Definition: In the general sense, the budget is described as a precise statement, representing a financial estimate of income and expenditure of the government for a certain period. In cost accounting, budget means a quantitative statement, prepared before a particular period to serve as an estimate of future receipts and disbursements.

The integrated process of preparing, implementing and operating budgets is called as Budgeting.

Features of Budget

• It is an estimate of the economic activities of an entity which related to a specified future period.
• It must be written and approved by the appropriate authority.
• It should be modified or corrected, whenever, there is a change in circumstances.
• It plays the role of a business barometer that helps in measuring the performance of the business by comparing actual and budgeted results.
• It is prepared on the basis of past experiences and trends in the business.
• It is a business practice, which is used to forecast the operating activities and financial position of the business.

Budget is used to fix targets in monetary terms and control the deviations if any. Further, it can also be used as a basis to measure the performance of the organization.

Classification of Budgets

• Based on time
  • Long-term Budget: The budget designed by the management for a long-term, i.e. three to ten years is called as long-term budget.
  • Short-term Budget: As the name suggests, the budget which is prepared for a period ranging from 1 to 2 years, is called short-term budget.
• Based on Capacity
  • Fixed Budget: The budget created for a fixed activity level, i.e. the budget remains constant regardless of the level of activity, is called as fixed budget.
  • Flexible Budget: The budget which changes with the change in the level of activity is a flexible budget. It identifies the fixed cost, semi-variable cost and variable cost, to show the expected results at different volumes.
• Based on Scope
  • Functional Budget: The budget which is concerned with the business functions is called as functional budget. It can be further classified as:
    • Sales Budget: Sales budget is used to determine the quantity of anticipated sales and the expected selling price per unit.
    • Production Budget: It is prepared to indicate the production for the specified period and is expressed in the units of outputs produced.
    • Materials Budget: The budget prepared to show the quantities of direct material and raw material required to manufacture the finished product.
    • Purchase Budget: Purchase budget is designed to estimate the quantity and value of different items to be bought at different points of time, considering the production schedule and inventory required.
    • Cash Budget: The budget highlights the cash needed by the business in a specified period, taking into account all the receipts and payments of the business.

Apart from those discussed above, there are other functional budgets also, i.e. plant utilization budget, direct material usage budget, factory overhead budget, production cost budget, cost of goods sold budget, selling and distribution cost budget, administration expenses budget, etc.

• Master Budget: Once all the functional budgets are created, then the financial officer will prepare a master budget. It is an integrated budget that reflects the estimated profit and loss and financial position using Budgeted Profit & Loss Account and Budgeted Balance Sheet of the concern.

• Based on Receipts and Expenditure
  • Capital Budget: The budget takes into account the estimated capital receipts and expenditure of the business for a specified period.
  • Revenue Budget: The budget that covers all the revenue receipts and expenses of a particular financial year is a revenue budget.

A budget acts as a map for the future economic activities of the business, which are prepared as per the policies of the different organizational functions. It aims at making optimum utilisation of the capital and other resources of the organization.

Definition: Process Costing is defined as a branch of operation costing, that determines the cost of a product at each stage, i.e. process of production. It is an accounting method which is adopted by the factories or industries where the standardized identical product is produced, as well as it passes through multiple processes for being transformed into the final product.

In simple words, process costing is a cost accounting technique, in which the costs incurred during production are charged to processes and averaged over the total units manufactured. For this purpose, process accounts are opened in the books of accounts, for each process and all the expenses relating to the process for the period is charged to the respective process account.

Hence, it ascertains the total cost and unit cost of a process, for all the processes carried out in industry. Further, the average cost represents the cost per unit, wherein the total cost is divided by the total number of outputs produced during the period to arrive at the cost per unit. The cost per unit can be calculated using First in First Out Method (FIFO), Average Method and Weighted average Method.

