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507 Cards in this Set

  • Front
  • Back
Accounting area focused on providing information to assist business owner and managers in making business decisions
Managerial Accounting
standards of conduct for judging right from wrong, honest from dishonest, and fair from unfair
focuses on three factors that affect the accounting reporting environment – opportunity, incentives, and character
Sarbanes Oxley Act of 2002
costs that can be traced to the object
direct cost
costs that cannot be traced to the object or that are not worth the effort of tracing
indirect costs
costs that change, in total, in direct proportion to changes in activity levels
variable costs
costs that stay the same, in total, regardless of activity level
fixed costs
have both a fixed and variable component
mixed costs
represent all of the costs associated with producing or manufacturing a physical product
manufacturing costs
includes all of the manufacturing costs other than direct materials and direct labor incurred to produce a physical product
Manufacturing overhead
the costs associated with running the business and selling the product as opposed to manufacturing the product
costs that are assigned to the product as it is being manufactured; they are counted as inventory until the product is actually sold
product/inventoriable costs
non manufacturing costs expensed in the period incurred
period costs
has the potential to influence a decision
relevant cost
will not influence a decision
irrelevant cost
costs that have already been incurred; irrelevant for decision making
sunk cost
direct materials and direct labor because at one time they were considered "primary" costs
prime costs
costs incurred to convert direct materials into a finished product
conversion costs
used by companies that make standardized or homogenous products or services
process cost system
is used in companies that offer customized or unique products and services
job order cost system
provides a detailed record of the costs incurred to complete a specific job
job cost sheet
describes the way total cost behaves, or changes, when some measure of activity changes
cost behavior
the range of activity over which we expect our assumptions about cost behavior to hold true
relevant range
fixed over a range of activity and then increase in a step–like fashion
step costs
shows total cost plotted on the vertical axis and a measure of activity, or cost driver, plotted on the horizontal axis
a statistical technique for finding the best fitting line based on historical data
least squares regression method
a decision–making tool that focuses on the relationship among the volume and mix of units sold, prices, variable costs, fixed costs, and profit.
cost–volume–profit (CVP) analysis
tells us how much each unit sold contributes toward fixed costs and profit
unit contribution margin
Contribution Margin Ratio
contribution margin/sales price
break even sales
total fixed costs/contribution margin ratio (%)
an extension of break–even analysis that allows managers to determine the number of units or total sales revenue needed to earn a target profit
target profit analysis
the difference between actual or budgeted sales and the break–even point
margin of safety
refers to how a company uses variable costs versus fixed costs to perform its operation
cost structure
measures the extent to which fixed costs are used to operate the business
degree of operating leverage
provides useful information for management to maker decisions
managerial accounting
Five points for managerial accounting
internal users
internal reports as needed
specific reason
segments or units, relevant to operations
Five points for financial accouting
F/S and quarterly and annual reports
Aggregated and in accordance with GAAP
looking ahead by establishing company objectives and performing only activities that add value to th ebusiness
coordinating of human resources and directing detailed activities to run smoothly
measuring and monitoring, insuring that planned goals and activities are being followed or achieved by the use of budgets, responsibility reports, and performance evaluations
purchase raw materials from suppliers and convert them into finished products
manufacturing firms
sell the goods that manufacturers produce
merchandising companies
Two points for merchandising
merchandisers to other businesses are called wholesalers
merchandisers to general public called retailers
provide a service to customers or clients
service companies
Why did they enact a Sarbanes Oxley Act
to reduce fraud and defer people from fraudulent activities
Three points for Sarbanes Oxley Act
Reduce opportunities for error and fraud
counteract the incentives to commit fraud with stiffer penalties
emphasize the importance of the character of managers and employees
Manufacturing Costs are the same as...
product costs
Three manufacturing costs
direct materials
direct labor
manufacturing overhead
10 components of manufacturing overhead
indirect materials
indirect labor
factory production manager's salary
factory rent
factory insurance
factory utilities
factory maintenance
factory depreciation
factory property tax (not income tax)
factory licenses and permits
Two examples for non–manufacturing costs (period costs)
marketing and selling expenses
general and administrative expenses
Product Costs =
When are period costs expensed?
