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Flashcards in Operations Management & Strategic Planning (26%) Deck (123):

Indirect Labor and Indirect Materials costs are what type of cost?

Conversion costs (as a component of OH)


Costs on an Income Statement

Net Sales

- COGS ----------> Product Costs

= Gross Profit

- SG&A Expenses ---------> Period Costs

= Net Profit (Loss)


Overhead Rate Methodology

  • Estimated amounts based on currently attainable capacity are always used for this formula— not historical, ideal, or theoretical amounts. This is likely to be a frequently tested concept on the CPA exam.

An overhead application rate is commonly called a predetermined ("estimated" = "budgeted") overhead rate and is computed as follows:

Estimated Total Overhead Costs / Estimated Activity Volume

  • Direct materials and direct labor are traced to the Work-in-Process (WIP) account, but overhead must be allocated to WIP. Since overhead costs are typically not directly traceable to specific units of production, an estimated overhead amount is applied to production based on a predetermined rate. Actual overhead costs are accumulated separately. At the end of the period, the applied overhead is compared to the actual overhead and an entry is made to adjust any difference.
  • The result of this calculation is the overhead allocation rate (or overhead application rate). The overhead allocation rate is normally established prior to the beginning of the period. That is, it is a predetermined rate.


Applied Overhead T-Account Entry

Actual Overhead T-Account Entry

OH Applied - sent to WIP

  • DR: Work-in-Process
    • CR: Factory Overhead Applied

Actual OH - sent from DM and DL (left side of T-Account)

  • DR: Factory Overhead Control Utilities Expense
    • CR: Accounts Payable


Closing out the OH Account - T-Account Entry

  • DR: Factory Overhead Applied
    • CR: Factory Overhead Control

Immaterial deltas are typically allocated to COGS.  

Material differences should be allocated PRO-RATA to WIP, FG and COGS based on their respective ending balances.  This will be tested on exam.  



MFG OH Overapplied to WIP vs. Underapplied MFG OH

Overapplied (allocated) = When more overhead costs are applied to products than are actually incurred, factory overhead is said to be overapplied. When the accounts are closed at the end of the period, overapplied overhead reduces Cost of Goods Sold.

Underapplied (allocated) = When actual OH is > OHA (or budgeted). When the accounts are closed at the end of the period, underapplied overhead increases Cost of Goods Sold.  For overhead to be underapplied, either the actual fixed costs must be greater than the budgeted fixed costs or the actual volume must be less than the budgeted volume.


Summary of OH Application (3 steps at 3 time periods during the year)

  1. At the beginning of the year, we calculate the predetermined overhead allocation rate (POR). For example, estimated overhead is divided by estimated direct labor hours.
  2. During the year, we periodically allocate overhead by multiplying the overhead allocation rate (POR) by the actual units of the allocation base.
  3. At the end of the year we dispose of over/underapplied overhead by taking the difference between actual overhead and applied overhead to Cost of Goods Sold.


Conversion Cost

Conversion cost is the sum of direct labor and overhead. It is so named because this is the cost of the efforts that convert raw material into finished goods.

Indirect labor is included in overhead and, thus, is part of conversion cost.


Flow of Inventory Calculation (must know this for multiple sections of CPA exam)

+ Beginning Inventory

+ Purchases

= COG Available for Sale

- Ending Inventory (reported on B/S)

= COGS (appears as line item on I/S)



Direct Materials Formula (Step 1)


+ DM Purchased

= DM Available for Use


= DM Used (flows to Total Manufacturing Costs)


Total Manufacturing Costs (Step 2)

DM Used

+ DL


= Total MFG Costs (flows to CGM)


CGM (Step 3)


+ Total MFG Costs

= WIP Available


= CGM (Flows to CGS)


CGS (Final Step in Inventory Flow, hits Income Statement)


+ CGM (i.e. Total Production Costs)

= CG Available for Sale




What inventory accounts are analyzed for:



CGM = Raw Materials and WIP

CGS = Finished Goods



Scrap is included in product costs along with normal spoilage.  

  • Scrap is the material left over after making a product. It has minimal or no sales value. Scrap is automatically included in work in process for a product because it is part of the material cost of a product. In many manufacturing settings, it is impossible to use every bit of material input. For example, the circular punch-outs for conduit boxes are scrap.
  • Normal spoilage is output that cannot be sold through normal channels. It is an inherent result of production. In many cases, it is not cost effective to attempt to reduce the normal spoilage cost to zero. It is a normal part of the production process and, therefore, its cost is included in the cost of units produced.
  • Abnormal spoilage is considered avoidable. It occurs as a result of an unexpected event, such as a machine breakdown or accident. This cost is treated as a loss rather than a normal production cost.


When a flexible budget is used, a decrease in production levels within a relevant range will do what to total costs?

Decrease total costs.  

Variable cost per unit is assumed to be constant throughout the relevant range. A decrease in production causes total variable costs to decrease, but not variable cost per unit. Also, variable cost per unit should not increase with lower production. 


Cost = FC + VC(vc/unit)

This formula is crucial in calculating many total cost questions.  Using the high-low method, remember the Rise/Run to arrive at vc/unit, then solve for FC by plugging in facts from one set of facts given.  


