Introduction to Accounting

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# Introduction to Accounting - PowerPoint PPT Presentation

Introduction to Accounting. FINAL EXAM REVIEW Chapters 10,11,12, 13, 14, & 15. Standard Cost Card – Variable Production Cost. A standard cost card for one unit of product might look like this:. Standards vs. Budgets. A standard is the expected cost for one unit.

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Introduction to Accounting

FINAL EXAM REVIEW

Chapters 10,11,12, 13, 14, & 15

A&MIS 212

Standard Cost Card – Variable Production Cost

A standard cost card for one unit of product might look like this:

A&MIS 212

Standards vs. Budgets
• Astandardis the expected cost for one unit.
• A budgetis the expected cost for all units.

Are standards the same as budgets?

A&MIS 212

A General Model of Variances

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price

Price Variance

Quantity Variance

Standard price is the amount that should have been paid for the resources acquired.

A&MIS 212

A General Model of Variances

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price

Price Variance

Quantity Variance

Standard quantity is the quantity allowed for the actual good output.

A&MIS 212

A General Model of Variances

Actual Quantity Actual Quantity Standard Quantity × × × actual price standard price standard price

Price Variance

Quantity Variance

AQP(ap - sp) sp(AQU - SQ)

AQP = Actual Quantitysp= Standard Priceap= Actual PriceSQ = Standard Quantity

A&MIS 212

ZippyMaterial Variances Example

Hanson Inc. has the following direct material standard to manufacture one Zippy:

1.5 pounds per Zippy at \$4.00 per pound

Last week 1,700 pounds of material were purchased for \$3.90 per pound, at total cost of \$6,630, and used to make 1,000 Zippies.

A&MIS 212

Material Price Variance
• Based on purchases:

AQP(ap - sp)

= 1,700 lbs.  (\$3.90 - \$4.00)

= - \$170 Favorable

• Based on usage:

AQU(ap - sp)

= 1,700 lbs.  (\$3.90 - \$4.00)

= - \$170 Favorable

A&MIS 212

Material Quantity Variance

Standard quantity = output  sq per unit

= 1,000 units  1.5 lbs./unit

= 1,500 lbs.

Quantity variance = (AQ – SQ)  sp

= (1,700 -1,500 lbs.)  \$4

= \$800 Unfavorable

A&MIS 212

ZippyMaterial Variances Summary

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price

1,700 lbs. 1,700 lbs. 1,500 lbs. × × × \$3.90 per lb. \$4.00 per lb. \$4.00 per lb.

=\$6,630 = \$ 6,800 = \$6,000

Price variance\$170 favorable

Quantity variance\$800 unfavorable

A&MIS 212

Material Variances
• The price variance is computed on the entire quantity purchased.
• The quantity variance is computed only on the quantity used.

Hanson purchased and used 1,700 pounds. How are the variances computed if the amount purchaseddiffers from the amount used?

A&MIS 212

ZippyMaterial Variances Continued

Hanson Inc. has the following material standard to manufacture one Zippy:

1.5 pounds per Zippy at \$4.00 per pound

Last week 2,800 pounds of material were purchased at a total cost of \$10,920, and 1,700 pounds were used to make 1,000 Zippies. Compute the price variance.

A&MIS 212

Zippy

Actual Quantity Actual Quantity Purchased Purchased × × Actual Price Standard Price

2,800 lbs. 2,800 lbs. × × \$3.90 per lb. \$4.00 per lb.

= \$10,920 = \$11,200

Price variance increases because quantity purchased increases.

Price variance\$280 favorable

Material Variances Continued

A&MIS 212

ZippyMaterial Variances Continued

Actual Quantity Used Standard Quantity × × Standard Price Standard Price

1,700 lbs. 1,500 lbs. × × \$4.00 per lb. \$4.00 per lb.

= \$6,800 = \$6,000

Quantity variance is unchanged because actual and standard quantities are unchanged.

Quantity variance\$800 unfavorable

A&MIS 212

ZippyLabor Variances Example

Hanson Inc. has the following direct labor standard to manufacture one Zippy:

1.5 standard hours per finished Zippy at \$6.00 per direct labor hour

Last week 1,550 direct labor hours were worked at an average cost of \$6.20 per hour, for a total labor cost of \$9,610, to make 1,000 Zippies.

A&MIS 212

ZippyLabor Rate Variance

Based on labor usage:

AQ  (ar - sr)

= 1,550 hrs.(\$6.20 - \$6.00)

= \$310 Unfavorable

A&MIS 212

ZippyLabor Quantity Variance

Standard quantity = output  sq per unit

= 1,000 units  1.5 hrs./unit

= 1,500 hrs.

