ACCT 2302
Fundamentals of Accounting II
Spring 2011
Lecture 22
Professor Jeff Yu
End of semester issues
 Please seek my help now rather than after the final exam. It will be too
late to do it then, and I will NOT be able to help at that time.
 Don’t forget to complete the online course evaluation.
 I will submit your grade on access.smu.edu as soon as I finish grading.
My intention is to give everybody as high of a grade as possible, but I
first have to make sure it is fair with everybody in the class. I commit to
grade fairly and consistently, and will assign grades strictly based on
your relative performance within the class (NOT your needs).
 The two weeks after the final exam will be my “silent period.” I may NOT
address ANY inquiries on your grade until May 17th.
 Final exam will NOT be returned, but you could see the score on
Blackboard and make appointments with me staring May 17th to view it in
my office. I will re-grade the entire exam for any grade disputes.
Final Exam Information
 In this class room and at university-scheduled time (posted on
the class schedule and explicitly stated in the syllabus).
Please plan to arrive 10 minutes earlier. The exam will start when
everyone in the room has an exam packet and will stop promptly
after THREE hours!
 Please spread out as much as possible when you get seated. I
may ask you to change seats if I determine that you sit too close
to the other student. Your cooperation will expedite the exam
handout process so that all students will have more time to work
on the exam.
 This is a closed-book exam. You are only allowed to bring a onepage (A4 size) cheat sheet (double-sided is OK) and you must
hand in the cheat sheet.
 The exam is cumulative. You will need a non-programmable
calculator. Please bring one!
Type of questions
 Multiple Choice Questions
Include both conceptual and numerical questions. No
partial credit on multiple choice questions.
 Problems
Show your work in the space provided with legible and
carefully labeled computations so that I can assign
partial credit. If I cannot understand your
computations, I will not assign partial credit.
Studying for the exam
• Carefully study lecture notes.
• Re-work practice problems in the lecture notes,
midterm exams and quizzes. They are the best predictors
of final exam questions!
• Practice using the posted practice questions on the class
website. Warning: since they are written by other
professor or used in other school, they may be very
different from my final exam questions for this semester.
Use these practice exams at your own risk.
• Come to my Q&A session (May 2 in class) and office
hours to clarify difficult materials.
Review: Manufacturing Cost Flows
Costs
Balance Sheet
Inventories
Income
Statement
Expenses
Raw Material
Purchases
Direct Labor
Manufacturing
Overhead
Goods Sold
How to show product cost flows using T-accounts?
Review: MOH Application in job-order costing
Manufacturing overhead is applied (allocated) to individual jobs
(work-in-process) based on a ___________ rate (POHR).
At the ________ of the period, calculate:
POHR = Estimated total MOH cost / __________ total activity level
________ the period, calculate:
Applied MOH = POHR * ________ activity level
At the _______ of the period, calculate:
_______ MOH - Applied MOH
to determine whether MOH was underapplied or overapplied.
Review: Job-Order Costing
1. If Applied MOH>Actual MOH, then MOH is ________ for the period.
If Applied MOH<Actual MOH, then MOH is __________ for the period.
2. What is the journal entry to apply MOH to jobs during the period?
3. What is the adjusting journal entry to close the overapplied
(underapplied) MOH to CGS at the end of the period?
Review: Cost Behavior
True Variable Cost (a=0, b>0)
Total cost: Y=bX, increases with X
Average cost: Y/X=b, constant
Fixed Cost (a>0, b=0)
Total cost: Y=a, constant
Average cost: Y/X=a/X,
decreases with X
Mixed Cost (a>0, b>0)
Total cost: Y=a+bX, increases with X
Average cost: Y/X=a/X + b,
decreases with activity level X.
Review: Cost Function & High-low Method
Cost Function: Y = a + bX
(1) Select the highest- & the lowest- activity levels: Xh, Xl
(2) Fit a line through the two data points: (Xh, Yh), (Xl, Yl)
Yh =a + bXh
Yl =a + bXl
b=(Yh - Yl)/(Xh - Xl)
a= ?
The slope of the line: b = Variable Cost per unit
The intercept of the line: a = Total Fixed Cost
Review: The Contribution Format Income Statement
Used primarily for
external reporting
Used primarily for Managerial
Decision making
Review: The Contribution Margin Method
Break - even Point in Units 
Fixed Expenses
CM per Unit
Break - even Point in Sales Dollars 
Units sales to attain Target Profit 
Fixed Expenses
CM Ratio
Fixed Expenses  Target Profit
CM Per Unit
Review: The Equation Method
Let B.E.P. in units = X
Sales – Variable Expenses – Fixed Expenses = NOI
Price * X
VC/unit * X
$$$
B.E.P in sales dollars = B.E.P. in Units * Price
$0
Review: CVP Analysis
Expected profit (NOI) may change due to:
 a change in fixed expenses
 a change in CM per unit (=price - VC/unit)
 a change in sales volume:
once the break-even point has been reached, NOI will
increase by CM per unit for each additional unit sold.
