Forecasting, Budgeting, and Analysis Chapter 2 Flashcards
How do Fixed Costs affect budgeting?
Costs independent of the level activity within the relevant range
Property Tax is the same whether you produce 100,000 units or zero units
However – Fixed Costs per unit vary given the amount of activity
If you produce fewer units- fixed costs per unit will be greater than if you produce more units – i.e. less units to spread the cost over
What is a Master Budget?
Budget targeted for the company as a whole
Includes budgets for Operations and Cash Flows
Includes set of budgeted Financial Statements
What is a Static Budget?
Budget targeted for a specific segment of a company. AKA Master Budget AKA Annual Business Plan AKA Profit Planning AKA Targeting Budget
How are Material Variances calculated?
SAM:
Standard Material Costs
- Actual Material Costs
= Material Variance
How are Labor Variances calculated?
SAL:
Standard Labor Costs
- Actual Labor Costs
= Labor Variance
How are Overhead Variances calculated?
OAT:
Overhead Applied
- Actual Overhead Cost
= Total Overhead Variance
How do Variable Costs affect budgeting?
The more Direct Materials or Direct Labor used- the more Variable Costs per unit
However – Variable Costs per unit don’t change with the level of activity like Fixed Costs per unit
How is Contribution Margin calculated?
Sales Price (per unit)
- VC (per unit)
= CM (per unit)
How is Break-even Point (per unit) calculated?
Total FC / Contribution Margin (per unit)
= BEP Per Unit
Assumption: Total Costs & Total Revenues are LINEAR
How does Absorption Costing compare to Variable Costing?
Absorption Costing - External Use- Cost of Sales- Gross Profit- SG&A
Variable Costing - Internal Use- Variable Costs- Contribution Margin- Fixed Costs
What is the focus in a Cost Center?
Management is concerned only with costs
What is the focus in an Investment Center?
Management is concerned with costs- profits- and assets
What is the focus in a Profit Center?
Management is concerned with both costs and profits
What is the Delphi technique?
Forecasting technique where Data is collected and analyzed
Requires judgement/consensus
What is Regression Analysis?
A forecasting technique where Sales is the dependent variable.
Simple Regression - One independent variable
Multiple Regression - Multiple independent variables
What are Naive Forecasting Models?
Very Simplistic
“Eyeball” past trends and make an estimate
What are Econometric Models?
Forecast sales using Economic Data
What are the characteristics of Short-term Cost Analysis?
Uses Relevant Costs Only
Ignore Sunk Costs
Opportunity Cost is a Must
What are the 2 approaches to compute sales dollars needed to achieve a desired profit? (CVP Analysis aka Cost-Volume-Profit Analysis)
1. Summation of Total costs and profits Sales dollars = VC + FC + Pretax profit If in units 2. Contribution Margin Sales = (FC + Pretax profit) / contribution margin
What is margin of safety?
The margin of safety is the excess of sales over BEP.
It can expressed in dollars or %.
Total Sales $ - BEP Sales $ = Margin of safety $
Margin of Safety $/Total Sales = Margin safety %
How does a Moving Average compare to Exponential Smoothing?
Both project estimates using average trends from recent periods
Difference: Exponential Smoothing weighs recent data more heavily
What is target costing?
TC is a technique used to establish the product cost allowed to ensure both profitability p/unit and total sales volume.
What is the Target cost computation?
Target cost = Market price - Required profit
What is transfer pricing in a non-global perspective?
When divisions within large company may engage in transaction with each other rather than going outside the company.
From a non-global perspective, a transfer price is the price charged for the sale or purchase of a product internally such as between two divisions within a domestic company.
Transfer = sales price
What are the implications of target costing?
Compromised quality
Increased marketing and downstream costs
Increased complexity in cost measurement
product re-design.
Which strategies may be established in transfer pricing in a non-global perspective?
- Negotiated price - it is a process where buyer and seller divisions want a better price.
- Market price - it can often be determine if an outside market exists. The selling division lower the price due to the costs savings of not having to market and distribute.
