MBA ACCOUNTING FOR DECISION MAKING – Simphiwe Nojiyeza
Presentation Outline
• Accounting Information and Managerial Decisions
• Financial statements and accounting concepts
• Accounting for and presentation of assets, liabilities
and owners’ equity
• Income statement and cash flows
• Financial Analysis
• Cost-Volume-profit (CVP) relationships
• Cost analysis for planning, control and decision-making
• Transfer pricing for decentralised enterprises
• Corporate goverance
What is Accounting?
•
•
•
•
•
It is the process of:
Identifying , measuring and communicating
Economic information about an entity
For decisions and informed judgments
The primary role of accounting is to provide
information for the decision-making needs of
internal and external stakeholders
Users and Uses of Accounting
Information
User
Management
Investors/Shareholders
Creditors/Suppliers
Employees
Securities and Exchange
Commission
Decision/Informed Judgment
Made
Planning, directing and controlling
Assessing amounts, timing, and
uncertainty of future cash returns on
their investment
Assessing probability of collection and
the risk of late (or non-) payment
Planning for retirement and future job
prospects
Reviewing for compliance of all
required information
Financial VS Management Accounting
• Financial accounting generally refers to
the process that results in the
preparation and reporting of financial
statements for an entity.
• Financial accounting is primarily
externally oriented and concerned with
the historical results of an entity’s
performance
Management Accounting
• Managerial accounting is concerned
with the use of economic and financial
information to plan and control many of
the activities of the entity and to
support the management decisionmaking process.
• Cost accounting relates to the
determination and accumulation of
product, process, or service costs.
Internal Auditing
• Internal auditors are professional
accountants who perform functions much
like those of an external auditor.
However, internal auditors are employed
in industry rather than public accounting.
• In most companies internal auditing is
done by book keepers
• The process assists members of the
organization to discharge their
responsibilities effectively
Auditing- Public Accounting
• Public accounting firms and individual
Certified Public Accountants (CPAs)
provide auditing services and issue an
independent auditor’s report.
• An independent auditor’s report usually
contains four brief paragraphs and states
whether the financial statements are
prepared in conformity with generally
accepted accounting principles. An
auditor’s report can be unqualified (a
“clean opinion) or qualified.
The Role of the Management
Accountant
• The role of the management accountant
involves interpreting information, packaging
information in order to facilitate decision
making.
• It also involves close coordination with the
financial, production and marketing functions
of an organization
A Basic Decision-Making Model
• Decision making is a process of identifying
various courses of action and selecting the
most appropriate one
• There are 4 steps to follow:
• Define the problem
• Identify objectives
• Identify and analyze available options
• Select the best option
Financial statements and Accounting
Concepts
Transactions are economic
interchanges between entities that are
accounted for and reflected in financial
statements
Transactions are summarized in
accounts
Accounts are used to organize like-kind
transactions.
Account balances are then used in the
preparation of financial statemen
Financial Statements
• Balance sheet (Statement of financial position)
reports on the financial position on a certain date
= Assets= Owner’s Equity+ Liabilities
• Income statement ( Statement of Comprehensive
Income) reports on profits and losses for a
particular period
• Statement of changes in equity reports on
investments by and distributions to owners.
• Cash Flow Statement- cash flows during the
period
Annual Report
• In addition to the financial statements,
the annual report will probably include
several accompanying notes or
explanations of the accounting policies
used and detailed information about
many of the amounts and captions
shown in the financial statements.
Balance Sheet-Elements
LO3
Assets represent the amount of resources
owned by the entity.
Main Street Store, Inc.
Balance Sheet
August 31, 2011
Assets
Current Assets
Cash
Accounts receivable
Merchandise inventory
Total current assets
Plant and Equipment
Equipment
Less: Accumulated
depreciation
Total assets
$
$
34,000
80,000
170,000
284,000
40,000
Liabilities and Owners' Equity
Current Liabilities
Short-term debt
$
20,000
Accounts payable
35,000
Other accrued liabilities
12,000
Total current liabilities
$
67,000
Long-term debt
50,000
Total liabilities
117,000
(4,000) Owners' equity
$
320,000
Total liabilities and
owners' equity
203,000
$
320,000
Liabilities are
amounts owed
to other entities.
Equity is the
ownership right
of the owner(s) of
the entity in the
assets that
remain after
deducting the
liabilities.
2-14
Balance Sheet
LO3
Assets
=
Liabilities
+
Equity
Main Street Store, Inc.
Balance Sheet
August 31, 2011
Assets
Current Assets
Cash
Accounts receivable
Merchandise inventory
Total current assets
Plant and Equipment
Equipment
Less: Accumulated
depreciation
Total assets
$
$
34,000
80,000
170,000
284,000
40,000
(4,000)
$
320,000
Liabilities and Owners' Equity
Current Liabilities
Short-term debt
$
20,000
Accounts payable
35,000
Other accrued liabilities
12,000
Total current liabilities
$
67,000
Long-term debt
50,000
Total liabilities
117,000
Owners' equity
Total liabilities and
owners' equity
203,000
$
320,000
2-15
Balance Sheet
LO3
Current assets are those assets that are likely to be converted into
cash or used to benefit the entity within one year.
Assets
Current Assets
Cash
Accounts receivable
Merchandise inventory
Total current assets
Plant and Equipment
Equipment
Less: Accumulated
depreciation
Total assets
Main Street Store, Inc.
Balance Sheet
August 31, 2011
Liabilities and Owners' Equity
Current Liabilities
$
34,000 Short-term debt
$
20,000
80,000 Accounts payable
35,000
170,000 Other accrued liabilities
12,000
$
284,000 Total current liabilities
$
67,000
Long-term debt
50,000
40,000 Total liabilities
117,000
(4,000) Owners' equity
203,000
$
320,000
Total liabilities and
owners' equity
$
320,000
Current
liabilities
are those
liabilities
that are to
be paid
within
one year.