as we spend the dollar
Prime costs =
Direct Materials Used + Direct Labor
Conversion Costs =
Direct Labor + Manufacturing Overhead
costs of goods purchased vs. costs of goods manufactured
income statement
merchandise inventory vs. finished goods, work in process inventory and raw materials inventory
Balance Sheet
Short COGM schedule
+ Current Manufacturing Costs
=Total Costs of Work in Process
Current Manufacturing Costs =
Direct Materials Used
+Direct Labor
+Manufacturing Overhead Applied
Direct Materials Used =
Beg Raw Materials
+ Purchases
= Total Available
–End Raw Materials
Costs of Goods Sold
Beg Finished Goods
=Available for Sale
–End finished goods
(+ or – adjustment for under/over applied OH)
involve the measuring recording and reporting of product costs
cost accounting systems
gathered from materials requisitions forms – those that list the quantity and cost of direct materials used on a specific job
direct materials
Three journal entries for direct materials
1. debit raw materials inventory; credit cash
2. debit work in process – DM (job1, job2); credit raw materials inventory
3. Debit Manufacturing Overhead; credit raw materials inventory
gathered from direct labor time tickets that show how much time a worker spent on various jobs each week
direct labor
Two direct labor journal entries
1. Debit factory labor; credit wages payable
2. debit work in process –DL (job1, job2); debit WIP– IDL (j1, j2); credit Factory Labor
cannot be traced to a specific activity so must be allocated to everything in the factory in a particular period
Manufacturing Overhead
______ ______ to accumulate the bills as they come in
Record debits
For manufacturing overhead, the debit side of the account accumulates all of the ______ costs as they are incurred. The timing does not necessarily related to the production of the product
MOH debit journal entry
debit MOH; credit various payables
_______ recorded show the ___________ of overhead to the process as units of product are made.
Actual is on the _____.
debit side
If you have a debit balance it is ______ applied. and if you have a credit balance it is _____.
Total estimated Annual OH Cost/Total estimated annual activity (driver)
Use the PDOHR computed to multiply times the...
actual units and record on credit side of T account.
Journal entry to record Applied overhead
WIP–MOH Applied – debit
MOH Applied – Credit
Determine the actual costs of MOH and record on...
the debit side
Determine the balance of MOH and...
label it under applied or over applied
Journal entry for an over applied MOH balance
Debit MOH; Credit COGS
Journal entry for an under applied balance
Debit COGS; Credit MOH
Journal entry for completion of work
Debit Finished Goods; Credit Work in Process
When is a good moved into COGS?
when it reaches the customer
Journal spent for sale of goods
Debit accounts receivables or cash; credit sales revenue
Debit COGS; credit Finished Goods Inventory
how a total cost responds to changes in some measure of activity
cost behavior
the amount of the item selected also known as volume
activity index
Total Cost =
variable costs (times total) + fixed costs
As activity goes up, variable costs per unit is _______, not _____.
Fixed costs per unit has an...
inverse cost per unit
Six steps for computing High–Low
1. determine high activity
2. determine low activity
3. find the difference between the two for activity and cost
4. calculate the variable cost per unit
5. calculate total variable costs at high and low and calculate fixed costs.
6. determine cost formula, then total cost at a particular level of activity
traditional income statement
total of direct materials
direct labor
variable manu overhead
fixed overhead
= Gross Margin
total of
variable selling/administrative
fixed selling/administrative
–operating expenses
=operating income
contribution margin income statement
–variable costs
–Fixed expenses
=Operating income
a decision making tool that focuses on the relationship among the volume and mix of units sold, prices, variable costs, fixed costs, and profit
cost volume profit
Five assumptions of CVP analysis
linear costs and revenue functions
all costs can be classified as either fixed or variable
only volume affects total cost and total revenue
production volume is equal to sales volume
constant product mix
Profit =
fixed cost + profit wanted
contribution margin
Break Even units =
FC/CM per unit
Break Even Sales =
FC/CM Ratio
Target income units =
(FC + Target operating income)
Target operating income sales =
(FC + Target Operating Income)
Margin of Safety =
Actual or budgeted sales – break–even sales
model allows managers to perform "what–if" analysis to see how changing one or more variables will affect the others
CVP for Decision Making
Three points for CVP for Decision Making
changing prices
changing variable costs and volumes
changing fixed costs and prices
refers to how a company uses variable costs versus fixed costs to perform its operations
cost structure
Higher fixed costs =
higher operating leverage
Degree of Operating Leverage =
Contribution Margin
Net Operating Income
used because companies generally have more than one product or service; usually assumes a constant mix; sales mix uses traditional break even analysis
multi–product CVP mix
determine the weighted average unit contribution margin of products
compute break–even sales
How do you determine the weighted average contribution margin?
divide the total CM $ by the total # of units
How do you determine break–even units?
by taking the total fixed costs and dividing it by the weighted average contribution margin
For multi–product CVP, take the break–even units...
and allocate based on the proportionate ratio of the product mix
Five Steps in the Decision Making Process
1. Identify the decision problem (issues)
2. Determine the decision alternatives
3. Evaluate the costs and benefits of the alternatives
4. Make the decision
5. Review the results of the decision
One point for identify the decision problem
the problem, NOT the system
One point for evaluate the costs and benefits of the alternatives
select alternatives where the benefits outweigh the cost
One point for review the results of the decision
Evaluate the decision after you've implemented it
decisions involve a choice among alternative courses of action
incremental analysis
Two steps for incremental analysis
1. Identity the decision alternatives
2. Identify the probable effects of those decisions on future earnings (cost – benefit)
Why is identifying the decision alternatives a critical step?
