Professional Documents
Culture Documents
Unit 9
Budgeting Concepts, Methodologies and Preparation
1- A budget is a plan for the future expresses in quantitative terms.
A budget promotes goal congruence among operating units. A
budget is a planning, communication and coordination, control,
motivation and allocation tool. The budget sets specific goals for
income, cash flows and financial position. Budgets are primarily
quantitative not qualitative and they incorporates non-financial
measures as well as financial measures into its outputs.
2- Planning is a process of charting the future to attain desired goals.
Planning consists of selecting organization goals, predicting results
under various alternative ways to achieve those goals, deciding
how to attain the desired goals and communicating the goals and
how to attain them to the entire organization.
3- Good planning helps managers to attain goals, recognize
opportunities, provide basis for controlling operations, forces
managers to consider expected future trends and conditions,
checking progress towards the objectives of the organization and
minimize the negative effects of unavoidable events.
4- Strategy is the starting point in preparing the organization plans
and budgets. It's the organization's plan to match its strength with
the opportunities in the market place to achieve its desired goals
over the short and long term. The strategy is the path chosen by
the organization to attain its long term goals.
5- Strategy, plans and budgets are interrelated and affect one
another.
Strategy shows how an organization matches its strength with
opportunities to attain its desired goals in the market place in short
and long-run planning. These plans lead to the formulation of
budgets. Budgets provide feedback to managers about the likely
effects on their strategic plans. Managers use this feedback to
revise their strategic plans, and that may lead to changes in the
budgets.
6- Budgeting (Targeting) is the steps involved in preparing the
budget.
Gross margin
Other expenses
=
Operating income
Causal forecasting
methods
(regression
Time
series
methods
Learning
curve
Expected
value
Exponenti
al
smoothin
Weighted
moving
average
Simple
moving
average
The regression analysis is almost necessary for computing the fixed and
variable portion of mixed costs.
Regression doesnt determine causality.
Correlation analysis
- Coefficient of correlation (R): Is the strength of the linear
relationship between tow variables.
A value of 1 indicates perfect inverse linear relationship
between x and y.
A value of 0 indicates no linear relationship between x and y.
A value of + 1 indicates direct linear relationship between x
and y.
- Coefficient of determination (R2) (coefficient of
correlation square): Is the explanatory power of the regression
that measures the percentage of the total variance in cost that
can be explained by the regression equation.
- T value: Measures if the independent variable has a valid longterm relationship with dependent variable.
- Standard error of the estimate (SE): A measure of the
accuracy of the regression's estimate.
4)
Benefits of expected value: Expected value analysis
forces managers to think of all the possibilities that could
happen with each decision, and to evaluate decisions in a
more organized manner.
5)
Criticisms of expected value: It depends on repetitive
trials, but in reality, most business decisions involve only one
trial.
4-Expected value of perfect information (EVPI): is the
difference between the expected profit under certainty and the expected
monetary value of the best act under uncertainty.
- EVPI = EVwPI EvwoPI.
- EVPI = Expected value of perfect information.
- EVwPI = Expected value with perfect information.
- EVwoPI = Expected value without perfect information.
The dealer is not willing to pay more than the EVPI to obtain
information about future demand.
Gross margin
XXX
_ Period cost
XXX
Operating income
XXX
Variable costing
Sales revenue
XXX
_ Cost of goods soled
(DM+DL+ Vari OH)
XXX
Manufacturing Contribution
margin XXX
_ nonmanufacturing variable costs
XXX
Contribution margin
XXX
_ Fixed MOH
XXX
_ Fixed non MOH
XXX
Operating income
XXX
Horngreen equation:
(1)
The difference in operating income between
absorption and variable costing = Fixed cost per unit X
the inventory per unit.
(2)
The difference in operating income between
absorption and variable costing = Fixed manufacturing
cost per unit X (beginning inventory ending
inventory).
(3)
Actual Vs. normal costing and budgeted cost:
a. Actual costing = Actual DM+ Actual DL+ Actual OH
- Overhead = Actual rate X Actual allocation base
b. Normal costing = Actual DM+ Actual DL+ Applied OH
- Applied OH = Budgeted rate X Actual allocation base.
