MANAGEMENT ADVISORY SERVICES (MAS) (ALSO CALLED
MANAGEMENT CONSULTING SERVICES, BUSINESS
ADVISORY SERVICES, MANAGEMENT SERVICES)
Refers to that area of accounting work concerned with
providing advice and technical assistance to help clients
improve the use of their resources to achieve their goals.
CONSULTING SERVICES
Professional services that employ the practitioner’s
technical skills, education, observations, experience,
and knowledge of the consulting process.
THE SIX (6) CONSULTING SERVICES ARE:
1. CONSULTATIONS
The practitioner provides counsel in a short
time frame, based mostly on existing personal
knowledge about the client, the technical
matters involved, the circumstances, client
representations, and the mutual intent of the
parties.
Example:
- Suggesting computer software for
further client investigation.
THE SIX (6) CONSULTING SERVICES ARE:
2. ADVISORY SERVICES
The practitioner’s function is to develop
findings, conclusions, and recommendations
for client’s consideration.
Example:
- Defining requirements for an
information system.
THE SIX (6) CONSULTING SERVICES ARE:
3. IMPLEMENTATION SERVICES
The practitioner’s function is to put an action
plan into effect.
Example:
Executing steps to improve productivity.
THE SIX (6) CONSULTING SERVICES ARE:
4 . TRANSACTION SERVICES
The practitioner’s function is to provide services
related to a specific client transaction, generally
with a third party.
Example:
- Insolvency services and analysis of a potential
merger or acquisition.
THE SIX (6) CONSULTING SERVICES ARE:
5. STAFF AND OTHER SUPPORT SERVICES
The practitioner’s function is to provide
appropriate staff and other support to perform
tasks specified by the client.
The staff provided will be directed by the client
as circumstances require.
Example:
- Data processing facilities management
and controllership activities
.
THE SIX (6) CONSULTING SERVICES ARE:
6. PRODUCT SERVICES
The practitioner’s function is to provide the
client with a product and related professional
services in support of the installation, use, or
maintenance of the product.
Example:
- Sale and delivery of packaged training
programs and sale and installation of
systems development methodologies.
CONSULTING PROCESS
– THE ANALYTICAL APPROACH AND PROCESS APPLIED
IN A CONSULTING SERVICE
ACTIVITIES INVOLVED IN A CONSULTING PROCESS
1. Determination of client objectives
2. Fact – finding
3. Definition of the problems or opportunities
4. Evaluation of alternatives
5. Formulation of proposed action
6. Communication of results
7. Implementation
8. Follow - up
FACTORS FOR THE EMERGENCE AND GROWTH OF
MAS CONSULTANCY
1.
2.
3.
4.
5.
Growth in size and complexity of business firms
Complexities in managing and conducting a business
Lack of competent staff
Trend towards industrialization
Need for adequate and timely information in
management decision-making
6. Development of techniques for the solution of
management problems, and businessmen’s awareness
of their usefulness
CHARACTERISTICS OF MAS
1. Services are rendered for management rather than
for third parties.
2. Involves problem solving.
3. Relates to the future.
4. Broad in scope.
5. Involves varied assignments.
6. Engagements are usually non-recurring.
7. Engagements require highly qualified staff.
8. Human relations play a vital role in each
engagement.
STAGES IN MAS ENGAGEMENTS
1.
2.
3.
4.
5.
6.
7.
Negotiating the engagement
Preparing for and starting the engagement
Conducting the engagement
Preparing and presenting the reports and recommendations
Implementing the recommendations
Evaluating the engagement
Post engagement follow-up
These stages constitute the specific activities involved in the MAS
engagement cycle which, in general terms are the following:
1. Pre-engagement considerations
2. Engagement planning
3. Engagement management and execution
4. Engagement conclusion
MAS CLASSIFICATION BASED ON REQUIRED EXPERTISE
1. Usual Service
1.1 Evaluation of form of business organization
1.2 Analysis of financial and operating statements
1.3 Design and installation of accounting systems
1.4 Design of filing systems for storing accounting records
1.5 Suggestions for improvements in internal control
1.6 Establishment of control to assist management and expedite the
audit process
1.7 Preparation of insurance claims in case of business interruption
MAS CLASSIFICATION BASED ON REQUIRED EXPERTISE
1. Usual Service (continued)
1.8 Research and evaluation of alternative methods of handling a
transaction for its effect on finance and tax consequences
1.9 Assistance in the preparation of forecasts and budgets
1.10 Presentation and explanation of statements
1.11 Assisting clients in purchase or sale of business
1.12 Testifying on client’s behalf
1.13 Determination of the effect of various employee compensation
plans on net income
1.14 Aid in labor union negotiations
MAS CLASSIFICATION BASED ON REQUIRED EXPERTISE
2. Somewhat Specialized Services:
2.1 Assisting in the installation of a mechanized accounting system
2.2 Making a cost analysis of operations
