Part 1 Financial Planning, Performance and Control 30%Unit 9Budgeting Concepts, Methodologies and Preparation1- A budget is a plan for the future expresses in quantitative terms. A budget promotes goal congruence among operating units. A budget is a planning, communication and coordination, control, motivation and allocation tool. The budget sets specific goals for income, cash flows and financial position. Budgets are primarily quantitative not qualitative and they incorporates non-financial measures as well as financial measures into its outputs.2- Planning is a process of charting the future to attain desired goals. Planning consists of selecting organization goals, predicting results under various alternative ways to achieve those goals, deciding how to attain the desired goals and communicating the goals and how to attain them to the entire organization.3- Good planning helps managers to attain goals, recognize opportunities, provide basis for controlling operations, forces managers to consider expected future trends and conditions, checking progress towards the objectives of the organization and minimize the negative effects of unavoidable events.4- Strategy is the starting point in preparing the organization plans and budgets. It's the organization's plan to match its strength with the opportunities in the market place to achieve its desired goals over the short and long term. The strategy is the path chosen by the organization to attain its long term goals.5- Strategy, plans and budgets are interrelated and affect one another.Strategy shows how an organization matches its strength with opportunities to attain its desired goals in the market place in short and long-run planning. These plans lead to the formulation of budgets. Budgets provide feedback to managers about the likely effects on their strategic plans. Managers use this feedback to revise their strategic plans, and that may lead to changes in the budgets.6- Budgeting (Targeting) is the steps involved in preparing the budget.7- Pro forma statements is a budgeted financial statements (budgeted income statements, budgeted balance sheet and budgeted cash flows), are forecasts of goals for a future period that assist in the allocation of resources.8- Strategic plan and strategic budget An organization must complete its strategic plan before the beginning of any budgeting process. Strategic budget is a form of long-range planning identifying and specifying the organization goals and objectives (usually 5 years).9- The external environment in planning and budgetingAn organization must interact with the external environment in which it operates, as this external environment factors affects the company's plans and budgets. Three interrelated environments affect management's planning and budgeting:1. The industry in which the company operates, including the company's current market shares.2. The country or national environment in which the company operates, including governmental regulatory measures, labor market and the activities of competitors.3. The wider macro environment in which the company operates. For instance, if the economy entering a period of lower demand.10- Budget cycleThe budget cycle includes the following elements:1- Planning the performance of the company as a whole, as well as planning the performance of its subunits.2- Providing a frame of reference, a set of expectations can be compared against actual.3- Investigation variations from plans.4- Planning again, in light of feedback and changed conditions.11- Advantages of budget (PCCMA)1- As a planning tool budget forces managers to think ahead. Without budget the organization will operate in retroactive instead of proactive manner.2- Budgets promote coordination and communication among operating units. Budgets promote goal congruence among operating units. Budgets require departmental managers to make plans in conjunction with other interdependent units. If a firm doesn't have an overall budget, each department will set its own objectives without regards to what is good for the firm as a whole.3- As a control tool budget provides a frame of reference for measuring performance and provide a means for controlling operations. The budget provides a formal benchmark to be used in feedback and performance evaluation. Budgeted performance is a better criterion than past performance for judging managers.4- The budget is a motivational tool. Challenging budgets improve employee performance because no one wants to fail. The budget should be challenging but achievable.5- The budget promotes efficient allocation of organization resources among operating units.12- Types of plans:1- Strategic plans (long-term plans): are broad, general and long-term plans (usually 5 years or longer), it's done by the company's top management. This type of planning doesn't focus on detailed financial targets, but looks at strategies, objectives and goals of the company by examining the internal and external factors affecting the company.2- Intermediate plans (Tactical plans): are designed to implement specific parts of the strategic plan. It's made by upper and middle manager (one to 5 years).3- Short-term or operational plans are the primary basis of budget: refine the overall objectives from the strategic and tactical plans in order to develop the programs, policies and performance expectations required to achieve the company's long-term goals.13- Characteristics of successful budget:The common factors in a successful budget include:1- The budget must be aligned with the organization strategy.2- The budget must have the support of management at all levels.3- The budget should be motivating devise.4- The budget should be coordinated.5- People who are charged in carrying out the budget need to feel ownership of the budget.6- The budget should be flexible.7- The budget shouldn't be rigid.8- To be useful, the budget should be an accurate representation of what is expected.9- The time period of a budget should reflect the purpose of the budget14- Time frames for budgets Annual Budget: The budget generally prepared for a set period of time, commonly one year, and the annual budget subdivided into months or quarters. Rolling or Continuous Budget: Budgets can also be prepared in continuous basis. The budget covers a set number of months, quarters or years into the future. Each month or quarter just completed is dropped and a new month or quarter's budget is added to the end of the budget. At the same time the other periods can be revised to reflect any new information available. Thus, the budget is being updated continuously and always covers the same amount of time in the future.15- Who should participate in the budget process? (Budget Participants)1. Board of directors: The budget begins with the mission statement formulated by the board of directors. The board of directors doesn't create the budget, but responsible for reviewing and the approval of the budget or send it back to revision. The board usually appoints the members of the budget committee.2. Top management: Senior management translates the mission statement to a strategic plan, they involvement doesn't extend to dictating the numerical contents of the budget since they lacks the detailed knowledge of daily operations. Importance of top management involvement1. Reviewing and the approval of the budget ensure top management that the budget guideline is being followed.2. Top management active involvement in reviewing and approving the budget discourage lower-level managers from playing budget games.3. The active top management involvement also motivates lower-managers to attain the company goals and objectives because they know the manager cares about the budget.4. The single most important factor in assuring successful budget is for upper management to demonstrate that they take the project seriously and considers it vital to the organization's future.3. Budget committee: (The highest authority for all matters related to the budget). The committee directs budget preparation, approves departmental budgets submitted by operating managers, rules on disagreements, monitoring the budget, reviewing results, approving revisions, draft the budget calendar and budget manual.4. Middle and lower management: Once the middle and lower managers receive their budget instructions, they draw up their departmental budgets in conformity with guideline and submit them to the budget committee16- Authoritative budget (Top-down budget, Imposed budget): The top management sets the overall goals of the organization and prepares the operational budget to attain those goals. Advantages:1. Provides better decision making than participative approach.2. Increase coordination among operating units.3. Reduces the time required to prepare for budgeting.4. Facilitates implementation of strategic plan. Disadvantages:1. Reduces communication between employee and managers.2. May limit the acceptance to goals and objectives.3. May result in a budget not possible to achieve.4. Often lacks the commitment of lower managers and employee responsible for implementing the budget.17- Participative budget (bottom-up budget, self-imposed budget):Lower managers are participants in budget preparation.Advantages of participative budget:1. Managers are more motivated to achieve budgeted goals.2. Greater support for budget.3. Greater understanding of what to be accomplished.4. Greater accuracy of budget estimates. Managers with direct operational responsibilities have a better understanding of what results can be achieved and at what costs.5. Managers can't blame unrealistic objectives as an excuse for not achieving budget expectations, since they are participants in preparing those objectives.Disadvantages of participative budget:1. Without a review, self-imposed budgeting may be too slack, resulting in suboptimal performance. Suboptimal decision making is not likely to occur when guidance is given to subunit managers about how standers and goals affect them. An effective budgeting process combines both top down and bottom up budgeting approaches. Divisions prepare their budget based on the budget guidance submitted by the firm's budget committee. Senior managers review and make suggestions to the proposed budget before sending it back to divisions for revision.18- The budget development process:1. Budget guidelines are set and communicated.2. Initial budget proposals are prepared by responsibility centers.3. Negotiations, reviewing and approval.4. Revision.5. Reporting on variances.6. Use of the variance reports.19- Best practice guidelines for the budgeting process include the following:1. The development of the budget should be linked to corporate strategy.2. Communication is vital.3. Funding resources should be allocated strategically.4. Managers should be evaluated on performance measures other than meeting budget targets.5. Reduce budget complexity and budget cycle time.6. Link cost management effort to budgeting.7. Reviewing the budget on regular basis throughout the year.8. The strategic use of variance analysis. For a budget to be useful, it must be finalized before the fiscal year begins.20- Budget planning calendar: is the schedule of activities for the development and adoption of the budget.21- Budget manual: is the details of the budget process and who can the departmental managers prepares their own budgets.22- Goal congruence: Refers to the aligning of goals of the individual managers with the goals of the organization as a whole.23- Budgetary slack and its impact on goal congruence: Budgetary slack or padding the budget: is a serious ethical issue in budgeting. It describes the practice of underestimating budget revenues or overestimating budgeted costs, to make budget targets easier to achieve. On the positive side Budgetary slack can provide managers an excuse against unforeseen circumstances. On the negative side budgetary slack misrepresents the true profit potential of the company, and can lead to inefficient resources allocation and poor coordination of activities among the company.24- Avoiding problems of budgetary slack: The best way to avoid problems of budgetary slack is to use the budget as a planning and control tool, but not for managerial performance evaluation.25- Standard costs: are costs for direct materials, direct labor and manufacturing overhead that are estimated to apply under specific conditions. Four reasons for using standard costing1. Cost management (costing inventory).2. Pricing decisions.3. Budgetary planning and control.4. Financial statement preparation.26- Ideal standard costs vs. Practical standard costs1. Ideal (Theoretical, Perfection, Maximum efficiency, tight) standard costs Attainable only under the best possible conditions. Based on no allowance for waste, spoilage, machine breakdown, or other downtime. Encourages continuous improvement.2. Practical (Currently attainable) standard costs Challenging but attainable. Based on allowance for normal waste, spoilage and downtime. Serve as a better motivating target for manufacturing personnel. Discourages continuous improvement. When the level of outputs (denominator) is low in absorption costing, that means that high amount of overhead will be inventoried in finished goods, consequently result in higher income.27- Setting standard costs: standard costs can be derived from several resources:1. Activity analysis: Activity analysis is the most accurate way to estimate standard costs. It's a team development approach performed by people from several different areas, based on investigating all factors involved in producing a product. The cost of Activity analysis itself can be so high2. Historical data: Historical data based on using the data of costs involved in similar product in prior periods to determine standard costs. Standard costs based on past data may make inefficiencies to continue.3. Benchmarking: Based on using the best performance company or unit as a standard. Factors affecting the selection of budget methodology:1. Types of business.2. Organizational structure.3. Complexity of operations.4. Management philosophy.Budgeting systems/approaches:1- Master budget. 2- Flexible budget. 3- Project budget. 4- Continuous (rolling budget). 5- Kaizen budget. 6- Activity-based budget. 7- Zero-based budget. 1- Master/Static/Comprehensive Budget (Annul business plan): Is made up of several deferent budgets, and some budgets can't be developed until other budgets have already been completed. The development of master budget: Sales budget: Shows the expected sales in units and its expected selling price. Production budget: Follows the sales budget, and it shows the resources needed to carry out the manufacturing operations that allow the firm to satisfy its sales goals and desired amount of inventory at the end of the budget period.Budgeted sales (units)+ Ending finished goods inventory (units) Beginning Finished goods inventory (units)= Budgeted production (units) Direct labor budget Factory overhead budget Ending inventory budget

