Accounting Study Guide - Chapters 8-11
Chapter 8:
Ch. 8
Marketing managers are typically responsible for volume variances / Reasonable efforts that are attainable by most
employees are represented by practical standards. / Benefits of a standard cost system include: Motivating employees /
Boosting morale / Alerting management /to trouble spots / Efficient use of management to control costs
A Static budget is one that is set for a period of time and that does not change over that time despite changes in
performance by the business.
The flexible budgets shown in exhibits 8.1 and 8.3 use which of the following formats? Sales
Contribution margin; Contribution margin Fixed costs = Net income
Variable costs =
$27,000 unfavorable
ECU Inc,'s static budget is based on a planned activity level of 36,000 units.
At the same time the static budget was prepared, the management accountant for ECU prepared two additional budgets,
one based on 31,000 units and one based on 41,000.
The company actually produced and sold 40,000 units. In evaluating company performance, management should
compare the company's actual revenues and costs to which of the following budgets?
A budget based on 40,000 units
$2,250 F
S. Stark Company prepared the following static budget. This static budget is based on sales projections of 6,000 units:
What would be reported for net income on a flexible budget, assuming 12,000 units were sold?
$36,600
Explanation
Revenue $104,000 Variable Cost $62,000 = $42,000 Contribution Margin Fixed Costs $5,400 = $36,600 Net income.
Fixed costs do not vary with changes in volume.
Sales Price Variance = Actual Units sold X (planned cost per unit - actual cost per unit)
Budgeted units x budgeted sales = Flexible
Actual units x budgeted sales price = Static
Flexible - static = Sales volume variance (If its positive, its favorable, if negative, its unfavorable)
Sales Volume Variance = (Actual Units SoldBudgeted Units)Budgeted Selling Price
Production Manager: responsible for production delays that affect product availability, which may restrict sales volume.
How to calculate a flexible budget - Contribution margin (price per unit) x # of units asking about minus Fixed costs
A budget that shows revenues and costs at a variety of volume levels is a Flexible budget
The primary advantage of a standard cost system is efficient use of management talent to control costs
Variance: The difference between the standard and the actual amount
Variance is unfavorable when standard costs are less than actual costs
Flexible budgets can use a variety of volume levels - True
Sales variances are favorable when actual sales exceed expected sales.
A budget that shows revenues and costs at a variety of volume levels is a Flexible budget
Chapter 9:
Margin captures the managers ability to _blank_. control operating expenses relative to the level of sales
Turnover = Sales / operating assets
.
Managers are usually held responsible for items over which they have predominant control rather than absolute control
ROI = Operating Income / Operating Assets -> convert to percentage (move to the right two decimal places)
To solve the asset valuation problem companies can chose to use original cost instead of book value in the denominator
of the ROI formula. False
Velvet Company's current return on investment (ROI) is 12%. Division Three has a a current ROI of 16%. The manager
of Division Three has an offer for an investment that will return 13%. The manager will likely _blank_. accept the
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investment if evaluated on residual income
Return on investment (ROI) is defined as _blank_. operating income operating assets
A manager of a(n) Investment center is accountable for assets and liabilities as well as earnings
Given operating income of $40,000 and operating assets of $100,000, return on investment (ROI) is _blank_. 40%
Using the book value of operating assets as the valuation base in ROI calculations _blank_. is done in most companies,
may not accurately reflect performance, can cause motivational problems
A manager has a current return on investment (ROI) of 15%. The company's ROI is 12%. If offered an investment that
returns 13%, the manager is likely to _blank_. only accept it if evaluated on residual income
Return on investment (ROI) is a measure of the amount of _blank_. wealth generated by operating assets
An approach that measures management's ability to maximize earnings above some targeted level is _blank_.
Residual income = Operating income - (Operating assets x Desired ROI)
Decentralization promotes _______. training lower-level managers for increased responsibility
A cost center:
Incurs expenses but does not generate revenue
Fall on the lower levels of the organizational chart
Managers of cost centers are judged on his ability to keep costs within budget parameters
The philosophy of management by exception states that managers should focus attention _blank_ from expectations. only
on significant deviations
The concept that states that managers should only be evaluated based on revenues and costs that they control is the
_blank_ concept. Controllability
Why do companies typically use operating income and assets as opposed to net income and total assets in calculating
return on investment (ROI)? Operating income and operating assets are more controllable than net income and total
assets. Net income and total assets do not measure performance as accurately.
Given operating income of $150,000 and operating assets of $100,000 the return on investment (ROI) is _blank_. 150%
Using the book value of operating assets as the valuation base in ROI calculations ______. Can cause severe
motivational problems. Managers will consider compariesons unfair because they do not accurately reflect performance.