Quantity variance = (AQ – SQ)  sp

= (1,550 -1,500 hrs.)  \$6

= \$300 Unfavorable

A&MIS 212

ZippyLabor Variances Summary

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate

1,550 hours 1,550 hours 1,500 hours × × × \$6.20 per hour \$6.00 per hour \$6.00 per hour

= \$9,610 = \$9,300 = \$9,000

Rate variance\$310 unfavorable

Efficiency variance\$300 unfavorable

A&MIS 212

Labor Efficiency Variance –A Closer Look

Poorlytrainedworkers

Poorqualitymaterials

UnfavorableEfficiencyVariance

Poorsupervisionof workers

Poorlymaintainedequipment

A&MIS 212

Hanson Inc. has the following variable manufacturing overhead standard tomanufacture one Zippy

1.5 standard hours per Zippy at \$3.00 per direct labor hour

Last week 1,550 hours were worked to make 1,000 Zippies, and \$5,115 was spent forvariable manufacturing overhead.

A&MIS 212

ZippyVOH Spending Variance

Based on labor usage:

AQ  (ar - sr)

= 1,550 hrs.  (\$3.30 - \$3.00)

= \$465 Unfavorable

A&MIS 212

ZippyVariable Efficiency Variance

Standard quantity = output  sq per unit

= 1,000 units  1.5 hrs./unit

= 1,500 hrs.

Efficiency variance = (AQ – SQ)  sp

= (1,550 -1,500 hrs.)  \$3

= \$150 Unfavorable

A&MIS 212

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate

1,550 hours 1,550 hours 1,500 hours × × × \$3.30 per hour \$3.00 per hour \$3.00 per hour

= \$5,115 = \$4,650 = \$4,500

Spending variance\$465 unfavorable

Efficiency variance\$150 unfavorable

A&MIS 212

Suppose budgeted fixed overhead associated with the production of Zippys is \$9,000 and the budgeted labor hours at standard total 1,800 hours per period. The standard fixed overhead cost per unit is determined as follows:

POR = \$9,000/1,800 standard hours (DQ)

= \$5 per standard labor hour

A&MIS 212

Unit FOH Standard

The standard fixed overhead cost per unit is computed as

= sq  POR

= 1.5 hours  \$5 per standard hour

= \$7.50 per complete unit

A&MIS 212

Assume the fixed overhead cost incurred (actual) was \$9,350.

= Actual – Budgeted fixed overhead

= \$9,350 - \$9,000

= \$350, Unfavorable

A&MIS 212

= Budgeted FOH – Applied FOH

= \$9,000 – 1,000 units @ \$7.50

= \$9,000 - \$7,500

= \$1,500, Unfavorable

A&MIS 212

Volume Variance Check

What was the production level used to find the denominator quantity (DQ)?

1,800 standard hours/1.5 hours per unit

= 1,200 units

Volume variance in unit = 1,000 – 1,200 U

Volume variance in \$ = 200 units @ \$7.50

= \$1,500, Unfavorable

A&MIS 212

ZippyPer Unit Standard Cost

Direct material (1.5 lbs. @ \$5) \$ 7.50

Direct labor (1.5 hrs. @ \$6) 9.00

Variable overhead (1.5 hrs. @ \$3) 4.50

Fixed overhead (1.5 hrs. @ \$5) 7.50 Total standard cost per unit \$28.50

A&MIS 212

Chapter 12 Topics
• Segment margin
• Report format
• Omission of costs
• Treatment of traceable costs
• Treatment of common costs
• Telescoping of segments

A&MIS 212

E12-2

A&MIS 212

E12-2

A&MIS 212

Chapter 12 Topics
• Return on investment
• ROI = Net income from operations

Average Operating Assets

• ROI = Margin  Turnover
• ROI = NIO/Sales  Sales/Avg. Op. Assets

A&MIS 212

Chapter 12 Topics
• Residual income
• RI = NIO – (Cost of Capital  Average Operating Assets
• Instead of the cost of capital, a problem might refer to the rate of return required by management, or the minimum rate of return expected

A&MIS 212

Example

Sales \$25,000,000

Net operating income \$ 3,000,000

Average operating assets \$10,000,000

A&MIS 212

Example

ROI = \$3,000,000/\$10,000,000

= 30%

Or

Margin = \$3M/\$25M = 12%

Turnover = \$25M/\$10M = 2.5

ROI = 12%  2.5 = 30%

A&MIS 212

Example
• Residual income

= \$3M – 20%  \$10M

= \$3M - \$2M

= \$1M

A&MIS 212

Points Regarding ROI & RI
• Both utilize average operating assets as their measures of investment
• Both would exclude non-operating items from consideration because the purpose is to monitor operations.

A&MIS 212

• The discussion of ROI in chapter 12 is in the context or evaluations the accounting return on investment earned by an entity (division or investment center), not a project being evaluated. In chapters 13, 14, and 15, we sometimes talk about the incremental ROI of a project, which is somewhat different, yet similar.

