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GNDU Question Paper-2022
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 differences between Cost Accounting, Financial Accounting and
Management Accounting.
2. MN Limited gives you the following information related to the year ending 31st March,
2021:
(1) Current Ratio 2.5:1
(2) Debt-Equity Ratio 1:15
(3) Return on Total Assets 15%
(4) Total Assets Turnover Ratio 2
(5) Gross Profit Ratio 20%
(6) Stock Turnover Ratio 7
(7) Current Market Price per Equity Share Rs. 16
(8) Net Working Capital Rs. 4,50,000
(9) Fixed Assets Rs. 10,00,000
(10) 60,000 Equity Shares of Rs. 10 each
(11) 20,000, 9% Preference Share of Rs. 10 each
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(12) Opening Stock Rs. 3,80,000
You are required to calculate:
(i) Quick Ratio
(ii) Fixed Assets Turnover Ratio
(iii) Proprietary Ratio
(iv) Earnings per Share
(v) Price-Earning Ratio.
SECTION-B
3. A Funds flow statement is a better substitute than income statement. Discuss.
4. Describe how cash flow statement is different from funds flow statement.
SECTION-C
5. What is CVP Analysis? How does it help in managerial decision making?
6. A company manufactures three products. The budgeted quantity, selling prices and unit
costs are as under:
A
Rs.
B
Rs.
C
Rs.
Raw Materials (@ Rs. 20 per kg)
80
40
20
Direct wages (@ Rs. 5 per hour)
5
15
10
Variable overhead
10
30
20
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Fixed Overhead
9
22
18
Budgeted production (in units)
6,400
3,200
2,400
Selling price per unit (in Rs.)
140
120
90
Required
(i) Present a statement of budgeted profit.
(ii) Set optimal product-mix and determine the profit, if the supply of raw materials is
restricted to 18,400 kg.
SECTION-D
7. Explain the significance of Responsibility Centres in an organisation.
8. What is a transfer price? Explain the various Transfer Price methods in use.
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GNDU Question Paper-2022
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 differences between Cost Accounting, Financial Accounting and
Management Accounting.
Ans: A Fresh Beginning: The Company Town Story
Once upon a time, there was a busy little town called Businessville. The town was built
around one big factory that produced everything from clothes to gadgets. Now, the factory
was like a heart — it kept the town alive, and it needed three wise men to help it function
smoothly.
1. Mr. Cost Accounting was a careful and detail-oriented fellow. He loved numbers but
not just any numbers — he was obsessed with the cost of things. He would peek into
the factory, note down how much raw material was used, how much the workers
were paid, how much electricity was consumed, and even the smallest screw cost.
His job? To calculate exactly what it cost to produce each product, be it a shirt, a
shoe, or a mobile phone.
2. Mr. Financial Accounting was more of a formal gentleman. He wore a neat suit,
carried big ledgers, and was always worried about rules and laws. His job was not to
look inside the factory like Mr. Cost but to prepare reports for outsiders — like the
government, banks, investors, and shareholders. He focused on preparing the profit
and loss account, the balance sheet, and the cash flow statements to show the world
how well (or poorly) the company was doing.
3. Mr. Management Accounting, on the other hand, was like a wise advisor. He wasn’t
obsessed with legal formats like Mr. Financial, nor was he stuck only with costs like
Mr. Cost. Instead, he looked at both their data, mixed it with future predictions, and
then advised the factory managers on how to make better decisions. He was like the
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GPS of the company, showing directions — “Should we expand? Should we cut
costs? Should we enter a new market?”
And that, my friend, is how the three gentlemen shaped Businessville. But let’s not stop
here. Let’s walk deeper into their lives, explore their specialties, and see how they differ —
yet complement each other.
The Core Purpose
• Cost Accounting: Its main purpose is to find out the cost of producing a product or
service. For example, how much does it cost to make one bottle of cold drink?
Without knowing this, the company can’t set the right price.
• Financial Accounting: Its main goal is to present a true and fair picture of the
company’s financial position. It tells the outside world: “Here’s how much we
earned, here’s how much we spent, and here’s what we own and owe.”
• Management Accounting: Its purpose is to help managers make decisions. It’s not
about reporting to outsiders but helping insiders take smart steps. For example,
“Should we buy new machines or continue with old ones? Should we increase
advertising or reduce staff costs?”
So, the difference is simple:
• Cost = Knowing the cost.
• Financial = Showing performance.
• Management = Guiding decisions.
The Audience They Serve
Think of it like three teachers teaching to different students:
• Cost Accounting teaches the management (factory managers) how much every
product costs so they can control wastage and improve efficiency.
• Financial Accounting teaches the outsiders (government, investors, banks,
shareholders, etc.) because they want to see if the company is trustworthy and
profitable.
• Management Accounting teaches the decision-makers (the company’s bosses and
executives) so they can take smart, future-oriented steps.
The Type of Data They Use
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• Cost Accounting → Uses internal data: raw materials, wages, machine hours,
overheads.
• Financial Accounting → Uses historical data: sales, purchases, income, expenses,
assets, liabilities.
• Management Accounting → Uses both past data (from financial & cost) and future
data (forecasts, budgets, projections).
Example:
Suppose the factory makes 10,000 pens.
• Cost Accounting says: “Each pen costs ₹5 to produce.”
• Financial Accounting says: “This year, the company made a profit of ₹2,00,000 by
selling pens.”
• Management Accounting says: “If we reduce the cost per pen to ₹4.50 and increase
sales by 20%, profit could rise by ₹50,000 next year.”
Time Orientation
This is where they really differ:
• Cost Accounting: Works with present (current costs of production).
• Financial Accounting: Looks at the past (last quarter, last year).
• Management Accounting: Focuses on the future (budgets, strategies, forecasts).
It’s like three photographers:
• Cost Accounting takes a snapshot of today’s factory costs.
• Financial Accounting shows you the old album of last year’s financial health.
• Management Accounting gives you a vision board for tomorrow.
Rules and Flexibility
• Cost Accounting: Not bound by strict law, but companies may follow standard
costing methods.
• Financial Accounting: Very strict. It must follow legal rules like Accounting
Standards, IFRS, or GAAP. Otherwise, reports won’t be valid.
• Management Accounting: Absolutely flexible. It’s like cooking at home — you can
add salt, spice, or sugar as per taste. Managers prepare reports in any form that
helps them take decisions.
Reports They Produce
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• Cost Accounting → Cost sheets, production reports, variance analysis.
• Financial Accounting → Profit & Loss Account, Balance Sheet, Cash Flow Statement.
• Management Accounting → Budgets, forecasts, performance reports, decision
models.