Activity Based Costing (ABC) vs. Traditional Cost Systems

ABC shifts costs away from high-volume simple products toward lower volume and more complex products.  Cost drivers are used as a basis for cost allocation and activities that are non-value adding are eliminated or reduced to the greatest extent possible.  

Adopting ABC will effect:

  1. more precise cost accuracy
  2. more cost pools
  3. more allocation bases

A tradition system tends to over-cost high volume products and undercost low volume products.  


  1. Re-engineering
  2. Shared Services
  3. Outsourcing
  4. Off-shoring

  1. a process analysis approach that typically results in radical change. This is a different approach from incrementally reducing and eliminating non-value added activities, and otherwise improving processes.
  2. one part of an organization provides an essential business process where previously it was provided by multiple parts of that same organization
  3. taking an internal activity and moving it to an external third party service provider
  4. moving a process outside of the country.  Off-shore operations are especially vulnerable to cultural/language issues and difficulty protecting intellectual property rights.


Absorption costing (required by SEC) vs. Direct Costing

  • ONLY difference concerns the treatment of Fixed MFG Costs.  
  • Variable Costing (Direct) treats FC as a period expense and is used only for internal decision making.  

Absorption costing: Assigns all three factors of production (direct material, direct labor, and both fixed and variable manufacturing overhead) to inventory. i.e. Fixed Cost = Product Cost

  1. The absorption model assigns all manufacturing costs to products.

Direct costing: (also known as variable costing) Assigns only variable manufacturing costs (direct material, direct labor, but only variable manufacturing overhead) to inventory.

  1. The direct model assigns only variable manufacturing costs to products.

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Variable (Direct) Costing Method of Arriving at Income =  Contribution Margin Format

The contribution margin equals sales minus variable costs. Fixed costs are deducted from the contribution margin to calculate income.


- Variable MFG

- Variable SGA (these are still NOT product costs!)

= Contribution Margin

- Fixed MFG

- Fixed SGA

= Operating Income


Absorption Costing Method of Arriving at Income =  CGS Format

Fixed Mfg. OH is allocated to each item produced.  If we produce more than we sell, a portion of the Fixed Mfg. OH is capitalized as inventory (becomes an asset) until it is sold.  


- VC for units sold

- FC for units sold

= Gross Margin

- Variable SGA

- Fixed SGA

= Operating Income


Remember that variable selling and administrative expenses under the Absorption and Direct (Variable) Costing methods are:

NOT Product Costs

Remember also that under both methods it is POSSIBLE to arrive at the same net income total.  


Absorption vs. Direct (Variable) Income

If Units Sold = Units Produced

  • AC income = VC income

If Units Sold > Units Produced

  • AC income < VC Income

If Units Sold < Units Produced 

  • AC income > VC income

when we produce more than we sell, under the AC method, which capitalizes any remaining FC to inventory as an asset, income will be higher than VC income.  



Job Order Costing

Job order costing is used to accumulate costs related to the production of large, relatively expensive, heterogeneous (custom-ordered) items. Costing follows the general rules for manufacturing cost flows and is relatively straightforward.  

As with traditional costing methods, estimated amounts based on currently attainable capacity are always used for this formula.  

  • Immaterial differences between the two amounts are usually allocated to COGS.
  • If the difference is material, it should be prorated to WIP, finished goods, and COGSbased on their respective ending balances.


Applied OH

Applied Overhead = (bud. FOH/bud. volume) X (actual volume)


Process Costing

Process costing is used to accumulate costs for mass-produced, continuous, homogeneous items, which are often small and inexpensive.  Job Order Costing is exactly the opposite.

Since costs are not accumulated for individual items, the accounting problem becomes one of tracking the number of units moving through the work-in-process (WIP) into finished goods (FG) and allocating the costs incurred to these units on a rational basis. The cost allocation process is complicated because:

  • There may be partially completed items in beginning and ending inventories.
  • Each of the three factors of production (labor, material, and overhead) may be at different levels of completion, making it necessary to perform separate calculations for each factor.
  • Some costs do not occur uniformly across the process; this is particularly true for direct materials (DMs). This is why the two categories of the factors of production indicated are typically DMs and conversion costs (i.e., direct labor [DL] and overhead [OH]). DL and OH are normally included together because they are typically uniformly incurred.



CGS is called what in Process Costing?

The term "cost of goods transferred out" is often used in process costing rather than the "cost of goods finished" since the units could be transferred through several departments prior to going to FG inventory. Cost of goods finished would only accurately apply to the last department in the sequence.


Which of the following types of budgets is the last budget to be produced during the budgeting process?

  • Cash
  • Capital
  • Cost of Goods Sold
  • Marketing


The cash budget is the last budget to be prepared and includes a plan for earning and financing all of the strategic action plans of the enterprise and other incidental issues earning and requiring cash flow.


Define Static Budget

Budgeted Costs for Budgeted Output

A static budget is a comprehensive financial plan produced at the beginning of the year for the entire enterprise and does not change (or flex) during the year. Thus, it uses budgeted costs based on budgeted output.

