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
Management by exception
o Helps management focus on current processes that need attention
o Variances are a signal to investigate the problem and provide an answer
Variance Framework
o Visual method for calculating variances
o Moving from left to right; you move from actual amounts to standard amounts
o Compare Actual Quantity by Standard Price to Standard Quantity by Standard Price
(2) Formula Approach
o Price Variance Formula
Actual Quantity x (Standard Price – Actual Price) = Price Variance
o Quantity Variance Formula
(Standard Quantity – Actual Quantity) x Standard Price = Quantity Variance
(2) Sales Volume Variances
o Sales Mix Variance and Sales Quantity Variance
Helps company break down the financial impact of both factors
Sales Mix Variance
o Subset of the sales volume variance
o Framework Approach
Comparing the Total Actual Volume x Expected Mix % x Standard Contribution Margin to the Total Actual Volume x Actual Mix % X Standard Contribution Margin
o Formula Approach
Total Actual Volume x (Expected Mix % - Actual Mix %) x Standard Contribution Margin
Sales Quantity Variance
o Framework Approach
Comparing the Total Expected Volume x Expected Mix % x Standard Contribution Margin to the Total Actual Volume x Expected Mix % X Standard Contribution Margin
o Formula Approach
(Total Expected Volume – Total Actual Volume) x Expected Mix % x Standard Contribution Margin
Direct Materials Price Variance
o Calculated as soon as the materials are purchased
o Framework Approach
Comparing the Actual Quantity Purchased x Actual Price to the Actual Quantity Purchased x Standard Price
o Formula Approach
Actual Quantity Purchased x (Standard Price – Actual Price)
Direct Materials Quantity and Usage Variance
o Quantity Variance (Usage variance) uses the standard quantity in the flexible budget
o Framework Approach
Comparing the Actual Quantity Used x Standard Price to the Standard Quantity Allowed x Standard Price
o Formula Approach
(Standard Quantity Allowed - Actual Quantity Used) x Standard Price
Direct Labor Rate Variance
o Framework Approach
Comparing the Actual Hours Used x Actual Rate to the Actual Hours Used x Standard Rate
o Formula Approach
Actual Quantity x (Standard Rate - Actual Rate)
Direct Labor Efficiency Variance
o Use more or less direct labor often results because of an issue of managing the efficiency of labor usage
o Framework Approach
Comparing the Actual Hours Used x Standard Rate to the Standard Hours Allowed x Standard Rate
o Formula Approach
(Standard Hours Allowed – Actual Hours Used) x Standard Rate
Direct Labor Mix Variance
o Subset of the labor efficiency variance
o Framework Approach
Comparing the Total Actual Quantity x Actual Mix % x Standard Rate to the Total Actual Quantity x Standard Mix % x Standard Rate
o Formula Approach
Total Actual Quantity x (Standard Mix % – Actual Mix %) x Standard Rate
Direct Labor Yield Variance
o Subset of the labor efficiency variance
o Framework Approach
Comparing the Total Actual Quantity x Standard Mix % x Standard Rate to the Total Standard Quantity Allowed x Standard Mix % x Standard Rate
o Formula Approach
(Total Standard Quantity Allowed - Total Actual Quantity) x Standard Mix % x Standard Rate
Variable Overhead Spending Variance
o Framework Approach
Comparing the Total Actual Costs to the Actual Activity Used x Standard Variable Overhead Rate
Actual activity used refers to the activity of the base that the organization uses to apply overhead costs
o Formula Approach
(Actual Activity Used x Standard Rate) – Actual Costs
Variable Overhead Efficiency Variance
o Framework Approach
Comparing the Actual Activity Used x Standard Variable Overhead Rate to the Standard Activity Allowed x Standard Variable Overhead Rate
o Formula Approach
(Standard Activity Allowed - Actual Activity Used) – Standard Rate
Fixed Manufacturing Overhead Variances; fixed costs
o Cost application process treats fixed costs as if they were variable
o This process creates a signal on how the actual production output compares to the expected production output
Fixed Overhead Spending Variance
o Framework Approach
Comparing the total actual costs to the master budget costs
o Formula Approach
(Master Budget Production Volume x Fixed Overhead Rate) – Actual Costs Spent
Master Budget Costs – Actual Costs Spent
Fixed Overhead Volume Variance
o Framework Approach
Comparing the master budget costs to the applied costs
o Formula Approach
(Actual Production Volume - Master Budget Volume) x Fixed Overhead Rate
Applied Costs - Master Budget Costs
Variance Framework (manufacturing, service, or merchandise industry)
o Regardless of the industry an organization operates in variances can be used to effectively manage the complexity of a company
o The variance framework computes signals that management should investigate to determine why actual costs are different than expected costs
Internal and External Factors of Price Variances
o Purchasing department responsible for price variances
o Internal Factors
Decisions about the quantity and cash discounts available
Quality of the materials
The delivery method used
o External Factors
Rising or falling prices based on economic events or demands from another department that require the organization to expedite a purchase or delivery
Internal and External Factors of Price Variances
o Production department responsible for price variances
o Internal Factors
Experience
Training
Motivation of the production crew
How well the equipment is maintained
How well quality control processes are managed
o External Factors
Decisions made in other departments that can’t be controlled by production
• A decision like to purchase lower-quality materials
HR & Production w/ Direct Labor Variances
o HR
Responsible for finding, hiring, and initially training new employees
Achieving standard labor rates; impacted by the economy
o Production
Efficiency of labor b/c managers are responsible of ongoing training and motivating the team
Overhead Variances w/ Management Process
o Overhead is a compilation of many factors; and the process is complicated
o Overhead costs exceeds the combined cost of direct materials and direct labor
o Companies w/ complicated overhead structures expand their system for tracing overhead variances to include different types, prices and inputs of overhead
(2) Behavioral Considerations for Managers
o Managers should be involved in developing the plan for the unit over which manager has control
o Managers should be held accountable only for the costs, revenues, or assets for which the manger has “substantial control”
(4) General Types of Responsibility Centers
o Cost center: Organizational unit in which the manager of the unit has control only over the costs incurred
o Revenue center: A business unit set up to focus exclusively on generating sales and revenue
