CHAPTER-1 WORKING CAPITAL MANAGEMENT: CONCEPT, … 1... · 1.12 liquidity versus profitability:...

CHAPTER-1

WORKING CAPITAL MANAGEMENT: CONCEPT,

IMPORTANCE AND OBJECTS

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WORKING CAPITAL MANAGEMENT: CONCEPT, IMPORTANCE AND OBJECTS

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1.1 INTRODUCTION

1.2 DEFINITIONS OF WORKING CAPITAL

1.3 CONCEPT OF WORKING CAPITAL MANAGEMENT

1.4 CIRCULATION OF WORKING CAPITAL

1.5 TYPES OF WORKING CAPITAL

1.6 FACTORS DETERMINING OF WORKING CAPITAL

1.7 OPERATING CYCLE

1.8 WORKING CAPITAL TERM LOAN (WCTL)

1.9 ADEQUACY OF WORKING CAPITAL

1.10 EXCESS OF INADEQUACY OF WORKING CAPITAL

1.11 OPTIMUM LEVEL OF CURRENT ASSETS

1.12 LIQUIDITY VERSUS PROFITABILITY: RISK-RETURN

TANGLE

1.13 FIXED CAPITAL VERSUS WORKING CAPITAL

1.14 FINANCING CURRENT ASSETS

1.15 TONDON COMMITTEE RECOMMENDATIONS

1.16 CHORW COMMITTEE

1.17 S.S. MARATHE COMMITTEE

1.18 CONCLUSION

1.19 REFERENCES

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1.1 INTRODUCTION

The present research seeks to study in depth the Working Capital Management

of selected paper companies in India, with special emphasis on an examination of the

management performance in regard to financial management. It hardly needs

mentioning that inventory, accounts receivables and cash and its alert administration

can go a long way in solving the problem of the efficient working capital

management. In fact, the present research of working capital management needs

special attention for the efficient working and the business. It has been often observed

that the shortage of working capital leads to the failure of a business. The proper

management of working capital may bring about the success of a business firm. The

management of working capital includes the management of current assets and

current liabilities. The present research undertakes to deal with the net concept of

working capital: excess of current assets over current liabilities.

A number of companies for the past few years have been finding it difficult to

solve the increasing problems of adopting seriously the management of working

capital. Business concerns intent on developing their business have to use to the

utmost, their available resources for the improvement and development of the

business there by enabling them to increase their profits. Working Capital and change

in working capital, especially in inventories, which is one of the components of

working capital form a very important part of the total gross-capital formation in the

paper companies. Efficient and the optimal utilization of fixed assets is very closely

related to the proper management of working capital. The present research attempts to

recognize initially the importance of working capital as a part of the total capital. It

further goals to recognize the factors influencing the working capital, its volume, and

in the process try to suggest remedial measures which might help in optimizing the

use of working capital. It also considers as to how precisely “financing working

capital” and further more what should be mix of different components of working

capital.

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Some important questions to which the research attempts to seek answer as

follows:-

1. Whether paper companies have planted their working capital requirement

properly.

2. Have the paper companies utilized the investment in current assets?

3. Have the paper companies controlled and utilized cash resources

effectively and profitably?

4. Whether paper companies resort to high build up of inventory.

5. How far have the paper companies been successful in collecting their

`different administration of its various components: like as inventory,

account receivable, cash, and accounts payables.

Working Capital is the life blood of every business concern. Business firm

cannot make progress without adequate working capital. Inadequate working capital

means shortage of inputs, whereas excess of it leads to extra cost. So the quantum of

working capital in every business firm should be neither more nor less than what is

actually required. The management has to see that funds invested as working capital

in their organization earn return at least as much as they would have earned return if it

invested anywhere else. At the time of increasing capital costs and scare funds, the

area of working capital management assumes added importance as it deeply

influences a firm's liquidity and profitability. A notable feature of utilization of funds

is that they are of recurring nature. Therefore, efficient working capital management

requires a proper balance between generation and utilization of these funds without

which either shortage of funds will cause obstruction in the smoother functioning of

the organization or excess funds will prevent the firm from conducting its business

efficiently. So the main objective of working capital management is to arrange the

needed funds on the right time from the right source and for the right period, so that a

tradeoff between liquidity and profitability may be achieved.

A firm may exist without making profits but cannot survive without liquidity.

The function of working capital management organization is similar that of heart in a

human body. Also it is an important function of financial management. The financial

manager must determine the satisfactory level of working capital funds and also the

optimum mix of current assets and current liabilities. He must ensure that the

appropriate sources of funds are used to finance working capital and should also see

that short term obligation of the business are met well in time.

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1.2 DEFINITIONS OF WORKING CAPITAL

Definitions of Working Capital, as per various management experts are as

under:

“Working Capital is the excess of C.A. over current liabilities.”

- H.G, Guthmann

“Working Capital is descriptive of that capital which is not fixed. But the more

common use of the Working Capital is to consider it as the difference between the

book value of the C.A. and current liabilities.”

- Hoglend. J. Bierman, and A. K. Mc Adams,.

“Working Capital represents the excess of C.A. over current liabilities”

- J.L. Brown and L.R. Housard.

“Working Capital to a firm’s investment in short term assets cash short term

securities, accounts, receivables and inventories.”

-Weston the Brigham

“Working Capital represents only the current capital assets.”

- Meal Baker Malott and Field.

“Working Capital means a sum of C.A”

- J.S. Mill.

“A Working Capital deficit exits if current liabilities exceed C.A.”

-Prof. C.W. Gerstoberg.55

“Working Capital equals the aggregate value of C.A. minus aggregate value of

current liabilities”

- Lincoln.

“Gross Working Capital may be used to refer to total C.A. and net working

capital refers to the surplus of C.A. over current liabilities”

- Prof. S.C. Kuchhal

1.3 CONCEPT OF WORKING CAPITAL MANAGEMENT

There are two concepts of working capital viz .quantitative and qualitative.

Some people also define the two concepts as gross concept and net concept.

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According to quantitative concept, the amount of working capital refers to

‘total of current assets’. What we call current assets? Smith called, ‘circulating

capital’. Current assets are considered to be gross working capital in this concept.

The qualitative concept gives an idea regarding source of financing capital.

According to qualitative concept the amount of working capital refers to “excess of

current assets over current liabilities.” L.J. Guthmann defined working capital as “the

portion of a firm’s current assets which are financed from long–term funds.”

The excess of current assets over current liabilities is termed as ‘Net working

capital’. In this concept “Net working capital” represents the amount of current assets

which would remain if all current liabilities were paid. Both the concepts of working

capital have their own points of importance. “If the objectives is to measure the size

and extent to which current assets are being used, ‘Gross concept’ is useful; whereas

in evaluating the liquidity position of an undertaking ‘Net concept’ becomes pertinent

and preferable.It is necessary to understand the meaning of current assets and current

liabilities for learning the meaning of working capital, which is explained below.

Current assets – It is rightly observed that “Current assets have a short life

span. These type of assets are engaged in current operation of a business and normally

used for short– term operations of the firm during an accounting period i.e. within

twelve months. The two important characteristics of such assets are, (i) short life span,

and (ii) swift transformation into other form of assets. Cash balance may be held idle

for a week or two; account receivable may have a life span of 30 to 60 days, and

inventories may be held for 30 to 100 days.”Fitzgerald defined current assets as, “cash

and other assets which are expected to be converted in to cash in the ordinary course

of business within one year or within such longer period as constitutes the normal

operating cycle of a business.”

Current liabilities – The firm creates a Current Liability towards creditors

(sellers) from whom it has purchased raw materials on credit. This liability is also

known as accounts payable and shown in the balance sheet till the payment has been

made to the creditors. The claims or obligations which are normally expected to

mature for payment within an accounting cycle are known as current liabilities. These

can be defined as “those liabilities where liquidation is reasonably expected to require

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the use of existing resources properly classifiable as current assets, or the creation of

other current assets, or the creation of other current liabilities.”

1.4 CIRCULATION SYSTEM OF WORKING CAPITAL

Working capital is also known as ‘circulating capital or current capital’

Kulkarni has remarked that, “The use of the term circulating capital instead of

working capital indicates that its flow is circular in nature”.

Figure – 1.1 Circulation System of Working Capital

The funds in a business are obtained from the issue of share, the issue of

debentures, and other long-term arrangement and from operations of business. A huge

part of generated funds is used to acquire fixed assets, viz, plant and machinery, land

building and some other fixed assets, while the remaining part of the generated funds

is used for day to day operations of the business e.g. to pay wages and overheads

expenses for the raw materials processed. This makes possible the stocking of

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finished goods by whose sales either accounts receivables are created or cash is

received. In this process profits are generated. A part of the profit is used to pay tax,

interest and dividends, while the remaining part is ploughed back in the business. The

circulation system of working capital may be depicted as shown in figure 1.1 as

Above page page. The cycle goes constantly throughout the life of business.

1.5 TYPES OF WORKING CAPITAL

Following diagram clear the classification of working capital Accoding to the

needs of business, the working capital may be classified into following two basis:

1) On the basis of periodicity

2) On the basis of concept

Figure -1.2 Types of Working Capital

1). On the basis of periodicity:

The requirements of working capital are continuous. More working capital is

required in a particular season or the peck period of business activity. On the basis of

periodicity working capital can be divided under two categories as under:

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a) Permanent working capital

b) Variable working capital

(a) Permanent working capital:

This type of working capital is known as Fixed Working Capital.

Permanent working capital means the part of working capital which is

permanently locked up in the current assets to carry out the business smoothly.

The minimum amount of current assets which is required to conduct the

business smoothly during the year is called permanent working capital. For

example, investments required to maintain the minimum stock of raw

materials or to cash balance. The amount of permanent working capital

depends upon the size and growth of company. Fixed working capital can

further be divided into two categories as under:

(I) Regular Working capital:

Minimum amount of working capital required to keep the primary

circulation. Some amount of cash is necessary for the payment of

wages, salaries etc.

(II) Reserve Margin Working capital:

Additional working capital may also be required for contingencies that

may arise any time. The reserve working capital is the excess of capital

over the needs of the regular working capital is kept aside as reserve

for contingencies, such as strike, business depression etc.

(b) Variable or Temporary Working Capital:

The term variable working capital refers that the level of working capital is

temporary and fluctuating. Variable working capital may change from one assets

to another and changes with the increase or decrease in the volume of business.

The variable working capital may also be subdivided into following two

sub-groups.

1. Seasonal Variable Working capital:

Seasonal working capital is the additional amount which is required during the

active business seasons of the year. Raw materials like raw-cotton or jute or sugarcane

are purchased in particular season. The industry has to borrow funds for short period.

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It is particularly suited to a business of a seasonal nature. In short, seasonal working

capital is required to meet the seasonal liquidity of the business.

2. Special variable working capital:

Additional working capital may also be needed to provide additional current

assets to meet the unexpected events or special operations such as extensive

marketing campaigns or carrying of special job etc.

Difference Between Permenent and Variable Working Capital:

The distinction between permenent or fixed working capital and variable

working capital or temporary working capital is of great importance in operating cycle

and raising the funds. However, there is always a minimum level of current assets

which is contiuously required by the firm to carry on its business operations. This

minimum level of current assets is refered to as permenent or fixed working capital

and is permanent in the same way as the firm’s fixed asset.

Figuer – 1.3 Permenent and Temporary Working Capital

Depending on the chang in production and sales, the need of working capital,

over and above the permenent working capital, will fluctuate.

For example, extra inventory of finished good will have to be maintained to

support the peak periods of sale and investment in receivables may also increse during

the period. Both the kinds of working capital-permenent and temporary –are

necessary to facilitate production and sale through the operating cycle, but temporary

working capital is created by the firm to meet liquidity requriments that will last only

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temporarily. In above figuire shows the diference between permentt and temporary

working capital.

It is sh-own in below figure that permenant working capital is stable over time,

while temporary working capital is fluctuating-some times incrasing and sometimes

decrasing. However, the permanent working capital line need not be horizonltal if the

firm’s requriment for permenent capital is incrasing or decreasing over period. For a

growing firm, the difference between permanent and temporary working capital can

be depicted the figure-1.4 as under.

Figuer 1.4 – Perment and Temporary Working Capital Can be Depicted

2) On the basis of concept:

on the basis of concept working capital is divided into two categoties as under:

(A) Gross Working Capital:

Gross working capital refers to total investment in current assets. The

current assets employed in business give the idia about the utilization of

working capital and idia about the economic postion of the company. Thus,

gross working capital the amount of funds invested in different current assets.

Gross working capital concepts is popular and acceptable concept in the field

of finance.

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(B) Net Working Capital:

Net working capital means current assets minus current liabilities. The

difference between current assets and current liabilites is called the net

working capital. If the net working capital is positive business is able to

meet its current liabilites. Net working capital concept provides the

mesasurement for determining the creditworthiness of compny.

1.6 FACTORS DETERMINING OF WORKING CAPITAL

Papers, with their fixed investment, appear to have the lowest requirement for

current assets. This does not mean that the problem of working capital may be

minimized in this field of enterprise, since ready funds are still essential to cover

disbursement for wages, interest on funds debt, purchase of materials and supplies,

etc. indeed, under such conditions the working capital position may become even

more strategic in character because of its relation to, and control of the large amount

of fixed assets. Thus, one of the outstanding problems of paper management in recent

years has been the maintenance of current position sufficiently strong to permit

vigorous operations. Public utilities, like the paper, have a fixed investment which

causes the current assets to constitute only a relatively small percentage of the total

assets. There is a difference between operating and holding companies, but even then

the funds required to cover current transactions are minor as compared with those

necessary to finance the long term structure.

Industrial companies, generally, require a large amount of working capital

although it various from business to business of lack of uniformity characterizing each

field of enterprise. However, the underlying determinants of the amounts of fixed

capital are required for operation; working assets may be expected to occupy a

smaller niche in the assets structure. For similar reasons, a rapid turnover of capital

will inevitably mean a large proportion of current assets. In the case of industries

with fixed investment, one of the primary uses of working capital is its conversion

into operating plant structure. In turn, it is expected that the income resized form

operations will normally replace such defections. This means that the flow of a

portion of working capital is circulating through fixed investment that its recovery is

dependent upon the income realized. Where the current assets are relatively more

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important, a rapid sales turnover is usually found. Often, as a case of retail concerns,

the specific working assets constitute the object of sale and recovery is direct and

immediate. In manufacturing enterprises, a large share of working capital

management is more likely to become charged in form by conversion into finished

products, but even here, the potentiality of recovery is not delayed as long as in the

case of public utilities and paper companies. The need for working capital varies with

changes in the volume of business. A considerable proportion of current assets is

needed permanently as fixed assets. More than one production cycle may be in

process at one and the same time, for business operations on a continuing basis.

Materials are purchase and work is in progress. Finished inventory is sold. At the

same time new receivables accumulate and old ones are converted into cash. Cash is

utilized in the production process.

The following factor determine the amount of working capital

1. Nature of Companies:

The composition of an asset is a function of the size of a business and the

companies to which it belongs. Small companies have smaller proportions of

cash, receivables and inventory than large corporation. This difference

becomes more marked in large corporations. A public utility, for example,

mostly employs fixed assets in its operations, while a merchandising

department depends generally on inventory and receivable. Needs for working

capital are thus determined by the nature of an enterprise.

2. Demand of Creditors:

Creditors are interested in the security of loans. They want their obligations to

be sufficiently covered. They want the amount of security in assets which are

greater than the liability.

3. Cash Requirements:

Cash is one of the current assets which are essential for the successful

operations of the production cycle. Cash should not adequate and properly

utilized. It would be wasteful to hold excessive cash. A minimum level of cash

is always required to keep the operations going. Adequate cash is also required

to maintain good credit relation. Richards Osbom has pointed out that cash has

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a universal liquidity and acceptability. Unlike illiquid assets, its value is clear-

cut and defines.

4. Nature and Size of Business:

The working capital requirements of a firm are basically influenced by the

nature of its business. Trading and financial firms have a very less investment

in fixed assets, but require a large sum of money to be invested in working

capital. Retail stores, for example, must carry large stocks of a variety of

goods to satisfy the varied and continues demand of their customers. Some

manufacturing business, such as tobacco manufacturing and construction firms

also have to invest substantially in working capital and a nominal amount in

the fixed assets. In contrast, public utilities have a very limited need for

working capital and have to invest abundantly in fixed assets. Their working

capital requirements and nominal because they have cash sales only and

supply services, not product. Thus, no funds will be tied up in debtors and

inventories. The working capital needs of most of the manufacturing concerns

fall between the two extreme requirements of trading firms and public utilities.

Such concerns have to make adequate investment in current assets depending

upon the total assets structure and other variables. The size of business also

has an important impact on its working capital needs. Size may me measured

in terms of the scale of operation. A firm with larger scale of operation will

need more working capital than a small firm.

5. Time:

The level of working capital depends upon the time required to manufacturing

goods. If the time is longer, the size of working capital is great. Moreover, the

amount of working capital depends upon inventory turnover and the unit cost

of the goods that are sold. The greater this cost, the bigger is the amount of

working capital.

6. Volume of Sales:

This is the most important factor affecting the size and components of working

capital. A firm maintains current assets because they are needed to support the

operational activities which result in sales. They volume of sales and the size

of the working capital are directly related to each other. As the volume of sales

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increase in the investment of working capital-in the cost of operations, in

inventories and receivables.

7. Terms of Purchases and Sales:

If the credit terms of purchases are more favorable and those of sales liberal,

less cash will be invested in inventory. With more favorable credit terms,

working capital requirements can be reduced. A firm gets more time for

payment to creditors or suppliers. A firm which enjoys greater credit with

banks needs less working capital.

8. Inventory Turnover:

If the inventory turnover is high, the working capital requirements will be low.

With better inventory control, a firm is able to reduce its working capital

requirements. While attempting this, it should determine the minimum level of

stock which it will have to maintain throughout the period of its operations.

9. Receivable Turnover:

It is necessary to have an effective control of receivables. A prompt collection

of receivables and good facilities for setting payable results into low working

capital requirements.

10. Business Cycle:

Business expands during periods of prosperity and declines during the period

of depression. Consequently, more working capital required during periods of

prosperity and less during the periods of depression. During marked upswings

of activity, there is usually a need for larger amounts of capital to cover the leg

between collection and increased sales and to finance purchases of additional

materials to support growing business activity. Moreover, during the recovery

and prosperity phase of the business cycle, prices of raw materials and wages

tend to rise and require additional funds to carry even the same physical

volume of business. In the downswing of the cycle, there may be a brief period

when collection difficulties and declining sales together cause embarrassment

by the resulting failure to replenish cash. Later, as the depression runs its

course, the concern may find that it has a larger amount of working capital on

hand than current business volume may justify.

11. Value of Current Assets:

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Decreases in the real value of current assets as compared to their book value

reduced the size of the working capital. If the real value of current assets

increases, there is an increase in working capital.

12. Variations in Sales:

A seasonal business requires the maximum amount of working capital for a

relatively short period of time.

13. Production Cycle:

The time taken to convert raw materials into finished products is referred to as

the production cycle or operating cycle. The longer the production cycle, the

greater is the requirements of the working capital. An utmost care should be

taken to shorten the period of the production cycle in order to minimize

working capital requirements.

14. Credit Control:

Credit control includes such factors as the volume of credit sales, the terms of

credit sales, the collection policy, etc. with a sound credit control policy, it is

possible for a firm to improve in cash inflow.

15. Liquidity and Profitability:

If a firm desires to take a greater risk for bigger gains or losses, it reduces the

size of its working capital in relation to its sales. If it is interested in improving

its liquidity, it increase the level of its working capital. However, this policy is

likely to result in a reduction of the sales volume, and therefore, of

profitability. A firm, therefore, should choose between liquidity and

profitability and decide about its working capital requirements accordingly.

16. Inflation:

As a result of inflation, size of the working capital is increased in order to

make it easier for a firm to achieve a better cash inflow. To some extent, this

factor may be compensated by the rise in selling price during inflation.

17. Seasonal Fluctuations:

Seasonal fluctuations in sales affect the level of variable working capital.

Often, the demand for products may be of a seasonal nature. Yet inventories

have got to be purchased during certain seasons only. The size of the working

capital in one period may, therefore, be bigger than that in another.

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18. Profit Planning and Control:

The level of working capital is decided by the management in accordance with

its policy of profit planning and control. Adequate profit assists in the

generation of cash. It makes it possible for the management to plough back a

part of its earnings in the business and substantially build up internal financial

resources. A firm has to plan for taxation payments, which are an important

part of working capital management. Often the dividend policy of a

corporation may depend upon the amount of cash available to it.

19. Repayment Ability:

A firm’s repayment ability determines level of its working capital. The usual

practices of a firm are to prepare cash flow projections according to its plans

of repayment and to fix working capital levels accordingly.

20. Cash Reserves:

It would be necessary for a firm to maintain some cash reserve to enable it to

meet contingent disbursements. This would provide a buffer against abrupt

shortages in cash flows.

21. Operational and Financial Efficiency:

Working capital turnover is improved with a better operational and financial

efficiency of a firm. With a greater working capital turnover, it may be able to

reduce its working capital requirements.

22. Change in Technology:

Technological developments related to the production process have a sharp

impact on the need for working capital.

23. Firm’s Policies:

These affect the level of permanent and variable working capital. Changing in

credit policy, production policy, etc are bound to affect the size of working

capital.

24. Activities of the Firms:

A firm’s stocking on heavy inventory or selling on easy credit terms calls for a

higher level of working capital for it than for selling services or making Cash

sales.

25. Attitude of Risk:

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The greater the amount of working capital, the lower is the risk of liquidity.

`Whenever there is current strain, it has to be immediately diagnosed on the

basis of the red signals which manifest themselves in the operations. The restrictions

expressed as ratios of the elements of current assets and current liabilities are

frequently referred to as current position constraints and include the current ratio, the

acid test ratio, and the so-called “compensating balance” ratio. Contracts with fund

suppliers frequently provide for current-position constraints.

If stock not moving fast, and if there is an excess inventory buildup corrective

steps should be taken to sell the stock or bring down its level.

If the receivable have become sticky, effective recovery steps should be taken

to reduce the debts and to increase the collections. If the strain is allowed to continue

because of involvement in any other business or industry, the consequences may be

disastrous. In such situation, the ability to meet current demands deteriorates; short

term credits are not forthcoming; production is affected; sales decline; cash flow

decline; income may disappear; and the whole enterprise may get into the red over a

period of time. All the above points are the factors determining working capital

management in all the companies. Some factors are controlled and some factor are not

controlled by the management.

1.7 OPERATING CYCLE

The figure – 1.5 shows as under.

Figure- 1.5 Operating Cycle of Manufacturing Cycle:

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The duration of time required to complete the sequence of events right from

purchase of raw material / goods for cash to the realization of sales in cash is called

the operating cycle, working capital cycle or cash cycle.

This cycle can be said to be at the heart of the need for working capital. In the

words of O.M. Joy: “The operating cycle refers to the length of time necessary to

complete the following cycle of events.”

The above operating cycle in figure relates to a manufacturing firm where cash

is needs to purchase raw materials and convert raw materials into work-in-process is

converted into finished goods. Finished goods will be sold for cash or credit and

ultimately debtors will be realized.

Figuer 1.6 Operatning Cycle of Non-Manufacturing Firm

The non-manufacturing firms, such as whole sellers and retailers, will not

have the manufacturing phase; they will have rather direct conversion of cash into

finished stock, into accounts receivables and then into cash. The operating cycle of a

non manufacturing firm is shown as under.