If left off in the initial stage, you won't look at it later.
Qualitative issues must always...
be considered in any decision
able to impact the decision at hand
relevant data
Just because it's relevant for one decision...
doesn't mean it's relevant for another
Two points for relevant data
1. costs and revenues that occur in the future
2. differ across alternatives should be the only factors to be considered
costs that have already been incurred and will not change or be avoided by any future decision (never relevant)
sunk costs
the foregone benefit (lost opportunity) that occurs from choosing one alternative over another.
Opportunity costs
What is the opportunity cost associated with?
the choice that you DO NOT select
a measure of the limit placed on a specific resource
unused part of the resource; More than enough ability to satisfy additional demand of the resource
Idle (excess)
Why would you have idle capacity?
If you made those units, you couldn't sell them, so you don't make them.
the limit on more or more resource has been reached and doing one thing means giving up the opportunity to do something else
Capacity is usually easier to see on a...
progression line
total number of units you can make
the difference between full and normal (full – normal)
excess or "idle" capacity
determined by each individual business; level at which we can usually operate because we can sell that number of units
normal capacity
max units that can be made
full capacity
Four types of decisions
Special Order or Accept Order at a special price
Make or Buy
Keep or Drop
Sell or Process Further
one time decision only; not a regular customer; no repeating
special order or Accept order at a special (reduced) price
What do you have to do with an order at a reduced price?
Make it clear that if they continue, they don't get the lower price
Special Order or Accept Order at a Special Price
–Always consider ________ _____
–Only consider __________ ______
–Consider if you ___________ ________ ______
__________ ______
capacity first
relevant costs
cannibalize current sales
qualitative issue
Which costs are always relevant for a special order?
Variable costs
When are Fixed costs relevant in a special order?
Only if they change (new part)
could impact long term pricing decisions
Qualitative issue
What is cannibalizing sales?
Taking sales from regular customers
Special Order or Special Price decision
Offer Price – New Variable Costs – New Fixed Costs or Other Costs = Balance of Offer Price
How do you make your decision?
If Balance of Offer Price is positive, accept
If Balance of Offer Price is negative, reject
Always convert...
unit fixed costs to total fixed costs
these decisions are commonly referred to as insourcing vs. outsourcing
Make or Buy
Make formula:
Direct Materials + Direct Labor Cost + Variable Overhead + Fixed Overhead = Total
Buy Formula
Fixed Overhead + Purchase Price = Total
Which one do you pick in make or buy?
The smaller total.
What does the total difference column tell you?
whether you will make or lose money by choosing buy
Four qualitative issues
packaging standards
supplier reliability
demand for product
future pricing increases
look at profitability of the segment. Beware to use segment margin when making decisions
Keep or Drop (continue or discontinue) a segment)
Two types of fixed costs in Keep or Drop decisions
Direct Fixed Costs
Common (indirect, allocated) fixed costs
those that can be attributed to a specific segment of the business and go away if that segment is eliminated
direct fixed costs
shared by multiple segments and will remain even if one segment is eliminated
common (indirect, allocated)
When do you keep a segment?
If segment (division) margin is positive (can still absorb other corporation allocated costs
When do you dispose of a segment?
If segment (division) margin is negative and continues to drain income of the corporation
substitute products vs. complementary products
Keep or Drop Formula
Sales – Variable Costs = Contribution Margin – Direct Fixed Costs (goes away) = Segment Margin – Common Fixed Costs (remains) = Net Income/Loss
Should you keep the division or not?
If segment margin is positive, keep.
If segment margin is negative, eliminate
sell at some point or process more
sell or process further
Two points for sell or process further
1. process as long as incremental revenues are greater than incremental costs
2. multiple products – joint products – all costs incurred prior to the point at which two products are separately identifiable
What is the split–off point?
The original selling price
Formula for sell or process further
New Selling Price – Old Selling Price = difference – Further Processing Costs = Balance
How do you decide if you could sell or process further?
If the balance is positive, process it to the end.
If the balance is negative, spell at split off.
If the balance is zero, you are indifferent.
Joint costs are __________ to any decision made after the split off point.
looks at sales mix and how funds and space should be allocated to particular items or areas
Constrained (limited) resources
If you make more than one
If you make less than one per resource...
Four directions for Constrained resources
1. Find CM/unit
2. Convert CM/unit to CM per resource
3. Rank items in #2
4. Consider demand
Sell more of the units that have the highest contribution margin per ________
Four more steps to constrained limits:
1. Determine the ___________ __________ ___________ of the organization.
2. Find the contribution margin ___ ____ of the limited resource. Determined by ________ or ___________ the $ contribution margin per unit of each product _____ the number of units of the ________ _________ required for each product.
