers to unanticipated
resources. of tasks and improve the company’s developments and fresh
resources market position and market conditions
financial performance
The Chartered Accountant Student August 2017

PLANNED STRATEGY
New initiatives plus Actual
ongoing strategy Company
Company Experi- features continued
Strategy
ences, Know-how, from prior periods
Resource Strength
to
& weaknesses and d ap t iv e reactions
A es
c ircumstanc
Competitive Chan g in g
Capabilities
REACTIVE STRATEGY
A Company’s Actual Strategy Is Partly Planned & Partly Reactive
Strategic Management
Developing the company’s vision, environmental scanning (both external and internal),
strategy formulation, strategy implementation and evaluation and control.
Managerial process to develop

vision, set objectives, craft,
implement and evaluate strategy
Concept
Initiate corrective adjustments

where deemed appropriate
Strategic Management
To create competitive
advantage
Objectives
Guide company through

dynamic environment
August 2017 The Chartered Accountant Student

Strategic Levels in Organisations
CORPORATE LEVEL
CEO, Board of Directors,
other senior exectives and HEAD OFFICE
corporate staff
BUSINESS LEVEL
Divisional managers DIVISION A DIVISION B DIVISION C
and staff
FUNCTIONAL BUSINESS BUSINESS BUSINESS

LEVEL FUNCTIONS FUNCTIONS FUNCTIONS
Functional managers
MARKET MARKET MARKET
Levels of Strategic Management
Strategic Management in Educational Medical Governmental agencies

Government and Not-for-profit Institutions Organizations and departments
Organisations • Significant change • Advances in the • Formulating,
in the competitive diagnosis and implementing, and
climate treatment of evaluating strategies
• There are many organizations diseases • Efficient and
that do not have any commercial • Adopting effective utilization
objective of making profits. different • Providing better of resources
strategies for facilities and • Public funds are
• They are set up for social, attracting best services to the used.
charitable, or educational students patients • Several government
purposes. • There are • Diversification - organizations are
making significant
interactions hospitals opening surpluses
• There are not-for-profit and
between pathological labs
government organizations that • Little freedom to
outperform many private firms Academic • Better alter missions or
in managing their affairs. institutions and collaboration with redirect objectives.
industries physicians • Legislators and
• Often function as a monopoly, • Online politicians can have
produce a product or service that education is new direct or indirect
offers little or no measurability of control.
phenomena
performance. • Issues get discussed
and debated in
• Dependent on outside financing. the media and
legislatures.

Chapter 2 : Dynamics of Competitive Strategy

Competitive Strategy Time
An organization must identify its position relative to Short-term Long-term
the competitors in the market. Competitive strategy Errors in Changes in the
External
generates competitive advantage, increase the loyalty interpreting the environment lead
of customers and beat competition. A competitive environment cause to obsolescence
strategy consists of: strategic failure of strategy
Strategic Risks
• Attract customers.
• Withstand competitive pressures.
• Strengthen an organization’s market position. Organizational Inconsistencies
capacity is with the strategy
Internal
Having a competitive advantage is necessary for a unable to cope are developed
firm to compete in the market. up with strategic on account
demands of changes in
Competitive Landscape internal capacities
Competitive landscape relates to identifying and and preferences
understanding competitors
It permits the comprehension of vision, mission,
core values, niche market, strengths and weaknesses of
competitors. Strategic Analysis
Competitive intelligence is required to understand
competitive landscape.
Put all the
information
External Analysis Internal Analysis
Determine
Determine the weak- together. Customer Analysis: Performance Analysis:
Understand the strengths nesses of the Segments, Motivations, Profitability, sales,
Identify the of the competitors.
the competitors competitors unmet needs. customer satisfaction,
competitor Competitor Analysis: product quality, relative
Strategic groups, cost, new products,
Steps to understand the Competitive Landscape performance, obectives, human resources.
strategies, culture, cost Determinants Analysis:
Strategic Analysis structure. Past and current
Proper diagnosis of the company’s situation is necessary Market Analysis: strategies, strategic
for managerial preparation for deciding on a sound Size, growth, profitability, problems, organizational
long-term direction, setting appropriate objectives, entry barriers. Capabilites and
and crafting a winning strategy. The analytical Environmental Analysis: constraints, Financial
sequence is from strategic appraisal of the external Technological, resources, strengths, and
and internal situation, to evaluation of alternatives, government, economic, weaknesses.
to choice of strategy. Two most important situational cultural, demographic.
considerations are:
(1) industry and competitive conditions and
(2) an organisation’s own competitive capabilities,
Opportunities, threats, Strategic strengths,
resources, internal strengths, weaknesses, and
trends, and strategic, weaknesses, problems,
market position.
uncertainties constraints and
uncertainties
Strategy Balance
evolves over of external
a period and internal Risk
of time factors Strategy Identification & Selection
• Identify strategic alternatives
Strategy is result Strategic analysis involves Identify potential • Select strategy
of a series of small a workable balance imbalances or risks • Implement the operating plan
decisions taken between diverse and and assess their • Review strategies
over extended conflicting internal and consequences.
period of time. external considerations.
Issues to consider for Strategic Analysis Framework of Strategic Analysis

Industry and Competitive Analysis

Industry and competitive analysis provides a way of thinking strategically about any industry’s overall situation
and drawing conclusions about whether the industry represents an attractive investment for organisational funds.
Dominant Economic Factors to consider include size, of market, its growth

Issues in Industry Features of the Industry rate, position in life cycle, rivals, buyers, profitability,
and Competitve capital requirement, etc.
Analysis
Nature and Strength of Delving into the industry’s competitive process
Competition to discover what the main sources of competitive
pressure are and how strong each competitive force is.
Triggers of Change There are driving forces that impact and bring
changes in the industry’s structure and competitive
environment. Analyzing driving forces involves
identifying what the driving forces are and assessing
their impact.
Strategic Group It is done by comparing the market positions of each

Mapping competitor separately or for grouping them into like
positions in an industry
Likely Strategic Moves To outmanoeuvre rivals organisations need to monitor

of Rivals actions, strategies, and anticipate likely moves of
competitors.
Key Success Factors They are strategy elements, product attributes,

resources, competencies, competitive capabilities, and
business outcomes that affect ability to prosper and
lead to competitive success or failure.
Prospects and Financial Strategists assess industry outlook carefully, decide

Attractiveness of whether industry and competitive conditions present
Industry an attractive business opportunity for the organisation
or whether its growth and financial prospects are
gloomy.
Core Competence
C.K. Prahalad and Gary Hamel defined core competency as the collective learning in the organization, especially
coordinating diverse production skills and integrating multiple streams of technologies. Capabilities that are
valuable, rare, costly to imitate, and non-substitutable are core competencies.
Competitor Competence that is unique and difficult for

C.K. Prahalad
differentiation competitors to imitate.
and Gary Hamel
identified major
core competencies
Customer value A fundamental benefit for the end customer that has
in three areas
real impact.
- competitor
differentiation,
customer value
Application of Competence must be applicable to whole organization
and application.
competencies and can open up potential market to be exploited.

Value Chain Analysis Value Creation

Value chain analysis has been widely used as a means The concept of value creation was introduced primarily
of describing the activities within and around an for providing products and services to the customers
organization, and relating them to an assessment with more worth. Value is measured by a product’s
of the competitive strength of an organization (or features, quality, availability, durability, performance and
its ability to provide value-for-money products or by its services for which customers are willing to pay.
services). The primary activities of the organization
are grouped into five main areas: inbound logistics, Value to Customer
operations, outbound logistics, marketing and sales, Customer’s

Surplus
and service. For an organisation it is important to Price
identify those competences which critically underpin
Profitable
the organization’s competitive advantage. These are Pricing Band
known as the core competences and will differ from Firm’s
Margin
one organization to another.
Firm’s Cost of Value Creation

Firm Infrastructure
Support Human Resource Management

Margin
Activities
Technology Develoment 0
Procurement
Inbound Marketing & Service
Operations Outbond Thus, we can say that the value creation is an activity or
logistics logistic Sales
Margin performance by the firm to create value that increases
the worth of goods, services, business processes or
even the whole business system.
Primary Activities
Value Chain (Michael Porter)

Portfolio Analysis
Experience Curve
Competitive Advantage Experience curve is akin to a learning curve which
explains the efficiency increase gained by workers
Competitive advantage allows a firm to gain an edge through repetitive productive work. Experience curve
over rivals when competing. ‘It is a set of unique features is based on the commonly observed phenomenon that
of a company and its products that are perceived by unit costs decline as a firm accumulates experience
the target market as significant and superior to the in terms of a cumulative volume of production. The
competition.’ concept of experience curve is relevant for a number of
Competitive advantages and the differences they areas in strategic management.
create in the firm’s performance are often strongly
related to the resources firms hold and how they are Product Life Cycle
managed. Resources and capabilities are not inherently Product life cycle (PLC) an S-shaped curve which
valuable, but they create value when the firm can exhibits the relationship of sales with respect of time
use them to perform certain activities that result in a for a product that passes through the four successive
competitive advantage. stages of introduction (slow sales growth), growth
(rapid market acceptance) maturity (slowdown in
Competitive Advantage growth rate) and decline (sharp downward drift).
Capabilities
(Organizational Routlines) y
urit De
Mat
Sales
clin
e
th
ow
Gr
Resources
duction
Intro
Tangible Intangible
Time
Physical Financial Human Skills Technology Reputation
Product Life Cycle

Boston Consulting Group (BCG) Growth-Share ADL Matrix

Matrix The ADL matrix is a portfolio analysis technique that is
BCG helps to classify different businesses on a two- based on product life cycle. The approach forms a two
dimensional growth-share matrix dimensional matrix based on stage of industry maturity
and the firms competitive position, environmental
Relative Market Share assessment and business strength assessment. Stage
High Low of industry maturity is an environmental measure that
represents a position in industry’s life cycle. Competitive
Stars Question Marks position is a measure of business strengths that helps
Market Growth Rate
in categorization of products or SBU’s into one of five

High
competitive positions: dominant, strong, favourable,

tenable and weak.
General Electric Matrix [“Stop-Light” Strategy Model]

Cash Cows Dogs The strategic planning approach in this model has been
inspired from traffic control lights. The lights that are
Low
used at crossings to manage traffic are: green for go,

amber or yellow for caution, and red for stop. This
model uses two factors while taking strategic decisions:
Business Strength and Market Attractiveness.
BCG Growth-Share Matrix
Business Strength
• Stars are products or SBUs that are growing rapidly.
Strong Average Weak
Attractiveness
• Cash Cows are low-growth, high market share

businesses or products. High Invest/ Invest/Expand Select/Earn
Market
Expand
• Question Marks are low market share business in
high-growth markets. Medium Invest/ Select/Earn Harvest/Divest
Expand
• Dogs are low-growth, low-share businesses and
products. Low Select/Earn Harvest/Divest Harvest/Divest
Ansoff’s Product Market Growth Matrix The GE Portfolio Matrix

A useful tool to decide product and market growth
strategy. SWOT Analysis
Existing Products New Products Strength Strength is an inherent
To enable capability of the
management organization which it
Markets
Existing
Market Product create a can use to gain strategic

Penetration Development firm-specific advantage over its
competitors.
business
Market model that Weakness A weakness is an inherent
Markets
Diversification will best limitation or constraint

New
Development
align, fit, or of the organization
match an which creates strategic
Ansoff’s Product Market Growth Matrix organisational disadvantage to it.
resources and
♦ Market penetration refers to a growth strategy capabilities to Opportunity An opportunity is a
the demands favourable condition in the
where the business focuses on selling existing organisation’s environment
products into existing markets. of the
which enables it to
♦ Market development refers to a growth strategy environment strengthen its position.
where the business seeks to sell its existing products
into new markets. Threat A threat is an unfavourable
♦ Product development refers to a growth strategy condition in the
where business aims to introduce new products into organisation’s environment
existing markets. which causes a risk
♦ Diversification refers to a growth strategy where a for, or damage to, the
business markets new products in new markets. organisation’s position.

TOWS Matrix SO (Maxi-Maxi)

The strengths can be used to capitalize or build upon
Heinz Weihrich developed a matrix called TOWS existing or emerging opportunities.
matrix by matching strengths and weaknesses of an
organization with the external opportunities and ST (Maxi-Mini)
threats. The incremental benefit of the TOWS matrix ST is a position in which a firm strives to minimize
lies in systematically identifying relationships between existing or emerging threats through its strengths.
these factors and selecting strategies on their basis.
Thus TOWS matrix has a wider scope when compared WO (Mini-Maxi)
to SWOT analysis. TOWS analysis is an action tool The firm needs to overcome internal weaknesses and
whereas SWOT analysis is a planning tool. make attempts to exploit opportunities to maximum.
Internal Elements
WT (Mini-Mini)
Organizational Organizational A firm facing external threats and internal weaknesses
Strengths Weaknesses may have to struggle for its survival.
Environmental Globalization
opportunities SO WO
Maxi-Maxi Mini-Maxi For a company globalization means two things: (a)
External Elements
(and risks)
the company commits itself heavily with several
manufacturing locations around the world and offers
products in several diversified industries, and (b) the
ST company’s ability to compete in domestic markets with
Environmental WT foreign competitors.
Threats Maxi-Mini Mini-Mini • It is a conglomerate of multiple units in different
countries but linked by common ownership.
• Multiple units draw on a common pool of resources.
• The units respond to some common strategy.
Chapter 3 : Strategic Management Process

The major dimensions of strategic decisions
Strategic Planning • Strategic decisions require top-management
involvement.
Strategic Planning is the process of determining • Strategic decisions involve commitment of
the objectives of the firm, resources require to organisational resources.
attain these objectives and formulation of policies • Strategic decisions necessitate consideration of
to govern the acquisition use and disposition of factors in the firm’s external environment.
resources. Strategic uncertainty is a key construct in • Strategic decisions are likely to have a significant
strategy formulation. impact on the long-term prosperity of the firm.
• Strategic decisions are future oriented.
Strategic Decision Making • Strategic decisions usually have major
multifunctional or multi-business consequences.
Decision making is a managerial process of Strategic Intent

selecting the best course of action out of several
alternatives. According to Jauch and Glueck Strategic intent provides the framework within which
“Strategic decisions encompass the definition of the firm would adopt a predetermined direction
the business, products to be handled, markets and would operate to achieve strategic objectives.
to be served, functions to be performed and Strategic intent could be in the form of vision and
major policies needed for the organisation to mission statements for the organisation at the
execute these decisions to achieve the strategic corporate level. It could be expressed as the business
objectives.” definition and business model at the business level of
the organisation.

1. Vision: Vision implies the blueprint of the Vision

company’s future position.
A Strategic vision is a road map of a company’s
2. Mission: Mission delineates the firm’s business, its future – providing specifics about technology
goals and ways to reach the goals. and customer focus, the geographic and product
markets to be pursued, the capabilities it plans to
3. Business Definition: It seeks to explain the develop, and the kind of company that management
business undertaken by the firm, with respect to is trying to create.
the customer needs, target markets, and alternative
technologies.
Essentials of a strategic vision
4. Business Model: Business model, as the • There is challenge in developing a strategic vision
name implies is a strategy for the effective that is creative and future directed.
operation of the business, ascertaining • Forming a strategic vision is an exercise in
sources of income, desired customer base, and intelligent entrepreneurship.
financial details. • A well-articulated strategic vision creates
enthusiasm in organisation.
5. Goals and Objectives: These are the base of • Vision statement illuminates the direction in which
measurement. Goals are the end results, that the organization is headed.
organization attempts to achieve. On the other
hand, objectives are time-based measurable
targets, which help in the accomplishment Mission
of goals.
A company’s mission statement is typically focused
The vision, mission, business definition, and on its present business scope – “who we are and
business model explain the philosophy of the what we do”. Mission statements broadly describe
organisation but the goals and objectives represent an organizations present capabilities, customer
the results to be achieved in multiple areas of focus, activities, and business makeup.
business.
Following points are useful while writing a mission of a
company:
• A role of mission statement is to give the organization
its own special identity, business emphasis and path
Goals and Objectives for development to make it unique.
• A company’s business is defined by what needs
Business Model it is trying to satisfy, which customer groups it is
targeting, the technologies it uses and the activities
it performs.
Business definition • Good mission statements are unique to the
organization for which they are developed.
Mission Purpose
Both mission and purpose go hand in hand, they
can be used together while maintaining the basic
Vision difference between them. Mission refers to the
particular needs of the society. Purpose relates to
what the organization strives to achieve in order to
Strategic fulfil its mission to the society.
Intent
Goals and Objectives
Goals are open-ended attributes that denote the
future states or outcomes. Objectives are close-
ended attributes which are precise and expressed in
specific terms. Thus, the objectives are more specific
Elements of Strategic Intent and translate the goals to both long term and short
term perspective.

Objectives should be quantitative, measurable, realistic, Strategic Management

understandable, challenging, hierarchical, obtainable,
and congruent among organizational units. Objectives The strategic management process is dynamic
are short-term and long-term. Long term objectives and continuous. It involves strategy formulation,
are subdivided into short term such as monthly, implementation, and evaluation The strategic
weekly or daily objectives. management process can best be studied and applied
using a model.
Environmental Analysis
Strategic
Develop Vision, Mission and Generate, Analyse and Implement Evaluation
Objectives select Strategies Strategies and Control
Organisation Appraisal
Analysis Implementation Evaluation
Strategic Management Model
The strategic management consist of following stages 3. Formulating strategy: The stage involves
identifying strategic alternatives, in depth
1. Strategic vision, mission and objective: First a analysis and choosing the most appropriate
company must determine what directional path alternative which will serve as strategy of
the company should take and what changes in the firm.
the company’s product – market – customer –
technology – focus would improve its current 4. Implementation of strategy: Implementation
market position and its future prospect. and execution is an operations-oriented,
Deciding to commit the company to one path activity aimed at shaping the performance of
versus another pushes managers to draw some core business activities in a strategy-supportive
carefully reasoned conclusions about how to manner. Good strategy execution involves
try to modify the company’s business makeup creating strong “fits” between strategy and
and the market position. Corporate goals and organizational capabilities, between strategy
objectives flow from the mission. and the reward structure, between strategy and
internal operating systems, and between strategy
2. Environmental and organizational analysis: and the organization’s work climate and culture.
The stage would reveal organisational strengths
and weaknesses which could be matched with 5. Strategic evaluation and control: Assessing
the threats and opportunities in the external periodically that organisation is moving towards
environment. External environment of a firm achieving its strategic intent is desirable. The
consists of economic, social, technological, final stage of strategic management process –
market and other forces which affect its evaluating the company’s progress, assessing
functioning. Organisational analysis involves the impact of new external developments, and
a review of financial resources, technological making corrective adjustments – is the trigger
resources, productive capacity, marketing point for deciding whether to continue or change
and distribution effectiveness, research and the company’s vision, objectives, strategy, and/
development, human resource skills and so on. or strategy-execution methods.

STRATEGIC MANAGEMENT – A CAPSULE FOR QUICK REVISION
In the August 2017 issue, the Capsule for quick recap of IIPCC/Intermediate Paper 7B: Strategic Management broadly
covers the topics of strategic management discussed in detail in Chapter 1 to 3 of the Study Material. In continuation, the
capsule on this subject published in this issue covers the remaining Chapters 4 to 8 of the Study Material. Kindly note that
this capsule would be beneficial for both Intermediate and IIPCC of Paper 7B: Strategic Management.
It may be kept in mind that the capsule is not the replacement of the Study Material. Reading of Study Material is absolute
essential. This capsule is intended to assist you in the process of revision of concepts discussed in the Study Material.
CHAPTER 4 : CORPORATE LEVEL STRATEGIES

Strategies are formulated at different levels of an organization The corporate strategies a firm can adopt may be classified
– corporate, business and functional. Corporate level strategy into four broad categories. The basic features of the corporate
occupies the highest level of strategic decision making and covers strategies are as follows:
actions dealing with the objective of the firm, acquisition and Strategy Basic Feature
allocation of resources and coordination of strategies of various Stability The firm stays with its current businesses
SBUs for optimal performance. and product markets; maintains the
We can classify the different types of strategies on the existing level of effort; and is satisfied with
basis of levels of organisation, stages of business life cycle and incremental growth.
Expansion Here, the firm seeks significant growth-
competition. maybe within the current businesses; maybe
Basis of Types by entering new business that are related
Classification to existing businesses; or by entering new
Level Corporate Level businesses that are unrelated to existing
Business Level businesses.
Functional Level Retrenchment The firm retrenches some of the activities in
Stages of Entry/Introduction Stage - Market some business (es), or drops the business as
Business Life Penetration Strategy such through sell-out or liquidation.
Cycle Combination The firm combines the above strategic
Growth Stage - Growth/Expansion Strategy
alternatives in some permutation/
Maturity Stage - Stability Strategy combination so as to suit the specific
Decline Stage - Retrenchment/Turnaround requirements of the firm.
Strategy
Competition Competitive Strategies - Cost Leadership, Stability Strategy
Differentiation, Focus A stability strategy is pursued by a firm when:
Collaboration Strategies - Joint Venture, • It continues to serve in the same or similar markets and deals
Merger & Acquisition, Strategic Alliance in same or similar products and services.
• The strategic decisions focus on incremental improvement of
Corporate Strategy Alternatives functional performance
Stability strategy is not a ‘do nothing’ strategy. It involves
keeping track of new developments to ensure that the strategy
Growth/ Retrenchment Combination
Stability Expansion continues to make sense. This strategy is typical for those firms
whose product have reached the maturity stage of product life
cycle. Small organizations may also follow stability strategy to
Strategic consolidate their market position and prepare for the launch of
Diversification Merger &
Acquisition Alliances growth strategies.
Growth/Expansion Strategy
Intensification Growth/Expansion strategy is often characterised by significant
Diversification
reformulation of goals and directions, major initiatives and
moves involving investments, exploration and onslaught into
Vertically Horizontally Concentric Conglomerate new products, new technology and new markets, innovative
Integrated Integrated Diversification Diversification decisions and action programmes and so on. Expansion also
includes diversifying, acquiring and merging businesses.
Market
Penetration
• Expansion through diversification
Diversification is defined as entry into new products or product
Market Forward Backward
Development lines, new services or new markets, involving substantially
different skills, technology and knowledge. For some firms,
Product diversification is a means of utilising their existing facilities and
Development
capabilities in a more effective and efficient manner.
The Chartered Accountant Student March 2018