Two approaches to predict profit using CVP analysis:
1)Income Statement approach
2)Incremental approach: ΔNOI = ΔCM – ΔFE
Review
 Margin of Safety (units, sales, percentage)
 Degree of Operating Leverage
 Sales Mix and Break-even Analysis
Review: Steps for Implementing ABC
1. Define activity cost pools & activity measures.
2. Assign overhead costs to activity cost pools: first-stage
allocation.
3. Calculate activity rates: for each activity cost pool, divide
total assigned OH costs by estimated total activity levels.
4. Assign OH costs to the specific product or customer
using the activity rates: second-stage allocation
Assigned OH = Activity Rate * Actual activity level
5. Prepare management reports: calculate product margin
and customer margin.
Review: Profit Planning
Budgeted Sales $ = budgeted sales in Units * unit price
Expected cash collections (inflow)
Budgeted Account Receivable Balance
Budgeted Production units = budgeted Sales in Units
+ desired ending F.G. Inventory – beginning F.G. Inventory
Review: Profit Planning
Budgeted R.M. Purchase in units
= budgeted Production in Units * R.M. needed for each unit
+ desired ending R.M. inventory – beginning R.M. Inventory
Expected cash disbursements for R.M. (or Accounts Payable)
Budgeted DL cost = budgeted DL hours * hourly rate
(Adjust for “guaranteed hours” & higher hourly rate for overtime)
Budgeted MOH cost (Important: calculation of POHR)
Budgeted S&A expense
Budgeted ending F.G. Inventory
CASH Budget
Review: Performance Evaluation
Evaluation Tool
Cost Center
(controls costs only)
Profit Center
(controls costs & revenues)
Investment Center
(controls costs & revenues
& Investments)
Spending Variance;
Standard Cost Variances
Segmented
Income Statement
(Segment Margin)
Return on Investment (ROI);
Residual Income
Review: Flexible Budget
Flexible budget is prepared based on the actual activity level and
is used for performance evaluation (control) purpose.
Activity Variance = Flexible budget amount – planning
(static) budget amount
Spending Variance = Actual cost – flexible budget cost
Spending variance is unfavorable if positive, favorable if negative;
Spending variance captures the efficiency of cost control.
Revenue Variance = Actual revenue – flexible budget revenue
Revenue variance is favorable if positive, unfavorable if negative;
Review: Standard Cost
 Standard vs. Budget:
• A budget is set for total costs;
• A standard is set for per unit cost;
 Quantity standards are set for each unit of production
(How much units of input are needed for each unit of output?)
SQ = standard quantity of materials allowed for the actual output
SH = standard hours allowed for the actual output
Price standards are set for each unit of input
(How much should be paid for each unit of input?)
Standard Price (SP) for materials
Standard Rate (SR) for labor and overhead
Review: Standard Cost Variances
Materials Price Variance
Materials Quantity Variance
AQ(AP - SP)
SP(AQ - SQ)
Labor/VOH Rate Variance Labor/VOH Efficiency Variance
AH(AR – SR)
SR(AH – SH)
AP (AR)= Actual Price (Actual Rate): the amount actually paid for
each unit of the materials (labor or VOH).
SP (SR)= Standard Price (Standard Rate): the amount that should
Have been paid for each unit of the materials (labor or VOH).
AQ (AH)= Actual Quantity (Actual Hour): the amount of materials
(labor or VOH activity) actually used in the production.
SQ (SH)= Standard Quantity (Stan. Hour) allowed for the actual output
= actual production in units * standard quantity (hours) per unit
Review: Materials Variances
When material purchased ≠ material used
To compute the PRICE variance, use the total
quantity of raw materials PURCHASED.
To compute the QUANTITY Variance, use only the
quantity of raw materials USED.
Review: Segmented Income Statement
Sales
- Variable Expenses
Contribution Margin
- Traceable Fixed costs
Segment Margin
 NOI for the company = the sum of segment margins
minus Common fixed costs.
 Important: CVP analyses using the segmented
income statement!