- Cost - When no external market exists, a reasonable assessment of cost + reasonable profit markup is added.
What is transfer pricing in a global perspective?
is a methodology for allocating profits or losses among related entities within the same corporate legal group in different tax jurisdictions.
What is the Arm’s Length Principle in transfer pricing?
The principle states that transfer prices must approximate the prices for comparable transactions between unrelated parties who are acting on their fee will.
In order to determine comparability in transfer pricing what factors should be assessed?
The nature of goods Contractual terms Economic conditions Functions performed Risks assumed
Comparability will have a subjective element, as finding comparable transactions can be challenging if factors make a specific transaction unique. Multiple tests may be tested to determine “the best method”
Comparability in transfer pricing can be grouped in two categories. Name the 2 methods
Transactional and Profitability
Define the Profitability Method in transfer pricing comparability.
There are 3 different types of Profitability Methods:
a. Comparable Profits Method - looks at companies in similar situations and industries to the company being tested to determine profit margins. This data is actually easier to find than data on individual transactions.
b. Transactional Net Margin Method - looks at individual transactions (or group of transactions) from a profitability perspective and then applies that profitability to the tested company.
c. Profits Split Method - based on evaluating the contribution of each tested party to the combined operating profit or loss of the entity as a whole. PSM can be analyzed in 2 ways:
1. The Comparable Profit Split uses profit of uncontrolled taxpayer with similar transactions or activities to allocate the combined operating profit/loss of tested companies.
2. The Residual Profit Split is applied when one party owns the majority of the intangible assets. The profits are split based on functions performed by the party that does not own the intangible assets, while the residual profit is then allocated to the other related party.
What are the penalties, rules, and adjustments can be assessed to transfer pricing
The IRS has the authority to adjust prices not found to be within the established “arm’s length” range. The adjustment can be to midpoint of the range, and a penalty may be assessed depending on the size of the adjustment.
Define the Transactional Method in transfer pricing comparability.
The transactional method can be done in 4 different ways:
a. Comparable Uncontrolled Price Method- based on actual transactions, the CUP method identifies a transaction that is identical to the one in question. This is likely the best estimate of “arm’s length”.
b. Resale Price Method - uses list prices less discount for tangible property transactions from retail sales to unrelated parties.
c. Gross Margin Method - Similar to RPM, but this method is used for transactions involving services.
d. Cost Plus Method - the C+ looks at mark up % applied to actual costs on transactions between unrelated parties.
What is “Marginal Analysis”?
The operational decision method, referred to as marginal analysis is used when analyzing business decisions such as accepting or rejecting special orders, making or buying a product or service, selling or processing further, and adding or dropping a segment. Marginal analysis focuses on the relevant revenues and costs that are associated with a decision.
What are Direct Costs?
Costs that can be identified with or traced to a given cost object. DC are relevant. VC are generally DC.
What are relevant revenues and costs?
Costs and revenues are relevant if they change as a result of selecting different alternatives. Relevant costs include incremental costs (the additional costs incurred to produce an additional unit of output) and opportunity costs (the costs of foregoing the next best alternative when making a decision).
What are Prime Costs?
DM and DL. They are generally relevant.
What are Discretionary Costs?
Are costs arising from periodic (usually annual) budgeting decision by management to spend in areas not directly related to manufacturing. Discretionary Costs are generally relevant.
Ex. costs to maintain landscaping at corporation’s headquarters are generally viewed as discretionary.
What are Incremental Costs?
a.k.a Marginal costs, differential costs, out-of-pocket costs.
Are the additional costs incurred to produce an additional unit of output. Incremental Costs are relevant costs and include all VC and any avoidable FC associated with a decision.
What are opportunity Costs?
The costs of foregoing the next best alternative when making a decision. OC are relevant costs.
Ex. Jones Corp. had an opportunity to use its capacity to produce an extra 5.000 units with a contribution margin of $5, or to rent out the space for $10,000. The opportunity cost is the next best option. The 1st best $25,000 in CM, 2nd best $10,000. The opportunity cost is $10,000. We have to forego on the $10,000 to get the $25,000.