Direct material used+ Direct labor+ Manufacturing overhead= Cost of goods manufactured Beginning finished goods inventory+ Cost of goods manufactured= Goods available for sale Ending finished goods inventory= Cost of goods sold

Sales revenue Cost of goods sold= Gross margin Other expenses= Operating income Cash budget: Shows cash flows (receipts, disbursement and cash balances) for a firm over a specified period. Master budget based on one level of activity (one year). The relationship between strategic goals, objectives, budgets, operations and control: The budget expresses the strategy by describing the sales plan, the costs needed to achieve sales goals and cash flows needed. The master budget reflects the impact of operating budget and financial budget.

The benefits of master budget: Master budget is relatively easy to prepare, and ensure that comprehensive attention is given to resources requirement. The limitation of master budget: Master budget amounts are confined to one year at one level of activity. Budget amounts may be much different from actual results.2- Flexible budget: Is prepared for many levels of activity. Flexible budgets represent budgets that provide the ability to accommodate comparison with many levels of actual sales or production volume. Benefits of flexible budget:1. Can be displayed on any number of volume levels within the relevant range.2. Offer managers more realistic comparison of budgeted and actual revenue and cost items under their control.3. Most appropriate for firms facing a significant level of uncertainty in unit sales volume for next year. Limitation of flexible budget:1. Flexible budgets are highly dependent on the accurate identification of fixed and variable costs and the determination of the relevant range.2. Errors in determination of the relevant range or misestimates in anticipated outputs expected from variable costs could distort performance evaluation.3- Project budget: Is used when a project is completely separated from other elements of a company, or is the only element of the company.4- Continuous/Rolling/Perpetual budget: Add budgeted month or quarter, as each current month or quarter expires.5- Kaizen (Continuous improvement) budget: Depends on continuous improvement not only from the organization but also from the suppliers.6- Activity based budget (ABB): Focuses on costs of activities or cost drivers necessary for operations.7- Zero-based budget: Requires justification of all expenditures every year.8- Incremental budget: Starts with prior year's budget and uses projected changes to estimate the future budget.9- Life cycle budget: Estimates a product's revenue and expenses over its entire life (value chain), which includes:a. Upstream costs (researches and development).b. Manufacturing costs (production costs).c. Downstream costs (marketing, distribution and customer service).10- Probabilistic budget: Based on expected values and their probabilities.Unit 8Analysis and Forecasting Techniques Forecasting Techniques

Causal forecasting methods (regression analysis)Expected valueLearning curveTime series methods

Simple moving averageWeighted moving averageExponential smoothing

Quantitative methods of forecasting rely on managers experience. Quantitative methods use mathematical models and graphs.1- Causal forecasting (regression analysis)(least-squares analysis): Looks for a cause and effect relationship between the dependent variable we trying to forecast and one or more independent variables, if it's a linear relationship within the relevant range.a. Simple linear regression: Is the linear relationship between one dependant variable and one independent variable. (y = a + b x )Y= value of the dependent variable, estimated cost.A= the y intercept (fixed cost).B= the slop of the regression line (unit variable cost, the coefficient of independent variable measuring the increase in y for each unit increases in x).X= the independent variable. The regression analysis is almost necessary for computing the fixed and variable portion of mixed costs. Regression doesnt determine causality. Correlation analysis Coefficient of correlation (R): Is the strength of the linear relationship between tow variables. A value of 1 indicates perfect inverse linear relationship between x and y. A value of 0 indicates no linear relationship between x and y. A value of + 1 indicates direct linear relationship between x and y. Coefficient of determination (R2) (coefficient of correlation square): Is the explanatory power of the regression that measures the percentage of the total variance in cost that can be explained by the regression equation. T value: Measures if the independent variable has a valid long-term relationship with dependent variable. Standard error of the estimate (SE): A measure of the accuracy of the regression's estimate.b. Multiple regression analysis: It's also possible for one dependant variable to be affected by more than one independent variable. Advantages or benefits of regression analysis:1. Regression analysis is the only way to compute the fixed and variable portions of costs that contain mixed costs.2. The results from the regression equation can be used in conclusions and forecasts. Disadvantages, limitations or shortcomings of regression analysis:1. To use regression analysis, historical data is required for the dependent variable or independent variable. If historical data is not available, regression analysis can't be used.2. If there has been significant change in the conditions surrounding historical data, the use of the regression in estimating the future will be questionable.3. Analysis is valid only with relevant range.4. If the choice of the independent variable is inappropriate, the results will be misleading.2- Time series methods: forecasts the pattern of the desired variable's activity in the future by looking at its patterns in past periods. Patterns (components) of Time series:a. Trend (secular) pattern: Resulting from long-term, multiyear factors.b. Cyclical pattern: Resulting from long-term, multiyear, cyclical movement in the economy.c. Seasonal pattern: resulting from factors within one day or one year.d. Irregular (Random) pattern: resulting from short-term, unanticipated factors. Using time series methods:1. Simple moving average: = total amount of sales number of months.2. Weighted moving average: the more recent data is assigned a greater weight. This method can be used to remove seasonal fluctuations from data.Example: Forecasting May sales from actual sales of 4 months sales (1+2+3+4 = 10)

3. Exponential smoothing: requires less data than moving average method.Forecasts month = percentage X actual of last month + (Percentage 1) X forecasts of last month. EXAMPLE: In January, ABC Corporation began using exponential smoothing to forecast sales for each month. Actual and forecasted sales, in millions, for ABC for the months of January, February, March and April are as follows. Forecasted sales for January through April have been calculated using exponential smoothing and an alpha of .1.