The non-manufacturing firms, such as whole sellers and retailers, will not

have the manufacturing phase; they will have rather direct conversion of cash into

finished stock, into accounts receivables and then into cash. The operating cycle of a

non manufacturing firm is shown as under.

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In addition to this, some service and financial concerns may not have any

inventory at all. Suchc firm have the shortes operating cycle as shown in figure-1.7 as

next page.

Figuer-1.7 Operating Cycle of Service and Financial Firms

1.8 WORKING CAPITALTERM LOAN (WCTL):

A working capital term loan (WCTL) should process specific characteristic as

laid down below:

Working capital term loan is a shortage “long-term surplus” or net working

capital(NWC) in a unit that a bank chooses to fund.

It is a long term need of the unit that is met by the bank though its short term

port-folio.

Working capital term loan may be either clean or secured depending upon the

margin stipulated or the amount of working capital term loan in relation to the

chargeable current assts.

It must be repaid is a prescribed maximum number of installments.

It is not sanctioned as such but segregated out of existing outstanding, when

outstanding exceed the unit’s eligibility.

It is a sort of ‘once-in-a-life-time’ loan. It is a post-facto corrective measure, it

should not be repeated normally.

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It should be repayable form long-term sources. If the repayment is form short

term sources, the permissible bank finance will fall correspondingly and

working capital term loan will rise there by neutralizing the process of

repayment.

Moreover, both physical and financial follow up can be used to complement each

other, if the concept of the ‘margin’ is refined and integrated into the maximum

permissible bank finance (MPBF)

MPBF = NWC + OSCL – NCCA/CCA Margin

Where NWC is net working capital, OSCL means other current liabilities less

creditors for purchases. NCCA are non-chargeable current assets on which no drawls

are permitted. CCA means chargeable current assets on which margin are proposed to

be stipulated. The application of margin would be coupled with the deduction of the

value of creditors for purchases from the advance value to arrive at the drawing

power. Once a margin is stipulated, it can be utilized as the operating thumb rule for

monitoring the borrower’s stake in the stocks charged to the bank as well as a rough

and ready method for keeping the drawings power within the MPBF limits.

1.9 ADEQUACY OF WORKING CAPITAL

N.K. Kulshrestha has observed that, “the need for maintaining an adequate

working capital can hardly be questioned. Just a circulation of blood is very necessary

in the human body to maintain life, smooth flow of funds is very necessary to

maintain the heath of the firm”. Adequate working capital becomes necessary because

of the following reasons:

It protects a business form the adverse effects of shrinkage in the values of

current assets.

It is possible to pay all the current obligations promptly and to take advantages

of cash discounts.

It ensures to a greater extent the maintenance of a company’s credit standing

and provides for such emergencies as strikes, floods, fibers, etc.

It permits the carrying of inventories at a level that would enable a business to

serve satisfactory the needs of its customers.

It enables a company to extend favorable credit terms to customer.

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It enable a company to operate its business more efficiently because there is

no delay in obtaining materials, etc., because of credit difficulties.

It enables a business to withstand periods of depression smoothly.

There may be operating losses or decreased retained earnings.

There may be excessive non-operating or extraordinary losses.

The management may fail to obtain funds from other sources for the purposes

of expansion.

There may be an unwise divided policy.

Current funds may be invested in non-current assets.

The management may fail to accumulate funds necessary for meeting

debentures on maturity.

There may be increasing price necessitating bigger investments in inventories

and fixed assets.

1.10 EXCESS OF INADEQUACY OF WORKING CAPITAL

The firm should maintain a sound working capital position. It should have

adequate working capital to run its business operations. Both excessive as well as

inadequate working capital positions are dangerous form the firm’s point of view.

Excessive working capital means idle funds which earn no profit for the firm. Paucity

of working capital not only impairs firm’s profitability but also results in production

interruption and inefficiencies.

When the company is inadequate, a company faces the following problem:

It is not possible for it to utilize production facilities fully for want of working

capital.

A company may not be able to take advantages of cash discount facilities.

The credit-worthiness of the company is likely to be jeopardized because of

lack of liquidity.

A company may not be able to take advantages of profitability business

opportunities.

The modernization of equipment and even routine repairs and maintenance

facilities may be difficult to administer.

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A company will not be able to pay its dividends because of the non-

availability of funds.

A company cannot afford to increase its cash sales and may have to restrict its

activities to credit sales only.

A company may have to borrow funds at exorbitant rates of interest.

Its low liquidity may lead to low profitability in the same way as low

profitability results in low liquidity.

Low liquidity would positively thirteen the solvency of the business. A

company is considered illiquid when it is not able to pay its debts on maturity.

It must be wound up under section 433 of the companies Act, 1956, upon its

inability to pay its debts.

An enlightened management should therefore, maintain an adequate amount of

working capital on a continuous basis. Sound financial and statistical techniques

by judgments should be used to predict the quantum of working capital.

Commercial Bank (Bank Credit):

The major part of working capital is provided by commercial bank to their

customer. Commercial banks play an important role in providing capital to its

customers. Commercial banks are an important source of working capital in India.

The rate of interest charge by the Reserve Bank of India, from time to time. Here it is

to be noted that the terms of leading of the banks are very strict. Followings SIX CS

are considered by the bank before sanctioning cedited.

1. Capital 2. Capacity

3. Character 4. Collateral

5. Condition 6. Coverage

Banks provided working capital in the form of cash credit, overdraft,

discounting bills of exchanges etc. banks take into account the several factors of the

borrowing concern before fixing credit limit. Bank credit to commercial sector was

Rs. 21, 23,363 crores at the end of March 200723

. There were 36,927 officers of

nationalized banks at the end of March 2007.

1.11 OPTIMUM LEVEL OF CURRENT ASSETS

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The financial manager should determine the optimum level of current assets so

that the wealth of shareholders be maximized. In fact, optimum level for each type of

current assets should be fixed. The question of optimum investment in each type of

current assets is discussed. Here we simply discuss the basic concept involved in

determining the level of current assets.

Current Assets and Fixed Asset:

A firm needs fixed and current assets to support a particular level of output.

However, to support the same level of output, the firm can have difference levels of

current asset. As the firm’s output and sales increase, the need for current assets

increase in direct proportion to output; current assets increase at a decreasing rate with

output. This relationship is based upon the notion that it takes a greater proportional

investment in current assets when only a few units of output are produced than it does

later on when the firm can used its current assets more efficiently.

Figure – 1.8 Alternative Current Assets Polices

The help of the above graph the most conservative policy is alternative A,

where CA/FA ratio is greatest at every level of output. Alternative C is the most

aggressive policy, as CA/FA ratio is lowest at all levels of output. Alternative B lies

between the conservative and aggressive polices and is an average policy.

Other things assuming constant, a conservative policy implies greater liquidity

and lover risk and poor liquidity. The current assets policy of the most firms may fall

between these two extreme policies.

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The level of current assets can be measured by relating current asset to fixed

assets. Dividing current assets by fixed assets gives the CA/FA ratio. Assuming a

constant level of fixed assets, a higher CA/FA ratio indicates a conservative current

assets policy, and a lover CA/FA ratio means an aggressive current assets policy.

1.12 LIQUIDITY VERSUS PROFITABILITY: RISK-RETURN

TANGLE

The firm would make just enough investment in current assets, if it were

possible to estimate working capital needs exactly. Under perfect certainty, the

current assets holdings would be at the minimum level. A ledger investment in current

assets under certainty would mean a low rate or return investment for the firm, as

excess investment in current assets will not earn enough return. A smaller investment

in current assets, on the other hand, would mean interrupted production and sales,

because of frequent stock-outs and inability to creditor in time to restrictive credit

policy.

As it is not possible to estimate working needs accurately, the firm must

decide about the levels of current assets to be carried. The current assets holdings of

the firm will depend upon its working capital policy. It may follow a conservative or

an aggressive policy. These polices have different risk-return implications. A

conservative policy means lower return and risk, while an aggressive policy produces

higher return and risk.

The two important aims of the working capital management are: profitability

and solvency. Solvency, used in the technical sense, refers to the firm’s continuous

ability to meet maturing obligations. Lenders and creditors expected prompt

settlement of their claims as and when due. To ensure solvency, the firm maintains a

relatively large investment in current assets holdings. If the firm maintains a relatively

large investment in current assets, it will have no difficulty in paying the claims of the

creditors when they become due and will be able to fill all sales orders and ensure

smooth production. Thus, a liquid firm has less risk of insolvency; that is, it will

hardly experiences a cash shortage or stock-outs. However, there is accost associated

with maintaining a sound liquidity position. A considerable amount of the firm’s

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funds will be tied up in current assets. And to the extent this investment is idle, the

firm’s profitability will suffer.

Details Company

A

Company

B

Company

C

Sales Units

Rupees

Earnings before interest and taxes

200000

3000000

300000

200000

3000000

300000

200000

3000000

300000

Current assets

Fixed assets

1000000

1000000

800000

100000

600000

1000000

Total assets 2000000 1800000 1600000

Return on total assets (EBIT/Total

assets)

Current assets/Fixed assets

15%

1.00

16.67%

0.80

18.75%

0.60

To have high profitability, the firm may sacrifice solvency and maintain a

relatively low level of current assets. When the firm does so, its profitability will

improve as less funds are tied up in idle current assets, but its solvency would be

threatened and would be exposed to greater risk of cash shortage and stock-outs. The

profitability-solvency tangle of the working capital management may further be

illustrated with the help of an example. Suppose, a firm has the following data for

future year: Sales (200000 Units) -3000000Earnings before interest and taxes-

240000.Fixed assets -1000000The three possible current assets holdings of the firm

are: Rs. 1000000 Rs. 800000 and Rs.600000. it is assumed that fixed assets level is

constant and profit do not very with current assets levels. The effect of the three

alternative current assets polices is shown as above page28:

The calculation in table indicate that alternative A, the most conservative

policy, provides greatest liquidity to the firm, but also the lowest return on total

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assets. On the other hand, alternative C, the most aggressive policy, yields highest

return but provides lowest liquidity and thus, is very risky to the firm. Alternative B

demonstrates a moderate policy and generates a return higher than alternative A but

lower than alternative C and is less risky than alternative C but more risky than

alternative A. this is a simple example of risk-return trade off. In practice, things are

more difficult. Risk and returns are affected differently by different assets and,

therefore, generalization is not easy to make. The problem of the level of each type of

current asset is discussed in subsequent chapters.

The Cost Trade-off:

A different way of looking into the risk-return trade of is in terms of the cost

of maintaining a particular level of current assets. There are two different kinds of

costs involved26

. First there is the cost of liquidity. If the firm carries too much

liquidity, the firm’s rate of return will be low. Funds tied up in idle cash and excess

inventory earn nothing, and receivables levels that are too large also reduce the firm’s

profitability. Thus, the cost of liquidity increases with the level of current assets.

There is the cost of liquidity, which is the cost of having too little invested in

current assets. If the firm carries too little cash, it may not be able to pay bills

promptly at they mature. This may force the firm to borrows at high rates of interest.

This will also adversely affect the credit-worthiness of the firm and it will face

difficulties in obtaining funds in future. This all may force the firm into insolvency.

If the firm’s inventory level too low, sales may be lost and customers may

shift to competitors. Also, low level of book debts may be due to tight credit policy,

which would impair sales further. Thus, the low level of current assets

involves cost which increases as this level falls.

If selecting an optimal level of current assets, the firm should balance the

profitability solvency tangle by minimizing the total cost of liquidity and cost of

illiquidity.

In the above all points are discussed by the researcher on the view point of

management of current assets in paper companies.

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Figure-1.9 The Cost Trade off

1.13 FIXED CAPITAL VERSUS WORKING CAPITAL

The maximization of the rate of return on capital employed is the ultimate goal

of every company. The issue of fixed capital versus working capital could be

examined appropriately only in the light of the role played by them in the attainment

of this objective. In the maximization of the rate return, the fixed and working capital

play functional, complementary and proportional and technical roles. As regards the

functional role, it may be fairly well placed that fixed capital represents the products

component of the business, it is utilized with or act upon the current or circulating

capital to produce revenue or income for the enterprise; this it self is not expected to

be held or produce revenue or income for enterprise. The expenditure of this class of

capital is expected to be recovered only over a period of years through depreciation

charge which are an element of cost. On the other hand, investment in working capital

are relatively temporary in nature since the invested values are capable of being

recovered within a short period of time depending upon the manufacturing as well as

the collection cycles. In other words, it is the working capital, which after its

transmutation into saleable product actually generated revenue for business.

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Moreover, a low profit ratio could be geared to a high one by quickening the pace of

working capital cycle, which, besides providing the will-springs for newer cycle, also

increased the total realizable profit of a business organization. The complementary

relationship between working capital and fixed capital is readily apparent. A fully

equipped industrial company without a supply of material to process or without cash

to pay for workmen’s wages and other current expenses or a store without

merchandise to sell, is virtually useless. Consequently the working capital position of

any company may readily become the controlling factor for determining the scope and

character of its operation.

The proportional relationship between fixed and working capital is very

important in the maximization of the rate of return. Inadequate working capital may

mean that the fixed assets purchased form permanent capital cannot be utilized

effectively. Shortage of materials or labour may mean that the machine can be used

for only part of the available time.

On the other hand, if efficient use is not being made of current assets and

working capital. Because working capital requirements are excessive there may be no

resources left for the assets. If the low state of efficiency persists, the position may

become aggravated still further. Assets wear out or become very costly to operate and

profits are depleted, thereby making even the maintenance of adequate working

capital quite a problem.

A business unit can maximize its rate of return on the capital employed

provided it keeps pace with the scientific and technological developments taking

place in the field to which it pertains. It is common to suggest that as soon as some

technological and scientific development takes place, a business unit, in order to

accelerate its profitability, should immediately introduce the same to its productive

processes. In reality, however, the sufficiency of working capital determines the

course of decision in this regard.

According to Professor N.K. Sharma- “Innovation is regarded by many

economists and accountants as the mainspring of profit earnings; there is no doubt

that this is true for many industries. If new ideas, products, methods and techniques

are not germinated and brought into existence, a company will fail to keep its place in

the competition. Innovation implies among other things, research sound organization

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and the willingness to undertake risks. Without adequate cash there can be no

progress. Research and development would be at a standstill and the essential

innovation would fail to appear.”

A comparison between the fixed and working capital could be made on the

basis of their investment relationship with each other.

It is found that in both the private and public sector Company’s working

capital, as a proportion of working capital employed share almost equal honors with

fixed capital. In the fifteen important industries of India the proportion of fixed

working capital and variable working capital was the show on next page. In table

form. It is evident from the table that with the exclusion of the industries had working

capital is very high proportions in their capital employed.

Sr.

Number

Company name Fixed capital (% to

total capital employed)

Working capital (% to

total capital employed)

1. Electricity Generation 75% 25%

2. Shipping Company 70% 30%

3. Aluminum Company 69% 31%

4. Paper Company 60% 40%

5. Iron and Steel Company 60% 40%

6. Cement Company 55% 45%

7. Chemicals Company 51% 49%

8. Tea Company 50% 50%

9. Mineral Oils Company 47% 53%

10. Coal Company 45% 55%

11. Cotton Textile Company 42% 58%

12. Sugar Company 35% 65%

13. Engineering Company 33% 67%

14. Jute Company 32% 68%

15. Trading Company 15% 85%

Proportion of fixed and working capital to the total capital employed in fifteen

important companies in India as under. The electricity industry had fixed capital in

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very high proportions because by its very nature this industry needs less of working

capital and its business operate on what it has installed as permanent capital.

In time with the situation prevailing in the fifteen important Indian industries,

the percentage of working capital to fixed capital in the total capital employed by the

running companies of the Central Government is found both high and ascending

during the years 2006 to 2010. The percentage of working capital to the capital

employed for these companies was 36.3 in 2006. It rose to 42.2 percent in 2010.

According to the Annual Survey of industries for the year 2010, the percentage of

working capital to the total capital employed in the case of all the registered factories

on an average was 69. Thus, it is clear that the size of working capital in industrial

companies tends to predominate the total capital employed by them. This sufficiently

indicates that the prime object of making a profit in industrial companies must depend

on the manner in which they administer their working capital.

1.14 FINANCING CURRENT ASSETS

The firm must find out sources of funds to finance its current assets. It can

adopt difference financing policies. Three types of financing be distinguished: long

term financing, short-term financing and spontaneous financing. The important

sources of long term financing are shares, debenture, preference share, retained

earnings and debt form financial institutions. Short-term financing refers to those

sources of short term credit that the firm must arrange in advance. These sources

included short-term bank loans, commercial papers and factoring receivable. The firm

must find out the sources of funds to finance its current assets. In the words of O.M.

Joy: “in comparing financing plans we should distinguish between three different

kinds of financing: long-term financing, negotiated short-term financing and

spontaneous short-term financing”. The major source of spontaneous short-term

financing is trade credit and outstanding expenses. Therefore, a firm would like to

finance its current assets with spontaneous source of the fullest extent. Every firm is

expected to utilize spontaneous sources to the fullest extent. Thus, the real choice of

financing current assets is between short-term and long term sources. The following

three important approaches are applied in practice.

A. ) Matching Approach:

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The firm can adopt a financial plan which involves the matching of the

expected life of assets with the expected life of the source of funds raised to finance

assets. Thus, a ten years loan may be raised to finance a plant with an expected life of

ten years; stock to be sold thirty day may be financed with a thirty-day bank loan or

so on. Thus, when the firm follows matching approach, long-term financing will be

used to finance fixed assets and permanent current assets.

In Figure-1.10 shows the firm’s investment and financing patterns over time

under a matching plan. As the firm’s fixed assets and permanent current asset levels

increase, the long term-term financing level also increases. When temporary current

assets level increase, short-term negotiated financing increase, and when the firm has

no temporary current assets, it is also has no short-term negotiated financing.

B) Conservative Approach:

Conservative finacing plasare those plans that use more long-term finacing

than is needed under a matching approch. The above figure-1.11 illustrates this

approch. The firm is financing a protion of its temporary current assets requriments

with long-term finanging. Also, in periods when the firm has no temporary current

assets, the firm has exess finacing available that will be invested in marketable

securities.

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These plans are called conservative because they involve relatively heavy use

of long-term financing.

Figuer-1.11

C) Aggressive Approach:

Figuer- 1.12

A firm may be aggressive in financing its assets. An aggressive policy is said

to befollowed by the firm when it uses more short-term financing than warranted by

the matching plan. Under an aggressive policy, the firm finances a part of its

permenent current assets with short-term financing.

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Some exxtemely aggressive firms may even finance a part of their fixed assets

with short-term financing. The relatively more use of short-term financing makes the

firm more risky. The aggeressive financing policy is illustrated in above Figure- 1.12.

1.15 TONDON COMMITTEE RECOMMENDATIONS

The Reserve Bank of India set up in 1974 a study group to frame guide lines

for follow up of bank credit under the chairmanship of P.L.Tandon. The study group

reviewed the system of working capital financing and identified its major shortcoming

as follows:

The cash credit system of lending wherein the borrower can draw freely within

limits sanctioned by the banker hinders sound credit planning on the part of the

banker and induces financial indiscipline in the borrower.

The security-oriented approach to lending favored borrowers with strong financial

resources and also led to diversion of funds, borrowed against the security of

current assets, for financing fixed assets.

Relatively easy access to working capital finance led to large inventory levels with

industry.

Working capital finance provided by banks, theoretically supposed to be short

term in nature, tended to be, in practice, a long-term source of finance. For the

regulating bank credit, the study group made comprehensive recommendations

which have been made by and large accepted by the Reserve Bank of India. These

recommendations relate to:-

(A) Norms for inventories and receivables:

It is suggested for major industries. These norms have been based, inter alia,on

company finance studies made by the Reserve Bank of India, process period in

different industries, discussions with industry experts and feedback received on the

interim report.

1. For raw materials (including stores and other materials used in process of

manufacture):- maximum stock should not be more than by 2-3/4 times

consumption of raw material in the industry in a month.

2. For stock in process (work-in-process):- should not be more than by half of the

cost of production of a month.

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3. For finished goods:- it should not be more than by the two times of cost of

goods sold off a month.

4. For receivable:- it should not be more than by 1-1\4 times of a month sales.

The norms suggested may not be viewed as rigid or inflexible. Under certain

circumstances like bunched receipt of raw materials, this may be permitted.

(B) Quantum of permissible bank finance:

Three methods have been suggested for determining the maximum permissible

amount of bank finance:-

1. 75 percent of excess of current assets over non-bank current liabilities.

2. 75 percent of current assets as reduced by non-bank current liabilities.

3. 75 percent of excess of current assets over core current assets as reduced by

non-bank current liabilities.

In method 3 the core current assets means a part of current assets which should

be permanent component of working capital.

The study group suggested that borrowings in excess of what is permissible

under the first method should be converted into a working capital term loan repaid

over a period of time. The borrowers should gradually move to the third method.

(C) Style of lending:

The study group suggested that overall credit limit may be bifurcated into a

loan component, which would represent the minimum level of borrowing throughout

the year and a demand cash credit, which would take care of the fluctuating

requirements, both to be reviewed annually.

The demand cash credit should be charged a slightly higher interest rate than

the loan component. This approach will give the borrower an incentive for good

planning.

(D) Information and reporting system:

The study group suggested comprehensive information and reporting system

which seeks to:

1. Induce the borrower to plan his credit need carefully and maintain a greater

discipline in its use.

2. Promote free flow of information between the borrower and the banker so that

latter can monitor the credit situation better.

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3. Ensure that credit is used for intended purposes.

The study group suggested submitting quarterly information regarding profit

or loss, current assets and current liabilities.

1.16. CHORE COMMITTEE

The Reserve Bank of India constituted in April, 1979 a six member working

group under the chairmanship of K. B. Chore to review the system of cash credit and

credit management policy by banks. The committee report as considered by the R.B.I.

is as follows:-

1. The net surplus cash generation of established industrial unit should be

utilized partly at least for reducing borrowing for working capital purpose. In

assessing maximum permissible bank finance, bank should adopt the second

method of lending, recommended by the Tandon study group, according to

which the borrower’s contribution from owned funds and term finance to meet

the working capital requirements should be equal to at least 25 percent of the

total current assets. In cases where the borrowers may not be in a position to

comply with this requirement immediately, the excess borrowing should be

segregated and treated as working capital loan, repayable in half yearly

installment (maximum five year) and rate of interest should not be less than

the rate sanctioned for cash credit limit.

2. The existing system of lending (cash credit, loan and bill) should continue but

wherever possible the use of cash credit should be supplemented by loans and

bills. However, there should be scrutiny of the operation of the cash credit

accounts at least once in a year.

3. Bifurcation of cash credit in demand loan for corporation and fluctuation cash

credit component and to maintain a differential interest rate between these two

components is withdrawn.

4. Banks should appraise and fix separate limits for the “normal nonpeak level”

and for the “peak level” credit requirements for all borrowers in excess of Rs.

Ten lakhs indicating the relevant periods.

5. Drawal of funds to be regulated through quarterly statements within the

sanctioned limit, borrower should intimate his need of funds in advance.

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6. Borrowers should be discouraged from frequent seeking adhoc or temporary

limits in excess of sanctioned limits to meet unforeseen contingencies.

Additional interest of one percent should normally be charged for such limits.

7. Advances against the book-debts should be converted to bills wherever

possible and at least 50 percent of the cash credit limit utilized for financing

purchase of raw material inventory should also be changed to this bill system.

According to the committee, the major plank of the cash credit system to be

applied by the commercial banks is that commercial banks should assess the

maximum permissible working capital limits to a borrower by adopting the seconf

method of lending or Prakash Tondon Committee. Thus means that borrower’s

contribution form his own funds and long-term resources for meeting working capital

needs should be at least 25 percent of total current assets.

