exam 2- MA

break even unit in sales (equation method)

$0= unit cm * Q - fixed expenses

segmented financial information

*both US GAAP and IFRS require absorption costing for external reports. -GAAP and IFRS require publicly traded companies to include segmented financial data in their annual reports. -must use same methods -this requirement motivates managers to avoid using the contribution approach for internal reporting purposes bc if they did they would be required to: 1. share this sensitive data with the public 2.reconcile these reports with applicable rules for consolidated reporting purposes

master budget

*consists of a number of separate but interdependent budgets 1.sales budget 2. production budget 3. cash budget 4. budgeted i/s and budgeted b/s

production budget

*must be adequate to meet budgeted sales and to provide for the desired ending inventory -prepared after the sales budget. -lists the number of units that must be produced during each budget period to meet sales needs and to provide for the desired ending inventory -directly influences the dm, dlm and moh, which in turn enables the preparation of the ending finished goods inventory budget -these budgets combined with data from the sales budget and the selling and administrative expense budget to determine the cash budget **if royal co. was a merchandising company it would prepare a merchandise purchases budget instead of a production budget

self imposed budget (participative budget)

-a budget that is prepared with the full cooperation and participation of managers at all levels -should be reviewed by higher levels of management to prevent budgetary slack -most companies issue broad guidelines in terms of overall profits or sales. lower level managers are directed to prepare budgets that meet those targets

2 keys to building a segmented income statement

-a contribution format should be used because it separates fixed from variable costs and it enables the calculation of a CM -traceable fixed costs should be separated from common fixed costs to enable the calculation of a segment margin.

variable vs. absorption costing

-advocates of absorption costing argue that it better matches costs with revenues. contend that foh is just as essential to manufacturing products as are the variable costs. -advocates of variable costing view fixed manufacturing costs as capacity costs. they argue that fixed manufacturing costs would be incurred even if no units were produced

advantages of budgeting

-budgets communicate managements plans throughout the organization -budgets force managers to think about and plan for the future -the budgeting process provides a means of allocating resources to those parts of the organization where the can be used most effectively -the budgeting process can uncover potential bottlenecks before they occur -budgets coordinate the activities of the entire organization by integrating the plans of its various parts -budgets define goals and objectives that can serve as benchmarks for evaluating subsequent performance

common costs and segments

-common costs should not be arbitrarily allocated to segments based on the rationale that "someone has to cover the common costs" for two reasons: 1. this practice may make a profitable business segment appear to be unprofitable 2.allocating common fixed costs forces mangers to be held accountable for costs the cannot control

Variable costing and the theory of constraints(TOC)

-companies involved in TOC use a form of variable costing. however, one difference of the TOC approach is that it treats direct labor as a fixed cost for three reasons: 1. many companies have a commitment to guarantee workers a minimum number of paid hours 2. direct labor is usually not the constraint 3. TOC emphasizes the role direct laborers play in driving continuous improvement. since layoffs often devastate morale, managers involved in TOC are extremely reluctant to lay off employees.

cash budget

-detailed plan showing how cash resources will be acquired and used over a specified time period -all of the operating budgets have an impact on the cash budget

inappropriate methods of allocating costs among segments

-failure to trace costs directly -inappropriate allocation base

advantages of self imposed budgets

-individuals at all levels of the organization are viewed as members of the team whose judgments are valued by top management -budget estimates prepared by front line managers are often more accurate than estimates prepared by top managers -motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above -a manager who is not able to meet a budget imposed from above can claim that it was unrealistic. self imposed budgets eliminate this excuse

responsibility accounting

-managers should be held responsible only for those items that they can control to a significant extent -enables organizations to react quickly to deviations from their plans and to learn from feedback obtained by comparing budgeted goals to actual results. the point is to not penalize individuals for missing targets

budgeted i/s

-number for the budgeted i/s come from other budgets that have already been prepared 1. sales revenue comes from the sales budget 2. cogs on a per unit basis comes from the ending finished goods inventory budget 3.the selling and administrative expenses come from the selling and administrative expenses budget 4.the interest expense comes from the cash budget

variable costing

-preferred by some managers for internal decision making and must be used when an income statement is prepared in the contribution format. -treats only those costs of production that vary with output as product costs. -dovetails with the contribution approach income statement -supports CVP analysis

sales budget

-shows the expected sales for the budget period expressed in dollars and units. it is usually based on a company's sales forecast. -sales budget multiplies the budgeted sales in units for each month by the selling price per unit

absorption costing

-used for external reporting purposes. -treats all costs of production as product costs, regardless of whether they are variable or fixed. since no distinction is made between variable and fixed costs, absorption costing is NOT well suited with cvp computations.

enabling cvp analysis

-variable costing categorizes costs as fixed and variable so it is much easier to use this income statement format for cvp analysis -absorption costing assigns per unit foh costs to production. this can potentially produce positive net operating income even when the number of units sold is less than the break even point.

support decision making

-variable costing correctly identifies the additional variable costs incurred to make one more unit. it also emphasizes the impact of total fixed costs on profits. -absorption costing gives the impression the foh is variable with respect to the number of units produced, but it is not. this can lead to inappropriate decisions and product discontinuation decisions

changes in net operating income

-variable costing income is only affected by changes in unit sales. it is not affected by the number of units produced. as a general rule, when sales go up, and vice versa. -absorption costing income is influenced by changes in unit sales and units of production. net operating income can be increased simply by producing more units even if those units are sold.

cm is used...

