m.accounting final
operating assets definition
include cash, accounts receivable, inventory, plant and equipment, and all other assets held for productive use in the organization and/or the investment centre. Examples of assets that would not be included in the operating assets category (i.e., examples of non-operating assets) are land held for future use, an investment in another company, or a factory building rented to someone else. The operating assets base used in the formula is typically computed as the average of the operating assets between the beginning and the end of the year.
relaxing (or elevating) the constraint (page 553)
increasing the capacity of a bottleneck -For example, the stitching machine operator could be asked to work overtime. This would result in more available stitching time and hence more finished goods that can be sold.
The sales budget is constructed by?
multiplying the budgeted sales in units by the selling price.
how to compute effect on operating income if sales volume goes up or down
multiplying the unit CM by the change in units sold or by multiplying the change in sales dollars by the CM ratio
Definition of a segment
"a part or activity of an organization about which managers would like cost, revenue, or profit data." -A company's operations can be segmented in many ways. For example, a grocery store chain like Loblaws or Sobeys can segment its business by geographic region, by individual store, by the nature of the merchandise (i.e., fresh foods, canned goods, paper goods), by brand name, and so on. As we will see, it is possible to classify segments according to managers' ability to control revenues, costs, and profits. Importantly, the tools used to evaluate segment managers' performance depend directly on what they have control over.
labour rate and efficiency variance formula
(AHxAR)-(AHxSR)-(SHxSR)
manufacturing o/h spending and efficiency formula
(AHxAR)-(AHxSR)-(SHxSR)
material price variance and material quantity variance formula
(AQxAP)-(AQxSP)-(SQxSP)
Quantity and Price standards
-Quantity standards specify how much of an input should be used to make a unit of product or provide a unit of service. -Cost (price) standards specify how much should be paid for Page 385each unit of the input.
Any increase in ROI must involve at least one of the following:
1. Increased sales. 2. Reduced operating expenses. 3. Reduced operating assets.
Criticisms of Return on Investment
1. Just telling managers to increase ROI may not be enough. Managers may not know how to increase ROI; they may increase ROI in a way that is inconsistent with the company's strategy; or they may take actions that increase ROI in the short run but harm the company in the long run (such as cutting back on research and development). 2. A manager who takes over a business segment typically inherits many committed costs over which the manager has no control. These committed costs may be relevant in assessing the performance of the business segment as an investment but make it difficult to fairly assess the performance of the manager relative to other managers. 3. As discussed in the next section, a manager who is evaluated based on ROI may reject profitable investment opportunities.
Two broad categories of costs are never relevant in decisions. These irrelevant costs are
1. sunk costs (e.g., a previously owned computer used to download the movie), and 2. future costs that do not differ between the alternatives (e.g., car lease payments when making a "go to a movie" versus "download a movie" decision).
Preparing the Master Budget
1.A sales budget, including a schedule of expected cash collections. 2.A production budget. 3.A direct materials purchases budget, including a schedule of expected cash disbursements for raw materials. 4.A direct labour budget. 5.A manufacturing overhead budget. 6.An ending finished goods inventory budget. 7. A selling and administrative expense budget. 8. A cash budget. 9.A budgeted income statement. 10.A budgeted balance sheet.
Advantages of budgets (6)
1.Budgets communicate management's plans to employees throughout the organization, leading to a better understanding of the organization's goals and objectives. 2.Budgets require managers to think about and plan for the future. Without a budget, many managers would spend too much time dealing with short-term issues. 3.The budgeting process provides a means of allocating resources to those parts of the organization where they can be used most effectively and are most needed. 4.The budgeting process can uncover potential bottlenecks before they occur, by identifying the demands that will be placed on key activities and processes. If necessary, changes can be made to any activity or process that does not currently have the capability or capacity to meet the budgeted level of activity on a timely basis. 5.Budgets coordinate the activities of the entire organization by integrating the plans of the various areas. Budgeting helps to ensure that everyone in the organization is working toward achieving the overall goals of the company. 6.Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent actual performance. Periodic comparison of actual results to budgeted amounts allows management to determine whether the organization's goals are being met and to take corrective action as necessary.
