Accounting for Managers ppt.pptx

Financial & Managerial Accounting
(MPMF-621)
After completing this course you should be able to
• Explain the features of financial and managerial accounting
• Understand the steps in the accounting cycle
• Prepare the four financial reports, make financial Analysis and
interpret the result
• Distinguish the different product costing systems
• Apply budgeting for planning and control purpose
• Use the steps in decision making to give solution to non routine
problems in the business environment
• Aware of the different modern management accounting tools

Chapter 1: Introduction to Financial Accounting
1.1 Accounting and Users of Accounting Information

Accountants prepare four financial statements :
Balance Sheet
Income
Statement
Statement of
Cash Flows
Statement of
Shareholders
Equity
What are the Accounting Information

Who Uses Accounting Information?
Users
Internal
Users
Management
Employees
Functional
Departments
External Users
Investors
Customers
Labour
Unions
Tax Authority
Academicians

Common Questions Asked Users
1. Can we afford to give our
employees a pay raise?
Human Resources
2. Did the company earn a
satisfactory income?
3. Should any product lines be
eliminated?
4. Is cash sufficient to pay dividends
to stockholders?
5. What price for our product will
maximize net income?
6. Will the company be able to pay
its debts as they become due?
Investors
Management
Finance
Marketing
Creditors
Why they Use Accounting Information?

What are the Qualities of Useful Accounting
Information?
• To be useful, accounting information should be both
relevant and reliable
• Information has the quality of relevance when it
influences the economic decisions of users by helping
them evaluate past, present or future events or
confirming or correcting their past evaluations
• Information has the quality of reliability when it is free
from material error and bias and can be depended
upon by users to represent faithfully what it is
expected to represent

1.2 Financial & Managerial Accounting
• We can divide accounting into two fields—
Financial accounting and Managerial
accounting.
• Financial accounting provides information for
external decision makers, such as outside
investors and lenders.
• Managerial accounting focuses on information
for internal decision makers, such as the
company’s managers.

Financial Accounting Vs. Managerial Accounting
Areas of Comparison Financial Accounting Management Accounting
1. Primary users of
information
Persons and organizations
outside the business entity
Various levels of internal
management
2.Purpose of the
Information
Communicate organization’s
financial and operating
information to outside parties
Help managers make
decisions to fulfill an
organizations goal
3. Types of accounting
systems
Double entry system Not restricted to double
entry system; any useful
system can be used

4. Restrictive guidelines Adherence to GAAP No formal guidelines or
restrictions, only criterion is
usefulness
5. Units of measurement Historical (past) Monetary unit Any useful monetary (historical
and future) or physical measure
such as machine hours, labor hours
etc
6. Focal point for analysis Business entity as a whole Various segments of the business
entity.
7.Report Summarized report; concerned
primarily with the entity as a
whole
Detailed report; concerned about
details of parts of the entity’s
products, departments, territories
7. Frequency of reporting Periodical on a regular basis Whenever needed; may not be on
a regular basis
8. Degree of objectivity Demands objectivity; historical in
nature
Heavily subjective for planning
purposes, but objective data are
used when relevant and future in

Various users
need financial
information
The accounting profession
has attempted to develop a
set of standards that are
generally accepted and
universally practiced.
Financial Statements
 Balance Sheet
 Income Statement
 Statement of Stockholders’ Equity
 Statement of Cash Flows
 Note Disclosure
Generally Accepted
Accounting Principles
(GAAP)
1.3 Accounting Principles & Standards

Generally Accepted Accounting Principles (GAAP) are
Standards that are generally accepted and universally practiced.
These standards indicate how to report economic events. The
followings are accounting concepts and principles that serves as
building block for Accounting practices
1. Business entity concept 7. Revenue Realization principle
2. Going concern assumption 8. Matching Principle
3. Historical cost principle 9. Adequate disclosure principle
4. Objectivity Principle 10. Consistency principle
5. Monitory unit principle 11. Materiality principle
6. Periodicity principle
What are Generally Accepted Accounting Principles?

 GAAP setting bodies for business Organizations
 Financial Accounting Standards Board (FASB)
 International Accounting Standards Board (IASB)
 These organization are coordinators. In fact, accounting
principles and standards are prepared under the
participations of professionals, academicians and different
organization.
 In addition, accounting regulations will discipline accounting
choices in a given country
Who set Generally Accepted Accounting Principles?

1.4 Bases of Accounting & Recording Systems
1. Cash-Basis Accounting
• Revenues and expenses are recognized only
when cash is received or payments are
made.
• Mainly used by small business
organizations.
• Do not show accurate picture of true
profitability.

2. Accrual Bases of Accounting
• A system of accounting in which revenues
and expenses are recorded as they are
earned and incurred, not necessarily when
cash is received or paid.
• Provide a more accurate picture of a
company’s profitability.
• Statement users can make more informed
judgment concerning the company’s earning
potential.
• It is an acceptable method under GAAP

Illustration: During 2014, Crown Consulting billed its client for
$48,000. On December 31, 2010, it had received $41,000, with the
remaining $7,000 to be received in 2015. Total expenses during
2014 were $31,000 with $3,000 of these costs not yet paid at
December 31. Determine net income under both methods for the
year 2014.
Cash-Basis Accounting
Cash receipts $41,000
Cash disbursement 28,000
Income $13,000
Accrual-Basis Accounting
Revenues earned $48,000
Expenses incurred $31,000
Income $17,000
Cash-Basis Vs. Accrual Accounting

Accounting Record Systems
• There are two record keeping systems in
accounting
– Single entry : is record system where by only one
part of a transaction is recorded
– Double entry systems is a record system where by
both sides are recorded in the form of debit and
credit
• Double entry system is generally more
acceptable these days

1.5 Forms of Business Organizations
& Accounting
Based on legal formation, Business
Organizations in Ethiopia are classified as:
1. Sole proprietorship
2. Partnerships
– Ordinary Partnership
– Joint Venture
– General partnership
– Limited partnership
3. Companies
– Private Limited Companies
– Share Companies
4. Cooperatives (Unions)
5. Public enterprises

Based on their activity, business organization can also be
classified
1. Service giving business organizations
– Financial institutions
– Hotels & Tourism
– Schools & Health centers
2. Merchandizing business organizations
– Wholesalers
– Retailers
3. Manufacturing business organizations
– Food & Beverages factories
– Chemical factories
– Plastic & Metal tools factories
• Accounting is applicable in every type of
organizations

Assets Liabilities
Stockholder’s Equity
= +
Chapter 2: Financial Accounting Procedures
2.1 Accounting Equation and Rule of Debit & Credit
Assets are all properties under the ownership of an
organization such as cash, inventories and fixed assets.
Assets are claimed by either creditors or owners. Claims of
creditors must be paid before owners claims.
Liabilities are creditors claim such as accounts payable and
bank loan

Revenues result from business activities entered into for the purpose
of earning income. Common sources of revenue are: sales, fees,
services, commissions, interest, dividends, royalties, and rent.
Expenses are the cost of assets consumed or services used in the
process of earning revenue. Common expenses are: salaries expense,
rent expense, utilities expense, tax expense, etc
Dividends are the distribution of cash or other assets to stockholders.
Dividends reduce retained earnings. However, dividends are not an
expense

Chart of accounts is accounts and account numbers arranged in
sequence in which they are presented in the financial statements.
Chart of Accounts

Account Name
Debit / Dr. Credit / Cr.
 Is used to record increases and
decreases in a specific asset, liability,
equity, revenue, or expense items.
 An account has two sides
 Debit = “Left side”
 Credit = “Right side”
Account
An account can be
illustrated in a T-
account form.
The Account

Chapter
3-23
Assets
Assets
Normal Balance
Normal Balance
Chapter
3-27
Normal Balance
Normal Balance
Expense
Expense
Normal
Balance
Credit
Normal
Balance
Debit
Debits/Credits Rules
Chapter
3-24
Liabilities
Liabilities
Normal Balance
Normal Balance
Chapter
3-25
Normal Balance
Normal Balance
Stockholders
Stockholders’
’ Equity
Equity
Chapter
3-26
Normal Balance
Normal Balance
Revenue
Revenue

Balance Sheet Income Statement
= + =
-
Asset Liability Equity Revenue Expense
Debit
Credit
Debits/Credits Rules
LO 2 Define debits and credits and explain their use
in recording business transactions.

