Management Accounting

Question 1

Chapter 7 - Costing Methods

1. What is COGM? Calculate
2. What is Job costing versus process costing
3. What are the types of Job Costing?
4. What is Spoilage for Job Costing?
5. What is Process Costing?
6. What are Equivalent Units (EU)?
7. What are methods to cost EU?
8. What is Spoilage for Process Costing?
   What is Traditional costing?
   What is Activity-based costing?
   What is Joint product costing? and Methods?
   What is Service department cost allocations? And Methods

Answer 1

1. What is COGM?
   The value of the goods transferred from WIP to finished goods is referred to as the cost of goods manufactured (COGM).
   COGM = Beginning WIP + DM used + DL used + OH applied – Ending WIP

The value of finished goods sold is the cost of goods sold (COGS).
COGS = Beginning finished goods + COGM – Ending finished goods

2. What is Job costing versus process costing
   Job costing and process costing are two ways of allocating costs to a unit of inventory.
   (i) Job costing is used by organizations whose products or services are able to be uniquely identified.
3. What are the types of Job Costing?
   Variable costing - This is a method of inventory valuation in which only variable OH costs are included as inventoriable costs. All fixed and all non-manufacturing costs are classified as period costs and expensed during the specific time period in which they are incurred.

Absorption costing - when the inventoriable costs include both fixed and variable costs. Supporters of this approach stress that items like plant and equipment (and, subsequently, depreciation) are required to produce inventory. Where fixed OH is inventoried, the cost only appears on the income statement when the inventory is sold; it will sit in inventory on the balance sheet until that time.

4. What is Spoilage for Job Costing?
   Spoilage must be accounted for in a job costing system:

Normal spoilage occurs as a regular part of operations and cannot be attributed to any particular job. Accordingly, the cost of normal spoilage is viewed as part of OH.

Abnormal spoilage occurs under atypical and abnormal circumstances. If abnormal spoilage occurs, then the cost should be removed from inventory and recorded as a period expense.

5. What is Process Costing?
   (ii) Process costing is used by organizations whose products are mass produced. In each period, process costing systems divide the total costs of producing an identical or similar product or service by the total number of units produced to obtain a per-unit cost.
6. What are Equivalent Units (EU)?
   Where the process is continuous, there are often items of inventory at various stages of production. In order to cost inventory, there needs to be a way to understand the cost of both WIP and finished goods. To do this, management uses equivalent units (EU). EU are a way of referring to all units in reference to the number of fully completed units they represent. For example, if you have two units 50% complete, that would be equal to one EU.

In a typical production process, DM is added at the beginning of the process, while conversion costs (that is, DL and OH) are incurred throughout the process. Therefore, for WIP, the costs for DM are often complete earlier than those for DL or OH. The EU of DM may therefore be higher than the EU of conversion costs. To account for this, DM EU are tracked separately from conversion costs.

7. What are methods to cost EU?

Weighted Average
EU produced = Units transferred to next process OR finished goods + EU in ending WIP
DM Cost per EU = Total DM Cost / (Units Finished + EU DM WIP)
Conversion Cost per EU = Total Conversion Costs / (Units Finished + EU conversion WIP)

Step 1: Determine Units to Account for
WIP Beg + Started in Production

Step 2: Compute output in terms of EU
Looks at
(1) Completed + Transferred Out (provided) = Completed
(2) WIP, Ending

Step 3: Compute costs to account for
Total Cost = Total DM Cost + Total CC Cost
Total DM Cost = WIP beginning cost DM + Current Period Costs DM
Total CC Cost = WIP beginning cost CC + Current Period Costs CC

Step 4: Compute cost per EU
Cost per EU DM = Total DM Cost / EU DM
Cost per EU CC = Total CC Cost / EU CC

Step 5: Assign total costs to quantities in Step 2

FIFO
Under the first in, first out (FIFO) method, costs incurred during the current period (including costs transferred in) are used to calculate the cost of units completed during the current period. Both beginning and ending WIP inventories are converted to an EU basis. This method is theoretically superior because it accounts for the fact that beginning WIP was not fully produced in the current period. Both methods are acceptable, however, as the impact of this adjustment tends to be minor when spread over a larger period of time.

