Cost Accounting Exam 8,15

Sales forecast

What do we want our sales and net income to be

Quantitative Criteria 3 Financial Considerations

1) Accounting rate of return 2) Payback period 3) Discounted Payback period 4) Net Present Value 5) Internal Rate of Return 6) Profitability Index

Qualitative criteria 3 Non Financial Considerations

1) Employee Moral 2) Employee Safety 3) Employee Responsibility 4) Corporate image 5) Social Responsibility 6) Market Share 7) Growth Strategic Planning 8 Sustainability 9) Growth

Benefits of a budget (4)

1) Enhanced managerial perspective 2) Advanced warning of problems 3) Coordination of activities 4) Performance Evaluation

Two drawbacks to the payback period

1) ignores the total life of an investment and its total profitability 2) it ignores the timing of cash flows and therefore the fact that the value of future cash flow today is less than the actual amount to be received in the future

Assume in preparing cash budget the accountant discovers that a cash shortage will likely occur in a specific month. What actions might the accountant recommend to management to deal with the cash shortage?

1. Cash is an essential organizational resource because it is the medium of exchange for organizational inputs and outputs. A shortage of cash creates liquidity problems and may prevent the firm from acquiring inputs that are crucial to its survival. A firm can cover periods of cash shortages with loans, equity sales, or sales of assets. When the cash budget indicates a potential shortage, the accountant should suggest that management address the issue with the organization's bank and (if extremely critical) creditors to make advance arrangements to borrow funds or defer payments.

Budget Definition

A comprehensive financial plan for future operations based on a single level of activity The Quantitative expression of a companies commitment to planned activities and resource acquisition

To calculate payback period

Amount to be invested / Estimates annual net cash flows.

Financial Budgets:

Cash Budget and budgeted financial statements, and capital expenditures budget

Capital Budgeting

Decisions are important due to the amount of money involved committed for usually extensive lengths of time.

Those investments with the ....... NVP are most desirable

Higher

Profit and Positive Cash Flow are

NOT the same Accrual Basis of accounting and non-cash items revenue and expenses

Depreciation is a

Non cash activity

When Comparing 2 Projects the ......... is often used to develop riskiness of Investment

Payback Period

Greatest Advantage of Master Budget perceived by Management

Planning

NVP =0

Return is equal to investment

NVP<0

Return is less than investment

Master Budget Definition

a "package" of related budgets that collectively summarizes the planned activities of a business.

Profitability Index

a ratio of projects net cash flows to the projects net investment

Flexible Budget definition

a series of budget projections for different levels of activity.

The average amount invested is computed by

adding the original cost to any expected salvage value and dividing this number by 2

Operational Budgets

are usually generated for a year and then are broken down usually into months perhaps weeks

Return on Average Investment

average annual net income from an investment / average amount invested

Managers and those in decision making capacity should

be involved in the budgeting process (Not always the case in real life) Imposed vs Participatory budgeting

Therefore the only difference

between net income and net cash flows relates to depreciation. Since depreciation is an expense decreases annual net income from an investment, it must be added back to annual net income to find the net annual cash flows

Management must evaluate

capital investments proposals and decide how to invest a company's financial resources. This process is called Capital Budgeting

Budgets also promote

coordination among various segments of a business by allowing individual managers to communicate with each other.

Planning is the

cornerstone of effective management, and effective planning that requires that managers must predict, with reasonable precision, the key variables that affect company performance and conditions

Cash Flows from Operations

critical day to day operation of a business Question: Can I pay my obligations as they come due?

Capital Budgeting relies upon

estimates of future operating results. Perhaps the most important component of these estimates is the investment impact on future cash flows as generated from long lived assets

Rapidly growing companies that are "profit rich" and "Cash Poor" often have

excessively long operating cycles. Much of these companies cash is tied up in inventory or accounts receivable. Cash obligations for payroll, debt service and overhead continue

The Statement of Cash Flow is the

financial statement that "tells" the story of the cash inflows and outflows for the period of time covered by the Income Statement

Budgets alert managers

in advance of potential threats and opportunities that a company may face in the future.

Continuous Budgeting

is a process in which there is an on going 12 month budget at all points in time during a budget period; a new budget (12 months into the future) is added as each current month expires

Budget Slack

is the intentional underestimation of revenues and/or overestimation of expenses in a budgeting process for the purpose of including deviations that are likely to occur so that results will occur within budget limits

Payback period

is the length of time necessary to recover the entire cost of an investment from its resulting annual net cash flows.

Philosophies for setting budgetary targets 1) Behavioral Approach

is widely used and involving setting budget targets at reasonably achievable levels Based primarily on historical data with REASONABLY efficient operation (Goal meet or beat the budget)

Once capital budgets decisions have been made and the money has been spent

it is often very difficult to reverse the decision and free up cash

Capital Investments refers to

large expenditures made by a company to acquire plant assets. (Also referred to as Property plant and equipment)

Financial and Non Financial Considerations are important when

making capital budgeting decision Financial-cash flow, amount of money involved; non financial-opportunity costs ethical and legal

Capital Budgeting (for plant and equipment)

often covers 5-20 years discussed in chapter 15

2) Total Quality Management Approach

reflects the idea that every segment of a business must continually strive to improve. Budget levels are often set at levels which demand optimum efficiency (Goal Meet the budget)

NVP >0

return is greater than discount rate

In our analyses we will assuming that all

revenue is received in cash and all expenses (other than depreciation) are immediately paid in cash

Operating Budgets:

sales budgets (units and $), production schedules, manufacturing costs, operating expenses, and budget income statement

Controlling refers to

seeing that things go according to plan and that corrective action is taken when actual results fall short of plans (When Cash outflows exceed inflows)

Planning refers to

setting financial and operating goals for a business and ultimately for each responsibility center

The higher the PI is

the more profitable that subject is per investment dollar

Use of Flexible Budget keeps

the original one form becoming obsolete with changes in business activity

Discounting future cash flows

the process of determining the present value of an investment future net cash flows. This method considers both the amount of timing of the investment future cash flows

Tactical Planning is

the process of determining the specific means or objectives by which the strategic plans of the organization will be achieved; it is short range in nature (1-18 months)

Strategic Planning is

the process of developing a statement of long range (5-10 years) goals for the organization and defining the strategies and policies that will help the organization achieves these goals Strategic Planning should drive Tactical Plan

Actual Information that is compared to budget information must be

timely and accurate to achieve maximum benefit from the budgeting process

Present value tables are used

to discount future cash flows

The Net Present Value (NVP) Formula

total present value of its future cash flows - initial cost of investment

Financial Forecasts

used to predict future cash flows must be accurate as possible