Cost Accounting Exam 4

Chapter 21

Chapter 21

Capital Budgeting

Is the process of making long-run planning decisions for investments in projects.

capital budgeting decisions

To make ______ _____ _____, managers must analyze each project by considering all the life-span cash flows from its initial investment through its termination.

1. Identify Projects
2. Obtain information
3. Make predictions
4. Make decisions by choosing among alternatives
5. Implement the decision, evaluate performance, and learn

Five Stages in Capital Budgeting?

Identify Projects

Identify potential capital investments that agree with the organization's strategy.

Obtain information

Gather information from all parts of the value chain to evaluate alternative projects.

Make predictions

Forecast all potential cash flows attributable to the alternative projects.

Make Decisions by Choosing Among Alternatives

Determine which investment yields the greatest benefit and least cost to the organization.

1. Obtain funding and make the investment selected in stage 4.
2. Track realized cash flows, compare against estimated numbers and revise plans if necessary.

Implement the decision, evaluate performance and learn is separated into two phases, what are they?

Working capital

Refers to the difference between current assets and current liabilities

1. Net present value (NPV)
2. Internal rate of return (IRR)
3. Payback period
4. Accrual accounting rate of return (AARR)

Four Capital Budgeting Methods?

Discounted cash flow (DCF)

Measure all expected future cash inflows and outflows of a project discounted back to the present point in time.

1. NPV
2. IRR

The two DCF methods are?

time value of money

The key feature of DCF methods is the ____ ____ ___ ______ which means that a dollar received today is worth more than a dollar received at any future time.

Required rate of return (RRR)

Is the minimum acceptable annual rate of return on an investment.

RRR

Is internally set, usually by upper management, and typically represents the return that an organization could expect to receive elsewhere for an investment of comparable risk.

1. The discount rate
2. Hurdle rate
3. Cost of capital
4. Opportunity cost of capital

RRR is also called what 4 things?

Net present value

_____ _____ _____ method calculates the expected monetary gain or loss from a project by discounting all expected future cash inflows and outflows back to the present point in time, using the RRR.

zero or postive

Based on financial factors alone, only projects with a _____ or _____ NPV are acceptable.

Internal rate of return

_____ _____ _____ method calculates the discount rate at which an investment's present value of all expected cash inflows equals the present value of its expected cash outflows.

IRR; RRR

A project is accepted only if the ____ equals or exceeds the _____.

shareholder value maximization

NPV is generally preferred because its use leads to ______ _____ ______.

dollars

NPV is expressed in _____, not in percentages

combination

IRR projects cannot be added or averaged to represent the IRR of a ______ of projects.

IRR; NPV

____ is more prone than ____ to indicate erroneous decisions.

IRR

____ implicitly assumes that project cash flows can be reinvested at the project's rate of return.

NPV

____ accurately assumes that project cash flows can only be reinvested at the company's required rate of return.

The payback

_____ _____ method measures the time it will take to recoup, in the form of expected future cash flows, the net initial investment in a project.

does not

Like the NPV and IRR methods, the payback method ____ ___ distinguish among the sources of cash flows.

Shorter

_____ payback period are preferable.

1. Fails to recognize the time value of money
2. Doesn't consider the cash flow beyond the payback point.

The two weaknesses of the payback method are?

Net initial investment / Uniform increase in annual future cash flows

Payback period formula?

The Accrual Accounting Rate of Return Method (AARR)

____ ____ ___ ___ ___ ____method divides the average annual [accrual accounting] income of a project by a measure of the investment in it.

Increase in expected average annual after-tax operating income / net initial investment

AARR formula?

1. Initial machine investment.
2. Initial working capital investment.
3. After-tax cash flow from current disposal of old machine.

Three components of net-initial investment cash flows?

1. Annual after-tax cash flow from operations (excluding the depreciation effect).
2. Income tax cash savings from annual depreciation deductions.

Two components of cash flow from operations?

1. After-tax cash flow from terminal disposal of asset (investment).
2. After-tax cash flow from recovery of working capital (liquidating receivables and inventory that was needed to support the project).

Two components of Terminal Disposal of Investment?

post investment audit

A _____ _____ ____may be done to provide management with feedback about the performance of a project so that management can compare actual results to the costs and benefits expected at the time the project was selected.

overstating

A post-investment audit may prevent managers from _____ the expected cash inflows from projects and accepting projects they should reject.

evaluated

Even though NPV is the best for capital budgeting decisions, managers will be tempted to make the decisions based on the method on which they will be _____.

strategy

A company's _____ is the source of its strategic capital budgeting decisions.

Chapter 22

Chapter 22

A management control system

Is a means of gathering and using information to aid and coordinate the planning and control decisions throughout an organization and to guide the behavior of its managers and other employees.

balanced scorecard

Some companies design their management control system around the concept of the ______ _____.

within; outside

Well-designed management control systems use information from both ____ the company and from _____ the company.

formal management control

The _____ _____ ____ ____ system of a company includes explicit rules, procedures, performance measures, and incentive plans that guide the behavior of its managers and other employees.