Practical Example
Let’s say Businessville Factory produces smart watches.
• Cost Accounting: Calculates that each watch costs ₹1,200 to make (materials, labor,
overhead).
• Financial Accounting: Reports that by selling 1,000 watches at ₹1,500 each, the
company made a net profit of ₹2,00,000 last year.
• Management Accounting: Advises — “If we invest in marketing and sell 1,500
watches next year, even if the cost per unit goes down to ₹1,100 due to bulk
production, profit will increase significantly.”
Relationship Between Them
These three aren’t competitors; they’re teammates:
• Without Cost Accounting, neither Financial nor Management Accounting can know
the exact cost structure.
• Without Financial Accounting, there’s no authentic record of overall performance.
• Without Management Accounting, data from the other two won’t turn into
strategies.
It’s like a cricket team:
• Cost Accounting is the bowler (controls runs by minimizing cost).
• Financial Accounting is the scorekeeper (records runs, wickets, results).
• Management Accounting is the captain (uses information to make winning
strategies).
Key Differences (Quick Table for Revision)
Aspect
Cost Accounting
Financial Accounting
Management
Accounting
Purpose
Ascertain cost, control
expenses
Show financial performance
& position
Aid in decision-making
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Aspect
Cost Accounting
Financial Accounting
Management
Accounting
Audience
Internal (managers)
External (shareholders,
govt, banks)
Internal (management)
Data Type
Current operational
data
Historical financial data
Past + present + future
data
Orientation
Present
Past
Future
Rules
Flexible, guided by
techniques
Must follow standards
(GAAP/IFRS)
Fully flexible
Reports
Cost sheets, variance
reports
P&L, Balance Sheet, Cash
Flow
Budgets, forecasts,
strategies
Conclusion: Tying It All Together
So, dear student, think of Cost Accounting, Financial Accounting, and Management
Accounting as three siblings.
• One is obsessed with details (Cost).
• One is bound by rules and traditions (Financial).
• One is forward-looking and practical (Management).
Alone, they can’t run a company. But together, they make sure the company knows how
much it spends, how much it earns, and how it can grow in the future.
And that’s the beauty of accounting — it’s not just numbers, but a story of past, present,
and future.
2. MN Limited gives you the following information related to the year ending 31st March,
2021:
(1) Current Ratio 2.5:1
(2) Debt-Equity Ratio 1:15
(3) Return on Total Assets 15%
(4) Total Assets Turnover Ratio 2
(5) Gross Profit Ratio 20%
(6) Stock Turnover Ratio 7
(7) Current Market Price per Equity Share Rs. 16
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(8) Net Working Capital Rs. 4,50,000
(9) Fixed Assets Rs. 10,00,000
(10) 60,000 Equity Shares of Rs. 10 each
(11) 20,000, 9% Preference Share of Rs. 10 each
(12) Opening Stock Rs. 3,80,000
You are required to calculate:
(i) Quick Ratio
(ii) Fixed Assets Turnover Ratio
(iii) Proprietary Ratio
(iv) Earnings per Share
(v) Price-Earning Ratio.
Ans: The Story Begins
Imagine a company named MN Limited. It has just finished its financial year on 31st March,
2021. The management is proud, investors are curious, and examiners (like your teacher)
want to check whether students like you can analyze the company’s performance through
numbers.
Now, here’s the fun part: instead of directly throwing formulas, let’s treat these numbers as
“hints” in a mystery novel. You are the detective, and your mission is to calculate five
special ratios:
1. Quick Ratio
2. Fixed Assets Turnover Ratio
3. Proprietary Ratio
4. Earnings per Share (EPS)
5. Price-Earnings Ratio (P/E)
Every hint given in the problem is like a clue in a treasure hunt. Let’s gather them carefully,
and then use them to solve the mystery.
Step 1: Collecting the Clues
MN Limited provides:
1. Current Ratio = 2.5:1
2. Debt-Equity Ratio = 1:15
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3. Return on Total Assets = 15%
4. Total Assets Turnover Ratio = 2
5. Gross Profit Ratio = 20%
6. Stock Turnover Ratio = 7
7. Market Price per Equity Share = ₹16
8. Net Working Capital (NWC) = ₹4,50,000
9. Fixed Assets = ₹10,00,000
10. Equity Shares = 60,000 shares of ₹10 each (so Equity Share Capital = ₹6,00,000)
11. Preference Shares = 20,000 shares of ₹10 each (so Preference Share Capital =
₹2,00,000 at 9%)
12. Opening Stock = ₹3,80,000
At first sight, this feels overwhelming — too many numbers! But if we decode one by one, it
will all fall into place.
Step 2: Work Out Current Assets & Current Liabilities
We are told:
Current Ratio = Current Assets ÷ Current Liabilities = 2.5
Net Working Capital (NWC) = Current Assets – Current Liabilities = ₹4,50,000
Let’s assume Current Liabilities = x.
Then Current Assets = 2.5x.
So,
Current Assets – Current Liabilities = 2.5x – x = 1.5x = 4,50,000
⟹ x = 3,00,000
Current Liabilities = ₹3,00,000
Current Assets = 2.5 × 3,00,000 = ₹7,50,000
Perfect! This will help us in Quick Ratio later.
Step 3: Work Out Total Assets
We know:
Fixed Assets = ₹10,00,000
Current Assets = ₹7,50,000
So,
Total Assets = 10,00,000 + 7,50,000 = ₹17,50,000
Clue solved.
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Step 4: Decode Debt-Equity Ratio
Debt-Equity Ratio = 1:15
This means:
Debt / Equity = 1/15
Let Equity = E.
Debt = (1/15)E.
But what is Equity here? It means Shareholders’ Funds = Equity Share Capital + Preference
Share Capital + Reserves (if any). We’ll clarify as we move along.
We already know Total Assets = ₹17,50,000.
So:
Debt + Equity = 17,50,000
Debt = (1/15) Equity.
So: (1/15)E + E = 17,50,000
⟹ (16/15)E = 17,50,000
⟹ E = 17,50,000 × (15/16) = ₹16,40,625
Debt = 17,50,000 – 16,40,625 = ₹1,09,375
Equity = ₹16,40,625
Debt = ₹1,09,375
Now we know the company is almost entirely financed by shareholders — very little debt!
Step 5: Sales, Gross Profit & Net Profit
Clue:
Total Assets Turnover Ratio = Sales ÷ Total Assets = 2
So,
Sales = 2 × 17,50,000 = ₹35,00,000
Gross Profit Ratio = Gross Profit ÷ Sales = 20%
So,
Gross Profit = 20% × 35,00,000 = ₹7,00,000
Return on Total Assets = Net Profit ÷ Total Assets = 15%
So,
Net Profit = 15% × 17,50,000 = ₹2,62,500
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Sales = ₹35,00,000
Gross Profit = ₹7,00,000
Net Profit = ₹2,62,500
We’re getting closer!