2-16
LO4
Income Statement
The income statement shows the profit (or loss) for the
period of time under consideration.
Revenues result from
the entity’s operating
activities (e.g., selling
merchandise).
Costs and expenses
are incurred in
generating revenues
and operating the
entity.
Main Street Store, Inc.
Income Statement
For the Year Ended August 31, 2011
Net sales
Cost of goods sold
Gross profit
Selling, general, and admin. expenses
Income from operations
Interest expense
Income before taxes
Income taxes
Net income
Earnings per share of common stock
outstanding
$
$
1,200,000
850,000
350,000
311,000
39,000
9,000
30,000
12,000
18,000
$
1.80
$
$
$
Gains and losses are also reported on the income statement and result from nonoperating activities, rather than from the day-to-day operating activities that
2-18
generate revenues and expenses.
LO4
Statement of Changes
in Owners’ Equity
Main Street Store, Inc.
Statement of Changes in Owners' Equity
For the Year Ended August 31, 2011
Paid-In Capital:
Beginning balance
Common stock, par value $10; 50,000 shares
authorized, 10,000 shares issued and
outstanding
Additional paid-in capital
Balance, August 31, 2011
Retained Earnings:
Beginning balance
Net income for the year
Less: Cash dividends of $.50 per share
Balance, August 31, 2011
Total owners' equity
$
$
$
$
$
-
100,000
90,000
190,000
18,000
(5,000)
13,000
203,000
This financial statement shows the detail of owners’
equity and explains the changes that occurred in the
components of owners’ equity during the year.
2-19
Statement of Cash Flows
LO4
Main Street Store, Inc.
Statement of Cash Flows
For the Year Ended August 31, 2011
Cash Flows from Operating Activities:
Net income
$
18,000
Add (deduct) items not affecting cash:
Depreciation expense
4,000
Increase in accounts receivable
(80,000)
Increase in merchandise inventory
(170,000)
Increase in current liabilities
67,000
Net cash used by operating activities
(161,000)
Cash Flows from Investing Activities:
Cash paid for equipment
$
(40,000)
Cash Flows from Financing Activities:
Cash received from issue of long-term debt
50,000
Cash received from sale of common stock
190,000
Payment of cash dividend on common stock
Net cash provided by financing activities
Net increase in cash for the year
The purpose of this
financial statement
is to identify the
sources and uses of
cash during the
year.
(5,000)
$
235,000
$
34,000
2-20
LO4
Financial Statement Relationships and the
Accounting Equation
If assets equal $300,000 and liabilities equal $125,000, what is owners’
equity?
Balance Sheet
Assets
= Liabilities
300,000 = 125,000
Owners'
+ Equity
+ 175,000
Owners’ equity equals $175,000
($300,000 - $125,000)
Now, suppose that total assets increase $12,000 during the year and total
liabilities decrease $3,000 during the year.
Balance Sheet
Assets
=
300,000
12,000
312,000
Liabilities +
125,000
(3,000)
122,000
Owners'
Equity
175,000
15,000
190,000
Owners’ equity must have increased by
$15,000. Since owners’ equity was
$175,000 at the beginning of the year, it
must be $190,000 at the end of the
year.
2-21
Balance Sheet
LO4
Account
Definition
Cash
Cash on hand and in the bank
Accounts receivable
Amounts due from customers
Merchandise inventory
Cost of merchandise acquired and not yet sold
Equipment
Cost of equipment purchased and used in business
Accumulated depreciation Portion of the cost of equipment that is estimated to have
been used up in the process of operating the business
Short-term debt
Amounts borrowed that will be repaid within one year of the
balance sheet date
Accounts payable
Amounts due to suppliers
Other accrued liabilities
Amounts owed to various creditors
Long-term debt
Amounts borrowed from banks or other creditors that will
not be repaid within one year from the balance sheet date
Owners' equity
Residual claim of owners, computed as "assets minus
liabilities"
2-22
LO4
Captions
Net sales
Cost of goods sold
Gross profit
Selling, general, and
administrative expenses
Income from operations
Interest expense
Income taxes
Net income per share of
common stock
outstanding
Income Statement
Explanation
Amount of sales of merchandise to customers, less the
amount of customer returns of merchandise
Represents the total cost of merchandise removed from
inventory and delivered to customers as a result of sales
Difference between net sales and cost of goods sold;
Represents the seller's maximum amount of "cushion"
from which all other expenses of the business must be
deducted before it is possible to have net income
Represents the operating expenses of the entity
Represents one of the most important measures of the
firm's activities
Represents the cost of using borrowed funds
Shown after all of the other income statement items have
been reported because income taxes are a function of the
firm's income before taxes
A significant item in evaluating the market value of a share
of common stock; Often referred to as "earnings per
share" or EPS
2-23
Statement of Changes
in Owners’ Equity
LO4
Captions
Paid-in capital
Common stock
Additional paid-in capital
Explanation
Represents the total amount invested in the entity by
the owners
Reflects the number of shares authorized by the
corporation's charter, the number of shares issued to
stockholders, and the number of shares still held by
the stockholders
Difference between the total amount invested by the
owners and the par value or stated value of the stock
Retained earnings
Represents the cumulative net income of the entity
that has been retained for use in the business
Dividends
Distributions of earnings to the owners
2-24
LO4
Statement of Cash Flows
Captions
Explanation
Cash flows from operating Shown first; Net income is the starting point for this
activities
measure of cash generation
Depreciation expense
Added back to net income because it is subtracted to
arrive at net income, but does not require the use of cash
Increase in accounts
receivable
Increase in merchandise
inventory
Increase in current
liabilities
Deducted because it reflects sales revenues, included in
net income, but not yet received in cash
Deducted because cash was spent to acquire the
increase in inventory
Added because cash has not yet been paid for the
products and services that have been received during the
current fiscal period
Cash flows from investing Shows the cash sources and uses related to long-lived
activities
assets
Cash flows from financing Shows the cash sources and uses related to transactions
activities
with creditors and stockholders
2-25
LO6
Accrual Accounting Vs. Cash Flows
Revenue Recognition -Timing is the Key
Accrual accounting
recognizes:
Cash flow
recognizes:
Revenue
Revenue
when revenue is earned,
at the point of sale of
services or products.
when payment is received
for services rendered
or products sold.