The major advantages of decentralization include:
1.By delegating day-to-day problem solving to lower-level managers, top management can concentrate on bigger issues, such as overall strategy. 2.Empowering lower-level managers to make decisions puts the decision-making authority in the hands of those who tend to have the most detailed and up-to-date information about day-to-day operations. 3.By eliminating layers of decision making and approvals, organizations can respond more quickly to customers and to changes in the operating environment. 4.Granting decision-making authority helps train lower-level managers for higher-level positions. 5.Empowering lower-level managers to make decisions can increase their motivation and job satisfaction.
two guidelines are followed in assigning costs to the various segments of a company under the contribution approach:
1.First, according to cost behaviour patterns (i.e., variable and fixed). 2.Second, according to whether the costs are directly traceable to the segments involved.
The participative budget approach has a number of advantages (4):
1.Individuals at all levels of the organization are recognized as members of the team whose views and judgments are valued by top management. 2.Budget estimates prepared by front-line managers are often more accurate and reliable than estimates prepared by top managers, who have less detailed knowledge of factors that impact day-to-day operations. 3.Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above. Participative budgets create commitment to attaining the budget goals for revenues, expenses, and profit. 4. A manager who is not able to meet a budget that has been imposed from above can always say that the budget was unrealistic and impossible to meet. With a participative budget, this excuse is not available.
The major disadvantages of decentralization include:
1.Lower-level managers may make decisions without fully understanding the company's overall strategy. 2.If lower-level managers make their own decisions independently of each other, coordination may be lacking. 3.Spreading innovative ideas may be difficult in a decentralized organization. Someone in one part of the organization may have a terrific idea that would benefit other parts of the organization, but without strong central direction the idea may not be shared with, and adopted by, other parts of the organization. 4.Lower-level managers may have objectives that clash with the objectives of the entire organization. For example, a manager may be more interested in increasing the size of his or her department, leading to more power and prestige, than in increasing the department's effectiveness.
The cash budget is composed of four major sections:
1.Receipts section 2.Disbursements section 3.Cash excess or deficiency section 4. financing section (borrowings, loan repayments, and interest expense)
An operating segment for financial accounting purposes is a component of an enterprise
1.That engages in business activities from which it may earn revenues and incur expenses. 2.Whose operating results are regularly reviewed by the enterprise's chief operating officer to make decisions about resources to be allocated to the segment and assess its performance. 3. For which discrete financial information is available.
continuous or perpetual budget
12-month budget that rolls forward one month (or quarter) as the current month (or quarter) is completed. In other words, one month (or quarter) is added to the end of the budget as each month (or quarter) comes to a close. This approach always keeps managers focused at least one year ahead, which helps them from becoming too narrowly fixated on short-term results.
Balanced Scorecard
A balanced scorecard consists of an integrated set of performance measures that is derived from the company's strategy and that supports the company's strategy throughout the organization. A strategy is essentially a theory about how to achieve the organization's goals and deals with issues such as how to attract customers, what products or services to sell, what markets to enter, and how to compete with rivals. According to some experts, there are three potentially successful generic strategic approaches to outperforming competitors: 1. Cost leadership: By maintaining low cost through efficiency relative to competitors, a company can make superior profits at current industry prices. Alternatively, the company can become a price leader because other firms are unable to undercut its prices. Low costs may also serve as a barrier against potential new market entrants and thereby protect long-term profitability. However, technological change or imitation of low-cost techniques by rivals can threaten the success of this strategy. 2.Differentiation: For products or services that are perceived as unique, customers will sometimes pay premium prices, giving the company higher profit margins. This cushion of higher profits reduces the effect of supplier or buyer power. Brand loyalty, however, may fail if the cost differential between the firm and the cost leader in the industry becomes too wide. 3. Focus or niche: By serving a narrow, strategic target market more effectively than rivals who are competing more broadly, a firm may be able to achieve superior profitability. The risk of being overtaken by broad-target firms who have economies of scale is a constant threat to the success of this strategy.
