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GNDU Question Paper-2021
Bachelor of Commerce
(B.Com) 5
th
Semester
MANAGEMENT ACCOUNTING
Time Allowed: Three Hours Max. Marks: 50
Note : Attempt Five questions in all, selecting at least One question from each section. The
Fifth question may be attempted from any section. All questions carry equal marks.
SECTION—A
1. Explain the nature and scope of Management Accounting.
2. A company supplies the following information :
Balance Sheet
Capital and Liabilities
Rs.
Share Capital
2,00,000
Reserves and Surplus
50,000
Debentures
1,00,000
Creditors
40,000
Bills Payable
20,000
Other Current Liabilities
10,000
Total
4,20,000
Assets
Rs.
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Goodwill
1,20,000
Plant and Machinery
1,50,000
Stock
50,000
Debtors
45,000
Cash
17,000
Bills Receivable
28,000
Misc. Current Assets
10,000
Total
4,20,000
Sales (credit) for the year = Rs. 4,00,000
Gross Profit = Rs. 1,60,000
Calculate :
(i) Current ratio
(ii) Quick or liquid ratio
(iii) Inventory turnover
(iv) Average collection period
(v) Proprietor’s funds to liabilities.
SECTION—B
3. What is a fund flow statement ? Explain its uses and significance for management.
4. Highlight the difference between cash flow statement and fund flow statement.
SECTION—C
5. Define C.V.P. analysis. How does it help managers in decision making ? Discuss.
6. LNM Ltd. purchases 20,000 belts per annum from an outside supplier at Rs. 2 each. The
management feels that the company should manufacture the belts instead of buying
them. A machine costing Rs. 50,000 will be required to manufacture the belts. The
machine has a life of 5 years and a salvage value of Rs. 5,000. The company has an annual
capacity of 30,000 units and idle time facilities can be used for manufacture. Information
is available :
• Material cost per belt – Rs. 2.00
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• Labour cost per belt – Rs. 0.50
Variable overheads are 100% of labour cost.
(a) The company should continue to purchase the belts from outside supplier or should
make them in the factory.
(b) The company should accept an order to supply 50,000 belts at a reduced selling price of
Rs. 1.50 per belt.
SECTION—D
7. What is activity based costing ? How is it a refinement over traditional costing ?
8. What is a transfer price ? Explain the various transfer price methods used by
companies.
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GNDU Answer Paper-2021
Bachelor of Commerce
(B.Com) 5
th
Semester
MANAGEMENT ACCOUNTING
Time Allowed: Three Hours Max. Marks: 50
Note : Attempt Five questions in all, selecting at least One question from each section. The
Fifth question may be attempted from any section. All questions carry equal marks.
SECTION—A
1. Explain the nature and scope of Management Accounting.
Ans: The Story of Management Accounting
Imagine a ship sailing across the vast ocean. The captain wants to reach the destination
safely, avoid storms, and make sure there’s enough food and fuel for everyone onboard.
Now, just think—what would happen if the captain didn’t have a map, a compass, or
updates about the weather?
The ship would wander aimlessly, wasting resources, and maybe never reach the
destination.
In the world of business, management accounting is exactly like those maps, compasses,
and weather updates. It doesn’t just look at where the business has been (that’s the job of
financial accounting), but instead focuses on helping managers decide the best path
forward. It guides them in planning, controlling, and making decisions.
So, let’s dive deeper into this journey by first understanding the nature of management
accounting, and then the scope (the areas it covers).
Nature of Management Accounting
The nature of management accounting tells us what it really is and how it works. Think of it
as the personality traits of a person.
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1. Decision-Oriented
Just like Google Maps tells you the best route, management accounting provides
information to managers for better decision-making. It answers questions like:
• Should we increase production?
• Should we drop this product?
• How can we reduce costs?
2. Future-Focused
Unlike financial accounting, which records what already happened, management accounting
is like looking out of the ship’s telescope. It focuses on the future—budgets, forecasts, and
planning ahead.
3. Selective in Nature
It doesn’t flood managers with all kinds of data. Instead, it selects and presents only the
most useful information. Imagine if the captain only received relevant weather warnings
instead of a huge book on climate history.
4. Not Bound by Rules
Financial accounting has strict rules (like accounting standards), but management
accounting is flexible. It adapts to what the business needs. If one method doesn’t work,
managers can change it.
5. Interdisciplinary
Management accounting borrows tools and knowledge from economics, statistics,
engineering, psychology, and even management theories. It’s like a chef mixing spices from
different cuisines to cook the perfect dish.
6. Confidential
This information is meant for internal use only. Just like the captain’s secret strategy map is
not shared with pirates, management accounting information is not for outsiders—it’s for
managers inside the business.
7. Continuous Process
It never stops. Businesses are always planning, controlling, and making decisions, and so
management accounting works continuously like the heartbeat of the organization.
In short, the nature of management accounting shows that it is a decision-making
tool, future-oriented, flexible, and purely for internal guidance.
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Scope of Management Accounting
Now that we know its nature, let’s see how wide its scope is—what areas it covers. Think of
this as the different rooms inside a house called Management Accounting.
1. Financial Accounting
It starts by using data from financial accounting (like profit and loss, balance sheet). But it
doesn’t stop there. It rearranges and reinterprets this information to help managers make
decisions.
2. Cost Accounting
Management accounting is deeply connected with cost accounting. It tracks the cost of
production, labor, and overheads to identify where money is being spent and how to control
it.
3. Budgeting and Forecasting
This is like setting the GPS location for the ship. Budgets set targets, and forecasts predict
future conditions. Managers use them to stay on track.
4. Decision-Making Tools
Techniques like marginal costing, break-even analysis, standard costing, and variance
analysis are used. These tools act as decision-support systems for managers.
5. Financial Planning and Control
It ensures funds are available when needed and used properly. For example, should a
company borrow money or issue shares? Management accounting guides such financial
planning.
6. Performance Evaluation
Managers use management accounting to evaluate how departments, employees, and
projects are performing. Like a report card for business activities.
7. Internal Controls
It ensures that resources are not misused or wasted. Internal audits, checks, and control
systems come under this scope.
8. Reporting to Management
Reports, charts, and dashboards are prepared regularly to keep managers updated. Think of
it as weather updates for the captain during the voyage.
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9. Tax Policies
Though not its main job, management accounting also helps in tax planning and ensuring
that the company complies with tax regulations in the most cost-effective way.
10. Strategic Role
Today, management accounting is not limited to cost control or budgets. It plays a role in
strategy—like entering a new market, launching a new product, or competing globally.