Expenses
Expenses
when they are incurred.
when they are paid.
2-26
What are Current Assets?
Current assets include cash and those assets that are
expected to be converted to cash or used up within one
year, or an operating cycle, whichever is longer.
Current
Assets
include
Cash
Inventorie
s
Short-term
Securities
Accounts
and Notes
Receivable
Prepaid
Expenses
Deferred
Tax Assets
5-27
Cash
LO1
Coins and
paper
money
Checking
accounts
Cash
Petty cash
funds
includes.
..
Money orders
Undeposited
receipts
5-28
LO2
The Internal Control System
Internal control objectives are to ensure:
1. Effective and efficient operations.
2. Reliable financial reporting.
3. Compliance with applicable laws and regulations.
Internal Control Over Cash
 Require daily deposits.
 Make all payments by check.
 Promptly reconcile bank statements.
5-29
LO3
Bank Statements
Bank Statement
Beginning Bank Balance
+
Deposits processed by the bank
Checks which have cleared the account
+/Other adjustments made by the bank
=
Ending Balance
5-30
LO3
Bank Reconciliation - Objective
Identify Differences Between
Ending cash balance reported on bank
statement
Compared to
Ending cash balance in depositor’s accounting
records.
Provides information for adjusting journal
entries.
5-31
LO4
Short-Term Marketable Securities
Bond
Investments
Readily
Marketable
Marketable
Securities
are . . .
Capital
Stock
Investments
Current Assets
Almost As
Liquid As
Cash
5-32
LO5
Uncollectible Accounts
If a company makes credit
sales to customers, some
accounts inevitably will
turn out to be
uncollectible.
PAST DUE
5-33
LO5
Balance Sheet Presentation
Accounts receivable
Less: Allowance for bad debts
Net realizable value of accounts receivable
The net realizable value is the amount of
accounts receivable that the business
expects to collect.
5-34
LO6
Notes Receivable
A note is a
written
promise to
pay a specific
amount at a
specific future
date.
Notes typically
include an
interest charge
for use of the
money during
the time period
of the note.
5-35
LO7
Inventories
In a perpetual inventory system, inventory entries
are as follows:
GENERAL JOURNAL
Cost of Goods
is an Titles and Explanation
Datesold Account
ExpenseEntry on Purchase Date
Inventory
Accounts Payable (or Cash)
Entry on Sale Date
Cost of Goods Sold
Inventory
Debit
Credit
$$$$
$$$$
$$$$
$$$$
5-36
LO8
Specific Identification
When a unit
is sold, the
specific cost
of the unit
sold is
added to
cost of
goods sold.
5-37
LO8
Weighted-Average
Calculate the average cost
of the items in beginning
inventory plus purchases
made during the year.
Cost of Goods
Units Available
Available for ÷
for Sale During
Sale During
the Year
the Year
5-38
LO8
Last-In, First-Out Method (LIFO)
Recent
Costs
Costs of
Goods Sold
Oldest
Costs
Ending
Inventory
5-39
Noncurrent Assets
Lan
d
Buildings
Equipment
1) Classified as assets because
they are owned by the
organization.
2) Have the ability to generate
revenue beyond one year.
Intangible Assets
Natural Resources
6-40
LO1
Land
Land is a nondepreciable asset.
All costs incurred to get
land ready for use are
capitalized.
Title insurance premiums
Purchase
price
Delinquent
taxes
Real estate
commissions
Razing costs
of building
on the land
Title and legal fees
6-41
Buildings and Equipment
LO1
All costs incurred to get an asset ready for use
are capitalized.
Purchase
price
Installation
costs
Architectural
fees
Transportation
costs
Cost of
permits
Excavation and
construction costs
6-42
Depreciation
LO2
Depreciation is the allocation of the cost
of an asset to the years in which the
benefits of the asset are expected to be
received. It is an application of the
matching concept.
Balance Sheet
Acquisition
Cost
(Unused)
Income Statement
Cost
Allocation
Expense
Does not reflect decline in
value.
(Used)
6-43
Depreciation Methods
LO3
Straight-Line Methods
Accelerated Methods
Straight-line
Sum-of-the-years’-digits
Units of production
Declining balance
Accelerated Depreciation
Annual
Depreciation
Expense ($)
Annual
Depreciation
Expense ($)
Straight-Line Depreciation
Years of Life
Years of Life
6-44
LO3
Declining-Balance Method
Double the
Annual Depreciation
Book Value at
= Straight-line
×
Expense
Beginning of Year
Depreciation Rate
Since we are using
two times the
straight-line rate,
this is called the
Double-DecliningBalance Method.
1
Life in Years
×2
6-45
Comparing Depreciation Methods
LO3
Straight-Line
$10,000
$6,000
Annual
Depreciation
Annual
Depreciation
$8,000
$4,000
$2,000
$0
1
2
3
4
$8,000
$6,000
$4,000
$2,000
$0
2
3
4
5
Life in Years
Double-DecliningBalance
Total depreciation at
end of useful life will be
the same regardless of
depreciation method
$15,000
Annual
Depreciation
$12,000
$10,000
1
5
Life in Years
$20,000
Units-of-Production
$16,000
$14,000
$10,000
$5,000
$0
1
2
3
Life in Years
4
5
6-46
LO4
Depreciation for Tax Reporting
Most corporations use the Modified Accelerated
Cost Recovery System (MACRS) for tax purposes.
MACRS depreciation provides for rapid write-off of
an asset’s cost in order to stimulate new
investment.