Expansion or growth strategy can either be through (i) Vertically integrated diversification: In vertically integrated
intensification or diversification: Igor Ansoff gave a framework diversification, firms opt to engage in businesses that are
as shown which describes the intensification options available to related to the existing business of the firm. The firm remains
a firm. vertically within the same process sequence moves forward
Market Penetration Basic Feature or backward in the chain and enters specific product/process
Increase market share Add product features, steps with the intention of making them into new businesses
Increase product usage product refinement for the firm.
Increase the frequency used Develop a new-generation
Increase the quantity used product Forward and Backward Integration:
Find new application for Develop new product for the
Forward integration is moving forward in the value chain and
current users same market
entering business lines that use existing products.
Market Development Diversification involving
Expand geographically new products and new
target new segments markets On the other hand, backward integration is a step towards
Related / Unrelated creation of effective supply by entering business of input
Product-Market Expansion Grid providers.
(a) Intensification (ii) Horizontal Integrated Diversification: Through the

• Market Penetration: Highly common expansion strategy is acquisition of one or more similar business operating at the
market penetration/concentration on the current business. same stage of the production-marketing chain that is going
The firm directs its resources to the profitable growth of its into complementary products, by-products or taking over
existing product in the existing market. competitors’ products.
• Market Development: It consists of marketing present
products, to customers in related market areas by adding
RELATED UNRELATED
different channels of distribution or by changing the content
DIVERSIFICATION DIVERSIFICATION
of advertising or the promotional media.
Exchange or share assets or • Investment in new
• Product Development: Product development involves
competencies by exploiting product portfolios.
substantial modification of existing products or creation
• Brand name • Employment of new
of new but related items that can be marketed to current
• Marketing skills technologies.
customers through establish channels.
• Sales and distribution • Focus on multiple
capacity products.
(b) Diversification
• Manufacturing skills • Reduce risk by operating
Diversification endeavours can be related or unrelated to existing
• R&D and new product in multiple product
businesses of the firm. Based on the nature and extent of their
capability markets.
relationship to existing businesses, diversification endeavours
• Economies of scale • Defend against takeover
have been classified into four broad categories:
bids.
(i) Vertically integrated diversification
• Provide executive
(ii) Horizontally integrated diversification
interest.
(iii) Concentric diversification
(iv) Conglomerate diversification Related vs. Unrelated Diversification
Forward Backward Horizontal (iii) Concentric Diversification: Concentric diversification

Integration Integration Integration
too amounts to related diversification. In concentric
Raw diversification, the new business is linked to the existing
Materials B
a businesses through process, technology or marketing.
c (iv) Conglomerate Diversification: In conglomerate
Intermediate k diversification, no such linkages exist; the new
Goods w businesses/ products are disjointed from the existing
a By Products businesses/products in every way; it is a totally unrelated
r diversification.
Manufacturing F d Competitive
Horizontal
Products • Expansion through Mergers and Acquisitions
o
Acquisition or merger with an existing concern is an instant
r
Marketing/ Complementary means of achieving the expansion. Merger and acquisition in
Sales w Products simple words are defined as a process of combining two or more
a organizations together.
r  Merger is considered to be a process when two or more
After Sales
d
companies come together to expand their business
Service
operations. In such a case the deal gets finalized on friendly
Diversification
March 2018 The Chartered Accountant Student

terms and both the organizations share profits in the newly Retrenchment/Turnaround Strategy
created entity.
 When one organization takes over the other organization (i) Retrenchment Strategy: It is followed when an organization
and controls all its business operations, it is known as substantially reduces the scope of its activity.
acquisitions. In this process of acquisition, one financially (ii) Turnaround Strategy: Retrenchment may be done either
strong organization overpowers the weaker one. internally or externally. For internal retrenchment to take
place, emphasis is laid on improving internal efficiency,
Types of Mergers known as turnaround strategy.
1. Horizontal merger: Horizontal mergers are combinations of (iii) Divestment Strategy: Divestment strategy involves the sale or
firms engaged in the same industry. liquidation of a portion of business, or a major division, profit
2. Vertical merger: It is a merger of two organizations that centre or SBU. Divestment is usually a part of rehabilitation or
are operating in the same industry but at different stages of restructuring plan and is adopted when a turnaround has been
production or distribution system. attempted but has proved to be unsuccessful.
3. Co-generic merger: In Co-generic merger two or more (iv) Liquidation Strategy: A retrenchment strategy considered
merging organizations are associated in some way or the the most extreme and unattractive is liquidation strategy,
other related to the production processes, business markets, which involves closing down a firm and selling its assets.
or basic required technologies. It is considered as the last resort because it leads to serious
4. Conglomerate merger: Conglomerate mergers are consequences such as loss of employment for workers and
the combination of organizations that are unrelated to other employees, termination of opportunities where a firm
each other. There are no linkages with respect to customer could pursue any future activities, and the stigma of failure.
groups, customer functions and technologies being used.
Combination Strategy
• Expansion through Strategic Alliance The above strategies are not mutually exclusive. It is possible to
A strategic alliance is a relationship between two or more adopt a mix of the above to suit particular situations. An enterprise
businesses that enables each to achieve certain strategic may seek stability in some areas of activity, expansion in some
objectives which neither would be able to achieve on its own. and retrenchment in the others. Retrenchment of ailing products
The strategic partners maintain their status as independent followed by stability and capped by expansion in some situations may
and separate entities, share the benefits and control over be thought of. For some organizations, a strategy by diversification
the partnership, and continue to make contributions to the and/or acquisition may call for a retrenchment in some obsolete
alliance until it is terminated. product lines, production facilities and plant locations.
CHAPTER 5 : BUSINESS LEVEL STRATEGIES

An organization’s core competencies should be focused on satisfying customer needs or want in order to achieve organisational
objectives. This is done through business-level strategies. Business level strategies are the courses of action adopted by an organisation
for each of its businesses separately, to serve identified customer groups and provide value to the customers by satisfaction of their
needs. In the process, the organisation uses its competencies to gain, sustain and enhance its strategic or competitive advantage.
Porter’s Five Forces Model –Competitive

Competitive Analysis
Analysis
(Porter’s Five Forces)
Michael Porter believes that the basic unit of analysis for
understanding is a group of competitors producing goods or
services that compete directly with each other. It is the industry
Business Level Strategies
where competitive advantage is ultimately won or lost. It is
through competitive strategy that the organisation attempts to
adopt an approach to compete in the industry.
Michael Porter’s Best Cost A powerful and widely used tool for systematically diagnosing the
Generic Strategies Provider Strategy significant competitive pressures in a market and assessing the
strength and importance of each is the Porter’s five-forces model
of competition. This model holds that the state of competition in
Cost an industry is a composite of competitive pressures operating in
Differentiation five areas of the overall market:
Leadership Focus Strategy
Strategy
Strategy

Threat of New Entrants
Competitive pressures associated with the market
manoeuvring and jockeying for buyer patronage that New entrants are always a powerful source of competition.
goes on among rival sellers in the industry. They can reduce industry profitability because they add
new production capacity and can substantially erode existing
Competitive pressures associated with the threat of new firm’s market share positions. To discourage new entrants,
entrants into the market. existing firms can try to raise barriers to entry. Common barriers
to entry include:
Competitive pressures coming from the attempts of
companies in other industries to win buyers over to Capital
their own substitute products. Requirements
Competitive pressures stemming from supplier Economies of

Possibility of
bargaining power and supplier-seller collaboration. Scale
Aggressive
Retailation
Competitive pressures stemming from buyer bargaining
power and seller-buyer collaboration. Threats of New
Entrants
Access to Product
Distribution Differentiation
The strategists can use the five-forces model to determine Channels
what competition is like in a given industry by undertaking the
following steps:
Step 1: Identify the specific competitive pressures associated Switching
Brand Identity
with each of the five forces. Costs
Step 2: Evaluate how strong the pressures comprising each of
the five forces are (fierce, strong, moderate to normal, or
weak).
Step 3: Determine whether the collective strength of the five Bargaining Power of Buyers
competitive forces is conducive to earning attractive Buyers of an industry’s products or services can sometimes exert
profits. considerable pressure on existing firms to secure lower prices or
better services. This leverage is particularly evident when:
POTENTIAL
NEW
ENTRANTS Competitive presures
coming from the threat Buyers have full knowledge of the sources of
of entry of new rivals products and their substitutes.
INDUSTRY
COMPETITORS They spend a lot of money on the industry’s
products i.e. they are big buyers.
SUPPLIERS BUYERS
Competitive
RIVALRY AMONG
Competitive pressures The industry’s product is not perceived as
pressures stemming stemming from buyer
from Suppliers
EXISTING FIRMS
Bargaining Power
critical to the buyer’s needs and buyers are
Bargaining Power more concentrated than firms supplying
the product. They can easily switch to the
Competitive substitutes available.
FIRMS IN OTHER pressures
INDUSTRIES coming from
OFFERING sunstitute Bargaining Power of Suppliers
SUBSTITUTE products Suppliers can influence the profitability of an industry in a
PRODUCTS
number of ways. Suppliers can command bargaining power over
a firm when:
Porter’s Five Force Model of Competition
Their products are
crucial to the buyer
Porter’s five forces model is one of the most effective and and substitutes are
not available.
enduring conceptual frameworks used to assess the nature of the
competitive environment and to describe an industry’s structure.
They can erect high
The interrelationship among these five forces gives each industry switching costs.
its own particular competitive environment. By applying
Porter’s five forces model of industry attractiveness to their own They are more
concentrated than
industries, the manager can gauge their own firm’s strengths, their buyers.
weaknesses, and future opportunities.
The Nature of Rivalry in the Industry

The intensity of rivalry in an industry is a significant determinant of industry attractiveness and profitability. The intensity of rivalry can
influence the costs of suppliers, distribution, and of attracting customers and thus directly affect the profitability. The more intensive the
rivalry, the less attractive is the industry. Rivalry among competitors tends to be cutthroat and industry profitability low when:
Competitors
The industry
Competitors in Competitors Competitors have little
An industry has faces slow or
the industry are operate with face high exit opportunity to
no clear leader. diminished
numerous. high fixed costs. barriers. differentiate
growth.
their offerings.
Threat of Substitutes
A final force that can influence industry profitability is the
Michael Porter’s Generic Strategies
availability of substitutes for an industry’s product. To predict According to Porter, strategies allow organizations to gain
profit pressure from this source, firms must search for products competitive advantage from three different bases: cost leadership,
that perform the same, or nearly the same, function as their differentiation, and focus. Porter called these base generic
existing products. strategies. These strategies have been termed generic because
they can be pursued by any type or size of business firm and even
Business-Level Strategies by not-for-profit organisations.
An organization’s core competencies should be focused on
satisfying customer needs or wants in order to achieve above
average returns. This is done through Business-level strategies Michael Porter’s Generic
Customers are the foundation of an organization’s business- Strategies
Cost leadership emphasizes producing
level strategies. Who will be served, what needs have to be met, standardized products at a very low per-
and how those needs will be satisfied are determined by the unit cost for consumers who are price-
senior management. sensitive.
Differentiation is a strategy aimed
at producing products and services
Who are the customers? considered unique industry wide and
Knowing one’s customers is very important in obtaining and directed at consumers who are relatively
price-insensitive.
sustaining a competitive advantage. Being able to successfully Focus means producing products and
predict and satisfy future customer needs is important. Perhaps services that fulfill the needs of small
one of Compaq’s mistakes was not understanding who their real groups of consumers.
customer was and what that customer -- end user -- wanted.
How to satisfy customer needs? Porter’s strategies imply different organizational arrangements,
Organizations must determine how to bundle resources and control procedures, and incentive systems. Larger firms with
capabilities to form core competencies and then use these core greater access to resources typically compete on a cost leadership
competencies to satisfy customer needs or create value for them. and/or differentiation basis, whereas smaller firms often compete
Business level strategies detail actions to be taken to provide on a focus basis.
value to customers and gain a competitive advantage by
exploiting core competencies in specific individual product or
COMPETITIVE SCOPE
service markets. Having selected a market, the organization must Cost

Broad Leadership Differentiation
develop a plan to be successful in that market. Business strategy
Target
therefore looks at how the organization can compete successfully
in the individual markets that it chooses to operate within.
Narrow Focussed Cost Focussed

Business level strategy is concerned with issues such as:
Target Leadership Differentiation
Achieving advantage over competitors.
Low-Cost Differentiated
Meeting the needs of key customers. products/services products/services
COMPETITIVE ADVANTAGE
Avoiding competitive disadvantage.
Michael Porter’s Generic Strategy

Cost Leadership Strategy

Differentiation Strategy
Cost leadership emphasizes producing standardized products at
a very low per-unit cost for consumers who are price-sensitive. Differentiation is a strategy aimed at producing products and
It is a low cost competitive strategy that aims at broad mass services considered unique industry wide and directed at
market. It requires vigorous pursuit of cost reduction in the areas consumers who are relatively price-insensitive. This strategy
of procurement, production, storage and distribution of product is aimed at broad mass market and involves the creation of a
or service and also economies in overhead costs. Because of its product or service that is perceived by the customers as unique.
lower costs, the cost leader is able to change a lower price for its The uniqueness can be associated with product design, brand
products than its competitors and still make satisfactory profits. image, features, technology, dealer network or customer service.
Because of differentiation, the business can charge a premium
Achieving Cost Leadership Strategy for its product.
To achieve cost leadership, following are the actions that could
be taken: Basis of Differentiation
There are several basis of differentiation: product, pricing and
Forecast the demand of a product or service promptly. organization.
 Product: Innovative products that meet customer needs
Optimum utilization of the resources to get cost advantages. can be an area where a company has an advantage over
competitors. The pursuit of new product offerings can be
Achieving economies of scale leads to lower per unit costly – research and development, as well as production
cost of product/service. and marketing costs can all add to the cost of production
Standardisation of products for mass production to yield and distribution. The payoff, however, can be great as
lower cost per unit. customer’s flock to be among the first to have the new
product.
Invest in cost saving technologies and try using advance
technology for smart working.  Pricing: It can fluctuate based on its supply
and demand, and also be influenced by the customer’s ideal
Resistance to differentiation till it becomes essential. value for the product. Companies that differentiate based
on product price can either determine to offer the lowest
price, or can attempt to establish superiority through
Advantages of Cost Leadership Strategy higher prices.
A cost leadership strategy may help to remain profitable even  Organisation: Organisational differentiation is yet another
with: rivalry, new entrants, suppliers’ power, substitute products, form of differentiation. Maximizing the power of a brand, or
and buyers’ power. using the specific advantages that an organization possesses
can be instrumental to a company’s success. Location
Rivalry – Competitors are likely to avoid a price war, since the
low cost firm will continue to earn profits after competitors advantage, name recognition and customer loyalty can all
compete away their profits. provide additional ways for a company differentiate itself
from the competition.
Buyers – Powerful buyers/customers would not be able to
exploit the cost leader firm and will continue to buy its product. Achieving Differentiation Strategy
Suppliers – Cost leaders are able to absorb greater price To achieve differentiation, following are the measures that could
increases before it must raise price to customers. be adopt by an organization to incorporate that:
Entrants – Low cost leaders create barriers to market entry

through its continuous focus on efficiency and reducing costs. Offer utility for the customers and match the products with
their tastes and preferences.
Substitutes – Low cost leaders are more likely to lower costs to
induce customers to stay with their product, invest to develop
substitutes, purchase patents. Elevate the performance of the product.
Disadvantages of Cost Leadership Strategy

Offer the promise of high quality product/service for
Cost advantage may not be remaining for long as competitors buyer satisfaction.
may also follow cost reduction technique.
Cost leadership can succeed only if the firm can achieve Rapid product innovation.
higher sales volume.
Cost leaders tend to keep their costs low by minimizing Taking steps for enhancing image and its brand value.
advertising, market research, and research and development,
but this approach can prove to be expensive in the long run.
Fixing product prices based on the unique features of the
Technology changes are a great threat to the cost leader. product and buying capacity of the customer.

Advantages of Differentiation Strategy Achieving Focused Strategy

A differentiation strategy may help to remain profitable even To achieve focused cost leadership/differentiation, following are
with: rivalry, new entrants, suppliers’ power, substitute products, the measures that could be adopted by an organization:
and buyers’ power.
Selecting specific niches which are not covered by cost
Rivalry - Brand loyalty acts as a safeguard against competitors. leaders and differentiators.
It means that customers will be less sensitive to price increases, Creating superior skills for catering to such niche markets.
as long as the firm can satisfy the needs of its customers.
Generating high efficiencies for serving such niche markets.
Buyers – They do not negotiate for price as they get special
features and also they have fewer options in the market. Developing innovative ways in managing the value chain.
Suppliers – Because differentiators charge a premium

Advantages of Focused Strategy
price, they can afford to absorb higher costs of supplies and
Premium prices can be charged by the organisations for their
customers are willing to pay extra too.
focused product/services.
Entrants – Innovative features are an expensive offer. So, new Due to the tremendous expertise about the goods and services
entrants generally avoid these features because it is tough for that organisations following focus strategy offer, rivals and
them to provide the same product with special features at a new entrants may find it difficult to compete.
comparable price.
Disadvantages of Focused Strategy
Substitutes – Substitute products can’t replace differentiated The firms lacking in distinctive competencies may not
products which have high brand value and enjoy customer be able to pursue focus strategy.
loyalty.
Due to the limited demand of product/services, costs are high
which can cause problems.
Disadvantages of Differentiation Strategy
In long run, the niche could disappear or be taken over
In long term, uniqueness is difficult to sustain. by larger competitors by acquiring the same distinctive
competencies.
Charging too high a price for differentiated features may
cause the customer to switch-off to another alternative. Best-Cost Provider Strategy
The new model of best cost provider strategy is a further
Differentiation fails to work if its basis is something that is development of above three generic strategies. It is directed
not valued by the customers. towards giving customers more value for the money by
emphasizing both low cost and upscale differences. The objective
is to keep costs and prices lower than those of other sellers of
Focus Strategies comparable products.
Lower Cost Differentiation
Focus means producing products and services that fulfill
Overall
the needs of small groups of consumers. Focus strategies are A Broad Cross Broad
Low Cost
Section of Differentiation
most effective when consumers have distinctive preferences Buyers
Leadership
Strategy
Strategy
or requirements and when rival firms are not attempting to
Market Target
Best Cost
specialize in the same target segment. Risks of pursuing a focus Provider
strategy include the possibility that numerous competitors Strategy
will recognize the successful focus strategy and copy it, or that A Narrower Focused
Buyer Segment Focused Low Differentiation
consumer preferences will drift toward the product attributes (or Market Cost Strategy Strategy
desired by the market as a whole. An organization using a focus Niche) Company’s
strategy may concentrate on a particular group of customers, Figure: The Five Generic Competitive Strategies
geographic markets, or on particular product-line segments
in order to serve a well-defined but narrow market better than Best-cost provider strategy involves providing customers more
competitors who serve a broader market. value for the money by emphasizing low cost and better quality
 Focused cost leadership: Firms that compete based on difference. It can be done:
price and target a narrow market are following a focused cost (a) through offering products at lower price than what is being
leadership strategy. offered by rivals for products with comparable quality and
 Focused differentiation: Firms that compete based on features or
uniqueness and target a narrow market are following a focused (b) charging similar price as by the rivals for products with much
differentiations strategy. higher quality and better features.

CHAPTER 6 : FUNCTIONAL LEVEL STRATEGIES

The reasons why functional strategies are needed can be
enumerated as follows:
 Functional strategies lay down clearly what is to be done
at the functional level. They provide a sense of direction
Marketing
Strategy to the functional staff.
 They are aimed at facilitating the implementation
of corporate strategies and the business strategies
Human formulation at the business level.
Resource Financial  They act as basis for controlling activities in the different
Strategy Strategy functional areas of business.
 They help in bringing harmony and coordination as they
Functional are formulated to achieve major strategies.
Strategies  Similar situations occurring in different functional areas
are handled in a consistent manner by the functional
managers.
Research and Thus, strategies need to be segregated into viable

Development Production functional plans and policies that are compatible with
Strategy Strategy each other. In this way, strategies can be implemented by
the functional managers. Environmental factors relevant
Logistics
to each functional area have an impact on the choice of
Strategy
functional strategies. Corporate strategies influence the
formulation of functional strategies.
Marketing Strategy
Marketing is a social and managerial process by which
Once higher level corporate and business strategies have individuals and groups obtain what they need and want
been developed, management need to formulate and through creating, offering and exchanging products of value
implement strategy for each of the functional areas of with others.
business. Strategy of one functional area cannot be looked
at in isolation. Different functional areas of the business Marketing Mix
are interwoven together and how a functional strategy is Marketing mix is a systematic way of classifying the key
synergised with other functional strategies determines its decision areas of marketing management. It is the set of
effectiveness. controllable marketing variables that the firm blends to
Functional strategies play two important roles. Firstly, produce the response it wants in the target market. The
they provide support to the overall business strategy. original framework of marketing mix comprises of 4Ps-
Secondly, they spell out as to how functional managers will product, price, place and promotion. These are subsequently
work so as to ensure better performance in their respective expanded to highlight certain other key decision areas like
functional areas. people, processes, and physical evidence. The elements of
Strategies in functional areas including marketing, original framework are:
financial, production, R & D and human resource  Product: It stands for the “goods-and-service”
management are based on the functional capabilities of an combination the company offers to the target market.
organisation. For each functional area, first the major sub  Price: It stands for the amount of money customers have
areas are identified and then for each of these sub areas, to pay to obtain the product.
content of functional strategies, important factors, and their  Place: It stands for company activities that make the
importance in the process of strategy implementation are product available to target consumers and include
identified. marketing channel, distribution policies and geographical
In terms of the levels of strategy formulation, functional availablity.
strategies operate below the SBU or business-level strategies.  Promotion: It stands for activities that communicate the
Within functional strategies there might be several sub- merits of the product and persuade target consumers to
functional areas. Functional strategies are made within the buy it. Modern marketing is highly promotional oriented.
framework of corporate level strategies and guidelines therein There are at least four major direct promotional methods
that are set at higher levels of the organization. Operational or tools – personal selling, advertising, publicity and sales
plans at the SBU level tell the functional managers what promotion.
has to be done while policies state how the plans are to be Expanded Marketing Mix: Typically, all organizations
implemented. use a combination of 4 Ps in some form or the other.