o Profit center: Usually found at higher levels of an organization than cost centers. The manager is responsible for costs and revenues
o Investment center: Found at the highest levels in the organization. Responsible for managing costs, revenues, and assets
Controllable Costs
Costs that managers can significantly influence or directly control. These costs should be used when assessing the performance of the manager or management team
Direct Costs
Include controllable costs and any other costs that are directly connected to the operations of the unit
Indirect Costs
Costs that are allocated to the business unit that represent general admin costs for the organization. Not controllable by the business unit being allocated the costs
Indirect Costs w/o Internal Evaluation Decisions
o Allocating indirect costs can interfere with effective performance evaluations that are internal to the organization
o Analyzing decisions regarding keeping or dropping a business unit from the organization
o There is no direct relationship between indirect costs and the business unit they are assigned
Transfer Pricing
o Used to motivate performance and discipline processes in cost and revenue centers
o It allows both cost and revenue centers to be reestablished as profit centers to better align incentives with the organization
o If the price is set correctly, the receiving business unit will expect quality and timeliness in the transaction, and the supply unit will be incentivized to provide quality and timeliness
Transfer Pricing
o 1st Managing Issue
Does the organization want the transfer to take place between the two business units?
The organization should determine if there is an outside alternative
The organization must determine if it is cheaper to buy externally or internally produce and transfer the product by comparing the external market price
o 2nd Managing Issue
What should the transfer price be so both units will be incentivized to participate?
The supplying unit needs to cover its variable costs, plus any opportunity costs of making the transfer and any incremental fixed costs
The receiving unit does not want to pay more than the price available in the external market
o Setting Transfer Price
When there is production capacity, business units will negotiate the transfer price somewhere between the variable cost plus the average of any incremental fixed costs to produce as the floor
If the supplying unit is running out of production capacity, the supplying unit will include the lost contribution margin on outside business in the price floor
Minimal Transfer price
• (Total Variable Costs + Contribution Margin Lost + Incremental Fixed Costs) / Total Units Supplied
Pros and Cons of Transfer Pricing
Pros:
• This approach creates positive competitive pressure to keep costs down and quality up on good and services being delivered within the organization
Cons:
• Managers sometimes make suboptimal decisions when choosing to transfer or not due to poor accounting information or misaligned incentives.
Whale Curve Chart
o Demonstrates an analysis of customer profitability by organizing customers from most profitable to least profitable and comparing that relationship to total profits
o If the company can track all the costs related to each customer, they can identify the profitability of each customer
o The top of the whale curve demonstrates a crossover point for individual customer profitability. The customer to the right of the curve are unprofitable & reduce profitability
Customer Profit Migration Chart
o The twofold relationship between the total margin on purchased goods and services that a customer generates and the total costs to serve that customer’s relations with the SBU (Strategic Business Uni)
o The same crossover point in the whale curve is demonstrated in the migration chart with the customers whose margin on purchases and offsetting use of support processes results in either a small profit or small loss
SBU Portfolio
o The customers who purchase a high volume of product or services or who select high-margin products and engage in customer support processes efficiently are the most profitable customers for the SBU
o Customers who demand a lot of special support activities in the CRM process and yet don’t produce much profit margin on product sales are the most unprofitable customers
Measurement Surrogation
o Measures function as imperfect surrogates for the actual strategic objective
o If managers focus too much on a specific measure, they start making decisions strictly to increase that measure
o Example: Too much focus on reducing reported costs and increasing reported revenues can lead to a loss of focus on sustainable cost drivers and quality revenue drivers
Return on Investment (ROI)
o ROI = Income / Investment
o Income: After-tax net income, pre-tax income, operating profit, gross margin, cash flow
o Investment: Total Assets, Long-term Debt and Equity (Total Assets – Short-term Debt) and Equity (Total Assets-Total Debt)
o Advantages:
Easily understood by managers and widely used in practice
Make it easy to compare performance across different business units
o Disadvantages:
Will discourage SBU managers from investing in business projects that are good for the company if the project’s ROI will dilute the SBU’s current ROI
Key Performance Indicators (KPIs)
o Small set of critical data points that indicate to the executives whether the company is on track to accomplish its strategic objectives
o Each strategic objective established should be identified by one or two KPIs
DuPont Equation
o Profit / Assets = (Profit/Sales) x (Sales / Assets)
o Return on Assets = Profit Margin x Asset Turnover
o Profit Margin: Measures the percentage of sales revenue that is captured as profit
o Asset Turnover: Reports on the number of sales dollars generated by each dollar invested into assets. Companies that generate a lot of sales dollars from assets can still accumulate a significant profit
Residual Income Method
o Residual Income = Current Income – Required Income
o Required Income = Assets x Hurdle rate
o The hurdle rate represents the company’s minimum required ROI and is used to calculate Required Income
o Company doesn’t make economic profit until it earns enough to pay the cost of its debt and equity financing. Establishing a hurdle rate must be clear before economic value
o Advantages:
Avoids the ROI incentive problem on projects with desirable rates of return that are below the high performing SBU’s current rates of return
o Disadvantages:
The concept of capital costs and economic income is a bit more difficult to understand & communicate than the ROI concept
These measures can cause a bias when comparing performance between SBUs that are different in size because of larger SBUs
Balanced Scorecard (BSC) Model
o Financial perspective
“How do we look to our shareholders?”
