ACC 122: Managerial Accounting Exam 1 review PDF

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This is a review for the first exam in managerial accounting....

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ACC 122 Managerial Accounting Summary Review for Exam # 1 Prologue, Chapters 1, 13, 14, 2, and 3 from Brewer Text (8th ed) Prologue: The role of management accounts: Managerial accounting provides essential information needed to run an organization. The primary role of managerial accountants is to provide financial information for decisionmaking. Today, managers are rebuilding organizations from the ground up to support its strategic goals. Differences and similarities between financial and managerial accounting: Both branches of accounting utilize the same accounting system. An accounting system identifies both internal and external transactions. Then, it identifies, records, analyzes, organizes, summarizes, and communicates the information that produces reports for both internal and external users. The goal is to provide useful financial information. It is the use of the data that differs. Financial accounting produces financial statements for external users. It has a historical perspective with emphasis on verifiability and precision. These statements must follow GAAP with a focus on the company as a whole. These financial statements are mandatory. Managerial accounting produces more specialized reports for internal users. These reports have a future focus with emphasis on relevance, timeliness, and flexibility. There is no prescribed format, reports are produced on an as needed basis, and they often focus on a segment or part of the business. Managerial accounting application: Managerial accounting applies to all types of businesses, applies to all forms of business organizations, and applies to not-for-profit and governmental organizations, in addition to profit-oriented companies. Functions of management: Managers plan, organize, lead, and control. Accounting influence is greatest in the areas of planning and control. Planning is the primary management function. Through the selection of goals and objectives, the company develops budgets to guide financial progress toward the goals. Control involves the comparison of actual data to the plans. The role of ethics in accounting: High profile scandals have highlighted the need for strong ethics in the financial arena. Transparency and openness are essential for the smooth functioning of the free-market economy. Many, including investors and creditors, rely on the financial statements, so it is incumbent on the accounting profession to provide clear, reliable, and verifiable financial information. The Institute for Management Accountant (IMA) has created standards of ethical conduct for management accountants. The guidelines cover four areas: 

Competence

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Confidentiality

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Integrity

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Objectivity

In addition to the importance of ethics, the text covers several different perspectives that are important to management accountants: 

Strategic Management Perspective – A Company needs to clearly identify its strategies for how it intends to succeed in the marketplace and how it will distinguish itself from its competitors. 1

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Enterprise Risk Management Perspective – Risk management is a process used to identify a company’s risks and to develop plans for responding to the risks so that the company can meet its goals.

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Corporate Social Responsibility Perspective – Companies serve many stakeholders in addition to its shareholders. These include customers, employees, suppliers, and the communities in which they operate. Corporate social responsibility requires companies to consider the needs of all its stakeholders when making decisions.

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Process Management Perspective – A business process is a series of steps that are followed in order to complete a task in business. These processes are fundamental to meeting its business objectives, but often cross departmental boundaries, requiring managers to cooperate and work collaboratively. A value chain is often used to describe how an organization’s functional departments interact with one another to form a business process.

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Leadership Perspective – Business leaders must unite the behaviors of the company’s employees around the achievement of strategic goals and making optimal decisions.

The changing business environment: Today’s business environment is radically different than twenty years ago. Several significant changes are discussed in the text and in the class lecture and include: 

The role of business in society

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Growth of the service economy

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Considerations of the value chain

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Just-in-time production systems

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Growth and intensity of international competition

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Importance of economic freedom

Chapter 1 – Managerial Accounting and Cost Concepts In accounting, costs can be classified differently depending on the needs of managers. The chart on the next pages summarizes cost classifications discussed in this chapter. Manufacturing costs: Manufacturing consists of activities and processes that convert raw materials into finished products. Manufacturing costs (product costs) include: 

Direct materials – basic raw materials and parts used in the manufacturing process. Direct materials are those that can be physically and conveniently traced to a product.

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Direct labor – work of factory employees that can be physically and conveniently traced to a product. Direct labor is often referred to as touch labor, as these employees physically touch the product.

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Manufacturing overhead – costs that are indirectly associated with the product. This includes both indirect materials and indirect labor, as well as other costs to operate and maintain the production facility. As the amount of direct labor has decreased with automation, the amount of manufacturing overhead has increased. It often makes up more than 50% of total manufacturing or product cost. 2

Product versus period costs: Product costs are costs that will enter inventory until sold. Hence, these costs are known as inventoriable costs. These costs are not expensed until the item is sold and the costs are transferred to costs of goods sold. Period costs are nonmanufacturing costs. They are expensed in the period incurred. These costs include marketing and selling costs, administrative costs, and research and development costs. These costs are never inventoried but are always expensed (show on the income statement) as incurred. Prime versus conversion costs: Prime costs are direct materials and direct labor. Conversion costs are direct labor and manufacturing overhead. Both prime and conversion costs are manufacturing costs and product costs and inventoriable costs.

