BEC Flashcards
What is Capital Budgeting? How is it used?
Managerial Accounting technique used to evaluate different investment options
Helps management make decisions
Uses both accounting and non-accounting information
Internal focus
GAAP is not mandatory
What values are used in Capital Budgeting?
Capital Budgeting ONLY uses Present Value tables.
Capital Budgeting NEVER uses Fair Value.
When is the Present Value of $1 table used?
For ONE payment- ONE time.
When is the Present Value of an Annuity Due used?
Multiple payments made over time- where the payments are made at the START of the period.
When is the Present Value of an Ordinary Annuity of $1 (PVOA) used?
Multiple payments over time- where payments are made at the END of the period.
Think A for Arrears.
What is the calculation for the Present Value of $1?
1 / (( 1+i )^n)
i : interest rate
n : number of periods
What is Net Present Value (NPV)?
A preferred method of evaluating profitability.
One of two methods that use the Time Value of Money
: PV of Future Cash Flows - Investment
How is NPV used to calculate future benefit?
NPV : PV Future Cash Flows - Investment
If NPV is Negative- Cost is greater than benefits (bad investment)
If NPV is Positive- Cost is less than benefit (good investment)
If NPV : 0- Cost : Benefit (Management is indifferent)
What is the rate of return on an investment called?
The Discount Rate.
What does the Discount Rate represent?
The rate of return on an investment used.
It represents the minimum rate of return required.
What are the strengths of the Net Present Value system?
Uses the Time Value of Money
Uses all cash flows- not just the cash flows to arrive at Payback
Takes risks into consideration
What are the weaknesses of the Net Present Value system?
Not as simple as the Accounting Rate of Return.
How do Salvage Value and Depreciation affect Net Present Value?
NPV includes Salvage Value because it is a future cash inflow.
NPV does NOT include depreciation because it is non-cash.
Exception - If a CPA Exam question says to include tax considerations- then you have to include depreciation because of income tax savings generated by depreciation.
If multiple potential rates of return are available- which is used to calculate Net Present Value?
The minimum rate of return is used.
What is the Internal Rate of Return (IRR)?
It calculates a project’s actual rate of return through the project’s expected cash flows.
IRR is the rate of return required for PV of future cash flows to EQUAL the investment.
Investment / After Tax Annual Cash Inflow : PV Factor
Which rate of return is used to re-invest cash flows for Internal Rate of Return?
Cash flows are re-invested at the rate of return earned by the original investment.
How does the rate used for Internal Rate of Return (IRR) compare to that used for Net Present Value (NPV)?
Rate of return for IRR is the rate earned by the investment.
Rate of return for NPV is the minimum rate.
What are the strengths and weaknesses of the Internal Rate of Return system?
Strengths: Uses Time Value of Money- Cash Flow emphasis
Weakness: Uneven cash flows lead to varied IRR
When is NPV on an Investment positive?
When the benefits are greater than the costs.
IRR is greater than the Discount Rate
When is NPV on an Investment Negative?
When Costs are greater than Benefits
IRR is less than the Discount Rate
When is NPV Zero?
When benefits equal the Costs
IRR : Discount Rate
What is the Payback Method? How is it calculated?
It measures an investment in terms of how long it takes to recoup the initial investment via Annual Cash Inflow
Investment / Annual Cash Inflow : Payback Method
Compare to a targeted timeframe; if payback is shorter than target- it’s a good investment. If payback is longer than target- it’s a bad investment.
What are the strengths of the Payback Method?
Takes risk into consideration
2 year payback is less risky than a 5 year payback
What are the weaknesses of the payback method?
Ignores the Time Value of Money
Exception: Discount payback method
Ignores cash flow after the initial investment is paid back
What is the Accounting Rate of Return?
An approximate rate of return on assets
ARR : Net Income / Average Investment
Compare to a targeted return rate; if ARR greater than target- good investment. If ARR less than target- bad investment.
What are the strengths of the Accounting Rate of Return (ARR)?