Step 1: Determine Units to Account for
WIP Beg + Started in Production (SAME AS WEIGHTED AVERAGE)

Step 2: Compute output in terms of EU
Looks at:
(1) WIP Beg
(2) Started + Completed = Started - WIP
(3) WIP End

Step 3: Compute costs to account for
Total Cost = Total DM Cost + Total CC Cost
Total DM Cost = Current Period Costs DM ** DIFFERENT FROM WA
Total CC Cost = Current Period Costs CC ** DIFFERENT FROM WA

Step 4: Compute cost per EU
Cost per EU DM = Total DM Cost / EU DM Quantity from Step 2
Cost per EU CC = Total CC Cost / EU CC Quantity from Step 2

Step 5: Assign total costs to quantities in Step 2

What is Spoilage for Process Costing?
Normal spoilage occurs as a regular part of operations. Accordingly, the cost of normal spoilage is typically viewed as part of the cost of producing good units — even when the amount of spoilage is significant. (unlike job costing which would be apply to OH)

Abnormal spoilage occurs under atypical circumstances, such as out-of-control operations. The cost of abnormal spoilage should be removed from inventory, coded as a period expense (like abnormal job costing spoilage), and highlighted for further analysis.

What is Traditional costing?
Traditional cost-accounting techniques allocate costs to products based on a predetermined OH rate using a single cost driver. Typical cost drivers include the number of direct labour hours, dollars, or machine hours required to manufacture a unit.

The advantage of this method is its simplicity. It is determined easily and can be applied consistently. The disadvantage, however, is that the more costs that are included in OH and not impacted by the selected cost driver, the less accurate the allocation.

What is Activity-based costing?
Activity-based costing (ABC) recognizes that the activities within a company vary, and that each activity typically has a different driver that affects costs. ABC allocates costs to products by defining different cost pools and assigning a driver to each based on how the specific pool’s costs are created. When implemented effectively, this method provides management with a more accurate representation of the cost of a product. This allows for better guidance for strategic decisions like pricing and capacity management.

Step 1: Identify the cost objective
Step 2: Identify activities and cost drivers
Step 3: Assign indirect costs to cost pools
Step 4: Calculate activity rates
Step 5: Assign indirect costs to cost objectives

What is Joint product costing? and Methods?

Joint products share one or more production processes and incur joint costs that cannot be traced to the individual products. After a split-off point in the production process, one product might be sold while one or more other products receive additional, separate processing. For example, cow’s milk might be standardized for a specific butter-fat content, and then split into separate production processes. Some of these processes, such as cheese-making, might incur further joint costs and then be split into even more production processes for different types of cheese. It is important to appropriately assign costs in order to show the true profitability of each product.

(A) Physical Output Method
Allocation = Proportion of Weight * Cost at split-off

(B) Sales value at split-off point method
Allocation = Proportion of Sales * Cost at split-off
Sales of product at split off point

(C) Net realizable value method
Allocation = Proportion of (Total Value of Production - Seperable Cost)
Production of finished product (Highest realizable amount)

What is Service department cost allocations? And Methods
Typing to apply admin overhead to operating overheads.

Direct Allocation Method
Simple method and easy to understand
Major disadvantage is that no service department costs are allocated to other service departments.
% proportation to each operating overhead

Step-down allocation method
Detemine the Support function that services the other functions the MOST. The allocate to other functions including other support.
Under the step-down allocation method, service department costs are allocated to both operating
The step-down allocation method is fairly easy to perform and understand.
Major disadvantage is that it accounts for only some of the concurrent use of support services among service departments.and service departments, beginning with the service department that provides the MOST services to other departments.

Reciprocal allocation method
Great Equations for each support group and substitute. Does matter which Support equation you substitute for.
Under the reciprocal allocation method, service department costs are allocated simultaneously from all service departments to both operating and service departments. The costs of service departments are allocated one at a time, in a “step-down” manner.
Most accurate allocation method

Question 2

Chapter 8 - Transfer Pricing

What is the minimum/maximum transfer price?
Transfer price methods? (meaning/when to use/pros/cons)

Answer 2

What is the minimum/maximum transfer price?
Minimum transfer price = variable costs up to the point of transfer + Opportunity cost to the selling division
Maximum transfer price = External selling price
When the producing division is not operating at full capacity, the opportunity cost is $0

