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Chapter 3 > Chapter 4 > Flashcards

Chapter 4 Flashcards

1
Q

Projections

A
  • What-if scenarios
  • precursor to actual forecast
  • Prepared for internal use
  • Assist managers in making decisions regarding products, acquisitions, revenues, expenses etc
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2
Q

Sensitivity Analysis

A
  • process of experimenting with different parameters and assumptions regarding a model and cataloging the range of results to view the possible consequences of a decision
  • Use probabilities to approximate reality
  • Also called “what-if” analysis
  • risk management tool
  • test the effect of specific variables on overall profitability
  • Used to determine which variables are the most sensitive to change and will have the greatest effect on bottom-line

Drawback: implicit assumption that variables are independent

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3
Q

Scenario Analysis

A

Different scenario which represent alternative possible outcomes

Find weighted total of scenario

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4
Q

Forecasting Techniques

A
  • Driven by historical data and actual expectation rather than hypothetical scenarios
  • Use for both external and internal users
  • Either quantitative or qualitative methods
  • Qualitative is based on opinions and judgments of managements and other experts
  • Quantitative use historical data and are categorized as either time series methods or causal methods
    • Time series use past trends to predict future variables
    • Causal methods are based on cause-and-effect relationships between variables
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5
Q

Forecasting Analysis

A
  • Extension of Sensitivity Analysis
  • Purpose: predicting future values of a dependent variable (one you are trying to explain) using information from previous time periods
  • Forecasting Revenues = sales are dependent variable
  • Forecasting Expenses = total cost are dependent variable
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6
Q

Regression Analysis

A

Linear regression is a method for studying the relationship between two or more variables

Used to predict the value of dependent variables

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7
Q

Simple Linear Regression Model

A

Explains the variation in a dependent variable as a linear function of one or more independent variables

Only one independent variable

Estimated the dependent variables

Most accurate method for classifying an object as either fixed or variable

y = a + Bx

Where:

y = dependent variable

x = independent variable (regressor)

a = y-axis intercept for the regression line

B = slope of regression line

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8
Q

Coefficient of Correlation (r)

A
  • Measures the strength of the linear relationship between the independent variable (x) and dependent variable (y)
  • Range of r is from -1.00 to 1.00
  • Perfect Positive Correlation (+1.00): dependent and independent variable move together in the same direction
    • increase in one is increase in another
    • upward slope
  • Prefect Inverse Correlation (-1.00): dependent and independent variables move in equivalent opposite directions
    • decrease in one is increase in another
    • downward slope
  • No Correlation (0.00): dependent and independent variables are not related in a linear fashion
    • movement in the independent variable cannot be used to predict movement in the dependent variable
  • Projecting Total Cost: (dependent variable) when predicting total cost as a function of fixed costs, variable costs and volume (independent variable), management’s expectation of the correlation coefficient is between 0.00 and 1.00
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9
Q

Coefficient of Determination (R^2)

A

Coefficient of determination is the proportion of the total variation in the dependent variable (y) explained by the independent variable (x)

Between 0 and 1

Higher the R^2, the greater proportion of the total variation in Y that is explained y the variation in x

Higher the R^2, the better the fit of the regression line

Percentage of variation in the dependent variable explained by the variation in the independent variables

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10
Q

High-Low Method

A

Technique used to estimate the fixed and variable portions of cost, usually production costs

Steps:

  1. Gather Data
    1. compare high and low volumes and costs- remove outliers
  2. Analyze Data
    1. Divide the difference between the high and low dollar total costs by the difference in the high and low volumes to obtain variable cost per unit
    2. Use either high volume or low volume to calculate the variable costs
    3. Subtract the total calculated variable costs from the total cost to obtain the fixed costs
  3. Formulate Results
    1. allows for preparation of a flexible/performance budget
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11
Q

Flexible Budget Formula

A

Results of high-low method

Series of budgets that are prepared for a range of activity levels rather than a single activity

Total Cost = Fixed Costs + (Variable Cost per Unit * Number of Units)

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12
Q

Learning Curve

A

Analysis based on the premise that as workers become more familiar with a specific task, the per-unit labor hours will decline as experience is gained and production becomes more efficient

