ACCT 230 Exam 1

3 Sets of Books

Financial, Management, and Tax

Audience of Financial Books

Investors and Creditor

Objective of Financial Books

Communicate profit, cash flows and financial position

Rules of Financial Books

U.S. GAAP and IFRS

Rule Setter of Financial Books

In the U.S.: SEC and FASB

Example of Financial Books

Annual Report

Audience of Management Books

Management

Objective of Management Books

Facilitate Management Decisions

Rules of Management Books

None

Rule Setter of Management Books

Management

Examples of Management Books

Budgets and Product Profitability

Audience of Tax Books

Taxing Authorities

Objective of Tax Books

Facilitate preparation of tax returns

Rules of Tax Books

Tax Code

Rule Setter of Tax Books

Tax Authority (IRS)

Example of Tax Books

Tax Return

3 Major Types of Business

Service, Merchandise, and Manufacturing

Service Companies

Provide services; do not carry inventory.

Merchandise Companies

Buy and resell inventory to customers.

Manufacturing Companies

Buy raw material which they convert to a finished product and offer for sale to customers.

Managerial Accounting

The provision of accounting information for a company’s internal users of information

Goal of Managerial Accounting

Help managers carry out their basic functions.

Financial vs. Managerial Accounting

Financial = External + Past

Managerial = Internal + Future

Basic Functions of Managers

Planning, Controlling, and Decision Making

Planning

Establishing goals and objectives and identifying ways to achieve them (Ex: Preparing budgets)

Controlling

Monitoring and ensuring the proper implementation of plans (Ex: Performance Evaluations)

Decision Making

Selecting the best course of action among competing (Ex: Which product lines to offer or what price to charge?)

Managerial Accounting Certifications

Certified Management Accountant (CMA), Chartered Global Management Accountant (CGMA), and Certified in Strategy and Competitive Analysis (CSCA)

Skills of a Manager

Big Data Management Skills

An Ethical Perspective

Strategic Management Skills

Enterprise Risk Management Skills

A Corporate Social Responsibility Perspective

Process Management Skills

Leadership Skills

Cost Object

Anything for which cost data are desired including products, customers, jobs, organizational subunits, etc.

Two Ways to Assign Costs to Cost Objects

Direct and Indirect

To Determine Direct or Indirect Cost

Must identify the cost object first

Direct Cost

Costs that can easily and conveniently be traced to a specific cost object (Direct cost is CAUSED by the cost object)

Indirect Cost (aka Common Costs)

Costs that cannot be easily traced to a specific cost object and are shared among multiple cost objects

Product Cost

Includes all costs required to purchase or manufacture inventories

Product Cost for a Retailer

Includes cost of purchasing inventory

Product Cost for a Manufacturer

Includes all cost required to manufacture inventories

3 Broad Categories of Product Cost for Manufacturing Companies (Manufacturing Costs)

Direct material, direct labor, and manufacturing overhead

Direct Material

Raw material that becomes an integral part of the finished product and whose costs can be conveniently traced to it (natural resources or parts purchased from another company)

Financial Statement Analysis

A set of tools used to make the general-purpose financial statements more useful to varied users of financial information

Tools of Financial Analysis

Horizontal, vertical and ratio analysis

Limitations of Financial Statement Analysis

Comparisons with a standard of:

1. Past history of the company

2. Similar company

3. Industrial averages

Horizontal Analysis

Focuses on the dollar and/or percentage changes in accounts on the income statement and/or balance sheet from year to year. Facilitates identifying trends over time (aka Trend Analysis). Can be shown as a percentage of the base year or as a percentage change.

Vertical Analysis

Used to evaluate the relationships within a single financial statement. Compares to prior years and/or other companies. Expresses each item within a financial statement as a percent of a selected item on the statement.

Vertical Analysis for the Balance Sheet

Expressed as a percentage of total assets (account balance/total assets)

Vertical Analysis for the Income Statement

Expressed as percentages of net sales (account balance/net sales)

Ratio Analysis- Liquidity

Ratios express the mathematical relationship between two or more financial variables. Liquidity ratios provide a measure of a company’s ability to meet current obligations in a timely manner.

Working Capital

A widely used general measure for evaluating (current assets-current liabilities)

Current Ratio

A widely used general measure for evaluating a company’s ability to pay short-term liabilities with current assets (current assets/current liabilities)

Acid-test (Quick) Ratio

Also measures ability to pay short-term debt but excludes less liquid current assets ((cash+marketable securities+current receivables)/current liabilities)

Ratio Analysis- Assessing Profitability

Profitability rations provide a measure of the earnings and/or earnings potential of the company

Gross Margin Percentage

Provides a measure of the percentage of sales that remain after the cost of inventory is covered (gross margin/sale)

Net Margin Percentage

Provides a measure of the percentage of sales that remain after all expenses are covered (net income/sales)

Return on Total Assets

Measures the ability of the firm to earn a return on its assets. That is, provides a measure of how efficiently assets are used ((net income+(interest expense(1-tax rate))/average total assets)

Return on Equity

Measures the ability of the company to earn a return on the stockholder’s investment (net income/average she)

Ratio Analysis- Assessing Asset Management

Asset management rations assess how well a company has effectively and efficiently utilized its assets

Accounts Receivable Turnover

Used to assess the liquidity of the receivables; measures the number of times, on average, receivables are collected during the period (net sales/average accounts receivable)