Transfer price methods

Understanding how each division will think about transfer prices now allows a discussion of three common transfer-pricing approaches:

• cost-based transfer pricing
• market-based transfer pricing
• negotiated transfer pricing

2.1 Cost-based transfer pricing
Under cost-based transfer pricing, transfer prices are based on a formula applied to some measure of the product’s cost.
• Full-cost bases measure the full absorption cost of the product being transferred PLUS A MARKUP. *
• Variable costs measure the variable cost of the product being transferred PLUS A MARKUP. *

When to use?
• useful when market prices arent available/inappropriate/too costly to obtain
• appropriate when selling unit operates as a cost centre

Pros
• It’s simple.
• It can be readily calculated using available accounting data.

Cons
• It may encourage decisions that do not benefit the company as a whole.(Suboptimal decisions)
• The distribution of profit may be unfair to the seller or buyer.
• It may encourage production inefficiencies because costs are passed on to the buyer.

Market-based transfer pricing

Under market-based transfer pricing, transfer prices are based on external market conditions such as the prices of external suppliers or the prices charged to external customers.

The use of market prices will generally lead to optimal decision-making when three conditions are satisfied:
• The immediate market must be perfectly competitive and information readily available. (Perfect Competition)
• Interdependencies between the departments must be minimal. (No Interdependence)
• There must be no additional costs or benefits to the organization as a whole in using the external market instead of transacting internally. (No Arbitrage)

Pros
• It’s simple, if external market prices are readily available.
• If the selling division is operating at full capacity, it will encourage transfers only if they are beneficial to the company as a whole.

Cons
• External market prices may not be readily available.
• Suboptimal decisions may be made by the seller and/or the buyer if the seller has excess capacity.

Negotiated transfer pricing

Under negotiated transfer pricing, the seller and buyer work together to come up with an internal transfer price for the product or service. Because the two must work together, the negotiation process can be time-consuming. Note that, although the negotiated price may have no specific relationship to either costs or market prices, cost and market price information often provides useful reference points in the negotiation process.

As discussed at the beginning of this chapter, and ignoring relevant qualitative effects (for example, timeliness of delivery), the goal of both parties will be to benefit themselves. To achieve this, understanding the limits of the transfer price range is important. During negotiation, the parties will each fall within the following acceptable ranges:

Operating at full capacity *
Minimum transfer price for seller -> Variable cost + Opportunity cost (Market price)
Maximum transfer price for buyer -> Market price

Excess capacity
Minimum transfer price for seller -> Variable cost

A number of factors may lead to companies sourcing cheaper inputs from suppliers, including the following:
• geographical location, thus reducing transportation costs
• locked-in contracts and subsequent market fluctuations
• competitors going out of business and needing to liquidate their product quickly

Pros
• Divisions are given independence and control.
• Divisions build relationships with each other.
• The price usually benefits the overall organization.

Cons
• The price is determined by each division’s negotiating ability.
• It’s time-consuming.

Question 3

Chapter 14 - Pricing

What is Cost Based Pricing? and types (3)
What is Demand-based pricing? and types (7)
What is Value-based pricing?
What is a Short-term pricing decisions?
What are the key Pricing Considerations?

Answer 3

What is Cost Based Pricing?
- set prices as a function of cost. (Cost + Markup on Cost)

Issues:
Issues with cost-based pricing

(i) Use of poor-quality cost information can lead to poor pricing and product decisions.
(ii) Potential death spiral -> falling sales volume for a company -> high selling price -> customers go to competitors with lower costs -> continued falling sales volumes ->fixed cost allocated to each unit increases -> leading to an even higher cost per unit.

(A) Variable product cost-based pricing -> Mark-up up on variable components

• Pro: suitable for non-competitive markets, as it is focused on recovering relevant costs and it ensures an entity is achieving a positive contribution margin
• Con: not suitable when fixed costs are a large component of total costs; the company

(B) Full Absorption Costs
- Addresses issue with Variable by adding fixed costs.

Pros

• easy to use
• Full absorption costing is the method required for financial reporting per generally accepted accounting principles.
• Recovers all of the costs.

Cons

• The downside to this method is that it is based on budgets, which could be inaccurate.
• Ignores competition and may result in an entity turning down opportunities that would still provide positive contribution margin that may not otherwise be received.