Salvage values are ignored
Useful lives are set by the Internal
Revenue Service
6-47
LO5
Maintenance and Repair Expense
Preventative
maintenance
expenditures and
routine repair costs
are clearly expenses
of the period in
which they are
incurred.
6-48
LO6
Disposal of Depreciable Assets
Update depreciation
to the date of disposal.
Journalize disposal by:
Recording cash
received (debit).
Removing accumulated
depreciation (debit).
Recording a
gain (credit)
or loss (debit).
Removing the
asset cost (credit).
6-49
LO7
Assets Acquired by Capital Lease
An operating
lease is an
ordinary lease
for the use of an
asset that does
not involve any
attributes of
ownership.
A capital lease
results in the
lessee (renter)
assuming
virtually all of
the benefits and
risks of
ownership for
the leased asset.
6-50
LO9
Intangible Assets
Noncurrent assets
without physical
substance.
Often provide
exclusive rights
or privileges.
Intangible
Assets
Useful life is
often difficult
to determine.
Usually acquired
for operational
use.
6-51
Buy or Lease an Asset?
LO8
Balance Sheet
Assets
Buy
=
1. Date of Acquisition
Computer
Equipment
+217,765
Income Statement
Liabilities
+
Owners'
Equity
Net
income
+217,765
Depreciation Expense
-Note Principal
Interest Expense
Balance Sheet
1. Date of Acquisition
Computer
Equipment
+217,765
Lease
2. Annual Depreciation
Accumulated
Depreciation
3. Annual Lease Payment
- Expenses
Note Payable
2. Annual Depreciation
Accumulated
Depreciation
3. Annual Lease Payment
Assets
= Revenues
=
Liabilities
Income Statement
+
Owners'
Equity
Net
income
= Revenues - Expenses
Capital Lease
Liability
+217,765
Depreciation Expense
-Lease Liability
Interest Expense
Leasing the computer is essentially the same as buying it. Both methods of acquiring the asset
yield the same economic impact and the same effect on the financial statements.
6-52
LO9
Goodwill
Goodwill
Occurs when one
company buys
another company.
Only ‘purchased’
goodwill is an
intangible asset.
The amount by which the
purchase price exceeds the fair
market value of net assets acquired.
6-53
LO1
Nature of Liabilities
• Liabilities are obligations that represent
“probable future sacrifice of economic
benefits.”
• The term accrued expenses is often used on
the balance sheet to describe liabilities.
• Current liabilities are those liabilities that will
be paid within one year of the current balance
sheet date.
7-54
LO1
Nature of Liabilities
Current liabilities include:
• Accounts payable
• Short-term debt (Notes payable)
• Current maturities of long-term debt
• Unearned revenue or deferred credits
• Other accrued liabilities
Noncurrent liabilities include:
• Long-term debt (Bonds payable)
• Deferred tax liabilities
• Minority interest in subsidiaries
7-55
LO6
Noncurrent Liabilities
Long-Term Debt
Interest on debt is tax deductible
but dividends on stock are not.
The after-tax cost of debt can be
less than the cost of equities.
Long-term debt can provide positive
financial leverage. Leverage is the
difference between the ROI and the ROE.
7-56
LO 1
Owners’ Equity Section
Owners' Equity
Paid-in capital
Common stock $1 par, 100,000 shares
issued and 95,000 outstanding
Additional paid-in capital
Total paid-in capital
Retained earnings
Total paid-in capital and retained earnings
Less: cost of treasury stock (5,000 shares)
Total owners' equity
$
100,000
2,800,000
2,900,000
1,400,000
4,300,000
(150,000)
$ 4,150,000
8-57
Paid-in Capital
LO 1
Common Stock
On January 1, 2010, Matrix, Inc. issued 100,000 of its $3 par value
common stock for $14 per share. The following entry is recorded:
GENERAL JOURNAL
Date
Account Titles and Explanation
2010
Jan. 1 Cash
Common stock
Additional-paid-in-capital
Debit
Credit
1,400,000
300,000
1,100,000
This transaction has the following effect on the financial statements of
Matrix:
Balance Sheet
Assets
Cash
+1,400,000
=
Liabilities
Income Statement
+
Owners'
Equity
Common
Stock
+300,000
Additional
Paid-in
Capital
+1,100,000
Net
income
=
Revenues
-
Expenses
8-58
Common Stock
LO 1
Issued shares
that have been
reacquired.
Treasury
Issued shares
include outstanding
and treasury
shares.
Unissued
Outstanding
Authorized
Shares
Issued shares that
are owned by
stockholders.
8-59
LO 2
Preferred Stock
Normally no voting
rights, but dividend
payment has
preference over
common stock.
Has a par or stated
value with dividend
expressed as a
percent of par.
If callable,
may be retired.
If convertible, may be
exchanged for
common shares.
8-60
LO 2
Preferred Stock Versus Bonds
Comparison of Preferred Stock and Bonds Payable
Similarities
Preferred Stock
Bonds Payable
Dividend is usually fixed
Interest is fixed claim to
claim to income
income
Redemption value is fixed
Maturity value is a fixed claim
claim to assets
to assets
Is usually callable and may be
Is usually callable and may be
convertible
convertible
Differences
Dividend may be skipped,
Interest must be paid or firm
even if it must be caught up
faces bankruptcy
before payments to common
Principal must be paid at
No maturity date
maturity
Dividends are not an
Interest is a tax deductible
expense and are not tax
expense
deductible
8-61
LO 2
Additional Paid-in Capital
Represents the excess of the amount
received from the sale of preferred or
common stock over par (or stated) value.
8-62
LO 2
Retained Earnings
Represents the cumulative earnings of a
corporation less the cumulative dividends paid
since the business started operations.
Retained earnings
is NOT cash.
8-63
LO 3
Cash Dividends
Dividends must be
declared by the board
of directors before
they can be legally paid.
The company must have
sufficient cash and
retained earnings
to pay the dividend.
The company is not
legally required to
pay dividends, but
once declared a
legal liability
is created.
