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Capital Budgeting Flashcards

1
Q

What is Capital Budgeting? How is it used?

A

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

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2
Q

What values are used in Capital Budgeting?

A

Capital Budgeting ONLY uses Present Value tables.

Capital Budgeting NEVER uses Fair Value.

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2
Q

What is Cost Accounting?

A 
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

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3
Q

When is the Present Value of $1 table used?

A

For ONE payment- ONE time.

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3
Q

What is the difference between Cost Accounting and Managerial Accounting?

A

Cost Accounting - External Focus- GAAP

Managerial Accounting - Internal Focus- Not GAAP

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4
Q

When is the Present Value of an Annuity Due used?

A

Multiple payments made over time- where the payments are made at the START of the period.

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4
Q

What are Product Costs (aka Inventory Costs)?

A

Prime Costs

Conversion Costs

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5
Q

When is the Present Value of an Ordinary Annuity of $1 (PVOA) used?

A

Multiple payments over time- where payments are made at the END of the period.

Think A for Arrears.

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5
Q

What are included in Prime Costs?

A

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

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6
Q

What is the calculation for the Present Value of $1?

A

1 / (( 1+i )^n)

i = interest rate
n = number of periods
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6
Q

What is Factory Overhead?

A

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).

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7
Q

What is Net Present Value (NPV)?

A

A preferred method of evaluating profitability.

One of two methods that use the Time Value of Money

= PV of Future Cash Flows - Investment

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7
Q

What is included in Fixed Factory Overhead?

A

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

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8
Q

How is NPV used to calculate future benefit?

A

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)

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8
Q

What is included in Variable Overhead?

A

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)

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9
Q

What is the rate of return on an investment called?

A

The Discount Rate.

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9
Q

Where is Under/Over-applied Variable OH recorded?

A

If Immaterial – Goes to COGS

If Material – Goes to WIP- Finished Goods- or COGS- based on their Ending Balance

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10
Q

What does the Discount Rate represent?

A

The rate of return on an investment used.

It represents the minimum rate of return required.

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10
Q

Where is Under/Over-applied Fixed OH recorded?

A

It always goes to COGS

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11
Q

What are the strengths of the Net Present Value system?

A

Uses the Time Value of Money

Uses all cash flows- not just the cash flows to arrive at Payback

Takes risks into consideration

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11
Q

What is indicated by a Debit balance in Actual Factory Overhead? How is it corrected?

A

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.

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12
Q

What are the weaknesses of the Net Present Value system?

A

Not as simple as the Accounting Rate of Return.

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12
Q

What is indicated by a Credit balance in Applied Factory Overhead? How is it corrected?

A

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.

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13
Q

How do Salvage Value and Depreciation affect Net Present Value?

A

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.

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13
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)
14
If multiple potential rates of return are available- which is used to calculate Net Present Value?
The minimum rate of return is used.
14
What variables are used to calculated Work in Process (WIP)?
Beginning Balance (End Bal of Previous WIP) DR Direct Materials Used DR Direct Labor Used (Conversion Cost) CR COGM DR Factory Overhead Applied (Conversion Cost) = Ending Balance (Goes to BS)
15
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
15
What variables are included in Finished Goods calculations?
``` Beginning Balance DR COGM = COGAS (Cost of Goods Avail for Sale) CR COGS = Ending Balance (Goes to BS) ```
16
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.
16
How does Freight In affect Cost Accounting calculations?
Inventory (Product) Cost Part of DM Purchases
17
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.
17
How does Freight Out affect Cost Accounting?
Selling (Period) Cost Not part of inventory
18
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
18
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 o DM to WIP to FG to COGS o You’re likely going to be solving for the last job in the queue
19
When is NPV on an Investment positive?
When the benefits are greater than the costs. IRR is greater than the Discount Rate
19
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)
20
When is NPV on an Investment Negative?
When Costs are greater than Benefits IRR is less than the Discount Rate
20
What is the Step Method for allocating service department costs?
Services can be allocated to both other service departments and the product(s)
21
When is NPV Zero?
When benefits equal the Costs IRR = Discount Rate
21
Under process costing- how are the units shipped calculated?
Beginning Inventory + Units Started - Ending Inventory = No. Units Shipped
22
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.
22
Which two inventory methods are used under Process Costing?
FIFO Weighted Average
23
What are the strengths of the Payback Method?
Takes risk into consideration 2 year payback is less risky than a 5 year payback
23
What is another name for Process Costing?
Equivalent Units of Production
24
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
24
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)
25
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.
25
How are Direct Materials calculated under the Weighted Average Method?
Beginning Inventory + Current Costs / EFU WA
26
What are the strengths of the Accounting Rate of Return (ARR)?
Simple to use People understand easily
26
How are Conversion Costs calculated under Weighted Average Method?
Beginning Inventory + Current Costs / EFU WA
27
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.
27
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)
28
What is an Expected Return?
An approximate rate of return on assets.
28
How are Equivalent Finished Units calculated for Conversion Costs?
Units Shipped + EI x % Complete CC = EFU (Weighted Average) - Beginning Inventory x % Complete = EFU (FIFO)
29
What is the primary duty of the board of directors?
To monitor management behavior.
29
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
30
What is the responsibility of the Nominating or Corporate Governance Committee of the board of directors?
Oversees the board Responsible for hiring new CEO
30
How are Conversion Costs calculated under the FIFO method?
Current Costs / EFU FIFO FIFO method uses Current Period costs only and ignores Beginning Inventory
31
What is the responsibility of the audit committee of the board of directors?
The audit committee appoints and oversees the external auditor.
31
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 ```
32
What is the duty of the compensation committee of the board of directors?
The compensation committee handles the CEO's compensation package.
32
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 ```
33
What does the NYSE and NASDAQ require of the board of directors?
They require the board to be independent.
33
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
34
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.
34
How do Cost Pools and Allocations compare under ABC versus traditional costing system?
Cost Pools and Allocations increase compared to a traditional costing system
35
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.
35
What is Backflush Costing?
Connected to Just-in-Time Production- which is part of Activity-Based Costing and Total Quality Management (TQM) o Works backward to “flush out” COGS o ‘Mostly’ GAAP
36
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
36
What are the characteristics of By-Products?
Usually immaterial and common costs aren’t allocated to them o Low Market Value o Can be valued at NRV o Can be treated as a contra expense and netted against COGS o Can be treated as a contra sale and netted against Sales o Recognition rules are very flexible with valuing and classifying by-products
37
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.
37
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)
38
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.
39
What characteristics are promoted by the COSO framework on internal control?
Reliable financial reporting Effective and efficient operations Compliance
40
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 ```
41
What are control activities?
A component of internal control that includes actions being taken to promote the control environment.
42
What are the basic elements of internal control?
``` Control Environment Risk Assessment Control Activities Information and Communication Monitoring ```
43
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.
44
How does Monitoring affect internal control?
Internal Control activities must be constantly monitored and evaluated for effectiveness.
45
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
46
What are possible responses to risk under the COSO framework for enterprise risk management?
Avoid or Reduce Share or Accept

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