3. Select the item that generates the ________ contribution margin ___ ______ of limited resource.
4. To maximize net income, the units that generate the ______ contribution margin ___ ____ of limited resource should be produced
appropriate limiting resource
per unit
dividing or multiplying
limited resource
per unit
per unit
Three functions of management
the process of setting goals and objectives
long term; general; not very quantitative
short term; more specific actions; more quantitative
operations for longer than one year; less detailed
operations in the next year; a lot more detail in terms of numbers
implementation of the plan; making sure we have resources
Two types of planning
backward looking part to see if goals were met
a formal written statement of management's plans for a specified future time period, expressed in financial terms. Used as a planning and communication tool for management
Four benefits of budgeting:
1. requires _______ __ ___ _______
2. provides ____________ __________ ___ ____________; Facilitates the ____________ __ ___________; results in _________ ______________ ___________ of the overall operations
3. Creates an _____ ________ _______ for potential problems
4. __________ ______________ to meet planned objectives and can be used to reward employees performance
looking to the future
communication within the organization
coordination of activities
greater management awareness
early warning system
motivates personnel
the impact of ______ _________ should always be considered
human behavior
Three points for human behavior
participative budgeting : each level should participate in development
bottom up verses top down approaches
budgetary slack : potential disadvantage through underestimation of revenues or overestimation of expenses
get directives and you have to do it
top down
part of it; increases motivation
Using slack when there are large fluctuations that are...
out of the manager's control
Continuous (rolling budgets) that extend _ ________ _______ into the future. When one period ends, another is ________ ____ ___ ___ ___.
a certain period
automatically added at the end
a comprehensive set of budgets that cover all phases of an organization's planned activities for a specific period of time
Master budget
Budgets in the Master Budget (2)
Operating budgets
Financial budgets
cover the organization's planned operating activities for a particular period
Operating budgets
The operating budgets are the individual budgets that...
result in the preparation of the budgeted income statement
Seven Operational budgets
raw materials purchases
direct labor
manufacturing overhead
cost of goods sold
selling and administrative expense
prepare cash receipts from this budget
prepare cash disbursements from this budget
raw materials purchases
cost of our product for what we SOLD, not what we made
Cost of Goods Sold
focus primarily on the cash resources needed to support operations and planned capital expenditures.
Financial budgets
Financial budgets are the individual budgets that will...
impact the preparation of the budgeted balance sheet
Two Financial Budgets
Cash budget
Capital expenditures
Two cash budgets
Cash collections (receipts)
Cash payments (disbursements)
start with a low price and go up
market penetration
start with a high price and go down
market skimming
1st prepared and starts with a sales forecast
Formula for Sales budget
Expected Unit Sales
x Unit selling price
= total sales revenue
Sales budget does not represent what we ____, but tells us what customers ___.
shoes the units to be produced to meet anticipated sales
Production budget
What is essential in scheduling production requirements?
a realistic estimate of ending inventory
What does the production budget show us?
what we have to make to meet the current sales level and make sure our customers don't go elsewhere
What is the formula for Production budget?
Expected Unit Sales
+ desired ending finished goods units
= total required units
– beginning finished goods units
= required production units
what is desired ending finished goods units also called?
safety stock
shows both the quantity and cost of direct materials to be purchased
Raw Materials Purchases Budget
Formula for raw materials purchases budget
Expected units to be produced
x Quantity of materials per unit
= Total raw materials needed for production
+ desired ending materials inventory
= total materials required
– beginning direct materials
= direct materials to be purchased
x cost per each
= total cost of direct materials purchases
contains the quantity (hours) and cost of necessary to meet production requirements
Direct Labor
Formula for Direct Labor BUdget
Expected Units to be produced
x Direct labor time (hours) per unit
= Total required direct labor hours
x Direct labor cost per hour
= Total direct labor cost
shows the expected manufacturing overhead costs for the budget period. It can be based on the production budget or some other activity based.
Manufacturing Overhead Budget
MOH budget formula
variable costs amount of product (based on sales)
x quantity of production driver
= total variable costs
+ fixed costs
= total manufacturing overhead/activity base
= manufacturing overhead rate per activity base
reflects the costs that were incurred to make only the units that were sold during the period and willl be used on the income statement
Cost of Goods Sold Budget
The portion of the total costs that remain in inventory for units not sold will be shown...
on the budgeted income statement at a later time
Formula for COGS budget
budgeted units to be sold
x budget manufacturing cost per unit
= budgeted cost of goods sold
What is the budgeted manufacturing cost per unit made up of?
direct materials
direct labor
variable overhead
fixed overhead
projects anticipated selling and administrative expenses for the budget period; uses sales units as the starting point.
selling and administrative expenses
Formula for selling and administrative expenses
variable expenses based on unit sales
x variable rate per unit
= total variable costs
+ fixed expenses
= total selling and administrative expenses
Two points for prepare the cash receipts schedule
1. determine the payment
2. write percentages and calculate
Amount paid each month
Payment percentages for each month
+ direct labor
+ cash overhead
+ selling and administrative
+ cash for equipment
shows the anticipated cash flows.
