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Accounting Exam 2

Terms in this set (79)

Identify standards against which the results of ratio analysis may be compared
o Budget Standards
o Industry Standards
o Previous Year Standards
o Bank or Investor Standards
What do ratios reveal?
They reveal important information that may not be obvious or apparent in the financial statements
How do managers use ratios?
to monitor operating performance and evaluate their success in meeting goals.
Tries to satisfy both parties
How do creditors use ratios?
to evaluate the solvency of a business and to assess the risk of future loans.
Prefers high current ratio
How do investors use ratios?
use ratios to evaluate the performance of a business and the business's ability to meet the investors' specific goals.
Prefer low current ratio
Think current assets are less productive than investments in long term assets
Identify common classes of ratios
- Liquidity
- Solvency
- Activity
- Profitability
- Operating
Liquidity
measures the ability to meet cash needs as they arise. Meet short term obligations.
Solvency
measures the extent of a firm's financing with debt relative to equity and its ability to cover interest and other fixed charges. (Long term obligations)
Activity
measures the liquidity of specific assets and the efficiency of managing the use of assets. (Asset management ratios)
Profitability
measures the overall performance and efficiency in managing assets, liabilities and equity.
Operating
assist in measuring the effectiveness of how the business is operated
Profit Margin %
Profit (net income) / total sales (revenue)
Mix of Sales %
Revenue for an operating segment / total revenue
Average Daily Rate
Rooms Revenue / # of rooms sold
Available rooms
# of rooms x time period
Paid Occupancy
Paid Rooms occupied / available rooms
Revenue Per Available Room
Rooms Revenue / available rooms
Total Occupancy
# of rooms with people in them / rooms you have to sale
Cost % for Food and Beverage
food or beverage cost / food or beverage revenue
Cost % for labor
total labor cost / total revenue or departmental revenue
Identify the limitations of ratio analysis
o They do not provide answers in and of themselves and are not predictive
o Ratios should be used with other elements of financial analysis
o Best used when comparing to a standard
o Based on historical costs
o There are no "rules of thumb" that apply to interpretation of ratios
Fixed
Remain constant in the short run even when sales volume varies
Fixed cost per unit goes down as unit sales go up
Ex: Salaries, rent expense, insurance, property taxes, depreciation expenses
Variable
Costs that change proportionally with the volume of the business
Variable costs per unit remain constant
Ex. food cost, hourly wages, travel agent commissions
Mixed
Costs that are partly fixed and partly variable
A mix of both fixed and variable costs
Because of their mixed element, mixed costs per unit go down(not as fast as fixed) as sales go up
Ex. leases, executive, maintenance agreements
High/Low
Estimation method based on data from two extreme periods of sales activity
Scattergram
Includes data in all periods of a time span
- Straight line drawn through estimated center of points
Regression Analysis
- Mathematical approach to fitting a straight line to data points perfectly, all data points used.
Indifference point
is the level at which the period cost is the same under either arrangement
Revenue =
Fixed lease cost / variable cost %
If annual revenue is expected to exceed the indifference point, select ....
fixed lease
If annual revenue is expected to be less than indifference point, chose ....
variable lease
Direct costs
are costs directly associated with a revenue center/department or function.
Indirect costs
cannot be so easily identified to one particular function
Controllable Costs
Costs over which a person is able to exert influence
Differential Costs
Costs that differ between 2 alternatives
Relevant Costs
- All costs that must be considered in a decision-making situation
- Must be differential, future and quantifiable
Sunk Costs
- Past costs relating to past decisions
- Not relevant because they are in the past
Opportunity Costs
- The cost of the best foregone opportunity
Cost - volume - profit (CVP) analysis
is a technique that examines changes in profits in response to changes in sales volumes, costs, and prices.
CVP assumes
Fixed costs remain fixed
Variable costs fluctuate in a linear fashion with revenues
Revenues are directly proportional to volume (are linear)
Mixed costs can be divided into their fixed and variable elements
All costs can be assigned to individual operated departments
CVP model consider
- Only quantitative factors capable of being measured or expressed in numerical terms
- No qualitative factors relating to or involving comparisons based on qualities
CVP limitations
- Ignores qualitative factors
- Results will be suspect if all the assumptions on which CVP analysis is based do not apply or hold in the actual situation being analyzed
Contribution Margin
Total revenue - total variable costs
Contribution margin per unit
selling price per unit - the variable cost per unit
Contribution margin %
contribution margin per unit / selling price