Step 6: Now Solve the Required Ratios
(i) Quick Ratio
Formula:
Quick Assets = Current Assets – Inventory – Prepaid Expenses
(Since prepaid is not given, we’ll just subtract Inventory).
Now, how to find Closing Stock?
Clue: Stock Turnover Ratio = Cost of Goods Sold ÷ Average Stock = 7
First,
COGS = Sales – Gross Profit = 35,00,000 – 7,00,000 = 28,00,000
Average Stock = Opening Stock + Closing Stock ÷ 2
28,00,000 ÷ Average Stock = 7
⟹ Average Stock = 28,00,000 ÷ 7 = 4,00,000
But Opening Stock = 3,80,000.
So, (3,80,000 + Closing Stock)/2 = 4,00,000
⟹ 3,80,000 + Closing Stock = 8,00,000
⟹ Closing Stock = 4,20,000
Closing Stock = ₹4,20,000
Now,
Quick Assets = Current Assets – Closing Stock = 7,50,000 – 4,20,000 = 3,30,000
Quick Ratio = 3,30,000 ÷ 3,00,000 = 1.1:1
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(ii) Fixed Assets Turnover Ratio
Formula:
= 35,00,000 ÷ 10,00,000 = 3.5 times
(iii) Proprietary Ratio
Formula:
= 16,40,625 ÷ 17,50,000 = 0.9375 ≈ 93.75%
This shows the company is almost entirely owned by shareholders.
(iv) Earnings per Share (EPS)
Formula:
Net Profit = ₹2,62,500
Preference Dividend = 9% × 2,00,000 = 18,000
Profit available for Equity = 2,62,500 – 18,000 = 2,44,500
EPS = 2,44,500 ÷ 60,000 = ₹4.075 per share
(v) Price-Earning Ratio (P/E Ratio)
Formula:
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= 16 ÷ 4.075 ≈ 3.93 times
Final Answers
1. Quick Ratio = 1.1:1
2. Fixed Assets Turnover Ratio = 3.5 times
3. Proprietary Ratio = 93.75%
4. Earnings per Share (EPS) = ₹4.08 (approx.)
5. Price-Earnings Ratio = 3.93
Step 7: Wrapping It Like a Story
Think of it like this:
• The Quick Ratio tells us how much “ready cash and near-cash” MN Limited has for
every ₹1 it owes soon. At 1.1:1, the company is safe but not extremely liquid.
• The Fixed Assets Turnover Ratio at 3.5 shows MN Limited squeezes ₹3.5 of sales out
of every ₹1 invested in machines and buildings — impressive efficiency!
• The Proprietary Ratio of 93.75% screams that this company hardly relies on
borrowed money. It’s financially rock-solid.
• The EPS of about ₹4.08 means each equity share earns a neat return.
• Finally, the P/E Ratio of 3.93 means investors pay ₹3.93 in the market for every ₹1 of
company’s earnings.
It’s like finishing a mystery novel — the detective (you!) has revealed all the hidden truths.
MN Limited stands strong, safe, and profitable.
SECTION-B
3. A Funds flow statement is a better substitute than income statement. Discuss.
Ans : A Funds Flow Statement is a Better Substitute than Income Statement – Discuss
Imagine you are watching a cricket match. The scoreboard shows that your favorite team
has scored 250 runs. That looks impressive, right? But what if I tell you that the team lost 8
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wickets while scoring those runs, and their star players are already back in the pavilion?
Suddenly, the situation doesn’t look so bright.
This is exactly the difference between an Income Statement and a Funds Flow Statement.
The Income Statement is like the scoreboard—it shows the total runs (profits), but it doesn’t
tell you the whole story of how those profits came about, what resources were used, or
whether the company is still in a strong position. The Funds Flow Statement, on the other
hand, is like a commentary—it explains where the money came from, where it went, and
what the financial health of the company looks like beyond just the “runs scored.”
Let us dive into this discussion in detail, like a smooth journey.
Step 1: What is an Income Statement?
The Income Statement (also known as the Profit and Loss Account) is a financial statement
that shows:
• Revenue earned by the business,
• Expenses incurred,
• And finally, the Net Profit or Net Loss.
It is like a movie that focuses only on the “performance” of the business in terms of profit-
making. If a company shows ₹10 lakh profit, the Income Statement is happy. But it does not
ask:
• How much cash is actually left in hand?
• Did the company borrow heavily to make that profit?
• Are the profits tied up in stocks and debtors?
So, while the Income Statement is important, it gives a narrow view.
Step 2: What is a Funds Flow Statement?
The Funds Flow Statement is like a detective. It goes beyond just profits and looks at
changes in financial position between two balance sheet dates. In simple words, it
answers:
• From where did the funds (money/resources) come?
• Where were those funds used?
For example, even if a company shows profits, the Funds Flow Statement may reveal that
most of the money is blocked in purchasing new machinery or paying off loans. This gives a
clearer picture of financial health.
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Step 3: Why is Funds Flow Statement Considered Better?
Now, let’s carefully walk through the reasons why the Funds Flow Statement is often said to
be a better substitute than the Income Statement:
(a) Broader Picture of Financial Health
The Income Statement only focuses on profit. But profit is not the same as liquidity. A
business can be “profitable” on paper but still face a cash crisis.
• Example: A company earns profit by selling goods on credit. Until that money is
collected, profit doesn’t help in paying salaries or bills.
The Funds Flow Statement highlights this by showing changes in working capital.
(b) Helps in Decision-Making
Managers, investors, and lenders want to know more than just profit. They want to know:
• Can the company repay loans?
• Is it investing wisely?
• Are funds being used for growth or just routine expenses?
The Funds Flow Statement provides answers, while the Income Statement cannot.
(c) Explains Sources and Applications of Funds
If you see a friend suddenly driving a luxury car, you would wonder, “Where did the money
come from?” Similarly, if a company suddenly expands, stakeholders want to know the
source of funds.
The Income Statement won’t answer this—but the Funds Flow Statement will show whether
money came from issuing shares, taking loans, or selling old assets.
(d) Detects Financial Weakness
A business might show profits every year but still fail because it doesn’t manage its funds
properly. Funds Flow Statement reveals these weaknesses—like over-dependence on loans,
or funds locked in slow-moving stock.
