MS NOTES

INTRODUCTION TO MS
Determine SP
Introduce new product
Provide useful Managers  decision Improve process
Management Management Accounting (MA)
Relevant information making Open a new branch
Services (MS) Financial Management Minimize cost

Characteristics of Management Accounting (MA) Vs. Financial Accounting (FA)

1. User  Managers (internal users) 1. External users
2. No accounting standards (only as needed) 2. PFRS  FS (quarterly/annually)
3. Relates to the future 3. Past transactions

Line – directly involved in revenue-generating activities

Staff – supports the line position (IT dept, payroll, legal)

Organizational Structure
Stockholder

BOD

CEO

VP - Line VP/CFO - Line VP - Line VP - Staff

(Marketing) (Finance) (Operations) (HR) Managers

Treasurer Controller Internal Audit

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

COST CONCEPTS

Cost  SP  Demand  Net Income  Stock Price

↑ ↑ ↑

office factory
Ex: Calculator
(cost object)

CLASSIFICATION DM
Product – incurred to manufacture a product DL
- ex. Manufacturing/inventoriable cost OH  rent, utilities, taxes, depreciation, insurance
1. Type of factory
BS: Inventory  I/S: COGS
Period – non-manufacturing cost Selling  sales commission, advertisement, delivery
- Operating Expenses Admin  salaries to officers, R&D, BDE, depreciation (OFFICE)
Expensed as incurred  I/S

2. Traceability Direct  DM, DL

Indirect  OH
Total Assumption: valid within the relevant
Per Unit
range
Variable Cost VC
3. Behavior Direct
Constant
Total Cost
(Mixed)
Fixed Cost Constant Inverse FC

COST SEGREGATION TECHNIQUES Cost Function (linear equation)

1. High-Low Method  basis is cost drivers not cost Slope (VC/u)
∆𝑌 𝑌𝐻 − 𝑌𝐿 Y = a + bx
VC/u = b= = Independent variable
∆𝑋 𝑋𝐻 − 𝑋𝐿
(units sold)
Fixed Cost/
2. Scattergraph  plots data points Y-intercept
TC Total Cost
Units
FORMULA (COGS)
3. Least Squares / Regression  most accurate
DM used
a. Y = a + bx
DL
b. Σ𝑦 = 𝑛𝑎 + 𝑏Σ𝑥
OH
c. Σx𝑦 = 𝑎Σ𝑥 + 𝑏Σ𝑥 2
TMC
WIP, beg FG, beg
(WIP, end) (FG, end)
Correlation Analysis COGM COGS
 Used to measure the strength of linear relationship between two or more variables.
 The correlation between two variables can be seen by drawing a scatter diagram:
 If the points seem to form a straight line, there is a high correlation.
 If the points form a random pattern, there is a low correlation or no correlation at all.

GOODNESS OF FIT  accuracy/reliability of cost function

1. Coefficient of Correlation (r) – measures the degree of relationship between two variables
-1 negative correlation
0 no correlation
+1 positive correlation

0
2. Coefficient of Determination (𝒓𝟐 ) – strength of the cost function The closer to one, the better
1

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

CVP ANALYSIS
 study of the effects of changes in costs and volume on a company’s profits
 important in profit planning
 considers interrelationships among:
 Volume or level of activity
 Unit selling prices
 Variable cost per unit
 Total fixed costs
 Sales mix

Contribution Margin (I/S)  focuses on the behavior of cost

Sales xx
Manufacturing Cost (DM, DL, VOH)
- Variable Cost (xx)
Variable S&A
Contribution Margin xx
- Fixed Cost (xx) Fixed OH
Profit / NI / OI xx Fixed S&A

Formulas: 𝐹𝐶 If Multiple products Analysis: BEP

Units =
𝐶𝑀/𝑢 ↓ Favorable
1. Break-even point (BEP)  Sales mix ↑ Unfavorable
𝐹𝐶
 Sales = TC (VC + FC) Pesos =
𝐶𝑀𝑅
 Composite BEP
 Profits = 0  WACM - The lower, the better
 CM = FC 𝐶𝑀
 BEP = VC + FC 𝑆𝑎𝑙𝑒𝑠

2. Target/Desired Profits (TP)

𝐹𝐶 + 𝑃𝑟𝑜𝑓𝑖𝑡
𝑈𝑛𝑖𝑡𝑠 =
𝐶𝑀/𝑢 Before tax
TP
𝐹𝐶 + 𝑃𝑟𝑜𝑓𝑖𝑡
𝑃𝑒𝑠𝑜𝑠 =
𝐶𝑀𝑅

 the lower the better

3. Margin of Safety Extent to which sales can decrease before incurring a loss
The higher, the better

Units = 𝑆𝑎𝑙𝑒𝑠𝑈𝑛𝑖𝑡𝑠 (actual/planned) – BEP in units

MOS Pesos = 𝑆𝑎𝑙𝑒𝑠𝑃𝑒𝑠𝑜𝑠 – BEP in pesos
𝑀𝑂𝑆
Ratio = 𝑆𝑎𝑙𝑒𝑠
𝐶𝑀
= 𝑃𝑟𝑜𝑓𝑖𝑡
4. Degree of Operating Leverage (DOL)
 % ∆ in Sales  effects in profit 1
= 𝑀𝑂𝑆
 ∆ % sales x DOL = ∆ % profit before tax

Example: DOL= 5
↑ 10% Sales x 5  ↑50% Profit

5. Sensitivity Analysis
 “what if” technique that examines the impact of changes on any variables.
 ∆ in SP, VC, FC  effect on profit

Assumptions:

 The behavior of both costs and revenues is linear throughout the relevant range of the activity index.
 Costs can be classified accurately as either variable or fixed.
 Changes in activity are the only factors that affect costs.
 All units produced are sold.
 When more than one type of product is sold, the sales mix will remain constant (the percentage that each product
represents of total sales will stay the same).

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

ABSORPTION VS. VARIABLE COSTING

Income Statement: Absorption Costing (AC) Variable Costing (VC)

DM DM
Sales Sales
DL DL
- COGS (product) V - COGS
GP
OH OH  V
F GP
-OPEX (period) S&A V -OPEX FOH
Profit F
Profit S&A V
F

Absorption costing  normal accounting

 accepted for external reporting

 compliance with GAAP/PFRS
 includes all manufacturing costs (direct materials, direct labor and both variable and fixed overhead) in the cost of
a unit of product.
 Treats fixed manufacturing overhead as a product cost.
 Also called Full Costing and Conventional Costing.

Variable Costing  use only internally, for management purposes

 Costing method that includes only variable manufacturing costs (direct materials, direct labor, and variable
manufacturing overhead) in the cost of a unit of product.
 Treats fixed manufacturing overhead as a period cost.
 Also called Direct Costing.

Product costs

 are costs that are a necessary and integral part of producing the finished product.
 do not become expenses until the company sells the finished goods inventory.
Period Cost

 costs that are matched with the revenue of a specific time period rather than included as part of the cost of a
salable product.
 include selling and administrative expenses and companies deduct them from revenues in the period in which
they are incurred.

Note:

 Selling and administrative expenses are period costs under both absorption and variable costing.
 Companies use the cost-volume-profit format in preparing a variable costing income statement.