Cost Behavior: Cost behavior refers to how costs change in relation to changes in activity. 

Variable Cost – Varies in direct proportion to the changes in the level of activity. As a result, the variable cost per activity remains the same. Direct materials and direct labor are variable costs.

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Fixed Cost – A fixed cost remains constant regardless of changes in the level of activity. Consequently, as activity increases or decreases, the fixed cost remains unchanged. As a result, the fixed cost per activity will decrease as activity increases and will increase as the activity decreases. Committed fixed costs represent investments with a multiyear planning horizon and cannot be reduced in the short term. Discretionary fixed costs are the result of annual decisions and can be reduced for short periods of time.

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Mixed Cost – Contain both variable and fixed costs. The equation for a straight line can be used to express the relationship between mixed costs and the level of activity. This equation is Y = a + bX.

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Linearity and the Relevant Range – Management accountants generally assume costs are linear. The relevant range is the range of activity over which the assumption of linearity is reasonable valid.

Cost Classifications for Decision Making: Decisions involve making decisions among alternatives. 

Differential Cost and Differential Revenue – A future cost/revenue that differs among the alternatives. This is also known as incremental cost/revenue. 3

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Sunk Cost – A cost that has already been incurred and that cannot be changed by any decision. Sunk costs are not relevant.

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Opportunity Cost – The potential benefit that is given up when one alternative is selected over another.

Chapter 13 – Statement of Cash Flows Usefulness of the statement of cash flow: The statement of cash flow reports the cash receipts, cash payments, and the net change in cash for the period. It should help users assess: 

Ability to generate future cash flows

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Ability to pay dividends and meet obligations of the business

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Explain the differences between net income and net cash provided by operating activities

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Cash investing and financing during the period

Classification of cash flows: The statement of cash flow breaks the total cash flow into: 

Operating activities – items that affect the net income of the business

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Investing activities – items that affect the long-term assets of the business

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Financing activities – items that affect the company’s capital (debt and equity)

Significant noncash activities: Some transactions in a company do not involve cash. Significant noncash items are reported in a separate schedule at the bottom of the statement of cash flows. This follows the principle of full disclosure. An example of a noncash transaction would be the conversion of bonds into common stock. Direct vs. indirect methods: In the determination of cash from operating activities, a company must convert net income from an accrual basis to a cash basis. There are two ways to do this. Since 99% of firms use the indirect method, this is the only method covered. This method begins with the net income or loss and makes adjustments to account for changes in cash. Preparing the statement of cash flow: There are three steps in the preparation of the statement of cash flow. They are: 

Determine the net cash from operating activities by converting the net income or loss from an accrual to a cash basis

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Analyze changes in noncurrent asset, liability, and equity accounts and record as investing and financing activities

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Complete the reconciliation of cash

Operating activities: There are three activities to complete to determine the net cash from operating activities: 

Start with the net income (positive) or net loss (negative)

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Add back noncash charges (depreciation and amortization) 4

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Subtract gains or add losses (Gain and losses are related to book values and the cash received, but not specifically to cash, so these items are being taken out of the net income.)

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Determine changes in the noncash current asset and current liability accounts (Increases in noncash asset accounts are uses of cash; decreases in noncash asset accounts are sources of cash; increases in current liability accounts are sources of cash; decreases in current liability accounts are uses of cash)

Investing and financing activities: The focus in these sections is on the noncurrent asset and liability accounts. In general, investing activities are changes in the noncurrent asset section of the balance sheet. Increases in these asset accounts are uses of cash and decreases are sources of cash. However, accounts must be analyzed to understand what has actually taken place. For example, if there are offsetting transactions, it is not enough to report just the change. A sale of an asset will result in proceeds coming into the business, or an increase in cash. A purchase of an asset will result in a decrease in cash. Each transaction must be included. The same is true for the financing activities that generally affect the noncurrent liabilities and the equity. Retained earnings is not included, as the net income is already included in the operating activities and the dividends are a use of cash under financing activities. Reconciliation: At the bottom of the statement of cash flow, there is a reconciliation of cash. Once you add together the net cash flows from operating, investing, and financing, you will have computed the net change in cash for the period. This should be identical to the difference in cash from the beginning to the end of the period. If not, you have an error. To the net change in cash, you add the beginning cash to get the ending cash. This completes the statement of cash flow. Free cash flow: Free cash flow is the cash flow that is left over or remaining after the company has met all operating obligations and has invested in the fixed assets to maintain the business. Companies must also maintain the current level of dividends to satisfy the equity investors. Interest payment to satisfy the debt investors are included in the income statement so they are not considered in free cash flow. As a result, the formula for free cash flow is: Free cash flow = operating cash flow – capital expenditures – dividends Capital expenditures are investments in plant assets made during the period. This will include equipment, machinery, and buildings necessary for continuing the business. It does not include investments in nonoperating assets.