2.3 Finding sources of capital and figuring the approximate cost of
small business loans, bond issue, and stock issuance
2.4 Giving advice on dividend policy and plans for expansion
2.5 Calculations on government contracts and allocating costs in
compliance with reporting requirements
2.6 Advising on accounting and tax matters relative to estate planning
MAS CLASSIFICATION BASED ON REQUIRED EXPERTISE
2. Somewhat Specialized Services (continued) :
2.7 Surveying credit losses
2.8 Assisting in bankruptcy and receivership proceedings
2.9 Recruiting accounting and bookkeeping personnel for the client
2.10 Preparing an analysis of paper flow
2.11 Presenting and analysing the pros and cons of various retirement
and profit-sharing plans
2.12 Advising on various wage incentive plans
MAS CLASSIFICATION BASED ON REQUIRED EXPERTISE
3. Highly Specialized Services:
3.1 Reviewing the organization structure
3.2 Auditing management policies
3.3 Conducting motion studies
3.4 Surveying an industry of trade for current trends
3.5 Evaluating the desirability of a particular area for plant location
3.6 Preparing market analysis
3.7 Reviewing an insurance program
3.8 Advising on data processing allocation
REASONS FOR HIRING MANAGEMENT CONSULTANTS
1. Help define specific problems and develop solutions
2. Provide specialized skills and experience
3. Provide confidential service in which the identity of the
client is concealed
4. Train client personnel
5. Help improve intra-company communications
6. Render an independent opinion
7. Help get results
MANAGEMENT CONSULTANT
A person who is qualified by education,
experience, technical ability, and temperament
to advise or assist businessmen on a
professional basis in identifying, defining, and
solving specific management problems involving
the organization, planning, direction, control
and operation of the firm.
MAS BY CPAs
CPAs performing management consulting and other
advisory services are considered in the practice of
professional accounting and are bound by the Code of
Ethics for Professional Accountants.
SCOPE OF MAS
MAS are usually related to the services rendered by CPAs
in the areas of auditing, tax and accounting, and may
involve activities such as:
1. Counseling management in the analysis, planning,
organizing, operating and controlling functions;
2. Reviewing and suggesting improvement in policies,
procedures, systems, methods, and organizational
relationships;
3. Introducing new ideas, concepts and methods to
management; and
4. Conducting special studies, proposing plans and
programs, and providing guidance and technical
assistance to their implementation.
ADVANTAGES OF CPAs OVER OTHER PROFESSIONALS IN MAS PRACTICE
- They are already familiar with the client and his business, and enjoy
the client’s confidence.
- They are members of a profession with recognized standing and are
equipped with technical know-how in accounting and taxation
ANALYTICAL APPROACH AND PROCESS
1.
2.
3.
4.
5.
Ascertaining the pertinent facts and circumstances
Seeking and identifying objectives
Defining the problem or opportunity for improvement
Evaluating and determining possible solutions
Presenting findings and recommendations
In case the client requests the consultant to proceed, the
latter may also be involved in:
7. Planning and scheduling actions
8. Advising and providing technical assistance in implementing
ANALYTICAL APPROACH AND PROCESS
THREE (3) BROAD STAGES
1. Analysis Stage
- Consists of ascertaining the pertinent facts and
circumstances, seeking and identifying objectives, and
defining the problem or opportunity for improvement.
2. Design Stage
- Consists of evaluating and determining possible solutions
and presenting findings and recommendations.
3. Implementation Stage
- Consists of planning and scheduling actions and advising
and providing technical assistance in implementing.
BROAD AREAS OF MAS
1. AREAS NORMALLY RELATED TO THE ACCOUNTING
AND FINANCE FUNCTIONS:
1.1. Financial Accounting Systems Design and
Development
1.2 Management Accounting Systems Design
and Development
1.3 Development and Establishment of
Budgetary Controls
BROAD AREAS OF MAS
1. THE FIELD COVERS THE FOLLOWING:
1.1. Cost Accounting
1.1.1 Development of standard cost system
1.1.2 Cost analysis and control
1.1.3 Variance analysis
1.2 Financial Management
1.2.1 Establishment of capital budgeting procedures
1.2.2 Study of the cost of capital and cost of debt
1.2.3 Financial analysis for project studies
1.2.4 Establishment of operating and cash budgets
1.2.5 Valuation of common stocks for purposes of merger and
sale
BROAD AREAS OF MAS
AREAS NOT NORMALLY RELATED TO THE ACCOUNTING AND FINANCE
FUNCTIONS:
1. General Management Consultation
1.1 Management or Operations Audit – examination of the manner in which an
organization conducts business with the objective of pointing out improvements
that will increase its efficiency and effectiveness.
1.2 Measurement of Operating Performance – measuring results relative to the
assets used to achieve those results (fixed asset turnover).