Simple to use
People understand easily
What are the weaknesses of the Accounting Rate of Return (ARR)?
Can be skewed based on Depreciation method that is used.
Ignores the Time Value of Money.
What is an Expected Return?
An approximate rate of return on assets.
What is the primary duty of the board of directors?
To monitor management behavior.
What is the responsibility of the Nominating or Corporate Governance Committee of the board of directors?
Oversees the board
Responsible for hiring new CEO
What is the responsibility of the audit committee of the board of directors?
The audit committee appoints and oversees the external auditor.
What is the duty of the compensation committee of the board of directors?
The compensation committee handles the CEO’s compensation package.
What does the NYSE and NASDAQ require of the board of directors?
They require the board to be independent.
What is the main goal in an executive compensation package?
The package should ensure that the goals of management should match those of the shareholders.
How can an executive compensation package ensure that goals of management align with those of shareholders?
Executive compensation should create an incentive for management to govern in a shareholder-friendly way that doesn’t sacrifice the long-term success of the enterprise for short-term gain.
Which influences help mold the direction that management takes?
They range from internal (Board of Directors- Audit Committee- Internal Control) to external (Creditors- SEC- IRS)
These influences should not be tainted by undue influence from management or have financial ties to management such as compensation-related duties
What is shirking?
When management doesn’t act in the best interest of shareholders.
It can be alleviated by tying compensation to stock performance or company profit.
What requirements are imposed on a public company under Sarbanes-Oxley?
Management must submit a report on the effectiveness of Internal Control in the 10K.
Management must disclose significant Internal Control deficiencies.
CEO/CFO must certify that the financial statements comply with securities laws and fairly present the financial condition of the company.
What characteristics are promoted by the COSO framework on Internal Control?
Reliable financial reporting
Effective and efficient operations
Compliance
What are the elements of the control environment?
Integrity & Ethics Competence The Board of Directors & Audit Committee Management's Operating Style Organizational Structure Authority & Roles of Responsibilities HR Policies
What are control activities?
A component of Internal Control that includes actions being taken to promote the control environment.
What are the basic elements of Internal Control?
Control Environment Risk Assessment Control Activities Information and Communication Monitoring
What is the significance of the Information and Communication aspect of Internal Control?
Management must have access to relevant and timely information to make good decisions.
How does Monitoring affect Internal Control?
Internal Control activities must be constantly monitored and evaluated for effectiveness.
What activities does the COSO framework for enterprise risk management include?
Identifies Risk Factors Promotes Risk Response Decisions Compares Management Risk vs. Shareholder Goals Aids in evaluating opportunities Promotes Quicker Capital movement
Does NOT eliminate all risk
What are possible responses to risk under the COSO framework for enterprise risk management?
Avoid or Reduce
Share or Accept
What is Cost Accounting?
Cost Accounting is a component of GAAP that records Ending Inventory on the Balance Sheet for
o Direct Materials
o Direct Labor
o Work in Process
o Finished Goods
Cost Accounting also records for the Income Statement
What is the difference between Cost Accounting and Managerial Accounting?
Cost Accounting - External Focus- GAAP
Managerial Accounting - Internal Focus- Not GAAP
What are Product Costs (aka Inventory Costs)?
Prime Costs
Conversion Costs
What are included in Prime Costs?
Direct Material USED - Have become part of the product or had a direct impact on the product
Direct Labor Used - Employees who worked on product and had direct impact
What is Factory Overhead?
All factory costs except for DM and DL used in production- including Spoilage (except for abnormal spoilage- which is a period cost and not included in OH).
What is included in Fixed Factory Overhead?
FFO : Estimated Costs / Normal Capacity
Uses Normal Activity
Examples of Fixed Factory OH: Depreciation (SL)- Utilities- Taxes
Under/Over-applied Fixed OH always goes to COGS
What is included in Variable Overhead?
VO : Estimated Activity / Actual Activity
Uses Actual Activity
Examples of Variable Factory OH: Deprecation (Units of Prod)- Indirect materials (supplies & insignificant items)- Indirect labor (factory foreman- janitors- machine maintenance)
Where is Under/Over-applied Variable OH recorded?