The Master Budget is a static budget.  


Regression Equation and Graph

y = A + Bx

  • y = dependent variable
  • A = the y-intercept
  • B = the slope of the line
  • x = independent variable

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Correlation Coefficient (R)


The correlation coefficient (R) measures the strength of the relationship between the dependent and independent variables. The correlation coefficient can have values from −1 to 1 where:

  • 1 indicates perfect positive correlation (as x increases, so does y),
  • −1 indicates perfect negative correlation (as x increases, y decreases), and
  • 0 indicates no correlation (you cannot predict the value of y from the value of x).


Coefficient of Determination (R2 or R-squared)

The coefficient of determination, identified as R2 (R-squared), indicates the degree to which the behavior of the independent variable predicts the dependent variable. The coefficient of determination is calculated by squaring the correlation coefficient. R2 can take on values from 0 to 1.

  • The closer R2 is to 1, the better the independent variable predicts the behavior of the dependent variable.


Transfer Pricing Methodologies

  1. Market price - Market price is the "theoretically correct" transfer price. The price the purchasing unit would have to pay on the open market.
  2. Cost-based price - one of several variations on the selling units' cost of production: variable cost, full cost, cost "plus" (a percentage or a fixed amount).
  3. Negotiated price - a price that is mutually agreeable to both the selling and purchasing unit.


Transfer Pricing:

  1. Goal Congruence
  2. Suboptimization
  3. Goal Incongruence

  1. Goal Congruence - Senior management establishes the methodology for setting internal TP's in such a way as to promote goal congruence. Goal congruence occurs when the department and division managers make decisions that are consistent with the goals and objectives of the organization as a whole.
  2. Suboptimization - when both managers act in their individual best interests, the organization as a whole may suffer resulting in suboptimization. Typically occurs in decentralized organizations.  
  3. Goal Incongruence - exists when actions encouraged by the reward structure of a department conflict with goals for other departments or the organization as a whole.


Transfer Pricing - rule that helps to ensure goal congruence is achieved.  

Transfer Price per Unit = Additional Outlay Cost per Unit + Opportunity Cost per Unit

Opportunity Cost per Unit = Selling Price per Unit - Additional Outlay Cost per Unit

General rule is that the minimum transfer price (floor) is equal to the avoidable outlay costs, while the maximum transfer price (ceiling) is equal to the market price. However, this is only true where idle capacity exists to make the transfer.


Breakeven Point (BEP) Decrease Rationale

The breakeven point is the ratio of fixed costs to the contribution margin ratio (or contribution margin per unit for the unit breakeven point). If the fixed costs are decreased (numerator), and the contribution margin is increased (increasing the denominator of either breakeven formula), then the ratio and, therefore, the breakeven point decrease. Decreasing the fixed costs causes the numerator of the ratio to decrease, and increasing the contribution margin causes the denominator to increase. Both changes have the effect of decreasing the ratio. This also makes real-world sense. If fixed costs have decreased, it is easier for the firm to break even because there are less fixed costs to cover. Likewise, if the contribution margin increases, each unit provides a greater contribution to covering fixed costs, thus requiring the sale of fewer units to break even.


Break-even Point (BEP)

In the linear Cost-Volume-Profit Analysis model (where marginal costs and marginal revenues are constant, among other assumptions), thebreak-even point (BEP) (in terms of Unit Sales (X)) can be directly computed in terms of Total Revenue (TR) and Total Costs (TC) as:

  • TR = TC
  • P x Units = TFC + VC x Units
  • P x Units - VC x Units = TFC
  • (P - VC) x Units = TFC
  • BE Units = TFC / (P - VC)



Contribution Margin

CM focuses on cost behavior whereas Gross Margin is used for traditional external reporting

CM = Revenue (or Sales) - Variable Costs

For breakeven analysis:

  • Total Contribution Margin = Total Fixed Costs
  • Unit CM x Units = TFC
  • BE Units = TFC / Unit CM
  • BE Sales = TFC / (CM/P)

CM is the selling price per unit minus the variable cost per unit. “Contribution” represents the portion of sales revenue that is not consumed by variable costs and so contributes to the coverage of fixed costs.


Margin of Safety

MoS = Current Output - Break-even Output

or Current Sales - Break-even Sales


Standards vs. Budget

Standards are developed for each factor of production (materials, labor and overhead) and may be used to value inventory (raw materials, WIP, FG) and CoGS.  

Standard costs are budgeted amounts, but are actually entered into the General Ledger.  


  1. Cost (Price or Rate) Variances
    1. remember for cost variances always calculate using S - A, it results in proper signage for favorable (unfavorable)
  2. Quantity (Usage or Efficiency) Variances

Price Variances (responsibility of purchasing department)

  • Price/Rate = (Difference in Prices) x Actual Units
  • Usage/Efficiency = (Difference in Quantities) x Standard Rate

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For purposes of allocating joint costs to joint products, the sales price at point of sale reduced by cost to complete after split-off is assumed to be equal to the...

Relative sales value at split-off.


Joint Costs Allocation - Net Realizable Value Method

Remember you must subtract the separable costs from the Sales Value for each product and then compute the weight for each product.  Example attached, Product A carries an 80% weight based on 72/90.


