Domain 4 Financial Management

Product Costs

Product costs are expenses that can be matched specifically to the normal costs of production; they are expensed in the period in which the revenue is earned.

ACCOUNTING PRINCIPLES: Full Disclosure

-The full disclosure principle recognizes that statement preparers must make compromises between a level of detail sufficient to help users with their decisions and condensing that information enough to keep it understandable. -Regardless of the degree and extent of disclosure deemed appropriate, no material or potentially significant information that could impact user decision making should be omitted from disclosure. -Supplementary information may be presented outside the main body of the statements—for example, in footnotes.

The Goal of Financial Reporting

-The goal of financial reporting is to provide stakeholders with information to exercise due diligence in decision making. -Management may use financial reports to develop strategy, gauge performance, and allocate economic resources. -Investors and lenders may use financial reports to make decisions about the size, conditions, timing, and risk level of investments and loans.

Quick Ratio (Acid Test Ratio)

cash, cash equivalents, and receivables/current liabilities

LIQUIDITY/SHORT-TERM DEBT RATIOS: Quick ratio (acid-test ratio)

cash, cash equivalents, and receivables/current liabilities Like the current ratio, but eliminates inventory, the least liquid of current assets and therefore the least available for cash to reduce current debts. It is the proportion of most liquid sources of funding (cash, cash equivalents, receivables) to liabilities. Since inventory is excluded, stable current ratio but declining quick ratio could indicate temporary or permanent increase in inventory.

LIQUIDITY/SHORT-TERM DEBT RATIOS: Net working capital

current assets - current liabilities Not actually a ratio. Measures the relationship of short-term debt to short-term assets by simply subtracting current liabilities from current assets. A larger number indicates a greater ability to pay current debts—greater liquidity, in other words.

Current ratio formula

current assets/current liabilities

Operating leverage

fixed costs/total costs

LEVERAGE RATIOS: Operating leverage

fixed costs/total costs Proportion of fixed costs required to produce goods or services. The higher the operating leverage, the greater the impact of changes in price and variable costs, up or down. Higher operating leverage means higher risk, because fixed charges must be met regardless of sales levels.

Gross Profit Margin Formula

gross profit/net sales or (net sales - cost of good sales)/net sales

Net profit margin profit

net profit/net sales

Financial Leverage Ratio

total assets/common shareholders' equity

Debt ratio formula

total liabilities/total assets

Debt to equity ratio

total liabilities/total equity

Common-size Financial Statements

-Common-size financial statements express all account balances as percentages of one relevant aggregate balance. -Both income statements and statements of financial position may be put in either a horizontal or vertical common-size format.

Companies Forming Partnerships and Mergers

-Companies form partnerships and mergers to increase their influence over a market or over the company in which they are purchasing an interest. -Benefits include economies of scale and other efficiencies and cost savings, diversification for financial stability, and better international impact. -Antitrust laws exist to prevent mergers that would significantly reduce competition.

FOUR ACCOUNTING CONSTRAINTS: Conservatism

-Conservatism involves prudence and adequate consideration of the risks and uncertainty in business situations that require judgment. -It includes selecting the accounting method that is least likely to overstate net income and financial position and doesn't anticipate gains or losses. -Consistent understatement must also be avoided. -Conservatism implies a pessimistic frame of mind that does not recognize revenue until it has been earned and that recognizes expenses when incurred.

FUNDAMENTAL QUALITIES OF ACCOUNTING INFORMATION: Consistent

-Consistent means that the same standards are applied over time so that financial statements from differing periods can be compared. -For this reason, organizations must show that new accounting methods are preferable to prior methods.

Benefits of Process Costing

-Continuous operations can take place while organizations get timely, accurate, and inexpensive cost information each period, due in part to the use of equivalent units. -Production cost reports provide built-in checks and balances, such as balancing units to be accounted for against units already accounted for.

Additional information provided by the payback method can help managers:

-Control the risks associated with the uncertainty of future cash flows -Minimize the impact of an investment on a firm's liquidity problems -Control the effect of the investment on performance measures

Examples of Intangible Assets

-Copyrights are government protections granted to authors and artists of all types. They expire 70 years after the author's or artist's death. -Patents are exclusive rights to sell, use, or manufacture something for a period of 20 years. -Trade names and trademarks are symbols or words that distinguish an organization or product. They remain in force while in continuous use. -Contracts are arrangements guaranteeing the rights and obligations between parties, including franchises, licenses, and service contracts. -Leases are intangibles but are classified as part of plant, property, and equipment (PPE). -Customer intangibles are data with value regarding customers, such as customer lists and contracts with customers. -Goodwill is the excess of the price paid for a subsidiary over the fair value of the subsidiary's net assets. From a purchase accounting perspective, goodwill is not amortized but is instead re-valued each year, with any impairments being recognized if the value goes down.

Cost center

-Cost centers generate costs (expenses, no or few revenues, a net cost) -EXAMPLES: Data processing, human resources, accounting and customer service

Adjusting Inventory

-Inventory is sometimes adjusted for shrinkage, which occurs when the physical count is lower than the accounting total due to theft, error, or deliberate overstatement. -The opposite would indicate an accounting error or a deliberate understatement. -Because of this, internal auditors should be alert to such possibilities when reviewing adjustments in this area.

Standard Costing Key Points

-Quantity standard times price standard equals unit standard cost for direct materials, direct labor, and overhead. -Standards set an ideal to strive for.

What should internal auditors compare the results of ratio analysis?

-Related nonfinancial information -The results of other organizational units -To relationships among the elements such as by using a segmented audit cycle

Salvage Value

-Salvage value is the estimated value of an asset if it is sold at the end of its depreciation period or service life. -Salvage value can be zero.

INVENTORY COSTS: Stockout (or shortage) costs

-Stockout (or shortage) costs are incurred for running out of an item in demand. -This can result in back orders, lost sales, a damaged reputation, and lost customers.

Effective Tax Rate

-The effective tax rate is the total tax paid divided by the total amount the tax is paid on, or taxable income. -The effective tax rate is also called the average tax rate because it is the tax that would be due if the taxpayer were subject to a constant rather than a progressive tax rate.

Businesses Financed by Debt

-The greater the proportion of the business financed by debt, the higher leveraged the company is. For example, a business that sells U.S. $30 billion in equity and incurs U.S. $370 billion in debt is said to be 30% equity-financed and 70% debt-financed. The company's ratio of debt to total financing, here 70%, is called the firm's leverage. -Usually, companies that are heavily financed by debt have more problems when there are issues in the money markets, as they struggle to fund their assets.

PROCESS COSTING: Departmental Production Report

-The key document in a process costing system is a departmental production report. -This report tracks the number of units moving through the department, provides a computation of unit costs, and shows how costs were charged to the department.

Opportunity Costs

-The potential benefits given up when one alternative is selected over another. -These costs are not typically entered into the accounting records of an organization but must be considered in management decision making.

Spot Markets and Forward Markets

-The two types of FX markets are the spot and forward markets. -Spot markets are for transactions that settle in one or two days -Forward markets are quotations for foreign exchange where the transaction will take place more than two days in the future, commonly within a year. -When the spot and exchange rates are equal, they are on par. -When the spot market values the currency higher than the forward market, the currency is trading at a discount. -The opposite situation is a premium. -These differences are caused by interest rate differences between the two countries: The currency with the higher interest rate will sell at a discount in the forward market.

Accounts payable payment period or average days' payables ratio

365/AP Turnover Ratio

ABC: Activity Center

A logical grouping of activities, actions, movements, or sequences of work.

Income Statement

A summary of the profitability or success of an organization over a period of time, such as a year.

Cash conversion cycle formula

A/R Collection Period + Inventory Processing period - A/P Payment Period

ASSET MANAGEMENT RATIOS: Cash conversion cycle

A/R Collection Period + Inventory Processing period - A/P Payment Period Measures the average number of total days it takes to convert money from a cash outflow (start of production) to a cash inflow.

Accounting Rate of Return (ARR) Formula

ARR = Increase in Expected Average Annual Operating Income/Initial Required Investment

FINANCIAL STATEMENTS ASSERTIONS: Completeness

All transactions that occurred during a period and should have been recognized during that period have been recorded.

Operating Expenses

Also called selling, general, and administrative expenses

ABC: Resource

An economic element applied or used to perform activities (such as salaries and materials).

Cost driver (also called allocation base)

Any factor that has a cause-and-effect relationship with costs, such as a rise in sales volume that affects a rise in sales commissions.

OTHER BOND FEATURES: Stock warrants

Bonds may be issued with stock warrants (options to purchase stock at a set price for a given time) attached as an incentive.

Comparing Net Present Value (NPV) and Internal Rate of Return (IRR)

Both the NPV and IRR methods are widely accepted as decision-making tools. In comparing the two models, it is important to keep in mind that: ---A spreadsheet formula can be used to automate the IRR and NPV methods. ---The NPV method makes a more realistic assumption about the rate of return that can be earned on cash flows from a project. If the NPV and IRR methods disagree about the worthiness of a project, it might be wiser to use the data from the NPV method.

BREAK-EVEN POINT FORMULA - UNIT CONTRIBUTION MARGIN

Break-even point number of units = Fixed costs (FC)/Unit contribution margin (UCM)

TYPES OF BONDS: Callable bonds

Callable bonds are bonds that the issuer can call and retire before maturity, such as during periods of high interest rates.

Choosing a Transfer Pricing Method

Choosing a transfer pricing model depends on the circumstances of a specific organization. Key factors to consider are: -Is there an outside supplier? If not, there is no market price, and the best transfer price is based on cost or negotiated price. -Is the seller's variable cost less than the market price? If not, the seller's costs are likely too high, and the buyer may be more likely to buy outside. -Is the selling unit operating at full capacity? In other words, will the order from the internal buyer cause the selling unit to deny full-profit external sales opportunities?

Asset

Company-owned economic resource that can be expected to provide future economic benefits; must be quantifiable within a reasonable degree of accuracy.

REQUIRED DISCLOSURES: Contractual Obligations

Contractual obligations include covenants on liabilities (or assets) requiring that certain balances be maintained, etc.

Cost Avoidance

Cost avoidance (elimination of future costs)

TYPES OF BONDS: Debenture bonds

Debenture bonds have no collateral (are unsecured).

Differential Costs

Differential costs (also called incremental costs). The difference in costs between any two alternatives.

Financial Statement Disclosures

Disclosures include schedules that drill down to a more useful level of detail than presented on the statements, such as the inventory valuation method that was used (e.g., last-in, first out [LIFO], etc.) or a schedule of inventory by classification type.

FINISHED GOODS

FINISHED GOODS are products that are ready to purchase.

Inflation Adjustments

Financial statements are not adjusted for inflation. If comparing two sets of financial data where there is a wide gap in years, the statement amounts should be adjusted. The most current year is set as a base year, and the other statements are adjusted by the inflation rate so they can be expressed in base-year amounts.

Net Income - Preferred Dividends/Weighted Average Number of Common Shares Outstanding

For the above example, assume that ABC, Inc., had 10 million shares at the start of year 3 (Y3) and issued 1 million more shares on June 1 (after 5 months). Weighted average shares outstanding is determined by multiplying the number of shares outstanding by the prorated number of months outstanding (months outstanding/12 months) and then summing the amounts found, in this case, (10 million × 5/12) + (11 million × 7/12), for a weighted average of 10,583,333 shares.

Accounts Payable Application Controls

Here are some examples of such application controls: -Creation of a purchase requisition in the procurement application using the required form with its entry restrictions -Requisition approval process; monthly review of requisitions for unauthorized requisitions or excessive order quantities -Generation of the purchase order that references the approved requisition; monthly review of purchase orders for authorization and order quantities -Review and reconciling against the general ledger account on a monthly basis to determine if there were goods received but not invoiced by the vendor; review of unmatched purchase order reports -At the point where accounts payable releases invoices for payment, check of vendor payment terms to determine the best time to pay; at the end of the month, comparison of the accounts payable sub-ledger to the general ledger control total, noting and correcting any differences

3 CLASSIFICATIONS OF TAX: Proportional

High- and low-income taxpayers pay the same fraction of income.

3 CLASSIFICATIONS OF TAX: Regressive

High-income taxpayers pay a smaller fraction of their income than do low-income taxpayers.

3 COMPONENTS OF MASTER BUDGET: Operating Budget

Identifies resources needed for operations and is concerned with the acquisition of these resources through purchase or manufacture.

Sunk Cost

If a cost is in the past, it is a sunk cost and not relevant.

Improper Revenue Recognition

Improper revenue recognition can take the form of deliberately: -Overstating revenues, such as by recording false receivables. -Understating revenues, such as by improperly recognizing revenue in a later period.

TWO MAJOR TYPES OF DISTRIBUTION CHANNELS: Conventional Distribution Channel

In a conventional distribution channel, independent organizations are linked laterally with minimal cooperation or concern for the total performance of the channel. The focus is on buyer-seller transactions rather than close collaboration throughout the channel.

TWO METHODS OF OBTAINING OWNERSHIP OF AN ORGANIZATION: Stock acquisition

In a stock acquisition, only 50% or more of the common stock must be owned. The investee can be maintained as a separate entity with consolidated financial statements.

FINANCIAL STATEMENTS ASSERTIONS: Presentation and disclosure

Items in the financial statements are properly described, sorted, and classified.

TYPES OF TAXES: Corporate income tax

Levied on the accounting profits of corporations.

Price/Earnings (P/E) Ratio Formula

Market Price of Stock/Earnings per Share

BUDGETING APPROACHES: Incremental Budgeting

Most organizations follow a traditional approach of constructing next year's budget by starting with the current year's budget as a baseline and then adjusting each line item for expected price and volume changes.

Return on assets (ROA) formula

Net Income/Average Total Assets

Chart of Accounts

Numerical listing of all accounts used to record an entity's transactions, including assets, liabilities, owner's equity, revenue, expenses, gains, and losses.

Liability

Obligation or debt that must be paid with assets or services in the future.

Benefits of Post-Audit of Capital Projects

Post-audits can be expensive to conduct; however, their benefits can often outweigh the cost. These benefits include: -Evaluating profitability to ensure that resources are used wisely. -Positively impacting the behavior of managers; holding managers accountable. -Providing feedback to managers to improve future capital budget decisions, such as: ---Spending more time vetting assumptions. ---Being more conservative about both costs and benefits.

Posting

Posting is recording an item from a journal in the general ledger, including summarizing and classifying the items.

Accounts payable turnover formula

Purchases/Average Accounts Payable

Responsibility Accounting

Responsibility accounting is a method of holding responsibility center managers responsible for those line items (revenues or costs)—and only those line items—that they can actually control. It is part of an effective profit planning and control system

Return on Investment (ROI) Ratios

Return on assets (ROA)

BUDGETING: Solutions to Not Being Able to Adapt to Changes

Smaller or less complex organizations are more likely to be able to adapt to changes. More complex organizations base their budgets on more assumptions, and the further these assumptions are from actual results, the less useful a static budget becomes over time. Potential solutions include: -Using a flexible budget, which is an incremental budget for fixed costs but allows variable costs to adjust to the actual sales volume. -Use of a continuous or rolling budget.

Solvency

Solvency is the ability of a company to meet its long-term debts and other financial obligations.

TYPES OF TAXES: Capital gains tax

Tax levied on the profit released upon the sale of a capital asset.

4 TRANSFER PRICING MODELS: Negotiated price model

The negotiated price model sets the transfer price through negotiation.

Asset management ratios

These ratios measure how efficiently an organization's assets are used to generate income.

Debit

To make an entry on the left-hand side of a journal.

Cash Basis Accounting

-In cash basis accounting, the organization recognizes revenue only when cash is received and recognizes expenses only when cash is paid out. -Items promised to be paid or received, such as accounts payable and receivable, are ignored. -Cash basis accounting is not allowed under GAAP or IFRS. -However, it may be used for tax purposes.

US - Financial Accounting Standards Board (FASB) and Generally Accepted Accounting Principles (GAAP)

-In the United States, the primary standards-setting body is the Financial Accounting Standards Board (FASB), an independent, nonprofit group under the authority of the SEC. The FASB's Accounting Standards Codification® is the official source for all Generally Accepted Accounting Principles (GAAP) standards. -This online resource organizes all standards using a logical numbering system. -In the U.S., financial statements of public companies must conform to U.S. GAAP.

FUNDAMENTAL QUALITIES OF ACCOUNTING INFORMATION: Relaible

-.Reliability is a measure of neutrality, representational faithfulness, and verifiability. ---NEUTRALITY refers to making choices that are free from bias toward a predetermined result and placing the relevance and reliability of information above other concerns. ---REPRESENTATIONAL FAITHFULNESS is the assurance that descriptions of events and financial transactions correspond closely to what occurred in reality. ---VERIFIABILITY is the extent to which a high degree of consensus can be formed between independent measurers when using the same techniques.

Financial goal for a for-profit organization

-A for-profit organization's goal is to maximize the economic value of the organization over the long term. -For a publicly owned organization, this means maximizing the value of the organization's common stock. -Shareholders expect to receive a return on their investment in stock (from dividends and/or share price growth, since stock pays no interest) that exceeds the rate that can be earned from other investments of similar risk.

FOUR ACCOUNTING ASSUMPTIONS: Going Concern

-An entity is assumed to be operationally viable going into the future—for long enough at least to validate the use of accounting methods such as asset capitalization, depreciation, and amortization. -If liquidation of the entity is certain, this assumption does not apply and different accounting methods must be used.

Users of financial statements:

-Are assumed to have a reasonable understanding of business and economics and to be willing to apply reasonable diligence in the study of the information. -Include present and potential investors, creditors, managers, financial advisors, brokers, and auditors. -Should be able to use financial reports to assess the amounts, timing, and uncertainty of planned cash receipts from dividends, securities, or loans as well as net cash inflows.

Four Accounting Constraints

-Cost-benefit relationship -Materiality -Industry practices -Conservatism

Managerial Accounting

-Managerial accounting is internal financial reporting, and it is primarily concerned with: ---Providing timely information to decision makers so they can make wise choices regarding how available finances should be expended in pursuit of organizational goals. ---Breaking down or estimating how much various aspects of operations are costing. -Managerial accounting may use methods and processes that are not allowed for external financial reporting. While much of the detailed data gathered in managerial accounting can be used in financial accounting, only those sources of information that are made to conform to external accounting standards can be used for financial reporting purposes. Organizations have great flexibility in choosing managerial accounting methods since the primary objective is to enhance decision-making ability. For example, a lean manufacturing organization may wish to use lean accounting methods to show the value of reducing inventories. (Lean accounting is not addressed in these materials.)

ACCOUNTING PRINCIPLES: Historical Cost

-Most assets and liabilities are reported at the levels at which they were acquired or incurred rather than fair market value. -For example, fuel costs are reported at the level at which the fuel purchases were made, not at the level in effect at the time of the financial report or some point on the future. -The historic value should be supported with evidence, such as receipts or records of payment. -An exception to this is the reporting of certain marketable securities.

FOUR ACCOUNTING ASSUMPTIONS: Periodic Reporting

-Operations can be separated artificially and recorded in different periods (e.g., week, month, quarter, year), thus allowing for comparisons of past and present performance. -Even end-of-year inventory levels must include items still in production, which is called work-in-process inventory.

Par value

-Par value is a nominal price per share, set at issuance, usually at a low price to make it unlikely that the stock price will go below this value. -No-par stock has a par value of zero.

Financial Statements

Statement of financial position (balance sheet), income statement (profit and loss), statement of cash flows, and statement of retained earnings.

Financing Decisions

-The goal of financing decisions is to provide sufficient funds to support an organization's strategic goals. ---Long-term financing includes the issuance of stocks or bonds or entering into long-term debt arrangements or leases. ---Short-term financing includes the issuance of commercial paper (short-term commercial loans) and arranging for credit lines and revolving credit. -Corporate treasury is involved in managing the organization's liquidity and cash position. -An organization must have sufficient cash on hand to meet its obligations that are coming due. -If, for example, an organization were to offer a "no payment for six months" deal, it should be certain that it has sufficient liquidity during this time period to pay its debts, expenses such as payroll, and dividends, or it may have to resort to high-cost borrowing while waiting for customers to pay their obligations. -Financing decisions also include bank and shareholder relationship management. -Maintaining good relations with these providers of funds is critical. -Reviewing bank relationships periodically can ensure that the organization is getting the best deals possible.

Statement of Cash Flow

A financial statement that reconciles the income statement to the beginning and ending cash on the statement of financial position.

Statement of Financial Position (balance sheet)

A financial statement that shows, at a given point in time, what an organization owns, what it owes (or its obligations) to others, and its capital position (retained earnings and owner/shareholder investments).

Statement of Shareholders' Equity

A financial statement that starts with the balances from the end of the prior period and shows changes due to net income (loss) and dividends for the period or any new issuances or repurchases of stock.

Ledger

Accounting book of final entry, in which transactions are listed under separate accounts; subledgers provide more detailed information about individual accounts (e.g., sales, purchases)

FOUR ACCOUNTING CONSTRAINTS: Industry practices

Accounting procedures should follow applicable industry practices.

On-top Adjustments

Adjustments made by management to reflect judgment calls and deviations from calculated results and estimates; typically are made after a first draft of the financial statements.

Statement of Shareholders' Equity (Retained Earnings)

The statement of shareholders' equity (or statement of retained earnings) starts with the balances from the end of the prior period and shows changes due to net income (loss) and dividends for the period or any new issuances or repurchases of stock.

FOUR ACCOUNTING ASSUMPTIONS: Monetary Unit

-A stable currency will be used to measure and record economic activity. -GAAP ignores the effects of inflation or deflation for most measures at present.

STATEMENT OF SHAREHOLDERS' EQUITY: Capital Stock

-Capital stock is the par value of issued shares. (Par value is a nominal price per share, set at issuance, usually at a low price to make it unlikely that the stock price will go below this value. -No-par stock has a par value of zero.) -There may be several classes of stock such as Class A and Class B. -Capital stock can have the following subcategories: ---Common stock ---Preferred stock ---Treasurey stock

Accounting Principles

-Historical cost -Revenue recognition -Matching -Full disclosure

Investment Decisions

-The goal of investment decisions is to invest in assets that generate a return in excess of the cost of the funds expended. -This involves capital budgeting and financial planning and analysis to make strategic, long-term capital budgeting decisions. -It also involves short-term decisions on investments that balance the need for: ---Capital preservation ---Liquidity ---A reasonable return on investment

CATEGORIES OF CAPITAL STOCK: Common Stock

-Common stock is the default classification for an organization's public shares granting a portion of ownership. -Different classes of common stock will carry different rights, such as voting rights.

Four Accounting Assumptions

-Economic entity -Going concern -Monetary unit -Periodic reporting

Economic Events

-Economic events include credit sales, collecting cash from accounts receivable, recording payments due to vendors or employees, making such payments, and so on. -Accountants need to systematically record the monetary impact of these events. -They can also classify these events to better understand what funds the organization has and what it is doing with those funds.

Financial Accounting

-Financial accounting is primarily concerned with external financial reporting -This requires external auditors to provide assurance that financial statements fairly present the actual financial situation of an organization -With the passage of the U.S. Sarbanes-Oxley Act (SOX); Canadian Bill 198, commonly called C-SOX; and the Financial Instruments and Exchange Law in Japan, commonly called J-SOX, internal controls over financial reporting (ICFR) is a necessary assurance area for impacted organizations (those that are U.S. SEC-registered and publicly traded)

Corporate Finance: 3 Major Types of Decisions

-Investment Decisions -Financing Decisions -Dividend Decisions

Accounting

-Recording and reporting of an entity's financial activity, including assets, liabilities, equity, revenues, expenses, and earnings. -Accounting is the framework that provides financial control over the actions and resources of an organization.

4 Fundamental Qualities of Accounting Information

-Relevant -Reliable -Comparable -Consistent

SOFP

-The statement of financial position should separately present minority interest, issued capital, and reserves. -The relationship between these three topics on the statement of financial position is illustrated by the accounting equation: ASSETS - LIABILITY = EQUITY -Statement of financial position account balances for asset, liability, and equity accounts are carried forward as beginning balances in the next period.

​​1. Financial Accounting and Finance

(A) Identify concepts and underlying principles of financial accounting (types of financial statements and terminologies such as bonds, leases, pensions, intangible assets, research and development, etc.) - BASIC (B) Recognize advanced and emerging financial accounting concepts (consolidation, investments, fair value, partnerships, foreign currency transactions, etc.) - BASIC (C) Interpret financial analysis (horizontal and vertical analysis and ratios related to activity, profitability, liquidity, leverage, etc.) - PROFICIENT (D) ​​Describe revenue cycle, current asset management activities and accounting, and supply chain management (including inventory valuation and accounts payable) - BASIC (E) Describe capital budgeting, capital structure, basic taxation, and transfer pricing - BASIC

FOUR ACCOUNTING ASSUMPTIONS: Economic Entity

-An economic entity is any entity that has separately identifiable accounting and accountability. -An entity could be an individual, a type of corporation, or a business unit. -Economic entities differ from legal entities, which are legally separate businesses or subsidiaries.

FOUR ACCOUNTING CONSTRAINTS: Cost-benefit relationship

-Gathering information involves significant costs, and while each individual user of the information will place more or less value on some types of data, statement preparers must select a level of information that will provide perceived benefits to a wide enough body of users to outweigh the perceived costs of furnishing this information. -In addition to the direct preparation costs, there is the cost of the information entering the public domain (use by competitors).

Trial Balance

-Total of all debits and credits; if debits do not equal credits, an error has occurred (e.g., mistake in entry, omission, double posting). -At the end of a year or other financial reporting period, accountants prepare a trial balance, which is a summary of the organization's accounts and their balances at a specific point in time. -The trial balance, after making certain adjustments, is used to prepare a key output: external financial reports.

Liquidity

-Liquidity is the ability of an organization to meet its current and future obligations in a cost-effective and timely fashion -Liquidity can also refer to how quickly an asset can be converted to cash

Categories of Liabilities

-Liabilities are an organization's present obligations due to past transactions or events requiring the future transfer of assets or provision of services—or what companies owe to others. Liabilities are listed in order of the time frame in which they are due. ---CURRENT LIABILITIES, such as accounts payable or sales commissions payable, are expected to be settled within the normal operating cycle or one year of the statement of financial position date and include the portion of long-term debt expected to be paid in this period. ---LONG-TERM LIABILITIES (e.g., mortgages, bonds) are any liabilities not qualifying as current liabilities or other liabilities (those liabilities that are not material individually).

FOUR ACCOUNTING CONSTRAINTS: Materiality

-Materiality is a threshold level above which items would make a difference to a decision maker (material) and below which the items are insignificant (immaterial). -It is a judgment call that includes not only the magnitude of monetary amounts relative to some overall amount but must also consider the nature of the item and the circumstances in which decisions must be made. -Therefore, no specific materiality guidelines can be set. -Materiality may vary due to a number of factors, including the person, firm, industry, or transaction in question.

