CMA Part 1 Flashcards
External Users of Financial Statements
o Shareholders o Financial institutions o Suppliers o Customers o Competitors o Regulators
Inherent Limitations in Financial Statements
o Periodicity Monthly, Quarterly, Annual statements are good indicators of business cycle o Historical Information Old info should be considered with current info o Valuation Historical cost, estimates, fair value o Accounting Methods o Omissions
Purpose of Income & Balance Sheet
o Income Statement Show revenues, gains, losses and expenses Either single-step or multi-step o Balance Sheet Show assets, liabilities, owner’s equity
Repurchase of Treasury Stock
Increase for cost of shares; reduces equity
Resale of Treasury Stock
o When stock is resold for greater than repurchase price of stock; added to Paid-in-Capital
o When stock is resold for less than repurchase price of stock; taken away from Paid-in-Capital
Stock Splits
Does not impact equity accounts once par value reflects new share size
Stock Dividends
o Small stock dividend is less than 20-25% of number of outstanding shares
o Retained earnings reduced; common stock is increase; difference goes to PIC
Statement of Cash Flows
o Reconciles overall change to cash position over a period and help understand cash resources
o Operating (Central Operations)
Cash flow from customers; to employees & suppliers; and cash for interest & tax
o Investing
Longer term investing activities like PP&E
o Financing
Company’s Financial Strategy
Transactions in entity’s own stock; cash inflows from borrowings; payments of dividends; principal amount of borrowings
Two Types of Bad Debt Methods
o Allowance method
Balance Sheet Approach
• Percentage of existing ARs will not be collectible & adjust allowance account
Income Statement Approach
• Percentage of sales are uncollectible & record bad debt expense
o Direct write-off method
Waits on an account is uncollectible then remove AR offsetting to bad bet
Cash basis
Factoring a Receivable
o Sold for cash immediately, rather than waiting for cash to be collected
o Involves a discount to cover risk of non-payment by customers
Factoring a Receivable with Recourse
o Company selling AR bears risk of loss to collecting customer’s balances
o Fees are typically lower than factoring without recourse
Periodic Inventory Valuation Method
o Precise records not kept at the moment of sale
o Entity determines how much it spent on new inventory
o Ending inventory and beginning inventory to determine COGS
Perpetual Inventory Valuation Method
o Records any amounts associated with inventory purchases and sales directly to inventory account when transaction take place
o Match cost of sales and inventory transactions throughout the year
o Required for moving average costing system
(4) Four common methods to account for Cost of Raw Materials and Inventory
o Specific Identification Method
Common with unique finished goods; Assign actual costs to goods (i.e. antiques)
o FIFO (First-in, First-out)
Good purchased first are expensed as cost of sales first
First item place in inventory are the first to be sold
o LIFO (Last-in, First-out)
Good purchased last are expensed as cost of sales first
Last produced products are being sold first
o Average Cost
Based on moving average cost per unit
Factors to Choose Which Inventory Costing Method
o FIFO reflects the actual physical flow of goods better
o LIFO not allowed under IFRS
o If inflation, LIFO will have higher cost of sales and net income will be lower
o In deflation, LIFO will have lower cost of sales and net income with be higher
What is the Lower of Cost or NRV principle?
o NRV = Net Realized Value
o Amount of money a business expects to receive when sell or collect on assets
(3) Three Classification of Debt Securities
o Trading
Organization intends to resell these securities in the near term
o Held-to-maturity
Organization has the ability and intent to hold the security until it matures
o Available-for-sale (AFS)
Any securities not specifically designated as trading or held-to-maturity
(3) Three Methods of Accounting for Equity Investments
o Fair Value Method (less than 20%)
Used when organization owns small amount of stock in another company and cannot significantly influence or control the investee’s operations
o Equity Method (20% to 50%)
Used when organization can exert significant influence, but not control, over investee’s operations
o Consolidation Method (50% or more)
Used when organization can exert control over the investee’s operations
How to record dividend distributions and net income to investments?