A&MIS 212

Overview of Ch. 13

In chapter 13, we consider the use of accounting information to analyze the impact of decisions on the profitability of an organization. In general, profitability is a function of the income and cash flow generated by a business. Specific projects or options about which a decision must be made are the subject of this chapter.

A&MIS 212

Chapter 13 - Assumptions
• The approach to decisions outlined in chapter 13 is based on some key assumptions
• The incremental investment is too small to affect the decision under consideration
• Revenues, variable costs and fixed costs can be adequately modeled with linear models.

A&MIS 212

Chapter 13 - Assumptions
• Total fixed costs will not change unless a problem or case specifies otherwise.
• As in chapter 6, any changes in per-unit prices or variable costs will be made explicit. Otherwise, assume no changes in the per-unit amounts

A&MIS 212

Maximizing Income
• Given the above assumptions, one can focus on the impact of decision options on the income from operations and ignore changes in investment. Also, since the incremental investment is small, we can ignore the time value of money (chapter 14).

A&MIS 212

Decisions Mentioned in Ch. 13
• Replace equipment (or not)
• Adding or dropping product lines
• Make or buy component parts
• Accept or reject special order
• Utilizing constrained resources
• Sell or process further

A&MIS 212

Incremental Perspective

The first four categories of decisions mentioned above can be approached by looking at changes in contribution margin less any change in fixed costs incurred to determine the impact on income from operations. If you are not told of any specific change in total fixed cost, then assume that it is indeed fixed.

A&MIS 212

Resource Environments
• Unconstrained – If there are no important constraints, then we will evaluate the effects of the decision options on contribution margin or income from operations. If fixed costs do not change, then we can focus on the effects on contribution margin. If fixed costs do change, then evaluate the effects on income from operations.

A&MIS 212

Resource Environments
• Single constraint – If there is a single binding constraint, we must determine the contribution margin per unit of the constrained resource. Then we use this information to determine how best to use the constrained resource to maximize contribution margin and income from operations.

A&MIS 212

Resource Environments
• Multiple constraints – In the case of multiple constraints in a complex environment, we would maximize an objective function subject to a set of constraints (in Mgt. Sci. 331 & A&MIS 525).

A&MIS 212

Sell or Process Further

Pp. 636-9 of text

A&MIS 212

Sell or Process Further

Pp. 636-9 of text

A&MIS 212

Introduction to Accounting

Capital Budgeting

A&MIS 212

Objective

To initiate and maintain projects and activities that earn an adequate rate of return on the required investment. To be adequate, the returns must be consistent with investor expectations, management plans, and business opportunities.

A&MIS 212

Capital Budgeting

Capital budgeting concerns the analysis and evaluation of projects that require investment in working capital or property, plant & equipment. These tend to be large projects that involve significant cash inflows and outflows over several fiscal years. However, the methods covered are applicable to investment decisions made by individuals as well as organizations.

A&MIS 212

Internal rate of return

The internal rate of return (IRR) is that interest return, positive or negative, that equates the present value of the investment with the present value of the cash inflows. In cases where there are multiple investments over time, it is that rate that equates the present value of the cash inflows with the present value of the cash outflows.

A&MIS 212

Internal rate of return

Thus, it as the discounted rate of return for which the net present value is zero.

A&MIS 212

Internal rate of return

Symbolically,

PV = i =0CFi (1+r)-i

To find the internal rate of return, find that value of r such that

0.0 = i=0CFi (1+r)-i

N

A&MIS 212

Internal Rate of Return (IRR)

Alternatively, one can write out the terms of the above expression as follows:

0 = CF0 + CF1(1+r)-I + CF2(1+r)-2 +… + CFN(1+r)-N

Again, the objective is to find a rate r such the above expression is satisfied.

A&MIS 212

Internal rate of return

Next we illustrate use of the annuity table to find IRR when the cash flows are uniform from one period to the next

A&MIS 212

Interpolation Example (p. 676)

Investment required \$6,000

Annual cost savings \$1,500

Life of project 15 years

A&MIS 212

Table method (equal cash flow)

PV = CF [1 – (1 + r)-N] / r

\$6,000 = \$1,500  PVOA (10 periods, r %)

PVOA (10, r %) = \$6,000 = 4.000

\$1,500

A&MIS 212

Factor Interpolation

20% factor (table) 4.192 4.192

Project factor (computed) 4.000

22% factor (table) 3.923

Difference 0.192 0.269

A&MIS 212

For example one

Investment of \$6,000 and annual cash flows of \$1,500 for 10 years:

0.0 = - \$6,000 + \$1,500(1+ r)-1 +

\$1,500(1+ r)-2 +  + \$1,500(1+ r)-10

IRR (r) = 21.406% (using Excel worksheet)