Investment Centre
An investment centre is any segment of an organization whose manager has control over cost, revenue, and investments in operating assets. For example, the president of General Motors Canada, a division of the General Motors Company, would have a great deal of discretion over investments in the division.
Benefits + Criticisms of Residual Income
As shown above, compared to ROI, the use of residual income can lead managers to make decisions more consistent with shareholders' objectives. Further, some claim that residual income is more closely related to shareholder returns than other metrics, such as sales growth, net income, and ROI. However, the following criticisms of residual income are worth noting: 1. Residual income is based on historical accounting data, which means that in particular, the accounting values used for capital assets can suffer from being out of date when costs are rising. This can lead to inflated amounts for residual income. 2. the residual income approach does not indicate what earnings should be for a particular business unit. A means of comparison is needed, which could involve using external benchmarks based on key competitors or evaluating trends in residual income over time (e.g., tracking the percentage change over several periods). 3. Residual income is a financial metric that does not incorporate important leading non-financial indicators of success, such as employee motivation and customer satisfaction.
Define a sell or process further decision
Deciding what to do with a product from the split-off point forward is known as a sell or process further decision. Joint costs are irrelevant in these decisions because by the time the split-off point is reached, the joint product costs have already been incurred and therefore are sunk costs. -It will always be profitable to continue processing a joint product after the split-off point as long as the incremental revenue from such processing exceeds the incremental processing cost incurred after the split-off point. Joint product costs that have already been incurred up to the split-off point are sunk costs, which are irrelevant in decisions concerning what to do from the split-off point forward.
Ideal vs Practical Standards
Ideal standards are those that can be attained only under the best circumstances. Some managers feel that such standards have motivational value. They argue that it is a constant reminder of the need for ever-increasing efficiency and effort. However, few firms use ideal standards because most managers feel they are discouraging for even the most diligent workers. Moreover, when ideal standards are used, variances from the standards have little meaning. Large variances from the ideal are normal, so it is difficult to manage by exception. Practical standards Are defined as standards that are tight but attainable. Variances from practical standards typically signal a need for management attention because they represent deviations that fall outside normal operating conditions.cc
Profit Centre
In contrast to a cost centre, a profit centre is any business segment whose manager has control over both cost and revenue. Like a cost centre, however, a profit centre manager generally does not have control over investment funds.
operating income definition
Note that operating income, rather than net income, is used in the ROI formula. Operating income is income before interest and taxes and is sometimes referred to as EBIT (earnings before interest and taxes).
ROI can also be expressed as follows:
ROI= Margin x Turnover where: Margin= Operating income divided by sales and: Turnover=sales divided by avg operating assets
Basic idea behind responsibility accounting
The basic idea behind responsibility accounting is that managers should be held responsible for those items—and only those items—that they can actually influence to a significant extent. Each revenue or cost item in the budget is the responsibility of a manager who is held responsible for subsequent deviations between budgeted goals and actual results. In effect, responsibility accounting personalizes accounting information by holding individuals responsible for revenues and costs.
The Direct Labour Budget
The direct labour budget is also developed from the production budget. By knowing in advance what will be needed in terms of labour hours throughout the budget year, the company can plan to adjust the number of employees as required.
The Direct Materials Purchases Budget
The direct materials purchases budget details the raw materials that must be purchased to meet the production budget and to provide for adequate inventories -After the production requirements have been computed, a direct materials purchases budget can be prepared: Raw materials needed to meet the production scheduleXXXX Add desired ending inventory of raw materialsXXXX Total raw materials needsXXXX Less beginning inventory of raw materialsXXXX Raw materials to be purchased
The Manufacturing Overhead Budget
The manufacturing overhead budget provides a schedule of all costs of production other than direct materials and direct labour.