(e) Long-Term Planning Tool
The Income Statement is short-term—it just reports one year’s performance. The Funds
Flow Statement helps in long-term planning, because it tracks the movement of funds over
time and shows trends in financial management.
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Step 4: But is Funds Flow Statement Perfect?
Now, just like every hero has a few flaws, the Funds Flow Statement also has some
limitations:
• It does not replace the Income Statement completely. After all, profit is still the
primary aim of business.
• It is based on historical data, so it may not always predict the future.
• Preparing it requires rearranging information from both the Balance Sheet and
Income Statement, which can be time-consuming.
So, instead of saying that the Funds Flow Statement completely replaces the Income
Statement, it is more accurate to say that it is a better substitute when deeper analysis is
required.
Step 5: A Human Example to Connect
Think of your personal life. At the end of the month, you calculate your salary minus
expenses, and you feel happy that you “saved ₹5,000.” That’s your Income Statement.
But later, when you check your bank account, you realize:
• You paid ₹3,000 to reduce your old loan,
• You bought a phone for ₹10,000,
• You borrowed ₹7,000 from a friend.
Now, you see the real picture—your savings are not what you thought. That’s your Funds
Flow Statement, which explains where the money came from and where it went.
Step 6: Conclusion – Which is Better?
So, is the Funds Flow Statement a better substitute than the Income Statement?
The answer is: Yes, but with a condition.
• For a quick snapshot of profit, the Income Statement is useful.
• But for a deeper, more reliable understanding of financial health, the Funds Flow
Statement is definitely better.
In fact, both are complementary. The Income Statement tells you how much profit was
earned, while the Funds Flow Statement tells you how that profit was managed. Together,
they give a complete picture.
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Final
To conclude, saying that the Funds Flow Statement is a “better substitute” than the Income
Statement is like saying commentary is better than the scoreboard. The scoreboard (Income
Statement) is essential, but without commentary (Funds Flow Statement), you may
misunderstand the situation. For students, managers, and investors, the Funds Flow
Statement is a powerful tool to look beyond profits and understand the true financial story
of a business.
4. Describe how cash flow statement is different from funds flow statement.
Ans: A Fresh Beginning: The Story of Two Friends
Imagine two friends: Cash and Funds. Both live in the world of accounting, and while they
sound similar, they have very different personalities. Students often confuse them because
their names are close, but once you get to know them, you realize they are not twins at all—
more like cousins.
Cash is that friend who is very straightforward. Whatever money is in his pocket today is
what he talks about. He only cares about actual cash in hand and in the bank. If you ask him
about yesterday or tomorrow, he shrugs—because he’s only interested in what is moving in
and out right now.
Funds, on the other hand, is broader and more thoughtful. He doesn’t just look at cash; he
looks at the overall financial resources of a business. He talks about how money shifts from
one part of the company to another, how working capital changes, and how the long-term
plans affect short-term liquidity. He is less about today’s pocket money and more about the
bigger financial picture.
Now let’s explore them in detail and see how their worlds differ.
1. Their Purpose: What They Want to Show
• Cash Flow Statement is like Cash showing his diary of daily movements: “See, this is
where money came in, and this is where it went out.” It focuses purely on inflows
and outflows of cash and cash equivalents during a particular period.
• Funds Flow Statement is like Funds showing his strategic journal: “This is how the
resources of the business moved around.” It explains changes in working capital and
financial position between two balance sheet dates. It’s not just about cash—it’s
about total resources.
So, Cash Flow is short-term and direct, while Funds Flow is broader and more analytical.
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2. The Focus: Narrow vs. Wide
Think of Cash Flow Statement as a zoomed-in camera lens focusing only on cash and bank
transactions. Whether money came from operations, from selling an asset, or from taking a
loan—it records it clearly.
Funds Flow Statement is like a wide-angle camera lens. It doesn’t restrict itself to cash
alone. Instead, it looks at how all resources (funds) move, especially through working
capital changes. For example, an increase in stock or debtors reduces working capital—even
if no actual cash has moved.
3. Time Orientation: Present vs. Past Comparison
• Cash Flow Statement talks about the current period’s movement of cash. For
example, “During this year, we got ₹10,000 from operations, spent ₹3,000 on
equipment, and repaid a loan of ₹2,000.”
• Funds Flow Statement compares two balance sheet dates. It explains why working
capital increased or decreased between the two. For example, “Last year working
capital was ₹20,000; this year it’s ₹25,000. Let’s see how it changed.”
Thus, Cash Flow is like reading today’s newspaper, while Funds Flow is like comparing last
year’s and this year’s annual reports.
4. Basis of Preparation: What They Rely On
• Cash Flow Statement is prepared on the basis of cash and cash equivalents (like
petty cash, current account, short-term deposits). Non-cash items (like depreciation)
are adjusted to find the net effect on cash.
• Funds Flow Statement is prepared using working capital concept (current assets –
current liabilities). It studies the movement of funds between two balance sheets
and the reasons behind it.
So, Cash Flow lives in the cash world, and Funds Flow lives in the working capital world.
5. Accounting Standards and Recognition
Here’s another interesting difference:
• Cash Flow Statement has strong recognition worldwide. For example, Accounting
Standard (AS) 3 in India makes it compulsory for companies to prepare it.
International standards (IAS 7) also support it.
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• Funds Flow Statement, on the other hand, has lost its popularity. It was widely used
earlier, but now most companies and regulators give priority to Cash Flow because it
is more practical and immediate.
So, in today’s corporate world, Cash Flow is the star performer on stage, while Funds Flow
sits in the audience, still important but less visible.
6. Structure and Headings
The structure also makes them different:
• Cash Flow Statement is divided into three parts:
1. Cash from Operating Activities (core business operations),
2. Cash from Investing Activities (buying or selling assets),
3. Cash from Financing Activities (loans, shares, dividends).
• Funds Flow Statement usually has two parts:
1. Statement of Changes in Working Capital,
2. Statement of Sources and Applications of Funds.
So, Cash Flow gives a step-by-step story of cash, while Funds Flow explains how resources
shifted overall.
7. Practical Usefulness
Let’s imagine you are an investor.
• If you want to know whether a company can pay dividends this year, repay loans, or
meet day-to-day expenses—you’d look at the Cash Flow Statement. It tells you
about liquidity.
• If you want to know how the company is managing its resources in the long run,
whether it is strengthening its working capital base, and how funds are being
generated and used—you’d study the Funds Flow Statement.
In short: Cash Flow helps in short-term decision-making, while Funds Flow helps in long-
term planning.
8. Treatment of Non-Cash Items
Another key point:
• In Cash Flow, non-cash expenses like depreciation, goodwill amortization, or
provision for doubtful debts are added back because they don’t involve cash.