Forecasts for May = (.1 * 20) + (.9 * 21.6).3- Learning curve: Describes that the more experience people have in doing a task, the more efficient they become in doing this task. Benefits of learning curve analysis: Can be used in life-cycle costing decisions. Can be used in development a production plans and labor requirements. Limitation of learning curve analysis: Appropriate only in labor-intensive operations involving repetitive tasks. The learning rate assumed to be constant.1- Expected value: is the sum of the conditional profit (loss) for each event times the probability of each event's occurrence.1) The decision alternative is under the managers control.2) The state of nature is the future events will occur.3) The payoff is the financial results of the combination of the managers decision and the actual state of nature.4) Benefits of expected value: Expected value analysis forces managers to think of all the possibilities that could happen with each decision, and to evaluate decisions in a more organized manner.5) Criticisms of expected value: It depends on repetitive trials, but in reality, most business decisions involve only one trial.4- Expected value of perfect information (EVPI): is the difference between the expected profit under certainty and the expected monetary value of the best act under uncertainty. EVPI = EVwPI EvwoPI. EVPI = Expected value of perfect information. EVwPI = Expected value with perfect information. EVwoPI = Expected value without perfect information. The dealer is not willing to pay more than the EVPI to obtain information about future demand.

Section C: Cost management 20%Unit 4Cost management terminology and concepts1- Management accounting (Internal reporting): Measures and reports financial and nonfinancial information that helps managers make decisions to attain an organization's goals.2- Financial accounting: External reporting based on generally accepted accounting principles (GAAP).3- Cost accounting: Provides information for management accounting and financial accounting.4- Cost management: Describe approaches and activities of managers in short-run and long-run planning, and control decisions that increase value for customers and lower costs of products and services.5- Cost, Cost Pool and Cost object:1. Cost: is a resource sacrificed or forgone to achieve a specific objective.2. Cost pool: Costs are often collected into meaningful groups.3. Cost object: Anything for which a measurement of costs is desired (product, service, customer, activity or organization unit).6- Cost accumulation and Cost assignment:1. Cost accumulation: is the collection of cost data in some organized way by an accounting system.2. Cost assignment: After accumulating costsa. Tracing: Accumulated costs that have a direct relationship with a cost object.b. Allocating: Accumulated costs that have an indirect relationship with a cost object.7- Direct cost of a cost object: Easily traced (direct row material and direct labor).8- Indirect cost of a cost object: Not easily traceable to a cost pool or cost object (Indirect material, indirect labor, other indirect costs (Common costs)). Overhead allocation using allocation bases (Cost driver):When direct tracing isn't possible management accountants uses allocation bases (cost drivers).9- Cost drivers: Are Activities that cause costs increase as the activity increases.

10- Cost allocation is necessary for: Product costing. Pricing. Investment and disinvestment decisions. Managerial performance measures. Make-or-buy decision. Determination of profitability. Measuring income and assets for external reporting.11- Manufacturing costs (Product costs):1- Direct materials (traced).2- Direct manufacturing labor costs (traced).3- Indirect manufacturing costs (Factory over head) (allocated).12- Prim costs: (DM&DL).13- Conversion costs: (DL&MOH).14- Nonmanufacturing costs (Period costs): Selling, general and administrative costs.15- Types of inventory in manufacturing firms1. Direct material inventory.2. Work-in-process inventory.3. Finished goods inventory.16- Cost behavior:1. Variable cost: (fixed per unit, variable in total).2. Fixed cost: (variable per unit, fixed in total in short-term and within a relevant range). Relevant range: Is the range for which the cost relationships hold constant. Marginal cost: is the cost incurred by a one-unit increase in the activity level of a particular cost driver (constant within the relevant range).3. Simi-variable costs (Mixed costs): It includes both fixed and variable costs. Methods of estimating mixed costs:a. High- low method.b. Regression method.17- Cost of goods sold in merchandising firms:Beginning inventory+ Purchases_ Ending inventory= Cost of goods sold

18- Cost of goods sold in manufacturing firms: Beginning row materials inventory XXX+ Purchases XXX_ Returns and discounts XXX+ Fright-in XXX -----------= Row materials available for use XXXXX_ Ending Row materials inventory XXX -----------= Direct materials used in production XXXXX+ Direct labor XXX+ MOH XXX----------= Total manufacturing costs XXXXX+ Beginning work-in process inventory XXX_ Ending work-in process Inventory XXX----------= Cost of goods manufactured XXXXX+ Beginning finished goods inventory XXX----------= Goods available for sale XXXXX_ Ending finished goods inventory XXX-----------= Cost of goods sold XXXXX19- Cost classification for decision making:1. Controllable Vs. Non controllable costs:a. Controllable are those that are under discretion of a particular manager.b. Non controllable are those that are committed to another level of the organization. Controllability of a given cost differs according to the levels of the organization. A given cost may be controllable to some level of the organization, and non controllable to another levels.2. Avoidable Vs. Committed costs:a. Avoidable are those that may be eliminated by not engaging in an activity, or performing it more efficiently (Direct materials).b. Committed is the cost that governed mainly by past decision, and can't be eliminated in the short-run. It arises from holding property, plant or equipment. (Insurance, real estate taxes, lease payment and depreciation). They are by nature long-term and can't be reduced by lowering the short-term level of production.3. Incremental Vs. Differential cost:a. Incremental is the additional cost inherent in a given decision.b. Differential is the difference in total cost between two decisions.4. Engineered Vs. Discretionary costs:a. Engineered are those that have a direct, observable cause-and-effect relationship between the level of output and the quantity of resources consumed (Direct material and direct labor).5. Discretionary is the cost that management decides to incur in the current period. It's a periodic cost that has no strong impact input-output relationship (advertising and research & development).6. Outlay (explicit) Vs. Opportunity (Implicit) cost:a. Outlay (explicit, accounting, and out-of-pocket costs) requires actual cash disbursements.b. Opportunity (implicit) is the benefit lost when choosing one option that stops receiving the benefits from alternative option.7. Economic Vs. Imputed cost:a. Economic is the sum of explicit and implicit costs.b. Imputed are those that should be involved in decision making even though no transaction has occurred. They may be explicit or implicit).8. Relevant Vs. Sunk cost:a. Relevant costs are those future costs that will vary depending on the decision taken when choosing between two or more options to determine the best option that offers the highest benefit to the organization. Relevant cost has two properties: It differs for each decision option. It will be incurred in the future.b. Sunk cost is the cost that incurred in the past, thus, it has no impact on the decision (irrelevant cost).

9. Joint costs, separable costs and by-product: Split-off point: Is the point that multiple end products become separately indentified from the input of a single product.a. Joint cost is the cost incurred before the split-off point. Since it's not traceable it must be allocated.b. Separable cost is the cost incurred beyond the split-off point.c. By products are products of relatively small total value that produced from the same process of manufacturing products with greater value and quantity (Joint products).

10. Normal Vs. abnormal spoilage:a. Normal spoilage is the spoilage that occurs under normal operating conditions. It's essentially uncontrollable in the short-run. It's treated as product cost.b. Abnormal spoilage is the spoilage that not expected to occur under normal, efficient operating conditions. The cost of abnormal spoilage should be separately identified and reported to management. Abnormal spoilage thought to be more controllable by production management than normal spoilage. Abnormal spoilage treated as period cost (loss).11. Rework, scrap and waste:a. Rework consists of products that need more efforts to meet salable conditions.b. Scrap consists of row materials left over from the production cycle, but can be used in other production or to be sale to customers for a nominal price.c. Waste consists of row materials left over from the production cycle, but can't be reused, and is not saleable at any price. It must be discarded.12. Carrying cost: Is the cost of storing or holding the inventory.13. Transferred in cost: Is the cost incurred in a department before transferring the product to another department.14. Value adding cost: Is the cost of activities that adds a value to the customer and can't be eliminated without reducing the quality or quantity of the output required by the customer.20- Capacity levels in production:1. Ideal capacity (Theoretical): Don't allow for any plant maintenance, holidays or downtime.2. Practical capacity: = theoretical capacity normal holidays.21- Capacity levels in demand:1. Master-budget capacity: Is the expected level of demand for the current budget period.2. Normal capacity: Is the long-term average level of master-budget capacity.22- Costing techniques:1. Absorption Vs. variable costing;a. Absorption costing (inventory costing) treats all manufacturing costs as production costs (required for reporting under GAAP).b. Variable costing considers only variable manufacturing costs as product costs.c. Super variable (throughput) costing considers only material costs as a production costs.Absorption (inventory) costing Sales revenue XXX_ Cost of goods soled (DM+DL+Fix OH+Vari OH) XXX Gross margin XXX_ Period cost XXX Operating income XXXVariable costing Sales revenue XXX_ Cost of goods soled (DM+DL+ Vari OH) XXX Manufacturing Contribution margin XXX_ nonmanufacturing variable costs XXX Contribution margin XXX _ Fixed MOH XXX _ Fixed non MOH XXX Operating income XXX