1. Analyze business transactions
2. Journalize the
transactions
6. Prepare an adjusted trial
balance
7. Prepare financial
statements
8. Journalize and post
closing entries
9. Prepare a post-closing
trial balance
4. Prepare a trial balance
3. Post to ledger accounts
5. Journalize and post
adjusting entries
The Accounting Cycle

 Book of original entry where transactions are recorded for
the first time .
 Transactions are recorded in chronological order.
 Contributions to the recording process:
1. Discloses the complete effects of a transaction.
2. Provides a chronological record of transactions.
3. Helps to prevent or locate errors because the debit and
credit amounts can be easily compared.
The Journal
2.2 Recording & Summarizing Transactions

Journalizing - Entering transaction data in the journal.
Illustration: On September 1, stockholders’ invested $15,000 cash
in the corporation in exchange for share of stock, and Softbyte
purchased computer equipment for $7,000 cash.
Account Title Ref. Debit Credit
Date
Cash
Common stock
Sept. 1 15,000
15,000
General Journal
Equipment
Cash
7,000
7,000
Journalizing

Compound Entries
Illustration: On July 1, Butler Company purchased a delivery truck
costing $14,000. It pays $8,000 cash now and agrees to pay the
remaining $6,000 on account.
Account Title Ref. Debit Credit
Date
Equipment
Cash
July 1 14,000
8,000
General Journal
6,000
Accounts payable
Journalizing

.
•Posting is the process of summarizing accounts from a
journal to a ledger
•A Ledger is a book of secondary entry
•General Ledger contains the entire group of accounts
maintained by a company
Posting

LO 5 Explain what a ledger is and how it helps in the recording process.
Posting
Standard Form of an Account

Posting –
process of
transferring
amounts from
the journal to
the ledger
accounts.
Posting

LO 7 Prepare a trial balance and explain its purposes.
Trial Balance

Adjusting Entries
 Ensure that the revenue recognition and expense
recognition principles are followed.
 Necessary because the trial balance may not contain
up-to-date and complete data.
 Required every time a company prepares financial
statements.
 Will include one income statement account and one
balance sheet account.
2.3 The Basics of Adjusting Entries

1. Prepaid Expenses.
Expenses paid in cash and
recorded as assets before
they are used or consumed.
Eg. Supplies,
Prepaid Insurance
Deferrals
3. Accrued Revenues.
Revenues earned but not yet
received in cash or recorded
Eg. Interest Income.
4. Accrued Expenses.
Expenses incurred but not
yet paid in cash or recorded.
Eg. Salary expense, Interest
Expense
2. Unearned Revenues.
Cash received and recorded
as liabilities before revenue is
earned.
Eg. Unearned Rent
Accruals
Types of Adjusting Entries

Trial Balance –
Each account is
analyzed to
determine whether
it is complete and
up-to-date.
Types of Adjusting Entries

 Buildings, equipment, and vehicles (assets with long
lives) are recorded as assets, rather than an expense,
in the year acquired.
 Depreciation allocates a portion of the asset’s cost as
an expense during each period of the asset’s useful life.
 Depreciation does not attempt to report the actual
change in the value of the asset.
LO 5 Prepare adjusting entries for deferrals.
Depreciation

Summary of Basic Relationships

 Multiple-column form used in preparing financial
statements.
 Not a permanent accounting record.
 Five step process.
 Use of worksheet is optional.
LO 1 Prepare a worksheet.
Steps in Preparing a Worksheet
Using a Worksheet

Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200 15,200 15,200
Supplies 2,500 1,500 1,000 1,000
Prepaid Insurance 600 50 550 550
Equipment 5,000 5,000 5,000
Notes Payable 5,000 5,000 5,000
Accounts Payable 2,500 2,500 2,500
Unearned Revenue 1,200 400 800 800
Common Stock 10,000 10,000 10,000
Dividends 500 500 500
Service Revenue 10,000 400 10,600 10,600
200
Salaries Expense 4,000 1,200 5,200 5,200
Rent Expense 900 900 900
Totals 28,700 28,700
Supplies Expense 1,500 1,500 1,500
Insurance Expense 50 50 50
Accumulated Depreciation 40 40 40
Depreciation Expense 40 40 40
Accounts Receivable 200 200 200
Interest Expense 50 50 50
Interest Payable 50 50 50
Salaries and Wages Payable 1,200 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600 22,450 19,590
Net Income 2,860 2,860
Totals 10,600 10,600 22,450 22,450
Balance Sheet
Adjusted Income
Trial Balance Adjustments Trial Balance Statement
(a)
(b)
(a)
(g)
(c)
(d)
(d)
(e)
(b)
(e)
(f)
(f)
(g)
(c)
Preparing a Worksheet

 Income statement is prepared from the income
statement columns.
 Balance sheet and retained earnings statement are
prepared from the balance sheet columns.
 Companies journalize and post adjusting entries.
Preparing Statements from a Worksheet
2.4 Completing the Accounting Cycle

Illustration 4-4

LO 1

At the end of the accounting period, the company makes
the accounts ready for the next period.
LO 2 Explain the process of closing the books.
Closing the Books

Purpose is to prove the equality of the permanent account
balances after journalizing and posting of closing entries.
Preparing a Post-Closing Trial Balance
LO 3

LO 1 Identify the differences between service and merchandising companies.
Merchandising Companies
Buy and Sell Goods
Wholesaler Retailer Consumer
The primary source of revenues is referred to as
sales revenue or sales.
2.5 Accounting for Merchandizing Operation

Income Measurement
Cost of goods sold is the total cost
of merchandise sold during the
period.
Not used in a
Service business.
Merchandising Operations

The operating cycle
of a merchandising
company ordinarily
is longer than that of
a service
company.
Operating
Cycles

Companies use either a perpetual inventory system or a periodic inventory
system to account for inventory.
Flow of Costs

Perpetual System
 Maintain detailed records of the cost of each inventory
purchase and sale.
 Records continuously show inventory that should be on
hand.
 Company determines cost of goods sold each time a
sale occurs.
Flow of Costs

Periodic System
Beginning inventory $ 100,000
Add: Purchases, net 800,000
Goods available for sale 900,000
Less: Ending inventory 125,000
Cost of goods sold $ 775,000
LO 1
Flow of Costs
 Do not keep detailed records of the goods on hand.
 Cost of goods sold are determined by count at the end
of the accounting period.
 Calculation of Cost of Goods Sold:

LO 2
Seller places goods Free On
Board the carrier, and buyer pays
freight costs.
Seller places goods Free On
Board to the buyer’s place of
business, and seller pays freight
costs.
Freight Costs – Terms of Sale
FOB Shipping Point & FOB Destination

Purchaser may be dissatisfied because goods are damaged
or defective, of inferior quality, or do not meet specifications.
Return goods for credit if the sale
was made on credit, or for a cash
refund if the purchase was for
cash.
May choose to keep the
merchandise if the seller will
grant an allowance (deduction)
from the purchase price.
Purchase Return Purchase Allowance
Purchase Returns and Allowances

2% discount if
paid within 10
days, otherwise
net amount due
within 30 days.
1% discount if
paid within first 10
days of next
month.
2/10, n/30 1/10 EOM
Credit terms may permit buyer to claim a
cash discount for prompt payment
Purchase Discount

 Made using cash or credit (on account).
 Normally recorded when
earned, usually when
goods transfer from seller
to buyer.
 Sales invoice should
support each credit sale.
Recording Sales of Merchandise

Chapter 3: Financial Statement Preparation and
Interpretation
3.1 International Financial Reporting Standards (IFRS)
• A set of global accounting and reporting standards,
issued by the IASB
• Increasingly used by many large and mutinational
companies
• Accepted by most security market authorities
• Used as a basis for national accounting requirements
(partially or in full) or as a benchmark for the
development of national accounting rules
• Accepted by Ethiopian government in 2014 (
Proclamation No. 847/2014)

International Accounting Standards Board (IASB)
• A private sector body
• Operates under the International Accounting
Standards Committee Foundation (IASCF)
• Has no responsibility to any governmental
organization
• Has no enforcement authority
• Develops and issues both main standards (IAS / IFRS)
and interpretations

Standard-setting due process of the IASB
Discussion
paper
Comment
analysis
Exposure
draft
Standard Effective
Date
Comment
analysis
Research
Standard Setters
Others
9-15 months 9-15 months 6-18 months

IFRS in the world
• Recent decisions of various governments
result in the requirement or permission of the
use of IFRS by more than one hundred
countries
• Europe: IAS Regulation of 2002
–Requirement of use of IFRS for
consolidated financial statements of EU
qouted companies as from 1 January 2005
–Member state option to extend the
application of IFRS to not-listed companies
and to individual financial statements
• Adoption of IFRS as national accounting
rules in a number of countries (Australia,
Singapore, Hong Kong, Ethiopia …)
• US: convergence process of US accounting
rules and IFRS started in 2002.

Primary Financial Statements
• Primary financial statements answer basic
questions including:
– What is the company’s current financial status?
– What was the company’s operating results for the
period?
– How did the company obtain and use cash during
the period?
• Basic financial statements includes
1. Income Statement
2. Statement of Retained Earnings
3. Balance Sheet
4. Statement of Cash Flows

Structure and Content of Financial Statements
• Each component of the financial statements must be
clearly identified and the following should be disclosed:
Name of the enterprise
Whether individual or consolidated statements
Reporting date or period covered by the statement
Reporting currency
The level of precision in the presentation of figures
• Where, in exceptional circumstances, an enterprise is
required to, or decides to, change its reporting date, it is
required to state why the change occurred and the fact
that the comparative amounts are not comparable

3.2 The Income Statement
• Shows the results of a company’s operations
over a period of time.
• What goods were sold or services performed
that provided revenue for the company?
• What costs were incurred in normal
operations to generate these revenues?
• What are the earnings or company profit?

The Income Statement
Revenues
• Assets (cash or AR) created through business
operations
Expenses
• Assets (cash or AP) consumed through
business operations
Net Income or (Net Loss)
• Revenues - Expenses

The Example Company
Income Statement
For the Years Ended December 31, 2013 and
2014
2014 2013
Revenues:
Sales $100 $ 85
Other revenue 30 15
Total revenues $130 $100
Expenses:
Cost of goods sold $ 62 $ 58
Operating & admin. 16 12
Income tax 20 18
Total expenses $ 98 $ 88
Net Income $ 32 $ 12

3.3 Statement of Change in Shareholders Equity
• Shows the increase or decrease in net asset of
owners or share holders
• It is a bridge between Income statement and
balance sheet

Statement of Changes in Shareholders Equity
Share
Capital
€’000
Other
Reserves
€’000
Retained
Earnings
€’000
Total
€’000
Opening balance x x x x
Changes in accounting policy - - x x
Restated balance x x x x
Changes in equity for year
Dividends (x) (x)
Total comprehensive income x x x
Issue of share capital x - - x
Total changes in equity x x x x
Closing balance x x x x

• Balance sheet (Statement of Financial position)
answers the following questions
– What are the resources of the company?
– What are the company’s existing obligations?
– What are the company’s net assets?
• Summary of the financial position of a company
at a particular date
–Assets: cash, accounts receivable, inventory, land,
buildings, equipment and intangible items
–Liabilities: accounts payable, notes payable and
mortgages payable
–Owners’ Equity: net assets after all obligations have
been satisfied
3.4 The Balance Sheet

Assets
Cash $ 40
Accounts receivable 100
Land 200
Total assets $340
Liabilities
Accounts payable $ 50
Notes payable 150
$200
Owners’ Equity
Capital stock $100
Retained earnings 40
$140
Total liabilities
and owners’ equity $340
Sample Balance Sheet
Must
Equal

Exercise 1
The following accounts and amounts are from the records of Jackson
company for the year ended April 30, 2010, the company’s first year of
operations. Prepare an income statement, statement of retained
earnings, and balance sheet for Jackson Company.
Accounts payable $ 19,000
Accounts receivable 104,000
Cash 90,000
Commissions earned 375,000
Common stock 100,000
Dividends 10,000
Equipment 47,000
Income taxes expense 27,000
Income taxes payable 6,000
Marketing expense 18,000
Office and equipment rental expense 91,000
Salaries and commission expense 172,000
Salaries payable 78,000
Supplies 2,000
Utilities expense 17,000

3.5 Statement of Cash Flows
• Reports the amount of cash collected and paid
out by a company in operating, investing and
financing activities for a period of time.
– How did the company receive cash?
– How did the company use its cash?
• Indicates ability of a company to generate
income in the future.
• It has three components: Cash flow from
Operating, Investing and financing activities
• Can be prepared in two ways: Direct or
Indirect method

1. Operating Activities
Cash Inflow
• Sale of goods or
services
• Sale of investments
in trading securities
• Interest revenue
• Dividend revenue
Cash Outflow
• Inventory payments
• Interest payments
• Wages
• Utilities, rent
• Taxes

2. Investing Activities
Cash Inflow
• Sale of plant assets
• Sale of securities,
other than trading
securities
• Collection of principal
on loans
Cash Outflow
• Purchase of plant
assets
• Purchase of securities,
other than trading
securities
• Making of loans to
other entities

3. Financing Activities
Cash Inflow
• Issuance of own stock
• Borrowing
Cash Outflow
• Dividend payments
• Repaying principal on
borrowing
• Treasury stock
purchase

CASH
OUTFLOWS
Operating
Activities
Financing
Activities
Investing
Activities
CASH
INFLOWS
Financing
Activities
Operating
Activities
Investing
Activities
Statement of Cash Flows

The Example Company
Statement of Cash Flows
December 31, 2014
Cash Flows From Operating Activities:
Receipts 48
Payments (43) 5
Cash Flows From Investing Activities:
Receipts 0
Payments (4) (4)
Cash Flows Used By Financing Activities:
Receipts 10
Payments (6) 4
Net Cash Flow 5