The Participative Budget Approach
The success of a budget as a planning and control tool is determined in large part by the process by which it is developed. The most successful approach to developing a budget allows managers to participate in preparing their own budget estimates—rather than having a budget imposed by top management. This participative budget approach is particularly important if the budget is to be used to control and evaluate a manager's activities. If a budget is imposed on a manager by top management, it may generate resentment and conflict rather than cooperation and increased productivity.
constraint
When a limited resource of some type restricts a company's ability to fully satisfy demand for its products or services
Define an avoidable cost
a cost that can be eliminated in whole or in part by choosing one alternative over another. -By choosing the alternative of going to the movie, the cost of downloading a movie can be avoided. By choosing the alternative of downloading a movie, the cost of the movie ticket can be avoided. Therefore, the cost of the movie ticket and the cost of downloading a movie are both avoidable costs. On the other hand, the lease payments on the car are not an avoidable cost because you would continue to lease your car under either alternative. Avoidable costs are relevant costs. Unavoidable costs are irrelevant costs.
Define a relevant cost
a cost that differs among the alternatives under consideration and that will be incurred in the future (i.e., the cost has not already been incurred).
Cash Budget
a detailed plan that shows how cash resources will be acquired and used over some specified time period.
The Sales Budget
a detailed schedule showing the expected sales for the budget period; typically, it is expressed in both dollars and units of product. An accurate sales budget is the key to the entire budgeting process -Importantly, the sales budget helps determine how many units must be produced by manufacturing companies. For this reason, the production budget is prepared after the sales budget for manufacturing companies. The production budget in turn is used to determine the budgets for manufacturing costs, including the direct materials purchases budget, the direct labour budget, and the manufacturing overhead budget. These budgets are then combined with data from the sales budget and the selling and administrative expense budget to determine the cash budget.
Define a common fixed cost
a fixed cost that supports the operations of more than one segment but is not traceable in whole or in part to any one segment. Even if the segment were entirely eliminated, there would be no change in a true common fixed cost. note the following: -The salary of the Frito-Lay product manager at PepsiCo is a traceable fixed cost of the Frito-Lay business segment of PepsiCo. -The salary of the CEO of General Motors Canada is a common fixed cost of the various divisions of General Motors Canada. -The cost of the automatic bar-coding machine at Cassalatta is a common fixed cost of the Consumer Products Division and the Business Products Division. The cost of the receptionist's salary at an office shared by a number of doctors is a common fixed cost of the doctors. The cost is traceable to the office, but not to any one of the doctors individually. -Common fixed costs are not allocated to segments—the total amount is deducted to arrive at the income for the company as a whole
Define a special order
a one-time order that is not considered part of the company's normal ongoing business.
Zero-Base Budgeting
an alternative approach sometimes used where the organization faces significant constraints on the availability of resources such as the government and not-for-profit sectors. Under zero-base budgeting, managers are required to justify all budgeted expenditures, not just changes in the budget from the previous year. The baseline is zero rather than last year's budget. As a result, zero-base budgets can be an effective means of identifying operational inefficiencies and reducing costs dramatically or avoiding continual cost increases as is often the case with the incremental approach. -The key challenge with the zero-base budgeting approach is that it requires considerable time and effort, so an important issue for companies that use this approach is deciding the frequency of the zero-base review
return on investment (pp.475)
defined as operating income divided by average operating assets: -The higher the ROI of a business segment, the greater the profit generated per dollar invested in the segment's operating assets.
Define a responsibility centre, and the three primary types (page 473-)
definition: any part of an organization whose manager has control over and is accountable for cost, profit, or investments. -The three primary types of responsibility centres are cost centres, profit centres, and investment centres.1 As discussed below, organizations categorize responsibility centres into one of these three types based on the manager's authority to control cost, revenue, and investment funds.