(ADD-IN) Life-cycle Costs
The life cycle of a product goes through five stages: development, introduction, growth, maturity, and decline. A pricing decision based on life-cycle costing factors must take into consideration the fact that 80% to 90% of a product’s life-cycle cost will be incurred during the pre-production stages.
The objective of product life-cycle management is to maximize profits over a product’s entire life cycle, rather than to maximize revenues and minimize costs for each stage of the life cycle.

(C) Target Based Costs
market-based pricing strategies start with a target price — the estimated price for a product or service that customers are potentially willing to pay. This estimate is based on an understanding of customers’ perceived value for a product or service and how competitors will price competing products or services. This understanding of customers and competitors is increasingly important because:
• Competition from lower-cost producers is continually restraining prices.
• Products are on the market for shorter periods of time.
• Customers are more knowledgeable and demanding.

What is Demand-based pricing? -

• focuses on two things:
  (1) the value to customers and -> use fo consumer demand to determine preceived value
  (2) the demand (competition).

Types
Predatory pricing occurs when a company deliberately prices below its costs in an effort to drive out competitors and restrict supply.
Key points:
1. Deliberate price cutting or offers of “free gifts / products”
2. Forces smaller / weaker rivals out of business or prevents new entrants
3. Works in the short term but not in the long term
4. Anti-competitive and illegal if it can be proven, but very difficult to prove

Penetration pricing - setting the price low in order to attract customers and gain market share. The price will be raised later once this market share is gained. Penetration pricing differs from predatory pricing in that penetration is only short term to gain market share and does not focus on eliminating competition.
Key points:
1. Price set to “penetrate the market”
2. Low price to secure high volumes
3. Intent is to lower costs over the long term by gaining production and distribution economies of scale before competitors
4. Suitable for products with long product life
5. May be useful if launching into a new market

Price skimming - goods are sold at higher prices initially so that fewer sales are needed to break even. Over time, the price is lowered, and the audience that the product is available to widens.
Key points:
1. High price, limited volumes
2. Short window of opportunity
3. Suitable for products that have short life cycles or that will face competition at some point in the future (such as after a patent runs out)

Price bundling - offering several products or services for sale as one combined product.
Key points:
1. Offered when customers purchase more than one product or service from a company
2. The more you buy, the less you pay
3. Package deals

Peak-load pricing - practice of charging a higher price for the same product or service when demand approaches physical capacity limits. This pricing strategy tries to reduce demand to compensate for the limited supply.
Key points:
1. Prices adjusted to demand and volume
2. The higher the demand, the higher the price

Loss leader pricing - strategy where a product is sold at a price below its market cost to stimulate the sales of other, more profitable goods or services. A loss leader is usually a product that customers purchase frequently, so they are aware that its unusually low price is a bargain. The seller must use this technique regularly if it expects its customers to come back. The retailer will often limit how much a customer can purchase. Some loss leader items are perishable and cannot be stockpiled.
Key points:
1. Products sold below market price
2. Customer draw to stimulate sales of more profitable goods or services
3. Purchases of other items more than cover “loss” on item sold

Tender / contract pricing- Tendering or contracting is the process of making an offer, bid, or proposal, or expressing interest in response to an invitation or request for tender.
Key points:
1. Proposal submitted for a contract / job
2. Aims to cover materials and labour costs, and generate a profit
3. Often undisclosed and in competitive markets

What is Value-based pricing?
Value-based pricing is the practice of setting prices based on a trade-off between the perceived value to the consumer and the producer’s incentive to produce the product (which is a function of price and cost). Value-based pricing uses value curves, which rank the attributes of the focal firm’s cost-volume-profit versus its main rivals to see which firm offers the most value for the price charged.
Key points:
1. Focuses on a single market segment
2. Compares based on the next best alternative
3. Focuses on differentiated features, not the brand

What is a Short-term pricing decisions?

Short-term pricing decisions typically have a time horizon of less than a year and include decisions such as:

1. Pricing a one-time-only special order with no long-run implications
2. Adjusting product mix and output volumes in a competitive market

Qualitative considerations need to be factored in when making short-term pricing decisions, such as whether existing customers are going to be upset with the discounted offers.

What are the key Pricing Considerations?