Balanced Scorecard

The balanced scorecard is a strategic performance measurement and management framework for implementing strategy by translating an organization’s mission and strategy into a set of performance measures.  These performance measures are generally in four primary perspectives: 

  1. Financial - investment focused 
  2. Customer - customer centric
  3. Internal business processes - operations 
  4. Learning and growth - employees


An increase in production levels within a relevant range most likely would result in?

Increasing Total Cost.  


Relevant Costs

Relevant costs and benefits

  • future costs and benefits that differ among alternatives
  • avoidable costs are those that can be eliminated by choosing one alternative over the the other - they are always considered relevant.  


Irrelevant Costs

  1. Sunk costs—A sunk cost is a cost that has already been incurred and cannot be changed. For example, when deciding whether to buy a new car or keep your current car, the price paid for the current car is irrelevant as it occurred in the past and cannot be changed.  On the other hand, the market value of the current car if you sold it is relevant to the decision as it differs between the two alternatives: if you buy the new car, you can sell the current car for its market value; if you keep the current car, you forgo receiving its market value.
  2. Future costs and benefits that do not differ between alternatives—Future costs that do not differ between alternatives tend to be fixed costs or allocated costs.


Unavoidable Costs compared to Fixed Costs

Fixed costs are not equivalent to unavoidable costs. Unavoidable costs cannot be changed while fixed costs can change. Remember that fixed costs are fixed with respect to output. For example, utility costs of heating fluctuate constantly with weather conditions and the commodity price per unit of natural gas—but this does not make them variable. Fixed costs are always fixed with regard to the volume of units produced/sold.


Sell Now or Process Further Decision - Relevant Costs

  • Joint costs are not relevant

When making this decision, the only relevant facts are the differential future costs and benefits:

  • separable costs incurred beyond split-off point, and
  • the difference between the revenue that can be earned at split-off and the revenue that can be earned after further processing.  

Remember that the joint costs are not relevant.


Keep or Drop a Product Line (or Business Segment) Decision - Relevant Costs


When organizations track performance by product line or business segment, they often discover that some products and segments do not perform as well as others and that some may even be operating at a loss. The problem then becomes whether to continue producing the product or segment or to eliminate it.

The decision is not as straightforward as it might appear because:

  1. Some of the costs charged to the product or segment may not be eliminated if the product or segment is eliminated
  2. Changes in one part of the organization may impact other parts of the organization
  3. There may or may not be alternative uses for the resources freed up by elimination of the product or segment.

Remember that VC are generally avoidable costs and FC are both avoidable and unavoidable.  

Key Points:

  1. elimination of losing segment will also eliminate the CM provided by losing segment.  
  2. Some costs are avoidable and some are not
  3. There may be unintended negative consequences on other remaining segments


Special Order Decision - Relevant Costs

Only relevant costs are the costs directly attributable to the special order, and if the company is operating at capacity, the opportunity costs associated with the production that must be cancelled in order to complete the special order.  

  • SO's with Excess Capacity: can be completed with existing capacity, only sales revenues and the (avoidable) variable costs of producing need to be considered.
  • SO's without Excess Capacity: acceptance of a SO means that other units must be removed from production schedule to make room for the SO.  The foregone profits related to the units that were removed from production represent opportunity cost that must included in the analysis of the SO.  


The Outsourcing (make or buy) Decision - Relevant Costs

The decision of whether to outsource production - to make or buy a component - is based on comparative analysis of the external purchase costs and the relevant costs of internal production.  

The buy price is usually given on the exam.  

One additional component when making a make or buy decision would be the quality of the supplier's product.  Is it adequate?


Exponential Smoothing

Exponential smoothing is a quantitative approach to predicting sales based on historical amounts.


High Low Method of calculating estimated variable cost

  • Remember most questions might not give you FC and you will have to solve for FC.  Do this by plugging in one of the total costs from either end of the range and using the VC per unit that you found with high/low and plug that into the cost equation of y = Mx + B

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Typical product-costing systems synchronize the recording of accounting-system entries with the physical sequence of purchases and production. The alternative (which is normally used in high-speed automated environments) of delaying journal entries until after the physical sequences have occurred is referred to as?

Backflush Costing


Just-in-Time (JIT)

Note - sales forecasts must be shared with vendors for JIT to be effective.  

Just-in-time (JIT) is a demand-pull inventory system which may be applied to purchasing so that raw material arrives just as it is needed for production. JIT may also be applied to production so that each component of the completed good is produced only when needed by the next production step.  And, finished goods are produced only when sales orders are received. 

  • Reduction of inventories, ideally to 0.  
  • Emphasis on solving production problems immediately
  • Emphasis on reducing production cycle time
  • Focus on simplifying production activities


Advantages of JIT Inventory System

  • Lower investments in inventories and in space to store inventory.
  • Lower inventory carrying and handling costs.
  • Reduced risk of inventory obsolescence.
  • Reduced manufacturing costs.
  • The luxury of dealing with a reduced number (when compared with traditional systems) of reliable, quality-oriented suppliers.