Features of Process Costing

• The plant has various divisions, and each division is a stage of production.
• The production is carried out continuously, by way of the simultaneous, standardized and sequential process.
• The output of a process is the input of another.
• The production from the last process is transferred to finished stock.
• The final product is homogeneous.
• Both direct and indirect costs are charged to the processes.
• The production may result in joint and by-products.
• Losses like normal and abnormal loss occur at different stages of production which are also taken into consideration while calculating the unit cost.
• The output of one process is transferred to another one at a price that includes the profit of the previous process and not at the cost.
• At the end of the period, if there remains the stock of finished goods, then it is also expressed in equivalent completed units. It can be calculated as:
  Equivalent units of semi-finished goods or WIP = Actual number of units in process × Percentage of work completed

Process costing is employed by the industries whose production process is continuous and repetitive, as well as the output of one process is the input of another process. So, chemical industry, oil refineries, cement industries, textile industries, soap manufacturing industries, paper manufacturing industries use this method.

Definition: Standard Costing is a costing method, that is used to compare the standard costs and revenues with the actual results, in order to arrive at the variances along with its causes, to inform the management about the deviations and take corrective measures, for its improvement.

The term ‘standard cost’ can be defined as the expected cost per unit of the products produced during a period, which is based on various factors. It aims at measuring the performance, controlling the deviations, inventory valuation and deciding the selling price of the product especially when quotations are prepared.

The three main elements of standard cost are Direct Material Cost, Direct Labor Cost and Overheads.

Need of Standard Costing

• Future cost estimation: Standard Costs are determined after considering all the possibilities that may arise in the future. It also helps in deciding whether a particular project is to be undertaken, by determining its profitability.
• Performance check: Standard cost acts as targets to the cost centres which should not be transcended. In such a situation, these targets are helpful in checking the performance through comparison with the actual results.
• Budgeting: The standard costs are used to prepare budgets, and evaluate the performance of the executive staff on the basis of these budgets.

The basic objective of standard costing is to measure the differences between standard costs and actual costs, and analysing them to maintain the productivity of the organization.

Process of Standard Costing

• Establishing Standards: First and foremost, the standards are to be set on the basis of management’s estimation, wherein the production engineer anticipates the cost. In general, while fixing the standard cost, more weight is given to the past data, the current plan of production and future trends. Further, the standard is fixed in both quantity and costs.
• Determination of Actual Cost: After standards are set, the actual cost for each element, i.e. material, labour and overheads is determined, from invoices, wage sheets, account books and so forth.
• Comparison of Actual Costs and Standard Cost: Next step to the process, is to compare the standard cost with the actual figures, so as to ascertain the variance.
• Determination of Causes: Once the comparison is done, the next step is to find out the reason for the variances, to take corrective actions and also to evaluate the overall performance.
• Disposition of Variances: The last step to this process, is the disposition of variances by transferring it to the costing profit and loss account.

Standard costing can be helpful in ascertaining the profitability of the business at any level of production. Further, it is also useful in practical management functions, i.e. planning and controlling.

Definition: Cost Accounting implies a branch of accounting which deals with recording, classifying, accumulation, allocation and control of the cost of production. It captures the incomes and expenditures and prepares statements and reports for the respective period, so as to determine and control costs.

It aims at keeping a record of the cost of production, by ascertaining input cost at each level of production including fixed cost such as rent and depreciation.

Objectives of Cost Accounting

• Determination of Cost: To accumulate, allocate and ascertain cost for each cost object is the primary objective of the cost accounting.
• Basis for fixing selling prices: As the prices of the cost object, i.e. the product is determined by the external factors such as market demand for the product, competitor’s price, etc. However, the basis for ascertaining the price is the total cost of production and the cost accounting techniques helps in determining it.
  Along with that, it acts as a guide for estimating prices for tender and quotations.
• Cost Control: Another important objective of the cost accounting system is to control the costs. It keeps a check on the expenses made by the company, against the set standards and the deviations are recorded and reported continuously.
• Cost Reduction: The management works to further reduce the cost to increase the profitability of the company. Cost reduction implies the actual and permanent reduction in the cost of production without compromising with the quality and the suitability of its desired use.
• Determination of Closing Inventory: To ascertain the value of closing inventory at the end of the period for the preparation of financial statements of the concern.
• Assisting Management: To report to the management about the inefficiencies of the workers and eliminates wastes like material, expenses, equipment, tools and so forth.
  It also ensures optimum utilization of resources of the organization by making sure that no machines are left idle, the workers get incentives for their performance, proper utilization of by-products and so forth.
• Economies of Production: To reflect different sources of economies of scale, concerning the process, type of equipment, inputs used, the output generated etc.