Managers may avoid replacing obsolete equipment because purchasing new equipment would increase the dollar amount
of operating assets, reducing the roi
A manager has a current return on investment (ROI) of 15%. The company's ROI is 12%. If offered an investment that
returns 13%, the manager is likely to _blank_. only accept it if evaluated on residual income
Decisions that are in the best interest of a division of the company, but not in the best interest of the company as a whole
result in _blank_. Suboptimization
Margin captures the managers ability to _blank_. control operating expenses relative to the level of sales
Turnover is a measure of _blank_. the amount of operating assets employed to support the achieved level of sales
Reducing operating assets while other factors remain constant will _blank_ ROI. increase
Why do companies typically use operating income and assets as opposed to net income and total assets in calculating
return on investment (ROI)? Managers usually have more control over operating income and assets.
Investment centers _blank_. are responsible for revenues, expenses and investment, are accountable for assets and
liabilities
Return on investment (ROI) is a measure of the amount of _blank_. wealth generated by operating assets
Decentralization: delegating authority and responsibility
Advantages:
encourages upper-level management to concentrate on strategic decisions
Improves the quality of decisions by delegating authority down a chain of command
Motivates managers to improve productivity
Trains lower-level managers for increased responsibilities
Improves performance evaluation
Ch. 9 Accounting Study review
Return on investment (ROI) is a measure of the amount of _blank_. wealth generated by operating assets
Investment Centers:
are accountable for assets and liabilities
Are responsible for revenues, expenses and investments
Cost variances are favorable when actual costs _______ standard costs: Less than
When comparing the static and flexible budget, which volume variance is always zero? Fixed cost
A favorable material variance _________: could be due to shrewd negotiations, could be due to purchasing inferior goods
According to a philosophy known as management by exception, _blank_ should be investigated.
variances
Only significant cost
Sometimes the sales staff will deliberately underestimate the amount of expected sales. This practice is known as
_blank_. Lowballing
Flexible budget variances _blank_ variances. can be caused by price or usage
The primary advantage of a standard cost system is _blank_. efficient use of management talent to control costs
Sales variances are favorable when actual sales _blank_ expected sales. exceed
Which manager is typically responsible for volume variances? Marketing
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The static and flexible budgets use the same _blank_. total fixed costs , per unit sales price, per unit variable costs
A budget that shows revenues and costs at a variety of volume levels is a _blank_ budget. Flexible
If poor production quality control leads to inferior goods that are difficult to sell, the unfavorable volume variance would be
the responsibility of the _blank_ manager. Production
The primary difference between the static and flexible budget is the _blank_. expected number of units sold
Flexible budgets can use a variety of volume levels.
Responsibility center: an organizational unit that controls identifiable revenue or expense items, can be divided into 3
categories
Cost center: an organizational unit that incurs expenses but does not generate revenue - manager of cost center is judged
on ability to keep costs within budget parameters
Profit center: differs from a cost center in that it not only incurs costs but also generates revenue - Managers of a profit
center is judged on ability to produce revenue in excess of expenses.
Investment center: Type of responsibility center for which revenue, expense, and capital investments can be measured.
managers are responsible for revenues, expenses and the investment of capital - normally appear at the upper levels of
an organization chart. Managers are responsible for assets and liabilities as well as earnings.
Responsibility report - Performance reports for the various company responsibility centers that highlight controllable items;
show variances between budgeted and actual controllable items
Management by exception: The philosophy of focusing management attention and resources only on those operations
where performance deviates significantly from expectations
Controllability concept: Evaluating managerial performance based only on revenue and costs under the managers direct
control.
Managers are usually held responsible for items over which they have predominant rather than absolute control.
Responsibility reports should include only budgeted and actual amounts of controllable revenues and expenses with
variance highlighted to promote management by exception.
ROI (Return on Investment): the ratio of wealth generated (operating income) to the amount invested (operating assets) to
generate the wealth.
Formula: ROI = Operating Income / Operating assets
Higher ROIs indicate better performance.
Margin: Ratio that measures control of operating expenses relative to sales; computed as operating income divided by
sales. Along with turnover, a component of return on investment.
Turnover: Measure of sales in relation to operating assets; calculated as sales divided by operating assets. Along with
margin, a component of return on investment.
ROI = Margin x Turnover
3 actions a manager can take to improve ROI: 1) Increase sales, 2) reduce expenses, 3) reduce the investment base
Residual income = Operating income - (operating assets x Desired ROI)
Balanced Scorecard: A management evaluation tool that uses both financial and nonfinancial measures to assess how
well an organization is meeting its objectives.
