D196: PRINCIPALS OF MANAGERIAL AND FINANCIAL

ACCOUNTING
STUDY GUIDE

UNIT 2: THE ROLE AND PURPOSE OF ACCOUNTING 15%

MODULE 1: ACCOUNTING INFORMATION

1. What is the role and purpose of accounting?
Accumulate and report on financial information about performance, financial
position, and cash flow of a business. Used to reach decisions about how to
manage the business, invest in it, or lend money to it.

2. Who uses accounting information and why?

Businesses use accounting to: analyze transactions, handle routine
bookkeeping tasks, and structure information so it can be used to evaluate
the performance and health of the business. Used by creditors, investors,
and both decisions makers inside and outside of organizations use it to:
allocate resources, evaluate performance, and determine a company’s
profitability.

3. What are the important influences on accounting?

Three particularly important factors that influence the environment in which
accounting operates are the development of “generally accepted accounting
principles” (GAAP), international business, and ethical considerations.

4. What is the role of ethics in accounting?

Maintaining high ethical standards is important in accounting because
accounting decisions often impact real-world economic decisions.
Accountants have a moral and economic incentive to be ethical and to
conduct themselves ethically. Accountants are the scorekeepers, so they
must remain unbiased.

NOTES
Managerial Accounting: is internal decision making such as product costs,
break even analysis, budgeting, performance evaluation, and outsource
production.
Financial Accounting: is external decision making such as investors and
creditors. Credit analysis estimate the value of the company.
Balance Sheet: reports the resources of a company (assets), the company’s
obligations (liabilities), and the owner’s equity, which represents the difference
between what is owned (assets) and what is owed (liabilities).
Income Statement: reports the amount of net income earned by a company
during a period. REVENUE – EXPENSES = NET INCOME

Statement of Cash Flows: reports the amount of cash collected and paid out by
a company in the following three types of activities: operating, investing, and
financing.
Financial Accounting Standards Board (FASB): a non-government with no
legal authority agency in the U.S. that sets the accounting standards for publicly
listed companies.
Generally Accepted Accounting Principles (GAAP): rules governing financial
accounting. In the U.S., GAAP is set by a private, non-governmental group called
FASB and Worldwide GAAP is set by the International Accounting Standards Board
(IASB) which is based in London.
Governmental Accounting Standards Board (GASB): sets the accounting
and financial reporting standards for state and local governments following GAAP.
It is a private, non-governmental organization that seeks to improve accounting
practices and procedures.
International Accounting Standards Board (IASB): was formed in 1973 to
develop international accounting standards to attempt to harmonize conflicting
national standards.

MODULE 2: ACCOUNTING CYCLE

5. What is the Accounting Cycle?
The four steps of the accounting cycle are:
1. Analyze Transactions
2. Record the effects of the transactions
3. Summarize the effects of transactions
4. Prepare reports
The purpose of the accounting cycle is to help you see how the accounting
process eventually turn from transactions to financial statements, thereby
making financial data into useful information for decision-making by
managers.
6. What is the Accounting Equation?
ASSETS = LIABILITIES + EQUITY
Think ALE
Expanded Accounting Equation:
 ASSETS=LIABILITIES + COMMON STOCK – DIVIDENDS + REVENUES –
EXPENSES

NOTES
Arm’s Length Transaction: transaction in which a buyer and seller with equal
bargaining power act independently to get the best possible deal.