Balance Sheet 12/31/13
Cash $ 80,000
Other 4,550,000
Total $4,630,000
Liabilities $2,970,000
Cap. stock 900,000
R/E 760,000
Total $4,630,000
Revenues $12,443,000
Expenses 11,578,400
Net income $ 864,600
Income Statement
Cash $ 110,000
Other 4,975,000
Total $5,085,000
Liabilities $2,860,400
Cap. stock 1,000,000
R/E 1,224,600
Total $5,085,000
Balance
Sheet 12/31/14
Cash--Op. Act. $ 973,000
Cash--Inv. Act. (1,188,000)
Cash--Fin. Act. 245,000
Net increase $ 30,000
Beg. cash 80,000
End. cash $ 110,000
Cash Flow Statement
R/E 12/31/10 $ 760,000
Net income 864,600
Dividends (400,000)
R/E 12/31/11 $1,224,600
Stmt of Retained Earnings

Exercise 2
Martin Service Corporation began the year 2009
with cash of $55,900. In addition to earning a
net income of $38,000 and paying a cash
dividend of $19,500, Martin Service borrowed
$78,000 from the bank and purchased
equipment with $125,000 of cash. Also,
Accounts Receivable increased by $7,800, and
Accounts Payable increased by $11,700.
Determine the amount of cash on hand at
December 31, 2009.

3.6 Notes to the Financial Statements
Notes are used to convey information required by GAAP
or to provide further explanation.
Four general types of notes:
Summary of significant accounting policies:
assumptions and estimates.
Additional information about the summary totals.
Disclosure of important information that is not
recognized in the financial statements.
Supplementary information required by IFRS

Analyzing financial statements involves:
Characteristics
Comparison
Bases
Tools of
Analysis
 Liquidity
 Activity
 Profitability
 Solvency
 Intracompany
 Industry
averages
 Intercompany
 Horizontal
 Vertical
 Ratio
LO 1 Discuss the need for comparative analysis.
LO 2 Identify the tools of financial statement analysis.
Chapter 4: Financial Statement Analysis and
Interpretation

LO 3 Explain and apply horizontal analysis.
4.1 Horizontal Analysis
Horizontal analysis, also called trend analysis, is a
technique for evaluating a series of financial statement data
over a period of time.
 Purpose is to determine the increase or decrease that
has taken place.
 Commonly applied to the balance sheet, income
statement, and statement of retained earnings.

Changes suggest
that the company
expanded its asset
base during 2009
and financed this
expansion primarily
by retaining income
rather than assuming
additional long-term
debt.
Horizontal Analysis

Overall, gross profit
and net income were
up substantially.
Gross profit
increased by
17.1%, and net
income,26.5%.
Quality’s profit trend
appears favorable.
Horizontal Analysis

In the horizontal analysis of the balance sheet the ending
retained earnings increased 38.6%. As indicated earlier, the
company retained a significant portion of net income to
finance additional plant facilities.
Horizontal Analysis

Vertical analysis, also called common-size analysis, is a
technique that expresses each financial statement item as a
percent of a base amount.
 On an income statement, we might say that selling
expenses are 16% of net sales.
 Vertical analysis is commonly applied to the balance
sheet and the income statement.
4.2 Vertical Analysis

These results
reinforce the earlier
observations that
Quality is
choosing to
finance its growth
through retention
of earnings rather
than through
issuing additional
debt.
Vertical Analysis

Quality appears
to be a profitable
enterprise that is
becoming even
more successful.
Vertical Analysis

Enables a comparison of companies of different sizes.
Vertical Analysis

4.3 Ratio Analysis
Ratio analysis expresses the
relationship among selected items of
financial statement data. There are five
types of ratios
• Liquidity Ratio
• Asset management Ratio
• Debt management Ratio
• Profitability Ratio
• Market value Ratio

The discussion of ratios will include the
following types of comparisons.
A single ratio by itself is not very meaningful.
Ratio Analysis

Liquidity Ratios
Measure the short-term ability of the company to pay its
maturing obligations and to meet unexpected needs for cash.
 Short-term creditors such as bankers and suppliers are
particularly interested in assessing liquidity.
 Ratios include the current ratio, the acid-test ratio
Ratio Analysis

Ratio of 2.96:1 means that for every dollar of current liabilities, Quality has
$2.96 of current assets.
Ratio Analysis Liquidity Ratios
1. Current Ratio
$1,020,000
344,500
2.96

Ratio Analysis
2. Acid-Test Ratio
Liquidity Ratios

Ratio Analysis
2. Acid-Test Ratio
$100,000 20,000 230,000
344,500
1.02
Acid-test ratio measures immediate liquidity.
Liquidity Ratios

Ratio Analysis
3. Receivable Turnover
Measures the number of times, on average, the company collects
receivables during the period.
$2,097,000
230,000 + 180,000
2
10.23
Asset Management Ratio

A variant of the Receivable turnover ratio is to convert it to an
average collection period in terms of days.
Receivables are collected on average every 36 days.
Average Collection Period
ACP = 365/ Receivable Turnover Ratio
365 days / 10.2 times = every 35.78 days
Ratio Analysis Asset Management Ratio

Ratio Analysis
4. Inventory Turnover
Measures the number of times, on average, the inventory is sold during
the period.
$1,281,000
600,000 + 500,000
2
2.3 times

LO 5 Identify and compute ratios used in analyzing a
firm’s liquidity, profitability, and solvency.
A variant of inventory turnover is the inventory holding Period.
Inventory turnover ratios vary considerably among
industries.
365 days / 2.3 times = every 159 days
Inventory Holding Period
= 365 days/ Inventory Turnover Ratio
Ratio Analysis Asset Management Ratio

Ratio Analysis
5. Asset Turnover
Measures how efficiently a company uses its assets to generate sales.
$2,097,000
1,835,000 + 1,595,000
1.22 times
2

LO 5 Identify and compute ratios used in analyzing a
firm’s liquidity, profitability, and solvency.
Solvency Ratios
Solvency ratios measure the ability of a company to survive
over a long period of time.
 Debt to Total Assets and
 Times Interest Earned
are two ratios that provide information about debt-paying
ability.
Ratio Analysis

Ratio Analysis
6. Debt to Total Assets Ratio
Measures the percentage of the total assets that creditors provide.
$832,000
45.3%
$1,835,000
Solvency Ratios

Ratio Analysis
7. Times Interest Earned
Provides an indication of the company’s ability to meet interest payments
as they come due.
$468,000
13 times
$36,000
Solvency Ratios

Profitability Ratios
Measure the income or operating success of a company for a
given period of time.
 Income, or the lack of it, affects the company’s ability to
obtain debt and equity financing, liquidity position, and the
ability to grow.
 Ratios include the profit margin,, return on assets,
return on common stockholders’ equity, earnings per
share, and payout ratio.
Ratio Analysis

Ratio Analysis
8. Net Profit Margin (NPM)
Measures the percentage of each dollar of sales that results in net
income.
$264, 000
2097,000
12.6%

Ratio Analysis
9. Return on Asset (ROA)
An overall measure of profitability.
$264,000
1,835,000 + 1,595,000
13.4%
2

Ratio Analysis
10. Return on Equity ( ROE)
Shows how many dollars of net income the company earned for each
dollar invested by the owners.
$264,000
$1,003,000 + $795,000
29.4%
2