However, the above elements of marketing mix are not evolved, which are given below:
exhaustive. It is pertinent to discuss a few more elements
that may form part of an organizational marketing mix Social Marketing: It refers to the design, implementation, and
strategy. They have got more currency in recent years. control of programs seeking to increase the acceptability of a social
idea, cause, or practice among a target group.
Growth of services has its own share for the inclusion
of newer elements in marketing. A few new Ps are as
follows: Augmented Marketing: It is provision of additional customer
services and benefits built around the core and actual products that
 People: all human actors who play a part in delivery of the relate to introduction of hi-tech services like movies on demand,
market offering and thus influence the buyer’s perception, on-line computer repair services, secretarial services, etc. Such
namely the firm’s personnel and the customer. innovative offerings provide a set of benefits that promise to elevate
customer service to unprecedented levels.
 Process: the actual procedures, mechanisms and flow of
activities by which the product / service is delivered.
Direct Marketing: Marketing through various advertising media
 Physical evidence: the environment in which the market that interact directly with consumers, generally calling for the
offering is delivered and where the firm and customer consumer to make a direct response.
interact.
Relationship Marketing: The process of creating, maintaining, and
Marketing Strategy Formulation enhancing strong, value-laden relationships with customers and
Marketing Analysis: A company must carefully analyze its other stakeholders.
environment in order to avoid the threats and take advantage
Services Marketing: It is applying the concepts, tools, and
of the opportunities. Areas to be analyzed in the environment techniques, of marketing to services. Services is any activity or
normally include: benefit that one party can offer to another that is essentially
1. Forces close to the company such as its ability to serve intangible and does not result in the banking, savings, retailing,
educational or utilities.
customers, other company departments, channel
members, suppliers, competitors, and publics.
Person Marketing: People are also marketed. Person marketing
2. Broader forces such as demographic and economic forces, consists of activities undertaken to create, maintain or change
political and legal forces, technological and ecological attitudes and behaviour towards particular person.
forces, and social and cultural forces.
Organization Marketing: It consists of activities undertaken
to create, maintain, or change attitudes and behaviour of target
audiences towards an organization. Both profit and non-profit
Analysis
organizations practice organization marketing.
Planning Implementation Control

Develop strategic Carry out the Measure results Place Marketing: Place marketing involves activities undertaken
plans plans to create, maintain, or change attitudes and behaviour towards
Evaluate results particular places say, business sites marketing, tourism marketing.
Develop marketing Take corrective
plans action
Enlightened Marketing: It is a marketing philosophy holding that a
company’s marketing should support the best long-run performance
of the marketing system; its five principles include customer-
Strategic marketing management process oriented marketing, innovative marketing, value marketing, sense-
of-mission marketing, and societal marketing.
Strategy Formulation: Marketing planning involves deciding Differential Marketing: It is a market-coverage strategy in which a
firm decides to target several market segments and designs separate
on marketing strategies that will help the company attain its offer for each.
overall strategic objectives. A detailed plan is needed for
each business, product, or brand. A product or brand plan
Synchro-marketing: When the demand for a product is irregular
may contain different sections: executive summary, current due to season, some parts of the day, or on hour basis, causing idle
marketing situation, threats and opportunity analysis, capacity or overworked capacities, synchro-marketing can be used
objectives and issues, marketing strategies, action programs, to find ways to alter the pattern of demand through flexible pricing,
promotion, and other incentives.
budgets, and controls.
Strategy Control: Strategic control involves monitoring and Concentrated Marketing: It is a market-coverage strategy in which
a firm goes after a large share of one or few sub-markets.
measuring of results and their evaluation. This would lead to
taking corrective actions in the 4 P’s of marketing.
Demarketing: It includes marketing strategies to reduce demand
temporarily or permanently. The aim is not to destroy demand,
Strategic Marketing Techniques but only to reduce or shift it. This happens when there is overfull
Over the years, a number of marketing strategies have been demand.

Financial Strategy products, transportation and deployment of inventory.

The financial strategies of an organization are related to Improvement in logistics can result in saving in cost of doing
several finance/ accounting concepts considered to be central business.
to strategy implementation. These are: acquiring needed When a company creates a logistics strategy, it is defining
capital/sources of fund, developing projected financial the service levels at which its logistics systems are highly
statements/budgets, management/ usage of funds, and effective. A company may develop a number of logistics
evaluating the worth of a business. strategies for specific product lines, specific countries
Various methods for determining a business’s worth can be or specific customers to address different categorical
grouped into three main approaches which are as follows: requirements.
(i) Net worth or stockholders’ equity: Net worth is the total
assets minus total outside liabilities of an organisation. Supply Chain Management
(ii) Future benefits to owners through net profits: These The term supply chain refers to the linkages between
benefits are considered to be much greater than the suppliers, manufacturers and customers. Supply chains
amount of profits. A conservative rule of thumb is to involve all activities like sourcing and procurement of
establish a business’s worth as five times the firm’s current material, conversion, and logistics. Planning and control of
annual profit. A five-year average profit level could also supply chains are important components of its management.
be used. Naturally, management of supply chains include closely
(iii) Market-determined business worth: This, in turn, working with channel partners – suppliers, intermediaries,
involves three methods. First, the firm’s worth may be other service providers and customers.
based on the selling price of a similar company. The Supply chain management is defined as the process of
second approach is called the price-earnings ratio method planning, implementing, and controlling the supply chain
whereby the market price of the firm’s equity shares is operations. It is a cross-functional approach to managing
divided by the annual earnings per share and multiplied the movement of raw materials into an organization and
by the firm’s average net income for the preceding years. the movement of finished goods out of the organization
The third approach can be called the outstanding shares toward the end-consumer who are to be satisfied as
method whereby one has to simply multiply the number efficiently as possible. It encompasses all movement and
of shares outstanding by the market price per share and storage of raw materials, work-in-process inventory,
add a premium. and finished goods from point-of-origin to point-of-
consumption. Organizations are finding that they must
Production/Operations Strategy rely on the chain to successfully compete in the global
Production System market.
The production system is concerned with the capacity, Modern organizations are striving to focus on core
location, layout, product or service design, work systems, competencies and reduce their ownership of sources of raw
degree of automation, extent of vertical integration, and such materials and distribution channels. These functions can be
factors. Strategies related to production system are significant outsourced to other business organizations that specialize
as they deal with vital issues affecting the capability of the in those activities and can perform in better and cost
organisation to achieve its objectives. effective manner. In a way organizations in the supply chain
Strategy implementation would have to take into account do tasks according to their core-competencies. Working in
the production system factors as they involve decisions which the supply chain improve trust and collaboration amongst
are long-term in nature and influence not only the operations partners and thus improve flow and management of
capability of an organisation but also its ability to implement inventory.
strategies and achieve objectives. Is logistic management same as supply chain management?
Supply chain management is an extension of logistic
Operations Planning and Control management. However, there is difference between the
Operations planning and control provides an example of two. Logistical activities typically include management of
an organizational activity that is aimed at translating the inbound and outbound goods, transportation, warehousing,
objectives into reality. Some companies use quality as a handling of material, fulfilment of orders, inventory
strategic tool. management, supply/demand planning. Although these
activities also form part of Supply chain management, the
Logistics Management latter has different components. Logistic management can
Management of logistics is a process which integrates the be termed as one of its part that is related to planning,
flow of materials into, through and out of an organization to implementing, and controlling the movement and storage of
achieve a level of service that the right materials are available goods, services and related information between the point
at the right place at the right time, of right quality and at of origin and the point of consumption.
the right cost. For a business organization effective logistics Supply chain management includes more aspects
strategy will involve raising and finding solutions to the apart from the logistics function. It is a tool of business
questions relating to raw material, manufacturing locations, transformation and involves delivering the right product

at the right time to the right place and at the right price. Research and Development Strategy
It reduces costs of organizations and enhances customer Research and Development (R&D) personnel can play an
service. integral part in strategy implementation. These individuals
are generally charged with developing new products and
Implementing Supply Chain Management improving old products in a way that will allow effective
System strategy implementation. R&D employees and managers
The following are the major steps which are required for the perform tasks that include transferring complex technology,
successful implementation of Supply Chain Management in adjusting processes to local raw materials, adapting processes
the business organizations: to local markets, and altering products to particular tastes
and specifications.
Product development: Customers and suppliers must work together Strategies such as product development, market
in the product development process. When products are developed penetration, and concentric diversification require that new
and launched in shorter time, it would help organizations to remain products be successfully developed and that old products be
competitive. significantly improved. But the level of management support
for R&D is often constrained by resource availability.
Procurement: Procurement requires careful resource planning,

Human Resource Strategy
quality issues, identifying sources, negotiation, order placement, Strategic Role of Human Resource Manager
inbound transportation and storage. Organizations have to coordinate The prominent areas where the human resource manager can
with suppliers in scheduling the uninterrupted supplies and also to play strategic role are as follows:
involve them in planning the manufacturing process.
Providing purposeful direction: The human resource
manager leads people and the organization towards the
desired direction involving people. He can ensure harmony
Manufacturing: Flexible manufacturing processes must be in place to between organisational objectives and individual objectives.
respond to market changes. They should be adaptive to accommodate
customization and changes in the taste and preferences. Changes in Creating competitive atmosphere: In the present business
the manufacturing process be made to reduce manufacturing cycle. environment, maintaining competitive position or gains
is an important objective of any business. Having a highly
committed and competent workforce is very important for
getting a competitively advantageous position.
Physical distribution: Delivery of final products to customers is the
last position in a marketing channel. Availability of the products at Facilitation of change: The human resource manager will
the right place at right time is important for each channel participant. be more concerned about furthering the organization not
Through physical distribution processes serving the customer become just maintaining it. He can devote more time to promote
an integral part of marketing. acceptance of change rather than maintaining the status
quo.
Diversion of workforce: In a modern organization,

Outsourcing: Outsourcing is not limited to the procurement of management of diverse workforce is a great challenge.
materials and components, but also include outsourcing of services Workforce diversity can be observed in terms of male
that traditionally have been provided within an organization. The and female, young and old, educated and uneducated,
company ought to focus on those activities where it has competency unskilled and professional employee and so on. Motivation,
and everything else will be outsourced. maintaining morale and commitment are some of the key
tasks that a HR manager can perform.
Empowerment of human resources: Empowerment

Customer services: Organizations through interfaces with the involves giving more power to those who, at present, have
company’s production and distribution operations develop customer little control on what they do and little ability to influence
relationships so as to satisfy them. They work with customer the decisions being made around them.
to determine mutually satisfying goals, establish and maintain
relationships. This in turn helps in producing positive feelings in the Building core competency: The human resource
organization and the customers. manager has an important role to play in developing core
competency of the firm. A core competence is a unique
strength of an organization which may not be shared by
others. Organization of business around core competence
Performance measurement: There is a strong relationship between implies leveraging the limited resources of a firm.
the supplier, customer and organisation. Supplier capabilities and
customer relationships can be correlated with a firm performance. Development of works ethics and culture: A vibrant
Performance is measured in different parameters such as costs, work culture will have to be developed in the organizations
to create an atmosphere of trust among people and to
customer service, productivity and quality.
encourage creative ideas by the people.

CHAPTER 7: ORGANISATION AND STRATEGIC LEADERSHIP

Organization Structure Simple Structure
In order to implement strategies organisations need an A simple structure is an organizational form in which the
organizational structure. Changes in corporate strategy often owner-manager makes all major decisions directly and
require changes in the way an organization is structured monitors all activities, while the company’s staff merely
for two major reasons. First, structure largely dictates how serves as an executor. Little specialization of tasks, few rules,
operational objectives and policies will be established to little formalization, unsophisticated information systems and
achieve the strategic objectives. The second major reason direct involvement of owner-manager in all phases of day-to-
why changes in strategy often require changes in structure day operations characterise the simple structure.
is that structure dictates how resources will be allocated to
achieve strategic objectives. Functional Structure
A functional structure groups tasks and activities by business
Chandler’s Strategy-Structure Relationship function, such as production/operations, marketing, finance/
accounting, research and development, and management
New strategy is New Organizational information systems.
formed administrative performance
problems emerge declines
Divisional Structure
A divisional structure can be organized in one of the four ways:
Organizational A new organizational by geographic area, by product or service, by customer, or
performance improves structure is established by process. With a divisional structure, functional activities
are performed both centrally and in each division separately.
Changing organizational design
Multi Divisional Structure
Multidivisional (M-form) structure is composed of operating
Old Organizational Design New Organizational Design
divisions where each division represents a separate business to
One large corporation Mini-business units & which the top corporate officer delegates responsibility for day-
cooperative relationships
to-day operations and business unit strategy to division managers.
Vertical communication Horizontal communication
Centralised top-down decision Decentralised participative Strategic Business Unit (SBU) Structure
making decision making
The SBU structure is composed of operating units where each
Vertical integration Outsourcing & virtual
organizations
unit represents a separate business to which the top corporate
officer delegates responsibility for day-to-day operations
Work/quality teams Autonomous work teams
and business unit strategy to its managers. The structure is
Functional work teams Cross-functional work teams
relevant to multi-product, multi-business enterprises. An
Minimal training Extensive training
SBU is a grouping of related businesses, which is amenable
Specialised job design focused Value-chain team-focused job
to composite planning treatment. The three most important
on individual design
characteristics of a SBU are:
 It is a single business or a collection of related businesses
which offer scope for independent planning and
Simple which might feasibly stand alone from the rest of the
Structure organization.
Hourglass
Structure  It has its own set of competitors.
 It has a manager who has responsibility for strategic
Functional
Structure planning and profit performance, and who has control of
profit-influencing factors.
Network
Structure Organisational Matrix Structure
Structure
Divisional A matrix structure is the most complex of all designs
Structure because it depends upon both vertical and horizontal
flows of authority and communication (hence the term
Matrix matrix). A matrix structure has dual lines of authority, dual
Structure
Multi sources of reward and punishment, shared authority, dual
Strategic Divisional reporting channels, and a need for an extensive and effective
Business Structure
Unit communication system. Matrix structure was developed to
Structure combine the stability of the functional structure with the
flexibility of the product form.

Network Structure
A company with network structure is often called a virtual
organization because it is composed of a series of project
groups or collaborations linked by constantly changing
non-hierarchical, cobweb-like networks. It could be termed
a “non-structure”, by its virtual elimination of in-house
business functions as many activities are outsourced.
Hourglass Structure
With the diminishing role played by middle management as
the tasks performed by them are increasingly being replaced
by the technological tools, a new form of organisation
structure is seen. Hourglass organization structure consists of
three layers with constricted middle layer. A shrunken middle
layer coordinates diverse lower level activities. Contrary to
traditional middle level managers who are often specialists,
the managers in the hourglass structure are generalists and
perform wide variety of tasks.
Strategic Leadership Strategy Supportive Culture

Every organisation has a unique organizational culture.
It has its own philosophy and principles, its own ways of
A strategic leader sets the firms direction
by developing and communicating vision approaching problems and making decisions, its own work
Strategic of future, formulate strategies in the light climate. It has its own embedded patterns of how to do things.
leadership of internal and external environment, its own ingrained beliefs, behaviour and thought patterns,
brings about changes required to and practices that define its corporate culture.
implement strategies and inspire the staff
to contribute to strategy execution. An organization’s culture is either an important
contributor or an obstacle to successful strategy execution.
The beliefs, vision, objectives, and business approaches and
practices underpinning a company’s strategy may or may not
Uses charisma and enthusiasm to inspire be compatible with its culture. Strong culture promotes good
people to exert them for the good of the strategy execution when there’s fit and impedes execution
organization. They offer excitement, when there’s negligible fit.
Transformational vision, intellectual stimulation and
leadership style personal satisfaction. They inspire
involvement in a mission, giving followers
a ‘dream’ of a higher calling so as to elicit Entrepreneurship and Intrapreneurship
higher performance. The terms Entrepreneur and Intrapreneur are frequently
used in the business world.
Entrepreneurship is the attempt to create value through
Focus is more on designing systems, recognition of business opportunity, the management of
Transactional controlling the organization’s activities risk taking appropriate to the opportunity and through
leadership style and improving the current situation. They management skills to mobilize financial, human and
try to build on the existing culture and
enhance current practices. The style uses material resources. The person who perceives the business
the authority to exchange rewards, such idea and takes steps to implement the idea is known as an
as pay and status. entrepreneur. He takes all types of risks, not only to put
the product or service into reality but also to make it an
extremely demanding one.
Strategic leader has several responsibilities, including the An intrapreneur is nothing but an entrepreneur who
following: operates within the boundaries of an organisation. He is an
• Making strategic decisions. employee of a large organisation, who is vested with authority
• Formulating policies and action plans to implement of initiating creativity and innovation in the company’s
strategic decision. products, services and projects, redesigning the processes,
• Ensuring effective communication in the organisation. workflows and systems. The intrapreneurs believe in change
• Managing human capital (perhaps the most critical of the and do not fear failure. They discover new ideas, look for such
strategic leader’s skills). opportunities that can benefit the whole organisation and
• Managing the company’s operations. take risks, promote innovation to improve the performance
• Sustaining high performance over time. and profitability of the organisation.

CHAPTER 8 : STRATEGY IMPLEMENTATION AND CONTROL

Strategic management process does not end when the firm Organizational success is a function of good strategy and
decides what strategies to pursue. There must be a translation proper implementation. The matrix in the figure below
of strategic thought into strategic action. This requires represents various combinations of strategy formulation and
support of all managers and employees of the business. implementation:
Implementing strategy affects an organization from top to
bottom; it affects all the functional and divisional areas of a
business. Strategy implementation requires introduction of
change in the organisation to make organisational member
adapt to the new environment. A B
Strategy Formulation
Sound
Strategic control has been discussed as an integral part of
strategic management. Strategic control focuses on whether
the strategy is being implemented as planned and the results
produced are those intended. In addition, we will also have an
C D
Flawed
overview of the emerging concepts in strategic management
namely strategy audit, business process reengineering and
benchmarking.
Weak Excellent
Strategy Implementation
Strategy formulation and implementation matrix
Square A is the situation where a company apparently has

formulated a very competitive strategy, but is showing
difficulties in implementing it successfully.
Square B is the ideal situation where a company has

succeeded in designing a sound and competitive strategy
and has been successful in implementing it.
Square C is reserved for companies that haven’t succeeded in

coming up with a sound strategy formulation and in addition are
bad at implementing their flawed strategic model.
Square D is the situation where the strategy formulation

is flawed, but the company is showing excellent
implementation skills.
Successful strategy formulation does not guarantee successful

strategy implementation. It is always more difficult to do
something (strategy implementation) than to say you are
going to do it (strategy formulation)! Although inextricably
Interrelationship between Strategy linked, strategy implementation is fundamentally different
Formulation and Implementation from strategy formulation. Strategy formulation and
implementation can be contrasted in the following ways:
Strategic implementation is concerned with translating a
strategic decision into action, which presupposes that the Strategy Formulation Vs. Strategy Implementation
decision itself (i.e., the strategic choice) was made with some Strategy Formulation Strategy Implementation
thought being given to feasibility and acceptability. The Strategy formulation focuses on Strategy implementation focuses
allocation of resources to new courses of action will need effectiveness. on efficiency.
to be undertaken, and there may be a need for adapting the Strategy formulation is primarily Strategy implementation is
organization’s structure to handle new activities as well as an intellectual process. primarily an operational process.
training personnel and devising appropriate systems. Strategy formulation requires Strategy implementation requires
conceptual intuitive and motivation and leadership skills.
analytical skills.
Relationship with strategy formulation Strategy formulation requires Strategy implementation
A company will be successful only when the strategy coordination among the requires coordination among
formulation is sound and implementation is excellent. executives at the top level. the executives at the middle and
lower levels.

Strategic Change Strategic Control

The changes in the environmental forces often require Controlling is one of the important functions of management,
businesses to make modifications in their existing strategies and is often regarded as the core of the management process.
and bring out new strategies. Strategic change is a complex The controlling function involves monitoring the activity
process that involves a corporate strategy focused on new and measuring results against pre-established standards,
markets, products, services and new ways of doing business. analysing and correcting deviations as necessary and
maintaining/adapting the system. Primarily there are three
Steps to initiate strategic change: For initiating strategic types of organizational control, viz., operational control,
change, three steps can be identified as under: management control and strategic control.
Recognize the need for change: The first step is to diagnose which
parts of the present corporate culture are strategy supportive and
which are not. This basically means going for environmental scanning Operational Management Strategic
involving appraisal of both internal and external capabilities and Control:
then identify the problems/improvement areas and determine scope Control: When Control:
The thrust of compared with
for change. Strategic Control
operational operational control,
control is on is the process
management control of evaluating
individual tasks
is more inclusive and strategy as it is
or transactions
Create a shared vision to manage change: Objectives and vision of more aggregative,
as against total or formulated and
individuals and organization should coincide. Strategy implementers in the sense of
more aggregative implemented.
have to convince all those concerned that the change in business embracing the
management It is directed
culture is not superficial or cosmetic. The actions taken have to integrated activities
be fully indicative of management’s seriousness to new strategic functions. towards
of a complete
initiatives and associated changes. identifying
department, division
or even entire problems,
organisation, instead changes
or mere narrowly in premise
Institutionalise the change: This is basically an action stage
which requires implementation of changed strategy. Creating and circumscribed and making
sustaining a different attitude towards change is essential to ensure activities of sub- necessary
that the firm does not slip back into old ways of thinking or doing units. adjustments.
things. Besides, change process must be regularly monitored and
reviewed to analyse the after-effects of change. Any discrepancy or
deviation should be appropriately addressed.
Strategic control focuses on the dual questions of whether:

Kurt Lewin’s Model of Change: To make the change lasting, (1) the strategy is being implemented as planned; and (2) the
Kurt Lewin proposed three phases of the change process results produced by the strategy are those intended.
for moving the organization from the present to the future.
These stages are unfreezing, changing and refreezing. Types of Strategic Control: There are four types of strategic
control as follows:
Unfreezing the situation: The process of unfreezing simply makes Premise control: Strategic Special alert Implementation
the individuals or organizations aware of the necessity for change and Premise control surveillance: control: At times control:
prepares them for such a change. Lewin proposes that the changes
is a tool for Contrary to the unexpected Implementation
should not come as a surprise to the members of the organization.
Unfreezing is the process of breaking down the old attitudes and systematic and premise control, events may force control is directed
behaviours, customs and traditions so that they start with a clean slate. continuous the strategic organizations towards assessing the
This can be achieved by making announcements, holding meetings monitoring of the surveillance is to reconsider need for changes in
and promoting the ideas throughout the organization.
environment to unfocussed. It their strategy. the overall strategy
verify the validity involves general Sudden changes in in light of unfolding
and accuracy of monitoring of government, natural events and results
Changing to new situation: Once the unfreezing process has been
completed and the members of the organization recognise the need the premises on various sources calamities, terrorist associated with
for change and have been fully prepared to accept such change, their which the strategy of information attacks, unexpected incremental steps and
behaviour patterns need to be redefined. H.C. Kellman has proposed has been built. It to uncover merger/acquisition actions.The two forms
three methods for reassigning new patterns of behaviour. These are
compliance, identification and internalisation. primarily involves unanticipated by competitors, of implementation
monitoring two information industrial disasters control are:
types of factors: having a and other such
(i) Monitoring
(i) Environmental bearing on the events may trigger
Refreezing: Refreezing occurs when the new behaviour becomes strategic thrust
a normal way of life. The new behaviour must replace the former factors organizational an immediate and
behaviour completely for successful and permanent change to take (ii) Industry factors strategy. intense review of (ii) Milestone reviews
place. In order for the new behaviour to become permanent, it must
strategy.
be continuously reinforced so that this new acquired behaviour does
not diminish or extinguish.