 Revenues INCREASE Owner’s Equity and Expenses and Dividends DECREASE

Owner’s Equity
 The accounting equation must ALWAYS balance after a transaction has been
accounted for.
 REVENUES – EXPENSES = NET INCOME
 Net Income: is a major source of change in owner’s equity from one
accounting period to the next. Revenues and expenses, then may be
thought of as temporary subdivisions of owner’s equity.
 Dividends: reflect payments to the owners. A transaction involving
dividends paid reduces owner’s equity as it is the account that shows
distributions of net income (earnings) to owners.
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UNIT 3: FINANCIAL STATEMENTS 20%
MODUEL 3: FINANCIAL STATEMENTS OVERVIEW
1. What are the four financial statements covered in this module? Define and
explain the purpose and components of each.
1. Balance Sheet: summary of financial position of a company as of
right now. Reports the resources of a company (assets), company’s
obligations (liabilities), and the difference between what is owned
(assets) and what is owed (liabilities), called owner’s equity.
2. Income Statement: Used to assess a company’s profitability and
the accountant’s best effort at measuring the economic
performance of a company (How much did the company make last
month, quarter, year??). Reports the amount of net income earned
by a company during a period, with annual and quarterly income
statements being most common.
3. Statement of Cash Flows: represents the accountant’s efforts at
showing the change in cash during a period of time. Reports the
amount of cash collected and paid out by a company in operating,
investing, and financing activities. Same time period as the income
statement, with annual and quarterly being the most common.
 4. Statement of Retained Earnings: identifies the changes in
accumulated investments by owners and earnings or profits since
day one. Displays changes in retained earnings from one accounting
period to the next. Portrays the accumulated profits or losses of a
company at a point in time.

2. What is the importance of Notes to the Financial Statements and what is

included in these Notes?
They are critical to be able to properly interpret the information contained in
the financial statements. The notes contain such information as the
assumptions made in computing certain numbers. Before you can evaluate
the number, you need to evaluate the assumptions made in computing that
number.

Contain information relating to details that are important in evaluating the

summary totals that are contained in the financial statements. Contain
qualitative information that cannot be summarized and included in the
financial statements themselves.

An important part of reading and interpreting the financial statements.

NOTES
Operating Activities: part of the day-to-day business of the company. Major
operating cash inflow results from selling goods or providing services, while major
operating cash outflows include payments to purchase inventory and to pay
wages, taxes, interest, utilities, rent, and similar expenses.
Investing Activities: associated with buying and selling long-term assets –
primarily the purchase and sale of land, buildings, and equipment. Investing is
the productive capacity of the business.
Financing Activities: cash is obtained from or repaid to owners and creditors.
For example, cash received from owners’ investments, cash proceeds from a loan,
or cash repayments to repay loans. Obtaining the capital, or financing that a
business needs to buy the resources that it needs.
Articulation: refers to the relationship between an operating statement (income
statement or statement of cash flows) and comparative balance sheets, whereby
an item on the operating statement helps explain the change in an item on the
balance sheet from one period to the next.
Retained Earnings: amount of accumulated earnings of the business that have
not been distributed to owners.
Capital Stock: portion of owner’s equity contributed by owners in exchange for
shares of stock.
Dividends: distributions to the owners (stockholders) in a corporation.
Classified Balance Sheet: distinguishes between current and long-term assets.
Revenue: amount of assets created for sale of goods or satisfying liabilities.
Revenues are not assets, only one source of an asset!
Expenses: amount of liabilities created/consumed in doing business or the
amount of assets consumed. Also caused when liabilities are created in
generating revenues. Costs incurred in normal business operations to generate
revenues. (Employee salaries and utilities). Expenses are not liabilities! One use of
an asset, one way to create a liability.
Net Income: also called earnings or profit, is an overall measure of company’s
performance. Reflects the company’s accomplishments (revenues) in relation to
its efforts (expenses) during a particular period of time. OPERATING INCOME –
INTEREST EXPENSE AND TAXES
Operating Income: reports results of what company does on a daily basis, or its
operations. Calculated by SALES - COST OF GOODS SOLD – OPERATING
EXPENSES
Gains: money made on activities outside the normal business of a company.
Losses: money lost on activities outside the normal business of a company.
EARNINGS (LOSS) PER SHARE = NET INCOME/OUTSTANDING NUMBER OF
SHARES OF STOCK
GROSS PROFIT = SALES – COST OF GOODS SOLD

 The Statement of Cash Flows shows the cash inflows (receipts) and cash
outflows (payments) of an entity during a period of time. In other words, it is
the result of the sources and uses of cash flows over a period of time.
Companies receive cash primarily by:
 Selling goods or providing services
 Selling other assets
 Borrowing
 Receiving cash from investments by owners
Companies used cash to:
 Pay current operating expenses such as wages, utilities, and
taxes
  Purchase additional buildings, land, and otherwise expand
operations
 Repay loans

 Financial Statements are interrelated and tie together (articulate).