- Budgeted rate = Budgeted OH Budgeted allocation base.
- Over-applied O.H.: Applied O.H. > Actual O.H.
c. Standard costing
- Overhead = budgeted rate X standard allocation base
(1)
If the over-applied overhead balance is immaterial:
Dr. Applied O.H.
Cr. Cost of good soled
Cr. Actual O.H.
(2)
If the over-applied overhead balance is material:
Dr. Applied O.H.
Cr. Work-in-process inventory
Cr. Finished goods inventory
Cr. Cost of goods soled
Cr. Actual O. H.
- Under-applied O.H.: Applied O.H. < Actual O.H.
(1)
If the under-applied overhead balance is
immaterial:
Dr. Applied O.H.
Dr. Cost of goods soled
Cr. Actual O.H.
(2)
If the under-applied overhead balance is material:
Dr. Applied O.H.
Dr. Work-in-process inventory
Dr. Finished goods inventory
Dr. Cost of goods soled
Cr. Actual O.H.
d. Budgeted cost: is what expected to occur.
(4)
Cost accumulation:
a. Traditional costing:
1-Job-order costing: appropriate for customized
(heterogeneous) product (single or departmental rate).
2-Process costing: appropriate for similar (mass,
homogeneous) product (single or departmental rate).
3-Operation costing: appropriate for organizations that
uses both job-order and process costing (e.g., leather
and fabric bags).
b.Activity based costing (ABC): every activity has its own
cost pool.
c. Life-cycle costing (value chain): R&D and design
(Upstream cost), manufacturing costs and marketing,
distribution and customer service (down-stream cost).
(5)
Standard costing, flexible budgeting, and variance
analysis:
a. Standard costing estimates what should be.
b. Flexible budgeting is the calculation of the cost that should
have been consumed given the achieved level of production.
c. Variance analysis is the difference between standard and
flexible budget.
(6)
Cost allocation:
a. Allocating joint cost.
b. Allocating service departments costs.
(7)
Target costing: market price of the product taken as a
given.
Unit 5
Cost accumulation systems
Standard cost represents what costs should be.
Budgeted cost represents expected actual costs.
Product costing is the process of accumulating, classifying
and assigning direct material, direct labor and factory
overhead costs to products or services.
Types of product costing systems:
(1) Cost accumulation methods: The nature of the industry
forces managers to use job, process or operation costing
systems.
(2) Cost measurement methods (management decision):
actual, normal or standard costing systems.
(3) Overhead allocation methods (management decision):
traditional (peanut-butter) or activity-based costing
system.
Beginning WIP
XXX
+ Started units this period
XXX
_____
EUP for Materials
XXX
If materials added at the end of the process
Total Units Completed
XX
+ Amount of materials needed to Complete BWIP
100%
+ Amount of materials added to Date on EWIP
zero
_____
EUP for Materials
XXX
(2) Weighted average costing:
Material Conversion
Total units completed and transferred
XXX
XXX
+ Amount added to EWIP
XXX
XXX
(3)
Total unit cost = (1) + (2)
Accounting for spoilage: For costing the finished goods
inventory and there are normal spoilage, we add the
number of good units to the number of normal spoilage
units, then multiplying this number by the unit cost, then
dividing the total amount by the number of good units to
have the cost of finished goods inventory.
2-Operation costing: is mixed from job and process costing.
3-Activity-based costing (transaction-based costing): is a cost
accounting system based on the activity level as a cost object.
- Characteristics of ABC:
1.ABC applies more focused and detailed approach for gathering
costs.
2.ABC can be part of job order or process costing systems.
3.ABC can be used in manufacturing or service businesses.
4.ABC treats production costs as variable.
5.The costs driver in ABC is often a non-financial variable.
6.ABC may be used for internal and external purposes.
4-ABC (volume-base) Vs. traditional (peanut-butter) (nonvolume-based) costing:
1. Traditional costing involve:
- Accumulating costs in general ledger accounts.