Horngreen equation: (1) The difference in operating income between absorption and variable costing = Fixed cost per unit X the inventory per unit.(2) The difference in operating income between absorption and variable costing = Fixed manufacturing cost per unit X (beginning inventory ending inventory). (3) Actual Vs. normal costing and budgeted cost:a. Actual costing = Actual DM+ Actual DL+ Actual OH Overhead = Actual rate X Actual allocation baseb. Normal costing = Actual DM+ Actual DL+ Applied OH Applied OH = Budgeted rate X Actual allocation base. Budgeted rate = Budgeted OH Budgeted allocation base. Over-applied O.H.: Applied O.H. > Actual O.H.c. Standard costing Overhead = budgeted rate X standard allocation base(1) If the over-applied overhead balance is immaterial: Dr. Applied O.H. Cr. Cost of good soled Cr. Actual O.H.(2) If the over-applied overhead balance is material:Dr. Applied O.H. Cr. Work-in-process inventory Cr. Finished goods inventory Cr. Cost of goods soled Cr. Actual O. H. Under-applied O.H.: Applied O.H. < Actual O.H.(1) If the under-applied overhead balance is immaterial:Dr. Applied O.H.Dr. Cost of goods soled Cr. Actual O.H.(2) If the under-applied overhead balance is material:Dr. Applied O.H.Dr. Work-in-process inventoryDr. Finished goods inventoryDr. Cost of goods soled Cr. Actual O.H.d. Budgeted cost: is what expected to occur.(4) Cost accumulation:a. Traditional costing:1- Job-order costing: appropriate for customized (heterogeneous) product (single or departmental rate).2- Process costing: appropriate for similar (mass, homogeneous) product (single or departmental rate).3- Operation costing: appropriate for organizations that uses both job-order and process costing (e.g., leather and fabric bags).b. Activity based costing (ABC): every activity has its own cost pool.c. Life-cycle costing (value chain): R&D and design (Upstream cost), manufacturing costs and marketing, distribution and customer service (down-stream cost).(5) Standard costing, flexible budgeting, and variance analysis:a. Standard costing estimates what should be.b. Flexible budgeting is the calculation of the cost that should have been consumed given the achieved level of production.c. Variance analysis is the difference between standard and flexible budget.(6) Cost allocation:a. Allocating joint cost.b. Allocating service departments costs.(7) Target costing: market price of the product taken as a given.

Unit 5Cost accumulation systems Standard cost represents what costs should be. Budgeted cost represents expected actual costs. Product costing is the process of accumulating, classifying and assigning direct material, direct labor and factory overhead costs to products or services. Types of product costing systems:(1) Cost accumulation methods: The nature of the industry forces managers to use job, process or operation costing systems.(2) Cost measurement methods (management decision): actual, normal or standard costing systems.(3) Overhead allocation methods (management decision): traditional (peanut-butter) or activity-based costing system.

1- Process costing accounting: is used to assign costs to inventoriable goods or services, it's applicable for homogenous (mass) products. Process costing accumulates costs by process or department and then assigns them to large number of nearly identical products. Steps in process costing:1. Accounting for all units (physical flow of quantities): important to determine any normal spoilage, ignores the % percentage of completion.1- Account for all units (same for FIFO and weighted average)

Beginning WIP XXX+ Started units this period XXX Total units to account for XXXX

2. Computing equivalent units of production:(1) First in first out (FIFO) costing: Material Conversion Total units completed and transferred XXX XXX_ Beginning WIP (regardless % of completion) XXX XXX Units started and completed this period XXX XXX+ Amount needed to complete BWIP XXX XXX+ Amount completed on EWIP XXX XXX EUP under FIFO XXX XXX

If materials added at the beginning of the processTotal Units Completed XX+ Amount of materials needed to Complete BWIP zero+ Amount of materials added to Date on EWIP 100% _____EUP for Materials XXX

If materials added at the end of the processTotal Units Completed XX+ Amount of materials needed to Complete BWIP 100%+ Amount of materials added to Date on EWIP zero _____EUP for Materials XXX

(2) Weighted average costing: Material Conversion Total units completed and transferred XXX XXX+ Amount added to EWIP XXX XXX EUP under weighted average XXX XXX

3. Compute unit cost:A. Under FIFO(1) DM: Current cost EUP (FIFO) = unit cost(2) Conversion: Current cost EUP (FIFO) = Unit cost(3) Total unit cost under (FIFO) = (1) + (2)B. Under weighted average:(1) DM: BWIP cost + Current manufacturing cost EUP (WA) = Unit cost(2) Conversion: BWIP + Current MC EUP (WA) = Unit cost(3) Total unit cost = (1) + (2) Accounting for spoilage: For costing the finished goods inventory and there are normal spoilage, we add the number of good units to the number of normal spoilage units, then multiplying this number by the unit cost, then dividing the total amount by the number of good units to have the cost of finished goods inventory.2- Operation costing: is mixed from job and process costing.3- Activity-based costing (transaction-based costing): is a cost accounting system based on the activity level as a cost object. Characteristics of ABC:1. ABC applies more focused and detailed approach for gathering costs.2. ABC can be part of job order or process costing systems.3. ABC can be used in manufacturing or service businesses.4. ABC treats production costs as variable.5. The costs driver in ABC is often a non-financial variable.6. ABC may be used for internal and external purposes.4- ABC (volume-base) Vs. traditional (peanut-butter) (non-volume-based) costing:1. Traditional costing involve: Accumulating costs in general ledger accounts. Using a single cost pool to combine the costs from all the related accounts. Selecting a single cost driver to use for the entire indirect cost pool. Allocating the indirect cost pool to final cost object using a single rate or departmental rate. The effect is an averaging of costs that may result in significant inaccuracy when products or service units don't use similar amounts of resources. All overhead costs don't fluctuate with volume.2. Activity-based costing involves: Identifying the organization's activity that constitutes O.H. and defining activity cost pools and activity measures (resource cost driver). Assigning the costs of resources consumed to activity centers. Calculating activity rates by dividing total cost of each activity by its cost driver. Assigning overhead costs to cost object.5- ABC terms: Activity: is a work performed within an organization. Resource: is an economic element used to perform activities. Resource cost driver: is a measure of the amount of resources consumed by an activity. It's used to assign resource cost consumed by an activity to a particular cost pool (percentage of total square feet required to perform an activity). Activity cost driver: measures how much activity used by a cost object. It's used to assign cost pool costs to cost object (machine hours required to produce product). 6- Benefits of ABC costing:1. Helps reduce distortion caused by traditional cost allocation.2. Provides more accurate product cost.3. Provides more accurate measurement of activity-driving costs.4. Provides managers easier access to relevant costs for making business decisions.7- Limitations of ABC:1. Even if activity data are available, for some costs it might be not practical to find a specific activity that caused the incurrence of the cost.2. ABC reports are not GAAP.3. ABC system is time and money consuming.4. ABC usually requires more than a year for successful development and implementation.5. ABC generates vast amount of information. Too much information can mislead managers.

Unit 6Cost allocation techniques1- Four purposes for cost allocation:1. To provide information for economic decisions.2. To motivate managers and employees.3. To justify costs or compute reimbursement.4. To measure income and assets for reporting to external parties.2- Criteria to guide cost allocation decisions:1. Cause an effect (most preferred): Identifies the variables that cause resources to be consumed.2. Benefits received (used when a cause-and-effect relationship can't be determined): Identifies the beneficiaries of the outputs of the cost object. The costs are allocated among the beneficiaries in proportion to the benefits each received.3. Fairness or equity (least preferred): This criterion is often used in government contracts when cost allocation is the base for establishing a price satisfactory to the government and its suppliers.4. Ability to bear (least preferred): This criterion allocates costs to the cost object according to its ability to absorb costs allocated to it. 3- Joint cost allocation: Joint costs are those costs incurred before the split-off point.1. Physical measure at split-off point: weight or volume. Weight or volume of product Y Total weights or volumes of all joint products X joint costs = Amount allocated to joint product Y Advantages:(1) Easy to use.(2) The criterion for the allocation of the joint costs is objective. Limitations:(1) Each product can have its own unique physical measure.(2) Focusing on physical nature of the products can lead to cost distortion of products.2. Sales value at split-off point: values at split-off point. Sales value of product Y Total sales value of all joint products X joint costs = Amount allocated to joint product Y Advantages:(1) Easy to calculate.(2) Costs are allocated according to the individual product's value. Limitations:(1) Market prices for some industries change constantly.(2) Sales price at split-off point might be not available, because additional processing is necessary for sale.3. Net realizable value (NRV): Estimated NRV = Final sales value after adding separable costs Added processing costs (separable costs that incurred after split-off point). Estimated NRV of product Y *Total NRV of all joint products X joint costs = Amount allocated to joint product Y* If one of the two products is not processed further, we will add the NRV of the further processed product to the sales value at split-off point of the other product. Advantages:(1) It produces an allocation that yields an incremental profit among products.(2) Selling price at spilt-off point doesn't have to be available. Limitations:(1) More difficult to calculate than the other two methods.(2) Based on an estimated value. The by-product: when using any method of joint cost allocation, the sales revenue of by-products if inventoried, treated as a reduction of the costs of production of the main product, and the remaining costs are allocated to the main products not to the by-product, and at any way no joint costs are allocated to by-product.4- Inventory costing choices: Absorption (Full) Vs. Variable (Direct) costing:1. Absorption costing (GAAP costing): Advantages:(1) Absorption costing is GAAP.(2) The Internal Revenue Service requires the use of absorption costing in financial reporting. Limitations:(1) The level of inventory affects net income because fixed costs are component of product costs.(2) The net income reported under absorption method is less reliable than under variable method (especially for use in performance evaluation) because the level of inventory affects the net income as it includes fixed costs into its components.2. Variable costing (Direct costing): Variable costing is a management tool used to calculate breakeven point CPV (Cost volume profit analysis). Advantages:(1) Variable costing attains the objective of management control systems as costs are listed separately so that they may be easily traced and controlled by managers.(2) The net income reported under contribution method is more reliable than under absorption method (especially for use in performance evaluation) because the cost of the product doesn't include fixed costs into its component, and therefore the level of inventory doesn't affect net income.(3) The contribution margin yield from variable costing aids in decision making. Limitations:(1) Variable costing is not GAAP.(2) The Internal Revenue Service doesn't allow the use of variable costing in financial reporting.

5- Service cost allocation:1. Direct method: costs of services between service departments are ignored, and all costs are allocated directly to production departments.2. Step-down method: Service department costs are allocated to other service departments and to production departments, starting with service department that provides the greatest amount of services to other departments.3. Reciprocal method: Service department costs are allocated to each other; this will generate new overhead costs for service departments to be allocated to other departments.6- Allocating service department costs to production departments by Dual rate for SBU evaluation: The cost allocation method that separates fixed and variable costs. Variable costs are allocated to production units by multiplying budgeted rate times the actual usage of allocation base, and fixed costs are allocated by multiplying budgeted fixed costs times the capacity demanded. Dual-rate example:Fact Pattern: Longstreet Companys Photocopying Department provides photocopy services for both Departments A and B and has prepared its total budget using the following information for next year: Fixed costs $100,000 Available capacity 4,000,000 pages Budgeted usage Department A 1,200,000 pages Department B 2,400,000 pages Variable cost $0.03 per pageAssume that Longstreet uses the dual-rate cost allocation method, and the allocation basis is budgeted usage for fixed costs and actual usage for variable costs. How much cost would be allocated to Department A during the year if actual usage for Department A is 1,400,000 pages and actual usage for Department B is 2,100,000 pages? A. $42,000 B. $72,000 C. $75,333 D. $82,000Answer (C) is correct. Based on budgeted usage, Department A should be allocated 33 1/3% [1,200,000 pages (1,200,000 pages + 2,400,000 pages)] of fixed costs, or $33,333 ($100,000/3). The variable costs are allocated at $.03 per unit for 1,400,000 pages, or $42,000. The sum of the fixed and variable elements is $75,333. Single rate example:Assume that Longstreet uses the single-rate method of cost allocation and the allocation base is budgeted usage. How much photocopying cost will be allocated to Department B in the budget year? A. $72,000 B. $122,000 C. $132,000 D. $138,667Answer (D) is correct. Department B is budgeted to use 66 2/3% of total production (2,400,000 3,600,000), so it should be allocated fixed costs of $66,667 ($100,000 66 2/3%). The variable cost allocation is $72,000 (2,400,000 pages $.03 per page), and the total allocated is therefore $138,667 ($66,667 + $72,000).Unit 7Operational efficiency and business process performance1- Just-in-time system(JIT) (demand pull): A comprehensive production and inventory system that purchases or produces materials and parts only as needed and just in time to be used at each stage of the production process. Just-in-time production (lean production): A demand-pull manufacturing system that produces each component of a production line as soon as and only when needed by the next step in the production line. Just-in-time purchasing: the purchase of goods or materials so that they are delivered just as needed for production. JIT (demand pull) systems vs. traditional (demand push) systems: Lot sizes based on immediate need are typical of just-in-time systems, while lot sizes based on formulas are characteristics of traditional inventory management systems. Benefits:1. Reduces carrying costs and non-value adding activities.2. Increases inventory turnover (cost of goods sold average inventory).3. Decreases setup costs.4. Lower investments on space.5. Greater emphasis on improving quality. Limitations:1. Increases stock-out costs.2. Not appropriate for high-mix manufacturing environments. JIT system depends on reliable suppliers which can ensure on-time deliveries of high quality goods for just-in-time use. Wok cells: describes multi-skilled workers that can do multi-tasks. The employee in work cells in a strong need to have a strong training.2- Enterprise resources planning (ERP)(Demand Push): A material requirement planning (MRP) is an approach that uses computer software to help manage a manufacturing process. MRP system translates the finished goods when entered to the system into row materials needed and the time required to deliver it. Benefits of MRP systems:1. Less coordination required between functional areas.2. Lower setup time.3. Lower inventory carrying cost.4. Reduces idle time.5. Better manufacturing process control. Limitations: Potential inventory accumulation. Workstations may receive parts that they are not ready to process. MRP basic goals is: Right part, right time, and right quantity.3- Manufacturing resource planning (MRP II): MRP II system translates the finished goods when entered to the system into row materials needed and time required to deliver it and cash flows.4- Enterprise resource planning (ERP):a. ERP is a software program that is used to plan and keep records of resources, including1. Finances,2. Labor capabilities and capacity,3. Materials, and4. Property. b. MRP is a common function contained in ERP.1. Although ERP and MRP are similar, they are not interchangeable since ERP includes functions not included in MRP.2. An ERP system would allow a company to determine what hiring decisions might need to be made or whether a company should invest in new capital assets.a) A company that only need to maintain inventory and materials levels would only need to implement a MRP system.c. Operational benefits of ERP:1) Reducing operational costs through improved communication across departments.2) Facilitating inventory management.3) Facilitating day-to-day operations through real-time information.5- Outsourcing: Is a process of purchasing goods or services from outside rather than producing it within the organization. Benefits:1. Can be cheaper.2. Having a reliable service, reduced cost.3. Can improve efficiency and effectiveness by gaining outside expertise. Limitations:1. Can result in a loss of in-house expertise and capabilities.2. Can reduce process control.3. May reduce control over quality.4. It depends on outside parties.6- Theory of constraints (TOC) and throughput costing: Throughput margin = Sales revenue DM cost material handling cost. Inventory = (Material costs in direct material, work-in-process, and finished goods inventories) + (R&D costs) + (costs of equipment and buildings). Operating expenses = All costs of operations, not including direct materials. The basic principle of TOC is to maximize the throughput contribution margin through the constraint. Definition: It describes methods to maximize operating income when faced with some bottleneck and some non-bottleneck operations. It's a means of making decisions for a company to be competitive when it needs to be able to respond quickly to customer orders. Theory of constraint is an important way for a company to speed up its manufacturing time so it can improve its customer response time and its profitability. Manufacturing cycle time (manufacturing lead time) (throughput time):It's the amount of time between receiving customer's order and the shipment of the order. Drum-buffer-rope system: Is a TOC system that balancing the flow of production through the constraint so reducing the amount of inventory at the constraint and improving overall productivity. The drum is the constraint, the buffer is the minimum amount of work-in-process input needed to keep the drum busy, and the rope is the sequence of processing and including the constraint. The steps in TOC analysis:1. Identifying the constraint.2. Determine the most profitable product mix given the constraint.3. Maximize the flow through the constraint.4. Increase the capacity at the constraint.5. Redesign the manufacturing process for greater flexibility and speed.7- Capacity management:1. Capacity planning:a. Capacity planning is an element of strategic planning that is closely related to capital budgeting.8- Value-chain analysis: Is a strategic analysis tool used to identify the value added activities to be increased and non-value added activities to be decreased.1. Upstream activities (research & development, design).2. Manufacturing activities.3. Downstream activities (marketing and distribution, customer service). Value adding cost: is the cost of activities that adds value to the customer (material and labor for regular repairs). Non-value adding cost: is the cost of activities that don't add value to the customer (rework and warehousing costs), and can be eliminated without affecting the end products.9- Value-chain analysis:1. The value chain: R&D, design, production, marketing, distribution, and customer service.2. Value chain analysis: is a strategic tool that allows the firm to focus on the activities that add value and reduce cost.1) The first step in the value chain analysis is to identify the firms value-creating activities.2) The second step is to determine how each value-creating activity can produce competitive advantage for the firm.3. The supply chain (the supplier, the firm, and the customer): describes the flow of goods, services and information from their original sources of materials and services to the delivery of products to customers, regardless of whether those activities occur in the same organization or in other organizations. It usually encompasses more than one firm.1) Supply chain management: refers to the coordination of business processes across companies to better serve end customer.2) Customers want companies to use the value chain and supply chain to deliver products that are: Lower cost with increased efficiency. High level of quality. Constant innovation. Supply chain analysis should extend to all parties in the chain.3) Goals of supply chain management:1. Maximizing customer value.2. Achieving sustainable competitive advantages.4) Supply chain activities involves: Product development. Sourcing. Production. Logistics. Information system needed to coordinate these activities.5) Benefits of effective supply chain management:1. Generally improve performance and reduce costs.2. Reduces stock-out costs and carrying costs.6) Issues and problems in supply chain management:1. Communication problems between companies.2. Trust issues.3. Incompatible information system.4. Required increases in personnel resources and financial resources. 10- Activity based management (ABM): Is the management decisions and activity analysis that use activity-based costing information to satisfy customers and improve operational control, management control and profitability. ABM applications can be classified into two categories:1. Operational ABM: Enhances operation efficiency and asset utilization and lowers costs. Its focuses are on doing things right and performing activities more efficiently. Operational ABM applications use management techniques such as activity management, business process reengineering, total quality management, and performance measurement.2. Strategic ABM: Its focuses are on choosing appropriate activities for the operation, eliminating nonessential activities and selecting the most profitable customers. Strategic ABM applications use management techniques such as process design, customer profitability analysis, and value chain analysis. Advantages of ABM:1. Uses continuous improvement to maintain the firm's competitive advantages.2. Eliminates non-value-added activities.3. Works well with just-in-time processes.4. Allocates more resources to activities, products that add value. Disadvantages of ABM:1. Not used to external financial reporting.2. Implementing ABC/ABM is expensive and time-consuming.3. Changing to ABC/ABM will result in different pricing, process design, manufacturing technology, and product design decision.11- Process analysis and business process reengineering: Reengineering: Is the process innovation and core process design. Instead of improving existing products. Business process reengineering (BPR) involves changes that are:1. Fundamental.2. Radical.3. Dramatic.12- Benchmarking: Is the continuous, systematic process of measuring products, services, and practices against the best level of performance. Thus helping the organization to be competitive.13- Best practice analysis: Refers to the collective steps in a gap analysis. A gap analysis is the space between what is and what an organization hopes to be.14- Cost of quality analysis (COQ): Refers to the costs incurred to prevent, or arising as a result of producing low-quality product.a. Conformance costs: Preventive costs and appraisal costs.b. Non conformance costs: Internal failure costs and external failure (lost opportunities) costs.