Chapter 14 – Financial Statement Analysis: The Big Picture Tools of financial analysis: 

Horizontal analysis – evaluates financial statement data over a period of time

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Vertical analysis – evaluates financial statement data by expressing items as a percent of a base amount

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Ratio analysis – expresses relationships among selected items of financial statement data

Purpose of financial statement analysis: The purpose for financial statement analysis is to identify a company’s financial strengths and weaknesses. Internally, this becomes the starting point for planning 5

actions to improve future performance. Externally, the information helps investors, creditors, regulators and others effectively evaluate a company. While such analysis is important, there are some limitations including: 

Financial statements are historical documents – many users are interested in the future

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Must recognize differences in accounting methods

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Qualitative data can often be as important as the financial data contained in the statements

Need for comparative analysis: Numbers by themselves are difficult to interpret. Comparisons can add meaning to numbers. Such comparisons can be made on a number of different bases: 

Intracompany basis – within a company comparing one period to another

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Intercompany basis – comparing data with one or more competitors

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Industry basis – comparing company data to industry averages published by ratings organizations or others

Horizontal analysis: Horizontal analysis is often called trend analysis. Its purpose is to determine if increases or decreases have occurred. This can be done on an amount basis or a percentage basis. Looking at absolute amounts will provide the level of economic change. Looking at percentage changes shows the significant changes. 

Trend percentage – a special type of horizontal analysis is to create trend percentages which shows changes in an item compared to some base year, usually the first year of the data.

Vertical Analysis: Vertical analysis is also called common-size analysis. It expresses each item on the financial statements as a percentage of another. The income statement items are based on the sales or revenues, so that each item on the income statement is expressed as a percent of sales. The balance sheet items are expressed as a percent of total assets. This simple techniques allows an analyst to quickly see significant differences across years or between companies. This points to areas needing additional analysis. Ratio analysis: Ratio analysis expresses relationships among selected items on the financial statements. Ratio analysis allows analysts to make intracompany, intercompany, and industry comparisons. Ratios are generally split into many different categories based on their use. While this course only includes about fifteen ratios, there are hundreds of ratios, many used only in specific industries. The categories and their respective ratios are: 

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Liquidity ratios – evaluating a company’s ability to meet its short-term obligations o

Working capital

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Current ratio

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Acid-test (quick) ratio

Asset management ratios – evaluating a company’s effectiveness in the use of its assets 6

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Accounts receivables turnover

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Average collection period

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Inventory turnover

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Average sale period

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Operating cycle

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Total asset turnover

Debt ratios – evaluating a company’s use of financial leverage o

Times interest earned (TIE)

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Debt to equity ratio

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Equity multiplier

Profitability ratios – evaluating a company’s ability to generate profitable results o

Gross margin percentage

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Net profit margin percentage aka profit margin on sales

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Return on assets (ROA)

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Return on equity (ROE)

Market value ratios – evaluating investors’ satisfaction with a company o

Earnings per share

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Price to earnings (PE) ratio

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Dividend payout ratio

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Dividend yield

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Book value per share

Financial leverage: Financial leverage is used by companies that include debt in their capital structure. Shareholders generally like companies to use debt, as it can increase their overall return on equity. When a company’s ROE > ROA, financial leverage is positive. Such a company has earned more on the borrowed money than the interest needed to pay for the use of the money. This additional amount goes to the owners (shareholders), enhancing their overall return. If a company’s ROA > ROE, they have not effectively used the borrowed funds, causing their overall returns to fall. This is negative leverage. Leverage works both ways, but companies that can effectively employ borrowed funds to enhance their returns are experiencing positive financial leverage. Chapter 2 – Job-Order Costing: Calculating Unit Product Costs

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Cost accounting: Cost accounting involves the measuring, recording, and reporting of product costs. From this information, the company can determine both the total product cost and the unit cost. A cost accounting system consists of the accounts for the various manufacturing costs. Two types of cost accounting systems are job-order and process. Job-order versus process costing: In each case, the objective of the cost accounting system is to be able to compute the total product costs and the unit cost. Different products generally lead to different ways to account for costs. 

Job-order costing – Under job-order costing, each job or batch has its own distinguishing characteristics. Each job is unique, so its costs must be collected i...