Average Collection Period

A popular variant of the receivable’s turnover ratio that coverts it into an average number of days it takes to collect an account receivable (365/accounts receivable turnover)

Inventory Turnover

Measures the number of times, on average, the inventory is sold during the period. It indicates the liquidity of the inventory (cogs/avg inventory)

Average Sale Period (in days)

A variant of the inventory turnover ratio--computes the average days taken to sell the average inventory balance one time (365/ inventory turnover)

Operating Cycle

Measures the elapsed time from when inventory is received from suppliers to when cash is received from customers (avg sale period + avg collection period)

Total Asset Turnover

Measures how efficiently a company’s assets are being used to generate sales (sales/avg total assets)

Financial Leverage

Results from the difference in the rate of return a company earns on its assets and the rate of return it must pay its creditors (after-tax)

Positive Financial Leverage

The return on assets exceeds return paid to creditors (i.e., is higher than the cost of obtaining capital)

Negative Financial Leverage

The return on assets is less than the return paid to creditors (i.e., is less than the cost of obtaining capital)

Ratio Analysis Debt Management

Debt management ratios provide insight into the ability of a company to

pay ALL liabilities—current and long-term. Provides a measure of risk.

Time Interest Earned

Measures a company’s ability to meet interest payments as they become due ((income before taxes+interest expense)/interest expense)

Debt to Equity Ratio

Measures the relative proportion of financing provided by creditors as opposed to stockholders (total liabilities/total she)

The Equity Multiplier

Indicates the portion of a company’s assets that are funded by equity (avg total assets/avg she)

Raw Material

The term RAW MATERIAL refers to any materials that go into the final product and includes both DIRECT and INDIRECT materials

Direct Labor

Labor costs that can be easily traced to individual units of product (aka Touch Labor)

Factory Labor

Includes both direct and indirect labor

Manufacturing Overhead

Includes all manufacturing costs except direct materials and direct labor. These costs cannot be easily traced to specific units produced (also called indirect manufacturing cost, factory overhead, and factory burden)

Indirect Material

Materials that are relatively insignificant to the product--not worth tracing to each unit so are treated as part of manufacturing overhead

Indirect Labor

Factory labor that is difficult to trace to each unit is included as part of manufacturing overhead

Other Examples of Manufacturing Overhead

Maintenance and repairs on production equipment, heat and light, property taxes, depreciation, insurance, etc. on manufacturing facilities. (i.e., facilities costs that are related to operating the factory

Treatment of Production Costs

Assign to inventory as incurred; expense through COGS when inventory is sold (i.e., in accordance with the matching principle)

Period Costs (Nonmanufacturing Costs)

Selling costs, administrative costs, and includes other selling, general & administrative expenses

Selling Costs

Includes all costs necessary to secure customer orders and get the finished product into the hands of the customer

Administrative Costs

Includes all executive, organizational, and clerical costs associated with the general management of an organization

Other Selling, General & Administrative Expenses for Period Costs

Such as rent, insurance, depreciation, property taxes, etc. on selling and administrative facilities.

Treatment of Period Costs

EXPENSED in the period incurred (or allocated among periods benefitted for costs such as prepaid rent, supplies or depreciation)

Prime Costs

DM+DL

Conversion Costs

DL+OH

Cost Structure

Refers to the relative proportion of each type of cost in an organization

Cost Behavior

Refers to hoe a cost will react to changes in the level of activity. Understanding cost behavior facilitates planning and controlling.

Activity Base (Cost Driver)

Is a measure of what causes variable costs to change (such as units produced, units sold, labor hours, number of customers, etc.)

Relevant Range

Is the operating range over which a firm finds it practical to operate in the short-run;

• it is the range of activity within which the assumptions made about

cost behavior are valid. For example, outside of the relevant range,

total rent, a fixed cost, may NOT remain constant

• The relevant range of activity pertains to fixed cost as well as

variable costs

Commonly Used Classifications of Costs for Cost Behavior

Variable cost, fixed cost, and mixed cost

Variable Cost

A cost that varies, in total, directly and proportionally to changes in the level of activity.

Fixed Cost

A cost that remains constant, in total, regardless of changes in the level of the activity.

Committed Fixed Costs

Represent investments with a multi-year planning horizon that cannot be easily adjusted in the short term.

Discretionary Fixed Costs

Usually arise from annual decisions by management and they can be easily reduced in the short term.

Mixed Cost

A cost that contains both variable and fixed elements (aka Semi-variable Costs)

Traditional Format for Income Statements (Merchandiser)

Separates product costs from selling and administrative expenses as required for external reporting purposes. Required to be used for external reporting purposes. PROBLEM: This method does not distinguish between variable and fixed costs.

Contribution Margin Approach Format for Income Statement (Merchandiser)

Separates costs into fixed and variable categories and computes a contribution margin. Emphasizes cost behavior important to managers. The contribution approach is used as an internal planning and decision-making tool (aids cost-volume-profit analysis, performance evaluation, and budgeting, as we will see…)

Cost Classifications for Decision Making

Differential Cost & Revenue, Opportunity Cost, and Sunk Cost

Differential Cost and Revenue

Costs or Revenues that differ among the alternatives

Opportunity Cost

Benefits foregone by choosing an alternative

Sunk Cost

A cost that has already been incurred and cannot be changed by decisions made now or in the future