Identify what the shareholders are expecting will define the types of financial performance measures
o Customer perspective
“What do our customers value?”
Identify what value customers are willing to pay for
o Internal perspective
“At what business processes must we excel?”
How the company’s internal processes are tied to successfully delivering on the customer perspective
The three types of internal processes are innovation, production and delivery, and post-sale service or support
o Learning perspective
“How do we sustain change and progress?”
Identify the key areas to improve to support key internal processes and values
o Hypothesis
Specific strategic linkages between strategic objectives are established using linked KPIs. The linkages are “hypotheses” that are tested with data to observe
o How to Implement
Implementation team includes key leaders, managers, and front-line employees
Variable and Fixed Costs
o Fixed costs can shift in total ass a company moves between significant cost structures
o As volume increase or decreases, there are “step-up” or step-down” costs
o Costs tend to be fixed in very short horizons and variable over long horizons
Cost Pools, Cost Objectives, Cost Drivers
o Cost Pools
Set of costs that are related together, both functionally and behaviorally
o Cost Objectives
The target of the cost assignment system. Tied to the company’s income statement and represent the revenue objects
o Cost Drivers
Establish a relationship between cost pools and cost objects
Represent a consumption relationship if cost is variable
Represent an allocation method if cost is fixed
Establish cost driver rates which are used to track and allocate costs
• Cost driver rate = Cost Pool Total / Cost Driver Volume
• Assigned Cost = Cost Driver Rate x Cost Object Activity
Absorption Costing Income Statement vs. Variable Costing Income Statement
o Absorption Costing Income Statement
Tracks the full production cost of inventory to the balance sheet and onto the income statement.
This traditional statement is required for external financial reporting
Benefits:
• By allocating fixed costs to production, managers have a more complete measure of the full costs of inventory
• Financial reporting standards require a full cost valuation of inventory on the balance sheet
Limitations:
• Creates a troubling incentive in managers to overproduce and build inventory
o Variable Costing Income Statement
The only production costs used to value the inventory on the balance sheet are the variable costs of production
Fixed production costs are fully expensed to the income statement in the period occurred
This statement is not allowed for external financial reporting
Benefits:
• Avoid the troubling incentive to overproduce and build inventory
Limitations:
• Inventory is undervalued on the balance sheet because all fixed assets are expensed to the income statement. Managers need to know this to help make decisions like pricing
• Using these systems internally still need to use absorption costing system for external financial reports
Joint Cost Allocations
o Part of absorption costing system and costs must be allocated, but there is no “optimal” method for allocating joint costs
o Fixed with respect to the individual activity in each joint product
o The process of allocating joint costs may suggest to management that these costs are affected by individual project lines, but they are not!
Cost Allocations
o Physical units method
Based on simple logic that as more of a product is produced, it should bear more of the joint process costs
o Split-off method
Based on logic that joint process adds value to the main products, so the value established at the point the products are identifiable and ready for sale
Net Realizable Value method vs Gross Margin method
o Net realizable value (NRV) method
Joint costs should be allocated based on product’s ability to pay the costs, defined as the product’s NRV
o Gross Profit (Gross Margin) method
Used to reduce the impact on product line profitability due to allocation method
Start w/ overall gross profit then work backwards to ensure that each product line reports the same gross profit percentage
(2) Types of reporting of by-products
tablish separate product line in the company’s profit report for the by-products. The relatively lower performance of the by-product stands out in the overall report
o Offsets the joint process cost with the by-product revenue before computing the joint cost allocation. The decrease in cost will be allocated
Job Order Costing vs. Process Costing models
o Job Order Costing model
Used when the customer receiving the product can be identified before the process begins and the job with its associated costs are tracked together
o Process Costing model
Used when a company is building similar products without separately identifying each product during the process and the company can only identify the buyer during the selling process
(3) Steps process for Overhead
o Step 1
Before the reporting period starts, establish an overhead application rate by determining the overhead cost budget and overhead application basis
o Step 2
Use the overhead application rate during the year to apply costs to actual job or service invoices as the work takes place. Track the actual overhead costs yearly
o Step 3
At the end of the year, reconcile the overhead to determine if overhead costs have been over or under applied during the year
(3) Steps using FIFO method
o Step 1
Beginning Inventory = represents the prior month’s production costs to get beginning inventory partially completed
Include costs in costs transferred out in the current month (COGS)
o Step 2
Account for the production costs to complete the beginning work-in-process inventory
o Step 3
Account for the remaining units of work transferred out to the warehouse with all the work performed in the current month
Types of Spoilage
o Normal Spoilage
Represents units of work that are lost in the production process and cannot be transferred forward to the next department
Accepted cost of production
Transferred forward to the finished goods inventory account
o Abnormal Spoilage
Unacceptable loss in the production process
Transferred into a loss account that is immediately recognized on the income statement
Weighted Average process Costing Method
o Aggregating costs spent and work done in the previous period on beginning inventory with costs spent and work done in current period
o Doesn’t show how costs and work actually flow in most companies
o Use of computers gives little reason for the weighted-average method to be used
Activity Based Costing (ABC) model
o Focuses on breaking down and identifying how costs are actually consumed
o Fully costing product lines or customer lines using activities as the consignment base
o Activities include unit-level activities, batch-level activities, product line activities and facility support activities
o Limitations
More costly and time intensive to design, implement, and maintain
Based on longer time horizon than traditional systems
Profit-and-loss reports based on ABC methods may not conform to external reporting requirements
Life-cycling costing method
o Provides companies with a more complete view of the costs of establishing and sustaining a product or customer
o Begins in research and development stage
o By tracking upstream costs prior to the manufacture of a product and downstream costs companies can establish a more strategic view of managing all three product states (R&D, production, and post-sale support)
Cost Assignments under Direct method
o The direct method avoids the reality that support departments serve each other and instead makes the cost assignments using traditional two-step process
Building a cost assignment rate
Using the rate to assign costs to the cost object
Cost Assignments under Step-Down method
o Pays attention to the fact that support departments also support each other
o Management determines the order used to assign costs by identifying the support department order
Cost Assignments under Reciprocal method
o Represents the reality that support departments provide resources to each other as well as to production departments
o Creates two step solution
Simultaneous assignment of costs between the supports department
Direct assignment of costs to the production departments
High-Low Method
o Highest and lowest activity levels like production volume
o Companies compare the change in production costs to the change in activity level at these two points to establish a variable cost per unit (rise over run)
o Variable cost per unit is then used to solve for the total fixed costs
Total Cost = (Variable Cost per unit x Total Units) + Total Fixed Costs
Regression Analysis
o Based on all the data provided in a report. Uses all the data points instead of just two
o More comprehensive approach to identify variable and fixed costs
o A line is fitted as tightly as possible to the data points
o The coefficient or slope of the line (rise over run) represents the variable cost per unit
o The coefficient for the intercept point represents the total fixed costs
(2) Approaches for Over or Under Applied Manufacturing Overhead
o 1st method
To proportionally adjust the ending balance in all “downstream accounts”
The most accurate approach and the best method to use when the over-or-under applied amount is significant
o 2nd method
To simply adjust the COGS account directly for the full amount of the variance
Over-adjust the COGS and leave inaccuracies in the ending balances for all inventory accounts
Material Requirements Planning (MRP) model (“Push” System)
o Focuses on launching a master production schedule into a series of detailed daily schedules
o Raw material and work-in-process inventory levels are based on the scheduling of purchases and release events in order to have components arrive as needed in the production process
o MRP systems help manage complex organizations and production processes to reduce inventory and workflow interruptions
Just-In-Time (JIT) systems
o Involves ordering and receiving inventory for production and customer sales only as it needed to produce goods, not before
o Very low tolerance for errors; similar to MRP systems
o Initial objective is to reduce all inventory in the company to extremely low or zero levels
o To improve quality, reduce speed, and increase throughput
Lean manufacturing
o Changes management focus from optimizing separate technologies, processes, and assets to optimizing the flow of products and services to a horizontal view
o Reducing time spent waiting in the production process, eliminating unnecessary movement of inventory and people, and reducing processing
(3) Problems with Inventory
o Cost
Economic holding costs occur because of money tied up in unsold inventory; out of pocket costs are incurred to move, store, and secure the inventory; and shrinkage cost exists if inventory is lost, damaged, or become obsolete
o Quality
Hidden in the inventory pile and continue until discovered when the inventory is used
o Timeliness
Inventory must “sit in line” waiting for production results in delayed or lost sales
Theory of Constraints (TOC) vs. Just-In-Time (JIT) management systems
o JIT removes all inventory everywhere
o TOC identifies the bottleneck (workflow slows down) in the company and coordinate the whole system. Keeping a buffer of inventory in front of the bottleneck
(3) Parts of the Drum-Buffer-Rope used by TOC
o Drum
The current pace of the bottleneck to downstream processes so that output from the bottleneck is anticipated and handled as perfectly as possible
o Buffer
The purpose of buffer inventory is never to let the bottleneck stand idle waiting for upstream operations to catch up
o Rope
The rope represents constraints placed on upstream operations, so they don’t overwhelm the bottleneck operation with so much inventory that cost, quality and timeliness problems become an issue
Value Chain Analysis
o Careful review of all primary and support activities to determine how each activity relates to strategy and how it contributes to the profit margin
o Primary and support activities are either central or secondary strategy
o The central activities are the focus of the company’s investment and improvement efforts while the secondary activities are managed for the greatest efficiency
(3) Accounting Terms to Throughput Accounting
o Throughput
Computed as revenue minus extremely variable costs
o Inventory
Represents all the money tied up in the production system
Labor and overhead costs are not allocated to inventory, but are immediately expensed to the income statement
o Operational Expense
Represents all costs other than raw materials that are used to convert inventory into throughput, including labor costs.
Fixed expenses and immediately expensed to the income statement
Practical (Normal) production capacity vs. Theoretical (Ideal) level of capacity
o Practical production capacity
The level of output that can realistically be achieved based on current management policies and machine and labor scheduling expectations
Allow for unavoidable productivity loses from machine breakdowns, production errors, employee vacations
o Theoretical capacity
All policy constraints and scheduling limitations are removed, and no productivity is lost from breakdowns, errors.
The ideal capacity that is never actually achieved
Primary and Support Activities
o Primary Activities
Add value directly to the production process as they are focused on the logistics of receiving inputs, converting them, delivering and marketing a finished product, and supporting the product with after-sales service
o Support Activities
Competitive advantage derives mainly from technological improvements or innovations in business models or processes
Like human resources processes or general management can be important
Business Process Reengineering (BPR)
o To remove unproductive management layers, wipe out redundancies, and radically remodel processes
o Starts with high-level assessment of the company’s mission, strategic goals and customer needs
o Reviews every process, activity, and employee role in the company using the BPR cycle of identifying a process, reviewing and analyzing the process, designing a new process, and testing and implementing the new process
Kaizen Activity Cycle plan
o Plan
A current or proposed process is assessed, and an improvement plan is established
o Do
Changes are made, and data are gathered to determine if the changes are effective
o Check
Evaluation of the data takes place, decisions regarding adjustments are made, and additional action and data gathering occur
o Act
The company determines the process should be improved, the new process is rolled out, new performance standards are set, and the organization acts on the change
Prevention vs Appraisal Costs
o Prevention Costs
Incurred to ensure that tasks are performed correctly the first time and that the product or service meets customer requirements
Examples: process or product design, employee training, education of suppliers
o Appraisal Costs
Represent what the company spends on inspection, testing, and sampling of raw materials, work-in-process, and finished goods and services
Examples: quality inspectors, and cost to adjust measuring and test equipment
Internal vs External Failure Costs
o Internal Failure Costs
Scrap and rework costs that are incurred to dispose of or fix defective products before they are shipped to the customer
Costs of downtime or reduced yield due to production of detective parts or svcs
o External Failure Costs
The highest costs of low-quality product and include compliant processing costs, customer returns, warranty claims, product recalls, field service, and product liability. Example: Future lost sales due to external failure is significant
(3) Objectives of Internal Controls
o Operations
Make sure the business runs effectively and efficiently
o Reporting
Ensure that financial and nonfinancial reports generated by the business are reliable, timely and transparent
o Compliance
Ensure that businesses are compliant with applicable laws and regulations
Foreign Corrupt Practices (FCPA)
o Access to assets can only be permitted with management’s authorization
o The companies’ records accurately reflect transactions and the disposition of assets in accordance with GAAP or other relevant accounting standards
(5) Components of Effective Internal Control System
o Control Environment
Company’s attitude and culture toward internal controls
o Risk Assessment
Periodically review processes to identify risks and stay competitive
o Control Activities
Have controls in place to safeguard assets and ensure the proper recording of business transactions
o Information and Communication
Identify, capture, and communicate information accurately, efficiently, securely
o Monitoring Activities
Periodically review controls to ensure they work
Internal controls
o Location of Internal Controls
Organization-wide
Division Level
Operating unit
Function (Ex. Accounting, Marketing and IT)
o Risks
Designed to ensure that an organization meets its objective
Risk that a company will fail to achieve one of its objectives
o Likelihood of Internal Control Failures
Function of inherent risks and effectiveness of various controls
Inherent Risk x Control Effectiveness (Preventive, Detective, and Corrective)
(4) Design Principles to Maintain Effective Controls
o Control
The systems should safeguard assets and ensure reliable data
o Compatibility
Internal controls should be specific to an industry or business unit
o Flexibility
Internal controls need to be able to accommodate growth of the organization
o Cost-benefit
The tradeoff balance between effectiveness and the cost to the company should be maintained
(3) Personnel Controls
o Hiring
Screen potential employees to ensure that they have the skills, education, or certifications necessary to perform the job well
o Training
Devote adequate resources to training and tracking employee performance to help them improve
o Job Rotation and Mandatory Vacations
Useful to cross-train employees and prevent or detect fraud
Safeguarding Controls
o Petty cash in a locked container with the key held by the controller
o Computer systems in a locked room with access restricted to appropriate personnel
o Pre-numbered forms
o Prenumbered purchase orders
Segregation of Duties
o Separating of responsibilities for key business transaction
Authorization or approving transactions
Recording transactions
Custody of assets
Periodic reconciliation
o To reduce the risk of fraud and errors
Inherent Control Risk
o Occur in the absence of any controls
o B/C of the industry in which a company operation that a company chooses to make
(3) Basic Categories of Controls
o Preventive
Designed to prevent control failures from occurring
o Detective
Controls that are designed to detect control failures after they occur
o Corrective
Designed to reverse or reduce the errors found through detective controls
(4) Ways to Handle Internal Control Risk