Cost Accounting is useful in reaching the cost of production of every unit, process, job and operation. It also assists the management in making a comparison between the actual cost and the estimated cost. Further, it also provides data on periodic intervals, i.e. weekly, monthly or quarterly, with respect to the profit and loss of the entity to estimate future profitability.

Introduction to Strategic Cost Management (SCM)

Strategic Cost Management (SCM) is a vital business discipline that aligns cost management with a company’s overarching business strategy. Unlike traditional cost-cutting methods, SCM focuses on long-term profitability and competitive advantage by optimizing resources across the value chain. SCM isn’t just about reducing expenses—it’s about making smart, data-driven decisions that bolster a company’s competitive edge and strategic objectives.

In today’s fast-paced business environment, SCM plays a pivotal role in helping businesses navigate rising costs, economic shifts, and market disruptions. By effectively integrating cost management with strategy, companies can not only survive but thrive in a competitive marketplace.

What is Strategic Cost Management (SCM)?

Strategic Cost Management is an integrated approach to managing costs with the goal of improving a company’s financial performance and competitive positioning. It combines cost data with strategic decision-making to achieve a sustainable competitive advantage. Unlike conventional cost management, SCM provides a holistic view that helps organizations identify areas where cost optimization can be achieved without sacrificing quality or customer satisfaction.

SCM is crucial for businesses looking to achieve cost leadership or differentiation strategies, both of which are critical for market success. It helps organizations:

• Align cost structures with business strategies
• Enhance profitability through informed decision-making
• Improve operational efficiency and reduce waste
• Drive long-term value through cost-effective innovation

Stages of Strategic Cost Management

Strategic Cost Management involves several key stages that allow organizations to integrate cost considerations into their strategic planning and execution processes:

• Formulating Strategies : The first stage involves developing the core business strategy. This could be pursuing cost leadership, differentiating products/services, or focusing on niche markets. A strong understanding of costs and value drivers is crucial for this step.
• Communicating Strategies Across the Organization : Effective communication ensures that every department is aligned with the overall strategic objectives. It involves informing and engaging stakeholders, from top management to operational teams.
• Planning and Executing Tactics : This phase involves creating detailed action plans and implementing tactics that support the strategic goals, focusing on efficiency and reducing unnecessary costs.
• Implementing Controls and Tracking Performance : Finally, robust monitoring and control mechanisms are put in place to track the success of SCM initiatives. These controls help ensure that the cost management efforts stay aligned with the overall strategy.

Why is Strategic Cost Management Important?

The need for SCM arises from its ability to link cost management directly to business strategy. Here’s why SCM is a game-changer for businesses:

• Cost Analysis with Strategic Focus: SCM provides clarity on how costs relate to the company’s broader objectives, helping identify areas where cost savings can directly contribute to strategic goals.
• Achieving Sustainable Competitive Advantage: By using cost information to drive decision-making, SCM helps companies gain a long-term advantage by either leading in cost-efficiency or offering differentiated, higher-value products.
• Proactive Cost Management: SCM doesn’t just react to cost increases. It actively identifies cost drivers and leverages opportunities for cost optimization in real-time.
• Value Chain Optimization: SCM helps businesses optimize each step of their value chain—from procurement to post-sale support—leading to greater overall efficiency and profitability.

Core Components of Strategic Cost Management

SCM is made up of three critical components that drive successful cost management strategies:

• Strategic Positioning Analysis: This analysis determines a company’s position in the market relative to its competitors. By understanding its comparative performance, businesses can identify where they stand in terms of cost leadership or differentiation.
• Cost Driver Analysis: Understanding what drives costs is key to effective cost management. Cost drivers can be classified as:

  Structural Cost Drivers: These are long-term factors such as economies of scale, capacity utilization, and vertical integration.

  Executional Cost Drivers: These are more short-term factors, including labor efficiency, process optimization, and supply chain management.
  
  Identifying and optimizing these drivers can significantly reduce costs and improve profitability.
• Value Chain Analysis (VCA): Value chain analysis, a concept introduced by Michael Porter in 1985, is central to SCM. VCA helps businesses break down all activities involved in the creation of a product or service. By identifying inefficiencies in the value chain, companies can focus on areas for improvement and cost reduction, ultimately enhancing customer value.