 In a typical annual report, the notes go on for 30 pages or more, whereas

the primary financial statements fill only 3 pages.

MODULE 4: ANALYZING FINANCIAL STATEMENTS

3. What are common-size financial statements and how are they used?
An accounting tool that focuses on the line items on financial statements as
a percentage of selected (or common) figure. They make it easier to analyze
a company over time and to compare financial statements of one company
to another.

For the income statement it is generated by dividing all the financial

statement amounts for a given year by sales for that year.

For balance sheet it is generated by dividing each balance sheet item by

total assets for that year.

4. What is horizontal analysis and what information does it provide?

Shows allows you to see how a company’s financial performance is changing
over a period of time. Compares data across the same company.

(YEAR 2 – YEAR 1)/YEAR 1 = % IN CHANGE FROM YEAR TO YEAR

e.g. = (C4-F4)/C4

5. What is vertical analysis and what information does it provide?

Analyze financial statements that list each line item as a percentage of base
figure within the statement. Compares companies in the same industry at
the same point in time and allows you to quickly see how a company
compares to others in its industry.

PERCENTAGE OF SALES = INCOME STATEMENT/AMOUNT OF SALES

e.g. = C5/C$5
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UNIT 4: BUDGETING CASH FLOWS 10%
MODULE 5: BUDGETING CASH FLOWS
1. What is the Cash Budgeting Process? Why is it important to any
organization?
The two primary components in managing cash flows is the management of
accounts receivable (credit sales) and accounts payable (credit purchases).
Creating a cash flow budget several months into the future allows a
company to better match its cash inflows with its cash outflows.
Proper cash flow management is the foundation to a company’s success.
Cash budgeting allows a company to establish the amount of credit that it
can extend to customers without having problems with liquidity. Helps
provide a shortage of cash during periods in which a company encounters a
high number of expenses.
2. Define cash inflow and outflow.
Cash Inflow: receiving cash investments from owners, cash from bank
when borrowing money, cash from customers, cash from sale of old
machines, buildings, etc.

Cash Outflow: paying to buy new machines, buildings, etc., paying

employee wages, suppliers for inventory purchases, interest on loans,
principal on loans, dividends.

NOTES
 Many times, a business is successful in producing and selling its products
but fail because they are unable to match their cash inflows with demands
for cash outflows.
  By knowing when cash deficits and surpluses are likely to occur,
management can plan to borrow cash when needed and repay these
borrowings when excess cash is available.

 Knowledge of amounts and timing of cash outlays is critical for effective

cash control and planning.

 A budget of cash disbursements coupled with budget cash collections, is a

useful tool in analysis. This budget can cover varying lengths of time ranging
from a quarter to a year or even three to five years. Lists all forecasted cash
outlays for period of interest.

 Advantage of forecasting cash flows is being able to know months ahead of

time that a cash need will arise.

 Cash sales and the collect of cash from current and past sales made on
credit are the principal sources of cash inflows.

 Estimating cash and credit sales and, most importantly, estimating the
pattern of the collection of outstanding accounts receivable are key to
budgeting cash receipts. The collection pattern for receivables is a function
of such factors as industry, firm size, and the firm’s credit policies.

 Column charts are used to compare different categories of items or the

same category over time.

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UNIT 5: CONTROLLING COSTS AND PROFITS 10%
MODULE 6: CONTROLLING COSTS AND PROFITS
1. What is a budget and why do we prepare them?
The purpose of a budget is to plan, organize, track, and improve your
financial situation. It begins by estimating how much revenue will be
received or how many products will be sold and then determining how much
production must occur to meet that demand. Once production amounts are
determined, the materials, workers, and other costs of meeting planned
production level are determined.