So, the scope of management accounting is wide and covers everything from cost
control and planning to performance evaluation and strategy.
Diagram: Nature and Scope of Management Accounting
Here’s a simple diagram to tie it all together:
MANAGEMENT ACCOUNTING
|
------------------------------------------------
| |
Nature Scope
(What it is like) (What it covers)
| |
- Decision-Oriented - Financial Accounting
- Future-Focused - Cost Accounting
- Selective - Budgeting &
Forecasting
- Flexible - Decision-Making
Tools
- Interdisciplinary - Financial Planning
- Confidential - Performance
Evaluation
- Continuous - Internal Controls
- Reporting
- Tax & Strategy
Wrapping Up Like a Story
So, management accounting is like the compass and guiding star of a business. Without it,
managers would be like captains lost at sea, unsure of where to go and how to save
resources.
• Its nature shows us that it is future-oriented, flexible, decision-focused, and internal
to the organization.
• Its scope proves that it touches almost every area of management—planning,
controlling, evaluating, strategizing, and ensuring resources are wisely used.
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That’s why management accounting is not just about numbers—it’s about navigating
the business ship safely through the storms of competition, towards the shores of success.
2. A company supplies the following information :
Balance Sheet
Capital and Liabilities
Rs.
Share Capital
2,00,000
Reserves and Surplus
50,000
Debentures
1,00,000
Creditors
40,000
Bills Payable
20,000
Other Current Liabilities
10,000
Total
4,20,000
Assets
Rs.
Goodwill
1,20,000
Plant and Machinery
1,50,000
Stock
50,000
Debtors
45,000
Cash
17,000
Bills Receivable
28,000
Misc. Current Assets
10,000
Total
4,20,000
Sales (credit) for the year = Rs. 4,00,000
Gross Profit = Rs. 1,60,000
Calculate :
(i) Current ratio
(ii) Quick or liquid ratio
(iii) Inventory turnover
(iv) Average collection period
(v) Proprietor’s funds to liabilities.
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Ans: Imagine a small, bustling bakery called “Balance Bite.” The owner, Priya, keeps two lists
— one for everything she owns (assets) and one for everything she owes (liabilities + her
own money). One day she opens those lists with her accounting student friend (that’s you),
and together you turn them into clear, friendly numbers that tell the bakery’s story. Let’s
follow that conversation — step by step — and learn what each ratio means for Balance
Bite. I’ll also show a little diagram so the story has a map.
The starting scene — the Balance Sheet (the bakery’s snapshot)
Liabilities & Capital
• Share Capital (owner’s money): ₹2,00,000
• Reserves & Surplus (retained profits): ₹50,000
• Debentures (long-term borrowings): ₹1,00,000
• Creditors (suppliers to be paid): ₹40,000
• Bills Payable: ₹20,000
• Other Current Liabilities: ₹10,000
Total Liabilities & Capital = ₹4,20,000
Assets
• Goodwill: ₹1,20,000
• Plant & Machinery: ₹1,50,000
• Stock (inventory): ₹50,000
• Debtors (amount customers owe): ₹45,000
• Cash: ₹17,000
• Bills Receivable: ₹28,000
• Misc. Current Assets: ₹10,000
Total Assets = ₹4,20,000
(A matched balance — assets equal capital + liabilities — like both sides of a scale.)
Tiny diagram: Balance sheet map (visual snapshot)
ASSETS | LIABILITIES & CAPITAL
-----------------------------------------|-------------------------------
----
Fixed: Goodwill 1,20,000 | Share capital 2,00,000
P&M 1,50,000 | Reserves & Surplus 50,000
| Debentures 1,00,000
Current Assets: | Current Liabilities:
Stock 50,000 | Creditors 40,000
Debtors 45,000 | Bills Payable 20,000
Bills Rec. 28,000 | Other CL 10,000
Cash 17,000
Misc CA 10,000
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-----------------------------------------|-------------------------------
----
Total Assets = 4,20,000 | Total Liab+Cap = 4,20,000
Now for each question — told like a little chapter in the bakery’s story.
(i) Current ratio — “Can Priya pay her short-term bills?”
What it measures: Short-term solvency — whether current assets (things that can be
converted to cash within a year) can cover current liabilities (short-term bills).
Current assets (we add the current items):
• Stock = 50,000
• Debtors = 45,000
• Bills Receivable = 28,000
• Cash = 17,000
• Misc. Current Assets = 10,000
Total Current Assets = 50,000 + 45,000 + 28,000 + 17,000 + 10,000 = ₹1,50,000.
Current liabilities:
• Creditors + Bills Payable + Other Current Liabilities = 40,000 + 20,000 + 10,000 =
₹70,000.
Current ratio = Current Assets / Current Liabilities = 150,000 / 70,000 = 2.1429 ≈ 2.14 : 1.
Story interpretation: For every ₹1 of short-term debt, Priya has about ₹2.14 of short-term
assets. That’s comfortable — lenders usually like at least 1.5–2:1. Priya can likely meet near-
future bills — but remember, some current assets (like stock) aren’t instantly cash.
(ii) Quick (Liquid) ratio — “How much immediate liquidity is there if stock can’t be sold
quickly?”
What it measures: Immediate liquidity — excludes inventory (stock), since stock may take
time to sell.
Quick assets = Current Assets − Inventory = 150,000 − 50,000 = ₹1,00,000.
Quick ratio = Quick Assets / Current Liabilities = 100,000 / 70,000 = 1.4286 ≈ 1.43 : 1.
Story interpretation: Without counting cakes sitting on shelves, Priya still has ₹1.43 in liquid
assets for each ₹1 she owes short-term. That’s pretty healthy — above the typical 1:1
benchmark, showing short-term safety even if sales slow temporarily.
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(iii) Inventory turnover — “How fast are cakes turning into cash?”
What it measures: How many times inventory is sold and replaced in a year. High turnover
means inventory is converted into sales often — good for perishable bakery items.
We need COGS (Cost of Goods Sold).
Given: Sales (credit) = ₹4,00,000 and Gross Profit = ₹1,60,000.
So COGS = Sales − Gross Profit = 400,000 − 160,000 = ₹2,40,000.
Inventory turnover = COGS / Average Inventory.
We only have one inventory number (closing stock = ₹50,000). Without opening stock, we
assume average inventory ≈ closing inventory (a standard approach when no opening figure
is given).
So Inventory turnover = 240,000 / 50,000 = 4.8 times.
Days in inventory (optional insight) = 365 / 4.8 ≈ 76 days.