8-64
Stock Dividends
LO 4
Distribution of additional shares of stock to
stockholders.
No change in par value
of stock or in total
stockholders’ equity.
Stockholders retain percentage
ownership in the company
(preemptive right)
Reasons for stock dividends:



Preserve cash.
Decrease market price of stock.
Reduce retained earnings.
8-65
LO1
Revenue
Income Statement
Revenue is generated when a firm sells a product or
provides a service to a client or customer and receives
cash, creates an account receivable, or satisfies an
obligation.
Revenue is generally measured by the amount of cash
received or expected to be received from a transaction.
Revenue is realized when the product or service has been
exchanged for cash, claims to cash, or an asset that is
readily convertible to a known amount of cash.
Revenue is earned when the firm has completed, or
substantially completed, the activities it must perform to
be entitled to the revenue benefits.
Companies should disclose unusual revenue recognition
methods, such as percentage-of-completion or
installment methods.
9-66
LO2
Cost of Goods Sold
In a perpetual inventory system, cost of
goods sold is determined for each sale.
Calculation of cost of goods sold in a
periodic inventory system
Beginning inventory
Gross purchases
Less: Purchase discounts
Less: Purchase returns and allowances
Net Purchases
Add: Freight-In
Cost of goods available for sale
Less: Ending inventory
Cost of goods sold
$ 47,000
$ 361,200
(3,500)
(1,800)
355,900
2,000
357,900
404,900
(53,100)
$ 351,800
9-67
Gross Profit
LO3
Gross profit is the excess of sales over
cost of goods sold.
Year
2008
2007
2006
$ 400,000 $ 355,000 $ 320,000
285,000
250,000
225,000
115,000
105,000
95,000
Item
Sales
Cost of goods sold
Gross profit
Gross profit ratio = Gross profit ÷ Net sales
Year
Gross
Profit
Sales
Gross
Profit
Ratio
2008 $115,000 ÷ $400,000 = 28.75%
2007
105,000 ÷
355,000 = 29.58%
2006
95,000 ÷
320,000 = 29.69%
9-68
LO4
Expenses
Outflows or other using up of assets or incurring
liabilities from delivering or producing goods, rendering
services, or carrying out other activities that constitute
the entity’s ongoing central operations.
1. Some expenses are recognized concurrently with the
revenues to which they relate (matching principle).
2. Some expenses are recognized in the period in which
they are incurred (administrative salaries).
3. Some expenses result from an allocation of the cost
of an asset to the period (depreciation).
9-69
LO4
Operating Expenses
Operating expenses usually are reported in
the following classifications on the income
statement:
1. Selling expenses.
2. General and administrative expenses.
3. Research and development expenses.
9-70
LO5
Multiple-Step Income Statement
Matrix, Inc.
Income Statement
For the Year Ended December 31, 20xx
Sales, net
Cost of goods sold
Gross profit
Operating expenses:
Selling expenses
General and admin.
Depreciation
Income from operations
Other revenues and gains:
Interest income
Gain
Other expenses and losses:
Interest
Loss
Income before taxes
Income taxes
Net income
$
$
197,350
78,500
17,500
785,250
351,800
433,450
293,350
140,100
62,187
24,600
86,787
27,000
9,000
$
(36,000)
190,887
62,500
128,387
9-71
LO8
Gains and Losses
Increases (gains) or decreases (losses) in an entity’s net assets
result from nonoperating activities. Gains/losses are usually
reported as other income and excluded from operating income.
Matrix, Inc.
Income Statement
For the Year Ended December 31, 20xx
Sales, net
Cost of goods sold
Gross profit
Operating expenses:
Selling expenses
General and admin.
Depreciation
Income from operations
Other revenues and gains:
Interest income
Gain
Other expenses and losses:
Interest
Loss
Income before taxes
Income taxes
Net income
$
$
197,350
78,500
17,500
785,250
351,800
433,450
293,350
140,100
62,187
24,600
86,787
27,000
9,000
$
(36,000)
190,887
62,500
128,387
9-72
LO9
Statement of Cash Flows
Provides relevant information about the cash
receipts and cash payments of an enterprise
during a period. The statement shows why cash
and cash equivalents changed during the period
by reporting net cash provided or used by . . .



Operating
Activities
Investing
Activities
Financing
Activities
9-73
LO9
Cash Inflows
Operating Activities
Cash received
from revenues
Investing Activities
Sale of operational assets
Sale of investments
Collections of loans
Financing Activities
Issuance of stock
Issuance of bonds
and notes
Enterprise
Cash paid for
expenses
Purchase of operational assets
Purchase of investments
Loans to others
Payment of dividends
Repurchase of stock
Repayment of debt
Cash Outflows
9-74
L O 10
Cash Flows from Operating Activities
Supplemental
Reconciliation
Direct
Presentation
Cash Flows from Operating Activities
Cash received from customers
Cash paid to suppliers
Cash paid for operating expenses
Cash Flows from Operating Activities
$ 175,000
120,000
27,630
27,370
Cash Flows from Investing Activities
Proceeds from sale of Equipment
43,000
Cash Flows from Financing Activities
Proceeds from sale of Stock
Principal paid on Bonds
Principal paid on Notes
Net Cash Flows for the Period
Add: Beginning Cash Balance
Ending Cash Balance
$
50,000
(100,000)
(10,000)
(60,000)
10,370
21,000
$ 31,370
Net Income
$ 15,020
Add (Deduct) items not affecting cash:
Depreciation expense
5,000
Increase in accounts payable
4,600
Minority interest in subsidiaries
25,000
Gain on sale of land
(17,250)
Increase in accounts receivable
(3,000)
Increase in inventory
(2,000)
Net Cash Flow from Operations
$ 27,370
Note that net cash flow
from operations and cash
flows from operating
activities reconcile.