Strategy Audit includes three basic activities:

Strategic Surveillance
Examining the underlying bases

of a firm’s strategy.
Premise Control
Special Alert Control

Comparing expected results
with actual results.
Strategy Formulation Implementation Control
Strategy
Implementation Taking corrective actions
Time 1 Time 2 Time 3 to ensure that performance
conforms to plans.
Strategy Audit
“Strategy audit is a process for taking an objective look at the
existing strategies of the organization. It involves assessing the
direction of a business and comparing that to the course to the Richard Rumelt’s Criteria for Strategy Audit
direction required to succeed in a changing environment.”
“A strategy audit is an examination and evaluation

of areas affected by the operation of a strategic
management process within an organization”. Consistency: Consonance: Consonance
A strategy should not refers to the need for
present inconsistent strategists to examine
A strategy audit provides an excellent platform for discussion goals and policies. sets of trends, as well
with the top management regarding necessary corporate Organizational conflict as individual trends, in
actions or changes in the existing business plan. It also and interdepartmental auditing strategies.
identifies a company’s need to adjust the existing business bickering are often A strategy must represent
plan as well as its business. symptoms of managerial an adaptive response to
disorder, but these the external environment
Need of Strategy Audit problems may also and to the critical changes
A strategy audit is needed under the following conditions: be a sign of strategic occurring within it.
 When the performance indicators reflect that a strategy inconsistency.
is not working properly or is not producing desired
outcomes.
 When top-priority goals and objectives of the strategy are
not being accomplished.
 When a major change takes place in the external
environment of the organization. Feasibility: A strategy must
 When the top management plans: neither overtax available
a) to fine-tune and an introduce a new set of strategies resources nor create Advantage: A strategy must
unsolvable sub-problems. provide for the creation
and The final broad test of and/or maintenance of a
b) to ensure that a strategy that has worked in the past strategy is its feasibility; competitive advantage in
continues to be in-tune with subtle internal and that is, can the strategy a selected area of activity.
external changes that may have occurred since the be attempted within the
Competitive advantages
physical, human, and
formulation of strategies. normally are the result of
financial resources of the
Adequate and timely feedback is the cornerstone of effective enterprise? The financial superiority in one of three
strategy audit. Strategy audit can be no better than the resources of a business areas: (1) resources, (2)
information on which it is based. are the easiest to quantify skills, or (3) position.
and are normally the first
limitation against which
strategy is audited.

Business Process Reengineering
Time 3
Business Process Reengineering (BPR) is an approach to
unusual improvement in operating effectiveness through Customer Cycle Time
the redesigning of critical business processes and supporting
business systems. It is revolutionary redesign of key business
processes that involves examination of the basic process itself.
It looks at the minute details of the process, such as why the
work is done, who does it, where is it done and when it is Customer need is
recorded by the Customer need satisfier is
done. BPR refers to the analysis and redesign of workflows organization provided by the organization
and processes both within the organization and between
the organization and the external entities like suppliers,
Customer Time Cycle
distributors, and service providers. The orientation of
redesigning efforts is basically radical. In other words, it is
a total deconstruction and rethinking of business process in Benchmarking
its entirety. Benchmarking is an approach of setting goals and measuring
productivity of firms based on best industry practices or
BPR involves the following steps: against the products, services and practices of its competitors
or other acknowledged leaders in the industry. It developed out
Determining objectives: Objectives are the desired end results of the
redesign process which the management and organization attempts to
of need to have information against which performance can
realise. This will provide the required focus, direction, and motivation be measured. Benchmarking helps businesses in improving
for the redesign process. performance by learning from the best practices and the
processes by which they are achieved. Thus, benchmarking is a
process of continuous improvement in search for competitive
Identify customers and determine their needs: The Process advantage. Firms can use benchmarking practices to achieve
designers have to understand customers – their profile, their steps in improvements in diverse range of management functions like
acquiring, using and disposing a product. The purpose is to redesign product development, customer services, human resources
business process that clearly provides value addition to the customer.
management, etc.
The various steps in Benchmarking Process are as under:

Study the existing process: The study of existing processes will
Identifying the need for benchmarking: This step will define
provide an important base for the process designers. The purpose is to the objectives of the benchmarking exercise. It will also involve
gain an understanding of the ‘what’, and ‘why’ of the targeted process. selecting the type of benchmarking. Organizations identify realistic
However, some companies go through the reengineering process with opportunities for improvements.
clean perspective without laying emphasis on the past processes.
Clearly understanding existing decisions processes: The step will

involve compiling information and data on performance.
Formulate a redesign process plan: Formulation of redesign plan is
the real crux of the reengineering efforts. Customer focused redesign
concepts are identified and formulated. Alternative processes are
considered and the optimum is selected. Identify best processes: Within the selected framework best
processes are identified. These may be within the same organization
or external to them.
Implement the redesigned process : It is easier to formulate new

process than to implement them. It is the joint responsibility of the Comparison of own process and performance with that of others:
designers and management to operationalise the new process. Benchmarking process also involves comparison of performance of the
organization with performance of other organization. Any deviation
between the two is analysed to make further improvements.
Central Thrust of BPR

BPR is a continuous improvement process. Although BPR Prepare a report and implement the steps necessary to close the
is a multi-dimensional approach in improving the business performance gap: A report on benchmarking initiatives containing
recommendations is prepared. Such a report also contains the action
performance its thrust area may be identified as “the plans for implementation.
reduction of the total cycle time of a business process.” BPR
aims at reducing the cycle time of process by eliminating
the unwanted and redundant steps and by simplifying the Evaluation: Business organizations evaluate the results of the
systems and procedures and also by eliminating the transit benchmarking process in terms of improvements vis-à-vis objectives
and waiting times as far as possible. Even after redesigning and other criteria set for the purpose. They also periodically evaluates
and reset the benchmarks in the light of changes in the conditions that
of a process, BPR maintains a continuous effort for more and impact the performance.
more improvement.

Intermediate Course
Intermediate Course
Paper: 8 A
Financial Management
ISBN : 978-81-8441-889-7
Financial
Management
Module - 1
Board of Studies
FINANCIAL MANAGEMENT
Financial Management-A Capsule for Quick Revision
To sustain and grow their financial standing, organisations across the world essentially require managers who are competent in various
domains of finance. One of the fundamental domains of finance, financial management deals with the functions relating to how much
and which assets are to be acquired, how to raise capital to acquire the assets and what is to be done to maximize the shareholder’s wealth.
Financial management comprises the processes of planning and controlling subsystems of funds.
A study in financial management will help the students to understand the functions of financial managers, providing with an overview
of broad issues and problems that financial managers face in various commercial domains of our economy. This subject introduce various
concepts and theories relating to finance, which are fundamental to the methodologies and proficiencies offered as aids to understand,
identify and solve the problems of financial managers. Study of financial management will help the Chartered Accountancy students
to develop an acumen, so as to grow competencies in financing decision, investment decision, dividend decision and working capital
management. Keeping in view the importance of the Subject, Board of Studies (BoS) has decided to bring a capsule on Financial Management.
In the beginning of each topic, a chapter overview has been provided to present a holistic viewpoint on the topic’s coverage. This capsule,
though, facilitates the students in undergoing quick revision, under no circumstances; such revisions can substitute the detailed study of
the material provided by the BoS.
SCOPE AND OBJECTIVES OF FINANCIAL MANAGEMENT

Chapter Overview Short- term Finance
Working capital Management (WCM)
Decisions/Function
Scope of Financial Management:

Scope and Objectives of Role and functions of Chief
Finance Officer (CFO) Determination of size of the enterprise and
Financial Management
determination of rate of growth.
Relations of Financial
Profit Maximisation vis-a
Management with other
vis Wealth Maximisation
disciplines of accounting Determining the composition of assets of the enterprise.
Meaning of Financial Management Determining the mix of enterprise’s financing i.e., consideration
of level of debt to equity, etc. and short term functions/decisions
Financial management comprises the forecasting, planning,
organizing, directing, co-ordinating and controlling of all activities
relating to acquisition and application of the financial resources of an
undertaking in keeping with its financial objective. Analysis, planning and control of financial
affairs of the enterprise.
Two Basic Aspects of Financial Management

Procurement of Funds:
There are two basic aspects of financial management viz.,
procurement of funds and an effective use of these funds to achieve Since funds can be obtained from different sources, therefore their
business objectives. procurement is always considered as a complex problem by business
concerns. Some of the sources for funds for a business enterprise are:
Procurement of funds
Debentures and Bonds
Aspects of Financial Management
Utilization of Funds
Owner’s Funds Hire Purchases & Leasing

Finance functions/ finance decision
Value of a firm will depend on various finance functions/decisions.
It can be expressed as Commercial Banks Angel Financing
(Short, Medium & Long)
V = f (I,F,D).
Venture Capital
The finance functions are divided into long term and short term
functions/decisions
Effective Utilisation of Funds:
Investment
Decisions (I) The Finance Manager has to point out situations where the funds are
being kept idle or where proper use of funds is not being made. All
the funds are procured at a certain cost and after entailing a certain
amount of risk.
Long term
Finance
Function Utilization for Fixed
Decisions Assets
Dividend Financing
Utilization for Working
Decisions(D) Decisions (F) Capital
The Chartered Accountant Student December 2017

Evolution of Financial Management Conflict between Profit versus Value maxi-

The evolution of financial management is divided into three phases.
misation Principle:
Financial Management evolved as a separate field of study at the
beginning of the century. The three stages of its evolution are As a normal tendency, the management may pursue its own personal
goals (profit maximization). But in an organization where there is
a significant outside participation (shareholding, lenders etc.), the
Stages of Evolution of Financial Management management may not be able to exclusively pursue its personal goals
due to the constant supervision of the various stakeholders of the
company-employees, creditors, customers, government, etc.
Traditional Phase Transitional Phase Modern Phase
The below table highlights some of the advantages and disadvantages
of both profit maximisation and wealth maximization goals
Objectives of Financial Management
Goal Objective Advantages Disadvantages
Profit Large (i) Easy to (i) Emphasizes
Profit Maximization amount of calculate the short
Maximisation Wealth / Value profits profits term gains
maximisation (ii) Easy to (ii) Ignores risk
determine or
the link uncertainty
between (iii)Ignores the
financial timing of
decisions and returns
How do we measure the value/wealth of a profits. (iv) Requires
immediate
firm? resources.
Shareholders Highest (i) Emphasizes (i) Offers
Stockholders hire managers to run their firms for them...... Wealth market the long term no clear
Maximisation value of gains relationship
shares (ii) Recognises between
Managers set aside their interest and maximise stock prices... risk or financial
uncertainty decisions and
(iii) Recognises share price.
the timing of (ii) Can lead to
Stockholders wealth is maximised... returns management
(iv) Considers anxiety and
shareholders’ frustration.
Firm value is maximised.... return.
Societal wealth is maximised... Role of Finance executive in today’s World

vis-a-vis in the past
Today, the role of chief financial officer, or CFO, is no longer confined
Value of a firm (V) = Number of Shares (N) × Market price of to accounting, financial reporting and risk management. Some of
shares (MP) the key differences that highlight the changing role of a CFO are as
Or follows
V = Value of equity (Ve) + Value of debt (Vd)
What a CFO used to do? What a CFO now does?
Budgeting Budgeting
Three Important Decisions for Achievement
Forecasting Forecasting
of Wealth Maximisation
Accounting Managing M & As
Treasury (cash management) Profitability analysis (for example,
Investment by customer or product)
Decisions Preparing internal financial Pricing analysis
reports for management.
Financing Preparing quarterly, annual Decisions about outsourcing
Decisions filings for investors.
Tax filing Overseeing the IT function.
Tracking accounts payable and Overseeing the HR function.
accounts receivable.
Dividend Travel and entertainment Strategic planning (sometimes
Decisions expense management. overseeing this function).
Regulatory compliance.
Risk management.
December 2017 The Chartered Accountant Student

Relationship of financial management with Decision – Chief focus of an accountant is to
related disciplines: making collect data and present the data.
The financial manager’s primary
Financial management is not a totally independent area. It draws responsibility relates to financial
heavily on related disciplines and areas of study namely economics, planning, controlling and decision
accounting, production, marketing and quantitative methods. Even making.
though these disciplines are inter-related, there are key differences
among them.
Financial Management and Other Related
Financial Tre atment In accounting, the measurement Disciplines:
Management of Funds of funds is based on the accrual
and principle. Financial management also draws on other related disciplines such
Accounting: as marketing, production and quantitative methods apart from
accounting. For instance, financial managers should consider the
The treatment of funds in financial impact of new product development and promotion plans made in
management is based on cash the marketing area since their plans will require capital outlays and
flows. have an impact on the projected cash flows.
TYPES OF FINANCING
Chapter Overview Sources of Finance
Sources of Finance Long-term
Equity Preference Loans 1. Share capital or Equity shares

Share Share Retained Debentures/ from
Earnings Bonds Others 2. Preference shares
Capital Capital Financial
Institution 3. Retained earnings
4. Debentures/Bonds of different types
5. Loans from financial institutions
Classification of Financial Sources 6. Loans from State Financial Corporations
7. Loans from commercial banks
There are mainly two ways of classifying various financial sources
(i) Based on basic Sources (ii) Based on Maturity of repayment period 8. Venture capital funding
9. Asset securitisation
10. International financing like Euro-issues, Foreign currency loans
Sources of Finance based on Basic Sources Medium-term
Based on basic sources of finance, types of financing 1. Preference shares

can be classified as 2. Debentures/Bonds
3. Public deposits/fixed deposits for duration of three years
4. Medium term loans from Commercial banks, Financial Institutions,
State Financial Corporations
5. Lease financing/Hire-Purchase financing
Sources of Finance 6. External commercial borrowings
7. Euro-issues
8. Foreign Currency bonds
Short-term
Internal Sources External Sources
1. Trade credit
2. Accrued expenses and deferred income
3. Short term loans like Working Capital Loans from Commercial banks
4. Fixed deposits for a period of 1 year or less
5. Advances received from customers
Mainly retained Debt or Borrowed Share Capital 6. Various short-term provisions
earnings Capital
Owner’s Capital or Equity Capital:

Loan from A public limited company may raise funds from promoters or from the
Others Financial Debentures Preference Equity
Shares investing public by way of owner’s capital or equity capital by issuing
Institutions Shares ordinary equity shares.
Preference Share Capital:

Sources of Finance based on Maturity of Payment
These are a special kind of shares; the holders of such shares enjoy
Sources of finance based on maturity of payment can be classified as priority, both as regards to the payment of a fixed amount of dividend
and also towards repayment of capital on winding up of the company

Debt Securitisation:
Securitization is a process in which illiquid assets are pooled into

marketable securities that can be sold to investors. The process leads
to the creation of financial instruments that represent ownership Bank
interest in, or are secured by a segregated income producing asset or Trade Credit
Advances
pool of assets.
Lease Financing: Accrued

Certificates of Expenses &
Leasing is a general contract between the owner and user of the asset Deposit Deferred
over a specified period of time. The asset is purchased initially by Income
the lessor (leasing company) and thereafter leased to the user (lessee
company) which pays a specified rent at periodical intervals.
Advances
Treasury
from
Bills
Short term Sources of Finance: Customers
There are various sources available to meet short- term needs of Commercial
finance. The different sources are as shown alongside Paper
FINANCIAL ANALYSIS AND PLANNING - RATIO ANALYSIS

Chapter Overview
Liquidity Ratios*/
RATIO ANALYSIS Short-term Solvency
Ratios
Capital Structure
Application of Ratio Leverage Ratios/ Ratios
Types of Ratio Analysis in dicision Long term Solvency
making Ratios
Coverage Ratios
Types of Ratios
* Liquidity Ratio/Short term Activity Ratios/

Solvency Ratio Efficiency Ratios/
Relation of financial Performance Ratios/
* Leverages Ratio/Long Turnover Ratios* Related to Sales
term Solvency Ratios manegment with other
*Activity Ratio/Efficiency disciplines of accounting.
Related to overall
Ratios/Performance Return on Investment
*Profitability Ratios (Assets/ Capital
Profitability Ratios Employed/ Equity)
Required for analysis

from Owner’s point
Ratio and its Types: of view
Related to Market/
Valuation/ Investors
Ratio analysis is a comparison of different numbers from the
balance sheet, income statement, and cash flow statement against
the figures of previous years, other companies, the industry, or
even the economy in general for the purpose of financial analysis.
Summary of Ratios:
Types of the Ratios is as given slongside:
Summary of the ratios has been tabulated as under
Ratio Formulae Comments

Liquidity Ratio
Current Ratio Current Assets A simple measure that estimates whether the business can pay
Current Liabilities short term debts. Ideal ratio is 2 : 1.
Quick Ratio Quick Assets It measures the ability to meet current debt immediately. Ideal
Current Liabilities ratio is 1 : 1.
Cash Ratio (Cash and Bank Balances + It measures absolute liquidity of the business.
Marketable Securities )
Current Liabilities

Basic Defense Interval Ratio ( Cash and Bank Balances + It measures the ability of the business to meet regular cash
Marketable Securities) expenditures.
Operating Expenses – No. of days

Net Working Capital Ratio Current Assets – Current Liabilities It is a measure of cash flow to determine the ability of business to
survive financial crisis.
Capital Structure Ratio
Equity Ratio Shareholders’ Equity It indicates owner’s fund in companies to total fund invested.
Capital Employed
Debt Ratio Total Outside Liablilities It is an indicator of use of outside funds.
Total Debt + Net Worth

Debt to equity Ratio Total Outside Liabilities It indicates the composition of capital structure in terms of debt
and equity.
Shareholders’ Equity
Debt to Total assets Ratio Total Outside Liabilities It measures how much of total assets is financed by the debt.
Total Assets
Capital Gearing Ratio ( Preference Share Capital + It shows the proportion of fixed interest bearing capital to equity
Debentures shareholders’ fund. It also signifies the advantage of financial
+ Other Borrowed Funds) leverage to the equity shareholder.
( Equity Share Capital +

Reserves & Surplus – Losses)
Proprietary Ratio Prorietary Fund It measures the proportion of total assets financed by
Total Assets shareholders.
Coverage Ratios
Debt Service Coverage Ratio Earnings available for debt service It measures the ability to meet the commitment of various debt
(DSCR) services like interest, installment etc. Ideal ratio is 2.
Interest + Instalments
Interest Coverage Ratio EBIT It measures the ability of the business to meet interest. Ideal ratio
Interest is > 1.
Preference Dividend Coverage Net Profit/Earning after taxes (EAT) It measures the ability to pay the preference shareholders’
Ratio Preference dividend liability dividend. Ideal ratio is > 1.
Fixed Charges Coverage Ratio EBIT + Depreciation This ratio shows how many times the cash flow before interest
Interest + Re-payment of loan and taxes covers all fixed financing charges. The ideal ratio is > 1.
1 – tax rate
Activity Ratio/ Efficiency Ratio/ Performance Ratio/ Turnover Ratio
Total Asset Turnover Ratio Sales/COGS A measure of total asset utilisation. It helps to answer the question -
What sales are being generated by each rupee’s
Average Total Assets
worth of assets invested in the business?
Fixed Assets Turnover Ratio Sales/COGS This ratio is about fixed asset capacity. A reducing sales or profit
Fixed Assets being generated from each rupee invested in fixed assets may
indicate overcapacity or poorer-performing equipment.
Capital Turnover Ratio Sales/COGS This indicates the firm’s ability to generate sales per rupee of long
Net Assets term investment.
Working Capital Turnover Sales/COGS It measures the efficiency of the firm to use working capital.
Ratio Working Capital
Inventory Turnover Ratio COGS/Sales It measures the efficiency of the firm to manage its inventory.
Average Inventory
Debtors Turnover Ratio Credit Sales It measures the efficiency at which firm is managing its
Average Accounts Receivable receivables.