o Using the equity method, the company records investment at cost then increase/decrease the investment by their pro-rata share of the net income/loss of the investee
o Investment is decreased by their pro-rata share of the dividends declared by the investee
Consolidation Method of Accounting
o Ownership above 50% to create control
o Present financial statements as one entity with parent and subsidiary
o Subsidiary assets and liabilities are recognized at fair value at time of purchase in consolidated financial statements
o Any amount of ownership not held by investor, the non-controlling interest will be reflected in equity section of consolidated balance sheet
(3) Characteristics of a Liability
o Probable future sacrifice of economic benefit
o Arises from a present obligation to transfer assets or provide services to other entities
o Results from past transactions or events
Current vs. Non-current Liability
o Current Liabilities – settled with current assets within the next year or cycle (less than a year)
o Non-current liabilities – settled beyond the next year or cycle (more than a year)
Determining Depreciation Calculations
o The asset’s expected useful life
o The expected salvage value at the end of the asset’s useful life. Should not be depreciated below salvage value
o The depreciation method must be selected and should reflect the asset’s usage pattern
(4) Common Depreciation Methods
o Straight Line Depreciation
Recognizes depreciation equally over the assets’ useful life
o Sum of year’s digits (SOYD)
Records more depreciation in early years than in later years
o Double declining balance (DDB)
Calculates deprecation by multiplying the asset’s book value by 2/n
N = number of years in the asset’s useful life
o Units of Production (UOP)
Spreads the depreciable cost evenly over the number of units produced during the asset’s life
Process of Calculating Impairment Losses on Long-Term Tangible Assets
o Step 1 – Recoverability Test
Compare book value of an asset to the sum of the future undiscounted cash flows
If the future cash flow exceeds the book value, the asset is considered recoverable and no impairment exists. If not, them an impairment loss is used
o Step 2 – Impairment Loss
Management must estimate the asset’s fair value.
A loss will be recognized for the difference between BV and FV
(3) Intangible Assets
o Intangible assets with finite life
Amortized similar to depreciation of tangible assets
Impairment follows the same two-step process as tangible asset impairment
o Intangible assets with indefinite life
Carried at cost and reviewed for impairment when circumstances indicate a possible problem and at least annually
o Goodwill
Recorded when a business is acquired for more than fair value of its net identifiable assets. Requires two step process to review for impairment
(2) Warranty Methods
o Assurance Warranty Approach
Warranties automatically attached to sale of product
Expense the estimated warranty cost and record assurance warranty liability
o Service Warranty Approach
Extended warranties sold separately from product
Deferring revenue at time of sale and recognize the service warranty revenue over time
Operating Leases
o Lessor only transfers the right to use property to the lessee
o Retains most of the risks and benefits of ownership
o Recorded on straight line basis over the life of the lease
o Right of use (ROA) asset and lease liability for the PV of minimum lease payments are recorded at the lease signing
Finance Leases
o Lessor transfers some of the rights & benefits of ownership to the lessee
Borrowing
• Lessee records a liability for PV of the minimum lease payments & amortizes the liability as payments, similar to mortgage loan
Purchase
• Lessee records the property an ROU asset and recognizes amortization expense, similar to depreciation on owned assets
(5) Criteria to Determine Finance Lease (Only one must be met to classify a lease as finance)
o Transfer of ownership to the lessee at the end of the lease term