Ratio Analysis
11. Earnings Per Share (EPS)
A measure of the net income earned on each share of common stock.
$264,000
275,400 + 270,000
$0.97
2

Ratio Analysis
12. Payout Ratio
Measures the percentage of earnings distributed in the form of cash
dividends.
$61,200
23.2%
$264,000

Ratio Analysis
13. Price-Earnings Ratio
Measures the net income earned on each share of common stock.
$8.00
8.23 times
$0.97
Market Value Ratios

( )( )( ) = ROE
Profit
margin
TA
turnover
Equity
multiplier
NI
Sales
Sales
TA
TA
CE
x x = ROE
The Du Pont Model
This model relates the different types of ratios as
follows

Advantages of Ratio Analysis
• They facilitate inter-company comparison
• They downplay the impact of size and allow
evaluation over time or across entities
without undue concern for the effects of size
difference
• They serve as benchmarks for targets such as
financing ratios and debt burden
• They help provide an informed basis for
making investment-related decisions by
comparing an entity’s financial performance
to another

Limitations of Ratio Analysis
 It is restricted to information reported in the
financial statements
 It is based on past performance
 Comparability is hampered when accounting policies
are not uniform across an industry
 The past may not predict the future
 “Window dressing” techniques can make statements
and ratios look better
 Comparison with industry averages is difficult for a
conglomerate firm that operates in many different
divisions

Individual Assignment 1
Select any private bank of your choice in Ethiopia, Review the
2013/14 annual report and answer the following questions
1. Which of the financial Reports were prepared by the bank?
2. Calculate the following ratios from the 2014/15 financial
report?
a) Loan to Deposited Ratio
b) Non Performing Loan to Total Loan Ratio
c) Total Debt to Total Asset Ratio
d) Return on Asset
e) Return on Equity
f) Earning Per Share
3. What especial thing have you observed from the financial
statement you have reviewed?

Unit 5: Introduction to cost and Managerial
Accounting
5.1 What is Management Accounting?
The followings are important characteristics of management
accounting
•It is a separate branch of accounting which provides
information for management decision
•It is futuristic in its approach
•Collection of accounting data for analysis and interpretation
is made according to the need of the management.
•It only gives useful information for decision making, it does
not take part in execution of decision.

5.2 Cost Concepts & Classifications
What is the difference between Price, Cost,
Expense and Loss?
– Price is the amount at which goods or services are sold
–Cost refers to an outlay or expenditure of money to acquire Fixed
assets, goods and services. All costs initially represent an
asset
– Expense is an expired cost or amount incurred in generating
revenue
– Loss is cost incurred because of catastrophe or
unfavorable business condition

What is Cost Accounting?
• Cost accounting is an accounting
information system that records, measures
and reports information about cost.
• Cost accounting deals with accumulating
cost of manufacturing a product and other
functional processes and identifying these
costs with units produced or some other
cost object to enable the determination of
profit.
• Cost accounting can be applied in any
organization but the detail concept will be
applied in manufacturing organizations.

Cost can be classified in different ways from
different points of view
1. Time period points of view
• Budgeted cost/future cost
• Historical/sunk cost
2. Management function points of view
• Manufacturing cost
• Marketing cost
• Administrative cost
Classifications of Cost

3. From Cost Assignment points of view
• Direct cost
• Indirect cost
4.From GAAP Points of view
• Product cost/capitalized cost
• Periodic cost/non capitalized cost
5. Cost behavior point of view
• Fixed cost
• Mixed cost
• Variable cost

122
6. From decision making points of view
• Relevant cost
• Irrelevant cost
7. From controllability of cost points of view
• Controllable cost
• Uncontrollable cost
8. From commitment to expenditure point of
view
• Committed cost
• Programmable cost
9. Other cost classifications
• Opportunity cost
• Incremental cost
• Out of pocket cost
• Joint cost

Manufacturing cost
Types of inventories in manufacturing Companies
– Raw materail inventory
– Work in process inventory
– Finished goods inventory
The three main manufacturing cost are
1.Direct material cost
2.Direct labor cost
3.Manufacturing overhead cost

124
What is Manufacturing Overhead cost(MOH cost)?
MOH Cost Includes:
– Indirect materials, such as glue, nails, screws
– Indirect labor, such as supervisor’s salary and
Janitorial services.
– Tax on manufacturing facilities.
– Utilities for the manufacturing process.
– Depreciation on manufacturing facilities
– Repair and maintenance cost
– Plant Insurance
– Plant Rent

5.3 Financial Statement for a Manufacturing
Organization
In order to prepare financial statements for manaufacturing
organizations, we have to go through the following
schedules:
Schedule1: Cost of Direct Material Used
Beginning direct material inventory XX
Add: Purchase in the period XX
Direct material available for use XX
Less: Ending direct material inventory (XX)
Cost of direct material used XX

Schedule 2: Cost of Goods Manufactured
Work in process at the beginning----------------------- XX
Add: Cost of direct material used -------------XX
Direct labor cost -------------------------- XX
Manufacturing over head cost -----------XX
Cost incurred in current period ----------------------- (XX)
Total cost incurred to date ------------------------------ XX
Less: Work in process ending ---------------------------XX
Cost of goods manufactured ----------------------------XX

Schedule 3: Cost of Goods Sold
Finished goods beginning --------------------- XX
Add: Cost of goods manufactured -----------XX
Cost of goods available for sale -------------- XX
Less: Finished goods ending ---------------- (XX)
Cost of Goods Sold ----------------------------- XX
Schedule 4: Income Statement
Revenues XX
Cost of goods sold XX
Gross profit XX
Operating expenses (XX)
Operating income XX

Exercise 3: Consider the following account balance for ABC
manufacturing company in the year 2014.
Beginning Balance End Balance
Direct material inventory $22,000 $26,000
WIP inventory 21,000 20,000
Finished goods inventory 18,000 23,000
Purchase of direct material 75,000
Direct labor cost 25,000
Indirect labor cost 15,000
Plant insurance 4,000
Insurance- administrative 5,000
Depreciation - plant building and equipment 9,000
Depreciation - administrative building 3,000
Repair and maintenance – factory equipment 4,000
Marketing, distribution and customer service cost 93,000
General and administrative cost 29,000

Required
1. Calculate cost of direct material used
2. Calculate cost of goods manufactured
3. Calculate cost of goods sold
4. Prime cost ( DM + DL)
5. Conversion cost ( DL + MOH)
6. If revenue for the year is $300, 000, calculate
operating income

130
5.4 Marginal Costing Vs Absorption Costing
Absorption/Full costing is a costing system
which treats all manufacturing costs
including both the fixed and variable MOH
costs as product costs
Direct material cost XX
Direct labor cost XX
Variable MOH Cost XX
Fixed MOH cost XX
Total Inventor able cost XX

ABSORPTION COSTING INCOME STATEMENT
SALES XXXX
LESS: COST OF GOODS SOLD:
BEG. FIN.GOODS INV. XXX
PLUS: COGM XXX
GOODS AVIABLE FOR SALE XXX
LESS: END. FIN. GOODS INV. (XXX)
COST OF GOODS SOLD ( XXX)
GROSS MARGIN(PROFIT) XXX
LESS:
SELLING EXPENSES (FIXED &VARIABLE) XXX
ADMINISTRATIVE EXPENSES (F&V) XXX (XXX)
NET INCOME BEFORE TAXES (NIBT) XXX
LESS: TAXES ( XXX)
NET INCOME AFTER TAXES (NIAT) XXX