9-75
Statement of Cash Flows
L O 10
Indirect Presentation
Net Income
Add (Deduct) items not affecting cash:
Depreciation expense
Increase in accounts payable
Minority interest in subsidiaries
Gain on sale of land
Increase in accounts receivable
Increase in inventory
Net Cash Flow from Operations
Cash Flows from Investing Activities
Proceeds from sale of Equipment
Cash Flows from Financing Activities
Proceeds from sale of Stock
$50,000
Principal paid on Bonds
(100,000)
Principal paid on Notes
(10,000)
Net Cash Flows for the Period
Add: Beginning Cash Balance
Ending Cash Balance
$ 15,020
5,000
4,600
25,000
(17,250)
(3,000)
(2,000)
27,370
43,000
About 98%
of major
corporations
use the indirect
method of
presentation!
(60,000)
10,370
21,000
31,370
9-76
L O 11
Interpreting the Statement
A business entity should have positive cash
flows from operational activities. If operating
activities do not generate cash, the entity must
look to outside parties for funds to meet its
day-to-day activities.
9-77
Financial Statement Ratios
Ratios are used to interpret the financial position
and results of operations of an entity and may be
grouped in the following four categories:
1. Liquidity.
2. Activity.
3. Profitability.
4. Debt, or financial leverage.
11-78
Operational Analysis
• Gross Profit Margin = Gross Profit / Sales X
100 /1
• Operating Margin = Operating Profit / sales X
100 /1
• Profit Margin = Net profit after tax / sales X
100 /1
Resource Management
• Inventory Turnover = Cost of Sales / Average
Inventory
• Debtor Collection Period =Accounts
Receivable / Credit Sales x 365
• Credit Payment Period = Accounts Payable /
Credit purchases x 365
• Turnover to Net Assets = Sales / Net Assets
Profitability
• Return on Assets = Operating Profit / Total assets x 100 /1
• Return on Capital Employed = Operating profit / Capital
employed X 100 /1
• Return on Equity = Profit after tax / Owner’s equity X 100
/1
• Earnings per share (EPS) = Net profit after tax = Number of
ordinary shares issued
• Dividend per share = Dividends for the year / Number of
ordinary shares issued
• Earnings retention = Earnings per share – Dividend per
share / Earnings per share X 100 or Retained Earnings for
the year / Profit due to ordinary shareholders X 100/1
Market indicators / Liquidity
• Price / Earnings (P/E) Ratio = Market price per
share / Earnings per share
• Current Ratio = Current Assets / Current
Liabilities
• Acid Test Ratio = Current Assets – Inventory /
Current Liabilities
• Leverage : Debt to Assets= Total debt / Total
assets X 100 /1
• Debt to equity= Non
Cost Volume Profit Relationships
•
•
•
•
•
•
•
•
•
•
Cost behaviour
Cost Classifications
Cost Volume Profit Relationships
Contribution Margin Concept
The traditional income statement format and the
contribution margin income statement format
An expanded contribution margin model
Sales Mix Cosniderations
Breakeven Point
Target Profit, analysis, Operating Leverage
Margin of Safety
LO3
Relationship of Total Cost
to Volume of Activity
How a cost will react to
changes in the level of
business activity.
– Total variable costs
change when activity
changes.
– Total fixed costs
remain unchanged
when activity changes.
12-84
Total Fixed Cost
LO4
Monthly Basic
Telephone Bill
Your monthly basic telephone bill
probably does not change when
you make more local calls.
Number of Local Calls
12-85
Fixed Cost per Unit
The average cost per local call decreases
as more local calls are made.
Monthly Basic Telephone
Bill per Local Call
LO4
Number of Local Calls
12-86
Total Variable Cost
LO5
Total Long Distance
Telephone Bill
Your total long distance telephone bill is
based on how many minutes you talk.
Minutes Talked
12-87
Variable Cost Per Unit
The cost per long distance minute talked is
constant. For example, $0.10 per minute.
Per Minute
Telephone Charge
LO5
Minutes Talked
12-88
LO6
The High-low Method
 Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit
 Fixed cost = Total cost – Total variable cost
Fixed cost = $9,700 – ($0.90 per unit × 9,000 units)
Fixed cost = $9,700 – $8,100 = $1,600
 Total cost = Fixed cost + Variable cost (Y = a + bX)
Y = $1,600 + $0.90X
12-89
LO7
The Contribution Margin Format
Used primarily for
external reporting.
Used primarily by
management.
Both formats report the same operating income!
12-90
LO9
The Contribution Margin Format
Contribution margin ratio
12-91
L O 10
Multiple Products and
Sales Mix Considerations
Sales mix is the relative combination in which
a company’s different products are sold.
Different products have different selling
prices, costs, and contribution margins.
A change in the sales mix will result in a
different contribution margin ratio.
12-92
L O 10
Multiple Products and
Sales Mix Considerations
How will average total contribution margin change if Jones sold 1,500
lawn tractors, all other factors held constant?
Lawnmowers
Sales
$ 250,000 100%
Variable expense
150,000
60%
Contribution margin $ 100,000
40%
Fixed expense
Operating income
Lawn tractors
$450,000 100%
202,500
45%
$247,500
55%
Total
$ 700,000 100%
352,500 50%
$ 347,500 50%
170,000
$ 177,500
Average total contribution margin ratio provided from all products:
$347,500
$700,000 = 50%
Increases
Due to selling more(rounded)
product with a higher CM ratio.
12-93
L O 11
Break-Even Point Analysis
How many units must Evans sell to
cover its fixed costs (break even)?
Answer: $30,000 ÷ $4 per unit = 7,500 units
12-94
L O 11
Break-Even Point Analysis
The break-even formula may also be
expressed in sales dollars.
Fixed costs
Break-even point in dollars =
Contribution margin ratio
Unit sales price
Unit variable cost
12-95
L O 11
Break-Even Point Analysis
Break-even formulas may be adjusted to
show the sales volume needed to earn
any amount of operating income.