Implementing Strategic Cost Management for Competitive Advantage

Strategic Cost Management isn’t a one-time initiative. It requires continuous improvement and frequent re-evaluation. The most successful companies implement SCM early in the product life cycle, using cost insights to adjust strategies and operations dynamically. Here are the steps to implement SCM effectively:

• Early Integration: Incorporate SCM at the product design and planning stages to prevent high costs later.
• Data-Driven Decision Making: Leverage advanced analytics and business intelligence tools to gather real-time data on costs, and use that data for informed decision-making.
• Cross-Functional Collaboration: Encourage collaboration across departments to ensure cost management strategies are aligned throughout the organization.
• Monitor and Adjust: SCM should be an ongoing process. Regular performance tracking and adjustments are essential to respond to market changes or internal inefficiencies.

Latest Trends in Strategic Cost Management

In response to the rapidly changing business environment, new trends in SCM are emerging, such as:

• Artificial Intelligence (AI) & Machine Learning: AI-powered tools are now being used to predict cost trends, optimize resource allocation, and identify cost-saving opportunities through predictive analytics.
• Cloud-Based Cost Management: Many businesses are leveraging cloud platforms for real-time cost tracking and performance analysis, which allows for quicker decision-making and greater transparency.
• Sustainability and Green SCM: Companies are increasingly focusing on sustainable cost management by reducing waste, optimizing energy usage, and investing in eco-friendly technologies to align with both cost efficiency and corporate social responsibility goals.
• Automation & Digital Transformation: Automation technologies, such as robotic process automation (RPA), are reducing labor costs and improving process efficiency, while digital transformation enables better visibility across the value chain.

Conclusion: Unlock the Power of Strategic Cost Management

Strategic Cost Management is a powerful tool that can align your organization’s cost structures with its strategic goals, driving both short-term profitability and long-term competitive advantage. By focusing on value chain optimization, understanding cost drivers, and integrating strategic positioning into decision-making, companies can not only survive but thrive in today’s dynamic business environment.

Definition: Accounting is a process, which systematically and comprehensively records business events and transactions, and translate it into the financial information of the business entity to assist the stakeholders in the decision-making process.

In this process, the transactions are identified, recorded, arranged, summarized, simplified properly and then communicated to the interested parties.

Generally Accepted Accounting Principles (GAAP)

Generally Accepted Accounting Principles (GAAP) provide the rules for the preparation of the accounting statements, in the form of concepts, conventions, assumptions and principles. It not only removes confusion but also provide consistency and uniformity in the process. These are the fundamental assumptions, on which the entire system of accounting is based.

Branches of Accounting

• Financial Accounting: It is that branch of accounting, which involves the recording of the transactions, inclined towards the preparation of trial balance and final accounts.
• Cost Accounting: Cost account is the accounting discipline, which deals with costs, i.e. the unit costs of the goods produced and services provided. It helps the management of the organization in fixing the price, controlling costs and providing relevant information for the purpose of decision making.
• Management Accounting: The accounting system which supplies the necessary information to the management, for rational decision making. The information may be concerned with funds, costs, profits and losses and so forth. This information is helpful in determining the effect of the decisions and analysing the performance of the entity.
• Tax Accounting: The accounting system that deals with the tax return and its payment, instead of preparation of final accounts of the enterprise, is called tax accounting.
• Social Accounting: This branch of accounting is commonly termed as social responsibility accounting. It aims at unveiling the facilities provided by the entity to the society, in terms of medical, housing, education, and so forth.

These accounting branches have been developed as a result of rapid economic development and technological improvements, that increased the company’s scale of operations. Due to this very reason, the management functions has become complicated and resulted in the development of branches.