ACCOUNTING PRINCIPLES: Matching

-When practical to do so, expenses should be recognized in the period in which the corresponding revenues are recognized. -Therefore, payroll and material expenses to produce a shoe aren't recognized when the shoe is produced but when it is sold. -Depreciation and amortization are ways to apply the cost of a long-lived asset over the periods in which the benefits are received. -Product costs are expenses that can be matched specifically to the normal costs of production; they are expensed in the period in which the revenue is earned. -Period costs are expenses that affect the organization as a whole but cannot be specifically allocated to a product or product line; they are expensed immediately because they cannot be matched against specific revenues.

Impairment

-Process of recording and presenting the fair value of an asset for which the value has depleted faster than the calculated depreciation or amortization. -Also, the amount by which stated capital (outstanding shares multiplied by stated value) is reduced by distributions (e.g., dividends) and losses.

Journals and Ledgers and Subledgers

-The journal is used as the book of original entry for financial transactions. -There is a general journal as well as journals for specific purposes. -Journals help to show the full effects of a transaction in chronological order and help prevent or reveal errors because they use dual-entry accounting. -The ledger and subledgers are used to keep all data regarding specific account balances in one place. -Entries are made in chronological order.

Minority Interests

The stockholders' equity of a subsidiary company that may be allocated to those owners who are not part of the controlling (majority) interest.

Categories of Assets

-Assets are resources obtained, owned, or controlled by an organization as a result of past transactions or events that will probably result in future economic benefits to the organization. -The assets are arranged from most to least liquid. -Typical categories include current assets; plant, property, and equipment (PPE); long-term assets; and "other" assets. -CURRENT ASSETS include cash and cash equivalents and assets held for sale or expected to be realized in the current operating cycle or within one year of the statement of financial position date. Cash, marketable securities, prepaid items, accounts receivable, and inventory are examples. -NONCURRENT (PPE and long-term assets) have an ongoing value and are not readily convertible to cash. -"OTHER" line items include cash and cash equivalents, inventories, accounts receivable, intangible assets, general financial assets, equity method investments, and liquid assets (if material).

METHODS OF BREAK-EVEN ANALYSIS: Graph Methods

-A CVP graph (or break-even chart) shows the interrelationships among cost, volume, and profit graphically. -The activity level (unit volume) is shown on the horizontal (x) axis, and dollars are shown on the vertical (y) axis. -Total costs and total revenues are both plotted as lines; their point of intersection is the break-even point. -The gradient or slope of the total cost line is the variable cost. If the lines are parallel (identical slopes), they each have the same variable costs. -The total revenues line starts at 0. -The total costs line starts at the fixed cost.

BUDGETING APPROACHES: Kaizen Budgeting

-A kaizen budget ("kaizen" is Japanese for continuous improvement) is a continuous improvement budgeting method that focuses on planned future operating processes. -Kaizen budgeting starts by identifying areas of improvement and determining changes needed to achieve the future state. -Budgets are prepared based on the improved practices or procedures, which typically results in more efficient, lower-cost budgets.

ABC: Resource cost driver

-A measurement of the amount of resources consumed by an activity. -Resource costs used in an activity are assigned to a cost pool using a resource cost driver. An example of a cost driver is the amount of leather to make a pair of boots.

Why are Accounting Rate of Return (ARR) and payback period useful screening measures?

-ARR can check whether new investments will adversely affect financial accounting ratios, specifically those that may be monitored to ensure compliance with debt covenants. -Payback period can help identify investment proposals that managers should consider more. If a proposal doesn't provide a payback within some specified period, the potential project can be rejected without additional consideration

Activity-based Costing (ABC)

-Activity-based costing (ABC) is a method of assigning costs to products, services, and customers based on the consumption of resources caused by activities. -ABC is a costing method designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore "fixed" costs. -It is often used to supplement, rather than replace, an organization's more traditional costing system.

Actual Costing Key Points

-Actual cost for direct materials, direct labor, and overhead -Most accurate but least useful (delays)

Indirect Costs

-Any costs that are related to a cost object but cannot be easily and accurately traced to the product (such as overhead). -Indirect costs for a hamburger include maintenance costs of the fast-food machinery, utility costs, and the manager's salary. -Indirect costs for a service firm include the cost of office furniture and cubicles. -Indirect costs are allocated (assigned to a cost object) through reasonable estimation.

Features of Operating Budgets

-Are tools for short-term planning and control -Typically cover a one-year period and state revenues and expense planning for that year. (However, some organizations use continuous rolling budgets, e.g., adding a new month to the end of the budget as each month passes.) -Fine-tune an organization's strategic plan. -Help to coordinate the activities of several parts of an organization. -Assign responsibility to managers, authorize the amounts they are permitted to spend, and inform them of performance expected. -Are the basis for evaluating a manager's performance.

Supplier Relationship Management (SRM)

-As CRM focuses on building loyalty with key customers, SRM develops long-term relationships with key suppliers. -Depending on the industry or organization, building relationships with suppliers can take many different forms. -Some will be custom-tailored to provide critical, high-quality goods, while others might be handled through standardized PSAs that are nonnegotiable. -Determining an organization's supply needs is a cross-functional project involving marketing, research and development, production, logistics, and finance. -SRM is a key risk management activity because even an independent supplier's actions and ethics can impact the organization's reputation risk and other aspects of enterprise risk. -Finding reliable and trustworthy suppliers and ensuring that they operate according to sound governance, risk management, and control frameworks and ethics are key aspects of SRM.

INVENTORY COSTS: Carrying costs (also called holding costs)

-Carrying costs (also called holding costs) are the costs of housing the inventory. -This includes rent, depreciation, taxes, insurance, material handling, labor, investment costs, etc. -These costs may be a significant percentage of inventory costs.

Recognition Prior to Delivery

-Certain long-term construction contract situations span years and require early recognition of income. -Methods include the completed contract method and the percentage-of-completion method.

Two Primary Types of Product Costing Systems

-Cost measurement (allocation) systems -Accumulation costing systems

What can auditors use analytical procedures to detect?

-Differences that are not expected -The absence of differences when they are expected -Potential errors -Potential irregularities or illegal acts -Other unusual or nonrecurring transactions or events

Investment Valuation Ratios

-Dividend yield -Dividend payout ratio -Price/earnings (P/E) ratio -Book value per common share

3 COMPONENTS OF MASTER BUDGET: Capital Budget

-Evaluates and selects projects that require large amounts of funding and provide benefits far into the future. -The capital budget feeds into the cash budget and other financial budgets. -Often, the capital budget is considered separate from the master budget, but all of an organization's budgets comprise an interrelated system.

Historical Cost Adjustments

-Fixed assets are valued on a statement at historical cost, but this value becomes more distorted over time. -Adjustments to fair value may be appropriate in some situations.

Relevant Costs: Example of a coffee shop manager considering to buy a new espresso maker

-For example, let's say that a coffee shop manager is considering buying a new espresso maker. -The prices for different espresso makers are relevant to the decision because those costs differ according to each machine's features and benefits. -An example of an irrelevant cost is the monthly rent for the cafe. -The building's rent remains the same whether or not the manager purchases the new espresso maker or which model is selected.

TYPES OF BONDS: Government bonds

-Government bonds are issued by government entities, either repaid through general tax revenues (general obligation bonds) or through revenues of the item financed (revenue bonds). -They are backed by the full faith and credit of the government and are considered to have less risk.

Profitability Ratios

-Gross profit margin -Operating profit margin -Net profit margin -Earnings per share (basic and complex)

Tax Minimization Strategies

-In a global economy, tax minimization strategies are particularly important. -One of the most important components in such a strategy is transfer pricing; this is discussed later. -Additional tax minimization strategies include: ---Merging and restructuring organizations in an attempt to reduce cost and risk while increasing operational efficiency. ---Structuring the organization for tax efficiency in areas such as cross-border mergers, spin-offs, foreign acquisitions, divestitures, and joint ventures to optimize after-tax cash flow. ---Off-shoring aspects of the business to the same or another company in another country to lower the cost of operations in the new location; alternately, moving headquarters to a low- or zero-income-tax country. ---Using tax incentives for exporters. ---Using cross-border financing strategies. ---Maximizing benefits through cash repatriation, including dividends, interest, and royalties. ---In the United States, using modified accelerated cost recovery (MACRS), which allows for accelerated depreciation based on the life of the asset. Faster acceleration allows a taxpayer to deduct greater amounts during the first few years of an asset's life.

Changes in Supply Chain Management and Risks

-International standards require oversight of a company's suppliers to ensure that the products it sells meet customer expectations. -Boundaries separating organizations are blurring due to technological interconnectivity, a fact that has major implications for internal auditors. -Organizations are replacing some contract-driven supply chains (multi-year contracts with PSAs) with free markets. In light of these changes, supply chain risks include: ---An organization depending too heavily on a single supplier of a critical component. ---Off-shore suppliers with language, management, and transportation issues. ---Ineffective supply chain management systems not addressing CRM and SRM concerns.

Product costing provides cost information for all types of organizations for:

-Inventory management and costing of products and services -Management planning, cost control, and performance measurement -Strategic and operational decision making

Drawbacks of Zero-based Budgeting

-It encourages managers to exhaust all their resources during a budget period for fear that they will be allocated less during the next budget cycle. -It can encourage a significant amount of unnecessary purchasing if a manager has incorporated budget slack into the budget. -The annual review process can be time-consuming and expensive. -Not using prior budgets can lead to ignoring lessons learned from previous years. These drawbacks can be mitigated by performing zero-based budgeting only on a periodic basis or by performing this budget process for a separate department each year, perhaps following an internal audit of that department.

4 Common Cost Decision-Making Applications that Use Relevant Cost Analysis

-Make or buy decisions -Special order decisions -Sell or process further decisions -Keep or drop decisions

The Areas that Manage Current Assets

-Management of current assets is handled by several different functional areas. -Treasury manages cash and cash equivalents, investing cash in safe short-term investment vehicles to generate a return without risking loss of capital. Inventory managers set policies for inventory levels and ensure inventory level adequacy. -Accounts receivable is responsible for ensuring that accounts are collected and for monitoring the status of the average age of accounts receivable.

Managerial Costing Systems

-Managerial costing systems are general methods for costing products for the purpose of valuing inventories and the cost of goods sold. -The purpose of a managerial costing system is to provide cost data to help managers plan, organize, direct, and control.

Types of Inventory and Types of Organisations

-Manufacturers will have raw material, WIP, and finished goods. -Retailers will have just one category: merchandise (finished goods). -Service companies will have little or no inventory.

4 Transfer Pricing Models

-Market price model -Full cost (absorption) model -Variable cost model -Negotiated price model

Net Cash Flows from Investing

-Net cash flows from investing includes acquisition and disposal of debt and equity securities for investment purposes, from both an issuing and a collection standpoint. -Property, plant, and equipment are also included.

3 Components of a Master Budget

-Operating budget -Financial budget -Capital budget

Leverage Ratios

-Operating leverage -Financial leverage index -Financial leverage

INVENTORY COSTS: Ordering costs

-Ordering costs are incurred when placing orders for more inventory. -This includes all material and labor in order processing, office supplies, clerical labor, etc. -Electronic forms and payment transfers can reduce ordering costs.

Prepayments

-Prepayments are either prepaid expenses (cash paid for goods or services prior to their consumption and treated as assets) or unearned revenues (cash received from customers as prepayment for goods or services and treated as liabilities or deferred revenues). -Prepayments require adjusting entries because they expire through the passage of time but no recurring entry is made to record this expiration. -Prepaid insurance or rent are examples. -The adjusting entry would credit the asset account (decreasing it) and debit the expense account (increasing it). -The adjusted trial balance is the trial balance after all adjusting entries have been made, reflecting the proper balance of each account.

3 Classifications of Tax

-Progressive -Proportional -Regressive

Inventory Costs

-Purchasing costs are the costs of goods acquired from suppliers. -Ordering costs are incurred when placing orders for more inventory. This includes all material and labor in order processing, office supplies, clerical labor, etc. -Electronic forms and payment transfers can reduce ordering costs. -Carrying costs (also called holding costs) are the costs of housing the inventory. This includes rent, depreciation, taxes, insurance, material handling, labor, investment costs, etc. These costs may be a significant percentage of inventory costs. -Stockout (or shortage) costs are incurred for running out of an item in demand. This can result in back orders, lost sales, a damaged reputation, and lost customers. -Set-up costs result from the process of preparing to go into production to fill an order. This includes labor for cleaning and adjusting machinery.

Responsibility Centers

-Responsibility centers are areas of the organization that are empowered to make their own decisions but are held responsible and accountable for costs, profits, revenues, and/or investments. -Responsibility centers can be a single individual, a department, a functional area, or a division.

Other bond features

-Restrictive covenants -Sinking fund requirements -Stock warrants

Benefits and Drawbacks of Kaizen Budgeting

-The benefits of a kaizen budget include its proactive changes, which are often mandated by organizational policies that attempt to lower costs without sacrificing productivity. -The drawbacks include: --Managers may lower quality levels or move production processes to cheaper labor markets. ---Some projects that should have been cut or added may be ignored in favor of incremental improvements.

INVENTORY VALUATION METHOD: First-in, first-out (FIFO)

-The first-in, first-out (FIFO) inventory valuation method assumes that the oldest goods are used or sold first. -Ending inventory will consist of the most recent purchases, meaning that this method best approximates current cost for held inventory. -However, current revenues will be matched against older costs, violating the matching principle and possibly distorting net income and gross profits. -This method is appropriate when the physical flow of goods follows the accounting method (not required). -Income cannot be manipulated under this method if the proper methodology is followed.

Step C—Posting to general ledger

-The general ledger is the primary ledger for an organization, containing all asset, liability, equity, revenue, and expense accounts. -Each of these subcategories has its own subsidiary ledger. -Posting is recording an item from a journal in the general ledger, including summarizing and classifying the items. -For tracking and completeness checks, the general journal contains a ledger account number referring to where each specific account was posted to the general ledger.

Federal Economic Policy

-The goal of federal economic policy is to exert a stabilizing influence on the economy in order to minimize the severity of the peaks and recessions of economic cycles. -The responsibility for control of the economy in the United States is split between Congress, using fiscal policy, and the Federal Reserve Board, using monetary policy.

RECOGNITION AFTER DELIVERY METHODS: Installment Sales Method

-The installment sales method recognizes revenue as cash is collected from prior sales. -This method is used for sales on installment where title for the goods is held until the final payment is collected. -At the time of sale, revenue up to the cost of sales plus other direct expenses (selling and administrative) is recognized, but the remainder, or gross profit, is deferred until cash is collected. -Special accounts must be set up for all installment sales transactions, for gross profit on sales on installment, and for each year's deferred gross profit. -Ordinary expenses are treated as normal and are closed to the income summary account each year. -Only the deferral of gross profit will affect calculation of net income.

4 CAPITAL INVESTMENT DECISIONS: Internal Rate of Return (IRR)

-The internal rate of return (IRR), or project yield, is the rate of return promised by an investment project over its useful life. -The IRR is the discount rate that will result in the net present value of a project being equal to zero. -Once the IRR for a project is computed, it is compared with the firm's required rate of return. ---If the IRR is greater than the required rate, the project is acceptable. ---If the IRR is equal to the required rate, managers decide whether to accept or reject it. ---If the IRR is less than the organization's required rate of return, the project is rejected.

Limitations of the Income Statement (Statement of Operations)

-The primary drawbacks of the income statement are that judgments and estimates may be used and different accounting methods, principles, and criteria can be applied, making statements from two different firms less comparable. -From an internal auditing standpoint: ---Judgments and estimates pose higher risk, because estimates must be tested and the standards against which to test are also subject to interpretation. ---Differing accounting methods are less of an issue for internal auditors because the method used can be tested for validity; the most likely intervention would be a suggestion to use a more appropriate method. -One other limitation of the income statement is that some items are omitted because they are very difficult to value, such as unrealized gains and losses on some securities or even more amorphous concepts such as the value of customer service or customer satisfaction.

Straight-line Depreciation Method

-The straight-line depreciation method assumes that the asset has the same usefulness and repair expense per year. -This may be unrealistic, but the method is popular because it is straightforward. -The straight-line method determines the amount to depreciate per year by simple division: Straight-line depreciation per period = depreciable base/estimated service life

Auditing a Statement of Financial Position

-When auditing a statement of financial position, evidence such as samples and counts of items should be accumulated as close to the date of the statement as possible, because items such as inventory or marketable securities are always fluctuating. -The statement of financial position is also the primary statement auditors use when performing tests of details of general ledger balances, such as physical examination of inventory or vendor monthly statements for accounts payable.

ASSET MANAGEMENT RATIOS: Accounts payable payment period or average days' payables

365/AP Turnover Ratio -How long it takes to pay the average account. -An increasing period might indicate cash flow issues.

Receivables collection period or average days' accounts receivable formula

365/Average A/R Turnover Ratio

ASSET MANAGEMENT RATIOS: Receivables collection period or average days' accounts receivable

365/Average A/R Turnover Ratio -Length of time required to convert account receivable to cash. -Should be compared with company's credit terms to detect issues with collection. -It takes ABC, Inc., an average of 70 days to convert A/R to cash. If the credit term is less than this amount, the organization has trouble collecting or has lax credit.

Inventory processing period or average days' sales in inventory ratio

365/Inventory Turnover Ratio

ASSET MANAGEMENT RATIOS: Inventory processing period or average days' sales in inventory

365/Inventory Turnover Ratio -How many days it would take an organization to process and sell a single inventory turn. -A higher ratio is better.

TYPES OF TYPES OF PARTNERSHIPS AND MERGERS: Business combinations and mergers

A business combination is when the operations of two or more organizations are brought under common control. --A friendly takeover is performed when the boards of directors of the organizations work out a mutually agreed-upon deal to present to shareholders --An aggressive takeover is when the investee attempts to avoid takeover. It is likely that the investor will make a tender offer, which bypasses the organization and works directly with shareholders. In a horizontal merger, organizations in the same industry merge; a vertical merger is a supply chain merger (customers and suppliers). Mergers between publicly held companies are accomplished through stock purchases. The purchaser tenders an offer for stock at a certain price. In a two-tier tender offer, the purchaser offers to buy stock at a certain price per share until a certain point (e.g., acquisition of controlling interest) is reached. After this point, the offer price drops. The higher price rewards sellers who move quickly but also speeds the stock acquisition.

Budget Challenges

A common concern expressed by managers is that the budgets produced over the months before the start of the next year are out of step with the actual operating environment either before or soon after they are produced.

Forward Exchange Contract

A forward exchange contract is an agreement to buy foreign currency in the future at a price determined by the forward market, often as a fair value hedge against the cash flow variability from changes in exchange rates.

Standard Costing: Price Standard

A price standard is the amount that should be paid for the quantity of input to be used.

ACCUMULATION COSTING SYSTEMS: Process Costing

A process costing system accumulates product or service costs by process or department and then assigns them to a large number of nearly identical products by dividing the total costs by the total units produced.

Advantages and Disadvantages of Market Price Model

ADVANTAGES -Helps to preserve unit autonomy -Provides incentive for the selling unit to be competitive with outside suppliers -Has arm's-length standard desired by taxing authorities DISADVANTAGES -Intermediate products often have no market price -Should be adjusted for cost savings such as reduced selling costs and no commissions

Accounts for Current Assets Involved in the SoFP

Accounting for current assets can involve the following current asset statement of financial position accounts: -Accounts receivable -Allowance for doubtful accounts (a contra account) -Cash -Due from accounts (amounts of deposits currently held at another company) -Marketable securities (if less than one year) -Interest receivable -Inventory, including raw materials, work-in-process, and finished goods -Prepaid insurance -Prepaid rent -Stock and bond investments (if available for sale or maintained in a trading account) -Supplies

Activity Method Formula

Activity depreciation per period = (depreciable base x units in period)/Total Estimated Units in Service Life Depreciation expense in year two is calculated as follows: [(Cost - Salvage) x (Estimated Hours of Use in Year Two)]/Total Estimated Hours of Use = [($300,000 - $70,000) x (700 hours)]/2,000 hours = $80,500.

PERIOD COSTS: Administrative costs

Administrative costs. All executive, organizational, and clerical costs associated with the general management of the organization as a whole. These include executive compensation, public relations, and secretarial costs.

COST MEASUREMENT METHOD: Actual Costing

An actual costing system records the actual costs incurred for direct materials, direct labor, and overhead (by allocating actual amounts). The actual costs are determined by waiting until the end of the accounting period and then using the costs from recorded amounts.

Effective Tax Rate and Marginal Tax Rate

An important distinction when exploring tax rates is to distinguish between the marginal rate and the effective rate. ---The effective tax rate is the total tax paid divided by the total amount the tax is paid on, or taxable income. ---The marginal tax rate is the rate paid on the last dollar of income earned. When applied to a progressive tax code like that in the U.S., which has progressively higher tax rates for higher income earners, it is the last dollar of income that puts someone into a higher tax bracket. Thus marginal tax rates refer to a progressive system with tax brackets. In contrast, the effective tax rate is also called the average tax rate because it is the tax that would be due if the taxpayer were subject to a constant rather than a progressive tax rate. For example, IAS 12, "Income Taxes," requires a reconciliation disclosure on IFRS filings on the tax that should be expected if the current tax rate were applied to the accounting profit or loss, a type of effective or average tax rate.

ABC: Activity

Any type of action, work, or movement performed within an entity.

TYPES OF TAXES: Value-added tax (VAT)

Applies the equivalent of a sales tax to every operation that creates value.

Financial Statement Assertions

As noted by the American Institute of Certified Public Accountants (a governing body for accounting in the United States) in their Statements on Auditing Standards, there are several general assertions that management should be able to make regarding its financial statements: -Existence or occurrence -Completeness Rights and obligations -Valuation or allocation -Presentation and disclosure To meet financial reporting objectives, management must ensure that each transaction, account, or disclosure is evaluated according to each of these assertions, at a level appropriate to the assessed level of risk.

FINANCIAL STATEMENTS ASSERTIONS: Valuation and Allocation

Assets, liabilities, revenues, and expenses are recorded at appropriate amounts in accord with appropriate accounting principles. Transactions are mathematically correct, appropriately summarized, allocated to appropriate accounting periods, and properly recorded in the entity's books and records.

Valuation of Bonds

Bond values are found by determining the present value of the principal amount (par value) and of the interest payments. However, bond values are set in reference to the market interest rate for bonds of a similar risk level. The market value or yield-to-maturity of a U.S. $1,000,000 8% bond due in six years at a period when similar bonds are trading for 10% is calculated as follows: --First, the fixed annual interest payment, or annual coupon, is determined, which is 8% × U.S. $1,000,000 = U.S. $80,000. (The 8% is called the coupon rate.) --Next, the market rate is used to calculate the present value for both the principal and the interest payment. Present value (PV) adjusts the value of funds to be received in the future to the value they would have if received today (based here on the ability to invest the money today and earn the market rate). Present value is discussed more later in this section. ---The present value of the principal (using "Present Value of a Single Sum" tables as are presented later) = PV of 6, 10% = U.S. $1,000,000 × 0.56447 = U.S. $564,470. ---The present value of the interest payment (an annuity, which uses "Present Value of an Ordinary Annuity" tables, not shown here) = PV-OA of 6, 10% = U.S. $80,000 × 4.35526 = U.S. $348,421. --The yield-to-maturity (YTM) or market value is the combination of the present values of each separate cash flow: YTM = U.S. $564,470 + U.S. $348,421 = U.S. $912,891. If this amount were paid for the bond, the investor would receive a 10% yield over the six-year period.

Cost-volume profit (CVP) analysis: Uses

CVP analysis has many decision-making applications, including setting prices for products and services, introducing a new product or service, replacing equipment, deciding whether to make or buy, and performing strategic "what-if" analyses. Additional uses include: ---Determining how many units must be sold to earn a target profit level at either a targeted operating income or targeted net income. ---Determining the sensitivity of profits (or break-even) to possible changes in cost or sales volume. ---Calculating the break-even point with two or more products using the weighted average contribution margin. CVP analysis is also used for planning purposes. Because of that, it is important to measure the opportunity costs of any investment decision.

How to calculate the production/merchandise purchases budget?

Calculated by addding budgeted sales to the desired ending inventory minus the beginning inventory

Book value per common share formula

Common Shareholders' Equity/Outstanding Common Shares

INVESTMENT VALUATION RATIOS: Book value per common share

Common Shareholders' Equity/Outstanding Common Shares Shareholders' portion of all assets as stated on the statement of financial position if liquidated.

DISTRIBUTION CHANNEL ACTIVITIES: Advertising and sales promotion

Communicates product availability, location, features and benefits

REQUIRED DISCLOSURES: Contingent liabilities (loss contingencies)

Contingencies are events that have an uncertain outcome but are likely to be resolved in the future. Gain contingencies, or those contingencies likely to result in a gain, are not reported. Contingent liabilities, such as pending litigation, must be recorded when they can be reasonably estimated and are likely to occur.

Two Criteria - Contingent Liabilities

Contingent liabilities satisfy two criteria: -The amount of the loss can be estimated reasonably. -All available information implies that it is probable that a liability will exist on or before the financial statement date. The FASB gives the term "probable" specific meaning in the prior definition as part of three possible states for contingencies: "Probable" means that the event(s) are likely to happen. "Reasonably possible" means that the likelihood of occurrence is somewhere between probable and remote. "Remote" means that there is only a slight chance the event(s) will occur. Probable events that cannot be reasonably estimated in value should not be recorded, but a recorded contingent liability could still have an uncertain payee or date of payment.

TYPES OF BONDS: Corporate Bonds

Corporate bonds are issued by corporations.

Cost-volume profit (CVP) analysis: Five Factors

Cost-volume-profit (CVP) analysis helps managers understand the interrelationships among cost, volume, and profit by focusing on the interactions among five factors: -Prices of products -Volume or level of activity -Per-unit variable costs -Total fixed costs -Mix of products sold

OTHER BOND FEATURES: Restrictive Covenants

Covenants or indentures are the rights and obligations of the bond issuer and the bondholder, including restrictions on management actions such as not selling receivables (negative covenants) or keeping select ratios above a benchmark level (affirmative covenants).

PRODUCT COSTS: Conversion Costs

DIRECT LABOR COSTS + OVERHEAD COSTS -The combination of direct labor and overhead costs. -Manufacturing overhead is part of conversion cost. -It includes all costs of manufacturing except direct materials and direct labor. (Conversion cost adds back in direct labor but still omits direct materials because conversion cost is the cost to convert the raw materials into finished goods.) -Manufacturing overhead includes depreciation of factory equipment and buildings, maintenance and repairs of equipment, utility costs, property taxes, supervisor costs, and other costs associated with operating the manufacturing facilities.