o Accept Risk
Low potential loss, and low likelihood
o Implement Controls
Low potential loss, and high likelihood
o Purchase Insurance
High potential loss, and low likelihood
o Avoid Risk
High potential loss, and high likelihood
Corporate Governance
o The system of rules and procedures by which a corporation is directed and controlled
o Must meet certain requirements set forth by federal and state regulators
o Structure
The rights and responsibilities of various stakeholders
The rules and policies for addressing business functions
The ability to direct the affairs of the organization through a board of directors
Responsibilities of the Board of Directors
o Ensure that the company operates in the best interest of the shareholders
o Establish corporate policies
o Appoint senior management like CEO or CFO
o Serve on various committees like audit committee who is responsible for financial reporting process oversight
Basic Requirements of SOX Sections (301, 407, 404)
o SOX Section 301
Requires audit committee independence
o SOX Section 407
Requires audit committees to have at least one member who qualifies as a financial expert
o SOX Section 404
Requires public companies to establish and maintain a system of internal controls, which must be audited
Basic Requirements of SOX Sections (202, 201, 302)
o SOX Section 202
Prohibits accounting firms from providing some non-audit services
o SOX Section 201
Requires lead audit partners to rotate off engagements every five years to help maintain independence
o SOX Section 302
Puts management on the hook for internal control failures
Role of Public Company Accounting Oversight Board (PCAOB)
o Created by the Sarbanes-Oxley Act of 2002 (SOX
o Oversees audit firms that audit public companies
o Responsible for issuing auditing standards and periodically reviewing auditors for quality and compliance with those standards
Audit Risk
o The likelihood that company’s financial statements are materially misstated, and the auditor expressed an inappropriate audit opinion (Auditors make the wrong call)
o Audit Risk = Inherent Risk x Control Risk x Detection Risk
(4) Types of Risk models
o Audit Risk
Chosen by the auditor
o Inherent Risk
Risks related to the business decisions, culture, and environment of the audit client
o Control Risk
Likelihood that the client’s internal control systems will fail to prevent or detect and correct material misstatements
o Detection Risk
Likelihood that the auditor’s procedures will fail to detect a material misstatement
Types of Audit Opinions
o Unmodified opinion o Unmodified opinion with an emphasis-of-matter or other-matter paragraph o Qualified opinion o Adverse opinion o Disclaimer opinion
Top-Down vs. Bottom-Up
o Top-down Approach
Auditors identify significant accounts and disclosures and then determine the risk of material misstatement
Then examine the controls in place for those areas and plan tests to gather evidence on the internal controls
o Bottom-up Approach
Test internal controls and examine how they might lead to material misstatements in the financial statements
(2) Types of Information Systems
o Financial accounting systems
Generate financial reports, budgets, cost accounting information, and other accounting and finance information
o Operating information systems
Collect, process and summarize information related to operations and generate reports for management to understand operations
Information Systems General Controls
o Organizational, personnel, and operations controls
o Systems development controls
o Network, hardware, and facility controls
o Disaster recovery and backup controls
o Accounting controls
Segregating IT Duties
o Systems development
IT analysts and developers accountable for system creation
o IT operations
The computer operators, data library custodian, and those responsible for the systems input and output
o Technical support
Administrator of network security, databases, and network utilities
Stages of Development Life Cycle
o Analysis o Systems Design o Prototyping o Development/Programming o Quality Testing o Implementation and maintenance
Disaster Recovery and Backup Controls
o To protect company information systems from natural disasters like floods, fires
o To develop plans of how to secure company data
o Quickly restart operations
o Continue serving customers in the event of a natural disaster or unexpected event
Typical Types of Network, Hardware, Facility Controls
o LANs, WANs, VPNs o Computer equipment in locked room with restricted access and protection from natural disasters o Duplicate systems o Appropriate storage for company data o Data encryption o Routing verification o Message acknowledgement o Antivirus software and firewalls
Accounting Controls
o To ensure the accuracy and reliability of financial information for decision making
o Examples: Summarizing batch totals, feedback controls, only allowing authorized personnel access to accounts
(3) Application Controls
o Input Controls
Help prevent and detect errors and irregularities related to the input of data
• Supervisors should confirm the accuracy of source data before employees input data into the system
• Appropriate approval procedures
• Dual observation/review of data before it is input into the system
• Manually calculated totals of various fields should be batched. Batch totals are compared to computer-calculated totals
o Processing Controls
Cover how the system turns input data into information output
• Using standard processing procedures
• Automating as much as possible
• Using predefined values as appropriate
• Balancing the processing totals against the batch total to ensure accuracy
• Confirming that the balance of the subsidiary ledgers equals the general ledger control account
• Matching source documents to the processing records
• Implementing redundant data processing
o Output Controls
Help determine if the input and processing activities result in valid output for decision making
• System should have password protection
• Master file changes should be tracked and logged
o (If review of every entry is impossible, exception reports can show significant changes to master files)
• Identify problems after processing is complete like key balance sheet account reconciliation and discrepancy reports