Functions of Accounting

• Systematic record keeping: The first and foremost function of accounting is the systematic record keeping of the financial transactions, on a regular basis.
• Facilitating rational decision making: Another important function of accounting is to communicate the results, i.e. the net profit or loss to the users, with the help of financial statements, so as to help the interested parties in rational decision making.
• Legal compliance: The accounting statements must be prepared keeping in mind the compliance with the relevant laws.
• Protection of business assets: Accounting not only keeps a record of all the business assets but also ensures no unauthorized use of assets or property belonging to the enterprise.
• Determination of Profit/loss: Accounting plays a very important role in the ascertainment of profit earned or loss sustained by the enterprise in an accounting period. This is possible only when a proper record of all the business transactions, revenues and expenses are maintained.
• Ascertaining the profitability, liquidity and solvency of the entity: With the help of the financial statement, i.e. Balance sheet and profit and loss account, the financial position of the enterprise can easily be ascertained.

The fundamental objective of accounting is to keep complete records of the business transactions, so as to determine the financial performance and position of the enterprise and convey the information to the user groups such as shareholders, employees, creditors, suppliers, government and other groups.

Definition: A Balance Sheet refers to the position statement, which lists out the balances of the assets, liabilities and owner’s equity, i.e. capital, of an enterprise at a specified date. While the assets show the resources owned by the company, liabilities and capital exhibits the funding of resources.

Characteristics of Balance Sheet

• The preparation of Balance Sheet is not for a period, but at a particular date.
• The preparation of the balance sheet is possible only when profit and loss account for the period is prepared because it reflects the financial position of the company adequately. That is why the Profit & Loss Account, Balance Sheet and Cash flow Statement are collectively called as Final Accounts.
• The totals of the two sides, i.e. assets and liabilities of the balance sheet must tally as Assets = Liabilities + Capital. If not so, then there must be an error.
• The balance sheet reflects the nature and value of assets and liabilities and the position of capital on a given date.
• It can be prepared, taking into account the debit and credit balances of the real and personal accounts, as per trial balance. The real account’s debit balance is an indicator of the asset of the firm, whereas the credit balance of the personal account is an indicator of liability.

Format of Balance Sheet

• Equity and Liabilities: It indicates what the firm ‘owes’ to others.
  
  • Shareholder’s Funds: It shows the shareholder’s contribution to the firm in any form.
    
    • Share Capital: The portion of the firm’s capital, raised from the issue of shares. It encompasses equity share capital and preference share capital.
    • Reserves and Surplus: It covers retained earnings and shares premium. It encompasses capital reserves, debenture redemption reserves, general reserve, revaluation reserve and surplus.
  • Non-Current Liabilities: The liabilities which can be settled after one year from the date of reporting, is called non-current liabilities.
    
    • Long-term Borrowings: Term loans from banks and financial institutions which have a tenor of more than a year are called long-term borrowings.
    • Deferred tax liabilities: A deferred tax liability arises when the amount allowed for tax purposes exceeds the charge in the financial statements.
    • Long-term provisions: Provisions for employee benefits comes under long-term provisions. It includes provident fund, leaves encashment, gratuity, superannuation fund, etc.
  • Current Liabilities: These are short-term liabilities which need to be settled within a period of one year or less.
    
    • Short-term Borrowings: The borrowings that are to be repaid within one year is called short-term borrowings and includes commercial paper, working capital loans, corporate deposits, etc.
    • Trade Payables: The amount due to suppliers from whom goods are bought on credit are called trade payables. It includes sundry creditors and bills payables.
    • Short-term provisions: It refers to the provisions made by the firm for dividend and taxes.
  • Assets: These are the resources owned by the firm, that provide future economic benefits.
    
    • Non-current Assets: The assets which remain with the entity for more than a year are non-current assets.
      
      • Fixed Assets: Assets bought by the company for long-term use, and are not converted into cash quickly are called fixed assets.
        
        • Tangible Assets: The assets that are used in their physical form are called tangible assets. It includes land, building, vehicles, furniture, plant, etc.
        • Intangible Assets: Assets with no physical shape and structure are called intangible assets, such as copyright, patent, trademark, design, software, etc.
      • Non-current Investments: It consists of financial securities of other companies such as shares, debentures, bonds and so forth.
      • Long-term loans and advances: Loans and advances made to subsidiary companies, associate companies, comes under this category.
    • Current Assets: The assets that can be converted into cash within a period of one year or less are current assets.
      