What costs are “Irrelevant”?
Costs that do no differ among alternatives and should be ignored in a marginal cost analysis.
What are sunk costs?
C. Costs, which are not different among alternatives, are irrelevant and should be ignored in marginal cost analysis. Sunk costs are not relevant costs.
Ex. E Company is evaluating whether to replace a piece of equipment. The costs of the old equipment is a sunk cost and is not relevant to the replacement decision. Additionally, under either alternative (keep or replace) electricity would remain the same. The costs of electricity is a VC. Even so, the cost of electricity is not relevant because it does not change regardless of the selective alternative.
What are Controllable Costs?
For any business unit or decision, controllable costs are those that are authorized by the business unit manager or the decision maker. Controllable Costs are relevant.
What are Uncontrollable Costs?
UC at a specific level costs that were authorized at a different level. UC are not relevant costs because they cannot be changed by the manager making the decision.
What are Sunk Costs?
Are costs that are unavoidable because they were incurred in the past and cannot be recovered as a result of a decision. Sunk costs are not relevant costs.
What are Unavoidable Costs
Are costs that will be the same regardless of the chosen course of action and are no relevant to future decisions. These costs will continue regardless of the course of action taken. They have no effect on the decision.
What are avoidable costs and Revenues result from?
Avoidable costs and revenues result from choosing one course of action instead of another. As a result, the firm avoids the cost and revenue associate with the course of action not selected. They are relevant to the decision.
Define Special Order Decisions.
Special orders require a firm to decide if a specially priced order should be accepted or rejected. Decisions of this character involve a comparison of spo price to the relevant costs and a analysis of the strategic issues that relate to the acceptance or rejection of the order.
What are the relevant costs in SPO’s if excess capacity is presumed?
When there is excess capacity, a comparison should be made of the incremental costs of the order to the incremental revenue. A SPO should be accepted if the selling price per unit is greater than the variable cost per unit.
Accept if SP > VC
What are the relevant costs in SPO’s if full capacity is presumed?
If the company is operating at full capacity, the opportunity cost of producing the special order should be included in the analysis.
The Opportunity Cost is the contribution margin that would have been produced if the SPO was not accepted.
What are the some of the strategic factors to consider when accepting a SPO?
- Effect on regular-priced sales and other long-term pricing issues.
- The possibility of future sales to this customer.
- The possibility of exceeding plant capacity or the complexities of the order itself
- The pricing of the special order
- The impact of income taxes
- The effect on machinery and/or the scheduled machine maintenance program.
What is the make vs. buy decision?
Also referred as insourcing vs. outsourcing, is similar to the special order decision. Managers should select the lowest-cost alternative.
How to determine the Relevant Costs and Other Make or Buy Issues?
Excess Capacity - The cost of making the product internally is the cost that will be avoided (or saved) if the product is not made. This will be the maximum outside purchase price.
No Excess Capacity - The cost of making the product internally is the cost that will be avoided (saved) if the product is not made + the opportunity cost associated with the decision
What are the strategic factors in make vs. buy decisions?
- Quality of product purchased vs. quality manufactured
- The reliability of the purchased product
- The value of service contracts or other warranties
- The risks associated with outsourcing or buying outside the organization, including inflexibility, loss of control, and less confidentiality.
- The most efficient use of the entity’s resources.
What is the sell or process further decision is based on?
Profitability.
How is decided if a sell or process further decision is profitable?
The decision is made by comparing the incremental cost and the incremental revenue generated after the split-off-point.
Which costs associated with the decision to keep or drop a segment?
The Relevant Costs
Fixed costs associated with the segment must be identified as either avoidable (Relevant) or unavoidable, even if the segment is discontinued.
A firm should compare the fixed costs that can be avoided if the segment is dropped (i.e., the cost of running the segment should be kept if the lost contribution margin exceeds avoided fixed costs and dropped if the lost contribution margin is less than avoided fixed costs.
