P2 Flash Cards
(56 cards)
1
Q
8/77777777777777777777777ABC is….
A
Cost pools, cost drivers, OH per unit
2
Q
Absorption costing is….
A
- Based on no. units/hours
- Arbitrary allocation of OH
- not always suitable for modern businesses, so use ABC instead
3
Q
Advantages of ABC
A
more accurate costing
more detailed insight
better forecasting/planning
4
Q
Disadvantages of ABC
A
No evidence it improves profit
Historic and internally focused
hard to identify cost drivers
5
Q
Activity Based Management is…
A
- Classifying activities as value adding / non value adding
- Applying principle of ABC to business management
- Doesn’t reduce costs, but helps managers understand their costs better
- Best in orgs with high overheads e.g. NHS
(ABC emphasis tracing costs to cost objects, ABM emphasises tracing costs & managing processes & work)
6
Q
Disadvantages of ABM
A
- too inwardly focused
- not all OH costs are variable
- complicated & expensive to implement
7
Q
Just-In-Time is
A
- no inventory
- pull system
- produce when needed
8
Q
To succeed with JIT you need:
A
- quality, reliable production
- speed & flexibility
- versatile labour force
- reliable suppliers in close proximity
9
Q
Advantages of JIT
A
no cash tied in inventory
less storage space needed
fewer bottlenecks, better coordination
10
Q
Disadvantages of JIT
A
- relies on predictable demand
- no buffer inventory if issues
- harder to switch suppliers
11
Q
Total Quality Management (TQM)
A
- get it right first time
- cost to prevent less than cost to correct
- continuous improvement, no waste
12
Q
Types of Quality costs
A
Conformance: prevention & appraisal
Non-conformance: internal failure & external failure
13
Q
Kaizen is
A
small, incremental improvements
all encouraged to make suggestions, bottom up
14
Q
Business process re-engineering is
A
- radical redesign of processes to achieve cost reduction, improved quality & customer satisfaction
- not a cost cutting exercise, though long term savings may result
- not a one-off
- strategic outlook required
15
Q
TPAR=
A
return per factory hour (TP cont/time needed on bottleneck)
______________________________________________________________
Cost per factory hour (total factory costs/total time on bottleneck)
16
Q
Target costing 5 steps
A
- market research for pricing
- calc required profit per unit
- subtract profit from price to find target cost
- cost gap between actual & target costs
- close cost gap
17
Q
Standard costing vs target costing
A
Standard VS target
reactive proactive
cost control cost reduction
internal forces external forces
price pushed to market price pulled from market
18
Q
4 types of value
A
- cost value (production cost)
- exchange value (purchase price)
- use value (functionality value)
- Esteem value (increase in status)
19
Q
Porters value chain
Primary activities (5)
Support activities (4)
A
Primary activities
- inbound logistics
- outbound logistics
- operations
- marketing & sales
- service
Support activities
- infrastructure
- technology development
- HR
-Procurement
20
Q
The capital investment process (3 phases)
A
- creation phase - objective opportunities, assess environment
- Decision phase - initial proj. screening, examine alternatives, financial analysis
- Implementation phase - review investment decisions, post-completion audit
21
Q
Compound interest formula
A
end total = initial invesment x (1 + interest rate)^no. periods
22
Q
Present value formula
A
present value = end total x 1 / (1 + r)^n
Discount factor = 1 / (1 + r)^n
(assumes initial investment at T=0 and other cashflows start at T=1)
23
Q
Advantages of NPV
A
- time value of money
- considers cashflows, rather than subjective profits
- considers whole proj. life
- accounts for risk
24
Q
Disadvantages of NPV
A
- fairly complex
- not well understood by non-finance managers
- difficult to determine cost of capital
- does not consider short-term
25
Annuities
constant annual cash flow for set no. of years
PV of annuity = annual cashflow x annuity factor
Annuity factor = 1- (1+r)^-n / r
26
Perpetiuities
annual cashflow for the forseeable
PV of perpetuity = annual cashflow / r
27
Advanced / delayed annuities / perpetuities (when cash flows don't start at T=1)
Advanced
- cash flows start at T=0
- ignore the T=0 cashflow and add 1 to the discount factor
Delayed
- cashflows start later than T=1
- apply discount factor as usual
- then discount back to T=0 using appropriate discount factor
28
Internal rate of return (IRR)
- the rate of return at an NPV = 0
- IRR > cost of capital = accept
IRR = R1 + (R2 - R1) x NPV1 / NPV1 - NPV2
29
Advantages of IRR
time value of money taken into account
understood by managers
don't need to know cost of capital
if IRR > cost of capital then shareholder wealth increase
30
Disadvantages of IRR
no consideration of size of initial investment
interpolation - only an estimate
complex
may conflict with NPVs
not a measure of absolute profitability
31
MIRR formula
(terminal value of inflows / present value of outflows)^1/n - 1
32
Capital Rationing steps (when insufficient funds for all beneficial projects)
1. calc profitability index for each proj.