Cash budgets
Three sections of the cash budget
cash receipts
cash disbursements
includes expected receipts from sales and selling of assets (marketable securities) or stocks
cash receipts
payments for direct materials, direct labor, manufacturing overhead, selling and administrative expenses, dividends, and the purchase of assets
cash disbursements
Do not include depreciation in disbursements why?
Because you only pay for something once
shows expected borrowing and the repayment of the borrowed funds plus interest
Formula for cash budgets
beg cash balance
+ cash receipts
= total available cash
– cash disbursements
=excess (deficiency of cash)
=ending cash balance required
If overhead amount has depreciation...
you have to remove it
Three other industries that use budgeting besides manufacturing companies
service enterprises
not–for–profit organizations
industry that purchases goods ready for resale
industry that provides labor and intellectual skills to the public
service enterprises
governmental industries that seek to generate receipts sufficient to cover expenditures
Not–for–Profit Organizations
essentially the same; predetermined unit costs that are used as a measure of performance
standards and budgets
usually relates to a unit amount
represents optimum levels of achievable performance under PERFECT operating conditions
efficient levels of performance that are ACHIEVABLE under expected operating conditions; rigorous or tight
normal (attainable or practical)
no challenges
loose standards
the amount of inputs and the price for those inputs that should be required to make a perfect unit of product (outcome) and suggested price
Standard unit of cost is the...
expected cost to produce one unit based on standard prices and quantities
a budget based on a single level of activity; not good to use if actual activity is very different from planned
changes the costs and revenues for different levels of activities to compare to actual
Three points for flexible budgets
a series of static budgets
results is variance analysis
done for comparison purposes
Two standards for cost components
DM price std.
DM quantity std.
cost/unit of DM that SHOULD BE INCURRED
DM price std.
amount of DM that should be used per unit
DM quantity standard
Standard DM cost/unit =
DM price standard x DM quantity standard
when we get something
freight in
not included in direct labor because this is indirect labor because the project hasn't started yet
Three things for price
cost of materials
freight in
Two things for quantity
amount of materials in the finished product
allowance for normal waste
Total unit cost is always...
not included in the material number because we don't expect it
abnormal waste
price/hour that should be paid
DL price (rate) standard
time that should be used to make one good unit
DL quantity (efficiency) standard
Standard DL cost per unit =
DL price standard x DL quantity standard
Three things for price for labor
labor rate
payroll taxes
fringe benefits
Quantity for labor
production time
set–up/down time
rest/break time for employees
budgeted OH divided by expected activity
Overhead standards
Overhead should be...
separated into fixed and variable portions
total estimated VOH $ / total estimated VOH driver
total estimated fixed OH cost / total estimated FOH driver
For the three poles, what are their titles?
1. Actual Cost
2. Budgeted Input
3. Budgeted Output
What is the difference between pole 1 and pole 2?
Price variance or rate variance
What is the difference between pole 2 and pole 3?
Quantity variance or efficiency variance
Pole 1: __ x __
Pole 2: __ x __
Pole 3: __ x __
Actual price x Actual Quantity/hours/rate
Standard price x actual quantity
standard price x standard quantity allowed (std amount * good output)
If the number is negative, it is...
If the number is positive, it is...
involves accumulating and reporting costs and revenues on the basis of the manager who has the authority to make the day–to–day decisions about the times
responsibiliity accounting
what is the responsibility accounting used for?
a performance evaluation tool
Decentralized means that the control and authority of operations is...
delegated to many managers throughout the organization
sometimes used to identify an area of responsibility in decentralized operations
if the manager has the power to incur it within a given period of time.
costs incurred directly by a level of responsibility are...
controllable at that level. (direct)
All costs are controllable by...
top management
Variable costs are always considered...
Fewer costs are controllable by the individual manager as one moves...
down to lower levels of management
What is responsibility looking at?
the items on a financial statement that are within a manager's control
What kind of organization is used throughout the organization?
horizontal organization structure
The people at the very top leave some of the day–to–day decisions to...
those at the lower level
What is decentralized performance evaluation looked at in?
terms of evaluating managers
We are looking at the...
segment level
We are going to use the _______ _______ ______ in this chapter.
segment margin concept
We are looking for the segment level...
for the performance.
Have different levels in an organization with...
managers at each level
As we move down in an organization, we get fewer and fewer costs and revenues that are...
controllable at that level by that manager
At the very top level, everything...
is controllable
The College of Business is...
one segment of LSU
It's not fair if you evaluate someone on...
something you cannot control
costs incurred directly and allocated to a responsibility level
Two points for non controllable things
Common fixed costs
Three advantages of non–controllable costs
recognize knowledge and ability at lower levels
fosters development of managers
keeps day to day running at lower levels
Two disadvantages of non–controllable costs
sometimes duplication of effort
could leaf to manager decision making autonomy
We should not use non–controllable costs as...
an evaluation mark on employees.
