ACTG 211 Scott Anderson Exam 3 Definition and Ratio List

Objectivity

arm’s length negotiation

Going Concern

company will be around long enough to use up assets and pay all liabilities

Consistency

follow the same procedures each accounting period so can compare financial statements

Conservatism

if multiple options exist, pick the least favorable

Full Disclosure

“Full Monty” must disclose all relevant information

Fair - In general usage

Unit of EMOTIONAL measure without objective reference
ex: That’s not fair!! do it for the children!

Fair in accounting

1) estimate of value based on references to other objective value (fair value accounting)

2) auditor’s opinion after considering all management assertions in the financial statements (presents fairly)

Fair in baseball

a ball hit on the ground between first and third base

Days in each month

Thirty days hath September,

April, June, and November;

February has twenty-eight alone,

All the rest have thirty-one,

Excepting leap year, that's the time

When February's days are twenty-nine

Rule of 72

To estimate roughly how long it will take of an investment to double in value, divide the interest rate as a number into 72.

Example: if the return is 5% per year it will take approximately 72/5 = 14.4 years for the investment to double in value.

Responsibility accounting

allocating accounting information to those people who are accountable for controlling it

Controllable vs. non-controllable costs

Control : Costs which the assigned manager can control or influence significantly or not.
Un-controllable costs : are costs that are beyond the control of anyone in the organization

Static budget

planning budget with projected level of activity

Flexible Budget

planning budget updated for the actual level of activity

Variance

Compared actual result TO standard or projected result

Favorable vs Unfavorable Variance

The effect on net income.

Favorable Variance

Revenue is Actual >Standard and expense S>A

Un-favorable variance

Revenue is S>A and expense is A>S

Target Cost definition and fomrula

given to a specific price target. Target cost = Price-margin

Design to Cost

manufacturing a product to a specific cost target

Cost Plus

price is a markup on cost

T and M

Time and Materials, labor price and/or materials price includes allocation of both overhead and margin

Mark up vs. Margin

Margin: Price-cost
Mark up % = Margin/cost
Margin % = margin/revenue

Hurtle Rate

Required minimum rate of return

WACC stands for

Weighted average cost of capital

WACC definition

1. Economic cost of liability and equity components weighted for their presence in the capital structure

2. frequently approximated by “10%” or the incremental borrowing rate

Risk Adjust Rate of Return

arbitrarily defined (higher) rate of return due to the uncertainties of the cash flows

Focus is on after-tax rate of return on invested cash.. why?

1. Considers the time value of money (DCF: discounted cash flow)
   2. Use cash not accounting data

Why use cash not accounting data?

1. Accoutning data is based on transactions

2. accounting data has non-cash elements

3. NCF = NIAT +Non-cash charges

NPV versus IRR

NPV: at assumed discount rate
Formula for NPV = PV of cash flows in - PV of cash flows out
Decision rule: Do project if NPV >0

IRR - discount rate that where NPV = 0
Decision rule: Do project if IRR > Hurtle Rate

Profit (loss) vs Rate of Return differences

1. Profit and loss are based on accrual accounting (accounting concept)

2. ROR (aka DCF) is based on the time value of money and cash in/cash out (Finance concept)

3. very possible to have profitable project that does not meet minimum ROR criteria

Assumption of DCF analysis

1. All cash flows occur at the end of the period

2. All cash flows immediately reinvested at the discount rate

Reinvestment Rate Fallacy

That all cash flows will actually be reinvested and earn the discount rate