1. ACCT 595 &601 FINANCIAL AND MANAGERIAL ACCOUNTING

1. Define Accounting and identify the main branches within the accounting profession. Identify the three major Financial Statements and the main users of Financial Accounting information.ANSWER:

1 Accounting: An information system that measures, processes, and communicates financial information about an identifiable economic activity.

2 Branches:1. Financial Accounting (external reporting) 2. Management Accounting (internal reporting)

3 3 Major financial statements: 1. Income Statement (shows Profitability of a company consisting of

revenues and expenses statement)2. Balance Sheet (Shows financial position of a company consisting of

assets and liabilities and stockholder's equity) 3. Statement of Cash Flows (shows Company's Liquidity consisting of

cash inflows and outflows)4 Users of financial accounting Info.

Outsiders/external decision makers(ex. Creditors, lenders, banks, stockholders, actual + potential investors, government regulators)

2. Explain the Income Statement. What are Revenues, Expenses, NI and EPS? Identify differences among income statements in: Single Step or Multistep forms and Contribution Margin form or Gross Margin form. Explain Gross Profit Margin, Net Profit Margin and Rate of Return on Equity.ANSWER:

1-Income statement: Also called the statement of earnings, the statement of operations, or the profit + loss statement. Its purpose is to measure a company’s performance over an accounting period 2-Revenues: the increases in stockholders’ equity that result from operating a business3-Expenses: the decreases in stockholders’ equity that result from operating a business4-Net Income (NI): when revenues exceed expenses, the difference is called net income5-Earnings Per Share (EPS): is the NI earned on each share of common stock6-Single step income statement:derives income before income taxes in a single step by putting the major categories of revenues in the first part of the statement and the major categories of costs + expenses in the second part. Income taxes are shown as a separate item as on the mutistep income statement. (source #1)

ORjust two groups exist: revenues and expenses. Expenses are deducted from revenues to get net income (single step). Its main advantage is simplicity. (source#2)

1 Multiple-step income statement: goes through a series of steps , or subtotals, to arrive at net income. It separtes operating sources of net ncome from nonoperating ones. (source #1)

ORProvides more useful information because it separates operating and non-operating activities and classifies expenses by function. It allows instant comparisons and ratio computations which evaluates performance of the company (source#2)1-Contribution Margin: Total revenues – total variable costs2-Gross Margin: difference between net sales and cost of goods sold

3-Gross Profit Margin: Gross margin is an ambiguous phrase that expresses the relationship between gross profit and sales revenue. The ambiguity arises because it can be expressed in absolute terms:

4-Net Profit Margin: (Net profit/Net sale)5-Rate of Return on Equity: the profitability of stockholders’ investmentsReturn on Equity=Net Income/Average Stockholders’ Equity

3. Identify the sequence of steps in the accounting information processing cycle. Discuss Transaction Analysis and Double Entry accounting. Describe the Journal and the Ledger. What is the Chart of Accounts?ANSWER: Accounting cycle:

1. Analyze business transactions from source documents2. Record the entries in the journal3. Post the entries to the ledger and prepare a trial balance4. Adjust accounts and prepare an adjusted trial balance5. Close the accounts and prepare a post-closing trial balance6. Prepare financial statements

Transaction Analysis: 5 steps1. Analyze the transaction to determine its effect on assets, liabilities, and

stockholders’ equity2. Apply the rules of double entry3. Record the entry4. Post the entry5. Prepare the trial balance to confirm the balance of the accounts Double entry: each transaction must be recorded with at least one debit and one

credit, so that the total dollar amount of debits and the total dollar amount of credits equal each other

Journal (book of original entry): a chronological record of events where transactions first enter the accounting records. Later, the debit and credit portions of each transaction can be transferred to the appropriate account in the ledger

1 Ledger: The journal is used to record the details of each transaction. The ledger is used to update each account

2 Chart of Accounts: A scheme that assigns a unique number to each account to facilitate finding the account in the ledger; Also called account balance (source #1)

ORList of numbers with corresponding account names (source #2)