Story interpretation: Priya sells and replaces her cake inventory about 4.8 times a year —
roughly one cycle every 76 days. For a bakery, that suggests either sizeable batches or slow-
moving specialty items; she might look to speed it up (promotions, fresher product mix) to
reduce holding costs.
(iv) Average collection period — “How long customers take to pay”
What it measures: The average number of days debtors (accounts receivable) remain
unpaid.
Formula = (Average Debtors / Credit Sales) × 365.
Again, with only one debtor figure, we take it as the average: Debtors = ₹45,000. Credit
sales = ₹4,00,000.
So Average collection period = (45,000 / 400,000) × 365 = 0.1125 × 365 = 41.0625 ≈ 41.06
days.
Story interpretation: Customers pay Priya on average in about 41 days. If Priya prefers
tighter cash flow, she might encourage faster payment—discounts for early payment,
stricter credit terms, or follow-up on slow accounts.
(v) Proprietor’s funds to liabilities — “How much of the business is funded by Priya vs
creditors?”
What it measures: The relationship between owner’s capital and outside liabilities — an
indicator of financial stability and solvency.
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Proprietor’s funds = Share Capital + Reserves & Surplus = 200,000 + 50,000 = ₹2,50,000.
Liabilities (excluding proprietor) = Debentures + Creditors + Bills Payable + Other CL =
100,000 + 40,000 + 20,000 + 10,000 = ₹1,70,000.
Proprietor’s funds to liabilities = 250,000 : 170,000 = divide both by 10,000 → 25 : 17 ≈
1.47 : 1.
Story interpretation: For approximately every ₹1 of outsider funding, Priya has ₹1.47 of her
own funds. This indicates the bakery is more equity-financed than debt-financed — a
conservative and often safer capital structure.
A quick checklist for Priya (actionable takeaways)
• Current ratio ≈ 2.14 : 1 — short-term position comfortable.
• Quick ratio ≈ 1.43 : 1 — immediate liquidity is good.
• Inventory turnover = 4.8 times (≈76 days per cycle) — could be improved for
perishable goods.
• Average collection period ≈ 41 days — consider tightening credit policies.
• Proprietor’s funds : liabilities ≈ 1.47 : 1 — sound equity base, less reliance on
lenders.
Final note — assumptions and clarity
1. We assumed closing inventory = average inventory (standard when opening
inventory not given). If opening inventory were provided, the inventory turnover
could shift.
2. All sales are considered credit sales (the problem said so), which is why we used
credit sales for the collection period.
3. “Current assets” were taken as Stock, Debtors, Bills Receivable, Cash and Misc.
Current Assets; “current liabilities” include Creditors, Bills Payable and Other Current
Liabilities.
Closing lines — the moral of the story
Priya’s bakery is on firm ground: she has more than enough short-term assets to meet short-
term needs, good immediate liquidity, and a solid owner-funded base. But the clock on
inventory and receivables shows room to sharpen operations: sell faster, collect quicker,
and watch cash flow sparkle. Accounting ratios are not just numbers — they are the
bakery’s heartbeat. Read them, act on them, and the business will smell sweeter every
morning.
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SECTION—B
3. What is a fund flow statement ? Explain its uses and significance for management.
Ans: Fund Flow Statement: A Story of Money’s Journey
Imagine for a moment that your best friend, Rohan, runs a small café in your town. Every
day, customers walk in, sip coffee, buy sandwiches, and leave money in the cash box. But at
the same time, Rohan also pays rent, buys raw materials, pays salaries, and spends on
electricity.
Now, Rohan is very smart at making coffee, but not very good at understanding where his
money is coming from and where it is going. At the end of each month, when he checks his
bank balance, he often gets confused:
• “I earned so much last month, so why is my cash balance low?”
• “Where did all that profit disappear?”
This confusion is not just Rohan’s; in fact, every business—whether it’s a small café or a
giant company like Reliance or Infosys—faces this challenge. That’s where the Fund Flow
Statement steps in like a detective.
It answers one simple but very important question:
How did funds move in and out of the business during a specific period?
What is a Fund Flow Statement?
In simple words, a Fund Flow Statement is like a financial map. It shows how funds (money
or working capital) have been generated and how they have been used in the business
between two balance sheet dates.
• It tells us the sources of funds (from where money came)
• It tells us the uses of funds (where that money went)
Think of it like a movie of your money’s journey:
• Scene 1: A loan was taken from the bank (source).
• Scene 2: That money was used to buy a new coffee machine (use).
• Scene 3: Some money was earned from sales (source).
• Scene 4: A part of it was used to pay off old debts (use).
By the end of the movie, you get a crystal-clear idea of what really happened to the funds.
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Diagram: Simple Representation of Fund Flow
+------------------+
| Sources of |
| Funds |
+------------------+
|
v
+------------------+
| Fund Flow |
| Statement |
+------------------+
|
v
+------------------+
| Uses of |
| Funds |
+------------------+
This diagram shows that funds flow from sources to uses, and the statement connects both
ends.
Uses of a Fund Flow Statement
Now let’s bring Rohan back into our story. He finally decides to prepare a fund flow
statement for his café. What benefits does he get?
1. Understanding Movement of Money
Earlier, he thought profit equals cash in hand. But now he sees the reality:
• Part of his profit was blocked in buying new chairs.
• Some money went into paying past electricity dues.
• Another chunk was used to stock up raw materials.
The statement gave him a full picture of movement, not just profit numbers.
2. Better Planning and Budgeting
With this knowledge, Rohan can plan wisely:
• If he sees too much money locked in stock, he decides not to over-purchase.
• If he sees heavy loan repayments coming, he arranges funds beforehand.
For big companies, this planning helps them avoid financial crises.
3. Identifying Financial Strength
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The statement tells whether the business is generating funds internally (from profits) or
depending too much on external loans.
• If most funds come from profits, the business is strong.
• If funds mainly come from loans, it shows weakness.
Rohan realizes his café is stable because most of his funds came from sales rather than
loans.
4. Helps in Decision-Making
Suppose Rohan wants to open a new branch. By studying his fund flow statement, he can
decide:
• Do I have enough internal funds to invest?
• Or should I borrow from the bank?
Thus, it becomes a decision-making tool.
5. Building Investor Confidence
Investors and banks love transparency. If Rohan shows his fund flow statement, banks can
easily judge:
• Is his café capable of repaying loans?
• Is he handling funds responsibly?
For big corporations, this is a major reason why fund flow statements are important—they
help build trust with lenders and shareholders.