If Immaterial - Goes to COGS
If Material - Goes to WIP- Finished Goods- or COGS- based on their Ending Balance
Where is Under/Over-applied Fixed OH recorded?
It always goes to COGS
What is indicated by a Debit balance in Actual Factory Overhead? How is it corrected?
Under-applied overhead.
If it’s Fixed OH- under-applied goes to COGS.
If it’s Variable OH- under-applied goes to COGS if immaterial- but is allocated to WIP- FG or COGS based on ending balances.
What is indicated by a Credit balance in Applied Factory Overhead? How is it corrected?
A credit balance indicates over-applied overhead.
If Fixed overhead- it is corrected from COGS.
If Variable overhead- it is corrected through COGS if immaterial- but if material overage is allocated to WIP- FG or COGS based on ending balances.
Which variables are used to calculate Direct Material balances?
Beginning Balance DR Net purchases (plus freight-in)CR Direct Materials Used
: Ending balance (goes to BS)
What variables are used to calculated Work in Process (WIP)?
Beginning Balance (End Bal of Previous WIP)DR Direct Materials UsedDR Direct Labor Used (Conversion Cost)CR COGMDR Factory Overhead Applied (Conversion Cost)
: Ending Balance (Goes to BS)
What variables are included in Finished Goods calculations?
Beginning BalanceDR COGM
: COGAS (Cost of Goods Avail for Sale)
CR COGS
: Ending Balance (Goes to BS)
How does Freight In affect Cost Accounting calculations?
Inventory (Product) Cost
Part of DM Purchases
How does Freight Out affect Cost Accounting?
Selling (Period) Cost
Not part of inventory
When is Job-Order Costing used?
Used when costs are easily connected to a specific product or product line
Can also be applied to services
Calculation is the same as normal cost accounting - just use your T Accounts
- DM to WIP to FG to COGS
- You’re likely going to be solving for the last job in the queue
What is the Direct Method for allocating service department costs?
No services allocated between service departments- even if they serve each other. Only allocate to product(s)
What is the Step Method for allocating service department costs?
Services can be allocated to both other service departments and the product(s)
Under process costing- how are the units shipped calculated?
Beginning Inventory+ Units Started- Ending Inventory
: No. Units Shipped
Which two inventory methods are used under Process Costing?
FIFO
Weighted Average
What is another name for Process Costing?
Equivalent Units of Production
How will Equivalent Finished Units under FIFO compare to EFU under the Weighted Average method?
EFU FIFO will always be LESS than EFU Weighted Avg (unless Beginning Inventory is Zero)
How are Direct Materials calculated under the Weighted Average Method?
Beginning Inventory + Current Costs / EFU WA
How are Conversion Costs calculated under Weighted Average Method?
Beginning Inventory + Current Costs / EFU WA
How are Equivalent Finished Units calculated for Direct Materials?
Units Shipped + EI x % Complete DM
: EFU (Weighted Average Method)
- Beginning Inventory x % Complete
: EFU (FIFO)
How are Equivalent Finished Units calculated for Conversion Costs?
Units Shipped+ EI x % Complete CC
: EFU (Weighted Average)
- Beginning Inventory x % Complete
: EFU (FIFO)
How are Direct Materials calculated under the FIFO method?
Current Costs / EFU FIFO
Note: FIFO method uses Current Period costs only and ignores Beginning Inventory
How are Conversion Costs calculated under the FIFO method?
Current Costs / EFU FIFO
FIFO method uses Current Period costs only and ignores Beginning Inventory
How is WIP calculated?
Beginning balance (DM- DL- OH)+ Current Costs (DM- DL- OH)- COGM (Goes to Finished Goods)+ DM EFU x Cost per DM EFU+ CC EFU x Cost per CC EFU
: Ending WIP
How do period costs and product costs relate to net sales- gross margin and operating income?