4. Define the concept of Accrual Accounting Income and explain its underlying Accounting Principles. How Accrual Income differs from Cash Income? Explain Adjusting Entries and identify four situations requiring adjusting entries. Describe the Allowance Method for Uncollectible Accounts. Why is this method required?ANSWER:

1 Accrual Accounting: the attempt to record the financial effects of transactions and other events in the periods in which those transactions or events occur, rather than only in the periods in which cash is received or paid by the business; all the techniques developed by the accountants to apply the matching rule

2 Accounting principles:1. Recording revenues when earned2. Recording expenses when incurred3. Adjusting the accounts

3 Adjusting entries: used to apply accrual accounting to transactions that span more than one accounting period

4. Recorded costs are allocated between 2 or more accounting periodsex. Prepaid rent, prepaid insurance, supplies, costs of a building2. Expenses are incurred but not yet recorded ex. Wages earned by employees in the current accounting period but after the last pay period3. Recorded unearned revenues are allocated between 2 or more accounting periodsex. Payments collected for services yet to be rendered 4. Revenues are earned but not yet recorded ex. Fees earned but not yet collected or billed to customers

1 Allowance Method for Uncollectible Accounts:Bad debt losses are matched against the sales they help to produce[ex. When MGMT extends credit to increase sales, it knows that it will incur some losses from uncollectible accounts. Those losses are expenses that occur at the time sales on credit are made and should be matched to the revenues they help to generate. Of course, at the time the sales are made, MGMT cannot identify which customers will not pay their debts, nor can it predict the exact amount of money that will be lost.] Therefore, to observe the matching rule under generally accepted accounting principles, losses from uncollectible accounts must be estimated, and the estimate becomes an expense in the fiscal year in which the sales are made

5. Discuss the Balance Sheet. What are the Assets, Liabilities and Owner’s Equity? Identify and explain the basic components of a classified Balance Sheet.ANSWER: Balance Sheet: shows the financial position of a business on a certain date,

usually the end of the month or yearIt represents 2 different views of a business: the left side shows the resources of the business; the right side shows who provided those resources (the creditors and the owners

Assets: are economic resources owned by a business that are expected to benefit future operations

Liabilities: present obligations of a business to pay cash, transfer assets, or provide services to other entities in the future

Owners’ Equity: represents the claims by the owners of a business to the assets of the business

Basic components of a classified balance sheet:Assets: are divided into 4 categories listed in the order of their ease of conversion into cash

1. Current assets2. Investments3. Property, plant, and equipment4. Intangible assets

Liabilities: are divided into 2 categories, based on when the liabilities fall due1. Current liabilities2. Long term liabilities

Stockholders’ equity: 2 parts Contributed capital Retained earnings

Other forms of business organization: (although the form of a business organization does not usually affect the accounting treatment of assets and liabilities, the equity section of the balance sheet for a sole proprietorship or partnership is different from the equity section of a corporation’s balance sheet) Sole proprietorship Partnership

6. Explain the financial accounting concepts of Cost and Expense. How are they related and how do they differ? How are Cost and Expense related to accounting Depreciation, Depletion and Amortization?ANSWER:1 Cost: “the amount of money invested in an asset. Used in the course of

operations” (Weiss)2 Expense: “measures the value resources which are used up( gone) in the activity

of selling goods and services during a given time period” (Weiss)OR

The decrease in stockholders’ equity that results from operating a business (source #2)

Relation:Cost has to be shifted to an expense.ex. equipment. From costexpense/depreciation expense

1-Depreciation: the periodic allocation of the cost of a tangible long-lived asset (other than land and natural resources) over its estimated useful life2-Depletion: the exhaustion of a natural resource through mining, cutting, pumping, or other extractions, and the way in which the cost is allocated3-Amortization: the periodic allocation of the cost of an intangible asset to the periods it benefits

7. Explain the differences between the two accounting Inventory Systems and identify conditions for the applicability of each system. What is the purpose accounting Inventory Systems? How do the Accounting Entries, for sales and inventories, differ between the two systems? Discuss the importance of taking a Physical Count of inventory-on-hand under the two different inventory systems.ANSWER:

1 Periodic inventory system: a system for determining inventory on hand by taking a physical count at the end of an accounting period

2 Perpetual inventory system: a system for determining inventory on hand by keeping continuous records of the quantity and, usually, the cost of individual items as they are bought and soldConditions

4 companies that sell items of low value in high volume have traditionally used the periodic inventory system

ex. Drugstores, department stores, discount stores5 companies that sell items of high unit value have tended to use the perpetual

inventory systempurpose of inventory systems:

1. periodic inventory system enables MGMT to respond to customers’ inquiries about product availability, to order inventory more effectively and thus avoid running out of stock, and to control the financial costs associated with investments in inventory

2. perpetual inventory system reduces the amount of clerical workaccounting entries-in the periodic system the cost of each item is recorded in the merchandise inventory account when it is purchased. As merchandise is sold, its cost is transferred from the merchandise inventory account to the cost of goods sold account. Thus, at all times the balance of the merchandise inventory account equals the cost of goods on hand, and the balance in cost of goods sold equals the cost of merchandise sold to customers.-in the perpetual system as soon as any purchases or sales are made, the inventory figure becomes a historical amount, and it remains so until the new ending inventory amount is entered at the end of the next accounting period.Physical count: maintaining control over merchandise inventory is facilitated by taking a physical inventory

3 most companies experience losses of merchandise. When such losses occur, the periodic inventory system provides no means of identifying them because the costs are automatically included in the cost of goods sold

4 the perpetual inventory system makes easier to identify such losses

8. Describe the four Inventory Costing Methods. Compare FIFI and LIFO inventory valuation and explain the consequences for financial statements of using FIFO or LIFO accounting.ANSWER:

1. Specific identification method: this method prices the inventory by identifying the cost of each item in ending inventory

2. Under the Average-cost method, inventory is priced at the average cost of the goods available for sale during the period

3. First-in, first-out (FIFO) method: is based on the assumption that the costs of the first items acquired should be assigned to the first items sold

4. Last-in, first-out (LIFO) method: is based on the assumptions that the costs of the last items purchased should be assigned to the first items sold and that the cost of ending inventory reflects the cost of the merchandise purchased earliest

During a period of declining prices the LIFO method would produce a higher gross margin than the FIFO method. During a period of inclining prices, the reverse would occurConsequences for financial statementsThe LIFO method is best suited for the income statement because it matches revenues and cost of goods sold. But it is not the best measure of the current balance sheet value of inventory, particularly during a prolonged period of price increases or decreases. FIFO on the other hand, is best suited to the balance sheet because the ending inventory is closest to current values and thus gives a more realistic view of the current financial assets of a business

9. Describe the Statement of Cash Flows and define its components. Also explain the Schedule of Noncash Investment and Financing Activities.ANSWER:1 The statement of cash flows shows how a company’s operating, investing, and

financing activities have affected cash during an accounting period. It explains the net increase (or decrease) in cash during the period3 components:

1. Operating activities: business activities that involve the cash effects of transactions and other events that enter into the determination of net income

2. Investing activities: business activities that involve the acquisition and sale of long-term assets and marketable securities, other than trading securities or cash equivalents, and the making and collecting of loans

3. Financing activities: business activities that involve obtaining resources from stockholders and creditors and providing the former with a return on their investments and the latter with repayment

2 Schedule of non-cash investment and financing activities: significant investing and financing transactions involving only long-term assets, long-term liabilities, or stockholders’ equity that do not affect current cash inflows or outflows

10. How is the Direct Method different from the Indirect Method of preparing the Statement of Cash Flows? How is the Cost of Goods Sold related to Cash Payments to Suppliers? Explain the relationships between Sales Revenue and Cash Collection from Sales.ANSWER:

1 Direct method: the procedure for converting the income statement from an accrual basis to a cash basis by separately adjusting each item on the income statementIndirect method: the procedure for converting the income statement from an accrual basis to a cash basis by adjusting net income for items that do not affect cash flows, including depreciation, amortization, depletion, gains, losses, and charges in current assets and current liabilities (source #1)