If they have too much authority, they might make...
decisions that will make them go rogue.
____________ decision–making authority is kept at the very top of the organization.
High level executives make...
the decisions
What works with small organizations
centralized decision–making authority
In a centralized decision–making authority, the owner understands everything that's going on...
and actually helps with the work.
Based on a concept called the controllability principle
responsibility reporting system
managers should be responsible for what they can control
controllability principle
Information can be broken down into...
What are the four types of responsibility centers?
cost center
revenue center
profit center
investment center
incurs costs and expenses but does not directly generate revenues
cost center
What is cost center?
usually some type of production or service department
What is the hierarchy?
profit center
revenue center
cost center
responsible for generating revenue through targets and quotas
revenue center
What is the revenue center usually?
a sales department – car sales
incurs costs and also generates revenues
profit center
managers are judged on the...
profitability of their centers
Direct versus common fixed costs
segment margin; controllability
authority to make decisions about how and where to invest the company's assets
investment center
top level company
investment center
system that incorporates financial and non–financial and non–financial measures in an integrated system that links performance measurement and a company's strategic goals.
balanced scorecard
The measures reflect past performance (________ __________) as well as future performance (________ __________).
lagging indicators
leading indicators
There are four commonly employed perspectives:
internal process
learning and growth
employs financial measures like net income, return on assets, credit rating, etc.
What is the question for financial?
What value do we provide for our shareholders?
evaluates performance from the customer's viewpoint and compares to competitors
What is the question for customer?
What value do we provide to our customers?
Measures used in customer are...
customer retention, brand recognition, customer recommendation
Somebody in upper level management...
sets the quotas
Franchises have to keep a certain branding, so...
not all profit goes to the individual restaurant
McDonald's cost?
McDonald's Revenue
Front counter (smile and get you to buy things you didn't even want)
McDonald's profit
the whole location (investment headquarters in Oak Brook, IL)
evaluates internal operating process and assesses value chain for effectiveness and efficiency
internal process
What is the question for internal?
What internal processes are required to meet the needs of our customers, employees, and shareholders?
What are the areas that the internal process looks at?
percent of defect free products, stock outs, waste reduction, etc.
We need to focus not only on the customer, but...
on the employees
development of the company and employee retention
learning and growth
What is the question for Learning and Growth?
How will we sustain our ability to change and improve
Examples of learning and growth
employee attrition
cross–trained employees
training hour
ethnic violations
Can't always adjust...
cost so easily
shows the effectiveness of the manager utilizing the assets at his disposal
return on investment (ROI)
Return on Investment short formula =
net operating income/average invested assets
Return on investment long formula:
profit margin x Investment Turnover
Profit margin =
net operating income/sales revenue
investment turnover =
sales revenue/average invested assets
Average invested assets =
beginning total assets + ending total assets/2
Judgmental issues (2)
valuation of invested assets
margin measure
Improving (ROI): (2)
increase sales
decrease variable or fixed expenses
We want to set...
benchmarks for people to achieve.
With the ROI formula, we can...
see how well we're doing
Net operating incomes based on a...
controllable margin or segment margin
the income that remains after subtracting from the controllable margin the minimum rate of return on a company's average operating assets
residual income
Amount of dollars that we have left
residual income
Equation for residual income
Net Operating Income
– (minimum rate of return x invested assets)
= residual income (can be negative)
ignores the fact that one division might use substantially fewer assets to attain the same level of residual income as another divisions
Company establishes...
hurdle or goal (minimum acceptable rate of return)
Average invested assets
measures the economic wealth that is created when a company's after–tax net income exceeds its cost of capital
economic value added
Three points for economic value added
uses after–tax net operating income
cost of capital as the hurdle rate
total capital employed rather than average invested assets
to determine whether the company is generating sufficient after–tax income to cover the cost of capital
related party transactions
transfer price
goods are exchanged between departments or divisions at a transfer price
internal sales
based on existing market prices of competing goods and services
market–based transfer price
What is the ceiling?
market–based transfer price
One point for market–based transfer price
not always a well–defined market for the good or service being transferred
determined through agreement of division managers
negotiated transfer price
one point for negotiated transfer price
where people haggle
based on variable costs alone or variable costs plus fixed costs plus a mark up amount
cost–based transfer price
What is the floor for transfer price?
cost–based transfer price
What does the top level manager make you sell at?
cost–based transfer price
One point for cost–based transfer price
leads to loss of profitability for the company and unfair evaluations
variable costs are defined as variable costs of units sold internally
notes usually __ ____ include selling, marketing, administrative overhead or research and development costs
do not
Three disadvantages for Note
market price information is sometimes not easily obtainable
lack of trust between two negotiating divisions
negotiations lead to different pricing strategies from division to division
Capacity formula =
Minimum Transfer Price = Variable Costs + Opportunity Costs (Lost Contribution Margin))
TP =
VC + Lost CM (LCM) Opportunity Cost
Marketing costs change because...
we don't have to market to those outside our organization.
