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Three Levels of Planning
Operations Budgeting; highest level to lowest level
Long-term decisions about the business; big pictue (senior managers, board of directors)
usually involves asset acquisition / disposition (mid-level and senior managers)
Master Budget (usually for year): sales, production, and financing;
broken down into quarters or months
Advantages of Budgeting
time consuming and expensive but:
Enhances performance measurement (budget sets goals);
Enhances corrective actions
Start with sales budget;
calculate inventory purchase budget;
calculate GSA budget
Receipts and Payment Schedules
cash receipts schedule comes from sales budget;
cash payments for inventory comes from inventory purchase budget;
cash payments for GSA comes from GSA budget
Pro-Forma Financial Statements
Come from BUDGET, covers a period of time (M, Q, Y);
Accrual Basis - NOT cash basis;
Income Statement; Balance Sheet; Statement of Cash Flows
The Balance Sheet
The balance sheet is a financial statement that indicates the financial condition of a business as of a given point in time. It includes assets, liabilities, and stockholders' equity, and it represents a statement of the basic accounting equation. The assets and liabilities are divided into current and noncurrent classifications on the basis of liquidity, and comparisons of assets and liabilities often provide an indication about the company's ability to meet obligations as they come due (i.e., solvency).
The assets accounts reported on the balance sheet are listed in order of liquidity and are divided into four categories:
Property, Plant and Equipment;
and Intangible Assets.
Long-term notes receivable, land, securities, the cash value of life insurance, and special investment funds.
Liabilities and Shareholders' equity
Liabilities and shareholders' equity. Liabilities are divided into two categories:
current liabilities and long-term liabilities.
The Income Statement
Consists of two basic categories:
Revenues and Expenses.
Revenue less expenses equal net income.
Asset inflows (or liability decreases) associated with operating transactions during a given period, include sales, fees earned, service revenues, and other revenues (e.g., interest, book gains).
Represent the asset outflows (or liabilities increases) required to generate the revenues, include the cost of goods sold, operation expenses (e.g., wages, rent) and other expenses (e.g., interest, book losses).
The Statement of Shareholders' Equity
Consists of the changes in two basic accounts:
and Earned Capital (primarily Retained Earning).
The Statement of Cash Flow
Contains three categories:
cash flows from Operating activities,
Static budgets are prepared for a single, planned level of activity (best guess). Performance evaluation is difficult when actual volume differs from the planned volume. Comparing static budgets with actual costs is like comparing apples and oranges.
The relevant question is . . .
"How much of the favorable cost variance is due to lower volume, and how much is due to good cost control?"
To answer the question, we must FLEX the budget to the actual volume.
Shows revenue and expenses that should have occurred at the actual sales level (what would the static budget look like if we knew the actual sales volume?);
Reveal variances due to good cost control or lack of cost control (takes out the effect of difference in volume);
Improve performance evaluation (more accurate assessment of cost control)
Preparing a Flexible Budget
Static budget - before the period begins;
Flexible budget - after the period using known sales volume.
Both use Standard prices forecasted from past experiences.
Static Budgets and Performance
Total variance (favorable and unfavorable) are due to differences in activity and cost control.
Flexible Budget Performance Report
How much variance is due to fewer units (static v. flex), and how much is due to cost control (flex v. actual)
Standard Cost Systems
A standard represents the amount a price, cost, or quantity should be, based on certain anticipated circumstances.
Accountants, engineers, purchasing agents, and production managers combine efforts to set standards that encourage efficient future production.
Predetermined before the period begins; used for planning material, labor and OH requirements;
benchmarks for measuring performance - "what should happen
Use of Standards by Nonmanufacturing Organizations
Standard cost analysis may be used in any organization with repetitive tasks.
A relationship between tasks and output measures must be established.
Managers focus on quantities and costs that exceed standards, a practice known as "management by exception"
Standard Cost Variances
Compare actual to flex budget:
Standard Cost Variances = Price Variance + Usage Variance
Based on totals, never per unit!!!
Total Material Variance = Material Price Variance + Material Usage Variance
Based on totals, never per unit!!!