...first to cover fixed expenses. any remaining cm contributes to net operating income

format of cash budget

1. cash receipts section lists all cash inflows excluding cash received from financing 2.cash disbursements section consists of all cash payments excluding repayments of principal and interest 3.cash excess of deficiency section determines if the company will need to borrow money or if it will be able to repay funds preciously borrowed 4. financing section details the borrowings and repayments projected to take place during the budget period

3 steps to prepare a CVP graph

1. draw a line parallel to the the volume axis to represent total fixed expenses. 2. choose some sales volumes and plot the representing total expenses at that sales volume. draw al line through the data point back to where the fixed expenses line intersects the dollar axis. 3. choose sales volume and plot the point representing total sales dollars at the chosen activity level. draw a line through the data point pack to the origin.

4 key assumptions of CVP analysis

1. selling price is constant 2. costs are linear and can be accurately divided into variable (constant per unit) and fixed(constant in total) elements. 3. in multi product companies the sales mix is constant 4. in manufacturing companies, inventories do not change. (units produced=units sold)

interpreting the CVP graph

1. the break even point is where the total revenue and total expense line intersect 2. the profit or loss at any given sales level is measured by the vertical distance between the total revenue line and the total expense lines. *if a company has volume above the break even point, it will experience financial difficulties

profit graph (simpler form of cvp graph)

1.compute the profit at two different sales volumes 2. plot the points 3. connect them with a straight line

segment margin

=CM-TFC -SM is a valuable tool for assessing the long run profitability of a segment -allocating common costs to segments reduces the value of the segment margin as a guide to long run segment profitability.

which of the following statements is NOT true concerning the cash budget? a. it is not necessary to prepare any other budgets before preparing the cash budget b.the cash budget should be prepared before the budgeted income statement c. the cash budget should be prepared before the budgeted balance sheet d. the cash budget builds on earlier budgets and schedules as well as additional data

A. it is not necessary to prepare any other budgets before preparing the cash budget

continuous budgets

a 12 month budget that rolls forward one month (or quarter) as the current month (or quarter) is completed *keeps managers focused on the future at least one year ahead

which of the following statements is true in regard to a cvp graph

a cvp graph shows the break even point as the intersection of the total sales revenue line and the total expense line

traceable fixed cost of a segment (TFC)

a fixed cost that is incurred because of the existence of the segment(if the segment were eliminated the fixed cost would disappear) *TFC of a segment may be a CF of another segment

common fixed cost (CF)

a fixed cost that supports the operations of more than one segment, but is not traceable in whole or in part to any one segment

which method will produce the highest values for work in process and finished goods inventories?

absorption costing

units produced<units sold

absorption income<variable income

units produced>units sold

absorption income>variable income

in an income statement segmented by product line, a fixed expense that cannot be allocated among product lines on a cause and effect basis should be:

classified as a common fixed expense and not allocated

which of the following is true regarding the cmr of a single product company?

cmr * selling price per unit = the cm per unit

if both fixed and variable expenses associated with a product decrease, what will be the effect on the cmr and the break even point, respectively

cmr-increase break even point-decrease

cmr

cmr=total cm/total sales cmr=cm per unit/selling price

structuring sales commissions

companies generally compensate salespeople by paying them either a commission based on sales or a salary plus a sales commission. *commissions based on sales dollars can lead to lower profits in a company **to eliminate this type of conflict, commissions can be based on cm rather than on selling price alone

at the break even point:

contribution margin would be equal to fixed expenses

omission of costs

costs assigned to a segment should include all costs attributable to that segment from the company's entire value chain *omitting up and down stream costs will result in the under costing of products

failure to trace costs directly

costs that can be traced directly to specific segments of a company should not be allocated to other segments. rather, such costs should be charged directly to the responsible segment

degree of operating leverage (formula)

degree of operating leverage=cm/net operating income

planning

developing objectives and preparing various budgets to achieve those objectives

unit product cost-variable costing

dm dl voh

unit product cost-absorption costing

dm dl voh foh

dl budget

enables the company to match its dl hours provided with its production needs

companies with low fixed cost structures(or high variable costs)...