OR1 Under the direct method, each item on the income statement is adjusted from

the accrual basis to the cash basis. The result is a statement that begins with cash receipts from sales and interest and deducts cash payments for purchases, operating expenses, interest payments, and income taxes to arrive at net cash flows from operating activities. The indirect method, on the other hand, does not require the individual adjustment of each item on the income statement; it lists only those adjustments necessary to convert net income to cash flows from operations (source #2)

2 Cost of goods sold: The amount a merchandiser paid for the merchandise it sold during an accounting period or the cost to a manufacturer of making the products it sold during an accounting period

3 Revenues: increases in stockholders’ equity that result from operating a business

11. Contrast managerial accounting information and financial accounting information.ANSWER:

Financial accounting: (Weiss)1. Designed to provide info. to outsiders2. Past to present3. Has specific dates4. Is required by law 5. Must follow General Accepted Accounting Principles (pure

Accounting) Managerial accounting: (Weiss)

1. Provides info. to insiders 2. Decision oriented/forward looking3. Doesn’t have specific dates4. Not required by law/it is up to the organization5. Not based on GAAP

12. Distinguish direct from indirect costs.ANSWER:

1 Direct cost: accurate estimate. 2 Indirect cost: rough decision rule.

(Weiss)3 Direct costs of a cost object: are related to the particular cost object and can

be traced to that cost object in an economically feasible (cost-effective) way4 Indirect costs of a cost object: are related to the particular cost object but

cannot be traced to that cost object in an economically feasible (cost effective) way

13. How does tracing differ from allocation?ANSWER:

1 The term cost tracing is used to describe the assignment of direct costs to the particular cost object

2 The term cost allocation is used to describe the assignment of indirect costs to a particular cost object

14. Discuss some key cost calculations in the schedule of the cost of goods manufactured.ANSWER:

Total Manufacturing Cost (TMC) = Direct Material + Direct labor + Manufacturing OverheadCGM (Cost of Goods Manufactured) = TMC – Work-In process Inventory

CGS (Cost of Goods Sold) = Cost of Goods Manufactured – Finished Good Inventory

15. Describe and contrast marginal cost, average variable cost and average cost.ANSWER:

1 Marginal cost: the change in total cost as the result of one unit change in output

2 Average variable cost: total variable cost/total number of output units3 Average cost: total cost/ total number of output units

16. Describe and contrast total variable cost, total fixed cost and average cost.ANSWER:

1 Total variable cost: cost changes in total proportion to change in a cost driver (TVC=VC*Q)

2 Total fixed cost: does not change in total despite changes in a cost driver3 Average cost: (Total Variable Cost + Total Fixed Cost) / Total Quantity

17. Discuss certain pitfalls in the use or misuse of average cost.ANSWER:

Average variable cost does not change by output quantity(Total variable cost increases as output quantity increases)Average fixed cost does change by output quantity(Total fixed cost does not change by output quantity)[For many decisions, managers should thing in terms of total costs rather than unit costs because fixed cost per unit change when the related level of total volume changes. Consequently, unit costs should be interpreted with caution when they include a fixed cost component. For decision making, managers should think in terms of total variable costs, total fixed costs, and total costs rather than unit costs.]

18. Define and explain TMC, CGM and CGS.ANSWER:

1 Total manufacturing cost (TMC): total cost of materials, direct labor, and factory overhead incurred and charged to production during an accounting period

TMC= Direct material cost (DM)+ Direct labor cost (DL)+ Manufacturing overhead (MOH)2 Cost of goods manufactured (CGM): cost of goods brought to completion, whether

they were started before or during the current accounting period (source #1)OR

Cost of all goods that were completed/finished no matter when we started working (WEISS)

3 Cost of Goods Sold (CGS): the amount a merchant paid for the merchandise sold during an accounting period

19. Explain specific differences among TMC, CGM and CGS.ANSWER:

4 TMC=DM + DL + MOH5 CGM=TMC- WP (WP: work in process)6 CGS=TMC-WP-FG (FG: finished goods)

OR CGS=CGM-FG

20. What is the basic operating breakeven point in $-sales and how is it different from the breakeven quantity?ANSWER:

1 The breakeven point (BEP) is that quantity of output sold at which total revenues equal total costs – that is, the quantity of output sold at which the operating income is $0