o Bargain Purchase Option – option to purchase the asset significantly below market value
o Lease term exceeds (75%) of remaining useful life of the asset
o PV of minimum lease payments exceeds (90%) of FV of asset
o Leased asset is so specialized that it has no alternative future use to the lessor
Permanent Differences
o Occurs when GAAP revenues are not taxable, or GAAP expenses are not deductible under tax law; Differences never reconcile
Non-Taxable Revenues
• Interest from some bonds issued by state or life insurance proceeds
Non-Deductible Expenses
• Fines and penalties, premium paid for life insurance policies when the payer is the beneficiary
Deferred Tax Asset
o Taxable income is recognized before book income due to timing differences (overpayment or advance payment) Ex. Warranty paid
o Calculate using enacted tax rates from future periods when timing differences are expected to reverse
Deferred Tax Liability
o Book income is recognized before taxable income due to timing differences
(due for current period but has not yet paid) Ex. Depreciation of fixed assets
o Calculate using enacted tax rates from future periods when timing differences are expected to reverse
Revenue Recognition Process
o Identify the contract with a customer
o Identify performance obligations in the contract
o Determine the transaction price
o Allocate the transaction price to the performance obligations in the contract
o Recognize revenue as, or when, the performance obligations are satisfied
Revenue recognized over time
o Customer simultaneously receives and consumes the benefit of the performance obligation
o The satisfaction of the performance obligation creates or enhances an asset already controlled by the customer
o The good or service has no alternative future use to the selling organization and the organization has a right to payment for work completed
Intangible Assets (GAAP vs. IFRS)
o GAAP
Carried at amortize cost
All development costs are expensed as incurred except software development
o IFRS
Carried at amortize cost or revalued at fair value
Development costs for internally developed intangible assets may be capitalized once the technological feasibility
Inventory Accounting (GAAP vs. IFRS)
o GAAP
LIFO can be used
Does not allow write-up of inventory previously written down
o IFRS
Does not allow the use of LIFO inventory costing method
Inventory previously written down for lower of cost can be written back up to original cost
Impairment Testing (GAAP vs. IFRS)
o GAAP
Impairment is reviewed at induvial asset level
Two step model used
Prohibited recognizing reversals of prior impairment losses
o IFRS
Organization should review for impairment at the cash generation unit (CGU)
One step model used
Recognizes reversals of prior impairment losses
Strategy
o Long-term planning and work of the organization
o Guides the day to day operations work in organization
(5) Strategic Planning Process
o Define the vision and mission o Environmental Scanning o Strategy Design o Strategy Implementation o Evaluation and Control
Organization’s Aspects
o The world in which the organization operates o Competitors, current and potential o Customers, current and potential o Suppliers and other stakeholders o The organization’s internal structure
SWOT
o Used for both environmental scanning and designing strategy
o Strengths, Weakness, Opportunities, Threats
Cost Leadership strategy
Involves establishing a position across the industry as a lower-cost production or provider by developing certain cost advantages
Differentiation Strategy
o Identifies what customers in the industry value with respect to unique product or service
o Establish a position to provide those unique needs
Focus Strategy
o Identifying a certain segment or niche within the industry
o Establish either lower-cost advantage or differentiation advantage in serving that particular industry segment
(4) Classifications of the BCG Growth-Share Matrix
o Cash Cows
Large share of an established (slow growth) market.