PI = NPV / initial investment
2. Rank according to PI
3. Allocate funds
33
Discounted payback profitability index =
(measures no. times proj. recovers initial funds invested)
PV of net cash inflows / initial cash outlay
34
Accounting Rate of Return (ARR) =
ARR = ave. annual profit (net cash flow - depn / no. yrs)
_____________________________________________________________
ave. value of investment (initial inv + residual value / 2)
35
3 pros & 3 cons of ARR
+ simple to understand
+ widely used & accepted
+ considers whole proj. life
- ignores time value of money
- not measure of absolute profitability
- uses subjective accounting profits, not cash flows
36
Inflation on cashflows
(assume values inflated unless told otherwise)
current / real = excludes inflation
money / nominal = includes inflation
to convert cost of capital between money & real:
(1 + money cost of capital) = (1 + real rate of return)(1 + inflation rate)
37
Capital asset replacement decisions - Equivalent Annual Cost (EAC)
EAC = PV of costs / annuity factor for year n
(calc PV of costs for each replacement cycle, divide PV by annuity factor to find annual cost, select replacement cycle with lowest annual cost)
38
Price Elasticity of Demand (PED)
PED = % change in demand / % change in price
39
PED equation of line =
price = maximum price - (% change price / % change quantity) x (quantity demanded)
P= a - bQ
40
Profit maximisation model/ optimum price (6 steps)
1. find a and b (a = max. price) (b = %change price / % change demand)
2. determine marginal cost
3. MC = MR
4. MR= a-2bq so q = MR-a / -2b
5. P(optimum price) = a - bq
6. total contribution = (p-MC) x q
profit = total contribution - fixed costs
41
Limitation of profit maximisation model
- demand unlikely to be determined with certainty
- usually aim to achieve target profit, not maximum
- difficult to determine accurate marginal cost (likely to vary with demand e.g. bulk discounts)
42
Total cost-plus pricing ,how to calc
marginal costs + fixed costs = total prod. cost
+ non-production cost = total cost
+ profit = selling price
43
3 pros & 3 cons of total cost-plus pricing
+ profit achieved if sales volumes are as budgeted
+ good for contracting industries with low fixed costs
+ can be used to justify price increases
- arbitrary calc of fixed cost element
- profit not achieved if sales volumes lower
- ignores life cycle stages, customers & competition
44
Marginal cost-plus pricing, how to calc
variable cost + % contribution margin
45
3 pros and 2 cons of marginal cost-plus pricing
+ can cut price to below total cost
+ good for relevant costing decisions
+ good for scarce resource situations
- no guarantee costs will be covered
- price wars lead to loss making decisions
46
4 objective of decentralisation
1. ensure goal congruence
2. increase manager motivation
3. reduce head office bureaucracy
4. better training for junior managers
47
Profitability Indicators formulas
1. operating profit margin
2. asset turnover
3. return on capital employed
1. operating profit margin = operating profit / turnover x100%
2. Asset turnover = turnover / capital employed
3. ROCE = operating profit / capital employed x100%
48
3 pros & 3 cons of ROCE (Or ROI)
+ widely used & accepted
+ relative measure, enables comparison
+ can be broken down for more detailed analysis
- dysfunctional decision making (e.g. wouldn't accept project with a good ROI if it is less than the depts current ROI)
- different accounting policies confuse comparisons
- manipulation for ROI related bonuses
49
Residual income =
residual income = controllable profit - (capital employed x cost of capital)
50
3 pros and 4 cons of residual income
+ resolves dysfunctional aspect of ROI
+ risk can be incorporated
+ cost of financing brought home to divisional mangers
- doesn't facilitate comparison
- can mislead, as increases over time
- subject to manipulation
- does not relate size of profits to assets employed
51
Economic Value Added (EVA) =
EVA = economic profit - (economic capital employed x cost of capital)
(measures performance of company in terms of value that's been added during a period, directly linked to shareholder wealth)
52
Steps to calc EVA
1. profit after tax
ADD BACK: accounting depn, provision for doubtful debts, interest paid, goodwill amortised, development costs
TAKE OFF: economic depn, impairment to goodwill
= economic profit
2. capital invested = opening cap. employed + net replacement cost
3. EVA = economic profit x (capital invested x cost of capital)
53
Transfer Pricing 6 objectives
1. goal congruence
2. performance measurement
3. record movement of goods
4. maintain divisional autonomy
5. minimise global tax liability
6. fair profit allocation between divisions
54
minimum price selling division will accept =
maximum price buying division will pay =
minimum price selling division will accept = marginal cost + opportunity cost
maximum price buying division will pay = final selling price - additional variable costs
55
Standard Deviation =
SD = square root of: sum of (x - x mean)^2 / n
56
Expected values 3 pros & 4 cons
+ takes risk into account
+ easier decisions with single number
+simple calc
- probabilities are subjective
- little meaning for one-off project (as is a long-run average)
- answer may not exist
- ignores risk attitudes