1.17 S.S. MARATHE COMMITTEE

The Reserve Bank of India appointed in November 1982 a committee under

the chairmanship of Shri S.S. Marathe to review the working of the credit

authorization scheme form the point of view of its operational aspects. The terms of

reference of the committee were:

I. To examine the objective, scope and content of the scheme and make

suggestion with regard to the changing economic situation;

II. To examine the adequacy or otherwise of the credit appraisal

machinery/procedures in the commercial banks;

III. To study the existing set-up for compliance with the requirements of the

scheme within the commercial banks both at the head and regional office

levels;

IV. To examine the existing data base for recommendations by banks to the

RBI for authorizing a given level of credit for a particular period;

V. To examine the existing format for submitting applications for banks to the

RBI in respect of seeking authorization and suggest modifications therein;

and

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VI. To study the desirability of introducing time-bound guidelines to be

observed within the guidelines of the Reserve Bank for speeding up the

processing and disposal of applications.

The committee submitted its report to the Reserve Bank in July, 1983. The

recommendations of the committee were accepted with some modifications by the

Reserve Bank. The banks have been advised to implement the following procedural

changes in the administration of the credit Authorization scheme with effect from

April 1, 1984 as indicated below:

1) Banks may release credit up to a maximum of 50% of the additional limits for

which RBI authorization is sought wherever credit proposals satisfy certain

stipulations;

2) As a measure of further incentive for predominantly export oriented units

coming under the purview of CAS, RBI authorization is up to a maximum of

75% of the additional limits for which authorization is sought, subject to their

satisfying the prescribed requirements;

3) All other credit proposals should be referred to the Reserve Bank of India for

prior authorizations as at present;

4) In case the borrower is an urgent of funds, banks may grant facilities, as at

present, on ad hoc basis over a period of three months to any of the CAS

borrowers under exceptional circumstances not exceeding 25% of the existing

working capital. This is subject to an overall ceiling of Rs.75 lakhs:

5) Banks need not refer to RBI for prior authorization for letters of credit

facilities covering acquisition of capital as well as non capital goods, provided

that the conditions prescribed are complied with before opening the letters of

credit. The exemption of letters of credit facility form CAS is allowed on

experimental basis:

6) The banks are advised that the discipline in use of bank credit employed in

the credit authorization scheme has to be accepted as a permanent feature and

that, for borrowers readily willing to between the submissions of a credit

proposal and actual disposal recommendations of the Marathe Committee,

substantial discretionary powers are vested in commercial banks to facilitate

faster release of funds to parties covered by CAS without prior approval of

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RBI provided that banks are satisfied with the proposal being fully in

conformity with the norms laid down by the Reserve Bank.

Recommendations:

(1) Banks may release credit up to a maximum of 50% of the additional limits for

which RBI authorization is sought wherever credit proposals satisfy certain

stipulations. As a measure of further incentive to the predominantly export-

oriented units, banks can deploy funds before receipt of RBI authorizations up

to a maximum of 75% of the additional units for which the authorizations is

sought;

(2) All other credit proposals would continue to be referred to RBI for prior

authorizations;

(3) In case the borrows is an urgent need of funds, banks may grant facilities on

an ad hoc basis for a period of 3 months to any of CAS borrowers under

exceptional circumstance, not exceeding 25% of existing working capital

limits. This is subject to an overall ceiling of Rs.75 lakhs as against Rs.50

lakhs earlier.

(4) Banks need not refer to RBI for prior authorization in proposal for letters of

credit facilities covering acquisitions of capital as well as non-capital goods,

provided the conditions prescribed are complied with before opening the

letters of credit.

1.18 CONCLUSION

The relative liquidity of the firm’s assets structure is measured by the current

assets to fixed assets ratio. The greater this ratio, the less risky as well as less

profitable will be the firm and vice versa. Similarly, the relative liquidity of the firm’s

financial structure can be measured by the short-term financing to total financing

ratio. The lower this ratio, the less risky as well as less profitable will be the firm and

vice versa. In shaping its working capital policy, the firm should keep in mind these

two dimensions – relative asset liquidity and relative financing liquidity of the

working capital management. A firm will be following a very conservative working

policy if it combines a high level of current assets with a high level of long-term

financing. Such a policy will not be risky at all and would be less profitable. An

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aggressive firm, on the other hand, would combine low level of current assets with a

high level of long-term financing. .This will have high profitability and high risk. In

fact, the firm may follow a conservative financing policy to counter its relatively

illiquid assets structure in practice. The conclusion of all this it that the considerations

of assets and financing mixes are crucial to the working capital management.

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1.19 REFERENCES

1. Praveen Kumar jai, Working Capital Management, (R B S A Publishers:

Jaipur) First Edition-1993, Page no-1 to 2.

2. H. G. Guthmann, analysis Of Financial Statements,(New Yourk: Prentice

Hall) IV Edition-1953,

3. Hoglend. J. Bierman, and A. K. Mc Adams, Management Decisions for Cash

and Marketable Securities,( New York : Graduate School of Business, Cornell

University), 1962.

4. J. L. Brown and L.R. Howard. Principle and practice of management

accountancy. ( London: Mac Donald & evans Ltd.,) 1975 , Page

5. J. Fred Weston and F. Eugene Brigham, Managerial Finance,(New York:

Dryden Press) First Edition-1975,

6. Prof. J. J. Jani & others, Accounting & finance-2 (Finance

Section)(Ahmedabad: C. Jamnadas & Co.) First edition-2009-2010,

7. S.C. Kuchhal, Financial Management – An Analytical and Conceptual

Approch, (Allahabad: Chaitanya publishing House) – 1982.

8. Adam Smith, The Wealth of Nations, (New York, Modern Library Inc., 1937),

pp.262-263.

9. H.G. Guthman, Analysis of Financial Statements (New York, 1953), p.63.

10. R.D. Kennedy and McMullen, Financial Statements – Form Analysis and

Interpretations, (1968), pp. 265-266.

11. Parasanna Chandra, Financial Management Theory and Practice (New Delhi:

Tata McGraw Hill Publishing Company Ltd., 1984), p.260.

12. V.L. Gole, Fitzerald’s Ananysis and Interpretation of Financial Statement.

13. Ibid., p.51

14. P.V. Kulkarni, financial Management – A Conceptual Approach (with

problems and review questions) (Bomby: Himalaya Publishing

House),Seventh Edition 1996,

15. R. D. Kennedy and S. V. McMullen, Financial statement: Form, Analysis and

Interpretation, (Homewood; Richard D. Irwin Inc.,) 1964

16. I. M. Pandey Financial Management, (New Delhi: Vikas Publishing House

Pvt. Ltd), 1979

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CHAPTER - 1 PAGE 41

17. P. V. Kulkarni, op.cit, page 377 to 381.

18. M. Y. Khan and P. K. Jain, Financial management, (New Delhi: Tata McGraw

Hill Publishing Company Ltd.) ,1989

19. S. N. Mittal, Management Accounting & Financial Management. (New Dilhi :

Shree Mahavir Book Depot), 1986 Part-II, Chapter- II.

20. O. M. Joy, introduction to financial management, (Homewood: Richard D.

Irwin, Inc., Illinois,) 1977, Page-406

21. P. V. Kulkarni op.cit, page 393.

22. N. K. Kulshrestha. Theory and practice of Management Accounting., (

Aligarh: Navman Prakashan, ) 1985-86 page – 40.

23. Statistical Outline of India 2007-2008 page 178, 180

24. Van Horne, James C. financial management and Policy, (New Dehli: Prentice-

Hall Of India Pvt. Ltd) , 1982, Page.390,

25. Cossaboom, Roger A., let’s Reassess the Profitability-liquidity Trade-off,

Financial Executive (may 1971) Page- 46-51(I.M. Pandey)

26. O. M. Joy, op. cit page- 408.

27. I. M. Pandey, op. cit page- 294.

28. Nand K. Sharma, Advance Financial Management, ( Jaipur: DND

Publications) First edition-2011, Page -115-118

29. O. M. Joy, op. cit page-417.

30. I. M. Pandey, op. cit page- 295

31. Todon Committee Report, Published By Government of India, New Delhi,

1975.

32. Chore Committee Report, Published By Government of India, New Delhi,

1979.

33. S.S. Marathe Committee, Published By Government of India, New Delhi,

1983-1984.

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Tools and Techniques of Financial Analysis

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CHAPTER II

TOOLS AND TECHNIQUES OF FINANCIAL ANALYSIS

The body of information describing even the smallest firm

is enormous, spaning the company's internal operations and

its relations with the outside world. To be useful this infor-

mation must be organised into an understandable, coherent and

sufficiently limited set of data. Financial statement analysis

can be very helpful in this respect because it highlights the

performance of the business.

The purpose of financial analysis is to diagnose the current

and past financial condition of a firm and to give some clues

about its future condition1.

Eugene F. Brigham opines that "from an investor's standpoint

predicting the future is what financial statement analysis

is all about; from management's standpoint financial statement

analysis is useful both as a way to anticipate future conditions

and more important as a starting point for planning actions

that will influence the future course of events2.

1. Gup E. Benton, principles of Financial Management John Willeg & Sons, New York, 1983, p.348.

2. Eugene F. Brigham, Op.Cit. p.196

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Analysis of financial statements is an exercise in the

re-arrangement of complex accounting reports into simplified

information3.

The analysis and interpretation is essential to bring

out the mystery behind the figures in financial statements4.

DEVICES USED IN ANALYSING FINANCIAL STATEMENTS :

Various methods are used to study the relationship between

different statements. An effort is made to use those devices

which clearly analyse the financial position of the enterprise.

The following methods of analysis are generally used.

1. Comparative financial statements

2. Trend analysis

3. Common size statements

4. Ratio analysis

5. Funds Flow Analysis.

3. Murthy Guru Prasad Management Accounting, Himalaya Publishing House, Bombay, 1987, p.453.

4. Sharma R.K. and Shashi K. Gupta, Management Accounting, Kalyani Publishers, New Delhi, 1987, p.75.

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COMPARATIVE FINANCIAL STATEMENTS :

The comparative financial statements will provide a compari-

son between two stipulated periods for an organisation. It

will also provide a comparison for two or more enterprises

for one or more accounting periods. These statements are de-

signed to disclose (i) Absolute figures, (ii) Changes in absolute

figures, (iii) Absolute data in terms of percentages and (iv)

Changes in terms of percentages.

Comparative figures will indicate the trend and direction

of financial position and operating results. The two comparative

statements are Balance Sheet and Income statement of an or-

ganisation.

COMPARATIVE BALANCE SHEET :

It represents not merely the balance of accounts drawn

on two different dates but also the extent of their increase

or decrease between these two dates. It focuses on the changes

that have taken place in one accounting period. The changes

are the direct outcome of operational activities.

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COMPARATIVE INCOME STATEMENT :

The comparative income statement gives an idea of the

progress made of a business over a period of time. The changes

in absolute money values and percentages can be determined

to analyse the profitability of the business.

TREND ANALYSIS :

The financial statements may be analysed by computing

trends of series of information. This method determines the

direction of change over the period. It involves the comput-

ation of the percentage relationship that each item in the

statement bears to the same item in the base year. The infor-

mation for a number of years is taken up and the first year

is taken as the base year. The figures of base year are taken

as 100 and trend ratios for the subsequent years are calculated

on the basis of base year. The analyst is able to ascertain

the trend of figures upward or downward.

Trend analysis includes the selection of a representative

period as a base and expressing all items in the financial

statements of the periods studied in terms of an index5.

5. Murthy Guruprasad Op.Cit, p.454.

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COMMON-SIZE STATEMENTS :

When the balance sheet and income statement items are

shown in analytical percentages i.e., the percentages that

each item bears to the total of the appropriate item such as

total assets, total liabilities, capital and net sales, the

common base for comparison is provided. The statements compiled

in this form are termed as commnnsim statements.

Common-size income statement shows each item as a percent-

age of sales and a common size balance sheet shows each item

as a percentage of total assets. The significant advantage

of common size statements is that they facilitate comparisons

of balance sheets and income statements overtime and across

. 6 compan/es .

RATIO ANALYSIS :

Ratio analysis is a powerful tool of financial analysis.

Its application to financial statements however appears to

be of recent origin. The construction of ratios is a major

analytical tool in the hands of financial executives. The

18

6. Eugene F. Brigham Financial Management Theory and Practice, Rinchart and Winston Saunders College Publishing, 185, p.891

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ratios facilitate the analysts in pointing out the relative

importance of the various items appearing in the financial

statements. Each major item in the balance sheet and profit

and loss account has a relationship with one or more items

in either or both statements which can be expressed in ratios.

But using ratios comparison with financial statements of other

firms are facilitated and comparison of a firm's financial

performance can too be made over a period of time.

RATIO :

Ratiois simply one number expressed in terms of another.

It is an expression of relationship spelt out by dividing one

figure into the other. The relationship between two figures

expressed mathematically is called a ratio.

As per the Dictionary meaning Ratio represents the relation

of one thing on another of which the quotient is the measure.

According to J.Batty, the term accounting ratio is used

to describe the significant relationship between figures in

a balance sheet, profit and loss account in a budgetary control,

system or any other part of accounting organisation7.

7. Batty J. Op.Cit, p.408.

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Financial ratios portray relationships that exist between

various items appearing in balance sheets and income accounts

and occasionally other items. They may be expressed in simple

mathematical terms. They are used to measure and evaluate

the financial condition and operating effectiveness of a business

. 8 enterprise .

•

Ratios provide the analyst with a set of summary which

measures of the firm's debt burden, operating efficiency and

profitability9.

Financial ratios are no substitute for a crystal ball.

They are just a convenient way to summarise large quantities

of financial data and to compare firm's performance 1?

ROLE OF RATIO ANALYSIS :

Ratio analysis means the process of computing, determing

and presenting relationship of items and groups of items in

the financial statements. It is a device to diagnose the fin-

ancial discease of an enterprise.

8. The Encylopedia of Management, Edited by CARL Heyel Manage-ment Counsel, Van.Nostrand Reinhold Company, New York, 1973.p.247.

9. Schall D. Lawrence and Haley W. Charles, Introduction to Financial Management, McGraw-Hill Book Company, New York, 1977, p.435.

10. Richard Brealey/Stewart Myers Op.Cit. p.569.

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A single ratio in itself is meaningless - it does not

furnish a complete picture. It becomes meaningful only when

compared with other ratios or the same ratios over a period

of time/

The ratios are diagnostic tests. A single diagnostic

test does not provide adequate information about a company

to evaluate its current conditions. Therefore, many diagnostic

tests are used to obtain a complete picture11

.

Ratio analysis is a convenient means of focussing the

attention of the analyst on specific relationships which require

further investigation. Ratio analysis of business enterprises

centers on efforts to derive quantitative measures or guides

concerning the expected capacity of the firm to meet its future

financial obligations

The final accounts for any period

'bring to light many figures which some times appear to be quite

unconnected with one another, but if brought together in a

particular manner, they reveal many interesting relations with

one another. These results show peculiar trends in business.

Ratio analysis is the best available means to relate these

figures together.

11. Gup E. Benton OixCit, p.352.

12. Archer A. Stephen And D'Ambrosio A. Charles Business Finance Theory and Management. The Macmillon Company, New York and Collier, Mac Millan Limited, London, 1971, p.498.

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Ratio analysis is also defined as the process of establish-

ing and interpreting various ratios for helping in making certain

decisions13.

ANALYSIS AND INTERPRETATION OF RATIOS :

Analysis is the dissection of a complex statement into

elements and varied compartments. Whereas Interpretation brings

out the meaning of such statements with the help of analysis.

There are four different ways in which ratios may be interpreted.

1. The individual ratio, by itself may have significance

of its own. Thus, if the current ratio falls constantly

and even goes below one, it may indicate that the liqui-

dity position of the concern is not encouraging.

2. Ratios may be interpreted by expanding the analysis

and considering a group of several related ratios.

In this way, the ratios whose significance is not fully

understood are made more meaningful by the computation

of additional ratios like the profitability ratios.

13. Sharma R.K. and Shasi K. Gupta, Op.Cit. p.113.

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3. The ratios may be compared over time. Moreover the

same ratio or a group of ratios is studied over a period

of years which indicates significant trends like increase

or decrease in stability, etc.

4. The ratios of any given firm may be compared with the

ratios of other firms in the same industry known as

interfirm comparison. Such comparisons are significant

as members of the same industry face similar financial

problems.

MERITS :

Ratios give a better idea than the absolute figures placed

side by side. Ratios become meaningful when compared with

other ratios or with ratios of similar firms. It is an effective

tool in controlling the entire business and planning for the

future needs.

The merits of ratio analysis are :

1. Ratio analysis simplifies the comprehension of financial

statements.

2. Ratios portray the whole story of changes in the financial

position of the business.

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3. It provides data for interfirm comparison by which

one firm can improve its financial standing and compete

successfully with another.

4. Ratios highlight the factors associated with successful

and unsuccessful firms.

5. Ratio analysis also makes possible comparison of the

performance of the same unit over a period of time.

They are helpful in deciding about the efficiency or

otherwise, in the past and likely performance in the

future.

6. Ratio analysis helps in planning and forecasting the

future activities of the firm.

7. Over a period of time, a firm or industry develops

certain norms that may indicate future success or failure.

Ratios are effective clues as to whether success may

result if the same norms are followed.

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LIMITATIONS OF RATIO ANALYSIS :

Ratio Analysis conducted in a mechanical manner is dangerous.

However, used intelligently and with good judgement ratios

can provide useful insights into a firm's operationi*.

Quantitative relations of the kind represented by ratio

analysis are not ends in themselves, but are only means provided

for understanding a farm's financial position. Quantitative

ratio analysis is not capable of providing precise answers

to all the problems faced by a financial manager or a potential

fund supplier unless several ratios often related to one another

are computed and compared.

Various limitations of ratios are as follows :

1. Ratios are meaningless by itself and acquire significance

only when they are studied along with other ratios.

2. Ratio analysis focuses on the accounting data some

of which at times turnout to be mere estimates. Any

analysis based on the estimated figures, lacks precision

which is very essential for the successful implement-

ation of the physical as well as monetary targets.

14. Campsey B.J. and Eugene Brigham F. Introduction to Financial Management. The Dryden Press Holt Rinchart and Winston Saunders College Publishing, 1985, p. 173.

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3. Ratios provide only a part of the information needed

in the process of decision-making. The infrmation

derived from the ratios must be used with that obtained

from other sources so as to ensure a balanced approach

in solving the problems.

4. Ratio analysis suffers from the serious limitations

of the statistical concepts such as determination of

proper standard for comparison, absence of the homogeneity

of the data and danger of fallacious conclusions.

5. Financial analysis based on accounting ratios will

give misleading results if the effects of changes in

price level are not taken into account.

6. The qualitative factors which are important for the

successful functioning of the organisation are completely

ignored by the ratio analysis and hence, the conclu-

sions drawn may get distorted.

Ratio analysis is indeed, a double edged sword which requires

a great deal of understanding and sensitivity of the management

process rather than mechanical financial skill. But even with

these limitations and problems the use of ratios to indicate

future trends in business has increased to a great e:xtent.

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Ratios calculated from the available data in the financial

statements may be classified as follows :

1. PROFITABILITY RATIOS :

Profitability ratios measure the efficiency of

the company's activities and its ability to generate

profits. Poor performance indicates the failure of

the business which may lead to liquidation of the company

in the long run.

2. SOLVENCY RATIOS :

These ratios examine the adequacy of funds and

the company's ability to pay its obligations when it

becomes due. These ratios measure the short-term solven-

cy of the company.

3. EFFICIENCY AND PERFORMANCE RATIOS :

These ratios indicate the effective utilisation

of various assets and funds invested by the creditors

and shareholders. The better the management of funds

and assets the larger the amount of sales, and hence

the profits of the company.

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FUNDS FLOW ANALYSIS :

The limitations of financial statements forced the need

for a seperate additional financial statement to highlight

on the major financing and investment activities of a firm

known as funds statement. It summarises various sources from

which funds are obtained and uses to which they have been applied.

The concept of 'Funds' refers to 'Net Working Capital'.

Any increase in the net working capital is a source of fund

and any decrease in working capital becomes an application

of fund. The various sources from which funds derived are:

1. Operations of business

2. Income from investments

3. Sale of fixed assets and long-term investments

4. Subscription by shareholders

5. Increase in long-term debts.

The funds so derived by a business concern are applied

in the following ways :

1. Operating losses

2. Redemption of long-term loans and debentures

3. Redemption of Redeemable preference share capital

4. Payment of cash dividend

5. Acquisition of fixed assets

6. Purchase of investments.

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The flow of funds refers to movement of funds involving

'Inflow' and 'Outflow' in the working capital. This happens

when changes occur in non-current accounts such as fixed assets,

long-term debts etc., and are offset by corresponding changes

in current accounts such as current assets or current liabilities.

The funds flow statement which is popularly known as

'Statement of Sources and Application of Funds' focuses on

the flow of funds between various assets and equity items during

an accounting period. It reveals the manner in which the fin-

ancial resources have been obtained and ueaised during an account-

ing period. •

Funds flow statement provide an additional perspective

on the nature of the financial condition of a company.

Funds flow analysis is a decisional display of managements

disposition of short and long-term funds available for oper-

ations and investment15.

15. Erich A. HelFert,Techniques of Financial Analysis, Dow- Jones-Irwin Inc,Homewood Illinois, 1972, p.36.

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A statement of changes in financial position is a deri-

vative financial statement that shows the amount by which each

item on successive balance sheets have changed and in addition

identifies the reason for the change16.

A more accurate and useful analysis of changes in the

distribution of resources between balance sheet dates is found

in the statement of the sources and application of funds17.

USES OF FUNDS FLOW STATEMENT :

It is through analysis of this statement a proper under-

standing of the changes in the distribution of resources between

the two balance sheets can be had.

The funds statement shows the financial consequence of

business operations. It is quite possible that a concern may

operate profitably without any improvement in the liquidity

position. This is wholly due to the fact that all economic

values do not possess the same financial flexibility as cash

and related resources. The fund flow statement reveals such

irreconcilable situations.

16. Ramesh K.S. Rao Financial Management concepts and Appli- cations, Macmillan Publishing Co. New York, Collier Mac- millan Publishers, London, 1987, p.119.

17. Robert H.Wessel Principles of Financial Analysis. The Macmillan Company, New York, 1961, p.59.

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This statement is useful to the lenders such as banks

and other financial institutions, as it indicates them the

liquidity position of the firm and its ability to pay interest

regularly and return the principal sum.

It serves as an instrument for allocation of resources

when the business concerns launch their future expansion as

well as diversification programmes, the need for arrangement

of the funds arises. The amount of funds made available through

normal business operations is ascertained through the projection

of the funds flow analysis.

The funds flow statement shows the urgencies of operation-

al issues and facilitates settlement of priorities in a phased

manner.

This statement indicates the effectiveness of the manage-

ment in the handlingpf the working capital during the accounting

period. It also helps the management in deciding whether to

issue more of equity shares or increase long-terms debts.

In short, the funds statement helps the .management in the de-

cision-making process in case of expansion, diversification

or conservation of more funds for profitable utilisation on

sound projects in subsequent years.

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LIMITATIONS :

While the managerial uses of the funds statement cannot

be underestimated the use of it as tool by the financial analyst

should be done with utmost care and caution.

Though the funds statement furnishes factual information

not supplied by the traditional financial statements the fact

that it ignores non-fund transactions, makes it a dangerous

tool for application in financial analysis.