Unit sales =
Fixed costs + Desired income
Contribution margin per unit
Fixed costs + Desired income
Dollar sales =
Contribution margin ratio
12-96
LO1
Budgeting
A budget is a comprehensive financial
plan for achieving the financial and
operational goals of an organization.
Planning
Control
Developing
objectives for
acquisition
and use of
resources.
Steps taken by
management to
ensure that
objectives are
attained.
14-98
98
L O2
Participative Budgeting
Flow of Budget Data
Top Management
Middle
Management
Supervisor
Supervisor
Middle
Management
Supervisor
Supervisor
Time consuming but enhances employee
motivation and acceptance of goals.
14-100
The Budget Time Frame
L O3
Operating Budget
2010
Operating Budget
2011
Operating Budget
2012
2013
The annual operating budget
may be divided into quarterly
or monthly budgets.
14-101
The Budget Time Frame
L O3
Continuous or
Perpetual Budget
2010
2011
2011
2011
2011
Quarte
r IV
Quarte
rI
Quarte
r II
Quarte
r III
Quarte
r IV
Budget for
last quarter
of 2011 and
first 3
quarters
of 2012
Budget for
2012 by
quarters
Budget for
2011 by
quarters
Budget for
last 3
quarters
of 2011 and
first
quarter
of 2012
Budget for
last 2
quarters
of 2011and
first 2
quarters
of 2012
2012
This budget is usually a four-quarter
budget that rolls forward one quarter
as the current quarter is completed.
14-103
The Budgeting Process
L O4
Sales Budget
Purchases
Budget
(Merchandiser)
Production
Budget
(Manufacturer)
OR
Direct
Materials
Budget
Operating Expense
Budget
Direct
Labor
Budget
Manufacturing
Overhead
Budget
Cost of Goods
Sold Budget
Budgeted Income Statement
Budgeted Statement of Cash Flows
Budgeted Balance Sheet
14-104
L O4
Sales Budget
Sales
Budget
Estimated
Unit Sales
Estimated
Unit Price
Analysis of economic and market conditions
+
Forecasts of customer needs provided by marketing
personnel
14-105
L O5
The Production Budget
Production must be adequate to meet budgeted
sales and to provide sufficient ending
inventory.
Budgeted product sales in units
+ Desired product units in ending inventory
= Total product units needed
– Product units in beginning inventory
= Product units to produce
14-107
L O5
Raw Materials Purchases Budget
The materials purchases budget is based on
production quantity and desired materials
inventory levels.
×
=
+
=
–
=
Units to produce
Material needed per unit
Material needed for units to produce
Desired units of material in ending inventory
Total units of material needed
Units of material in beginning inventory
Units of material to purchase
14-108
L O6
Selling and Administrative
(S&A) Expense Budget
• Selling expense budgets contain both variable
and fixed items.
– Variable items: shipping costs and sales
commissions.
– Fixed items: advertising and sales salaries.
• Administrative expense budgets contain mostly
fixed items.
– Executive salaries and depreciation on company
offices.
14-109
L O7
Budgeted Income Statement
Production costs per unit Quantity
Cost Total
Direct materials
3.00 lbs. $ 0.90 $ 2.70
Direct labor
0.10 hrs. $ 10.00
1.00
Manufacturing overhead
4.91
Total unit cost
$ 8.61
Total mfg. OH for quarter $188,400
= $4.91 per unit
Total labor hours required 38,400 units
(rounded)
From production and overhead budgets
Units Produced
January
12,800
February
16,200
March
9,400
Total
38,400
Mfg. OH
$ 62,800
66,200
59,400
$ 188,400
Manufacturing
overhead is
applied based on
number of units
produced.
14-111
LO3
Direct Costs and Indirect Costs
Direct costs
Indirect costs
• Can be easily and
conveniently traced to a
unit of product or other
cost objective.
• Cannot be easily and
conveniently traced to a
unit of product or other
cost object.
• Would not be incurred if
the product or activity was
discontinued.
• Would be incurred even if
the product or activity
was discontinued.
13-112
Standard Costs
LO9
Based on carefully
predetermined amounts.
Standard
Costs are
Used for planning material, labor,
and overhead requirements.
The expected level
of performance.
Are standards the same as
budgets?
A standard is the expected cost
for one unit.
A budget is the expected cost
for all units.
Benchmarks for
measuring performance.
14-113
L O 11
Costing Products with
Standard Costs
Price
Standards
Final, delivered
cost of materials,
net of discounts.
Rate
Standards
Use wage
surveys and
labor contracts.
Quantity
Standards
Use product
design specifications.
Time
Standards
Use time and
motion studies for
each labor operation.
14-115
LO4
Costs for Cost Accounting Purposes
Merchandisers . . .
– Buy finished goods.
– Sell finished goods.
Current Assets
– Cash
– Receivables
– Prepaid Expenses
– Merchandise Inventory
MegaLoMart
Manufacturers . . .
– Buy raw materials.
– Produce and sell
finished goods.
Current Assets
– Cash
– Receivables
– Prepaid Expenses
– Inventories
• Raw Materials
• Work in Process
• Finished Goods
13-116
L O 11
Costing Products with
Standard Costs
Rate
Standards
Activity
Standards
The rate is the
variable portion of the
predetermined overhead
rate.
The activity is the
base used to calculate
the predetermined
overhead.
14-117
L O 11
Costing Products with
Standard Costs
Standard costs for a product
might look like this:
Inputs
Raw materials
Direct labor
Variable overhead
Fixed overhead
Total standard unit cost
A
B
AxB
Standard
Quantity
or Hours
Standard
Price
or Rate
Standard
Cost
per Unit
3.0 lbs.
2.5 hours
2.5 hours
2.5 hours
$ 4.00
14.00
3.00
4.50
per
per
per
per
lb.