Significance for Management
For managers, the fund flow statement is not just a piece of paper; it is like a financial
compass. Let’s see why:
1. Detecting Financial Bottlenecks
Management can spot areas where money is unnecessarily blocked, such as:
• Excess inventory
• Idle machinery
• Outstanding payments from customers
By correcting these, they can free up funds.
2. Balancing Short-Term and Long-Term Needs
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Management has to maintain a balance between day-to-day expenses (like salaries,
electricity) and long-term investments (like machinery, land). Fund flow helps them allocate
funds in the right direction.
3. Performance Evaluation
If the company earned profit but funds are constantly draining, management knows
something is wrong. Maybe expenses are too high, or working capital is not managed well.
4. Guiding Future Strategy
Fund flow analysis tells management whether to expand, cut costs, reduce debt, or focus on
increasing sales.
A Small Example
Let’s see a short case:
Rohan’s Café (Fund Flow for 2024–25)
• Sources of Funds:
o Net Profit: ₹2,00,000
o Bank Loan: ₹1,00,000
o Sale of Old Furniture: ₹20,000
o Total = ₹3,20,000
• Uses of Funds:
o Purchase of Coffee Machine: ₹1,50,000
o Payment of Old Loan: ₹50,000
o Increase in Stock: ₹40,000
o Rent Advance Paid: ₹30,000
o Total = ₹2,70,000
Net Increase in Funds = ₹50,000
Now Rohan can proudly say:
• “I generated funds from profits and bank loan.”
• “I invested mainly in assets and loan repayment.”
• “My cash position improved by ₹50,000.”
This clarity gives him confidence for the future.
Conclusion
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So, if we wrap up our story:
• A Fund Flow Statement is like a detective that uncovers the real journey of money.
• It shows where funds came from (sources) and where they went (uses).
• It is useful for planning, decision-making, evaluating strength, and building
confidence.
• For management, it acts as a financial compass that guides strategies, detects
bottlenecks, and ensures smooth sailing of the business.
In Rohan’s case, the café is now on track, and he no longer feels lost when checking his bank
balance. For companies, it’s the same—fund flow is the secret weapon to manage money
wisely.
4. Highlight the difference between cash flow statement and fund flow statement.
Ans: Cash Flow Statement vs Fund Flow Statement: A Story for Easy Understanding
Imagine you are the owner of a shop in your town. Every day, people come in, buy
products, and pay you in cash or through digital modes. At the end of each day, you count
how much cash is left in your drawer. On weekends, you sit with your accountant to
understand the bigger picture of how your money is moving not just daily but also over
months.
Now here’s where two different financial superheroes enter your story:
1. Cash Flow Statement – “The Daily Cash Detective”
2. Fund Flow Statement – “The Long-Term Storyteller”
Both of them talk about money, but they speak different languages. Let’s walk through this
step by step.
1. The Cash Flow Statement: Tracking Daily Movements of Money
Think of the cash flow statement as your personal diary that records only the cash
movements. It doesn’t care about profits on paper, credit sales, or promises of money in the
future. It is interested only in:
• How much cash actually came into your pocket.
• How much cash actually went out.
For example:
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• If you sell goods worth ₹10,000 but the customer promises to pay after one month,
the cash flow statement says: “Not interested, because no cash has actually come
yet.”
• But if you paid ₹5,000 to your supplier today, the cash flow statement immediately
notes it down as cash going out.
So, in simple words, a cash flow statement shows the inflow and outflow of real cash in a
business during a specific period (usually a year).
It is usually divided into three parts:
1. Operating Activities – Money earned or spent from your main business (like selling
goods, paying wages, etc.).
2. Investing Activities – Money spent on buying assets (like machinery) or earned from
selling investments.
3. Financing Activities – Money borrowed, repaid, or invested by owners.
It answers the question:
“Where did the cash come from and where did it go during this period?”
2. The Fund Flow Statement: Telling the Long-Term Story
Now, meet the second superhero: the fund flow statement. This one is less about daily cash
and more about the overall movement of financial resources.
Imagine you want to know:
• How much money your business generated from profits.
• Where those profits were invested.
• How your working capital (current assets – current liabilities) increased or
decreased.
For example:
• If you took a loan of ₹50,000, bought machinery worth ₹40,000, and used the rest
for increasing stock, the fund flow statement explains this longer-term shift.
Unlike the cash flow statement, it doesn’t restrict itself to just “cash.” Instead, it deals with
funds in a broader sense, often focusing on working capital.
It answers the question:
“How did funds move between different parts of the business, and how was working
capital affected?”
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3. The Key Differences – A Simple Comparison
Here’s where students usually get confused. Let me break it down in the simplest way:
Basis
Cash Flow Statement
Fund Flow Statement
Focus
Movement of cash only
Movement of funds/working capital
Nature
Short-term view (daily/periodic
cash movements)
Long-term view (sources & uses of funds)
Scope
Includes only cash inflows and
outflows
Includes all financial changes (even non-cash,
like credit transactions)
Objective
To show liquidity and cash
position
To show financial position and how resources
were used
Division
Operating, Investing, Financing
activities
Sources of funds and Applications of funds
Utility
Helpful in knowing immediate
solvency
Helpful in understanding long-term financial
planning
So, while the cash flow statement is like your daily money diary, the fund flow statement is
like your annual report card that explains where your business is truly standing financially.
4. A Simple Story Example to Tie It Together
Let’s imagine:
You earn ₹20,000 this month. Out of that:
• You spend ₹5,000 on groceries,
• ₹3,000 on electricity and water bills,
• And you save ₹12,000 in your locker.
Your cash flow statement would record:
• Cash in (salary): ₹20,000
• Cash out (expenses): ₹8,000
• Net cash left: ₹12,000
Now let’s zoom out. Suppose over the past year:
• You took a bank loan of ₹1,00,000,
• Bought a bike for ₹70,000,
• Increased your savings account by ₹30,000.
Your fund flow statement would record:
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• Source of funds: Bank loan (₹1,00,000)
• Application of funds: Bike (₹70,000), Savings (₹30,000)
See the difference?
• Cash flow = short-term view of how money comes in and goes out daily/monthly.
• Fund flow = long-term view of how resources were raised and used.
5. Why Both Are Important
• The cash flow statement ensures you never run out of liquidity. Even a profitable
business can collapse if it doesn’t have cash to pay bills.
• The fund flow statement helps managers and investors understand how wisely
resources are being used and whether the company is building strength for the
future.
Think of it this way:
• Cash flow = “Am I able to pay my bills today?”
• Fund flow = “Am I financially stronger or weaker compared to last year?”