AC = Product Cost  Inventory (B/S)  COGS (I/S)

Fixed OH
VC = Period Cost OPEX (I/S)

Summary:

AC VC In short:
P = S (10,000 = NI = NI
sold) ↓ 10,000 COGS ↓ 10,000 OPEX P > S = AC NI > VC NI
↑ NI ↓NI P < S = AC NI < VC NI
Produced P = S = AC NI = VC NI
P > S (8,000 sold) ↓2,000 EI ↓10,000 OPEX
10,000
↓ 8,000 COGS
↑ NI
P < S (14,000 ↓NI
↓4,000 OPEX last year
sold) ↓14,000 COGS
↓ 8,000 OPEX this year

Reconciliation
Inventory
VC NI Beg. xx
ADD : ↑ in inventory Produced xx xx Sold
± (∆ in inventory x FOH/unit DEDUCT : ↓ in inventory End xx
AC NI

 whenever there’s sales, increase in income is equal to contribution margin

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

Potential Advantages of Variable Costing

 Variable costing has several potential advantages relative to absorption costing:

o Net income computed under variable costing is unaffected by changes in production levels.

o The use of variable costing is consistent with cost-volume-profit analysis and incremental analysis.

o Net income computed under variable costing is closely tied to changes in sales and provides a more realistic
assessment of the company’s success or failure.

o The presentation of fixed and variable cost components on the variable costing income statement makes it
easier to identify these costs and understand their effect on the company’s results

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

STANDARD COSTING AND VARIANCE ANALYSIS
Ideal, benchmark, Comparison between actual
measure of performance and standard
Uses:
Should be cost
Standard Cost 1. Evaluate performance of management
best estimate of the management
2. Simplify costing
Planned unit cost of the product
12/31
1/1
@ Standard cost

The Need for Standards

o A standard is a measure of acceptable performance established by management as a guide in making decisions.

o A standard is a benchmark or “norm” for measuring performance. In managerial accounting, standards relate to
the cost and quantity of inputs used in manufacturing goods or providing services.
o A standard cost is a determined unit cost which is used as a measure of performance.
o A standard is the budgeted cost per unit of product.
o Both standards and budgets are predetermined costs, and both contribute to management planning and control.
 A standard is a unit amount.
 A budget is a total amount.

Advantages of Standard Cost

 They facilitate management planning.

 They promote greater economy by making employees more “cost-conscious”.
 They are useful in setting selling prices.
 They contribute to management control by providing a basis for evaluation of cost control.
 They are useful in highlighting variances in management by exception.
 They simplify costing of inventories and reduce clerical costs.’

Two levels of Standard

o Ideal standards - represent optimum levels of performance under perfect operating conditions.
o Normal standards - represent efficient levels of performance that are attainable under expected operating
conditions.

Direct Materials (DM) Variance

AP x AQ Point of Purchase (if silent)

Materials Price Variance (MPV) Point of Production
SP x AQ
SP x SQ Materials Usage/Quantity Variance (MUV)  ALWAYS Point of Production

Materials Price Variance JEs:

o Key Points RMI (AQ Purchase x SP) xx
 Actual > Standard = unfavorable MPV – unfavorable xx
 Actual < Standard = favorable MPV – favorable xx
AP (AQ Purchase x AP) xx
o Accountability
 The purchasing agent is generally responsible for the price variance because he has the control over the
price paid for the acquisition of the materials.

Materials Quantity Variance JEs:

o Key Points WIP Inventory (SQ x SP) xx
 Actual > Standard = unfavorable MQV – unfavorable xx
 Actual < Standard = favorable MQV – favorable xx
AP (AQ used x SP) xx
o Accountability
 The production manager is generally responsible for the quantity variance because he has the control
over the use of the materials

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

Direct Labor (DL) Variance

AR x AH JEs for LRV & LEV:

Labor Rate Variance (LRV)
SR x AH
SR x SH Labor Efficiency Variance (LRV) WIP Inventory (SH x SP) xx
LRV – unfavorable xx
LEV – unfavorable xx
LRV – favorable xx
Labor Rate Variance
LEV – favorable xx
o Key Points Wages Payable (AH x AR) xx
 Actual > Standard = unfavorable
 Actual < Standard = favorable

o Accountability
 The production manager is generally responsible for the labor rate variance because he has the
responsibility for seeing that labor price/rate variance are kept under control.

Labor Efficiency Variance

o Key Points
 Actual > Standard = unfavorable
 Actual < Standard = favorable

o Accountability
 The production manager is generally responsible for the labor efficiency variance since he has the control
over the staffs which are directly involved in the production.

Overhead (OH) Variance (short-cut)

Variable Spending Fixed Spending

Variable Fixed
Actual AVR x AH + AFR x AH
BAAH SVR x AH + BFC Spending
Controllable
BASH SVR x SH + BFC Efficiency Total
Standard SVR x SH + SFR x SH Volume Uncontrollable

- There’s no such thing as Fixed Efficiency Variance

- Fixed cost is uncontrollable

MIX AND YIELD

 Two types of Materials and Labor

 Only applicable to DM and DL

DM:
AP x AQ x AM
Total Materials Price Variance
SP x AQ x AM
SP x SQ x SM
Materials Mix Variance
= Materials Usage
SP x AQ x SM Variance
Materials Yield Variance
SP x SQ x SM

DL:

AR x AH x AM
Labor Rate Variance
SR x AH x AM
SR x SH x SM
Labor Mix Variance
SR x AH x AM = Labor Efficiency Variance
SR x SH x SM Labor Yield Variance

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

Factory Overhead (FOH) Variance

1. Two-way Analysis
a. Controllable Variance
 responsibility of the production department managers to the extent that they can exercise control
over the costs to which the variances relate.

Actual FOH xx
BASH (xx)
Controllable Variance xx

b. Volume Variance
 responsibility of the executive and departmental management.

BASH xx
Standard FOH (xx)
Volume Variance xx

 Key Points
o Actual FOH > Budgeted FOH = unfavorable controllable variance
o Budgeted FOH > Standard FOH = unfavorable volume variance

Applied FOH xx
Controllable Variance – unfavorable xx
Volume Variance – unfavorable xx
Controllable Variance – favorable xx
Volume Variance – favorable xx
Factory Overhead Control xx

2. Three-way Analysis
a. Spending Variance

Actual Factory Overhead xx

BAAH:
Fixed as budgeted xx
Variable (AH x SR) xx (xx)
Spending Variance xx

b. Efficiency Variance

BAAH:
Fixed as budgeted xx
Variable (AH x SR) xx xx
BASH:
Fixed as budgeted xx
Variable (SH x SR) xx (xx)
Efficiency Variance xx

c. Volume Variance

BASH:
Fixed as budgeted xx
Variable (SH x SR) xx xx
Standard Factory Overhead (xx)
Volume Variance xx

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

 3. Four-way Analysis
a. Variable Spending Variance

Actual Variable FOH xx JEs:

BAAH: Variable (AH x SR) (xx)
Variable Spending Variance xx Factory Overhead Control xx
Various Accounts xx
b. Fixed Spending Variance WIP (std. costs) xx
Applied FOH xx
Actual Fixed FOH xx
BAAH: BFC (xx)
Fixed Spending Variance xx

c. Efficiency Variance

BASH:
Fixed as budgeted xx
Variable (AH x SR) xx xx
BASH:
Fixed as budgeted xx
Variable (SH x SR) xx (xx)
Efficiency Variance xx

d. Volume Variance

BASH:
Fixed as budgeted xx
Variable (SH x SR) xx xx
Standard FOH (xx)
Volume Variance xx

Reporting Variances

o All variances should be reported to appropriate levels of management as soon as possible.

o Variance reports facilitate the principle of “management by exception” by highlighting significant differences.
o Top management normally looks for significant variances. These may be judged on the basis of some quantitative
measure, such as more than 10% of the standard or more than P1,000.