(a) Structure of industry
(b) Product Life Cycle

Question 4

Chapter 4 - Budgeting - Variance Analysis

Answer 4

AQ = Actual quantity (unit)
AP = Actual price per unit
SP = Budgeted price per unit
SQ = Standard quantity (unit)

Use terms Favourable and Unfavourable

AQ,AP,SQ,SP (AQ - SP)

Actual, Flex, Static -> Static Bud. Var, Flex Bud Var. -> Sales Vol. Var -> Rate Var Efficiency Var
AFS -> SFSRE

First set -> 11,312,121 OR 113 - 12121
Second set -> 24,424,343 OR 244 - 24343 (4 fours)

Letter Set -> TTT,A,MMM

Third Set (Variance only) -> 31,414 OR 31414
Fourth Set -> 4

T = Times
A = Times, Minus, Times
M = Minus, Times

Question 5

Chapter 5 - Cost-Volume-Profit

Calculate Contribution margin
Calculate Contrtibution Ratio
Calculate WACO
Calculate WACR
Calculate breakeven
Calculate required quantity with target profit
Calculate required sales dollars with target profit
What are the Cost-Volume-Profit assumptions?

Answer 5

Calculate Contribution margin
Selling price - COG price

Calculate Contrtibution Ratio
Profit/Sales

Calculate WACM
Total Profit/ Total Quantity

Calculate WACR
Total Profit/ Total Sales

Calculate breakeven
Fixed Asset/ CM ro WACM

Calculate required quantity with target profit
(fixed + target) / CM or WACM

Calculate required sales dollars with target profit
(fixed + target) / CR or WACR

What are the Cost-Volume-Profit assumptions?

CVP analysis is a commonly used and very useful tool. It does, however, have limitations and it is important that management is aware of these when making decisions.

Some of the key assumptions when using CVP are as follows:

• Selling price is constant — Any change to sales price will impact CVP decisions, and management should be cognizant of this, including planned changes, promotional sales, and other variations.
• Costs are linear and can be accurately divided into variable (constant per unit) and fixed (constant in total) elements — Many costs operate as fixed within a relevant range and are not truly linear, but CVP ignores this consideration. For more information on cost behaviours, see the eBook chapter on costing nature and classification.
• In multiproduct companies, the sales mix is constant — If the sales mix were to vary, the weight of the products would be incorrect and it would impact the analysis.

Question 6

Chatper 15 - Quality Control and Process Improvement

What is cost management?
What is quality management? Types of tools?
What are some process improvement tools (4)

Answer 6

What is cost management?
Cost management deals with the effective and efficient use of resources to achieve organizational objectives

here are two broad groups of activities and the resultant costs:

1. Value-added activities, from the customer’s perspective, add value to the good or service. An example of a value-added activity is increasing the quality and, as a result, the reliability of the transmission in an automobile.
2. Non-value-added activities, from the customer’s perspective, do not add value to the good or service. Examples of non-value-added activities are the wait times associated with holding raw materials in a factory, or a plumber returning to a job site to repair a leaking tap that was just installed. The usual prescription is to identify and eliminate non-value-added activities..

Effective cost management requires that the reason for the non-value-added activity be identified before the activity is eliminated.

What is the cost of quality?
The cost of quality recognizes that the most expensive place to discover poor quality is after delivery to the customer. This is because when a customer experiences poor quality, they are unlikely to purchase your goods or services again in the future.

What are some Quality mangement tools?
Measurement tools are used to measure how an entity is doing at achieving quality. These tools can be categorized as statistical and non-statistical.

Statistical tools
At the centre of quality is the understanding that every process is subject to random variability (measured by the standard deviation). Knowing the system’s average and standard deviation provides the foundation for predicting the attributes of future production.

• Statistical process control — The focus is on the inputs and processes within a system.
• Statistical quality control — The focus is on the outputs of a system.
• Process capability analysis — An analysis tool that discovers the mean and standard deviation of the process.
• Control charts — A graphical tool used to monitor a process.
(i) Pareto analysis - The purpose of Pareto analysis is to identify the barriers to quality and to prioritize them with respect to process improvement

Non-statistical tools
It is important to look at quality control not only from a statistical perspective but also to utilize non-statistical tools for a more in-depth look at a process or to assist in ranking the issues.
(i) Cause-and-effect diagrams
(ii) Check Sheet

What are some Process Improvement Tools?
1. Lean Management -
Lean management is a management philosophy that focuses on the elimination of any element in any business process that does not add value to the final product or service that a customer purchases and/or uses. Traditionally considered a manufacturing concept, lean management has emerged to apply as much to the service industry as it does to manufacturing.

A lean organization understands customer value very well, and focuses its key processes to continuously add and emphasize customer value. Lean management includes the following key elements:

(i) . A just-in-time management system - A just-in-time management system is a plan to deliver products and services as customers demand them
(ii) . Activity analysis - With activity analysis comes the understanding that making a good or service involves a sequence of activities that add value to that product or service.
(a) Processing: any activity that adds value, meaning that it enhances the customer’s perception of the offering (order-taking, assembly, and even evaluating student assignments are examples of processing)
(b) Moving: any activity that involves the physical movement of resources (for example, parts or people)
(c) Storing: any waiting and holding on to work in process that does not result in value to the customer (exceptions, like the aging of cheese and wine, exist)
(d) Inspecting: the verification that the quality of the good or service is to standard (this adds no value because the customer expects that quality would be built in from the beginning, and reflects the fact that the organization is unable to create a design that guarantees quality output)

(iii) . A zero-defects approach - he zero-defects approach employs a system that forbids mistakes to be passed on to the next stage of the product or service process (it must be corrected or eliminated before moving on). The philosophy behind the zero-defects approach is that an additional investment in prevention
2. Six Sigma - Six Sigma is an internationally recognized total quality management approach / process that focuses on trying to manufacture a high quality of products and services.
3. Supply Chain Management - Supply chain management is a tool used to manage the flow of goods and services from the raw materials stage through to consumption by the end user.
4. Total Qaualtity Management - Total quality management (TQM) is a process of controlling product quality from its raw materials stage up to the moment its finished products leave the organization.

Question 7

Chapter 13 - Performance Management - Balance Scorecard

What are the 4 Prospectives?
What are the 3 components of the framework?

Answer 7

Balanced scorecard overview

• a framework for measuring performance with a balanced perspective.
• promotes focus on the key strategic goals, both financial and non-financial, and reduces ambiguity, mixed signals, and overreliance on a subset of important yet incomplete indicators

the BSC is often structured into four perspectives:

1. Financial (how the company is seen by its owners and investors)
2. Customer (how the company is seen by customers and the market)
3. Internal business process (what the company must excel at executing)
4. Learning and growth (generally, employee competencies, technology, and corporate culture — in other words, skills and capabilities development),

The BSC provides results on three levels:
• An organization will be able to assess whether it achieved its strategy from an overall standpoint.
• Performance within each perspective can be analyzed.
• Each goal within the different perspectives can be assessed individually.

FRAMEWORK

GOALS / MEASURES / TARGET for each of the 4 PROSPECTIVES (FINANCIAL / CUSTOMER / INTERNAL PROCESS / LEARNING AND GROWTH)

Question 8

Chapter 1 - Budgetting - Big Picture

What are the types? (pros/cons if available)

Answer 8

Budget methods

4. 1 Traditional budgeting
   - assigned increase or decrease percentage across all line items (revenues and expenses) - this can be on a per-account basis or to the budget as a whole-
   - may be appropriate in companies with simple operations or companies that are just starting out.
   - (PRO) very simple
   - (PRO) easy-to-implement approach
   - (PRO) fast and cost efficient
   - (CON) it is fundamentally flawed; equal allocation of resources to ineffective and effective parts of the organization (highly damaging in environments where budget cuts need to occur)

4.2 Static and flexible budgeting

• Static budgets are created based on a planned level of sales and/or production, and they are not adjusted if actual units or activity levels (such as machine hours) differ from plan.
• (PRO) Static budgets allow for high-level analysis and are a good tool for communicating a company’s budget to external stakeholders who don’t require additional details.
• (CON) provide misleading information for cost control when actual units or activity levels differ from plan
• Flexible budgets are adjusted automatically to reflect planned costs for the actual level of activity (units sold or produced). - ALLIVIATES THE ABOVE CON
• (PRO) More detail than static budget resulting in easier costs control.
• (PRO) The advantage of the flexible budget is that it separates cost control from activity control.

4.3 Priority budgeting

• To address the limitations of the traditional approach, some companies use priority budgeting.
• This is where companies allocate resources based on their strategic plan.
• (PRO) more effective at helping an organization achieve its strategy goals than traditional
• (CON) Priority budgeting requires a strong understanding of the organization and the different subunits and their contributions to the strategic plan.
• (CON) Difficult decisions need to be made with this approach (in terms of prioritizing resources)

4.4 Top-down and participative budgeting

(A) Top-down Budgeting - higher-level managers impose operating targets and/or budgets on those lower in the organization.
(B) Participative budgeting -top management sets overall operating targets based on strategic objectives, and lower-level managers prepare their own departmental budgets based on what they believe is achievable. Then, top management and lower-level managers usually negotiate the final budgets together.

4.5 Zero-based budgeting

• Budgeted revenues are based on analyses of the marketing strategy, demand for products or services, competition, and so on. Budgeted expenses are set at zero, and then all amounts must be justified.
• (PRO) Zero-based budgeting can reduce budgetary slack by requiring managers to justify all budgeted items without reference to prior budgets.
• (CON) Approach is very costly and requires considerable management time.

4.6 Activity-based budgeting

• Activity-based budgeting is another approach for detailed budgeting of costs.
• Under this approach, cost budgets are developed from the activities for each functional area, including activities involved in the direct and indirect production of goods / services, and administration and support.
• Using this approach, the demand for each activity is first estimated, and then a budgeted cost per unit of activity is used to develop budgeted costs by function / product / service.
• (PRO) Compared to traditional budgeting, activity-based budgeting produces more accurate budgets
• (PRO) helps managers identify resource needs,
• (PRO) links budgeted costs to activity levels for each area of responsibility.

Question 9

Chapter 2 - Budgeting - Master and Cash Budget

Answer 9

What is the model
Operating Budget

Sales Forecast -> Revenue Budget -> Production Budget -> DM / DL / Overhead Budgets -> COGM and COGS Budget -> Cash Budget
**Selling and Admin Budget created from Revenue and added to Cash budget

Question 10

Chapter 3 - Budgeting - Pro Forma Statements

What is a proforma statement?
What are the uses of a proforma statement?

Answer 10

What is a proforma
Pro forma statements are the outcome of revising the budgeted financial statements for a specific substantial event or circumstance. It starts with the budget and then incorporates the anticipated details of the event. This is similar to a sensitivity analysis, where various “what if” scenarios are prepared to determine the potential impact on the company’s financial results and financial position.

Purposes
2.2 Business planning - EVALUATE ALTERNATIVES
Management can use pro forma statements to compare alternative business plans by analyzing the projected results of each plan to decide which one best serves the interests of the business. Simulating different business plans can be useful in evaluating the financial effects of the different alternatives under consideration. Pro forma statements for each plan provide important information about future expectations for sales and earnings forecasts, cash flows, assets and liabilities, and proposed capitalization.

2.3 Financial modeling - MINIMIZES RISK BY FORECASTING OUTCOMES
Pro forma financial statements can help minimize the risks associated with starting and operating a new business by providing a projection of future profits and cash requirements for its first year and beyond.

Multi-year financial plans include pro forma income statements, balance sheets, and cash flow statements for given time periods. These statements will include assumptions related to large events or transactions and provide details on the timing of cash requirements.

Pro forma statements provide data for calculating the anticipated impact on financial ratios. For example, pro forma statements can help management identify potential lending covenant violations in advance of their occurrence so that strategies can be deployed to prevent any default.

Finally, in many organizations, pro forma financial statements are prepared for three to five years and presented to the Board of Directors to assist in communicating the impact of management’s vision on the company’s financial results.

2.4 External reporting - REQUESTED BY CURRENT/POSSIBLE STAKEHOLDERS
Businesses may include pro forma statements in external reports prepared for shareholders, creditors, or potential investors. For example, banks may request pro forma statements to verify that cash flow will be adequate to meet commitments before advancing a loan or line of credit. Lenders may require pro forma statements to confirm compliance with debt covenants, such as debt service coverage and debt-to-equity ratios. Investors may require pro forma to see the expected results on free cash flows or earnings per share (EPS).

Pro forma financial statements can also be used to project certain amounts when a company issues an earnings announcement to the public (for example, a pro forma income statement reporting the EPS).