Review: ROI and Residual Income
ROI = NOI ÷ AOA
NOI
Sales


Sales
AOA
Turnover
Margin
RI = NOI - Required rate of return × AOA
Review: equipment replacement decision
In deciding whether to replace or keep existing equipment,
consider the following relevant costs:
 Purchase or rental costs of new equipment
 Disposal value of old equipment
 Cost savings from using the more efficient new
equipment instead of the old equipment
Review: Decision to Add/Drop Segments
Relevant factors to consider:
(1)Segment margin
(2)The interaction between segments
Recall: Common fixed costs are unavoidable, hence
irrelevant in the decision. Traceable fixed costs are
avoidable.
Review: Transfer Pricing decision
Buyer: Max. transfer price = best price from outside suppliers
Seller: Min. transfer price = VC per unit + Opportunity cost per unit
Opportunity cost per unit = Total CM on lost sales / # of units transferred
(1) If idle capacity = 0, then opportunity cost per unit = CM per unit,
minimum transfer price = Market price
(2) If idle capacity >= units transferred, then opportunity cost per unit = 0,
minimum transfer price = VC per unit
(3) If 0< idle capacity <= units transferred, then
min. transfer price = w*VC per unit + (1-w)*Market price
where the weight: w = idle capacity ÷ units transferred.
Review: Decision to Accept/Reject a Special Order
Similar to Transfer pricing:
With ample idle capacity . . .
Relevant costs usually will be the variable costs
associated with the special order, plus any special
processing cost or costs of special tools required.
Without enough idle capacity . . .
Relevant costs: the costs above, plus the opportunity
cost of using the firm’s facilities for the special order.
Review: “Make or Buy” Decision
DECISION RULE
 Step 1: calculate the relevant costs of making each unit
of the part after eliminating sunk costs and future costs that
do not differ between making or buying the parts.
 Step 2: Compare the unit cost calculated from step 1 with
the price offered by outside suppliers.
Note: watch out for any relevant opportunity costs.
Review: Optimal Use of Limited Resources
When facing a limited resource constraint, the firm should
produce products with the highest contribution margin
PER UNIT OF SCARCE RESOURCE.
Example:
Product
CM/unit
MH/unit
CM/MH
A
18
9
2
B
20
4
5
C
16
5
3.2
If Machine hour is constrained, then the production order
should be: B, C, A
Review: Sell or Process Further?
Decision Rule: process further only when the incremental
revenue from such processing exceeds the incremental
processing cost incurred after the split-off point.
Joint costs are irrelevant to the decision.
Review: DCF Analysis
Net Present Value (NPV) Method
Compare PV of all cash inflows with PV of all cash
outflows that are associated with the project.
If NPV >= 0, accept the project. Otherwise, reject it.
Internal Rate of Return (IRR) Method
Calculate IRR: the discount rate that sets NPV = 0.
Accept the project if IRR >= the required rate of return
(cost of capital). Otherwise, reject it.
Review: Screening decision of Capital Budgeting
NPV = PVs of cash inflows - PVs of cash outflows
PV factor of IRR =
Initial investment required
Net annual cash inflow
Payback Method: Payback period is the length of time
that it takes for a project to recover its initial investment
out of the net cash inflows.
Simple rate Annual Incremental NOI
= Initial investment
of return
Review: Tax effects in Capital Budgeting
1. Investments: No tax effect.
Note: examples of investments include costs of new equipment, working
capital needed, release of working capital, etc.
2. Tax-deductible cash expenses: (let tax rate=t)
After-tax cost = (1-t)×cash expenses
3. Taxable cash receipts:
After-tax benefit = (1-t)×cash receipts
4. Depreciation: Not cash flow, but tax deductible
Depreciation tax shield = t × depreciation deduction
Note: straight-line depreciation with 0 salvage value is assumed in
calculating depreciation deduction.
Homework Problem
Dana Co.’s cost of capital is 10% and tax rate is 30%. It is deciding whether to
repair an old machine (Project A) or to buy a new machine to replace it (Project B).
Repairing the old machine costs $5,000 now, while buying a new machine costs
$20,000 now. The old machine, after being repaired, will have the same useful life
of 5 years as the new machine. But using the new machine will save the company
$5,000 per year in operating costs during the next 5 years, compared with using
the repaired old machine. The salvage value of the new machine at the end of year
5 is $3,000. The salvage value of the old machine is zero before the repair, but
after the repair the old machine can be sold for $2,000 at the end of year 5.
Q: (1) Ignoring any tax effect, which project has higher NPV?
(2) For tax purpose, the cost of the new machine will be depreciated over 4
years on a straight-line basis with zero reduction for salvage value. What is
the annual tax savings from the depreciation tax shield for Project B?
(3) If Project A’s annual net cash inflow is $2,000 for the next 5 years and there
is no depreciation deduction, what is the after-tax NPV for Project A?