accountaning management notes @ mba bec doms

Question -- Accounting

Module 1

What are the characteristics of a company structure?

Author - Cynthia Enns, EBS MBA; edited by Irene Gelyk. 1 of 223

Answer -- Accounting

Limited liability of owners (shareholders) to equity (share capital) of companyPublic accounts, audited



Module 1

What is financial accounting?



Legal obligation on directors & managers to report to owners on how resources have been deployed during the accounting period



Module 1

Who uses accounting information?



Internal (MEDS)Directors Senior

ExecutivesManagers Employees

External (PACTS)Shareholders AnalystsCreditors Tax

authoritiesPublic



Module 1

What is the Accounting Equation?



Assets = Owner’s Equity + Liabilities

OR

Assets – Liabilities = Owner’s Equity



Module 1

What is gross profit in a manufacturing company?



Sales LESS Cost of Sales



Module 2

What is the impact of different inventory valuation methods (in rising prices)?



FIFO Income is higherHigher taxesHigher dividendsClosing inventory is higher

LIFO Lower profitGood for tax minimization

AVERAGE

Weighted average unit cost



Module 2

What are the FOUR methods of recognizing revenue?



1. *Shipping & invoicing2. Time of sales order3. Time of production, i.e., shipbuilding4. Time of collection, i.e., installment

plans



Module 2

What are the conditions necessary to recognize sales?



1. Principle revenue-producing service has been performed

2. Costs to create revenue have occurred3. Amount collectable can be estimated



Module 2

How do you calculate Cost of Goods (CoG’s) [relationship between valuation & profit]?



Beginning inventory + purchases LESS ending inventory = CoG’s

> Ending inventory valuation > profit < Ending inventory valuation < profit



Module 2

What are the THREE different methods of calculating depreciation?



1. Straight-line depreciation= acquisition costs – est. residual value est. useful life

2. Reducing balance depreciation

(n = estimated life)

3. Consumption method -- based on running hours

Module 2Author - Cynthia Enns, EBS MBA; edited by Irene Gelyk. 20 of 223


What are the THREE main “measurement of effort” Conventions?



1. Matching convention: profit = matching the effort (costs) with units shipped & invoiced (sales) during the period

2. Allocation convention: determine the consumption of means of production; determine the value of closing WIP (work-in-progress) and inventories of raw materials

3. Costs convention: historical/acquisition cost of different means of production



Module 2

What are TWO “measurement of sales” conventions?



1. Realization convention: only products sold are measured as sales

2. Accruals convention: cash does not have to be received to create value



Module 2

What are the different profit measurements? When are they used?



Gross profit (sales less CoG’s) measures efficiency of transformation*Net profit before interest and taxes managerial efficiencyNet profit after interest and before taxes assesses financial structure



Module 2

What are some of the principle features of depreciation?



Allocation of cost of assets purchased in 1 accounting period over the accounting periods in which they are usedCost of productionInfluences reported profitThe effect on cash position (lowers taxes, etc.)



Module 2

What is the difference between product & period costs?



Product costs = raw materials, direct labour, factory overhead (cost of sales/closing inventory)Period costs = selling, distribution, marketing, general admin. (P+L accounts)



Module 2

How do you determine whether a cost should be capitalized or written off?



Take a conservative approach!Write off expenditure UNLESS

Clearly related to acquisition + asset could not be made operational w/o costs (i.e., land & survey fees)



Module 3

What is ‘GEARING’ and how is it calculated? What is the effect on ROI?



Gearing or Leverage is the relationship between shareholders funding (OE) to loans

Healthy profits better returnsLower profits lower ROI



Module 3

How are bad debt provisions calculated and accounted for?



Consider risks attached to each customer, severity of pursuing, general economic environment, i.e., interest ratesB/SH debtors less provisionsP+L charge for bad debts; topped up each year.



Module 3

Why would a company choose to lease vs. own assets?



A voice substantial outflow of cashSpreads out cash flowsCan replace leased asset no gain/lossMaintenance costs coveredLease payments are an allowable charge against profits before tax.