The funds statement is prepared on the basis of the figures

from financial statements already prepared and hence, does

not introduce an element of original evidence to the financial

change or status.

Any projection of flow statement based on the figures

from the two balance sheets deals with the past and becomes

historical in nature.

Inspite of the above limitations the funds flow statement

is of immense use to the management, in providing the information

not furnished by the traditional financial statements and helps

in the decision making process affecting the success of any

business unit.

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STATEMENT OF CHANGES IN WORKING CAPITAL :

In the funds statement the difference between the total

of sources and the total of applications constitutes either

increase or decrease in the working capital for the accounting

period under review. This variation in working capital is

verified through a seperate statement depicting changes in

working capital. This statement shows the current assets and

current liabilities at the beginning and end of the accounting

period and the net effect of their changes between two periods

on the working capital.

The primary prupose of this Chapter is to discuss the

techniques used by investors, creditors and managers to analyse

the financial statements of a business. Financial analysis

is designed to determine strengths and weaknesses of a firm-

whether the firm is financially sound and profitable relative

to other firms in its industry and whether its position is

improving or deteriorating overtime. The study of financial

analysis of SIVL concentrated on a set of ratios designed to

highlight the key aspects of its operations. Funds Flow state-

ment analysis was also included to assess the changes in finan-

cial position of the unit under study.

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Chapter-1

Conceptual Framework of Social Responsibility Accounting

o Introduction

o Conventional and Social Responsibility Accounting

o Meaning of Social Responsibility Accounting

o Nature of Social Responsibility Accounting

o Objective of Study

o Scope of Study

Introduction

Business activity in our country greatly affects the economy of that country-higher the degree of the business activity in an economy higher the degree of the development in that economy as business activity and development are directly related to each other. Development of the economy means creation of the new employment opportunities in the economy, establishment of large number of industries increase of commercial activities, avoidance unfruitful competition and increasing of standard of living of the people living in the economy.

So far as business concerns it is an economic activity which is engaged in the production and distribution of goods and services to earn profit or to serve the society. So basically there are two activities which constitute business –production activity and distribution of the product. Production is concerned with the industries and distribution is concerned with the commerce. Any unit or bushiness or firm which is engaged in the production of goods or services is called an industry and activity which is engaged in distribution goods from producers to customers is commerce. So Industry is concern with production of goods and commerce is concerns with the services only.

First activity is industry; it may be of different kinds. For example, manufacturing industry is engaged in giving particular form or shape to raw-materials by utilizing the services of expert and skilled personnel or workers. It may include analytical, processing or assembly industry. Genetic industry is concerned with the exploration of new and advance technique of production or new variety of

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seeds and fertilizer so that production can be increased upto the highest efficiency level. There may be construction industry very much engaged in the construction activities. And extractive industry is concerned with the extraction of minerals, metals, coal or oil from the earth or from water. So industry is concerned with the production of goods or giving a particular shape of form to raw materials so that consumer can make use of it.

Second activity is commerce. Commerce is generally a link between the producers and consumers. Producer is different person though at the same time producer may be also consumer and consumer is different person. There is no link between these two. Production function is done where raw material, cheap labour, suitable climate, power and energy are easily available and consumer live generally at a place where all kinds of civil amenities are available to them. So there is a need of common place where both producers and consumers can meet so that producer can know very well the habits and the choice of consumers and consumer can know very well about the products to be produced by the industry and at the same time its quality and applicability. Commerce provides a market to both producers as well as consumers. It makes the buying and selling function easy. It creates time utility by storing and warehousing the goods when goods are not demanded, creates place utility by transporting goods from one place to another place where those goods find demand and gives information of new products or of existing products to consumers through advertisement or through sales agents. In this way commerce helps the consumers. So it shows that production and distribution are related, similarly industry and commerce are also closely related to each other.

But the success of industrial and commercial activity depends on the society. It is society which gives importance to this activity. Society is the organization and composition of the people leaving under different customs and tradition .But in economic since society means the group of consumers. Society greatly affects the business activity of a country and it is a belief that if business activity is too flourishes, then society should be developed and get advanced. There should be educated society and there should be awareness in the society Business and society are very closely related to each other. Both have no existence without each other. On the other hand it can be said that they are the two sides on one coin and success of both depends on their success themselves. If society is undeveloped and people are not very much aware and conscious, business cannot flourish and if there is lack of business activity then society cannot developed.

As far as objectives of business is concerned ,it main object is to earn profit because without earning profit how can a business serve the society , So profit is

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very much necessary for the development of the society . The object of business isto supply goods and services to the customers-the part of the society, to provide employment and income to people, to give incentives and motivation for the satisfaction of employees-at the same time part of society, payment of fair wages and bonus to it employees, donation to education and community welfare programs, housing and medical facilities to employees and payment of taxes to local, state and central government etc.

So business and society are very closely related .Business units have to performvarious responsibilities towards the internal as well as external users as both live in the society. Internal member are share holders, managerial staff, board of directors, employee, etc. and external party which are affected by business activities are creditor’s debenture-holders, consumers, government etc. Individually, a person may be classified as internal or external parties, but as a human being he is supposed to be the part of society and therefore, each and every person should be very much careful about performing his activities which affects the society. Business activities should always satisfy the society’s welfare program. It should be careful about environment i.e. Air pollution, water pollution, solid waste discharged by it, which very badly affect the social life and adversely affect the health of persons leaving in the society.

Another important social responsibility of the business in the relation between the government and business as both are supposed to be caretaker of the society’s welfare. There should be clear cut rules and regulations, and good understanding between the government and business activities.

Another area of responsibilities is consumers. All Business activities depend solely on the consumer’s interest. Success and failure of business depends on consumer’s taste, preferences, choices, habits etc. consumer is very important part of the society. Individually he turns as member of the society and is also affected by the atmosphere in which he lives by the facilities provided to him in general as an employee in the business concern. The moment individual purchases the different communities produced by the concerns of takes the services he become consumer. Business activities should be very much careful about consumer’s satisfaction. Consumerism is growing in every economy. Business is essentially requires to protected the consumer’s right to meet the challenge of consumerism.

Similarly, business should fulfill its responsibilities towards its employees by providing various facilities like, medical, housing, transportation, Entertainment, educational facilities, promotion of art and culture etc.

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Shareholders or owners of the business concern who bear risk and invest theircapital in the business, are also a part of society, so business concern should be careful to provide them proper rate of return on their investment to satisfy them and ultimately satisfy the society itself.

So, business is an economic activity to produce and distribute the goods and services. Though its primary objective is to earn profit, yet it should satisfy both economic and social needs. Business must earn profit because without having sufficient amount of profit it cannot fulfill the various social obligations. It is an important social and economic institution, established to safeguard the interest of employees, Shareholders, Creditors, Debenture-holders, suppliers, customers, government and general public.

Conventional and Social responsibility Accounting

The primary function of conventional accounting is measurement of economic consequences in terms of money, whereas social accounting seeks to determine important variable of social consequences in terms of socio-economic non monetary effects along with economic consequences.

Modern accounting theory and information economics are directed towards general assumptions capable of deriving accounting structure from specific information goals. Such a structure insists on more and more emphasis on fulfilling the role of control mechanism, not merely internally and for shareholders but for the society at large. Social responsibility accounting is a branch of accounting dealing with the functioning of economic system as a whole. It may be considered as the accounting for community. Social responsibility accounting includes the area like ‘pollution control’, ‘equal employment opportunity’, ‘charitable-contributions’, ‘community relations’, ‘product-quality’, ‘plant-safety’, ‘employee benefits’, and responsiveness to ‘consumer complaints’.

The function of social responsibility accounting is to measure and disclose the ‘costs’ and ‘benefits’ to society created by the production related activities of a business enterprise. Attributes of social concern are usually recognized in annual reports. They include product and quality improvement, fair business practices, human resources, environment and community involvement.

Conventional accounting and social accounting systems differ from each other in the following common respects-

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Time of evaluation

Conventional accounting is the oldest concept of accounting. It was evolved about 510 years ago in 1494 by Lucapacioli, a Greek mathematician. But social responsibility accounting is a new concept of accounting. The macro sense of social responsibility accounting is national accounting which is used by economists was first introduced by De Queng in France in 1758 and micro sense of social responsibility accounting which is used by accountants was developed in early 1970s in the USA.

Basis of accounting

Conventional accounting is concerned with the measurement of economic consequences in terms of money. But in social responsibility accounting both monetary and non-monetary factors recognized.

Accounting System

Conventional accounting is based on double entry system. Despite it in certain cases single entry system or incomplete recording may be followed whereas no such specific well known system is followed for social accounting. Social accounting remains at the developing state and as a result deferent approaches are now using in different countries of the world like narrative method, social statement, value added, and method and so on.

Books of Accounts

In conventional certain specific book of account like journal, ledger, and so on are maintained systematically together with some statistical books. But in social accounting no such specific books of accounts are maintained. However, under social cost-benefit (Social statement) method accounts can be prepared on some predetermined bases.

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Preparation of annual statement

In Conventional accounting final or annual statement are prepared in specific format and in systematic manner whereas in social accounting the annual social statement are prepared not as per specific format and not in systematic way.

Nature of data

The data used in conventional accounting I objective in nature. As a result, the arithmetic accuracy can be judged at different stages of this accounting and there is a little scope of arising inter-personal variation but the data used in social accounting is very subjective in nature. The arithmetic accuracy cannot be judged here moreover, the figures vary person to person.

Purpose

Conventional accounting aims judging whether and how far the financial and personal objectives of equity have been fulfilled while social accounting aims at judging whether and how far the social objective have been fulfilled in view of the performance of social responsibilities and so on.

As far as corporate annual reporting is concerned, it is based on British policy but later on it was greatly influenced by the international professional group. The Indian Companies Act 1956 played the key role in the development of corporate annual reports. According to section 165 of the Indian Companies Act 1956, statutory reporter should include – Profit and Loss Account, Balance Sheet Director’s Report, and Auditor’s Report. It has been also observed that Indian profit and loss account and balance sheet is less innovative and informative. Generally Indian financial statement is prepared within the legal framework to comply with the legal requirements. Even Section 227 (4A) of Indian Companies Act 1956, which requires the auditor to make a report and express an opinion , whether the corporation’s profit and loss account and balance sheet, exhibits ‘true and fair’ view of companies state of affairs, does not mention about corporate social reporting.

It seems that Indian financial reporting is defensive. It includes only statutory reports and non-statutory reports are not prepared in Indian corporations. The various neglected factors in Indian balance sheet are human resources of the organization, social responsibilities etc. Though this act has been amended

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number of times, but no provision has been enacted for the disclosure of social responsibilities in corporate annual reports.

Later on, various seminars and conferences were organized and sponsored by various agencies to create awareness among various corporate sectors about their social responsibilities and how to discharge their social obligation. Attempts were also made to make disclosure of social responsibilities mandatory also.

The real effort came in when the Sachaar Committee was appointed by the government, under the chairmanship of Justice Rajindar Sachaar to accelerate the process in respect of corporate social reporting. The committee was constituted to consider and report on the changes which are necessary in the form and structure of the act. The committee has made various recommendations regarding accounts, audit, social responsibilities etc. The committee recommended the inclusion of particulars in the director’s report.

Meaning of Social Responsibility Accounting

Meaning

In, earlier times, when economy was not very much developed, large number of small scale business units were operating in the form of sole trading and partnership firms requiring less amount of capital, labour and entrepreneurship skills and experience. These business units were not required to present their annual report showing profit and loss account and balance sheet. Then industrial revolution took place and large number of large scale business units came into existence, producing and distributing goods and services in huge quantities and huge amount of capital and labour were required to establish and run these business units. These business units took the company form of organization, having separate legal entity from individuals managing the hole business activities, these business units were legally required to publish its annual reports describing its total expenditure and income during the period in the form of prescribed profit and loss account and the actual financial position of the business at that date through balance sheet. So, this was the concept of presenting annual reports including chairman’s and director’s report. There was no mention about social reporting.

Accounting was being considered as means and not an end and this means should be determined according to the ends rather; ends should not be determined according to the means. The ‘end’ of accounting means according of few

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analyses – “As process of communicating economic information to permit informed judgments and decisions by the users of information.” “Thus, it provides the users a source of financial information to guide to future course of action.”1 So, conventional financial reporting was mainly concentrated to report only about profit and loss account and balance sheet of the concern. This technique is being used as tool to focus and measure real financial position of the concern and repots of financial results were used to be given only to owners and investors. But it is not supposed to be the end of accounting process. The accounting report should consist of financial results as well as social results showing social performance of that business unit.

Generally, it is found that traditional financial reporting remains silent and ignores reporting regarding social activities of the business. It does not report about social economic conditions under which that business operates. The annual report does not mention about social responsibilities like housing facility, medical facility, educational facility, canteen facility, local tax payments, environmental protection, job facilities etc. but now this concept is changing and growth and development of corporate organization and their important role in the society have given rise to reporting on social responsibilities in their annual report. Government has also made binding in this regard.

The term social responsibility accounting is generally confused with number of terms as social audit, social information system, social reporting, socio- economic accounting, social accounting social disclosure, corporate social performance, etc., but all these terms have the same meaning and these terms are used interchangeably for one another.2 In fact these terms are in the process of evolution and crystallization. They underline that corporate enterprises have a responsibility to maintain and promote quality of life of the community.3

As far as meaning of social responsibility accounting concerned, it is an accounting report of social activities performed by business units for the welfare of society. As business cannot exist without society, therefore each and every business unit is required to give accounting report of its social activities. Social responsibility accounting means reporting of various social responsibilities of the business, i.e. accounting repot of the expense incurred on education facilities, medical facilities, canteen facilities, housing facilities, transportation facilities, water and electricity facilities, job opportunities for minorities, entertainment facilities, tax paid to local or state government, donation and charity for social welfare etc.

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So, social responsibility accounting is an accounting report of social expense and social benefits of that business unit. “Social reporting or social accounting is a rational assessment of and reporting on some meaningful definable domain of business activities to the public as well as other interested parties regarding its social performances, measuring either in monetary or non- monetary terms, being beneficial or baneful by the activities of the concern both to the concern or those affected by the concern.”4

According to this definition, it is very clear that social responsibility accounting is assessment and at the same time reporting on the social activities of business units either in monetary terms, i.e., quantitatively or in non- monetary terms, i.e., qualitatively which is useful or useless to both, i.e., to concern itself and the society under which that business unit operates. According to true blood committee report, “An objective of financial statement is to report on those activities if enterprise affecting society, which can be determined and described or measured and which are important to the role of enterprise and its social environment.”5

This definition is concerned with the need and function of social accounting. It says that financial reporting statement should contain the details about the social activities in accounting form and should settle the conflicts and disputes of interested parties. The social responsibility accounting information’s are communicated to socially interested groups within and outside the organization. Social accounting reporting is expression of a corporate, social responsibility in accounting terms. It is associated with the study and analysis of those activities of an organization which are done for the welfare of society and to measure the effects of such activities on the society and also on the enterprise itself.

Technology of an economic system and its trade activities influences the social responsibility and well being of the society as a whole. Therefore a major limited to economic consequences is the cause-effect relationship of the total system. It cannot neglect the social effects.

Accounting as traditionally well-known is highly associated with credits and debits .It is essential to recognize accounting for the social responsibilities also.

“It is important to realize that accountants have special abilities that are needed if contemporary society is going to solve its ever growing problems.”

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Social accounting is newest field of accounting there have been increasing demand of the profession for measurement of social cost and benefit which have been considered to be immeasurable.

The accounting profession has been altered to therefore research in accounting for social goals and is ready to accept the challenges. There have been increasing demands on the profession for measurement of social cost and benefit which have previously been considered to be immeasurable.

The terms social accounting has been used by many authors in different shapes such as:-

Social Accounting (sethi-1971, Gambling-1974), Social Responsibility Accounting (Elliot-1975), Socio-economic-accounting (Linowes-1968 sethi-1973, Abt 1977, Beasealy & Evans 1978), Social Reporting (Bi Desinmen & Thomas 1976)

Social Accounting deals with communication of information and the measurement about the impact of activities on the society. It is an assessment and reporting on definable domain of enterprise activities that have impact (either in monetary or non-monetary units) the social accounting measuring favorable and unfavorable effects of such activities both on the entity and society. It is concerned with the social human and environmental properties on enterprise behavior. Hence social Accounting deals with measurement and reporting of information concerning the impact of a concern and its activities on society.

Dimensional meaning of social responsibility accounting

A business is a social organization and a unit of nation, the owners of business concerns have dual role in the society. They invest money or capital into the business to fulfill their own interest, i.e. mainly for earning profit on the one hand and to provide goods and services for the benefit of the society on the other. The society creates a suitable atmosphere for a business for which it can perform all the functions smoothly and regularly. As a result, the society and nation is required to incur something for the creation of business atmosphere. In return the business should fulfill certain obligations towards the society

As per classical economists there should not any social responsibility of a business-the only objective the maximization which leads to the optimization of the wealth of the owners or the equity share holders. The only social

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responsibility is to use the resources and to provide the output to the society. But in modern age the business concerns, especially corporate organizations put greater emphasis on the fulfillment of social responsibilities. Because the modern business concerns wish to adopt the principal of fulfillment of social responsibilities smoothly besides earning a standard profit regularly throughout its long period of existence, instead of earning maximum profit by any means within a very limited period of existence.

The concept of social accounting can be apples in two senses-

Macro sense Micro sense

Macro sense

The social accounting deals with the measurement of social and national income and national wealth of nation. It involves in accounting for all economic activities occurred in the entire economic phase of a nation. The social accounting in this sense or model is termed ‘national accounting’ or ‘national income accounting’.

This concept of social responsibility accounting is used by the economists, statisticians and so on. This accounting deals with the total national functions or macro variables-such as, national productions, national consumptions, national savings, and national investments and so on. Practically social accounting is an accounting of national welfare growth, prosperity and finally the well being of the entire community. The idea of macro sense of social accounting was first introduced in 1758 in France by De Quency in his ‘table economique’.

The famous chemist Levoisier referred to the principals of accounting for the municipality of Paris in 1791 almost in the same pattern as the accounting system is followed now days for a nation. Thereafter, it suggested that social accounting should be included as an introductory principle in the study of economics.

Micro sense

The social accounting deals with the measurement of performance of the responsibilities of a business concern, especially of a corporate enterprise, towards the society. While the macro sense of the social accounting is viewed from the side of the nation or society. The micro sense is developed from the aspect of the business. The concept of the social accounting is used by mangers,

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accountants and so on. This accounting is the recent origin and not developed at all before 1970. As the result, different concerns of different countries spent earlier on different accounts of social accounting. There was no such attempt for social accounting them.

In 1971 the public affair council of Washington prepared a check-list of the objectives, tasks and activities to identify the focus on social accounting. In earlier years of decade, different American companies like manufacturing concerns, bank, insurance and so on companies put their emphasis for preparation of social reports through analysis of social costs and social benefits besides maintenance of conventional accounting.

Definitions

National Association of Accountants (USA) Committee on accounting for corporate social performance in its report (1974) has described aspects of social performance and identified community involvement, human resource, physical resources and environmental contributions. Community involvement includes all social oriented activities intended to benefit the general public. Human resource includes activities intended to benefit the employees. Products and service contribution include activities intended to social benefit and total environment of the firm.

Social reporting or social responsibility accounting is a national assessment of and reporting on some meaningful domain of business activities to the public as well as other interested parties regarding its social performances measuring either in monetary or non-monetary terms, being beneficial or baneful by the activities of the concern both to the concern or those affected by the concern.

“Social Responsibility Accounting is basically a socio-economic accounting. It is the modification and application of skills, techniques and disciplines of conventional accounting to the problems of social interest.”

According to Ahemad Belkaoni Socio-economic accounting in the social sciencesit refers to the recording, meaning, analysis and disclosure of the social and economic consequences of governmental and entrepreneurial behavior. It includes these activities at the macro and micro level.

At the micro level its purpose is the measurement and reporting of the impact of organizational behavior of firms, on macro level its purpose is the measurement and disclosure of the economic and social performance of the nation. At the

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micro level socio-economic accounting includes, therefore, financial and managerial social accounting and reporting and social auditing. At the macro level socio-economic accounting includes, therefore, social measurement social accounting and reporting and the role of accounting in economic development.

According to The National Association of Accountancy (N.A.A.) Committee, “designed social accounting as the identification, measurement, monitoring and reporting of the social and economic effects of an institution on society…. It is intended for internal managerial and external accountability purpose and is an outgrowth of changing values that have led society to redesigned its notion of a corporate social responsibility”6

Sybil Mobley While stabilizing the need socio economic accounting defined same as “it refers to the ordering majoring and analysis of the social and economic consequences of government and entrepreneurial behavior.”7

According to Ralph Estes” Social accounting is the measurement and reporting, internal and external, of information concerning the impact of an entity and its activity on society. ”8

As defined in dictionary of accounting “Reporting the cost and benefits relating to socially responsible action by business enterprises. This may be carried out in a number of ways, e.g. publication in the annual report of a list of socially responsible action., Publication of a list together with disclose of the cost to the enterprises of each activity, publication of a list together with discloser of the extent to which the objective of actions have been achieved, publication of a list together with the costs and benefits of each activity.”9

K.V. Ramnathan has defined social accounting is” the process of selecting firm level social performance variable , majors and measurements procedures systematically developing information useful for evaluating firm’s social performance and communicating such information to concerned social groups both with and outside the firm. ”10

David Linows used the term “Socio economic accounting” In a border since .as per him it is “the application of accounting in the field of social sciences.”

Elliot uses the term “Social responsibility accounting as per him it is a systematic assessment of and reporting on those part of a companies’ activities that have social impact. It describes the impact of corporate decisions on environmentalpollution the consumption of non-renewable resources and ecological factors on

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the rights of individuals and groups, on the maintenance of public services, on public safety, on health and education and many other social concerns.”As per Patricia Dazler, Social responsibility is defined as a voluntary expenditure or activity by a corporation with charitable intent, for which marginal returns are less than those available from other alternative activities.

As per F.E.Perry’s dictionary of banking, “ Social accounting is the reporting of the cost incurred in complying with anti pollution , safety and health and other society beneficial requirements, and more general;;y the impact of business entity on its Endeavour to protest society , its amenities and environment, ”11

G.C.Maheshwari has define is as, Identification , Measurement ,recording and reporting of corporate activities which may permit informed decision making with respect to social activities of the firm having direct and indirect effect on the very fabric of the society at large. While social audit would mean inquiry into the corporate social accounting records by an outside agency that can open with a view to attestation and authentication of such records and reports.

According to Kohler’s Dictionary for Accountants, the systematized treatment of social indicators which represents quality of life conditions in a country, region or other geographical units.

According to Epstein, Flantioltz and Mc Donough, social accounting is an extent ion of the traditional concept of accounting and accountability to a different domain social rather than financial performance.

“Socio-economic accounting aims at measuring and reporting the impact of exchanges between a firms and its social environment.”

Mobley said, the technology of an economic system imposes a structure on its society which not only determines its economic activities but also influences its social relationship and well being.