At breakeven point total operating income is 0$

QBE=F/(P-V) in units

RBE=F/[1-(V/P)] in dollars ($)

21. Explain the use of “Target Operating Income” and “Target Net Income” in the computation of the required sale in units and dollars, respectively.ANSWER:

2 Target operating income: operating income that a company aims to earn per unit of a product or service soldTarget operating income=Revenues –VC-FC

=Target net income/(1-Tax rate)Answers question: how many units must be sold (to earn an operating income of X amount of $s3 Target net income: net income that a company aims to earn knowing the

quantity of units to sell to earn a net income of X amount of $s(Net income: operating income minus income taxes)

Target net income: (Target operating income) X (1-Tax rate)Managers want to know the effect of their decisions on operating income after

income taxes are paid

22. What are the differences between Income Statements in Contribution Margin and Gross Margin forms?ANSWER:

4 Gross margin: Revenues – Cost of goods Sold5 Contribution margin: Revenues – All variable CostVariable operating costs are deducted from revenues when calculating contribution margin but are not deducted when calculating gross margin

23. Discuss the managerial function of “Planning.”ANSWER:

A process that starts with:1. Identifying goals, targets, and objectives2. Identifying all alternative ways of getting there3. Achieving those goals, targets, and objectives by assigning resourcesResources: skills, money, personnel, equipment machinery, etc.

(WEISS24. Define “Budgeting” and relate it to “Planning.”ANSWER:

1 Budget: Quantitative expression of a proposed plan of action by management for a specified period and is an aid to coordinating what needs to be done to implement that plan (source#1)

OR Budget: quantitative expression of a plan for a course of action:Is used in:2 the implementation of a plan3 the control of the planto coordinate/audit activitiesfor performance evaluation (WEISS)

ORBudget: assignment of resources

1 A quantitative # reflection of a plan2 Used to: Implement the plan Control the plan Coordinate activities/operations1 Used for performance evaluation (WEISS)

25. Discuss different kinds of budgets.ANSWER:

2 Master budget: expression of management’s operating and financial plans for a specified period (usually a year) and compromises a set of budgeted financial statements

3 Operating budget: focuses on activities of selling goods and services for a given period of time

4 Financial budget: part of the master budget that focuses on the impact of operations and planned capital outlays on cash. It is made up of the capital expenditures budget, cash budget, budgeted balance sheet, and budgeted statement of cash flows

5 Rolling budget: budget of plan that is always available for a specified future period by adding a period (month, quarter, or year) in the future as the period just ended is dropped (source #1)

OrRolling budget: budget for a product’s life cycle (WEISS)

1 Static budget: a budget that is prepared in the beginning of a period for a single level of output (WEISS)

Flexible budget: prepared at the end of the period around the known/actual (or average) level of output (WEISS)

26. What is a “Variance” in accounting? List several variances and explain the informational content (meaning) of each variance.ANSWER:

1 Variance: the difference between the actual and the budgeted (WEISS)2 A favorable variance has the effect of increasing Operating Income relative

to the budgeted amount3 An unfavorable variance has the effect of decreasing operating income to

the budgeted amount4 Sales variances:

1. Static-budget variance2. Flexible-budget variance

5 Static-budget variance: is the difference between an actual result and the corresponding budgeted amount in the static budget

6 Flexible-budget variance=(Actual result-flexible budget amount): is the difference between an actual result and the corresponding flexible budget amount based on the actual output level in the budgeted period

7 Sales volume variances=(budgeted output-actual output level) arise solely from the difference between the budgeted output level used to develop the static budget and the actual output level used to develop the flexible budget

or8 Sales volume variance is the difference between a flexible-budget amount

and the corresponding static-budget amount9 Price variance: is the difference between the actual price and the budgeted

price multiplied by the actual quantity of input10 Efficiency variance: is the difference between the actual quantity of input

used and the budgeted quantity of inputs that should have been used to produce the actual output, multiplied by the budgeted price