Determining Market Value for an LCM Calculation

Determining market value for an LCM calculation has two restrictions related to the net realizable value (NRV), which is the sales price of an asset, usually inventory, less the costs of completion and transportation or disposal that can be predicted within reason. These restrictions are: -The market value cannot be greater than the inventory's NRV (a ceiling). -The market value cannot be less than the NRV less an allowance for an ordinary profit margin (a floor). -This ceiling and floor are controls to prevent inventory from being overstated or understated. -If the ceiling were not there, inventory could be reported at replacement cost, which for damaged or obsolete inventory would be considerably higher than the funds received from a sale less the selling costs. Without the floor, inventory could be understated and the loss overstated.

Why is distingusishing between relevant and irrelevant costs important?

Distinguishing between relevant and irrelevant costs is important for two primary reasons: -Irrelevant data can be ignored and need not be analyzed, which saves decision makers time and effort. -Bad decisions can result from mistakenly including irrelevant cost and benefit data when analyzing alternatives.

Dividend yield formula

Dividends per Common Share/Market Price per Common Share

INVESTMENT VALUATION RATIOS: Dividend yield

Dividends per Common Share/Market Price per Common Share The rate of return of one share of stock per period. Dividend yield shows the percentage of stock value returned as dividends in the period.

Weighted Average Method of Calculating Equivalent Units Formula

EQUIVALENT UNITS OF PRODUCTIONS = UNITS TRANSFERRED TO NEXT DEPARTMENT OR FINISHED GOODS + EQUIVALENT UNITS IN ENDING WORK-IN-PROGRESS INVENTORY

Four Types of Inventory Valuation Methods

Each uses a different method for calculating ending inventory and cost of goods sold. -FIFO -LIFO -Moving average cost -Specific identification

DISTRIBUTION CHANNEL ACTIVITIES: Transportation

Eliminates geographic/location gaps between buyers and sellers

Eliminating Entries

Eliminating entries help avoid presenting redundant information between a parent and its subsidiaries for stock ownership of a subsidiary and intercompany debt, revenue, and expenses. For stock ownership, the portion of the subsidiary's stock purchased by the parent is the parent's asset, and this portion is eliminated from the subsidiary's statement of financial position and statement of equity. The remaining portion not acquired is reported in the subsidiary's equity account. Intercompany debt occurs when a parent makes a loan to a subsidiary. The parent's financial statement lists this as an asset, a note receivable, and the subsidiary lists it as a liability, a note payable. Elimination entries remove both the asset and the liability to show that this is essentially a cash transfer between the entities. Intercompany revenues and expenses occur when the entities sell products or services to one another, enter into leasing arrangements, or otherwise transfer assets. For example, company X sells its subsidiary, company Y, saleable goods for $400,000 on May 1. The cost of these goods for company X was $250,000. To eliminate double-counting on the consolidated statements, the transactions are essentially reversed at the statement of financial position date, December 31. The transactions that need to be eliminated are company X's credit to sales—intercompany (by issuing a debit in the same amount) as well as company X's debit to cost of goods sold—intercompany. To get the transaction to balance, the difference is credited to the same account separately.

Exchange Rates

Exchange rates are listed in reference to a primary currency. Exhibit 3-75 uses the U.S. dollar (USD) as the primary currency, and other currencies are listed in relation to it. The "USD ($) Equivalent" column shows how many dollars are needed per one unit of foreign currency; the "Currency per USD ($)" column shows the inverse, or the amount of foreign currency needed to buy one U.S. dollar. Currency dealers provide bid-offer quotes such as €0.8400 - 0.8499/US $, meaning that the dealer would buy or bid one U.S. dollar for €0.84 and sell or offer one U.S. dollar for €0.8499.

TYPES OF BONDS: First mortgage bonds/mortgage bonds

First mortgage bonds/mortgage bonds are secured by real estate. Generally, bonds secured by assets, such as mortgage bonds, are considered to have less risk.

REQUIRED DISCLOSURES: Capital Stock Disclosures

For each class of stock, the organization should disclose the number of shares authorized, issued (fully paid versus not), and outstanding (beginning and ending balances) as well as: -Par value, if any. -Treasury stock held. -Nature and purpose of any equity reserves. -Board actions regarding dividend declarations.

Methods for Effective Benchmarking and Comparison

For effective benchmarking, the project/organization being assessed and the source project/organization must be reasonably comparable. Methods for ensuring a like comparison include common-size financial statements and making adjustments for inflation, historical cost, and accounting methods.

Four Basic Flows that Connect the Entities in a Supply Chain

Four basic flows connect the entities in a supply chain: -Physical materials and services flow from suppliers through the intermediate entities. -Cash from customers flows back "upstream" toward the raw material supplier. -Information flows back and forth along the chain. -There is a reverse flow of products returned for repair, recycling, or disposal.

DISTRIBUTION CHANNEL ACTIVITIES: Product inventory

Helps meet buyers' time-of-purchase and variety preferences

Notable Relations Between Current Asset Accounts or Ratios

Here are a few relationships between current asset accounts or ratios to note: -Accounts receivable turnover should be paired with an accounts receivable aging schedule to determine how long receivables have been outstanding. -Profits drop when inventory increases faster than sales. Increasing accounts receivable combined with stable inventory overall but an increasing finished goods inventory indicates that sales are lagging. Inventory turnover ratios would also be declining.

TWO METHODS OF OBTAINING OWNERSHIP OF AN ORGANIZATION: Asset acquisition

In an asset acquisition, 100% of the investee's assets must be purchased. Acquisition results in the investee ceasing to be a business entity, and all accounts are rolled into the investor's books as a statutory merger or statutory consolidation. -A statutory consolidation results in a new corporation that issues new common stock, replacing both old stocks. -In a statutory merger, one survivor organization keeps its stock and the other subsidiaries convert their stock into shares of the survivor.

Differences Between Job Costing and Process Costing

JOB COSTING -Used with a wide variety of distinct products or services. -Total job costs consist of actual direct materials, actual direct labor, and overhead applied using a predetermined rate or rates. -Costs accumulate by the individual job or order and are tracked separately. -Unit cost is computed by dividing total job costs by units produced or served at the end of the job. PROCESS COSTING -Used with similar or identical products and a more or less continuous flow of units. -Costs are assigned uniformly to all units passing through a department during a specific period. -Costs accumulate by process or department. The flow of costs is simplified because costs are traced to fewer processing departments. -Unit cost is computed by dividing total process costs of the period by the units produced or served at end of the period.

MRO (maintenance/repair/operations) OR SUPPLIES INVENTORY

MRO (maintenance/repair/operations) or supplies inventory includes those supplies required for repairs and maintenance of machinery, computers, and so on.

Capital Budgeting Process Steps

Managers use a capital budgeting process to plan significant outlays on projects that have long-term implications for the organization. Capital budgeting steps include: 1. Identify and define potential projects; define clear boundaries for an investment project. Understand what the project will do and what it will not do. 2. Evaluate and select the projects; analyze project revenues and benefits (both financial and nonfinancial), costs, and cash flows for the project's entire life cycle. 3. Monitor and review the projects selected and make modifications and alterations as new developments warrant.

Costs Associated with Manufacturing Organizations

Manufacturing organizations purchase or extract materials and combine or convert them into new finished goods. A manufacturer must produce goods as well as market them. Because of this, manufacturing organizations have the most complicated costs of the three types of organizations.

Manufacturing Overhead

Manufacturing overhead includes depreciation of factory equipment and buildings, maintenance and repairs of equipment, utility costs, property taxes, supervisor costs, and other costs associated with operating the manufacturing facilities.

INVESTMENT VALUATION RATIOS: Price/earnings (P/E) ratio

Market Price of Stock/Earnings per Share Proportion of a share's price to its earnings. A higher number is better; a declining trend may indicate poor growth potential.

PERIOD COSTS: Marketing or selling costs

Marketing or selling costs. All costs necessary to secure customer orders and get the finished product into the hands of the customer. These include advertising, shipping, sales commissions, and storage costs in shipping warehouses.

Merchandise Organizations

Merchandise organizations (retailers, wholesalers, and distributors) buy goods for resale at markup without changing the basic form of the items.

Mixed Costs

Mixed costs are costs that can change from fixed to variable depending on whether the decision takes place over the short run or the long run.

Expenses

Money spent or liabilities incurred resulting from an organization's efforts to generate revenues from ongoing operations.

ASSET MANAGEMENT RATIOS: Average A/R turnover

Net Credit Sales/Average A/R -Average A/R turnover is the number of times accounts receivable are collected each year. -Average A/R is calculated by finding the average between the current and prior years' A/R. -Increasing A/R turnover indicates effective credit extension and collection processes. -If too high, credit policies may be restricting sales. A declining ratio indicates lax collections or that bad debts need to be written off sooner. A/R at ABC, Inc., are created and paid 5.25 times in the year.

Average A/R turnover formula

Net Credit Sales/Average A/R or rearranged receivables collection period formula Accounts Receivable Turnover Ratio = 365/Receivables Collection Period

Earnings per share (EPS) formula

Net Income - Preferred Dividends/Weighted Average Number of Common Shares Outstanding

Fixed assets turnover formula

Net Sales/Average Net Fixed Assets

Net profit

Net profits are calculated by subtracting interest and taxes from operating profits

Benefits of Normal Costing

Normal costing is used by most organizations because: ---Actual overhead costs are not readily available or cannot be easily allocated within the time frame allowed for period-end statements. ---It helps an organization keep product costs current. ----Using a standard rate for overhead plus actual labor and actual materials costs enables immediate calculation of unit costs. ---It lets an organization smooth out or "normalize" fluctuations in overhead rates in order to have the same cost per unit per level of production from one period to the next.

FINANCIAL STATEMENTS ASSERTIONS: Rights and Liabilities

On a given date, assets are the rights and liabilities are the obligations of an entity.

LESSEE'S PERSPECTIVE TYPES OF LEASES: Operating Leases

Operating leases are generally short-term, pure rental agreements, where the asset and the related liability remain off the lessee's books. (Lease expense is debited and cash is credited.)

Operating profit

Operating profit is net sales less cost of goods sold and operating expenses (also called selling, general, and administrative expenses).

Operating profit margin formula

Operating profit is net sales less cost of goods sold and operating expenses (also called selling, general, and administrative expenses). operating profit/net sales

Activity Based Costing Key Points

Overhead assigned to activities and then units. For cross-departmental processes. Can address nonmanufacturing costs.

Payback Period Formula

PAYBACK PERIOD = Original Investment/Annual Cash Flow

Variable Costing: Product Costs and Period Costs

PRODUCT COSTS Direct materials Direct labor Variable overhead PERIOD COSTS Fixed overhead Selling expenses Administrative expenses

Absorption Costing: Product Costs and Period Costs

PRODUCT COSTS Direct materials Direct labor Variable overhead Fixed overhead PERIOD COSTS Selling expenses Administrative expenses

TYPES OF TAXES: Sales tax

Percentage of the amount paid for some purchases of goods and services. Sales taxes are the most important source of revenue for states. They are credited to a sales taxes payable account (cash is debited) rather than being reported as part of revenue. When the tax is paid, the transactions are reversed. The tax is not reported as an expense.

Period Costs

Period costs are expenses that affect the organization as a whole but cannot be specifically allocated to a product or product line; they are expensed immediately because they cannot be matched against specific revenues.

DISTRIBUTION CHANNEL ACTIVITIES: Service and repairs

Provides essential customer support and service

DISTRIBUTION CHANNEL ACTIVITIES: Risk reduction

Provides mechanisms such as insurance, return policies, and futures trading

DISTRIBUTION CHANNEL ACTIVITIES: Personal selling

Provides sales, product information, and supporting services

ASSET MANAGEMENT RATIOS: Accounts payable turnover

Purchases/Average Accounts Payable -A/P turnover is how many times a company's accounts are generated and paid in a year. -A lower ratio is preferable (as long as accounts are paid in a timely fashion). -To calculate purchases, the cost of goods sold (COGS) is adjusted by the change in inventory (Purchases = COGS + Ending Inventory - Starting Inventory). ABC, Inc., generated and paid its A/P 8.68 times during the year.

INVENTORY COSTS: Purchasing costs

Purchasing costs are the costs of goods acquired from suppliers.

Soft Dollar Savings

Qualitative savings, such as management time or building space

RAW MATERIALS INVENTORY

RAW MATERIALS INVENTORY or cycle stock may be purchased and held for a period in advance of the time it is needed for production.

If the investor has a passive interest (less than 20% ownership):

RECORDED AT: Cost VALUATION: Fair value method: Report unrealized net gain/loss of similar securities in portfolio. UNREALIZED GAINS/LOSSES: --If available-for-sale, record in other comprehensive income and separate component of stockholders' equity. --If trading, record as part of net income. -The investment is recorded at cost. -The investment is valued using the fair value method . -The fair value method compares the cost to each security's market value, and the net gain or loss on all similar securities is recorded to unrealized holding gain or loss and to securities fair value adjustment. -If the shares are available-for-sale (the intended use is flexible), unrealized holding gains and losses are recorded in other comprehensive income and as a separate component of stockholders' equity. -If the shares are held as trading shares (planned to be sold in the near future), they are held at cost on the statement of financial position and gains and losses are recognized as part of net income upon sale.

If the investor has significant influence (between 20% and 50% ownership):

RECORDED AT: Cost adjusted by investor's share of investee's net income/dividends. VALUATION: Equity method: Proportional share of investee's net income/loss, dividends. UNREALIZED GAINS/LOSSES: Not recognized. -The investment is recorded at cost, adjusted every period by the investor's share of the investee's net income and dividends. -The equity method is required. This method acknowledges a relationship with substance between investor and investee. -The investor's proportional share of the investee's net earnings increases the investment carrying amount. -Net losses and dividends paid to the investor decrease the carrying amount. (Dividends reduce the investee's owners' equity.) -Unrealized holding gains and losses are not recognized.

METHODS OF BREAK-EVEN ANALYSIS: Equation Method

REVENUES - VARIABLE COSTS - FIXED COSTS = OPERATING INCOME (USP x Q) - (UVC x Q) - FC = 0 = OI -At the break-even point, operating income is zero. -You should set operating income to zero and inserting the numbers in the equation and solve to get the break-even point for the scenario. -Solve for q (quantity sold)

Who uses financial ratios?

Ratios are a primary decision-making tool for managers (assessment of performance against a standard), lenders, credit reporting agencies, investors, regulators, and others in understanding an organization's risks and returns.

Limitations of Ratios

Ratios do have limitations, for example, the effects of inflation when comparing statements over a long period of time or different organizations using different accounting methods. A primary limitation is that ratios should not be relied upon as a sole decision-making factor but should be combined with nonfinancial data such as consideration of strategy or management talent. Also, the interpretation of ratios may not be entirely objective. People can use numbers selectively to support a preconceived bias, especially where some elements must be adjusted or unexpected variables occur. Furthermore, management tracks ratios themselves and has the power to adjust certain ratios by initiating transactions that may improve the ratio even if the action isn't in the long-term best interest of the organization. For example, if management uses some current assets to pay current liabilities, both numbers will be reduced. If the current ratio was already above 1.0, the result will be an apparent increase and, if below, an apparent decrease. Such equal changes to both numerator and denominator can alter the appearance of a ratio without any actual change in performance. Auditors should be wary of such "window dressing." Comparing statements across national boundaries adds a level of difficulty. Languages and currencies need translating, and accounting practices need to be standardized. Ratios themselves have many variations, and precalculated ratios published in financial statements may not all use the same numerators or denominators. The best course is to recalculate all ratios when comparing statements so that each set of ratios will be based on the same assumptions.

DISTRIBUTION CHANNEL ACTIVITIES: Marketing intermediaries

Reduce the number of transactions for producers and end users

FUNDAMENTAL QUALITIES OF ACCOUNTING INFORMATION: Relevant

Relevant information has feedback and/or predictive value and timeliness. -Information with feedback value helps confirm or correct the results of prior expectations. -Information with predictive value helps in making decisions about past, present, or future events. -Information can have both feedback and predictive value, because learning from past decisions helps managers make better future decisions. -Timeliness is the concept that information must be available at the time the decisions need to be made or it will be of no value.

STATEMENT OF SHAREHOLDERS' EQUITY: Retained Earnings Formula

Retained earnings are the undistributed earnings of the organization, calculated using the following formula. Beginning Balance of Retained Earnings + Net Income (Period Revenue - Period Expenses) - Dividends Declared during the Period = Ending Balance of Retained Earnings Note that revenues less expenses equals net income (net loss). The dollar amount of a cash dividend is deducted from retained earnings (not from additional paid-in capital) at the time the board declares the dividend.

ABC: Two-Stage Allocation

STAGE ONE: Assign overhead (resource) costs to activity cost pools (activities or activity centers) using pertinent resource cost drivers. STAGE TWO: Based on how a cost object uses resources (using pertinent activity cost drivers that measure a cost object's drain on an activity), assign activity costs to cost objects such as products, services, or customers.

Strengths and Weaknesses of Internal Rate of Return

STRENGTHS -Considers time value of money -Easy to compare projects requiring different amounts of investment WEAKNESSES -Assumption of reinvestment rate of return could be unrealistic -Complex to compute if done manually

Stengths and Weaknesses of Net Present Value

STRENGTHS -Considers time value of money -Uses realistic discount rate for reinvestment -Additive for combined projects WEAKNESSES -Not meaningful for comparing projects requiring different amounts of investment -Favors large investments

Strengths and Weaknesses of Accounting Rate of Return

STRENGTHS -Data readily available -Consistent with other financial measures WEAKNESSES -Ignores time value of money -Uses accounting numbers rather than cash flow

DISTRIBUTION CHANNEL ACTIVITIES: Processing and storage

Separates large quantities into individual orders; maintains inventory and assembles orders for shipment

TYPES OF BONDS: Serial bonds

Serial bonds have staggered maturity dates.

Service Organizations

Service organizations provide intangible services to customers (health care, insurance, banking, etc.).

DISTRIBUTION CHANNEL ACTIVITIES: Pricing

Sets the basis of exchange between buyer and seller

Step H—Reversing

Some adjusting entries made to prepare the financial statements need to be reversed as of the beginning of the next accounting cycle.

Statement Interrelationships

Some of these interrelationships -Net income from the income statement (statement of operations) is the starting point for both the statement of shareholders' equity (after prior balance information) and the statement of cash flows. -Totals for each account on the statement of shareholders' equity are used on the statement of financial position. -The final cash and cash equivalents balance on the statement of financial position will tie to the statement of cash flows. -Certain items on the statement of shareholders' equity are also used in the financing activities section of the statement of cash flows. Also, as shown in the walkthrough: -Cash flows from operating activities on the statement of cash flows comprise items listed on the income statement. -Cash flows from investing activities generally comprise changes in long-term assets found on the statement of financial position. -Cash flows from financing activities generally comprise changes in long-term liability and equity items found on the statement of financial position and the statement of shareholders' equity.

Steps in the Acccounting Cycle

Step A—Identification and analysis Step B—Recording in journal (journalizing) Step C—Posting to general ledger Step D—Trial balance and working papers Step E—Adjusting entries and adjusted trial balance Step F—Closing accounts and post-close trial balance Step G—Preparing external financial statements Step H—Reversing

Straight-line Depreciation Formula

Straight-line depreciation per period = depreciable base/estimated service life

TYPES OF BONDS: Subordinate bonds

Subordinate bonds have a lesser claim to cash in a default situation than other bonds.

TYPES OF TAXES: Use tax

Tax that is collected for a particular need, such as a gas tax levied to maintain roads.

TYPES OF BONDS: Term bonds

Term bonds all have the same maturity date.

Accounting for Leases

The FASB issued Accounting Standard Update (ASU) No. 2016-02, "Leases (Topic 842)," which changed lease accounting for reporting on interim periods within a fiscal year. The FASB states that lessees need "to recognize on the statement of financial position the assets and liabilities for the rights and obligations created by those leases." Lessor accounting is largely unaffected. While both operating and capital leases still exist: ---Operating leases with lease terms of more than 12 months need to be recognized on the statement of financial position, with lease payments listed as a lease liability and the asset listed as a right-of-use asset for the lease term. ---Leases of less than 12 months have the option of being recognized as a straight-line expense. The practical result of retaining these two lessee categories is that there will be little change to the statement of cash flows or the statement of comprehensive income (a statement that differs somewhat from the income statement, intended to provide a more holistic view of income).

PROFITABILITY RATIOS: Earnings per share (EPS), complex

The complex EPS ratio is not provided, but it is similar to the basic version except that the denominator also adds various dilutive securities. Companies with dilutive securities must report diluted earnings per share on the income statement so that investors can judge the impact of these items on EPS. A firm may have securities such as preferred stock or bonds that can be converted into common shares at the option of the owner. These securities are considered dilutive because they will increase the number of shares outstanding and therefore reduce earnings per share. Other items that could dilute EPS include the impact of warrants and other options. (Warrants are certificates allowing the holder to purchase stock shares at a set price over a given period of time.)

Depreciable Base

The depreciable base is the asset's original cost less its salvage value.

4 TRANSFER PRICING MODELS: Full cost (absorption) model

The full cost (absorption) model uses the seller's variable cost plus an allocation of fixed costs.

Actual costs

The historical cost paid for goods or services.

What are the keys to successful cost-benefit analysis?

The keys to a successful cost-benefit analysis include verifying that all relevant costs and benefits are considered and properly quantifying them.

4 TRANSFER PRICING MODELS: Market price model

The market price model is a true arm's-length model that sets the internal transfer price for a good or service at the going market price.

Most Basic Supply Chain

The most basic supply chain includes the supplier, the producer, and the customer.

Primary Reasons Organizations Depend on the Lateral Supply Chain

The primary reasons organizations depend on the lateral supply chain include: -To achieve economies of scale. (The potential capacity of a specialist to achieve economies of scale is always greater.) -To improve business focus and expertise. (This can lead to lower pricing and higher quality.) -Because it's possible. (Advanced communication technology has erased many of the barriers to doing business at a distance.)

Reasons for Holding Inventory

The reasons for holding inventory include: -To meet future demand -To cover fluctuations in supply or demand using safety stock (inventory held as a buffer against errors of timing or quantity) -To fill the pipeline (This is called pipeline or transportation inventory; it covers the transportation time for new inventory to reach its destination.) -To hedge against price fluctuations by increasing inventory when prices are favorable and holding back when they aren't -For economies of scale when purchases in large quantities may qualify for discounts that offset the extra cost of holding the inventory

Net Realizable Value (NRV)

The sales price of an asset, usually inventory, less the costs of completion and transportation or disposal that can be predicted within reason

4 TRANSFER PRICING MODELS: Variable cost model

The variable cost model sets transfer prices at the unit's variable cost, omitting fixed costs. This method will lower the selling unit's profits and increase the buying unit's profits due to the low price.

OTHER BOND FEATURES: Sinking fund requirements

These are requirements to invest in a bond sinking fund each period and accumulate enough funds to pay off the bonds at maturity.

FINANCIAL STATEMENTS ASSERTIONS: Existence or occurrence

This assertion regards temporal associations. Assets, liabilities, and ownership exist at a specific date; reported transactions represent events that actually occurred during a defined period.

Step A—Identification and analysis

This step involves determining what internal and external events (including transactions) to record using revenue recognition and matching principles and accounting assumptions. (Nonfinancial data is not recorded.)

Amortize

To allocate acquisition costs of intangible assets to the periods of benefit. It is called depreciation for plant assets and depletion for wasting assets (natural resources).

Calculating Purchases

To calculate purchases, the cost of goods sold (COGS) is adjusted by the change in inventory (Purchases = COGS + Ending Inventory - Starting Inventory).

Benefits of Variable Costing

To fix this and other improper management incentives, an organization may want to use variable costing for internal reporting. Variable costing: -Allows a manager less latitude about what to produce. -Can provide a disincentive for accumulating inventory, such as a percentage carrying charge for all ending inventory. -Emphasizes the impact of fixed costs on profits. -Makes it easier to estimate product, customer, and business unit profitability. -Ties in with cost control methods such as standard costs and flexible budgets.

Credit

To make an entry on the right-hand side of a journal.

Supply Chain Management: International Considerations

To remain competitive, many organizations pursue distribution channels with a global reach. Organizations interested in global expansion: -Study distribution trends and patterns in nations of interest -Explore trends in technology (radio frequency identification, satellite communications), regional cooperatives (the European Union, for example), and transportation services -Assess the likelihood and impact of terrorism or civil unrest -Investigate foreign exchange matters and banking institutions -Determine cost and capital requirements -Evaluate the product or service fit with different distribution strategies

What is traditional budget relevance a function of?

Traditional budget relevance is a function of: -The volatility of the economic environment -The sensitivity of the organization's products and services to changes in its environment -The complexity of the organization

FACTORS TO CONSIDER IN SETTING TRANSFER PRICES: Decentralized Planning Decisions

Transfer pricing affects selling and buying units' incentives. The method used should encourage managers to purchase internally versus externally in ways that are consistent with objectives. Transfer pricing: ---Should help each business unit determine the optimum tradeoff between costs and revenues. ---Should help measure the economic performance of business units. ---Should be simple to understand and easy to administer.

FACTORS TO CONSIDER IN SETTING TRANSFER PRICES: Control

Transfer pricing can ensure that costs are assigned to the business unit managers responsible for them so that the managers are motivated to control the costs.

CATEGORIES OF CAPITAL STOCK: Treasury Stock

Treasury stock is stock that has been reacquired by the company. It is broken out separately because a company cannot "own" itself.

Two Basic Types of Intangibles Exist

Two basic types of intangibles exist—purchased and internally developed. -Purchased intangibles are recorded at their acquisition cost plus any costs required to make the intangible ready for use (e.g., legal fees). -For internally developed intangibles, costs are expensed as they are incurred, including all research and development costs. However, directly traceable costs such as legal fees can be capitalized.

Nondiscounting Models

Two common nondiscounting models include the payback period and the accounting rate of return.

Unit Standard Cost Formula

UNIT STANDARD COST = PRICE STANDARD x QUANTITY STANDARD

LESSEE'S PERSPECTIVE TYPES OF LEASES: Capital Leases

Under Accounting Standards Codification ASC 840-10-25-1 (for U.S. GAAP), a capital lease is any lease meeting at least one of the following capitalization criteria: --The lease transfers ownership of the property to the lessee by the end of the lease term. --The lease has a bargain purchase option allowing purchase at a significantly reduced price. --The lease term spans 75% or more of the estimated economic life of the leased property. --The present value of minimum lease payments, less executor costs, at the beginning of the lease term equals 90% or more of the excess of the fair market value of the leased property over any investment tax credit to be realized by the lessor. Accountants cannot use this criterion for the last 25% of the estimated economic life of the property. -Note that this calculation uses the present value of an annuity due because payments are due at the beginning of each period. -Capital leases are called financing leases under International Accounting Standard (IAS) 17, which defines them as leases that transfer substantially all of the risks and rewards of owning the asset, whether title is or is not eventually transferred.