132
Variable/Marginal costing
It is a costing system which treats only the
variable manufacturing costs as product costs.
The fixed manufacturing overheads are
regarded as periodic cost
Direct material cost XX
Direct labor cost XX
Variable MOH Cost XX
Total inventarable cost XX

VARIABLE COSTING INCOME STATEMENT
SALES XXXX
LESS: TOTAL VARIABLE COSTS:
VARIABLE MFG. COSTS XXX
VARIABLE SELLING COSTS XXX
VARIABLE ADMINISTRATIVE COSTS XXX (XXXX)
-------- -------
CONTRIBUTION MARGIN XXX
LESS: TOTAL FIXED COSTS:
FIXED MFG. COSTS XXX
FIXED SELLING COSTS XXX
FIXED ADMIN. COSTS XXX ( XXX)
----------- ---------
NET INCOME BEFORE TAXES XXX
LESS: TAXES ( XXX)
-----------
NET INCOME AFTER TAXES (NIAT) XXX

Exercise 4
ABC Company’s management wants to prepare
an income statement for the year 2008. The
operating information for the year are given
below:
Required: using absorption and marginal
costing
1. Compute the inventor able cost per unit
2. Prepare Income statement for the year 2008

Beginning inventory 0
Production 800 units
Sales 600units
Ending Inventory 200 units
Selling price Br.100
Variable manufacturing cost per unit:
 Direct material cost per unit 11
 Direct manuf. labor cost per unit 4
 Manufacturing overhead cost per unit 5
Total variable manufacturing cost per unit 20
Variable selling & Adm cost per unit 19
Total Fixed manufacturing Overhead cost 12,000
Total Fixed selling & Adm Expenses 10,800

Job Order Cost System
 Costs are assigned to each job or batch.
 Key feature: Each job or batch has its own
distinguishing characteristics.
 Objective: Compute the cost per job.
 Measures costs for each job completed – not for set
time periods.
 Furniture companies, service firms and repair shops
are some examples that use job order costing
5.5 Job order Vs. Process Costing

 Used when a large volume of similar products are
manufactured – cement production, refining of
petroleum, production of ice cream.
 Costs are accumulated for a time period – (week or
month).
 Costs are assigned to departments or processes for a
specified period of time.
Process Costing System

Illustration 17-3
Nature of job order & Process Cost Systems

Job order Vs. Process Costing Systems

 Allocates overhead using a single predetermined rate.
► Job order costing: direct labor cost may be the relevant
activity base.
► Process costing: machine hours may be the relevant
activity base.
 Assumption was satisfactory when direct labor was a major
portion of total manufacturing costs.
► Wide acceptance of a high correlation between direct labor
and overhead costs.
Traditional Costing Systems
5.6 Traditional Costing vs Activity-Based Costing

Activity-Based Costing
 ABC allocates overhead costs in two stages:
Stage 1: Overhead costs are allocated to activity cost pools.
Stage 2: Assigns overhead allocated to the activity cost
pools to products, using cost drivers.
 The more complex a product’s manufacturing operation, the
more activities and cost drivers are likely to be present.
Traditional Costing and Activity-Based Costing

Over Head cost Allocation in Activity-Based Costing

Exercise 5
Sino-Afro Optics produces two types of eyeglasses – standard
and deluxe. Operational data for 2013 is provided below
The company has a traditional costing system in which
manufacturing overhead is applied to units based on direct
labor-hours. Data concerning manufacturing overhead and
direct labor-hours for 2013 appear below:
143
Items Standard Deluxe
Unit direct material cost 900.00 1,200.00
Unit direct labor cost 144.00 192.00
Unit direct labor hour 0.60 0.80
Estimated annual production units 70,000.00 10,000.00
Estimated total manufacturing overhead 2,900,000
Estimated total direct labor hours 5,000

Required:
144
1. Determine unit product costs of the Standard and Deluxe
products under the company’s traditional costing system.
2. The company is considering replacing its traditional costing
system with an activity-based costing system. Below is data
relevant to the activity-based costing system which has three
activity cost pools:
Determine unit product costs of Deluxe and Standard under
the activity-based costing system.
Activity and activity measures Estimated
overhead cost
Expected activity
Standard Deluxe Total
Supporting direct labor (direct labor hrs) Br.1,500,000 4,200 800 5,000
Batch setups (setups) 600,000 50 200 250
Safety testing (tests) 800,000 20 80 100
Total manufacturing overhead cost Br.2,900,000

Unit 6: Cost – Volume – Profit (CVP)
Analysis
6.1 What is CVP analysis?
Cost-Volume-Profit is the manner of evaluating the
total revenues, the total costs and operating profit,
as changes occur in volume of production, sales
price, unit variable cost and fixed costs of a product.
CVP Assumptions:
1. All costs can be analysed into their fixed and variable elements.
2 . Fixed costs remain fixed even over a wide range of activity.
3. Variable costs always vary directly with activity.
4. Selling prices & variable costs are constant per unit.
5 . Only levels of activity affect costs and revenues
6. Only one product can be effectively dealt with

The importance of CVP
• Managers use this analysis to answer different questions
like
• How will incomes and costs be affected if we still sell
1.000 units? But if you expand or reduce selling prices?
If we expand our business in foreign markets ?
• The cost-volume-profit is a necessary tool for
forecasting and management control.
• We use the following abbreviations in CVP analysis
146
SP Unit selling price
VC Unit variable cost
CM Unit Contribution Margin
FC Total Fixed cost
Q Quantity of out put
TOI Target Operating Income
NI Net Income
t Tax rate

6.2 Applications of CVP Analysis
1. Break-Even Analysis : Break even point (BEP) is
the level of sales at which profit is zero. According
to this definition, at break even point sales are
equal to fixed cost plus variable cost . Formula to
calculate BEP can be derived from the following
equation.
[Break even sales = fixed cost + variable cost]
TR-TC = Profit TR-TC=0
Where: Q= output and SP=price
if: (Q*SP)-FC-(Q*VC)=0
(Q*SP)-(Q*VC)-FC=0
Q(SP-VC)=FC
VC
SP
FC
Q


147

2. Target Operating Income
How many units of product X should be
produced and sold to reach a target operating
income of TOI. The following formula will be
used to calculate quantity produced to attain
target operating income of TOI.
VC
SP
TOI
FC
Q



149

3. Net income after tax
Quantity for target net income after tax (NI)
will be calculated using the following formula
VC
SP
t
NI
FC
Q



 1
150

4. Sensitivity Analysis
• Sensitivity analysis is a “what if” technique that
managers use to examine how a result will
change if the original predicted data are not
achieved or if an underlying assumption
changes.
• In the context of CVP analysis, sensitivity analysis
answers the following questions:
– What will be the operating income if units sold
decrease by 15% from original prediction?
– What will be the operating income if variable cost per
unit increases by 20%?
151

5. Safety Margin:
is the difference between budgeted sales
revenue and break-even sales revenue. The
amount by which sales can drop before
losses begin to be incurred.
Margin of Safety = Actual/budgeted Sales - Breakeven Sales
152

Exercise 6
ABC Company is a retailer of office soft ware packages .ABC
sells each office soft ware package at $200 to customers. ABC
purchases each packages for $120 from a whole seller .In
addition a fixed cost of $2000 will be incurred with in a
relevant range of 0- 120 soft ware packages bought and sold
Requirements (solved independently)
a. What is the break-even point in quantity and in dollar
amount?
b. Show the break-even point using break-even chart
c. How money units must be sold to earn target operating
income of $1200. What is the dollar value of unit sold?
d. Calculate the margin of safety in quantity and in dollar
considering requirement “b” & “ c” above
e. What quantity of soft ware package should be sold to earn a
net income of $960 assuming an income tax rate of 40%
153

f) Assume that currently ABC Company is selling 50
units of office software package; ABC is considering
placing an advertisement that will increase sales by 10%.
Additional fixed cost of $500 will be incurred because of
the advertisement. Should ABC advertise or not? Why?
or why not?
g) Assume that currently ABC Company is selling 50
units of office soft ware package. ABC is contemplating
whether to reduce the selling price to $185. At this
price, it will sell 60 unites. At this quantity the soft ware
whole seller who supplies the office soft ware will sell
the package to ABC for $115 per unit instead of
$120.Should ABC reduce the selling price or not? Why?
Or why not?
154

Unit 7: Alternative Choice Decisions
7.1 Steps in Decision Making?
Decision making is the process of choosing the best course of
action from alternatives available for a given problem. Decision
process involves several steps. These steps include:
1. Recognize and define the problem
2. Identify alternative solution to the problem
3. Identify the cost and benefits of each alternatives
4. Evaluate each alternatives solution from there cost and
benefit point of view
5. Assess qualitative factors related to each solution.
6. Select the alternatives with the greatest benefit
7. Implement the alternatives selected
8. Follow up

Relevant and Irrelevant Information
Is the item a future
cost or benefit?
The cost or
benefit is not
a relevant item.
Does the cost or
benefit differ
from decision
alternatives?
The cost or
benefit is not
a relevant item.
The cost or benefit
is a relevant item.
No
No
Yes
Yes

Decision Problems
The followings are some of the non routine decision
making problems which managers will encounter:
1. One time only special order
2. Make or buy (in sourcing or outsourcing)
3. Eliminate or keep an Unprofitable Segment
4. Sell at split off or process further decision
5. Pricing decision
6. Carrying cost of inventory
7. Equipment replacement decision
8. Product mix under capacity constraint

7.2 One-Time-Only Special Orders
Accepting or rejecting special orders when
there is idle production capacity and the
special orders has no long-run implications
Decision Rule: does the special order generate
additional operating income?
– Yes – accept
– No – reject
Compares relevant revenues and relevant
costs to determine profitability

Sunbelt Company produces 100,000 Smoothie blenders per month,
which is 80% of plant capacity. Variable manufacturing costs are $8 per
unit. Fixed manufacturing costs are $400,000, or $4 per unit. The
blenders are normally sold directly to retailers at $20 each. Sunbelt has
an offer from Kensington Co. (a foreign wholesaler) to purchase an
additional 2,000 blenders at $11 per unit. Acceptance of the offer would
not affect normal sales of the product, and the additional units can be
manufactured without increasing plant capacity. What should
management do?
Exercise 7

Baron Company incurs the following annual costs in producing
25,000 ignition switches for motor scooters.
Instead of making its own switches, Baron Company might
purchase the ignition switches at a price of $8 per unit. “What do
you advice Baron Company?”
7.3 Make or Buy Decision

Cont’d -----
1. Assume that through buying the switches,
Baron Company can use the released productive
capacity to generate additional income of
$38,000 from producing a different product.
Should the management make or Buy switches?
2. Assume that through buying the switches,
Baron can rent the idle capacity for $ 12,000.
Should the management make or Buy switches?

Exercise 8: Woodmasters Inc. makes tables. The cost to
manufacture an unfinished table is $35. The selling price per
unfinished unit is $50. Woodmasters has unused capacity that can
be used to finish the tables and sell them at $60 per unit. For a
finished table, direct materials will increase $2 and direct labor costs
will increase $4. Variable manufacturing overhead costs will increase
by $2.40 (60% of direct labor). No increase is anticipated in fixed
manufacturing overhead. Should Woodmasters process further?
7.4 Sell or Process Further Decision

Exercise 9: Venus Company manufactures three models of tennis
rackets:
 Profitable lines: Pro and Master
 Unprofitable line: Champ
Illustration 21-16
Should Champ
be eliminated?
7.5 Eliminate or keep an Unprofitable Segment

The price of a good or service is affected by many factors.
 Company must have a good understanding of market forces.
 Where products are not easily differentiated from competitor
goods, prices are not set by the company, but rather by the
laws of supply and demand – such companies are called price
takers.
 Where products are unique or clearly distinguishable from
competitor goods, prices are set by the company.
7.6 Pricing Decision

 Laws of supply and demand significantly affect product price.
 To earn a profit, companies must focus on controlling costs.
 Requires setting a target cost that will provide the company’s
desired profit.
 Target cost: Cost that provides the desired profit when the
market determines a product’s price.
Target Costing

 First, company should identify its market niche where it wants to
compete.
 Second, company conducts market research to determine the
target price – the price the company believes will place it in the
optimal position for the target consumers.
 Third, company determines its target cost by setting a desired
profit.
 Last, company assembles a team to develop a product to meet
the company’s goals.
Target Costing

 In an environment with little or no competition, a company
may have to set its own price.
 When a company sets price, the price is normally a function of
product cost: cost-plus pricing.
 Approach requires establishing a cost base and adding a
markup to determine a target selling price.
 In determining the proper markup, a company must consider
competitive and market conditions.
 Size of the markup (the “plus”) depends on the desired return
on investment for the product:
Cost-Plus Pricing

Exercise 10: Thinkmore Products, Inc. is in the process of setting a
selling price on its new video camera pen. It is a functioning pen that
will record up to 2 hours of audio and video. The per unit variable
cost estimates for the new video camera pen are as follows.
Cost-Plus Pricing

In addition, Thinkmore has the following fixed costs per unit at a budgeted
sales volume of 10,000 units. If Thinkmore is planning to use 30% markup on
Cost, what will be the selling price under each of the following alternative
conditions
1. Total cost is used as a base
2. Variable cost is used as a base
Cost-Plus Pricing

8.1 Fundamentals of Budgeting
A Budget is a formal written statement of management’s
plans for a specified future time period, expressed in
financial terms.
 Primary way to communicate agreed-upon objectives
to all parts of the company.
 Promotes efficiency.
 Control device - important basis for performance
evaluation once adopted.
Unit 8: Budgetary Planning and Control

Length of Budgeting
• Strategic plan is a plan that sets the overall goals
and objectives of the organization
• Long-range planning produces forecasted financial
statements for 5- or 10-year periods. Long-range
planning are coordinated with capital budgets
• Capital budget is a budget that details the planned
expenditures for facilities, equipment, new
products, and other long - term investments
• The master budget is an annual business plan that
includes a coordinated set of detailed operating
schedules and financial statements .

Financial budget
A major part of a master budget that focuses on the
income statement and its supporting schedules.
Operating budget (profit plan)
The part of a master budget that focuses on the effects that
the operating budgets and other plans (such as capital
budgets) will have on cash.
8.2 Operating and Financial Budget
The two major parts of a master budget are the operating budget and
the financial budget.