15- Efficient accounting processes: benefits of improving accounting processes that it increases companys ability to minimize the costs of these processes and maximize the efficiency.1. Areas for improvement:1) Accounts payable.2) Cash cycle.3) Closing and reconciliation processes.4) Data analysis.2. Techniques for creating future vision for finance function.1) Benchmarking.2) Current use assessment (customer-centered approach).3. Steps needed to improve accounting processes:1) Process walk-throughs (understanding current process).a. Benefits of process walk-throughs:1. Identifying waste and over-capacity (duplication of effort, tasks done are not necessary, output not being done).2. Identify the root cause of errors.2) Process design: to cover every aspect of the internal users need.3) Risk-benefit evaluation: The greater the changes being made, the less the firm can be sure of a successful outcome. If the risks are determined to be too great, a return to the process design step may be necessary.4) Planning and implementing the redesign (top-down implementation):5) Process training:4. Reducing the accounting close cycle: soft closes can be used for month-end closes, and more detailed closing for quarter-end and year-end closes. To speed up the closing:1) A standardized chart of account should be used across all company locations.2) Bank reconciliation can be done daily.3) Depreciation can be calculated a few days before the closing.4) Standardized accounting procedures.5. Centralization of accounting as a shared service: Benefits of shared service:1) Utilizing a smaller number of highly trained people.2) The result is usually fewer errors.3) Greater efficiency can be generated by assigning tasks to a smaller number of managers.4) Accounting errors can be searched more easily.

Unit 10Cost and variance measures Performance evaluation is the process by which managers at all levels gain information about the performance of tasks within the firm and judges that performance against pre-established criteria as set out in budgets, plans, and goals. Operational control (management-by-exception approach): means the evaluation of operating level employees by middle-level managers. Operational control Focuses on detailed short-term performance measures. Has a management-by-exception approach that is identifies units or individuals whose performance does not comply with expectations so that the problem can be promptly corrected. The use of standards: To set performance expectations. To evaluate and control operations. To motivate employees. To manage by exception. The use of variances: Variance analysis enables management by exception. Variance analysis assigns responsibilities. Variance will guide managers to seek explanations and take early corrective action. Sometimes variances suggest a change in strategy. Variances may signify that standards need to be reevaluated. Effectiveness and efficiency: An operation is effective if it attained or exceeded its goals (can be measured by the sales volume variance). An operation is efficient if it has not wasted resources (can be measured by the flexible budget variance). We can assess the effectiveness of a company by comparing the actual results with its master budget. To be able to calculate variances we need to calculate 3 columns.1- Actual amount column = actual price/cost X actual output.2- Static/master-budget = budgeted price/cost X budgeted output.3- Flexible budget = budgeted price/cost X actual output.

1- Static-budget variance (operating income variance) = Actual result static-budget amount. A flexible budget will help in evaluating efficiency: the flexible budget calculates budgeted revenues and budgeted costs based on actual output level in the budgeted period.2- We can calculate flexible budget depending on budgeted selling price, budgeted variable OH and budgeted fixed OH multiplied by actual output.3- Flexible budget variance = actual amounts flexible budget. (Measures the efficiency of resources).4- Sales volume variance = flexible budget static budget. (Inaccurate forecasting of output units sold) (As the only different is in the amount of sales volume).5- Static budget variance = flexible budget variance + sales volume variance (the difference due to the performance of the company)6- Sales volume variance for operating income = budgeted contribution margin per unit X (actual units sold budgeted units to be sold). The three elements causes the flexible budget variance is:1. Selling price variance.2. Variable cost variance (DM, DL, and variable O.H.3. Fixed cost variance7- Selling price variance = (actual selling price budgeted selling price) X Actual units sold. Direct costs variance (DM & DL): we can investigate the favorable/unfavorable variance in DM or DL by calculating the price variance (the difference between actual and budgeted input price costs), and efficiency variance (the difference between the actual and budgeted input quantity).8- Price variance (input-price variance) (rate variance) = (Actual price standard price) X Actual quantity of input.9- Efficiency variance (usage variance) = (actual quantity of input budgeted quantity of input that should have been used to produce the actual output){standard material X actual output} X standard price.

Variable and fixed manufacturing overhead variance. To be able to calculate variances we need to calculate 4 columns.1- Actual amount = actual per unit cost X actual allocation base.2- Budget according to normal costing = budgeted rate X actual allocation base.3- Flexible budget = standard per unit cost X actual output X budgeted rate.4- Applied O.H. according standard costing = standard per unit cost X actual output X budgeted rate.