Net Sales - Product Costs
: Gross Margin
- Period Costs
: Operating Income
What is the focus of Activity Based Costing (ABC)?
Focuses on eliminating non-value-added activities for poor quality and inventory and things customers don’t want or don’t care about
Inventory is expensive to store and storing something is not a value-added expenditure
Uses Cost Pools - Different departments can have different OH rates
Uses Several OH rates based on Activity - Cost Pool / Cost Driver
How do Cost Pools and Allocations compare under ABC versus traditional costing system?
Cost Pools and Allocations increase compared to a traditional costing system
What is Backflush Costing?
Connected to Just-in-Time Production- which is part of Activity-Based Costing and Total Quality Management (TQM)
- Works backward to flush out COGS
- Mostly GAAP
What are the characteristics of By-Products?
Usually immaterial and common costs aren’t allocated to them
Low Market Value
Can be valued at NRV
Can be treated as a contra expense and netted against COGS - Can be treated as a contra sale and netted against Sales
Recognition rules are very flexible with valuing and classifying by-products
What are Cost Functions?
Measure how costs change relative to activity levels
High-Low Method
Change in Cost (High-Low pts) / Change in Activity (High-Low pts)
How does a price increase affect supply?
When the prices of an item increases supply increases- because more sellers are willing to sell.
What is a supply curve shift?
When supply changes due to something other than price.
What are the characteristics of a positive supply curve shift (shift right)?
Supply increases at each price point
Higher Equilibrium GDP
Number of sellers increases - market can get flooded
Examples: Government subsidies or technology improvements that decrease costs for suppliers
What are the characteristics of a negative supply curve shift (shift left)?
Supply decreases at each price point
Lower Equilibrium GDP
Cost of producing item increases
Examples: Shortage of gold- so less gold watches are made; wars or crises in rice-producing countries means there is less rice on the market
How does price affect the demand for an item?
When the prices of an item increases- demand for it decreases.
What is a Demand Curve Shift?
When demand changes due to something other than price.
What is a Positive Demand Curve Shift (Shift Right)?
When demand increases at each price point
Price of substitutes go up - price of beef rises- so people buy more chicken
Future price increase is expected - War in Middle East- people go out and buy gas
Market expands - i.e. people get new free health care plan- demand at clinic rises
Expansion - more spending increases equilibrium GDP
What is a Negative Demand Curve Shift (Shift Left)?
Demand decreases at each price point.
Price of complement goes up - price of beef goes up- less demand for ketchup
Boycott - Company commits social blunder- consumers boycott
Consumer income rises - Demand for inferior goods drops as people have more money to spend
Consumer tastes change
Contraction - less spending decreases equilibrium GDP
What is the Marginal Propensity to Consume?
How much you spend when your income increases
Calculate: Change in Spending / Change in Income
What is the Marginal Propensity to Save?
How much you save when income increases
Calculate: Change in Savings / Change in Income
Also equals 1 - Marginal Propensity to Consume
How is the multiplier effect calculated?
(1 / 1-MPC) x Change in Spending
How does increased spending by consumers and the government affect the demand curve?
As spending by consumers or the government increases- the demand curve increases (shifts right).
How does spending change due to the multiplier effect?
The increase in demand ends up being larger than the amount of additional income spent in the economy due to the multiplier effect.
One consumer spends money- which:
*Increases the income of a business
*Increases the income of a vendor
*Increases income of employees
*Increases tax revenue
How is Price Elasticity of Demand calculated?
% Change in Quantity Demand / % Change in Price
Under elastic demand- how does price affect revenues?
Price increases- Revenue decreases
Price decreases- Revenue increases
What conditions would indicate Elastic Demand?
Many substitutes (luxury items)
Considered elastic if elasticity is greater than 1
10% drop in demand / 8% increase in price : 1.25 (Elastic)
Price increases- Revenue decreases
Price decreases- Revenue increases
How does revenue react to price under Inelastic Demand?
Price increases- Revenue increases
Price decreases- Revenue decreases
What conditions would indicate Inelastic Demand?