Used to set standards and to project costs, as variable costs per unit should decline until a stead-state period is achieved

Once steady state occurs, labor hours per unit will remain constant

Activity must be repetitive in nature, involve intense labor and have little to no labor force turnover or breaks in production

Cumulative average time per unit falls to a fixed percentage of the previous average time

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13
Q

Cost-Volume-Profit (CVP) Analysis

A

Used by managers to forecast profits at different levels of sales and production volume

Point at which Revenues equals costs = Breakeven Point

aka Breakeven Analysis

Assumptions:

  1. All costs can be separated into either variable or fixed costs depending on behavior
  2. Volume is only relevant factor affecting cost
  3. All costs behavior in a linear fashion in relation to production volume
  4. Cost behaviors are to remain constant over the relevant range of production b/c assumption that efficiency of production does not change
  5. Cost show greater variability over time
  6. Assumes that product mix remains constant
  7. Direct Costing or Contribution Approach is used -→ No Absorption Approach
  8. Selling Price Remains Unchanged
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14
Q

Absorption Approach

A

Required for financial reporting under (GAAP)

Does not segregate fixed and variable costs

Encourages management to reduce inventory

Revenue

Less: COGS

= Gross Margin

Less: Operating Expenses

Equals Net Income

Difference between Contribution Approach is the treatment of fixed factory overhead

All fixed factory OH is treated as a product cost and is included in inventory values

COGS is both variable and fixed

Selling, general, and admin expenses are period costs used in the determination of net income

Reported on income statement separately from COGS

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15
Q

Contribution Approach

A

aka Variable Costing Method

To the income statement uses variable costing (direct)

Useful for internal decision making

Revenue

Less: Variable Cost

= Contribution Margin

Less: Fixed Costs

= Net Income

Variable costs include direct labor, direct materials, variable manufacturing OH, shipping and packaging, and variable selling expenses

Fixed costs include fixed OH, fixed selling, and most G&A expenses

  • Total or Per Unit: revenue, variable costs, and contribution margin may be expressed in total and on per-unit
  • Unit Contribution Margin: unit sales price minus the unit variable cost
  • Contribution Margin Ratio: contribution margin expressed as a percentage of revenues

Difference between Absorption Approach is the treatment of fixed factory overhead

All fixed factory OH is treated as a period cost and is expenses in the period incurred

Inventory costs only include variable manufacturing costs

Selling, general, and admin expenses are period costs used in the determination of net income

Above are a part of the total variable costs for the contribution margin

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16
Q

Breakeven Point in Units

A

= Total Fixed Costs

Contribution Margin per Unit

Where Contribution Margin = Selling Price - Variable Cost

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17
Q

Breakeven Point in Dollars using Contribution Margin per Unit

A

= Unit Price * Breakeven Point (in Units)

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18
Q

Breakeven Point in Dollars using Contribution Margin Ratio

A

= Total Fixed Costs

Contribution Margin Ratio

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19
Q

Required Sales Volume for Target Profit

A

pretax profits used

Sales (units) = (Fixed Cost + Pretax Profit)

Contribution Margin Per Unit

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20
Q

Sales Dollars Needed to Obtain a Desired Profit

A
  1. Summation of Total Costs & Profits

Sales Dollars = Variable Costs + Fixed Costs + Pretax Profit

  1. Contribution Margin Ratio

Sales = Fixed Costs + Pretax Profits

Contribution Margin Ratio

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21
Q

Predicting Profits Based on Volume

A

Profit = Units Above Breakeven Point * Contribution Margin Per Unit

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22
Q

Setting Selling Prices Based on Assumed Volume

A

Sales Price per Units = (Fixed Costs + Variable Costs + Pretax Profits)

Number of Units Sold

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23
Q

Margin of Safety Concepts

A
  1. Sales Dollars

= Total Sales (in $) - Breakeven Sales (in $)

  1. Percentage

= Margin of Safety in Dollars

Total Sales

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24
Q

Breakeven Charts

A

Graphically display the results of breakeven analysis

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25
Q

Target Costing (Used for Target Pricing)