10- Variable manufacturing overhead variance:1. Calculating allocated (applied) V. M.O.H. according to standard costing. Applied O.H. = budgeted V.O.H. rate X standard allocation base for actual output. Standard allocation base for actual output = budgeted (standard) per unit rate X actual output. When comparing allocated input allowed for actual output according to standard costing (4) with flexible budget (3), there will be never variance because they are the same.2. Calculating V.M.O.H. variance (variable O.H. flexible budget variance) = actual amount flexible budget amount (applied O.H.).3. Efficiency variance = (actual quantity of allocation base budgeted quantity for actual output) X budgeted O.H. rate.4. Spending variance = (actual rate per unit budgeted rate per unit) X actual allocation base. Under/over applied V.O.H. = flexible budget variance = efficiency variance + spending variance. If O.H. is applied based on amount of the allocation base used for the actual units of output rather than standard amount allowed, there will be no variable O.H. efficiency variance.11- Fixed manufacturing overhead variance:1. Calculating allocated (applied) fixed M.O.H. according standard costing. Applied O.H. = budgeted F.O.H. rate X standard allocation base for actual output. Standard allocation base for actual output = budgeted (std.) per unit allocation base X actual output.2. Calculating F.M.O.H. variance = actual amount applied O.H. Flexible budget (F.M.O.H. in the flexible budget is the same budgeted F.M.O.H.).3. Calculating production volume variance (denominator-level variance) = budgeted O.H. applied O.H. (Uncontrollable).4. Calculating spending (budget) variance = actual F.O.H. flexible (budgeted) F.O.H. Under/over applied F.O.H = production volume variance When comparing between budgeted amount and flexible budget there will be no variance because flexible budget with respect to F.M.O.H. depends on budgeted amount. Efficiency variance for materials or labor can be divided into mix variance and yield variance.12- Two-way analysis (volume and controllable): Overhead variance = (Budgeted V.O.H. rate X Standard allocation base allowed for actual output) + budgeted F.O.H Actual total O.H.13- Three-way analysis (spending, efficiency, and volume): Spending variance = (Budgeted V.O.H. rate X actual allocation base) + budgeted F.O.H Actual total O.H.14- Sales volume, mix, and quantity variances:1. Sales volume variance = sales mix variance + sales quantity variance.2. Sales volume variance = Budgeted contribution margin per unit X (actual units sold budgeted units to be sold).3. Sales mix variance = (actual sales mix ratio for a product budgeted sales mix ratio for a product) X actual units sold for the two products X budgeted contribution margin per unit for a product.4. Mix ratio for actual input = sum of (actual quantity X standard price total actual quantity.5. Mix ratio for budgeted input = sum of (standard quantity X standard price) total standard quantity.15- Yield variance = (total standard quantity total actual quantity) X budgeted sales ratio.16- Partial and total factor productivity:1. Total productivity = total output total input.2. Partial productivity for materials = total output total material costs.3. Partial productivity for labor = total output total labor costs.

Unit 11Responsibility accounting and performance measuresCMA EXAM: The performance measurement portions focus on a few performance measures, specifically Return on Investment (ROI) and Residual Income (Rl). For these measurements you need to know what they are, how they are calculated and how they are used. You also need to be able to identify the weaknesses that are inherent in each one. Responsibility accounting is the breaking down of costs into those costs that can be controlled by the manager and those that cannot be controlled by the manager. There are a number of different cost classifications and allocation methods within this section that you need to be aware of. Transfer pricing is a topic that you need to know from both a theoretical standpoint and a numerical one as well. The questions may require you to understand the issues that company faces in establishing the transfer price as well as being able to calculate an acceptable transfer price under certain situations. The final topic covered in this Section is performance feedback, and more specifically the balanced scorecard, you need to know conceptually what the balanced scorecard is and how it works as well as be familiar with Its application.

The objective of this unit is (management control) which provide variety of tools that top managers (such as CFOs) use to evaluate middle-level managers (such as plant managers, product-line managers, heads of (R&D) departments, and regional sales managers) and the organization as a whole. The mid-level managers have a significant responsibility in helping the organization achieve its strategic goals. Management control: refers to the evaluation by upper-level managers to the performance of mid-level managers. Management control: Focuses on higher level managers and long-term, strategic issue. Is more consistent with management-by-objectives. The objectives of management control:1. Motivate managers to exert more effort to achieve the organization's goals.2. Promotes goal congruence among the organization.3. Determine fairly the rewards earned by manager's effort and skills and the effectiveness of their decisions. Management control issues: Responsibility centers (strategic business units). Contribution and segment reporting. Common costs. Transfer pricing. Performance measures & financial measures (ROI, RI and EVA). The balanced scorecard.1- Responsibility centers (strategic business units) (SBUs): consists of a well-defined set of controllable operating activities over which the SBU manager is responsible Responsibility accounting: is a system measures the plans-by-budgets and actions-by-actual results of each responsibility center. Types of responsibility centers:1. Cost center: the manager is accountable for costs only. Cost SBU: is the production or support SBUs within the firm that have the goal of providing the best quality product or service at the lowest cost. (E.g. maintenance department.) Strategic issues related to implementing cost SBUs: Cost shifting. Excessively focusing on short-term objectives. The criteria to choose the cost allocation method, are the same objectives for management control: To motivate managers to exert more effort. To promote goal congruence. To provide a bases for fairly evaluation for managers performance. Responsibility and controllability: Controllability: is the degree of influence that a specific manager has over costs, revenues and related items for which he/she is responsible for. Controllable cost: is any cost that primarily subjected to the influence of a given responsibility center manager for a given period. In practice, controllability is difficult to pinpoint for two reasons:1. Few costs are under the sole influence of one manager.2. With a long enough time, all costs will come under deferent manager's control. A current manager may be affected by the previous manager's decisions.2. Revenue center: the manager is accountable for revenues only. Revenue SBU: is SBU that responsible for sales, defined either by product line or geographical area.3. Profit center: the manager is accountable for revenues and costs. Profit SBU: is the SBU that generates revenues and incurs the major portion of the costs for producing these revenues. Strategic role of profit SBUs: Three strategic issues cause firms to choose profit SBUs rather than cost or revenue SBUs:1. It provides incentive for desired coordination among the marketing, production, and support functions. (The handling of rush orders is a good example).2. It motivates managers to consider their product as marketable to outside customers.3. It motivates managers to develop new ways to make profit from their products and services.4. Investment center: the manager is accountable for investments, revenues and costs. Investment SBU: is the SBU that includes assets employed by the SBU as well as profits in performance evaluation. (Is most like an independent business). Products that have little need to coordination between manufacturing and selling functions are good candidates for cost centers (e.g. food and paper products). Products that need close coordination between manufacturing and selling functions are good candidates for profit centers (e.g. high-fashion products). Firms that have many profit SBUs because of its many different product lines; its preferred approach is to use investment SBUs.2- The contribution income statement for performance evaluation purposes: Gross margin = sales revenue variable M. costs fixed M. costs. Manufacturing contribution margin = sales revenue variable M. costs. Contribution margin = sales revenue variable M. costs variable selling& administration expenses. A segment is a product line, geographical area, or any meaningful subunit of the organization. Segment margin = contribution margin fixed costs (controllable & non-controllable. Segment operating income = segment margin allocated common costs. Economic performance = Revenue all costs except fixed manufacturing costs allocated to the segment.3- Common costs: are the indirect joint costs that allocated to operating units in some logical way. Two specific approaches in common cost allocation:1. Stand-alone method: the costs are allocated according to the percentage.2. Incremental method: the primary party receives the stand-alone costs and the second party receives the balance of the common costs.4- Financial measures:1. Product profitability analysis allows management to determine whether a product is providing any coverage of fixed costs.2. Business unit profitability analysis performs the same function on the segment level.3. Customer profitability analysis enables a firm to make decisions about whether to continue servicing a given customer.5- Performance measures: Types of performance measures:A) Financial measures:1) Internal financial measures (such as operating income).2) External financial measures (such as stock price).B) Non-financial measures:1) Internal non-financial measures based on internal non-financial information (such as defect rates and manufacturing lead time).2) External non-financial measures based on external non-financial information (such as customer satisfaction ratings and market share). Return on investment (ROI), accounting rate of return, or accrual accounting rate of return: ROI = Income (profit) investment = (income revenue) X (revenue investment). Or ROI = return on sales (ROS) (profit margin) X investment turnover. Or ROI = [(revenue cost) / revenue] X revenue / investment. ROS: Tells how much of each revenue dollar becomes income; the goal is to get higher income per revenue dollar. ROS: measures the manager's ability to control expenses and increase revenues to improve profitability. Investment turnover: Tells who many revenue dollars are generated by each dollar of investment, the goal is to make each investment dollar work harder to generate more revenues. In investment SBUs managers can increase ROI in basically 3 ways:1. Increase sales.2. Reduce expenses.3. Reduce assets. Residual income (RI) = Income (required rate of return X investment). Required rate of return is the imputed cost of the investment. Goal congruence is more likely to be achieved by using RI rather than ROI as a measure of the subunit manager's performance. Advantages and Limitations of ROI and Residual IncomeROIEasily understood Comparable to interestrates and to rates of returns on alternative investments Widely used Disincentive for high ROI units to invest in projects with ROI higher than the minimum rate of return but lower than the unit's current ROI.