2.5 DETERMINING EXTERNAL FINANCING REQUIREMENTS
Pro forma statements also provide information on projected cash balances and deficiencies, and can be used to answer questions such as:

• Will enough cash flow be generated internally to finance the operating decisions?
• If there is a cash deficiency, how much external financing is required?

A pro forma balance sheet will provide this information. Once the amount of required external financing is known, the company can again use pro forma statements to determine the best source of these funds. If debt will be issued, then added payments for principal and interest must be incorporated into revised pro forma statements along with any transaction costs that might be involved. If equity is issued, then dividend payments and EPS amounts are revised.

Question 11

Chapter 10 - Information Systems - Design, Acqusition, Development

What are the 7 steps and tell me about them

Answer 11

Systems development life cycle process

Depending on the nature and complexity of the application being acquired or developed, different steps to systems development may be required. The SDLC approach is used once management has identified a need and has approved the funding and resources.

There are typically seven phases of the cycle:

Phase 1: Initial feasibility study

• describes the identified problem to be solved and the timeframe required for implementation of the solution\
• identifies alternative solutions
• concludes on the best solution, based on current practices and future business needs, and how it aligns with the business strategy
• identifies the potential future impacts of the solution on future projects and resources
• determines the cost and benefits of implementing the solution (a preliminary financial analysis)

Phase 2: Requirements analysis and definition
The second phase is an interactive process between stakeholders and the project team where the specific resource and technical requirements for the system being selected are determined. Specifically, this stage includes the business process documentation of what the stakeholders (including any potential users) expect from the system (such as information needs, functional requirements, capacity requirements, user requirements, and number of users).

Phase 3: Application design / selection
Application design is based on the results of the requirements definition phase. Users will document the business process and, once it is understood, it will be provided to the programming team to document the system blueprint and IT technical matters. Some of the areas addressed in the design stage are:

• documenting business processes by preparing system flow charts to show how information will flow through the system
• documenting inputs and outputs, such as how the screen layouts will look and the types of reports users will obtain
• documenting how the system will process and compute data
• documenting the database design
• developing test plans
• developing a data conversion plan, if there is an existing system to migrate from
• developing an implementation plan

As a result of the application design phase, two sets of specifications are produced: the functional specifications and the detailed systems specifications. The functional specifications will be presented to the end user in a stand-alone document guide for approval. This guide must be detailed enough to show the user how the system works. The detailed systems specifications include — in addition to the functional specification documentation — instructions that are more technical in nature. These documents are provided to the programmer.

If a company decides to purchase an off-the-shelf system, the design phase (phase 3), would be replaced by a “selection” phase. In this phase, the organization would find a vendor, usually through a request for proposal / quote (RFP/RFQ) or an invitation to public tendering process. The proposals would be evaluated by the project team and a vendor would be selected based on the specified criteria developed.

Phase 4: Systems development / configuration
The detailed design is provided to the programmer to create the source code (that is, to code and develop the programs) for the system.
During this phase, the programmers will test the application to make sure it is in line with the design documents and is working as intended.

Phase 5: Preliminary testing
perform final user acceptance testing to determine whether the application is operating as intended.

Phase 6: System implementation
all the testing has passed the user specifications and approval is obtained from the appropriate stakeholders, the system is migrated (by moving all the source code) to the live “production” environment.

(i) Parallel
(PRO) Low risk
(PRO) comparable to existing
(CON) expensive
(CON) confusing for staff

(ii) Direct Cutoff
(PRO) Cost - effective
(PRO) Useful when no option
(CON) Highest Risk of conversion errors - no fall back
(CON) requires immediate resolution of issues
(CON) Data integrity issues could arise, with no paper trail

(iii) Modular - introduced to limited part of organization
(PRO) limited exposure
(PRO) experienced user can help new user as time progresses
(CON) Confusing for staff and potential conflict
(CON) Data integrity issues when data is being communicated from old to new or vise versa

(iv) Phased
(PRO) allows staff time to become accustomed
(CON) Costly to maintain both
(CON) Mix-ups can occur

Phase 7: Post-implementation evaluation
The post-implementation evaluation is generally conducted after the new system has been used for a sufficient number of months / quarters. It is done to identify both what was done well and areas for improvement throughout the entire SDLC process. As well, it evaluates whether the system objectives, costs / benefits, and milestones were met.