| Finance Cliff Notes |
| Written by Edvin Eshagh | ||||||||||||||||||||||||||||||||||
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Review Finance Key Concepts (source: ISBN:978-0-07--352699-7) Chapter 1 p5 Accounting types include:
p7 p8 p9 p12 Primary financial statement are: Financial statemetns are a subset of the total information encompassed by financial reporting p15 Management is intended primarly for planning and control decisions p16 p17 In United States, there organizations are particularly important for establishing accounting principles, which include: Secuirities and Exchange Commission (SEC), Financial Accounting Standards Board (FASB), International Accounting Standards Board (IASB) Securities and Exchange Commission (SEC) - a government agency with legal power to establish accounting principles and financial reporiting requirements for publicly owned corporations p18 International Accounting Standards Board (IASB) - Attempts to harmonize the diffierence in financial reporting practices between countries International Financial Reporting Standards (IFRS) - Countries either require the use of IASB standards or have plans to require their use in the future p19 An audit is an investigation of a company's financial statements, designed to determine the fairness of these statement. Congress passed the Sarbanes-Oxley Acti in 2002; creating PCAOB, among other things, it ban's auditors from providing many nonaudit services for their audit clients. It is the responsibility of CEO and CFO of companies to certify the fairness of the company's financial statements. American Institute of CPAs (AICPA) - prior to FASB, AICPA provided generally accepted accounting resources. It works closely with FASBin establishing and interpeting GAAP p20 Institute of Internal Auditors (IIA) - dedicated to the promotion and devlopment of the practice of internal auditing American Accounting Association (AAA) -Improving accounting education by better preparing acounting professors and on advancing knowledge in accounting dicipline through research and publication. Its impact is through accounting faculty and students Commitee of Sponsoring Organizations of Treadway Commission (COSO) - best known for developing the standards for evaluating internal control - particularly internal control over financial reporting. p21 Certified Management Accountant (CMA) - issued by IMA and IIA; managers may voluntairly earn CMA p23 Accountants may specialize in: public accounting, management accounting, governement accounting, Accounting education p24 Government Accountability Office (GAO) - audits many agencies of federal govenment p25 p27
Chapter 19 p852 non-value-added activity - raw materials, work in progress, finished goods inventory, design meets engineering spec (not customers), poor quality, rework/scraps, distribution delays Value Chain activity: 1) R&D and design, 2) Suppliers and production, 3) Marketing and Distribution, 4) Customer services p854 P857 Research shows 80% of production-related expenses are committed once the production process begins p858 Target Cost = Target Price - Profit Margin Components of Target Cost:
P859 p861 Characteristics of Target Costing:
p862 p863 Manufacturing Efficiency Ration = Value Added Time / Cycle time => goal is 100% Measuring Quality - defects per million units produced, number of merchandise returns, number of waranty claims Total Quality Management - assigning responsibility for managing quality, providing good quality measures for decision making, and evaluating and rewarding quality performance p864
Interconnectedness of the value chain - when quality is low in one part of the value chain, the quality costs can increase for all components in that chain. p866 p867 p868 Activity based management requires an understanding of the link between activities that consume resources and the costs associated with those resources. The objective of activity-based management is to manage the activities a that drive those costs Target costing is a business process aimed at the earliest states of new product/services. It's primary objective is to reduce development time. The cross functional, cross-organizational value chain approach allows for simultaneous, rather than sequential, consideration of possible solution. It's components include: 1) concept development via planning and marketing, 2) product development using engineering, 3) production with continuous improvement
Chapter 20 p890 Managing CVP starts by identifying the activities that cause costs to vary. Increase/decrease in activities are matched with increase/decrease in cost Activity Based Management is defined in terms of output - i.e. units sold, dollars of sales revenue; in terms input activities includes direct labor hours, machine-hours, passenger miles flow, etc p891 Fixed cost- remain constant; include: administrative and executive salary, property taxes, rent, leases, insurance Semi variable costs - mixed costs - contain both fixed and variable costs Volume variation and change in fixed and variable costs:
p894 Economies of Scale - Fixed cost per unit at higher levels of activity; representing efficient use of company's productive assets. In general, most businesses can reduce unit costs by using their facilities more intensively. Cost Behaviors - Lump sum step (increment cost at step, during each step remaining fixed for some volume), curve line rather than straight line cost (unusual patterns of cost behavior is most likely to occur at extremely high or extremely low levels of volume) . Unusual patterns of cost behavior tend to offset one another; which is why we can use straight line estimate relevant range - range over which production output may be expected to vary - observed in semi-variable cost pattern. Break Even Point - Total Revenue = Total Cost Operating Income = Revenue - Variable Cost - Fixed Cost => The profit here is Not Net Income, because it excludes non-operating gains and expenses (i.e. taxes are excluded because they depend on taxable income rather than operating volume.) p898 Contribution Margin - amount by which revenue exceeds variable costs Contribution Margin Units = Unit Selling Price - Variable Cost Per Unit Contribution Margin Ratio = Contribution Margin Per Unit / Unit Sales Price p900 Desired level of operating income = sales volume (units) = [ Fixed Costs + Target Operating Income ] / Contribution Margin per Unit sales volume (dollars)=[ Fixed Costs + Target Operating Income ] / Contribution Margin Ratio Operating Income = Margin of Safety * Contribution Margin Ratio Margin of Safety - Dollar amount by which actual sales volume exceeds the break-even sales volume. i.e. dollars in excess of the break-even point Change in Operating Income = Change in Sales Volume * Contribution Margin Ratio p901 Projected Operating Income = (Fixed Cost + Projected Operating Income ) / Contribution Margin Ratio p902 Unit Contribution Margin = Selling Price - Unit Variable Cost Projected Unit Sales = ( Fixed Costs + Target Operating Income ) / Unit Contribution Margin p903 Sales mix = relative percentage of total sales provided by different products. Managers apply cost-volume relationship to the business viewed as a whole. thus, they use the average contribution margin ratio, reflecting the company's current sales mix. Average contribution ratio - computed by weighting the contribution margin ratios of each product line by percentage of total sales which that product represents p904 Semi variable Cost - contains both fixed and variable cost. high-low estimate - Average( high, low) of the total sales and units per month p905 Contribution Margin = Sales Revenue - Total Variable Costs Unit Contribution Margin = Unit Sales Price - Variable Costs per Unit Contribution Margin Ratio = ( Unit Sales Price - Variable Costs per Unit ) / Unit Sales Price = Sales - Total Variable Costs ) / Sales Sales Volume (in units) = ( Fixed Costs + Target Operating Income ) / Unit Contribution Margin Sales Volume (in dollars) = ( Fixed Costs + Target Operating Income ) / Contribution Margin Ratio Operating Income = Margin of Safety * Contribution Margin Ratio Change in Operating Income = Change in Sales Volume * Contribution Margin Ratio Chapter 21 p928 Incremental decision - short-run decision - focus on common concepts used for short-run decisions such as sunk costs, opportunity costs, out-of-pocket costs, and incremental costs and revenues relevant costs - important for a particular business decision - p931 and vary among the courses of action being considered p929 Sunk costs - Costs already incurred and can not be changed and can not affect future decisions. Should you drive or fly... already paid car insurance is a sunk cost p930 Incremental costs - differential costs - incremental revenue - The differences in the costs incurred and the revenue earned under the alternative courses of action (i.e. renting or not renting) Business decision must consider 1) opportunity costs, 2) sunk costs, 3) out-of-pocket costs p931 Opportunity cost - benefit that could have been obtained by pursuing an alternative course of action. Passing $4000/mo job to go to school is $4000 opportunity cost of attending school Out-of-pocket-cost - costs that have not yet been incurred and that may vary among the possible courses of action. p932 - it usually refers to planned cash outflow. Many businesses fail because of poor, short-run cash planning p933 Only additional variable costs per unit are relevant to a decision, because fixed costs remain constant Contribution margin enables managers to decide what products to eliminate in order to maximize the contribution margin per unit of limited input p934 Unit Contribution Margin = Unit Selling Price - Unit Variable Costs Contribution Margin Per Hour = Unit Contribution Margin / Direct Labor Hours Required Per Unit Complementary products - Products for which sales of one contributes to the sales of another p935 Not all variable costs are incremental, and some fixed costs may be incremental in a given situation p936 Company will be indifferent between buying and making the part when the total incremental costs of making the part equals the total incremental cost of buying the part Price * Volume = Total Incremental fixed costs + incremental variable costs * Volume p938 Joint products - result from a shared manufacturing process Joint costs - costs related to joint products Split-off point - Once joint products can be separated and maybe sold independently of the other, or may be processed further p940 Incremental analysis - comparing one course of action to another by determining differences expected to arise in revenue and costs Unless company selects best possible course of action, it incurs an opportunity cost Chapter 22 p964 Responsibility center - describe a subunit within a business organization; where manager is responsible for directing the activities Income statement measures the overall profit performance of a business entity Management Responsibility: 1) Planning and allocating resources - to set future performance goals and allocate resources 2) Controlling operations - Identify those portions performing inefficiently or below expectations to focus management attention 3) Evaluating the performance of center - evaluating the skills of the center manager p965 Cost center - business section that incurs costs but does not directly generate revenue ( accounting, finance, data processing, legal, laundry, maintenance, janitorial) Cost centers are evaluated on: 1) their ability to control costs, 2) quantity and quality of the services that they provide. At times, costs serve as an objective basis for evaluating the performance of the cost center p966 Profit center - is part of a business that generates both revenue and costs. Their managers have decision-making responsibility over both input and output related resources. The managers do not have authority or responsibility for major capital acquisitions (belongs to CEO, board members, etc) p963 Investment center - is a profit center for which management has been given decision making responsibility for making significant capital investments related to the center's business activities. Not all profit centers can be evaluated as investment centers. p968 Responsibility accounting system - Accounting system designed to measure the performance of each center within a business. It holds individual managers responsible. It identifies strength/weakness of organizational unit. Components of successful responsibility system: 1) budgets are prepared for each center, 2) Measure performance 3) evaluate performance report with budget Responsibility income statement - shows revenue, expense, and operating results of a center p970 Cost assigned to a center by either: 1) Fixed and Variable costs, or 2) direct traceable cost Variable costs are related to specific revenue dollars, they are usually traced directly to the profit center responsible for generating that revenue Change in sales volume = 1) Change in unit sales * contribution margin per unit 2) or, dollar change in sales volume * contribution margin ratio p971 Contribution margin ignores fixed costs;, thus it is primarily a short-run planning tool Traceable fixed costs - are easily traced to a specific business center - Salaries, depreciation specifically used by center Responsibility Margin - Contribution margin - Fixed costs Common fixed costs - indirect fixed costs - jointly benefit several parts of the business They can not be assigned to specific sub-units except by arbitrary means (i.e. proportion to relative sales volume , square feet, etc) Traceable fixed costs usually includes only those fixed costs traceable to profit centers. Costs traceable to service departments (cost centers like accounting, janitorial, etc), benefit many parts of business, thus, they are classified in responsibility income statement as fixed costs p972 Common costs at the lower levels of management responsibility become traceable costs as they fall under the control of the managers of larger responsibility centers Responsibility margin - useful for longer-run measure of profitability than contribution margin because it considers traceable fixed costs for business units p974 Controllable costs - are under manager's immediate control (i.e. salaries, advertising, etc) Committed fixed costs - manager cannot change (i.e. depreciation, property tax) Performance margin = contribution margin - controllable fixed costs It includes only the revenue and costs under manager's direct control; making it useful for evaluating manager's ability to control costs Responsibility margin = Performance Margin - Committed Fixed Costs p975 In income statement, Operating Income = Responsibility Margin - Fixed Costs It is not recommended because: 1) common fixed costs often would not change even if a business center were eliminated. Allocation of these costs only distorts the amount contributed 2) Common fixed costs are not under direct control of the center's manager 3) Allocation of common fixed costs may imply changes in profitability that are unrelated to the center's performance. Transfer price - the transfer price of a product when it is transferred from one department to another (wholesale vs retail outlet). p976 If costs were used as a transfer price, the profit center would be using some of its resources in a manner that produces no profit. Cost as a transfer price would shift margin from department that originated the product to the departments that eventually sell that product to outside customers Transfer price via 1) Market value - profit margin winds up in the profit center that originated the product rather than the center that transferred it 2) Negotiated transfer price - used when market price does not exist. Negotiated transfer price allocated the profits associated with the transferred product between the two divisions by agreeing on a price. 