- Using a single cost pool to combine the costs from all the related
accounts.
- Selecting a single cost driver to use for the entire indirect cost
pool.
- Allocating the indirect cost pool to final cost object using a single
rate or departmental rate.
The effect is an averaging of costs that may result in
significant inaccuracy when products or service units don't
use similar amounts of resources. All overhead costs don't
fluctuate with volume.
2. Activity-based costing involves:
- Identifying the organization's activity that constitutes O.H. and
defining activity cost pools and activity measures (resource cost
driver).
- Assigning the costs of resources consumed to activity centers.
- Calculating activity rates by dividing total cost of each activity by
its cost driver.
- Assigning overhead costs to cost object.
5-ABC terms:
- Activity: is a work performed within an organization.
- Resource: is an economic element used to perform activities.
- Resource cost driver: is a measure of the amount of resources
consumed by an activity. It's used to assign resource cost
consumed by an activity to a particular cost pool (percentage of
total square feet required to perform an activity).
- Activity cost driver: measures how much activity used by a
cost object. It's used to assign cost pool costs to cost object
(machine hours required to produce product).
-
- Limitations:
(1)
More difficult to calculate than the other two
methods.
(2)
Based on an estimated value.
The by-product: when using any method of joint cost
allocation, the sales revenue of by-products if
inventoried, treated as a reduction of the costs of
production of the main product, and the remaining
costs are allocated to the main products not to the byproduct, and at any way no joint costs are allocated to
by-product.
4-Inventory costing choices: Absorption (Full) Vs.
Variable (Direct) costing:
1. Absorption costing (GAAP costing):
- Advantages:
(1)
Absorption costing is GAAP.
(2)
The Internal Revenue Service requires the use of
absorption costing in financial reporting.
- Limitations:
(1) The level of inventory affects net income because
fixed costs are component of product costs.
(2) The net income reported under absorption method is
less reliable than under variable method (especially for
use in performance evaluation) because the level of
inventory affects the net income as it includes fixed
costs into its components.
2. Variable costing (Direct costing): Variable costing is a
management tool used to calculate breakeven point CPV
(Cost volume profit analysis).
- Advantages:
(1)
Variable costing attains the objective of management
control systems as costs are listed separately so that they
may be easily traced and controlled by managers.
(2)
The net income reported under contribution method is
more reliable than under absorption method (especially
for use in performance evaluation) because the cost of the
product doesn't include fixed costs into its component,
and therefore the level of inventory doesn't affect net
income.
(3)
The contribution margin yield from variable costing
aids in decision making.
- Limitations:
(1)
Variable costing is not GAAP.
(2)
The Internal Revenue Service doesn't allow the use of
variable costing in financial reporting.
6)
Issues and problems in supply chain
management:
1. Communication problems between companies.
2. Trust issues.
3. Incompatible information system.
4. Required increases in personnel resources and
financial resources.
10Activity based management (ABM): Is the
management decisions and activity analysis that use activitybased costing information to satisfy customers and improve
operational control, management control and profitability.
ABM applications can be classified into two categories:
1. Operational ABM:
- Enhances operation efficiency and asset utilization and
lowers costs. Its focuses are on doing things right and
performing activities more efficiently.
- Operational ABM applications use management techniques
such as activity management, business process
reengineering, total quality management, and performance
measurement.
2. Strategic ABM:
- Its focuses are on choosing appropriate activities for the
operation, eliminating nonessential activities and selecting
the most profitable customers.
- Strategic ABM applications use management techniques
such as process design, customer profitability analysis, and
value chain analysis.
Advantages of ABM:
1. Uses continuous improvement to maintain the firm's
competitive advantages.
2. Eliminates non-value-added activities.
3. Works well with just-in-time processes.
4. Allocates more resources to activities, products that add
value.
Disadvantages of ABM:
1. Not used to external financial reporting.
2. Implementing ABC/ABM is expensive and time-consuming.
3. Changing to ABC/ABM will result in different pricing, process
design, manufacturing technology, and product design
decision.