Chapter 10:
Ch. 10 Accounting Study guide
Capital investments are purchases of _blank_. long-term operational assets
Which of the following terms refer to a company's cost of capital?
Desired rate of return
Cutoff rate
Hurdle rate
Discount rate
Required rate of return
Which of the following is not a factor in explaining why the present value of a future dollar is less than one dollar? Sunk
Costs
Subtracting the cost of the investment from the present value of the future cash inflows determines the _blank_ of the
investment. Net Present Value
The desired rate of return uses compounding interest because _blank_. it assumes all cash inflows are reinvested
Read the definition of capital investment in your textbook. Which of the following would the authors of the book not
consider to be a capital investment? purchasing $500,000 of common stock in Target Corporation.
Acme's Company has two investment opportunities. Both investments cost $6,000 and will provide the same total future
cash inflows. The schedule of expected cash receipts for each investment is given below:
Acme should choose Investment I because of the time value of money.
Explanation: The expected cash flows are equal in the two investment opportunities. The time value of money concept
recognizes that the present value of a dollar received in the future is less than a dollar. As a result, the cash flows
expected from Investment I are preferable since the cash flows occur earlier during the four periods.
What amount of cash must be invested today in order to have $60,000 at the end of four years assuming the rate of return
is 10%? ( and ) ,$40,981
According to chapter 10, which one of the following statements best describes an annuity due? Series of cash flows of
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equal amounts collected at the beginning of each period
UNCC Company has an investment opportunity. The investment cost $5,000 and will provide the following net cash flows
at the end of each year:
What is the total present value of Investment Z's cash flows assuming a 9% minimum rate of return? ( and ) $3,371.
ExplanationNet present value = PV of cash flows Cost of investment. Calculate Investment Z's cash flows one at a time
and then sum the totals. Then subtract the original cost of the investment.
Sally has an investment that costs her $7,000 but will produce annual cash flows of $2,500 for a period of 4 years. Given
a desired rate of return of 12%, what is the present value index? ( and ) 1.080
Explanation
Net present value of cash inflows = Expected cash flows PV factor for each
Net present value of cash inflows = $2,500 3.037349 = $7,593 (rounded)
PV factor from Appendix Table 2 (n = 4, i = 12)
Present value index = Present value of cash inflows Present value of cash outflows
Present value index = $7,593 $7,000 = 1.08
Mendez Company is considering a capital project that costs $16,000. The project will deliver the following cash flows:
Using the incremental approach, the payback period for the investment is:
Glossary
accumulated conversion factor: Factor used to convert a series of future cash flows into their present value equivalent
when applied to cash flows of equal amounts spread over equal interval time periods; this factor can be computed by
adding the individual single factors applicable to each period.
Annuity: Series of equal cash flows received or paid over equal time intervals at a constant rate of return - must meet 3
criteria, 1) equal payment amounts, 2) equal time intervals between payments and 3) a constant rate of return
capital investments: Purchases of operational assets involving a long-term commitment of funds that can be critically
important to the companys ultimate success; costs normally recovered through using the assets
time value of money: The concept that the present value of one dollar to be exchanged in the future is less than one dollar
because of interest, risk, and inflation factors. - recognized that the present value of a dollar received in the future is less
than a dollar.
cost of capital: Return paid to investors and creditors for supplying assets (capital); usually represents a companys
minimum rate of return.
minimum rate of return: Minimum rate of profitability required for a company to accept an investment opportunity; also
called desired rate of return, required rate of return, hurdle rate, cutoff rate, and discount rate.
desired rate of return: The rate of return that a company aspires to attain.
accumulated conversion factor: Factor used to convert a series of future cash flows into their present value equivalent
when applied to cash flows of equal amounts spread over equal interval time periods; this factor can be computed by
adding the individual single factors applicable to each period.
annuity:Series of equal cash flows received or paid over equal time intervals at a constant rate of return
ordinary annuity:Annuity in which cash flows occur at the end of each accounting period. Likely to be received throughout
the period, not just at the end.