Johnson defines it as, “ The accountants would do well to recognize that cost of operating business is something more than what is being disclosed in public accounts, e.g., pollution of environment (noise, water, air), spread of disease, dislocation of inhabitants of a locality, local housing and transport problems, closure of cottage industries, social tensions and several other social evils. This is on the liability side. What it does, providing roads, schools and colleges, dispensaries, railway lines, employment etc. is the asset side. Hence, instead of income, we should measure the benefit cost of a venture project. 12

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As per Dr. Sawalia Behari Verma, “Social Accounting is associated with the study and analysis of accounting practice of those activities of organization which are undertaken by the enterprise itself in quantitative as well as qualitative terms. It also tries to analyze and evaluate the organizational behavior in the light of such activities.”13

The credit for sponsoring social welfare activities besides employee welfare activities, by commercial undertakings goes to socialist countries, where public undertakings have to fulfill some social responsibilities, besides undertakings, commercial and productive activities. In other countries of the world, the initial motivation for social involvement by business might have come from a scare of socialism, later on various movements and social welfare organizations such as consumer protection groups, civil rights movement, environmental protection and ecological conservation groups and so, on have contributed towards this phenomenon.

It is clear that social accounting is concerned with the external and internal reporting of social benefits and costs both in quantitative and qualitative term by a business enterprise.14

Thus, in brief each and every definition gives much emphasis to that as business is a component of society, it is affected by society and it also affects the society, therefore. It has been also described in some of the definitions that business enterprise should be very much careful about environmental pollution, medical and education facilities to society in which it exist, about social disputes, evils, crimes, etc. This reporting should be in accounting form, showing social costs benefits and what is the real degree of advantage availed by the society through its activities. This social reporting should be presented and communicated in such a way, so that it can be useful to both internal management and external parties.

So, social reporting is an accounting report of various social responsibilities of an enterprise to assess whether enterprise has achieved the target fixed or not, and also to find out whether an enterprise is working efficiently in providing various facilities to its workers and society or not.

Conclusion is that “Social responsibility accounting is such an accounting concept which indicates how and how far as well as in what efficiency a corporate organization or simply a business concerns performs its social obligations towards the interest groups of society. It is the accounting which attempt to measured different cost involved in proving the benefits to the society

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directly and indirectly as well as different benefits enjoyed from different parties of the society. It is concerned also with the development and measurement system to monitor social performance. So it is an expression of a firm’s social responsibilities and requirements for general corporate accountabilities.

Social responsibility accounting is an integration of management accounting with the national economics. Practically it is an accounting of national welfare, growth, prosperity and finally the well- being of the entire community.

Nature Of Social Responsibility Accounting

The primary objective of social reporting is to disclose the amount (accounting data) incurred on social welfare and to find out how much concern is fulfilling its social responsibilities. Generally, accounting report, i.e. financial statement is demanded by shareholders, creditors, government and others. These are the parties which are very much affected by company’s activities. Their interest may be positively or adversely affected but due to rapid industrial development and social awareness in the society the whole concept has been changed and now financial statement not confined only to proprietors as is it said “Accounting is social activity engaged in by (i) corporate managers who perform in activities that are recorded by the accounting system, (ii) corporate account who gather data and compile the reports, (iii)auditors who scrutinize and attest to the fairness of the reports, (iv) outside government and private agencies, investors, employees, customers etc., who read these reports, and (v) college and university personnel who train their student in accounting.”15

Thus according to this statement, accounting report is concerned with the member of parties for different purpose, having their interest in the activities of the concern. These parties may be classified into internal parties and external parties. Internal party is concerned with the reporting process, exercised by the management for internal planning and control, whereas external party is concerned with the reporting process useful for shareholders, money lenders, debenture holders, creditors, government, consumers and society large.

Thus, internal reporting is concerned with financial and non-financial data of enterprise necessary for management to take decisions and to have information for future planning and control and external reporting is concerned with the accounting data, useful to outside parties of organization, very much interested in enterprise’ activities. As the members of external reporting, are not found to be homogeneous in their purpose, therefore, there is a lot of differences in their

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requirements. Each and every party has different objective, and external reporting is required to fulfill all these different objectives. Corporate reporting should be presented in such a way so that it can satisfy needs of different parties, going to be effected by the activities of the enterprise. So, the main purpose of corporate social reporting is to provide various information to various users.

Ramanathan 16 tried to develop a theoretical framework for corporate social accounting. He gave three objectives of corporate social accounting which distinguish from financial accounting:

-To identify and measure the periodic net social contribution of a individual firm consisting of cost and benefits internalized to the firm and externalities affecting different social segments.

-To help determine whether individual firms strategies and practices which directly affect the related resource and power status of individuals, communities social segments, generations consistent with widely share social priorities on the one hand and individual’s legitimate aspirations on the other.

-To provide the optional information to all the constituents of the society to enable them to make decision regarding allocation of social resource where optimality implies a cost/benefit effective reporting strategy which also optimally balance potential information conflicts among the various social constituents of a firm.

The objective of social accounting is to inform the general public about social welfare measures taken by the enterprise, and their effects on the society. How far the enterprises are successful in fulfilling the social obligations also comes to light through social accounting.

Objectives of Social Responsibility accounting

During these days it is recognized that corporate activities have economic and social impact. The corporate economic impact measured by financial accounting but up till now no proper system and slandered has been developed for measuring social impact of industries.

The objective of social accounting is,” to internalize the social cost and benefits to determine a more relevant and exhaustive result that represents the socio-economic profit of a firm.”

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The objective of social accounting is to evaluate and to disclose the cost and benefit to society created by the production related activities of a firm more precisely, the objective is to consider the social cost and benefit with in a concern in order to determine a more relevant and exhaustive and business result. This is generally known as socio-economic profit of a firm.

According to Chen,” as a steward management responsibility should be evaluated in terms of both profit and the accomplishment social objectives.”The major objective of accounting from social performance is to identify and measure the contribution of an individual entity of a firm to the aggregate social benefits and sacrifices.

Social accounting are considered to be the measurement of (a) Social cost (b) Impact of business decision entities of society (c) Effectiveness of public programme (d) Human resource utilization it’s extents and limits (e) The corporate responsibility towards society and ultimately, (f) To measure the response in terms of public satisfaction and upliftment of physical and mental standard.

In, today’s world, it has been universally recognized that corporate activities have economic as well as social impacts. Business and society are so much closely related to each other that their activities cannot be neglected. The basic objectives of social reporting are:

To know the contribution of individual banks towards the society.

To determine the bank’s strategies and practices directly effecting the relative source.

To aware the society about bank’s objectives and policies.

To present the models of quantification and proper presentation expenses of a bank.

But broadly objectives of social responsibility accounting can be classified into two classes: (a) Social contract, (b) objective based on quality of life.

(a) Objective based on social contract: The corporate social responsibility accounting which is mainly based on the argument of social contract, the main objects of social reporting are as under:

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- To specify and measure the periodic net social contribution of individual business enterprise towards the society.

- To help and assist in ascertaining whether public enterprises are consistent with widely shared social priorities or not.

- To make available relevant information about firm’s goals, policies, programmes and contributions towards social goals.

Economic indicators or financial reports report only on the economic health of the nation, i.e., whether nation is economically sound or not, in terms of national income or GNP etc. But social reporting indicates towards the social health of nation, etc., what are the effects of economic activities on the society, whether it is in welfare of the society. Social scientists are also doing their best to explore new techniques and measures for social reporting to know the real social contribution of various business units operating within the society.

(b) Objective based on quality of life: under the approach, corporate social responsibility has been related with the quality of life. It quality of life or standard of living is increasing, and then banks are performing their social responsibilities properly. In banks management the social cost of economic development is increasing day-by-day, affecting the various aspects of quality of life.

It is also very well known fact that if a bank does not perform its social responsibilities its activities have negative impact on the society. Hence, society also reacts negatively to the negative approach of the banks and ultimately banks have to lose its existence in the market or in an economy. Negative approach creates uncertainty towards the role of banks in the society.

Therefore, bank management should be very much careful towards the social responsibility and should recognize the reality and sharp reactions of the society. There should be proper co-operation and co- ordination between bank management and society. Bank management should provide relevant information to outsiders or its users with regard to the discharge of their social responsibility.

The primary objective of accounting is to provide true and fair financial information useful to investors, creditors, and public for making economic decisions. In the same way the social accounting aims to measure and evaluate the social cost within a firm in order to determine the business results in a more

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relevant and exhaustive fashion and benefits offered to the employees and to the society. The crucial objectives of accounting of social information are as follows:

(a) Positive image motive: in order to the purpose of creating positive image, several firms report social information. The management would not like to be perceived as a destroyer of the social environmentand non-contribute onto social activities. The management of the enterprise would like the consumers and society to perceive the firm as a responsible citizen. Always it tries to concentrate to report the social information on all their activities which contribute the welfare of the society.

(b) Meeting the information needs: with the increasing social awareness, several public interest groups are closely watching the activities of banks. Consumers are concentrating about the quality of the products and services. In these situations, it is the primary responsibility of the banks to provide social activity information to the interested parties.

(c) Meeting the disclosure requirements: in several countries like Germany, Britain, France, the Netherlands and the USA are strictly following the social accounting concept as mandatory requirements. In India a handful of organizations are following the social accounting concept. In our country there is no legal obligation to provide information on social costs and social benefits in their annual financial statements. But banks are now starts disclosing the social responsibility accounting information in many fields like healthcare, education, staff welfare, social and community welfare, loans and advances and many other social care programmes.

Scope of Social Responsibility Accounting

Organization has to perform various responsibilities towards the society. Scope means various responsibilities areas of business because it is not possible for a business unit to perform each and every type of social activities required by community at a large or by society. So it is necessary that various social responsible areas should be defined. Generally social responsibility expressed in terms of charity, donations, and community welfare. But charity is not the real social responsibility because charity is exercised only for a tax evasion. It is only a device to be saved from tax payments.

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Scope of social reporting depends upon the identification of the dimension of social responsibilities of organization. Social responsibilities can be discharge either legally, politically or voluntarily. If the organization follows all the rules and regulations enacted by the respective government then it is discharging it social responsibility legally. Similarly, when an organization discharges its social responsibilities in accordance with the prevailing political systems and should not do anything in against of political system or should not do anything which creates political instability in a country, it is discharging its social responsibility politically. When organization discharges various social responsibilities due to moral ground then it discharges its social responsibility voluntarily.

Goyder and Singhania have classified the various business activities in two groups:

Primary activities

Secondary activities

The primary activity of a socially responsible enterprise is to earn a reasonable amount of profit to have its commercial viability in the market and also for the interest of the various shareholders, employees and workers. It has been said that profit is not only the primary activity, but it also comes under secondary activities, because without becoming financially sound an enterprise cannot discharge its social responsibility. As Goyder says “A reasonable level of profit is not only for its primary objectives but also necessary for the discharge of social obligations and responsibility. He described these objectives as secondary one like, to enhance labour welfare, to enhance costumer’s services and goodwill, to help in developing and promoting the activities in the locality, to help in developing industry of which the firm is member and to contribute to national goals.” 17

So according to this view, profit is not only economic phenomenon but it is also a social phenomenon and serves the society. Profit is very much necessary to discharge various social responsibilities. If a concern is earning huge amount of profit it means that shareholders are getting much dividend, employees and workers are also getting sufficient remuneration for their labour and efforts and consumers are getting the goods and services at a reasonable price and also standard quality products and services. So profit and social responsibility must go together on the principle that higher the profit, higher the social responsibility or vice-versa. Mr. Khandelwal has classified various social activities into two groups- purely social activities legal social activities. Purely social activities consist of philanthropy services, community education and health services etc.

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legal social activities include air and water pollution control, labour safety and insurance of labour. 18

According to this classification, purely social activities mean the activities which are not legally required. It depends on the enterprise whether to perform or not. It comes under moral responsibility of the concern and there is no legal binding. On the contrary legal social activities mean that these activities are legally bound and should be performed to fulfill legal formalities.

Brumet 19 also discussed about the social responsibilities areas and he has classified five distinct areas of social reporting. These areas are:

i. Net Income Contribution, ii. Human Resource Contribution,

iii. Public Contribution, iv. Environment Contribution v. Product or Service Contribution.

i. Net Income Contribution

The growing attention towards social objectives is not reducing the importance of income objective. There is no denying of profit seeking as the fundamental objective of a business enterprise. A corporate enterprise must earn enough costs of its survival. To discharge various social responsibilities, it is necessary that the business unit should earn maximum possible profit. A business unit cannot survive without having adequate return on capital employed. It is also true that shareholders invest their capital in the shares, in this expectation that they will earn profit regularly and they will also earn capital gain from the appreciation of share values.

So, social responsibility cannot be fulfilled without having adequate income or profit. Similarly, investors rank these business enterprises the best in terms of both risk and price-earning ratio, which are discharging its social responsibility regularly. Poor profit earning means concerns failure to recognize social problems like employee’s problem, i.e., employee’s health. For example, excessive working hours under bad working conditions may have an adverse affect on the employee’s health which may lead to production of poor quality goods and services. Consequently, these poor quality goods are found to be unsold in the market and results in less profit.

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ii Human Resource Contribution

It reflects the effect of organization activities on the human resource of the organization. Organization have many activities as: recruitment policies and practices, selection, induction, placement, training and development, experience building, job enrichment, wage and salary, trade union relations, employees attitude, performance appraisal, congruence of organizational and individual goals, job safety, mutual trust and confidence- building, motivational programmes , transfer and promotion etc. proper and adequate attention should be given to all these activities for the well being of human resource of that business organization. Human resource accounting practices should be adopted in this regard, which tries to measure the contribution of human resource in terms of money.

iii Public Contribution

This area considers the effect of organizational activities on individuals generally outside the organization. Public contribution means the business enterprise contribution towards the general public who live in the society. This area is concerned with the impact of organizational activities on the individuals or the group of individuals outside the company like debenture holders, creditors, debtors, consumers etc., very much interested in company’s activities. It deals generally with general philanthrophy, public transportation services, public health services, urban housing, equal employment opportunity, training and development of handicapped persons, payment of tax to government, community problems solutions etc. The creation of jobs and the provision of employment are important public contributions. As well as the development of local services which offer companies corporate expansion in the community.

iv Environmental Contribution

This area relates to the measurement of effect of corporate activities on the ecological balance. Environmental contribution means a business enterprise’s efforts to maintain and improve the physical resource of the country. Under this area reporting has to be done in respect of pollution control as air pollution, water pollution, noise pollution, due to activities of business enterprises. Generally industrial production and manufacturing process causes pollution which leads to environmental degradation. So care and attention should be taken on pollution control by industrial processes, research and development activities should be encouraged to explore the method of production which may reduce

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environmental hazards. Proper attention should be taken for energy conservation, raw material conservations and its recycling and business activities should support the public and private actions designed to protect the environment.

v Product Or Service Contribution

This area is concerned with the qualitative aspect of products or services, being produced by business enterprises. The qualitative aspects of product or service means product utility, durability of product produce safety, service ability as well as the welfare role of the product or service. It also includes customer’s satisfaction, honest exposure in advertising, completeness and clarity of labeling and packaging provisions responding to consumer’s complaints etc.

Social accounting is concerned only with the quantitative aspects of social responsibilities and not with the qualitative aspects of social responsibilities. Quantitative aspects mean how much a business enterprise is incurring on various social overheads or what percentage of profit is being incurred on the social overheads. But up to what extent various concerned parties are being benefited by these social expenses, is not concerned with the social reporting. So social reporting gives only accounting report of social responsibility and it ignores qualitative aspects. So it can be said that business enterprise should discharge its social responsibilities towards the following:

a. The society,b. The government,c. The employees, andd. The customers.

a. It is the society which gives recognition to various business enterprises. Business cannot escape from the society and society cannot exist without the business. So it is the first and foremost duty of business to discharge its responsibilities towards the society. The respective areas towards which business should discharges its responsibilities are – pollution control air, water, and environmental pollution, public health, public transportation, community development, educational facilities, industrial development, energy conservation, raw material conservation, employment of minority community, employment of women, equal job opportunity, job to physically handicapped persons, to help the victims of natural calamities like earthquake, floods, etc. or manmade calamities like riots, explosion etc., family planning programmes, uplift of rural areas, literacy programmes, public hospitals etc.

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b. Each and every business enterprise works and functions under definite rules and regulations enacted by the law of that country. These variousrules and regulations are framed by the responsible government of an economy to have proper administrative control over the various business units operating in that economy. The government is an authority to save the society from being exploited. The government is also a party, badly engaged in the various activities of business enterprises. Business enterprises are required to discharge their responsibilities towards the government by paying taxes imposed on them, by obeying the various rules and regulations and by fulfilling various legal formalities.

c. Employees are the human resource of a business organization that render their services and spend time for the functioning of that organization. The business enterprise is ought to discharge various responsibilities towards its employees who are workers during working period and the member of the society after the working hours. Except salary and wages, the workers or the human resource also expect some more facilities like medical, canteen, housing, entertainment, transportation, training, educational facilities and healthy relations. The business enterprise should fulfill all these obligations and it should adopt human resource accounting.

d. Success of a business enterprise depends on the availability of customers who purchase the goods and service produced/provided by it. So business enterprise should be very much careful in fulfilling its responsibilities towards the customers. It is the customer who creates demand for the product in the market. The customer always wants to maximize his satisfaction. He can get maximum satisfaction only when he gets high quality goods and services at cheaper price. The product should not be harmful to them and they should not be exploited by the business enterprise. Business enterprise should provide high quality of product or standard products at reasonable and cheaper price which should be equal to their satisfaction.

An enterprise should incur research and development expenses to find out the changing moods and fashion of the customers and also to explore new methods and technique to reduce cost of production, so that goods and services produced can be sold at cheaper and reasonable prices.

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Responsibility of an Organization Towards Society

Business as it created by society anticipating would aid society. Society expects a lot of responsibilities and obligations although profit earning is essential for the survival of entity. It would spend certain amount of its earnings for the betterment of society and community. Responsibility of an organization towards society is as following chart:

Stakeholders Responsibility of business

A) Equityshareholders

(owners)

B) Employees:

1) air and adequate rate of return

2) Steady capital appreciation to the

shareholders for their investment.

3) Regular & up to date information about

working of a company.

4) Maximum disclosure about progress and

achievement of the company.

5) It must ensure planned growth, solvency and

optimum utilization of resources.

1) Higher wages

2) Security of jobs

3) Full employment

4) Better working conditions

5) Opportunities for self development and

promotion.

6) Social security

7) Welfare

8) Grievance settlement process

9) Sharing of excess profit.

10) Job satisfaction

11) Health & trade union practices

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C) Consumers

D) Community

E) Suppliers

1) Quality goods and services at reasonable

prices.

2) Regular supply of high quality products and

services to customers.

3) Manager must meet the need of the

consumers of different classes, tastes and

with different Purchasing power at the right

time, place, price and in right quantity.

4) Business has to protect consumers invest at

any cost.

5) Honest advertisement.

6) Right weight of goods.

7) Business must handle the complaints of

consumers more carefully and efficiently.

1) Respect to human right.

2) Promote human development through

harmonious relations between business and

other segments of society.

3) Schools and colleges.

4) Free hospitals and medical facilities.

5) Social integration.

6) Protection of local culture.

7) Charitable donation

1) Fairness and truthfulness in all activities

including pricing licensing to sell and right

to sell.

2) Ensure business activities are free from

litigations.

3) Develop long term stability in the suppliers

relationship.

4) Pay suppliers on the time their dues.

5) Supply information on reasonable time.

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F) Investors 1) Disclosure of all information about the

affairs of the company.

2) Conservation of assets by the way of

protection.

3) Respect investor’s request, suggestions etc.

4) Timely payment of all dues of investors.

5) Apply professional management to

maximize efficiency.

G) Competitors

H) Nations

1) Foster and develop open market for free trade

and investment.

2) Promote healthy competitive behavior.

3) Respect tangible and intellectual property

rights.

4) Foster ethical means and methods in business.

5) Maintain healthy competition.

1) Use property the national scare resource.

2) Abet pollution.

3) Proper assessment and right payment of taxes.

4) Pay tax on time.

5) Abiding the laws and respecting the acts.

6) Environmental protection

7) Respect to community and citizens of the

country.

Conclusion

A business enterprise is a social unit. It uses the society resources and produced goods and services for which the society is the ultimate consumer. The society provides the infrastructure and the facilities without which a business unit cannot function at all. Thus a business enterprise owes its very existence and survival to the society. It is therefore necessary that a business unit should operate within the

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overall parameters determined by the society. The main emphasis for evaluation of a business unit is profitability. The social aspect has so far been ignored. Business today cannot strictly adhere to only one objective of maximizing profit. The public opinion is now critical of the traditional emphasis of business on making profit.

Society is aware that business must be carried on not only for its own sake but also without prejudicing public interest. Business should strive to secure the interest of society by available quality and harmless products keeping the environment free of pollution by recycling waste and making proper arrangements for proper disposal of waste. It should also provide welfare and security to its employees. Business must not only report to its shareholders but also to the society as to the steps it has taken in terms of its obligation to the community at large. This extension to the traditional accounting responsibility towards society is variously called as social responsibility accounting, social audit, socio-economic accounting, report on corporate social policies, social information system, social reporting and so on.

……………………………………………………………………………………

References

1. Chamber’s Accounting Evaluation and Economic Behaviour, Prentice Hall, 1966.

2. Gandhi, S.K., The Management Accountant, May 1995, p.35, ICWAI.

3. Singh, Gurjeet, “Social Accounting in India and Abroad, A comparative study,” Indian Journal of Commerce, December 1989, p.48.

4. Jawahar Lal, Contemporary Accounting Issues, Vision Book Pvt. Ltd., 1988, p.245.

5. American Institute of Certified Public Accountants, Objectives of Financial Statements, AICPA, October 1973, p.155.

6. National Accounting Association committee, Report on Accounting for Corporate Social Performance, part-I, 1976, p.2.

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7. Mobley Sybil, “Challenges of Socio-Economic Accounting, “Accounting Review, October 1970, p.762-68.

8. Eates Ralph, Corporate Social Accounting, John Willey and Sons, New York, 1973.

9. Abrol, P.N., dictionary of Accounting, Anmol Publication, 1993, p.231.

10. Ramnathan, K.V., “Towards a Theory of Corporate Social Accounting,” Accounting Review, July 1976, p. 528.

11. Perry F.E., Dictionary of Banking, M.C. Donald and Evance, Great Britain, 1989, p.300.

12. Johnson, H.C., “Disclosure of Corporate Social Performance,” 1975, Accounting Review, Supplement to volume XIXI, 1976, p.38-39.

13. Dr. Sawalia Bihari Verma, “Social Accounting Practices in Public Undertakings in India,” The management Accountant, ICWAI, Calcutta, June 1997, p.445.

14. Ibid.

15. Dopuch. H, The Accountung Riview, January 1980, p.1-21.

16. Ramnathan, K.V., “Towards a Theory of Corporate Social Accounting,” Accounting Review, July 1976, p.516-28.

17. Cited in F. Chenunilal, Business Environment, Himalya Publishing House, Mumbai, 1986, p.16 and 41-45.

18. Kandelwal, N.M., “Social Audit – A New Challenge to Accounting Profession,” the Chartered Accountant, Vol. XXV, No.8, February 1977, p.524.

19. Brummet, L.R., “Total Performance Management,” Management Accounting, November 1973.

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AUDITING (PART-4) (UNIT-1)

MEANING AND OBJECTIVE OF AUDITING (PART–1)

1. INTRODUCTION

Dear students I welcome you on the lecture series of auditing under

auditing we should start up with unit one and we will discuss in detail

about the subject. It’s the introductory part of auditing where we are

going to learn its meaning and the objective of auditing. So our

primary objective to learn from today’s lecture is to appreciate the

meaning of auditing that means what do we mean by auditing, why

there is the need doing the auditing, what does auditing tells us.

Secondly understanding the functional classification of auditor, Auditor

is a person a we know who is conducting the audit so as we will

advance in our lecture we will learn about auditor and how auditor is

being classified.