Batch Controls
o Record Counts
Counting the number of records in a batch or lines in a document to determine completeness
o Control Totals
Totaling a financially meaningful field such as the amount field as a check figure
o Hash Totals
Totaling a field where the total has no logical meaning
Flowchart
o Decision points where the next action depends on the decision made
o Automated processing
o Manual operations
o When the process produces an output document (electronic or paper form)
o Where data is stored online in the information system
Accounting Information Systems (AIS)
o Formalized process to collect, store, and process accounting information
o Captures pertinent information and recordkeeping needed in order to produce financial statements and performance reports
o Physical or Electronic system
General Ledger and Reporting System
o General Ledger and Reporting system is another subsystem of the AIS
o Fewer operational functions than the AIS cycles and focuses primarily on info functions
o The process of recording, classifying, and categorizing an organization’s economic transactions and producing summary financial reports
Customer Relationship Management (CRM) system
o Nonfinancial system that runs in parallel with an AIS
o Captures information about sales calls, shipment tracking, and customer profiles
o An enterprise resource planning system can be used to link the CRM system to AIS
Enterprise Resource Planning (ERP)
o The integrated management of core business processes such as inventory management, accounting, finance, HR, supply chain management
o Shared database allows employees in one business function to view and access data generated in other business functions
Database Management System (DBMS)
o The interface or program between a company’s database and the application programs that access the database
o Defines, reads, manipulates, updates, and deletes data in a database. It controls access to the data and maps each user’s view of the data
Data Warehouse
o Aggregate data from multiple sources into a central integrated data repository
o Analyze business activities and operations
o Does not process data
Enterprise Performance Management (EPM)
o Facilitates the linking of an organization’s strategies to specific plans and actions
o Sub-processes of EPM
Planning, budgeting, and forecasting
Performance reporting
Profitability and cost analysis
o Benefits of EPM
Packages can improve efficiencies in planning, budgeting, reporting processes by relying on a centralized database and workflow
Reduce or even eliminate the need for spreadsheet-based business activities by acting as a central repository for performance data
Provides a more holistic view of an organization’s performance by linking its financial and operational data and metrics
Data Governance (4)
o Set of defined procedures, policies, rules and processes which oversees these attributes: Availability Usability Integrity of data Security of data
(4) First Stages in the Data Life Cycle
o Data Capture:
The initial stage of data wherein the data is generated or recorded by many means
o Data maintenance:
The process that puts data into useful forms. No evaluations or analysis performed
o Data Synthesis:
The stage where new data is created by using existing data and deriving logic outputs
o Data Usage:
Employing the data within the business activities and process of an organization
(4) Last Stages in the Data Life Cycle
o Data Analytics
A specialized stage wherein data is used in models to facilitate pattern recognition and evaluation of correlations and associations
o Data Publication
Involves making data available outside of an organization.
This is not always a willful act of the organization as data breaches and cyberattacks technically fall under this stage
o Data Archival
Data is set aside from active usage and stored for future use
o Data Purging
The final stage of the data life cycle where data is deleted or removed from existence
ISACA’s COBIT
o Control Objectives for Information and Related Technologies that guides IT management and governance
o Provides a variety of resources, technical guides, and trainings
o Focuses on security, risk management, and information governance
Documented Record Retention Policy
o A documented record retention policy helps ensure that data is secure by providing a framework to provide clear guidance about how information can be used, and which employees can perform data-related functions
o Ensure that an organization complies with applicable legal and regulatory requirements
o Safeguard an organization against the loss of key strategic information
Cyberattack
o An attempt by an individual or organization to gain access to the information system or computer of another individual or organization to maliciously or deliberately inflict harm by altering, disabling, destroying or stealing electronic information
o Techniques
Malware
• Breach of a system or computer to block access to computer or server functions, gather and transmit data, or disrupt system processing
Phishing
• False presentation or fraudulent communication of information from a reputable source with the goal of installing malware or stealing info
Denial-of-service attack
• Overloads a network or computer with requests to process info
• These requests exhaust the processing power or bandwidth of the computer or network
Safeguards
o Vulnerability testing
Used to identify existing vulnerabilities
Unlike penetration testing, vulnerability testing does not assess if and how the vulnerability could be exploited
o Biometrics
The use of physical features and measurements for identity verification
o Firewalls
Prevent unauthorized users in a computer network by monitoring the incoming and outgoing traffic and placing a barrier around network systems and databases
o Access controls
Limit who can access a place or resource
(3) Processes of Systems Development Life Cycle
o Systems analysis
Evaluative process to assess user needs, resource requirements, and costs and benefits. Understand the end goals and uses of the system to ensure proper design
o Conceptual design
The process of creating plans for meeting the needs of the organization and providing detailed specifications on how to achieve the desired system.