Module 3

What is a revaluation reserve?



Entry in balance sheet (s/h equity) to indicate a revaluation of land/property



Module 3

What is the difference between a Finance Lease and an Operating Lease?



Finance lease ownership reverts to lessee at end of lease

On balance sheet fixed assets & lease payments as creditorsInterest charged to P+L, capital deducted from both

Operating lease ownership remains with lesser

Not capitalizedPayments are expensed annually (capital + interest)



Module 4

How do you calculate cash flow from operating activities?



= Profit + bad debt provision + depreciation Loss/Gain on sale

Less in working capital Inventories cash Debtors /creditors cash



Module 4

What are the EIGHT major categories of cash flow?

(Our Really Tall Cat Ate Everyone’s Meaty Food)



1) Operating activities2) Returns on investment & servicing of finance3) Taxation4) Capital Investments5) Acquisitions and disposals6) Equity dividends paid to shareholders7) Management of liquid resources8) Financing



Module 5

What are the FIVE fundamental accounting concepts?



1) Going concern concept – a company will continue to do business in future

2) Accruals – company doesn’t wait for money to change hands before accounting for revenues & costs

3) Consistency – 4) Prudence – conservatism5) Non-aggregation –



Module 5

How are consolidated or group financial statements prepared?



Holding/Parent company must publish group P+L & Balance Sheet but also its own Balance Sheet (not P+L)Adds all assets and shows minority interests entries



Module 5

What is the distinction between the Companies Act 1985/89 and Accounting Standards?



1) Companies Act states that companies must disclose certain information in a “True & Fair view of … GAAP”

2) Accounting Standards set controls on how the numbers are to be compiled – must be disclosed.



Module 5

What THREE sets of rules constrain management when constructing corporate financial statements?



1) Companies Acts/Legislation – government of country

2) Accounting standards – profession/regulations

3) Listing requirements – Stock Exchange Commissions (SEC)



Module 5

What do auditors do?



Examine co. system of accountingCompares of accounting statements to underlying recordsVerifies of title/existence/value of assetsVerifies liabilitiesVerifies that results of P+L are fairly statedConfirm statutory regulations complied with and accounting standards have been applied correctly (S C A L P S)



Module 6 – Capital Structure Ratios

Times Interest Earned Ratio Calculation



Switches to the profit and loss account in order to measure the gearing position and margin of safety in relation to earnings



Module 6 – Liquidity Ratio

Current Ratio (sometimes called Working Capital Ratio)



It is often stated as a rule of thumb that a 2 times current ratio indicates a sound financial situation.



Module 6

Return on Capital Employed



Capital employed is usually defined as the total assets of a company minus the current liabilities. Alternatively, one can add together the owner’s equity and the long-term loans and provisions.



Module 6 – Profitability Ratio

Return on Total Assets



Note that the whole balance sheet figure for total assets (fixed assets plus current assets) has been selected for the fraction



Module 6

What are the efficiency ratios?

(some times referred to as activity or turnover ratios)



Activity or turnover ratiosHow effectively are costs managed?1) Inventory Turnover2) Average collection period3) Fixed assets turnoverMeasures company’s asset management



Module 6

Return on Owner’s Equity



Most important profitability ratio is the one that relates the profit earned to the capital (contributed and accumulated) of the ordinary shareholders of the company.



Module 6 – Liquidity Ratio

Quick Ratio (also called ACID TEST)



The quick ratio therefore removes inventory from the calculation, thus providing a more rigorous test of the company’s ability to pay its maturing obligations.One times or great is considered good



Module 6 – Profitability Ratio

Gross Profit Margin



The gross profit margin is the first critical measure of profit an analyst or manager examines since a company must earn significant gross margin if it is going to bear the burden of other corporate overhead.



Module 6

What are the TWO different liquidity ratios?



1) Current Ratio2) Quick Ratio (Acid Test)

Measures a company’s ability to meet its maturing short-term obligations



Module 6 -- Profitability Ratios

Profit Margin



Module 6

What are the Capital Structure Ratios?



