Managerial Accounting Exam 2

Planning/static budgets

Prepared for a single level of activity. Made before the period begins, valid only for the planned level of activity

Flexible budgets

Prepared for any level of activity within the relevant range. What revenues & costs should have been given the actual level of activity. Helps managers control costs & improve performance evals

Variable & fixed costs in a flexible budget

Total variable costs change in direct proportion, fixed costs remain unchanged

Activity variance

Difference in the ACTUAL level of activity & the PLANNED level of activity

Revenue & spending variance

Difference b/t the ACTUAL amount of revenue/cost & how much it should have been given the actual level of activity

Budgets w/ multiple cost drivers

Needed to adequately explain all costs, makes them more accurate

Performance report

Actual results → revenue & cost variances → flexible budget → activity variances → planning budget

Management by exception

Compares actual results to a budget so that significant deviations can be flagged as exceptions & investigated

Decentralization advantages

Decision-making is spread throughout the org. Lower-level managers gain experience in making decisions & off better info. Top management focuses on strategy, lower-level management can respond fast & increase job satisfaction

Decentralization disadvantages

Lack of coordination, lower-level managers may not have the same objectives, may make decisions w/o seeing the big pic, difficult to spread innovative ideas

Responsibility centers

Any part of an organization whose manager has control over costs, profit, & investments 

Cost center

Manager has control over costs but not revenues or investment funds

Profit center

Manager has control over costs & revenues but not investments

Investment center

Manager has control over costs, revenues, & investments in operating assets

Return on Investment equation

ROI = NOI / average operating assets

Net operating income is…

Income before interest & taxes (EBIT)

Average operating assets are..

Cash, accounts receivable, inventory, plant & equipment

Net Book Value equation

NBV = cost - accumulated depreciation

Margin equation

Margin = NOI / sales

Turnover equation

Turnover = sales / average operating assets

ROI equation

ROI = margin * turnover

Criticisms of ROI

Management may not know how to increase in the absence of a scorecard, may be many committed costs, may reject profitable investment opportunities 

Residual income equation

RI = NOI - (avg operating assets * minimum required rate of return) 

Why use residual income?

Encourages managers to make profitable investments that would be rejected by mangers using ROI

Transfer pricing

Price charged when 1 segment of a company provides goods/services to another segment. Acts in the best interest of the company

3 approaches to transfer pricing

Negotiated transfer prices, set transfer prices at cost using variable or absorption cost, transfers at market price

Negotiated transfer prices

Results from discussions b/t selling & buying divisions. Buying division determines upper limit, selling division determines lower limit

Pros: preserves division autonomy, managers negotiating are likely to have better info about costs & benefits

Acceptable transfer prices

Selling division transfer price must be greater than or equal to variable cost per unit + (total contribution margin on lost sales/number of units transferred)

Buying division transfer price must be less than or equal to cost of buying from outside supplier OR profit to be earned per unit sold

Transfers at cost

Set transfer price at the variable cost or absorption cost incurred by the selling division 

Cons: suboptimization, selling division doesn’t show profit on internal transfers, cost-based transfer prices don’t provide incentives to control costs

Transfers at market price

Works best when product/service is sold to outside customers & the selling division has no idle capacity.

Operating departments

Carry out the central purposes of the organization

Suboptimization

When responsibility managers forgo additional company profits by making decisions not in the best interests of the company 

Service departments

Do not directly engage in operating activities. Costs are charged to operating departments to encourage the wise use of resources, measure profitability,  provide operating departments w/ more complete cost data, incentivize service departments to operate efficiently. Ex: human resources, accounting, purchasing.

Variable service departments…

Charged to consuming departments according to the activity causing incurrence of the cost

Fixed service departments…

Charged to consuming departments in predetermined amounts based on peak-period or long-run average servicing needs

Budgeting costs..

are charged to service departments

Cons of allocating fixed costs

Using a variable allocation base that fluctuates period to period, using sales dollars as an allocation base