1.3 Mergers and Acquisitions Studies
1.4 Development of Compensation Programs
1.5 Pension Plan Review
1.6 Special Studies on Industry Potential
1.7 Long-Range Planning
BROAD AREAS OF MAS
AREAS NOT NORMALLY RELATED TO THE ACCOUNTING
AND FINANCE FUNCTIONS:
2. Project Feasibility Studies
- Involves financial, technical, and marketing evaluation of
proposed projects
BROAD AREAS OF MAS
SIX (6) AREAS NOT NORMALLY RELATED TO THE
ACCOUNTING AND FINANCE FUNCTIONS:
3. Organization and Personnel
3.1 Review of Existing Organization Structure
3.2 Organization and Administrative Manual Preparation
3.3 Job Evaluation and Salary Administration
3.4 Development of Personnel Rating Programs
3.5 Retirement Plan Studies
3.6 Studies of Office Cost Reduction Systems
3.7 Determining Cost of Alternatives in Collective Bargaining
Agreements
BROAD AREAS OF MAS
SIX (6) AREAS NOT NORMALLY RELATED TO THE
ACCOUNTING AND FINANCE FUNCTIONS:
4. Industrial Engineering
4.1 Production, Planning, Scheduling, and Control
4.2 Plant Layout Studies
4.3 Inventory Management Studies
4.4 Materials Control System Design and Development
4.5 Preventive Maintenance System Design and
Development
4.6 Development of Work Standards
4.7 Purchasing Management, including Value Analysis
BROAD AREAS OF MAS
SIX (6) AREAS NOT NORMALLY RELATED TO THE
ACCOUNTING AND FINANCE FUNCTIONS:
5. Marketing
5.1 Product Profitability Analysis
5.2 Pricing Policy Determination
5.3 Market Forecasting
5.4 Distribution Cost Analysis
5.5 Salesmen’s Incentive Compensation Evaluation
BROAD AREAS OF MAS
SIX (6) AREAS NOT NORMALLY RELATED TO THE ACCOUNTING
AND FINANCE FUNCTIONS:
6. Operations Research
6.1 Involves the use of mathematical techniques, such as
linear programming, PERT/CPM, queuing theory,
simulation, etc. to solve operational problems.
The services listed above are not necessarily exhaustive nor complete. The
practitioner may offer other services not mentioned above depending on
the practitioner’s competence, experience, technical ability, and
professional integrity to meet or deliver such other services he offers.
ROLE OF CONSULTANTS AND CLIENTS IN MAS ENGAGEMENTS
1. IN FULL SCOPE ENGAGEMENTS
- These cover all the seven (7) phases in the analytical approach and
process
- Consultant: limited to that of an advisor; in the implementation
stage, his role is merely to provide technical assistance.
ROLE OF CONSULTANTS AND CLIENTS IN MAS ENGAGEMENTS
2. IN SPECIAL STUDY ENGAGEMENTS
- The client seeks only an impartial and objective study of a case and
the resulting recommendations. These involve only the first 5 stages
in the analytical approach and process.
- Consultant: to proceed through the first five phases of the analytical
process, apply objective judgment to the facts, and present findings
and recommendations to the client for decision and further action.
- Client: to supply pertinent information and to make decision on the
case. Any action beyond the point of decision is solely the
responsibility of the client.
ROLE OF CONSULTANTS AND CLIENTS IN MAS ENGAGEMENTS
3. IN INFORMAL ADVICE
- Its structure is informal and no presumption should exist that an
extensive study has been performed.
- Consultant: To respond as practicable at the moment and express
the basis for the response.
MAS PRACTICE STANDARDS
- All CPAs engaged in MAS practice should observe a set of
MAS Practice Standards, which are classified into
general and technical standards.
GENERAL STANDARDS
1. Professional Competence
- The MAS practitioner shall undertake only those engagements which he or his
firm can reasonably expect to complete with professional competence.
2. Due Professional Care
- The MAS practitioner shall exercise due professional care when performing
professional services.
3. Planning and Supervision
- The MAS practitioner shall adequately plan and supervise an engagement in a
manner that provides reasonable assurance that the work is conducted in
accordance with the understanding with the client and with the professional
standards and rules of conduct.
4. Sufficient Relevant Data
- The MAS practitioner shall obtain sufficient relevant data to complete the
engagement in accordance with the understanding with the client and to provide
a reasonable basis for making conclusions and formulating recommendations in
relation to any professional services performed.
5. Forecasts
- The MAS practitioner shall not permit his name to be used in connection with any
forecast of future transactions in a manner that may lead to the belief that the
practitioner vouches for the achievability of the forecast.