2. What is a master budget and why is it important?

Master Budget: an integrated group of detailed budgets that outline the
overall operating and financing plans for a specific period, usually one year.
It can be broken down by month or by quarter, or it can be shown for a full
year.
3. What is the master budgeting process for a manufacturing firm?
1. Starts with a Sales Budget or Sales Forecast
2. Based on sales budget, a Production Budget is created after taking
into consideration what level of finished goods the company wants and
how much beginning inventory is on hand.
3. The production budget drives the Direct Materials, Direct Labor,
and Manufacturing Overhead Budgets
4. These budgets are combined with the Selling and Administrative
Expense Budget, which represents period rather than manufacturing
costs, to determine what the cash budget will be.
5. Once cash inflows and outflows are known, Budgeted Income
Statement and Balance Sheet (known as Pro Forma Financial
Statements) can be prepared that show what these financial
statements will look like at the end of the period if the budget is met.

4. What are organizational segments?

An organizational segment is a component of a business that generates its
own revenues and creates its own product, product lines, or service
offerings.

5. What is the responsibility of accounting and how does it impact an

organization?
Accounting plays a vital role in running a business as it helps you track
income and expenses, ensures statutory compliance, and provides investors,
management, and government with quantitative financial information which
can be used in making business decisions.

6. What are profit and cost centers and why do they matter?
Profit Center: organizational unit in which the manager has control over
both costs and revenues.
Cost Center: organizational unit in which the manager has control only
over the costs incurred.
Help identify relative profitability of different revenue generating divisions.
Helps management in taking various decisions related to income generating
operations of the business.

7. What is a segment margin statement?

Statement that shows the amount of profit or loss produced by one
component of a business. It can be used to understand a company’s profit
for specific geographic regions. It can also be used to determine the
vulnerability of a company’s overall gross margins.
 8. How do you interpret profit and cost center performance results?
By analyzing and reviewing the Segment Margins Statement to understand
the cost behavior, budgeting, etc. Helps improve costing of products and
service.

NOTES
Manufacturing Overhead Budget: includes all production costs other than
those for direct materials and direct labor. As manufacturing overhead is a major
element of total manufacturing costs in many organizations, those that are able to
effectively plan and control these costs have significant advantage in the
marketplace.

Selling and Administrative Budget: includes planned expenditures for all non-
production expenditures. The costs of supplies used by the office staff, the
salaries of the sales manager and company president, and the depreciation of
administrative office buildings (not all production facilities) all belong in this
category. Because this budget covers several areas, it can be quite large and may
be supported by individual budgets for specific departments within the selling and
administrative functions.

Decentralized Company: an organization in which managers at all levels will

have the authority to make decisions concerning the operations for which they are
directly responsible.
Responsibility Accounting: system in which managers are assigned and held
accountable for certain costs, revenues, or assets. There are two important
behavioral considerations when assigning responsibilities to managers.
1. The responsible manager should be involved in developing the plan
for the unit over which the manager has control.
2. A manager should be held accountable only for those costs,
revenues, or assets over which the manager has substantial control.
Cost Variance: different between actual costs and budgeted costs.
Responsibility Center: also known as cost, profit or investment center
depending on the operation.
Cost Center: organizational unit in which the manager of that unit has control
only over the costs incurred.
Profit Center: found at higher levels in an organization. Manager has
responsibility for both costs and revenues.
Investment Center: manager is responsible for costs, revenues, and assets.

 Fixed Budget Costs are constant each production period (e.g. each
quarter) while Variable Budget Costs are based on expected sales or
production volume for each production period.

 If the manager becomes aware of a cost variance, manager is responsible

for taking corrective action to eliminate the variance.

 If the actual cost is less than the budgeted amount, this is favorable for the
company, but it might also indicate that there are additional assets that
could be leveraged more effectively.
 If the actual cost is more than budgeted amount, this may be unfavorable
for the company, and management should modify operations to make the
budgeted and actual costs more similar.