11 Production volume variance: the difference between budgeted fixed overhead and fixed overhead allocated on the basis of actual output produced

12 Sales mix variance: the difference between 1. The budgeted contribution margin for the actual sales mix and2. The budgeted contribution margin for the budgeted sales mix1 Sales quantity variances: the difference between1. The budgeted contribution margin based on actual units sold of all products at

the budgeted mix and2. The contribution margin in the static budget

27. How do flexible budget variances differ from sales volume variances?ANSWER:

See question 26

28. Distinguish a price variance from an efficiency variance.ANSWER:

See question 26

29. What is the production volume variance (also known as the output level variance?)ANSWER:

See question 26

30. Activity based costing leads to a better understanding and control of which major category of cost? Explain how this is accomplished.ANSWER:

Activity based costing (ABC) focuses on individual activities as the fundamental cost objects. ABC systems calculate the costs of individual activities and assign costs to cost objects such as products and services on the basis of the activities needed to produce each product or serviceABC systems focus on indirect costs refining the assignment of indirect costs to departments, processes, products, and other cost objects7 steps to approach:

1. Identify the products that are chosen cost objects

2. Identify the direct costs of the products3. Select the cost-allocation bases to use for allocating indirect costs to the

products4. Identify the indirect costs associated with each cost allocation base5. Compute the rate per unit of each cost allocation base used to allocate indirect

costs to the products6. Compute the indirect costs allocated to the products7. Compute the total costs of the products by adding all direct and indirect costs

assigned to the products

31. What are the characteristics of the markets that lead to job order costing versus the markets that lead to process costing?ANSWER:

2 Job costing: for distinct products or servicesapplied to custom made, unique items, usually expensive per unit (WEISS)ex. Dental care 3 Process costing: applied to mass-produced, identical items. Most of the items

are cheap/ have small value (WEISS)4 Dealing with large, homogeneous, standardized, inexpensive items (WEISS)

32. How are relevant and variable costs related?ANSWER:

1 Relevant costs: expected future costs that differ among alternative courses of action being considered

2 Variable cost: cost that changes in total in proportion to changes in the related level of total activity or volume

In order for variable costs to be relevant they must: 1. Occur in the future2. Differ among the alternative courses of action: (costs that do not differ

will not matter and, hence, will have no bearing on the decision being made)

33. Explain how the “High/Low” Method is used in estimating cost curves.ANSWER:

It uses only the highest and lowest observed values of the cost driver within the relevant range and their respective costs. (The cost function is estimated by using these 2 points to calculate the slope coefficient and the constant or intercept)

A cost driver is a variable, such as the level of activity or volume that causes cause to increase34. What is “Regression Analysis” and how is it different from the “High/Low” Method?ANSWER:

1 Regression Analysis: is a statistical method that measures the average amount of change in the dependent variable associated with a unit change in one or more independent variables

The regression method is more accurate than the high low method because the

regression equation estimates costs using information from all observations, whereas the high-low equation uses information from only 2 observations

35. Discuss “Learning Curves” and “Experience Curves” and explain why they may be important when estimating cost curves.ANSWER:

2 Learning curve: function that measures how labor hours per unit decline as units of production increase because workers are learning and becoming better at their jobs

3 Experience curve: function that measures the decline in cost per unit in various value-chain functions such as manufacturing, marketing, distribution, and so on, as units produced increase

Managers use learning curves to predict how labor-hours, or labor costs, will increase as more units are produced. As workers become more familiar with their tasks, their efficiency improves. Managers learn how to improve the scheduling of work shifts. Plant operators learn how best to operate the facility. As a result of improved efficiency unit costs decrease as productivity increases, and the unit-cost function behaves non-linearly. These non-linearities must be considered when estimating and predicting unit costs.

Missing questions:1. Question# 2: Gross Profit Margin2. Question# 4: Accrual Accounting Income (not sure if the same as Accrual

Accounting). How Accrual income differs from Cash Income3. Question #10: How is the CGS related to Cash Payments to suppliers. Explain

the relationship between Sales Revenue and Cash Collection from Sales