OR

Contribution margin $ / revenue
Once enough units have been sold to cover all fixed costs, then
the contribution margin per unit from all remaining sales becomes profit.
Breakeven in units
fixed costs / CM per unit
Breakeven in $
fixed costs / CM %
Desired Profit level in units
Fixed Costs + desired profit / CM per unit
Desired Profit Level in $
Fixed costs + desired profit / CM $
Safety Margin
the excess of budgeted sales over the break-even sales. In a sense it provides the amount by which sales can drop before losses are incurred.
Budgeting
- process of identifying, gathering, summarizing, and communicating financial and nonfinancial information about an organization's future activities.
- Quantitative and/or financial plans
- A road map to assist a business or organization in reaching its objectives or strategy.
Focus on budgeting should be on...
overall organizational goals
What are some characteristics of a budget?
o Usually a long-range plan, covering a fiscal or calendar year
o Prepared prior to the beginning of a new calendar or fiscal year
o Kept STATIC and used as a standard to measure against actual performance
o Based on assumptions from the organization and outside economic projections.
What types of budgets are there?
Capital Budgets, Operating Budgets, Cash Budgets
Capital Budgets
Focus on purchases of long-term assets
Renovations of an asset
Operating Budgets
Project revenues and expenses for the entire operation
Cash Budgets
Sources and uses of cash
Identifies any shortfalls
Steps in preparing a budget:
1. Update Strategic Plan
2. Complete Capital Budget
3. Complete a marketing plan that identifies the upcoming plan for the next year and how the business will be operated
4. Forecast Revenues
- Determine Volumes
- Determine Pricing
5. Forecast Cost of Sales
- % of revenue
6. Forecast Payroll
- Variable—review productivity factors, based on volumes
- Fixed
7. Forecast Other Expenses
- Variable—based on volumes
- Fixed
8. Forecast Non-Operating Income and Expenses
9. Individual budgets for each operating and overhead department are consolidated into an Income Summary
10. Cash Budget is then prepared.
Once the budget is complete what do you do?
1. A completed budgeted should be analyzed to the forecasted year end results and industry expectations to measure reasonableness
2. Once the budget is in place then each month actual results should be compared to the budgeted results to determine variances and to detect if any budgeted assumptions are not reasonable.
3. During the year the budget is adjusted as new information is available and it becomes a forecast.
Characteristics of a forecast
o Usually a short-range plan, covering a smaller interval of time such as 30-60-90 days. Some forecast can even be weekly.
o Updated and used as a standard to measure against actual performance and to static budget.
o Based on current assumptions from the organization and outside economic projections
Why do we forecast?
So that management can take the metrics in the budget and adjust them with actual/updated information. This allows management to adjust operations in order to achieve the financial/strategic goal originally established in the budget
In order for budgets to be used effectively for control purposes, budgets must be compared to ________ at least on a _________ basis.
actual results; monthly
Budgetary Control steps
- Determine variances
- Determine significant variances
- Analyze significant variances
- Determine the problem
- Take corrective action to resolve problem
Revenue variances occur due to
price and volume differences
Price Volume Variance (P-VV)
minor variance due to interrelationship of Price and volume variance.
Cost of goods sold analysis
The amount paid for the goods sold differs from the budget, and the total amount sold differs from the budgeted sales.
The differences of cost of goods sold is due to
cost and volume
Variable labor variance analysis differences due to
volume, rate and efficiency
Rate time variance unfavorable variances:
net income is reduced from the budgeted expectations
Rate time variance favorable variances:
net income is increased from the budgeted expectations.
Variances do not interpret directly as "bad" or "good" behavior on the part of the management. (T/F)
True
A positive variance does indicate that there are not any problems and therefore should still be investigated
False, it does NOT
Revenues: if actual exceeds budget it is (favorable or unfavorable)
Favorable
Revenues: if budget exceeds actual it is (favorable or unfavorable)
Unfavorable
Expenses: if actual exceeds budget it is (favorable or unfavorable)
Unfavorable
Expenses: if budget exceeds actual it is (favorable or unfavorable)
Favorable
Favorable sign
+ or "F"
Unfavorable sign
- or "U"
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