2) Cash cycle.
3) Closing and reconciliation processes.
4) Data analysis.
2. Techniques for creating future vision for finance
function.
1) Benchmarking.
2) Current use assessment (customer-centered
approach).
3. Steps needed to improve accounting processes:
1) Process walk-throughs (understanding current
process).
a. Benefits of process walk-throughs:
1. Identifying waste and over-capacity
(duplication of effort, tasks done are not necessary,
output not being done).
2. Identify the root cause of errors.
2) Process design: to cover every aspect of the
internal users need.
3) Risk-benefit evaluation:
The greater the changes being made, the less the firm can
be sure of a successful outcome.
If the risks are determined to be too great, a return to the
process design step may be necessary.
4) Planning and implementing the redesign (topdown implementation):
5) Process training:
4. Reducing the accounting close cycle: soft closes can
be used for month-end closes, and more detailed closing
for quarter-end and year-end closes.
To speed up the closing:
1)
A standardized chart of account should be used
across all company locations.
2)
Bank reconciliation can be done daily.
3)
Depreciation can be calculated a few days
before the closing.
4)
Standardized accounting procedures.
5. Centralization of accounting as a shared service:
Benefits of shared service:
1)
Utilizing a smaller number of highly trained
people.
2)
The result is usually fewer errors.
3)
Greater efficiency can be generated by
assigning tasks to a smaller number of managers.
4)
Accounting errors can be searched more easily.
Unit 10
Cost and variance measures
Performance evaluation is the process by which managers at
all levels gain information about the performance of tasks
within the firm and judges that performance against preestablished criteria as set out in budgets, plans, and goals.
- Operational control (management-by-exception
approach): means the evaluation of operating level
employees by middle-level managers.
- Operational control
Focuses on detailed short-term performance measures.
Has a management-by-exception approach that is identifies
units or individuals whose performance does not comply with
expectations so that the problem can be promptly corrected.
The use of standards:
- To set performance expectations.
- To evaluate and control operations.
- To motivate employees.
- To manage by exception.
Unit 11
Responsibility accounting and performance measures
CMA EXAM: The performance measurement portions focus on a few
performance measures, specifically Return on Investment (ROI) and
Residual Income (Rl). For these measurements you need to know what
they are, how they are calculated and how they are used. You also
need to be able to identify the weaknesses that are inherent in each
one. Responsibility accounting is the breaking down of costs into
those costs that can be controlled by the manager and those that
cannot be controlled by the manager. There are a number of different
cost classifications and allocation methods within this section that you
need to be aware of.
Transfer pricing is a topic that you need to know from both a
theoretical standpoint and a numerical one as well. The questions
may require you to understand the issues that company faces in
establishing the transfer price as well as being able to calculate an
acceptable transfer price under certain situations.
The final topic covered in this Section is performance feedback,
and more specifically the balanced scorecard, you need to know
conceptually what the balanced scorecard is and how it works as
well as be familiar with Its application.
The objective of this unit is (management control)
which provide variety of tools that top managers (such
as CFOs) use to evaluate middle-level managers (such
as plant managers, product-line managers, heads of
(R&D) departments, and regional sales managers) and
the organization as a whole. The mid-level managers
have a significant responsibility in helping the
organization achieve its strategic goals.
Management control: refers to the evaluation by upperlevel managers to the performance of mid-level
managers.
Management control:
- Focuses on higher level managers and long-term, strategic
issue.
- Is more consistent with management-by-objectives.
The objectives of management control:
1. Motivate managers to exert more effort to achieve the
organization's goals.
2. Promotes goal congruence among the organization.
3. Determine fairly the rewards earned by manager's effort
and skills and the effectiveness of their decisions.
Management control issues:
1)Internal non-financial measures based on internal nonfinancial information (such as defect rates and
manufacturing lead time).
2)External non-financial measures based on external nonfinancial information (such as customer satisfaction
ratings and market share).
Return on investment (ROI), accounting rate of return,
or accrual accounting rate of return:
- ROI = Income (profit) investment = (income revenue) X
(revenue investment).