Statement Presentation of Variances

o In income statements prepared for management under a standard cost accounting system, cost of goods sold is
stated at standard cost and the variances are disclosed separately.

o When there are no significant differences between actual costs and standard costs, companies report their inventories
at standard costs.

o If there are significant differences between actual and standard costs, the financial statements must report inventories
and cost of goods sold at actual costs.

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

BUDGETING
goals
in order to achieve the objectives
 Planning tool used by management to set targets
of the organization
performance reviews

 Spearheaded by the Budget Committee

 overall responsible for budget preparation
 composed of the President, Treasurer, Controller and Managers of different
departments
 head by the Budget Director

 A budget is a formal written statement of management’s plans for a specified time period, expressed in financial
terms.
 The role of accounting during the budgeting process is to:
 Provide historical data on revenues, costs, and expenses.
 Express management’s plans in financial terms.
 Prepare periodic budget reports.

Short-term  1 year
Types of Budgets
Long-term  >1 year (Capital Budgeting)

Benefits of Budgeting

 Requires all levels of management to plan ahead.

 Provides definite objectives for evaluating performance.
 Creates an early warning system for potential problems.
 Facilitates coordination of activities within the entity’s overall operations.
 Results in greater management awareness of the entity’s overall operations.
 Motivates personnel throughout the organization.

Essentials of Effective Budgeting

o In order to be effective management tools, budgets must be based upon:

 A sound organizational structure in which authority and responsibility are clearly defined.
 Research and analysis to determine the feasibility of new products, services, and operating techniques.
 Management acceptance which is enhanced when all levels of management participate in the preparation
of the budget, and the budget has the support of top management.

o A continuous twelve-month budget results from dropping the month just ended and adding a future month.

o Zero-based budgeting is a budget and planning process in which each manager must justify a department’s entire
budget from a base of zero every period.

o Life-cycle budget estimates a product’s revenues and expenses over its entire life cycle beginning with research
and development, proceeding through the introduction and growth stages, into the maturity stage, and finally, into
the harvest or decline stage.

o Kaizen budgeting assumes the continuous improvement of products and processes, usually by way of many small
innovations rather than major changes.

o The responsibility for coordinating the preparation of the budget is assigned to a budget committee. The budget
committee usually includes the president, treasurer, chief accountant (controller), and management personnel from
each major area of the company.

o Long-range planning involves the selection of strategies to achieve long-term goals and the development of
policies and plans to implement the strategies. Long-range plans contain considerably less detail than budgets.

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

 Operating  Sales, DM, DL, OH, COGS, S&A budget  Budgeted I/S
 production and sale
Master Budget FS
 end goal of budgeting Budgeted SCF, B/S
Financial Beg. Bal
 set of interrelated budgets
 constitutes a plan of action  cash + Receipts
- Disbursements
for a specified time period
- Minimum cash balance
+ -
Bank loans
excess financing
Techniques: Shares
End Bal. End bal.
1. T-accounts
2. Follow instructions

Sales Budget: the starting point in preparing the master budget.

Budgeted Income Statement: the important end product of the operating budgets.

 This budget indicates the expected profitability of operations for the budget period.
 The budgeted income statement provides the basis for evaluating company performance.

Cash Budget: shows anticipated cash flows.

 Because cash is so vital, this budget is often considered to be the most important financial budget.
 The cash budget contains three sections, (a) Cash receipts, (b) Cash disbursements and (c) Financing.

The Flexible Budget

 A flexible budget projects budget data for various levels of activity. In essence, the flexible budget is a series
of static budgets at different levels of activity.

 Flexible budget reports are appropriate for evaluating performance since both actual and budgeted costs are
based on the actual activity level achieved.

Management by Exception

 Management by exception means that top management’s review of a budget report is focused either entirely or
primarily on differences between actual results and planned objectives.

 For management by exception to be effective, there must be guidelines for identifying an exception. The usual
criteria are:
o Materiality—usually expressed as a percentage difference from budget.

o Controllability of the item—exception guidelines are more restrictive for controllable items than for items
the manager cannot control.

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

INCREMENTAL ANALYSIS / RELEVANT COSTING
 method of choosing the best option among alternatives

Future General Rule:

Relevant Cost - All variable cost are relevant. (DM, DL, VOH, VS&A)
Incremental/Differential
 cost must differ among alternatives - FC are relevant if avoidable, otherwise, irrelevant

Types:

1. Make or Buy
 Choose the option that has the lower cost.
 In most cases, fixed costs are irrelevant.
 Consider opportunity costs, if any.
 Opportunity costs: The potential benefit that may be obtained by following an alternative course of
action.
w/ excess capacity  for relevant cost, apply General Rule
2. Accept or Reject Special Order w/o excess capacity  General Rule + Opportunity Cost (lost CM)

 Accept the order when the additional revenue from the special order exceeds additional cost
 Provided the regular market will not be affected.
 In most cases, fixed are irrelevant
 The relevant information is the difference between the variable manufacturing costs to produce the
special order and expected revenues.
 If the company is operating at full capacity, it is likely that the special order would be rejected.

3. Retain or replace equipment

 Relevant items to be considered:
 The effects on variable costs
 The cost of the new equipment
 Any disposal value of the existing asset must also be considered
 Book value of old asset is irrelevant  Sunk Cost

4. Retain or Eliminate unprofitable segment/product

 Continue if segment’s avoidable revenue is greater than the avoidable costs;
 Otherwise consider shutting down the segment since allocated fixed cost is usually unavoidable, it is
considered irrelevant.
 Sales
- VC
- FC (avoidable)
Segment Margin + retain
- eliminate

5. Sell immediately or Process Further

 Process further if additional revenue from processing further is greater than further processing costs.

Split-off point

Joint Cost A
(DM, DL, OH) B Further processing cost (FPC)
Common; C
Sunk Cost

Rule: Process further of incremental revenue > incremental cost

↑ in SP (FPC)

6. Which products to produce given scarce resources?

 ranking of products  limited
 basis: CM per scarce resource

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

RESPONSIBILITY ACCOUNTING
 involves accumulating and reporting costs (and revenues) on the basis of the manager who has the authority to
make the day-to-day decisions about the items.

Objective: proper evaluation of responsibility centers  Divisions, departments, branches, segments

 Headed by managers (controllability)

A cost over which a manager has control is called a controllable cost. It follows that:

 All costs are controllable by top management because of the broad range of its activity.
 Fewer costs are controllable as one moves down to each lower level of managerial responsibility because of the
manager’s decreasing authority.

Decentralization

o Refers to the separation or division of the organization into more manageable units wherein each unit is managed
by an individual who is given decision authority and is held accountable for his or her decisions.

o Goal congruence occurs when units of organization have incentives to perform for a common interest. The
purpose of a responsibility system is to motivate management performance that adheres to company overall
objectives.

o Sub-Optimization occurs when one segment of a company takes action that is in its own best interests but is
detrimental to the firm as a whole.