6. Diagram for Clarity
Here’s a simple diagram to visualize:
+---------------------+
| CASH FLOW |
+---------------------+
| Focus: Only Cash |
| Inflows & Outflows |
| Short-term Liquidity|
+---------------------+
|
v
+---------------------+
| FUND FLOW |
+---------------------+
| Focus: All Funds |
| Sources & Uses |
| Long-term Planning |
+---------------------+
7. Final Thought
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If financial statements were characters in a movie:
• The Cash Flow Statement would be the detective, always chasing the real cash in
hand.
• The Fund Flow Statement would be the historian, calmly narrating how resources
were raised and invested over time.
Both are telling you about money, but one is concerned with “today’s wallet,” while the
other tells the story of “overall wealth and financial journey.”
And that, dear reader, is the beautiful difference between the two!
SECTION—C
5. Define C.V.P. analysis. How does it help managers in decision making ? Discuss.
Ans: C.V.P. Analysis – A Story of Costs, Sales, and Smart Decisions
Imagine you are the captain of a small ship.
Your goal is to take your ship from the harbor (expenses) to an island called Profitland. On
the way, you must cross a point called Break-even Island. Once you pass that point, every
mile you sail adds treasure (profit) to your ship. But if you don’t reach Break-even Island,
you are only burning fuel (incurring losses).
This whole journey of understanding when the ship stops losing money and starts earning
profit is what we call Cost-Volume-Profit (C.V.P.) Analysis.
Definition of C.V.P. Analysis
Cost-Volume-Profit (C.V.P.) analysis is a managerial accounting tool that studies the
relationship between costs (fixed and variable), sales volume (units sold or services
rendered), and profits.
In simple words, it helps managers answer questions like:
• At what sales level will we cover all our costs?
• How much profit can we earn if we sell more?
• What will happen to our profit if costs increase or selling price decreases?
It’s like a compass that guides managers in their decision-making journey.
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Key Elements in C.V.P. Analysis
Before moving ahead, let’s break down the three main characters of our story:
1. Costs
o Fixed Costs: These are like the rent of your ship. You have to pay them
whether you sail or not. (e.g., factory rent, salaries, insurance).
o Variable Costs: These are like fuel. The more miles you travel (more units you
produce), the more fuel you burn. (e.g., raw material, electricity, direct
labor).
2. Volume
o This means the number of units sold or services rendered. More volume =
more revenue, but also more variable cost.
3. Profit
o The ultimate treasure. Profit comes only after crossing the break-even point,
where total sales cover total costs.
How C.V.P. Analysis Helps Managers in Decision Making
Now let’s imagine a business as a ship again. Managers are the captains, and their job is to
steer the ship safely and profitably. C.V.P. analysis gives them the map. Here’s how:
1. Finding the Break-even Point (B.E.P.)
Managers often ask: “How much should we sell so that we don’t make a loss?”
C.V.P. analysis gives them the break-even point, which is the minimum sales required to
cover all costs.
• If you sell less than B.E.P. → Loss.
• If you sell more than B.E.P. → Profit.
This helps managers set sales targets and motivates the team to reach Break-even Island
first.
2. Profit Planning
Once the break-even point is clear, managers can set profit goals.
For example: “If we want ₹50,000 profit, how many units should we sell?”
C.V.P. analysis answers this with simple calculations.
This is like saying: “If we want to collect more treasure, how many more miles do we need to
sail beyond Break-even Island?”
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3. Decision on Pricing
Suppose a competitor reduces their product’s price. Managers wonder: “If we also reduce
price, will we still make profit?”
C.V.P. analysis helps by showing the effect of changing selling price on sales volume and
profit.
4. Choosing the Right Product Mix
Many companies sell multiple products. Some bring high profit, some low. Managers need
to know which product to push more in the market.
C.V.P. analysis helps compare contribution margins (the difference between selling price
and variable cost).
Products with higher contribution margin are like stronger sails on the ship – they push the
business faster towards profits.
5. Impact of Cost Changes
Sometimes raw material prices rise, or wages increase. Managers worry: “What if our costs
increase, will we still be safe?”
C.V.P. analysis shows how rising costs affect break-even and profits.
This helps in making strategies like cost control, increasing efficiency, or adjusting prices.
6. ‘What-if’ Scenarios
Business is uncertain. Managers often think: “What if sales drop by 10%? What if costs rise
by 15%?”
C.V.P. analysis allows managers to test such scenarios before they happen.
It’s like rehearsing a storm before facing it in the ocean.
Diagram – CVP Relationship
Here’s a simple diagram to visualize:
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• The horizontal axis shows sales volume.
• The vertical axis shows costs and revenues.
• The point where the sales line crosses the total cost line is the Break-even Point.
• Left side of B.E.P. = Loss.
• Right side of B.E.P. = Profit.
A Simple Example
Let’s take a bakery example.
• Selling price per cake = ₹100
• Variable cost per cake = ₹60
• Fixed cost (rent, salaries, etc.) = ₹40,000
Contribution per cake = 100 – 60 = ₹40
Break-even point = Fixed Cost ÷ Contribution = 40,000 ÷ 40 = 1000 cakes
So, the bakery must sell 1000 cakes just to cover costs. Every cake sold beyond that gives
₹40 profit.
This clarity helps the bakery owner in setting targets, deciding prices, and planning profits.
Why is C.V.P. Analysis Loved by Managers?
• It turns complex numbers into simple insights.
• It removes guesswork and provides logical answers.
• It prepares the business for risks and uncertainties.
• It helps in long-term planning and short-term decisions alike.
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Conclusion
In the story of business, C.V.P. analysis is like a guiding lighthouse. It shows managers when
they are safe from losses, how far they are from profits, and what they should do if storms
(cost increase, sales drop, or competition) hit their ship.
So, defining simply:
C.V.P. analysis is the study of how costs and sales volume affect profits, helping managers
in decision making by providing insights into break-even point, profit planning, pricing,
cost control, and risk management.
When a student writes this in exam as a story with examples and diagrams, not only will
they understand it deeply, but even the examiner will enjoy reading and happily award high
marks.
6. LNM Ltd. purchases 20,000 belts per annum from an outside supplier at Rs. 2 each. The
management feels that the company should manufacture the belts instead of buying
them. A machine costing Rs. 50,000 will be required to manufacture the belts. The
machine has a life of 5 years and a salvage value of Rs. 5,000. The company has an annual
capacity of 30,000 units and idle time facilities can be used for manufacture. Information
is available :
• Material cost per belt – Rs. 2.00
• Labour cost per belt – Rs. 0.50
Variable overheads are 100% of labour cost.