Equity Investments and Investment Valuation

When organizations purchase equity interests in other organizations in the form of capital or preferred stock, accounting treatment for the investment depends on the amount of influence the investor can exercise over the investee -passive interest (less than 20% ownership) -investor has significant influence (between 20% and 50% ownership) -controlling interest (greater than 50% ownership)

PROFITABILITY RATIOS: Net profit margin

net profit/net sales Net profits are calculated by subtracting interest and taxes from operating profits; net profit margin, therefore, is the portion of sales remaining after covering net profits. It measures the effectiveness of debt, tax management, operations, pricing, and cost controls. Normal net profit margin depends on the industry; a relatively low margin could mean that competitors are forcing price cuts or poor cost controls.

Financial leverage index formula

return on common equity/return on assets

LEVERAGE RATIOS: Financial leverage index

return on common equity/return on assets If the return on assets is lower than the return on common equity, the organization is trading on the equity at a gain, a greater return than the interest related to their fixed cost debts. Shareholders prefer a higher degree of financial leverage, because, if the organization is profitable, the use of the alternate source of funds multiplies their equity investment. However, when the organization is not profitable, their loss is equally magnified. A financial leverage index of 1 would indicate that the return on common equity is the same as the return on assets, meaning that the firm has no debt.

LEVERAGE RATIOS: Financial leverage

total assets/common shareholders' equity -Financial leverage, or trading on the equity, is relative use of fixed interest (debt or preferred stock). -Shareholders prefer a higher degree of financial leverage. -The alternate source of funds multiplies their equity investment, assuming profitable operations. -If unprofitable, the loss is equally magnified. -Generally, invested capital should exceed borrowed capital. -Values over 1 indicate that the firm is using debt efficiently.

DEBT MANAGEMENT RATIOS: Debt ratio

total liabilities/total assets Measures how much of an organization's assets are financed by debt. A lower debt ratio is better, because it implies that relatively fewer liabilities exist. A relatively low debt ratio means that an organization finances its activities more through equity but also relatively low financi

DEBT MANAGEMENT RATIOS: Debt to equity ratio

total liabilities/total equity Measures an organization's proportion of liabilities to equity. A reasonable ratio of debt to equity varies among industries, with capital-intensive organizations generally carrying more debt in relation to owners' equity. Under 100% is desirable.

2. Managerial Accounting

(A) Explain general concepts of managerial accounting (cost-volume-profit analysis, budgeting, expense allocation, cost- benefit analysis, etc.) - BASIC (B) Differentiate costing systems (absorption, variable, fixed, activity-based, standard, etc.) - BASIC (C) Distinguish various costs (relevant and irrelevant costs, incremental costs, etc.) and their use in decision making - BASIC

Depreciation

A method of allocating the cost of tangible assets over the periods of expected use. Includes accelerated, activity, and straight-line methods.

Financial goal for a not-for-profit organization

A not-for-profit organization's goal is to achieve the goals set in the organization's charter in a manner that maximizes the benefits to stakeholders while making the most efficient use of resources possible.

Account

An account is simply a place to record transactions that fit within a specific category (i.e., a "bucket" for those types of transactions).

Intangible Assets

Assets that have no physical substance; exclude financial instruments by definition.

FUNDAMENTAL QUALITIES OF ACCOUNTING INFORMATION: Comparable

Comparable statements reflect the use of standards and techniques similar to those used in other organizations so that real similarities and differences can be differentiated from those caused by divergent accounting rules

General Ledger

Listing of all of an entity's financial transactions, through offsetting debit and credit accounts.

Dividend Decisions

The goal of dividend decisions is to decide what portion of after-tax profit should be distributed to shareholders in the form of a dividend and what portion should be allocated to retained earnings, or the funds used for the sustenance and growth of the organization.

Financial Reporting

The process of presenting information about an entity's financial position, operating performance, and cash flow for a specified period.

Two Different Income Statement Formats

The income statement can be presented in two different formats. -MUTIPLE-STEP STATEMENTS separate operating from nonoperating expenses and deduct the matching costs and expenses from each revenue or income category. Intermediate components of income can be highlighted. -SINGLE-STEP STATEMENTS deduct the total of all expenses from the total of all revenues in a single step, eliminating classification issues. Since this is a common format for IFRS financial statements, an IFRS statement of profit and loss (P&L) and other comprehensive income is presented as an example. (This is how an income statement is referred to in IFRS.)

Capitalize

To record an expenditure that will benefit future periods as an asset rather than treating it as an expense during the period of its occurrence.

Financial goal for a public institution or government

A public institution's or government's goal is to provide the maximum benefits to its constituents while making the most efficient use of resources possible.

Dual-entry/double-entry accounting

An accounting system in which each transaction is recorded in at least two places: a debit to one account and a credit to another account; also known as double-entry accounting.

Closing

The process of transferring account balances from subledgers to trial balance accounts at the end of an accounting period; typically associated with income statement accounts.

Accrual Basis Accounting

An accounting system that records transactions as they occur, recognizing revenue when earned and expenses when incurred, regardless of when the related cash is actually received or paid. -Accrual basis accounting relies on the principles of revenue recognition and matching. -Accrual basis accounting is the accepted norm for most organizations, and it is considered a better indicator of an organization's continuing viability than is cash basis accounting.

Lower of cost or market (LCM)

An asset valuation principle in which "cost" is the original cost and "market" refers to the market-determined asset value, the lower of which becomes the new value.

The Objective of External Financial Reporting

The objective of external financial reporting is preparation of relevant and reliable financial statements that fairly and accurately represent the activities of the organization in accordance with IFRS or U.S. GAAP.

Fiancial Risk Analysis: Types of Risk

Another task of finance is to perform financial risk analysis, which involves measuring, managing, and responding to the organization's exposure to many types of risk, including: -Risks of capital budgeting decisions -Risks related to the ability of others to fulfill their financial or contractual obligations to the organization -Risks from foreign exchange, interest rates, and other international trading risks -Risks derived from the use of complex financial instruments

Financial reporting:

-Provides specific business data (not macroeconomic data). -Includes estimates and judgments. -Is primarily historical. -Is not intended to be used as the sole source of organizational information. -Has a procurement cost.

Dividend payout ratio formula

Cash dividends per share/Earnings per share

Domain 4 Financial Managment (20%)

​​1. Financial Accounting and Finance 2. Managerial Accounting

Hard Dollar Savings

Actual quantitative savings

Keep or Drop Decisions

-A decision to keep or drop a product or service or whether to add a new one is largely determined through relevant cost analysis and the impact the decision will have on net operating income. -Avoidable costs must be distinguished from unavoidable costs. -Only those costs that are avoidable are relevant to consider in the decision analysis. -Once avoidable costs are identified, their associated contribution margin can be determined and the decision to keep, add, or drop a product or service can be made more confidently. -If the avoidable fixed costs saved are greater than the contribution margin amount lost, it will be better to eliminate the segment; overall net operating income should improve. -If the avoidable fixed costs saved are not as much as the contribution margin amount that will be lost, it will be better to keep the product or service.

PENSION TYPES: Defined benefit plan

-A defined benefit plan is more complex, because the employer promises a specific level of benefits starting at retirement. -Actuaries determine the minimum pension liability by calculating the actuarial present value of expected minimum payments to be made upon retirement (actuarial because of compensation for deaths, early retirements, etc.). To do this, they use one of three base measurements of service cost: ---Vested benefit obligation—Benefits are calculated only for vested employees, disregarding future salary increases. ---Accumulated benefit obligation—Benefits are calculated for all employees regardless of vesting, disregarding salary increases. ---Projected benefit obligation—Benefits are calculated for employees regardless of vesting, and future salary levels are accounted for. (This is the preferred method, as it is the most conservative and provides the largest liability balance.) -IAS 19, "Employee Benefits," requires reporting the present value of defined benefit obligations and the plan assets' market value at each statement of financial position date. It encourages the use of an actuary in calculating obligations.

PENSION TYPES: Defined contribution plan

-A defined contribution plan defines the required annual contribution to the plan but makes no guarantee of the ultimate benefit level paid. -Contribution formulae reflect years of service and other factors such as profit sharing. -The employer's annual pension expense equals the calculated required contribution. -A liability is recorded only if the employer fails to fund the plan to this level. -An asset is recorded for overpayments.

Post-Audit of Capital Projects

-A key element of the capital investment process is a follow-up analysis once the capital project has been implemented. -A post-audit compares the actual benefits of the investment with the projected benefits and the actual operating costs with the projected operating costs. -The post-audit evaluates the overall outcome of the investment, and auditors propose corrective action if necessary. -It is important that auditors take into account that the assumptions driving the initial analysis might be invalidated by changes in the actual operating environment.

Lease

-A lease is a contract providing a lessee (renter) with less than total interest in a property or good owned by the lessor (the lender of the item). -The lessor provides the lessee with specific rights in exchange for periodic payments. -The GAO study mentioned elsewhere includes lease accounting issues in the category of cost and expense recognition, which is one of the most common reasons for required restatements. -Therefore, internal auditors need to be able to determine if leases are properly categorized.

Make or Buy Decisions: Considerations When Outsourcing

-A make or buy analysis of relevant costs plays a key role in the decision to outsource, but there's more to successful outsourcing than potential profit margins. -Organizations also need to evaluate the qualitative factors of dealing with an external supplier. -These include an external supplier's ability to: ---Ensure on-time delivery and a smooth flow of parts, materials, and services ---Maintain acceptable quality control

Master Budget

-A master budget is a summary of an organization's plans that sets specific targets for sales, production, distribution, and financing activities over a year, an operating period, or a shorter duration. -It generally culminates in a cash budget, a budgeted income statement, and a budgeted statement of financial position. -It sets quantitative goals for all operations, including detailed plans for raising capital for long- and short-term investments. -The master budget is a map showing where an organization is heading. If it is properly designed, it will show the company heading in the same direction as the company's strategy and long-term plan.

ABC: Activity Cost Driver

-A measurement of the amount of an activity used by a cost object. -Activity cost drivers assign costs in cost pools (batch, lot, product, facility, or unit) to cost objects. -An example of an activity cost driver is the number of labor hours required for the activity of performing set-up for a particular product.

Merchandizing Organization Budget

-A merchandising organization does not have a production budget. -Instead, the production budget is replaced by a merchandise purchases budget, which shows the amount of merchandise an organization needs to purchase during the period (one such budget for each item in stock). -Instead of budgeted production in units, as shown in Exhibit 3-91, the last items in a merchandise purchase budget are budgeted purchases.

TYPES OF TYPES OF PARTNERSHIPS AND MERGERS: Partnerships

-A partnership (business type) is an association between two or more persons or corporations to be co-owners in a business for profit, such as a law firm. -General partnerships carry unlimited personal liability for the actions of all partners; limited liability partnerships (LLPs) limit liability to each partner's own actions. -A joint venture is an agreement between two separate organizations to accomplish a single project together.

Sales Forecast

-A sales forecast is a subjective estimate of the future sales of an organization's products or services. -Without an accurate sales forecast, all other budget elements will be inaccurate. -Many organizations generate several independent sales forecasts from different sources such as marketing, managers, and the sales department. Forecasters consider: ---Historical sales trends ---Economic and industry condition indicators ---Competitors' actions ---Rising costs ---Pricing policies ---Credit policies ---Amount of advertising and marketing ---Unfilled back orders

Special Order Decisions

-A special order pricing decision involves a one-time opportunity to accept or reject an order for a specified quantity of a product or service. -Determining whether to accept or reject a special order request involves evaluating profitability based on relevant and opportunity costs and capacity utilization. If there is excess capacity—more than enough to cover the order—the organization needs to identify variable costs associated with the special order that are not normally incurred. These are relevant costs, and they determine the break-even price. If the price offered for the special order is greater than the unit cost, the order is profitable and should be accepted. For example, this could be a manufacturer with a supply chain issue who will buy a large number of units but only if a special bulk price is offered. Given the excess capacity, even a discounted price will create more net income than leaving the capacity idle (if unit costs are covered). If the firm is operating at or near capacity, the break-even price is the normal sale price. When there is no excess capacity, a special order should be taken only if the offered price exceeds the normal sale price. A firm must also consider the opportunity costs of accepting the order and evaluate whether doing so would result in the loss of other more-profitable sales. In the same bulk purchase example, full price would be offered because taking the order would require turning away other full-price customers.

TYPES OF TYPES OF PARTNERSHIPS AND MERGERS: Special purpose entities (SPEs) or variable interest entities (VIEs)

-A special purpose, or variable interest, entity is a subsidiary created by the parent company to perform a specific task, often part of an off-balance-sheet accounting arrangement. -Many organizations have misused SPEs, such as Enron's use of multiple SPEs to hide massive amounts of debt. Enron also needed to divert income to failing SPEs, a liability unknown to shareholders. -Internal audit activities should include SPEs in their audit universe and periodic risk assessments. FASB ASC 810-10-15 includes provisions for the use of SPEs.

TYPES OF TAXES: Excise tax

-A specific cash amount levied on a particular commodity, such as liquor. -Excise taxes are based on the quantity, not the value, of the product purchased.

Supply Chain

-A supply chain (sometimes referred to as a logistics network) is a global network used to deliver products and services from raw materials to end customers through an engineered flow of information, physical distribution, and cash. -A supply chain can most accurately be viewed as a set of linked processes or business cycles that take place in the extraction of materials for transformation into products or services for distribution to customers. -These processes are carried out by the various functional areas within the organizations that comprise the supply chain.

Absorption Costing

-Absorption costing (also known as full costing) is a method of inventory costing in which all variable and fixed manufacturing costs are included as product costs; thus inventory "absorbs" all manufacturing costs. Absorption costing: ---Uses a gross margin format on an organization's income statement. ---Is the format required for external financial reporting. ---Highlights the differences between manufacturing and nonmanufacturing costs. ---Treats each finished unit as having absorbed its share of the fixed manufacturing costs. ---Defers fixed manufacturing costs in ending inventory to future periods. Under absorption costing, if more units are bought than sold (inventory is increasing), net income will be higher than under variable costing, because fixed manufacturing costs are all sitting in inventory.

Accelerated Depreciation Methods

-Accelerated depreciation methods have a steadily decreasing charge so that assets are depreciated quickly in early years, which can match the use patterns of many assets. -Items that have increasing maintenance costs will have more balanced total costs if an accelerated depreciation method is applied.

Historical Cost Versus Fair Market Value

-According to the principle of historical cost, using the values actually paid or received is more reliable than estimates of current value. For example, until an asset is actually sold, its value to the organization remains uncertain. Aside from the high cost of constantly reassessing the values of all assets and liabilities, such a practice would allow for easier manipulation of the financial statement elements. The alternative is presenting the fair market value of the items, as is applied to most short- and long-term securities not intended to be held to maturity (available-for-sale or trading account securities) with readily determinable market value(s). -Fair value, or fair market value, is the amount an asset could be acquired (or sold) for or a liability incurred (or settled), assuming willing parties that are not involved in a liquidation. For nonmonetary exchanges of assets, the fair value is the current market value of either the asset given up or the asset received in an exchange, whichever is easier to determine.

Common Accounting Terms Used in Financial Accounting and Finance

-Accounting -Accrual Basis Accounting -Amortize -Assest -Chart of Accounts -Capitalize -Closing -Credit -Debit -Depreciation -Dual-entry/double-entry accounting -Equity -Expenses -Financial statements -Fiancial reporting -General Ledger -Impairment -Intangible Asset -Journal Entry -Ledger -Liability -Lower of cost or market (LCM) -Minority Interests -On-top Adjustments -Statement of cash flows (balance sheet) -Statement of shareholders' equity -Statement of financial position -Trial balance

REQUIRED DISCLOSURES: Accounting policies and valuation methods used

-Accounting policies where more than one method is available should be disclosed. -These include valuation methods for inventory; depreciation methods; property, plant, and equipment; and other items involving estimates. -Disclosure requirements include the accounting method used, the method of valuation, balances by class of assets, and basic assumptions made.

Accruals

-Accruals are either accrued revenues, which are earned revenues yet to be received as cash, or accrued expenses, which are incurred but unpaid expenses. -When unrecorded accruals exist, the revenue and related asset accounts as well as the expense and related liability accounts will be understated. -For accrued revenues, the adjustment will debit (increase) the asset account (e.g., interest receivable) and credit (increase) the revenue account (e.g., interest revenue). -For accrued expenses, the relationship will be the same, except that it will involve the expense and liability accounts.

Accumulation Costing Systems

-Accumulation costing systems accumulate costs and assign them to a particular cost object such as a product or service. -Organizations typically use one of two basic types of accumulation costing systems when they need to assign costs to products and services: job costing or process costing. -Many organizations have custom costing systems that are neither purely job costing or purely process costing but involve elements of both.

Normal Costing Key Points

-Actual cost for direct materials and direct labor but predetermined rate for overhead. -At year end, actual overhead reconciled with applied overhead.

STATEMENT OF SHAREHOLDERS' EQUITY: Additional paid-in capital

-Additional paid-in capital is the difference between par value and the amount actually paid for a share of stock when the stock is issued. (It is unrelated to later trading of shares on the stock market.) It is also called contributed capital.

BUDGETING APPROACHES: Activity-based Budgeting

-An activity-based budget (ABB) focuses on activities. -ABB proponents feel that traditional budgeting, which focuses on departments or products, obscures the relationship between costs and outputs by oversimplifying the measurements into volume drivers like labor hours, machine hours, or outputs for an entire department. -ABB adds activity-based cost drivers, such as the number of set-ups in an operation, to make a clear connection between resource consumption and output. -This allows managers to see how resource demands are affected by changes in offerings, product designs, manufacturing processes, market share, and customer base.

Annuities

-An annuity is a security that requires periodic payments in equal amounts per equal time periods and in which the interest is compounded over the same interval. -An example is a mortgage. -An ordinary annuity requires payment at the end of each period, while an annuity due requires payment at the start of each period. -Due to compounding, these annuities will result in differing values over time. -The present and future values of annuities can be calculated using spreadsheet formulas, manual formulas, or present and future value tables of an ordinary annuity/annuity due.

Budgeting

-An effective budgeting system serves two primary functions in an organization: planning and control. A budget is a detailed plan that helps an organization deal with uncertainty and the future. -It is key to helping an organization achieve specific goals and objectives. -To accomplish organizational goals over the short and long terms, a budget must be aligned with an organization's strategy. This helps match the organization's strengths with opportunities in the market. A budget also: -Sets standards that can control the use of an organization's resources and motivate employees. -Provides a process of checks and balances on the actions of people within the organization who are accountable for different aspects of the budget. This ensures that all parts of the organization are working together to achieve the organization's objectives.

PROCESS COSTING: Steps in Preparing a Departmental Production Report

-Analyze the physical flow of production units; determine beginning work-in-process (WIP) inventory and all units that enter the production department during an accounting period. Also determine units that are complete and transferred out from the department or are in the WIP inventory at the end of a period. -Analyze the physical flow of production units; determine beginning work-in-process (WIP) inventory and all units that enter the production department during an accounting period. Also determine units that are complete and transferred out from the department or are in the WIP inventory at the end of a period. -Determine total costs to account for; these include current costs incurred and the costs of the units in WIP. -Compute unit costs; costs per unit are calculated for overall costs as well as for direct materials, direct labor, and factory overhead. -Assign total manufacturing costs; these are assigned to units completed and transferred out during the period and units still in process at the end of the period.

Continuous Budgeting

-Another popular budgeting method is continuous budgeting (also called a rolling budget), which is a 12- to 18-month budget system that rolls forward one period (month, quarter) as the current period is completed. -As each period ends, the upcoming period's budget is revised and another period is added to the end of the budget. -This system has the advantage of keeping managers focused on the future at least one year ahead and ensures that the budgets reflect changes in the operating environment. -Budgeting is a regular monthly task.

Direct Costs

-Any costs that can be easily and accurately traced to a cost object (usually direct labor and direct materials). -Direct materials are those that become an integral part of the finished product and that can be physically traced to it. -Direct labor costs are those that can be easily traced to individual units of product.

Sunk Costs

-Any costs that have already been incurred and that cannot be changed by any decision made now or in the future. -These are not differential costs and should be ignored when making a business decision.

Cost object

-Any object that can have a cost applied to it and can be used to determine how much a particular thing or activity costs. -These include products, services, customers, projects, departments, and activities.

TYPES OF TAXES: Ad valorem tax

-Any tax for which the tax base is the value of a good, service, or property. -Sales taxes, tariffs, property taxes, inheritance taxes, and value-added taxes are different types of ad valorem tax.

Two methods of obtaining ownership of an organization

-Asset acquisition -Stock acquisition

Asset Disposal

-Assets can be voluntarily disposed of through sale, exchange, or abandonment or through involuntary conversion, such as a fire. -Depreciation is prorated for the portions of the years that assets are depreciated to the dates of disposal. -The depreciated book value of a disposed asset will not always equal its value at disposal, because depreciation is primarily a method of cost allocation and the salvage value is an estimate that was made in the past. -The gain or loss on disposition is an adjustment to correct net income over the period the asset was depreciated. -These gains or losses are displayed on the income statement as part of normal operating activities unless it is a business segment being disposed of. -Business segments would need to report the results of continuing and discontinued operations in separate accounts. -Losses from involuntary conversion may be reported as extraordinary items if criteria are met. -Auditors reviewing asset disposals will be interested in the adequacy and effectiveness of internal controls over these disposals.

TYPES OF TAXES: Property tax

-Based on the value of taxable property, including residential housing, farms, factories, and business equipment. -Local governments rely heavily on property taxes.

Bonds

-Bonds are debt instruments that can be raised from or issued by lenders, governments, or companies. -They are the most common type of long-term asset or liability on the statement of financial position. -A bond indenture (agreement) will detail the bond issuer's promise to pay a sum of cash at a set maturity date plus a specific rate of periodic interest on the face value. -The face value, or par value, of a bond is the amount owed at maturity. -Interest on bonds can be a fixed, or less commonly, a floating rate, with usually semiannual annuity payments, or it can be set at zero.

Similarities Between Job Costing and Process Costing

-Both systems assign material, labor, and predetermined overhead costs to products and provide a mechanism for computing unit product costs. -Both systems use the same basic accounts, such as manufacturing overhead, raw materials, work-in-process, and finished goods. -The flow of costs through the accounts is basically the same in both systems.

Main similarity and difference between absorption costing and variable costing

-Both variable and absorption costing expense all nonmanufacturing costs (both fixed and variable) in the period in which they occur. -The only difference between the methods is how they account for fixed manufacturing costs.

Key Processes within Supply Chain Management

-CUSTOMER RELATIONSHIP MANAGEMENT (CRM) -CUSTOMER SERVICE MANAGEMENT involves managing details related to the product service agreements worked out during the CRM process. The central task of this process is to keep customers satisfied and loyal, thus reducing the risk of loss of market share. -DEMAND MANAGEMENT keeps demand and supply in balance to avoid the risks of unnecessary accumulations of inventory or stock shortages. This is accomplished through demand forecasting and tracking technologies. -ORDER FUFILLMENT involves delivering the right product or service at the right time in the right amounts. This is primarily a logistics function and also involves the ability to determine customer needs and build infrastructure required to source, make, and deliver the desired goods. Customer satisfaction may depend on ensuring the highest level of quality in order fulfillment possible (while remaining cost-effective). -MANUFACTURING FLOW MANAGEMENT facilitates producing all the required products in quality condition on schedule. This involves the logistics team ensuring that supplies arrive when they are needed from suppliers. It also means that the sales and operations team must develop schedules that fit sales and production requirements and remain consistent with available capacity. -SUPPLIER RELATIONSHIP MANAGEMENT (SRM) -PRODUCT DEVELOPMENT AND COMMERCIALIZATION involves successfully developing new products or services and then marketing them. It depends on excellent relationships with both suppliers and customers. The CRM team identifies the needs of customers. The SRM team develops relationships with suppliers who can reliably deliver quality materials. And finally, the research and development team designs the product or service with the needs of manufacturing, logistics, purchasing, and sales in mind.

Break-even Analaysis

-CVP analysis can be used for break-even analysis. -Break-even analysis is an important analysis to assess how various "what-if" decision alternatives will affect operating income. -The break-even point is the output level at which total revenues and total costs are equal. ---Below the break-even point, there is a loss. ---At break-even, operating income is zero. ---Above the break-even point, operating income levels are profitable

CVP Analysis: Opportunity Costs

-CVP analysis is also used for planning purposes. -Because of that, it is important to measure the opportunity costs of any investment decision. -The cost of using noncash or cash resources to make a product or develop a service should reflect the alternative use of those resources as well as the forgone interest (the opportunity cost) of the cash used to make the investment. -If cash is borrowed, the interest expense should be included in the analysis.

CVP Model Equations

-CVP analysis is based on a model of the relationships among its three factors—costs, revenues, and profits—and it tracks how they change as the volume of activity changes. The CVP model is: PROFIT = TOTAL REVENUE - TOTAL COST or, equivalently, since total costs include both variable- and fixed-cost elements: REVENUES = FIXED COSTS + VARIABLE COSTS + PROFIT -Replacing revenues with the quantity of units sold times the unit selling price and replacing variable cost with unit variable cost times the quantity of units sold, the CVP model is: UNIT SELLING PRICE x QUANTITY SOLD = FIXED COSTS + UNIT VARIABLE COST x QUANTITY SOLD + PROFIT The symbolic form of the model is: USP x Q = FC + UVC x Q + OP Where: USP is the unit selling price. Q is the quantity sold. FC is the total fixed cost. UVC is the unit variable cost. OP is the operating profit (profits not including unusual or nonrecurring items and income taxes)

Future Value of a Single Sum

-Calculating the future value of a sum that is invested for a certain number of periods at a given interest rate involves a formula that factors in the interest rate (or likely earnings rate of a business venture) and the number of periods. In actual practice, this calculation is often done in a spreadsheet application using preset formulas. -This allows the practitioner to simply enter the input values needed and determine the answer. -Alternatively, a "Future Value of a Single Sum" table can be used, as shown in Exhibit 3-85, which calculates the future value of one monetary unit against multiple time periods and interest rates. -Multiplying any present value by the amount in the table will result in the same answer as if a future value formula is used. -Note how all amounts are greater than 1.0, which means that future value is always higher than the initial present value.

Present Value of a Single Sum

-Calculating the present value of a single sum similarly could use a spreadsheet formula or involve manual calculations that require knowing the interest rate and the future value. -Another way would be to multiply the principal amount by the appropriate amount in Exhibit 3-86. -Note how all the values are less than 1.0, which means that the present value or value today will always be less than the future value.

Features of Relevant Costs

-Can be either fixed or variable costs, but they are often variable because they differ for each option and have not already been committed. -Depend on changes in supply and demand for resources. -Are avoidable; they can be eliminated in whole or in part by choosing one alternative over another. -Are oriented toward the future. -Are focused on short-term decisions. -Are different for each alternative choice. -Should include opportunity costs—the benefit given up when one alternative is selected over another.