Types of Responsibility Centers:

1. Cost Center  Maintenance, IT, HR, Payroll, Production  Variance Analysis

 cost (actual vs. standard)

2. Revenue Center  Sales Department, Marketing Department  Variance Analysis

 revenue (actual revenue vs. target revenue)

3. Profit Center  SM Department Store, supermarket, cinema  Sales

 revenue - VC
 cost CM
- Controllable FC
Controllable Profit Margin
4. Investment Center  Head office of SM
 revenue
 cost
 investment
IBIT

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒
1. Return on Investment (ROI) = 𝐴𝑣𝑒.𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐴𝑠𝑠𝑒𝑡 Invested asset/capital
at BV
𝐵𝐵 + 𝐸𝐵
2

Performance 2. Residual Income (RI) = Operating Income – (Ave. Operating Asset x

Measure Minimum Rate of Return)
 the higher,  Required/acceptable return
the better

3. Economic Value Added (EVA) = Op Inc after Tax – (Ave. Op Asset x WACC)
 focus is more on LT capital  at MV  Required /
 TA - CL acceptable return

 Return on Investment  most common measure of performance for investment centers

 Operating income refers to earnings before interest and taxes. Operating assets includes all assets acquired to
generate operating income.
 Residual Income – difference between operating income and the minimum peso return required on a company’s
operating assets.

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

  Economic Value Added – more specific version of residual income that measures the investment center’s real
economic gains.
 It uses the weighted average cost of capital (WACC) to compute the required income.

ROI is patterned after the DuPont technique to compute Return on Assets:

Return on Assets = Return on Sales x Asset Turnover

𝑁𝐼 𝑁𝐼 𝑆𝑎𝑙𝑒𝑠
𝐴𝑠𝑠𝑒𝑡𝑠
= 𝑆𝑎𝑙𝑒𝑠
x 𝐴𝑠𝑠𝑒𝑡𝑠

Principles of Performance Evaluation

o The human factor is critical in evaluating performance.

o Behavioral principles include:
 Managers of responsibility centers should have direct input into the process of establishing budget goals
of their area of responsibility.

 The evaluation of performance should be based entirely on matters that are controllable by the manager
being evaluated.

 Top management should support the evaluation process

 The evaluation process must allow managers to respond to their evaluations.

 The evaluation should identify both good and poor performance.

o Performance evaluation under responsibility accounting should be based on certain reporting principles.

o Performance reports should:

 Contain only data that are controllable by the manager of the responsibility center.

 Provide accurate and reliable budget data to measure performance.

 Highlight significant differences between actual results and budget goals.

 Be tailor-made for the intended evaluation.

 Be prepared at reasonable intervals.

Service Allocation Method

1. Direct Method: Service Department  Production Department

2. Step Method: Service Department & Production Department
3. Reciprocal/Algebraic Method: Considers the reciprocal services among the Service Department

Balance Scorecard
- financial & non-financial
- more holistic; basis for future performance of managers
1. Financial  ROI, RI, EVA  Internal  Monetary

2. Customer  Pricing, quality, customer service  External

3. Internal  Production, bottlenecks, breakdowns, delivery  Internal

Process  Customer focus Non-monetary

4. Learning &  Development of employees, trainings,  Internal

Growth compensated, monetized sick leave
 Employee focus

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

TRANSFER PRICING ABC Company
Transfer Price  price charged by one division to another SP 100 Selling Buying
VC (40)
Objective: to set transfer price to achieve goal congruence Ink Marker Supplier
CM 60
End Goal: to maximize the NI of the whole company 2,000 units
Capacity:
10,000 units ₱120/units

Objectives of Transfer Pricing: Customer

 To facilitate optimal decision-making.

 To provide a basis in measuring divisional performance.
 To motivate the different department heads in improving their performance and that of their departments.

Maximum Transfer Price  Market Price

Rules
w/ excess capacity  variable cost
Minimum Transfer Price
w/o excess capacity  VC + CM (opportunity cost)

Maximum vs. Minimum Transfer Prices

To minimize the effect of sub-optimization, a range for transfer price must be set based on the following limits:

 Maximum transfer price: Cost of buying from outside suppliers

 Minimum transfer price: Variable cost per unit + Lost Contribution Margin per unit on outside sales
o When a company segment is operating at full capacity, the lost CM per unit on outside sales is the
opportunity cost of transferring products to another company segment.

Other Types of Transfer Pricing

1. Cost plus (cost + markup)

 may be based on full cost, variable cost, or some modification including a markup.
 often leads to poor performance evaluations and purchasing decisions
 Under this approach, divisions sometimes use improper transfer prices which leads to a loss of
profitability and unfair evaluations of division performance.
 does not provide the selling division with proper incentive.
 does not reflect the selling division’s true profitability and doesn’t even provide adequate incentive for the
selling division to control costs since the division’s costs are passed on to the buying division.

2. Variable Cost (DM, DL, VOH, VS&A)

 uses all of the variable costs, including selling and administrative costs, as the cost base and provides for
fixed costs and target ROI through the markup
 is more useful for making short-run decisions because it considers variable cost and fixed cost behavior
patterns separately.
 more consistent with cost-volume-profit analysis used to measure the profit implications of changes in
price and volume.
 provides the type of data managers need for pricing special orders
 avoids arbitrary allocation of common fixed costs to individual product lines.

3. Full production cost (DM, DL, OH)

 uses total manufacturing cost as the cost base and provides for selling/administrative costs plus the
target ROI through the markup.

4. Negotiated Price
 selling division, establishes, a minimum transfer price and the purchasing division establishes a maximum
transfer price.
 Companies often do not use negotiated transfer pricing because:
 Market price information is sometimes not easily obtainable.
 A lack of trust between the two negotiating divisions may lead to a breakdown in negotiations.
 Negotiations often lead to different pricing strategies from division to division which is sometimes
costly to implement.

5. Market-based Price
 based on existing market prices of competing goods
 often considered the best approach because it is objective and generally provides the proper economic
incentives.

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

CAPITAL BUDGETING

 Involves long-term investment decision

 involves choosing among various projects to find the one(s) that will maximize a company’s return on its financial
investment.
 Top management/BOD are involved  accept/reject

The capital budgeting decision, under any technique, depends in part on a variety of considerations:

 The availability of funds.

 Relationships among proposed projects.
 The company’s basic decision-making approach.
 The risk associated with a particular project.

Payback Period Do not consider time value of money

Non-discounting
Accounting Rate of Return
Techniques
Net Present Value (NPV)
Discounting Profitability Index (PI) Considers time value of money
Internal Rate of Return (IRR)

Non-Discounting

1. Payback Period
 Time it takes to recover the initial investment (years)
 The shorter the payback period, the more attractive the investment. 0 1 2 3 4 5 6 7
 Advantage: Easy to compute and understand
Even (10M) 2M 2M 2M 2M 2M 2M 2M
 Disadvantages:
1. Ignores Time Value of Money (TVM) Uneven (10M) 2M 3M 5M 4M 2M 1M 6M
2. Ignores performance beyond the payback period

Formula:
𝑰𝒏𝒊𝒕𝒊𝒂𝒍 𝑰𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
𝑷𝑩𝑷 =
𝑵𝒆𝒕 𝑪𝒂𝒔𝒉 𝑰𝒏𝒇𝒍𝒐𝒘

2. Accounting Rate of Return (ARR) / ROI

 Measures the profitability of project based on income
 Advantages:
1. Simplicity of calculation
2. Management’s familiarity with the accounting terms used in the computation.
 Disadvantage: Does not consider TVM

Formula:
𝑨𝒏𝒏𝒖𝒂𝒍 𝑰𝒏𝒄𝒐𝒎𝒆 w/ salvage value  average 
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡+𝑆𝑎𝑙𝑣𝑎𝑔𝑒 𝑉𝑎𝑙𝑢𝑒
𝑨𝑹𝑹 = 2
𝑰𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
w/o salvage value  Initial Investment (simple)

 The required rate of return is generally based on the company’s cost of capital.
 Decision Rule: Acceptable if rate of return > management’s required rate of return.
 The higher the rate of return for a given risk, the more attractive the investment.