Residual Income definition and formula
definition: the operating income that an investment centre earns above the minimum required return on its operating assets. Thus, we use operating income as defined with ROI but reduce it by a special charge computed as a percentage of average operating assets. In equation form, residual income is calculated as follows: formula: residual income= operating income - (avg operating assets x minimum required rate of return)
In preparing segmented income statements, some managers like to separate the traceable fixed costs into two classes—____ & _____. discretionary and committed.
discretionary and committed. discretionary=under the immediate control of the manager, whereas committed fixed costs are not
profitability index
dividing the contribution margin by the quantity of the constrained resource required per unit
theory of constraints (toc)
effectively managing a constraint is important to the financial success of an organization
The carrying cost of the unsold units is computed on the
ending finished goods inventory budget
cost centre
is a business segment whose manager has control over costs but not over revenue or investment funds. Service departments, such as accounting, finance, selling and administrative, legal, and personnel, are usually considered to be cost centres. In addition, manufacturing facilities are often considered to be cost centres. The managers of cost centres are expected to minimize cost while providing the level of services or the amount of product demanded by the other parts of the organization. For example, the manager of a production facility would be evaluated at least in part by comparing actual costs to how much the costs should have been for the actual number of units produced during the period. Flexible budget variances and standard cost variances, discussed in Chapters 9 and 10, are often used to evaluate cost centre performance. However, managers should not be held accountable for controlling common costs arbitrarily allocated to their segment.
A stretch budge
is one that is highly difficult to attain and often requires significant changes to the way the related activities are performed. However, in practice, most companies set their budget targets at a "challenging but attainable" level. Such targets can usually be met by competent managers exerting reasonable effort and are usually more motivating than stretch budgets.
some explanations for labour rate & efficiency variances
labour rate variance: Some of the possible explanations include hiring more than the usual number of new employees at wages less than the standard wage rate bringing down the average wage rate and less than the expected amount of overtime. labour efficiency variance: Some of the possible explanations include poor supervision, poorly trained workers, low-quality materials requiring more labour time to process, and machine breakdowns. In addition, if the direct labour force is essentially fixed, an unfavourable labour efficiency variance could be caused by a reduction in output due to decreased demand for the company's products.
The Selling and Administrative Expense Budge
lists the budgeted expenses for areas other than manufacturing. In large organizations, this budget is a compilation of many smaller, individual budgets submitted by department heads and other people responsible for selling and administrative expenses. For example, the marketing manager in a large organization would submit a budget detailing the advertising expenses for each budget period.
margin and turnover definition
margin= measure of management's ability to control operating expenses in relation to sales. The lower operating expenses are per dollar of sales, the higher the margin earned turnover= a measure of the sales that are generated for each dollar invested in operating Page 476assets.
some explanations for material price & quantity variances
materials price variance- an unanticipated change in the market price of the material, loss of bargaining power with a major supplier, or purchases in smaller quantities than usual causing the supplier to raise the per unit price. materials quantity variance- Some of the possibilities include poorly trained or supervised workers, improperly adjusted machines, and defective materials
segment margin
obtained by deducting a segment's traceable fixed costs from the segment's CM. -It represents the margin available after a segment has covered all of its own costs. The segment margin is the best gauge of the long-run profitability of a segment, because it includes only those costs that are caused by the segment
The masterbudget overview
see pages of textbook
The standard quantity per unit for direct materials
should reflect the amount of material required for each unit of finished product, as well as an allowance for unavoidable waste, spoilage, and other normal inefficiencies.
Hindrances of proper cost assignment (omission of cost, Inappropriate Methods for Assigning Traceable Costs among Segments, Failure to Trace Costs Directly, Inappropriate Allocation Base, Arbitrarily Dividing Common Costs among Segments)
textbook pp 471, 472
Benchmarking
the approach of comparing revenue, cost, or process performance to other high-performing companies, or to other successful business units in the same company, is known as benchmarking
Define traceable fixed costs
those fixed costs that can be identified with a particular segment and that arise because of the existence of the segment—if the segment had never existed, the fixed cost would not have been incurred, and/or if the segment were eliminated, the fixed cost would disappear. -Only the traceable fixed costs are charged to particular segments. If a cost is not traceable to a segment, then it is not assigned to the segment. For example, the maintenance cost for the building in which a Challenger jet is assembled is a traceable fixed cost of the Challenger business segment of Bombardier Ltd.
ultimate purpose of the budget and how is it undermined?
to motivate people and to coordinate their efforts. This purpose is undermined if managers become preoccupied with the technical aspects, or if the budget is used in a rigid and inflexible manner to control people.