Receivables (Debtors’) Velocity Average Accounts Receivable It measures the velocity of collection of receivables.
Average Daily Credit Sales
Payables Turnover Ratio Annual Net Credit Purchases It measures the velocity of payables payment.
Average Accounts Payables
Profitability Ratios based on Sales
Gross Profit Ratio Gross Profit This ratio tells us something about the business’s ability
x 100
Sales consistently to control its production costs or to manage the
margins it makes on products it buys and sells.
Net Profit Ratio Net Profit It measures the relationship between net profit and sales of the
x 100
Sales business.
Operating Profit Ratio Operating Profit It measures operating performance of business.

x 100
Sales
Expenses Ratio
Cost of Goods Sold (COGS) COGS
x 100
Ratio Sales
Operating Expenses Ratio Administrative exp. +

Selling & Distribution OH
x 100 It measures portion of a particular expenses in comparison to
Sales sales.
Operating Ratio COGS + Operating Expenses x 100
Sales
Financial Expenses Ratio Financial Expenses x 100

Sales
Profitability Ratios related to Overall Return on Assets/ Investments
Return on Investment (ROI) Return/ Profit / Earnings x 100 It measures overall return of the business on investment/ equity
Investments funds/ capital employed/ assets.
Return on Assets (ROA) Net Profit after taxes x 100 It measures net profit per rupee of average total assets/ average
Average Total Assets tangible assets/ average fixed assets.
Return on Capital Employed EBIT It measures overall earnings (either pre-tax or post tax) on total
x 100
ROCE (Pre-tax) Capital Employed capital employed.
Users and Objective of Financial Analysis : A Bird’s Eye view

Financial Statement analysis is useful to various shareholders to obtain the derived information about the firm
S.No. Users Objectives Ratios used in general

1. Shareholders Being owners of the organisation they are interested • Mainly Profitability Ratio [In particular
to know about profitability and growth of the Earning per share (EPS), Dividend per
organization share (DPS), Price Earnings (P/E), Dividend
Payout ratio (DP)]
2. Investors They are interested to know overall financial health of • Profitability Ratios
the organisation particularly future perspective of the • Capital structure Ratios
organisations. • Solvency Ratios
• Turnover Ratios
3. Lenders They will keep an eye on the safety perspective of their • Coverage Ratios
money lended to the organisation • Solvency Ratios
• Turnover Ratios
• Profitability Ratios

4. Creditors They are interested to know liability position of the • Liquidity Ratios
organisation particularly in short term. Creditors • Short term solvency Ratios/ Liquidity
would like to know whether the organisation will be Ratios
able to pay the amount on due date.
5. Employees They will be interested to know the overall financial • Liquidity Ratios
wealth of the organisation and compare it with • Long terms solvency Ratios
competitor company. • Profitability Ratios
• Return of investment
6. Regulator / Government They will analyse the financial statements to determine Profitability Ratios
taxations and other details payable to the government.
7. Managers:-
(a) Production Managers They are interested to know various data regarding • Input output Ratio
input output, production quantities etc. • Raw material consumption.
(b) Sales Managers Data related to quantities of sales for various years, • Turnover ratios (basically receivable
other associated figures and produced future sales turnover ratio)
figure will be an area of interest for them • Expenses Ratios
(c) Financial Manager They are interested to know various ratios for their • Profitability Ratios (particularly related to
future predictions of financial requirement. Return on investment)
• Turnover ratios
• Capital Structure Ratios
Chief Executive/ General They will try to find the entire perspective of the • All Ratios
Manager company, starting from Sales, Finance, Inventory,
Human resources, Production etc.
8. Different Industry
(a) Telecom • Ratio related to ‘call’
• Revenue and expenses per customer
(b) Bank • Loan to deposit Ratios
Finance Manager /Analyst will calculate ratios of their • Operating expenses and income ratios
(c) Hotel company and compare it with Industry norms. • Room occupancy ratio
• Bed occupancy Ratios
(d) Transport • Passenger -kilometre
• Operating cost - per passenger kilometre.
COST OF CAPITAL
Chapter Overview Sources of Capital:
Cost of Capital Equity shares
Preference shares
Cost of Cost of Combination Sources of Capital may

Cost of Preference Cost of Retained of Cost and include Debentures/
Debt Share Equity Earning Weight of each Bond/ other debt
source of instruments
Capital
Loan from financial
Weighted institutions
Average Cost
of Capital
(WACC)
Determination of the Cost of Capital:
Cost of capital is the return expected by the providers of capital Explicit/ Implicit: The cost of capital can either be explicit
(i.e. shareholders, lenders and the debt-holders) to the business as or implicit. The cash outflow of an entity towards the
a compensation for their contribution to the total capital. It is also utilization of capital which is clear and obvious is termed
known as Discount rate, Minimum rate of return etc. It can also as explicit cost of capital. On the other hand, Implicit
be stated as the opportunity cost of an investment, i.e. the rate of cost is the cost which is actually not a cash outflow but it
return that a company would otherwise be able to earn at the same is an opportunity loss of foregoing a better investment
risk level as the investment that has been selected. opportunity by choosing an alternative option.

Cost of Preference Share Capital:
The preference share capital is paid dividend at a specified rate
Cost of Equity on face value of preference shares. Payment of dividend to the
preference shareholders are not mandatory but are given priority
over the equity shareholder. The payment of dividend to the
preference shareholders are not charged as expenses but treated as
appropriation of after tax profit. Hence, dividend paid to preference
shareholders does not reduce the tax liability to the company.
Cost of Retained Weighted Average Cost of Cost of Redeemable

Earnings Cost of Capital Pref. Share Capital Preference Share Capital
(WACC) Cost of Preference
Share Capital
Cost of Irredeemable
Preference Share Capital
Cost of Irredeemable Preference Shares:

Cost of Long
term Debt. PD
(Kp) =
P0
Where,
PD = Annual preference dividend
P0 = Net proceeds in issue of preference shares
Cost of Long term Debt:

Cost of Redeemable Preference Shares
Cost of Irredeemable PD+(RV+NP)/n
(Kp) =
Debt RV+NP
Cost of long term Where, 2
Debt PD = Annual preference dividend
Cost of Redeemable RV = Redemption value of preference shares
Debt NP = Net proceeds on issue of preference shares
n = Life of preference shares
Cost of Irredeemable Debentures: Cost of debentures not redeemable Cost of Equity Share Capital:
during the life time of the company
Cost of equity capital is the rate of return which equates the present
I
Kd = (1-t) value of expected dividends with the market share price. Different
NP
methods are employed to compute the cost of equity share capital
Where,
which are as
Kd = Cost of debt after tax
I = Annual interest payment
Dividend Price
NP = Net proceeds of debentures or current market price Approach
t = Tax rate
Earning/ Price
Approach
Cost of Redeemable Debentures: If the debentures are redeemable Cost of Equity Share
after the expiry of a fixed period, the cost of debentures would be: Capital Realized Yield
Approach
Kd = ( RV-NP)
I(1-t)+
n Capital Asset Pricing
Model (CAPM)
( RV+NP)
2
Dividend Price Approach with Constant
Where,
I = Interest payment
Dividend
NP = Net proceeds from debentures in
D
case of new issue of debt or Current Ke =
P
market price in case of existing debt. Where, 0
RV = Redemption value of debentures Ke = Cost of equity
t = Tax rate applicable to the company D = Expected dividend
n = Life of debentures P0 = Market price of equity (ex- dividend)

Dividend Price Approach with Constant Realized Yield Approach:
Growth
According to this approach, the average rate of return realized in
D1 the past few years is historically regarded as ‘expected return’ in
Ke = +g
Po the future. It computes cost of equity based on the past records of
Where, dividends actually realised by the equity shareholders.
D1 = [D0 (1+ g)] i.e. next expected dividend
P0 = Current Market price per share
g = Constant Growth Rate of Dividend Capital Asset Pricing Model Approach
(CAPM):
Earning/ Price Approach with constant
Earning: Ke = Rf + ß (Rm − Rf)
Where,
Ke = Cost of equity capital
Ke = E
P Rf = Risk free rate of return
Where, ß = Beta coefficient
E = Current earnings per share Rm = Rate of return on market portfolio
P = Market share price (Rm – Rf) = Market premium
Earnings/ Price Approach with Growth in Cost of Retained Earnings

Earnings:
Like another source of fund, retained earnings involve cost. It is the
Ke = E +g opportunity cost of dividends foregone by shareholders.
P
Where,
E = Current earnings per share In absence of any information on personal tax (tp):
P = Market price per share Cost of Retained Earnings (KS) = Cost of Equity Shares (Ke)
g = Annual growth rate of earnings. If there is any information on personal tax (tp): KS = Ke -tp
Cash
Investment Investment
opportunity Shareholders opportunities
(real asset) Firm
(financial assets)
Invest Alternative pay Shareholders

dividend to invest for
shareholders themselves
Weighted Average Cost Of Capital (WACC): Marginal Cost of Capital:

It is the cost of raising an additional rupee of capital. Since the
It is an average rate of return expected by all contributors of
capital is raised in substantial amount in practice, marginal cost is
capital taking the weight of each element of capital to total
referred to as the cost incurred in raising new funds.
capital
To calculate the marginal cost of capital, the intended financing

WACC (Ko) = (% Debt × Kd) + (% Preff. Capital × Kp) + proportion should be applied as weights to marginal component
(% Equity Capital × Ke) costs. The marginal cost of capital should, therefore, be calculated
in the composite sense. The marginal weights represent the
proportion of funds the firm intends to employ.

FINANCING DECISIONS-CAPITAL STRUCTURE
Chapter Overview Net Income (NI) Approach:
According to this approach, capital structure decision is relevant to the value of the firm.
Capital Structure
Decision An increase in financial leverage will lead to decline in the weighted average cost of capital
(WACC), while the value of the firm as well as market price of ordinary share will increase.
Conversely, a decrease in the leverage will cause an increase in the overall cost of capital
and a consequent decline in the value as well as market price of equity shares
Capital Structure Theories
Capital Structure
• Net Income (NI) Approach Decision
The value of the firm on the basis of Net Income Approach can be ascertained as follows:
• Traditional Approach
• Net Operating Income (NOI) Approach
• Modigliani- Miller (MM) Approach V = Market Value of Equity + Market Value of Debt
• Trade-off Theory EBIT- EPS Analysis
• Pecking Order Theory EBIT
Overall cost of capital =
Value of the Form
Capital Structure decision refers to deciding the forms of financing (which sources to be
tapped); their actual requirements (amount to be funded) and their relative proportions Traditional Approach:
(mix) in total capitalisation.
This approach favours that as a result of financial leverage up to some point, cost of capital
Replacement comes down and value of firm increases. However, beyond that point, reverse trends
Capital Budgeting Decision Modernisation emerge. The principle implication of this approach is that the cost of capital is dependent
Expansion on the capital structure and there is an optimal capital structure which minimises cost
Diversification of capital.
Internal funds
Need to Raise Funds
Debt Net Operating Income Approach (NOI):
External equity
Any change in the leverage will not lead to any change in the total value of the firm and
Capital Structure Decision the market price of shares, as the overall cost of capital is independent of the degree of
leverage. As a result, the division between debt and equity is irrelevant.
As per this approach, an increase in the use of debt which is apparently cheaper is offset
by an increase in the equity capitalisation rate. This happens because equity investors
Existing Capital Desired Debt seek higher compensation as they are opposed to greater risk due to the existence of fixed
Payout Policy
Structure Equity Mix return securities in the capital structure.
V= NOI
KO
Where,
Effect of Return Effect of Risk
V = Value of the firm
NOI = Net operating Income
Ko = Cost of Capital
Effect of Cost of
Capital Modigliani-Miller Approach (MM):
Optimum Cpital
Structure The NOI approach is definitional or conceptual and lacks behavioral significance. It
does not provide operational justification for irrelevance of capital structure. However,
Modigliani-Miller approach provides behavioral justification for constant overall cost
Value of the Firm of capital and therefore, total value of the firm. This approach indicates that the capital
structure is irrelevant because of the arbitrage process which will correct any imbalance
i.e. expectations will chane and a stage will be reached where arbitrage is not possible.
Capital Structure Theories:

The following approaches explain the relationship between cost of capital, capital Modigliani-Miller (MM)
Approach
structure and value of the firm
Net Income (NI)

Approach
MM Approach MM Approach-
Capital Structure -1958: without
Relevance Theory 1963: with tax
tax
Traditional
Approach
Capital Structure
Theories
Net Operating The Trade-off Theory:
Income (NOI)
Approach
Capital Structure The trade-off theory of capital structure refers to the idea that a company chooses
Irrelevance Theory how much debt finance and how much equity finance to use by balancing the costs
Modigliani and and benefits.
Miller (MM)
Approach

EBIT-EPS Analysis:
Maximum
Value of firm The basic objective of financial management is to design an
appropriate capital structure which can provide the highest
earnings per share (EPS) over the company’s expected range of
earnings before interest and taxes (EBIT).
Costs of EPS measures a company’s performance for the shareholders.

finanacial The level of EBIT varies from year to year and represents the
distress success of a company’s operations.
PV of interest
tax shield However, The EPS criterion ignores the risk dimension as well
as it is more of a performance measure.
Value of (EBIT-I1) (1-t) (EBIT-I2) (1-t)

=
unlevered
E1 E2
Firm
Where,
EBIT = Indifference point

Optimal Debt E1 = Number of equity shares in Alternative 1
Level E2 = Number of equity shares in Alternative 2
I1 = Interest charges in Alternative 1
Debt 12 = Interest charges in Alternative 2
level T = Tax-rate
Alternative 1 = All equity finance
Alternative 2 = Debt-equity finance
Pecking order theory:
This theory is based on Asymmetric information, which

• It is a situation where a firm has
refers to a situation in which different parties have different
more capital than it needs or in
information.
Over- Capitalisation other words assets are worth less
than its issued share capital, and
earnings are insufficient to pay
dividend and interest.
• Debt
• Equity
• It is just reverse of over-

Trade- off capitalisation. It is a state, when
Under Capitalisation its actual capitalisation is lower
Theory
than its proper capitalisation as
warranted by its earning capacity.
Pecking Order Theory
• Internal Financing
• Debt
• Equity

FINANCING DECISIONS- LEVERAGES
Chapter Overview Chart Showing Operating Leverage,
Financial Leverage and Combined Leverage
Business and Financial
Risk
Profitability Statement
Analysis of Leverage Sales xxx
Types of Leverage Less: Variable Cost (xxx)
(i) Operating Leverage
(ii) Financial Leverages Contribution xxx Operating
(iii) Combined Leverages Leverage
Less: Fixed Cost (xxx)
Operating Profit/ EBIT xxx Combined
In financial analysis, leverage represents the influence of one Leverage
Financial
financial variable over some other related financial variable. These Less: Interest (xxx) Leverage
financial variables may be costs, output, sales revenue, Earnings
Before Interest and Tax (EBIT), Earning per share (EPS) etc. Earnings Before Tax xxx
(EBT)
Less: Tax (xxx)
Business Risk and Financial Risk:
Profit After Tax (PAT) xxx
Risk facing the common shareholders is of two types, namely Less: Pref. Dividend (if (xxx)
business risk and financial risk. Therefore, the risk faced by any)
common shareholders is a function of these two risks, i.e.
(Business Risk, Financial Risk). Net Earnings available xxx
to equity shareholders/
PAT
No. Equity shares (N)
Earnings per Share (EPS)
Business Risk Financial Risk = (PAT ÷ N)
•
It refers to the risk • It refers to the additional
associated with the firm’s risk placed on the firm’s Operating Leverage:
operations. It is the shareholders as a result of
uncertainty about the debt use i.e. the additional
future operating income risk a shareholder bears Operating leverage (OL) maybe defined as the employment of an
(EBIT), i.e. how well can when a company uses asset with a fixed cost in the hope that sufficient revenue will be
the operating incomes be debt in addition to equity generated to cover all the fixed and variable costs.
predicted? financing.
Contribution
Operating leverage =
EBIT
Types of Leverage:
% change in EBIT
There are three commonly used measures of leverage in financial Degree of Operating Leverage (DOL) =
% change in Sales
analysis. These are
Positive and Negative Operating Leverage:
Combined Operating Leverage

Leverage and EBIT
Negative Infinite/ Undefined Positive

Financial
Leverage
Operating at Operating at a
Lower than Operating at break- Higher Level than
break-even point even point break-even point
Operating
Leverage
EBIT= -Ve EBIT = 0 EBIT = +Ve

Financial Leverage: Combined Leverage:
Financial leverage (FL) maybe defined as ‘the use of funds with a • It maybe defined as the potential use of fixed
fixed cost in order to increase earnings per share.’ In other words, Combined costs, both operating and financial, which
it is the use of company funds on which it pays a limited return. leverage magnifies the effect of sales volume change
on the earning per share of the firm.
EBIT
Financial leverage = Degree of Combined Leverage = DOL X DFL
EBT
% change in EPS % change in EPS

Degree of Financial Leverage (DFL) = Degree of Combined Leverage (DCL) =
% change in EBIT % change in Sales
Positive and Negative Financial Leverage:
Financial Leverage
Financial Leverage as Financial Leverage as a

‘Trading on Equity’ ‘Double edged Sword’
Positive Infinite/ Undefined Negative • Financial leverage indicates • On one hand when cost of
the use of funds with fixed ‘fixed cost fund’ is less than
cost like long term debts the return on investment
and preference share capital financial leverage will help
EBIT level is more Operating at EBIT level is less along with equity share to increase return on equity
than Fixed Financial Financial break than Fixed capital which is known as and EPS. However, when
Charge even point Financial Charge trading on equity. When cost of debt is more than
the quantity of fixed cost the return it will affect
fund is relatively high return of equity and EPS
EPS: will change in comparison to equity unfavourably. This is why
in the same No Profit no Loss EPS : Negative capital, it is said that the financial leverage is known
direction as EBIT firm is ‘’trading on equity”. as “double edged sword”.
INVESTMENT DECISIONS
Chapter Overview:
Investment Decisions
• Identification of investment projects that are
strategic to business overall objectives;
Types of Investment Capital Budgeting Techniques: Capital • Estimating and evaluating post-tax
Decisions • Pay-back period Budgeting incremental cash flows for each of the
• Accounting Rare of Return (ARR) involves investment proposals; and
Basic Principles for • Net Present Value (NPV) • Selection of an investment proposal that
measuring Project maximizes the return to the investors
• Profitability Index (NI)
Cash Flows
• Internal Rate of Return (IRR)
Capital Budgeting in • Modified Internal Rate of Return
special cases (MIRR)
• Discounted Pay-back period
Capital Budgeting Process:
Planning Evaluation Selection Implementation Control Review

Chapter Overview 6. Less: Fixed Cost
(a) Fixed Cash Cost xxx
Generally, capital investment decisions are classified in two (b) Depreciation xxx
ways. One way is to classify them on the basis of firm’s existence.
Another way is to classify them on the basis of decision situation. 7. Earning Before Tax [6 - 7] xxx
8. Less: Tax xxx
9. Earning After Tax [7-8] xxx
Replacement and
Types of Capital Investment Decisions
Modernisation decisions 10. Add: Depreciation xxx
On the basis 11. Cash Inflow After Tax (CFAT) [9 +10] xxx
of firm’s existence Expansion decisions
Diversification decisions
Capital Budgeting Techniques:
In order to maximise the return to the shareholders of a company,

Mutualy exclusive decisions it is important that the best or most profitable investment
projects are selected as the results for making a bad long-term
investment decision can be both financially and strategically
On the basis of devastating, particular care needs to be taken with investment
decision situation Accept-Reject decisions
project selection and evaluation.
Contingent decisions
There are a number of techniques available for appraisal of
investment proposals and can be classified as presented below:
Estimation of Project Cash Flows

Capital Budgeting analysis considers only incremental cash flows Payback Period
from an investment likely to result due to acceptance of any
project. Therefore, one of the most important tasks in capital
budgeting is estimating future cash flows for a project. Traditional or
Non Discounting Accounting Rate of
Return (ARR)
Calculating Cash Flows
Net Present Value
Particulars No Depreciation is Depreciation is (NPV)
Charged Charged Capital
Budgeting
(RCrore) (RCrore) Techniques Profitability
Total Sales *** *** Index (PI)
Less: Cost of Goods *** *** Time adjusted or

Sold Discounted Cash Internal Rate of
Flows Return (IRR)
*** ***
Less: Depreciation - *** Modified Internal
Rate of Return
Profit before tax *** *** (MIRR)
Tax @ 30% *** *** Discounted
Profit after Tax *** *** Payback Period
Add: Depreciation* - ***

Cash Flow *** ***
Payback Period:
* Being non-cash expenditure, depreciation has been added back
while calculating the cash flow. The payback period of an investment is the length of time required
for the cumulative total net cash flows from the investment to
Statement showing the calculation of Cash equal the total initial cash outlay.
Inflow after Tax (CFAT):
Total initial capital investment
Sl. no. (R) Payback period =
Annual expected after-tax net cash flow
1 Total Sales Units xxx
2 Selling Price per unit xxx Accounting (Book) Rate of Return (ARR):
3. Total Sales [1 × 2] xxx
4. Less: Variable Cost xxx The accounting rate of return of an investment measures the
average annual net income of the project (incremental income) as
5. Contribution [3 - 4] xxx a percentage of the investment.

Average annual net income Sum of discounted cash in flows

Accounting rate of return = x 100 Profitability Index (PI) =
Investment Initial cash outlay or Total discounted
cash outflow (as the case maybe)
Net Present Value Technique (NPV):
The net present value technique is a discounted cash flow method Decision Rule:
that considers the time value of money in evaluating capital
investments.
If PI ≥ 1 Accept the Proposal
If PI ≤ 1 Reject the Proposal
n Ct
NPV = ∑ -I In case of mutually exclusive projects; project with higher PI should
(1+ k) t
t =1
be selected.
Where,
C = Cash flow of various years

K = discount rate
N = Life of the project
Internal Rate of Return Method (IRR):
I = Investment
Internal rate of return for an investment proposal is the discount
rate that equates the present value of the expected net cash flows
with the initial cash outflow.
Profitability Index /Desirability Factor/
Present Value Index Method (PI): NPV at LR
LR + x (HR-LR)
NPV at LR- NPV at HR
In comparing alternative proposal of comparing, we have to
compare a number of proposals each involving different amounts Where,
of cash inflows. One of the methods of comparing such proposals LR = Lower Rate
is to work out what is known as the ‘Desirability factor’, or
‘Profitability index’ or ‘Present Value Index Method’. HR = Higher Rate
Summary of Decision criteria of Capital

Budgeting techniques:
Techniques For Independent Project For Mutually Exclusive Projects
Non- Pay Back (i) When Payback period ≤ Maximum Project with least Payback period should be
Discounted Acceptable Payback period: Accepted selected
(ii) When Payback period ≥ Maximum

Acceptable Payback period: Rejected
Accounting (i) When ARR ≥ Minimum Acceptable Rate Project with the maximum ARR should be
Rate of of Return: Accepted selected.
Return (ARR) (ii) When ARR ≤ Minimum Acceptable Rate
of Return: Rejected
Discounted Net Present (i) When NPV > 0: Accepted Project with the highest positive NPV should
Value (NPV) (ii) When NPV < 0: Rejected be selected
Profitability (i) When PI > 1: Accepted When Net Present Value is same, project with
Index(PI) (ii) When PI < 1: Rejected Highest PI should be selected
Internal Rate (i) When IRR > K: Accepted Project with the maximum IRR should be
of Return (ii) When IRR < K: Rejected selected
(IRR)

MANAGEMENT OF WORKING CAPITAL
Chapter Overview Receivables Higher Credit Evaluate Cash sales
period attract the credit provide
customers policy; use liquidity but
and increase the services fails to boost
Management of revenue of debt sales and
Working Capital management revenue
(factoring)
agencies.
Cash (Treasury) Pre- Reduces Cost-benefit Improves or
Determinants of Management: payment of uncertainty analysis maintains
Working Capital expenses and profitable required liquidity.
• Functions of Treasury
Department in inflationary
environment.
• Treasury Management
Estimation of Working • Cash Management Cash and Payables are Cash budgets Cash can be
Capital Models Cash honoured and other cash invested in
equivalents in time, management some other
improves the techniques can investment
goodwill and be used avenues
Working Capital helpful in
Cycles getting future
discounts.
Payables Capital can Evaluate the Payables are
Inventory and be used in credit policy honoured in
Management Expenses some other and related time, improves
investment cost. the goodwill
Receivable Management: avenues and helpful in
Payables Management • Factors determining getting future
Credit Policy discounts.
• Financing of Receivables
• Monitoring of Rece
Investment and Financing
Financing of Working
Capital
Working Capital: In accounting term working capital is the Investment in working

difference between the current assets and current liabilities. capital is concerned with
the level of investment in Financing decision
the current assets. concerned with the
Working Capital = Current Assets – Current Liabilities arrangement of funds to
finance the working capital.
Scope of Working Capital Management

Approaches of Working Capital investment
Scope of Working Capital Management
Aggressive Moderate Conservative

Liquidity and Investment and
Profitability Financing
•Here investment in working capital is kept at

Aggressive minimal investment in current assets which means
Liquidity vs Profitability: The trade-off between the the entity does hold lower level of inventory, follow
components of working capital can be summarised as follows: strict credit policy, keeps less cash balance etc.
Component Advantages Trade-off Advantages •In this approach of organisation use to invest
of Working of higher side (between of lower side high capital in current assets. Organisations use to
Conservative keep inventory level higher, follows liberal credit
Capital (Profitability) Profitability (Liquidity)
and Liquidity) policies, and cash balance as high as to meet any
current liabilities immediately.
Inventory Fewer Use Lower
stock- outs techniques inventory
increase the like EOQ, JIT requires less •This approach is in between the above two
profitability. etc. to carry capital but approaches. Under this approach a balance
optimum level endangered Moderate
between the risk and return is maintained to gain
of inventory. stock-out and more by using the funds in very efficient manner.
loss of goodwill.