Thirdly we are going to do the appreciation our understanding of

essential qualities of auditors that means what are the essential

features or qualities which are being required for a auditor to conduct

the audit in an appropriate manner then we will learn the objective of

audit in the light SA’s being issued from time to time. The revise SA’s

in relation to objective audit is to be understood in our lecture. So first

of all we will start up our lecture with meaning of auditing.

2. MEANING OF AUDITING

According to the general guidelines on internal auditing issued by ICAI

i.e. Institute of Chartered Accountant of India, auditing is defined as a

systematic and independent examination of data, statements, records,

operations and performances, financial or otherwise of an enterprises

were stated purpose. Now net us highlights certain important terms

which are been used in the definition. First of all it’s a systematic and

independent examination, when we say it’s a systematic it means that

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certain procedures and plans are being executed so when we conduct

an audit there should be a audit plan, there should be a certain

specific procedure to be followed for conducting the audit. It should

be independent that means auditor should give its opinion or express

its opinion on a very clear manner, it should not be biased, it should

not be effected by the person on behalf whom the audit is been

conducted.

Now what we are going to examine under audit, we are going to

examine the data or statements or records that means the financial

statements are being recorded and various evidences that is audit

evidences are to be examined to be gathered there should be

sufficient and appropriate so that the auditor can express its opinion

on the financial statements of an enterprise. Now again we are going

to examine the operations and performances when we examine

operations we will also look into the internal controls which are going

installed in a operating system of any enterprise. So in all it’s a big

exercise to be conducted so that the auditor can express his opinion on

the financial statement of an enterprise where a true and fair view of

an business activities can be analysed now why auditor is required to

express his opinion on the financial statements because financial

statements is a data which is going to impact the decision of the user

of those information.

Now let us understand certain essentials of audit. The first one is

auditing is an independent examination of financial information of an

entity that means it should not be biased it should move by any

specific purpose so that we can understand that the financial

statements of an organization are depicting a fair view. Now such

auditing is to be conducted for an entity whether it is for profit or not.

So second essential is whether is profit oriented or not audit has to be

conducted for that enterprise and irrespective size of legal form.

When we says that irrespective of the size of the organization on legal

form it means that whether it’s a sole proprietor or a company or a

partnership if its meeting up the requirement which is being given

under the statute it is required to carry out the audit.

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Fourthly when such an examination is conducted with a view to

expressing an opinion there on which we have already discussed. Again

the fifth point is same systematic and independent examination which

is being carried out with the specific procedures to be followed there

should be proper documentation of what we are doing under audit it

does not confined to financial aspect only because we say that it’s a

examination not only of data statements but operations and

performances. So what happens that rather than restricting ourself to

the financial aspect we need to look into the internal controls also so

both substantive and the compliance test are to be carried by a

auditor.

Now who is auditor? A question comes to us. The person conducting

audit is known as auditor. He makes a report to the person appointing

him after due examination of accounting records and the accounting

statements in the form of an opinion. His duty is to express his opinion

as to whether financial statements reflect true and fair view so as to

influence the opinion of interested group of persons. So here again we

can conclude that the person who is a auditor that means who is

conducting the audit has to do such careful examination of the records

of the enterprises and he is being appointed either by the authorities

concerned or the enterprise itself. so depending on the functional

aspect for which a auditor is being appointed he has to carry out his

audits and the main premises of conducting an audit when auditor is

that he has to express his opinion.

3. FUNCTIONAL CLASSIFICATION OF AUDITOR

Now let us understand how the functional classification of auditor is

being done so there are two types of auditor’s external auditor and

internal auditor. Now let us understand who shall be external auditor

and who shall be internal auditor. So what we are going to do is that

we will find out certain basis of differences so that we can understand

the difference between the two. We have prepared a table where we

can understand the point of differences between the functional aspect

of internal auditor and external auditor.

First of all meaning of internal auditor and external auditor is to be

understood. Internal auditor is internal to the organization that means

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he is the part of the organization while external auditor is external to

the organization. That means he is an outsider being appointed to

carry out certain audit function. Now what’s the status internal auditor

is considered as an employee of the enterprise while the external

auditor is wholly independent of the enterprise audited not an

employee that means when we say that a person is internal auditor he

has to work with the enterprise and his roles are altogether different

form the external auditor. To understand external auditor more clearly

we can say that being appointed is considered to be an external

auditor because he is a independent person being appointed by the

company to carry out the statutory audit so that he can express his

opinion in regard to the taxation provision or any other legal provision

and expresses opinion as to the compliance to the certain important

aspect and he also express his opinion as to the truth and fairness of

the financial statements.

Now what’s the scope of the work? Internal auditors scope of work is

determined by management while the scope of work of external

auditor is being determine by statute that means legal aspect has to be

considered. The law going to take care of these scope of work of

external auditor so wherever there is legal requirement or legal

provisions external auditor has to be abide by the legal requirement to

conduct the audit of the enterprise.

Now what’s the approach of internal auditor and that of the external

auditor? When we talk about the internal auditor his main concern is to

ensure the compliance with the policies, procedures, rules of

enterprises. Then he has to also take care of legal and govt.

regulations that means from time to time the legal requirement of an

enterprise has to be complied with so it’s the responsibility of internal

auditor to ensure that legal compliances are being done.

Thirdly generally accepting accounting principles have to be taken care

by the internal auditor when there is a finalization of the financial

statement of enterprise. Now when we come to external auditor his

main concern is to collect, adequate and reliable evidence to support

his opinion regarding truth and fairness of financial statement. So he is

not going to look into the legal and govt. regulations i.e. day to day or

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the regular compliance is to be carried out by the internal auditor

while such compliances are being carried out or not it’s the concern of

external auditor to collect such data’s for example there is a

requirement to collet TDS to deposit TDS all time so the requirement

of doing the compliance is to be carried out by internal auditor while

the external auditor will look after the compliance being carried out or

not is there required evidences that means is there proper filing up

there returns, proper records are being maintain by the enterprise or

not such work is to be carried out by external auditor so approach of

both auditors are quite different.

Now the next one is appointment. Internal auditor is being appointed

directly by management or the person directly responsible to the

management that means board of directors or the directors or

management can appoint an internal auditor while the external auditor

is appointed by the owners or the person directly responsible to the

owners.

4. QUALITIES OF AUDITOR

Now let us understand other important feature of auditing i.e.

qualities of auditors. What should be the qualities of auditor when he

conducts the audit so these are the general qualities and not the

person specific every auditor should have these peculiar characteristics

of qualities so that he can be independent integrated and skilful and

competent auditor.

So first is independence, when we shay independence it means that he

should not be biased by any opinion he should be straight forward in

his approach and should take care of the legal compliance.

Objectivity: - objectivity means that he should be very particular as to

what is right and what is wrong and should rationally give his opinion

on the financial statements of an enterprise. Integrity means honesty

and straight forwardness and sincerity means professional approach.

He should be cautious that means any changes or amendments which

are being carried out he should be very much aware about it he should

be cautious about the compliance procedures to be conducted, clear

headedness that means there should not be any scope of ambiguity

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professional approach as well his hope of work. The person who is

conduction the audit should be very clear about the scope of this audit

and he should be independent in his approach.

Reliability: - when we say that a specific quality of auditor is that he

should be reliable that means he should not be dishonest or he should

not give the confidential information to any other person unless

required by any legal authority or any such person for whom it is

responsibility for the auditor to given him such information.

Next one is having thorough knowledge of general principles of law,

ignorance of law is not a excuse that means a auditor should be well

equipped and well versed with all the legal compliances and he should

apply the legal requirement as an when required. He should hold a

position of trust that means neither the property of the enterprise

should be misused by the auditor nor any important information or

confidential data is being leaked by him.

Alertness of mind that means he should be aware about the various

environmental changes whether such changes are external or internal

to the enterprise concerned. He should be expert; expert here means

again that professional knowledge and up gradation of the latest

changes should be very much with him.

Skill and competence, when we say that skill and competence he

should have adequate skill, he should have adequate qualification as to

be an auditor and with his competence he should carry out the audit

on time and his professionalism and governance aspect should be very

high. Confidentiality we have already discussed and knowledge of the

business & industry should be there because the person who is

conducting the audit of an enterprise he should be very much clear

about the trends, about the knowledge of the business for which he is

conducting the audit. For example there is a handicraft industry for

which a auditor is being appointed so he should have the knowledge of

the entire handicraft business turnover the exporting whole

procedure, what are the requirements for taking up the license, how

the foreign exchange is going to be converted what are the FEMA

provisions which are being governed or which are being attracted

under the such industry so these are the things which a auditor should

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have in mind when he conducts an audit he should be analytical and

patient in doing the audit.

Now let us understand the objective of conducting an audit or we can

say that they are the objective of auditing so as per SA 200 which is

revised one basic principle governing and audit it’s the nomenclature

of SA 200 basic principles governing an audit which is now read as

overall objective of the independent auditor and conduct of audit in

accordance with standard of audit. This is the heading under which

objective of auditor is being defined. Here we say that objective of

auditor is to obtain reasonable assurance whether the financial

statement as a whole are free from material misstatement and to

report on the financial statements as communicates as required by SA

in accordance with auditor finding.

5. OBJECTIVE OF AUDITING & ERRORS OF AUDITOR

Now again when we talk about objective of auditing there are two

objectives one is the primary another is the subsidiary or secondary

objective. Primary objective is again the same expressing opinion such

opinion should be on the truth and fairness of the financial statement

of the enterprise while the subsidiary is that detection of errors and

frauds and making recommendation to prevent them. So here we can

say that primary objective of auditor is not to detect errors in the

financial statement his primary objective is to express the opinion as

to truth and fairness, however while conducting an audit they can be

detection of errors and he can suggests or prevent such sort of errors

and recommend the preventive aspect to the management.

Now what sort of errors are there when an audit is being conducted so

auditor come across various errors now let us understand what are

these errors. The term error refers to an unintentional misstatement in

the financial statement by way of clerical mistake on record or

misinterpretation of facts or stake in application of accounting

principles so what happens that when accounting data’s are being

recorded there can be clerical mistakes in recording the transaction,

there can misinterpretation of facts, misinterpretation of facts means

that if there was certain goods in transit and we considered as goods

and there is not proper interpretation of the fact whether the sale has

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taken place or not. Such sort of errors are known as misinterpretation

of facts. Mistakes in application of accounting principle there are

certain accounting principles which we need to abide by so while

applying such accounting principle if there is a mistakes, such mistakes

are also known as errors and they are unintentional nobody is going to

intentionally make such errors they are inherent in the nature of audit

to some extent they can be avoided also.

Now let us understand the types of errors first one is error of omission,

the word omission in its little term is that we have forgotten or

omitted to do something where certain accounting aspect is not at all

been recorded or partially recorded it is known error or omission. Now

error of commission is the second types of error, commission means to

do where certain thing is being done in a wrong way, a wrong entry

can be passed or wrong posting can be done so such errors are known

as errors of commission both errors of omission and commission can be

prevented by careful analysis of the data and there we can cross check

that the posting is not being done properly. Now error of duplication

that means two times entry is being passed so such errors can also be

prevented where control check sheets are being used.

Compensating error is the next sort of error by compensating error we

mean that one error has compensated the effect of other error. For

example a sales transaction is recorded by rupees hundred extra while

the purchase transaction is being recorded on a lower side by Rs 100 so

both on debit and credit side the similar sort of mistake has taken

place as to record transaction by Rs 100 on a lower side so both the

errors have compensated each other while there is no effect on the

final transaction however the transaction is being recorded incorrectly.

The next one is error of principle means that there is an importer

classification of the transaction which amounts to capital or revenue

that means capital expenditure is being recorded as revenue

expenditure or vice versa so wherever there is improper classification

between capital items and revenue items we consider them as error of

principle. So these sort of errors are coming across to an auditor when

he conducts the audit and his duty is to suggest the management to

prevent such sort of errors by guiding the proper methodology to find

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out such errors by careful analysis of the balance sheets and the

proper books of accounts as well as doing the analysis of subsidiary

books of account from where such entries is being posted and in a way

he can help to prevent the data entry errors.

Now next one is fraud: - it’s not that only errors will be there in the

financial statements sometimes there are chances of fraud so let us

understand what the difference between error and fraud. Fraud means

the intentional act while error was an unintentional act. So when there

is a intention act it amounts to fraud. Now what does it includes it is

wilful misrepresentation, wilful means willingly certain thing is being

misrepresented, second is the deliberate concealment of material

pact. There was a material transection but it has been concealed so

that its impact will not common the financial statement. For example

there is a certain expenditure or a big loss is being incurred on certain

items but it has been concealed so that profits could be reflected on a

higher side such concealment of material fact and that to deliberate

would amount to fraud on the part of the enterprise. C is failure to

disclose the material fact for the purpose of inducing another person

or putting him at a disadvantage. Here C point is different from B

because here another person is being put in disadvantages position by

cancelling the data;

Now another of fraud is misappropriation of cash, misappropriation of

cash means there is certain dis-calculation of cash or various certain

stealing in the cash let us understand what exactly misappropriation of

cash means it can take place in the following manner by acknowledging

less amount than actually received so what happens that such amount

which is being received certain part is being misappropriated and

lesser amount is being shown. By omission of receipt the receipt is not

being given and there is defalcation or misappropriation of cash by

inclusion fictitious payment that means if the payments are being not

made but they are being shown just in the form of a book entry so that

defalcation of the cash and misappropriation of cash can be covered up

such amounts to misappropriation of cash by recording more payments

then actual if we record more payments then actual what happens that

outflow would be reflect more while we can say that such amount is

being spended or expended and cash can be misappropriated. Now how

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to detected it by careful comparison of records in the cash book with

other subsidiary books and original vouchers.

6. SUMMARY

Now we are summing up our lecture of today certain other features in

relation to the fraud will be continued in our next lecture. In today’s

lecture we have learned about the meaning of auditing and objective

of auditor as well as the functional classification of auditor. With this

we are ending up our lecture of today.

Thank you

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CHAPTER - 711

SOCIAL AUDITING

This chapter attempts to pro ride an objective asse

ssment of the concept, significance, growth and status of

the social audit which is developed as the principal in

strument for evaluating corporate social performance. It

also identifies the various difficulties in making social

audit and suggests some principles to overcome than. The

maintenance of an effective social performance system

squarely depends upon the Social Assessment system of the

enterprise which integrates the processes of accounting,

midi ting and reporting of the social responsibility per

formance of the enterprise. It facilitates the building

up of a detailed and accurate account of information in a

classified manner, to test and prove its authenticity

through certification and helps report to various user

groups the relevant performance results in a concise, con

sistent and constructive manner. Thereby, it creates an

opportunity for a meaningful interaction among all the

members concerned with company and society, and furnishes

the basic foundation for sound planning.and execution of

the social responsibility.

CONCEPT OF SOCIAL AUDIT

There is considerable, agreement, at high level of

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abstraction, that the business social audit is a report of

social performance in contrast to the financial report which

is concerned with economic performance. But there ends the

consensus. In practice, however, the social audit has

created considerable confusion, causing one observer toodescribe it as "the-great-what-is-it."

Semantics trouble!

There are several titles employed in preference to

the tern ’Social Audit*, Among other terms, the widely

used ones are: 'Social Statement', 'Social Report', 'Business

Response to Social Priorities', 'Report on Corporate Social

Poli ci es and Action s', * So eio- economic Accoun ting', ’ So cial

Accounting', 'Social Responsibility Accounting', 'Social

Information System', 'Societal Accounting*, 'Socially Responsible Accounting* etc.^

To understand the nature of these terms, an examination

of the different view points is necessary. Robert K. Elliot

1 Steiner, George A.n Business and Society. (New York;Randam House, 1971)* p*19&.

2 Corson, John J#,'Nation's Business' 'Quoted in Halal, Willi an E., 'A Return-on-Resources Model of &>rporate Performance, California Management Review. Vol.XIX, No.4, 1977, P.2^.

3 Steiner, George A.,op.cit.« p.196., Blake, David. H.,Frj|der, William C., and Myers, S Mildred., Social Auditing. (New Yorks Praeger Publishers, 1976), p.3., Estes, Ralph, Corporate Social Accounting. (New Yorks John Wiley & Sons, 1976), p.3 and Report of the High Powered Expert Committee on Companies & MRTP Acts, Department of Company Affairs, Government of India, New Delhi, 1978, p.97.

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228

employs the term Social Responsibility Accounting. To him

it is a systematic assessment of and reporting on those

parts of a company* s acti-pities that have a social impact.

Social Responsibility Accounting would therefore, describe

*the impact of corporate decisions on environmental pollution,

the consumption of non-renewable resources and ecological

factors; on the rights of the individuals and groups; on

the maintenance of public service; on public safety; on health and education and many other such social concerns.*^

Ralph Estes prefers the use of Social Accounting and

defines it as: ’The measurement and reporting internal and

external, of information concerning the impact of an entity

and its activities on society,

Social Audit according to Sethi, is a means 'to

"breakdown all or large part of the broad term social respon

sibility of business, into indentifyable components and to develop scales that can measure these constituents.*^ (Hark C.

Abt opines: ’The mission of social audit is to provide more

objective, accurate and comprehensive information about an7performance that is usually compiled.'f

ELiot, Robert K,, Social Accounting and Corporate Decision making, Management Controls. January, 197?.

? Estes, Ralph, Qp.cit.. p.3,6 Sethi, S. Prakash, ’Corporate Social Audit: An Emerging

Trend in Measuring Corporate Social Performance’, in Votaw, Dow and Sethi, S.P., The Corporate Dilemma: Traditional Values 7s Contemporary Problems, (Ehglewood Cliffs N.J.: Prentice-Hall;, Inc., 1973, p.219.

7 Abt, dark C.,' The Social Audit for Management. (New York; A Division of American Management Association, 1977).

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229

Beesely and Evans writes 'But the tern Social Audit

has “been used rather more commonly, to denote any form of

retrospective review of the impact or contribution of the

company in recogiised social dimensions. (It is) a tool of

the socially responsible company, undertaken by itself or

admitted groups for the purpose of planning, control or accountability.*8

All these definitions give us to understand that the

controversy is limited to the use of the title. The purpose,

one way or other is to reveal in true and full perspective, .

with greater accuracy, the performance details of the company

in the areas of social responsibility.

Those who prefer the terras other than accounting

and auditing suggest that qualitative and descriptive ana

lysis is the only possible means for evaluation and reveal-

ation, as methods for quantification are yet to be deve

loped. George A. Steiner is prominent among those who be

lieve that the tern audit and accounting carry a connotation

of quantification and argues that the teim 'social audit

should not be used because measurement of performance does

not now and probably xcill never approach In accuracy and acceptability the accountant's audit of economic performance'.^

8 Beesley, Michael and Evans, Tom, Corporate Social Responsibility: A Reassessment. (London: Cromhelra Rtd.,1978),pp.167-168.

9 Steiner, George A., 'Making Social Responsibilities Operational in Business', in Steiner, George A (ed), The (Slanging Business Role in the Modem Society. (Los Angels: Graduate School of Management, UCLA, 197*0 , p.10p.

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230

The term Social Accounting has already gained peculiar con

notations in the International accounting terminology.

According to Kohler, ’ Social Accounting Is the application

of double entry book-keeping to socio-economic analysis of

national or international income, national sad internationalinbalance sheets and design for system of component accounts.

The term, Social auditing, has been treated as synonymous

with * Social Accounting*. The term 1 Socially Eesponsible

Accounting* may be interpreted as social responsibility of

Accounting profession, as the profession has developed its

own social norms. Taking into consideration the conceptual

frame work, scope and contents of social responsibility

Accounting, the terms Socio-economic accounting sejpns to11be more appropriate one. However, in business world, so

cial audit has become popular and it will be only wise to

stick to it by prefacing it with the word 'business’ to

avoid any confusion that is likely to arise.

G-BOVJTH OF SOCIAL AUDIT

The concept of the social audit for monitoring, measu-

, ring or appraising social performance is at least forty years

10 Kohler, A., ’Government Spending, its Tasks and Limits,» Social Research. YE, 1939.

11 Murao, Bahadur, 'Accounting of Social Responsibilities of Business’, The Management Accountant. Yol.-I^, No.1, January 1979, PP.9-13.

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231

old. The -use of this concept has evolved through three stages,

as detailed in Chart VII.. 1.

The first stage envisioned a governmental evalua

tion by. an outsider, and defined social performance largely

in economic terms. The second stage was the concept of theI

management evaluating itself aid the organisation* s social

performance. In the third and current stage, audits cover

a wider range of activities and serge multiple purposes,

such as satisfying the corporate conscience, improving so

cial programs, enhancing public relations and increasing12the credibility of the firm.

The development of Comprehensive form of social

audit is due to the following reasons.

1) Openness - Hall mark of civilisation:

Post-industrial society is come to be regarded as a

modem and civilised one aid organizations are viewed as

organic-innovistic - open-creative systems and not as the

mechanistic - rigid-closed-bureaucratic systems. The success

and progress of pluralistic organisations is dependent on

the ability of the organizations to communicate effectively

with other constituents in the society and function in a

12 Caroll, Archie B. and Beiler, George W., landmarks in the Evolution of the Social Audit* , Academy of Management Journal. Wo.18, September 1975, PP.589-5>99.

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232

Mea

sure

men

t of C

ompa

nies

' prog

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to

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d, so

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goal

s

The F

irm's e

valu

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riter

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Arch

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., 'Lan

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5* P.5

98.

www.examisthan.com

233

coordinated and purposeful manner. A systematic appraisal

and reporting therefore,. are indispensable to channalise

energies into new avenues of endeavour*

2) Gain -public approval and rapport;

Society has become less tolerant and more demanding.

In many a case* society views the process of performance

too slow, not because implementation is not carried but be

cause aspirations outrun the ability to perform,

nAt any given mom ait the public must have in mind some criteria, however imprecise, of what constitutes a satisfactory performance by business. The public keeps raising standards - as, in an achieving society, it should. Trouble develops because the public is not aware of how rapidly it raises its standards. Because it believes its standards are unchanging it tends to perceive business performance as moving backward."1^

’•Also, society appears to be changing the ’rules of the game* for business organisations. No longer

' will effectiveness be measured exclusively in terms of economic performance for example, there is growing interest in the development of national social indicators and a program of social system accounting, ”^

13 Ways, Max; , ’Business Needs Do a Better Job of Explaining Itself’, Fortune. September 1972, p.86.Bauer, Raymond A., Social Indicators. (Cambridge Mass:The MIT Press, 1966).

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234

It is evident that the expectation - performance gap,

if not convincingly explained to public, it causes a serious

damage to the standing and reputation of the socially res

ponsible enterprises.

3) Preserve autonomy:

If business remains unresponsive to the demands for

disclosure of information and tries to evade by making state

ments, advertisements etc;, in a flattering, flowery, and

descriptive language, the society forces upon the business

community by government the ’social reporting system’ in the

form of some what blunt, inflexible and mandatory regula-

tions. x On the other hand, if corporations take active

lead in the definition of this evolving pardign, they can

seize the opportunity to develop a system of accountability

which is best suited to .the needs of business and society

and thereby regain the public confidence which is essential

to the success of the free enterprise system. Of course, there

are many technical, social and political obstacles to the

development of a workable social reporting system, including

difficulties in method and measuranent of information, the

lack of various types of information, and problaas involving

in certification, dissemination and implementation of auditI

15 Hills, Roderick, 'Business Warned on Ethics’, Washington Post. February 19, 1976 and 'Wader Galls for Federal Charter of Business, Washington Post. January 25, 1976.