Total Labor Variance = Labor Price Variance + Labor Usage Variance
Responsibility for Labor Variances
Production managers are usually held accountable for labor variances because they can influence the:
Mix of skill levels assigned to work tasks;
Level of employee motivation;
Quality of production supervision;
Quality of training provided to employees
Selecting Variances to Investigate
Management by exception tells us to consider:
The materiality of a variance (big enough to make a difference in decisions?),
How frequently it occurs (symptom of a larger problem),
The capacity to control the variance,
and The costs and benefits of investigating.
Accounting data that provides information:
Relating to the responsibilities of individual managers;
To evaluate managers on controllable items;
What are individual managers responsible for?
What can they do that will make a difference?
Decision Making is Pushed Down;
Decentralization often occurs as organizations continue to grow;
Why managers have different responsibilities
Advantages of Decentralization
Improves quality of decisions;
Improves performance evaluation;
Develops lower-level managers;
Encourages upper-level management to concentrate on strategic decisions
Challenges of Decentralization
Goal Congruence: Organization's lower-level managers make decisions that achieve top-management goals;
Big challenge: manager's goals must be same as the company's goals.
Managerial Performance Measurement
Cost Center (lowest level of responsibility; evaluated on cost variances, CH8):
Cost control, Quantity and quality of services;
Profit Center (evaluated basted on income statement):
Investment Center (highest level of responsibility):
Return on investment (ROI),
Residual income (RI)
Return on Investment (ROI)
Rate of return investment center managers earn on their assets;
ROI = Income / Operating Assets;
ROI = Margin x Turnover;
Operating assets are only those assets used in production.
Turnover = Sales Revenue / Operating Assets;
The amount of sales produced by every dollar invested in operating assets
managers and company agree on decisions; incongruence (or sub-optimization) results when managers make decisions based on what is good for them (ie, choosing investments based on ROI when bonuses are paid based on ROI), rather than what is good for company
Residual Income (RI)
Net operating income that an investment center earns above the desired ROI.
RI = Actual Income - (Operating Assets x Desired ROI)
Advantages of Residual Income
Residual income encourages managers to make profitable investments that would be rejected by managers using ROI.
Therefore... Goal Congruence
Comparing ROI and RI
calculate for each scenario:
for investment alone;
current + investment
Held as asset on balance sheet until sold, then goes to income statement as COGS;
Balance sheet = Raw material, Work in process, Finished goods.
Manufacturing Cost Flow
Product Cost made up of Direct Labor, Direct Material, and Manufacturing Overhead
All other manufacturing costs; Indirect Material, Indirect Labor, Other Costs
Materials used to support the production process.
Ex: grease for machines, cleaning supplies.
Kept as raw material until used.
Cost of personnel who do not work directly on the product.
Ex: Production Supervisor.
Cost Flow in Manufacturing Companies
3 types of inventory accounts: Raw Materials, Work in Process, Finished Goods
Work in Process (WIP)
Partially completed goods; some material, some labor and some applied OH used;
moved to finished goods at Cost of Goods Manufactured (COGM)
Cash, Raw Materials, Work in Process, Finished Goods, COGS, Manufacturing OH;
All have BB & EB except MOH.
EVERYTHING is labeled.
COGS goes on Income Statement
Flow of Overhead Costs
Using a Predetermined Overhead Rate (POHR) makes it possible to estimate total product costs sooner.
Actual overhead for the period is not known until the end of the period.
Predetermined Overhead Rate (POHR)
used to apply overhead to products, is determined before the period begins.
POHR = (Estimated manufacturing overhead cost for the period) / (Estimated allocation base for the period)
= POHR x Actual Activity;
POHR is based on estimates, and determined before the period begins;
Actual Activity is the actual amount of the allocation base such as units produced, direct labor hours, or machine hours.
Too little OH applied
too little cost in inventory (WIP, FG, COGS);
COGS is too low, profit is too high
Before period = calculate POHR;
During period = apply OH using POHR and actual allocation base;
After period = Adjust for over- or under-applied OH (OH Variance to zero out MOH, applied to COGS accounts)
Estimated OH = Budgeted OH (used before period, POHR);
Applied OH = Allocated OH (used during period to get OH to products in WIP account);
Actual OH = Incurred OH (used after periods to close out OH variance)
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