TECHNICAL STANDARDS
1. Role of MAS Practitioner
- The practitioner should not assume the role of management or take any
position which may impair the practitioner’s objectivity in performing an
engagement. The practitioner should maintain his independence to
enable him to render his professional judgment and opinions with
objectivity. His main role is that of an adviser.
2. Understanding with the Client
- Establish with the client a written or oral understanding about the
responsibilities of the parties and the nature, scope, and limitations of
services to be performed, and modify the understanding if circumstances
require a significant change during the engagement.
3. Client interest
- The MAS practitioner shall serve the client interest by seeking to
accomplish the objectives established by the understanding with the
client while maintain integrity and objectivity.
TECHNICAL STANDARDS
4. Communication with Client
- The MAS practitioner should inform the client of:
4.1 Conflicts of interest that may occur pursuant to the
”Integrity and Objectivity Rule”.
4.2 Significant reservation concerning the scope or benefits of
the engagement, and
4.3 Significant engagement finding or events.
TECHNICAL STANDARDS
4. Communication with Client (continued)
- Integrity: Requires a member to be, among other things, honest and
candid within the constraints of client confidentiality. Service and the public
trust should not be subordinated to personal gain and advantage. Integrity
can accommodate the inadvertent error and the honest difference in
opinion; it cannot accommodate deceit or subordination of principle.
- Objectivity: a state of mine, a quality that lends value to a practitioner’s
services. It imposes the obligation to be impartial, intellectually honest, and
free of conflicts of interest.
- Independence: precludes relationships that may impair a practitioner’s
objectivity in rendering attestation services.
TECHNICAL STANDARDS
4. Communication with Client (continued)
- Conflict of interest: May occur if the practitioner or his firm has a
relationship with another person, entity, product, or service, that, in the
practitioner’s professional judgment, the client or other appropriate parties
may view as impairing the practitioner’s objectivity.
- A practitioner may perform the professional service if he or she
determines that the service can be performed with objectivity because the
threats are not significant or could be reduced to an acceptable level through
the application of safeguards.
PROJECT FEASIBILITY STUDY
(PROJECT STUDY OR FEASIBILITY STUDY)
- Refers to the systematic gathering and analysis of data which aims to
find out the viability of the proposed business undertaking. Generally,
it involves:
a. collection of data which are relevant and necessary to all aspects
of the undertaking;
b. evaluation and analysis of the data gathered, and
c. formulation of recommendation.
PROJECT FEASIBILITY STUDY
(PROJECT STUDY OR FEASIBILITY STUDY)
BENEFITS
- Specific advantages from preparing Project Feasibility Studies may
be delineated, considering the different interested parties that may be
benefited by the study:
a. Proponents/Promoters/Organizers of new projects – it serves as a
basis for ascertaining the practicability / workability of proposed
projects.
b. Creditors – it serves as a basis for the creditors to decide whether
or not to provide financial assistance and to determine the appropriate
terms and conditions of such assistance.
c. Stockholders / Investors – to decide whether to invest in the
project of not.
PROJECT FEASIBILITY STUDY
(PROJECT STUDY OR FEASIBILITY STUDY)
BENEFITS (continued)
d. Management of existing firms – to ascertain the feasibility of
expansion programs. It also serves as a basis in deciding on the
possibility of taking over existing business, as well as the extent of the
capital outlay required.
e. Government Instrumentalities – to evaluate the project’s social
desirability and to check if the project meets the applicable legal
requirements, as well as to determine the level or extent of incentives
that may be granted.
f. National Economy as a Whole – a project study assists in
minimizing the risk of failure of business ventures. Thus, wastage of
valuable resources is reduced, thereby accelerating economic growth.
MAJOR ASPECTS OF A PROJECT STUDY
- The major aspects of a typical Project Feasibility Study are
briefly described as follows:
a. Management - the study of management aspect assists
in the selection of business structure, personnel setup, and
internal policies of the enterprise for an effective operation.
b Marketing – This ascertains the future demand for the
product. It involves the study of current and projected supply
and demand setup.
c. Technical – The study of technical aspect aims to choose
the process to be used, plant capacity, layout, machinery
design, materials, and other technical facors to attain cost
minimization and profit maximization.
MAJOR ASPECTS OF A PROJECT STUDY (continued)
d. Taxation – This covers the study of tax effects, as
well as legal tax savings measures and other government
incentives applicable to the project.
e. Legal – Various legal aspects are studied to
determine if requirements are met and possible
incentives and protection are availed of.
f. Financial – This quantifies the result of marketing,
technical, management, taxation, and legal phases and
expresses in peso terms the possible profitability of the
project.
MAJOR ASPECTS OF A PROJECT STUDY (continued)
g. Sources of Financing – It provides a study of the
possible sources of financing that can be tapped to
carry out the project.
h. Profitability – It weighs the ratio of capital outlay
in relation to profit that can be obtained.
i. Economic Benefits or Social Desirability – This
involves a study of the project’s contribution to the
nation, considering both the economic and
environmental aspects.