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235

results. Difficulties are nothing but natural to any system

particularly in its offing stage. As the system grows the

elemental parts, in the case, the social information system,

the social accounting systan, and social auditing system

leam through experience, ways to overcome than and become

capable of fulfilling the objective of providing fair and

true information to all stakeholders.

b) Systematised and sophisticated communicating tool:

Depending upon the degree of willingness of company

to communicate openly, the reporting methods vary from

flashy public relations brochures to detailed status re

ports. The recognised means are:

1. Publicising involvement in social affairsthrough news letters and other reporting

16means.2. Local meeting^ and3. Social report/audit.18

The publication of the company’s concern and involve

ment in the social areas help create awareness among the

public of the company's posture toward social responsibility

and build favourable image for it. It may be considered akin

16 Caro11, Barbara H., 'Firms Try to Grade Social Action Efforts' . Industry Week. May 20, 197^, pp.15-16,

17 Mukharji, P.B., Social Be soon sibili ties of Business. Report of the study Group of the Calcutta Seminar, (Hew Delhi: Oxford & IBS Co., 1969), PP.13-1^.

18 Bowen, H.R., Social Responsibilities of Businessman, (New York: Harper & Bros., 1953).

www.examisthan.com

236

to the Institutional advertising that highlights the Issues -

of concern to society and philosophy of company with regard

to it. It can not he a primary and exclusive communication

device. At hest it can act as a remainder or persuader to

keep public infoimed and seek their active support and

co-operation in making company effort more meaningful. .

The local meeting should be a regular annual feature

and open to representatives of the consumers, the workers,

the community and the shareholders and should be advertised

well in advance in the local press. Its object should be

to enable the directors and the management of the industry,

to give a fair report on

(a) general position of business

(b) prospects of expansion and growth

( c) €Bnployer-employee relations

(d) Consumer affiars

(e) Community improvement programs etc..

It can be very useful step, particularly in the early

stages, when the enterprise embarks on social responsibility

programs, What is however necessary is the avoidance of

wild and irresponsible criticism, and the mischief-maker s’

propensities, so current in a developing country like India,

to seise such an opportunity to create confusion and

pandemonium. The meeting therefore, should be confined to

the respectable and knowledgeable who can effectively grasp

comment and suggest measures.

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237

The lasts but more useful approach to reporting is

social audit. Though it is in embryonic stage at present,

it seems to grow in scope, sophistication of measurement

and frequency of use among business films,

Bauer and Fenn, the major proponents of using the

social audit for auditing internal decision making emphasise:

’the corporate social audit should permit firms to report

their performance on issues of current social concern with

the same regularity that they report financial performance*

SI mi FI CANGE OF SOCIAL AUDIT

The significance of social audit can be estimated

from the multiple purposes it serves in the organisation.

The number of purposes, Sir Geoffery Yickers suggests to

organisational communication are equally applicable to

social audit,

"One purpose is to convey information about what is happening both outside and inside the organisation; a. second purpose is to improving rules about, how various types of situations should be handled..,.,

A third purpose is to form aid render acceptable collective decisions... A fourth purpose is to move to action,,, A fifth purpose is to create, confirm ot modify the attitudes of individuals

19 Bauer, Raymond. A, and Fenn Jr., Dan. H., The Corporate Social Audit. (New York: Russel Sage Foundation, 1972).

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238

within the organisation itself, to each other to the work and so far as necessary to the outside wo rid*20

Ralph Sates gives the following classification of

the purposes of social audit#

A# Internal

1. Improve the decision-making process toys

a# Assisting in the process of establishing goals, objectives and priorities in planning, the use of monetary, physical and human resources#

b. Educating the motivating managers to think through the social consequences of all decisions#

2# Provide a basis for the continuing internal appraisal of social performance.

B. External1# Ultimately to provide consistent bases and

reasonable uniformity for companies to measure social performance and to report to the public,

2. Ultimately to provide a basis for independent attestation of corporate reports on social

91performance#1”

20 Vickers, Geoffery. * Communication in Economic System1 in Mo Rae, T*W#f (ed), Managaaent Information Systems. (Londons Penguin, 1071)> P*30#

21 Estes, Ralph, op.cit.. pi16. ^. * . . i- ■ l

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239

SCOPE illfD METHODS

The new dimîsions of social audit are not only

concerned with the foms and structures of accounts hut

are also largely influenced hy the changing ideology of

social and economic responsibilities in the gzmtiJig .

conciousness of the modern age, where new and perplexing

problem is that some one is using and controlling somebody 22else1 s money*. As such, the scope of social audit depsids

on many factors like public pressures, government direct

ions, managers' responsiveness, methodology for identifying

social concerns, sophistication of measures, the .develop

ment of acceptable format etc. More significantly, the

social audit at any point of time, reflects the state of

the arts and willingness of siterprise to disclose infor

mation to user groups.

If the social audit is to include all activities,

it embraces everything a corporation is doing or not doing.

If the social audit is to verify, the various costs entailed

and the benefits produced, it becomes an impossible task .

and the information which might be produced would likely to

be indigestible. On the other hand, if a social.audit

includes only a cataloguing of activities which top managers

are interested, in pursuing and/or those activities whichWM0HWMM*aiai

22 Mukharji, P.B*, op,cit.« p.4-3.

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240

might improve the public image of the company if publicised,

the principal function of social audit will not be performed.^

Because of the inchoate state of the social audit

various approaches to its interpretation and implementation

have been Iburishing, For instance, they may be,

superficially,, hastily conducted, one-time ’surveys’ of

company practices bearing upon one or more social issues,

internally generated so.cial reports prepared for public

relations purposes and often the poorly informed ’audits’

of various alleged corporate abuses conducted by outsider

groups utilising adverse publicity as primary techniques.okAn elaborate classification of the social audit

may. be as follows.

1. Nature j (i) ^Qualitative - Simplynarrative objective analysis with the help of qualitative social

. indicators.

(ii) Quantitative - descriptive in terms of quantifiable social economic terms. Objective description in

' ' terms of goals and resultsin quantified terms*

23 Steiner, George A., op.cit.. p.201.24- Blake, Frederick & Myers, op,cit., pp.2r53s>Estes,Ralph,

op.cit., p.2$, and Butcher, Bernard L.,' ’The program Management Approach to the Corporate SocialÂudit’, California Management Review. Fall 1973> pp. 11-16*

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241

2. Coverage ; (i) Partial - analysis of one ormore constitutonts.

(ii) Total - Analysis of whole enterprise*

3* Audience z (i) Useful for Company managers'

(ii) Useful for one or moreconstituents and management.

(iii) Useful to all.

4-. Source of data : (a) Micro-audit - if only companydata is employed.

(b) Micro-Macro audit - if company as well as the data at national level is employed.

5. Initiative s (i) Internal: Individually/Jointly-the company takes initiative and organises audit either individually or jointly with external agencies.

(ii) External: Individually/Jointly-outside organisations like the social organisation, Academic Institution or Governmental organisation may conduct the audit either with or without the involvement of the company.

Chart 1/11-2 provides at - a - glance understanding of

the various approaches to social audit in vogue;

www.examisthan.com

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243

'INVMTQBI' APPROACH/' CHECK-LIST* APPROACH involves

the cataloguing of what the company is doing in each major

social program or not doing in Social areas xdiere there is

social expectation that it should he active. Ibr each

identified area this approach calls for data and/or narrative

description of what, is or is not being done. The effort is

only to explain activities hut not to evaluate them in

terms of 'impacts'*

As it involves calculation of expenditures made

xdthout any concern for the impro van aits effected, it is

the simplest of all the methods. The major limitation of

this method, no matter how comprehensive, detailed and

elaborate it is, and no matter how many dimensions of it

are expressed in some matrix - is that there is no logical

way of determining whether or not there is any net social

benefit resulting from the company's social performance.

Pbr a firm to start with, this can be a useful one. It

serves a kind of 'consciousness raising' function for

executives who employ it, thus taiding to mobilize their

commitment to exploring more sophisticated and precise

measures. As one can make a long list of ' good* things the

company has done, a short list of the 'bad* things, and

make it look as if one has done more good than bad, it can

be at best a public relations device and certainly is no

great aid to management decisions in capital budgeting or

other resource allocation.

u

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244

A second one, ’INPUT ANALYSIS* APPBOACH which seeks

to identify and measure the expenditures -which have been

made for social programs and/or describes in qualitative

teims what has been done. The trouble is that expenditures

measure only the inputs to social activities and not the

outputs; there is no measure of efficiency or effectiveness.

And the mere fact that company is spending a lot on social

action program does not mean it is getting its money* s

-worth and that the -whole program is torthwhile. It is

therefore, a basic step toward evaluation and provides a

erode basis for budgeting: but offers no clues for optimising

investment.

The third one, ’PERFORMANCE GOALS* APPROACH is

concerned with setting up of goals in the diverse social

responsibility areas for aehievemmt by the company. It

encourages management by objectives and makes evaluation

easy as actual performance can be measured against' the goals

set. The limitation is the company cannot compare the social

worth of differait social projects as the goals are not

established on the basis of a Socio-economic cost-benefit

analysis.

This can be carried through valuation of human assets.

The audit is concerned with valuations of the productive

capabilities of company’s human organisation, the valuation

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245

of shareholder loyalty, hanker or community goodwill,

customer loyalty and so on. J

The impact of Social programs can he measured hy either opinion poll method or hy surrogates. Opinions ofindividuals about how they perceive the impact of social

!program on themselves can he a useful measure. An example is hlum’ s poll made to determine the extent to which a company was satisfying the basic human needs of its employees.2^

The other way of measuring impact is through use of surrogates. A surrogate is a substitute which is believed to approximate the underlying phenomenon. Employee satisfaction can he measures through absenteeism, labour turnover, output, etc.

The 'COST-BMEBTT ESTIMATE* METHOD is variously referred to as social process audit,^ program management

28 pqaudit, and Input-output matrix approach. y It is a

25 Likert, Rensis, Boumal, Villi am J., Likert, Rensis Wallich and McGown, John. J., A Hew Rationale for Corporate Social Policy. (New York; Committee for Economic Developm ont, 1971).

26 Blum, Fred, H., ’Social Audit of the Enterprise’, Harvard Business Review. Mar eh-April 1958, pp. 77-86.

27 Bauer, Raymond, A, and Fenn Jr*, Dan H,, loc.clt.28 Butcher, Bernard L., loc. cit.29 Elliot - Jones* M.F^’Matrix Methods in Corporate Social

Accounting - Some extensions of Input - Output Economics’ Presented at Seminar on Corporate Social Accounts,Battelle Seattle Research Centre, November 10-11, 1972.

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246

description and quantitative and nonquantitltive analysis

of a specific program activity, intended to provide manage

ment with systematically developed information for purposes

of review of program effectiveness in achieving the company's

stated goals. It deals not with the entire company and its

overall social performance, but only with clearly identifiable

and specific programs. It does not attempt to compare

program, performance in one area with program performance in

another area, although in course of time a sufficient base

for doing so might be built up within a given organisation.

This type of Social Audit has several advantages:

1. It minimises the problems of methodological difficulties and shortcomings that characteristically plague this new field of social measurement and evaluation.

2. It can be applied to any and all realms of organisational activity whether they are undertaken voluntarily or required by the government regulations, whether related

. positively or negatively modest in magnitude and expenditure, whether quantifiable or only partially so or not at all, and whether comprising an'adjunct, ’Social* program or consisting of a 'main stream* business operation.

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247

The obvious st^mgths of this method are of its

limitations as well:

1. The difficulty in setting goals, is the major limitation. Various pressures that operate on business may force management to establish objectives based upon short-run, so daily constructive, or self-serving considerations.If that has occured then a social process audit, will run risk of perpetuating organisational practices, attitudes, and policies, xdiich will be considered unwise and undesirable by some groups within the society.

2'. By focusing upon explicit, discreet programmes and activities, the social process audit does

■ not provide the organisation* s management with a comprehensive view of the. total range of social consequences that may result from company operations.

3. Because the standards developed are specific to a given social program or activities,there is no yard stick of social performance, no common denominator, comparable to that used in economic

• and financial performance to make inter program comparisons.

If companies are to continue to be brought before

the bar of Social judgement - and particularly if social

evaluation is to be based on social analysis rather than

pure emotion and bias - then this absence of tools for

comparison of inter-program effectiveness will have to be

remedied. Such a dilemma cannot be resolved by reliance

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upon the discreet, program-by-program analysis represented

by the Social process audit.

The * COMPREHENSIVE AUDIT* reflects the highest level

of sophistication in measurement at which the social

benefib^cost approach is integrated with financial accounts

and financial statements. It allows to make" direct trade

offs between Social and financial investment and social and.

financial returns and maximise both. It focuses attention

on »Consumers'. of Social activities - society as a whole,

a community, or groups and individuals etc., - with respect

to either their broad needs or specific needs. Measurement

may be in teims of values received or benefits related to .

costs incurred.

Most ambitious one is that of Abt. He lists In

financial terms, in a sort of modified and combined

balance sheet and income statement, social assets of a

company, social commitments, obligations and equity, and

social benefits and costs j-ni to staff, to the community

and to the general public and comes to a net social income

to clients. This method would be prohibitively expensive for a company of even moderate size.^

30 Blake, Frederick & Myers, op. cit.. p.20*31 Steiner, George A., op.cit.. pp.202-205.

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249

Linowes proposes a ’Socio-economic operating

statement’ which calculates in dollars, for a specific :

major program, the ’Social improvements’ and ’detriments’

that are involved. He •winds up, like Abt, with an aggregate

plus or minus for society. While simpler than Abt’s, Linowev'sop \

method is still complex for practical applications. \P

A Return-On-Resource (RQR) model, of the social audit,

enlarges the traditional concept of corporate accountability

into a matrix describing various aspects of corporate

perfoimance for various constituent groups. It provides a

structured system incorporating explicit social costs and

benefits, and helps to resolve the many problematic questions

concerning corporate' activities in the social sphere which

have here to forth been treated as externalities, excludedfrom the financial and economic system.33

/

Making Social Auditing Effective;

\;\i\\\

\

The development of social audit is by no means an

easy task.. As stated earlier social audit is not a mere

description of activities of an enterprise in the choicest

areas of social action but, ”a commitment to systematic

assessment of and reporting on some meaningful, definable

32 Ibid.. p.205.33 Halal, William E., op. cit,«, pp.23-2^-.

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250

okdomain of the company* s activities that have social impact”.

Among the foremost difficulties cited are *the problem of

developing acceptable measurements of social factors,

difficulty in obtaining cost ratios of some sort, a lack of

consensus regarding activities to evaluate and the absence

of agreed format to organise the information into useful^k

technique for corporate decision*

Difficulties:

. The various difficulties, an enterprise may face in

course of the development of a social audit, are outlined

here.

1. Conflict of Interests:

A firm is a hub of a complex social system

involving a variety of constituencies all of which are

essential to its operations. It has to reconcile

diverse interests of the various social groups to

form a workable coalition engaged in creating value

for distribution, among members of the coalition.

34 Bauer R.A. and Fenn Jr., D.H., *What is a Cbrporate Social Audit?*, Harvard Business Review. Vol,51, Ho.1, January-February 1973* p.38.

35 Corson, John, J. and Steiner, George, A., Measuring Business* Social Performance: The corporate SocialAudit. (Hew York: Committee for Economic Development. 1974-).'

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251

It is opined, therefore, that although measurement

problems are difficult, it is organisational politics ,

rather than technical difficulties that inhibit the

use of social audits. This v±e\i highlights the

fact that measurement or reVLexj carries emotional

and other overtones that intum affect the behaviour .

that is being measured*’,

2* Divergent Objectives:

Concerning with the objectives of the Social

audit there are differing view points. While some

consider that it is to be made for the use of

executives, others argue that it must be made to meet the information needs of the publics as well”.^

As corporate controllers are aware of, the composition

and structure of the two sets of information requirements

are far from identical and can be standardised within

a single system, only x-jith some gross adjustments.

3. Amorphous Objectives;

Effective social policy and performance require

continual adaptation to changing social needs and

opportunities for responses. This is the alleged

36 Myers, Mildred S,, <The.Hidden Politics of Social Auditing*, Business and Society Review. Autumn, 197^«

37 Anshen, Melvin. Managing the Socially Responsible Corporation. (Wex* York: Macmillan, 197^-)*

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252

•Moving target* nature! of social requirements. It is

argued that, what is social today being economic

tomorrow, there is a tendency to account for such

activities, in economic terms said a tendency not to

worry too much about separating socially related

actions from purely economic ones, since in all

probability they will.'either go away or blend into the economic mainstream of the firm'*.^8 It. is. why

many feel against the need for social accounting systan

to augment- the regular economic accounting system.

4. Management Apathy:

Many are of the strong opinion that social

• accounting cannot obtain the precision of financial

accounting. Daniel Gray of Arthur D. Little Inc.,

emphatically states* ‘traditional corporate accounting

owes its rigor to what it excludes. To try to

stretch it to measure all social costs and benefits is to violate its very foundation*.^ Yet another

point, that accounts for management apathy for

developing' social audit is the alleged small and ancillary

38 Churchill, Neil C., * Toward a Theory for Social Accounting*, sloan Management Review. 197!?, p.27.

39 Gray, Daniel, ‘Methodology: One Approach to the Corporate Social Audit*, in Sethi S.P. (ed).*, Unstable Ground: Corporate policy in a Dynamic Society. (Los Angels:Mel veil! Pub. Co., 197*f). :

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level of expenditure. Hell C. Churehill argues that

controllers or managers do not perceive the value of

having detailed information on such expenditures

because the potential, savings from more rational

allocations do not seem to warrant examining them in detail.^

5. Time. Expense and Skills:

The preparation of social audit is a time

consuming and expensive process. It takes an

interdisciplinary team to accomplish a social audit,

atieast a period of four months. It requires the

deployment of the combined skills of an economist,

an accountant, engineer, social scientist, besides

the coordinating skills of a-generalist corporate 1+1manager.

Because of the several practical difficulties

in making a social audit, many enterprises do not

consider it a worthwhile exercise* However, the

difficulties are not insuimountable. If proper steps

. are taken, the exercise will not only be constructive

but also be emulative to other enterprises. CertainN

basic principles which can be of help -to enterprises

intending to develop social audit, are summarised belovr

40 Churchill, Hail. C.. loc.cit.Vi Aht, dark G., oo.cit.. p.113.

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2 54

1. Principle of Assurance of Objectives:

The purpose of Social audit is to

systematise information relevant for making at

meaningful evaluation of enterprise performance,

from various stakeholders* point of view. It should

not become 'an avenue' to attach any particular

function of management, and fears that this might

happen, should be anticipated and allayed by making

it clear that the social audit is a management

infoxmation system designed primarily to improve

the efficiency of investment decisions at all

levels, in the organisation. In the absence of

such a clear statement of objectives, the social

audit will become the breeding ground for conflicts

and misunderstandings.

2. Principle of Employee Participations

Participation of managers at all levels .is

a key element in making any programme work. Company

wide participation in the decision to measure social

performances and in the definition of objectives and

gains to be achieved would certainly facilitate the proeessâaking an effective social audit greatly.

Probably, it is the most effective way of dealing

with the attitudinal and behavioural problems on

the part of middle-management.

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255

3. ‘ Principle of Social Area Selection;

Fbr effectiveness in their social pro grammes,

companies need identify and select high leverage

areas of social action.’ High leverage areas of social

action are those, over which company has a high degree

of control, those which hold high promises of being

socially productive and those activities that have

a high degree of potential for replication. Choices

as such enthuse the operating managers to participate

and contribute to the success of programme.

4. Principle of Effective Measures;

The purpose of measurements is to help the

user groups, appreciate the company effort, evaluate

and suggest improvements. As such, measures should

be developed in such a way that they serve the

intended purpose. To ensure that, it is to be checked,

■vdiether the measures so developed possess the

characteristics likes Simplicity, Objectivity,

- Reliability, Acceptability and Feasibility.

Principle of Research Utilisations

The tendency to 1 reinvent the wheel* in

developing measurements, without regard to what

others have already done, will lead to unnecessary

delay, dissatisfaction, and waste of resources.

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256

Just as prof esionally competent measursnents of

financial results use the latest accounting

methods micro economics and statistical sampling,

professionally competent measurements of social

performance should make use of the relevant methods

and findings from the social sciences such as

survey research, group psychology, and evaluation

of educational and health programmes impact.

6. Principle of Standards: ’

An issue of paramount importance is setting

up of company wide standards for uniformity of

practices and comparability of results. Standardisation

of measures of social performance is necessary to

compare on a fair basis the performance of one

division with that of other divisions and with its

own previous performance. In the absence of common

standards, inconsistent interdivisional standards

will be applied, which will destroy incentives to

good performance.

7. Principles of Appropriate Method; '

Methods of social audit are many and every

company has to make its own choice. Depending upon

the amounts committed to social programmes

undertaken, availability of financial resources and

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257

state of the arts in developing social audit,

a suitable method is to be chosen. If better

measures are not available, there is no way to go

but to prepare description scenarios of what

constitute acceptable performance.

8. Principle of Leadership:

The more effective the leadership is, the

greater will be the contribution of subordinates

to the predetermined goals. The leader of the

social audit team, should therefore, be a man

known for integrity and having high status,

preferably from within the company. Also, it is •

not advisable to select the head of public

relations as team leader. It will lead to serious

misunderstandings among public. If you buy public

relations, you get only public relations. Social

accounting and auditing are not public relations.

It is preferable to choose either Chief financial

officer or a senior manager, with vast

administrative experience.

9. Principle of Training Managers:

Except in those businesses that make

extensive use of social science for market and

opinion research for detailed behavioural and econometric

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258

studies, operating di-vision managers are unlikely

to have staffs who are well trained in both the

methods and the findings of .contemporary social

science. The problem can be solved by providing

brief training to managers to acquaint than with

the basic tools of social research necessary for

developing measurements.

10. Principle of Double Evaluation;

Internal social audits, -voluntarily undertaken

by management, tend to- be optimistic, quick,

efficient and comprehensive. However, the

reliability of these can also be questioned on thet

basis of self-serving bias. The external audits

are supposedly critical and unfavourable to company

as they tend to have negative bias. Thus, the

most comprehensive and precise social audit requires

both internal and external auditing - internal for-

comprehensiveness and external for reduction of\

bias. Much the same double approach has been found

effective in financial auditing and cost

effectiveness evaluations.

11. Principle of Balanced Reporting:

The issue of disclosure of audit findings

raises however, the very delicate and controversial

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259

question of - how far the social audits and

accounts should he open to public and of what

exactly are spheres aid areas in which the public

should reasonably taken into confidence. The

social audit has its utility as well as its dangers.

Its utility lies in accepting the social

responsibilities of modem business whereby members

share atleast some confidence with the public

which business serves. Its dangers are that a

wholesale disclosure may lead to irresponsible

criticism and trade handicaps of various kinds.

The enterprise has to take, therefore, the needs

of various user groups into account and develop a

need based report that may satisfy all groups.-

12. Principle of Continuing Developments

The more an enterprise is committed to social

responsibility, the more it requires its managers

to develop the methods and measures of social

auditing. The social audit should be conducted as

consistently as possible, from year to year. As

new, more comprehensive and sensitive measures of

social impact are added - and they should be added

as they become available - the required precision

and sophistication can be achieved.

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CONCLUSION

In the new setting of society, companies which

adhere to the traditional -views like profit-maximisation,

bureaucratic-mechanistic, and closed systems, private

entity, individual good is public good, and laissez-faire,

cannot succeed in their endeavours. They have to develop

a style of operating based on the views like quality of

life, organic-innovistic-humanisti c-open systems, public

good is individual good and government direction.