      • Current Investments: The holdings in shares of mutual funds, usually for a short term are called current investments.
      • Inventories: It refers to the stock of goods in various forms such as raw material, work-in-process and finished items.
      • Trade Receivables: The amount owed by the customers to the firm, to whom goods are sold, but not yet paid.
      • Cash and cash equivalents: It includes cash owned by the company and the credit balance with the bank and financial institutions.
      • Short-term loans and advances: Loans and advances provided to parties such as suppliers and employees are covered in this category.

As each and every transaction affects assets or liabilities of the business, that is why, the balance sheet can be regarded as true only at that point in time, when it is prepared. And due to this very reason, “as at” is written with the date. Usually, it is prepared on the last day of the accounting period.

Definition: Management Accounting refers to the application of professional knowledge, techniques and concept in preparing the accounting information in such a manner, which helps the management of the organization in the formulating plans and policies, controlling the operations of the organization, decision making, optimising the use of resources, disclosure to management and safeguarding assets.

In finer terms, management accounting can be understood as the processing and presentation of accounting and economic data, so that it would help in the evaluating performance of the management, formulating strategies, making comparisons, budgeting, forecasting, etc.

Characteristics of Management Accounting

• Decision-making system: The financial data provided by the management accounting, is helpful to the management in framing policies and assisting the day to day operations.
• Future-oriented: Management accounting is future-oriented as it helps in planning and deciding the future course of action.
• Qualitative and Quantitative Information: In management accounting, qualitative information relating to the performance of the managers and other staff is also considered, along with the other financial data.
• No set format: There is no set format for the disclosure of the information. Management accounting usually presents information in the form which is easily understandable to the managers and other users.
• Discretionary activity: Management accounting is not compulsorily required by the statute. Indeed, management accounting is done as per the requirement of the organization and hence, it can be done weekly, monthly, quarterly, half-yearly, etc.

Management Accounting Techniques

The following tools and techniques are used in management accounting for better decision making:

• Financial Planning: Financial Planning refers to the activity of deciding beforehand, what is to be done to reach the desired financial objectives, i.e. it is the process of managing the finances of the organization to get the maximum return. It includes cash flow planning, investment planning, tax planning, etc.
• Financial Statement Analysis: It refers to the process of analysing the financial data of the organization for rational decision making. This includes comparative statement analysis, ratio analysis, cash flow analysis, trend analysis, etc.
• Statistical and Graphical Techniques: Various statistical and graphical techniques are used by the management to make better economic decisions. These techniques include statistical quality control, linear programming, investment chart and so forth.
• Control Techniques: Standard costing and budgetary control are the techniques used by the management to keep a check on the utilization of resources.
• Reporting: The management accountant processes the data and presents it in reports to provide the relevant information required by the managers.

Therefore, the data available with the help of management accounting must be relevant and precise, presented in an understandable format, consistent and comparable, and it is available at regular time intervals.

For this purpose, the selection of information to be presented, an organization of information and the way in which it should be presented must be carefully chosen by the management accountant.

Definition: Trial Balance refers to a schedule, in which the balances of all ledger books are assembled into debit and credit columns, to check the arithmetical accuracy of the entries posted in the ledger accounts.

Trial Balance is a tabular statement, containing a specified date on which it is prepared, indicated at the top of the statement. The balances of all the assets, expenses, losses, drawings, cash and bank account are taken to the debit column whereas the balances of all the liabilities, incomes, gains, capital are transferred to the credit column.

Companies prepare trial balance periodically, usually at the end of the financial year which forms a basis for preparing final accounts. However, it can be prepared otherwise also, subject to the accounts are balanced.

When the total of debit and credit columns are equal, then the trial balance is regarded as balanced, i.e. the accounts are mathematically accurate, however, certain errors are still there, that might have occurred during journalizing and posting the entries into a ledger.

Objectives of Preparing Trial Balance

• To ensure arithmetical accuracy of the books of accounts, which indicates that the books are free from any mathematical errors and both the aspects of the account are recorded, in journal and ledger.
• To prepare financial statement, as trial balance forms a base for preparing final accounts at the end of the financial year.
• To act as a summary of the ledger, as it compiles the balances of all accounts.

Trial Balance prepared to verify as to whether the totals of the debit column equals the total of credit columns.