Financial Budget
Operating Budget
Sales Budget
Purchases Budget
Cost- of- Goods - Sold Budget
Operating Expenses Budget
Budgeted Statement
Of income
Budgeted
Balance
Sheet
Cash
Budget
Capital
Budgets
Ending inventory
Budget

 Requires all levels of management to plan ahead.
 Provides definite objectives for evaluating performance.
 Creates an early warning system for potential problems.
 Facilitates coordination of activities within the business.
 Results in greater management awareness of the entity’s
overall operations.
 Motivates personnel throughout organization to meet
planned objectives.
Benefits of Budgeting

Exercise 11
On January 1, 2014, Hardin Company budget
committee has reached agreement on the
following data for the 6 months ending June 30,
2014.
– Sales : First quarter 5,000; second quarter 6,000; third
quarter 7,000.
– The selling price in the three quarters is $30 per unit
– Ending raw materials inventory: 40% of the next
quarter’s production requirements.
– Ending finished goods inventory: 25% of the next
quarter’s expected sales units.
– Third-quarter production: 7,200 units.

• The ending raw materials and finished goods
inventories at December 31, 2013, follow the same
percentage relationships to production and sales that
occur in 2014.
• Three pounds of raw materials are required to make
each unit of finished goods. Raw materials purchased
are expected to cost $4 per pound
• 2 hours of direct labor hours are required to produce
each unit at the rate of $3 per hour
Instructions: Prepare the following budgets for Hardin Company by
quarters for the 6-month period ended June 30, 2014.
a) Sales budget
b) Production budget
c) Raw material usage budget
d) Raw material purchase budget
e) Direct labor budget

Budgeting Techniques
• Zero Base Budgeting
• Incremental Budgeting
• Line Item Budgeting
• Program Budgeting
• Rolling Budgeting

Budgetary control involves the following activities.
8.3 Static Budget & Flexible Budget

Static budget is a projection of budget data at the
beginning level of activity.
 When used in budgetary control, each budget
included in the master budget is considered to be
static.
 Ignores data for different levels of activity.
 Compares actual results with budget data at the
activity level used in the master budget.
Static Budget

Flexible budget projects budget data for various levels of
activity.
 Budgetary process is more useful if it is
adaptable to changes in operating
conditions.
 Essentially a series of static budgets at
different activity levels.
 Can be prepared for each type of budget in
the master budget.
Flexible Budgets

8.4 Flexible Budget and sales volume variance
• The difference between static budget and actual
performance is called static budget variance
• There are basically two reasons why actual
results might differ from the master budget
– Sales and other cost-driver activities were not the
same as originally forecasted (sales volume
variance).
– Revenue or variable costs per unit of activity and
fixed costs per period were not as expected (
Flexible budget variance)

Static-budget
variance
Flexible-budget
variance
Sales-volume
variance

8.5 Cost Variances
In order to find out the real cause of a
variance, further variance analysis should be
made. The followings are the different levels
of variance analysis that can be made.
Level 0 variance analysis

Exercise 12
XYZ Company manufactures and sells jackets to
retailers. The company has three variable costs
and one fixed cost. There are no other
operating expenses. The followings are the
budgeted and actual data for XYZ Company for
the year ended 2015
Budget Actual
Units sold 12,000 units 10,000units
Selling price $120 $125
DM cost per unit 60 62.16
DL cost per unit 16 19.8
VMOH cost 12 13.05
FMOH cost $276,000 $285,000

There is no beginning or ending inventories and the
relevant rang in which fixed cost remains constant
is from 0-12,000 units
Requirements:
1. Prepare budgeted income statement for 2005
2. Prepare actual income statement for 2005
3. Make level 0 variance analysis
4. Make level 1 variance
5. prepare the flexible budget at the end of 2005
6. Make level 2 variance analysis

8.6 Standard Costing
A standard is a norm against which the actual
performance can be measured.
– Ideal standard – a standard that a company
sets in which they meet their maximum degree
of efficiency. Does not take inefficient
conditions & wastages into consideration.
– Attainable standard – includes factors such as
lost time and normal wastes and spoilages.
Slide # 186

Determining Standards
• Materials cost standard
– Material Quantity standard is determined based on the
production or engineering department’s estimate of
the amounts and types of materials needed for
production of one unit of a product.
– Material price standard is based on the purchasing
agent’s knowledge of suppliers’ prices for one unit of
direct material.
• Labor cost standard
– Labor time standard is the time necessary to perform
one unit of a product established by experts under
normal condition.
– Labor rate standard :Human resource department will
provide the prevailing wage rates in the mkt.
Slide # 187

Determining Variances
• A variance is the difference between the actual
and the standard costs of materials, labor, and
overhead.
• The differences may be in usage and in prices.
• Therefore, the are four types of variance for
direct material and direct labor
– Materials price variance
– Materials quantity variance
– Labor rate variance
– Labor efficiency variance
Slide # 188

Materials and labor Variances
• DM Price or DL Rate Variances
• DM Quantity or DL Efficiency Variance
Slide # 189

Exercise 13
Assume XYZ Company that produces Male’s jacket in illustration 11 above and has
made the following standards for direct costs
Direct material
• Standard direct material for one Jacket---------- 2 squar yard
• Standard price per square yard of direct material------ $30
Direct labor
• Standard direct labor per Jacket----------------------- 0.8 hour
• Standard rate per hour ---------------------------------- $20
Actual result for each direct cost category for the 10,000 Jacket manufactured and sold
in 2015 are:
Direct material purchased and used
• inputs purchased and used ------------ 22,200 square Yard
• Actual price incurred per square yard -------------- $28
Direct manufacturing labor
• Direct manufacturing labor hours used ----------- 9000 hours
• Actual price incurred per labor hour ---------------- $22
Slide # 190

Required:
a) compute the flexible budget variance for direct
material
b) compute the flexible budget variance for direct
labor
c) compute the price and efficiency variance for
direct material cost and compare their sum with
the flexible budget variance you obtained in “a”
d) compute the price and efficiency variance for
direct labor cost and compare their sum with
the flexible budget variance you obtained in “b”
Slide # 191

8.7 Causes of variances
Causes of Direct material variance
• Raw material price fluctuations
• Poor planning resulting in emergency purchase
• loss of discount
• high transportation cost
• failure to take advantage of seasonal purchase
• uneconomical size of order
• Poor quality material resulting in more wastage
• Careless in handling of material in stores and on
shop floor

Causes of Labor Variances
1. Revision in pay scale
2. Industrial unrest
3. Overtime working
4. Use of incorrect grade of workers
5. Use of trainees in place of regular workers
6. Poor planning and scheduling
7. Poor supervision
8. Poor maintenance of machines
9. Poor quality of material
10. Increase in labor turnover
193

Just-In-Time Inventory Methods
 Inventory system in which goods are manufactured or
purchased just in time for sale.
 Reduce defects in finished products progressively with
the goal of zero defects in the long run.
Total Quality Management (TQM)
Chapter 9 : Managerial Accounting Today
Slide # 194

Balanced Scorecard
• The Balanced Scorecard is a strategic-based performance
measurement system that typically identifies objectives
and measures for four different perspectives
• In the early 1990s, Robert Kaplan and David Norton
introduced the balanced Scorecard
• Adopted by many companies in the 90’s
• More popular in Europe
• Popular with Government organizations
• Widely used in Education

The Balanced Scorecard perspectives

Refers to all business process associated with providing a
product or service.
For a manufacturing firm these include the following:
LO 8 Identify trends in managerial accounting.
Focus on the Value Chain
Managerial Accounting Today

What Does Kaizen Mean?
KAI ZEN
To modify, to change Think, make good, make better
= KAIZEN
Make it easier by studying it, and making the improvement
through elimination of waste.
+

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