FEASIBILITY STUDY GUIDELINE
(from the University of the Philippines Institute of Small-Scale Industries)
I. Summary of Project
A. Name of firm
B. Location head office / factory
C. Brief description of the project
1. History of business
2. Nature or kind of industry
3. Type of organization
4. Officers of the business and their qualifications
FEASIBILITY STUDY GUIDELINE (continued)
(from the University of the Philippines Institute of Small-Scale Industries)
II. Economic Aspects
A. General Market Description
1. Market Description – a brief description of the market to include the
following:
a. Areas of dispersion
b. Methods of transportation and existing rate of transportation
c. Channels of distribution and general trade practices
2. Demand
a. Consumption for past ten years
b. Major consumers of the product
c. Projected consumption for the next five years
FEASIBILITY STUDY GUIDELINE (continued)
(from the University of the Philippines Institute of Small-Scale Industries)
II. Economic Aspects (cont’d.)
A. General Market Description (cont’d.)
3. Supply
a. Supply for past ten years, classified as to source – imported or locally
produced. For imports, specify the form in which goods are imported,
the prices and the brand. For locally produced goods, the companies
producing them, their production capacities, brands, and market
shares shall be specified.
b. Factors affecting trends in past and future supply.
4. Competitive Position
a. Selling price – include a price study indicating the past domestic and
import prices, the high and low prices within the year, and the effect
of seasonality, if any.
b. Competitiveness of the quality of the product.
FEASIBILITY STUDY GUIDELINE (continued)
(from the University of the Philippines Institute of Small-Scale Industries)
II. Economic Aspects (cont’d.)
A. General Market Description (cont’d.)
3. Supply
a. Supply for past ten years, classified as to source – imported or locally
produced. For imports, specify the form in which goods are imported,
the prices and the brand. For locally produced goods, the companies
producing them, their production capacities, brands, and market
shares shall be specified.
b. Factors affecting trends in past and future supply.
4. Competitive Position
a. Selling price – include a price study indicating the past domestic and
import prices, the high and low prices within the year, and the effect
of seasonality, if any.
b. Competitiveness of the quality of the product.
FEASIBILITY STUDY GUIDELINE (continued)
(from the University of the Philippines Institute of Small-Scale Industries)
II. Economic Aspects (cont’d.)
B. Marketing Program
1. Description of present marketing practices of competitors
2. Proposed marketing program of the project describing the selling
organization, the terms of sales, channels of distribution, location of sales
outlets, transportation and warehousing arrangements, and their
corresponding costs
3. Promotion and advertising plans, including costs
4. Packaging
C. Projected Sales
1. Expected annual volume of sales for the next five years considering the
demand, supply, competitive position, and marketing program
FEASIBILITY STUDY GUIDELINE (continued)
(from the University of the Philippines Institute of Small-Scale Industries)
II. Economic Aspects (cont’d.)
D. Contributions to the Philippine Economy
1. Net annual amount of pesos earned or saved, and basis used
2. Labor employed
3. Taxes paid
FINANCIAL STUDY
Steps in Financial Study
Conducting the financial study involves the following steps:
a. Determine the specific financing requirements of the project with respect to
types and ost of the assets to be acquired.
b. Identify the altenative sources of financing, including the terms and conditions,
the effective cost, and the maximum amount of financing from each source.
c. Ascertain the desirable debt-equity ratio, i.e., the relationship between the
financing that can be obtained from creditors and financing that can be provided
by the stockholders.
d. Establish the project’s financial policy.
FINANCIAL STUDY
Major Parts of the Financing Study
1.
2.
3.
4.
5.
Statement of assumptions
Projected financial statements
Possible sources ofd outside financing
Details of various amoaunts contained in the projected financial statements
Analysis of financial projections
FINANCIAL STUDY
Statement of Assumptions
Assumptions – statements about the possible future behaviour of certain factors
affecting a project.
Examples of Assumptions Made in Feasibility Studies
- Sales volume, selling price, and distribution media
- Plant locatioin, capacity, and requirements
- Taxes
- Foreign exchange rate and price level changes
- Project timetable
FINANCIAL STUDY
Projected Financial Statements
1. Projected balance sheet
2. Projected income statement
3. Projected cash flow statement
FINANCIAL STUDY
The projected financial statements are used to evaluate the results of the financial
projections as to the project’s profitability, liquidity, and solvency, as well as its
ability to withstand difficulties. The evaluation is enhanced by preparing /
determining the following, amount others:
A. To measure profitability
1. Common-size projected financial statements
2. Rate of return on investment
1. A. discounted rate of return
2. Accounting rate of return
3. Profitability index
3. Cost-Volume-Profit (CVP) / Break-even analysis
4. Earnings per share
FINANCIAL STUDY
Projected Financial Statements (cont’d.)