RI Supports incentive to accept all projects with ROI above the minimumrate of return Can use the minimum rate of return to adjust for differences in risk Can use a different minimum rate of return for different types of assets

Favors large units when the minimum rate of return is low Not as intuitive as ROI Can be difficult to obtain a minimum rate of return

Both ROI and RI Congruent with top management goals for return on assets Comprehensive financial measure. Includes all elements important to topmanagement revenues,costs, and investment Comparability ,expands top management's span of control by allowingcomparison of businessunits Can mislead strategic decision making, not as comprehensive as the balanced scorecard, which includes customer satisfaction, internal processes and learning as well as financial measures, the balanced scorecard is linked directly to strategy. Measurement issues.Variations in the measurement of inventory and long-lived assets and in the treatment of nonrecurring items, income taxes. Foreign exchange effects, and the use/cost of shared assets Short-term focus;investments with long-term benefits might be neglected

Economic value added (EVA): is a more specific version of residual income. Economic value added (EVA) = after tax operating income [weighted average cost of capital (WACC) X (total assets current liabilities)]. When a company's EVA is positive then it has added to shareholders value.6- Transfer pricing: is the price of the product transferred from one subunit (department or division) to another unit in the organization or to the outside customer. Motivation and performance evaluation: The transfer price creates revenue for the selling subunit and purchase cost to the buying subunit affecting each subunit's operating income. This operating income can be used to evaluate subunit performance and to motivate their managers. Intermediate product: is the product or service transferred between subunits of an organization. Objectives of transfer pricing:1. Motivate subunit's managers to exert a high level of effort.2. Goal congruence.3. Reward managers fairly. Transferred pricing methods:1. Market-based transfer prices (the price of a similar product).2. Cost of production plus opportunity cost.3. Full absorption cost (there is no motivation to the seller to minimize costs).4. Variable cost (should be used only when the selling division has excess capacity).5. Negotiated transfer prices. Dual pricing: For example the seller could record the transferred product at the market price. However, the buyer could record the purchases at the variable price. Choosing the right transfer-pricing method: (exhibit 19.10 page 26) A general guideline (formula) for transfer pricing situations: Minimum transfer price when working at full capacity = incremental cost per unit incurred up to the point of transfer + opportunity cost per unit to the selling subunit. 7- Balanced scorecard: is a single report includes financial and non-financial performance measures for subunits. Organizations can translate its strategy into a set of performance measures by developing a balance scorecard. Balance scorecard measures performance from four perspectives.1. Financial.2. Customer satisfaction.3. Internal business process.4. Learning and growth. The balance scorecard is an accounting report that connects the firm's key performance indicators to measurement of its performance. Key performance indicators (KPIs): are specific measurable financial and non-financial factors that are critical to the success of the organization. Balance scorecard should include lagging indicators (such as output and financial measures) and leading indicator (such as many types of non-financial measures).

Unit 12Internal control Important introduction: The shareholders make the election of the board of directors, which establishes the overall policies. The board of directors makes the selection (appointment) of the officers (management). The management responsibility is to run day-to-day operations and reporting the financial statements. The traditional rule to the external independent auditor is to express his opinion about the fairness of the financial statements according to GAAP, and to address this report to the board of directors or the shareholders. The internal auditor department rule is to audit the management performance, financial and non-financial, and address his report to the board of directors. The audit committee is a sub-committee from the board of directors, and its responsibility is the appointment of the internal and external auditors, review internal and external auditor's reports. IMA definition of internal control (IC): The whole system of control (financial and otherwise) established by management to:1. Carry on the business of the organization in a regular and efficient manner.2. Ensure adherence to management policies, and safeguard the assets.3. Ensure as far as possible the completeness and accuracy of the records. Benefits of strong internal control system:1. Lower external control cost.2. Better control over the assets.3. Reliable information for use in decision making. A company with weak internal control system putting itself at risk for employee theft, loss of control over the information relating to operations, and other inefficiencies in operation and decision-making that can damage business. As a process, internal control is a means to an end, not an end in itself. Internal control can provide a reasonable assurance not a guarantee. The concept of internal control is based on two promises:1. Responsibility: Management and the board of directors are responsible for establishing and maintaining the internal control process. External and internal auditors are responsible for internal control process, but the final and ultimate responsibility for the control remains with management and the board of directors.2. Reasonable assurance: Management shouldn't spend more on control than the benefits received. Management must exercise its judgment to attain reasonable assurance that its control objectives are being met. Objectives of internal control according to (COSO model): (COSO) defines IC framework in the following categories (FOCS):1. Effectiveness and efficiency of operations.2. Reliability and integrity of financial reporting.3. Compliance with lows, regulation, and contracts.4. Safeguarding assets. The effective internal control reduces the need of management to review exception report on day to day basis. Major component of internal control according to COSO model(CRIME):(1) Control Environment.(2) Risk assessment.(3) Control procedures.(4) Information and communication.(5) Monitoring.1- Control environment (the tone at the top): establishes the foundation for an internal control system by providing discipline and structure. It encompasses the attitude of the board of directors and upper management regarding the significance of control. Environment control components (IC HAMBO):(1) I - Integrity and ethical values.(2) C - Commitment to competence.(3) H - Human resource policies and practices.(4) A - Assignment of authority and responsibility.(5) M - Managements philosophy and operating style.(6) B - Board of directors or audit committee participation.(7) O - Organizational structure.1. Integrity and ethical values: Integrity and ethical values are essential because they affect all aspects of control. Management creates an atmosphere leads to better risk management by:A) Removing incentives for dishonest, illegal, or unethical behaviors.B) Setting an example in its own behavior.C) Communicate entity values and behavioral standard by means of codes of conduct. The following would increase material misstatement. Excessive interest in increasing stock price, unduly aggressive forecast, interesting in minimizing profit for tax purpose, and the decision dominated by one individual or small group.2. Commitment to competence: Competence consists of knowledge and ability necessary by members of the organization to complete tasks. In the final analysis, it's the quality and competence of the employees that ensure the ability to carry out the control process.3. Human resource policies and practices: This component concern, among other things, hiring, training, evaluating, promoting, and compensating employees. Personnel are the key component of any control system, so supervision is necessary to ensure that duties are being carried out as assigned. Supervision becomes very important in small firms, or where segregation of duties is not possible. Job rotation and forced vacation allow employees to check the operations of other employees by performing their duties for a period of time.4. Assignment of authority and responsibility: This component of control environment pertains to the authority and responsibility of the operations as well as to determination of reporting relationships and authorization of transactions.5. Management's philosophy and operating style: Management philosophy and operating style represents the attitude toward business risk in every action in areas such as financial reporting, accounting estimates, and the selection of accounting principles. Effective control in an organization begins with and ultimately rests with management philosophy.6. Board of directors and audit committee participation: The board of directors consists of inside (officers and employees) and outside members (nonemployees who held the company's stock).1) The board is the governing authority of the corporation and is responsible for establishing overall corporate policy. Day-to-day operations are delegated to management.2) The directors have a fiduciary duty to the organization and its shareholders. They must exercise reasonable care in the performance of their duties.3) Director will not be responsible for honest error of judgment or act in good faith.4) Directors typically:b. Select and remove officers and set the compensation of officers.c. Determine the capital structure.d. Add, amend, and repeal bylaws.e. Initiate fundamental changes, such as mergers.f. Declare dividends. The audit committee is a subcommittee made up of outside directors (not employee) who are independent of management. Its purpose is to keep external and internal auditors independent of management. The effectiveness of audit committee may be limited by the close persona