Accounting 2

General decision rule If the internal rate of return is... Equal to or greater than the minimum required rate of return... Less than the minimum required rate of return... Then the project is... Acceptable Rejected When using the internal rate of return, the cost of capital acts as a ______________ that a project must clear for acceptance.

hurdle rate

Key terms and concepts (1) A_____________is a one time order that is not considered part of the company's normal ongoing business

special order

Last check for understanding... (2) In a flexible budget, when the activity declines, the total variable cost declines.

true

A general model for variance analysis

1) Actual Quantity of Input. at Actual $ (AQ x AP) 2) Actual quantity of input , of standard price (AQ x SP) Price Variance (2)-(1) (3) Standard Quantity allowed for actual output at standard price (SQ x SP) Quantity Variance (3)-(2) Spending Variance (3)-(1)

Quick check 1a (2/2) Evaluation of the Payback Method Short-comings:

1. Ignores the time value of money 2. Ignores cash flows after the payback period 3. Shorter payback period does not always mean a more desirable investment.

12-3: Prepare a make or buy analysis

A decision to carry out one of the activities in the value chain internally, rather than to buy externally from a supplier, this is a make or buy decisions. These decisions also involve decisions concerning whether to out-source development tasks, after-sales service, or other activities.

9-5: Prepare a flexible budget with more than one cost driver

According to exhibit 9-9, the net operating income in the flexible budget based on one cost driver (exhibit 9-5) is $30,510. While the net operating income in the flexible budget based on two costs drivers is $29,380. These two amounts differ because the flexible budget based on two cost drivers is more accurate than the flexible budget based on one driver. The difference is also that because the cost formula based on more than one cost driver are more accurate than the cost formulas based on just one cost driver, the variances will also be more accurate.

9-4: Prepare a performance report that combines activity variances and revenue and spending variances

Exhibit 9-8 displays Victoria's performance report that combines the activity variances (from exhibit 9-6) with the revenue and spending variances (from exhibit 9-7). The report brings together information from those two earlier exhibits in a way that makes it easier to interpret what happened during the period. The format of this report is a bit different from the format of the previous reports in that the variances appear between the amounts being compared rather than after them.

Last check for understanding... (1) If activity is higher than expected, total fixed costs should be higher than expected. If activity is lower than expected, total fixed costs should be lower than expected.

False

10-2: Compute the direct labor rate and efficiency variances and explain their significance

In exhibit 10-1, they had to compute June direct labor variances for the month. The data for the direct labor rate and efficiency variances that appear in exhibit 10-6. Based off this exhibit, the labor rate variance measures the difference between the actual hourly rate and the standard hourly rate, multiplied by the actual # of hours worked during the period. To understand the labor rate variance, note than the actual hourly rate of $21.60 is $0.40 less than the standard rate of $22/hr.

8-1: Understand why organizations budget and the processes they use to create budgets

Organizations realize many benefits from budgeting, including: 1. Budgets communicate management's plans throughout the organization 2. Budgets force managers to think about and plan for the future. In the absence of the necessity to prepare a budget, many managers would spend all of their time dealing with day-to-day emergencies 3. The budgeting process provides a means of allocating resources to those parts of the organization where they can be used most effectively 4. The budgeting process can uncover potential bottlenecks before they occur. 5. Budgets coordinate the activities of the entire organization by integrating the plans of its various parts. Budgeting helps to ensure that everyone in the organization is pulling in the same direction. 6. Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent performance.

12-1: Identify relevant and irrelevant costs and benefits in a decision

Relevant costs and relevant benefits should be considered when making decisions. Irrelevant costs and irrelevant benefits should be ignored. First being able to ignore irrelevant data saves decision makers tremendous amounts of time and effort. Second, bad decisions can easily result from erroneously including irrelevant costs and benefits when analyzing alternatives.

9-3: Calculate and interpret revenue and spending variances

Revenue variance: is the difference between the actual total revenue and what the total revenue should have been, given the actual level of activity for the period. According to exhibit 9-7, the revenue variance is labeled favorable (unfavorable) when the actual revenue is greater than (less than) the flexible budget. The expense variances are labeled favorable (unfavorable) when the actual expense is less than (greater than) the flexible budget.

Simple rate of return method (1) Management of the daily grind wants to install an espresso bar in its restaurant that: 1. Cost $140,000 and has a 10-year life. 2. Will generate incremental revenues of $100,000 and incremental expenses of $65,000 including depreciation. What is the simple rate of return on the investment project?

Simple rate of return= $35,000/$140,000= 25%

Simple rate of return method (2) Does not focus on cash flows -- rather it focuses on accounting net operating income. The following formula is used to calculate the simple rate of return:

Simple rate of return= Annual incremental net operating income/initial investment

Quick check 1a (1/2) Consider the following two investments: Project X Project Y Initial investment $100,000 $100,000 Year 1 cash inflow $60,000 $60,000 Year 2 cash inflow . $40,000 $35,000 Year 3 cash inflow . $0 . $25,000 Which project has the shortest payback period? a. Project X b. Project Y c. Cannot be determine

a. project X

Quick Check 3 The expected annual net cash inflow from a project is $22,000 over the next 5 years. The required investment now in the project is $79,310. What is the internal rate of return on the project? a. 10% b. 12% c. 14% d. Cannot be determined

b. $79,310/$22,000= 3.605, which is the present value factor for an annuity over five years when the interest rate is 12%.

Key terms and concepts (4) The machine or process that is limiting overall output is called the ________________ it is the constraint.

bottleneck

Key terms and concepts (3) When a limited resource of some type restricts the company's ability to satisfy demand, the company is said to have a ______________

constraint

Quick check 2 Which of the following may appear on a flexible budget performance report? a) An unfavorable activity variance b) A favorable revenue variance c) An unfavorable spending variance d) All of the above may appear on a flexible budget performance report

d) All of the above may appear on a flexible budget performance report

Key terms and concepts (2) When analyzing a special order, only the___________________ are relevant. Since the existing fixed manufacturing overhead costs would not be affected by the order, they are not relevant

incremental costs and benefits

9-1: Prepare a planning budget and a flexible budget and understand how they differ from one another.

planning budget: is prepared before the period begins and is valid for only the planned level of activity. A static planning budget is suitable for planning but is inappropriate for evaluating how well costs are controlled. If the actual level of activity differs from what was planned, it would be misleading to compare actual costs to the static, unchanged planning budget. flexible budget: is an estimate of what revenues and costs should have been, given the actual level of activity for the period.

The net present value method Year Cash flows Investment in equipment NOW $(160,000) Working capital needed NOW (100,000) Annual net cash inflows 1-5 80,000 Net present value 11% factor Presentvalue Investment in equipment 1.000 $(160,000) Working capital needed 1.000 (100,000) Annual net cash inflows 3.696 295,680 Net present value 35,680 Present value of an annuity of $1 factor for 5 years at 11%: Annual net cash flows 11% factor 3.696. Accept the contract because the project has a ___________ net present value.

positive