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• In Funds Flow, such items are not ignored; they are considered indirectly because
they affect reserves and overall funds.
9. Example for Better Understanding
Suppose you run a bakery.
• You sold cakes worth ₹50,000 but allowed customers to pay later. Cash in hand is
only ₹30,000. Cash Flow will report ₹30,000 as inflow.
• Funds Flow will consider the entire ₹50,000 sales as an increase in current assets
(debtors included) and explain how it affects working capital.
Thus, Cash Flow is practical in-hand money, while Funds Flow is total resources, whether
cash is received or not.
10. Summary of Key Differences (Story Conclusion)
To make it crystal clear, here’s how our two friends—Cash and Funds—stand apart:
Basis
Cash Flow Statement (Cash)
Funds Flow Statement (Funds)
Meaning
Records inflows & outflows of
cash
Explains changes in financial position (working
capital)
Focus
Liquidity and cash
management
Overall financial resources
Time
One accounting period
Comparison of two balance sheets
Basis
Cash & cash equivalents
Working capital
Structure
Operating, Investing, Financing
Changes in Working Capital, Sources & Uses
Standard
Mandatory (AS-3, IAS-7)
Not mandatory, less used today
Usefulness
Short-term liquidity analysis
Long-term financial planning
Final Words
So, Cash and Funds may sound alike, but they live very different lives. Cash Flow is quick,
practical, and widely loved by accountants and investors because it shows actual liquidity.
Funds Flow is broader, more strategic, and gives insights into resource management,
though it’s less popular today.
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When you understand both, you don’t just learn accounting—you learn the art of
storytelling with numbers: one story about today’s pocket money, and another about the
overall financial journey of a business.
SECTION-C
5. What is CVP Analysis? How does it help in managerial decision making?
Ans: CVP Analysis: A Story of Decisions Behind the Curtain
Imagine you walk into a bakery shop on a cozy evening. The aroma of freshly baked bread
fills the air. The baker, Mr. Arjun, is smiling at his customers, but behind that smile, he is
constantly calculating something in his mind. He wonders:
• “How many loaves of bread do I need to sell today to cover my costs?”
• “If I sell 100 extra cupcakes, how much more profit will I make?”
• “What will happen if the price of flour increases next month?”
These questions are not just the worries of a small baker—they are the heartbeat of every
business, big or small. And the tool that helps answer them is CVP Analysis—short for Cost-
Volume-Profit Analysis.
Now, let’s dive deep into this magical tool in the form of a journey that is simple to
understand, enjoyable to read, and yet academically strong.
What is CVP Analysis?
At its core, CVP Analysis is like a map for managers. It shows how changes in costs (C), sales
volume (V), and selling price (P) affect a company’s profit.
In other words, it answers:
• How many units must be sold to break even?
• How much profit will we earn if we sell a certain number of units?
• What happens if we change the selling price or reduce costs?
The name itself tells the story:
• Cost – the expenses of running the business (raw material, labor, rent, electricity).
• Volume – the number of products or services sold.
• Profit – the ultimate goal every manager chases.
So CVP analysis is like the bridge that connects business activities with profitability.
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The Logic Behind CVP
To understand CVP, imagine the bakery again:
• Arjun has fixed costs (rent of the shop, salaries, electricity). These don’t change
whether he bakes 10 cakes or 1,000.
• Then, he has variable costs (flour, sugar, butter). These rise as production increases.
• When he sells each cake, part of the selling price covers costs, and the rest becomes
profit.
CVP analysis combines these three parts and shows the exact point where Arjun stops losing
money and starts making money—the break-even point.
Key Components of CVP
1. Fixed Costs
Costs that stay the same, like rent, insurance, and salaries.
2. Variable Costs
Costs that rise with production, like raw materials.
3. Selling Price per Unit
How much each item is sold for.
4. Contribution Margin
This is the difference between selling price and variable cost per unit. It’s like the
"profit power" each unit carries to first cover fixed costs, and then contribute to
profits.
5. Break-even Point (BEP)
The magical number of units that need to be sold to cover all costs. Beyond this
point, the business starts making profits.
Why CVP Analysis is Important in Decision Making
Now comes the interesting part: how managers use CVP analysis for decision making. Let’s
break it down with real-life flavored examples.
1. Finding the Break-Even Point
Managers want to know: “How much do we need to sell to survive?”
• If Arjun’s fixed costs are ₹50,000 and each cake contributes ₹50, then he needs to
sell 1,000 cakes just to cover costs.
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• Selling less means losses, selling more means profits.
This helps businesses avoid shooting arrows in the dark.
2. Planning for Profit
Suppose Arjun dreams of earning ₹25,000 profit. CVP helps him calculate how many cakes
to sell for that target.
• Profit target + Fixed cost ÷ Contribution margin = Required units to sell.
It’s like knowing the exact steps to climb to the desired floor in a building.
3. What-if Scenarios
Managers often face questions like:
• “What if raw material prices go up?”
• “What if we reduce selling price to attract more customers?”
• “What if we invest in a new machine that reduces labor cost?”
CVP analysis plays out all these scenarios in numbers, so managers can see the
consequences before making decisions.
4. Pricing Decisions
Should Arjun price his cake at ₹200 or ₹250? A higher price may reduce sales volume, while
a lower price may attract more customers but cut margins. CVP helps balance this puzzle
and decide the best pricing strategy.
5. Product Mix Decisions
Sometimes businesses sell multiple products. CVP helps in deciding which product
contributes more to profit.
• If cakes give higher contribution margin than cookies, Arjun might focus more on
cakes.
6. Controlling Costs
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Managers can identify whether fixed or variable costs are eating into profits. If variable
costs are too high, they may negotiate with suppliers. If fixed costs are heavy, they might
shift to a smaller shop.
Advantages of CVP Analysis
• Clarity: Gives a clear picture of profit planning.
• Simplicity: Easy to use for managers without needing complex statistics.
• Flexibility: Useful for small shops as well as large corporations.
• Decision-making Power: Allows managers to make quick, data-driven decisions.
Limitations of CVP Analysis
But just like every tool, CVP has some limitations too:
• Assumes selling price and costs remain constant, which may not always be true in
real life.
• Works best for short-term decisions, not long-term strategies.
• Ignores market competition, customer behavior, and external economic factors.
Think of it like a compass—it shows direction, but not the weather conditions on the
journey.
Conclusion: CVP as the Manager’s Guiding Light
If business is a ship, then profit is the destination. But the sea is full of uncertainties—rising
costs, fluctuating sales, and unpredictable markets. CVP Analysis acts as the lighthouse that
guides managers safely through these waters.