B. To Measure Liquidity
1. Current ratio
2. Acid test ratio
3. Payback period
4. Cash break-even
C. To Measure Financial Leverage
1. Debt-to-equity ratio
2. Equity-to-assets ratio
3. Debt-service break-even point
4. Times interest earned
FINANCIAL STUDY
Possible Sources of Financing
Internal Source of Financing
- Funds obtained within the firm principally through earnings and depreciation
External Source of Financing
- Funds furnished by owners (equity and creditors (debt)
FINANCIAL STUDY
Classification of Funds
1. Short-term funds – will be needed for one year or less
Possible sources:
- Trade credit
- Commercial banks and other financial institutions
- Advances from customers
- Loans derived from relatives, friends, directors, stockholders, and officers
2. Intermediate funds – will be needed between one to five years
FINANCIAL STUDY
Classification of Funds (cont’d,)
3. Long-term funds – will be needed for five years or more
Possible soures:
- Issuance of capital stocks
- Issuance of bonds
- Retention of earnings
- Depreciation
- Suppliers/Manufacturers of machiner and equipment
- Long-term loans from banks and other financing institutions
FINANCIAL STUDY
Classification of Funds (cont’d.)
Factors to consider when obtaining long-term funds:
1. Control
- Common stocks may have voting rights
- Referred stocks are usually non-voting
- Ceditors share no direct participation in the management of the firm,
except to the extent that restrictions are included in loan agreements.
2. Cost
- Flotation costs of stocks and bonds
- Dividend requirements when shares of stocks are issued
- Dividends are not tax deductible
- Interest expense on loans is tax deductible
FINANCIAL STUDY
Classification of Funds
3. Risk
- Debt financing entails greater risk than equity financing, because debt
obligations have definite maturity dates and interest is a fixed charge which
must be paid even when profits decline
- Long-term bonds entail less risk than short-term notes because short-term
notes must be renewed periodically and renewals are subject to the
uncertainty of future interest rates and availability of funds.
FINANCIAL STUDY
SENSITIVITY ANALYSIS
Feasibility Studies involve projected data, developed under specific assumptions.
Uncertainty is therefore an unavoidable element.
Sensitivity analysis can be used to minimize the effect of uncertainty. It is used to
determine the impact of a change in a factor(s) influencing a projected result.
Example:
How will profit change if the projected sales volume is changed by 5%, 10%, 15%
20%?
How will profit change if the projected capacity level is changed by +-10%, +-20%,
or +-30%?
FINANCIAL STUDY
Attributes of a Good Feasibility Study
A good feasibility study must be:
1. Comprehensive
The study must have adequate information to meet the needs of the
user or users, areas covered must be clearly defined and wellinvestigated.
2. Objective
It must present / reflect both the positive and negative implications.
3. Simple
The report should be easy to understand. If technical terminologies are
indispensable, explanations should likewise be included.
FINANCIAL STUDY
Limitations / Constraints in Feasibility Study Preparation
Forecast is the primordial basis of feasibility study and as such, the basic limitations
may exist.
1. Unavailability of required and necessary information.
2. Incompetence or inexperience of the one making the judgment resulting in
erroneous conclusions and ;judgment resulting in erroneous conclusions and
ineffective recommendations.
3. The fact that the suy is based on forecast cannot be denied. Any significant
change in the business environment usually renders results of forecast not
coinciding with actual events
COSTS IN MANAGEMENT ACCOUNTING
1. COST
- The monetary measure of the amount of resources given up or used for some purpose.
- The monetary value of goods and services expended to obtain current or future benefits.
2. SOME COST TERMS USED IN MANAGERIAL ACCOUNTING
- Cost object
a. Anything for which cost is computed.
b. Example: a product, product line, a segment of the organization
- Cost driver
a. Any variable, such as level of activity or volume that usually affects costs over a
period of time.
b. Example: production sales, number of hours
- Cost pool
a. A grouping of individual cost items, an account in which a variety of similar costs
are accumulated.
b. Example: work in process, factory overhead control
COSTS IN MANAGEMENT ACCOUNTING
2. SOME COST TERMS USED IN MANAGERIAL ACCOUNTING
- Activity
a. An event, action, transaction, task, or unit of work with a specified purpose.
b. Value-Adding Activities – activities that are necessary (non-eliminable) to
produce the products
- Example: assembling the different component parts of the product.
c. Non-Value-Adding Activities – activities that do not make the product or
service more valuable to the customer.
- Example: moving materials and equipment parts from / to the
stockroom or a workstation.
DIFFERENT COSTS FOR DIFFERENT PURPOSES
A. AS TO TYPE
1. Product Costs – costs incurred to manufacture the product
- Product costs of the units sold during the period ar recognized as
expense (cost of goods sold) in the income statement.