o Physical design
The process of identifying the features, specifications, and equipment needed to make the system operational. Both the end user experience and the back end computational and processing power needed are considered
Systems Development Life Cycle
o Implementation and conversion
Making the system design becomes a reality in this step
Hardware and software are installed and tested
If a new system is replacing an older one, that data must be transferred and integrated in the processes and procedures of the new system
o Operations and maintenance
The process of fine-tuning the system
Hardware may need to be replaced over time due to wear and tear; and/or obsolescence and software may need to be updated to improve processing or to add functional options
Business Process Analysis
o Used to evaluate and improve core business processes by taking a fresh view of a business process and asking how it could be done either with greater speed or effectiveness
o Begins by gathering information about the current process and its objectives and then identifying alternative processes and determine whether the same objectives could still be achieved
o Diagrams and flowcharts can be used to help document the logical flow of the business process
Artificial Intelligence (AI)
o Process information more quickly and in larger quantities than the human mind can because it does not suffer from computational fatigue that would cause fatigue and strain for a human
o Help classify or categorize transactions into appropriate accounts
o Used to discover patterns and trends as well as potential errors or irregularities in accounting data
o Help improve financial reporting or help auditors detect misstatements or fraud activities
Robotic Process Automation (RPA)
o The use of software to complete routine, repetitive tasks such as manipulating data, recording transactions, processing information, and many other business and IT processes
Benefits of Robotic Process Automation (RPA)
- Typically used when there are high volumes of routinized actions
- Provide greater consistency and speed in the work performed so it allows organizations to scale processes faster than hiring and training additional workers to perform identical tasks
- Can lower companies’ costs by increasing throughput and reducing errors
Drawbacks of Robotic Process Automation (RPA)
- Needs to be updated if rules or processes change
- Updates can require a substantial amount of time and energy if the changes are significant
- The initial investment required to develop an RPA system can be costly
- Require significant amount of time to understand and define the procedures and processes and even more resources to test, verify, and/or audit the process to ensure accurate completion of the task
Cloud Computing
o Network of remote servers connected by the Internet that allows for improved processing of electronic information
o Provides access to larger data storage, processing speeds, and software applications
o Helps avoid data loss as the “cloud” or network of servers provide a safeguard by storing information on multiple servers at multiple geographic locations
Software as a service (SaaS)
o Cloud-based system setup that acts like a centralized system that enables local users to have more computing power and more software availabilities without repetitive installments and equipment
o Rather than building up local computing capabilities and installing software on each local PC, software as a service is based on delivering and licensing software through online applications, in an “on-demand format”
Blockchain
o Distributed, digital ledger of economic transactions that keeps track of all transactions within a peer-to-peer network
o Improves the validity of data as the record of transactions is widely distributed, but it cannot be copied
o One popular use of blockchain is for cryptocurrencies like Bitcoin
o Another use is a new type of contractual agreement called smart contracts. It allows for contractual terms to be completed without third-party involvement and oversight
(4) V’s of Big Data
o Volume
The scale of the data
Big Data is big as large amounts of data are stored in databases with information on thousands or even billions of observational units
o Velocity
The speed by which big data is generated and analyzed
Big data can involve the analysis of a constant stream of new data
o Variety
Big data comes in many different forms, such as relational databases, videos, emails, and more
o Veracity
The truthfulness or accuracy of data
Poor-quality data makes business decision making more difficult
Data Structured
o Structured data
Data is organized and has fixed fields like data in a spreadsheet with row or column identifiers which makes it easily searchable
o Semi-structured data
Although it doesn’t have organized fixed fields, this data may still contain organizing features such as tags or markers so it can have classification and groupings
o Unstructured data
Data is unorganized and not easily searchable. Often text-based so it is difficult to categorize and organize it into predefined, set data fields
Data Mining
o Involves statistical methods, computer learning, artificial intelligence, and large-scale computing power to analyze large amounts of data to reveal patterns and insight
o The primary goal is to provide useful information for decision making and anticipating future outcomes
Challenges of Data Mining
The quality of the data can affect data mining. If data has missing values, errors, or an insufficient sample size, the ability to conduct statistical tests and draw inferences can be limited
Often involves combining data from multiple sources which may come ina variety of formats
The size of the datasets could require computational power beyond the capabilities of standard computers
Produce large quantities of data that could demand significant time and effort to sift through
Managing Data Analytics
o Big data requires a compilation of disparate data sources into a unified, structured database
o Can be time consuming and intellectually challenging
o An organization must have procedures and processes in place to validate the data sources and verify that proper processing has taken place
o Specialized training in computer science, IT, and statistics is often needed to have the necessary skillset
o New technologies are being developed that require training and education
(4) Types of Data Analytics
o Descriptive
This form reports the characteristics of historical data using statistical properties like mean, median, range or standard deviation
o Diagnostic
This form looks at correlations to help identify unknown or uncertain empirical relationships by finding meaningful statistical associations
o Predictive
This form builds on descriptive and diagnostic analytics to make predictions about future events
o Prescriptive
This form uses the three other types of data to recommend the best course of action
Analytic Models
o Clustering
This technique helps discover and identify patterns of similarity and dissimilarity by grouping similar objects together
o Classification
This method attempts to predict which predefined category an item belongs to
o Regression
Analyzes the correlation of a dependent variable with an explanatory or independent variable. Can be performed with one independent variable or many independent variables
o Time Series
Considers data points over time, which allows patterns to be identified
o Exploratory Data Analysis
Summarizes the characteristics of a dataset to examine the data for patterns or anomalies, using visual methods
o Sensitivity (What-If) Analysis
Explores how a dependent variable might be affected under different possible set s of independent variables
o Simulation Models
Based on computational algorithms that follow specified assumptions to model possible outcomes
Data Visualization
o The creation, analysis, and evaluation of data presented in visual forms such as charts, graphs, diagrams, dashboards
o Organizations use data visualization to help identify patterns, trends, and outliers
o Provide understanding about correlations and relationships among critical success factors for an organization’s activities or industry and market behaviors
o Useful to make sense of big data
Presentation Options of Data Visualization
Histograms
• Show the distribution of numerical data
Boxplots
• Show data distribution by displaying the quartiles in which data occur
Scatterplots
• Show how two variables are related
Dot Plots
• Used when values fall into discrete categories and show values as small circles stacked on each other in each category
Tables
• List information in rows and columns
Dashboards
• Provide a quick summary view of key performance indicators
Types of Charts for of Data Visualization
Bar Charts
• Use horizontal or vertical bars to show the proportion of categorical data in each category
Pie Charts
• Used with categorical data to show the proportion of data in each category with slices in a circle
Line Charts
• Show a series of data points in a line for one variable. Multiple lines can be stacked onto the same chart to show multiple variables
Bubble Charts
• Enhance scatter charts by showing the size of the circle