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

Discounting

 Uses discounted CF
PV  considers TVM

1. Net Present Value (NPV)

 The higher the positive net present value, the more attractive the investment.

Formula: Even (equal)  ordinary annuity or annuity due

PVCI  PV of Cash Inflow Cashflow
-PVCO  PV of Cash Outflow (initial investment) Uneven (unequal)  PV of 1
NPV
0 1 2 3 4 5
 + accept
 - reject (1M) 300k 300k 300k 300k 200k

Discount Rate

 Cost of capital — the rate that the company must pay to obtain funds from creditors and stockholders.
 Assumptions:
 All cash flows come at the end of each year.
 All cash flows are immediately reinvested in another project that has a similar return.
 All cash flows can be predicted with certainty.

In theory, all projects with positive NPVs should be accepted. However, companies rarely are able to adopt all positive-
NPV proposals because:

 The proposals are mutually exclusive (if the company adopts one proposal, it would be impossible to also adopt
the other proposal).
 Companies have limited resources.

2. Profitability Index (PI)

 method that compares the relative merits of alternative capital investment projects.
 Used in mutually exclusive project
 Limited resource; only choose one project

Formula:
𝑷𝑽𝑪𝑰 𝑷𝑽 𝒐𝒇 𝑭𝒖𝒕𝒖𝒓𝒆 𝑪𝑭
𝑷𝑰 = 𝒐𝒓 ; the ↑, the better
𝑷𝑽𝑪𝑶 𝑰𝒏𝒊𝒕𝒊𝒂𝒍 𝑰𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕𝒔

3. Internal Rate of Return (IRR)

 The interest rate that makes the PVCI = PVCO (NPV = 0)
 Trial and error
 Technique: start in the middle rate

Formula:
𝑁𝑒𝑡 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝐶𝑜𝑠𝑡
PVF for IRR =
𝑁𝑒𝑡 𝐶𝑎𝑠ℎ 𝐼𝑛𝑓𝑙𝑜𝑤𝑠

Decision guide: Inverse:

IRR > Cost of Capital  accept ↑ discount rate, ↓ NPV
IRR < Cost of Capital  reject ↓ discount rate, ↑ NPV

 If positive NPV; always TRUE that IRR > Cost of Capital

 ↑ risk, ↑ discount rate, ↓ NPV

Remember:
1. To convert NI to CF 2. Tax shield/savings
↑ Deduction, ↑ Taxable Income, ↓ Tax
Net Income
+ Depreciation Expense (100%) Depreciation Expense x Tax Rate = Tax Shield
Cash Flows
 Loss
 Gain

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

Intangible Benefits

 Intangible benefits, such as increased quality, improved safety, or enhanced employee loyalty, are difficult to
quantify, and thus often are ignored in capital budgeting decisions.

 To avoid rejecting projects that should actually be accepted, managers can either:
o Calculate the net present value (NPV) ignoring intangible benefits, and if the resulting NPV is negative,
evaluate whether the intangible benefits are worth at least the amount of the negative NPV.

o Incorporate intangible benefits into the NPV calculation by projecting rough, conservative estimates of
their value. If, after using conservative estimates, the net present value is positive, the project should be
accepted.

Sensitivity Analysis

 uses a number of outcome estimates to get a sense of the variability among potential returns.
 In general, a higher risk project should be evaluated using a higher discount rate.

Post-Audit of Investment Projects

 A post-audit is a thorough evaluation of how well a project’s actual performance matches the projections made
when the project was proposed.

 Performing a post-audit is important for several reasons.

o Since managers know that their results will be evaluated, there is an incentive for them to make accurate
estimates rather than presenting overly optimistic estimates in an effort to get projects approved.

o A post-audit provides a formal mechanism for determining whether existing projects should be
continued, expanded, or terminated.

o Post-audits improve future investment proposals because managers improve their estimation
techniques by evaluating past successes and failures.

 A post-audit involves the same evaluation techniques that were used in making the original capital budgeting
decision—for example, use of the net present value method. The difference is that, in the post-audit, actual figures
are inserted where known, and estimation of future amounts is revised based on new information.

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

COST OF CAPITAL

 Discount rate, required return, minimum rate of return, hurdle rate

Capital
10%
8% IRR
Projects
ABC Co.

Tax shield
Sources Cost Formula
1. Creditors (bank loans) Interest (cost of debt) Interest Rate x (1 – tax rate)
𝐷
PS  𝑃
0
2. Shareholders (issue Dividends (cost of equity)
shares)
OS*
Dividends
Income
RE 0 1 2 3 4 5

𝑃0 𝐷1

* (1) (2)
RE OS
1. Dividend Discount Model (DDM) 𝐷1 𝐷1
(Gordon Growth Model) +𝑔 +𝑔 Stock issuance cost
𝑃0 𝑃0
 (gross of flotation costs)  (net of flotation costs)

2. Capital Asset Pricing Model (CAPM) same RF +  (MR – RF)

 𝑷𝟎 – current price Market risk premium
 𝑫𝟏 – next dividend
 G – growth rate in dividends per share (it  RF – Risk Free Rate (Treasury Bond)
is assumed that the dividend payout ratio,   - Beta (Volatility Risk)
retention rate, and therefore the EPS  MR – Market Returns (average returns of PSE)
growth rate are constant)

Weighted Average Cost of Capital (WACC)

 More than one source of capital

 Considers capital structure of the company

1. Debt
2. PS
3. RE
4. OS

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

FINANCIAL STATEMENT ANALYSIS
 Involves the evaluation of an entity’s past performance, present condition and business potentials by way of
analyzing the financial statements.

ABC Co.
Users FS Decision making

Comparative analysis may be made on a number of different bases.

 Intracompany basis—Compares an item or financial relationship within a company in the current year with the
same item or relationship in one or more prior years.

 Industry averages—Compares an item or financial relationship of a company with industry averages.

 Intercompany basis—Compares an item or financial relationship of one company with the same item or
relationship in one or more competing companies.

Tools:

1. Horizontal Analysis 2025 2026 𝑌2

 Also called trend analysis Sales 1M 1.4M −1
𝑌1
 Evaluate FS items over a period of time
1.4𝑀
 Changes as % ∆ 1𝑀
− 1 = 40%↑

2. Vertical (common size) Analysis 2025 2026

 Evaluate items w/n the FS as a percentage of a base amount Sales 1M 2M
 BS  Total Assets COGS (400K) 40% (1M) 50%
 IS  Sales GP 600K 60% 1M 50%
 Used when comparing the companies EXP (200K) 20% (600K) 30%
NI 400K 40% 400K 20%
(intercompany analysis)

3. Ratio Analysis
 Evaluate relationships among FS items

Characteristics:

a. Liquidity – ability to pay short-term obligations (suppliers)

b. Solvency – ability to pay long-term obligations (banks)
c. Profitability – analyze performance of a company

Patterns:

1. Return  NI (numerator)
2. Turnover  Sales (numerator)
3. Margin  Sales (denominator)

𝐼𝑆
2 years BS  Average  𝐵𝑆

- Operating Cycle = Days in AR + Days in Inventory

- Cash Conversion Cycle = Operating Cycle – Days in AP

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

FORMULAS

LIQUIDITY RATIOS
 Measure of adequacy of working capital.
Current Ratio
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠  Primary test of liquidity to meet current obligations from
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 current assets.