3) Cost-plus-transfer - add a predetermined markup to the cost of the transferred product when market value does not exist p978 Transfer prices are usually not paid in cash; they are only entries made in the accounting records to record the "flow" of goods and services Non-financial performance measures:
Chapter 24 p1002 Gross profit % = gross profit / sales Net income % = net income / sales Return on equity = net income / average shareholder's equity Return on assets = net income / average total assets Current ratio = current assets / current liabilities Inventory turnover = cost of goods sold / average inventory Accounts receivable turnover = net sales / average receivable p1003 Budget - is a comprehensive financial plan setting forth the expected route for achieving the financial and operational goals of an organization Controlling costs means keeping actual costs in line with the financial plan. p1004 Financial forecasting - process of budgeting Benefits of formal budget
p1005 Behavior approach theory - manager will be most highly motivated if they view the budget as a fair basis for evaluating responsibility center's performance. Therefore, budgeted amounts are set at a reasonable and achievable levels. Highly efficient managers should be able to exceed the budget Total quality management approach - every individual and segment of the organization should strive for improvement constantly. Goal of completely eliminating inefficiency and non-value-added activities. Achieve perfection across the entire value chain Even small failures to achieve the budget performance serve to direct management's attention toward those areas in which there is room for improvement. Managers should participate actively in the budgeting process Managers also should understand both the intended purpose of the budget and philosophy under the development of the budgeted amounts. If a behavioral approach is employed, a highly efficient unit may exceed the budgeted level of performance. If total quality management approach is used, a highly efficient unit should fall slightly short of the budget standards p1006 Capital expenditures budgets - summarize plans for major investments in plant and equipment, might be prepared to cover plans for as long as 5 to 10 years Financial budgets cover a period of one fiscal year. Companies often divide these budgets into four quarters and then subdivide into each month. As end of quarter nears, the budget for the next quarter is reviewed/revised Budgeted figures for relatively short periods of time enable managers to compare actual performance to the budget without waiting until the end of the year (i.e. milestones/gates in project management) p1007 Master budget for a manufacturing company:
Responsibility budget - portion of the budget relating to an individual responsibility center Two categories of budgeting: Logical stteps for preparing annual master budget
p1013 p1014 Operating budget estimates - used to prepare the budgeted income statement Current payable budget - cash payment in the near future. Certain expenses will not require an outlay of cash (i.e. expenses that result from expiration like insurance, depreciation of plant assets). Thus, only costs/expenses financed by current payable require cash payments. p1016 Debt service budget - summarize the cash payments (both principal and interest) required to service. p1021
Flexible budget - budget that can be adjusted easily to show budgeted revenue, costs, and cash flows at different levels of activity. Performance report - compares manufacturing costs originally budgeted with the department's actual performance for the period. p1025 Logical sequence of preparing master budget: 1) sales forecast, 2) Operating budget ( prepare budgeted income statement), 3) cash flow estimate, 4) balance sheets Operating cycle - average time required for the cash invested in inventories to be converted into cash