In excess, for LCM, we are not getting anything on it now, so...
you can't lose it.
payment for the use of someone else's money
interest (i)
two points about interest
stated as a per annum amount.
Yearly interest
original amount borrowed or invested
principal (p)
the number of years (periods) that the principal is borrowed or invested
computed on the principal only
simple interest
Simple interest formula
principal x interest rate x time
computed on the principal and on any interest earned that has not been paid our or withdrawn
compound interest
compound interest rate formula
Interest factor * principal = balance
a dollar today is not worth the same as a dollar in ten years in the future and vice versa.
significance of interest
is the value of an amount at a future date of a given amount invested assuming compound interest
future value of a single amount
Whenever we take the principle and add the interest to it, we look at the...
future value of 1 table (accumulated interest)
payments or receipts of equal amounts in each of the future periods
For an annuity, what table do you go to?
Future Value of an Ordinary Annuity Payments of One
the sum in the future of all of the payments (receipts) plus the accumulated compound interest on them
future value of an annuity
Future value formula
Deposit's Present value x (FV factor)
the amount of the value of the payments today
present value
the sum today of all of the payments (receipts) minus the accumulated compound interest on them
present value of an annuity
When we are talking about capital budgeting, we will be using...
present value
Expect assets to last us more than one year...
want to invest in assets that will pay for themselves
Ordinary annuity
made at the end of the period
process of making decisions to purchase capital assest
capital budgeting
Capital budgeting usually involves choosing...
among various capital projects to find the one that will maximize a company's return on its financial investment
amount of real dollars that will be available or saved
cash flows
Net Income adjusted for...
Depreciation and other non–cash items
What is a cash flow also called?
annual operating advantage
operating advantage
cost savings
Examples of outflows (4)
initial investment
repairs and maintenance
increase operating costs
overhaul of equipment
Examples of inflows
sale of old equipment (trade–in)
increased cash received from customers
reduced cash outflows related to operating costs (savings)
salvage value of equipment when project is complete.
the rate that a company must pay to obtain funds from creditors and stockholders
cost of capital
What is the cost of capital also called?
hurdle rate
required rate of return
discount rate
cutoff rate
projects that are unrelated to one another, so investing in one does not preclude investment in the other
independent projects
is a company that adopts one proposal it would be impossible to adopt another at the same time
mutually exclusive
thorough evaluations of how well a project's actual performance matches the original projection
post investment–audit
shows the profitability (net income) generated from the capital expenditure
accounting (annual) rate of return
Formula for accounting rate of return
expected net income/initial or average annual investment
Net income formula
sales – expenses (includes depreciation)
Cash flows equation
net income + depreciation
What is acceptable?
annual rate of return > required rate of return
What is unacceptable?
annual rate of return < required rate of return
Average investment =
beginning of the year + end of the year/2
What things go out?
cash of the investment
What things go in?
equal annual cash flow inflows
salvage value
What things go either ?
additional outlay or inflow
For all, look at...
cost of the investment
equal annual cash flows
salvage value
additional outlay or inflow
Cash payback...
the amount of time it takes you to recoup your money (your investment)
–talking just about the investment, not how much more beyond the investment
identifies the time period required to recover the cost of the capital investment from the annual cash flows produced by the investment
cash playback
Formula for even cash flows
investment/net annual cash inflow (NI + Depr. & +Amort) = number of years
For uneven cash flows...
continue until total investment is recovered and then count the yesrs
Apportion a part of a year if necessary to...
cover remaining investment (STOP AT ZERO)
Advantages of Cash Payback (2)
easy to calculate
shorter payback period than life of equipment acceptable (watch for other requirements)
2 Disadvantages of cash payback
does not consider the time value of money
ignores and cash inflows beyond the payback period
Investment/annual cash flow
years to pay off
Accept if the payback is...
shorter than the asset's life
Net Present Value considers...
all the inflows and outflows and the time value of money
cash inflows are discounted to their present value and then compared with the capital outlay required by the investment
net present value
Formula for present value of inflows
cash inflows x PV factor (PVOA)
+ Any salvage value x PV factor (PV 1$)
formula for present value of the outflows
Investment amount x 1@t
+ any additional outlay x PV factor
Net Present value=
present value of inflows – PV of outflows
For NPV, accept the project if...
NPV is positive
For NPV, reject the project if...
NPV is negative
For NPV, indifferent if...
NPV = 0
Three advantages of NPV
considers the time value of money
considers all of the cash flows related to the investment
tells whether the project should pay for itself
1 disadvantage of NPV
does not rank the projects
We are not looking for the factors, we are looking for...
the interest rate
Go to the life of the project and...
go across that row only
determines the interest yield (rate of return) of the investment.