 Measures the number of times that the current

𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠 liabilities could be paid with the available cash and
Quick Ratio
near-cash assets
(Acid Test Ratio) 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠  Ex. cash, current receivables and marketable securities

𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠  Measures the number of times receivables are

Receivables
recorded and collected during the period.
Turnover 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
Average Age of
Receivables 360  Indicates the average number of days during which the
(Average Collection Period) 𝐴𝑅𝑇𝑂 company must wait before receivables are collected.
(Days’ in Receivables)
𝐶𝑂𝐺𝑆  Measures the number of times that the inventory is
Inventory Turnover replaced during the period
𝐴𝑣𝑔. 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
Average Age of Inventory* 360  Indicates the average number of days during which the
(Inventory Conversion Period)
𝐼𝑇𝑂 company must wait before the inventories are sold.
(Days’ in Inventory)
𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠  Measures the speed with which a company pays its
Accounts Payable Turnover suppliers.
𝐴𝑣𝑔. 𝑇𝑟𝑎𝑑𝑒 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠

Average Age of Accounts 360  indicates the length of time during which payables
Payable remain unpaid.
𝐴𝑃𝑇𝑂
 The time it takes a company to acquire inventory, sell
Average Age of
that inventory, and receive cash from its customers in
Normal Operating Cycle Inventory + Average
exchange for the inventory sold.
Age of Receivables
Average Age of
Inventory + Average  The time (measured in days) it takes for a company to
Cash Conversion Cycle Age of Receivables convert its investments in inventory and other
+ Average Age of resources into cash flows from sales.
Accounts Payable

PROFITABILITY RATIOS
𝐼𝑛𝑐𝑜𝑚𝑒  Determines the portion of sales that went into
Return on Sales
company’s earnings.
(Net Profit Margin) 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

𝐼𝑛𝑐𝑜𝑚𝑒  Efficiency with which assets are used operate the

Return on Assets business.
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑠𝑠𝑒𝑡

𝐼𝑛𝑐𝑜𝑚𝑒  Measures the amount earned on the owner’s or

Return on Equity stockholders’ investment.
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐸𝑞𝑢𝑖𝑡𝑦

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡  Measures profit generated after consideration of

Earnings Per Share operating costs.
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐶𝐹  Measures the ability of the firm to translate sales to

Cash Flow Margin cash.
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒  It indicates the number of pesos required to buy ₱1 of

Price-Earnings (PE) Ratio earnings.
𝐸𝑃𝑆

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒  Measures the rate of return in the investor’s common
Dividend Yield stock investments.
𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒  It indicates the proportion of earnings distributed as

Dividend Pay-out Ratio dividends.
𝐸𝑃𝑆

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

 SOLVENCY RATIOS
𝐸𝐵𝐼𝑇  It determines the extent to which operations cover
Times Interest Earned (TIE) interest expense
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒

𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠  Proportion of assets provided by creditors compared to

Debt-Equity Ratio that provided by owners.
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦

𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠  Proportion of total assets provided by creditors

Debt Ratio
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦
Equity Ratio  Proportion of total assets provided by owners.
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

WORKING CAPITAL MANAGEMENT
 The administration and control of current assets and current liabilities with the goal of maximizing the value of
the firm with appropriate balance between profitability and risk.

Working Capital  resources of the business used in everyday operations

 Objective: To achieve balance between risk and return (income)
Matching  CL  CA; NCL  NCA
 Policies Conservative  ↑ WC; financing almost all asset investments with long-term capital.
Aggressive  ↓ WC; uses short-term liabilities to finance
Working Capital = Current Assets – Current Liabilities
(Cash, AR, Inventory) (AP, Short-term Loans)

Operating Cycle = Days in AR + Days in Inventory

360 360
(𝐴𝑅𝑇𝑂 ) (𝐼𝑇𝑂 )

Cash Conversion Cycle = Days in AR + Days in Inventory – Days in AP

360 360 360
( ) (𝐼𝑇𝑂 ) ( )
𝐴𝑅𝑇𝑂 𝐴𝑃𝑇𝑂

1. Cash Management
to meet cash requirements
 to maintain optimal level of cash to avoid idle cash
 Reasons for holding cash
1. Transaction motive - to facilitate normal transactions of the business.
2. Precautionary motive - to provide for buffer against contingencies.
3. Speculative motive - to avail of business and investment opportunities.
4. Contractual motive - by provisions of a contract (e.g., compensating balance in a bank).

Where:
D = demand / annual cash requirements
Baumol Optimal Cash Balance (OCB) = ට2 𝑥 𝐷 𝑥 𝑇𝐶 TC = transaction cost
Model 𝐶𝐶
CC = carrying cost / opportunity cost (%)

 Total cost of cash balance = holding costs + transaction costs

o Holding Costs = average cash balance* x opportunity cost
o Transaction Costs = number of transactions** x cost per transaction
 Where:
 *Average cash balance = OCB ÷ 2
 **Number of transactions per year = annual cash requirement ÷ OCB

Positive  bank > book  OC (Buyer)  Maximize

 Manage float (delay)
Negative  bank < book  DIT (Seller)  Minimize
1. Mail Float – check not yet received
2. Processing Float – received but not yet deposited
3. Clearing Float – deposited but not yet cleared

 To prepare Cash Budget Beg. Bal

+ Cash Receipts
- Cash Disbursements
- Minimum cash balance
+ -
excess financing
End Bal. End bal.

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

 2. Inventory Management
to meet customer demands
 To maintain optimal level of inventory
minimize cost

How many units to order? EOQ Model

 2 issues to resolve:
When to order? Re-Order Point (ROP)

Where:
2 𝑥 𝐷 𝑥 𝑇𝐶 D = annual sales demand
Economic Order Quantity (EOQ) = ට
𝐶𝐶
TC = ordering cost, shipping cost, setup cost
 quantity to be ordered, which minimizes CC = freight, insurance, storage cost, obsolescence
the sum of the ordering and carrying costs
𝐸𝑂𝑄
Average Inventory =
2

Assumptions of the EOQ Model:

1. Demand occurs at a constant rate throughout the year.

2. Lead time on the receipt of the orders is constant.
3. The entire quantity ordered is received at one time.
4. The unit costs of the items ordered are constant; thus, there can be no quantity discounts.
5. There are no limitations on the size of the inventory.

w/o safety stock (SS)  normal lead time

Re-Order Point
(ROP) w/ safety stock (SS)  normal lead time + SS

Mon Wed Mon Wed Thu

3 days SS
4 days
3 days x 100 = 300 units
4 days x 100 = 400 units

 Lead time – period between the time the order is placed and received.
 Normal time usage = Normal lead time x Average usage.
 Safety stock = (Maximum lead time – Normal lead time) x Average usage

3. Accounts Receivable Management Conservative (2/10, n/30)  ↓ Credit Sales, ↓ AR, ↓ Bad Debts
 To use effective credit policy
 Credit terms (n/30) Aggressive (relaxed) 5/10, n/60  ↑Credit Sales, ↑ AR, ↑ Bad Debts
 Cash Discounts (2/10)
Credit period
Disc period
0 10 30
2
%
 pay existing loan
 Ways to Accelerate collections investment opportunity
 Shorten credit terms.
 Offer special discounts to customers who pay their accounts within a specified period.
 Speed up the mailing time of payments form customers to the firm.
 Minimize float, that is, reduce the time during which payments received by the firm remain uncollected
funds.

 Factors considered in making Accounts Receivable Policies

1. Credit Standard: the Five C’s of Credit:
 Character – customers’ willingness to pay.
 Capacity – customers’ ability to generate cash flows.
 Capital – customers’ financial sources.
 Conditions – current economic or business conditions.
 Collateral – customers’ assets pledged to secure debt.

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

 2. Credit Terms
 Credit period and discount offered for customer’s prompt payment.
 Ex. cash discounts, credit analysis and collections costs, bad debt losses and financing
costs.

3. Collection Program
 Shortening the average collection period may preclude too much investment in receivable
(low opportunity costs) and too much loss due to delinquency and defaults.

4. Accounts Payable Management

 Analysis of credit terms:
1. Taking the cash discount – if cash discount is to be taken, a firm should pay on the last day of
the discount period.

2. Giving up cash discount – if the firm has to give up the cash discount, it should pay on the last
day of the credit period.

 Maximize the positive float

 Delay payment

Cost of Giving up Cash Discounts:

𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 360
= 𝑥
100% − 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑛
 Credit period – discount period

 How to know if we have to forgo cash discounts?

 Compare % of cost of giving up cash discounts to % of other alternative using the money for
investment or payment of loans.
 Decision Guide: Greater benefit.

5. Short-Term Loans Management

 Usual questions: What is the annual effective interest rate?

𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝐶ℎ𝑎𝑟𝑔𝑒𝑠 Interest expense + other fees - savings

𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒 (𝐸𝐼𝑅) =
𝑁𝑒𝑡 𝑃𝑟𝑜𝑐𝑒𝑒𝑑𝑠 Usable amount
annual

6. Bank Loans
o Single-payment notes – if the interest is payable upon maturity, the effective interest rate is equal to the
nominal rate.

o Discounted Note – the effective interest rate is higher than the nominal rate.

Effective interest rate = Interest Principal amount - Discounted interest

If the term is less than a year, the interest rate is annualized.

o Compensating Balance (CB) – an arrangement whereby a borrower is required to maintain a certain

percentage of amount borrowed as compensating balance in the current account of the borrower.

o Cost of Bank Loans

 Without compensating balance

𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑅𝑎𝑡𝑒 360 𝑑𝑎𝑦𝑠

Cost =
100%−𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑅𝑎𝑡𝑒
𝑥 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑒𝑟𝑖𝑜𝑑−𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑃𝑒𝑟𝑖𝑜𝑑

 With compensating balance

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 %
Cost = or
𝐹𝑎𝑐𝑒 𝑉𝑎𝑙𝑢𝑒−𝐶𝑜𝑚𝑝𝑒𝑛𝑠𝑎𝑡𝑖𝑛𝑔 𝐵𝑎𝑙𝑎𝑛𝑐𝑒 100%−𝐶𝐵 %

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

QUANTITATIVE ANALYSIS

 Application of mathematics in solving business problems

NETWORK MODELS

1. Network Models
 Involves project scheduling techniques that are designed to aid the planning and control of largescale
projects that have many interrelated activities.
 These models aid management in predicting and controlling costs that pertain to certain projects or
business activities.
2. Use of Network Models
 Planning
 Measuring progress to schedule
 Evaluating changes to schedule
 Forecasting future progress
 Practicing and controlling costs

Techniques:

1. Linear Programming
 Optimization Model
 Goal: To find the optimal/best solution in business operation
 Best possible combination

Maximize Income
Objective Subject to constraints
Minimize Cost (limited/scarce resource)

Note:

 If only two products  use trial and error (based on the choices)
 If more than two products  apply incremental analysis/relevant costing (CM/scarce resource)
 Limited resources must be allocated to the company’s most profitable products so that net income is
maximized.
 Linear programming models are extremely helpful in the analysis and solution of resource allocation
problems.
 Simplex method is a much-detailed linear programming technique especially useful if there are more than two
variables in a linear programming problem.

2. Decision Tree Analysis

 Normally devised to show several possible decisions or acts and the possible consequences (outcome or
events) of each act.
 Calculate the expected monetary value (EMV) of each outcome based on the decision.

(1) Alternative Couse of Action  (2) Apply probabilities (%)  (3) Computation of EMV  (4) Decision

Under Certainty
EMV Difference: Expected Value of Perfect Information (EVPI)
Under Uncertainty  price to pay to get access to perfect information
 Decision making involves:
 Risk – this occurs when the probability distribution of the possible future state of nature is known.

 Uncertainty – this occurs when the probability distribution of possible future state of nature is not
known and must be subjectively determined.

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

 3. Project Evaluation Review Techniques (PERT) – Critical Path Method (CPM)
 PERT - developed to aid managers in controlling largescale, complex problems.
 CPM - uses deterministic time and cost estimates
 Used in project management (scheduling/monitoring)
 Applicable to large scale projects
 Similar to Gantt Chart
 Graphical illustration of a scheduling technique in the form of a horizontal bar chart
 Milestones

Steps: 1 6
1. List of Activities A C 5
2. Time Required Longest path Start
3 6 D
3. Identify the critical path
Minimum time to complete the project B C
A – C – D = 12 months
Example: B – C – D = 14 months  critical path

Activities Time Required

Year 1 Year 2
A. Planning 1 month Parallel activities Jan A B D D
B. Excavation 3 months (can be done at the same time)
Feb B D D
C. Structuring 6 months
Mar B Total 14 months
D. Finishing 5 months Immediate predecessor / Series
(can’t proceed until the previous Apr C C
steps are done) May C C
June C C
July C C
Crashing  to speed up the process Aug C C
 behind schedule (delay) Sept C C
 Decision guide: Cost to crash > Penalty for Delay Oct D D
Nov D D
Slack Time  amount of time that can be added to an activity
Dec D D
without increasing the total time required on the
critical path
 length of time an activity can be delayed without forcing a delay for the entire project.

4. Learning Curve
 Process is improved over time due to learning & efficiencies
 Requires ↓ time & ↓ resources as we produce additional unit
 % of decrease takes effect every doubling of units

Example: 80% Learning Curve (10 hrs)

Time/unit
X2 X2 X2
1  2  4  8
Hours 10 8 6.4 5.12
# of units

 The cumulative average time per unit is reduced by a certain percentage each time production doubles.
 Incremental unit time (time to produce the last unit) is reduced when production doubles.

5. Forecasting
 Use if mathematics to predict future behavior
Time Series:
Example: Coffee Shop
1. Trend ↑, ↓, ↑, ↓
2. Seasonal summer ↑, rainy ↓ Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
3. Cyclical Christmas ↑, Jan ↓
4. Irregular random ↑ ↓
↑ ↓

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

 ECONOMICS

 Science of choice; it is the social science that studies the choices people, businesses, governments, and societies
make as they cope with scarcity.
 Fundamental economic problem is scarcity.
 Because the available resources are never enough to satisfy human wants, choices are necessary.