Chapter 24 p1048 Standard cost -per unit cost expected to be incurred during normal operating conditions Variance - Difference between actual and input prices or quantities. Its favorable when actual input costs/quantities are less than standard; and it is unfavorable when actual exceeds standard p1050 Manufacture standard - estimate of total overhead at normal level of production. p1051 Variable manufacturing costs - rise/fall in approximate proportion to changes in production volume Standard Quantity excludes waste p1052 Standard materials cost for each unit of product considers: 1) quantity of materials required, 2) price that should be paid to acquire materials p1053 Materials Quantity Variance = Standard Price * ( Standard Quality - Actual Quantity ) p1054 Labor rate variance - shows the extend to which hourly wage rate contributed to deviations from standard costs Labor efficiency variance - indicates the extent to which the number of labor hours worked during the period contributed to deviations from standard costs Labor Rate Variance = Actual Labor hours ( Standard Rate - Actual Rate ) Unfavorable labor rate variance can occur when using highly paid employees to perform lower grade tasks, poor scheduling, overtime Labor efficiency variance - labor usage variance - is a measure of worker productivity Labor Efficiency Variance = Standard Hourly Rate * ( Standard hours - Actual hours ) Unfavorable labor efficiency variance indicates that direct labor workers were unable to manufacture product in allowed time p1055 Process Inventory account is debited for the standard labor cost allowed, and Direct labor account is credited for the actual labor cost incurred. The unfavorable labor rate and efficiency variances are recorded by debit entries, because they both represent costs in excess of the budgeted standards Overhead variance - the difference between actual manufacturing overhead costs incurred and the standard overhead costs charged to production Variable costs = direct materials + direct labor Manufacturing overhead = Fixed cost + variable cost Elements of overhead costs: 1) Spending variance, 2) Volume variance p1056 Volume Variance - difference between the overhead applied to work in process (at standard cost) and overhead expected at the actual level of production. Volume variance = normal volume output - actual volume output Standard cost system treats all overhead as a variable cost. In reality, however, manufacturing overhead includes many fixed costs. Treating manufacturing overhead as a variable cost automatically causes a cost variance whenever the level of production varies from the normal volume. Access volume variance is considered favorable Volume variances are simply the natural result of fluctuations in the level of production from month to month. These fluctuations often occur because of seasonal sales demand, efforts to increase/decrease inventory levels, holidays, vacations. p1058 Favorable and unfavorable variances will balance out during the year, leaving small amount in each variance account at the year end; thus it can be closed into the cost of goods sold account. p1063 Materials variances may be caused by the quality and price of materials purchased and by the efficiency with which those materials are used. Labor variances stem from workers' productivity, pay scales of workers placed on the job, and the quality of the materials with which they work. Overhead variances result both from actual spending and from differences between actual and normal levels of production
Chapter 25 p1088 Motivation factors via accounting: 1) Create and set objective goals, 2) measure progress / feedback, 3) reward progress p1090 Invested capital in a segment or product line refers to expenditures made to purchase plant assets, develop new product lines, acquire subsidiary companies, purchase equipment, pay for significant training costs, etc. ROI = Capital Turn Over * Return On Sales Return On Sales = Earning / Sales Capital Turn Over = Sales / total investment p1091 Return On Sales (ROS) = the operating earning or profitability that can be expected from one dollar of sales. Operating earning rather than net income is used to compute the ROS because operating earning better reflects the resources that manager can control p1092 p1093 Short-Horizon problem with ROI can occur when manager leaves from one job to another (i.e. sells assets to reduce the average invested capital to improve current ROI; reduce cost of goods sold expenses by purchasing inferior-quality merchandise from suppliers at a lower price. This reduction in cost of goods sold expense increases the annual operating earnings for the period) ROI can present incentive for a manager to reject a good project that would increase the ROI for the firms as a whole because ROI of a new project maybe less than existing project p1094 Residual Income (RI) measurement - Amount by which the operating earnings exceed a minimum acceptable return on average invested capital Residual Income = Operating Earnings - ( Minimum Acceptable Return * Invested Capital ) Economic Value Added (EVA) measurement - Encompasses the average after tax cost of long-term borrowing and the cost of equity p1095 ROI, RI, EVA performance evaluation tools focus only on business financial outcome p1096 Balanced Score Card looks through four Lenses/perspectives: 1) Financial, 2) customer, 3) business, 4) learning and growth. p1097
Balance Sheet Lenses:
Problems with balance score card:
Management compensation
p1101 Design management compensation
p1102 Economic Value Added (EVA) - like RI, but it makes many adjustments for items like as taxes, interest, amortization. Like RI, it does not motivate managers to turn down investments expected to earn a return below their current ROI, but above the minimum acceptable return to the firm.
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