Internal (Interest) rate of return
The internal rate of return is the rate that causes...
the NPV of the project to be equal to zero
Formula for even cash flows
Investment/Annual Cash Inflows = Interest factor
Three steps for the interest factor
Trace the factor to PVOA tables by going to the number of periods first and then trying to find the interest factor on that row only
If found, read up to the interest rate at top of table
If not found, look for factor larger and then smaller that that computed (left and right of amount on table). Interest is in between the two respective rates
Accept project is IRR...
greater than cost of capital
Reject project if IRR...
less than cost of capital.
Indifferent if IRR...
equals the cost of capital
For uneven cash flows...
not gonna happen in this class.
this method takes into account both the size of the original investment and the discounted cash flows
profitability index (pi)
The PI ideally should be...
one or greater
What does the PI tell you?
the percent it will contribute
A PI greater than one tells us...
that is pays for itself and contributes profit.
If PI is less than one...
Formula for PI
PV of Cash Inflows/PV of investment (outflows)
What does a PI of less than one indicate?
that the project will be a drain on current income
Two points for PI
allows us to rank projects
takes into account the time value of money
Four advantages of PI
considers time value of money
best tool for ranking projects
considers all of the cash inflows and outflows related to the project
Allows for comparing project with different initial investment (size) amounts
What is an alternate method for calculating PI
What does the alternate method do?
gives you the number that adjusts the index of one
PI =
1 + change (subtract if negative change)
Three things we need to know for measuring and evaluating financial performance
the general categories to evaluate
the particular elements within each category
how to measure performance
Benchmarks can include..
the company's prior year results and the results of close competitors or the average for the industry
help when interpreting a company's ratios
The goal of managerial accounting is to...
provide information for decision makers to understand and evaluate the results of the business decisions.
Three financial analyses tools
horizontal analyses
Vertical analyses
ratio analyses
also called trend analyses
horizontal analyses
In horizontal analyses, we compute/compare financial statement items to comparable amounts in ______ _______ with the goal of identifying __________ ________, or _____.
prior periods
sustained changes
Year to year change
Current year total – prior or base year total x 100/prior year total
Who establishes the base year?
Trends are revealed in...
horizontal analyses
reveals whether a company grew during the year and indicates whether a company changes its reliance on debt vs. equity financing
analysis indicates key changes in operations of the company
For vertical analyses, create ______ _____ financial statements that express each line of the income statement (or balance sheet) as a ______ __ ______ ______ (or _____ ______).
common size
percentage of total sales
total assets
Take sales and tell what proportion the...
other numbers are of sales
One point for vertical analyses
stated item as a portion of another total item.
formula for vertical analyses
current item total x 100/category total
The vertical analyses information tells the reader...
whether the proportions within each statement category are changing
Vertical (common size) analysis of a company's balance sheet highlights...
key elements of the company
Vertical (common size) analysis of a company's balance sheet reveals the...
most important determinants of the company's profitability
compare one of more financial statement items to an amount for other items for the same year
ratio analyses
Ratio take into account differences in the size of amounts to allow for...
evaluations of performance given existing levels of other company resources.
Financial ratios are commonly classified with relation to...
Profitiability ratios focurs on _______ _the ________ of a _________ _______ by comparing it to other items reported on the financial statements
measuring the adequacy of a company's income
the extent to which a company generates income
profitability ratio
net profit margin =
net income/net sales revenue
net income =
sales – discounts, returns, and allowance
Gross profit percentage =
(net sales revenue – cost of goods sold)/net sales revenue
what does gross profit percentage tell us?
after we reimburse ourselves, how many dollars are left?
Total asset turnover =
net sales revenue/average total assets
average total assets =
beginning inventory + ending inventory/2
Return on equity
net income/average stockholder's equity
What is the going concern?
the business will still be in business next year
Nine profitability ratios
net profit margin
gross profit percentage
asset turnover
fixed asset turnover
return on equity
return on investment
earnings per share
quality of income
price/earnings ratio
Return on investment
net operating income/average invested assets
earnings per share
net income/average number of common shares
price/earning ratio
stock price/earnings per share
Liquidity ratios measure a company's...
ability to meet its current debt obligations.
One point for liquidity ratios
the extent to which a company is able to pay its currently maturing obligations
six liquidity ratios
receivables turnover
days to collect
inventory turnover
days to sell
current ratio
quick ratio
receivables turnover =
net sales revenue/average net receivables
days to collect –
365/receivables turnover ratio
Inventory turnover =
cost of sales/average inventory
Days to sell =
365/inventory turnover ratio
Current Ratio =
current assets/current liabilities
quick ratio =
(Cash + Short–term investments + Accounts receivable, net)/Current liabilities
Solvency ratios measure a company's ability to...
meet its long–term debt obligations
One point for solvency ratios
the ability to survive long enough to repay lenders when debt matures
debt to assets =
total liabilities/total assets
Three solvency ratios
times interest earned
capital acquisitions ratio