What are the decision factors involved in the keep vs. drop a segment?
Keep = lost CM > avoided fixed cost (cost given up > benefit) Drop = lost CM
What are the Strategic Factors to consider in a keep vs. drop decision?
- The complementary character of products and their relationship to the sales of other products.
- The impact of product addition or deletion on employee morale.
- The growth potential of each product regardless of individual profitability.
- Opportunity costs associated with available capacity.
What are Data driven technique for forecasting and projections and the two decision models?
Data driven decision-making models such as forecasting and sensitivity analysis allow for a formal depiction of the objective, the constraints, and the steps in a process. They may even point to the best solution among tested alternatives.
What is Sensitivity analysis?
Sensitive analysis is the process of experimenting with different parameters and assumptions regarding a model and cataloging the range of results to view the possible consequences of a decision. Also called “What-if” analysis.
What is the biggest drawback of sensitivity (what-if) analysis?
Is the implicit assumption that variables are independent. The reality is that variables do not typically operate in a vacuum, and a change in one will often result in changes in other that are difficult to predict with accuracy
What is Forecasting Analysis?
It is an extension of sensitivity analysis. Forecasting involves predicting the future values of a dependent variable (the variable one is trying to explain) using information from previous time periods.
What is Regression Analysis?
Linear regression is a method for studying the relationship between two or more variables. Linear regression is used to predict the value of a dependent variable [e.g., Total cost (Y)] corresponding to given values of the independent variable [e.g. fixed costs (A), variable cost p/unit (B), and production expressed in units (X)].
What are the components of the Simple Linear Regression Model?
Y = A + Bx
Total Costs = Fixed Cost + (Variable Cost X #units)
Y = The dependent variable we are trying to explain e.g. Total Cost
x = The independent variable that explains Y. The total activity or output
A = The Y intercept of the regression line. If Y is total costs, A would measure total fixed costs.
B = The slope of the regression line. If Y is total cost and x the output, B measures the change in total costs due to 1 unit change in output (variable cost p/unit)
What are the measures to evaluate regression analysis?
Coefficient of Correlation (r)
Coefficient of Determination (r2)
What is the Coefficient of Correlation (r)?
The Coefficient of Correlation (r) measures the strength of the linear relationship between the independent variable (x) and the dependent variable (Y)»_space; in a graph
- Perfect Positive Correlation (+1.00) means the Y and x move together in the same direction.
- Perfect inverse Correlation (-1.00) means the Y and x move in inverse direction.
- No Correlation (0.00) means Y and x are not related and the movement in one cannot be used to predict the movement of the other.
What is the Coefficient of Determination (r2)?
The Coefficient of Determination (r2) is the proportion of the total variation in the dependent variable (Y) explained by the independent variable (x).
It’s value lies between 0 and 1.
What is the interpretation of the Coefficient of Determination (r2)?
The higher the R2, the greater the proportion of the total variation in Y that is explained by the variation in x. That is, the higher the R2, the better the fit of the regression line.
Explain the Delphi Method.
The Delphi method of forecasting involves the use of multiple teams in geographically remote locations. Information is shared and gathered in a central point and compiled and then redistributed for comment. The method is highly interpersonal and requires significant judgment.
What is the Learning Curve analysis?
Learning curve analysis is based on the premise that as workers become more familiar with a specific task, the per-unit labor hours will decline as experience is gained and production becomes more efficient.
What is the Learning Curve equation?
Y = AXB
The equation for cumulative total hours (or cost) is found by multiplying both sides of the cumulative average equation by X. An 80 percent learning curve means that the cumulative average time (and cost) will decrease by 20 percent each time output doubles.
For example, if a job is subject to an 80% learning curve and the 1st unit required 50 labor hours to complete, what would be the cumulative average time p/unit after completing 4 units?
As cumulative quantities double, average cost per unit decreases by a specified % of the previous cost.
Cumulative # of Units Average time p/unit
1 50 hours
2 40 hours (50 x 80%)
4 32 hours (40 x 80%)
What is the High-Low Method?