1. The management accounting system for information about the firm's costs, revenues and income.
2. The human resources system for information about the recruiting and training of employees, absenteeism and accidents.
3. The quality system for information

The formal control system is composed of several systems such as?

informal management control system

The _____ _____ _____ ____ system includes the shared values, loyalties, and mutual commitments among members of the organization, the company's culture, and the unwritten norms about acceptable behavior for managers and other employees.

managers

Management control systems should also be designed to support the organizational responsibilities of individual ______.

structure

Management control systems must be aligned with an organization's _____.

motivate

Effective management control systems should ______ managers and other employees.

1. Goal Congruence
2. Effort

Two Aspects of Motivation?

Goal Congruence

Exists when individuals and groups work toward achieving the organization's goals�managers working in their own best interest take actions that align with the overall goals of top management.

Effort

Is the extent to which managers strive or endeavor in order to achieve a goal. ____ goes beyond physical exertion to include mental actions as well.

Decentralization

Is an organizational structure that gives managers at lower levels the freedom to make decisions.

Autonomy

Is the degree of freedom to make decisions.

1. Creates greater responsiveness to the needs of a subunit's customers, suppliers, and employees.
2. Leads to gains from faster decision making by subunit managers.
3. Assists management development and learning.
4. Sharpens the focus of subunit managers

Benefits of Decentralization?

1. Leads to suboptimal decision making, which arises when a decision's benefit to one subunit is more than offset by the costs or loss of benefits to the organization as a whole.
2. Leads to unhealthy competition.
3. Results in duplication of output.
4. R

Costs of Decentralization?

1. Cost Center
2. Revenue Center
3. Profit Center
4. Investment Center

To measure the performance of subunits in centralized or decentralized companies, the management control system uses one or a mix of the four types of responsibility centers, what are they?

Transfer Price

The price one subunit (department or division) charges for a product or service supplied to another subunit of the same organization.

revenues; purchase costs

The transfer price creates _____ for the selling subunit and ____ ____ for the buying subunit affecting each subunit's operating income.

Intermediate product

The product or service transferred between subunits of an organization.

1. Promote goal congruence so that division managers acting in their own interest will take actions that are aligned with the objectives of top management.
2. Induce managers to exert a high level of effort.
3. Help top managers evaluate the performance o

To help a company achieve its goals, transfer prices should meet four key criteria?

1. Market-based transfer prices.
2. Cost-based transfer prices.
3. Hybrid transfer prices.

There are three broad categories of methods top managers can use to determine transfer prices. They are as follows?

Market-Based Transfer Prices

Top managers may choose to use the price of a similar product or service that is publicly available. Sources of prices include trade associations, competitors, and so on.

1. The market for the intermediate product is perfectly competitive.
2. The interdependencies of subunits are minimal.
3. There are no additional costs or benefits to the company as a whole from buying or selling in the external market instead of transact

Transferring products or services at market prices generally leads to optimal decisions when three conditions are satisfied?

1. Full-cost bases.
2. Variable-cost bases.

Top managers choose a transfer price based on the costs of producing the intermediate product. Examples include?

Cost Based Transfer Prices

Useful when market prices are unavailable, inappropriate, or too costly to obtain, such as when markets are not perfectly competitive, when the product is specialized or when the internal product is different from the products available externally in term

1. They represent relevant costs for long-run decisions.
2. They facilitate external pricing based on variable and fixed costs.
3. They are the least costly to administer.

Despite its limitations, managers generally prefer to use full-cost-based transfer prices because?

Hybrid Transfer Prices

Takes into account both cost and market information.

1. Prorating the difference between maximum and minimum transfer prices.
2. Negotiated pricing. (most common hybrid type)
3. Dual pricing.

Types of hybrid transfer prices?

Prorating

Is the difference between the maximum and minimum cost-based transfer prices.

Dual Pricing

Using two separate transfer-pricing methods to price each transfer from one subunit to another. Example: selling division receives full cost pricing, and the buying division pays market pricing.

Negotiated Transfer Pricing

Occasionally, subunits of a firm are free to negotiate the transfer price between themselves and then to decide whether to buy and sell internally or deal with external parties.

Print out the chart on slide 29

Print out the chart on slide 29

Incremental cost per unit incurred up to the point of transfer + Opportunity cost per unit to the selling subunit

Minimum transfer price formula?

Incremental cost

Is the additional cost of producing and transferring the product or service.

Opportunity cost

Is the maximum contribution margin forgone by the selling subunit if the product or service is transferred internally.

Chapter 23

Chapter 23

balanced scorecard

Many organizations record financial and nonfinancial performance measures for their subunits on a _____ _____.

1. Return on investment
2. Residual income
3. Economic value added
4. Return on sales (this measure does not account for investment)

Four common measures of economic performance?

Return on Investment

Is an accounting measure of income divided by an accounting measure of investment.