1) Fixed to Current Asset Ratio2) Debt Ratio3) Times Interest Earned Ratio

Examine percentage of company’s total assets that are from shareholders (OE) and effect or risk on earnings



Module 6 – Efficiency Ratio

Inventory Turnover Ratio




Fixed Assets Turnover Ratio



Module 6

What are the SIX main Profitability Ratios?



Gross Profit Margin Profit MarginReturn on Total AssetsReturn on Specific AssetsReturn on Capital EmployedReturn on Owner’s Equity

Profitability ratios give management an insight into a company’s long-term survival.



Module 6 – Capital Structure Ratio

Fixed to Current Asset Ratio



This ratio highlights the fact that for every £1 invested in current assets, a company has invested around £#.## in fixed assets.




Debt Ratio & Debt/Equity Ratio



The debt ratios measures the proportion of assets that are financed by debt.




Debt/Equity Ratio




Available to Equity Ratio




Average Collection Period Ratio -- Sometimes called days sales outstanding



Represents the average length of time that a company must wait after making a sale before receiving the cash.



Module 6 (part one)

What are the basic stock market ratios?



Earnings per share (EPS)

Price/Earnings Ratio (PE)



Module 6 (part two)

What are the basic stock market ratios?



Dividend Yield

Dividend Cover



Module 6 – Profitability Ratios

Return on Total Assets



Whole balance sheet figure for total assets (fixed assets plus current assets) is used



Module 6

What are the FOUR categories of Ratios?



1) Liquidity2) Profitability3) Capital Structure

a. Assetsb. Financing (gearing)

4) Efficiency



Module 7

What are the FOUR examples of off-balance sheet transactions?



1) Quasi-subsidiaries2) Consignment inventories3) Sale/Repurchase agreements4) Debt factoring



Module 7

When can merger accounting be used?



When…1) Neither party is acquiring/acquired2) Neither party dominates transaction3) Relative size similar4) Primarily equity share exchange5) No one shareholder retains interest in

future performance of part of the combined entity



Module 7

What conditions could exist to capitalize development expenses?



1) Clearly defined project2) Expenses are separately identified3) Outcome has certainty on technical

feasibility and ultimate commercial viability

4) Sales will be greater than costs5) Adequate resources exist



Module 7

What are the key differences between merger & acquisition accounting?



Acquisition accounting -- shows goodwill (asset), note share premiumMerger accounting is more flexible – combined nature of distributable reserves



Module 7

When is a joint (quasi-subsidiary) venture considered to be consolidated?



1) Company is a lead partner & exercises a dominant role

2) Can take back goods under beneficial terms

3) Share profit/loss/dividends unequally



Module 7

What is GOODWILL?



It is the difference between fair value of net assets acquired in a corporate transaction and the price paid for assets.



Module 7

How are BRANDS valued?



1) Historic cost – all costs spent developing and maintaining brand can be capitalized (adjustment to reserve)

2) Earnings method – multiplier earnings



Module 8

What is the difference between job costing and process costing?



Job – costs allocated to individual items; direct costs (material & labour) & allocated overhead

Process – when identification of finished items is impossible (oil refining); take all costs in accounting period and divide by total quantify output during same period



Module 8

What are the key differences between Financial & Management Accounting?



Financial Management Backward looking, past

performance Forward looking, supports

mgmt decision-making Structured Non-structured GAAP No Compulsory No $ $, Q Company as whole Activities/departments Auditors No



Module 9

What are the assumptions underlying cost-volume-profit analysis?



All costs can be identified as Variable or Fixed

Costs behave the same Sales price/unit is unchangedSales mix = budgetAll production is sold



Module 9

What is contribution margin?



Sales = Fixed costs + Variable costs + Profit Breakeven sales = Fixed costs + Variable costsContribution margin = Sales revenue -

Variable costs



Module 9

How do you calculate Break Even Point?



Module 9

What are controllable/uncontrollable costs?



Controllable management has the ability to choose whether or not to incur the costs; valid for a particular manager as well (refers to the person, the manager or foreman or supervisor, who can be held accountable for the costs being measured)Uncontrollable not controllable in the short-term or outside of the control of the immediate manager, e.g., plant insurance



Module 9

What are Standard Costs?