It tells them:
• “How much to sell to survive.”
• “How to reach the profit target.”
• “What happens if things change.”
In short, CVP is not just about numbers—it’s about giving confidence to managers to take
the right decisions at the right time.
So the next time you enjoy a cake at a bakery, remember that behind its sweetness lies the
silent calculation of CVP analysis—ensuring both the baker’s survival and his growth.
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6. A company manufactures three products. The budgeted quantity, selling prices and unit
costs are as under:
A
Rs.
B
Rs.
C
Rs.
Raw Materials (@ Rs. 20 per kg)
80
40
20
Direct wages (@ Rs. 5 per hour)
5
15
10
Variable overhead
10
30
20
Fixed Overhead
9
22
18
Budgeted production (in units)
6,400
3,200
2,400
Selling price per unit (in Rs.)
140
120
90
Required
(i) Present a statement of budgeted profit.
(ii) Set optimal product-mix and determine the profit, if the supply of raw materials is
restricted to 18,400 kg.
Ans: A factory morning story — turning raw metals into numbers (and profit)
Imagine a small factory buzzing at dawn. Three product lines — A, B and C — sit on the shop
floor like three characters in a play. Each needs raw material (measured in kg), labour hours,
and overheads; each brings money in when sold. Our job is to tell the story of the budget:
how much money each product will make under the planned output, and what happens
when the raw-material pantry is shorter than planned (18,400 kg available). I’ll walk you
through every step, in plain language, with clear arithmetic so an examiner (and any
student) can follow comfortably.
Given (per unit figures and budgeted volumes)
For each product we are told unit costs and budgeted production:
• Product A
o Raw materials (Rs. 80)
o Direct wages (Rs. 5)
o Variable overhead (Rs. 10)
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o Fixed overhead (Rs. 9)
o Budgeted production = 6,400 units
o Selling price = Rs. 140
• Product B
o Raw materials (Rs. 40)
o Direct wages (Rs. 15)
o Variable overhead (Rs. 30)
o Fixed overhead (Rs. 22)
o Budgeted production = 3,200 units
o Selling price = Rs. 120
• Product C
o Raw materials (Rs. 20)
o Direct wages (Rs. 10)
o Variable overhead (Rs. 20)
o Fixed overhead (Rs. 18)
o Budgeted production = 2,400 units
o Selling price = Rs. 90
Important note: raw-material price is Rs. 20 per kg. So if raw material cost per unit is Rs. 80
for A, that means A uses 80/20 = 4 kg per unit. We'll use that shortly.
(i) Statement of budgeted profit — step-by-step
Step 1 — compute variable cost per unit (VC) and contribution per unit
Variable cost per unit = Raw materials + Direct wages + Variable overhead.
Contribution per unit = Selling price − Variable cost per unit.
Compute for each product:
• A
o VC = 80 + 5 + 10 = Rs. 95
o Contribution = 140 − 95 = Rs. 45
• B
o VC = 40 + 15 + 30 = Rs. 85
o Contribution = 120 − 85 = Rs. 35
• C
o VC = 20 + 10 + 20 = Rs. 50
o Contribution = 90 − 50 = Rs. 40
Step 2 — totals at budgeted production
Multiply unit figures by budgeted volumes.
• A (6,400 units):
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o Sales = 6,400 × 140 = Rs. 896,000
o Total VC = 6,400 × 95 = Rs. 608,000
o Total contribution = 6,400 × 45 = Rs. 288,000
o Total fixed overhead allocated (per unit FO × units) = 9 × 6,400 = Rs. 57,600
• B (3,200 units):
o Sales = 3,200 × 120 = Rs. 384,000
o Total VC = 3,200 × 85 = Rs. 272,000
o Total contribution = 3,200 × 35 = Rs. 112,000
o Total fixed overhead = 22 × 3,200 = Rs. 70,400
• C (2,400 units):
o Sales = 2,400 × 90 = Rs. 216,000
o Total VC = 2,400 × 50 = Rs. 120,000
o Total contribution = 2,400 × 40 = Rs. 96,000
o Total fixed overhead = 18 × 2,400 = Rs. 43,200
Step 3 — aggregate and compute budgeted profit
Sum across products:
• Total Sales = 896,000 + 384,000 + 216,000 = Rs. 1,496,000
• Total Variable Cost = 608,000 + 272,000 + 120,000 = Rs. 1,000,000
• Total Contribution = 288,000 + 112,000 + 96,000 = Rs. 496,000
• Total Fixed Overhead = 57,600 + 70,400 + 43,200 = Rs. 171,200
Budgeted Profit = Total Contribution − Total Fixed Overhead = 496,000 − 171,200 = Rs.
324,800.
So the planned production schedule yields a profit of Rs. 324,800.
(ii) Optimal product-mix when raw material is limited to 18,400 kg
Now the plot thickens: suppose the raw-material store has only 18,400 kg. We must
reassign what to produce (up to budgeted maxima) to maximize profit. This is a classic
constrained optimisation: the constraint is raw material (kg). The right approach is to
compute contribution per kg of raw material for each product, and produce in descending
order of this ratio (up to their budgeted quantities).
Step 1 — raw material usage per unit
Since raw material price is Rs. 20 per kg:
• A uses 80/20 = 4 kg per unit
• B uses 40/20 = 2 kg per unit
• C uses 20/20 = 1 kg per unit
Step 2 — contribution per kg
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Contribution per unit we already have: A = Rs.45, B = Rs.35, C = Rs.40.
So contribution per kg:
• A: 45 / 4 = Rs. 11.25 per kg
• B: 35 / 2 = Rs. 17.50 per kg
• C: 40 / 1 = Rs. 40.00 per kg
Interpretation: product C yields the highest contribution for every kg of raw material; B is
next best; A is the least efficient in terms of raw-material use.
Step 3 — allocate raw material to best contributors (subject to budgeted max production)
Follow the descending order: C → B → A.
• Produce full C: budgeted 2,400 units, each needs 1 kg → uses 2,400 kg. Remaining
raw material = 18,400 − 2,400 = 16,000 kg.
• Produce full B: budgeted 3,200 units, each needs 2 kg → uses 6,400 kg. Remaining =
16,000 − 6,400 = 9,600 kg.
• Now A: budgeted 6,400 units, each needs 4 kg; but only 9,600 kg remain. So units of
A producible = 9,600 / 4 = 2,400 units (partial, not full budgeted).