Advantages and Disadvantages of Negotiated Price Transfer Pricing Model

-Can be the most practical when significant conflict exists. -Need negotiation or arbitration rules, which can reduce autonomy. -Potential tax problems.

Capital Budgeting

-Capital budgeting involves investment. Investments include stocks and bonds, facilities, inventory, equipment, research, and hiring and training staff. -They all require a commitment of funds in the present with the expectation of future returns through additional cash inflows or reduced cash outflows.

Statement of Cash Flows Uses

-Cash is a primary short-term measure of success -Ability to repay debt -Growth strategy -How fiananced -Cash misappropriated? -Net income is the primary long-term measure of success; cash flow is the primary short-term measure, especially for small or young companies. Positive net income but poor cash flow can still bankrupt an organization. The net increase or decrease in cash is a key liquidity measure. A low cash balance at any point is cause for concern because the organization may not be able to meet immediate obligations. -Creditors and other users examine cash flow from operating activities because organizations are better able to repay debt over the long term if they are generating funds for these payments from their operations. Firms that have to borrow more or attract more equity investment to provide cash for debt service may be in a downward cycle. -Cash flows from the investing activities section of the statement can highlight major capital expenditures or, in other words, the organization's potential and strategy for long-term growth. The cash flow statement can also show if and where cash misappropriation may have occurred. The third section, cash flows from financing activities, can show whether a company's growth is financed more through operating profits, debt, or equity.

REQUIRED DISCLOSURES: Change in Accounting Policies

-Changes in accounting policies must be disclosed, including an explanation by management of why the new method is preferable. -Departures from GAAP or IFRS should be noted.

Step F—Closing accounts and post-close trial balance

-Closing is the process of reducing all temporary or nominal accounts to zero so they are ready to be reused. -On the income statement, such accounts include revenue and expense accounts by subcategory, such as sales or interest revenue accounts or expense accounts such as cost of goods sold or selling and administrative expenses. -The accounts are closed to an income summary account. -Revenues are debited and income summary credited; expenses are credited and income summary debited. -Assuming that revenues exceed expenses, net income or a credit balance would exist, and this balance is transferred from income summary to retained earnings. -The post-close trial balance is an adjusted trial balance prepared after closing to show that debits and credits of the real accounts (assets, liabilities, and equity) are equal.

Consolidated Financial Statements

-Consolidated financial statements present the results of operations and the financial position of a parent and its subsidiaries as if they were a single entity. -The subsidiaries can remain as legally separate entities. -Adjusting entries could be required to reverse entries made by one organization and not another.

Contingencies

-Contingencies are situations or circumstances with an uncertain potential for gain or loss, called gain or loss contingencies; they are tied to certain future events that may or may not occur. -Auditors must determine completeness, or whether all contingencies are recognized. -Following the accounting principle of conservatism, loss contingencies are recorded but gain contingencies are not.

Required Disclosures

-Contingent liabilities -Subsequent events -Contractual Obligations -Accounting policies and valuation methods used -Capital Stock Disclosures -Off-balance-sheet accounting (OBSA) -Other liabilities

Cost Behavior

-Cost behavior describes manager predictions of how certain costs will behave in response to changes in the level of business activity. As the activity level rises or falls, a particular cost may rise, fall, or remain constant. -For example, a manager at a manufacturing company who expects sales to rise by 10% next year will need to know how that will affect the total costs budgeted for the factory. - For example, the amount of raw materials and labor will increase, but the factory building itself won't expand, nor will a new custodian or secretary be necessary. -For accurate budgeting, the manager needs to understand the behavior of the costs affected. -To discern which costs will change and by how much, costs are often categorized as variable, fixed, or mixed. -All three cost patterns are found in most organizations.

Types of Responsibility Centers

-Cost centers generate costs (expenses, no or few revenues, a net cost) -Revenue or profit centers generate profit (revenues, expenses) -Investment centers make investments (revenues, expenses, investment return)

Cost Measurement (Allocation) Systems

-Cost measurement (allocation) systems apply costs to the appropriate products, jobs, or services. -Three cost measurement methods: ---Actual costing ---Normal costing ---Standard costing -The primary difference among these costing methods is the approach each takes to assigning or allocating overhead costs (all production costs other than direct materials and direct labor) to cost objects. -Allocation is necessary because overhead costs are not traceable to individual cost objects.

Typical Capital Budgeting Decisions

-Cost reduction. (Should new equipment be purchased to reduce costs?) -Expansion. (Should a new plant be acquired to increase capacity and sales?) -Equipment selection. (Which machine would be the most cost-effective to buy?) -Lease or buy. (Should new equipment be leased or purchased?) -Equipment replacement. (Should old equipment be replaced now or later?)

Cost-benefit Analysis

-Cost-benefit analysis is a managerial accounting analytical tool to assess the positive and negative consequences of a proposed action and find a balance between the benefits and the costs of specific actions. -It quantifies all of the positive factors (benefits) and subtracts all of the negative factors (costs). -The difference between the two indicates whether the planned action is advisable. -Cost-benefit analysis can include both quantitative and qualitative factors. -However, it often works best when most of the costs and benefits can be reduced to financial terms for ease of comparability.

Goals of Supply Chain Managment

-Create net value for customers and other key stakeholders. This is accomplished by building a competitive infrastructure, leveraging worldwide logistics, synchronizing supply with demand, and measuring performance globally. -Manage supply chain risks, including risks to the availability or quality of suppliers and the goods and services they supply as well as to the proper distribution of goods and services to customers. Each of the supply chain management processes discussed next plays a role in supply chain risk management.

Current Assets

-Current assets include cash and cash equivalents, inventory, and accounts receivable.

Liquidity/short-term debt ratios list

-Current ratio -Cash ratio -Quick ratio -Net working capital

Debt management ratios

-Debt management ratios include various ways of measuring the degree of financial leverage and debt coverage. -Essentially these show how much debt is in use and repayment risk.

Debt management ratios list

-Debt ratio -Debt to equity ratio

Description of Depreciation

-Depreciation is a method of allocating the cost of tangible assets over the periods of expected use. -It is a way of showing that assets decline in value over time, which is why land is not depreciated, because, unlike the buildings on the land, land rarely declines in value. -Depreciating an asset starts with the original cost and then moves on to determining the asset's depreciable base. -The depreciable base is the asset's original cost less its salvage value. -Salvage value is the estimated value of an asset if it is sold at the end of its depreciation period or service life. -Salvage value can be zero. -The service life of an asset differs from its functional life because service life includes not only wear and tear but also the economic viability of the asset due to obsolescence.

Investment valuation ratios

-Determining the value of an investment actively traded on an exchange (i.e., stock market) can use long-term debt and dividend ratios. -Other methods to value an investment include residual income and Economic Value Added (EVA®). (Neither of these are covered in these materials.)

Distribution Channel Decisions and Challenges

-Developing an overall channel strategy -Comparing costs of using intermediaries to achieve wider distribution -Determining channel membership (types of distribution) -Monitoring and managing channels -Determining whether to use direct and/or indirect channels (direct to consumer and/or indirect via a wholesaler) -Determining the number of marketing channels -Determining the length of the channel (levels of distribution) -Determining who should control the channel -Determining which types of intermediary should be used -Deciding whether electronic distribution should be used -Deciding whether it makes sense (in terms of cost) to keep inventory in the pipeline

Difficulties with Benchmarking

-Difficulties can arise when trying to find a benchmark organization due to the wide differences even among companies supposedly in the same industry. -Many organizations are highly diversified or own multiple subsidiaries that have nothing to do with a particular industry. -On the other hand, industry averages are available for most industries, but these are what they imply—a point halfway between the best and worst performers, not an ideal state. -Benchmarking close competitors may be more appropriate.

Acceptable Methods of Disclosure

-Disclosures are sometimes referred to as footnotes or notes. -They are acceptable if made either in the body of the statements (parenthetical explanations), as footnotes, or as notes appended after the statements.

Discounting Models

-Discounting models recognize the time value of money, including that projects promising earlier returns are preferable to projects promising later returns. -Discounted cash flow decision-making models include net present value and internal rate of return.

Economic Exposure

-Economic exposure is the risk that fluctuations in exchange rates will affect the future cash flows or value of the organization. -Measuring economic exposure requires determining the cash inflows and outflows for each currency. -Then an organization can work to reduce the total number of cash flows through means such as consolidating payments or matching cash inflows to cash outflows denominated in the same currency.

Factors Influencing Channel Design

-End-user purchase location preference -Product or service characteristics (complexity, features, service requirements, etc.) -Manufacturer's core capabilities and resources (Smaller producers will have more channel constraints.) -Required functions (what is necessary to move the product or service from the producer to the customer, such as storage, transportation, and servicing) -Availability, experience, and skills of intermediaries

3 Methods of Break-even Analysis

-Equation method -Contribution margin method -Graph method

Equivalent Units in Process Costing

-Equivalent units are a way of addressing how to account for WIP inventory in process costing -In job costing, partially completed units have a cost already attached to them. -In process costing, these values are more difficult to determine because costs are assigned to processes and departments, not jobs or items -Since product cost is calculated by determining the cost per unit in each department, partially completed units must be factored into these calculations. -At the end of a period, it is necessary to estimate what percentage of units remain incomplete—still on the production line or in work-in-process inventory. -An equivalent unit (EU) is a measure of the amount of work done on partially completed units expressed in terms of how many complete units could have been created with the same amount of work in the period under consideration. -To calculate equivalent units, the number of units that are partially complete is multiplied by the estimated percentage that are complete overall: EQUIVALENT UNITS = NUMBER OF PARTIALLY COMPLETED UNITS X PERCENTAGE COMPLETION For example, direct labor on 100 pairs of tennis shoes that is 90% complete would total 90 equivalent direct labor units. Equivalent units are calculated separately for direct labor, direct materials, and overhead because one category might be more complete than another for the same product. Equivalent units of production can be measured using the weighted average method or the first-in, first-out (FIFO) method.

How does overhead work in normal costing?

-Estimated overhead can be found by dividing budgeted annual overhead costs by budgeted volume or activity levels. -Overhead is applied throughout the year by multiplying the predetermined overhead rate by the actual amount of the allocation base used. -Finally, at the end of the year, actual overhead costs are reconciled with applied overhead. Typically, the difference is not large, and the variance can be disposed of by: ---Adding to or subtracting from the cost of goods sold account for the period. ---Prorating the net difference between the current period's applied overhead balances in the work-in-process inventory, finished goods inventory, and cost of goods sold accounts.

REQUIRED DISCLOSURES: Subsequent Events

-Events that occur after the statement of financial position date (usually the end of the fiscal year) but before the financial statement issuance date should be disclosed if material (i.e., useful to users), for example, the sale of a plant. -Subsequent events could be additional information that affects the estimates used in preparing the financial statements. -If the condition existed at the statement of financial position date, the statements are adjusted; if after the statement of financial position date, a footnote disclosure is made.

Tax Base and Tax Rate

-Everything a taxpayer earns, spends, and owns is called the tax base. - Taxes are most often levied as a percentage of the tax base (a percentage of a taxpayer's income or a percentage of the value of a good, service, or asset). -This percentage is called the tax rate.

Challenges in Inventory Management: Excess Inventory

-Excess inventory is a key waste to eliminate. In order to find the lowest overall cost for inventory, organizations use various inventory decision models to determine when and how much inventory to order or manufacture. -Balancing these costs is important. With larger order quantities: --Holding costs tend to go up, since more inventory is held on average. --Set-up or order costs tend to go down, since they respond to economies of scale. -Some organizations practice lean or just-in-time manufacturing, which focuses on the reduction or elimination of waste in all areas, especially inventory.

Exchange Rate Risk

-Exchange rate risk is the volatility of exchange rates between an organization's primary currency and any currencies used by its subsidiaries and trading partners. -The main uncertainty is the actual amount of money that will be exchanged.

Variable (direct) Costing Key Points

-Expenses fixed overhead as a period cost. (Absorption treats it as a product cost.) -Used when contribution margin format is desired on the income statement (for internal use) -Ties in well with standard costing

Fiscal Policy

-Fiscal policy refers to a government's use of taxes and spending to achieve its macroeconomic goals. -Fiscal policy can be discretionary—a deliberate action taken by Congress to control a swing in the economy, or it can be nondiscretionary—long-term policy that has the built-in tendency to exert a correcting action on economic swings.

Fixed Costs

-Fixed costs are the portions of the total cost that remain constant regardless of changes in the level of activity over the relevant range (see below). -An espresso machine has the same monthly rental fee whether it makes 12 cups that month or 120. -Fixed costs are independent of the level of production. -Rent, depreciation, insurance, property taxes, supervisory salaries, administrative salaries, and advertising are examples of fixed costs. -However, the following items are important to understand with regard to fixed costs: ---Very few costs are completely fixed. Most will change if there is a large enough change in activity (i.e., above or below the relevant range). ---The RELEVANT RANGE is the range of activity within which the assumptions about variable and fixed costs are valid. This is expressed as specific cost drivers for a specific duration of time. For example, a U.S. $500-per-month espresso machine has a relevant range of 0 to 1,000 cups per month. Above 1,000 cups per month, fixed costs step up to a new fixed level (e.g., U.S. $1,000/month for two machines). -Fixed costs create confusion when expressed on a per-unit basis because the average fixed cost per unit increases and decreases inversely with changes in activity. For example, the average fixed cost per cup of coffee will fall as more cups are sold, because the monthly rental cost of the machine will be spread out over more cups. Conversely, the average cost per cup will increase if fewer people buy coffee.

Net Present Value (NPV) Example

-For example, David's Cafe is considering purchasing a new espresso machine. The machine will cost U.S. $5,000, will last for five years, and will have zero scrap value at the end of its life. It will reduce labor costs by U.S. $1,800 per year due to fewer hours needed during peak times. David's Cafe requires a minimum pretax return of 20% on all investment projects. -Should the manager buy the new espresso machine? -The manager must determine whether the U.S. $5,000 cash investment now is justified. While the total cost savings is U.S. $9,000 (5 × U.S. $1,800), the cost reductions must also yield at least the 20% return (called the discount rate), or the company should invest the money elsewhere. -The present value of an annuity of U.S. $1,800 at the end of each period for five periods at 20% is U.S. $5,383. This is usually calculated using a spreadsheet formula, but a manual calculation or a "Present Value of an Ordinary Annuity" table (available in the Resource Center) could be used instead. The factor from the table for 20% for five periods is 2.9906. 1800 x 2.9906 = $5,383 NPV = 5,383 - 5,000 = 383 -David's Cafe should buy the new machine. The project's return exceeds the discount rate. Whenever the NPV is zero or greater, an investment project is acceptable.

Keep or Drop Decisions: Example

-For example, given a product line made up of four different products (e.g., cranberries, juice, sauce, and jelly), it is generally unwise to drop one of the products from the sales mix based solely on a recent net operating loss. -Instead, a manager should attempt to distinguish between traceable fixed expenses (e.g., jelly canning stations) and common fixed expenses for the product (e.g., cranberry harvesting). -The traceable fixed expenses are potentially avoidable costs if the product is dropped. -The common fixed expenses are unavoidable costs and will remain whether the product is dropped or kept.

Process Costing Key Points

-For highly automated/repetitive production -Accumulates costs by process or department -Unit cost = total process cost for period/units

When can acitvity based costing systems be helpdul?

-For tracking costs when organizations have expanded into multiple products and/or products that use varying amounts of resources (raw materials and other direct costs and also indirect costs such as customer service, quality control, and supervision) -When the cost of inaccurate costing data exceeds the added costs of collecting more information and implementing an ABC system -When strategic decision making includes product pricing decisions, allocation of funds, and process improvement

Job Costing Key Points

-For unique jobs that use unique resources -Can use actual, normal, or standard costing Unit cost = total job costs/units.

Future Value

-Future value is the value of an investment at a particular date in the future assuming that compound interest is applied. -Compound interest is the interest computed against the principal plus any previous accrued interest.

Auditing a Statement of Financial Position: General ledger Reconcilements

-General ledger reconcilements are typically considered a key control in overall ICFR. Each statement of financial position account should require periodic reconcilement by management (at least monthly but potentially on a more frequent basis if needed based on the nature of the account). -The reconcilement process and resident controls should receive direct assurance coverage emphasis by auditors. -The items on the statement of financial position would also be confirmed by contacting banks for cash balances, customers for accounts receivable, note makers for notes receivable, and so on.

Goodwill

-Goodwill arises when one entity (the parent company) gains control over another entity (the subsidiary company) and is recognised as an asset in the consolidated statement of financial position. -Under IFRS 3, Business Combinations, goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised. -Goodwill is not amortised but must be tested annually for impairment.

PROFITABILITY RATIOS: Gross Profit Margin

-Gross profit equals net sales minus the cost of goods sold (net sales - cost of goods sold). It is the money remaining from sales revenues after deductions for the direct costs of sales. -Gross profit margin is the proportion of net sales minus cost of goods sold to net sales. -When organizations are compared, a higher ratio indicates more effective management of pricing and control of costs. -For the organization's profitability over time, a rising trend indicates increases in operational efficiency. This ratio relates sales to production costs. -For each dollar of sales, ABC, Inc., generates U.S. $0.49 in gross profit.

Whay can cost-benefit analysis identify?

-Hard dollar savings (actual quantitative savings) -Soft dollar savings (qualitative savings, such as management time or building space) -Cost avoidance (elimination of future costs)

Cost Centers Manger Responsibilities

-Has fewest responsibilities because department generates little or no revenue and has control over few assets. -Must control costs through efficient use of resources. Rewarded for minimizing total costs without sacrificing quality. -Success at removing unfavorable cost variances and analyzing favorable variances is often tied to compensation.

3 CLASSIFICATIONS OF TAX: Progressive

-High-income taxpayers pay a larger fraction of their income than do low-income taxpayers. -The U.S. federal tax system is progressive.

COMMON-SIZE FINANCIAL STATEMENTS: Horizontal

-Horizontal common-size financial statements express the results for the same organization over several periods as a percentage of a base year, with other years shown as the percentage increase or decrease from the base year. -Each account is set at 100% for the base year. -Horizontal statements help determine how an organization is changing over time, because the percentages simplify analysis over use of currency amounts. The basic equation for percent change is: Current year - Prior year/Prior year

IFRS and the Statement of Comprehensive Income

-IFRS has five financial statements—including the statement of comprehensive income. -The statement of comprehensive income displays other comprehensive income and builds off of the income statement. -Sometimes this statement is combined with the income statement. -According to IAS 1, "Total comprehensive income is the change in equity during a period resulting from transactions and other events, other than those changes resulting from transactions with owners in their capacity as owners."

What does responsibility accounting do?

-Identifies responsibility centers based on the extent of a manager's responsibilities -Holds managers responsible for deviations between budgeted goals and actual results -Encourages managers to correct unfavorable discrepancies and to communicate feedback to higher management regarding sources of favorable and unfavorable discrepancies -Links specialized responsibilities and knowledge to specific performance measures -Personalizes cost accounting information by taking the perspective of personal control

Steps of Job Costing

-Identify the job by a unique code or other date-specific reference method. -Trace the direct costs for the job. -Identify indirect cost pools associated with the job (overhead). -Choose the cost allocation base (cost drivers) to use in allocating indirect costs to the job. -Calculate the rate per unit of each cost allocation base. -Assign cost to the cost object by adding all direct and indirect costs (based on a combination of machine and labor hours).

COST MEASUREMENT METHOD: Standard Costing

-In a standard costing system, costs are assigned to products using quantity and price standards for direct materials, direct labor, and overhead using a predetermined (standard) rate. -Manufacturing, service, food, and nonprofit organizations all make use of standard costing to some extent. -Standard costs are the expected or target costs for cost objects. -Establishing standards is the joint responsibility of operations, purchasing, personnel, and accounting. -Historical data, organizational policy, market expectations, strategy, time and motion studies, and activity analysis also play a role. -Standards are the benchmark or norm for measuring performance. -They can be set at an ideal level to encourage a higher level of performance or set at a currently attainable level.

Depreciation in the Statement of Financial Position

-In a statement of financial position, depreciation of the enterprise's assets may be reflected in a line titled "Net property, plant, and equipment." -Net PPE is calculated by subtracting accumulated depreciation from fixed assets, yielding net fixed assets

Taxes

-In the United States, the federal income tax accounts for nearly 42% of federal revenues. -It is imposed on incomes of individuals and organizations and is paid on all types of income, including wages, salaries, dividends, interest, rents, and capital gains.

LESSOR'S PERSPECTIVE 4 TYPES OF LEASES: Direct financing leases

-In these leases, the lessee uses the lease to finance the purchase of an asset. -The lessor keeps title to the asset, but the transaction is otherwise similar to a loan with the asset as collateral. -To qualify, the sales price of the asset must equal the cost of the asset. -Therefore, the lessor recognizes only interest revenue.

Indefinite Life Intangible Assets

-Indefinite life intangibles are expected to contribute to cash flows for an indefinite period because they are not restricted by contract, law, or regulation to a finite life. -Indefinite life intangibles (e.g., goodwill) are not amortized but are instead tested for impairment annually using the fair value test. -If the fair value is less than the carrying amount of the intangible, then the asset is impaired by this amount and should be written down.

TYPES OF BONDS: Industrial Revenue Bonds

-Industrial revenue bonds are tax-exempt bond issues by state or local governments to finance public projects. -They are not backed by the full faith and credit of the government.

REVENUE CYCLE: Substantive Tests

-Internal auditing for the sales and collection cycle includes substantive testing of transaction-level controls. -This is because revenue is received in many forms in this cycle and internal auditors provide assurance that the transactions are complete, accurate, and properly recorded, that payments are credited to the correct customer accounts, and that cash and goods are not misappropriated. -Depending on internal audit engagement objectives, internal auditors may test five financial statement control assertions.

REVENUE CYCLE AUDIT TESTS: Cash Receipts

-Internal auditors typically review the cash receipts journal when testing the adequacy and effectiveness of internal controls around the receipt of customer payments, depositing payments in bank accounts, and the proper recording of transactions in the accounting records. -Internal auditors can use observation to validate their understanding of these processes and control points, as there should be proper segregation of duties between: ---Mail room activities. ---Handling of cash receipts. ---Recording the related accounting entries. -Internal auditors may examine remittance advices, deposit tickets, bank statements, and postings to cash receipts journals and the related customer subsidiary accounts receivable ledgers. -Internal auditing should perform audit tests designed to detect fraud related to cash receipts. -Auditors may perform a "proof of cash" to validate that cash received was deposited to the organization's bank account and that transactions were properly recorded in the accounting records. -Other controls include the following: ---Vacation or rotation of duties policies are enforced. ---Checks are prelisted and restrictively endorsed. ---Statements are transmitted each month. ---Deposits and batches are reconciled. ---Customer correspondence and returned statements are part of document retention practices. -Note that credit card payments are not handled the same way as other accounts receivable. This is because the creditor is actually the bank issuing the card. Payments, less the bank fee (which must be recorded as an expense), are quickly collected electronically, thus becoming cash receipts.

COST MEASUREMENT METHOD: Normal Costing

-Normal costing is the most widely used method of costing. -It solves the problems associated with actual costing. -A normal costing system applies actual costs for direct materials and direct labor to a job, process, or other cost center and then uses a predetermined rate to assign overhead. -This rate is based on the predetermined factory overhead application rate and the activity of a cost driver or allocation base of the cost center.

International Accounting Standards Board (IASB) and International Financial Reporting Standards (IFRS)

-Internationally, the most significant standards-setting body is the International Accounting Standards Board (IASB), an independent private-sector body formed from the accountancy bodies of numerous countries. -The IASB is responsible for developing the International Financial Reporting Standards (IFRS), a set of standards required or permitted for use by over 115 countries as well as the European Commission. -The objective of the IASB when forming the IFRS was to create harmony among the regulations and accounting standards related to financial reporting across national boundaries. -In addition to comparability issues, multinational organizations needing to prepare financial information in multiple countries want to avoid the multiplication of costs in preparing different reports for each country. To partly alleviate this issue, in the U.S., the Securities and Exchange Commission (SEC) now allows foreign private issuers listing on U.S. exchanges to report using only IRFS.

Absorption (full) Costing Key Points

-Inventory absorbs all fixed and variable manufacturing costs -Required for external financial reporting

Perpetual Inventory Accounting vs Periodic Inventory System

-Inventory accounting is performed either on a perpetual basis, which keeps a continuous record of inventory changes as they occur, or by using the periodic inventory system, which determines only the inventory on hand at the end of a period by physical count. (This method is obsolete and is not addressed further in this text.) -Most computer-based systems are perpetual. They can reflect the changes to the cost of goods sold account, inventory control account, and all subsidiary ledger inventory accounts instantaneously and simultaneously.

Inventory Management

-Inventory management focuses on reducing the costs of holding and transporting inventory without sacrificing customer service. -Successful inventory management requires a systematic approach combined with accurate record keeping.

Inventory Valuation

-Inventory valuation is important to internal auditing because it is an estimate that can be manipulated with material effect on the financial statements. -The inventory cycle is related to the warehousing cycle; the former records the related costs while the latter records the physical flow of goods. -Controls should address both.

Investment center

-Investment centers make investments (revenues, expenses, investment return) -EXAMPLES: Usually contain several profit centers and can be primarily focused on either internal or external investments

Limitations of Absorption Costing

-It allows managers to manipulate operating income simply by increasing production. -It can encourage managers to increase inventory even if no additional demand exists if a bonus or some other incentive is tied to operating income. -It can encourage managers to produce items that absorb the highest fixed manufacturing costs instead of what is best for the company.

Benefits of ABC

-It reduces distortions caused by traditional cost allocation methods -It gives managers access to relevant costs -It measures activity-driving costs, which allows managers to assess how overall cost and value are affected -It normally results in substantially greater unit costs for low-volume products than is reported under traditional product costing. This results in better decision making regarding whether or not to add or drop a product line.

Limitations of ABC

-It requires numerous development and maintenance hours to implement and use, even with new software and databases -It does not relate all overhead costs to a particular cost driver and may need to be arbitrarily allocated. -It generates a tremendous amount of data, and managers can be misled into concentrating on the wrong data -Its reports do not conform to GAAP, so it may not be used as an external reporting system

ACCUMULATION COSTING SYSTEMS: Job Costing

-Job costing (also called job-order costing) is a costing system that assigns costs to a specific job (a distinct unit, batch, or lot of a product or service). -Job costing is used when many different products are made each period and each unique job uses a different amount of resources. -Job costing systems are often used by manufacturing organizations for capital asset construction such as roads, houses, and airplanes. -In the service sector, job costing is used in medical and legal organizations, advertising agencies, and repair shops. -In the merchandising sector, it is used for custom items and special promotions.