Few substitutes (groceries- gasoline)
Considered inelastic if coefficient of elasticity is less than 1
5% drop in demand / 10% increase in price : .5 (inelastic)
Price increases- Revenue increases
Price decreases- Revenue decreases
What is Unitary Demand?
Total revenue will remain the same if price is increased
Considered unitary if coefficient of elasticity : 1
How is Income Elasticity of Demand calculated?
% Change Quantity Demanded / % Change in Income
Normal goods greater than 1 (demand increases more than income)
Inferior goods less than 1 (demand increases less than income)
What conditions occur under periods of inflation?
Interest rates increase
Reduced demand for loans
Reduced demand for houses- autos- etc.
Value of bonds and fixed income securities decrease
Inferior good demand to increase
Foreign goods more affordable than domestic
Demand for domestic goods decrease
What happens under Demand-Pull inflation?
Overall spending increases
Demand increases (shifts right)
Market equilibrium price increases
What happens under Cost-Push inflation?
Overall production costs increase
Supply decreases (shifts left)
Market equilibrium price increases
Note: Demand-Pull and Cost-Push Inflation BOTH result in market equilibrium price to increase
What is the Equilibrium Price?
The price where Quantity Supplied : Quantity Demanded
What is Optimal Production?
When Marginal Revenue : Marginal Cost
What is the result of a Price Floor?
Causes a surplus if above equilibrium price.
What is GDP (Gross Domestic Product)?
The annual value of all goods and services produced domestically at current prices by consumers- businesses- the government- and foreign companies with domestic interests
Included: Foreign company has US Factory
Not included: US company has foreign factory
What is included under the income approach for calculating GDP?
Sole Proprietor and Corp Income
Passive Income
Taxes
Employee Salaries
Foreign Income Adjustments
Depreciation
What is included under the Expenditure Approach for calculating GDP?
Individual Consumption
Private Investment
Government Purchases
Net Exports
What is Nominal GDP?
Measures goods/services in current prices.
For what is a GDP Deflator used?
Used to convert GDP to Real GDP
What is Real GDP?
Nominal GDP / GDP Deflator x 100
What is Gross National Product (GNP)?
Like GDP; Swaps foreign production. US Firms overseas are included- Foreign firms domestically are not included
What is the Consumer Price Index (CPI)? How is it applied?
Price of goods relative to an earlier period of time- which is the benchmark. Year 1 : 1.0
((CPI Current - CPI Last) / CPI Last) * 100
How is disposable income calculated?
Personal Income - Personal Taxes
How is Return to Scale calculated?
% Increase in output / % Increase in input
Greater than 1 : Increasing returns to scale
Less than 1 : Decreasing returns to scale
When is the economy in Recession?
When GDP growth is negative for two consecutive quarters.
What is a Depression?
A prolonged- severe recession with high unemployment rates
No requisite period of time for the economy to officially be in a depression
What are the stages of the Economic Cycle?
Peak (highest)
Recession (decreasing)
Trough (lowest)
Recover (increasing)
Expansion (higher again)
What are leading indicators?
Conditions that occur before a recession or before a recovery
Example: Stock Market or New Housing Starts
What are lagging indicators?
Conditions that occur after a recession or after a recovery
Examples: Prime Interest Rates- Unemployment
What are coincident indicators?
Conditions that occur during a recession or during a recovery
Example: Manufacturing output
Which people are included in the calculation of unemployment?
Only people looking for jobs
What is Cyclical Unemployment?
GDP doesn’t grow fast enough to employ all people who are looking for work
Example: People are unemployed in 2010 because there aren’t enough jobs available due to the economy
What is Frictional Unemployment?
People are changing jobs or entering the work force. This is a normal aspect of full employment.
Example: A recent college graduate is looking for a job
What is Structural Unemployment?
A worker’s job skills do not match those necessary to get a job so they need education or training
Example: A construction worker wants to work in an office- so they quit their job and get computer training
How does inflation relate to unemployment?
High Unemployment : Low Inflation (Vice Versa)