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Introduction

Uses of Financial Reports

  • External users rely on financial reports:
    • Investors – assess financial health before investing.
    • Lenders – evaluate risk before giving loans.
    • Tax authorities, suppliers, and customers – review company’s financial status.

Internal Users: Managers

  • Managers are the largest consumers of accounting information.
  • They use this data for:
    • Planning
    • Decision-making
    • Controlling

Examples:

  • Bidding for a project or submitting a tender requires cost data.
  • HR departments may use accounting data to determine employee incentives.

Two Types of Accounting Systems

  1. Financial Accounting System

    • Records transactions between a company and outsiders:
      • Suppliers, employees, lenders, investors, customers.
    • Produces:
      • Income Statement
      • Balance Sheet
      • Cash Flow Statement

  2. Cost Accounting System

    • Tracks internal movement of goods/services.
    • Provides data for inventory valuation and managerial decision-making.

Case Study: Alpha Company

📌 Phase 1 – Simple Operations:

  • Produces engineering components for automobiles.
  • Made-to-order production model.
  • Data available:
    • Material purchase
    • Wages
    • Other expenses
    • Sales

➕ Simple Income Statement Example:

  • Sales: 10,000 units × ₹80 = ₹8,00,000
  • Material cost: ₹5,00,000
  • Other expenses: ₹2,00,000
  • Profit = ₹1,00,000

📌 Phase 2 – Complex Operations:

  • More products, more customers, imports, and storage.
  • Now includes:
    • Stored raw materials
    • Work in progress
    • Unsold finished goods

❌ Challenge:

  • Sales = 2,600 units
  • Material purchased = 100 tons
  • Material consumed = 72 tons
  • Production started = 3,400 units
  • Production completed = 3,000 units
  • Sales = 2,600 units

Cannot compare sales of 2,600 units with material for 100 tons and expenses for 3,400 units.

Solution: Introduction of Cost Accounting

  • Required: Cost of Sales = Sales − Value of inventory (closing stock)
  • Inventory components:
    • Raw material in stores
    • Work in process
    • Finished goods in warehouse

Role of Cost Accountant:

  • Tracks internal goods movement:
    • Material issued to production
    • Production transferred to warehouse
  • Supplies closing inventory values to financial accountant.

🧾 Revised Income Statement:

  • Profit = Sales − Expenses − Closing stock value

This marked the birth of cost accounting.

Evolution and Use of Cost Accounting

  • Originally for closing stock valuation.
  • Now used for:
    • Managerial decisions
    • Competitor analysis
    • Supplier/customer insights

Advanced Use Case

  • Accounting system also gathers:
    • Financial data of competitors, suppliers, and customers.

Example:

A software company specializing in supply chain looks for businesses with high inventory values.
Sales teams then pitch software to reduce inventory.

📌 Summary of Key Terms

Term Description
Financial Accounting Deals with external transactions and financial reporting.
Cost Accounting Deals with internal tracking for inventory, production, and decision-making.
Cost of Sales Sales minus value of unsold/unfinished/unused inventory.
Income Statement Summary of profit/loss over a period.
Closing Inventory Goods not yet sold or used at the end of the accounting period.
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