The various components of Operating Cycle
may be calculated as shown below:
(1) Raw Material Avereage stock of Raw material

=
A Storage Period Average Cost of Raw material
Level of current assets
Consumption per day

Conservative policy
(2) Work-in-Progress Avg Work-in-progress inventory
B holding period =
Average Cost of Production per day
Average policy
(3) Finished Average stock of finished goods
=
c Goods storage Average Cost of Goods Sold per
period day
Aggressive policy
(4) Receivables Average Receivables
(Debtors) =
collection period Average Credit Sales per day
Fixed asset level
Output (5) Credit period Average Payables
allowed by suppliers =
(Creditors) Average Credit Purchases
per day
Operating/ Working Capital Cycle: Working Capital cycle
indicates the length of time between a company’s paying for
materials, entering into stock and receiving the cash from sales
of finished goods. Estimation of Amount of Different Components
of Current Assets and Current Liabilities
Working Capital Cycle (i) Raw Materials Inventory:
Estimated Production (units)

× Estimated Cost per unit × Average
12 months / 365 days * raw material storage period
Cash
(ii) Work-in-Progress Inventory:

× Estimated WIP cost per unit ×
12 months / 365 days * Average W-I-P holding period
Receivables Raw Material Labour
Overhead (iii) Finished Goods:
× Estimated Cost of production per
12 months / 365 days * unit × Average storage period
(iv) Receivables (Debtors):
Estimated Credit Sales unit

×Cost of sales (excluding depreciation)
12 months / 365 days * per unit × Average collection period
Stock WIP
(v) Cash and Cash equivalents: Minimum desired Cash and Bank
balance to be maintained
(vi) Trade Payables (Creditors):

In the form of an equation, the operating cycle process can be
expressed as follows:
Estimated credit purchase × Credit period allowed by suppliers
12 months / 365 days *
Operating Cycle = R + W + F + D – C (vii) Direct Wages:

Estimated labour hours x wages
Where, rate per hour
×Average time lag in
12 months / 365 days * payment of wages
R = Raw material storage period
(viii) Overheads (other than depreciation and amortization):
W = Work-in-progress holding period
F = Finished goods storage period Estimated Overheads ×Average time lag in payment of
D = Receivables (Debtors) collection period. 12 months / 360 days * overheads
C = Credit period allowed by suppliers (Creditors).
*Number of days in a year may be taken as 365 or 360 days.

Estimation of Working Capital Requirements (e) Expected Net .…….. ……….. ……… ……….
Profit before Tax
(a-b-c-d)
Amount Amount Amount
(f ) Less: Tax ……... ……….. ………. ………
I. Current Assets:
(g) Expected ..……. ……… ……… ………
Inventories: Profit after Tax
- Raw Materials --- B. Opportunity ..…… ……… ………. ………
Cost of
- Work-in-process --- Investments
- Finished goods --- --- in Receivables
locked up in
Receivables: Collection
Period
- Trade debtors ---
Net Benefits ……… ……… ……… ……….
- Bills --- --- (A – B)
Minimum Cash Balance ---
Gross Working Capital --- --- Statement showing the Evaluation of Credit Policies (based on
Incremental Approach)
II. Current Liabilities:
Trade Payables ---
Particulars Present Proposed Proposed Proposed
Bills Payables --- Policy Policy I Policy II Policy III
days days days days
Wages Payables ---
Payables for overheads --- --- RS RS RS RS
III. Excess of Current Assets --- A. Incremental
over Current Liabilities Expected Profit:
[I – II]
IV. Add: Safety Margin --- Credit Sales ………. …………. ……….. ……….
V. Net Working Capital [III --- (a) Incremental ………. …………. ……….. ……….
+ IV] Credit Sales
(b) Less:
MANAGEMENT OF RECEIVABLES Incremental
Costs of Credit
Sales
Approaches of Evaluation of Credit Policies
(i) Variable Costs ………. …………. ……….. ……….
There are basically two methods of evaluating the credit policies to be (ii) Fixed Costs ………. …………. ……….. ……….
adopted by a Company – Total Approach and Incremental Approach.
The formats for the two approaches are given as under: (c) Incremental ………. …………. ……….. ……….
Statement showing the Evaluation of Credit Policies (based on Bad Debt Losses
Total Approach)
(d) Incremental ………. …………. ……….. ……….
Cash Discount
Particulars Present Proposed Proposed Proposed
Policy Policy I Policy II Policy III (e) Incremental ………. …………. ……….. ……….
Expected Profit
RS RS RS RS (a-b-c-d)
(f) Less: Tax ………. …………. ……….. ……….

A. Expected
Profit:
(g) Incremental ………. …………. ……….. ……….
(a) Credit Sales ………. …………. ……….. ………. Expected Profit
after Tax
(b) Total Cost
other than Bad ………. …………. ……….. ……….
Debts and Cash
Discount B. Required
Return on
(i) Variable Costs ………. …………. ……….. ………. Incremental
Investments:
(ii) Fixed Costs ………. …………. ……….. ……….
(a) Cost of ………. …………. ……….. ……….
……… ………. ………. ……..
Credit Sales
(c) Bad Debts ………. …………. ……….. ……….
(b) Collection ………. …………. ……….. ……….
(d) Cash discount Period (in days)

Financing of Receivables
(c) Investment in ………. …………. ……….. ……….
Receivable (a x
b/365 or 360) (i) Pledging: This refers to the use of a firm’s receivable to secure a
short term loan.
(d) Incremental ………. …………. ……….. ……….
Investment in (ii) Factoring: This refers to outright sale of accounts receivables to a
Receivables factor or a financial agency.
(e) Required Rate of ………. …………. ……….. ………. Factor

Return (in %) Customers send The factor pays
payment to the an agreed-upon
(f) Required Return ………. …………. ……….. ……….
factor percentage of the
on Incremental
Investments accounts receivable
(d x e) to the firm.
Incremental Net ………. …………. ……….. ………. Customer Firm

Benefits (A – B)
Goods
The basic format of evaluating factoring proposal is given as under:

Statement showing the Evaluation of Factoring Proposal
Particulars rs
A. Annual Savings (Benefit) on taking Factoring Service
Cost of Credit Administration saved ………...
Bad Debts avoided …………
Interest saved due to reduction in Average collection period (Wherever applicable) …………
[Cost of Annual Credit Sales × Rate of Interest × (Present Collection Period – New Collection Period)/360* days]
Total ………..
B. Annual Cost of Factoring to the Firm:
Factoring Commission [Annual credit Sales × % of Commission (or calculated annually)] ………..
Interest Charged by Factor on advance (or calculated annually ) ………...
[Amount available for advance or (Annual Credit Sales – Factoring Commission – Factoring Reserve)] ×
[ Collection Period (days)

x Rate of Interest]
360 *
Total ………..
C. Net Annual Benefits/Cost of Factoring to the Firm: ………..
Rate of Effective Cost of Factoring to the Firm
Net Annual cost of Factoring
= x 100 or
Amount available for advance
Net annual Cost of Factoring

x 100
Advances to be paid
Advances to be paid = (Amount available for advance – Interest deducted by factor)

Intermediate Course
Intermediate Course
Paper: 8B
Economics for Finance

ISBN : 978-81-8441-890-3
Economics
for Finance
Board of Studies
ECONOMICS FOR FINANCE
ECONOMICS FOR FINANCE: A CAPSULE FOR QUICK RECAP
At the Intermediate level , students are expected to not only acquire professional knowledge but also the ability to apply
such knowledge in problem solving. In this capsule for students, an attempt has been made to capture the significance and
importance of the subject of Economics for Finance with the intention to assist you in revision of concepts discussed in
the study material .
CHAPTER I: UNIT-I NATIONAL INCOME

National Income Usefulness of National Income Accounts
Net Value of all economic goods and services produced within the • For analyzing and evaluating the performance of an economy,
domestic territory of a country in an accounting year plus net factor • Knowing the composition and structure of the national income,
income abroad. • Income distribution, economic forecasting and for choosing
economic policies and evaluating them.
GNP at Market Prices

Gross National Product
GNP at Factor Cost
NNP at Market Prices

Net National Product
NNP at Factor Cost
Different concepts of GDP at Market Prices

Determination of National Income
Gross Domestic Product

National Income
GDP at Factor Cost
Net Domestic Product NDP at Market Prices

National Measurement of National
Income Income in India
NDP at Factor Cost
Accounting Per Capita Income
Limitations and Challenges of

National Income Computation Personal Income
Disposable Income
GNPMP NDPMP NNPMP Market Price

• GNPMP - Depreciation
• GDPMP + Net Factor • GDPMP - Depreciation • Factor Cost + Net Indirect
• NNPMp = NDPMP + Net
Income from Abroad • NNPMP - Net Factor Factor Income from abroad Taxes= Factor Cost + Indirect
• NNPMP = GDPMP + Net Taxes – Subsidies
Income from Abroad Factor Income from Abroad -
Depreciation
Factor Cost = Market Price - Gross Domestic Product at Net Domestic Product at Factor Net National Product at Factor
Factor Cost (GDPFC) Cost (NDPFC) is defined as the
Cost (NNPFC) or National Income
Net Indirect Taxes = Market • GDP MP – Indirect Taxes + total factor incomes earned by
Subsidies the factors of production. • NNPFC = National Income
Price - Indirect Taxes +
• Compensation of employees • NDPFC = NDPMP - Net Indirect • FID (factor income earned in
Subsidies + Operating Surplus (rent Taxes
domestic territory) + NFIA.
+ interest + profit) + Mixed = Compensation of employees
Income of Self - employed + + Operating Surplus ( rent
Depreciation + interest + profit) + Mixed
Income of Self - employed
Personal income is a measure of the actual Disposable Personal Income (DI) that is

current income receipt of persons from all available for their consumption or savings
sources.
• PI = NI + income received but not DI = PI - Personal Income Taxes
earned - income earned but not
received
April 2018 The Chartered Accountant Student

Product Method or Value Added

Distribution as Method is also called Industrial Origin
Value added Method or Net Output Method
factor incomes
Measurement of National
(Rent , Wages, Method or and entails the consolidation of the
Interest ,Profit) Production production of each industry less
Method intermediate purchases from all other
industries.
Under income method, national
Income
income is calculated by summation
Income of factor incomes paid out by all
production units within the domestic
Method territory of a country as wages and
salaries, rent, interest, and profit.
Circular flow of Transfer incomes are excluded.
income
Disposition Under the expenditure approach, also

Production called Income Disposal Approach, national
of goods and Consumption / Expenditure income is the aggregate final expenditure
services Investment Method in an economy during an accounting
year composed of final consumption
expenditure, gross domestic capital
formation and net exports.
UNIT-II: THE KEYNESIAN THEORY OF DETERMINATION OF NATIONAL INCOME

Determination of National Income The Keynesian theory of Determination of National Income
Two Sector Model Three Sector Model Four Sector Model The Investment Multiplier
• John Maynard Keynes in his masterpiece ‘The General Theory of Employment Interest and Money’ published in 1936 put forth a comprehensive
theory to explain the determination of equilibrium aggregate income and output in an economy.
• The equilibrium analysis is best understood with a hypothetical simple a two-sector economy which has only households and firms with all
prices (including factor prices), supply of capital and technology constant; the total income produced Y, accrues to the households and equals
their disposable personal income.
• The equilibrium output occur when the desired amount of output demanded by all the agents in the economy exactly equals the amount
produced in a given time period.
• In the two-sector economy, Aggregate Demand (AD) or aggregate expenditure consists of only two components: aggregate demand for
consumer goods and aggregate demand for investment goods / being determined exogenously and constant in the short run.
Circular Flow in a Two Sector Economy  The Keynesian assumption is that consumption increases
with an increase in disposable income (b > 0), but that the
Wages,Rent,Interest,Profit increase in consumption will be less than the increase in
Factor Payment disposable income (b < 1).
(Y)  The propensity to consume refers to the proportion of the
Factor input total and the marginal incomes which people spend on
consumer goods and services.
 The proportion or fraction of the total income consumed
Households Firms is called ‘average propensity to consume’ (APC)= Total
Consumption /Total Income
Goods and  Since Y = C + S, consumption and saving functions are
Services (O) counterparts of each other. The condition for national
Consumption income equilibrium can thus be expressed as C + I = C + S
expenditure  Changes in income are primarily from changes in the
(C) autonomous components of aggregate demand, especially
from changes in the unstable investment component.
 The investment multiplier k is defined as the ratio of change
 Consumption function expresses the functional relationship in national i ncome (∆Y) due to change in investment (∆I)
between aggregate consumption expenditure and aggregate  The marginal propensity to consume (MPC) is the
disposable income, expressed as C = f (Y). The specific form determinant of the value of the multiplier. The higher the
consumption function, proposed by Keynes C = a + bY marginal propensity to consume (MPC) the greater is the
 The value of the increment to consumer expenditure per unit value of the multiplier.
of increment to income (b) is termed as Marginal Propensity  The more powerful the leakages are, the smaller will be the
to Consume (MPC). value of multiplier.
The Chartered Accountant Student April 2018

Keynesian Consumption Function Effects of Changes in Autonomous Income
(A) Y= C+S C+I+ I

Y El
C
C+I
Aggregate Demand
C =f(Y)
E
Consumption
Slope = b
I
450
a O Y0 Y1 Y2 X
(B)
S
Saving/Investment
Income Y E
I+ I
I S=I E
I
O
Y0 Y1 Y2 X
Consumption and Saving Function
Income Output
Y=C+S
Y
Three Sector Model
Saving
Consumption
C • Aggregate demand in the three sector model of closed economy

(neglecting foreign trade) consists of three components namely,
Dissaving C =a+by household consumption(C), desired business investment
C
demand(I) and the government sector’s demand for goods and
Y
services(G).
• The government sector imposes taxes on households and
a business sector, effects transfer payments to household sector
450
x and subsidy payments to the business sector, purchases goods
o Y1 Y2 Disposable Income and services and borrows from financial markets.
• In equilibrium, it is also true that the (S + T) schedule intersects
S
Saving
Saving the (I + G) horizontal schedule.
o S Circular Flow in Three Sector Model

x
a Y: Y Y2 Disposable Income
S Dissaving Goods and Services Goods and Services
Consumption
Expenditure on Product Expenditure
Market
Determination of Equilibrium Income: Domestic Products
Two Sector Model Investment Expenditure
Govt.Purchases
(A)
Y
Subsidies Transfer
Aggregate Demand
C+S Payments
C+I < C+S House
B Business Taxes Government Taxes hold
C+I
C+I=C+S
C+I > C+S A E C
Government
Borrowings
45O
O Y1 Financial
Y0 Y2 X Market
(B) Investment Savings
Saving/Investment
S
Factor Payments Personal Income
S=I Factor
I I Market
E Factor Services Factor Services
O Y1 Y0 Y2 X
Income Output
Y1

Determination of Equilibrium Income: Circular Flow in Four Sector Model

Three Sector Model
C,I,G Net Capital Inflow Rest of the
(A) world
(Y=C+S+T) Exports
Imports
E1 C+I+G Expenditure on
Consumption
Aggregate expenditure
Domestic Products Product Govt.Purchase Expenditure

C+I Market
E Investment Expenditure
C
G
Subsidies Transfer
Payments
I Business Government Households
Taxes Taxes
Government
Borrowings
Y
45O Financial
O Market
S,I,G Y Yi Investment Saving
Income (Output)
Factor Payments Personal Income

Factor
(B) Market
Injections/Leakages
S+T
Determination of Equilibrium Income:
E1 Four Sector Model
I+G
G E
I C+S+T
(A) C+I+G+(K-M)
Aggregate expenditure
O Y Y1
E
Income (Output)
Four Sector Model

The four sector model includes all four macroeconomic sectors, the 45 O
household sector, the business sector, the government sector, and
the foreign sector and in equilibrium, we have Y = C + I + G + (X-M) O Y Income(Output)
 The domestic economy trades goods with the foreign sector
(B) S-I+M
through exports and imports. I,G,X,S,T,M
 Imports are subtracted from exports to derive net exports, +
which is the foreign sector’s contribution to aggregate
expenditures. If net exports are positive (X > M), there is net
Injections/Leakages
I+G+X
injection and national income increases. Conversely, if X<M,
there is net withdrawal and national income decreases.
 The autonomous expenditure multiplier in a four sector O
model includes the effects of foreign transactions and is stated Y
as 1 against 1 in a closed economy.
1-(b+v) (1-b) Income(Output)
 The greater the value of v, the lower will be the autonomous
expenditure multiplier.
 An increase in the demand for exports of a country is an
increase in aggregate demand for domestically produced
output and will increase equilibrium income just as would an
increase in government spending or an autonomous increase
in investment.

CHAPTER -II PUBLIC FINANCE

Unit-I Fiscal Functions: An Over View
Broadly speaking, Public Finance is the study of role of the Government in a market economy with regards to allocation, income
redistribution and market stabilization.
Fiscal Functions Allocation Function
Government
Public Finance Redistribution Function
intervention
Market Failures
Stabilization Function
Allocation Function Stabilization Function
♦ The allocation responsibility of the government involves ♦ One of the key functions of fiscal policy and aims at
appropriate corrective action when private markets fail to eliminating macroeconomic fluctuations arising from
provide the right and desirable combination of goods and suboptimal allocation.
services. ♦ Concerned with the performance of the aggregate economy
♦ A variety of allocation instruments are available by which in terms of labour employment and capital utilization,
governments can influence resource allocation in the overall output and income, general price levels, economic
growth and balance of international payments.
economy such as, direct production, provision of incentives
♦ Government’s stabilization intervention may be through
and disincentives, regulatory and discretionary policies etc.
monetary policy as well as fiscal policy. Monetary policy
has a singular objective of controlling the size of money
supply and interest rate in the economy, while fiscal policy
aims at changing aggregate demand by suitable changes in
government spending and taxes.
Distribution Function
♦ Aims at redistribution of income so as to ensure equity and Fiscal Policy Challenges

fairness to promote the wellbeing of all sections of people
♦ Conflicting goals of budgetary policy.
and is achieved through taxation, public expenditure,
♦ Designing the budgetary policy in a way that the pursuit of
regulation and preferential treatment of target populations.
one does not jeopardize the other.
Unit-II Market Failure

Market Failure is a situation in which the free market fails to allocate resources efficiently in the sense that there is either
overproduction or underproduction of particular goods and services leading to less than optimal market outcomes.
Negative Production Production imposes an external

Market Power cost on others
Types of Externalities Positive Production

Production imposes external
Externalities benefits on others
Causes of Externalities Negative Consumption
Market Failure
Consumption imposes external

costs on others
Positive Consumption
Consumption imposes external
Characteristics benefits on others
Public Goods Pure and Impure
Classification Public Goods
Quasi Public Goods

Incomplete
(Mixed Goods)
Information
Global Public Goods

Market Power Public Goods
Excess market power causes the single producer or small
number of producers to produce and sell less output than A public good (also called collective consumption good or
would be produced in a competitive market. social good) is one which all enjoy in common in the sense
that each individual’s consumption of such a good leads to
Externalities no subtraction of such a good leads to no subtraction from
Externalities are initiated and experienced, not through the any other individual’s consumption of that good.
operation of the price system, but outside the market and
therefore are external to the market.
Asymmetric Information
♦ Asymmetric information occurs when there is an imbalance
Spillover in information between buyer and seller i.e. when the buyer
effects knows more than the seller or the seller knows more than the
buyer. This can distort choices. With asymmetric information,
low-quality goods can drive high-quality goods out of the
market.
Either
consumers ♦ Asymmetric information, adverse selection and moral hazard
or producers affect the ability of markets to efficiently allocate resources and
result in costs Neighbourhood therefore lead to market failure because the party with better
or benefits that effects information has a competitive advantage.
do not reflect Externalities
as part of the
market price.
Consumtion
is collective in
nature
Third-party
effects or side-
effects Inadequate
Property Non-rival –
rights and consumption of
free rider the good
problems Pure Public
goods
Externalities cause market inefficiencies because they hinder characteristics
the ability of market prices to convey accurate information
about how much to produce and how much to buy. Since
externalities are not reflected in market prices, they can be a
source of economic inefficiency.
Non-
Indivisibility Excludable
Examples of Externalities
Negative Production Externalities
When a factory which produces aluminum discharges untreated

waste water into a nearby river and pollutes the water causing
health hazards for people who use the water for drinking and
Classification of Public Goods
bathing. Pollution of river also affects fish output as there will be Excludable Non-excludable
less catch for fishermen due to loss of fish resources. Rivalrous A B
Private goods food, Common resources such
Positive Production Externalities clothing, cars as fish stocks, forest
resources, coal
A firm which offers training to its employees for increasing Non- C D
their skills. The firm generates positive benefits on other firms rivalrous Club goods, cinemas, Pure public goods such as
when they hire such workers as they change their jobs. Another private parks, satellite national defence
example is the case of a beekeeper who locates beehives in television
an orange growing area enhancing the chances of greater
production of oranges through increased pollination. ♦ The quasi-public goods or services, also called a
Quasi near public good (for e.g. education, health services)
Negative consumption externalities
Public possess nearly all of the qualities of the private
Goods goods and some of the benefits of public good. They
Smoking cigarettes in public place causing passive smoking by
others, creating litter and diminishing the aesthetic value of the exhibit market failure as incomplete markets.
room and playing the radio loudly obstructing one from enjoying
a concert.
Private ♦ Private goods are ‘rivalrous’ ‘and excludable’
Positive consumption externalities and less likely to have the free rider problem.
Good
Consumption of the services of a health club by the employees of Additional resource costs are involved for
a firm would result in an external benefit to the firm in the form providing to another.
of increased efficiency and productivity.