Key Controls of Revenue Cycle/Sales and Collections Cycle

-Key controls in the sales and collections cycle may include proper segregation of duties, proper authorizations, use of proper documents that are prenumbered if appropriate, and use of proper internal verification procedures. -Since most sales and collections activities use electronic systems, often a key audit objective is to determine that IT general controls (ITGC) are working effectively. -It will be difficult to rely on the specific application controls given deficiencies in ITGC, such as access controls. -In enterprise resource planning systems or systems that perform a similar function for sales and collections, internal auditors also examine the customer master file and the transaction history file when performing comparisons. -While most controls in the sales and collections cycle relate to transactions rather than specific account balances, management may employ: -High-level detective controls and selected analytical review procedures (such as interest and fee-based income/expense yield analyses) for reasonableness monitoring related to account balances. -Analytical procedures to provide substantive reasonableness monitoring support. -For those controls that are proven to be operating effectively, the tests of details regarding these controls can usually be reduced. -This can lower audit costs without sacrificing audit quality. A check of any unusual transactions is often appropriate to make sure they were approved and reported.

TYPES OF SUPPLY CHAIN MANAGEMENT: Lateral or Horizontal Integration

-Lateral or horizontal integration is the favored approach to managing the supply chain. -It is difficult for one company to have the expertise necessary to excel in all elements of the chain. -Various aspects of a business are outsourced, and the challenge becomes synchronizing the activities of a network of independent organizations.

TYPES OF TAXES: Payroll tax

-Levied directly on wages and salaries. -This is the second most important source of federal revenue.

Limited Life Intangibles

-Limited life intangibles are not expected to be used indefinitely (e.g., high annual expense or projected obsolescence), are attached to wasting resources (e.g., rights to use a mine), or are bound by law or contract to a finite life (or renewal is prohibitively expensive). -Limited life intangibles amortize their cost over the period of expected use. (Amortization is analogous to depreciation, except that it is used for intangible assets.) -Like tangible assets, limited life intangibles can have a residual value if they can be sold at the end of their use, and this amount would not be amortized. -The system used to determine the amortization amount per period should reflect the asset's pattern of consumption. -Each period's amortization amount is treated as an expense by crediting the proper asset account or a separate accumulated amortization account per asset class. -Limited life intangibles are tested for impairment by means of a recoverability test. -If the sum of expected future cash flows from the asset is less than the carrying amount, an impairment exists and a write-off of the impaired amount is required. -Different methods are used to measure the loss.

Liquidity/short-term debt ratios

-Liquidity ratios primarily show an organization's ability to pay its short-term obligations without undue hardship. -For each of the liquidity or short-term debt ratios discussed below, the higher the ratio, the stronger the liquidity.

Make or Buy Decisions

-Managers are often faced with the decision to make a particular product (e.g., a component of a product) or offer a service internally or to buy it from an outside vendor (outsourcing). -Reaching a decision about whether to make or buy generally involves comparing the relevant cost to make the item internally with the cost to purchase it externally. --If the relevant costs are less than the purchase price, the decision should be to keep production inside. --If the outside purchase price is less than these avoidable costs, the logical decision is to outsource.

Product costs differ for manufacturers, merchandisers, and service providers

-Manufacturers consider only the costs needed to complete a product to be product costs (direct materials, direct labor, and overhead). -Merchandise companies buy their goods in a finished state. Their product cost is whatever they pay for the products purchased, including freight costs. These are typically charged into a single inventory account called merchandise inventory. -Service companies have little or no inventory. The service organization treats the inventory that does exist as if it were a manufacturer or a merchandise organization, depending on which is applicable.

Distribution Channel Activities

-Marketing intermediaries -Product inventory -Transportation -Financing -Processing and storage -Advertising and sales promotion -Pricing -Risk reduction -Personal selling -Service and repairs

3 COMPONENTS OF MASTER BUDGET: Financial Budget

-Matches sources of funds with uses of funds in order to achieve the goals of the organization. -It includes budgets for cash inflows, cash outflows, financial position, and operating income.

Intangible Assets Description

-Monitoring, valuing, and auditing intangibles can be a challenge, because many details of intangibles are subject to interpretation or estimation. -Intellectual property (IP) such as patents is a key area for internal audit attention because cost and expense recognition could be improperly recorded. -Intangible assets have no physical substance; financial instruments are excluded by definition. -While financial instruments get their value from their claim on resources, intangibles get their value from the benefits and rights the organization gets from their use. -Two basic types of intangibles exist—purchased and internally developed. -Intangibles can have either a limited or an indefinite life.

Step B—Recording in journal (journalizing)

-Most transactions affect two or more accounts. For example, a sale creates a reduction in inventory and an increase in sales, accounts receivable, and cost of goods sold. -Transactions may be recorded in a journal, which is totaled and posted to the general ledger at regular intervals. -Journal accounts include a general journal plus journals for cash receipts, cash disbursements, purchases, and sales. -Journal entries consist of a debit, a credit, a date, a journal entry identification number, a description, and an approval. Journal entries should be supported by original source documents.

Leverage ratios

-Much as a physical lever multiplies the amount of force applied, financial and operating leverage are ways to multiply gains from equity or fixed costs. -However, they also increase risks.

Net Cash Flows from Operations

-Net cash flows from operations is net income converted from an accrual to a cash basis to show the cash effects of transactions, omitting any investing or financing items. -Net income includes items that don't involve actual cash transactions, such as depreciation, and these noncash revenues and expenses must be removed. -Paper gains and losses refer to gains and losses that have no effect on operating cash flows in the current period. -An increase in current assets such as accounts receivable would be subtracted from net income because, under accrual accounting, these revenues are included in net income even though there was not the same increase in cash.

4 CAPITAL INVESTMENT DECISIONS: Net present value (NPV)

-Net present value (NPV) is the present value of a project's cash inflows minus the initial investment. -The project's return exceeds the discount rate. -Whenever the NPV is zero or greater, an investment project is acceptable.

OPERATING BUDGETS - SUPPORTING BUDGETS:Selling and Administrative Expenses Budget

-Nonmanufacturing expenses are often grouped into a single budget called a selling and administrative expenses budget. -Sales expenses are included in this category, because they are not allocated to production processes but must be expensed in the period in which they occur.

REQUIRED DISCLOSURES: Off-balance-sheet accounting (OBSA)

-OBSA methods allow organizations to acquire funds without having to report a related liability on the statement of financial position. -For example, two or more organizations may jointly create a subsidiary for the sole purpose of financing a project. -The subsidiary takes out a construction loan that is cosigned by the parent companies. -Proceeds from the project are used to repay the loan. -The parent companies don't need to record the debt on their statements of financial position, improving the look of their statements from a high level. -Despite the fact that all OBSA methods used are required to be disclosed in the notes to the statements, allowance of such methods can potentially reduce the usefulness of the statement of financial position for analysis.

Make or Buy Decisions: Producing things in house

-Often an organization will have a lower relevant cost to produce something in house when it involves a core competency (a strategic advantage). -For example, say an organization's customers demand same-day delivery. -An organization with an existing fleet of local delivery vehicles might have or might develop a core competency in this area, but only if it can expand its services for a lower cost than existing specialists in this area. -If the specialists can do the service for less (or with higher quality), then they have the core competency and it should be leveraged if the service is offered.

OPERATING BUDGETS - SUPPORTING BUDGETS: Production/Merchandise Purchases Budget

-Once the desired level of sales is determined, the production budget is created to satisfy the expected demand. -The production budget is the plan for acquiring resources and combining them to meet sales goals and maintain a specific level of inventory. -It is calculated by adding budgeted sales to the desired ending inventory minus the beginning inventory. -Inventory levels should be kept as low as possible without constricting sales. -The production budget must also take into account: ---Policies on stable versus flexible production schedules to minimize finished inventories. ---Conditions of production equipment. ---Availability of production resources such as materials and laborers. ---Experience with production yields and quality.

Operating Budgets

-Operating plans and budgets are financial plans for the future; they identify organizational objectives and the actions needed to achieve them. -Operating budgets are plans that identify needed resources and the way these resources will be acquired for all day-to-day activities, including sales and services, purchasing, production, and finished goods inventories as well as marketing and research and development. -The ultimate outcome of the operating budgets is a pro forma or budgeted set of financial statements. -The operating budget consists of a budgeted income statement plus supporting budgets.

Foreign Currency Transactions

-Organizations conducting international trade or those with branches or subsidiaries located in other countries will likely need to conduct transactions in multiple currencies. -This results in the need for foreign currency exchange and also raises issues of valuation for multinational organizations due to currency fluctuations between the primary and other currencies. -For example, consider the situation of a U.S. company's investment in a European venture denominated in euros. -If the value of the euro declines relative to the U.S. dollar, the value of the U.S. company's investment would decline as well. -International taxation and other legal and political factors also must be accounted for but are not covered here,.

Budget Period

-Organizations usually prepare budgets for a set time period. -A typical budget is established for the one-year period that corresponds to the fiscal year of an organization. -Annual budgets are often broken down into quarterly and monthly time periods to give managers regular opportunities to compare actual data with budgeted data. -This process can highlight any problems and allow managers to remedy them more quickly.

Capital Structure: Two Basic Sources of Funding:

-Owners and outside investors—Money from owners and investors is called equity financing; this includes common stock, preferred stock, and retained earnings. -Lenders (including suppliers who extend credit to the organization)—Borrowed money, called debt financing, is funds that have to be repaid, often with interest. It grants no ownership interest and can include bank loans or bonds.

Types of Taxes

-Payroll tax -Corporate income tax -Sales tax -Use tax -Value-added tax (VAT) -Property tax -Ad valorem tax -Capital gains tax -Excise tax

Pensions

-Pensions are deferred employee compensation to be paid during retirement. -A pension fund serves as a legally separate intermediary between the sponsor (the employer) and the beneficiaries. -Organizations record pension expense over the duration of the employee's service. -Two basic types of plans are defined contribution plans and defined benefit plans.

Period costs

-Period costs (also called operating expenses or nonmanufacturing costs) are all the expenses that cannot be included in product costs and must be expensed in the period in which they occur. -Costs that cannot be reasonably allocated to a specific product are expensed (and not inventoried) because they are not expected to provide measurable future benefits. -Period costs include marketing or selling costs, and administrative costs

CATEGORIES OF CAPITAL STOCK: Preferred Stock

-Preferred stock has both debt and equity qualities. -Organizations have no obligation to repay the principal amount (equity quality). -Although preferred stock usually has a fixed dividend (debt quality), the organization is not obliged to pay the dividend unless it is declared. -If a preferred dividend is declared, the dividend can go into arrears. -The organization must pay the arrears before paying any common stock dividends. -Preferred stock is rare; some organizations have authorized preferred shares, but few issue them.

Internal auditors can use financial ratios and analysis procedures at many points:

-Prior to an engagement, ratios can help determine areas of greatest risk. -During an engagement, ratios help to evaluate data to support engagement results. ---From a substantive testing perspective, internal auditors can use analytical review procedures to compile support and evidence regarding the reasonableness of select stated account balances or financial statement line items. ---The scope of analysis should match the risk assessment and significance of the area and the availability and reliability of the data. -At the end of an engagement, ratios can help as a reasonableness test.

When is process costing appropriate?

-Process costing is appropriate for highly automated, repetitive processes where the cost of one unit is identical to the cost of another, such as paint, newspapers, food, or chemicals. -In the service sector, check conversion and postal delivery organizations use process costing as do services like medical treatments and beautician services. -In the merchandising sector, process costing systems are used for items such as magazine subscription receipts.

Product Costing

-Product costing is the process of accumulating, classifying, and assigning direct materials, direct labor, and overhead costs to products and services. -The way in which a product or service is costed can have a substantial impact on reported net income and key management decisions.

What are product costs?

-Product costs (also known as inventoriable costs or manufacturing costs) are those costs associated with the manufacture of goods or the provision of services. -These costs are assigned to inventories and are considered assets until the products are sold. -At the point of sale, product costs become cost of goods sold on the income statement. -They are catregorized as PRIME COSTS and CONVERSION COSTS.

Investment Centers Manager Responsibilites

-Profit center manager role plus the right to expand or contract operations. -Responsible for investments, costs, and revenues. -Responsible for reviewing and approving capital budgeting, including investments such as R&D as well as temporary and long-term investments for capital preservation, return on investment, and strategic investment. -Can request more funds to increase capacity, develop new products, and expand geographically. -Performance measures are more difficult to identify because of the individualized nature of responsibilities of the manager and lack of control over many aspects of his or her operations. Strategic investments are evaluated for their fit with organizational strategy.

Profitability ratios

-Profitability ratios measure an organization's earning power. -They help judge operating performance (sales versus related expenses), leverage, and risk. -Gross, operating, and net profit margin are three measures often compared. For example, say that compared to industry averages over several years, gross profit margin has been holding steady but operating profit margin and net profit margin have been declining. The cause must be from indirect costs, since gross profit equals net sales less cost of goods sold while operating profit and net profit deducts cost of goods sold and a number of indirect items.

BUDGETING APPROACHES: Project Budgeting

-Project budgets are used when a project is completely separate from other elements of an organization or is the only element of a company. -This includes projects like a movie or an aircraft. -Project budgets are also used for smaller projects. -When these projects use resources and staff that are committed to an entire organization, care must be taken that the project budget links to appropriate responsibility centers.

The Accounting Cycle

-Quarterly and annual external financial reports are the result of the period-end financial reporting process, which is the critical end point of what is called the accounting cycle. -The accounting cycle includes entering transaction totals into the general ledger; initiating, authorizing, recording, and processing general ledger journal entries; and recording recurring and nonrecurring consolidating adjustments, combinations, and classifications.

Four Basic Types of Inventory

-RAW MATERIALS INVENTORY or cycle stock may be purchased and held for a period in advance of the time it is needed for production. -WORK-IN-PROCESS (WIP) INVENTORY consists of raw materials that have been only partly transformed into their finished state or yet-to-be installed components. For accounting purposes, WIP is an account holding all inventory in production but not yet complete as of the statement of financial position date. -FINISHED GOODS are products that are ready to purchase. -MRO (maintenance/repair/operations) OR SUPPLIES INVENTORY includes those supplies required for repairs and maintenance of machinery, computers, and so on.

GAAP - Principles of Two Main Categories

-RECOGNITION involves the timing and measurement of financial items accounted for. -DISCLOSURE requires inclusion in the financial statements or their notes of descriptive nonfinancial elements that, if omitted, could be misleading.

Return on investment (ROI) ratios

-ROI is simply return divided by investment. -Any amount greater than 1.0 indicates a positive return. -There are many common variations on ROI, depending on how the numerator and the denominator are defined.

Under perpetual inventory accounting:

-Raw material and merchandise purchases are debited to inventory -Each sale includes a debit to the cost of goods sold account and a credit to inventory -Discounts, freight-in, and returns and allowances are included in the inventory account

Point-of-Sale Recognition

-Recognition at the point of sale is usually straightforward, but some exceptions exist. -A repurchase agreement is the sale of product or inventory with an agreement to buy back the goods in the future. -If a repurchase agreement has set prices that cover the temporary buyer's total costs, the inventory and matching liability stay with the seller. -When this isn't the case, revenue could be recognized until the time of buyback.

Other Challenges in Inventory Management

-Reducing variability in the quality, amount, and timing of supply deliveries -Reducing production cycle times -Maintaining production equipment to ensure availability on demand -Improving demand forecasting

Relevant Costs

-Relevant costs are costs yet to be incurred (future costs); they are also differential costs (costs that differ for each option available to the decision maker). -'Relevant costs' can be defined as any cost relevant to a decision. A matter is relevant if there is a change in cash flow that is caused by the decision. -If a cost is in the past, it is a sunk cost. -If a cost will be the same regardless of the alternative selected, it is irrelevant.

Research and Development

-Research and development (R&D) consists of research, which is a methodical process or search designed to discover new knowledge, and development, which is the use of research to develop new processes and products or significantly improve existing ones. -Incremental improvements to processes or products are not considered to be R&D. -U.S. GAAP prescribes expensing R&D costs as they are incurred; IFRS prescribes capitalizing R&D costs. -R&D is not considered an intangible asset. If materials, PPE, or purchased intangibles are used in R&D, they are expensed unless they have an alternative future use, in which case they are treated as normal inventory, PPE, etc. -Personnel and contract services are always expensed. -Indirect costs are expensed to the extent that they can be reasonably allocated, except general and administrative costs, which are expensed as R&D only if clearly related.

Responsibility Centre Performance Measures

-Return on investment (ROI)—Divides the profit (excluding interest expense) of an investment center by the total assets of the investment center. -Residual income/Economic Value Added (EVA)—Calculates the difference between an investment center's profits or operating income and the opportunity cost of using assets. -Transfer pricing—Recognizes the interactions of different responsibility centers through the system of pricing products or services transferred within the same organization. -Productivity—A ratio measuring output against input. Revenues, market share, and operating costs. -Profitability analysis—For products, business units, and customers. -Benchmark values—From other managers or organizations. -Critical success factors—Specific measurable goals that must be met to achieve an organization's strategies; include both financial and nonfinancial measures.

Recognition After Delivery

-Revenue is recognized after delivery when there is no reasonable assurance that cash collections will equal the sale price. -Two methods of deferring revenue are the installment sales method and the cost recovery method.

When is revenue usually recognised?

-Revenue is usually recognized at the point of sale (i.e., at delivery), because only then is it realized or deemed realizable and earned. -Some situations can allow recognition at other times.

Revenue or profit center

-Revenue or profit centers generate profit (revenues, expenses) -EXAMPLES: Sales departments, bank branches, restaurants and retail shops

Income Statement (Statement of Operations) Uses

-Revenues - Cost of Goods Sold (COGS) = Gross Profit -Performance "bottom line" -Creditworthiness -Past performance, benchmarked against competitors -Future performance potential and risk levels of meeting future cash flows, also benchmarked against competitors.

Risks Related to Financial Reporting Objectives

-Risks related to financial reporting objectives should form the basis for the majority of internal controls, such as risks of erroneous valuation, incomplete disclosure, overstatement of assets, or fraud (e.g., misrepresentation). -Reliable financial reporting is the key internal control objective because of its importance not only in satisfying legal and regulatory issues but also in ensuring efficiency and stewardship over the organization's resources.

What accounts capture relevant data from the revenue cycle/sales and collections cycle?

-Sales -Cash receipts -Sales returns and allowances -Allowance for doubtful accounts -Bad debt expenses -Charge-off of uncollectable accounts Internal auditors examine transactions posted to each of these accounts as well as sales recorded in the sales journal and accounts receivable subsidiary ledger to determine whether key controls are operating effectively.

Operatng Budgets: Supporting Budgets

-Sales -Production/merchandise purchases -Direct materials -Direct labor -Overhead -Cost of goods sold -Selling and administrative expenses budgets.

Revenue can be recognized when the sale occurs only if:

-Sales aren't on consignment. -Prices are easily determined. -The payment obligation cannot be revoked by theft or loss. -It isn't part of a transfer payment. -Return levels can be estimated.

Sell or Process Further Decisions

-Sell or process further decisions concern selling a product or service before an intermediate processing step or deciding to add further processing and then sell the product or service for a higher price. -Common examples include decisions to: ---Add features to a product to enhance functionality ---Improve the flexibility or quality of a service ---Repair defective products so they can be sold at the normal sale price -For sell or process further decisions, it is profitable to continue processing a product or service as long as the incremental revenue received (the revenue attributable to the added processing) exceeds the incremental processing costs. This is a function of the relative demand for each product.

Profit/revenue Centers Manager Responsibilities

-Since profit margin is a function of both revenue and costs, manager is responsible for generating revenues and controlling costs. -Responsible for both cost and pricing of products. -Can decide what products to produce, the quality level, and marketing. -Limited to specific use of assets; no control over investments. -Primary performance measures are the profit generated, quality, and customer satisfaction.

Limitations of the Statement of Cash Flows

-Since the statement of cash flows can be prepared in two different ways (direct or indirect), the statements may be difficult to compare. -When the direct method is used, a separate schedule is required to reconcile net income to cash flows from operating activities. These statements can also become complex when items such as the following are included: -Allowance for doubtful accounts used for accounts receivable -Purchase of short-term available-for-sale securities (reducing cash but not net income) -Material noncash transactions (included only in the notes) -Gains from sale of assets (deducted to avoid double-counting of the gain)

Step E—Adjusting entries and adjusted trial balance

-To show the correct application of the matching and revenue recognition principles on the financial statements, accountants make adjusting entries so that expenses and their related revenues are matched to the same period. -Because of the nonstandard nature of most adjusting entries, such entries may require added assurance coverage or emphasis from auditors in terms of assessing ICFR. -Adjusting entries include recurring adjusting journal entries such as depreciation and amortization as well as accruals and prepayments.

Statement of Shareholders' Equity (Retained Earnings) Uses

-Sources of equity increase: operations or investment? -Beginning and ending equity shows prospects and priorities -Dividend information -Comparing equity at the end of the period to the beginning of the period can help form a picture of the organization's prospects and priorities. -If equity increased in the period, what was the primary source of that increase? New shares? Profitable operations? -Similarly, financial statement users sometimes study a company's dividends over time. -Regular dividends are considered the norm, so abnormal decreases or lack of dividends in particular years can be perceived negatively by the market.

REVENUE CYCLE AUDIT TESTS: Sales

-Specific documents that are generated in the sales cycle and that may need to be examined include customer purchase orders, sales orders, credit applications, picking sheets, bills of lading or other shipping documents, invoices and remittance advices, cash receipts journals, bank statements, and monthly billing statements. -Audit procedures for such documents include tracing a transaction forward or vouching backward to associated records and accounts. For example, vouching sales entries back to shipping documents could reveal nonexistent sales or possible duplicate sales. -Auditors should note that further testing may be required to determine if shipments were made to nonexistent customers. Independent verification of a customer's existence may be necessary, as accounts receivable generated from sales to phantom customers may be written off as uncollectable accounts.

Subsidiary accounting depends on whether the subsidiary uses the parent's reporting currency or the local currency of the primary economic environment:

-Subsidiary uses parent's reporting currency as its functional currency. The statements must be remeasured using historical exchange rates for the period. Remeasurement uses the temporal method, in which all nonmonetary balances or statement of financial position accounts other than cash, claims on cash, or obligations to pay cash as well as their associated expenses must be remeasured. -Subsidiary uses the local currency of the primary economic environment as its functional currency. The current rate method is used to translate the statements. This method translates all assets and liabilities using the exchange rate as of the statement of financial position date, while paid-in capital accounts use the historical exchange rates for the period.

Financial Accounting: Internal Audit's Role

-Supporting management's assessment of Internal Controls over Financial Accounting -Coordinating coverage and reliance efforts with external auditors and other assurance providers. -Note that while external audit is the primary type of auditor for financial accounting and reporting, internal auditors can and often do play a major assurance role on the financial accounting and reporting side as well.

Customer Relationship Management (CRM)

-The CRM process encompasses activities designed to locate customers, assess their potential needs, and determine the products and services necessary to build and maintain a loyal customer base. -During the CRM process, cross-functional teams (e.g., product design, operations, finance, and other areas) work with customers to: ---Determine their product and service needs and develop product service agreements (PSAs) that define the nature of those relationships. ---Improve order and delivery processes and reduce unpredicted variation in demand.

INVENTORY VALUATION METHOD: Moving Average Cost

-The average cost method is called the "moving" average when applied to perpetual inventory. -The moving average method is simple, and income cannot be manipulated using this method. -Since it is difficult to specifically identify every inventory flow, proponents argue that the use of averages is required. -This is especially true for bulk items such as crude oil. -A new average is calculated each time a purchase is made. -The average is applied to any sales prior to the next purchase.

PRODUCT COSTS: Prime Costs

-The combination of direct labor and direct materials costs. DIRECT LABOR COSTS + DIRECT MATERIAL COSTS

METHODS OF BREAK-EVEN ANALYSIS: Contribution Margin Method

-The contribution margin method is an algebraic adaptation of the equation method. -The contribution margin represents the amount remaining from sales revenue after variable expenses are deducted. -It is the amount available to cover fixed expenses and then to provide profits for the period. -If the contribution margin is not sufficient to cover the fixed expenses, there is a loss for the period. -The contribution margin is found by taking revenues and subtracting all costs of the output that vary with respect to the number of output units. USP x Q - UVC x Q - FC = 0 = OI (USP - UVC) x Q = FC + OI UCM x Q = FC + OI Q = (FC + OI)/UCM Break-even point number of units = Fixed costs (FC)/Unit contribution margin (UCM) Where: USP is the unit selling price. Q is the quantity sold. UVC is the unit variable costs. FC is the fixed costs. OI is the operating income UCM is the unit contribution margin (USP - UVC). -You should set operating income to zero and insert the numbers in the contribution margin method to find the break-even point (expressed in units).

Contribution Margin

-The contribution margin represents the amount remaining from sales revenue after variable expenses are deducted. -It is the amount available to cover fixed expenses and then to provide profits for the period. -If the contribution margin is not sufficient to cover the fixed expenses, there is a loss for the period.

OPERATING BUDGETS - SUPPORTING BUDGETS: Cost of Goods Sold Budget

-The cost of goods sold budget includes the total and per-unit production cost that is budgeted for a period. -This budget is sometimes called the cost of goods manufactured and sold budget, since it often also includes items budgeted to be in inventory. -It is created only after the production, direct materials, direct labor, and overhead budgets are formed, since it is basically a summary of those budgets.

RECOGNITION AFTER DELIVERY METHODS: Cost Recovery Method

-The cost recovery method is used when there is no reasonable basis for making an estimate of collectability. -This method defers recognition of profit until cash collections exceed the cost of goods sold (COGS). -At sale, total revenue and COGS are reported and a journal entry records the deferred gross profit. -A separate account, realized gross profit, is used in the period when the cash collections exceed costs.

ACCELERATED DEPRECIATION METHODS: Declining Balance Method

-The declining balance method of depreciation accelerates straight-line depreciation by applying some multiple, generally 1.5 (a 150% declining balance) or 2 (a double-declining, or 200%, declining balance) to the straight-line rate. In straight-line depreciation, an asset with a 20-year life would have a 5% per year straight-line depreciation (1/20). The depreciation rate is 25% (1/4 per year). A 150% declining balance would be 1.5 × 25% = 37.5% per year, and a double-declining balance would be 50%. -Unlike the other methods, this method starts with the original book value, not the depreciable base, and then depreciates the asset down to the salvage value. The final year may have a lower depreciation charge than calculated to ensure that the salvage value remains. As shown in Exhibit 3-72, this method may result in the depreciation ending earlier or later than with straight-line depreciation. Therefore, organizations sometimes switch to straight-line depreciation near the end of an asset's life.