- Product costs of the unsold units become the costs of inventory
and treated as asset in the balance sheet.
2. Period Costs – The non-manufacturing costs that include selling,
administrative, and research and development costs. These costs are
expenses in the period of incurrence and do not become part of the
cost of inventory.
DIFFERENT COSTS FOR DIFFERENT PURPOSES
B. AS TO FUNCTION
1. Manufacturing Costs – all the costs incurred in the factory to convert raw materials into
finished goods
a. Direct Manufacturing Costs – materials and labor
b. Indirect Manufacturing Costs – the manufacturing overhead or factory overhead costs
2. Non-Manufacturing Costs – all costs which are not incurred in transforming materials to finished
goods.
a. Research and Development – incurred in designing and bringing new products to the market
b. Marketing costs – advertising and promotion expenses
c. Distribution Costs – costs incurred in delivering the products to the customers
d. Selling Costs – salaries and commission of sales staff and other selling expenses
e. After-sales Costs – costs incurred in dealing with customers after sales. Examples are warranty,
repairs costs and costs incurred in receiving / entertaining / acting on customers’ complaints.
f.
General and Administrative Costs – all the non-manufacturing costs that do not fall under
categories (a)
DIFFERENT COSTS FOR DIFFERENT PURPOSES
C. AS TO TRACEABILITY / ASSIGNMENT TO COST OBJECT
1. Direct costs – costs that are related to a particular cost object and
can economically and effectively be traced to that cost object.
2. Indirect Costs – costs that are related to a cost object, but cannot
practically, economically, and effectively be traced to such cost object.
Cost assignment is done by allocating the indirect cost to the related
cost objects.
DIFFERENT COSTS FOR DIFFERENT PURPOSES
D. FOR DECISION-MAKING
1. Relevant Costs - future costs that will differ under alternative courses of
action.
2. Differential Costs – difference in costs between any two alternative courses
of action
a. Incremental Cost – increase in cost from one alternative to another
b. Decremental Cost – decrease in cost from one alternative to another
3. Opportunity Costs – income or benefit given up when one alternative is
selected over another.
4. Sunk / Past or Historical Costs – already incurred and cannot be changed by
any decision made now or to be made in the future.
DIFFERENT COSTS FOR DIFFERENT PURPOSES
E. AS TO BEHAVIOR (REACTION TO CHANGES IN COST DRIVER
1. Variable Cost – within the relevant range and time period under
consideration, the total amount varies directly to the change in
activity level or cost driver, and the per unit amount is constant.
.
VARIABLE COST (P)
ACTIVITY (units, hours, etc.)
(COST DRIVER)
DIFFERENT COSTS FOR DIFFERENT PURPOSES
E. AS TO BEHAVIOR (REACTION TO CHANGES IN COST DRIVER
2. Fixed Cost – within the relevant range and time period under consideration,
the total amount remains unchanged, and the per-unit amount varies inversely
or indirectly with the change in the cost driver.
FIXED COST (P)
ACTIVITY (units, hours, etc.)
(COST DRIVER)
DIFFERENT COSTS FOR DIFFERENT PURPOSES
a. Committed Fixed Costs – long term in nature and cannot be eliminated even
for short period of time without affecting the profitability or long-term goals of
the firm. Example: depreciation of buildings and equipment
b. Discretionary or( Managed Fixed Cost – usually arise from periodic (may be
annual, etc.) decisions by management to spend in certain fixed costs area such
as research, advertising, maintenance contracts. Discretionary fixed costs may
be change by management from period to period or even during (within) the
period, if circumstances demand such change. Examples: research and
development costs, advertising expense, maintenance costs provided by service
contractors.
DIFFERENT COSTS FOR DIFFERENT PURPOSES
E. AS TO BEHAVIOR (REACTION TO CHANGES IN COST DRIVER
3. Step Cost – when activity changes, a step cost sifts upward or
downward by a certain interval or step.
.
Step Variable Costs – have small steps
Step Fixed Costs – have large steps
COST (P)
COST (P)
ACTIVITY (units, hours, etc.)
ACTIVITY (units, hours, etc.)
DIFFERENT COSTS FOR DIFFERENT PURPOSES
E. AS TO BEHAVIOR (REACTION TO CHANGES IN COST DRIVER
4. Mixed Cost – This cost has both a variable and a fixed component
MIXED COST (P)
ACTIVITY (units, hours, etc.)
