ACCOUNTING 102 FINAL EXAM

Static Budget

Based on only one level of activity

Used when a company doesn’t expect that volume levels will change for the budget

Flexible Budget

Expected revenues and costs over a variety of volume level

Used when volume levels might change during the budget period

Management by Exception

Management often has limited time and must focus on problem areas

Variances tell management where problems are in the organization

Sales Variances

Comparing actual revenue (sales) to planned (also referred to as budgeted, projected, or standard) revenue

Total Sales Variance

(Actual Sales - Planned Sales) = Variance (Favorable or Unfavorable)

Sales Price Variance

(Actual Sales Price per unit - Planned Sales Price per unit) x Actual Units Sold = Variance (Favorable or Unfavorable)

Sales Volume Variance

(Actual Units Sold - Planned Units Sold) x Planned Sales Price per unit

Ideal Standards

Perfect performance under the best possible conditions - most companies cannot achieve ideal standards. Used as a STARTING POINT to develop practical standards.

Practical Standards

Reasonable efforts attainable by most companies

Lax Standards

Easily attainable - can be achieved with minimal effort

Material standards: Price Standards

Depends on quality, quantity, delivery terms

Determined by the purchasing department

Material standards: Usage standards

quantity of materials needed to make one unit

determined by the engineering department

Labor Standards: price standards

Depends on job requirements, union contracts, market conditions

Determined by Human Resources department

Labor Standards: usage standards

hours that should be used to produce one unit

determined by engineering department

Total flexible budget variance

(Actual Unit Cost - Standard Unit Cost) x Actual Units Made = Variance (F or U)

Price Variance

(Actual Price per unit - Standard price per unit) x Actual Total Quantity used = Variance (F or U)

MO Standards

Flexible budget at actual volume - Actual results at actual volume = flexible budget variance

Budget Tricks

Budget Slack

Low Balling

Budget slack

(costs), overstate budget costs on purpose so that when compared to actual results have a better change of getting a favorable variance

Low Balling

(revenue), understate budget revenue on purpose so that when compared to actual results have a better change of getting a favorable variance

Management styles

Centralized

Decentralized

Centralized

top makes all the decisions

Decentralized

authority for many decisions are transferred from top to lower levels

Types of responsibility centers

Cost center

Profit center

Investment center

Cost center

Only control costs, no control over revenue or investment

Normally at department level like cutting department and research & development

Profit center

control over costs and revenue or profits; no control over investment

Home construction center could have a lumber profit center plumbing profit center, tool profit center, etc.

Investment center

Can also control investments in addition to costs and revenue; each center can stand on its own

Different divisions in a company; a large company could have a manufacturing division, a home appliance division, a finance division, etc.

Return on Investment (ROI)

Operating Income / Operating Assets

Margin for ROI

Operating Income / Sales

Turnover for ROI

Sales / Operating Assets

Residual income (RI)

Operating income less desired return on investment

Evaluates on manager’s or an investment center’s avidity to earn more than a targeted earning goal (company desired return on investment (ROI))

Evaluating investment center

Return on investment (ROI) sometimes referred to as Rate of return (ROR)

Ratio of wealth generated (operating income) to the amount invested (operating assets)

Capital investments

Long-term operational assets or investments

Ex: production on equipment such as machinery, assembly line robots, etc.; new factory building, new campus dorm, adding a room to a restaurant, building a tunnel or bridge

Capital budgeting techniques

Developed to determine whether a company should undertake a long-term capital investment

Capital Budgeting Techniques

Payback method

Unadjusted rate of return

Net present Value (NPV)

Present Value index (Profitability index or PI)

Internal rate of return (IRR)

Payback method

IGNORES time value of money

How long it takes to recover initial investment (outflow), shorter the better

* Assuming even cash flows \*IGNORES time value of money => Investment / Annual cash inflows = payback time period
* Assuming uneven cash flows => a. accumulate annual cash inflows until the sum equals the amount of the investment. b. use an average of annual cash inflows and divid this amount into the investment to get the payback time period

Unadjusted rate of return

Average increase (from the investment) in annual net income / net (or average) investment

Net present value (NPV)

present value of the net cash inflows less the investment

Present value index (profitability index or PI)

present value of net cash inflows / investment

the higher the PI the better

Internal rate of return (IRR)

1. Find the IRR present value index factor = investment / annual cash inflows


1. use that number to find the IRR from table 2 (Present value of an annuity of $1)

Ordinary annuity

An equal stream of cash inflows and the end of each period of time