$
hour
hour
hour
$
12.00
35.00
7.50
11.25
65.75
14-119
LO4
Product Costs and Period Costs
Costs
Material Purchases
Direct Labor
Manufacturing
Overhead
Selling and
Administrative
Balance Sheet
Inventories
Raw Materials
Income
Statement
Expenses
Work in
Process
Finished
Goods
Period Costs
Cost of
Goods
Sold
Selling and
Administrative
13-120
LO5
Cost Accounting Systems
Determining unit
manufacturing
costs.
Planning and
control
functions.
Cost accounting systems provide the
INFORMATION
that supports successful decision-making.
Assessing the
efficiency and
effectiveness
of operations.
Providing
products or
services to
customers.
13-121
LO5
Cost Accounting Systems
Evaluate and
reward
employee
performance.
Disclose
inventories
and cost of
goods sold.
Cost accounting systems are the procedures
and techniques used by management.
Manage activities
that consume
resources.
Track resources
consumed by
products and
services.
13-122
LO6
Cost Accounting Systems
The predetermined overhead rate (POHR)
used to apply overhead to jobs is determined
before the period begins.
POHR =
Estimated total manufacturing
overhead cost for the coming period
Estimated total units in the
allocation base for the coming period
Ideally, the allocation base is a
cost driver that causes overhead.
13-123
LO6
Cost Accounting Systems
Smaller
amounts
If Manufacturing
Overhead is . . .
UNDERAPPLIED
Alternative 1
Close to Cost
of Goods Sold
Alternative 2
INCREASE
Cost of Goods Sold
INCREASE
Work in Process
Finished Goods
Cost of Goods Sold
DECREASE
Cost of Goods Sold
DECREASE
Work in Process
Finished Goods
Cost of Goods Sold
(Applied OH is less
than actual OH)
OVERAPPLIED
(Applied OH is greater
than actual OH)
Allocation
13-124
Cost Accounting Systems
LO8
Absorption Costing and Variable Costing
Absorption
Costing
Variable
Costing
Direct Materials
Product
Costs
Direct Labor
Product
Costs
Variable Manufacturing Overhead
Fixed Manufacturing Overhead
Period
Costs
Variable Selling and Administrative Expenses
Period
Costs
Fixed Selling and Administrative Expenses
13-125
LO1
Relevant Cost Information
Relevant
Irrelevant
Differential Cost -- will differ
according to alternative activities
being considered.
Allocated Cost -- a common cost that
has been arbitrarily assigned to a
product or activity.
Opportunity Cost -- income foregone
by choosing one alternative over
another.
Sunk Cost -- has already been incurred
and will not change.
16-126
LO1
Opportunity Cost
Example: If you were not
attending college, you could
be earning $20,000 per year.
Your opportunity cost of
attending college for one
year is $20,000.
Opportunity costs are not recorded in the
accounting records, but are relevant to
decisions because they are a real sacrifice.
16-127
LO3
Short-Term Allocation
of Scarce Resources
Managers often face the problem of deciding
how scarce resources are going to be utilized.
Usually, fixed costs are not affected by this
particular decision, so management can focus
on maximizing total contribution margin.
16-128
LO3
The Make or Buy Decision
• The relevant cost of making a component is
the cost that can be avoided by buying the
component from an outside supplier.
• Decision rule: Costs avoided must be greater
than outside supplier’s price to consider
buying the component.
16-129
LO6
Capital Budgeting Techniques
Methods that use present value analysis:
• Net present value (NPV).
• Internal rate of return (IRR).
Methods that do not use present value analysis:
• Payback.
• Accounting rate of return.
16-130
LO9
Payback Period
The payback period of an investment
is the number of years it will take to
recover the amount of the investment.
Managers prefer investing in projects
with shorter payback periods.
Ignores the
time value
of money.
Ignores cash
flows after
the payback
period.
16-131
L O 10
Accounting Rate of Return
The accounting rate of return focuses on
accounting income instead of cash flows.
Accounting
rate of return
=
Operating income
Average investment
16-132
LO7
Net Present Value (NPV)
General decision rule . . .
If the Net Present
Value is . . .
Then the Project is . . .
Positive . . .
Acceptable, since it promises a
return greater than the cost of
capital.
Zero . . .
Acceptable, since it promises a
return equal to the cost of
capital.
Negative . . .
Not acceptable, since it
promises a return less than the
cost of capital.
16-133
LO7
Internal Rate of Return (IRR)
• The actual rate of return that will be earned
by a proposed investment.
• The interest rate that equates the present
value of inflows and outflows from an
investment project – the discount rate at
which NPV = 0.
If annual cash inflows are unequal, trial and error
solution will result if present value tables are used.
Sophisticated business calculators and electronic
spreadsheets can be used to easily solve these
problems.
16-134
LO7
Net Present Value (NPV)
Chose a discount rate – the
minimum required rate of return.
Calculate the present
value of cash inflows .
Calculate the present
value of cash outflows  .
NPV = 
– 
16-135
Transfer Pricing for Decentralized
Enterprises
• What is Transfer Pricing?
• It involves determining appropriate selling
prices for goods or services when both the
buyer and the seller are within the same
entity
• When an enterprise has many divisions- one
division buys products from another division
Purpose of Transfer Pricing
• Optimize the profits for the enterprise as a
whole.
• Encourage the autonomy of individual
divisions.
• Provide information to evaluate the
performance of divisions.
• Move profits between divisions or locations.
Transfer Pricing Methods
•
•
•
•
•
•
Market based transfer prices
Variable cost transfer prices
Full cost transfer prices
Cost-plus a mark-up transfer prices
Negotiated transfer price
International Transfer Pricing
Corporate Governance
•
•
•
•
•
Background to the emergence of corporate governance
Definition of Corporate governance
Corporate governance code of practice
King Reports
Combined Code of Practice, the Board of Directors,
relationship with shareholders, accountability and
audit, internal control, audit committees, audit and the
role of auditors, responsibilities of directors, directors
remuneration, insolvency
• Wrongful trading and fraudulent trading
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