Require little investment and generate a lot of cash
o Stars
High share of a fast-growing market. Must spend significant resources to maintain
o Questions Marks
Small share in a fast-growing market. A lot of potential to do well
o Dogs
Small share of market that isn’t growing. An undesirable business
Scenario Analysis
Helps companies consider the complexities of an uncertain business environment with many factors that interact with each other
Contingency Planning
Developing alternative strategies in order to be prepared for unexpected outcomes
(5) Porter’s Five Forces
o Supplier Power o Customer Power o Threat of New Entrants o Threat of Substitute Products o Intensity of Competition
Strategy Implementation
Identifying short-term objectives, then establish processes to achieve those objectives
PESTLE Analysis
o Politics – regulation issues, tax policies, legal environment, political stability
o Economy – Inflation, unemployment, economic growth rate
o Social – Demographics, culture, education levels
o Technology – Manufacturing, computers, communication, transportation
o Legal – Regulations, Intellectual property, competition fairness
o Environmental – Scarcity of raw materials, pollution impacts, weather patterns
(3) Elements of Decision-making & Management Process
o Planning
Defined into operational objectives, performance measures are set, and resources are committed
o Controlling
Requires expectations to be established & incentivized, results father and reported, variances from budget are computed
o Evaluating
Rewarding performance, analyzing results, use insight gained to inform planning stage for upcoming operational cycle
(5) Steps in Budgeting Process
o Form the budget committee o Establish budget guidelines o Submit budget proposals o Negotiate budget proposals o Review and approve the final budget
(2) Budgeting Approach
o Bottom-Up
(Participating) involves time and resources, but results in a more informed budget with higher “ownership” by the employees
o Top-Down
(Authoritative) budgeting takes less time and resources, but budget may have blind spots and may be resisted by the employees
(5) Best Practices in Budgeting
o Link the budget to strategy
o Design budgeting processes that allocate resources strategically
o Establish budget targets based on realistic expectations & based on stretch goals
o Reduce budget complexity & budget cycle time
o Develop flexible budgets that accommodate change
(2) Cost Standards
o Ideal Cost Standards
Expected cost per input & input quantity based on assumption that prices paid are absolute lowest possible level & absolutely efficient without any error
Created in an authoritative Top Down budgeting approach
o Attainable Cost Standards
Reasonable expectations about average prices and usage. Created in a participative Bottom Up budgeting Approach
Standard Cost Sheet
“Recipe Card” that specifies standard prices and standard quantities o build a single product or service
(2) Ways to Reduce Budgetary Slack
o Limiting performance evaluation to controllable costs
o Periodically reviewing & adjusting the budget when outside factors affect
(2) Regression Analysis
o Simple Regression
Explore two sets of data to see if there is a relationship between them
One set of data is activity, or independent variable & dependent variable
Uses only one activity to predict costs
o Multiple Regression
Use many activities to help managers understand and forecast costs
Multiple R – Aggression Analysis
The simple correlation between two or more sets of data (ex. Volume and costs)
R Square & Adjust R Square – Aggression Analysis
o R Square
Show how much of the change in one or more sets of data explains the variance
o Adjusted R Square
R square adjusted for the size of the sample data set; more appropriate measure to use when explaining variance in cost data
Standard Error – Aggression Analysis
o Signifies 68% chance the estimated cost will be within the original estimate plus or minus the standard error
o Doubling the standard error 95% chance that estimated cost is actually within range of original estimate
Expected Value Computation
When multiple possible future outcomes, manger can mathematically combine several outcomes to form an expected value based on all possible outcomes
Expected Value of Set of Possible Outcomes
o EV = Σ(rp)
o R = result of the outcome
o P = probability of the outcome
Benefits of Expected Value Computations
o Incorporates multiple possibilities are generally more representative of an uncertain future
o Reduces multiple outcomes toa single value, easily understood and add to budget plan
Learning Curve Analysis
o Results in the bigger improvements at first with improvements becoming smaller over time
o Output doubles, the cumulative average time or cost of the total output is reduced by a constant percentage
Cumulative Average
o Y = aXb o Y = cumulative average per unit o a = time required for first unit o X = cumulative number of units o b = In learning curve % / In 2 o In = the natural log
Sales Budget
Simple composition of Volume x Price
(3) Production Cost Budgets
o Direct materials budget
o Direct labor budget
o Manufacturing overhead budget
Creating Direct Materials Budget
o Multiply budgeted production volume by the standard input quantity to determine total direct materials needed