(a) The company should continue to purchase the belts from outside supplier or should
make them in the factory.
(b) The company should accept an order to supply 50,000 belts at a reduced selling price of
Rs. 1.50 per belt.
Ans: The story of LNM Ltd., the belts, and the curious order
Imagine LNM Ltd. is a modest factory. Every year the company needs 20,000 belts for its
operations. For years it has simply bought them from a supplier at Rs. 2.00 per belt. One
day the managers start wondering: “Should we instead make the belts ourselves? And what
about that big order we were offered — 50,000 belts at Rs. 1.50 each — should we take it?”
We’ll follow two chapters: (a) the make or buy decision for the company’s own 20,000 belts,
and (b) whether to accept the outside order of 50,000 belts at Rs. 1.50.
What we know (clear facts)
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• Annual requirement: 20,000 belts
• Supplier price: Rs. 2.00 per belt
• Machine to make belts costs Rs. 50,000 (life 5 years, salvage Rs. 5,000)
• Annual capacity of factory: 30,000 belts (so making 20,000 fits comfortably)
• Per-belt manufacturing details:
o Material cost = Rs. 2.00
o Labour cost = Rs. 0.50
o Variable overheads = 100% of labour, therefore 0.50
• Idle facilities available (i.e., space/time is free to use within capacity)
Step-by-step arithmetic (we’ll compute carefully)
1) Cost of buying (current situation)
Buying 20,000 belts at Rs. 2.00 each:
• Multiply: 20,000 × 2.00 = 40,000.
So Total cost if buying = Rs. 40,000 per year.
2) Cost components if we make the belts
a. Variable cost per belt
• Material = 2.00
• Labour = 0.50
• Variable overhead = 0.50 (100% of labour)
Add them:
2.00 + 0.50 + 0.50 = 3.00
So variable manufacturing cost per belt = Rs. 3.00.
b. Annual depreciation of the new machine
• Cost of machine = 50,000
• Salvage value = 5,000
• Depreciable amount = 50,000 − 5,000 = 45,000.
• Life = 5 years.
Annual depreciation = 45,000 ÷ 5 = 9,000.
So annual depreciation = Rs. 9,000.
If we produce the required 20,000 belts in the year, depreciation per belt = 9,000 ÷ 20,000 =
0.45.
So depreciation per belt = Rs. 0.45.
c. Total cost per belt when making
Variable cost per belt (3.00) + depreciation per belt (0.45) = 3.45.
So manufacturing cost per belt = Rs. 3.45.
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d. Total annual manufacturing cost for 20,000 belts
20,000 × 3.45 = ?
Compute: 3.45 × 20,000 = (3.45 × 2) × 10,000 = 6.90 × 10,000 = 69,000.
So Total cost if making = Rs. 69,000 per year.
Compare buy vs make (simple verdict)
• Buy cost = Rs. 40,000
• Make cost = Rs. 69,000
Making costs more. The key reason: variable manufacturing cost per belt (Rs. 3.00) is
already higher than the purchase price Rs. 2.00, and adding the machine depreciation (0.45)
increases it further.
So for part (a): LNM Ltd. should continue to purchase the belts rather than make them —
buying is cheaper by Rs. 29,000 per year (69,000 − 40,000).
But wait — let’s explain the logic in plain language (why we include depreciation, what’s
relevant, and other angles)
Imagine you have a choice: buy a ready-made cake for Rs. 100 or bake one at home. Baking
needs flour, eggs, gas and you must buy an oven that costs Rs. 5,000. If the ingredients
alone cost Rs. 150, it’s silly to bake — same idea here.
• Relevant costs: For make vs buy we look at costs that change because of the
decision. If LNM buys, it avoids buying the machine and avoids manufacturing costs.
If it makes, it incurs variable costs + the cost of the machine (the machine’s cost is
relevant because buying it is a cash outflow that occurs only if we decide to make).
• Depreciation: It’s the accounting way to spread the machine’s cost over time. Since
the machine must be purchased to make belts, its annual depreciation is a real
annual cost of owning that machine — so we include it.
• Idle capacity: The factory can make up to 30,000 belts per year. That’s good because
making 20,000 fits. But idle capacity doesn’t magically make variable costs lower.
The main per-unit cost drivers (material, labour, variable overhead) remain.
We also check for hidden benefits: could the machine produce other profitable items, or
could the firm sell extra capacity? The question doesn’t give profitable alternatives, so we
stick to direct costs.
Part (b): Should LNM accept an order for 50,000 belts at Rs. 1.50 each?
Let’s treat this as a special external order. Two big constraints appear:
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1. Price vs variable cost:
o Selling price offered = Rs. 1.50 per belt.
o Variable manufacturing cost per belt = Rs. 3.00.
o Even ignoring depreciation, producing a belt costs Rs. 3.00 in materials +
labour + variable overhead, which is higher than the offered price 1.50. So
each belt would lose 3.00 − 1.50 = Rs. 1.50 on a pure variable basis.
2. Capacity:
o Annual manufacturing capacity = 30,000 belts.
o Order size = 50,000 belts → exceeds capacity.
o Even if the factory tanks capacity to 30,000, the remaining 20,000 belts
would need to be subcontracted or bought from outside; both options still
cost at least Rs. 2.00 each to buy (supplier price), which is still >1.50 selling
price.
Numeric check if we tried to produce 30,000 ourselves and buy 20,000:
• Produce 30,000: variable cost 3.00 × 30,000 = 90,000; plus depreciation maybe rises
because machine used more, but depreciation fixed at 9,000 per year (if we bought
machine for this purpose).
• Buy 20,000: 20,000 × 2.00 = 40,000.
• Total cost = 90,000 + 40,000 = 130,000.
• Revenue from selling 50,000 at 1.50 = 50,000 × 1.50 = 75,000.
• Loss = 130,000 − 75,000 = 55,000 (a big loss). So definitely not acceptable.
Even if LNM doesn’t manufacture and instead buys all 50,000 belts at Rs. 2.00 and sells at
1.50, every belt loses 0.50 — total loss 50,000 × 0.50 = 25,000. Still bad.
Conclusion for (b): The order at Rs. 1.50 should be rejected. The offered price is below both
variable cost of manufacture (3.00) and the purchase price (2.00). Accepting would cause a
cash loss.
Simple diagram to visualize the decision
+---------------------------+
| LNM needs / offered order|
+---------------------------+
/ \
/ \
(a) Own need 20,000 (b) External order 50,000
Buy = 20,000×2 = 40,000 Revenue = 50,000×1.5 = 75,000
| |
Make? compute costs Can we make cheaply?