Methods of Preparation of Trial Balance

• Total Method: Otherwise called gross trial balance method, under this method all the ledger accounts are totalled and the total of both debit and credit side is carried forward to the trial balance.This method saves time, as the time taken to balance the account is saved and the trial balance can be prepared as and when the accounts are totalled. However, this method is not used in general, because it does not help in the preparation of the final accounts.
• Balance Method: This method is used by the companies, as the trial balance is prepared on the basis of ledger account balances. As per this method, first of all, the ledger accounts are totalled and balanced and those balances are transferred to the trial balance. This method is also known as net trial balance method.Here, balance refers to the difference of totals of debit and credit side of a ledger account. Balancing of ledger account implies tallying both the debit and credit sides of the particular account by placing the balance on the side where the amount falls short.
• Total and Balance Method: Also known as a compound method, as its name suggests it is a combination of the two methods discussed above. In this method, the statement contains columns for both totals as well as balances.

Trial Balance is the third step of the accounting process, wherein once the accounts are posted in the ledger, a statement is prepared to show the debit and credit balances. It is prepared by listing all the accounts and then entering them in their respective columns.

The totals of the debit and credit columns must agree irrespective of the method is used for preparing Trial Balance. This is because of the dual effect, i.e. every debit has an equivalent credit, and it indicates that the trial balance does not contain any clerical errors. However, this is not absolute proof of accuracy, as an error of principle, an error of omission and compensating errors may still be there.

Adjusted Trial Balance

Suspense account is a temporary account is created when there is a disagreement in the debit and credit column of the trial balance after carrying forward all ledger account balances and errors are not detected at the right time, then the trial balance is equalized by transferring the difference of the two sides in this account, so as to proceed further and prepare final accounts.

Definition: Financial Statement are systematically maintained, written summary of all the ledger account heads, exhibited in a way that it provides a clear view of the financial position, profitability and performance of the enterprise.

These are prepared at the end of the accounting period, which is usually one year, after that it is audited by the auditor, to check their accuracy, transparency and fairness, for taxation and investment purposes.

Objectives of preparing financial statement

The objectives of the financial statement are as under:

• To ascertain the financial position, profitability and performance.
• To determine the cash inflows and outflows.
• To know the results of business operations.
• To provide information related to financial resources and obligations of the concern.
• To disclose the accounting policies.
• To check the efficiency and effectiveness of the company’s management.

A financial statement is a primary source of information to stakeholders to know the profit earned or loss sustained by the enterprise during a particular period and its financial status at the end of that particular period, which will assist in the rational decision making.

Components of Financial Statement

A financial statement is a combination of five major statements, as shown in the figure below:

Income Statement or Trading and Profit & Loss Account

The profit earned or loss sustained by the enterprise during an accounting period can be ascertained by the preparation of the income statement. The profit/loss is calculated at two levels, i.e. gross profit and net profit. The gross profit is nothing but the variance in the selling price and cost of goods sold, which is measured by preparing a trading account.

On the other hand, net profit can be calculated by preparing a profit and loss account. The profit and loss account is a summary of the company’s revenues and expenses and reflects the outcome of the company’s operations for the specified period.

Position Statement or Balance Sheet

A Balance Sheet can be understood as a snapshot indicating the company’s obligations and resources, i.e. liabilities and assets, at a specified date.

Although a single transaction, can make a huge difference in the overall picture of the company’s position, the balance sheet is correct at a specific point of time. And only because of this very reason, we use the word ‘as at’ along with the date. That is why it is called a position statement.

Cash Flow statement

Cash flow statement is a summary of company cash sources and applications. It ascertains the firm’s effectiveness in generating cash to pay off its obligations, funding the operations and investment activities.

The cash flow statement reflects the changes in the company’s cash and cash equivalents, i.e. commercial paper, certificate of deposit, treasury bills, marketable securities, short term government bonds, etc. between two accounting period.

Statement of changes in equity (if applicable)

It is a statement that indicates the changes in the company’s share capital, retained earnings and reserves over the accounting period, i.e. it reconciles the equity balances at the beginning with the balances at the end.

Explanatory notes

Otherwise called as notes to accounts, these are supporting notes annexed to any of the above statements. It provides additional information about the company’s operations and finance.

Simply put, the financial statement is nothing but a basic formal annual report that helps the company to conveys the financial information to the interested parties such as owners. investors, employees, government, tax authorities and so forth.