Relationship between Product Production Budget and Purchases Budget



ADD Desired End FG Inv.

= Total Needs


= Units to be produced----->

Units to be produced x DM/unit = Production Needs

Direct Materials Budget

Production needs

ADD Desired End DM Inv.

= Total needs


= DM to be purchased in units

x Price/unit = DM purchased in dollars


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When production levels are expected to decline within a relevant range, and a flexible budget is used, what effect would be anticipated with respect to each of the following?

  • VC/unit
  • FC/unit

  • No change to VC/unit 
  • FC/unit will increase

By definition, variable costs per unit do not fluctuate within a relevant range. However, as production levels decline there will be fewer units over which to spread fixed costs, and fixed costs per unit will increase.



  • Budget
  • Flexible Budget
  • Performance Report

  • Budget - quantification of the plan for operations
  • Flexible Budget - budget that is adjusted for changes in volume (sales)
    • VC/unit are assumed constant through a relevant range, FC/unit will change with production volume (i.e. production up, FC/unit are down because the allocation base gets bigger and vice versa)
  • Performance Report - compare budgeted and actual performance


In the contribution margin approach to pricing, the price at which the income remains constant is equal to the price that covers?

Variable Costs

Prices under the contribution margin approach are set at variable cost plus a percentage markup. The percentage markup, or contribution margin, will be used to cover fixed costs and any remainder will be profit. If the selling price is set at variable cost, no contribution margin will be generated. Therefore, income will remain constant.


The method for allocating service department costs that best recognizes the mutual services rendered to other service departments is the?

Reciprocal Allocation Method

The linear algebra or reciprocal allocation method recognizes reciprocity among service departments by explicitly including the mutual services rendered among support departments.


Each of the following business functions is considered part of a company's value chain, except

  • Accounting.
  • Customer service.
  • Marketing.
  • Research and development


The value chain is the activities required for a firm to deliver a product or service to market. The accounting function is not part of the value chain.


Gross Profit (or Margin) and Gross Margin Percentage


GP or GM = Sales (or Revenue) - CGS

GM% = GP / Sales


What impact does safety stock have on Economic Order Quanty?

No impact.  Safety stock is a buffer for variations in demand and lead-time for the delivery of material. Safety stock affects the reorder point, but does not enter into the quantity to be ordered.


Backflush Costing System

A backflush costing system is used in just-in-time inventory systems. Part of the philosophy of JIT is to reduce nonvalue-added activities, and reduce defects. Part of the aim is to reduce accounting costs that are nonvalue-added. Backflush costing systems simplify product costing by costing production at the completion of an order. Minimal inventories are maintained, and cellular production facilities are used.

Thus, there is much less need to maintain detailed records of cost by job. The job is simply costed at completion. There is no need to know the cost until that time. Inspection costs are reduced because zero defects is a goal. Production stops until the cause of the defect can be identified and fixed.


Four Perspectives of Benchmarking

  1. Financial - specific measures of financial performance
  2. Customer - targeted customers and market segments
  3. Internal Business Processes - internal operations that create value
  4. Learning, Innovation & Growth - internal employee initiatives


Dupont ROI

 - this separates ROI into two pieces for analysis

  • profit as % of sales
  • efficiency at which assets were utilized

Dupont ROI = Return on Sales x Asset Turnover

where ROS = Net Income / Sales

where AT = Sales / Total Assets


Return on Sales (AKA Profit Margin)

Net Income / Sales


Asset Turnover (AKA Capital Turnover)

Sales / Total Assets


Economic Value Added (EVA)

this is part of a more contemporary approach to strategic decision making under an umbrella called Value Based Management.  

EVA = NOPAT - WACC(Total Assets - Current Liabilities)

EVA = NOPAT – (WACC x Capital Invested)

Where Capital Invested or Net Assets = TA - CL


Residual Income

  • a general form of economic profit

Use of RI solves the diluted hurdle rate problem related to accrual accounting.  

RI = Operating Income - (RRofR x Invested Capital)


Price Elasticity Impact on Revenue

Elastic product - revenue is uncertain

Inelastic product - as price increases, revenue will increase as well.  


Traditional Gross Margin Income Statement

Absorption cost method that is required for SEC external reporting

  • Sales 20,000
  • - CGS 12,000
  • GM = 8,000
  • - SGA 3,000
  • EBIT = 5,000


Contribution Margin Income Statement

  • Sales 20,000
  • - VC 7,000
  • CM = 13,000
  • - FC 8,000
  • EBIT = 5,000


Operating Margin vs. Profit Margin

Remember that PM is also known as Return on Sales (ROS)

Operating Margin = Operating Income / Sales

  • Typically a better representation of how the business is performing before the inclusion of interest and taxes.  Operating Income = EBIT

Profit Margin = Net Income / Net Sales

  • Important measure in external reporting.  It is the after-tax ratio of income over sales.  



Receivables Turnover


  • the word turnover means that the named ratio is the denominator
  • typically when dealing with balance sheet and income statement accounts, use the average for the BS amount.  (but use total if not given proper facts to calculate average)

ART = Sales on Account / Avg. Accounts Receivable


Days Sales in Receivables (aka Average Collection Period)

Average A/R / Average Sales per Day


Inventory Turnover


CGS / Average Inventory


Liquidity Ratios (measures of short-term solvency)

  • Current (Working Capital)
  • Quick (or Acid Test)

  • Current Ratio = CA - CL
  • Quick (acid) = (CA - Inventory) / CL


Debt Utilization Ratios

- ability of firm to service LTD and provides a measure of risk, higher the ratio the greater risk.  

  • Debt to Assets
  • Debt to Equity
  • Times Interest Earned

  • Debt to Assets = Total Debt / Total Assets
  • Debt to Equity = Total Debt / Total OE
  • TIE = Operating Income / Interest Expense

TIE represents a firm's ability to make regular interest payments and service its debt obligations


Market Ratios

  • Price Earnings (PE)
  • Market-to-Book
  • Book Value per share

  • Price Earnings (PE) = Market Price per Share / EPS
  • Market-to-Book = Market Value per Share / Book Value per Share
  • Book Value per share = Common SOE / # CS outstanding


A manufacturing company properly classifies and accounts for one product as a by-product rather than as a main product because it...

Has low sales value when compared to the main products.


A basic assumption of activity-based costing (ABC) is that...

Products or services require the performance of activities, and activities consume resources.

ABC is based upon two principles. First, activities consume resources. Second, these resources are consumed by products, services, or other cost objectives (output). ABC allocates overhead costs to products on the basis of the resources consumed by each activity involved in the design, production, and distribution of a particular good.

When the company produces products that heterogeneously consume resources, an activity-based costing system improves costing.


Average Collection Period Calculation

Avg. A/R / Avg. Sales Per Day


Material Efficiency Variance

(Standard Quantity - Actual Quantity) x Standard Price

standard can also be stated as "budgeted" or "estimated"


Which of the following forecasting methods relies mostly on judgment?

  • Time series models
  • Econometric models
  • Delphi
  • Regression


The Delphi technique may be used to assist in developing qualitative forecasts.  This technique develops consensus among a group about the future through a series of structured questionnaires and an iterative process.


Sequence of Budget Preparation

  1. Sales - first budget developed
    1. first step in sales budget is determining sales volume
  2. Production
  3. Direct Materials Purchases
  4. Cash Disbursments - last in budgeting process



Risk Types

  1. Strategic Risk - addresses long-term & broad exposure related to overall strategy of the organization.  this is managed by rigorous planning and long-term forecasting.  
  2. Operational Risk - short-term in nature and includes risk covering processes, shared services, onshore/offshore & credit/default.  
  3. Market Risk - economic events or natural disasters.  


Contingency Planning Methods

  1. Safeguarding equipment
  2. Building in redundancy
  3. Backup procedures
  4. Insurance


Hedging and Diversification

  1. Hedging completely offsets risk.  Hedging is used to offsets uncertainty via options and future contracts related to commodities, foreign currency and other investment exposure to minimize price risk.  
  2. Diversification - cannot completely offset risk as with hedging, but reduces unsystematic and portfolio risk.  


Insurance and Risk

Insurance is used to offset exposure to specific and known hazards.  Insurance is unique in that it deals with pure risk (the risk of only losing) as opposed to speculative risk (where gain is possible).  


Six Sigma

  • only 3.4 defects per million units produced or outside of 99.999966% of production)

Six Sigma is a continuous improvement approach designed to systematically reduce defects by recognizing that:

  1. The overall yield of a group of related processes is much lower than the yields of the individual processes; and
  2. The total cost of a product or service is directly related to the defect rate.

The name, Six Sigma, reflects a level of quality that is nearly perfect. Considering a normal distribution and the fact that the term sigma indicates standard deviation, six sigma implies that no defective observations would be present until after six standard deviations from the mean (i.e., only 3.4 defects per million units produced or outside of 99.999966% of production).


Six Sigma Steps


Note: some would say that Six Sigma provides nothing new in the way of quality efforts and appears to be very consistent with TQM philosophies.

  1. Define the business  --  Business goals, objectives, processes, team responsibilities, resources, scope of operations, and quality definitions.
  2. Measure the processes  --  Defects per unit, defects per million opportunities, and production yield. Note that all defects are counted (not just the number of defective units).
  3. Analyze the process  --  Analysis is done to determine the root cause of defects. Tools commonly used with total quality management (TQM) such as Pareto diagrams (histograms) and/or Ishikawa (fishbone) diagrams are used to identify potential causes of defects.
  4. Improve the process  --  This involves (1) design experiments and (2) change management to allow statistical exploration of relationships to reveal how to improve quality levels. Once determined, training, policy, and procedures are effected to achieve the desired change.
  5. Control  --  TQM-type quality tools (e.g. control charts, run charts) are used to achieve sustained improvement in operational quality.


Mass Production vs. Lean Manufacturing

Mass production is typically characterized by:

  • higher setup times
  • dedicated equipment
  • low-skilled workers with a high degree of specialization.

Lean Production is characterized by:

  • using small batches of a high variety of unique products
  • lower setup times
  • flexible equipment
  • highly skilled, cross-trained workers


Project Risk Phases

  1. Planning Risks - related to adequately defining the project, properly organizing resources, and organizing and committing team members.
  2. Implementing Risks - related to managing people, time and cost restrictions, and properly managing the interrelationships of activities.
  3. Monitoring Risks - involve effectively monitoring resources, quality levels, cost and timeliness, and changing plans when necessary to ensure objectives are met.


Project Monitoring - Analyzing Cost-Time Tradeoffs


  • often used and is defined as the process of adding resources (such as overtime labor or adding additional materials or equipment) to shorten selected activity times on the critical path. Crash time is the shortest possible time to complete an activity after accelerating resources. Finishing the job early can save money, while going over the original time estimate can include penalties. Thus, crashing is frequently used by offsetting the costs and benefits of earlier completion with the costs and benefits of accelerating resources applied.


Critical Path Network Diagram

The critical path is the longest path in the network and indicates that if any activity on the critical path is delayed, then the project will not be accomplished according to the original schedule.

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When using PERT or CPM, activity slack is calculated as?

Slack time is always calculated as the maximum amount of time that an activity can be delayed without delaying the entire project.


Prime Costs vs. Conversion Costs

Prime Costs = Direct Materials and Direct Labor

Conversion Costs = Direct Labor and MFG. OH


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Committed Costs

Establish the present level of operating capacity and cannot be altered in the short run. Committed costs arise from a company’s basic commitment to open its doors and engage in business (depreciation, property taxes, management salaries).


Equivalent Units

  • Weighted Average
  • FIFO

Weighted Average -

  • Weighted average uses only two categories: goods completed and ending inventory. The format will differ in that weighted average combines prior period work (i.e., beginning inventory) with current period work (units finished this period not in [BI]) to determine "goods completed."


  • The FIFO method uses three categories, separating (1) beginning inventory from (2) the new or current period completed work (called "units started and finished"), while (3) ending inventory (at least for EU) is treated the same as with weighted average.


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Participative Budgeting

Is more time consuming and cumbersome because it involves more people in the process.  PB is a bottoms-up approach to budgeting.  


Breakeven analysis assumes over the relevant range that

  • Total costs are linear.
  • Fixed costs are nonlinear.
  • Variable costs are nonlinear.
  • Selling prices are nonlinear.

Total costs are linear. There are a number of underlying assumptions to breakeven analysis that need to be considered in the calculation and interpretation of breakeven computations. One of these assumptions is that the behavior of total cost and total revenue is linear, even though in actuality it may not be. It is important to note that under breakeven analysis, the linearity assumption is only applicable for a particular relevant range of activity and is not assumed for all levels of activity. Since the actual behavior of total cost and total revenue within a relevant range is usually close to being linear, this assumption will only slightly affect the precision and reliability in a given breakeven calculation.


Multiple regression differs from simple regression in that it

Has more independent variables. If only one independent variable exists, the analysis is known as simple regression. Multiple regression consists of a functional relationship with multiple independent variables.


Responsibility Accounting

What does manager control and how does that affect title?

  1. If a manager is only responsible for costs, his/her area of responsibility is called a cost center.
  2. If the manager is responsible for both revenues and costs, his/her area of responsibility is called a profit center. 
  3. Finally, if the manager is responsible for revenues, costs, and asset investment, his/her area of responsibility is called an investment center.


Direct Costs vs. Indirect Costs

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Direct - costs that are easily traceable to final product. 

  • Direct Material - The cost of significant raw materials and components that are directly incorporated in the finished product. For example, direct material costs of a leather briefcase include cost of leather (raw material) as well as buckles and zippers (purchased components).
  • Direct Labor - The wages and salaries paid for work that directly converts raw materials into a finished product. Continuing with our leather briefcase example, the direct labor costs associated with the manufacture of a leather briefcase include wages paid to workers who cut the leather, finish the leather, and sew the briefcase.

Indirect - costs that are not directly traceable to final product and must be allocated.  

  • Factory Overhead - The cost of indirect labor, indirect materials, and other manufacturing costs other than direct material and direct labor that are necessary to support the production process but are not easily traceable to the finished product. For example, factory overhead associated with production of a leather briefcase includes salaries paid to the production line supervisors, wages paid to mechanics who maintain the equipment, wages paid to custodians who maintain the factory, thread used to sew the briefcase together, electricity used to power the equipment and provide lighting to the factory, and depreciation on the factory building and equipment.


Factory Overhead


An indirect costs that can be variable and fixed and must be allocated to WIP based on the standard overhead rate (which you calculate based on the appropriate cost base - typically labor hours).  

  • Factory overhead can be variable (the total cost changes with the quantity produced) or fixed (the total cost remains the same regardless of the quantity produced, within reasonable limits). In the example above, the cost of thread is variable overhead because with the production of more briefcases, more thread is used; the depreciation on the factory building is fixed because the depreciation stays the same regardless of how many briefcases are produced.
  • In highly automated manufacturing environments, direct labor costs are frequently so insignificant a part of total production costs that they are not separately tracked but simply added to factory overhead costs.


Value-added vs. Non Value-added Costs

  • Value-added costs  --  Product costs that enhance the value of the product in the eyes of the consumer. Most direct costs are value-added costs. Continuing with the briefcase example, the leather that the briefcase is made of and the labor required to cut the pieces and sew them together are value-added costs.
  • Non Value-added costs  --  Costs that could be eliminated without deterioration of product quality, performance, or perceived value to the consumer. Many nonvalue-added costs are essential to production and cannot be completely eliminated. For example, oiling the machine that is used to sew the briefcase together is a nonvalue-added cost from the customer's viewpoint. However, if the machine wasn't oiled, sooner or later, it would stop sewing. Oiling the machine is an essential, but nonvalue-added, cost. Most, though not all, overhead costs are nonvalue-added costs. For example, the thread used to sew the briefcase together is usually an overhead cost, but most consumers would see it as a value-added cost.


Overhead Rate Steps Example

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Absorption vs. Direct Costing Example

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Effect of Product Costing on Operating Income

  • Absorption costing and direct costing assign different costs to inventory. Since direct costing does not include fixed manufacturing costs as part of product cost, the inventory valuation under absorption costing will always be greater than the inventory valuation under direct costing. From an external reporting point of view, direct costing understates assets on the balance sheet.
  • The difference between the two measures of income is due to the different treatment of fixed manufacturing costs. Direct costing deducts all fixed manufacturing costs as a lump sum period cost when calculating income. Absorption costing assigns fixed manufacturing costs to products and therefore only deducts fixed manufacturing costs when the units are sold.


Absorption vs. Direct Costing Income a.k.a...

The Income Reconciliation Rule

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Cash Budgeting Impacts

Increases in Cash:

  • Cash Sales
  • Decrease in A/R

Decreases in Cash:

  • Cash Expenses
  • Increase in A/P


Sales Variance Analysis

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  • Budgeted or planned sales  --  Quantities and prices are used instead of "standard" quantities and prices.
  • Sales variances work backwards  --  When compared to cost variances, that is:
    • When actual prices are greater than planned prices, favorable variances result (e.g. it is good for people to pay more than you had planned).
    • When actual quantities sold are greater than planned quantities sold, favorable variances result (e.g., it is good to sell more than you had planned).
  • Sales variances  --  Use slightly different names:
    • Sales price variance  --  Difference in prices × actual quantity sold.
    • Sales quantity variance  --  Difference in units × planned unit price.


Overapplied Overhead Impact on CGS

When more overhead costs are applied to products than are actually incurred, factory overhead is said to be overapplied. When the accounts are closed at the end of the period, overapplied overhead reduces Cost of Goods Sold.

Priceless Products incurs $20,000 in actual overhead costs during the period. Using their predetermined overhead allocation formula, Priceless applied $21,000 to products as overhead costs, resulting in $1,000 of overapplied overhead. Priceless regards this amount as immaterial and charges over/underapplied overhead to Cost of Goods Sold at the end of the period when the accounts are closed. How will this entry affect Cost of Goods Sold?

Cost of Goods Sold will decrease when the accounts are closed:

  • DR: Factory Overhead Applied $21,000
    • CR: Factory Overhead Control $20,000
    • CR: Cost of Goods Sold $1,000


Underapplied Overhead Impact on CGS

When more overhead costs are actually incurred during the period than are applied to products, factory overhead is said to be underapplied. When the accounts are closed at the end of the period, underapplied overhead increases Cost of Goods Sold.

Cost Conscious Products incurs $10,000 in actual overhead costs during the period. Using their predetermined overhead allocation formula, Cost Conscious applied $9,500 to products as overhead costs. If Cost Conscious charges over/underapplied overhead to Cost of Goods Sold at the end of the period when the accounts are closed, how will this affect Cost of Goods?
Cost of Goods Sold will increase when the accounts are closed:

  • DR: Factory Overhead Applied $9,500
  • DR: Cost of Goods Sold $500
    • CR: Factory Overhead Control $10,000


Cost Impacts within a relevant range while using a Flexible Budget:

  • Total Costs
  • Total Variable Costs
  • VC/unit
  • Total Fixed Costs
  • FC/unit

  • Total Costs - linear with production level, i.e. will increase or decrease accordingly.  
  • Total Variable Costs - linear with production level, i.e. will increase or decrease accordingly.  
  • VC/unit - assumed to be constant
  • Total Fixed Costs - assumed to be constant
  • FC/unit - inverse relationship with level of production, if production is increasing, FC/unit will decrease as the allocation base gets bigger for the fixed costs.  opposite is true if production is decreasing, FC/unit will increase.  



Inventory Purchases

EI - BI + COGS = Purchases

Arrived at by usual formula of:

BI + P = EI + COGS


  1. A strategy map in the balanced scorecard framework is?
  2. A strategy initiative in the balanced scorecard framework is?

  1. SMaps are Diagrams of the cause-and-effect relationships between strategic objectives.
  2. SInitiatives are key action programs required to achieve strategic objectives.


A company uses its company-wide cost of capital to evaluate new capital investments. What is the implication of this policy when the company has multiple operating divisions, each having unique risk attributes and capital costs?

High-risk divisions will overinvest in new projects and low-risk divisions will underinvest in new projects.