Budgeted cost for one cost item



Module 9

What are engineered & discretionary costs?



Engineering: unavoidable costs if company wants to continue productionDiscretionary: costs that need not be incurred (R&D, maintenance)



Module 10

How can costs be allocated between joint products? By-products?



1) Equal shares2) Physical characteristics3) Sales value at split4) Ultimate net sales value if further

processing

By-products all costs are to main product sales deducted from product costs before determining gross margin



Module 10

How do you determine process costing for equivalent units?



For each cost category

= Effort expended in this period to finish opening inventory

+ Units started & completed in period+ Efforts expended on closing inventory



Module 10

What are some (SEVEN) of the typical activity bases for Overhead (OH) costs?



1) Personnel – # of employ2) Computing – hours, # reports3) Machinery – machine hours4) Buildings – space occupied5) Power – machine hours, meter6) Executive salaries – sales7) Production schedule – # of differing

products



Module 10

What is a joint product? What is a by-product?



Joint product – must appear during the processes involved in producing main product. If management has the option of not allowing the second product to emerge from the process the two products cannot be deemed to be joint.By-product – is a joint product that has undesirable or low value



Module 10

What is the STEP method of allocating OH?



Recognizes that support departments provide services to other support departmentsChoose highest OH department – allocate to other departments (not including self)Continue – ignoring already previously allocated departments



Module 10

What is an equivalent unit?



In-process costingAssessment of degree of completeness of one unit under each major component of cost



Module 10

What happens when actual OH is > or < to budgeted OH?



Difference credited/debited to P+L under cost of goods (CoG’s)



Module 10

What is a predetermined OH rate?



Because these overheads are not directly attributable to cost units in the same manner as direct materials and direct labour where the actual usage of resources can be tracked precisely, accountants use a predetermined overhead rate with which to spread overheads across the units of production.



Module 10

What is Activity Based Costing (ABC)?



ABC – activities rather than products, cause costs to be incurred

Cost of products become goal (not just accounting inventory valuations)Different cost driversEmbraces all OHReflects complexity of production/marketingMore accurate costs – better planning



Module 11

What is the decision-making process?



1) Define problem & list alternatives2) Cost alternatives (just differences)3) Assess qualitative factors4) Make decision

Company wide point of view

Opportunity costs

Ignore sunk costs Ignore future costs that are same for all alternatives



Module 11

What is the difference between absorption and variable costing?



*When actual production planned production


*


Module 11

Should we Process Further (more relevant to joint or by-products)?



Ignore costs that are not relevantRelevant - $ spent on further, additional $ gained from revenue



Module 11

Considerations when faced with Special Sales Orders?



If price is > variable cost, then it contributes to Fixed CostsDemand for productFuture business from sale



Module 11

Considerations when closing down a unit?



Focus on contribution – coverage of fixed costsQualitative factorsOne-time costs



Module 11

What are relevant costs?



Future costs – not sunk costsCash costs – not depreciation or write offsAvoidable costsCost that differ among alternatives



Module 11

What is the impact on reported profit between Absorption & Variable Costing?



Absorption costing values inventory higher taxable profits are higher

if sales < production, profits sales > production, profits

Preferred by most tax authorities. Companies don’t always have a choice.



Module 12

What is Zero-Based Budgeting?



Management invites certain activities/centres to bid for their scarce resources as if they were starting from ZEROOrganized into “packages of work” which can be separated from each otherRanked in order of top management prioritiesTakes a high amount of effort to divide into costed packagesMay need to seek external opinions on definitions



Module 12

What are the perceived problems with budgeting?



1) Time taken2) Lack of top management commitment3) A form of punishment4) Dictatorial control5) Responsibilities blurred6) Circumstances can change (moving

goal post)7) Budgeting rewards inefficiency



Module 12

What are reasons for budgeting?



1) Coordination2) Planning3) Motivation4) Control



Module 12

How to devise a budget?