Thus the optimal production plan under the raw-material limit is:
• A = 2,400 units
• B = 3,200 units (full)
• C = 2,400 units (full)
Step 4 — compute profit under this mix
Contribution totals:
• A: 2,400 × 45 = Rs. 108,000
• B: 3,200 × 35 = Rs. 112,000
• C: 2,400 × 40 = Rs. 96,000
Total Contribution = 108,000 + 112,000 + 96,000 = Rs. 316,000
Fixed overhead remains the factory’s fixed cost (the total we computed from budgeted per-
unit allocations). Fixed overhead total (unchanged) = Rs. 171,200.
Profit under the constraint = Total Contribution − Fixed Overhead = 316,000 − 171,200 =
Rs. 144,800.
So constrained-profit = Rs. 144,800.
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Commentary — telling the economic story plainly
1. Why contribution per kg matters
The raw material is the scarce resource; producing the item that earns the most
contribution for every kg of that scarce input is the quickest route to higher profit.
That’s why C (Rs.40 per kg) is top priority, then B (Rs.17.5), then A (Rs.11.25).
2. Why fixed overhead total didn’t change
Fixed overhead is fixed for the period (factory rent, salaried staff, etc.). Even if we
produce fewer A units than originally budgeted, those fixed costs remain and must
be covered by contribution. That’s why total profit under constraint falls significantly
— the total contribution drops (from Rs.496,000 to Rs.316,000) while fixed costs stay
the same.
3. Numerical intuition
Under full budgeted production we had a comfortable profit (Rs.324,800). But when
raw material is limited, we still make the best use of each kg (by prioritizing C and B),
yet we cannot avoid losing contribution from curtailed A production — and since
fixed overhead is large (Rs.171,200), the final profit shrinks to Rs.144,800.
4. Managerial takeaway
o If raw material shortage is persistent, consider increasing purchases or
finding substitutes, because the marginal loss of profit is substantial.
o Alternatively, re-examine fixed overhead: if output will be permanently
lower, management should seek ways to reduce fixed costs to restore
profitability.
o If selling prices or variable costs change, re-evaluate contribution per kg —
the optimal mix can shift.
Final summary (concise)
• Budgeted (original) profit: Rs. 324,800 (Total sales Rs.1,496,000; Total contribution
Rs.496,000; Fixed overhead Rs.171,200).
• With raw material limited to 18,400 kg — optimal mix: produce C 2,400; B 3,200; A
2,400.
• Profit under constraint: Rs. 144,800 (Total contribution Rs.316,000 minus same fixed
overhead Rs.171,200).
SECTION-D
7. Explain the significance of Responsibility Centres in an organisation.
Ans: The Significance of Responsibility Centres in an Organisation
Imagine you are the captain of a very large ship. This ship has hundreds of workers—cooks,
engineers, security staff, navigators, cleaners, and more. Now, if every worker kept coming
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to you for even the smallest decision, what would happen? You would be overburdened,
confused, and unable to focus on steering the ship safely. The journey would be a mess!
To solve this, you decide to divide the ship into different departments—kitchen, engine
room, navigation, security, and housekeeping. Each department gets a leader who is
responsible for making sure things run smoothly in their area. The cook looks after food, the
engineer handles the engines, the navigator manages the route, and so on.
This, my friend, is exactly how responsibility centres work in an organisation. They are like
small, manageable parts of a large system, each with a leader who takes responsibility.
Now let’s break this story into the real-world business sense and explore it deeply.
1. What Are Responsibility Centres?
A responsibility centre is a segment or unit within an organisation where a manager is given
responsibility and authority for certain tasks, operations, or decisions.
• It’s like a mini-organisation inside the larger one.
• Each centre has specific goals and measures of performance.
• Managers of these centres are accountable for results.
In short: Responsibility centres make management more organised, efficient, and focused.
2. The Different Types of Responsibility Centres
Responsibility centres are not all the same. Just like departments in our ship story had
different roles, organisations also divide centres according to responsibilities:
(a) Cost Centres
• A cost centre is like the engine room of the ship.
• The manager here is responsible only for controlling costs.
• Example: The production department in a factory. Their job is to minimize wastage,
use raw materials wisely, and keep expenses under control.
• Performance is judged by how well costs are managed.
(b) Revenue Centres
• Think of the sales department as the navigator who brings new opportunities.
• Here, the manager is responsible only for generating revenue, not for costs.
• Example: A marketing or sales division that focuses on increasing sales volume and
revenue.
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(c) Profit Centres
• A profit centre is like the kitchen of the ship, where the cook manages both the
costs of ingredients and the revenue from food served.
• Managers here are responsible for both revenue and expenses.
• Example: A retail store branch where the manager decides pricing, promotions, and
cost control to ensure profits.
(d) Investment Centres
• This is the captain’s room, where big financial decisions are made.
• Here, the manager is responsible for revenues, costs, and also how investments are
used.
• Example: A division head who decides whether to invest in new machinery, expand
to new markets, or buy assets.
3. Why Responsibility Centres Are Significant
Now, let’s understand the deeper significance of responsibility centres—why they are so
important in organisations:
(a) Clarity in Roles and Accountability
When an organisation sets up responsibility centres, every manager knows what they are
accountable for.
• A cost centre manager knows he must keep expenses down.
• A revenue centre manager knows she must bring in sales.
• This clarity avoids confusion and finger-pointing.
It’s like saying: “You take care of the kitchen, I’ll handle the navigation.” Everyone knows
their job.
(b) Helps in Performance Measurement
How do you know if your team is doing well? Responsibility centres make it easy to measure
performance.
• You can check if the cost centre is reducing wastage.
• You can see if the revenue centre is increasing sales.
• You can track if the profit centre is generating enough profit.
Without responsibility centres, it would be like judging the whole ship without knowing
which department worked well and which failed.
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(c) Encourages Specialisation
Each centre focuses on its own area. This builds expertise.
• Cost centres become masters of efficiency.
• Revenue centres become experts at selling.
• Profit centres learn to balance both sides.
This specialisation increases overall efficiency.
(d) Promotes Accountability and Motivation
When managers are given authority along with responsibility, they feel ownership.
• A profit centre manager feels like a mini-CEO of his unit.
• This responsibility motivates them to perform better, just like department heads on
a ship take pride in their section.
(e) Facilitates Better Decision-Making
Responsibility centres decentralize power.
• Instead of one boss deciding everything, decisions are made at different levels.
• This makes the organisation more flexible and quick in responding to changes.
It’s like the ship: if the engine room has a problem, the engineer fixes it immediately without
disturbing the captain.
(f) Helps in Strategic Planning
By analysing each responsibility centre, management can decide where to invest more
resources and where to cut back.
• If one profit centre is performing extremely well, the company may expand it.
• If a cost centre is inefficient, steps can be taken to improve it.