A

concept of target costing uses the selling price of the product to determine the product costs to be allowed

When competition (cost leader) sets prices, any chance in price could easily cause a customer defection

Firs step establishing cost controls to ensure ongoing profitability

Target Cost = Market Price - Required Profit

Implication:

  • if management commits to target costs, serious measures must be employed to reduce costs
  • firms may sacrifice quality by reducing costs which can cause a loss in sales
  • may incur increased down stream costs in attempt to differentiate their produces and create brand loyalty and competitive advantage
  • advanced cost management techniques may have to be employed to attain a higher productivity level
  • product may have to be redesigned for the reduction of costs throughout the life cycle of a product (Kaizen Method)
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26
Q

Probability (Risk) Analysis

A

Is an extension of Sensitivity analysis

used to examine the possible outcomes given different alternative

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27
Q

Cost Determination

A

concept of target costing uses the selling price of the product to determine the product costs to be allowed

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28
Q

Cost-Based Pricing

A

Associated with:

Price stability

Price justification

Fixed-cost recovery

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29
Q

Weighted Average Contribution Margin Per Unit

A

Contribution Margin = Selling Price - Variable Cost

Weighted Average Contribution Margin Per Unit = (Contribution Margin * % Sold) + (Contribution Margin * % Sold) + etc

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30
Q

Ratio Analysis

A

Quick and easy way to evaluate a company’s past, present and future performance and financial standing

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31
Q

Liquidity Ratios

A

Focus is on current liabilities side of the company’s balance statement

Focus on whether a company will have enough current assets and other funds to pay the liabilities when they are due

Examples:

Current Ratio

Quick Ratio

Cash Ratio

Operating Cash Flow Ratio

Working Capital Turnover Ratio

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32
Q

Working Capital Ratio

A

= Current Assets - Current Liabilities

Components come from Balance Sheet

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33
Q

Current Ratio

A

= Current Assets

Current Liabilities

Components come from Balance Sheet

Higher Current Ratio is better b/c it implies that more current assets are available to pay short-term liabilities

34
Q

Quick Ratio

A

= Cash & Cash Equivalents + Short-term Marketable Securities + Receivables (Net)

Current Liabilities

Only includes more liquid sections of the current assets

Higher Quick Ratio the better b/c it implies that more current liquid assets are available to pay short-term liabilities

35
Q

Operating Cash Flow Ratio

A

= Cash Flow from Operations

Ending Current Liabilities

Measures how much cash a company has generated from operating activities to cover current liabilities

Higher ratio is more desirable and implies company is generating more cash from its core activities to pay current liabilities

36
Q

Working Capital Turnover Ratio

A

= Sales

Average Working Capital

Sales come from the Income statement

Working capital is calculated as the difference between current assets and current liabilities

Measures how well a company converts its working capital into sales

Higher the better

37
Q

Activity Ratios

A

Used to assess how efficient a company is at utilizing its resources to generate sales and profits

Examples:

Days in Inventory

Days Payable Outstanding

Days Sales in Accounts Receivable

Operating Cycle

Cash Conversion Cycle

38
Q

Days in Inventory

A

= Ending Inventory

COGS / 365

Indicates the average number of day required to sell inventory

Use Ending Inventory Data if not provided with multiple years

Output is in days

Lower the number of days the more efficient in converting inventory into sales

39
Q

Days Sales in Accounts Receivables

A

= Ending Accounts Receivable (Net)

Sales (Net) / 365

Indicates the receivables quality and the success of the firm in collecting outstanding receivables

Net Sales number is taken from the Income Statement and is equal to the Gross Sales minus Sales Return & Allowance

Receivables are often averaged in this ratio to align to the period covered by net sales

Use ending receivables if multiple year data is not provided

Computes Average number of days it takes to convert sales into cash

40
Q

Days Payables Outstanding

A

= Ending Accounts Payable

COGS/ 365

Accounts Payable will typically be averaged to align with the time period associated with the COGS

Use ending accounts payable if multiple year data is not available

Measures how long it takes for a company to pay its vendors for goods purchased on credit

41
Q

Cash Conversion Cycle

A

= Days in Inventory + Days Sales in Accounts Receivables - Days Payables Outstanding

The lower the cash conversion cycle the better because a company would want to minimize the number of days it takes to convert inventory into sales and sales into cash while taking as long as possible to pay its vendors

42
Q

Cash Conversion Cycle

A

= Days in Inventory + Days Sales in Accounts Receivables - Days Payables Outstanding

The lower the cash conversion cycle the better because a company would want to minimize the number of days it takes to convert inventory into sales and sales into cash while taking as long as possible to pay its vendors

43
Q

Debt Ratios

A

Measure the extent to which a company employs financial leverage in its capital structure

Although debt is cheaper than equity from a cost standpoint because of the tax benefits and lower interest rates, too much debt is risky

Examples:

Debt-to-Equity Ratio

Debt-to-Assets Ratio

Debt-to-Total Capital Ratio

Interest Coverage Ratio

Debt Service Coverage Ratio

44
Q

Debt-to-Equity Ratio

A

= Total Liabilities

Total Equity

Indicates the degree of protection to creditors in case of insolvency

Lower ratio is better

Lowering ratio can happen by paying down debt

Higher ratio implies more risk

45
Q

Total Debt Ratio

A

= Total Liabilities

Total Assets

or

= Debt / ( Debt + Equity)

Higher ratio indicates higher risk

Similar to debt-to-equity ratio

To improve, company must either reduce its liabilities or increase its total assets

46
Q

Times Interest Earned (Interest Coverage) Ratio

A

= Earning Before Interest Expense and Tax

Interest Expenses

Higher number implies a company has more funding to cover its required interest expenses associated with debt

47
Q

Profitability Ratios

A

Focus on determining how profitable a company is at various levels of its business

Examples:

Gross Margin

Operating Margin

Net Margin

Return on Equity

Return on Assets

48
Q

Gross Margin

A

= Sales (net) - COGS

Sales (net)

All else being equal, the higher the better

COGS is often forecasted to a specific percentage of sales– keeping gross margin constant

49
Q

Profit Margin

A

= Net Income

Net Sales

Goal is to increase the ratio done by controlling growth in costs while continuing to increase sales

Higher the better

Means a company is profitable after taking into account all costs associated with generating sales and operating its business

50
Q

Return on Equity (ROE)

A

= Net Income

Average Total Equity

Net Income comes from the Income Statement

Shareholder’s Equity comes from the Balance Sheet

Common to use average shareholder’s equity in the denominator

Higher is better = greater profitability, earnings per share and probable future stock growth

51
Q

Return on Assets (ROA)

A

= Net Income

Average Total Assets

Common practice is to take the average balance of assets from the beginning and end of the period in order to align with the period covered by net income

Higher implies that a company is generating more profits relative to its base of assets

52
Q

Inventory Turnover Ratio

A

= COGS / Average Inventory Balance

53
Q

Prime Costs

A

Prime Cost = Raw Material Cost + Direct Labor Cost.

54
Q

Operational and Tactical Planning

A

process of determining the specific objectives and means by which strategic plans will be achieved

short-term, cover periods of up to 18 months

Types:

  1. Single-Use Plans: developed to apply to specific circumstances during a specific time frame
  2. Annual Budget: type of single-use that translates the strategic plan and implementation into a period-specific operational guide
55
Q

Budget Policies

A
  • organization should implement formal budget policies
  • usually will extend for one year and involves numerous individuals
  • budget committee -→ which includes senior management
    • charged with dispute resolution and making final decisions
  • Guidelines
    • provided by management
    • based on entity’s short-term and long-term goals
    • Should include:
      • consideration of changes to the environment since the adoption of the strategic plan
      • organizational goals for the coming period
      • operating results year-to-date
    • Management Instruction will set the tone and corporate policy
56
Q