Unit-III Government Interventions to minimise Market Failure

♦ Governments intervene in various ways to correct the distortions in the market which occur when there are deviations
from the ideal perfectly competitive state.
♦ Government initiatives towards combating market failures due to negative externalities are either direct controls or
market-based policies that would provide economic incentives.
♦ Direct controls prohibit specific activities that explicitly create negative externalities or require that the negative externality
be limited to a certain level, for instance limiting emissions.
Government intervention to correct Market Failure
Minimise Market Correct Merit and Demerit Correcting Equitable

Power Externalities Goods Information Failure Distribution
Government interventions to Minimise Market Power Market Outcomes of Pollution Tax

♦ Because of the social costs imposed by monopoly,
governments intervene by establishing rules and regulations
designed to promote competition and prohibit actions that
are likely to restrain competition. Cost/ Marginal Private Cost
benefit Plus Tax
♦ E.g. Competition Act , 2002 (as amended by the Competition Marginal Social cost
(Amendment) Act , 2007). Marginal Private Cost
C
♦ Natural Monopolies such as electricity, gas and water supply
are subject to price control. B A 1
P1
P A
Government interventions to correct Externalities
♦ One method of ensuring internalization of negative
Marginal Social Benefit
externalities is imposing pollution taxes. Pigouvian taxes
by ‘making the polluter pay’, seek to internalize external
costs into the price of a product or activity.
Q1 Q Quantity
♦ Pollution taxes are difficult to determine and administer
due to difficulty to discover the right level of taxation,
problems associated with inelastic nature of demand for Effect of Subsidy on Output
the good and the problem of possible capital flight.
♦ Tradable emissions permits are marketable licenses to
emit limited quantities of pollutants and can be bought
and sold by polluters. The high polluters have to buy more P
S=MPC=MSC
permits and the low polluters receive extra revenue from
selling their surplus permits.
S=E
MSB
Q Q1 Quantity

Government Intervention in the case of Merit Goods: Government Intervention in the case of Demerit Goods
♦ Merit goods such as education, health care etc. ♦ Demerit goods are goods which impose significant
are socially desirable and have substantial positive negative externalities on the society as a whole and are
externalities. They are rival, excludable, limited in believed to be socially undesirable.
supply, rejectable by those unwilling to pay, and involve ♦ The production and consumption of demerit goods
positive marginal cost for supplying to extra users. are likely to be more than optimal under free markets.
♦ Left to the market, merit goods are likely to be under- The government should therefore intervene in the
produced and under-consumed so that social welfare marketplace to discourage their production and
will not be maximized. consumption.
♦ The possible government responses to under-provision
of merit goods are regulation, legislation, subsidies,
direct government provision and a combination of Outcomes of Minimum Price for a Demerit Good
government provision and market provision.
♦ When governments provide merit goods, it may give
rise to large economies of scale and productive efficiency MSC=MPC
and there will be substantial demand for the same. Minimum price
P1
B
P MPB
Market Outcome for Merit Goods A
C
Cost/
benefit Marginal Social Benefit
Marginal Private Cost
Q1 Q Quantity of
B Marginal Social Cost
alcohol consumed
A Welfare loss from
P underproduction/
underprovision
Government Intervention in the Case of Public Goods

MPB = MSB
♦ In the case of pure public goods where entry fees cannot
be charged, direct provision by governments through the
Q Q1 Quantity use of general government tax revenues is the only option.
Excludable public goods can be provided by government
and the same can be financed through entry fees.
Consumption of Merit Goods at Zero Price
Price S Price Intervention : Non-Market Pricing
♦ Price controls may take the form of either a price floor

(a minimum price buyers are required to pay) or a price
ceiling (a maximum price sellers are allowed to charge for
Free
Market a good or service).
Price ♦ When prices of certain essential commodities rise
excessively government may resort to controls in the form
of price ceilings (also called maximum price) for making
a resource or commodity available to all at reasonable
prices.
D ♦ With the objective of ensuring stability in prices and
Free
0 Q distribution, governments often intervene in grain
Quantity of
healthcare markets through building and maintenance of buffer
stocks.

Market Outcome of Minimum Support Price Market Outcome of Price Ceiling

Price Price S
S
Rs. Rs.
Price floor
150 150
Price ceiling
75 75
Q Quantity Quantity
Q1 Q2
Q1 Q2
Government Intervention for correction Information Failure Government Intervention for Equitable Distribution
♦ Government makes it mandatory to have accurate labeling ♦ One of the most important activities of the government is
and content disclosures by producers. For example: to redistribute incomes so that there is equity and fairness
SEBI requires that accurate information be provided to in the society.
♦ Some common policy interventions include:
prospective buyers of new stocks.
progressive income tax, targeted budgetary allocations,
♦ Public dissemination of information to improve unemployment compensation, transfer payments,
knowledge and subsidizing of initiatives in that direction. subsidies, social security schemes, job reservations, land
♦ Regulation of advertising and setting of advertising reforms, gender sensitive budgeting etc.
standards to make advertising more responsible, ♦ Government also intervenes to combat black economy
informative and less persuasive. and market distortions associated with a parallel black
economy
Unit-IV Fiscal Policy

Fiscal Policy: The focus of fiscal policy is on the aggregate economic activity of governments, aggregate expenditure, taxes,
transfers and issues of government debts and deficits and their effects on aggregate economic variables such as total output total
employment, unemployment rate, inflation, overall economic growth etc.
Through the use of budgetary instruments such as public revenue, public expenditure, public debt and deficit financing,
governments intend to favourably influence the level of economic activity of a country.
Fiscal Policy
Expansionary Fiscal Policy
Automatic
An expansionary fiscal policy is used to address recession and the
Objectives of Stabilizers
problem of general unemployment on account of business cycles.
Fiscal Policy Versus Instruments of Types of Fiscal
Discretionary Fiscal Policy Policy Expansionary Fiscal policy for Combating Recession
Fiscal Policy
Price LAS SAS1
Level
The objectives of Fiscal Policy SAS2
♦ Achievement and maintenance of full employment.
♦ Maintenance of price stability.
♦ Acceleration of the rate of economic development and P2
equitable distribution of income and wealth. P1
P3 AD2
Types of Fiscal Policy AD1

♦ Expansionary Fiscal Policy
♦ Contractionary Fiscal Policy Y1 Y2 Real GDP ( Y)

Instruments of Fiscal Policy Fiscal Policy for long term Economic Growth
♦ Government Expenditure : Generates income and also effect ♦ A well designed tax policy that rewards innovation and
of multiplier. entrepreneurship, without discouraging incentives will
♦ Taxes : Determine the size of the disposable income of public. promote private businesses who wish to invest and thereby
♦ Budget : A widely used tool to stimulate or contract aggregate help the economy grow.
demand.
♦ Public Debt: Public Borrowing and Debt Repayment system.
Fiscal Policy for Inequalities of Income and Wealth

Contractionary Fiscal Policy : Eliminating an inflationary gap
♦ A progessive direct tax system
♦ Decrease in government spending.
♦ Indirect taxes can be differential
♦ Increase in personal income taxes and/or business taxes.
♦ A carefully planned policy of expenditure
♦ A combination of decrease in government spending and
increase in personal income taxes and/or business taxes.
Contractionary Fiscal policy for Combating inflation Fiscal Policy Limitations
Price SAS2 ♦ In respect of choice of appropriate policy

Level ♦ Recognition lag
SAS1 ♦ Decision lag
♦ Implementation lag
♦ Impact lag
P3
P2
AD2
P1
AD1
Y
Real GDP ( Y)
CHAPTER-III MONEY MARKET

Unit-I The concept of Money Demand: Important theories
Money refers to assets which are commonly used and accepted as a means of payment or as a medium of exchange or of transferring
purchasing power.
A Medium of
Exchange
Functions of
Money
Money
Characteristics Classical
of Money Approach(QTM) A Standard
A Store of Value
Neo Classical of Postponed
Theories of Approach Payment
Demand for
Money Keynesian Theory Inventory Approach Functions of
of Demand to Transaction Money
Balances (Baumol)
Post-Keynesian
Development in
the Theory of Friedman’s
Demand for Money Restatement of the
Quantity Theory
The Basis of
A Unit of Credit
The demand for Account
Money as Behavior
towards Risk

♦ Generally acceptable
♦ Durable or long-lasting The Keynesian Theory of Demand for Money
♦ Difficult to counterfeit i.e. not easily
reproducible by people ♦ Keynes’ theory of demand for money is known as ‘Liquidity
♦ Relatively scarce, but has elasticity of Preference Theory’. ‘Liquidity preference’, a term that
Characterstics supply was coined by John Maynard Keynes in his masterpiece
of Money ‘The General Theory of Employment, Interest and Money’
♦ Portable or easily transported
♦ Possessing uniformity (1936), denotes people’s desire to hold money rather than
♦ Divisible into smaller parts in usable securities or long-term interest-bearing investments.
quantities or fractions without losing value
♦ Effortlessly recognizable
People hold money (M) in cash for three motives
Demand for Money
The demand for money is derived demand and is a decision Transactions motive
about how much of one’s given stock of wealth should be held ♦ The transactions motive for holding cash relates to ‘the
in the form of money rather than as other assets such as bonds
need for cash for current transactions for personal and
business exchange’.
Classical Approach : The Quantity Theory of Money ♦ Lr = kY, Where, Lr is the transactions demand for money,
♦ One of the oldest theories of Economics, was first propounded by k is the ratio of earnings which is kept for transactions
Irving Fisher of Yale University in his book ‘The Purchasing Power purposes and Y is the earnings.
of Money’ published in 1911. ♦ The aggregate transaction demand for money is a function
♦ There is strong relationship between money and price level and of national income.
the quantity of money is the main determinant of the price level
or the value of money. Precautionary motive
Fisher’s version of Equation : Equation of Exchange of ♦ Precautionary motive is to meet unforeseen and un
predictable contingencies involving money payments and
Transaction approach : MV = PT
depends on the size of the income, prevailing economic
♦ Where, M= the total amount of money in circulation (on an as well as political conditions and personal characteristics of
average) in an economy. the individual such as optimism/ pessimism, farsightedness
♦ V = transactions velocity of circulation i.e. the average number of etc.
times across all transactions a unit of money (say Rupee) is spent
in purchasing goods and services.
♦ P = average price level (P= MV/T). Speculative motive
♦ T = the total number of transactions. ♦ The speculative motive reflects people’s desire to hold cash
Fisher’s Extended version : Equation of Exachange to in order to be equipped to exploit any attractive investment
opportunity requiring cash expenditure.
include demand ( bank) deposits (M’) and Velocity in the
♦ The speculative demand for money and interest are inversely
total supply of Money : MV + M’V’ = PT
related.
The Neo classical Approach: The Cambridge approach
♦ In the early 1900s, Cambridge Economists Alfred Individual’s Speculative Demand for Money
Marshall, A.C. Pigou, D.H. Robertson and John Maynard
Keynes (then associated with Cambridge) put forward
a fundamentally different approach to quantity theory,
known neo classical theory or cash balance approach. m
Money increases utility in the following two ways

Interest Rate
♦ Enabling the possibility of split-up of sale and purchase to

two diffeent points of time rather than being simultaneous. rc
♦ Being a hedge against uncertainty.
Cambridge equation = Md = k PY
♦ Where Md = is the demand for money, Y = real national

income, P = average price level of currently produced
goods and services, PY = nominal income, k = proportion
of nominal income (PY) that people want to hold as cash
M2
balances.
Speculative Demand for Money.

Aggregate Speculative Demand for Money ♦ The Demand for Money as Behaviour
toward as ‘aversion to risk’ propounded
by Tobin states that money is a safe asset
but an investor will be willing to exercise a
trade-off and sacrifice to some extent the
r* The Demand higher return from bonds for a reduction
for Money
in risk.
Interest rate as Behaviour
toward Risk ♦ According to Tobin, rational behaviour
induces individuals to hold an optimally
r1 structured wealth portfolio which is
r2 Liquidity Trap comprised of both bonds and money and
Region the demand for money as a store of wealth
r0
depends negatively on the interest rate.
Unit -II Concept of Money Supply

0 M1 M2 M3 M4
The measures of money supply vary from country to country,
Speculative Demand for Money from time to time and from purpose to purpose.
An increase in income increases the transction and

precautionary demand for money and also a rise in the rate of The Concept of
interest decreases the demand for speculative demand money. Money Supply
The Sources Measurement Determinants The Concept

♦ Inventory Approach to Transaction
of Money of Money of Money of Money
Balances (Baumol) Supply Supply Supply Multiplier
♦ Baumol (1952) and Tobin (1956)
developed a deterministic theory of
Post- transaction demand for ‘real cash balance’, Importance of
Keynesian known as Inventory Theoretic Approach, Money Supply
Development in which money is essentially viewed as an
in the Theory
of Demand inventory held for transaction purposes.
for Money ♦ People hold an optimum combination of Monetary Monetary Policy Price Stability &
bonds and cash balance, i.e., an amount Development perspective GDP Growth
that minimizes the opportunity cost.
♦ The optimal average money holding is: a
♦ The central banks of all countries are
positive function of income Y, a positive empowered to issue currency and
function of the price level P, a positive therefore, the central bank is the primary
function of transactions costs c, and a source of money supply in all countries. In
negative function of the nominal interest effect, high powered money is the source
Sources of of all other forms of money.
rate i. Money Supply
♦ The supply responses of the commercial
banking system of the country to the
changes in policy variables initiated by
♦ Milton Friedman (1956) extending the central bank to influence the total
Keynes’ speculative money demand money supply in the economy. In India,
within the framework of asset price RBI is the Central Bank.
theory holds that demand for money is
♦ The measures of money supply vary from
Friedman’s affected by the same factors as demand country to country, from time to time and
Restatement
for any other asset, namely, permanent from purpose to purpose.
of the
income and relative returns on assets. ♦ Measurement of money supply is
Quantity
essenetial as it enables a framework to
Theory ♦ The nominal demand for money is Measurement evaluate whether the stock of money in the
positively related to the price level, P; of Money economy is consistent with the standards
rises if bonds and stock returns, rb and Supply for price stability, to understand the
nature of deviations from this standard
re , respectively decline and vice versa; is and to study the causes of money growth.
influenced by inflation; and is a function ♦ In India RBI has been publishing data
of total wealth. on four alternative measures of money
supply denoted by M1, M2, M3, M4 besides
the reserve money.

M1 = Currency and coins with the people + demand Current Practice : Money Multiplier Approach to
deposits of banks (Current and Saving accounts) + Supply of Money
other deposits with the RBI. ♦ The money multiplier is a function of the currency ratio which
M2 = M1 + savings deposits with post office savings banks.
depends on the behaviour of the public, excess reserves ratio of
M3 = M1 + net time deposits with the banking system.
M4 = M3 + total deposits with the Post Office Savings the banks and the required reserve ratio set by the central bank.
Organization (excluding National Savings The money multiplier approach to money supply propounded
Certificates). by Milton Friedman and Anna Schwartz, (1963) considers three
factors as immediate determinants of money supply
a) the stock of high-powered money (H)
New Monetary Aggregates b) the ratio of deposit to reserve, e = {ER/D} and
c) the ratio of deposit to currency, c ={C/D}
♦ Based on the recommendations of the Working Group on
Money (1998), the RBI has started publishing a set of four The additional units of high powered money that goes into
new monetary aggregates on the basis of the balance sheet ‘excess reserves’ of the commercial banks do not lead to any
of the banking sector in conformity with the norms of additional loans and therefore, these excess reserves do not lead
progressive liquidity. The new monetary aggregates are : to the creation of deposits.
When the required ratio falls, there will be multiple expansions

 Reserve money, also known as central bank money, base for demand deposits
money or high powered money, determines the level of
liquidity and price level in the economy.
Excess Reserve
Reserve Money = Currency in circulation + Bankers’ deposits Ratio is
with the RBI + Other deposits with the RBI negatively related Market Interest
= Net RBI credit to the Government + RBI to the
Rate.
credit to the Commercial sector + RBI’s
Claims on banks + RBI’s net Foreign assets
+ Government’s Currency liabilities to the
public – RBI’s net non-monetary Liabilities
NM1 = Currency with the public + Demand deposits with ♦ When the Reserve Bank lends to the
Effect of governments under WMA /OD it results
the banking system + ‘Other’ deposits with the RBI. Government in the generation of excess reserves (i.e.
NM2 = NM1 + Short-term time deposits of residents Expenditure excess balances of commercial banks with
(including and up to contractual maturity of one on Money the Reserve Bank).
year). supply
NM3 = NM2 + Long-term time deposits of residents + Call/
Term funding from financial institutions ♦ The Credit Multiplier also referred to
as the deposit multiplier or the deposit
expansion multiplier, describes the
Liquidity aggregates The Credit amount of additional money created by
L1 = NM3 + All deposits with the post office savings banks Multiplier commercial bank through the process
(excluding National Savings Certificates). of lending the available money it has
L2 = L1 +Term deposits with term lending institutions and in excess of the central bank’s reserve
refinancing institutions (FIs) + Term borrowing by FIs + requirements.
Certificates of deposit issued by FI’s.
L3 = L2+ Public deposits of non-banking financial companies Unit -III Monetary Policy
Determinants of Money Supply : Two Theories Monetary policy refers to the use of monetary policy instruments
which are at the disposal of the central bank to regulate the
♦ Determined exogenously by central bank. availability, cost and use of money and credit to promote economic
♦ Determined endogenously by changes in the economic growth, price stability, optimum levels of output and employment,
balance of payments equilibrium, stable currency or any other goal
activities which affect peoples desire to hold currency of government’s economic policy.
relative to deposites, rate of interest etc.
The concept of money multiplier Objectives of Monetary Policy

The money supply is defined as
The Monetary Policy
Monetary Policy
Analytics of Monetary Policy

Framework
M= m X MB Operating Procedures &
Where M is the money supply, m is money multiplier and MB is Instruments
the monetary base or high powered money. The Monetary Policy
The Organisational Framework Agreement
Money Multiplier( m) = Money Supply Structure for Monetary
Monetary Base Policy Decisions The Monetary Policy
Committee ( MPC)

♦ Price Stability Direct

Instruments
Objectives ♦ Economic Growth
of Monetary ♦ Ensuring an adequate flow of credit
Policy ♦ Creation of an efficient market for
government securities Cash Reserve
Ratio and Credit to Priority Administered
Liquidity Reserve Sector Interest Rate
Ratio
Interest Rate
Channel
Indirect
Instruments
Open Market Standing Market-based

Repos Operations facilities Discount
Asset Price Analytics of Exchange Rate Window
Channel Monetary Channel
Policy
Cash Reserve Ratio
♦ The Cash Reserve Ratio (CRR) refers to the fraction of the

total net demand and time liabilities (NDTL) of a scheduled
commercial bank in India which it should maintain as cash
Quantum deposit with the Reserve Bank irrespective of its size or
Channel
financial position.
A contractionary monetary policy-induced increase in interest Lower will be

rates increases the cost of capital and the real cost of borrowing Higher the liquidity in the
for firms and households who respond by cutting back on their CRR with the system and vice
investment and purchase expenditures respectively. RBI versa
The exchange rate channel works through expenditure switching

between domestic and foreign goods on account of appreciation
/ depreciation of the domestic currency with its impact on net
exports and consequently on domestic output and employment. Statutory Liquidity Ratio
♦ The Statutory Liquidity Ratio (SLR) is what the scheduled

Two distinct credit channels- the bank lending channel and the commercial banks in India are required to maintain as a
balance sheet channel- operate by altering access of firm and stipulated percentage of their total Demand and Time
household to bank credit and by the effect of monetary policy on Liabilities (DTL) / Net DTL (NDTL) in Cash, Gold or
the firm’s balance sheet respectively.
approved investments in securities.
♦ The SLR is also a powerful tool for controlling liquidity
Asset prices generate important wealth effects that impact,
in the domestic market by means of manipulating bank
through spending, output and employment.
credit. Changes in the SLR chiefly influence the availability
of resources in the banking system for lending.
Operating
Framework
A rise in the SLR
which is resorted to a rising fraction of a bank’s
Choosing the Choosing the Choosing the during periods of assets in the form of eligible
operating target intermediate target policy instruments instruments, and this reduces the
(e.g. Economic (e.g. Cash Reserve high liquidity, tends
(e.g. Inflation) Stability) Ratio) to lock up credit creation capacity of banks.
Monetary Policy
Instruments A reduction in has the opposite effect. The SLR
the SLR during requirement also facilitates a
periods of economic captive market for government
Direct Indirect downturn securities.