net present value: Capital budgeting evaluation technique in which future cash flows are discounted, using a desired rate
of return, to their present value equivalents and then the cost of the investment is subtracted from the present value
equivalents to determine the net present value. A zero or positive net present value (present value of cash inflows equals
or exceeds the present value of cash outflows) means the investment opportunity provides an acceptable rate of return
Cash INFLOWS generated from capital investments come from 4 basic sources:
Incremental revenue: Additional cash inflows from operating activities generated by using an additional capital asset
Cost Savings
Salvage Value
Reduction in the amount of working capital:
Working Capital: A measure of the adequacy of short-term assets; computed as current assets minus current liabilities
Cash OUTFLOWS: 3 categories:
Outflows for initial investment
Increases in operating expenses
Increases in working capital commitments
present value index: Present value of cash inflows divided by the present value of cash outflows. Higher index numbers
indicate higher rates of return
internal rate of return:Rate at which the present value of an investments future cash inflows equals the cash outflows
required to acquire the investment; the rate that produces a net present value of zero
Internal rate of return decision rule: if the internal rate of return is equal or great than the desired rate of return, accept the
investment opportunity
payback method: Capital budgeting evaluation technique in which the length of time necessary to recover the initial net
investment through incremental revenue or cost savings is determined; the shorter the period, the better the investment
opportunity.
Payback period = Net cost of investment / annual net cash inflow
Average annual cash inflow: add all years and divide by total!
unadjusted rate of return (simple rate of return): Measure of profitability computed by dividing the average incremental
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increase in annual net income by the average cost of the original investment (original cost divided by 2); does not account
for the time value of money.
Unadjusted rate of return = Average incremental increase in annual net income / Net cost of original investment
Payback = Cost of the investment / Annual Cash inflow
Postaudit: After-the-fact evaluation of an investment project; the capital budgeting techniques employed in originally
deciding to accept the project are used to calculate the results of the project using actual data; provides feedback
regarding whether the expected results were actually achieved
Techniques that use the time value of money concepts:
Net present value Method
Internal rate of return method
Techniques that IGNORE the time value of money:
Payback method
Unadjusted rate of return method
Annuity due: Series of cash flows of equal amounts collected at the beginning of each period
Chapter 11:
Ch. 11 Study guide:
Most manufacturing companies accumulate product cost in 3 distinct inventory accounts:
Raw Materials Inventory: Asset account used to accumulate the costs of materials (such as lumber, metals, paints,
chemicals) that will be used to make the companys products
Work in Process Inventory: Asset account used to accumulate the product costs (direct materials, direct labor, and
overhead) associated with incomplete products that have been started but are not yet completed
Finished Goods Inventory: Asset account used to accumulate the product costs (direct materials, direct labor, and
overhead) associated with completed products that have not yet been sold.
absorption (full) costing: Reporting method in which all product costs, including fixed manufacturing costs, are initially
capitalized in inventory and then expensed when goods are sold. (Contrast with variable costing.)
applied overhead: Amount of overhead costs assigned during the period to work in process using a predetermined
overhead rate.
Manufacturing Overhead account: Temporary account used during an accounting period to accumulate the actual
overhead costs incurred and the amount of overhead applied to production. A debit balance in the account at the end of
the period means overhead has been underapplied and a credit balance means overhead has been overapplied. The
account is closed at year-end in an adjusting entry to the Work in Process and Finished Goods Inventory accounts and
the Cost of Goods Sold account. If the balance is insignificant, it is closed only to Cost of Goods Sold.
overapplied overhead: The condition that occurs when the amount of overhead applied to work in process is greater than
the actual amount of overhead incurred
underapplied overhead: The condition that occurs when the amount of overhead applied to work in process is less than
the actual amount of overhead incurred
Predetermined Overhead rate = Total Expected overhead cost / allocation base
Applied overhead = predetermined overhead rate x annual direct labor hours
predetermined overhead rate: Allocation rate calculated before actual costs or activity are known; determined by dividing
the estimated overhead costs for the coming period by some measure of estimated total production activity for the period,
such as the number of labor hours or machine hours. The base should relate rationally to overhead use. The rate is used
throughout the accounting period to allocate overhead costs to work-in-process inventory based on actual production
activity.
schedule of cost of goods manufactured and sold:
Internal accounting report that summarizes the manufacturing product costs for the period; its result, cost of goods sold, is
reported as a single line item on the companys income statement.
Differences when actual and applied o overhead result in an ending balance in the manufacturing overhed account at the
end of the accounting period:
If the actual overhead exceeds applied overhead, the account balance represents underapplied overhead.
If the actual overhead is less than applied overhead, the balance represents overapplied overhead.
If the amount of over- or underapplied overhead is insignificant, it is closed directly to the cost of goods sold throught a
year-end adjusting entry.
Variable costing: Costing method in which only variable manufacturing costs are capitalized in inventory; all fixed costs,
including fixed manufacturing overhead, are expensed in the period incurred. On a variable costing income statement, all
variable costs are subtracted from revenue to determine contribution margin, then all fixed costs are subtracted from the
contribution margin to determine net income. Under variable costing, production volume has no effect on the amount of
net income. (Contrast with absorption costing.)
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