Variable = 3.00/unit Var cost = 3.00/unit > 1.50
Depn = 9,000/yr => 0.45/unit
Total = 3.45/unit => 69,000/yr
| |
Decision: Buy (40,000) Decision: Reject order
(Cheaper than 69,000) (Would create losses)
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Final takeaway
• For the company’s own need of 20,000 belts, buying at Rs. 2.00 each costs Rs.
40,000, while manufacturing would cost Rs. 69,000 (variable costs + machine
depreciation). Buying saves Rs. 29,000. So do not make — continue buying.
• For the one-time order of 50,000 belts at Rs. 1.50 each, the offered price is below
both the purchase price (Rs. 2.00) and the manufacturing variable cost (Rs. 3.00).
Accepting would cause a loss, and capacity constraints make it even worse. So reject
the order.
SECTION—D
7. What is activity based costing ? How is it a refinement over traditional costing ?
Ans: Activity-Based Costing (ABC): A Story of Costing That Thinks Differently
Imagine you’re at a big wedding function. The host has to spend money on food,
decoration, music, lighting, photographers, and so much more.
Now, suppose the host decides to divide the entire wedding expense among guests equally.
So, if the total cost is ₹10,00,000 and there are 500 guests, each guest is “assumed” to cost
₹2,000.
Sounds fair, right?
But think again.
• Some guests only eat a little food and leave early.
• Some stay all night, enjoy the dance floor, and eat twice.
• The groom’s side has expensive decorations, while the bride’s side has more
photographers.
Clearly, equal division of cost is not fair. Some activities consume more resources, while
others consume less.
This is exactly the difference between Traditional Costing and Activity-Based Costing
(ABC).
Traditional Costing: The “One-Size-Fits-All” Method
Traditional costing works like the wedding example where the cost is divided based on a
simple measure—usually labour hours or machine hours.
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For example:
• If a company spends ₹1,00,000 on overheads, and Machine A runs for 600 hours
while Machine B runs for 400 hours, then costs are allocated proportionately.
The logic is simple: more hours = more cost.
But is that always accurate?
Not really.
Because in reality, not all products consume resources in the same way. One product may
require more setups, another may demand more inspections, and another may use more
machine hours.
This is where Activity-Based Costing enters as a smarter system.
Activity-Based Costing (ABC): The Smarter Host
Think of ABC as a thoughtful wedding host. Instead of blindly dividing costs equally, ABC
asks:
• Which guest consumed more food?
• Who took part in the after-party with DJ lights?
• Who used the photographer’s time the most?
Costs are then allocated based on activities actually performed.
In a factory, ABC does the same. It doesn’t just look at machine hours or labour hours. It
looks deeper into activities such as:
• Material handling
• Machine setup
• Quality inspection
• Packing and shipping
Each of these activities consumes resources. So, ABC collects the cost of these activities in
separate cost pools, and then charges products according to how much of that activity they
use.
Step-by-Step Understanding of ABC
To make it crystal clear, let’s walk through the steps of ABC like a short journey:
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1. Identify Activities
Just like noting down all wedding arrangements (food, music, lights, decoration), in a
company we list activities like designing, machine setup, quality control, etc.
2. Create Cost Pools
Each activity gets its own “cost bucket.” Example:
o Setup costs = ₹50,000
o Inspection costs = ₹30,000
o Material handling = ₹20,000
3. Find Cost Drivers
A cost driver is like a “key reason” why the cost happens.
o Setup cost driver = number of setups
o Inspection cost driver = number of inspections
o Material handling driver = number of material moves
4. Assign Costs to Products
Products are charged based on how much of the activity they actually use.
o If Product A requires 10 setups and Product B requires 2 setups, then Product
A will get a larger share of setup costs.
This way, every product gets a fair and accurate cost based on actual usage of
resources.
Diagram for Easy Visualization
Here’s a simple diagram that shows the difference:
Traditional Costing
Overhead Costs
↓
Allocated based on a single base
(labour hours/machine hours)
↓
Products
Activity-Based Costing
Overhead Costs
↓
Activities (Setup, Inspection, Handling, etc.)
↓
Cost Drivers (No. of setups, No. of inspections, etc.)
↓
Products
This makes it clear that ABC takes a detailed, activity-wise route, while traditional costing
takes a shortcut.
How ABC is a Refinement Over Traditional Costing
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Now, let’s highlight the differences in a way that an examiner will enjoy reading:
1. Accuracy
o Traditional: Uses one broad base (like machine hours).
o ABC: Uses multiple activities, so the cost distribution is much more accurate.
2. Fairness
o Traditional: Overcharges simple products and undercharges complex ones.
o ABC: Assigns costs fairly according to resource consumption.
3. Decision-Making
o Traditional: May mislead managers by showing wrong product costs.
o ABC: Helps managers identify costly activities and improve efficiency.
4. Complexity
o Traditional: Easy but often misleading.
o ABC: More detailed and time-consuming, but very useful in competitive
industries.
A Mini Story of Two Products
Imagine a company makes two products: Luxury Sofa and Simple Chair.
• Traditional costing: Both use the same machine hours, so both are given almost the
same overhead.
• Reality: The sofa needs multiple inspections, special handling, and costly designs. The
chair is straightforward.
Traditional costing underestimates sofa cost and overestimates chair cost.
ABC, however, captures these differences correctly.
This means:
• The company can price products better.
• It avoids selling complex products too cheaply.
• It avoids overpricing simple products.
Why ABC Became Popular
Companies moved towards ABC because:
• Competition forced them to know the real cost of products.
• Overheads became a large part of total costs, and ignoring them led to wrong
pricing.
• Customers wanted variety, and variety means more activities.
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Human Touch Example
Think of your daily life. Suppose your monthly expenses are ₹10,000. If you divide it simply
by 30 days, you’ll say, “I spend ₹333 every day.”
But in reality:
• On weekends, you spend more on outings.
• On weekdays, you mostly spend on travel and food.
• Some days you don’t spend at all.
So, dividing equally hides the truth. But if you track expenses by activities (food, travel,
outings), you’ll know exactly where money goes.
That’s the power of ABC in business!
Conclusion
Activity-Based Costing is like a magnifying glass for managers. While traditional costing
gives a blurred picture by spreading costs evenly, ABC zooms in and shows the real story of
cost consumption.
It is a refinement because it:
• Improves accuracy,
• Helps in correct pricing,
• Encourages cost control,
• And supports better decision-making.