This makes long-term planning more accurate.
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4. Real-Life Examples
Let’s make this even simpler with examples:
• Cost Centre Example: The maintenance department in Indian Railways ensures
trains run smoothly at minimum cost.
• Revenue Centre Example: Amazon’s sales team focuses only on boosting sales, not
on production costs.
• Profit Centre Example: A Domino’s Pizza outlet manages both the cost of ingredients
and revenue from pizza sales.
• Investment Centre Example: Reliance Jio’s top management decides whether to
invest billions into 5G networks.
These examples show how responsibility centres exist everywhere—small shops,
multinational companies, even government offices.
5. Challenges of Responsibility Centres
Of course, no system is perfect. Responsibility centres also face challenges:
• Managers may focus only on their unit and ignore overall organisational goals.
• Sometimes performance is hard to measure (e.g., in a research department).
• If not coordinated well, responsibility centres may create silos.
But with proper communication and coordination, these challenges can be reduced.
6. Conclusion
Responsibility centres are like dividing a giant puzzle into smaller pieces so that solving it
becomes easier. They bring clarity, accountability, motivation, efficiency, and better
decision-making into organisations.
Just as a captain cannot sail a ship alone, no top manager can run a large organisation
single-handedly. Responsibility centres ensure that the burden is shared, tasks are
specialised, and success is measurable.
So, in the big story of management, responsibility centres act as guiding lights—helping
managers not only run the business smoothly but also plan for growth and stability.
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8. What is a transfer price? Explain the various Transfer Price methods in use.
Ans: Imagine a big company called “GlobalTech Ltd.”. GlobalTech has multiple departments:
one makes computer components, another assembles the final computers, and a third
handles marketing and sales. Now, the component-making department doesn’t sell its
products outside the company—it only provides parts to the assembly department. Here
comes the big question: At what price should the components be “sold” to the assembly
department?
This is exactly where transfer pricing comes in.
What is Transfer Price?
In simple words, a transfer price is the price at which goods, services, or even intangible
assets like patents are sold from one department of a company to another. Think of it as an
internal marketplace, where each department wants to make “profits” on what it produces,
even though they are all part of the same company.
Transfer prices are crucial because:
1. They help measure the performance of each department fairly.
2. They influence the profit of different departments, which affects bonuses and
incentives.
3. They impact taxation, especially for multinational companies, since profits can be
shifted to departments in low-tax countries.
So, in our GlobalTech example, if the component department sets a high transfer price, the
assembly department’s profit will shrink, even if the overall company profit remains the
same. Conversely, if the price is too low, the component department might look like it is
underperforming.
Methods of Transfer Pricing
Now, let’s explore the various transfer pricing methods—each one is like a different way for
the departments to “negotiate” internally. There are five main methods, which I’ll explain
with examples so they feel like a story rather than dry theory.
1. Cost-Based Transfer Pricing
This is the simplest method. The transfer price is based on the cost incurred by the
supplying department.
• Types:
o Full cost method: The price includes both fixed and variable costs.
o Variable cost method: Only variable costs are considered.
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Example story:
The component department spends ₹500 per unit to make a motherboard. Using the full
cost method, it charges the assembly department ₹500 per unit. If variable cost method is
used, and the variable cost is ₹300, the transfer price is ₹300 per unit.
Pros: Simple and fair.
Cons: Ignores market conditions; may discourage efficiency.
2. Market-Based Transfer Pricing
Here, the transfer price is set equal to the price charged in the open market for similar
goods or services.
Example story:
GlobalTech’s component department could sell its motherboards to an outside buyer for
₹800. If it supplies internally to assembly, the transfer price will also be ₹800.
Pros: Reflects real economic value; encourages efficient resource use.
Cons: Hard to apply if no external market exists.
3. Negotiated Transfer Pricing
Sometimes departments negotiate a price between themselves, balancing costs, market
price, and profit goals.
Example story:
The component department wants ₹700 per motherboard, while the assembly department
wants ₹600. After discussions, they agree on ₹650.
Pros: Flexible and can accommodate departmental goals.
Cons: Time-consuming; may create conflicts or unfair advantages.
4. Dual Pricing
This is a compromise method. The supplying department records its transfer at one price
(usually market price) for accounting purposes, while the buying department records it at
another (usually lower) for internal reporting.
Example story:
For internal reports, the component department charges ₹800 per motherboard (market
price), but assembly department books ₹650 to measure its performance fairly. The
difference can be adjusted at the corporate level.
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Pros: Solves inter-departmental disputes.
Cons: Complicated bookkeeping; can be confusing.
5. Standard Cost Transfer Pricing
Here, a pre-determined standard cost is used as the transfer price. Standard costs are
calculated based on expected efficiency and resource usage.
Example story:
GlobalTech sets a standard cost of ₹550 per motherboard at the start of the year.
Regardless of actual production cost (₹500 or ₹600), this standard cost is used for all
internal transfers.
Pros: Simplifies accounting and budgeting; motivates cost control.
Cons: Can become unrealistic if actual costs deviate significantly.
Why Transfer Pricing Matters
Now, let’s zoom out from methods to real-world impact:
1. Performance Evaluation – Each department is evaluated based on internal profits.
Transfer pricing ensures fairness.
2. Tax Implications – Multinational companies often face different tax rates in different
countries. Proper transfer pricing can prevent tax evasion issues with governments.
3. Resource Allocation – Helps the company make better decisions about which
departments to expand or invest in.
4. Conflict Resolution – Departments often have competing interests; transfer pricing
methods like dual pricing reduce disputes.
Key Takeaways
• Transfer pricing is like an internal marketplace within a company.
• Different methods—cost-based, market-based, negotiated, dual, and standard
cost—offer flexibility to balance fairness, efficiency, and simplicity.
• The choice of method depends on availability of market data, company policy, and
strategic goals.
• Done correctly, transfer pricing keeps every department motivated, ensures smooth
operations, and avoids conflicts with tax authorities.
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Story Conclusion
Think of GlobalTech as a family with multiple businesses. The component department is like
the chef who cooks, the assembly department is like the waiter serving the food, and the
accounting team is like the head of the family who ensures fairness. Transfer pricing is the
“recipe for fairness” that keeps everyone happy, motivated, and accountable. Without it,
some departments may feel shortchanged, others may overspend, and the whole family
might end up fighting over money.
In short, transfer pricing is not just numbers—it’s a tool for harmony, efficiency, and
strategy, written in the language of cost, negotiation, and market realities.
“This paper has been carefully prepared for educational purposes. If you notice any mistakes or
have suggestions, feel free to share your feedback.”