- Or ROI = return on sales (ROS) (profit margin) X
investment turnover.
- Or ROI = [(revenue cost) / revenue] X revenue /
investment.
- ROS: Tells how much of each revenue dollar becomes
income; the goal is to get higher income per revenue dollar.
- ROS: measures the manager's ability to control expenses
and increase revenues to improve profitability.
- Investment turnover: Tells who many revenue dollars are
generated by each dollar of investment, the goal is to make
each investment dollar work harder to generate more
revenues.
- In investment SBUs managers can increase ROI in
basically 3 ways:
1.Increase sales.
2.Reduce expenses.
3. Reduce assets.
Residual income (RI) = Income (required rate of return
X investment).
- Required rate of return is the imputed cost of the
investment.
- Goal congruence is more likely to be achieved by
using RI rather than ROI as a measure of the subunit
manager's performance.
Advantages and Limitations of ROI and Residual Income
ROI
Easily understood
Comparable to interest
rates and to rates of returns
on alternative investments
Disincentive for
high ROI units to
invest in projects
with ROI higher than
Widely used
RI
Bot
h
ROI
and
RI
Can mislead
strategic decision
making, not as
comprehensive as
the balanced
scorecard, which
includes customer
satisfaction, internal
processes and
learning as well as
financial measures,
the balanced
scorecard is linked
directly to strategy.
Measurement
issues.
Variations in the
measurement of
inventory and longlived assets and in
the treatment of
nonrecurring items,
income taxes.
Foreign exchange
effects, and the
use/cost of shared
assets
Short-term focus;
investments with
long-term benefits
might be neglected
Economic value added (EVA): is a more specific version of
residual income.
- Economic value added (EVA) = after tax operating
income [weighted average cost of capital (WACC) X
(total assets current liabilities)].
- When a company's EVA is positive then it has added
to shareholders value.
6-Transfer pricing: is the price of the product transferred from
one subunit (department or division) to another unit in the
organization or to the outside customer.
- Motivation and performance evaluation: The transfer
price creates revenue for the selling subunit and purchase
cost to the buying subunit affecting each subunit's operating
income. This operating income can be used to evaluate
subunit performance and to motivate their managers.
- Intermediate product: is the product or service
transferred between subunits of an organization.
Objectives of transfer pricing:
1. Motivate subunit's managers to exert a high level of
effort.
2. Goal congruence.
3. Reward managers fairly.
Transferred pricing methods:
1. Market-based transfer prices (the price of a similar
product).
2. Cost of production plus opportunity cost.
3. Full absorption cost (there is no motivation to the
seller to minimize costs).
4. Variable cost (should be used only when the selling
division has excess capacity).
Unit 12
Internal control
Important introduction:
- The shareholders make the election of the board of
directors, which establishes the overall policies.
7. Organizational structure:
- Key areas of authority, responsibility, and lines of reporting
should be reflected in the organizational structure.
2-Risk assessment: is the process of identifying, analyzing,
and managing the risks that have the potential to prevent
the organization from achieving its objectives. Assessment of
risk involves determining consequences as well as
likelihood.
Management is responsible for the assessment of the
risk. Organizations accept the fact that risk can only be
mitigated not eliminated.
The risk: is anything that endangers the achievement of an
objective.
The expected value of a loss due to a risk exposure is
the maximum value that should be spent on controls
designed to minimize the risk.
Types of risk:
1. External risks.
2. Internal risks.
Component of audit risk (AICPA audit risk model):
1. Inherent risk (IR): is the susceptibility of an
organization's objective to material misstatement arising
from the nature of the objective. This risk is greater in some
objectives than for others. (E.g. cash has greater inherent
risk than property, plant, and equipment, new, and
complex transactions).
2. Control risk (CR): is the risk that the controls will not
prevent or detect material misstatement in a timely manner.
It's the responsibility of the management.
- This risk depends on the effectiveness of the design and
operation of those controls. Control risk can't be eliminated
because of the inherent limitation of internal control.