ROI= Income / Investment

Equation for ROI?

1. Blends all the ingredients of profitability (revenues, costs, and investment) into a single percentage
2. May be compared to other ROI's both inside and outside the firm

ROI is the most popular metric for two reasons, what are they?

The Accounting Rate of Return (ARR)

ROI is also called what?

Income / Investment= Income / Revenues X Revenues / Investment

ROI may be decomposed into its two components as follows.. Formula?

DuPont Method

ROI = Return on Sales X Investment Turnover.
This approach is known as the _____ _____ of Profitability Analysis. It recognizes the two basic ingredients in profit making: increasing income per dollar of revenue and using assets to generate more revenues.

Residual Income (RI)

Is an accounting measure of income minus a dollar amount for required return on an accounting measure of investment.

RI= Income - (RRR x Investment)

Formula for RI?

Required rate of Return

RRR =?

imputed cost

Required rate of return times the investment is the _____ _____ of the investment.

Economic Value Added=
After-tax Operating Income - (Weighted Average Cost of Capital x (Total assets - Current Liabilities)

Is a variation of RI used by many companies. It is calculated as follows?

Return on Sales

Is also known as the income-to-revenues ratio or the sales ratio. It is frequently used, simple to compute, and widely understood. It does not take into account investment. It measures how effectively costs are managed

Operating Income / Revenues

Return on Sales =?

1. Current cost
2. Gross value of fixed assets
3. Net book value(NBV) of fixed assets

Possible alternative asset measurements include?

Current cost

Cost of purchasing an asset today identical to the one currently held.

Historical costs

Both, gross value of fixed assets and net book value use what?

NBV

_____ is the measure most commonly used by companies for internal performance evaluation.

subunit

The performance evaluation of a manager should be distinguished from the performance evaluation of that manager's _____, such as a division of the company.

incentive

An _____ should be some reward for performance.

incentive

An ______ may create an environment in which suboptimal behavior may occur: the goals of the firm are sacrificed in order to meet a manager's personal goals.

balance

The motivation for having some salary and some performance-based compensation is to _____ the benefit of incentives against the extra cost of imposing risk on a manager.

Moral hazard

_____ _____ describes a situation in which an employee prefers to exert less effort compared with the effort the owner desires because the owner cannot accurately monitor and enforce the employee's effort.

Intensity of Incentives

How large the incentive component of a manager's compensation should be relative to their salary component.

Benchmarks

Are metrics that correspond to the best practices of organizations and may be available inside or outside of the organization.

1. Design performance measures for activities that require multiple tasks.
2. Design performance measures for activities done in teams.

Managers need to do two things when designing the measures used to evaluate performance of individual employees, what are they?

Executive compensation plans

Based on both financial and nonfinancial performance measures, and include a mix of, base salary, annual incentives, and long run incentives.

1. Belief systems
2. Boundary systems
3. Internal control systems
4. Diagnostic control systems
5. Interactive control systems

What are the five control levels?

Belief systems

Articulate the mission, purpose, and core values of a company.

Boundary systems

Describe standards of behavior and codes of conduct expected of all employees.

Internal Control systems

Safeguard information and assets.

Diagnostic Control Systems

Theoretically provide information indicating when a system is in control or out of control.

Interactive control systems

Focus on communicating and implementing the organizations strategy. The purpose of this is to promote debate related to assumptions underlying the organizations strategy and ultimately to promote learning and growth.

interactive system

Successful balance scorecard adopters use the scorecard as an _____ _____.

MC Questions

MC Questions

Bonus

Of the three basic forms of management compensation (salary, bonus, benefits), the fastest growing part of total compensation is:

Compensation (salary, bonus) can influence a managers risk aversion.

Risk aversion by managers should be recognized when revising compensation plans because:

Banking regulators and corporate compensation committees.

Due in part to the failure of many banks in 2008, executive compensation is getting increased oversight by:

May encourage unethical behavior.

Any system of compensation:

Consistent in their objectives

The objectives of management compensation, when compared to the objectives used to develop performance measurement systems, are:

Simple, clear, and consistent

In developing compensation plans, the management accountant works to achieve fairness by making the plan:

Stock price performance

Bases for management bonus compensation often include:

Achieving a predetermined goal.

When strategic performance measures or critical success factors are used to determine bonus compensation, the bonus will usually depend either on the amount of improvement in the measure or on:

Excluded

The balanced scorecard critical success factors (CSF's) provide strong motivation in bonus compensation plans if the non-controllable factors are:

Can lose some motivation because of the delay in reward.

The stock option form of bonus payments to managers usually:

Alignment of manger's incentives and the organizations strategy.

In management compensation, the use of the balanced scorecard achieves:

Use of multiple critical success factors (CSF's)

The balanced scorecard evaluation of the firm is an especially strong financial tool because of its:

Cash and/or stock

A deferred bonus can consist of:

In two years or more

Performance shares grant stock for achieving certain performance goals: