MANAGEMENT ADVISORY SERVICES (MAS)

Number of items: 70 multiple-choice questions (MCQs), mix of theories and problems

Topics covered (based on CPA Syllabus effective May 2019):

Part I – MANAGEMENT ACCOUNTING (43%)

• Introduction to Management Accounting

• Cost Concepts and Behavior

• Cost-Volume-Profit Analysis

• Variable and Absorption Costing

• Standard Costing & Variance Analysis

• Financial Planning & Master Budget

• Activity-Based Costing & Activity-Based Management

• Strategic Cost Management

• Responsibility Accounting

• Balanced Scorecard

• Quantitative Techniques

• Relevant Costing & Differential Analysis

Part II – FINANCIAL MANAGEMENT (40%)

• Financial Statement Analysis

• Working Capital Management & Finance

• Operating Leverage, Financing Leverage and Total Leverage

• Capital Budgeting

• Cost of Capital

• Risks and Returns

• Capital Structure & Long-Term Financing Decision

Parts III, IV & V – “THE OTHERS” (17%)

• Macroeconomics

• Microeconomics

• Management Consultancy

• Project Feasibility Studies

• Ethical Considerations, among others

MANAGEMENT ADVISORY SERVICES (MAS)

Number of items: 70 multiple-choice questions (MCQs), mix of theories and problems

Topics covered (based on CPA Syllabus effective May 2019):

Part I – MANAGEMENT ACCOUNTING (43%)

• Introduction to Management Accounting

• Cost Concepts and Behavior

• Cost-Volume-Profit Analysis

• Variable and Absorption Costing

• Standard Costing & Variance Analysis

• Financial Planning & Master Budget

• Activity-Based Costing & Activity-Based Management

• Strategic Cost Management

• Responsibility Accounting

• Balanced Scorecard

• Quantitative Techniques

• Relevant Costing & Differential Analysis

Part II – FINANCIAL MANAGEMENT (40%)

• Financial Statement Analysis

• Working Capital Management & Finance

• Operating Leverage, Financing Leverage and Total Leverage

• Capital Budgeting

• Cost of Capital

• Risks and Returns

• Capital Structure & Long-Term Financing Decision

Parts III, IV & V – “THE OTHERS” (17%)

• Macroeconomics

• Microeconomics

• Management Consultancy

• Project Feasibility Studies

• Ethical Considerations, among others

MANAGEMENT ADVISORY SERVICES (MAS)

Number of items: 70 multiple-choice questions (MCQs), mix of theories and problems

Topics covered (based on CPA Syllabus effective May 2019):

Part I – MANAGEMENT ACCOUNTING (43%)

• Introduction to Management Accounting

• Cost Concepts and Behavior

• Cost-Volume-Profit Analysis

• Variable and Absorption Costing

• Standard Costing & Variance Analysis

• Financial Planning & Master Budget

• Activity-Based Costing & Activity-Based Management

• Strategic Cost Management

• Responsibility Accounting

• Balanced Scorecard

• Quantitative Techniques

• Relevant Costing & Differential Analysis

Part II – FINANCIAL MANAGEMENT (40%)

• Financial Statement Analysis

• Working Capital Management & Finance

• Operating Leverage, Financing Leverage and Total Leverage

• Capital Budgeting

• Cost of Capital

• Risks and Returns

• Capital Structure & Long-Term Financing Decision

Parts III, IV & V – “THE OTHERS” (17%)

• Macroeconomics

• Microeconomics

• Management Consultancy

• Project Feasibility Studies

• Ethical Considerations, among others

Consultancy -
External

MANAGEMENT ADVISORY SERVICES- refers to that area of accounting work concerned with providing

advice on technical assistance to help clients improve the use of resources to achieve their goals.

MANAGEMENT CONSULTANT- a person who is qualified by education, experience technical ability, and

temperament to advise or assist businessmen on a professional basis in identifying, defining and solving

specific management problems involving the organization, planning, direction, control and operation of the firm.

FACTORS FOR THE EMERGENCE AND GROWTH OF MS CONSULTANCY

1. Growth in size and complexity of business firms

2. Complexities in managing and conducting a business

3. Lack of competent staff

4. Trend towards industrialization

5. Need for adequate and timely information in management decision-making

6. Development of techniques for the solution of management problems, and

businessmen’s awareness of their usefulness.

REASONS FOR HIRING MANAGEMENT CONSULTANTS

a. Help define specific problems and define solutions.

b. Provide specialized skills and experience.

c. Provide confidential service in which the entity of the clients is concealed.

d. Train client personnel.

e. Help improve intra-company communications.

f. Render an independent opinion.

g. Help get results.

Capital Intensive Businesses

machinery
-

,
low variances

Labor Intensive Businesses people high (maraming errors)

-

, variances

 Industrialization is the process by which an economy moves from primarily agrarian production to mass-produced and technologically advanced goods
and services. This phase is characterized by exponential leaps in productivity, shifts from rural to urban labor, and increased standards of living.

 Intracompany means occurring within or taking place between branches or employees of a company.

Activities
Non-recurring
 MAS BY CPAs- CPAs performing management consulting and other advisory services are considered in the practice of
professional accounting and are bound by the Code of Ethics for Professional Accountants.

Characteristics of Management Advisory Services:

1) Services are rendered for the management rather than for third parties.
2) Involves problem solving.
3) Relates to the future. Forecasting
4) Broad in scope.
5) Involves varied assignments.
6) Engagements are usually none-recurring.
7) Engagements require highly requires qualified staff.
8) Human relations play a vital role in each engagement.

 Non-Recurring Item? In accounting, a non-recurring item is infrequent or abnormal transactions/events that is reported in the company's financial
statements/company occurences. Unlike other items reported by a company, non-recurring items do not arise from the normal company's operations.

Broad Areas of MAS

A) AREAS WHICH ARE NORMALLY RELATED TO THE ACCOUNTING AND FINANCE
FUNCTIONS

1) Financial Accounting
2) Management Accounting System Design and Development CFO Position

3) Budgetary Controls Budget

Master

Variances

The field covers the following:

 Cost Accounting
 Development of standard cost system
 Cost analysis and control
 Variance analysis

 Financial Management
 Establishment of capital budgeting procedures
 Study of the cost of capital and cost of debt
 Financial analysis for project studies
 Establishment of operating and cash budgets
 Valuation of common stock for purposes of mergers and sale
B) AREAS WHICH ARE NOT NORMALLY RELATED TO THE ACCOUNTING AND FINANCE
FUNCTIONS

1. General Management Consultation

Efficiency maximizing inputs to
get desired results
-

 Management or Operations Audit Effectiveness

- getting desired results

 Measurement of operating Performance (KPIs)


A +B A/B
Mergers and Acquisitions Programs Merger
- =


A +B
=

Consolidation
Development of Compensation Programs
-

 Pension Plan Review Acquisition

-

 Special Studies on Industry Potential

 Long-Range Planning Strategic Planning (mas
-

mahaba & mas

maraming long-range planning)

 Operational audit is a systematic review of effectiveness, efficiency and economy of operation. Operational audit is a future-oriented, systematic, and
independent evaluation of organizational activities.

 Key performance indicator is a quantifiable measure used to evaluate the success of an organization, employee, etc. in meeting objectives for performance.

 Business mergers involve two or more companies combining through a takeover and the emergence of one surviving company. On the other hand, business
consolidation happens when two or more companies combine to create a new single company.

 An acquisition is a business transaction that occurs when one company purchases and gains control over another company.

 Long range planning is the process used to implement an organization’s strategic plan. It is about aligning the business’ long-term goals and developing
action plans in line with the strategic plan. The times scale for long range plans can vary from three years to one or two decades depending on the type of
business.

 Strategic planning is a process to determine long-term organizational goals after careful examination of the organization’s current business and what it
should become.

2. Project Feasibility Studies Master

Budget :
Nominal to Real Accounts

sales to Assets ()
?

 Involves financial, technical and marketing evaluation of proposed projects

3. Organization and Personnel

 Review of Existing Organization Structure
 Organization and Administrative Manual Preparation
 Job Evaluation and Salary Administration
 Development of Personnel Rating Program
 Retirement Plan Studies
 Studies of Cost reduction System
 Determining of Cost Alternatives in Collective Bargaining Agreements

 Cost reduction is the process of decreasing a company's expenses to maximize profits.

 The CBA is the result of an extensive negotiation process between the parties regarding topics such as wages, hours, and terms and conditions of
employment.

4. Industrial Engineering
Non-value adding activities

 Production, Planning, Scheduling and Control

Value-adding activities

 Plan Layout Studies

 Inventory Management Studies
 Materials Cost System Design and Development
 Preventive Maintenance System Design and Development
 Development of Work Studies
 Purchasing Management, including Value Analysis
 Industrial engineers develop job evaluation programs, amongst other duties. Industrial engineers find ways to eliminate wastefulness in
production processes. They devise efficient systems that integrate workers, machines, materials, information, and energy to make a product
or provide a service.

 Plan layout shows a detailed layout of the whole site and the relationship of the proposed works with the boundary of the property, nearby
roads, and neighbouring buildings.

 Work study is the investigation, by means of a consistent system of the work done in an organization in order to attain the best
utilisation of resources.

 Just-in-time, or JIT, is an inventory management method in which goods are received from suppliers only as they are needed. The main
objective of this method is to reduce inventory holding costs and increase inventory turnover. Opportunity cost

Time
Lagged Importation 2-3 months
-

 EOQ is short for economic order quantity, the ideal order size for any product-driven business.
Reorder Point

Cost
Holding Cost Ordering

5. Marketing
 Product Profitability Analysis
 Pricing Policy Determination
 Market Forecasting
 Distribution Cost Analysis
 Salesmen’s Incentive Compensation Evaluation

 Forecasting is a technique that uses historical data as inputs to make informed estimates that are predictive in determining the direction
of future trends. Businesses utilize forecasting to determine how to allocate their budgets or plan for anticipated expenses for an
upcoming period of time.

6. Operations Research
Involves the use of mathematical techniques, such as

1. Linear programming a mathematical technique for maximizing or minimizing a linear function of several variables, such as
output or cost.

2. PERT/CPM: PERT is a visual project management technique where we plan, schedule, organize, coordinate and control uncertain
activities. Whereas CPM is a statistical technique where we plan, schedule, organize, coordinate and control well-defined activities.
CPM is a method used to control cost and time. CPM -
certain

PERT-uncertain ; optimistic ,
most-likely , pessimistic

3. Queuing theory scrutinizes the entire system of waiting in line, including elements like the customer arrival rate, number of
servers, number of customers, capacity of the waiting area, average service completion time, and queuing discipline.

4. Simulation, the imitation by one system or process of the way in which another system or process works.

5. etc. to solve operational problems.

 PERT refers to Program (Project) Evaluation and Review Technique.

 CPM refers to Critical Path Method.
 PERT uses a three-point estimation. They are optimistic, Most likely, and pessimistic.
 In CPM, we are supposed to assume that the project duration is certain. It is generally used to ascertain every activity’s earliest possible
starting time.
The services listed above are neither necessarily exhaustive nor complete. The practitioner may offer other services not
mentioned above depending on the practitioner’s competence, experience, technical ability, and professional integrity to meet
or deliver such other services he offers.

MAS QUALIFICATIONS BASED ON REQUIRED EXPERTISE

1. Usual Services:
 Evaluation of form of business organization
 Analysis of financial and operating statements
 Design and installation of accounting systems
 Design for filing system for storing accounting records
 Suggestions for improvement of internal control
 Establishment of control to assist management and expedite the audit process
 Preparation of insurance claims in case of business interruption
 Research and evaluation of alternative methods of handling a transaction for its effect
on finance and tax consequences
 Assistance in the preparation of forecasts and budgets
 Presentation and explanation of statements
 Assisting clients on purchase or sale of business
 Testifying on client’s behalf
 Determination of the effect of various employee compensation plans on net income
 Aid in labor union negotiations

2. Somewhat Specialized Services:

 Assisting in the installation of a mechanized accounting system
 Making a cost analysis of operations
 Finding sources of capital and figuring the approximate cost of small business loans, bond issue, and stock issuance
 Giving advice on dividend policy and plans for expansion
 Calculations on government contracts and allocating costs in complete with reporting requirements
 Advising on accounting and tax matters relative to estate planning
 Surveying credit losses
 Assisting in bankruptcy and receivership proceedings
 Recruiting accounting and bookkeeping personnel for the client
 Preparing an analysis of paper flow
 Presenting and analyzing the pros and cons of various retirement and profit-sharing plans
 Advising on various wage incentive plans

3) Highly Specialized Services:

 Reviewing the organization structure
 Auditing management policies
 Conducting motion studies
 Surveying an industry of trade for current trends
 Evaluating the desirability of a particular are for plant location
 Preparing market analysis
 Reviewing an insurance program
 Advertising on data processing allocations

 Assurance services are less formal than a financial statement auditor attestation services. Non-assurance services include other management
consulting, accounting andbookkeeping, tax services, and certain management consulting, which can also be defined underassurance services.

 In external audit, the lower the risk of internal control the higher the allowable detection risk can be (Scope of substantive testing).

 Dividend policy is concerned with financial policies regarding paying cash dividend in the present or paying an increased dividend at a later stage.

 There are four types of dividend policy. First is a regular dividend policy, the second is an irregular dividend policy, the third is a stable dividend
policy, and lastly no dividend policy.
  Credit losses is the Possible percentage or amount of losses from receivables

 PaperFlow streamlines document management by converting your paper documents into easy-to-manage electronic files. You can scan, index
and organize paper documents right from your desk, and then use those files with your other business applications.
packs

 Motion study is a systematic way of determining the best method of doing the work by scrutinizing the motions made by the worker or the Ideal capacity 120

machine. Normal Capacity 90-100

Lax capacity 30-40

 Value-Added Activities: These are those activities for which the customer is willing to pay for. Non-Value-Added Activities: These are those
activities for which the customer is not willing to pay for. They only add to cost and time.

ADVANTAGES OF CPAs OVER OTHER PROFESSIONALS IN MAS PRACTICE - They are already familiar with
the client and his business, and enjoy the client’s confidence. - They are members of a profession with recognized standing
and equipped with technical knowhow in accounting and taxation.

ANALYTICAL APPROACH AND PROCESS

3 BROAD STAGES

1. Analysis Stage – consists of ascertaining the pertinent facts and circumstances, seeking and identifying objectives, and defining
the problem or opportunity for improvement.

2. Design Stage – consists of evaluating and determining possible solutions and presenting findings and recommendations.

3. Implementation Stage – consists of planning and scheduling actions and advising and providing technical assistance in
implementing.

IN FULL SCOPE ENGAGEMENTS. These cover all the 3 broad phases in the analytical process. CONSULTANT: limited to
that of an advisor; in the implementation stage, his role is merely to provide technical assistance.

IN SPECIAL STUDY ENGAGEMENTS. The client seeks only an impartial and objective study of a case and the resulting
recommendations. These involve only up to design stage broad stages of analytical process.

CONSULTANT: apply objective judgment to the facts, and present findings and recommendations to the client for decision and
further action.

CLIENT: to supply pertinent information and to make decision on the case. Any action beyond the point of decision is solely the
responsibility of the client.

IN INFORMAL ADVICE. Its structure is informal and no presumption should exist that an extensive study has been performed.

CONSULTANT: to respond as practicable at the moment and express the basis for the response
MAS PRACTICE STANDARDS All CPAs engaged in MAS practice should observe a set of MAS Practice Standards, which are classified into
general and technical standards. These practice standards are as follows:

General Standards:

 PROFESSIONAL COMPETENCE (expected minimum competence)

 DUE PROFESSIONAL CARE (reasonable care and diligence)
 PLANNING AND SUPERVISION (in accordance of the agreement)
 SUFFICIENT RELEVANT DATA (to provide a reasonable basis for making conclusions and formulating recommendations)
 FORECASTS (consultant not required to vouch)

Technical Standards

 ROLE OF MAS PRACTITIONER (independence and not assume the role of management).
 UNDERSTANDING WITH THE CLIENT (documentation and written agreement).
 CLIENT BENEFIT (benefits known before start of engagement and reservation should made known to the client)
 COMMUNICATION OF RESULTS (if not all, significant information should be relayed to the client)

STAGES IN MAS MANAGEMENTS Engagements: 1. Negotiating 2. Preparation 3. Conducting 4. Preparing and

presenting the reports and recommendations 5. Implementation 6. Evaluation 7. Post engagement follow-up

These stages constitute the specific activities involved in the MAS engagement cycle which, in general terms, are the
following: 1. Pre-engagement considerations 2. Engagement planning 3. Engagement management and execution 4.
Engagement conclusion
 Activity
Total Cost T

Unit cost =

Activity
Total cost =

Unit cost

(indirect)

Relevant Range -the band or level of activity where the cost concepts and the relationship of
variable and fixed costs is considered valid. There must exist linear relationship between the cost
and the corresponding activity (cost driver)
How to separate the Variable cost and Fixed cost on a semi variable or mixed cost?

3 ways:

1) High-Low Method: The high-low method involves taking the highest level of activity and the
lowest level of activity and comparing the total costs at each level. If the variable cost is a fixed
charge per unit and fixed costs remain the same, it is possible to determine the fixed and variable
costs by solving the system of equations.

 The high-low method, as the name indicates, uses two extreme data points to determine the
values of a (the fixed cost portion) and b (the variable rate) in the equation Y = a + bX. The
extreme data points are the highest representative X − Y pair and the lowest representative X − Y
pair.

2) Scatter Graph Method: The scatter-graph method requires that all recent, normal data observations
be plotted on a cost (Y-axis) versus activity (X-axis) graph. The vertical axis of the graph represents
the total costs and the horizontal axis shows the volume of related activity.

3) Least-Squares regression model: is a statistical technique that may be used to estimate a linear
total cost function for a mixed cost, based on past cost data. The function can then be used to
forecast costs at different activity levels, as part of the budgeting process or to support decision-
making processes.

EY = na + bEX

EXY = EXa+bEX(squared)
 Master Budget Actual
Favorable
* variance is not always positive

Variances
* Always ~
Generally

Flexible Budget-vary depending the level activity

Standard Costing:
on
of

Static
Budget -

one level of activity

-predetermined overhead rate

/kilo

/kilo

16 1/hour
.

(24955 = 1550)

unfavorable

& STANDARD
ACTUAL
favorable

ACTUAL
STANDARD

 Priority in computing MPV will be the purchases. If there is a

MPV way to compute for purchases then use it compare to using Quantity
5 92 x43020
.
6 x 43020

258120
Based on

purchases
actual
used.
254678

3442F
STANDARD BUDGETED
 Material price variance is the difference between calculated
forecasts of how much a material costs and how much that material
costs during actual use.
Total Material Variance
:

 A material quantity variance is the difference between the

MPV 3442F
MQV 6/20U

basedon quantitis
actual amount of materials used in the production process and the
TMV 2678 U/

amount that was expected to be used.

AR X AH SR X AH

 Labor rate variance is the difference between the actual cost

of labor versus the expected cost of labor.

 Labor efficiency variance (LEV) is the difference between the

SR X AH SR X SH actual labor hours used to produce a certain output and the standard
labor hours budgeted for that output.

 Overall Labor Variance can be computed by adding both

LRV and LEV.

Total Labor Variance

Material Variances Labor Variances
LRV
APXAQ SPAQ SPSQ
155 U
45000x

r
92 643020x5 92 43020 x 642000X 6 1550 X 16
1575e
LEV 45000 x 5
400 F
. .

254678 4 258120 252000 24955 24800

266400 270000
.

TLV 245 F1
MPV 3441 6
.
F MQU 6/20U LRV 1550 LEV 400 F
MPV 3600 F

Total Material Variance

(678
. 4 U Labor Variance 245 F

Overhead Variances

800 X 50 787 5x50

750x30 7875xoe
.
.

43750 40000 39375 22800

Spending 3750U Efficiency 625U Volume 1125

Spending 300 0 F

VO Variance 4375U FO Variance 825F

Spending 4050 U

Efficiences
625 U
Budget 46e
125
 Total VO :
Total FOH :

S 3750 U S 300 U

V 1125 F
E 625 U

FO 975 F ,
VO 4375 U ,

3
VARIABLE
way FIXED way 2
way
ACTUAL VAL
ACI 4050 U
62501125 F
STANDARD STANDARD 4675U 1125 F

AP X AQ SPX AQ AP X AQ BUDGETED
Spending Efficiency Volume
Volume
SP X SQ SP X SQ Budget

volume
Spending Efficiency Spending

 A more expanded breakdown known as "four-way analysis" simply separates the spending variance into the variable and fixed
components. The four-way analysis consists of: 1.) variable spending variance, 2.) fixed spending variance, 3.) efficiency
variance, and 4.) volume variance.

 The spending variance for variable overhead is known as the variable overhead spending variance, and is the actual overhead
rate minus the standard overhead rate, multiplied by the number of units of the basis of allocation.

 Variable overhead efficiency variance refers to the difference between the true time it takes to manufacture a product and the
time budgeted for it, as well as the impact of that difference. It arises from variance in productive efficiency.

 The fixed overhead spending variance is the difference between the actual fixed overhead expense incurred and the budgeted
fixed overhead expense. An unfavorable variance means that actual fixed overhead expenses were greater than anticipated.

(EG. rent even fixed in nature may have higher amounts paid due to penalties.)

 The fixed overhead volume variance is the difference between the amount of fixed overhead actually applied to
produced goods based on production volume, and the amount that was budgeted to be applied to produced goods.

 The three-way analysis shows the difference between the total actual factory overhead and total standard factory overhead
costs split into three components: spending variance, efficiency variance, and volume variance. (SEV)

 The two-way analysis of factory overhead shows the difference between the total actual and total standard FOH costs split into
two components: budget variance and volume variance. (BV)

 Total Spending Variance: (Just the total of both spending variances)

300 UF + 3750UF= 4050 UF

Budget Variance:

Both Actual: APXAQ of VOH + APXAQ of FOH =43750+22800

Both Budgeted: SPXSQ of VOH + Budgeted FOH =39375+22500

Variance: 4675 UF
 Mixed and Yield Variances

 The Material/labor mix variance is calculated as the difference between the standard costs of the actual input
materials/labor in the actual mix used, compared to the standard cost of the actual input materials/labor if the standard
mix had been used.

 The material/labor yield variance is calculated as the difference between the standard costs of the actual input
materials/labor in the standard mix, compared to the standard cost of the standard quantity of input materials/labor in
the standard mix.

Example:

Material standard for 1 pack (200lbs pack of mixed seafoods)

30 %

60 = 200

Crab: comprise of 30% and overall 60 pounds for 1 200lbs package @USD7:20 per pound
:

45 %

90 : 200

Shrimp: comprise of 45% and overall 90 pounds for 1 200lbs package @USD4.50 per pound
:

Oyster: compromise of 25% and overall 50 pounds for 1 200lbs package @USD5.00 per pound
,

Actual production shown:

40 packs produced usage were:

Crab pounds purchased and used were 2285.7 pounds @USD7:50 per pound

Shrimp pounds purchased and used were 3649.1 pounds @USD4.40 per pound

Oyster pounds purchased and used were 2085.2 pounds @USD4.95 per pound

8020 pounds

MQV
 Labor Standard for 1 pack (200 pound package)

Department A worker (75%) (9 hours with a rate of USD 10.50 per hour)

Department B worker (25%) (3 hours with a rate of USD 14.30 per hour)

Actual shown that department A has a 450 hours’ work time with a rate of USD 10.50 per hour and department B has
a 50 hours’ work time with a rate of USD 14.40 per hour for the 40 packs.

Material Variances

Crab 142 75 457 04 17280

17323
17 .

16 .

1642095 5 16200
Shrimp

16056e
-

Oyster 10025 10 000

total 43520 53 .
1042 0 99
. 43588 7 .

43480

216 .
54 U 284 71
.
F 108 7 U
.

MPV Mix Yield

176 01
- F

MQU

40 53 .
F Material Variance

Labor Variances

35 5oe
A 4725

B 720 1716

54

Btzt se ne

en Yield

LEV

51F Labor Variance

 STATIC

 The predetermined overhead rate is set at the beginning of the year and is calculated as the estimated
(budgeted) overhead costs for the year divided by the estimated (budgeted) level of activity for the year. This
activity base is often direct labor hours, direct labor costs, or machine hours.

 Overall variance for Materials will be based on quantity used therefore the overall variance will be
P2678.4 UF on the problem given.

 Beware of just adding MPV and MQV for overall variance as the basis may be different. Generally MPV is
based on total purchase per quantity and MQV is based on used materials.

 Budget variance is considered to be controllable variance while volume variance is considered to be

uncontrollable variance.

 Benchmark is a standard or point of reference against which things may be compared or assessed.

 Performance evaluation is the process by which a manager or consultant examines and evaluates an
employee's work behaviour by comparing it with pre-set standards, documents the results of the comparison,
and uses the results to provide feedback to the employees to show where improvements are needed and why.
Responsibility accounting as a method of accounting in which cost are identified with persons assigned to their control
rather than with products or functions.

an accounting system that collects, summarizes, and reports accounting data relating to the responsibilities of individual managers. It is a
way to evaluate each manager on the revenue and expense items over which that manager has primary control.

• A responsibility accounting report contains those items controllable by the responsible manager. When both controllable
and uncontrollable items are included in the report, accountants should clearly separate the categories.

• To implement responsibility accounting in a company, the business entity must be organized so that responsibility is
assignable to individual managers. The various company managers and their lines of authority should be fully defined.

• Documentation in practice is very important especially on instances you are on some authority related to a particular
function.
Uncontrollable -

depreciation

controllable professors
-

Basic Principles of Responsibility Accounting:

• The organizational structure must be clearly defined, and responsibility delegated so that each person know his role.
• The extent and limits of functional control must be determined.
• Responsible individuals must be served with regular performance reports. (weekly, semi monthly or monthly will be
ideal)
• Every item should be a responsibility of some individuals within the organization.

No particular important transaction should be left out to be no one has responsibility, it will lead to disaster if something
went wrong and it will be line of defense of a person closest to be responsible. We simply can’t rely to implications.

In a nutshell responsibility accounting principles is all about:

• Objectives

• Controllable cost

• Management by Exception

Management by exception (MBE) is a practice where only significant deviations from a budget or plan are brought to the
attention of management.

(The idea behind it is that management's attention will be focused only on those areas in need of action. Example is variance.
Managers can hone in on that specific issue and let staff handle everything else.)

“Management by exception gives employees the responsibility to make decisions and fulfill their work or projects by
themselves.It consists of focus and analysis of statistically relevant anomalies in the data.”

Example: This model is similar to the vital signs monitoring systems in hospital critical care units. When one of the patient's
vital signs goes outside the range programmed into the machine, an alarm sounds and staff runs to the rescue. If the machine
is quiet, it's assumed that the patient is stable, and they will receive only regular staff attention.
 Decentralization decision making is
dispersed manager decides
i

.e
.
-

Benefits of Responsibility Accounting Centralization -

head always decides

• It necessitates the need of clearly defining and communicating the corporate objective and individual goals.

• Exception reporting, built into any fully developed responsibility accounting system, enables managers to concentrate on
the key issues which need their attention. (Management by exemption can be applied)

• It provides as system of closer control.

(Segmenting can make certain managers focus on his turf leading to compel management to set realistic plans and budgets.)

Implementation Process:

• Responsibility centres within the organization are identified. (Let’s say logistics, manufacturing and department store.)

• For each responsibility centre the extent of responsibility is defined. (What would be the scope of work of Production
Manager? And what things he/she is prohibited to do?)

• Accounting system that can accumulate information by areas of responsibility is specified.

(Specific accounting software designs that can filter the information per department or let say per segment)

• Controllable and non-controllable activities at various levels of responsibility are specified.

What is Controllable Cost? This is a cost that can be altered based on a business decision or need. These costs have
a direct relationship with a product, department or function.

(Examples include direct labor, direct materials, donations, training costs, bonuses, subscriptions and sues, and overhead
costs just to name a few.)

What is Uncontrollable Costs? This is a cost that cannot be altered based on a personal business decision or need. The costs
are allocated by the top management to several departments or branches.

(Examples include depreciation, insurance, administrative overhead allocated and rent allocated just to name a few.)
non-refundable

Responsibility Reporting

Responsibility reporting is an accounting and management reporting system directed towards controlling costs according to
responsibility centres.

It involves in defining and grouping of responsibilities within an organization structure, determination and assignment of cost
to appropriate levels of activities and strong emphasis and controllability
Example: A performance report of a department manager of a retail store would include actual and budgeted peso amounts
of all revenue and expense items under that manager’s control.

The report issued by the store manager (upper the department manager) would show only totals from all different
department supervisors’ performance reports and any additional items under the store manager’s control

The report to the company’s president includes summary totals of all the stores’ performance levels plus any additional items
under the president’s control. In effect, the president’s report should include all revenue and expense items in summary form
because the president is responsible for controlling the profitability of the entire company.

Important Consideration in Preparation of Responsibility Report:

• The report should include costs incurred for a particular responsibility centre. (deparment manager, store manager,
president)

• Distinguished into controllable cost and non-controllable costs depending upon the controllability relating to the concerned
responsibility.

• Common or joint costs pertaining to various responsibility centres should be allocated to Responsibility Centers. (some of
the expenses should prorated or shared by various departments example is electricity billings under one billing statement)

• Variance should be highlighted between costs incurred and budgeted cost for purpose of comparison & to take remedial
measure for adverse variance.
Responsibility centers are identifiable segments within a company for which individual managers have accepted authority
and accountability. Responsibility centers define exactly what assets and activities each manager is responsible for.

How to classify any given department depends on which aspects of the business the department has authority over?

Either:

1) Cost Centre 2) Revenue Centre 3) Profit Centre 4) Investment Centre

Cost Centers: Cost centers usually produce goods or provide services to other parts of the company. Because they only make
goods or services, they have no control over sales prices and therefore can be evaluated based only on their total costs.

One way for a cost center to reduce costs is to buy inferior materials, but doing so hurts the quality of finished goods. When
dealing with cost centers, you must carefully monitor the quality of goods.

Revenue Centers: usually have authority over sales only and have very little control over costs. To evaluate a revenue
center’s performance, look only at its revenues and ignore everything else.

Revenue centers have some drawbacks. Their evaluations are based entirely on sales, so revenue centers have no reason to
control costs. This kind of free rein encourages Al the concession manager to hire extra employees or to find other costly
ways to increase sales. Sales department is a revenue center.

Profit centres: Profit centres are businesses within a larger business, such as the individual stores that make up a mall, whose
managers enjoy control over their own revenues and expenses. They often select the merchandise to buy and sell, and they
have the power to set their own prices.

Investment Centers: You could call investment centers the luxury cars of responsibility centers because they feature
everything. Managers of investment centers have authority over and are held responsible for revenues, expenses, and
investments made in their centers. Return on investment (ROI) is often used to evaluate their performance.

Decentralization is a type of organizational structure in which daily operations and decision-making responsibilities are
delegated by top management to middle and lower-level managers.

This frees up top management to focus more on major decisions. For a small business, growth may create the need to
decentralize to continue efficient operations. Decentralization offers several advantages, though relinquishing control may
be difficult for a business owner accustomed to making all the decisions.
 Financial Statement Analysis and Working Capital Management:

FS Analysis: To look for the future by analysing the historical FS and other relevant reports.

Limitations:

 Comparison of financial data with other companies: difference with accounting treatment. Example FIFO vs. Weighted
Average.
 Beyond ratios: this indicator should be viewed as starting point for decisions in the future. Other qualitative data such as
projections, technological changes, consumer taste and within company changes should be look forward as well.

Example: (qualitative) Jollibee acquisition of Coffee bean last year.

April: Investment for business restructuring of JFC for 7BPHP
June: issuance of bond for 600MUSD for financing
July: 2nd quarter Net Income during this pandemic season.

Two ways in doing Analytical Statements:

1) Peso changes on Statements Vertical and Horizontal Analysis

2) Ratios

Horizontal analysis is all about comparison of all financial statements within the organization with a particular base year to see the
changes between same accounts in comparison of outstanding balance on a specific year. It can be more than two specific years by using
one base year which called trend percentage.

Vertical Analysis is also called Common size statement analysis. It can be used to analyse same industry businesses to know the strength
and weaknesses of the same company. For instance PSEI’s: Papa John’s vs. Shakey’s.

Peso change

25K
(25k)
-

500K

(4k)
 Base

Base

·
Ratio Analysis on stand point of stockholders:

Basic Earnings per Share= (Net Income after tax- Preferred Dividends)/# of outstanding Shares)

For instance you saw on Income Statement that the net income is P 1750,000 from statement of changes in equity preferred
S

dividends is automatically P 120,000. (Where in preferred shares of 20,000 are convertible into 5 common shares at some future
time and dividend is cumulative 6PHP/share.) From balance sheet you saw that P 5000,000 worth of shares is outstanding whereas
P10 par value per share is given. In the same period, Dividends to Ordinary stock is 1.2/share.

Solution:

(1750000-120,000)/500,000) = 3.26
J S

Cons on relying on basic EPS alone:

1) If there is extraordinary income. (Therefore create to sets using normal operations and one with inclusion of extraordinary gains or losses).
Extraordinary gains or losses should be net of tax as well.

2) Whenever a company has convertible securities on balance sheet: (Liabilities-Equity). Therefore use diluted earnings per share ratio.

Diluted Earnings/share= Net Income/Outstanding shares + potential shares. (Effect of converted share to net income will now be disregarded.)

Diluted Earnings per share= P 1750,000 /(P500k+P100k)=2.92PHP

S

20 preferreda

Price Earnings Ratio: Book Value Per Share # Market Value Per Share mP

Market
t
Price/Earnings Per Share
PIE =

Eps
= 12 3
.

It is the relationship between market price and earnings per share. Formula will be: MP/EPS. If on the given problem the MV
is 40PHP therefore P/E ratio is 12.3 by dividing to 3.26. Investors can decrease increase the PE determining how they see the
future of the company.
Prices of different Stocks in 2021:

 Symbol is the code where the trading is used in PSEi (see concepts of Beta in Cost of capital)
 Current Price: Price at the moment it has been look up ( trading hours is between 9:30AM-3:30PM with
lunch break 12:00nn to 1:00 PM) in Philippines except holidays, Saturday and Sunday.
 Previous Close: Previous day close. Let’s say today is Friday, The previous close is the closing amount last
Thursday 3:30PM.
 52 Weeks High: Highest amount within the year
 52 Weeks Low: Lowest amount within the year
 PE is Price Earnings Ratio
 Dividends is the percentage based on Current Price or Market Value.

Dividents Dividents per share 1 2

Dividend Pay-out Ratio: 36 8 %

.

= =
= .

Ratio
Pay-out 3 26.

Earnings per share

It is the relationship of declared dividends to BEPS. Formula will be Dividends/BEPS. Investors who seek growth on stock
market price want this to be small while investors who seek gains from dividends want it to be big as much as possible. The
dividends pay-out to the given problem will be 1.2/3.26=36.8%. (Capital gains vs gains through dividends). The RE if not declared
as dividends then it will be reinvested.

Dividends yield ratio:

It is the relationship between market price and dividends. This is the actual return that the investor invested in terms of
dividends and disregarding the market price growth. So if the investors have invested 40php just today and yields a dividend of 1.2
therefore 3% is the dividends yield. Formula= dividends/Market price acquisition.
Divident Dividends 1 2
.

= =
3%
Yield Ratio Market Price 40

N1 + [In+ (1-tax rate)]

Return on total Assets: Net income after tax+ (interest expense multiply to (1-tax rate)/average Total Assets. Expense x

Average Total Assets

 it shows how earnings would have been if acquired solely on equity side.
 note: Average Total asset is computed by adding (beginning assets and ending assets)/2
 This figure shows how well the assets have been used disregarding interest financing.
Assume on the problem that there is an interest expense of 640,000 and average total asset is 30,235,000. 30% tax too is
applied on the income.

Work back the interest by deducting the interest portion deductible to income tax. Assume 30% tax. Therefore: (640k*(70%) =
448000.00. the computation will then be:
S

1750,000 + 448000/30235000=7.3%
S S I

Return on Common Stockholders’ Equity:

Net Income-Preferred Dividends/(Average common stockholder’s equity)

t APIC

Assume that the average common equity including APIC related to issuance is 14,485,000 and deducting the average preferred
shares already.

(1750,000-120000) / 14485,000=11.3%

Book Value per share: (shareholders equity-preferred share equity)/Outstanding shares.

 Pump-and-dump is an illegal scheme to boost a stock's or security's price based on false, misleading, or greatly
exaggerated statements.

Usual short term ratio analysis:

Working Capital: Current Assets-Current Liabilities.

 It is a reassurance that short term liabilities will be paid in time. That’s why current in FS is important to be presented fairly to
know the sustainability of the company to such short term obligations. it is important for a smooth company run specifically on
instances like pandemic. (Cash is King in business)
 Current ratio can be used as alternative. Current Asset/ Current Liability. The rule of thumb is 2:1 current ratio is somewhat ideal
but not a general rule. Working capital requirement may vary depending on the industry. Some might need a different kind of
ratio. For instance a micro business apartment business more likely do not need big liquid amount if you do not have too much
employee.

Acid test Ratio: Cash+marketable securities+receivables/Current Liability: the best way to see the liquidity. This is a tool that
shows how well you can sustain without liquidation and relying heavily on inventory.
 Quick assets include cash on hand or current assets like accounts receivable that can be converted to cash
with minimal or no discounting.

Companies tend to use quick assets to cover short-term liabilities as they come up, so rapid conversion into
cash (high liquidity) is critical. Inventories and prepaid expenses are not quick assets because they can be
difficult to convert to cash, and deep discounts are sometimes needed to do so. (AR Assigning or pledging
or selling)

As current assets, quick assets are typically used, and/or replenished within 45 days.

Marketable securities are investments that can easily be bought, sold, or traded on public exchanges. The
high liquidity of marketable securities makes them very popular among individual and institutional investors.
These types of investments can be debt securities or equity securities.

Accounts Receivable Turnover and Inventory Turnover:

A/R turnover: Rough measure how many times A/R have been turned into cash in a year:

Formula= Sales on Account/Ave. A/R

Ave. A/R= Beginning+ Ending/2

Average Collection= 365 days/ AR turnover.

Illustration: Sales: 52M AR beg.: 4M AR end: 6M

Find the Average Collection Period and AR turnover. Assume 365 days.

What's your assessment if the average credit terms is 30 days?

AR turnover= 52M/5M= 10.4

10.4 times the A/R have been turned into cash based on Average receivables.

Average Collection= 365/10.4=35 days.

 Means to say in terms of days this is the average collection period. Compare it to you credit terms. It is not
necessarily equal but should be within the range. If there is a problem ask your collection team about this.

Inventory Turnover: measures how many times a company’s inventory has been sold and replaced during
the year.

Formula: COGS/Average inventory Balance

 Average Sales period: 365/inventory turnover

Illustrative: Average Sales period is 91.25 days and the average inventory balance is 9M

1) Find the Cost of Good Sold?

2) If it is a grocery store and the average turnover is 20 days what is the indication of the problem?

1) 91.25= 365/ inventory turnover Therefore Inventory turnover= 4 CGS/9M=4 CGS=36M

2) Your sales flow on same industry is way to slow compare to average in the industry. Check the sales support about this.
 This metric takes into account how much time the company needs to sell its inventory, how much time it takes to collect receivables,
and how much time it has to pay its bills without incurring penalties.
 CCC is one of several quantitative measures that help evaluate the efficiency of a company's operations and management.

Times Interest Earned:

Earnings Before interest and income taxes: It is synonymous with S-CGS-OE excluding interest and income taxes.

Times interest earned= EBIT/Interest expense

this ratio is used to protect the creditors. Although preferred to be paid, it should be greater vs. 2 as rule of thumb although it is
quite subjective.

Debt-Equity Ratio: Total Liabilities/ Total Equity= to analyse the reasonable balance of the composition of assets. It should be
relatively low if you are a stake holder, holding a bond of a certain company.
Economic Order Quantity is the level of inventory that minimizes
the total inventory holding costs and ordering costs.

Economic order quantity refers to that number (quantity) ordered in a

single purchase so that the accumulated costs of ordering and
carrying costs are at the minimum level. In other words, the quantity
that is ordered at one time should be so, which will minimize the total
of. Cost of placing orders and receiving the goods, and Cost of
storing the goods as well as interest on the capital invested.
Safety stock is similar to a reorder point, but it’s a surplus quantity to ensure that you don’t run completely out of stock if there are delays.

Can use percentage of lead time demand and if usually overstock lower the percentage if under then higher percentage should be used as
compare to initial percentage.

We’ll keep things simple by calculating based on two weeks of extra demand (14 days). Since the average daily sales for the Ghost are 2 (as
calculated, that means the safety stock for Ghost is about 14 x 2 = 28.
 Except CL

Cost of Capital A =
L + E

1) Another term is hurdle rate and minimum required rate of return.

2) Minimum means to say the return to maintain the market value of the firm’s securities.

On the concept of Cost of Sales and Revenue. The lower the COS means the higher the chance you generate a revenue.
Same with Cost of Capital, if you cannot find a project that can be profitable enough to cover the return of capital and cost
related to it, then do not continue to do the said proposal.

Uses of Cost of Capital:

1) Capital Budgeting Decisions: Cost of Capital will be lower or atleast equal to Net Revenues to be generated.

2) Establishing the Optimal Capital Structure:

Assets= 1) BONDS or any other liabilities + 2) PREFERRED SHARES + 3) COMMON SHARES + 4) RETAINED
EARNINGS (In cost of capital, the focal is all about different long term financing.)

An idea about the cost of each of the forgoing mentioned and the percentage beholds related to it in terms of capital
structure will lead to make a better decision making in terms of long term financing activities .

3) Making other Financial decisions: let’s say debt restructuring or issuance of new bonds (actual scenario BDO issuance
of bonds 1st week of July, 2020 Off shore loans of JFC last June etc. For every issued bonds there is a cost of capital for
that. Wondering if they have just issued a common shares or let’s say preferred shares? (Tax deductions/ dilution of
capital accounts of major stockholders)

Individual Computations to cover:

1) Cost of Debt

2) Cost of Preferred Stock

3) Cost of Common Stock

4) Cost of Retained Earnings

5) Weighted Average Cost of Capital

Cost of Debt: Imagine a scenario where your proposal will be back up by issuance of bonds, what will be the relevant
amounts?

1) Interest rates, the higher the interest rate, cost of debt increases

2) 2) The interest is tax deductible expense

 so if your interest expense amounts to 1000,000 per annum, truly speaking, it will just be 750,000 because the 250,000
S

will be deducted to total tax you will pay. Assume 25% tax and the venture is profitable.)
 Default risk of credit for different business: Interest rates of companies with good Financial statements and good
credit history will have a better interest rates of course.
 Tax deductions will be applicable to profitable projects only and of course tax rulings will be needed to be consider like
RCIT, MCIT, exemptions on the actual etc.
 Default risk is the risk a lender takes that a borrower will not make the required payments on a debt obligation
 Note: Numerator will be the amount of expected
expenses per year regarding the loan made. And the
denominator is the principal. For exam purposes use
this formula but of course in corporate world,
applicable data will be used like tax laws, different
basis applicable on the denominator side.


cost of debt
(EV-proceedsa
before tax =
Interest
per year +

x
(1 -
tax rate)
(FV + Proceeds) = 2

= cost of debt after tax

1) How much is the cost of debt before tax and after tax of an issued bond by Igi boy worth 1,000,000 on the paper with an
initial proceeds received @ 920,000? Annual interest is 12% in ten years. tax rate is 35%.

Solution: (IM )x 12% IM-920K

10

Numerator: 120K+ 8000 (note: on this problem, face value will be the basis of interest rate. the difference between FV
and proceeds should be divided by 10 to amortize annually until maturity.
Denominator: 960K (note: average of FV and Proceeds since both are given on the problem)
CoDBT=13.33% 128K

900K
IM + 920

CoDAT=8.67% 0 133333 x
.
(1-35%)

2) Assume interest is paid semi Annual what will be the cost of debt after tax?
Solution:

CoDBT: Numerator: 60K + 4000 Denominator: 960K=6.67%

CoDAT= 6.67(1-35%) = 4.34%

Cost of Preferred Stock: Imagine a scenario where your proposal will be back up preferred shares, what will be the relevant
amounts?

1) Payments are paid annually through dividends.

2) The dividend is not tax deductible expense

 The likeliness of a successful offering of preferred shares are: 1) high dividend amount and secondarily the credibility of
your company.
 It is quite costly since no tax deduction on the point of view of company issuer. (Recipients are the one taxed)
 Unless you will buy back the preference shares there is no maturity. It can be traded as well but volatility or movement is
not usual.
 Selling ownership here means a stake in your company. (Although there is a difference to gamble shares or ordinary
share.)
 







 Numerator will be the amount of expected dividends per year. Denominator is the amount net proceeds you will get in
issuing the shares. (POV of company)
 Proceeds from sale can be viewed to be the Offering price: Par value + APIC
 Floatation costs are incurred by a publicly-traded company when it issues new securities and incurs expenses, such
as underwriting fees, legal fees, and registration fees.

1) Merry Mart issued preferred stock to raise a fund for building a new branch in Tacloban City. Underwriting cost is 2%, a tie
up with PNB. It is expected that they will provide 6PHP dividends per year. Par value of share is 10PHP but currently
selling at offering price of 50PHP. What is the cost of preferred stock?
3

Solution: Numerator: 6 Denominator: 50* 0.98 Answer: 12.24% 50 -

(50 )
x 2%

 How about the 10% withholding tax? It is considered to be shouldered by the holder and not a cost of the company.
Although withheld, it is deducted to the net proceeds of the recipient. On this instance only 5.40 will be going to the
owner of a share.

Cost of Common Stock: Imagine a scenario where your proposal will be back up by common shares, what will be the relevant
amounts?

 Dividends, what if they already issued it? (remember common stocks are traded that’s why you need to make sure that
at the least it looks profitable)
 The likeliness of a successful offering of common shares are: (Market price increases, when you have hefty RE
(consider IARE tax, new on create law) and of course the dividends.
 It is quite costly since no tax deduction, as with the point of view of company. (Recipients are the one taxed)Unless you
will buy back the common shares there is no maturity.
 Selling ownership here means a stake in your company. Common shares, Corporation code of PH: Voting shares as
example

COST of Common Shares=

1) Gordon’s Growth Model: (how the cost of common stock formula derived?)

Market value of stock=

Numerator: Dividends to be received in one 1 year (PHP)

Denominator: Cost of Common Stock (%)-Constant growth in dividends (%)

  The constant growth model, or Gordon Growth Model, is a way of valuing stock. It assumes that a company's dividends
are going to continue to rise at a constant growth rate indefinitely. You can use that assumption to figure out what a fair
price is to pay for the stock today based on those future dividend payments.

Deriving the original equation:

Cost of common stock will be:

Dividends year
(Dividends per 1 year/ MV)+ Growth rate
per
- Growth rate
MV

If IPO:

(Dividends/(MV-Floatation cost)+ growth rate Divi dends

+ Growth rate
Mr-Floatation cost

Sample Problem:

ICT converge of Dennis Uy shares has market value of 60PHP. At the end of the year dividends is expected to be 6PHP. The
shares already held are operations from northern part of the country, now he decided to sell shares through IPO using the
market value to expand the operations to South part of the country. Tie up with PNB requires him to pay 5% of IPO price for
commission of PNB, marketing specialist fees, lawyers and CPAs for the IPO. The constant growth rate in dividends is
expected to be 5% as well. Cost of new capital stock will be (used in southern part) using Gordon Growth model? Assume
other things held constant such as stock transaction tax and broker’s commission. How much is the old stock cost of capital and
new stock cost of capital?

Solution:
l

Old stock cost of capital= 6/60 +5%= 15% 60

+ 5%

New stock cost of capital= 6/(60*.95) + 5%=15.53% 60 -

(60 x 5 )
%
+ 5%

 The tax code enforces a stock transaction tax on every sale, barter or exchange of shares in a listed company at a rate
of 6/10 of 1% based on the gross selling price or gross value in money of the shares of stock sold, bartered, exchanged or
otherwise disposed.
 The main limitation of the Gordon growth model lies in its assumption of a constant growth in dividends per share. It is
very rare for companies to show constant growth in their dividends due to business cycles and unexpected financial
difficulties or successes. The model is thus limited to firms showing stable growth rates.
 The second issue occurs with the relationship between the discount factor and the growth rate used in the model. If the
required rate of return is less than the growth rate of dividends per share, the result is a negative value, rendering the
model worthless. Also, if the required rate of return is the same as the growth rate, the value per share approaches
infinity.In short continuous growth should be always be there and growth rate cannot be equal nor exceed cost of common
stock.
 2) COST of Common Shares=

Capital Asset Pricing Model (CAPM): Cost of Common shares by using the relationship of expected return and market
risk.

Cost of Common shares using CAPM=

Risk Free Rate (%) + Beta(( Reqd/expected rate of return on (%)- Risk free rate (%))
Market Risk Premium

 Risk Free rate: expected return on a risk free investments. Let say BSP treasury bills with 3% return annually
 Beta: This is the move of your own stock compare to market. Lets take on SMC stock traded in PSEI, your analyst said
that your SMC stock has a beta of 1.01 (perfect scenario is 1 always). It means to say that the SMC stock behaviour
behaves very similar to market (PSEi). Let’s give an example like APVI, DITO or HLCM, MAC (this business maybe has
a beta far to 1). volatility
of a stock

 Required/expected rate of return : this is your estimated return. For instance after a year my stock will go high by
10%.
 Market risk premiums: ( Reqd rate of return on portfolio(%)- Risk free rate (%))

The beta indicates how volatile a stock's price is in comparison to stocks in general.
• Negative beta. A beta less than 0, which would indicate an inverse relation to the market, is possible but highly unlikely.
Some investors argue that gold and gold stocks should have negative betas because they tend to do better when the stock
market declines.

• Beta of 0. Basically, cash has a beta of 0. In other words, regardless of which way the market moves, the value of cash
remains unchanged (given no inflation).

• Beta between 0 and 1. Companies with volatilities lower than the market have a beta of less than 1 but more than 0. Many
utility companies fall in this range.

• Beta of 1. A beta of 1 means a stock mirrors the volatility of whatever index is used to represent the overall market. If a
stock has a beta of 1, it will move in the same direction as the index, by about the same amount. An index fund that mirrors
the S&P 500 will have a beta close to 1.

• Beta greater than 1. This denotes a volatility that is greater than the broad-based index. Many new technology companies
have a beta higher than 1.

Sample Problem:

The Risk free rate of return a treasury bill offered by BSP is 8%. APVI an SME offered in PSEI is highly volatile stock not
going with PSEI with 1.2 beta. The expected return after a year is 15%. How much is the cost of equity? And how much is
the market premium?

Solution:

Cost of capital using CAPM= 8%+ 1.2(15%-8%)= 16.4%

Market Risk Premium= 7% =( the chance of winnings you will get on PSEI index alone)

8%: it is a very safe bet since BSP is back up by government.

  The 15% is expected only through analyzation, meaning if someone will bet to APVI 15% return is expected either
through dividends or lets say market value increase (capital gains) you can sell to third person.
 Beta as explained, will be the amount expected it to move as compare to PSEI. Lets say today the index say 6500 and
next yr 7000, the 7.1 % movement of stock market uptrend will mean 8.57% movement of apvi alone only (more likely
of course and averagely)
 Therefore cost of capital of common stock using capm is the combination of the volatile risk part of market and the
stagnant gains of risk free investment

Limitations of CAPM
 Risk-Free Rate (Rf) The commonly accepted rate used as the Rf is the yield on short-term government securities. The
issue with using this input is that the yield changes daily, creating volatility.
 Return on the Market (Rm) The return on the market can be described as the sum of the capital gains and dividends for
the market. A problem arises when, at any given time, the market return can be negative. Another issue is that these
returns are backward-looking and may not be representative of future market returns.
 Ability to Borrow at a Risk-Free Rate CAPM is built on four major assumptions, including one that reflects an
unrealistic real-world picture. This assumption—that investors can borrow and lend at a risk-free rate—is unattainable in
reality. Individual investors are unable to borrow (or lend) at the same rate as the U.S. government. Therefore, the
minimum required return line might actually be less steep (provide a lower return) than the model calculates.
 Determination of Project Proxy Beta Businesses that use the CAPM to assess an investment need to find a beta
reflective of the project or investment. Often, a proxy beta is necessary. However, accurately determining one to
properly assess the project is difficult and can affect the reliability of the outcome. Used when the firm has no market
listing and thus no Beta of its own. It is taken from a comparable listed firm, and adjusted as necessary for relative
financial gearing levels.

COST of Common Shares using Bond plus Approach Model

Cost of common stock = (Cost of debt after tax) + risk premium

 This is a kind of estimation wherein you will just add additional premium on the risk undertaken and plus the fact that it
is relatively costly to capitalized using ownership.

Sample problem:

AMV has issued 1M stock 15% 5 year bond with proceeds of 960k. Tax rate is 35%. Compute the cost of equity using bond
plus approach with risk premiums of 5%

Answer is: 15.48% (IM )

((m -
( q60k))
x 15 % +

x (1 -
35% ) + 500

(IM 960k)
+ = 2

Cost of Retained Earnings:

Formula will still be:

Cost of retained earnings using Gordon growth model will be:

(Dividends per 1 year/MV)+ growth rate.

  Retained earnings can go to: Dividends or Reinvestment to increase the BV/ share leading to increase of market
price if fundamental analysis will be used.
 Reinvestment means there is required rate of return, Gordon growth mode lcan be used but surely like old stock and/or
not IPO, no floatation cost is involved.

Weighted average cost of capital

The computed cost WACC should not be lower with your expected return of a certain business

 Expected return should be “estimated” conservatively meaning.

Formula:

(Cost of debt* percentage structure)+(Cost of Preferred stock* percentage structure)+(Cost of Common Stock*
percentage structure)+ (retained earnings* percentage structure)

• Current liabilities will not be part of financing usually unless stated. Consider only bonds and other related long term
liabilities if the liability side is the one we are talking about.

• There are two ways in finding the WACC: weigh 1) the Book value method and 2) the Market value method. Using the
book value method you will just prorate everything according to the percentage from total LTL&E.

• The market value method will use the selling price in the market of debt and preferred shares. To complete the
denominator, only the MV of Common shares will be used but you will divide the total amount using the percentage from
BV of Common shares and RE.

Sample Problem: LTG computed the cost of capital of each using relevant data:

Book Value

• Mortgage Bond (1000 par) 10M

• Preferred Stock (100 par) 5M

• Common Stock (50 par) 15M

• Retained Earnings 10M

Book Value Weighs using book value as ratio to compute the different cost of capital: assume CoD= 8.66% CoPS= 12.24%
CoCS= 15.53% CoRE= 15%

Solution: ((10/40).0866))+((5/40).1224))+((15/40).1553))+((10/40).15))=13.27%
Capital Budgeting
What Is Capital Budgeting?
•Capital budgeting is the process a business undertakes to evaluate potential major
projects or investments.

(E.G. Construction of a new plant or a big investment in an outside venture are examples of
projects that would require capital budgeting before they are approved or rejected.)

•As part of capital budgeting, a company might assess a prospective project's lifetime
cash inflows and outflows to determine whether the potential returns that would be
generated meet a sufficient target benchmark. The process is also known as
investment appraisal.

accrual-cash)
Capital Budgeting >
-

cash flow (cash-accruals

Understanding Capital Budgeting further:

•Ideally, businesses would pursue any and all projects and opportunities that
enhance shareholder value. However, because the amount of capital any
business has available for new projects is limited, management uses capital
budgeting techniques to determine which projects will yield the best return over
an applicable period.

•Some methods of capital budgeting companies use to determine which projects

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to pursue include throughput analysis, net present value (NPV), internal rate
of return, discounted cash flow, and payback period, Accounting rate of
return, Profitability Index.
Reasons why capital budgeting is Important:

(Before making a huge financial decision, it helps to have clarity, define risk and have a
financial plan in place. If it’s unclear why you need to pursue capital budgeting before you
commit to a significant investment project, let’s review the top reasons.)

•Helps Clarify Decisions

•Lowers Risk
•Provides a Financial Plan
Helps Clarify Decisions

A budget is a financial plan, which is essential for any successful capital

project. After seeing the numbers of each budget laid out, you can select
which project makes the most financial sense to pursue now and which
projects should be put on hold. This process is vital for you to avoid
throwing money at a project that brings no gains to your business.

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Lowers Risk

With a capital budget, you’ll worry less about the risks you are taking with the
projects you undertake. You have done the analysis and decided on the
best potential investment. It’s easier to secure outside funding after completing
the capital budgeting process because you’ll be able to demonstrate this project
is a worthwhile investment.
Provides a Financial Plan
Capital projects require a significant amount of planning and budgeting because
they are substantial investments. If you go through the capital budgeting
process, you will understand how much money you’ll need and if it could
financially impact your other ventures. Capital projects can be independent,
which means they don’t affect the funding of other company projects, or
mutually exclusive, which are tied to other projects’ financing in some way.
Required investment • PV of expected Cash
Minimum required Inflows
rate of return (CoC) • Expected Rate of
Return
• Method that do not
apply PV.

• Payback Period
• Discounted Payback Period
• Accounting rate of return
• Net Present Value
• Internal rate of return
• Profitability Index
Payback period method Even cash flow:
The payback period is the time required to earn back the amount invested in an asset from
its net cash flows. It is a simple way to evaluate the risk associated with a proposed project.

An investment with a shorter payback period is considered to be better, since the investor's
initial outlay is at risk for a shorter period of time. The calculation used to derive the
payback period is called the payback method.

Formula: Divide the net cash outlay or initial investment less salvage value (which is
assumed to occur entirely at the beginning of the project) by the amount of net cash inflow
after tax generated by the project per year (which is assumed to be the same in every year).
Previous Equipment

Payback Period = Net Cash

Outlay or (Initial Investment-Salvage Value)

Net Cash Flow After Tax per year

Illustrative Problem:

Alaskan Lumber is considering the purchase of a band saw that costs $50,000 and which will
generate $10,000 per year of net cash flow. PP = 50
, 000
= 5
10 000

Alaskan is also considering the purchase of a conveyor system for $36,000, which will reduce
sawmill transport costs by $12,000 per year. Pp =

3
36000
=

12000

If Alaskan only has sufficient funds to invest in one of these projects, and if it were only using
the payback method as the basis for its investment decision, who will Alaskan Lumber buy?

Formula: Divide the net cash outlay or initial investment less salvage value (which is
assumed to occur entirely at the beginning of the project) by the amount of net cash inflow
after tax generated by the project per year (which is assumed to be the same in every year).
Answer:

Alaskan Lumber is considering the purchase of a band saw that costs $50,000 and
which will generate $10,000 per year of net cash flow. The payback period for
this capital investment is 5.0 years.

Alaskan is also considering the purchase of a conveyor system for $36,000, which
will reduce sawmill transport costs by $12,000 per year. The payback period for
this capital investment is 3.0 years.

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(Conclusion: it would buy the conveyor system, since it has a shorter payback period.)
Payback Period Method Uneven Cash Flow:

ABC International has received a proposal from a manager, asking to spend

$1,500,000 on equipment that will result in cash inflows in accordance with the
following table:

Year Cash Flow Cash Outlay 1500 000

Cash Flow I (150 000) 1350 00

1 150000 2
(150 000) I 200000

3
2 150000 (200000) 1000 000

4 (600000) 400 000

3 200000
5 (900 000)
4 600000
400 000
Op
5 900000 =
4 +
900 000
=
4 .
44

What is the payback period?

Or 4.44 years.
Payback reciprocal:
The payback reciprocal is the 1 is divided by payback period for an investment.

Example:
a financial analyst is reviewing a possible investment of $50,000, which will generate positive
cash flows of $10,000 per year. The payback period is 5 years, since cash flows of $50,000
will accumulate over the next five years. The payback reciprocal is 1/5 years, or 20%.
↓ I
=
or 20%
5
50 000

10 000

The payback reciprocal overstates the true rate of return because it assumes that the
annual cash flows will continue forever. It also assumes that the annual cash flows are
identical in amount. Since these two conditions are unrealistic you should avoid the use of
the payback reciprocal. Instead, you should compute the internal rate of return or the net
present value because they will discount each of the actual cash amounts to reflect the time
value of money.
 Bailout Payback Method
Bailout payback method shows the length of time required to repay the total
initial investment through investment cash flows combined with salvage value. The
shorter the payback period, the more attractive a company is.

Payback Period vs. Bailout Payback

bailout payback method, is similar like payback period method. The difference between
these two is that bailout payback model incorporates the salvage value of
the asset into the calculation and measures the length of the payback period when
the periodic cash inflows are combined with the salvage value

Example:
a financial analyst is reviewing a possible investment on a machinery for $50,000,
which will generate positive cash inflows of $20,000 and a cash outflow of 10,000 per
year. The financial analyst found out that the salvage value of the machinery to buy
will be 10,000 for the first two years of usage and 7,000 for the rest of the life of the
machinery after the first two years. What is the payback bailout period?
Acc Cash Flows Possible Salvage Value
Initial Investment
cashflow/yr from Operation or Particular year
50 000
1 . 10 000 10 000 10 000
10,000 X

2 - 10 000 20 000 10 000 20000 X

ACC
.
3 10000 30 000 7000 37000 x
CF CF SV
4 10 000 7000
.
40 000 47000 X
4- 40k 7K
10K
5 10 000 50 000 7000
600
3000
.

57000 v 4k > 4 + 4 6
4 + 4 3 50
-

10K
=
=
.
.
5 .

10000
Example: a financial analyst is reviewing a possible investment on a machinery for $50,000,
which will generate positive cash inflows of $20,000 and a cash outflow of 10,000 per year.
The financial analyst found out that the salvage value of the machinery to buy will be 10,000
for the first two years of usage and 7,000 for the rest of the life of the machinery after the first
two years. What is the payback bailout period?

First year: only 20,000 will be the possible accumulated net cash flow.
Second year: only 30,000 will be the possible accumulated net cash flow
Third year: only 37000 will be the possible accumulated net cash flow
Fourth year: only 47,000 will be the possible accumulated net cash flow
Fifth year: 57000 will be the possible accumulated net cash flow.

The answer will be between fourth and fifth year: 3000/10000= .3

Therefore: 40,000 cash flow of the first 4 years + salvage value of 7000 + 3000 (.3 years of
the 10000 cash flow after fourth year.)

Answer: 4.3 years

(Reminder: Always remember that when using payback period method, use the net cash
flow always. If the given is net income then work back the amount and analyze what is the
net cash inflow. For instance the depreciation should be added back to net income to get
the net cashflow. )

Advantages of the Payback Method

The most significant advantage of the payback method is its simplicity. It's an easy way
to compare several projects and then to take the project that has the shortest payback
time.
Disadvantages of the Payback Method

Ignores the time value of money: The most serious disadvantage of the payback method is that
it does not consider the time value of money. Cash flows received during the early years of a
project get a higher weight than cash flows received in later years. Two projects could have the
same payback period, but one project generates more cash flow in the early years, whereas the
other project has higher cash flows in the later years

Neglects cash flows received after payback period: For some projects, the largest cash flows
may not occur until after the payback period has ended. These projects could have higher returns
on investment and may be preferable to projects that have shorter payback times.

Ignores a project's profitability: Just because a project has a short payback period does not
mean that it is profitable. If the cash flows end at the payback period or are drastically reduced, a
project might never return a profit and therefore, it would be an unwise investment.

Does not consider a project's return on investment: Some companies require capital
investments to exceed a certain hurdle of rate of return; otherwise the project is declined. The
payback method does not consider a project's rate of return.
Discounted payback period

Example: An initial investment of $2,324,000 is expected to generate $600,000 per year for 6
years. Calculate the discounted payback period of the investment if the discount rate is 11%.

106462
+
5 =
5 33
.

320785
Advantages and Disadvantages of discounted payback period

Advantage: Discounted payback period is more reliable than simple payback

period since it accounts for time value of money. It is interesting to note that if a
project has negative net present value it won't pay back the initial
investment.

Disadvantage: It ignores the cash inflows from project after the payback period.
An attractive project having lower initial inflows but higher terminal cash flows
might be rejected.
What Is the Accounting Rate of Return – ARR
•The accounting rate of return (ARR) is the percentage rate of return expected on investment or
asset as compared to the initial investment cost.

•ARR divides the average revenue from an asset by the company's initial investment to derive
the ratio or return that can be expected over the lifetime of the asset or related project.

•ARR does not consider the time value of money or cash flows, which can be an integral part
of maintaining a business.

of SV of OLD
may have deduction equip

Formula: Net income after tax/ Initial Investment

or Net income after tax/ [(initial investment/2) + salvage value)(2]
NEW equip
Illustrative Problem:

XYZ Company is looking to invest in some new machinery to replace its current
malfunctioning one. The new machine, which costs $420,000, would increase annual cash
inflow by $200,000 and annual cash outflow by $50,000. The machine is estimated to have a
useful life of 12 years depreciated using straight line method and zero salvage value.

Compute for ARR and Payback period:

ARR Formula: Net income after tax/ initial Investment or average initial investment

Payback Period formula: Investment/ net cash inflow

Net Income After Tax

N1 =
Net Cash Flow + Non Cash Expense other ARR :
Initial Investment + SV (new)
ARR :
PP =
420000
2
=
2 8
.
years
Flow 150 000 (200K -

50k) 150 000 115K

Net Cash
=
= =
54 76 %
.

(420k + 0)/2
(35000) (420K = 12)
Dep (NCE) =

115 000
Net Income

ARR = 115000
=
27 38 %
.

420 000
XYZ Company is looking to invest in some new machinery to replace its current
malfunctioning one. The new machine, which costs $420,000, would increase annual cash
inflow by $200,000 and annual cash outflow by $50,000. The machine is estimated to have
a useful life of 12 years depreciated using straight line method and zero salvage value.

Compute for ARR and Payback period:

ARR Formula: Net income after tax/ initial Investment or initial investment/2

Payback Period formula: Investment/ net cash inflow

ARR: 115000/420000= 27.38%

(Some variant is using using the average investment wherein the Investment is divided by
2.if this is the case, the answer will be: 115000/210,000= 54.76%)
XYZ Company is looking to invest in some new machinery to replace its current
malfunctioning one. The new machine, which costs $420,000, would increase annual cash
inflow by $200,000 and annual cash outflow by $50,000. The machine is estimated to have
a useful life of 12 years depreciated using straight line method and zero salvage value.

Compute for ARR and Payback period:

Payback Period formula: Investment- salvage value/net cash savings after tax

Payback period: 420000/ 150,000= 2.8 years

The Black Stone company sells crushed stone to government contractors as well as to
small business owners involved in construction business. The company needs to replace
an old equipment with a new one. The new equipment can increase production as well as
improve the quality of crushed stone. The information about annual incremental revenues
and costs associated with the new equipment is given below:

The only non-cash expense in the above income statement is the

depreciation. The new equipment would cost $240,000 and the old
equipment can be sold to a small company for its salvage value of $15,000.

Payback Period and ARR?

ARR =
60 000
PP = 225 000 = 26 67 %
.

=
2 5
years 240000
-

225000 ↓I
.

90000
Or SV 15 000

NCF = 60K + 30K 60 000

= 53 33 %
.
225000
=
90k
225000 = 2
The Black Stone company sells crushed stone to government contractors as well as to small business
owners involved in construction business. The company needs to replace an old equipment with a
new one. The new equipment can increase production as well as improve the quality of crushed stone.
The information about annual incremental revenues and costs associated with the new equipment is
given below:

The only non-cash expense in the above income

statement is the depreciation. The new
equipment would cost $240,000 and the old
equipment can be sold to a small company for its
salvage value of $15,000.

Payback Period: 225000/90000= 2.5 years

ARR: 60,000/225000= 26.67% Or 60,000/(225000/2)= 53.33%

Accounting Rate of Return

Advantages:
1. Accounting rate of return is simple and straightforward to compute.

2. It focuses on accounting net income after tax. Creditors and investors use accounting
income to evaluate the performance of management.

Disadvantages:
3. Accounting rate of return method does not take into account the time value of
money. Under this method a dollar in hand and a dollar to be received in future are
considered of equal value.

4. Cash is very important for every business. If an investment quickly generates cash
inflow, the company can invest in other profitable projects. But accounting rate of
return method focus on accounting net operating income rather than cash flow.

5. The accounting rate of return does not remain constant over useful life for many
projects. A project may, therefore, look desirable in one period but undesirable in
another period.
Net Present Value Method

Net present value method (also known as discounted cash flow method) is a
popular capital budgeting technique that takes into account the time value of
money. It uses net present value of the investment project as the base to accept
or reject a proposed investment in projects like purchase of new equipment,
purchase of inventory, expansion or addition of existing plant assets and the
installation of new plants etc.
cash inflow project:

The management of Fine Electronics Company is considering to purchase an equipment to be attached with
the main manufacturing machine. The equipment will cost $6,000 and will increase annual cash inflow by
$2,200. The useful life of the equipment is 6 years. After 6 years it will have no salvage value. The
management wants a 20% return on all investments.

Should the equipment be purchased using NPV?

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Yes, the equipment should be purchased because the net present value is positive ($1,317).
Having a positive net present value means the project promises a rate of return that is higher
than the minimum rate of return required by management

Investments in assets are usually made with the intention to generate revenue or reduce costs
in future. The reduction in cost is considered equivalent to increase in revenues and should,
therefore, be treated as cash inflow in capital budgeting computations.
A project requires an initial investment of $225,000 and is expected to generate the
following net cash inflows:
Year 1: $95,000 X 0 893
.

Year 2: $80,000 * 0 797 .

Year 3: $60,000 X 0 . 712

Year 4: $55,000 X 0 .
636

Required: Compute net present value of the project if the minimum desired rate of
return is 12%
 Solution:

(100 10
-

(100 % )

CAPITAL BUDGETING ASSUMPTION

* Tax should be
(70 %)
paid in cash

SV Company SV allowed Code

by Tax
Profitability Index:
Sometime a company may have limited funds but several alternative
proposals.
In such circumstances, if each alternative requires the same amount of
investment, the one with the highest net present value is preferred.

But if each proposal requires a different amount of investment, then proposals

are ranked using an index called present value index (or profitability index).

(The proposal with the highest present value index is considered the best.)
Choose the most desirable investment proposal from the following
alternatives using profitability index method:
 NPV Advantages and disadvantages:

• The basic advantage of net present value method is that it considers the
time value of money. The most important feature of the net present value
method is that it is based on the idea that dollars received in the future
are worth less than dollars in the bank today.

• Cash flow from future years is discounted back to the present to find their
worth. The NPV method produces a dollar amount that indicates how
much value the project will create for the company. (discounted using
the required return). Therefore, Stockholders can see clearly how much a
project will contribute to their value.

• The disadvantage is that it is more complex than other methods that do not
consider present value of cash flows.
Internal Rate of Return

•The internal rate of return (IRR) is a metric used in capital budgeting to

estimate the profitability of potential investments. The internal rate of return
is a discount rate that makes the net present value (NPV) of all cash
flows from a particular project equal to zero. IRR calculations rely on the
same formula as NPV does.

Ways to get the IRR:

1)Use the present value table
2) Trial and error
Illustrative Problem:
The management of VGA Textile Company is considering to replace an old
machine with a new one. The new machine will be capable of performing
some tasks much faster than the old one. The installation of machine will cost
$8,475 and will reduce the annual labor cost by $1,500. The useful life of the
machine will be 10 years with no salvage value. The minimum required rate
of return is 15%. What is the internal rate of return of the reduction of labor
cost?

A.) 10% Formulate the present value of an annuity of the 1500

B.) 11% reduction on Labor cost for 10 years using the given
C.) 12% choices. If you find an amount that is equal to 8475 then
that’s the IRR.
D.) 13%
 The management of VGA Textile Company is considering to replace an old machine with a
new one. The new machine will be capable of performing some tasks much faster than the old
one. The installation of machine will cost $8,475 and will reduce the annual labor cost by
$1,500. The useful life of the machine will be 10 years with no salvage value. The minimum
required rate of return is 15%. What is the internal rate of return of the reduction of labor
cost?

Solution: (1-(1.12^-10))/0.12)*1500 =8475 therefore the IRR is 12%

the proposal is not acceptable because the internal rate of return promised by the proposal (12%)
is less than the minimum required rate of return (15%).

Notice that the internal rate of return promised by the proposal is a discount rate that equates the
present value of cash inflows with the present value of cash out flows.
in our example, the required investment is $8,475 and the net annual cost saving is $1,500.
The cost saving is equivalent to revenue and would, therefore, be treated as net cash
inflow. Using this information, the internal rate of return factor can be computed as
follows:
Internal rate of return factor = $8,475 /$1,500
= 5.650

(After computing the internal rate of return factor, the next step is to locate this discount
factor in “present value of an annuity of $1 in arrears table“. Since the useful life of the
machine is 10 years, the factor would be found in 10-period line or row. After finding this
factor, see the rate of return written at the top of the column in which factor 5.650 is
written. It is 12%)
Fin!
Master Budget
Nominal -> Real

ILLUSTRATIVE PROBLEMS

1. Basic operating budgets. Paniqui Company is in the process of preparing its operating
budgets for 2009. The company produces and sells only one product, “Healthy Kick”. The
following data are taken from its statement of assumptions:

a. Sales and collections.

 The product is currently sold at a unit price of P150 and is not expected to
change in 2008.
& The following estimates are developed by the Market Research
Department as probable sales in January 2009:
Unit sales Probability
40,000 .30
50,000 .50 49000

60,000 .20

 Sales in the succeeding months are expected to increase by 10% from each
month thereafter, except for the month of April which is expected to increase by
20% from the immediately preceding month.

 Eighty percent (80%) of sales is to be made on credit with terms of 2/10, n/40.
Billings are made on the date of sales and collections are made as follows:

40% in the month of sales with 55% paying within the discount period
50% in the first month after sale
5% in the second month after sale
5% uncollectibles

 The accounts receivable balance on December 31, 2007 3 is expected to be

P10,000,000, with 18% and 7% of it is coming from the November 2008 and
October 2008 sales, respectively.

b. Production. The finished goods inventory at the end is each month is set at 80% of
the next month’s sales.

c. Materials. A unit of product Healthy Kick needs 4 lbs. of material X costing P5 per
pound. Materials inventory at the end of the each month is estimated to be 60% of the
next month’s needs plus 12,000 lbs. Payments to materials suppliers are 60% in the
month of purchase and 40% in the following month of purchase. The accounts
payable balance on December 31, 2008 is estimated to be P600,000.

d. Labor. It takes 2 hours to produce a unit of product Healthy Kick. On the average,
production workers are paid at a rate of P40 per hour. Payroll costs amounting to
10% of the total payroll cost per month are estimated to be paid next month.

e. Factory overhead. The standard variable factory overhead rate is P5 per hour. Total
budgeted fixed overhead is budgeted at P6 million to be incurred evenly during the
year. The company’s normal capacity is 50,000 units per month.

f. Other information. Expenditures and other data are also assembled and presented
below:

December January February March

Cash balance, beginning P 135,000 P ? P ?
Paid employee benefits 1,000,000 1,000,000 1,000,000
Other cash marketing and 500,000 500,000 500,000
administrative expenses
Prepaid expenses 120,000 220,000 150,000 90,000
 Accrued expenses 32,000 45,000 60,000 75,000
Machineries and equipment, on 2,000,000 - -
cash
Dividends paid - - 500,000
Depreciation expense 200,000 200,000 200,000 200,000

g. Financing. The company can borrow at a multiple of P10,000 with an interest of 3%

per month. All borrowings will take place at the beginning of the month. The company
maintains a minimum cash balance of P100,000.

Required: Operating and financial budgets, together with supporting schedules, for the
months of January, February, and March 2009:
a. Sales in units and in pesos, net of discounts and allowance for doubtful accounts.
b. Collections from customers.
c. Production.
d. Materials purchases in units and in pesos.
e. Payments to materials suppliers.
f. Direct labor.
g. Factory overhead.
h. Total production costs.
i. Cost of goods sold.
j. Operating expenses incurred.
k. Income statement.
l. Cash budget.

STRAIGHT PROBLEM 1 ANALYSIS GUIDE

(Heading are omitted)

a. Sales budget
J F M A M
Sales in units 49,000 X
53,900
1 1
.
=

59,290 X 1 1
.
=

71,148 78,263
x Unit sales price P150 P150 P150
Gross sales in pesos P7,350,000 P8,085,000 P8,893,500
- Provision for BD 294,000 323,400 355,740
- Provision for sales discounts 25,872 28,459 31,305
Net sales in pesos 7,030,128 7,733,141 8,506,455
Budgeted sales in units in Jan. = Σ (Est. sales x Prob.)
Provision for bad debts = 5% (Gross sales x 80%)
Provision for sales discounts = 2% x Gross sales x 80% x 40% x 55%

b. Collections from customers

Year Month Credit Sales J F M Total
s
2006 Nov P18,000,000 P 900,000
Dec 12,500,000 6,250,000 P 625,000
2007 Jan 5,880,000 2,326,128 2,940,000 P 294,000
Feb 6,468,000 2,558,741 3,234,000
Mar 7,114,800 2,814,615
Collections from credit 9,476,128 6,123,741 6,342,615
customers
+ Cash sales 1,470,000 1,617,000 1,778,700
Total collections from P9,477,59
X
P7,740,74 P8,121,31
customers 10 946 8128
1 5
Computations:

January collections from January sales:

P5,880,000 x 40% x 55% x 98% P1,267,728
P5,880,000 x 40% x 45% 1,058,400 P2,326,128
February collections from February sales
P6,468,000 x 40% x 55% x 98% 1,394,501
P6,468,000 x 40% x 45% 1,164,240 2,558,741

March collections from March sales

P7,114,800 x 40% x 55% x 98% 1,533,951
P7,114,800 x 40% x 45% 1,280,664 2,814,615

c. Production budget
J F M April May
Sales in units 49,000 53,900 59,290 71,148 78,263
+ FGE (80% x next quarter’s 43,120 47,432 56,918 62,610
sales)
TGAS 92,120 101,332 116,208 133,75
8
- FGB 39,200 43,120 47,432 56,918
Budgeted production 52,920 58,212 68,776 76,840

d. Materials used and purchases budget

J F M April
Budgeted production in units 52,920 58,212 68,776 76,840
x Standard materials per unit 4 lbs. 4 lbs. 4 lbs. 4 lbs.
Materials needs in lbs. 211,680 232,848 275,104 307,360
+ MIE [(60% x next month’s 151,709 177,062 196,416
needs) + 12,000]
TMAU 363,389 409,910 471,520
- MIB 139,008 151,709 177,048
Materials purchases in lbs. 224,381 258,201 294,472
x Materials cost per unit P5.00 P5.00 P5.00
Materials purchases in pesos P1,121,905 P1,291,005 P1,472,360

e. Payments to materials suppliers

Year Months Credit J F M Total
Purchases
2006 Dec P1,500,000 P600,000
2007 Jan 1,121,905 673,143 P448,762
Feb 1,291,005 774,603 P516,402
Mar 1,472,360 883,416
Payments to materials suppliers P1,273,143 P1,223,365 P1,399,818

f. Direct labor costs

J F M
Budgeted production 52,920 58,212 68,776
x Standard DLH per unit 2 hrs. 2 hrs. 2 hrs.
Budgeted DLH 105,840 116,424 137,552
x Standard DLRate per hour P40 P40 P40
Bud DL costs P4,233,600 P4,656,960 P5,502,080

g. Factory overhead costs

J F M
Variable OH (Budgeted DLH x P5 P529,200 P582,120 P687,760
per DLH)
Fixed OH (P6 million / 12 mos.) 500,000 500,000 500,000
Budgeted factory overhead P1,029,200 P1,082,120 P1,187,760
h. Total production costs
J F M
Direct materials (Prod x 4 lbs. x P5) P1,058,400 P1,164,240 P1,375,520
Direct labor 4,233,600 4,656,960 5,502,080
Factory overhead 1,029,200 1,082,120 1,187,760
Total factory costs P6,321,200 P6,903,320 P8.605,360
>
Budgeted production 52,920 58,212 68,776
Unit costs P119.45 P118.59 117 27
.

P125.12

i. Cost of goods sold

J F M
39,200 x P120 P4,704,000
9,800 x P119.45 1,170,610
43,120 x P119.45 P5,150,684
10,780 x P118.59 1,278,400
47,432 x P118.59 P5,624,961
11,858 x P125.12 1,483,673
Cost of goods sold P5,874,610 P6,429,084 P7,108,634
DM 4 lbs. x P5 P 20
DL 2 hrs. x P40 80
VOH 2 hrs. x P5 10
fXOH P500,000 / 50,000 10
Std. U.C. P120

i. Income statement data

J F M
Sales P7,350,000 P8,085,000 P8,893,500
- Sales discounts 25,872 28,459 31,305
Net sales 7,324,128 8,056,541 8,862,195
- Cost of goods sold 5,874,610 6,429,084 7,108,634
- Operating expenses, excluding 2,413,000 2,585,000 2,575,000
Depreciation
- Depreciation expense 200,000 200,000 200,000
- Bad debts expense 294,000 323,400 355,740
Profit (loss) P1,457,482 P1,479,943 P1,377,179

Schedule of operating expenses

J F M
Cash operating expenses P2,500,000 P2,500,000 P2,500,000
Prepaid expenses, beg 120,000 220,000 150,000
Prepaid expenses, end (220,000) (150,000) (90,000)
Accrued expenses, beg (32,000) (45,000) (60,000)
Accrued expenses, end 45,000 60,000 75,000
Operating expense incurred P2,413,000 P2,585,000 P2,575,000

k. Cash budget
Schedule J F M Total
Cash balance, P 135,000 P 106,650 P
beginning 135,000
+ Collections from b 9,477,598 7,740,741 8,121,315 ?
customers
Total cash available 9,612,598 7,897,396 8,230,966 ?
for sale
Payments:
Payments to e (1,273,143) (1,223,365) (1,399,818) ?
suppliers
Direct labor f (4,233,600) (4,656,960) (5,502,080) ?
Overhead g (1,029,200) (1,082,120) (1,187,760) ?
Cash operating (1,500,000) (1,500,000) (1,500,000) ?
 expenses
Acquisition of M and (2,000,000) - - ?
E
Dividends - - (500,000) ?
Cash balance before (423,350) (615,049) (1,859,292) ?
financing
Borrowings 530,000 740,000 2,000,000 ?
Principal payments ?
Interest payments - 15,900 (38,100) ?
Cash balance, ending 106,650 109,651 102,608 102,608
 SALES BUDGET
• Probability of the outcome (in Illustrative problem the three
scenario is equal to 100%). This is the assumed mathematical
treatment for the Sale budget.
• If there is no indication of change in price it will remain constant.
• It is expressly stated that ADA will be considered on the report you
will prepare. (Problem requirement will prevail)
• ADA is computed by multiplying the total uncollectibles of credit
sales per period. ( do not over analyze by using the ending AR per
period as basis since it is impliedly stated that sales is the basis of
this: (look 40%+50%+5%+5%)).
• Keen to every details in the problem (April is the only anticipation
of 20% based on previous then in May it will go back to just 10%
increase)
• Basis of sales discount on your budget: 2%x40%x55%xGross salesX
portion that is in form of gross sales.
 Collection from Customer
7 8

• Typo ( Analysis Guide): change 2006 into 2008 and 2007 into 2009.
-
-

• 100%-18%-7%=(75%*10M)=(7500,000/.6)= (PHP 12.5M Credit sales

for December).
• 10M*18%=1.8M, 1.8M/10%= (PHP 18M Credit sales.)
• 7% outstanding account from October sales is irrelevant for
collection in 2009. (will be adjusted or cancelled in ADA probably).
• Computation for the collection of the current month sale:
(55%X40%X98%XCS basis)+(45%X40%XCS basis).
• Total Collection from customer means all cash received for the
period: Collection from Credits and Collection from cash sales.
 Production Budget
• The concept of desired inventory can be analyse using algebraic
method: Beginning Inventory+ Budgeted Production- FGE= Sales in
units. (transposition and playing of equation).

• The Finish goods beginning of January is assumed to be the desired

ending last December (timeline of making this budget seems to be
3rd quarter of last year). (49000X.8)=39200
 Materials used and purchases budget
• This portion is based on the production budget of all the periods
involved and all related other details on the problem EG. quantity
(Lbs).
• The computation of desired ending inventory is in quantity (Lbs).
• The desired ending inventory last period is the assumed beginning
inventory of period you are computing
• The material Purchase can be presented using equation
• (Assumed beginning inventory+ material purchases-desired Ending
Inventory=Budgeted materials to be used.
• Material purchases x per unit Cost= material purchases in pesos

• (211680X60%)+12000=139008=Materials inventory beginning for

January
 Payment to Material Suppliers

• The credit purchases outstanding 1.5M comes from 600k/.4. It is

assumed that the 60% of purchases or P900,000 has been paid last
year to come up for P600,000 given.
• The purchases of a particular month based on purchases budget will
just be allocated by 60% payments for the month the purchase have
been made and 40% following the month.
 Direct labor Budget
• Formula: Budgeted Production X Standard Hours X DLH rate per
hour in peso=DL Cost
• Cost
c or expenses is irrelevant with Cash flow
• For cash budget purposes kindly remove the clause that 10% will
be paid following the month the production has been done.
 Factory Overhead
• Variable Overhead:
Budgeted DLH is based on DL usage (qty)X Standard Cost per unit

• Direct labor hours is the total hours to produce an item so

basically it will be the basis of the estimation of VOH.

• Fixed Overhead is Fixed in nature

Formula: Capacity in units X FOH/unit.
50000*10=500,000 or
6000,000/12=500000
FOH per unit: PHP10=500,000/50000
Total capacity for the year=500,000*12=6000,000
 Total Production Cost

• All cost related to budgeted production regardless if it was paid

in cash or deferred payables will be consolidated.
• take note that production cost is different with cash flow.
• Payments of payroll, supplier and bills related should be
classified to which period it should be included. (Accrual system
of accounting)
• Direct material used in pesos for January= 52920*4*5=1058,400
( not the purchases and/or the materials payment)

• Typo: 8065360 instead of 8605360

Unit cost for march should be 117.27 instead of 125.12
 Cost of goods sold
• The beginning Inventory per unit for 2009 is assumed to be @
budgeted amount since no enough information about the
production cost last year (budgeted sales and budgeted
beginning Inventory as of December). Means to say P120
• (the COGS suggested solution is in FIFO system, the per unit cost
varies because production is not exactly 50,000) (all budgets
exceeded the capacity so relatively smaller to ideal 120/unit
capacity of fixed cost.
• For instance about the Paniqui, PHP 110 portion of the per unit
cost is relatively variable so no changes about it in terms of per
unit but the fixed part will have since the fixed budgeted Php
500k will be divided to number of units budgeted to be
produced comparing to capacity of 50k/month. EG:
500k/52920=9.45 and 500k/58212= 8.58
 Cost of goods sold

Typo: The portion of 11,858 sold in March should be multiply to 117.27,

therefore PHP 1390,587.66
Meaning the CGS for the period should be: Php.7015,548.66
 Schedule Operating Expense

• Typo: Cash operating expenses should just be 1500,000=

(employee benefits+ other cash operations outside the
production related amounts. Therefore 1413000,
1585000,1575000 will be the answer)
• Constructive accounting on how to adjust the cash expense
to accruals: (see the video for module 4)
 Income Statement data

• Net sales= Gross Sales-Sales returns and allowances- sales

discount
• Cost of Goods sold is not synonymous with the expelled x
amount in production but only on the related portion sold. Some
parts have been capitalized and the timing to out the items is a
factor too.
(FIFO has been used and see Cost of good sold budgeted on letter L.)
 Income Statement data

• Change the operating expenses consistent to the schedule

operating expense. Therefore Profit will be plus PHP 1M.
• Depreciation expenses ( given)
• BDE since based on sales , it will be periodic and unlike when it
is based on AR you will need to use T-accounts to adjust the
required allowance.
• Loss of 457,482 for january, loss of 479943 for February and loss
of 284093.66 for March.
 Cash Budget
• Change total cash available for sale into total cash before
disbursements.
• In computing the direct labor budget labor disregard the clause
that says 10% of current payroll will be paid next month for
discussion purposes.
• There is no clause that the overhead is being paid on terms so
everything will be disbursed according to period
• Cash operating expense of 1500,000 will not be needed to be
adjusted into accruals since cash flow is the topic about the cash
budget. Do not mixed it with the concept of operating expense
under accruals.
• Part of cash outflow for the particular period: Acquisition of
Machinery.
• Borrowings is on that amount because of by 10ks clause and cash
requirement beginning should not be lower than 100k.
• Interest rates of 3 percent per month is the basis of 15900. (put a
negative sign)
BUDGETING and FINANCIAL
MODELLING
 Budgeting concepts:
• Budgeting is a formal process of financial planning using estimated financial and
accounting data.
(planning means at start)

• A budget is a plan, expressed in quantitative terms on how to acquire and use the
resources of one entity during a certain period of time.

(This quantitative amounts are derived and based from past experiences. statistics, math and
other related formulas that is relevant to be used. Other qualitative information related to
budgeting will be expressed in numbers using multipliers E.G: ber months or weather etc. of a
new segment. Probability can be used for estimation with conservative and aggressive numbers
to find the best estimate.)

• A budget is “a financial statement, prepared and approved to be pursued during

that period for the purpose of attaining a given objective. It may include income,
expenditure and employment of capital.”

(Planning is important to at least be executed at par. For instance in standard costing,

significant difference or variance between standard or budget against actual either favorable or
unfavorable is not a good indication in some ways. You can blame production and planning
team about this depending on findings for continuous improvement.)
Budgeting and Forecasting

Forecasting is “a process of predicting or estimating a future

happening” (NAA, USA). It is a tool in the budgeting process.

Budgeting is more than estimating. It is an attempt, at the beginning of a

period to plan the profit and loss account for the period and to aim for a
definite balance sheet at its end, instead of relying upon chance.
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(for example upon getting the relevant predicted sales at start , a certain company will plan the
other related things such as production, safety stocks, general and administrative expenses
based on the relevant projected data and previous experiences. Of course the mode of payment
that affects the cash flows and other related balance sheet accounts like inventory end. The end
product will be budgeted FS.)

(This budget aims to be the real thing maybe better or atleast within the range it has been
predicted.)
Budgetary control is a means at which the actual state of affair is compared
with the budget so that appropriate action may be taken with regard to
any deviations before it is too late. It has the following objectives:

Organized procedures. Provide organized procedure for and after the

planning.
(Corrective actions to minimize all miscalculations on both budget and on actual to
avoid variances afterwards)

Coordinate all the activities of various departments for maximum profit

and optimum use of resources.
(by making activities coordinated means it will make the work a lot efficient and
effective)

Performance evaluation.
(To see how the actual things have been done comparing to budget and
evaluate the different team involved to such deviation or if applauded then to
give credits.)
 Budgetary control systems in a nutshell:
standard actual vs. budget feedback evaluate

Objectives and functions of budgeting:

1) Communication
2)
3)
Planning
Coordination
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4) Control and performance evaluation
5) Motivation (target)
 Feedback
• Feedback is the process of transmitting information about actual results to the
people who are responsible for comparing them against a budget or standard,
and initiating control action if required.

• Negative feedback – indicates that targets were missed and this was not what was
required. Control action is required to get back on target.
• Positive feedback – means that actual results were better than target results. It
leads to control action which causes actual results to maintain (or increase)
their path of deviation from planned results. It indicates that the target should be
moved.

(positive feedback sometimes can be because that the budget made is a

miscalculations . For instance a favorable variance have occurred because the target
budget is to easy to attain.)

(Management accountant’s role – to provide the feedback loop by recording actual

results, analyzing actual results and comparing them with the budget, and reporting
actual results and the comparisons with plans to the managers who are responsible
for whatever control actions might be necessary. )
Feedforward control is control based on comparing original targets or actual
results with a forecast of future results, and taking actions that anticipates and
makes allowances for future changes.

(is a mechanism in a system for preventing problems before they occur by

monitoring performance inputs and reacting to maintain an identified level. It is
now increasingly recognized that control must be directed towards the future to be
effective.)
 Advantages of budgeting

• motivates management to make an early and timely study of its problems.

(for instance weekly or monthly have not been met and the monthly or
quarterly comparison).

• A plan for spending.

• Basis for periodic evaluation and testing of managerial policies and

goals.mainly for departments and individuals.

• Directs capital and other resources into the most profitable

• Coordinates and correlates all business activities.

• Develops an attitude of “cost consciousness”. (Provides a plan for intelligent

use of resources and effective prevention of waste.)

• Builds and encourages productive competition and gives a sense of purpose

for each individual in the organization. (budget vs. actual production let say
and target sales vs actual sales.)
Disadvantages of Budgeting

It is not an exact science, it is used for approximations and judgments.

(sometimes it is the fault of budget committee or someone designated to work
on the budget to estimate it in a very unrealistic way or very idle way.)

Establishing a budget takes time and costly

Excessive emphasis on budgeting may result in attempts in lower level

management and employees to buck the system by providing inaccurate
estimates of future costs and revenues.

(personal experience: those employees should be blindfolded about the budget as

much as possible. It can lead to fraud. For instance the per unit cost basis of
manufacturing a pants is the budget and you miscalculated it making it significantly
lower then they can just follow it and keep the excess materials for themselves )
 Budgeting Process

Obtain estimates of sales, production levels, expected costs, and

availability of resources from each sub-unit.

Coordinate estimates.

Communicate the budget to responsible managers and the concerned

departments.
(collect their feedback and ask them if there is irregulaties on the
coordinated estimates.)

Implement the budget plan.

Report interim progress towards budgeted objectives.

(monthly, semi monthly or weekly will be ideal)
Budget Committee

is composed of executives in-charge of major functions of the

business and includes the sales manager, human resources
manager, finance manager, the production manager, the chief
engineer, the treasurer, and the chief accounts officer.

Example of a Budget Committee:

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(For example, the budget committee for AMV GENIUS INC. is in charge
of overseeing the yearly budget formation for every department within the
organization and approving the budgets. The committee is the only entity
within the organization that sees the whole financial picture of the firm.
They maintain the budget manual and make sure the departments are
adhering to their submitted yearly budgets.)

(others are blindfolded and will ask only their subordinates to give them
reports about the actual movement.)
Functions of Budget Committee:
Decide the company’s general policies and objectives.

Receive and review individual budgets concerning different

organizational segments.

Approve budgets which act as an authority/target for departmental

action.

Receive and analyze performance reports regarding the

implementation of budgets that leads to suggested modifications in
accordance with the objectives.

Suggest corrective action to improve efficiency and achieve

budgetary goals.
• A budget manual is a document which defines the responsibilities
of persons engaged in a budgetary program and sets out the routine,
the forms and records required under budgeting. It also specifies the
procedures to be followed in developing the budget.
(it acts like a user guidelines to users)

• Short-range-budget- It may cover periods of three, six, or twelve

months depending upon the nature of the business.

• Long-range-budget- It is a systematic and formalized process for

directing future operations towards a desired objective for period
extending beyond one year.
 Budget vs. Standard cost
(A budget usually refers to a department's or a company's projected revenues, costs,
or expenses. Both the quantity and cost per unit are projected. )

(A standard usually refers to a projected amount per unit of product, per unit of input
or per unit of output and it is multiplied to actual output if variable. The cost are
mainly based on budget but the quantity used is partly based on actual)

Let's assume that the budgeted manufacturing overhead for the upcoming year is
expected to be $1,000,000 in order to produce the expected 100,000 units of product.
(BUDGET)

The standard cost of manufacturing overhead per unit of product is $10. therefore 10PHP
is the the standard rate and if the actual output in quantity is not equal to budgeted then
surely there will be discrepancy. For instance only 99000 is produced. If fixed budgeted
amount, the per unit cost will just be higher making it 10.10. If variable in nature then
the total amount of variable cost will differ but per unit will still be the same.
(Standard)
Budgeting usually starts at budgeting the sales as what the illustrative
problem shown. Here are some guidelines we can use:

Review the past performances.

Obtain data from head office salesmen, dealers, and sales officers of different
territories (seasonal demands, culture and preferences).

Analyze general business barometers such as GNP, GPD, personal income

and purchasing power of the population, unemployment conditions,
government crop reports, steel, coal and oil production, wholesale price index,
business failures, industrial production index, government policies, and other
critical factors and phases of the country’s economy.

Sales analysis can It may be prepared on the lines of product, territory, and
customer.
Master Budget Operating and Financial Budget

The master budget is a one-year budget planning document for the firm encompassing all
other budgets. It coincides with the fiscal year of the firm and can be broken down into
quarters and further into months.

Continuous Budgeting
is the process of continually adding one more month to the end of a multi-
period budget as each month goes by.

If the firm plans for the master budget are to be an on-going document, rolling from year
to year, then normally a month is added to the end of the budget to facilitate planning. It
is called continuous budgeting.
 Depending on the size of the firm, the master budget is a comprehensive
budget planning document. It usually has two parts:

) The operating budget shows the income-generating activities of the firm, including
revenues and expenses. The result is a budgeted income statement.

2) The financial budget shows the inflows and outflows of cash and other elements of
the firm's financial position. The inflows and outflows of cash come from the cash
budget.

As such, the result of the financial budget is the budgeted balance sheet. Operating
budgets are prepared first as information from the operating budgets is needed for the
financial budgets.
Zero-based budgeting (ZBB) is an approach to making a budget from scratch.
The budget is not based on previous budgets. Instead, the budget starts at zero.

( Theories: It is quite time consuming and costly to do.)

Example:
Let’s say you run a hair salon and sell shampoo and conditioner to customers. Last year,
you purchased these from supplier for $30,000.

You decide to use zero-based budgeting for the upcoming year. As you’re listing
expenses, you realize you can make your own hair products for cheaper than the supplier’s
price. Making your own products will save you $22,000.

When creating your zero-based budget, you would only mark $8,000.

(means to say you do not give a damn anymore on previous year’s budget even taking
notes about the savings etc. unlike the typical budget you based your current year
budget from previous budgets and improve it. )

(the example seems easy but doing this things in corporate world, it is much easier to just
make a little ammendments on a already established budget. Imagine making your own
ppt, it is easier if there is already an established one right and just put addtionals and
minor changes?)
 You also realize that you can cut back on advertisements. Instead of spending $10,000 in
this example of zero-based budgeting, you only need to spend $3,000. You would mark
$3,000 for advertisements.

And, you find out you can get a better rate from a different office supplier, saving you
$500. Instead of $1,500, your supplies will now only cost you $1,000.

The main disadvantage is preparing such kind of budget is costly but on the other side, many
firms using previous year as basis if there is a fund excess for a segment, they tend to just use
it to non value adding things or maybe can cause fraud by using it for own use.
A performance budget is one that reflects both the input of resources and the output of
services for each unit of an organization. This type of budget is commonly used by
government bodies and agencies to show the link between taxpayer funds and the outcome
of services provided by federal, state, or local governments

(The goal is to identify and score relative performance based on goal attainment for
specified outcomes.)

A few examples of outcomes that a performance budget could address include:

•Decreases in mortality or morbidity rates of a health program (PHP1Billion)

•Improvement of water quality of a county's drinking supply (PHP 1B)
•Non-violent crime reduction in a city. (DDS: 500B)
•COVID mask 100,000 pieces to ensure the safety of frontliners (PHP1 trillion)
•Salary of nurses (PHP 100M)

A performance budget would be developed accordingly to identify those target numbers

and a method of evaluating performance. Performance budgets often rely on quantifying
otherwise qualitative or subjective factors so that they can be measured and accounted
for. (cost over benefit or benefit over cost?)
Variable Costing & Absorption Costing and Analysis

Two product costing methods:

Variable costing includes direct materials, direct labor and variable overhead, also referred as Direct
Costing.

Absorption costing includes direct materials, direct labor and both variable and fixed overhead, also
referred as Full Costing. Traditional

Absorption Costing versus Variable Costing

Differences in income from alternate methods will be small when:

I
ABSORPTION : VARIABLE :
Sales sales

(COGS)
Junits sold
(Variable) Mfg

Manufacturing a

Fixed overhead is a small % of total manufacturing costs.

Em
GP
ed) meen


Copex) selling & Admin (units sold)

Inventory levels are low. NI

 Inventory turnover is rapid. Fixed

Mfg
Notoutright expense,capitalite
a outright regardless
of units sold

 Period of analysis is long.

Income under Absorption = Income under Variable

+

MFG (End
FC Inv unsold)
-

MFG FC
(Beg Inv)

Examples:
 Absorption Costing

Product Costs ($65.00 per unit)

Direct Materials ($6.00)
Direct Labor ($14.00)
Variable Overhead ($11.00)
Fixed Overhead ($34.00)

Variable Costing

Product Costs ($31.00 per unit)

Direct Materials (($6.00)
Direct Labor ($14.00)
Variable Overhead ($11.00)
Period Expenses
Fixed Overhead ($34.00)

Example: Ice Age Company:

Selling Price: USD 40

Variable Product Cost: USD 15

Variable Period Cost: USD 2

Fixed Manufacturing: USD 600,000

Fixed Selling: USD 200,000

Absorption Costing vs. Variable Costing: Units Produced Equal Units Sold: Both 60000 units
Absorption Costing vs. Variable Costing: Units Produced exceeds Units Sold: Produced 60,000 and sold 40,000 no Beg Inv

500 000 End Inv

300 000 End Inv

 The net income under absorption is higher since some part of the fixed manufacturing are being
capitalized and be part of Balance Sheet while in variable costing it was outright expense
(period).
 Absorption Costing vs. Variable Costing: Units Produced is lower than Units Sold: Produced 60,000 and
sold 80,000.

 In using absorption costing, the capitalized portion of the previous period was being recognized on the
next period leading to a higher income for variable costing.
 Zbest Manufacturing reports the following costing data for the current year. 20,000 units were produced, and
14,000 units were sold.

Product cost per unit using absorption costing will be: $54.00 Product cost per unit using variable costing will be: $20

]
 Converting Variable Costing Income to Absorption Costing Income

Income under Absorption costing = Income under variable costing + Fixed overhead cost in ending inventory −
Fixed overhead cost in beginning inventory

60000 produced with $ 10 per unit Fixed manufacturing:

 Refer to Ice age illustrative

ACTIVITY BASED COSTING
Activity-Based Costing Activities
Traditionally, in a job order cost system and process cost system, overhead is allocated
to a job or function based on direct labor hours, machine hours, or direct labor dollars.
Traditional : Based on one activity level
only

However, in some companies, new technologies have changed the manufacturing

environment such that the number of hours worked or dollars earned by employees are
no longer good indicators of how much overhead will be needed to complete a job or
process products through a particular function. In such companies, activity-based
costing (ABC) is used to allocate overhead costs to jobs or functions.

Cost drivers are the actual activities that cause the total cost in an activity cost pool to
increase.
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Traditional Costing System:
Activity Based Costing:

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An activity center is a unit of the organization that performs some activity. For example, the costs of setting
up machines would be assigned to the activity center that sets up machines. This means that each activity
has associated costs. When the cost driver is the number of inspections, for example, the company must keep
track of the cost of inspections.
BASICS of CVP
Analysis
• The contribution margin represents the incremental money
generated for each product/unit sold after deducting the variable
portion of the firm's costs.

• The contribution margin is computed as the selling price per

unit, minus the variable cost per unit. Also known as dollar
contribution per unit, the measure indicates how a particular
product contributes to the overall profit of the company.

• It provides one way to show the profit potential of a particular

product offered by a company and shows the portion of sales that
helps to cover the company's fixed costs. Any remaining revenue
left after covering fixed costs is the profit generated.
• A break-even analysis is a financial calculation that weighs the
costs of a new business, service or product against the unit sell
price to determine the point at which you will break even. In
other words, it reveals the point at which you will have sold
enough units to cover all of your costs.

• the margin of safety is equal to the difference between current or

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forecasted sales and sales at the break-even point. The margin of
safety is sometimes reported as a ratio, in which the
aforementioned formula is divided by current or forecasted sales
to yield a percentage value.
• Cost-volume-profit (CVP) analysis is a way to find out how
changes in variable and fixed costs affect a firm's profit.

• Companies can use CVP to see how many units they need to
sell to break even (cover all costs) or reach a certain minimum
profit margin.

• CVP analysis makes several assumptions, including that the

sales price, fixed, and variable costs per unit are constant.
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• Relevant range is an accounting term that describes the
parameters of production or activity within which a company
maintains the same fixed costs. In accounting, fixed costs are
constant and independent of specific production rates.

• Tax considerations on CVP analysis, taxes are deducted in the

end and not to be considered as Variable in nature.

• Sensitivity analysis shows how the CVP model will change with
changes in any of its variables (e.g., changes in fixed costs,
variable costs, sales price, or sales mix). The focus is typically on
how changes in variables will alter profit.
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• The degree of operating leverage measures how much a
company's operating income changes in response to a change
in sales.

• The DOL ratio assists analysts in determining the impact of

any change in sales on company earnings.

• A company with high operating leverage has a large

proportion of fixed costs, meaning a big increase in sales can
lead to outsized changes in profits.
DOL ↑ FC
S , Effect on profit
↓ ↓ ↓
 Unit CM : 80 VC %: 60 %

CM %: 40 %
Peso units
400 000 1000 000
- 1,000,000 = 5000
40% 200

(8000-5000) 200 =
600000

128000
8000 x 20 % X 80 =
. 000
128
=
53 33 %
.
increase in profit
240000

640 000
=
2 67
.
20 % x 2 67
.
=
53 33 %
.

240000
A.) Unit contribution Margin= Sales-VC= P80

CM % VC rate=

Sales= 100% (always) = 200

VC= 60%=120
CM RATE= 40%= 80

B.)
Break even in peso= Fixed cost in peso/CM rate=
400,000/0.4= P1,000,000
Break even in Quantity=
1000,000/200= 5000 units
Or
Fixed cost in peso/CM in peso
400,000/80=5000 units
C.) margin of safety in terms of peso=
(Anticipated/budgeted/actual Sales- break even sales)Price=

(8000-5000)200= P600,000

In terms of quantity answer is 3000 units

In terms of rate:
Budgeted sales= 100% or P1.6M
Portion of Breakeven sales= 1M/1.6M= 62.5%
Margin of safety rate= 37.5%

D.) sales increase by 20% , how much will be the increase in profit?

(Anticipated sales)*( increase in percentage)*(contribution margin in

peso)=increase in profit

8000*0.2*80=P128,000

Or 53.33% increase in profit (128,000/240,000)

E.) DOL= CM/NI

640,000/240,000=2.67 ( meaning profit will change for 2.67 for every 1%

change in sales)

To prove:

20%*2.67=53.33%
Target Profit: Target profit is the expected amount of profit that the managers of a
business expect to achieve by the end of a designated accounting period. The target
profit is typically derived from the budgeting process, and is compared with the actual
outcome in the income statement. This results in a reported variance between the actual
and target profit figures, for which the accounting staff may provide a detailed
explanation. However, budgets are notoriously inaccurate, and become more inaccurate
the further into a budget year that you go. Thus, a secondary derivation of the target
profit that tends to be more accurate comes from a rolling forecast, where the target
information is updated regularly, based on a company's short-term expectations for the
next few months. This tends to result in relatively small differences between the target
and actual profit.

Sample Problem:

Unit sales price: P 400

Unit variable costs: P 240

Total fixed costs: P 800,000

How much is sales if profit is expressed as:

a. Profit before tax of P 400,000. (800 000 + 400 000)/160 = 7500 units

FC+P 400,000/CM in peso= 7500 units

~

7500 units*400= P 3,000,000 (can also be computed using: ((FC+ Target NIBT)/ (CM/Sales))) = P 3,000,000

b. Profit after tax of P 480,000, tax rate is 40%.

60 %

NIAT-NIBT= P 480,000/1-tax rate= P 800,000 480000 =

(1-40 %)

FC+P 800,000/CM in peso= 10,000 units (800 000 + 800 000)/160 =

10000 units

NIBT NIAT
CM FC
units CM/Unit

160 1600000 -
800 000 =
800000 x 60% =
480
, 000
10000 x =

20
10,000 units*400= P 4,000,000 10000 x
=
4000 000

(Can also be computed using: ((FC+ Target NIBT)/(CM/Sales)))= P 4,000,000

c. Profit is 20% of sales, before tax. p= (20 % 5 -
800000)

X-60% X-800 000 =

20 % X X -
60 % -20 % =
800 000

profit 20 % =
800 000
CM

240/400 20% 20 %

X = Sales X =
4000000

Sales 4, , 000
000 100% 4 000 000-400 =
10 000 units

X-0.6X-P 800,000=0.2X vC

FC
(2400 000)
(800 000)

Profit 800 000 20%

=P 4,000,000

P 4000,000 / P400= 10,000 units

d. Profit is P25 per unit, before tax. 400 x -

240x -

800 000 =
25X

240x

-25x=8000o
400 x -

P400X- P240X- P 800,000=25X 135 135

X =
5925 93 .
5926 units

= 5925.92 units- 5926 units

5926*400=2,370,400 (based on round up amount)

Can also be computed using:

P800,000/ 40%-6.25%=P 2370,370

Sales

e. Profit is 20% of sales, after tax of 40%. 800 000) (100 ) 12 000 000-400
%

30 000 units
(X
=

60% x 60% =
20 %
-

x
-

vc ( 7200 000)
60 % x
-
36% x
-

480000 =
20 % X
FC 2800 000
60 % x
-

36 % x -
20 % x =
480 000
NIBT

4% x = ,
480 000 4000000
X =
12 000 000 (20%) 2400 000

sales NAT

X-0.6X-800,000-((0.4(X-0.6X-P800,000))=0.2X = P 12,000,000

P 12,000,000/P400= 30,000 units

f. Profit is 20% of CMR, before tax. X -

60 % x -
800 000 =
20 % (40 % x) 100 % 2500 000 = 400 =
6250 units

40% X -
800 000 =
8% X
ve (1500 000)
40 % x -
8% x = 800
- 000
FC (800 000)

0.4X-800,000=.4(.2X) = P 2,500,000 32 %

32 %
x =
800 000

32 %
Profit 200 000 = 20 %=

CMR
40% =
2500 000

Sales
given
X =
2500000

sales

P 2,500,000/P400= 6250 units

The sales mix is a calculation that determines the proportion of each product a business sells
relative to total sales. The sales mix is significant because some products or services may be
more profitable than others, and if a company's sales mix changes, its profits also change.

Good
BEP 3315
,

000
5100

=
17000 Better 8500

195 3400
Best

Goodgoa
BED 3315000 + 234000 5460
= 18 200
Better
195

150 (30 % ) 200 (50 % ) 250 (20 % ) BEP 3315 000

Good of 10 :
=
195 WACM = 17919
185

185 WACM

A: ((.3X150) + (.5X200) + (.2X250)) = 195

B: (3,315,000/195) = 17000 Good: 5100 Better: 8500 Best: 3400

C: ((3315000+234000)/195)) = 18200 Good: 5460 Better: 9100 Best: 3640

D: it will change since the CM Average will be 185 and the breakeven will therefore be 17919.
• The term "labor-intensive" refers to a process or industry
that requires a large amount of labor to produce its goods or
services. (can be used for normal capacity or Boogey)

• The term "capital intensive" refers to business processes or

industries that require large amounts of investment to produce
a good or service and thus have a high percentage of fixed
assets, such as property, plant, and equipment (PP&E). (can
be used for ideal capacity)
Loading…
• Financial modeling is a representation in numbers of a
company's operations in the past, present, and the forecasted
future. Such models are intended to be used as decision-
making tools. Company executives might use them to estimate
the costs and project the profits of a proposed new project.

Loading…
Financial models help estimate the valuation of a business or make
comparisons in the industry.

Some common uses of financial modelling include:

Valuation: It estimates a company’s value or an investment, such

as stocks, bonds, or real estate.

Forecasting: You can also use it to forecast line items such as

future revenue, expenses, and cash flows.

Budgeting: Financial modelling helps build budgets and allocate

resources based on projections.

Risk management: Financial modelling also assesses market,

credit, or operational risks.
Loading…
• Static Budget - the budget is prepared for only one level of production volume.
Also called a Master budget.

• Flexible Budget - a summarized budget that can easily be computed for several
different production volume levels. Separates variable costs from fixed costs.
• Flexible budgeting can be used for different levels of activity
depending on the outcome (actual) or lets say (projections or
target)
Forecasting in accounting refers to the process of using current
and historic cost data to predict future costs.

Forecasting is important for planning purposes – it is necessary

to estimate and plan for costs that will be incurred prior to actually
incurring them.
Loading…
You may opt to read the article: https://happay.com/blog/financial-modelling/
Different Cost Formulas:

FIFO method- FIFO assumes that inventories that were purchased or produced
first are sold first and consequently the items remaining in inventory are those most
recently purchased or produced

Weighted average cost Periodic

Under weighted average cost formula, the cost of each item of inventory is
determined from the weighted average of the cost of similar items at the beginning
of a period and the cost of similar items purchased or produced during the period.
The weighted average may be calculated on a periodic basis or at each shipment
received

LIFO method (Last-In, First-Out)

is not allowed (per IFRS), but this does not preclude an entity from adopting
specific costing formulas where actual physical flows of inventory are matched
with direct costs, which may yield results similar to LIFO.
Different Cost Formulas:

The specific identification method relates to inventory valuation, specifically

keeping track of each specific item in inventory and assigning costs individually
instead of grouping items together. It is useful and usable when a company is able
to identify, mark, and track each item or unit in its inventory.

It is a method for inventory valuation or delivery cost calculation, by which the

unit cost is calculated every time inventory goods are accepted instead of
calculating the cost at the inventory clearance of the end of month or accounting
period.
 Find COGS,EI and GP using this cost formulas:
Loading…
1) Specific Identification Method: (no.3 from no.2) & (no.5 from
(remaining of no.2 and the rest no. 4)

2) FIFO

3) Weighted Average Periodic

4) Weighted Average Perpetual or Moving Average

Specific identification Method:

COGS: (18,000*52)+(5000*55)=P1,211,000

Note: the number 3 and number 5 is from 7,000

and 11,000

GP:
Sales= (7000*130)+(16000X135)=3070,000 1) Specific
Therefore GP is P1859,000 Identification Method:
(no.3 from no.2) &
(no.5 from (remaining
of no.2 and the rest
Ending Inventory: no. 4)

(2000X50)+(1000X55)+(3000X60)=PHP335,000
FIFO Method:

COGS: (2000*50)+(18000*52)+
(3000*55)=1201000
(or simply BI + Purchases-(recent purchases+
next most recent purchases and so fort).

GP: Sales=
(7000*130)+(16000X135)=3070,000
Therefore GP is 1869,000
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Ending Inventory: (recent purchases + next
most recent purchase and so fort which have
not been disposed yet).

(3000*60)+(3000*55)=345,000
WA Method:

(Cost of (Beginning Inventory) +

Purchases)/TGAS (QTY)= 53.31
1546000
=
53 31
.

29000

COGS:
(53.310344*23000)=1226138

GP: Sales= (7000*130)+

(16000X135)=3070,000

Therefore GP is 1843862

Ending Inventory:

53.310344*6000=319862
 Moving Average:

Ending Inventory:
338440

Sales:
3070,000

COGS:
1207560

GP: 1862440
 Allowance Method
Purchases 14700
AFPD 300
A/P 15000

Purchases 4900
AFPD 100
A/P 5000

A/P 15000
AFPD 300
Cash
14700

Opex
A/P 5000
Purchase Disc Lost 100
• Freight in vs. Freight out

• Direct charging method (capitalized as part of material)

• Indirect charging method (enters into debit side of OH account)

• Relative peso value method & Relative weight method

Relative Peso Method

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SPOILAGE AND REWORK
Charged to the specific job:

It means to say that the loss will be bear by the specific job
order where the loss occurred. Spoilage means it cannot be
reworked but can be sold on a lower price compare to good
finished product. Reworked items means still normal item but
with additional works to be done (ADDITIONAL COST).

Charged to all production:

It means to say that the loss from spoilage will be bear by

everything that has produced. It is consider normal losses
(PART OF APPLIED OH ESTIMATION) and will be part of
actual overhead control (debit). It will not normally increase the
cost per unit as it was assumed part of the estimation already.
Key notes for Spoilage and Rework:

Internal failure:
means charged to all production and not to specific job only.

In case of allowances for spoiled or rework cost

If problem requires charged to all production:

allowance must be included into applying factory overhead since it

is assumed normal or necessary and therefore part of estimation.

If requires just to specific job:

do not apply the portion of allowances since it is chargeable only to

the specific job
Spoiled Illustration:

FMV

509 46
.
490 -
250 = 240 spoiled gooa =
19 40
.

490
orig unit cost

*Cost of 185 units will be 500 and 509.46. 19 46.

*actual factory overhead including other consideration will be compare to applied (material or
immaterial.)
 Reworked illustration:

*Cost of 200 units will be 500 and 501.25.

*actual factory overhead including other consideration will be compare to applied (material or
immaterial.)
 Chix a manufacturer of cool toys received order of 30,000 units and
started working on it under JO#143. After completing the said JO, the
inspection found out that 4% were determined to be defective. The client
Mr. Luigi only accepts goods on a 140% of cost as agreed price. Since Mr.
Luigi is a good Samaritan, he agreed to buy the 4% defective units for a
consideration price of 15 pesos each. Chix was delighted on Mr. Luigi’s
antics.

Total costs charged to JO#143: DM: 276K DL: 84K applied FOH:
180K

1) If the spoilage is due to internal failure what is the unit cost of

good units?

2) If the spoilage is attributable to job 143 only, what is the agreed

price of the goods units?
 1) (276K+84K+180K)/30000=18PHP

(276K+84K+180K)-((.04X30000)*18)/((30000-(.04X30,000))=18PH

1) 540,000-(1200*15)/28800= 18.125 per unit

18.125*1.4=25.375
 Lover boy produced 200 units of heavy equipment with following cost per unit:
DM: 200
DL: 175
FOH applied:160% of DL. (150% in cases in which any defective unit costs are to
be charged to a specific order).

Final inspection revealed that 15 units were subjected for rework. Correction needs
50PHP Materials, 80PHP DL and OH at an appropriate rate each.

1) Assume charge to all jobs, what is unit cost of FG?

2) Assume to the specific order what is the unit cost of each units manufactured?
1) (200+175+(175*1.6))=655

2) (200 units*(200+175))+(175*1.5))+((15 units*(50+

(80*2.5))/200=656.25
Definition of Process Costing
Process costing is a term used in cost accounting to describe one method
for collecting and assigning manufacturing costs to the units produced. A
process costing system is used when nearly identical units are mass
produced while Job costing or job order costing is a system used to
collect and assign manufacturing costs to units that vary from one another.
Example of Process Costing
Let's assume that a company manufactures large quantities of an identical
product. The product requires several processing operations, each of
which occurs in a separate department. In the first department, the
following processing costs were incurred during the month of June:
Direct materials of $150,000
Conversion costs of $225,000
If the equivalent of 100,000 units were processed in June, the per unit
costs will be $1.50 for direct materials and $2.25 for conversion costs.
These costs will then be transferred to second department where its
processing costs will be added.
Weighted Average Method:
Weighted Average Method:
Weighted Average Method:
FIFO Method:
FIFO Method:

Loading…
FIFO Method:
Methods of allocating service department cost to producing
departments

Step Method: Unlike direct method, step method (also known

as step down method) allocates the cost of a service department to
other service departments as well as to operating departments. The
cost allocation under step method is a sequential process. It begins
with the allocation of cost of the service department that provides
the greatest amount of service to other service departments and
ends with the allocation of cost of the service department that
provides the least amount of service to other service departments.
(exam purposes if silent apply the rule)
Methods of allocating service department cost to producing
departments

Direct Method: The direct method is considered the most simple

method of allocating the cost of service departments to operating
departments. Under this method, the costs incurred by service
departments are not allocated to each other; rather, they are directly
allocated to operating departments using some appropriate
allocation base. In other words, we can say that the direct method
of departmental cost allocation ignores the service provided by a
service department to itself and to other service departments.
Reciprocal or Algebraic Method: Although it is the most accurate, it is also the
most complicated. In the reciprocal method, the relationship between the service departments
is recognized. This means service department costs are allocated to and from the other
service departments.
Reciprocal or Algebraic
method
 Find COGS,EI and GP using this cost formulas:

1) Specific Identification Method: (no.3 from no.2) &

(no.5 from (remaining of no.2 and the rest no. 4)
2) FIFO
3) Weighted Average Periodic
4) Weighted Average Perpetual or Moving Average
Specific identification Method:
COGS: (18,000*52)+(5000*55)=1,211,000

Note: the number 3 and number 5 is from 7,000

and 11,000

GP: Sales= (7000*130)+(16000X135)=3070,000

Therefore GP is 1859,000

Ending Inventory: (2000X50)+(1000X55)+

(3000X60)=PHP335,000
FIFO Method:
COGS: (2000*50)+(18000*52)+
(3000*55)=1201000
(or simply BI+Purchases-(recent costs+next most
recent cost and so fort).

GP: Sales= (7000*130)+(16000X135)=3070,000

Therefore GP is 1869,000

Ending Inventory: (recent costs+next most recent

cost and so fort which have not been disposed
yet).

(3000*60)+(3000*55)=345,000
WA Method:
COGS: (53.310344*23000)=1226138
GP: Sales= (7000*130)+(16000X135)=3070,000
Therefore GP is 1843862

Ending Inventory: (Cost of (Beginning Inventory +

Purchases)/TGAS (QTY)= 53.31
53.310344*6000=319862
Moving Average:

EI: 3384401
Sales:3070,000
COGS:1207560
GP:1862440
Strategic Cost
Management
Responsibility Centers :

Centers
costRevenue Centers

Profit Centers
·

Investment Centers
·

Manufacturing Business
Cycle :
O
Suppliers material storage
②
Labor Force Pro duction

Overheads
③

Customers Finished Goods

④

Materials Accounting
·
control of Materials -
limited access ,
segregation of duties ,

accuracy in
recording physical , control

·
Documents Used -

purchase requisition , purchase order , receiving

report , materials requisition slip

Schedule ofC ost of Goods Sold

Direct Materials Total Manufacturing Cost

Beg RM Inv Beg WI Inv

Net Purchases Cost Put in Production

(End m (nv) (End WIP Inv)

DM used Cost of Goods Manufactured

DL Beg FG Inv

OH Applied Total Goods Avail forS ale

Total Manufacturing
Cost (End FG Inv)

cost of Goods sold

Prime Cost :
DM + DL

Conversion Cost :
DL + OH

Exercise :

1 . RM Beg 2000

Purchases 9800

RM End D

Dm used 1) 800
37800

DL 26000
44000
OH 18000

TMC 55800

O
WIP Beg
WIP End (2100)
COGM 53700

FG Beg 700

O
FG End

COGS 54400

:
Normal Balance Actual -
Debit
: Applied
-
Credit

Applied > Actual Applied < Actual

OH COGS

COGS OH