Demand (Buyer) Market

Microeconomics – individual, businesses Supply (Seller) Buyer
Branches
Macroeconomics – entire economy of a country &
Seller

MICROECONOMICS

Law of Demand:
↑ Price, ↓ Demand
DEMAND

50
40 1. Movement along the demand curve  always because of Price (P)
P 30 2
1 2. Shift in demand  other factors (ex. Facemask)  same Price, ↑ Demand
20
10
D
1 2 3 4 5 (quantity demanded)

Downward Sloping:
If Price increases, the buyer will look for Substitutes.
1. Substitution Effect ex. ↑ Price of chicken, ↓ Demand
If Price of Complementary goods/product increases, Demand will decrease.
ex. ↑ Price of sugar, ↓ Demand of Coke
↑ Price of Gas, ↓ Demand of Cars

If Price ↓ (given same income), Demand ↑ Law of Diminishing Marginal

Ex. Monthly Income P50k x 10% = P5k Utility:
Jan. T-shirt P1k  5 The more we consume, the
2. Income Effect ↑ Demand
Feb. T-shirt P500  10 less marginal utility we
receive.
As Income ↑, Demand for normal goods ↑
Marginal: Additional
As Income ↑, Demand for inferior goods ↓
Utility: Satisfaction

Elasticity of Demand

 Sensitivity of demand due to price change

∆ 𝑖𝑛 𝐷𝑒𝑚𝑎𝑛𝑑
 Formula:
∆ 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒

> 1  Elastic  sensitive (luxury; w/ close substitute)  Ex. Fortuner, Coke, Airline Ticket

Types = 1  Unitary Elastic  ∆ in Price = ∆ in Demand  Ex. Electronic Products; Gadgets

< 1  Inelastic  not sensitive (necessities; no close substitute)  Ex. Rice, electricity, cigarettes

 Perfectly Elastic  Price ↑ = no more Demand

 Perfectly Inelastic  Price ↑ = no change in Demand  Ex. Insulin

SUPPLY

50 ↑ Price, ↑ Supply S>D Price Ceiling

40 Surplus
P 30
20 Equilibrium Price (perfect/optimal)
10

Shortage Price Floor

1 2 3 4 5
Supply

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

Upward Sloping

1. Number of Sellers  as the number of sellers ↑, supply ↑

 Ex. Apple, Samsung  Oppo, Vivo, Realme (more suppliers, more supplies)

Substitutes  the supplies will produce goods w/ higher returns.

2. Closely Related Goods
Complementary  if the price of complementary goods ↑, supply ↑
 Ex. ↑ Price of Ink, ↑ Price of Marker, ↑ Supply of Marker

Law of Diminishing Returns

 Adding an additional input result in a smaller increase in output

Ex. Workers: 10 hours  5 units/hr
11 hours  4 units/hr

Elasticity of Supply:

 Sensitivity of supply due to price change

∆ 𝑖𝑛 𝑆𝑢𝑝𝑝𝑙𝑦
 Formula:
∆ 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒

> 1 Elastic
Types = 1 Unitary Elastic Same concept w/ Elasticity of Demand
< 1 Inelastic

Short-run vs Long-run

1-5 years 6 years onwards

Variable Cost  Variable

Cost
Fixed
 Economies of Scale
Produce:  Average Cost ↓
As long as Price = Marginal Cost
P = MC; CM = 0

 Total product is the total quantity of the output produced in a given period.
 Marginal product is the change made in total product from a change in a variable input (e.g., labor).
 In economics, the term “marginal” is often used to mean “additional”

 Average product is the total product per unit of input (e.g., labor). It is total product divided by the quantity of labor
employed. Another term for average product is productivity.

 Increasing marginal returns occur when the marginal product of an additional worker exceeds the marginal
product of the previous worker. In most productions, increasing marginal returns occurs initially but decreasing
marginal returns will occur eventually.

 Economies of Scale arise because of labor and management specialization, efficient capital, and factors such as
spreading advertising cost over an increasing level of output.

Market Structure # of Sellers Products Control to Price Entry Example

1. Perfect/Pure Large Identical None Very Easy Divisorial
Competition
2. Monopolistic Many Differentiated Limited Easy Jollibee, McDonalds
Competition
3. Oligopoly Few Standardized Huge Hard PLDT, Globe; Shell, Petron
4. Monopoly One Unique Huge Blocked Meralco

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

MACROECONOMICS
Gross Domestic Product (GDP)

 Measure of income and output of a country

 Primary measure of wealth in a country (national income) Where:
C = Consumption
Expenditure Approach  GDP = C + I + G + X I = Investment
G = Government Spending
How to measure GDP? X = Net Exports (Export – Import)
Income Approach  Individuals  Salaries & Wages
Business  profit, rent, interest
Natural Resources  Depreciation (Depletion) Less: Income earned
Government  Taxes abroad (OFW)

Gross National Product (GNP) = GDP + Income Abroad

Ex. Output Price Nominal Real

Year 1 1,000 x 100 100,000 100,000
Year 2 1,500 x 120 180,000 150,000
(1,500 x 100)
Nominal  measure using current prices
GDP
𝑁𝑜𝑚𝑖𝑛𝑎𝑙
Real  measure is adjusted for inflation Real GDP = 𝐺𝐷𝑃 𝐷𝑒𝑓𝑙𝑎𝑡𝑜𝑟 (𝑚𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟)
(remove the effects of inflation)

Inflation: general increases in price of goods/services

Demand Pull  Demand > Supply Ex. Face Mask

1. Types (excessive) (demand)

Cost Push  ↑ Price of Sugar (supply)

↑ Price of Coke

2. Inverse Relationship w/ Unemployment

(↑GDP, ↓Unemployment, ↑Income, ↑Consumption, ↑Price) Philips Curve

Frictional – mismatch between workers & jobs

Unemployment Structural – changes of structure in a company (ex. Automation)
Cyclical – business cycle

Peak
2019 2022
Recession 2022
Recovery

Trough
2021
Role of Government: (Goal: ↑ GDP)
↓ taxes, ↑ Disposable Income, ↑ Consumption, ↑ GDP, ↑ Price
Taxes
1. Fiscal Policy ↑ taxes, ↑ Government Spending, ↓ Disposable Income, ↓ Consumption, ↓ GDP, ↓ Price

Government Spending  Government Projects

Ex. Infrastructure, ↑ employment, ↑ income, ↑ Consumption, ↑ GDP

2. Monetary Policy
 Money supply
 Control: Bangko Sentral ng Pilipinas (BSP)
Money Supply

1. Discount Rate ↑ ↓ *Bank Reserve Requirement:

2. Bank Reserve Requirement* ↑ ↓ - % of deposits the banks are
BSP not allowed to lend
Buy ↑
3. Open Market Operations
Sell ↓

T-bills
BSP (BTr) Public
Cash

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM

 Household
Equivalent in Accounting
M1 Cash in Bank
Money Supply Money
M2 Cash and Cash Equivalent Income Spending
Supply
M3 CCE & Short-term Investment

Business
Marginal Propensity to Consume (MPC) %  Spend
Income Money Multiplier (mm)
Marginal Propensity to Save (MPS) %  Save  effect of the release of money in the
economy
MPC + MPS = 100% 1
Formula:
𝑅𝑒𝑠𝑒𝑟𝑣𝑒 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡

Reference: Sir Brad’s Lecture + Pinnacle Handout Compiled by: CPM