Sales budget Production budgetDirect materials budget- Purchases budget- Purchases budget- cash flow budget

Direct labour budget

Management OH budget

Selling & Admin budget

Closing inventory budget

Cash budget



Budget P+L Budget Balance Sheet



Module 13

What are the Sales Variances?



Module 13

What are the fixed Overhead Variances?



Module 13

What is Standard Cost?



Budgeted or expected cost for individual cost items (or of a single unit of production)

= direct materials + direct labour + variable OH



Module 13

What are the Material Cost Variances?



Module 13

What are the Labour Cost Variances?



Module 14

How is Residual income calculated? Advantages?



Advantage: Residual income overcomes the dysfunctional element of ROI by encouraging divisional managers to invest, provided the expected returns exceed the imputed cost of capital. Interest rate can change it!

Divisional controllable profitLess Imputed interest= % net assetsRI



Module 14

How is divisional performance measured?



1) ROI – profits / net book value2) ROI – profits / current replacement

value

3) Assets depreciation profits 4) Subjective



Module 14

What are the FOUR types of divisions?



1) Cost centres2) Revenue centres3) Profit centres4) Investment centers



Module 14

What are the advantages/disadvantages for divisions?



Advantages DisadvantagesSpecialization Lack of ControlSize CostMotivation Internal RivalriesSharper DecisionsCareer Mobility



Module 14

How are Transfer Prices determined? (between divisions)



Market Price (best vs. objective)Cost-based prices (if no market price)

Full cost (includes fixed costs)Variable costsNegotiated costs



Module 14

What are some additional issues for International companies – between divisions?



1) Taxation2) Repatriation of profits



Module 15

What about inflation?



Should be includedNot part of NPVNot equal



Module 15

What is Risk Analysis?



Analyze variables in terms of probability of different values



Module 15

What is the payoff/payback period?



Time taken to recover original investment. When will you get your money back?Ignores the opportunity cost of the capital invested vs. discounted payback



Module 15

What is the difference between NPV & IRR?



NPV – absoluteIRR – Ratio

Provides different results to compare



Module 15

What are the PV formulas?



Or the reciprocal



Module 15

What are the steps in the Investment Process?



1) Search2) Evaluate – strategic plan

– financial & qualitative analysis

3) Control – budgeting



Module 15

How do you determine the Cost of Capital?



Average cost ofFixed interest loansFixed dividend sharesResidual equity sharesRetained earnings

USE optimum proportions as weight



Module 15

What are the KEY investment factors?



1) Capital investment – fixed & working capital

2) Operating cash flows – actual cash flow (including taxation)

3) Investment life – physical / technical / marketing

4) Cost of Capital



Module 15

What is sensitivity analysis?



Building a model of project, change parameters & check resultsDetermine critical factors & assess uncertainty / risk



Module 15

What is the Internal Rate of Return (IRR)?



IRR, sometimes called the Discounted Cash Flow Rate of Return or Yield (DCF) or simply the Rate of Return.

= Cost of Capital – NPV = 0

See Appendix 15.2 for example.



Module 15

What is life cycle costing?



Gathers all revenues & costs associated with product over its whole lifespan – to measure its ultimate profitability



Module 16

What are some of the shortcomings of current management accounting practices?



Driven by financial accounting, e.g., inventory/profitDirect labour overhead allocation by direct labour not validComputerized production control ’s variable/fixed costsOverheads increasing relative to quality, designBusiness more complex, wider product ranges, shorter lifecyclesGlobal markets



Module 16

What are the THREE concepts of throughput accounting?



Looking at situation from rate at which $ earned through sales

1) Depreciation excluded from performance - total factory costs (incl. Labour) + materials

2) Value is created when product sold- not inventory valuation profits

3) Profitability – rate at which cash is rec’d at bottleneck point (limiting factor which restricts production in short-term)



Module 16

What is Target Costing?



Focuses on target price based on customer perceived value, then deduct desired profit margin to determine target costValue engineering – improving processes to lower costs


accountaning management notes @ mba bec doms

Documents

accounting module

value module

cost of sales module

accounts module

audited module

hours module

accounting period module

owners equity module