Standards and Benchmarking

A
  • Standards are often set below expectations to motivate productivity and efficiency, but those standard costs much be revised periodically to reflect changes in previously determined standards
  • Ideal Standards: represent the costs that results from perfect efficiency and effectiveness in job performance
    • generally not historical → forward thinking
    • No provision is made for normal spoilage or downtime
    • Advantages: implied emphasis on continuous quality improvement CQI to meet the ideal
    • Disadvantages: demotivation of employees by the use of unattainable standards
  • Currently Attainable Standards: represent costs that results from work performed by employees with appropriate training and experience but without extraordinary effort
    • Provisions for normal spoilage and downtime
    • Advantages: fosters the perception that standards are reasonable
    • Disadvantages: required use of judgment and potential manipulation
  • Authoritative Standards: Set exclusively by management
    • Advantages: can be implemented quickly and will likely included all costs
    • Disadvantages: workers might not accept imposed standards
  • Participative Standards: set by both managers and individuals who are held accountable to those standards
    • Advantages: workers are more likely to accept participative standards
    • Disadvantages: participative standards are slower to implement
57
Q

Master Budgets

A
  • Called Annual Business Plan
  • documents specific goals for a period, normally one year or less
  • Includes an Operating (nonfinancial) budget and financial budget that outlines the sources of funds and detailed plans for their expenditure
  • Purpose: provide comprehensive and coordinated budget guidance for an organization consistent with overall strategic objectives
  • Control Objective: serves to communicate the criteria for performance over the period covered by the budget
  • AKA Static Budgets, Annual Business Plans, Profit Planning or Targeting Budgets
  • Use: useful for most industries but particularly useful for manufacturing settings
  • Components:
    • Compromises operating budgets and financial budgets prepared in anticipation of achieving a single level of sales volume for a specific period
    • Pro Forma Financial Statements
    • Assumptions: Pro Formas are supported by schedules that reflect the underlying operating assumptions that produce those statements
  • Limitations:
    • Master Budget confined to one year at a single level of activity
    • Seasonality not considered
    • Pro Forma might not provide the type of information useful in decision making
58
Q

Mechanics of Master Budgeting

A

Operating Budgets: established to describe the resources needed and the manner in which those resources will be acquired

Includes:

  • Sales Budgets
    • foundation of entire budget process
    • units and dollars
    • first to be produced
  • Production Budgets
  • Selling and Admin Budgets
  • Personnel Budgets

Financial Budgets: define the detailed sources and used of funds to be used in operations

Includes:

  • Pro Forma Financial Statements
  • Cash Budgets
59
Q

Sales Forecasting and Budgeting

A

Sales Budget: based on the sales forecast which are derived from input received from numerous organizational resources including opinions of sales staff, statistical analysis of correlation between sales and economic indicatory and opinions of line managements

Consider the following:

  • Past patterns of sales
  • sale force estimates
  • general economic conditions
  • competitors’ actions
  • changes in the firm’s prices
  • changes in product mix
  • results of market research studies
  • advertising and sales promotion

First step in sales planning process is to develop management guidelines specific to sales planning, including the sales planning process and planning responsibilities

60
Q

Operating Budgets: Production Budgets

A

Production. Inventory Budgets are prepared for each product or each department based on the amount that will be produced, stated in units

  • includes amount spent on direct labor, direct materials, and factory overhead
  • amount is based on the amounts of inventory on hand and inventory necessary to sustain sales

Establishing Required Level of Production

Budgeted Sales

+ Desired Ending Inventory

  • Beginning Inventory

Budgeted Production

Other Factors:

  • Company policy regarding stable production
  • Condition of production equipment
  • Availability of productive resources
  • Experience with production yields and quality
61
Q

Direct Materials Budget

A

Direct materials required to support the production budget are defined by the direct materials purchases budget and direct materials usage budget

  1. Direct Materials Purchases Budget: represents the $ amount of purchases of direct materials required to sustain production requirements
    1. Number of Units to be Purchased: # of units of direct materials to purchase is calculated from production budget

Units of Direct Materials Needed for a Production Period

+ Desired Ending Inventory at the End of the Period

- Beginning Inventory at the Start of the Period

Units of Direct Materials to be Purchases for the Period

  1. Cost of Direct Materials to be Purchased:

Units of Direct Material to be Purchased for the Period

X Cost per Unit

Cost of Direct materials to be Purchased for the Period (purchased at cost)