OPERATING BUDGETS - SUPPORTING BUDGETS: Direct Labor Budget

-The direct labor budget is prepared by the production manager and human resources. -It can help an organization plan production processes to smooth out production and keep a consistent workforce size throughout the year. -Organizations that have unions or that need to use contract employees can plan accordingly to avoid emergency hiring, labor shortages, or layoffs. -Labor budgets can be broken down into categories like semiskilled, unskilled, and skilled.

Step G—Preparing external financial statements

-The external financial statements are prepared. -A complete set of financial statements comprises a statement of financial position, an income statement, a statement of cash flows, a statement of shareholders' equity, and accompanying notes (such as management's discussion and analysis).

INVENTORY VALUATION METHOD: Last-in, first-out (LIFO)

-The last-in, first-out (LIFO) inventory valuation method assumes that the newest purchases are used or sold first. -Ending inventory will consist of the oldest purchases, including purchases possibly made years ago, so this method undervalues held inventory, assuming inflation. -The LIFO method is not allowed under IFRS but is allowed under GAAP.

Capital leases are similar to purchases:

-The lessee records an asset (e.g., leased equipment) and a related liability (a short-term liability for the current year's payments and a long-term liability for payments beyond the current year) when the lease is initiated. -The lessee records accumulated depreciation for the asset and divides the lease payment into two accounts: --An interest expense account—The interest expense portion is calculated by using the lessee's incremental borrowing rate or, if lower, the lessor's built-in rate of return on the asset (if known). --An obligations under capital leases account—This is the total payment less the interest portion. This amount reduces the total lease obligation each year. (The remaining total lease obligation is used to calculate the interest portion for the next period.) These amounts are all required disclosures as well as the gross amount held as capital leases by major class, contingencies, depreciation, and future lease payments for five years. IFRS disclosures under IAS 17 are similar but also include reconciliation between total minimum lease payments at the statement of financial position date and their present value.

Marginal Tax Rate

-The marginal tax rate is the rate paid on the last dollar of income earned. -When applied to a progressive tax code like that in the U.S., which has progressively higher tax rates for higher income earners, it is the last dollar of income that puts someone into a higher tax bracket. -Thus marginal tax rates refer to a progressive system with tax brackets.

Customer Relationship Management (CRM) and Supplier Relationship Management (SRM)

-The most important processes in supply chain management are customer relationship management and supplier relationship management. -These two processes create and manage the link between adjacent partners in the supply chain and provide the context for the other processes mentioned above.

FIFO Method of Calculating Equivalent Units

-The objective under FIFO is to obtain the correct costs of items completed during the period and items left in WIP inventory at the end of the period. -The FIFO costing method is an inventory valuation method that calculates the unit cost using only the costs incurred and work performed during the current accounting period. -FIFO considers the beginning inventory as a batch of goods separate from the goods started and completed within the same period. -This method assumes that the first work done is to complete the beginning WIP inventory. -Therefore, all beginning WIP inventories are assumed to be completed before the end of the current period. FIFO accounts separately for the cost of the units started in the previous period. -That cost was carried into the current period through the beginning WIP inventory. -If in the prior month the ending WIP inventory was 80% complete, the remainder, or 20%, is accounted for in the current month, called equivalent units to complete beginning inventory. -As with the weighted average method, a separate calculation is made for each cost category in each department or process.

Present Value

-The opposite of future value is present value, which is the value at the present moment of a sum to be received in the future, assuming discounting using compound interest. -For assets to be received or liabilities paid in the future as part of a contractual agreement, the asset would be recorded at its present value on the financial statements.

OPERATING BUDGETS - SUPPORTING BUDGETS: Overhead Budget

-The overhead budget includes all the production costs other than direct materials and direct labor. -This is sometimes called a fixed costs budget because most of the costs in this category do not vary with the rise and fall of production. This includes things like rent and insurance. -Variable costs that are included in this budget are those that may vary with production levels, such as batch set-up costs and the costs of electricity and other utilities. -Fixed costs are easy to budget, but the variable costs require forecasting the number of units to be produced, the production methods used, and other external factors.

4 CAPITAL INVESTMENT DECISIONS: Payback Period

-The payback period is the time required for an organization to recover its original investment. -If the cash flows of a project are an equal amount each period, then the following formula can be used to compute the project's payback period: PAYBACK PERIOD = Original Investment/Annual Cash Flow -If the cash flows are unequal, the payback period is computed by adding the annual cash flows until the original investment is recovered. -If a fraction of a year is needed, it is assumed that cash flows occur evenly within each year. For David's Cafe, U.S. $5,000/U.S. $1,800 = 2.7778, so the payback period is about two years and nine months. -Some organizations set a maximum payback period for all projects and reject any that exceed that level. -This provides a rough measure of risk, with the notion that the longer a project takes to pay for itself, the riskier it is. -Also, in some industries the risk of obsolescence is high and it is important to recover the initial investment quickly. -Note that there is a calculation called the discounted payback period that discounts the annual cash flows using the same present value calculations already described to avoid the drawback of failing to use discounting. For this reason, sometimes the nondiscounting method is called the simple payback period.

RECOGNITION PRIOR TO DELIVERY METHODS: Percentage-of-Completion Method

-The percentage-of-completion method recognizes revenues and gross profit based on that period's construction progress. -The same two accounts as discussed above accumulate billings and costs, except that the construction-in-process account also holds any to-date gross profit. -This method is appropriate when both parties have enforceable rights and both can be expected to perform their obligations. -One method of estimating the percentage complete is the cost-to-cost basis method: Cost-to-Cost Percent Complete = To-Date Cost Incurred/Most Recent Total Cost Estimate -This percentage is multiplied by the total revenue to find the amount of revenue to recognize to date. -Current period revenue is this amount less revenue recognized in prior periods.

The Premise of the ABC Approach

-The premise of the ABC approach is that an organization's products or services are the result of activities performed and that the required activities use resources, incurring costs. -Resources are assigned to activities, and activities are assigned to cost objects based on the activities' use. -The resource cost is calculated using a cost driver; the amount of activity consumed in a period is multiplied by the cost of the activity. -The calculated costs are assigned to the product or service.

Benefits and Limitations of Actual Costing

-The primary benefit of actual costing is that it is more accurate than other costing systems. -However, strict actual costing systems are rarely used because their limitations far outweigh the benefits. Limitations of an actual costing system include: ---Its inability to provide accurate unit cost information on a timely basis. Costs cannot be known until all of the invoices are received, which may not be until the end of the fiscal year or later. ---The difficulty of assigning overhead items such as property taxes, organizational employee salaries, and insurance, which do not have a direct relationship. For example, how much of a custodian's salary should be assigned to a unit of product or service? ---Distorted period costs due to overhead items such as property taxes that are billed once or twice a year. Even if an organization averages overhead costs by totaling manufacturing overhead costs for a given period and then dividing this total by the number of units produced, distorted costs can still occur. Because the number of units produced (or services offered) varies from period to period but fixed costs do not vary with these changes, actual costing makes costs per unit vary for products produced in different periods. -Organizations interested in smoothing out cost fluctuations in cost per unit turn instead to normal costing.

Examples of Distribution Channels

-The producer -Organizational buyers -Marketing intermediaries -Agents (used primarily in international markets; they secure an order for a producer and then take a commission) -Warehouses (e.g., break-bulk centers that convert bulk shipments into retail assortments) -Wholesalers -Distributors -Retailers -Direct sale (from producer to user without an intermediary) -Mail order (Internet and telephone). -Customers

OPERATING BUDGETS - SUPPORTING BUDGETS: Direct Materials Budget

-The production budget becomes the basis for preparing several other budgets for the period. The first is the direct materials budget, which determines the required materials and the quality level of the materials used to meet production. -The direct materials budget is often broken down into a direct materials usage budget and a direct materials purchase budget. -While the production budget specifies only the number of units to be produced, the direct materials usage budget specifies the material components and the cost of these materials. -The direct materials purchase budget is concerned with direct purchases of material components and finished good

The Revenue Cycle

-The revenue cycle (sometimes referred to as the sales and collections cycle) is a process that starts with a salesperson, a customer service specialist, or the customer placing an order. -A sales order is then generated, which typically results in a credit check unless the customer is paying in cash. If credit is approved or cash is received, the goods are shipped or handed off to the customer. Finally, an invoice is sent to the customer and the sale is recorded in the accounting records.

OPERATING BUDGETS - SUPPORTING BUDGETS: Sales Budgets

-The sales budget is the projection showing expected sales in units and their expected selling prices. -It is the basis for all of the other budgets, so it is important that the sales budget be as accurate as possible. -Preparation for the sales budget usually begins with an organization's forecasted sales level, its long- and short-term objectives, and its production capacity. -The sales budget defines the capacity needed throughout the organization, including production costs and selling and administrative costs.

Defined Benefit Plan: Calculating the Service Cost

-The service cost is a liability that accrues interest expense based on a settlement rate determined by actuaries reflecting the interest rate needed to settle the assets if the plan were terminated. The steps in calculating the service cost follow: ---The plan expenses are reduced by a positive (or increased by a negative) actual return on plan assets, which is the net change in the market value of the pension fund plus dividends, interest earned, and plan contributions and less benefits paid. ---After certain other additions or reductions, the result is the accumulated benefit obligation. If this amount is greater than the fair value of the plan assets, the employer records a liability.

STATEMENT OF CASH FLOWS - Two moments in time

-The statement of cash flows is used to show cash levels as of two moments in time: the beginning of the period and the end. -It is derived from the income statement and the statement of financial position and is used to reconcile these statements. -The cash flow statement is therefore always the final step in the process of generating external financial reports. -The net increase (or decrease) in cash calculated on the statement of cash flows should match the change in cash on the statement of financial position. -The beginning cash is taken from the ending cash of the prior year's statement of financial position, which should then be summed to arrive at the ending cash for the current year. -It should match the cash listed for the current year on the statement of financial position.

Limitations of the Statement of Financial Position (Balance Sheet)

-The statement of financial position cannot provide the true value of an organization because it cannot include nonfinancial measures, such as the value of employees, in its calculations. -Most of the assets and liabilities reported on the statement of financial position are valued at their historical cost, which can be significantly different from their current market values. -The differences can be material -Note also that estimates are used for items such as net accounts receivable, another limitation affecting the usefulness of the statements.

Time Value of Money

-The time value of money is the concept that money received today is worth more than money received tomorrow because the money could be invested to earn a return greater than the original investment. -This occurs through an investment that earns interest, through the agreed-upon payment for use of resources, or because the money is used in business to generate profits. -The longer the time period, the greater the future value.

Contra Accounts and Adjunct Accounts

-The use of dual-entry accounting has given rise to special accounts that either increase or reduce a primary account. -These types of accounts allow the primary account's value and the amount of the adjustment to be known. -Accounts that reduce an asset, liability, or equity account are called contra accounts, for example, discount on bonds payable or sales returns and allowances. -An adjunct account increases an asset, a liability, or an equity account, for example, premium on bonds payable.

Weighted Average Method of Calculating Equivalent Units

-The weighted average method calculates the equivalent units of production for a department using the number of units transferred to the next department or to finished goods plus the equivalent units in the department's ending WIP inventory. -Essentially, the costs and work carried over from the prior period are counted as if they belong to the current period. -In this method, beginning inventory work and costs are pooled with current work and costs, and an average unit cost is computed and applied to both units transferred out and units remaining in ending inventory. EQUIVALENT UNITS OF PRODUCTIONS = UNITS TRANSFERRED TO NEXT DEPARTMENT OR FINISHED GOODS + EQUIVALENT UNITS IN ENDING WORK-IN-PROGRESS INVENTORY -A separate calculation is made for each cost category in each department or process. -Under this method, it doesn't matter when a product is started. -All units completed in the same period or in the ending inventory of that period are treated the same. -The weighted average method is concerned only with the status of the products at the end of a period.

LESSOR'S PERSPECTIVE 4 TYPES OF LEASES: Sales-type leases

-These are alternative sales tools for manufacturers and dealers of an item. -If the sales price (fair value) of the asset is more (or less) than the cost of the asset (i.e., generates a profit or loss), a lease can qualify as a sales-type lease.

LESSOR'S PERSPECTIVE 4 TYPES OF LEASES: Leveraged leases

-These are direct financing leases where there is an intermediary between the lessor and the lessee (a long-term creditor). -To qualify, the lessor must have substantial financial leverage in the transaction.

LESSOR'S PERSPECTIVE 4 TYPES OF LEASES: Operating Lesases

-These are the same as the operating leases discussed above. -Operating leases are generally short-term, pure rental agreements, where the asset and the related liability remain off the lessee's books. (Lease expense is debited and cash is credited.)

Beenfits of Job Costing

-They provide detailed results of a specific job or operation. -They can accommodate multiple costing methods, such as actual, normal, and standard costing, and are flexible enough to be used by a wide variety of organizations. -They can have strategic value for an organization because they give a detailed breakdown of all the different types of costs. -They can help pinpoint sources of cost overruns across different jobs by providing gross margin and gross profit figures to compare profitability.

RECOGNITION PRIOR TO DELIVERY METHODS: Completed Contract Method

-This method recognizes revenues and gross profits only at project completion. -Accumulated construction costs are recorded in a construction-in-process account (an inventory account), and billings on construction in process (a contra inventory account) records billings. -There are no interim credits or charges to revenues, costs, or gross profit (income statement accounts). -This method is to be used only when the percentage-of-completion method (see below) is inappropriate, such as if most contracts are short-term or the percentage of completion cannot be reasonably estimated.

Equivalent Units Formula

-To calculate equivalent units, the number of units that are partially complete is multiplied by the estimated percentage that are complete overall: EQUIVALENT UNITS = NUMBER OF PARTIALLY COMPLETED UNITS X PERCENTAGE COMPLETION

Capital Investment Decision Models

-To make capital investment decisions, managers must estimate the quantity and timing of cash flows, assess the risk of the investment, and consider the impact of the project on the organization's profits. -There are many different methods to guide managers in accepting or rejecting potential investments. -We will discuss four here: net present value, internal rate of return, payback period, and accounting rate of return. -These capital investment decision models can be classified into discounting models and nondiscounting models. -Many organizations use several types in combination.

Assumptions of CVP Analysis

-Total costs can be divided into fixed and variable costs with respect to levels of output (the amount of goods produced or services provided by an organization). -Total revenues and total costs have a linear (straight-line) relationship to output units within a relevant range. In other words, within a limited range of output, total costs are expected to increase at a linear rate. CVP analysis makes other assumptions that may or may not be true in a specific scenario: -The selling price is constant. The price of a product or service will not change as volume changes. -In multiproduct companies, the sales mix (the relative proportion in which a company's products are sold) is constant. -In manufacturing companies, inventories do not change. The number of units produced equals the number of units sold. Typically, even if these assumptions do not hold true in every instance, the basic validity of CVP analysis remains. The analysis is simple, and it provides a manager with a low-cost approximation of the profit effect of an investment. However, it is important to acknowledge the basic assumptions of CVP analysis and to use extra forms of analysis as appropriate.

Transfer Pricing

-Transfer pricing is a system for pricing products, intermediate products, or services that are transferred from one organizational subunit (responsibility center or strategic business unit) to another within the same organization. -It may involve transfers of cash or be reflected as an accounting entry. -Firms have some discretion in setting transfer prices. In vertically integrated organizations, transfer pricing will need to be set to allow each portion of the business to be financially flexible. Transfer pricing: -Affects the strategic objectives of an organization such as whether business units behave independently and how managers are kept motivated. -Requires coordination among the marketing, production, and financial functions. -Can be used by a parent organization to transfer significant funds to or from franchisees and subsidiaries by changing prices. -Can play a role in tax minimization, as described more below. -However, transfer pricing is also constrained by existing tax laws and treaties. How to set transfer prices must be carefully considered.

Translation Exposure

-Translation exposure is the risk that fluctuations in exchange rates will affect reported income. -Hedging is a common means of offsetting the risk of translation exposure.

Misuses of Revenue Recognition

-Two related misuses of revenue recognition exist and are actively discouraged. -Trade loading or channel loading (or channel stuffing) is the practice of manufacturers inducing their wholesalers to carry more inventory than they can reasonably sell. -The practice inflates current-period profits at the expense of future profits. -In another situation, some retailers experience a high ratio of returned items to sales, and so, even after the sale, they delay revenue recognition until all return warranties are expired. -Or they record the sale and either create an allowance for returns or simply record returns as they happen.

REVENUE CYCLE AUDIT TESTS: Allowance for doubtful accounts and bad debt expense

-Unlike the more straightforward accounts, the allowance for doubtful accounts (contra-asset account) is based on management's estimate of the amount of uncollectable accounts receivable for the coming period, generally one year. -Management should have a documented methodology for calculating this estimate. It may be based on the accounts receivable aging schedule, what management knows about customers' financial conditions (in the aggregate and individually for major customers), economic trends and regulatory implications, etc. The offsetting entry to increase the allowance for doubtful accounts is recorded as bad debt expense. Internal auditors should evaluate the adequacy and reasonableness of management's process for estimating the allowance for doubtful accounts.

4 CAPITAL INVESTMENT DECISIONS: Accounting Rate of Return (ARR)

-Unlike the other capital budgeting methods discussed so far, the accounting rate of return (ARR) (also known as the simple rate of return) measures the return on a project in terms of net operating income, as opposed to using a project's cash flow. -The approach is to estimate the revenues that will be generated by a proposed investment and then to deduct from these revenues all of the projected operating expenses associated with the project. -The net operating income is then related to the initial investment using the following formula: ARR = Increase in Expected Average Annual Operating Income/Initial Required Investment -The ARR method does not consider a project's profitability. And, like the simple payback period, it ignores the time value of money, a deficiency that can lead a manager to choose investments that do not maximize profits.

Activity Method

-Unlike the straight-line method, the activity method isn't based on the passage of time but on a measure of productivity relative to the total expected productivity for an asset such as production equipment. -The measure can be either an output unit (parts produced) or an input unit, such as employee or machine hours. -The following formula calculates activity method depreciation: Activity depreciation per period = (depreciable base x units in period)/Total Estimated Units in Service Life Depreciation expense in year two is calculated as follows: [(Cost - Salvage) x (Estimated Hours of Use in Year Two)]/Total Estimated Hours of Use = [($300,000 - $70,000) x (700 hours)]/2,000 hours = $80,500.

Weighted Average and FIFO Methods Compared

-Unlike the weighted average method, FIFO is concerned with the status of products at both the end and the beginning of an accounting period. -By definition, the beginning WIP inventory will always be partially complete; otherwise it would have been moved to the next department. -The objective under FIFO is to obtain the correct costs of items completed during the period and items left in WIP inventory at the end of the period.

Consolidated Financial Statements Where Currency Translation or Remeasurement Is Required

-When a parent company is preparing consolidated financial statements, it must translate the statements of subsidiaries into a common currency. --The reporting currency is the currency in which the parent company has chosen to present its financial statements. --The functional currency is the currency of the subsidiary's primary economic environment; it could be the parent company's reporting currency, if the subsidiary is primarily an arm of the parent's operations, or it could be the local currency of the country in which the subsidiary is located, for relatively self-contained, integrated operations. -Under both remeasurement and translation, income statement accounts are translated using the average exchange rate for the period. -If the subsidiary is using neither the parent's reporting currency nor its local currency, then it isn't using the functional currency, and its statements would first be remeasured into the functional currency and then translated into the reporting currency. -For example, a British subsidiary of a U.S. company that uses the euro due to its many continental clients would fall into this category.

Step D—Trial balance and working papers

-Usually prepared at the end of the period, the trial balance displays debit and credit columns listing the balances for each account at a specific moment in time. The debit and credit columns must balance. -Discrepancies can reveal journalizing and posting errors. Correct reconciliation of the two columns cannot detect when transactions have not been journalized or are entered for the wrong amount or when incorrect or duplicate entries are posted in both columns. Errors can be corrected by tracing accounts between the journal and the ledger and looking for a specific dollar amount. Because duplicate posting doubles the error amount, the auditor looks for debits that should be credits (or vice versa) by dividing the amount out of balance by two and searching the journal for this amount. Transpositions (e.g., 14 instead of 41) or slides (79 instead of 790) result in evenly divisible numbers when dividing the difference by nine (e.g., 41 - 14 = 27; 27/9 = 3). -Worksheets or working papers are paper or electronic documents arranged in a columnar format for accumulating and recording adjusting entries when preparing financial statements. Accountants use worksheets to arrive at the figures needed for the financial statements before all of the journalizing and posting has been officially accomplished. Therefore, worksheets can be used to verify amounts in the journals and financial statements. Columns found on a worksheet include debit and credit columns for: ---The trial balance (both the trial balance and the adjusted trial balance). ---Adjustments (all adjusting entries). ---The income statement and the statement of financial position. (Items from the adjusted trial balance are moved to their respective financial statement column, either the income statement or the statement of financial position.)

Variable Costing

-Variable costing (also known as direct costing) is a method of inventory costing in which all variable manufacturing costs are included as product costs except for fixed manufacturing costs, which are treated as costs of the period in which they are incurred. Variable costing: ---Uses a contribution margin format on the income statement. ---Highlights the distinction between fixed and variable costs. ---Deducts fixed manufacturing costs as an expense. ----Expenses fixed manufacturing costs in the period in which the inventory is created. Under variable costing, if more units are bought than sold, net income will be lower than under absorption costing, because fewer costs end up in inventory compared to cost of goods sold.

Variable Costs

-Variable costs rise and fall as the output level rises and falls. -The cost of direct materials or direct labor used during a period will vary in direct proportion to the number of units produced. -Variable costs are normally expressed with respect to the total amount of goods and services an organization produces. -In a manufacturing organization, variable costs include direct labor, direct materials (raw materials), utilities, and waste disposal. -In a merchandising organization, the costs of goods sold, commissions to salespeople, and billing costs are variable costs. In a hospital, the costs of supplies, drugs, meals, and nursing services are variable costs. As output increases, variable costs increase at different rates. ---At low levels of production, many resources may not be used fully or most efficiently. ---At high production levels, diminishing returns cause variable costs to accelerate. ---Between the extremes, most resources are used efficiently and variable costs rise slowly.

COMMON-SIZE FINANCIAL STATEMENTS: Vertical

-Vertical common-size statements express the amounts as a percentage of a chosen base, such as sales or cost of goods sold on the income statement or total assets on the statement of financial position. -The base is set at 100%, and other amounts on the statement are expressed as a percentage of that total. -Such proportional weightings allow two organizations to be compared even if they have very different amounts of capital, such as comparing an organization with U.S. $1 million in total assets to an organization with U.S. $100 million. -The percentages make it easy to determine which has a higher relative proportion of inventory, for example.

Types of Supply Chain Management

-Vertical integration -Lateral or horizontal integration -Note that Japanese companies favor an intermediate form of integration called "keiretsu," in which suppliers and customers own significant stakes in one another.

TYPES OF SUPPLY CHAIN MANAGEMENT: Vertical Integration

-Vertical integration refers to the practice of ownership of many parts of a supply chain through expansion or mergers and acquisitions. -An example is a cell phone company that makes phones, owns retail outlets, provides coverage, owns infrastructure, and handles warranty service. -The primary benefit of vertical integration is control.

Relevant Range

-Very few costs are completely fixed. Most will change if there is a large enough change in activity (i.e., above or below the relevant range). -The relevant range is the range of activity within which the assumptions about variable and fixed costs are valid. -This is expressed as specific cost drivers for a specific duration of time.

General Limitations of Financial Statements

-Voluntary accounting method changes can be used to increase reported net income, but such changes must be disclosed and the organizations must report the impact of the accounting changes on earnings. -In addition, accounting changes when adopted should reflect management's decision or intention (as reflected by the underlying rationale or support provided) to use the adopted changes going forward for the organization's financial reporting. -Accounting changes are not intended to function as temporary management tools that would allow management to continually make preferential adjustments; rather, they need to be reflective of a consistent, conservative application of U.S. GAAP or IFRS.

REVENUE CYCLE AUDIT TESTS: Sales returns and allowances

-When a customer returns an item, the item is received and a credit memo is issued to accounts receivable. -In addition to examining these credit memos, internal auditors can examine the sales returns and allowances journal. -Internal auditors can make sure that returns are being tracked separately and recorded in the appropriate general ledger account (sales returns and allowances) rather than just reducing the sales totals.

REVENUE CYCLE AUDIT TESTS: Charge-off of uncollectable accounts

-When an account receivable is deemed to be uncollectable, it could be sold at a deep discount to a third-party collection agency, who may or may not have recourse back to the organization if it is unable to collect, depending on the terms of the contract. Internal auditors can verify that the terms of such contracts are in order and that any payments from collection agencies are properly recorded. The amount of accounts receivable that is not recovered is then charged off as a reduction of the allowance for doubtful accounts. -Internal auditors should verify that accounts receivable charge-offs are properly authorized and that they are treated separately from credit memos. There is no special journal for charge-offs. Monitoring the level of internal operating charge-offs in a unit can be a helpful planning tool in identifying areas where operational problems may exist that require further assurance coverage.

Lower of Cost or Market (LCM)

-When inventory value is impaired due to obsolescence or other factors, inventory is no longer valued at original cost. -Instead it is valued at the lower of cost or market (LCM), where cost is the original cost and market refers to the market-determined cost to reproduce or replace the item, the lower of which becomes the new value.

Accounting Method Adjustments

-When it is possible, any significant differences in accounting policies should be reconciled by calculating what the amounts would be if the same policies were followed for each statement. -Inventory valuation methods, depreciation methods, classification of leases, pension costs, and choices concerning capitalization versus expensing of costs all need to be standardized.

Capital Structure

-While capital budgeting is how businesses determine the best projects to invest in to ensure growth and future profitability, capital structure tells you where the money for capital projects comes from. -Capital structure is a term used in finance to refer to how a business is structured and financed. -Basically, it details the way a company finances its assets through a combination of cash, equity, and liabilities (debt). -Different types of capital impose different types of risks for an organization. For this reason, capital structure affects the value of a company, and therefore much analysis goes into determining what an organization's optimal capital structure is.

INVENTORY VALUATION METHOD: Specific Identification Method

-With the specific identification method, each specific item in inventory held or sold is tracked separately. -This is most often used for special order or low-volume, high-cost goods. -While specific identification matches cost flow to the physical flow of goods, it can be used to manipulate net income because the seller could select, from otherwise identical inventory, the lot that has the lowest or highest cost, affecting both ending inventory and cost of goods sold. -Also, indirect costs such as storage or discounts cannot be easily specifically identified.

BUDGETING APPROACHES: Zero-based Budgeting

.-A zero-based budget helps organizations avoid situations in which ineffective elements of the business continue to exist simply because they were part of a previous budget. -Such a budget starts with zero dollars allocated to budget items rather than making incremental changes to already existing allocations. -These budgets focus on constant cost justification by forcing managers to conduct in-depth reviews of each area under their control. -Zero-based budgets can create efficient and lean organizations by encouraging regular, periodic review of all activities and functions. -This budgeting approach is popular with government and nonprofit organizations.

Three Key Steps in Implementing an ABC System

1) Identify activities and resource costs. Activity analysis determines work performed by each activity and organizes it into activity centers and various levels of activity. Activity levels include: ---Unit—Volume- and unit-based activities. ---Batch—Set-up, purchase orders, inspections, and production scheduling. ---Product-sustaining—Product design, expediting, and implementing engineering changes. ---Facility-sustaining—Environmental health and safety, security, depreciation, taxes, and insurance. ---Customer—Customer service, phone banks, and custom orders. 2) Assign resource costs to activities. Resource costs are assigned to activities using resource cost drivers. A cause-and-effect relationship must be established between the driver and the activity. Common relationships include: ---Number of employees—personnel activities. ---Time worked—personnel activities. ---Set-up hours—set-up or machine activities. ---Machine hours—machine-running activities. ---Number of orders—production orders. ---Square feet—cleaning activities. ---Value added—general and administrative. 3) Assign activity costs to cost objects. After determining activity costs, the activity costs per unit are measured using an appropriate cost driver. The activity cost driver should be directly related to the rise and fall of the cost. Activity cost drivers determine the proportion of a cost to allocate to each product or service using the following formula: RATE = COST POOL/DRIVER

Steps in Consilidation

1. Determine the ownership percentage and minority interests of each subsidiary. 2. Combine the assets, liabilities, revenues, and expenses of each organization. --The investee's net assets multiplied by the investor's ownership percentage equals the book value of the subsidiary. --Differences between the purchase price and the book value are allocated to the appropriate underlying asset or liability accounts. --Accounts valued at historical cost can be increased until they reach market value. If all such accounts are marked up to market value, any excess becomes goodwill. When cost exceeds book value, the assets are adjusted upward or liabilities downward; when book value exceeds cost, the assets are adjusted downward or liabilities upward. --This step requires estimates, an area of concern for internal audit. 3. Record eliminating entries to reverse all intercompany transactions and balances. Investment accounts as well as all stockholders' equity from prior partial acquisitions must be eliminated to avoid double-counting. Eliminating entries are discussed in more detail after Exhibit 3-74. 4. Issue consolidated statements. The four primary statements are required.

Distribution Channel

A distribution channel is a group of interdependent entities that pool their efforts to distribute a product to end users.

Standard Costing: Quantity Standard

A quantity standard is the amount of input that should be used per unit of output.

Differences between ABC and Traditional Costing

ABC Uses activity- and volume-based cost drivers. Overhead assigned to activities and then to products or services. Focus on processes and costing issues that cross departmental boundaries. Nonmanufacturing and manufacturing costs may be assigned to products. TRADITIONAL COSTING Uses up to three volume-based cost drivers. Overhead assigned to departments and then to products or services. Focus on assigning cost and process improvement responsibilities to managers within departments. Only manufacturing costs are assigned to products.

Activity-based Budgeting vs Traditional Budgeting

ACTIVITY-BASED BUDGETING -Emphasizes value-added activities; budgeting units are in terms of activity costs -Encourages teamwork, continuous improvement, and customer satisfaction -Provides opportunities for cost reduction and elimination of wasteful activities -Identifies non-value-added activities -Coordinates and synchronizes activities of the entire organization to serve customer TRADITIONAL BUDGETING -Emphasizes input resources and expresses budgeting units in terms of functional areas -Encourages increasing management performance -Relies on past (historical) budgets and often continues funding items that would be cut if their cost-effectiveness (or lack of) were known -Minimizes variances and maximizes individual responsibility unit performances

Advantages and Disadvantages of Variable Cost Transfer Pricing Model

ADVANTAGES -Causes buyer to act as desired (to buy inside) -Good for selling units with excess capacity DISADVANTAGES -Unfair to seller if seller is a profit or investment business unit -Tax authorities may disallow or restrict due to tax avoidance use

Advantages and Disadvantages of Full Cost (absorption) Transfer Pricing Model

ADVANTAGES -Easy to implement and understand -Using standard fixed costs allows the buying unit to know the cost in advance and keeps the seller from becoming inefficient due to a captive buyer -Preferred by tax authorities over variable cost DISADVANTAGES -Overstates opportunity cost if excess capacity exists -Fixed costs should be ignored in the buyer's choice of whether to buy inside or outside the organization

Benefits of Absorption Costing

Absorption costing is the standard method used in most countries, including the United States, because it is required for external financial reporting under IFRS and GAAP and for tax reporting by the U.S. Internal Revenue Service. It is also used by the majority of organizations around the world for managerial accounting purposes, because many accountants argue that it better matches costs with revenues.

Additional Items on Income Statement

After income from continuing operations, any irregular items should be reported. Here are some irregular items that might be listed: -DISCONTINUED OPERATIONS: Assets to be reported as part of an operation or segment of a business that is or will be discontinued must be clearly distinguished from other activities and assets. Each discontinued operation would report its gain (loss) from continuing operations and its gain (loss) from the disposal of the operation on separate lines. -EXTRAORDINARY ITEMS: To qualify as an extraordinary item, an event/transaction should be both unusual in nature (highly abnormal for the particular operations, type of business, industry, or geographic region) and infrequent in occurrence (not reasonably expected to occur again, given the particular environment). Some items are always considered extraordinary; others never. Foreign currency gains and losses are never extraordinary; material gains and losses from early extinguishment of debt used to be extraordinary but are now subject to the above tests (unusual in nature, infrequent in occurrence). Extraordinary items are defined by accounting standards and may vary by industry. -CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE: When a different accounting principle is adopted from one in current use, the effect on net income is disclosed separately. Such changes to the principles or the methods of applying them must be justified by management unless externally required.

Purchase Accounting

All business combinations under IFRS and GAAP must use purchase accounting. -On the consolidated statement of financial position (balance sheet), assets and liabilities are recorded at their fair market values and the excess of cost over fair market value is recorded as goodwill. -The acquired retained earnings of the investee are not recognized. -Any equity securities issued as consideration are recorded at the issuer's fair market value. -On the statement of financial position, depreciable or amortizable assets have their excess of market over book values depreciated or amortized, reducing future earnings on the income statement. -The investee's earnings subsequent to the date of acquisition are included in the investor's books; prior earnings are not recognized. -Direct expenses from the combination are included in the purchase price of the investee company and are therefore capitalized by charging them to an asset account. -Indirect costs (e.g., a merger department, manager time and overhead allocated to the merger that would have been incurred even without the merger) are expensed as incurred. -Any security issuance costs are used to reduce the value of the security on the books.

Cost

Any resource given up to obtain an objective. Costs can be money, a new liability, or giving up an asset. They include actual (historical) and budgeted (forecasted) costs.

Bonds Premiums and Discounts

Bonds can be issued and resold at par, at a discount, or at a premium. --Selling at par means that the stated bond rate and the market rate are equal. --Selling at a discount means that the stated bond rate is lower than the market interest rate. The discount on the bond discussed above would be calculated as the face value less the market price of the bonds. For the running example, this is U.S. $1,000,000 - U.S. $912,891 = U.S. $87,109 discount on bond issued. --In the opposite situation, where the stated bond rate is greater than the current market rate for a similar risk bond, the stream of interest payments over the remaining life of the bond (the future value of the annuity) will be greater than a similar risk investment in the market at the current time, and so this requires the investor to pay a premium to purchase the bond. Discounts and premiums must be amortized to the interest expense (income) account over the life of the bond issue. By recording the bond interest expense (income) as the amount of interest paid (received) and recording the amortization of the bond premium or discount, the resulting total interest expense (income)—stated as a percentage of the face value or principal amount of the bond—will equal the market rate at the time of issue (purchase). Note that many bonds pay semiannual coupons, and a U.S. $1,000,000 8% bond due in six years with semiannual coupons would actually have 12 periods at 4%, since the rate quoted is still an annual rate. All present value calculations would use the 12 periods at a 4% amount in their calculations. The semiannual interest payment would be U.S. $40,000 per payment (still U.S. $80,000 per year).

INVESTMENT VALUATION RATIOS: Dividend payout ratio

Cash dividends per share/Earnings per share Proportion of a company's earnings paid out as dividends.

Average inventory turnover formula

Cost of Goods Sold/Average Inventory

ASSET MANAGEMENT RATIOS: Average inventory turnover

Cost of Goods Sold/Average Inventory -Average inventory turnover is the proportion of goods sold to goods in inventory. -It indicates how efficiently a company converts inventory into sales. -If relatively high, inventory is efficiently managed, while a declining ratio could show an inventory build-up due to poor demand or obsolescence. -Too high a ratio could mean lost sales due to stockouts.

PROFITABILITY RATIOS: Earnings per share (EPS), basic

Earnings per share (EPS) must be disclosed on the income statement. Basic earnings per share is calculated as income available to common shareholders per weighted average share of common stock. For the above example, assume that ABC, Inc., had 10 million shares at the start of year 3 (Y3) and issued 1 million more shares on June 1 (after 5 months). Weighted average shares outstanding is determined by multiplying the number of shares outstanding by the prorated number of months outstanding (months outstanding/12 months) and then summing the amounts found, in this case, (10 million × 5/12) + (11 million × 7/12), for a weighted average of 10,583,333 shares.

Examples of Loss Contingencies

Examples of loss contingencies include assessments, environmental liabilities, product recalls, the collectability of accounts receivable, and warranties, guarantees, or coupons.

Expropriation

Expropriation is the governmental seizure of property or a change to existing private property rights, usually for public benefit.

External Benchmarking

External benchmarking includes comparing an organization against either industry averages or specific competitors.

DISTRIBUTION CHANNEL ACTIVITIES: Financing

Facilitates the monetary or currency exchange function

Setting Transfer Prices

Factors to consider in setting transfer prices include control, decentralized planning decisions, and international issues.

Finance

Finance is a management decision-making role primarily concerned with: -Funding and maintaining sources of funds -Managing bank relationships -Conducting financial planning and analysis -Releasing funds for internal or external business investments and expenses -Ensuring that current obligations are met -Ensuring that the organization has sufficient liquidity or cash available at the right time to meet obligations

REVENUE CYCLE: Substantive Tests Examples

For example: -Existence tests include making sure that sales invoices have a supporting bill of lading. -One completeness test is to make sure that there are no gaps in the numerical sequence of shipping documents, which can double as a test for valuation (i.e., the timing of when orders shipped affects period totals). -For valuation and allocation, internal auditors look at accuracy, proper classification, timing, and posting and summarization. For example, to test accuracy, sales orders can be compared against approved price lists to ensure that the prices match. For classification, one test would be determining whether liabilities are improperly recorded as sales. For posting and summarization, a useful test is to examine reconciliations by comparing listings of cash receipts to deposits recorded on bank statements. -When auditing sales, completeness is less of an issue, but it can be tested by tracing the prenumbered shipping documents forward to the journal. The accuracy and timing of sales is generally more of a concern, with the exception that if controls are shown to be operating effectively, accuracy may also be less of an issue. When there is a risk of a control weakness, accuracy tests involve: --Selecting a sample of sales invoices and comparing them to the price lists. -Recalculating extensions and footings: ---Checking extensions by verifying that the unit volume times the unit cost agrees with the total dollar amount for each line item. ---Checking footings by summing the extensions and verifying the total against the invoice. -Tracing invoices to journal entries for sales and accounts receivable. Timing of sales is tested to ensure that sales are recorded in the proper period. This is done by tracing shipping documents to the sales journal. Taking a sample of sales transactions two weeks prior and two weeks after the period end date can be an effective procedure.

Foreign Exchange (FX) Rates

Foreign exchange (FX) rates are quotations of the number of units of one currency needed to exchange for a unit of a different currency.

Fiscal Policy: Things Governments May Do

Government taxation plays a significant policy role, and governments use different kinds of taxes and tax rates to achieve different objectives. They may: -Decrease the demand for goods and services in order to contract the economy -Raise money for public spending on infrastructure projects, education, health care, unemployment benefits, social security, defense spending, and transportation -Distribute the tax burden among individuals or classes of the population involved in taxable activities such as businesses -Redistribute resources between individuals or classes in the population -Fund foreign aid and military aid -Modify patterns of consumption or employment within an economy by making some classes of transactions more or less attractive

Dual-Entry Accounting

In a dual-entry system, each transaction is recorded in at least two places: a debit to one account and a credit to another account. -For assets, expenses, and dividends, a debit increases the account balance and a credit decreases the account balance. For example, when a customer pays an account receivable (an asset), the accounting entry will debit cash (increase) and credit accounts receivable (decrease). -For liabilities, revenues, capital stock, and retained earnings, a debit decreases the account balance and a credit increases the account balance. For example, to record the cash proceeds from a bank loan, the organization records an increase in liabilities with a credit to notes payable and records an increase in assets with a debit to cash. -The dual-entry accounting system is a self-checking system; the sum of all debits must equal the sum of all credits. Each debit entry should have a corresponding credit entry. Preparing periodic trial balances can ensure that the accounts balance at that specific moment in time.

TWO MAJOR TYPES OF DISTRIBUTION CHANNELS: Vertical Marketing System

In a vertical marketing system (VMS) approach, one organization is the channel manager responsible for directing channel activities, setting operating rules and guidelines, and providing assistance to channel partners. VMS channels dominate the retail sector.

TYPES OF BONDS: Income bonds

Income bonds pay interest only when the organization has profits.

Internal Benchmarking

Internal benchmarking includes comparing divisions against the best division in an organization or comparing the results of one division against its past performance record.

ROI RATIOS: Return on assets (ROA)

Net Income/Average Total Assets Note that the average total assets is calculated by summing the total assets from each of the two years listed on the statements of financial position and dividing by two: (U.S.$236,042,700 + U.S.$287,042,963)/2 = U.S.$261,542,832. ROA is the proportion of net earnings to total assets. It shows how well the company has used its assets to produce value. Net income should include only income from continuing operations. For each dollar invested in total assets, ABC, Inc., makes U.S. $0.19 in net income. A variation, total return on assets, adds interest expense to net income to give firms with high debt financing a more appropriate ratio.

ASSET MANAGEMENT RATIOS: Fixed assets turnover

Net Sales/Average Net Fixed Assets -Fixed asset turnover measures how efficiently a company uses its fixed assets (property, plant, equipment) to generate sales. -The higher the number, the more efficiently fixed assets are being used (or, possibly, there is a need to replace older assets). -Might be used to measure the effectiveness of significant investments in PP&E. -Net sales is sales minus sales discounts, returns, and allowances

Net Cash Flows from Financing

Net cash flows from financing involves capital structure transactions, including borrowing and repaying loans from creditors as well as obtaining and repaying equity capital from/to owners and providing a return on equity.

PROFITABILITY RATIOS: Operating profit margin

Operating profit is net sales less cost of goods sold and operating expenses (also called selling, general, and administrative expenses). For each dollar of sales, ABC, Inc., makes U.S. $0.26 in operating profit. The higher the operating profit margin, the greater the company's operating efficiency

Make or Buy Decisions: Opportunity Costs

Opportunity costs should also be part of the decision-making process. Common make or buy opportunity costs include: -Whether some part of the fixed overhead could be reduced by outsourcing. -Whether some part of the space being used in internal production could be repurposed.

Organizations with Multiple Supply Chains

Organizations may have multiple supply chains: -Dissimilar product categories may require different distribution channels. -Organizations with very different types of customers for the same product may choose a different distribution channel for each different customer segment.

Two Major Types of Distribution Channels

Organizations typically choose between two major types of distribution channels: conventional channels and vertical marketing channels.

Three Basic Steps to Record Transactions

Organizations use three basic steps to record financial transactions: -Identify and analyze individual transactions for their effect on financial accounts -Enter the transaction data into a journal -Transfer the journal data to the correct accounts in the ledger

REQUIRED DISCLOSURES: Other Disclosures

Other disclosures required include but are not limited to credit claims (schedule of obligations), claims of equity holders (contracts, senior securities), restricted cash, deferred taxes, lease information, and pension assets and liabilities.

If the investor has a controlling interest (greater than 50% ownership):

RECORDED AT: Fair market value. VALUATION: Fair market value. UNREALIZED GAINS/LOSSES: Not recognized. -Consolidated financial statements are required. The investee is considered a subsidiary and the investor the parent company. Statements treat both as if they were a single entity. -Unrealized holding gains and losses are not recognized.

Benchmarking

Ratios take on the most significance when compared to internal and external benchmarks. Benchmarking is the comparison of an organization or project to similar internal or external organizations or projects.

Journal Entry

Recording of a financial transaction (as a debit and then as a credit) by date; eventually posted to a ledger.

Relevant Costs: Quantitative and Qualitative Factors

Relevant costs should also include both quantitative and qualitative factors. -Quantitative factors are outcomes that are measured in numerical terms. These are broken down further into financial and nonfinancial measures. --Financial measures are expressed in monetary terms and include things like the costs of direct materials, labor, and marketing. ---Nonfinancial measures are expressed numerically but not in financial terms. These include a reduction in product development time or, for an airline, the percentage of on-time arrivals. -Qualitative factors cannot be measured in numerical terms and include issues like employee morale, customer goodwill, and the quality of a product or service. Relevant costs typically emphasize quantitative factors because of their financial ramifications. However, any decision should ultimately evaluate the tradeoffs between both of these types of factors.

ACCOUNTING PRINCIPLES: Revenue Recognition

Revenue should be recognized when it is realized or realizable and earned. -"Recognized" means that revenue has been recorded as a journal entry. -"Realized" means that assets such as goods or services have been exchanged for cash or claims to cash (e.g., an invoice for an account receivable). -"Realizable" means that the assets can be readily converted to cash without significant extra expense through sale in an active market at prices that can be easily determined. It can also relate to a determination that an account receivable (or some portion of it) is still considered collectible. -"Earned" means that the organization has done a substantial amount of what it promised to do (provided goods or services). A prepaid service contract is recorded as a liability until that service has been substantially performed. -For example, a company selling a new information system bills the client on completion of installation and testing. The revenue is recognized at this point, although payment may not be received from the client for 60 days. Revenue recognition is addressed more later.

Strengths and Weaknesses of Payback Period

STRENGTHS -Simple to use and understand -Measures liquidity -Allows for risk tolerance WEAKNESSES -Ignores time value of money (unless discounted payback period method is used) -Ignores cash flows beyond payback period

Sell or Process Further Decisions: Joint Costs

Sell or process further decisions require analysis of relevant costs and consideration of joint products or services. These involve situations in which two or more products or services are produced from a single common input and have common processes and production costs up to a split-off point. The split-off point is the point in the production process at which the joint products can be recognized as separate products. Joint costs are those costs incurred up to the split-off point. An example of a joint product is cranberries that are harvested and then sold as is (the split-off point) or further processed into juice, sauce, and jelly. Many managers erroneously consider joint costs as relevant to a sell or process further decision. However, joint costs are irrelevant because they are common costs that must be incurred to get the product or service to the split-off point. They are not directly attributable to any of the intermediate products or services; they are irrelevant in deciding what to do from the split-off point forward. The cost of the cranberries is irrelevant to the decision to sell or process further.

Advantages and Disadvantages of Standard Costing

The advantages of a standard costing system include: --It is less likely to incorporate past inefficiencies. --It can improve planning and control by providing readily available unit cost information such as materials price variances that can be used for pricing decisions. --It can simplify product costing. --It can be adapted in light of new data indicating changes during the budget period. The disadvantages of a standard costing system include: --Unreasonable standards might be set. --Standards might be authoritarian, inflexible, or secretive. --Standards might be poorly communicated. --Detailed computation of variances may place undue emphasis on profits, which can produce dysfunctional behavior in just-in-time manufacturing environments. (It may encourage inventories to be purchased in large quantities to take advantage of discounts.)

Income Statements (Statement of Operations)

The income statement (statement of operations, profit and loss statement) is a summary of the profitability or success of an organization over a period of time, such as a year. The following are important income statement terms: ---REVENUES are enhancements or inflows of assets and/or settlements of liabilities generated when an organization makes or delivers goods or services as part of its primary ongoing operations. ---EXPENSES involve the depletion or outflows of assets and/or the incurrence of liabilities resulting from an organization's production or delivery of goods or services as part of its primary ongoing operations. ---GAINS are increases in net assets (equity) due to incidental or peripheral transactions except those resulting from investments by or distributions to owners. Gains are usually reported net of related expenses. -LOSSES are decreases in net assets (equity) due to incidental or peripheral transactions except those resulting from investments by or distributions to owners. --INCOME is the combination of revenues and gains. While GAAP recognizes a difference between revenues and gains, IFRS does not consider them to be separate elements. Similarly, IFRS groups losses within expenses. -The income statement should separately present revenue, results of operations, finance costs, share of profit or loss from joint ventures (defined by use of equity method), minority interests, ordinary profit or loss, tax expense, extraordinary items, and net profit or loss.

Most Common Examples of Contingencies

The most common contingencies are pending lawsuits (e.g., discrimination, civil rights, consumer privacy, rate hearings for regulated industries)

Equity (shareholders' equity or net assets)

The residual ownership interest in an organization's assets after deducting all of its liabilities.

Service Life

The service life of an asset differs from its functional life because service life includes not only wear and tear but also the economic viability of the asset due to obsolescence.

Statement of Financial Position (Balance Sheet) Uses

The statement of financial position shows assets, liabilities, and equity as of a moment in time, typically the end of the fiscal year. It can give users an indication of liquidity. Other uses of the statement of financial position include: --Calculating rates of return. --Evaluating capital structure. --Assessing SOLVENCY, the ability to pay debts as they mature. (This involves examining current assets to estimate whether the organization has enough cash and cash equivalents to meet its short-term obligations as well as considering long-term debt. High long-term debt relative to assets lowers relative solvency.) --Comparing relative inventory levels to show whether the organization has sufficient stock to meet short-term sales goals or if it has an excess of inventory and thus risk of obsolescence. --Determining FINANCIAL FLEXIBILITY, the ability of an organization to respond to unexpected opportunities by changing the amounts and timing of cash flows, a key element in insolvency risk. --Noting increases in accounts receivable that can show a shift in customers' ability or willingness to pay. -Credit policy

ACCELERATED DEPRECIATION METHODS: Sum-of-the-Years'-Digits Method

The sum-of-the-years'-digits method starts with the depreciable base and reduces it by a fraction based on the number of remaining years of service. Note that the depreciable base used for calculating the depreciation fraction is kept constant and the book value starts at original cost and ends at salvage value.

Problems with Traditional Cost Accounting Systems Unlike Activity Based Costing

The traditional cost accounting systems discussed so far suffer from several defects that can distort costs and result in decision making based on inaccurate data: ---All manufacturing costs, even those that are not caused by any specific product, are allocated to products. Nonmanufacturing costs that are caused by products, such as set-up and materials-handling costs, are not assigned to products. ---Costs of idle capacity are also allocated to products, which essentially charges products with resources they don't use. ---In traditional methods, expenses are typically allocated to products using unit- or volume-based cost drivers such as direct labor hours, machine hours, direct materials costs, and units produced. These can provide inaccurate product costs because products do not consume most support resources in proportion to their production volumes. ---The use of volume-based cost drivers to calculate plant-wide or departmental rates produces inaccurate product costs when a large share of overhead costs is not volume-based and when organizations produce a diverse mix of products or services.

Inventory Management: Two KPIs

There are two key performance indicators (KPIs) for inventory: ---Reduction of inventory costs related to holding, ordering, and transporting materials, supplies, and finished goods ---Achievement of customer satisfaction targets related to the quality, availability, and on-time delivery of products (which may depend on the availability of supplies)

FACTORS TO CONSIDER IN SETTING TRANSFER PRICES: International Issues

Transfer pricing is complicated for multinational organizations. Transfer pricing can: ---Minimize tax liability. For countries with different corporate income tax rates, transfer pricing can transfer profits out of the high-tax country and minimize total tax liability. This strategy can require alternative ways to motivate managers (e.g., tying performance to revenues, production costs, etc., rather than accounting profits). ---Minimize risks of expropriation (a government takes an organization's assets) or currency transfer restrictions by moving funds out of a foreign country. Governments are well aware of these uses of transfer pricing and often create transfer pricing regulations to prevent its misuse. A common requirement is to use the market price model when feasible, as discussed next.

Unit Contribution Margin Formula

UCM = USP - UVC

FIFO -> CALCULATING EQUIVALENT UNITS

Under the FIFO method, equivalent units are determined using the following: -Units to be accounted for -Units accounted for -Equivalent units costs (using work done in the current period) -Cost to be accounted for (beginning WIP inventory + current period costs) -Cost accounted for The formula for computing the equivalent units of production under FIFO is more complex than under the weighted average method: EQUIVALENT UNITS OF PRODUCTIONS = EQUIVALENT UNITS TO COMPLETE BEGINNING INVENTORY + UNITS STARTED AND COMPLETED DURING THE PERIOD + EQUIVALENT UNITS IN ENDING WORK-IN-PROGRESS INVENTORY

Comparison of Weighted Average and FIFO Methods

WEIGHTED AVERAGE METHOD -Blends work and costs from the prior period with work and costs in the current period. -Easier to use because the calculations are simpler. -Best suited to inventories and manufacturing costs that are stable. -Less accurate in computing unit costs for current period output and for units in beginning work-in-process. FIFO METHOD -Equivalent units and unit costs relate only to work done during the current period. -Separates prior and current periods. -Produces a more current unit cost if changes occur in the prices for the manufacturing inputs from one period to the next. -More closely linked to continuous improvement efforts and gives management greater control over costs and performance evaluation.

WORK-IN-PROCESS (WIP) INVENTORY

WORK-IN-PROCESS (WIP) INVENTORY consists of raw materials that have been only partly transformed into their finished state or yet-to-be installed components. For accounting purposes, WIP is an account holding all inventory in production but not yet complete as of the statement of financial position date.

ADVICE CIA EXAM - RATIOS - MEMORIZE THE CURRENT RATIO AND THE GROSS PROFIT MARGIN

When studying for the CIA exam, it is more important to understand the various categories of ratios and their purposes (as described above) than to memorize individual ratio formulas. The most important ratios to memorize would be the current ratio and the gross profit margin. The other ratios are more important to understand from a "why it would be useful" perspective, such as the importance of having cash on hand.

LIQUIDITY/SHORT-TERM DEBT RATIOS: Cash ratio

cash and marketable securities/current liabilities -Proportion of cash or easily convertible securities to liabilities at one point in time. -A more conservative measure of liquidity used to determine if an organization can pay its obligations over the short term. -However, firms can use other sources than cash to pay current liabilities.

LIQUIDITY/SHORT-TERM DEBT RATIOS: Current ratio

current assets/current liabilities -Proportion of assets to liabilities at one point in time. ABC, Inc., has U.S. $8.98 in current assets for each dollar of its current liabilities, or 8.98 times the current assets. -The current ratio cannot provide data on cash flow timing, however. -Lowering current ratios over time shows declining liquidity but, if too high, could show that the firm has too much invested in low-yield short-term assets.