Yes, it is a bit more complicated than traditional costing, but in today’s competitive world, it
is worth the effort.
So, if traditional costing is like sharing wedding costs equally among guests, Activity-Based
Costing is like charging each guest based on how much food, decoration, and entertainment
they actually used.
And that’s why ABC is not just an accounting method—it’s a smarter way of thinking
about costs.
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8. What is a transfer price ? Explain the various transfer price methods used by
companies.
Ans: Transfer Pricing – A Story That Makes Sense
Imagine you are the owner of a big chocolate company called SweetBite Ltd..
Your company has two main divisions:
1. Cocoa Division – This division imports raw cocoa beans from Africa, processes them
into fine cocoa powder and chocolate paste.
2. Candy Division – This division uses that cocoa paste to make delicious chocolates,
bars, and candies that are sold in the market.
Now here’s the twist: your Candy Division doesn’t buy cocoa paste from outside suppliers—
it buys it from your own Cocoa Division.
So, the big question arises:
At what price should the Cocoa Division sell cocoa paste to the Candy Division?
If they set the price too high, the Candy Division will complain, because their profits will
shrink.
If they set it too low, the Cocoa Division will feel cheated.
And if they don’t agree at all, the whole company suffers.
That internal price charged between divisions of the same company is called the Transfer
Price.
What is Transfer Price?
In simple words:
Transfer price is the price at which goods, services, or even intangible things (like patents
or brand rights) are transferred between different divisions, subsidiaries, or branches of
the same company.
It is like playing cricket in your own backyard—your right hand bowls, your left hand bats,
but you still need to decide the rules fairly, otherwise the game won’t be fun.
Companies use transfer pricing when:
• They have multiple divisions or subsidiaries.
• They operate internationally (like TATA, Infosys, Coca-Cola, Amazon).
• They want to measure the performance of each unit properly.
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Transfer price ensures that every division feels motivated and the company as a whole
earns profit.
Why is Transfer Pricing Important?
1. Fair performance evaluation – Each division’s profit depends on transfer pricing.
2. Tax minimization – Multinational companies sometimes adjust transfer prices to
reduce tax liabilities in high-tax countries.
3. Resource allocation – Helps managers decide whether to produce in-house or buy
from outside.
4. Motivation – Fair transfer pricing motivates managers to work efficiently.
Transfer Pricing Methods – Explained with Story
Companies use different methods to decide transfer prices. Let’s walk through them one by
one, using our SweetBite Ltd. story.
1. Market-Based Transfer Pricing
Here, the transfer price is set equal to the price that the product would fetch in the open
market.
Example: If other suppliers are selling cocoa paste at ₹200 per kg, then the Cocoa Division
will also charge the Candy Division ₹200 per kg.
Advantages:
• Fair and realistic.
• Divisions feel they are dealing in real-world conditions.
Disadvantages:
• Sometimes, there may not be a proper outside market to compare.
Think of it like siblings buying chocolates from each other at the same price as in the
local shop.
2. Cost-Based Transfer Pricing
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In this method, the transfer price is based on the cost of production in the supplying
division.
There are sub-types:
• Actual Cost: Price = Total cost incurred.
• Cost Plus Mark-up: Price = Cost + Some profit margin.
• Variable Cost: Price = Only variable costs considered (like raw material, labor).
Example: If Cocoa Division spends ₹150 per kg to produce cocoa paste and adds a 20% profit
margin, then transfer price = ₹180.
Advantages:
• Simple and easy to calculate.
• Ensures that supplying division covers its cost.
Disadvantages:
• May not reflect market realities.
• Supplying division may not try to reduce costs, as everything is covered anyway.
Like one sibling asking: “I spent ₹50 to buy chips, give me ₹60 so I can make a profit.”
3. Negotiated Transfer Pricing
Here, managers of both divisions sit together and negotiate the price.
Example: Cocoa Division wants ₹200, Candy Division wants to pay only ₹150, and after
discussion they agree on ₹175.
Advantages:
• Promotes cooperation.
• Flexible and adaptable.
Disadvantages:
• Time-consuming.
• Stronger division may exploit weaker one.
Like bargaining with your sibling: “Okay, I’ll give you ₹20 if you let me play with your
bat.”
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4. Dual Pricing Method
This is like keeping both parties happy.
• Supplying division records sales at cost plus markup.
• Receiving division records purchases at cost (without markup).
• The difference is adjusted at the company level.
Example: Cocoa Division sells at ₹180 (cost + profit), Candy Division records at ₹150 (just
cost), and company adjusts ₹30 internally.
Advantages:
• Both divisions satisfied.
• Motivates performance.
Disadvantages:
• Complex accounting.
Like parents giving both kids pocket money to avoid fights.
5. Resale Price Method (used in MNCs)
Here, the price is decided based on the final resale price of the product.
Formula: Transfer Price = Final Sale Price – Distributor’s Margin
Example: If Candy Division sells a chocolate bar for ₹50, and its margin is 40% (₹20), then
transfer price for cocoa paste = ₹30.
Advantages:
• Works well when the resale market price is known.
• Common in international transactions.
Disadvantages:
• Difficult when resale price fluctuates.
6. Comparable Uncontrolled Price Method (CUP)
Used when companies operate in multiple countries. Price is decided by comparing with
what independent companies charge for the same product.
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Example: If Nestle buys cocoa paste at ₹210 from Africa, our Cocoa Division should also use
similar pricing.
Diagram: Transfer Pricing in Action
+-------------------+ Transfer Price +-------------------+
| Cocoa Division | ---------------------------> | Candy Division |
| (Makes Cocoa) | | (Makes Chocolates)|
+-------------------+ +-------------------+
^ |
| v
Outside Market Final Consumers
(Benchmark Price) (Revenue for Firm)
This diagram shows how the Cocoa Division supplies to the Candy Division at a transfer
price, while the company also considers the outside market.
Conclusion
So, the next time you enjoy a Dairy Milk or KitKat, remember: before that chocolate reached
your hands, two divisions of the same company might have debated over transfer price!
Transfer Price is simply the internal price at which one unit of a company supplies
goods or services to another unit.
Companies use different methods—Market-Based, Cost-Based, Negotiated, Dual Pricing,
Resale Price, and CUP.
The choice depends on:
• Availability of market prices,
• Nature of product,
• Tax implications, and
• The company’s overall strategy.
In short, transfer pricing is like setting fair rules in a family game—keep it balanced, and
everyone plays happily; mess it up, and fights begin.
“This paper has been carefully prepared for educational purposes. If you notice any mistakes or have
suggestions, feel free to share your feedback.”