enjoy greater stability in in income across good and bad years

operating leverage is a measure of

how sensitive net operating income is to percentage changes in sales

the contribution income statement is helpful to managers

in judging the impact on profits of changes in selling price, cost, or volume. *the emphasis is on cost behavior (variable costs are separated from fixed costs)

advantages of a high fixed cost structure(or low variable costs)

income will be higher in good years compared to companies with a lower proportion of fixed costs

disadvantages of a high fixed cost structure(or low variable costs)

income will be lower in bad years compared to companies with lower proportion of fixed costs

cost volume profit (CVP) analysis helps managers understand the

interrelationships among cost, volume, and profit by focusing their attention on the interactions among the prices of products, volume of activity, per unit variable costs, total fixed costs, and mix of products sold. Vital tool used in many business decisions such as deciding what products to manufacture/sell, what pricing policy to follow, what marketing strategy to employ, and what type of productive facilities to acquire.

control

involves the steps taken by management to increase the likelihood that the objectives set down at the planning stage are attained and that all parts of the organization are working together toward that goal

budget

is a detailed quantitative plan for acquiring and using financial and other resources over a specified forthcoming time period

the degree of operating leverage

is a measure, at any given level of sales, of how a percentage change in sales volume will effect profits.

segment

is a part of activity of an organization about which managers would like cost, revenue, or profit data examples-divisions of a company, sales territories, individual stores, service centers, manufacturing plants, marketing departments, individual customers, and product lines.

what are some benefits of budgeting

it facilitates the coordination of activities, it provides definite objectives for evaluating performance, it requires all levels of management to plan ahead on a recurring basis

which one of the following is NOT a benefit of budgeting

it guarantees that the company will achieve its objectives

selling and administrative expense budget

lists the budgeted expenses for areas other than manufacturing and it is typically a compilation of many smaller, individual budgets

downstream costs

marketing, distribution, customer service costs

MOS

mos in dollars=total sales-break even sales

to estimate profits at a particular sales volume

number of units sold above break even*cm per unit

target profit analysis

number of units that must be sold to attain a target profit using either the equation method or the formula method

operating budgets

ordinarily cover a one year period corresponding to a company's fiscal year. many companies divide their annual budget into four quarters

foh and variable and fixed selling and administrative expenses are treated as ______, in variable costing.

period costs

contribution format income statement

profit= (sales-variable expenses)-fixed expenses

equation method

profit= unit cm * Q - fixed expenses

moh budget

provides a schedule of all costs of production other than the dm and dl

dm budget

quantifies the raw materials that must be purchased to fulfill the production budget and to provide for adequate inventories

cost structure

refers to the relative proportion of fixed and variable costs in an organization. managers often have some latitude determining their organizations cost structure.

sales mix

refers to the relative proportions in which a company's products are sold

upstream costs

research and development and product design costs

a basic idea underlying _______ is that a manager should be held responsible for only those items that the manager can actually control to a significant extent

responsibility accounting

the margin of safety can be calculated by

sales - (fixed expenses/cmr)

contribution margin can be defined as

sales revenue minus variable expenses

cm

sales-VC

inappropriate allocation base

some companies allocate costs to segment using arbitrary basis. costs should be allocated to segments for internal decision making purposes only when the allocation base actually drives the cost being allocated.

units produced=units sold

the 2 methods report the same net operating income

all other things being equal, if a division's traceable fixed expenses increase:

the division's segment margin will decrease

margin of safety in dollars is

the excess of budgeted(or actual) sales over the break even volume of sales

the usual starting point for a master budget is

the sales forecast or sales budget

human factors in budgeting

the success of a budget program depends on three important factors: 1. top management must be enthusiastic and committed to the budget process 2.top management must not use the budget to pressure employees or blame them when something goes wrong 3. highly achievable budget targets are usually preferred when managers are rewarded based on meeting budget targets

budgetary control

the use of budgets to control an organizations activities is known as budgetary control

unit cm

unit cm= selling price per unit-variable exp. per unit

formula method

unit sales to attain the target profit= (target profit + fixed expenses)/ cm per unit

break even unit in sales (formula method)

unit sales to break even=fixed expenses/cm per unit

in a cvp graph,

unit volume is the horizontal (X) axis and dollars in the vertical (Y) axis

period costing in absorption costing

variable and fixed selling and administrative expenses are treated as period costs and deducted from the revenue incurred.

segment margin is sales minus

variable expenses and traceable fixed expenses

which of the following are considered to be product costs under variable costing?

variable manufacturing overhead

which of the following are considered to be product costs under absorption costing

variable manufacturing overhead and fixed manufacturing overhead

variable expense ratio(vcr) or the ratio of variable expenses to sales

vcr= total variable expenses/total sales vcr=variable expense per unit/selling price