A&MIS 212

IRR Interpolation

IRR = 20% + (0.192 / 0.269)  (2%)

IRR = 20% + 0.7137  (2%)

IRR = 20% + 1.4247%

IRR = 21.4247%

Note that the true IRR was 21.406%

A&MIS 212

Example 2

PV = CF [1 – (1 + r)-N] / r

\$10,000 = \$2,432.50 [1 – (1 + r)-N] / r

\$10,000 = \$2,432.50 

PVOA (6 years, r %)

PVOA (6 years, r %) = \$10,000.00

\$ 2,432.50

= 4.111

A&MIS 212

Example 2
• From Exhibit 14C-4, we see that in row 6 (6 periods) we find the PVOA factor 4.111 in the column 12%. What luck! The internal rate of return on this project is exactly 12% per year.

A&MIS 212

Example 3
• Investment is \$10,000
• Annual cash flows are \$3,000 per year for six years

0.0 = -\$10,000 + \$3,000(1+ r)-1 +

\$3,000(1+ r)-2 +  + \$3,000(1+ r)-6

IRR (r) = 19.905% (using Excel worksheet)

A&MIS 212

Example 3

PV = CF [1 – (1 + r)-N] / r

\$10,000 = \$3,000 [1 – (1 + r)-N] / r

\$10,000 = \$3,000  PVOA (6 years, r %)

PVOA (6 years, r %) = \$10,000/\$ 3,000

= 3.333

A&MIS 212

Example 3
• From Exhibit 14C-4, we see that in row 6 (6 periods) we find the PVOA factor 3.333 is between the columns for 18 and 20%. What rotten luck! The internal rate of return on this project has to be estimated by interpolation!

A&MIS 212

Factor Interpolation

18% factor (table) 3.498 3.498

Project factor (computed) 3.333

20% factor (table) 3.326

Difference 0.165 0.172

A&MIS 212

IRR Interpolation

IRR = 18% + (0.165 / 0.172)  (2%)

IRR = 18% + 0.9593  (2%)

IRR = 18% + 1.9186%

IRR = 19.9186%

Notice that this is very close to the true IRR of 19.905%

A&MIS 212

IRR Summary
• The internal rate of return is a method that recognizes the time-value of money through determining the interest return earned by investments.
• If cash flows are constant from period to period, we can use the annuity table to approximate the IRR.

A&MIS 212

IRR Summary
• If the cash flows vary from period to period, the best way to determine an IRR is to use a financial calculator or a computer program such as Excel to compute an exact rate.

A&MIS 212

Project ROI

Project ROI (Simple rate of return) =

Incremental income from operations

Incremental investment

Incremental revenue –incremental expenses

Incremental investment

OR

ΔROI = Incremental IO

Incremental investment

A&MIS 212

Payback period

Payback period is the number of periods it takes to recover the cash investment in a project without regard to any income on that investment.

Payback period = Project investment

Annual net cash inflow

A&MIS 212

Payback for Example 3 Above

Payback = \$10,000/\$3,000

= 3.33 years or

3 years, 4 months

A&MIS 212

Payback: Uneven Cash Flows

Payback = 2 + (4,000 / 6,000)

= 2 2/3 years or 2 years, 8 mo.

A&MIS 212

Assumptions for Chapter 14
• When working with discounted cash flow, assume cash inflows come at period end. (p. 672)
• Assume all cash flows generated by an investment are immediately reinvested at the project discount rate.

A&MIS 212

Discount rate for NPV
• Cost of capital
• Target rate of return set by financial managers for this purpose
• The opportunity cost of capital

A&MIS 212

Chapter 15
• Chapter 15 brings the issue of taxes into our study of capital budgeting.

A&MIS 212

Taxable Events

The following events affect income taxes and should be analyzed on an after-tax basis on the exam for capital budgeting questions.

• Revenue from operations
• Operating expenses (other than depreciation)
• Income tax savings due to the reduction in income for depreciation

A&MIS 212

Taxable Events
• Disposal of an asset for gain or loss
• Disposal of a fully-depreciated asset (tax methods) for its salvage value
• Special expenses usually described as repairs, overhaul, or renovation, which represent tax-deductible items
• Dividend income, interest income, and interest expense

A&MIS 212

Non-taxable Events

The following events do not affect income taxes when they occur and should be analyzed on a pre-tax basis on the exam for capital budgeting purposes.

• Deposits made for possible damages or the return of equipment if the deposits are returnable.
• Increases and decreases in working capital

A&MIS 212

Non-taxable Events
• Purchase of an operating asset or an investment
• Borrowing money (taking out a loan)
• Repaying the principal (not the interest) on a loan
• Payment of dividends by a corporation

A&MIS 212