3. Detection risk (DR): is the risk that material misstatement
of an element can't be detected by the auditor. It's the
responsibility of the auditor.
The level of detection risk is the only one of the three
components that subject to auditor's control.
4. Total audit risk (AR) = (IR) X (CR) X (DR).
3-Control procedures (control activities):
(1)
The Foreign Corrupt Practices Act
(FCPA):
1. All domestic concerns are prohibited from corrupt
payment to any foreign official, foreign political
official party, candidate for a political office in a
foreign country (only political payments to foreign
officials are prohibited). Doing this is a criminal
violation.
2. Regardless of whether they have foreign
operations, all public companies (companies under
Securities Exchange Act) must make and keep
books, records, and accounts in reasonable detail,
and must devise and maintain a system of internal
controls sufficient to provide reasonable assurance
that (1) transactions are executed according to
appropriate authorization, (2) transactions are
recorded according to GAAP, (3) access to assets is
permitted only to specific authorization (custody),
and (4) the recorded assets are compared with the
existing assets (independent reconciliation). The
responsibility to initiate and maintain the internal
control system is assigned to the company as a
whole.
3. The independent auditor has to attest to the
financial statements.
(2)
The Sarbanes-Oxley Act:
(1)
Section 201: services out the scope and practice of
external auditor:
1)An auditor cannot function in the role of management.
2)An auditor cannot audit his own work.
3)An auditor cannot serve as an advocacy role for his client.
(2)
Section 203: audit partner rotation:
PCAOB requires audit firm rotation every 5 years.
(3)
Section 302: corporate responsibility for financial
reporting:
Each report must include a certification by CEO and CFO that
signing officers has reviewed the report, and the report does
not contain any untrue material misstatement.
(4)
Section 404: management assessment of internal
control:
1. The act applies to issuers of publicly traded securities.
2. The act requires each member of audit committee, including
at least one who is financial expert, to be an
independent member of the issuer's board of directors.
3. The audit committee must be directly responsible for
appointing, compensating, and overseeing the work of
the public accounting firm (external auditor) employed by
the issuer. This auditor must report directly to the audit
committee not to the management.
4. Establishing the internal control system is the
responsibility of the management. The act requires
publicly traded companies to issue an annual report
includes:
a. That the management takes responsibility for
establishing and maintaining the firm's system of
internal control; and
b.That the system has been functioning effectively
over the reporting period.
c. Identification of the framework used to evaluate
the effectiveness of internal control system.
d.Any corrective actions taken.
e. That the external auditor has issued an attestation
report on management's assessment in two
opinions includes:
1. If the structure and procedures accurately and
fairly reflects the firm's transactions.
2. Reasonable assurance that transactions are
recorded according to GAAP.
- The external auditor's report must describe any
material weaknesses in internal control.
(5)
PCAOB issued its audit standard (AS) NO. 5: (An
audit of internal control over financial reporting that is
integrated with financial statements).
- AS 5 requires the external auditor to express an
opinion on both the system of internal control and
the fair presentation of financial statements.
3. Financial auditing:
- Involves safeguarding assets and the reliability and
integrity of information.
- Other types of engagement:
1. Program-result audit: program is a funded activity, not
continuing or normal operation of the organization. The
auditor obtains information about the costs, output,
benefits, and effect of the program.
2. Privacy engagement: address the security of personal
information, not the accuracy.
Corporate governance: is the joint responsibility of the board
of directors and management. It involves the relationship
between participants and stakeholders in the corporation, such
as CEO, shareholders, and management.
Unit 13
Internal control II and ethics for management
accountants
10.1.
Systems controls:
1-The segregation of accounting duties:
4.
b)
Disclose all relevant information that could
reasonably expected to influence user's
understanding of reports, analysis, or
recommendations.
c) Disclose delays or deficiencies in information,
processing, or internal control in conformance
with organization's policy and/or applicable lows .
Violation should be reported to immediate superior, if
he's involved the matter should be reported to the next
level of management, and if the CEO is involved then
the matter should be reported to audit committee or
the board of directors.