  1. Direct materials Usage Budget (Cost of Direct Materials Used) represents the number of units of direct materials required for production along with the related cost of those direct materials

Beginning Inventory at Cost

+ Purchases at Cost

- Ending Inventory at Cost

Direct Materials Usage (cost of materials used)

  • effected by philosophy regarding required inventory levels, safety stock and OOS decisions
62
Q

Direct Labor Budget

A

anticipated the hours and rates associated with workers directly involved in meeting production requirements

Budgeted Production (in units)

* Hours (or fractions of hours) required to produce each unit

Total Number of Hours Needed

* Hourly Wage Rate

Total Wages

63
Q

Factory Overhead Budget

A

Includes fixed and variable production costs that are not direct labor or direct materials

Applied to inventory (COG manufactured and sold) based on a representative statistic (cost driver) (ex. Direct Labor Hour)

64
Q

Cost of Goods Manufactured & Sold Budget

A

Accumulated the information from the direct labor, direct material, and factory overhead budgets

Cost of Goods Manufactured = Direct Labor + Direct materials + Factory overhead

(also includes WIP inventory budgets)

Cost of Goods Sold = Cost of Goods Manufactured + Beginning Finished Goods Inventory - Ending Finished Goods Inventory

65
Q

COGS & Pro Forma Financial Statements

A
  • COGS Budget feeds directly into the pro forma income statement
  • Budgeted COGs is matched with Budgeted sales as the basis for budgeted gross margin
66
Q

Operating Budgets: Selling and Administrative Expenses Budget

A

expenses represent the fixed and variable nonmanufacturing expenses anticipated during the budget period

Need to be detailed in order that the key assumptions can be better understood

Components:

Variable Selling Expenses:

  • Sales commissions
  • Delivery expenses
  • Bad-debt Expenses

Fixed Selling Expenses

  • Sales salaries
  • Advertising
  • Depreciation

General Administrative Expenses (All Fixed)

  • Administrative Salaries
  • Accounting and Data Processing
  • Depreciation
  • Other
67
Q

Selling & Admin Expenses and the Pro Formas

A

are not inventoried and are budgeted as period costs

matched against their entirety against the sales budget

68
Q

Order of Four Budget Types

A

Sales → Production → Direct Materials Purchased → Cash Disbursements

69
Q

Cash Budget

A
  • Cash budget shows itemized cash receipts and disbursements during the period, including the financing activities and the beginning and ending cash balances
  • Cash budget alerts management to period when there will be excess cash available for investment
  • Cash budget is usually broken down into monthly periods
70
Q

Engineering Standards Based on Attainable Performance

A

best basis upon which cost standards should be set to measure controllable production inefficiencies

71
Q

Sequence for Preparing Budgets

A

Production Budget → Material Purchases Budget → Budgeted Income Statement → Budgeted Balance Sheet

72
Q

Manufacturing Variances

A

purpose of determining and assigning responsibility is to use the knowledge about the variances to promote learning and continuous improvement.

73
Q

Labor Usage Variance

A

Difference between stand hours at standard wage and actual hours at standard wage

74
Q

Flexible Budget Variance

A

difference between the actual amounts and the flexible amounts for the actual output achieved

75
Q

Revenue Variance or Sales Price Variance

A

due to change in unit selling prices

found by comparing actual results with the flexible budget

76
Q

Materials Efficiency Variance

A

= Standard Price * (Standard Quantity Use - Actual Quantity Used)

77
Q

Spending Variance

A

Balance in OH Account is equal to the sum of that variances

Debit balances are unfavorable

credit balances are favorable

78
Q

Relevant Cost Examples

A

Differential Cost, Incremental Costs, Avoidable Costs

Not = Variable costs

79
Q

Most Direct Way to Prepare a Cash Budget?

A

Projected sales and purchases → percentages of collections, and terms of payments

80
Q

Information from a Cash Budget

A
  • Availability of funds for investment purposes
  • Availability of funds for distribution to owners
  • Availability of funds for the repayment of debt

Chapter 3 (4 decks)

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