Is a simple technique that is used to estimate the fixed and variable portions of cost, usually production costs.
What are the procedures for the High-Low Method?
- Compare the high and low volumes and costs
- Divide the difference between the high and low $ total costs by the difference in high and low volumes to obtain the variable cost p/unit
- Use either the high volume or the low volume to calculate the variable costs by multiplying the volume times the VC p/unit
- Subtract the total calculated VC from TC to obtain FC.
What is the result of the High-Low Method called?
Total cost formula, and, sometimes, a flexible budget formula.
What is the flexible budget formula?
Total Costs = FC + (VC p/unit X #units)
What are Operational and Tactical Planning?
Is the process of determining the specific objectives and means by which strategic plans will be achieved. Tactical plans are a short term planning to covering up to 18 months. An annual budget represents a type of single-use tactical plan.
Define a currently attainable standards.
It represents costs that result from work performed by employees with appropriate training and experience but without extraordinary effort. (It uses flex budgets)
Define ideal standards.
It represents costs that result from perfect efficiency and effectiveness in job performance.
Define flexible budget.
Is a budget that can be adjusted to any activity level; it shows how costs vary with production volume.
The budget VC per unit and fixed cost remain the same. The #of units or volume of actual is the only number that reflects the actual numbers instead of the budget.
Define a master budget.
The MB documents specific short-term operating performance goals for a period of time, normally one year or less. The plan generally includes an operating (non-financial) budget as well as a financial budget
List the operating budgets included in the master budget.
- Sales budget
- Production budget
- Direct materials budget
- Direct labor budget
- Overhead budget
- Cost of goods sold budget
- SG&A budget
List the financial budgets included in the master budget.
- Cash budget
2. Pro-forma FS (IS, BS, CF)
What are the benefits and limitations of the flex budget?
Benefit - It can display different volume levels within the relevant range to pinpoint areas efficiencies have been achieved or where waste has occurred.
Limitation - Flex budgets are highly dependent on the accurate identification of FC and VC and the determination of the relevant range (trash in, trash out).
What are the main 4 types of variances for raw material and direct labor?
PURE P - Price (DM) >> D X A U - Usage/Qty (DM) >> D X S R - Rate (DL) >> D X A E - Efficiency (DL) >> D X S
Where D is the difference in PURE and A is actual, and S is standard(budgeted).
What are the main 4 types of Overhead variances (VOH and FOH)?
VOH Rate »_space; D X Actual hours
VOH Efficiency »_space; D X Standard rate
FOH Spending/Budget »_space; Actual - Budget
FOH Volume »_space; Actual - Budget*
* based on Actual production X standard rate
D1 = Actual - Standard rate
D2 = Actual hours - Standard hours allowed for actual production volume
What are the 2 types of Sales and Contribution Margin variances?
Sales Price Variance =
(Actual SP - Budget SP) X Actual Units sold
Sales Volume Variance =
(Actual Units sold - Budget units) X Standard Contribution Margin/unit
What are the 4 types of Responsibility Segments?
- Cost SBU - controlling costs
- Revenue SBU - generating revenues
- Profit SBU - producing a target profit
- Investment SBU - return on assets invested to produce earnings generated by SBU
Define contribution by SBU - Strategic Business Units
Contribution by SBU - Strategic Business units, represent the difference between the contribution margin (Revenue - VC) and controllable FC (those costs that managers can impact in less than one year)
What is the purpose of the balanced scorecard?
The balanced scorecard gathers information on multiple dimensions of an organization’s performance defined by critical success factors necessary to accomplish firm strategy.
What dimensions or categories of business operation are frequently identified by the balance scorecard?
FICA Finance Internal business processes Customer satisfaction Advancement of human resource innovation
Explain Controllable Margin.
Contribution Margin - Controllable FC
Distinguish when to use Actual or Standard rate on variances exercises.
If price or rate variance the result will be:
Difference X Actual quantity or hour
If usage or efficiency variance the result will be:
Difference X Standard price or rate