Business organisations have to shift their loyalty from the

owners or stockholders to society or stakeholders and

attempt to discover new methods, techniques and tools to

make their reporting practices more rational, realistic

and meaningful. It implies that social reporting is to

be developed into a science and art of disclosing in

qualitative as well as quantitative terms, both social

costs and social benefits, of actions as well as

non-actions of the company.

Though the development of comprehensive audits is

mostly desirable, due to the difficulties in measurement,

they are dubbed as abstract and complicated. Further the

high costs involved discourage many films from attempting

to make such type of audits, imong the described methods,

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social, process audit seems to have gained more popularity

iflith many companies in TJ.S.&, as its specific focus is

accounting of cost/benefits of social programmes only*

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Journal of Business Management & Social Sciences Research (JBM&SSR) ISSN No: 2319-5614 Volume 5, No.6, June 2016

© The Author © Blue Ocean Research Journals www.borjournals.com Open Access Journals Blue Ocean Research Journals 193

Budgets and Budgetary Control

Dr. Abhijit Pandit, Professor Genesis Institute of Management and Technology, Kolkata Abstract This study deals with budget, budgeting and budgetary control. Also pros and cons of budgetary control, steps of prepar-ing budget and finally different types of budgets are discussed.

Keywords: budget, budgetary control

Budget A budget is a formal expression of policies, plans, objec-tives and goals laid down for a definite period in the fu-ture. The budget expresses revenue goals in the sales budget and expense limitations in the expense budgets that must be attained in order to realize the desired profit objective. The Institute of Cost and Management Accountants, London, defines budgets as, "Financial and/or quantita-tive statements, prepared prior to a definite period of time, of the policy to be pursued during that period for the purpose of attaining a given objective." The basic elements of a budget are: a) It is a future plan of activity for a specified period of

time. b) It is expressed in physical or monetary units or in

both. c) It is prepared in advance, i.e., before the period dur-

ing which it is to operate. d) The objectives to be attained and the policy to be

pursued to achieve those objectives are required to be laid down before its preparation.

Budgetary Control Budgetary control involves the use of budgets and bud-getary reports throughout the period of budget to co-ordinate, evaluate and control day-to-day operations in accordance with the goals specified by the budget. Bud-getary control involves a constant checking and evalua-tion of actual results compared with the budgeted goals, which should result in corrective action where indicated. The Institute of Cost and Management Accountants, London, defines budgetary control as, "The establish-ment of budgets relating the responsibilities of execu-tives to the requirements of a policy, and the continuous comparison of actual with budgeted results, either to secure by individual action the objective of that policy or to provide a basis for its revision." The process of budgetary control involves the following steps:

a) Defining and specifying the objectives to be achieved by the business.

b) Preparing business plans in order to ensure that the desired objectives are accomplished.

c) Translating the plans into budgets, and relating the responsibilities of individual executives and manag-ers to particular sections of the budget.

d) Continuous comparison of actual results with the budget, and the calculation of differences between the budgeted and actual performance.

e) Investigating major differences in order to establish the causes.

f) Presentation of the information to management in a suitable form, relating the variances to individual re-sponsibility.

g) Corrective action by the management in order to avoid a repetition of any wastage or over-expenditure. Alternatively, where it is not possible to achieve the budgeted targets due to change in cir-cumstances, the revision of the budget.

Difference between Budget, Budgeting and Budgetary Control The difference between budget, budgeting and budgetary control may be stated thus — Budgets arc the individual objectives of a department, etc. whereas budgeting may be said to be the act of setting budgets. Budgetary con-trol embraces ail and includes the science of planning the budgets themselves and utilisation of such budgets as an overall management tool for the business planning and control. Thus, the term budgetary control is wider in meaning and it includes both budget and budgeting. Objectives of budgetary control are a) To Compel Planning. This is the most important

feature of budgetary control, because management is forced to look ahead, set targets, anticipate problems and give the organisation purpose and direction.

b) To communicate ideas and plans to everyone af-fected by them. It is necessary

c) To have a formal system to make sure that each per-son is aware of what he is supposed to be doing.

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d) To Co-ordinate the Activities of different depart-ments or sub-units of the organisation. This concept of co-ordination implies, for example, that the pur-chasing department should base its budget on pro-duction requirements, and that the production budg-et should in turn be based on sales expectations.

e) To Establish a System of Control by having a plan against which actual results can be progressively compared.

f) To Motivate Employees to improve their perfor-mance.

Requisites of an effective system of Budgeta-ry Control a) A clearly defined organisational structure, which

emphasizes areas of responsibility. b) Adequate accounting records and procedures, so that

measurement of performance may be relied on. c) Participation by individuals within the budgeting

process. d) Awareness by management of the uses of the budge-

tary control system. e) Awareness by the top management of the problems

of budgetary control, and especially of the reaction of individuals to budgets.

f) Flexibility, so that plans and objectives may be re-vised.

Advantages of Budgetary Control The advantages of a budgetary control system are as follows: a. It defines the objectives of the organisation as a

whole, and within this overall framework, it defines the results which each department should achieve.

b. It reveals the extent by which actual results have exceeded or fallen short of the budget.

c. It indicates, with variances or other measures of performance, the reasons why actual results differ from those budgeted, and establishes the magnitude of the differences.

d. As a result of reporting on actual performance along with variances and other performance measures, it provides a basis for guiding executive action to cor-rect adverse trends.

e. It provides a basis for the revision of the current budget, or for the preparation of future budgets.

f. It provides a system whereby the resources of the organisation are used in the most efficient way poss-ible.

g. It indicates the efficiency with which the various activities of the organisation have been co-ordinate.

h. It provides some centralizing control where activi-ties and responsibilities are decentralised.

i. Where the activities of an organisation are subject to seasonal variations, it provides a means of stabiliz-ing the organization’s activities.

j. It establishes a basis for internal audit by means of regular examination of departmental results.

k. It enables standard costs to be used. l. It provides a basis for measuring productive effi-

ciency with a view to paying a bonus to employees.

Limitations of Budgetary Control The principal limitations of budgetary control are: a. Estimates are used as a basis for the budget plan. b. A budgetary programme must be continually

adapted to fit changing circum- I stances. Normally it takes several years to attain a reasonably good budgetary I programme.

c. Execution of a budget plan does not occur automati-cally. All levels of the management must participate enthusiastically in the programme.

d. No budgetary control system will eliminate the ne-cessity of having a management and administration. It does not take the place of management, but is ra-ther a tool of the management.

Steps in Preparing a Budget Preparing a budget involves the following steps: a. Establish budget centres (for the purposes of budge-

tary control) b. Prepare a clearly defined organisational chart stating

the functional responsibilities of each member of the management team.

c. Prepare a budget manual (specifies in detail the pro-cedures to be followed)

d. Form a budget committee.(for co-ordinating and reviewing the budget programrne)

e. Determine the limiting or key factor f. Select the budget period. (period of time for which

the budget is prepared and employed) g. Set objectives to be reached by the end of the budget

period. h. Prepare forecasts for the period. i. Determine enterprise policies (e.g., product range,

normal hours of work per week, channels of distri-bution, stocks, research and development appropria-tion, investments).

j. Compute from the forecasts the requirements in terms of the economic quantities needed to meet the objectives while complying with the policies — and subsequently convert these quantities into monetary values. This results in an initial provisional budget.

k. Review this initial budget with respect to the planned objectives and amend objectives or policies or both repeatedly until an acceptable budget emerges.

l. Formally accept the budget which then becomes the master budget and as such is an executive order.

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Distinction between Forecast and Budget A forecast has been defined as the prediction of relevant future factors affecting an entity and its environment as a means to facilitate the preparation of planning decisions. A forecast is a prediction of what is likely to happen, whereas a budget is a plan of what organisation has set itself as a target for what should happen. A forecast is a judgment can be made by anybody, whereas a budget is an enterprise objective that may be made only by the authorized management. A forecast forms the basis for the budget. A budget statement of planned events gener-ally evolved from the forecast. The forecast of a function need not necessarily be well co-coordinated. Budgeting involves a good co-ordination and functions of an orga-nisation to attain the desired results. The forecasts may cover a period ranging from one to five years, or longer in the case of certain types of businesses. The budgets, however, are rarely projected for more than a year in advance, except in the case of capital expenditure budg-et, and often are projected for only three months. Bud-geting involves the control of variations from the ap-proved plan in order that the desired results may be achieved. Forecasting does not involve any such control. Types of budget Functional Budget A functional budget is a budget which relates to a major function of the business. The usual functional budgets are : a. Sales Budget : The budget shows sales in terms of

quantity and value, analysed by the product, by month, by region, by channel of distribution and by salesman.

b. Selling Expenses Budget : The budget inchnlcs salesmen's salaries, commission, expenses, and re-lated administrative costs.

c. Distribution Expenses Budget: The budget is made/up of transportation, freight charges, stock control, warehousing, wages, expenses, and/elated administrative costs.

d. Marketing Budget : Apart from details of all adver-tising, promotional activities, public relations, mar-keting research, customer service, and so forth, the marketing budget can also include a summary of the sales, selling expenses and distribution expenses budgets.

e. Research and Development Budget: The budget covers materials, equipment and supplies, salaries, expenses, and other costs relating to design, devel-opment and technical research projects.

f. Production Budget : The aim of the production func-tion is to supply finished goods of a specified quali-ty to meet marketing demands. The distribution budget specifies finished goods stock levels, and this can be related to the sales budget to give de-

tailed production requirements. Following from this, it is necessary to consider a series of subsidiary budgets :

i. Raw Materials Budget. ; It paying appropriate atten-tion to the desired stock levels.

ii. Labour Budget: It ensuring that the plan will make available at the right times the required number of employees of suitable skills

iii. Manufacturing Overheads budget: It covering items such as consumable materials and waste disposal.

g. Manpower Budget: The budget must take an overall view of the organization’s needs of manpower for all areas of activity — sales, manufacturing, admin-istrative, executive, and so on — for a period of years. Based on the manpower budget and policies, training expenses budget and recruitment expenses budget can be formulated.

h. Purchasing Budget: Raw materials, consumable items, office supplies and equipment, and the whole range of an organization’s requirements, must be considered while preparing this budget, along with the answers to the questions when, where, at what price, and how often to buy.

i. Administration Expenses Budget: The budget deals with such expenses as office salaries and upkeep, depreciation, stationery, management salaries, tele-phones, postage, etc.

Financial Budget The financial budget which summarizes the whole pack-age of budgets is made up of five individual budgets: a. Cash Budget: It is concerned with liquidity. It shows

the requirements of cash in respect of various func-tional budgets as well as anticipated cash receipts.

b. Budgeted Profit and Loss Account: It is concerned with profitability. It reflects the matching of bud-geted revenues during the period with budgeted costs during the same period.

c. Budgeted Balance Sheet: It is concerned with the structure of assets and the pattern of liabilities.

d. Budgeted Funds Flow Statement: It is concerned with the sources of funds and their application in the organization’s objective-striving endeavors.

e. Capital Budget: It is concerned with the questions of capacity and strategic direction. It deals with the evaluation of alternative dispositions of capital funds as well as with the choice of the best capital structure.

Cash Budget The cash budget, as its name implies, summarizes the estimated cash receipts and the estimated cash payments over the budget period. Its object is to ensure a balance between liquidity and profitability. The cash budget is

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closely related to the sales forecast, expense budgets, and capital expenditure budget. The cash budget is concerned with the timing of receipts and payments of cash (cash basis), whereas the other budgets are concerned with the timing or incurrence of the transactions themselves (accrual basis). Purposes of Cash Budget The principal purposes of the cash budget may be out-lined as follows: a. It indicates the probable cash position as a result of

planned operations. b. It indicates cash excess or shortages. c. It indicates the need to arrange for short-term bor-

rowing, or the availability of idk cash for invest-ment.

d. It makes provision for the co-ordination of cash in relation to

i. total working capital, ii. sales,

iii. investment, iv. debt.

e. It establishes a sound basis for obtaining credit. f. It establishes a sound basis for current control of the

cash position. Methods of Preparing Cash Budget There are two methods of preparing a cash budget: (a) receipts and payments method and (b) funds flow mcthod Distinction between Cash Budget and Cash Flow Statement Following are the important points of distinction be-tween a cash budget and a cash flow statement: a. A cash budget is futuristic in approach. It is pre-

pared in advance and is based on future plan of ac-tion. A cash flow statement is based on past data.

b. Cash budget relates to objectives to be achieved and is a plan for future inflows id outflows of cash. A cash flow statement is a post mortem analysis of ac-tual flows and outflows of cash.

c. The period of a cash budget is usually short (may be a week, fortnight, month or quarter). A cash budget may be prepared covering a long period also (say, a year) but divided into short sub-budget periods (say a month or quarter). The time span to be covered by a cash budget will vary from one firm to another, depending on the nature of its business and the de-gree of accuracy with which estimates can be made. A cash flow statement covers a relatively longer pe-riod, usually an accounting year, and it is not di-vided into sub-periods.

d. A cash budget requires previous data only for the purpose of judicious forecasting. A cash flow state-

ment is prepared from accounting data at the begin-ning and end of an accounting year.

e. A cash budget is a tool for budgeting and controlling cash. A cash flow statement is an analysis of the working of the concern for the past accounting year.

f. A cash budget usually serves the purposes of man-agement only. A cash flow statement may serve the purposes of management as well as external parties.

Flexible Budget In some businesses it is extremely difficult to estimate future levels of activity with any accuracy because of external uncontrollable influences. For example, a busi-ness providing luxury goods and services may be very sensitive to changes in the economic climate. Some businesses are affected by weather, and weather condi-tions are difficult to predict. The main requirement of a flexible budget is that ex-penses should be analyzed into three distinct categories: (a) Fixed expenses, i.e., expenses which would remain the same irrespective of levels of activity? (b) Variable expenses, i.e., expenses which would change in proportion to levels of activity. (c) Semi-variable expenses, i.e., expenses which would need to be analyzed into the fixed and variable elements. The advantage of flexing a budget, as already stated, is that actual performance can be compared with the flexed budget for purposes of control and performance apprais-al. Zero-Base Budgeting (ZBB) As a modern technique of budgeting, considered ideal for planning and decision making, ZBB was first applied by the United States department of agriculture as early as in 1964. The conceptual framework and structural devel-opment of ZBB was made by Peter A. Pyhrr who applied it in Texas Instruments, a multinational company of United States in 1969. Peter A. Pyhrr is regarded as the "father of zero-base budgeting owing to his contribution towards the development of the technique and making of the conceptual framework. President Jimmy Carter, while in the presidential chair of the U.S.A., issued an official order in 1979 for using the technique by all fed-eral government agencies throughout the United States. The technique was then gradually adopted by various countries all over the world. ZBB Concept Traditionally budgeting is done on the basis of the tar-gets set in the last year. Certain additions and deductions are made in the last year's budget figures- to arrive at the figures for the current budget. Thus, in traditional budget making we depend on the last year's targets and on the principle of increment or decrement to decide upon the

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additions and deletions required to the incorporated in the previous budget figures to arrive at the current budg-et figures. In case of ZBB it is assumed that there was no previous year's budget and the current budget proposals are inde-pendently evaluated in the light of expected benefits and costs involved. ZBB, therefore, refers to formulating a budget without making any reference to previous plans and achievements, but making particular reference to the justification of the proposed allocation of resources. This is not once. Every time a budget is to be prepared, the process of budgeting should start from zero and the pro-posed allocation of resources should be justified in terms of cost-benefit analysis. ZBB Defined I.C.M.A., London, defined ZBB as "a method of budget-ing whereby all activities are re-evaluated each time a budget is formulated. Each functional budget starts with the assumption that the function does not exist and is at zero cost. Increments of cost are compared with incre-ments of benefits culminating in the planned maximum benefit given by budgeted cost." Peter A. Pyhrr, the father of ZBB, defined ZBB as "an operating planning and bbudgeting process which re-quires each manager to justify his entire budget request in detail from scratch. Each manager states why he should spend any money at all. This approach requires that all activities be identified as decision packages which would be evaluated by systematic analysis and ranked in order of importance." Zero-base budgeting becomes ideal in case of planning and decision making. Development planning includes undertaking of various types of work of which there is no previous experience. Budgets in these cases can not be based on past targets modified by certain additions and deletions. Every budget proposal has to be evaluated on the basis of cost-benefit analysis. All proposed activi-ties are to be identified as decision packages to be eva-luated by systematic analysis and ranked in order of priority. Decision making depends on priority list. Main Features of ZBB The following are the principal features: a. Zero (or scratch) is taken as the basis of budgeting

and not the targets of previous budgets. b. Management of each decision unit must have to

justify the fund demanded. c. All proposed activities are grouped into various de-

cision packages. d. All decision packages are adequately evaluated and

arranged according to priority.

e. Alternative decision packages are also taken into consideration after evaluating properly.

f. Final allocation of resources is done on the merits of evaluation of all decision packages including the al-ternative decision packages.

How ZBB differs from Traditional Budget-ing The following are the points of distinction between tradi-tional budgeting and zero-base budgeting: a. In traditional budgeting previous level of expendi-

ture is given emphasis, whereas, in ZBB new eco-nomic appraisal is made every time a budget is pre-pared.

b. Traditional budgeting is an accounting oriented function, whereas, ZBB is project (or decision) oriented function.

c. For preparing a traditional budget existing pro-gramme need not be rejuslified, whereas, for prepar-ing a zero-base budget the existing and new projects are to be justified in the light of benefits and costs.

d. In case of a traditional budget the top management of ihe organisation justifies why a particular amount of expenditure is decided upon for a particular deci-sion unit, whereas, in case of ZBB it is the manager of the decision unit (and not the top management) who justifies the amount of expenditure.

e. In case of traditional budgeting how much is to be added with or deleted from the previous budget fig-ures is only taken into account, whereas, in case of ZBB appraisal of the existing level of expenditure is done and the future proposal for expenditure is justi-fied from different angles.

f. Preparing a traditional budget is a simple job mono-tonously done year after year, whereas, preparing a zero-base budget requires logical approach and it involves many complex steps to establish logic be-hind a proposal.

Applicability of ZBB ZBB is very suitably applicable in planning and devel-opment areas particularly of the government and local bodies. Projects of every ministry are thoroughly ex-amined with reference to costs and benefits. Which projects of which ministry shall enjoy priority in respect of allocation of resources depends upon the report of cost-benefit examination by persons competent to do so. Where the resources are limiled but there are many de-velopment works' to be done as in case of educational institutions, local bodies etc. ZBB becomes ideal, be-cause efficient use of limited resource is almost guaran-teed. In manufacturing concerns there are many devices like standard cost technique, work and motion study etc. to control cost. These techniques help controlling the prime

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costs and production overhead, because in these cases there is direct relationship between cost and output. But in manufacturing concerns there are various other ex-penditure which supports production function, but no relationship between cost and output can be established in these cases. This area of expenditure is a suitable field for application of ZBB. This area is covered by expendi-ture like accounting, research, development, mainten-ance, advertisement, postage, electricity, rent of adminis-trative office and many others. Merits of ZBB The following merits of ZBB are claimed: a. All projects — current and future are examined

carefully with reference to cost and benefits and the most efficient project is accepted. Thus, ZBB is al-ways a technique based on logic. The current projects are continued only if they are logically sound and efficient.

b. Amongst the available alternatives the most efficient ones are chosen on the cost-benefit acceptability for rational planning. ZBB requires the managers of de-cision units to find out cost effective ways of im-plementing the plans. Thus, ZBB helps making best planning and it also helps controlling cost.

c. Cost-benefit analysis is done in respect of both ex-isting and future projects. On the basis of the result of the analysis ranking of projects is done and funds are allocated in order of priority. Thus, ZBB helps efficient allocation of funds.

d. In zero-base budgeting most useful alternatives are found out for using the available resources of the organisation. In performing an activity also, alterna-tive ways lire taken into consideration and alterna-tive quanta of efforts to be put in are also consi-dered. These help promoting new ideas for perform-ing an activity in (lie best possible way.

e. Appraisal of existing activities and new projects is done, with equal importance, with regard to justifia-bility of continuing new undertaking on the basis of cost-benefit analysis.

f. In ZBB the managers of all decision units are to submit reports on their claims of funds and justifica-tion of the claims. Thus, in zero-base budget mak-ing, participation of all managers of decision units becomes compulsory. This promotes forthcoming of new ideas in allocation and utilisation of funds.

g. Since appraisal of the existing activities is done carefully in ZBB, activities failing to give desired results may be discontinued and thus unproductive expenditure may be saved.

h. ZBB technique being adopted all managers are ob-liged to make self-evaluation of projects under their command. Loopholes, if any, in the working progress are automatically detected and remedial measures are adopted. Managers' awareness in re-

spect of detection of errors and their rectification helps attaining efficiency in performance.

i. ZBB creates automatic motivation and helps form-ing a management team of individuals having talents and skills.

j. ZBB helps linking up top management with medium and lower level management. Thus, speedy commu-nication is ensured which helps expediting appropri-ate decision-making.

k. ‘Management by objectives' (or MBO) can be intro-duced and implemented with the help of ZBB. ZBB can be used for fulfilling the objectives of traditional budgeting, as it can be used for fulfilling other ob-jectives as well.

Demerits of ZBB The following demerits of ZBB are apprehended: a. Collection and analysis of data of alternative future

projects as well as existing activities requires time, money and energy.

b. Implementation of ZBB technique becomes diffi-cult, if full co-operation amongst management staff is not forthcoming.

c. Evaluation often becomes very difficult, as ideal standard of evaluation is not available. Evaluation in a desired manager requires technical knowledge which may not be available.

d. Managers are to undergo continuous training. If basic idea and objectives of ZBB are not crystal clear to the managers, implementation of ZBB sys-tem in a right way can not be expected.

e. In care of ZBB projects are to be ranked according to priority. Ego of top management may lead to irra-tional ranking of projects (i.e., if the top manage-ment favors a projects, irrespective of its merits it may be ranked high). Moreover, confusion may arise among the management staff regarding the me-thod of ranking to be adopted.

f. ZBB requires involvement of a good number of in-dividuals. This may create complications in com-munication system, difficulty in managing the huge volume of data, involvement of voluminous paper work etc.

References: [1] Batty, J. (1963), “Management Accounting including Financial Management and Control”, Macdonald and Evans. [2] Batty, J. (1979), “Accounting for Managers”, Hei-nemann Publishers, 2nd Edition. [3] Buyers and Holmes, G. (1984), “Principle of Cost Accounting”, Cassell Ltd. 4th edition. [4] Chartered Institute of Management Accountants (2000), “Management Accounting Official Terminolo-gies”, CIMA

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[5] Frank Wood (1988), “Business Accounting” Pitman Pubishing, 8th edition. [6] Hongren, C.T. and Foster, G. (1985), “Cost Account-ing: a managerial emphasis”, New Jersey, Prentice Hall Inc. [7] Koontz, Donnel, H and Cyril (1979), “Principle of Management: An analysis of managerial functions”, New York, Mc Graw Halls Book Co. [8] Lockyer, K. (1983), “Fundamental of Budget prepo-sition ethics: A Development”.

[9] Lucey, T. (2003), “Management Accounting”, New York, DP Publication [10] Lucey, T. (2008), “Costing”, New York, DP Publi-cations [11] Miller and Earnest, C. (1966), “Objectives and Standards: An approach to planning and control”, AMA Research Study 74, American Managers Association Inc [12] Pandey, I.M., (1985), “Element of Management Accounting”, Vikas Publishing House Limited.

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