o If the organization maintains inventory of direct materials, determine materials to purchase as follows: Production Needs + Ending Inventory – Beginning Inventory
o Multiply the materials to be purchased by the standard price of materials to determine the final direct materials budget
Creating Direct Labor Budget
o Multiply budgeted production volume by the standard quantity of hours to determine direct labor hours needed
o Multiply direct labor hours needed by the standard price for labor to determine the budgeted direct labor payroll
(2) Types of Manufacturing Overhead
o Variable Costs
Vary as a total amount but are constant (fixed) as a cost rate
o Fixed Costs
Fixed at the total amount, but will have a varying fixed cost rate based on changing levels of production volume
Overhead Allocation Rates
Overhead Allocation Rate = Budgeted Annual MOH Costs / Budgeted Annual Activity Volume
Standard Cost Sheet
Lists the standard input quantity and standard input price to determine the production cost for each unit of a certain good
Compute Budget for Cost of Goods Sold (COGS)
o Use the production budget and standard cost sheet to calculate total production costs
o Then use beginning and ending finished goods inventory to find cost of goods sold
o Multiply the budgeted sales volume by the standard cost per unit
Selling & Admin Expenses
o Another form of overhead for company
o Typically have variable and fixed cost
Capital Projects vs. Spending on Operations
o Spending on operations involves less risk over shorter time periods
o Capital projects are extensive investments requiring significant financial, management, and labor capital over lengthy periods of time
(3) Key Analyses for Capital Budget Decisions
o Financial Analysis: NPV, IRR, payback, and ROI
o Risk analysis: assessing uncertainty with respect to outcomes and inputs
o Qualitative analysis: considering non-quantitative characteristics
(3) Sections of Traditional Cash Budgets
o Cash Receipts
o Cash disbursements
o Financing
(3) Approaches to Solve Cash
o Increase the amount of cash generated by operations or reduce the amount of cash used in operations
o Take out short-term operating loans
o Make the credit policy for customers stricter and negotiate for a less strict payables policy
Continuous Rolling Budget
o Used to establish and maintain a constant number of operating periods moving forward in the master budget
o Ex. Six months of weekly budgets, followed by a half year of monthly budgets, followed by a year of quarterly budgets, and an annual budget in the third year. Each month of operations concludes, the budget rolls forward
Flexible Budgets
o Used to examine possible future scenarios in sales volume
o Evaluate past operating results based on relevant budget costs
o Use a contribution margin statement approach, separating variable costs and fixed
o Based on what is actually produced and sold
Activity-based Budgeting
o Focuses on identifying and using core activities throughout the company
o To establish activity cost rates to assign costs to products, customers based on actual consumption relationships
Zero-based Budgeting
o Demands that all budgeting choices are taken back to a blank page to be fully evaluated
o If approved, put into master budget plan
o Projects are prioritized and allocated resources based on their alignment with strategy
Pro forma financial statements
o Provide a view of the organization’s future financial performance based on current financial statements and anticipated future actions
o Pro forma = “as a matter of form”
Pro forma Balance Sheet
o Determine whatever financing is needed to support the planned level of assets using:
Projected Total Assets – Equity – Remaining Liabilities = Balancing Debt Account
o The current amount of debt will be subtracted from balancing debt account to calculate the increase or decrease in debt financing needed
Changes in Balance Sheet
o Increase in debt (liability) accounts or equity accounts result in increases in the cash acct
o Increase in asset accounts (all asset accounts other than cash) result in decreases in cash
o This can be depicted as follows: ΔCash = ΔDebt + ΔEquity - ΔAssets
Changes in Cash Flow
o Cash Flow from Operations
Balance sheet accounts for current operating assets and liabilities
o Cash Flow from Investing
Balance sheet accounts for current non-operating assets and long-term assets
o Cash Flow from Financing
Balance sheet accounts for current non-operating liabilities and long-term liabilities, and equity
(3) Decision Making Feedback loop
o Planning
Operational objectives are defined, performance measures are set, and resources are committed
o Controlling
Expectations are established, results are gathered and reported, and variances are captured and reported
o Evaluating
Performance is rewarded, objectives are analyzed to see if they were met, and insight is gained to prepare for the next planning stage
Effective vs. Efficient Measures
o Effective
Determined by how well an organization achieves its revenue goals (output)
o Efficient
Based on how well an organization achieves its cost goals (input)
Ceteris Paribus principle
o “All other things being equal”
o The effect of one variable on another, keeping all other variables unchanged