Treasury bills of the ♦ Repo or repurchase option is a

Government of India
Statutory Liquidity Ratio
Cash collaterised lending because banks

borrow money from Reserve bank
Dated Securities of India to fulfill their short term
Gold monetary requirements by selling
securities to RBI with an explicit
State Government Loans agreement to repurchase the same
at predetermined date and at a fixed
Investment Policy Rate
Other insturments as notified rate. The rate charged by RBI for this
by RBI transaction is called the ‘repo rate’.
♦ Reverse Repo is defined as
an instrument for lending
funds by purchasing securities with
an agreement to resell the securities
Types of Repo
Market on a mutually agreed future date at an
agreed price which includes interest
for the funds lent .
Repo on
Repo on Corporate Other Repos ♦ The Monetary Policy Committee
sovereign debt securities
securities (MPC) consisting of six members shall
determine the policy rate to achieve
the inflation target through debate and
♦ The Liquidity Adjustment Facility(LAF) majority vote by a panel of experts.
is a facility extended by the Reserve ♦ The Monetary Policy Framework
Bank of India to the scheduled Agreement is an agreement reached
commercial banks (excluding RRBs) between the Government of India and
The Liquidity and primary dealers to avail of liquidity the Reserve Bank of India (RBI) on the
Adjustment in case of requirement (or park excess Monetary maximum tolerable inflation rate as 4
(LAF) funds with the RBI in case of excess Policy per cent Consumer Price Index (CPI)
liquidity) on an overnight basis against Committee inflation with a deviation of 2 percent.
the collateral of government securities ♦ Choice of a monetary policy action
including state government securities. is rather complicated in view of the
surrounding uncertainties and the
♦ In India, the fixed repo rate quoted for need for exercising complex judgment
sovereign securities in the overnight to balance growth and inflation
segment of Liquidity Adjustment concerns. Additional complexities
Policy Rate
Facility (LAF) is considered as the arise in the case of an emerging market
‘policy rate’. like India.
CHAPTER-IV INTERNATIONAL TRADE

Unit-I: Theories of International Trade
International trade is the exchange of goods and services as well as resources between countries and involves greater complexity
compared to internal trade
♦ Theories ♦ Innovative products at lower prices

International ♦ Wider choice in products and services for consumers are
♦ Important Theories of International
Trade Trade also claimed as benefits of trade
♦ Enhanced foreign exchange reserves
Arguments in favour of International Trade ♦ Increased scope for mechanization and specialisation,
research and development
♦ Contributes to economic growth and rising incomes ♦ Creation of jobs
♦ Enlarges manufacturing capabilities ♦ Reduction in poverty
♦ Ensures benefits from economies of large scale production ♦ Raising standards of livelihood
♦ Enhances competitiveness and profitability by adoption of ♦ Increase in overall demand for goods and services
cost reducing technology business practices ♦ Prospects of employment generating investments
♦ Deployment of productive resources ♦ Improvement in the quality of output
♦ Domestic monopolies ♦ Labour and environmental standards
♦ Cost- effective sourcing of inputs and components ♦ Broadening of productive base
internationally ♦ Development and strengthening of bonds between nations.

Arguments against International Trade Unit-II The Instruments of Trade Policy

♦ Negative labour market outcomes Trade policy encompasses all instruments that governments
♦ Economic exploitation may use to promote or restrict imports and exports
♦ Exhaustion of Natural Resources
♦ May result in consumerism
♦ Dependence Tariffs
♦ May result in Inflation
♦ Disregard for welfare of people
♦ Quick transmission of trade cycles The Instruments of
♦ Rivalries and risks in trade associated with changes in Non-Tariff Measures
governments’ policies of participating countries Trade Policy (NTMs)
Export-Related
Important Theories of International Trade Measures
The Mercantilist View of International Trade
♦ Mercantilism advocated maximizing exports in order to Tariff

bring in more precious metals and minimizing imports
through the state imposing very high tariffs on foreign ♦ Tariff, also known as customs duty is defined as a financial
goods. charge in the form of a tax, imposed at the border on goods
going from one customs territory to another. Tariffs are the
most visible and universally used trade measures.
The Theory of Absolute Advantage: Adam Smith
♦ According to Adam Smith’s Absolute Cost Advantage

theory, a country will specialize in the production and Forms of Import Tariffs
export of a commodity in which it has an absolute cost
advantage.
♦ A specific tariff is an import duty that assigns a
The Theory of Comparative Advantage : Ricardo Specific fixed monetary tax per physical unit of the good
Tariff imported whereas an ad valorem tariff is levied as
♦ Ricardo’s theory of comparative advantage states that a a constant percentage of the monetary value of one
nation should specialize in the production and export of the unit of the imported good.
commodity in which its absolute disadvantage is smaller
(this is the commodity of its comparative advantage) and
import the commodity in which its absolute disadvantage
is greater (this is the commodity of its comparative ♦ An ad valorem tariff is levied as a constant
Ad
disadvantage). percentage of the monetary value of one unit of the
valorem
tariff imported good.
The Heckscher-Ohlin Theory of Trade
♦ The Heckscher-Ohlin theory of trade, also referred to as

Factor-Endowment Theory of Trade or Modern Theory ♦ Mixed Tariff
of Trade, states that comparative advantage in cost of ♦ Compound Tariff or a Compound Duty
production is explained exclusively by the differences in ♦ Technical/Other Tariff
factor endowments. ♦ Tariff Rate Quotas
♦ Most-Favored Nation Tariffs
Other ♦ Variable Tariff
Tariff ♦ Preferential Tariff
Factor-Price Equalization Theorem
♦ Bound Tariff
♦ Applied Tariffs
♦ The Factor-Price Equalization Theorem states that
♦ Escalated Tariff
international trade equalizes the factor prices between
♦ Prohibitive Tariff
the trading nations. Therefore, with free trade, wages and
♦ Important subsidies
returns on capital will converge across the countries.
♦ Tariffs as a Response
New Trade Theory

Anti-dumping Duties
♦ New Trade Theory is the latest entrant to explain the
rising proportion of world trade in the developed world ♦ Dumping occurs when manufacturers sell goods in a
and bigger developing economies (such as BRICS) which foreign country below the sales prices in their domestic
trade in similar products. These countries constitute more market or below their full average cost of the product. It
than 50% of world trade. Accoring to this theory, two key hurts domestic producers
concepts ♦ Anti-dumping measures are additional import duties so as
♦ Economies of Scale and Network effects, affects to offset the foreign firm’s unfair price advantage.
international tarde in a major way.

Countervailing Duties
♦ Government Procurement Policies : Govt.
♦ Countervailing duties are tariffs to offset the artificially low may lay down policies w.r.t procurements.
prices charged by exporters who enjoy export subsidies ♦ Trade-Related Investment Measures : May
and tax concessions offered by the governments in their include rules on local content requirements
home country. of production.
Non- ♦ Distribution Restrictions.
Technical ♦ Restriction on Post-sales Services.
Measures ♦ Administrative Procedures.
♦ Rules of Origin : To determine the national
Create source of a product.
obstacles to ♦ Safeguard Measures : Initiated by countries
trade to restrict imports of a product temporarily
Increase Reduce the if its domestic industry is injured.
government prospect ♦ Embargos : Total ban on import or export
revenues of market of some commodition to a particular
access country or region for some or indefinits
period.
Effects of
Tariff
Protect Export Related Measures

Make
domestic imported
goods more ♦ Ban of Export : Exports of certain items may be banned
industries
expensive during shortages.
Increase ♦ Export Taxes : An export tax is a tax collected on exported
consumption goods and may be either specific or ad valorem and an
of domestic
goods export subsidy includes financial contribution to domestic
producers in the form of grants, loans, equity infusions also
usually provide etc. or give some form of income or price
support. Both distort trade.
Non-Tariff Measures ♦ Export subsidies and Incentives: Given by government to
boost exports.
♦ Non-tariff measures (NTMs) are policy measures, other ♦ Voluntary Export-Restraints : Voluntary Export Restraints
than ordinary customs tariffs, that can potentially have an (VERs) refer to a type of informal quota administered by
economic effect on international trade in goods, changing an exporting country voluntarily restraining the quantity
quantities traded or prices or both. of goods that can be exported out of a country during a
specified period of time, imposed based on negotiations to
appease the importing country and to avoid the effects of
possible trade restraints.
Category of Non-Tariff Measures
Technical Measures
Unit-III Trade Negotiations
♦ Sanitary and Phytosanitary (SPS) measures : applied to International trade negotiations, especially the ones aimed at
protect human, animal or plant life from risks arising from formulation of international trade rules, are complex interactive
addition, pests, contaminants, toxins or disease causing processes engaged in by countries having competing objectives.
organisms.
♦ Technical Barriers to Trade specifying details such as size,
shape, design, labelling/marking etc. Trade
Negotiations
♦ Non-technical measures relate to trade

requirements; for example; shipping RTAs GATT WTO
requirements, custom formalities, trade
rules, taxation policies, etc.
♦ Import Quotas: Restrictions on physical
♦ Unilateral trade agreements
Non- amount of imported goods.
♦ Price Control Measures : Imposing taxes on ♦ Bilateral agreements
Technical Major
Measures charges. ♦ Regional preferential trade agreements
Types of
♦ Non Automatic Licensing and Prohibitions: ♦ Trading bloc
Agreements
limiting or prohibiting certain types of ♦ Free-trade area
in
import.
International ♦ Customs union
♦ Financial Measures : Regulating access to
Trade
and cost of foreign exchange. ♦ Common market and economic and
♦ Measures Affecting Competition : Granting monetary union
exclusive or special preferences to one or a
few limited group of economic operations.

GATT Important Agreements under WTO
♦ The General Agreement on Tariffs and Trade (GATT) ♦ Rules of origin

provided the rules for much of world trade for 47 years ♦ Import licensing procedures
from 1948 to 1994. ♦ Subsidies and countervailing measures
♦ Eight multilateral negotiations known as trade rounds held ♦ Safeguards, Trade in Services (GATS)
under the GATT auspices. ♦ Intellectual Property Rights (TRIPS)
♦ The 8th of the Uruguay Round of 1986-94 was last under ♦ Settlement of Disputes (DSU)
GATT and culminated in the birth of WTO. ♦ Trade Policy Review Mechanism (TPRM)
♦ Plurilateral trade agreements on trade in civil aircraft
and government procurement.
WTO The principal objective of the
The eighth of the Uruguay WTO
Round of 1986-94, was the last To facilitate the flow of
and most consequential of all international trade smoothly, ♦ Slow progress of multilateral negotiations
rounds and culminated in the freely, fairly and predictably. ♦ Uncertainties resulting from regional trade
birth of WTO and a new set agreements
of agreements replacing the ♦ Inadequate or negligible trade liberalisation
General Agreement on Tariffs ♦ Those which are specific concerns to the developing
and Trade (GATT). A Few countries
concerns ♦ Protectionism and lack of willingness among
developed countries to provide market access
The WTO does its functions The WTO Activities of WTO
♦ Difficulties that they face in implementing the
by acting as a forum for trade are supported by the
present agreements
negotiations among member Secretariat located in Geneva,
♦ Apparent north-south divide
governments, administering headed by a Director General.
♦ Exceptionally high tariffs
trade agreements, reviewing It has a three-tier system of
♦ Tariff escalation, erosion of preferences and
national trade policies, decision making. The top
difficulties with regard to adjustments.
cooperating with other level decision-making body is
international organizations the Ministerial Conference,
and assisting developing followed by councils namely, The Doha Round, formally the Doha Development Agenda
countries in trade policy issues the General Council and
through technical assistance the Goods Council, Services ♦ The ninth round since the Second World War was officially
and training programmes. Council and Intellectual launched at the WTO’s Fourth Ministerial Conference in
Property (TRIPS) Council. Doha, Qatar, in November 2001.
♦ Sought to accomplish major modifications of the
Members International trading system through lower trade barriers
The WTO currently has 164 members, of which 117 are and revised trade rules
developing countries or separate customs territories ♦ Include 20 areas of trade.
accounting for about 95% of world trade.
The major guiding principles of the WTO Unit-IV Exchange Rate and its Economic Effects
♦ Trade without discrimination, most-favoured-nation Exchange rate is the rate at which the currency of one country
treatment(MFN) exchanges for the currency of another country.
♦ The National Treatment Principle (NTP)
♦ Freer trade
♦ Predictability The Exchange Rate
♦ General prohibition of quantitative restrictions Regimes
♦ Greater competitiveness Exchange
International Rate and its Changes in
♦ Tariffs as legitimate measures for protection
Economic Exchange Rates
♦ Transparency in decision making Trade
Effects
♦ Progressive liberalization Devaluation Vs
♦ Market access Depreciation
♦ A transparent, effective and verifiable dispute settlement
mechanism.
Important Agreements under WTO

Exchange Rate
♦ Agriculture
♦ SPS measures
♦ Textiles and clothing Direct Quote Indirect Quote
♦ Technical barriers to trade (TBT)
♦ Trade-related investment measures (TRIMs)
♦ Anti-dumping
♦ Customs valuation Foreign Currency is the Domestic Currency is
♦ Pre-shipment inspection (PSI) Base Currency the Base Currency (e.g.
(e.g. ` 66/US) $ 0.151 per rupee)

Cross rate Usually, the supply of and Changes in exchange rates

demand for foreign exchange ♦ portray depreciation or
♦ The rate between Y and Z which is derived from the given in the domestic foreign appreciation of one currency.
rates of another set of two pairs of currency (say, X and Y, exchange market determine
and, X and Z) is called cross rate. ♦ The terms, `currency
the external value of the appreciation’ and ‘currency
domestic currency, or in other depreciation’ describe the
Exchange Rate Regime words, a country’s exchange movements of the exchange
rate. rate.
♦ An exchange rate regime is the system by which a country
manages its currency in respect to foreign currencies.
Appreciation & Depreciation of Currency
♦ when its value increases with respect to the value of another
Floating Exchange Rate Regime
currency or a basket of other currencies. On the contrary,
currency depreciates when its value falls with respect to the
♦ The equilibrium value of the exchange rate of a country’s
value of another currency or a basket of other currencies.
currency is market determined i.e. the demand for and
supply of currency relative to other currencies determines
the exchange rate. Effect of Depreciation Effect of Appreciation
♦ A floating exchange rate allows a government to pursue ♦ Exchange rate ♦ An appreciation of a country’s
its own independent monetary policy and there is no need depreciation lowers currency changes in import and
of market intervention or maintenance of reserves. But,
the relative price of export prices will lead to changes in
volatile exchange rates generate a lot of uncertainties in
a country’s exports, import and export volumes, causing
relation to international transactions.
♦ Examples : Advanced economies like U.S.A, New Zealand, raises the relative changes in import spending and
Sweden. price of its imports, export revenue
increases demand ♦ adversely affect the competitiveness
both for domestic of domestic industry, cause larger
Fixed Exchange Rate import-competing deficits and worsen the current
goods and for exports, account
♦ Also referred to as pegged exchanged rate, is an exchange leads to output
rate regime under which a country’s government
expansion, encourages Devaluation
announces, or decrees, what its currency will be worth in ♦ is a deliberate downward
economic activity,
terms of either another country’s currency or a basket of adjustment in the value of a
increases the country’s currency relative to
currencies or another measure of value, such as gold.
♦ A central bank may implement soft peg policy under which international another currency, group of
competitiveness of currencies or standard.
the exchange rate is generally determined by the market,
or a hard peg where the central bank sets a fixed and domestic industries,
unchanging value for the exchange rate. increases the
♦ A fixed exchange rate avoids currency fluctuations and volume of exports
eliminates exchange rate risks and transaction costs, and promotes trade
enhances international trade and investment and lowers balance.
the levels of inflation. But, the central bank has to maintain
an adequate amount of reserves and be always ready to Determination of Nominal Exchange Rate
intervene in the foreign exchange market.
♦ Examples : Cuba, Hongkong, Dijibouti.
e
S$
Nominal Vs Real Exchange Rate
♦ Nominal Exchange Rate states how much of one currency

Exchange Rate Rs/$
can be traded for a unit of another currency.

♦ Real Exchange Rate : The ‘real exchange rate’ incorporates
changes in prices and describes ‘how many’ of a good or e eq
service in one country can be traded for ‘one’ of that good
or service in a foreign country.
♦ Real exchange rate =
Domestic price Index
Nominal exchange rate X
Foreign price Index
D$
♦ Real Effective Exchange Rate (REER) is the nominal
effective exchange rate (a measure of the value of a currency
against a weighted average of several foreign currencies)
divided by a price deflator or index of costs. Qe $

Home-Currency Depreciation under Floating Forward and /or Future Market

Exchange Rates ♦ Contracts buy or sell currencies for furture delivery which are
e carried out in forward and/or future
S$
♦ Current transactions which are carried out in the spot market
and contracts to buy or sell currencies for future delivery
Exchange Rate Rs/$
el El which are carried out in forward and futures markets

e eq E
Unit-V International Capital Movements
D1 $ Foreign capital may flow into an economy in different ways,
such as foreign aid, grants, borrowings, deposits from non
D$ resident Indians, investments in the form of Foreign Portfolio
Investment (FPI) and Foreign Direct Investment (FDI)
Qe Q1 $ (Billions)
International Trade
Home-Currency Appreciation under Floating
Exchange Rates
International Capital
e Movements
S$
S1 $
FDI FPI
Exchange Rate Rs/$
E
e eq Foreign direct investment is defined as a process whereby the
resident of one country (i.e. home country) acquires ownership
of an asset in another country (i.e. the host country) and such
e1 E1 movement of capital involves ownership, control as well as
management of the asset in the host country.
D$ Direct investments are real investments in factories, assets,

land, inventories etc. and have three components, viz., equity
O capital, reinvested earnings and other direct capital in the form
Qe Q1 $ (Billions) of intra-company loans. FDI may be categorized as horizontal,
vertical or conglomerate. Two- way direct foreign investments
reciprocal investments.
Foreign Exchange Market
Foreign portfolio investment is the flow of ‘financial capital’
with stake in a firm at below 10 percent, and does not involve
manufacture of goods or provision of services, ownership
The wide-reaching collection of markets and institutions that
management or control of the asset on the part of the investor.
handle the exchange of foreign currencies is known as the foreign
exchange market.
The main reasons for foreign direct investment are
♦ Profits
Being an over-the-counter market, it is not a physical place;
♦ Higher rate of return
rather, it is an electronically linked network bringing buyers and
♦ Possible economies of large-scale operation
sellers together and has only very narrow spreads. ♦ Risk diversification
♦ Retention of trade patents
♦ Capture of emerging markets
On account of arbitrage, regardless of physical location, at any
♦ Lower host country environmental and labour standards,
given moment, all markets tend to have the same exchange rate ♦ Bypassing of non tariff and tariff barriers
for a given currency. Arbitrage refers to the practice of making ♦ Cost–effective availability of needed inputs and tax and
risk-less profits by intelligently exploiting price differences of an investment incentives.
asset at different dealing places.
Foreign direct investment takes place through
Types of transactions in a forex market ♦ Opening of a subsidiary or associate company

♦ Equity injection
Spot Market ♦ Acquiring a controlling interest
♦ Mergers and acquisitions (M&A)
♦ Current transactions which are carried out in the spot market ♦ Joint venture and green field investment
and exchange involves immediate delivery

Benefits of foreign direct investment Benefits of foreign direct investment
♦ Include positive outcomes of competition such as cost- ♦ Exercising monopoly power

reducing and quality-improving innovations ♦ Decrease competitiveness of domestic companies
♦ Higher efficiency ♦ Potentially jeopardize national security and sovereignty
♦ Huge variety of better products and services at lower prices ♦ Worsen commodity terms of trade and cause emergence of a
♦ Welfare for consumers, multiplier effects on employment dual economy
♦ Output and income, relatively higher wages
♦ Better access to foreign markets
FDI in India
♦ Control of domestic monopolies and betterment of
balance of payments position ♦ Mostly a post reform phenomenon is a major source of non-
♦ Potential problems of foreign direct investment debt financial resource for economic development.
♦ Include use of inappropriate capital- intensive methods in ♦ The government has at different stages, liberalized FDI
a labour-abundant country by increasing sectoral caps, bringing in more activities
♦ Increase in regional disparity under automatic route and easing of conditions for foreign
♦ Crowding-out of domestic investments investment.
♦ Diversion of capital resulting in distorted pattern of ♦ Overseas direct investments by Indian companies, made
production and investment possible by progressive relaxation of capital controls and
♦ Instability in the balance of payments and exchange rate simplification of procedures for outbound investments from
and indiscriminate repatriation of the profits. India, have undergone substantial changes in terms of size,
♦ Anti-ethical market distortions geographical spread and sectoral composition. Outward
♦ Off–shoring or shifting of jobs Foreign Direct Investment (OFDI) from India stood at US$
♦ Overexploitation of natural resources causing 1.86 billion in the month of June 2016.
environmental damage

Intermediate Course
Advanced Accounting
END
ISBN : 978-81-8441-882-8
Module - 1
Board of Studies

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Intermediate Course

CHAPTER 1: INTRODUCTION TO ACCOUNTING STANDARDS

Concepts & Benefits Accounting Significance of

International Financial International

Issuance of Accounting Standards

Recognition Measurement Presentation

The Chartered Accountant Student October 2017

Accounting Standards Setting Process Significance of Global Standards

Constitution of study group

Finalisation of exposure draft (E.D.)

Effectively, there are now only 27 Accounting Standards.

October 2017 The Chartered Accountant Student

Ind AS Indian Accounting Standards - Benefits

Objectives and Concepts of Carve Outs

Sent to Formulation of Ind AS

Resulting into carve-outs Not resulting into carve-outs

Earlier Ind AS to be implemented from

The Chartered Accountant Student October 2017

Accounting for Transfer to Declaration

Meaning of Company and Maintenance of Books of Accounts of a Company

books of accounts, relevant books and financial statements

Preparation of Financial Statements Requisites of Financial Statements

October 2017 The Chartered Accountant Student

Remuneration Payable by Companies having no Profit or Inadequate Profit without Central

factors, e.g., their composition, the amount of

provisions and appropriations that must be

Declaration and Payment of Dividend

No Dividend can be declared except out of

Trading profits after Money provided (in pursuance

Capital cannot be returned to the shareholders by way of dividend.

Total amount drawn from

Drawn amount should first incurred in the FY in which dividend is

After such withdrawal should

No company should declare dividend

Transfer to Reserves Disclosure and Presentation of DDT in

Dividend Distribution Tax (DDT)

Accounting income as per Taxable income as per

DDT paid Differences between accounting income &

October 2017 The Chartered Accountant Student

Definition of Cash Flow Statement

Cash flow statement is a summary of

Significance of Cash Flow Statement

Historical Short term highly liquid

Cash increase Cash decrease

The Chartered Accountant Student October 2017

Classification of Cash Flow Activities

Classification of Cash Flow Activities

Investing activities Financing activities

Methods (Operating Cash flow)

Direct method Indirect method

Proforma of Cash Flow Statement prescribed by AS 3

Operating Activities: Operating Activities:

Net Cash Flow from Operating Activities xxx

October 2017 The Chartered Accountant Student

CHAPTER 5: PROFIT OR LOSS PRE AND POST INCORPORATION

Chapter Overview Methods for Computation

Apportionment of Close off old books and

Meaning of Profit or Loss prior to Incorporation Methods

Split up the profit Time basis (i)

Item Basis of Apportionment between Audit Fees Types of Audit

Variable expenses linked with (ii)For Tax Audit under the

Fixed Common charges [e.g., Interest on purchase

Expenses exclusively relating to (ii) From the date of

Expenses exclusively relating to (ii) From the date of