(COST DRIVER)
ANALYSIS OF MIXED COST
1. Mixed Cost or Total costs – have variable and fixed costs components
TC = FC + VC
Where:
TC = Total Cost
FC = Total Fixed Cost
VC = Total Variable Cost
ANALYSIS OF MIXED COST
2. Total variable cost varies directly with the activity level or cost driver
VC = bx
Where:
VC = Total variable cost
b = variable cost per cost driver
x = cost driver
Example: If the cost driver is number of units and variable cost per unit
is P5, then VC = 5x
The total or mixed cost function may be expressed as:
TC = FC + bx
RELEVANT RANGE
Relevant range is a range of activity that reflects the company’s normal
operating range. Within this relevant range, the aforementioned cost behaviour
is valid, i.e., :
Total Amount
Per Cost Driver
Variable Cost Varies directly with cost driver
Constant
Fixed Cost
Constant
Varies inversely with cost driver
Linearity Assumption – within the relevant range, there is a strict linear
relationship between the cost and cost driver. Costs may therefore be shown
graphically as straight lines.
THE COST FUNCTION
Since total cost is linearly related to the activity level or cost driver, the
cost function (cost formula) may be expressed as:
Y = a + bx
where: Y = Total cost
a = Total fixed cost
b = variable cost per cost driver
x = activity level or cost driver
SEPARATION OF THE FIXED AND VARIABLE COMPONENTS OF MIXED COST
1. High-Low Method
2. Scattergraph Method
3. Least Squares Regression Method
HIGH – LOW METHOD
1. Mixed Cost – Fixed Cost + Variable Cost
2. Slope = Rise/Run =
Y2 – Y1 = Change in Variable cost (Highest – Lowest)
X2 - X1
Change in Activity (Highest – Lowest)
3. Example: Highest Activity Level (March 2019) 850 units
Lowest Activity Level (Dec 2019)
300 units
4. Variable per unit =
4,675 – 2,925 = 1,750 = P3.18
850 - 300 = 550
5. Fixed Cost
= Total Cost – Variable Cost
= 4,675
- 3.18 x 850
= 4,675
- 2,704
Fixed Cost = 1,971
Cost
P4,675
2,925
Variable Cost
Units
LEAST SQUARE REGRESSION METHOD
1. Mixed Cost – Fixed Cost + Variable Cost
2. Slope (variable cost per unit) = n(Exy) – (Ex)(Ey)
n(Ex2) -(Ex)2
= 12 (1,195,600,000) – (35,400)(358,000)
12 ( 1,245,000,000)
Total Hours (x)
= 6.9506
1. 3700
Cost
Variable Cost
Units
2. 1600
3. 4100
4. 4900
5. 3300
6. 4400
7. 3500
8. 4000
9. 1200
10. 1300
11. 1800
12. 1600
Total Costs (y)
37,000
23,000
37,000
47,000
33,000
39,000
32,000
33,000
17,000
18,000
22,000
20,000
SEPARATION OF THE FIXED AND VARIABLE COMPONENTS OF MIXED COST
1. Multiple Regression Analysis
This is used when the dependent variable (cost, for example) is caused by more
than one factor. In other words, the dependent variable (cost) is related to more
than one independent variable (units, machine hours, etc.)
2. Correlation Analysis
Correlation – measure of the co-variation between the dependent and
independent variables
- If all plotted points fall on the regression line, there is perfect correlation
- If correlation between the cost and cost driver is high and the past relationship
between such variables will continue in the future, then the cost driver chosen
will be useful for predicting future levels of the costs being analysed.
COEFFICIENT OF CORRELATION
1. Coefficient of Correlation (denoted by r) – measure of the extent
of the linear relationship between two variables
2. Range of values of r: from -1 to 1
r = -1 < 0 < a
When r = 0, there is no correlation
Y
. .
. .
. .
. . .
.
.
.
x
COEFFICIENT OF CORRELATION
When r is positive, there is a positive or direct relationship between
the dependent (y) and independent (x) variables. That is, the value of
y increases when the value of x increases. The regression line slopes
upward to the right.
Y
. .
.
.
.
.
x
COEFFICIENT OF CORRELATION
When r is negative, there is a negative or inverse, or indirect
relationship between the variables. The value of y decreases as the
value of x increases. The regression line slopes downward to the
right.
Y
. . .
. ‘ .
x
COEFFICIENT OF DETERMINATION
1. Coefficient of determination (denoted by r2) is computed by
squaring the value of r. it represents the percentage of the
total variation in the dependent variable y that is explained or
accounted for by the regression equation.
2. A very high r2 means that the values in the regression
equation explain virtually the entire amount of the total cost.
The variables are highly correlated. i.e., the cost driver selected
is highly related to the dependent costl
STANDARD ERROR OF THE ESTIMATE
1. Standard error of the estimate – the standard deviation about the regression
line
2. Estimated values computed using the regression equation may differ from the
actual costs. The differences are called prediction errors or errors of estimate.
3. The standard error of estimate is calculated to serve as a confidence interval or
acceptable range of tolerance, for use in exercising control over the costs. By
comparing a cost variance with the standard error of estimate, management
can decide whether to investigate such variance or not.
• If r2 = 1, the standard error = 0
• A small value of the standard error indicates a good fit.