FORMULAS
PRODUCTION BUDGET = SALES BUDGET + ENDING FINISHED GOODS
INVENTORY – BEGINNING FINISHED GOODS INVENTORY

DIRECT MATERIALS BUDGET = PRODUCTION BUDGET x DIRECT

MATERIALS PER UNIT

DIRECT MATERIALS PURCHASE BUDGET = DIRECT MATERIALS

PRODUCTION BUDGET + ENDING DIRECT MATERIALS INVENTORY –
BEGINNING DIRECT MATERIALS INVENTORY

CASH COLLECTED FROM CUSTOMERS = (CURRENT PERIOD REVENUE x

CURRENT PERIOD COLLECTION RATE) + CASH COLLECTED FROM
PREVIOUS SALES

CASH PAYMENTS TO SUPPLIERS = (CURRENT PERIOD PURCHASES x

CURRENT PERIOD PAYMENT RATE) + CASH PAID ON PREVIOUS PERIOD
PURCHASES
SALES-VARIABLE COSTS = CONTRIBUTION MARGIN – DIRECT FIXED COSTS
= SEGMENT MARGIN

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UNIT 6: MANAGERIAL ACCOUNTING 25%

MODULE 7: MANAGERIAL ACCOUNTING OVERVIEW
1. What is Managerial Accounting and how does it differ from Financial
Accounting?
Managerial Accounting is primarily used by managers inside a business. The
information is tailored to the needs of the business and can provide
substantial competitive advantage. Financial accounting data is primarily for
use by outsiders, such as creditors and investors.

2. In relation to Decision-Making, explain the concepts of Planning, Evaluating,

and Controlling.
Planning
 Recognized needs
 Identify alternatives
 Evaluate choices
 Implement decisions
Evaluating
 Reward performance
 Provide feedback
 Analyze results
 Identify problems
Controlling
 Establish expectations
 Create performance measures
 Gather results
 Compute variances

3. Who provides accounting information?

 General prepared by the cost accountant or cost accounting manager.
Primary users of managerial accounting are company managers, whereas,
financial accounting primary users are external parties such as: lenders
(banks) and investors (partners and shareholders).

4. What is a product line and how is its information used?

Cluster of products that are marketed under the same brand umbrella, all
sold by the same company. It is cost-effective for a company to cluster
products into product lines, since they can build brands across a number of
products. One marketing campaign can be applied to each product line.

5. Describe and differentiate a manufacturing business, service business, and

merchandising business from one another.
Manufacturing Business: any organization whose main economic activity
involves using components or raw materials to make finished goods for sale
to customers. A manufacturer constructs physical products such as
machines, refrigerators, and furniture. Examples: General Motors, 3M and
U.S. Steel.

Service Business: any organization whose main economic activity involves

producing a nonphysical product that provides value to a customer. A
service organization provides customers with nonphysical product, such as a
new marketing plan or a cleaner house. Examples: Law Firm, Architecture
Firm, Consulting Firm, and Hospital.

Merchandising Business: a business that purchases goods for resale. A

merchandiser buys inventory from a variety of suppliers and makes this
inventory available in one place to its customers. Examples: Supermarket,
Clothing Retailer, and Furniture Retailer.

MODULE 8: CASH FLOW METHODS

1. What are product costs?
Costs incurred to create a product. They include direct labor, materials,
consumable production supplies, and manufacturing overhead. Associated
with inside the production facility.

Direct Materials
Include the cost of raw materials that are used directly in the
manufacture of products and kept in raw materials warehouse until
they are moved from the warehouse and placed in manufacturing
process.

Direct Labor
 Includes hourly wages and other payroll-related costs and expenses of
factory employees who work directly on products.

Manufacturing Overhead
Includes all manufacturing costs incurred during the manufacturing
process that are not classified as direct materials or direct labor.

2. What are period costs?

All costs not included in product costs. Listed as an expense in the
accounting period in which they occurred. Examples: marketing expenses,
rent (not tied to a production facility), office depreciation, and indirect labor.
Associated with activities that occur outside the production facility.

3. How are product and period costs recorded?

Product costs are reported in the income statement as part of cost of
goods sold once the product is sold to a customer. Remember, product
costs include direct materials, direct labor, and manufacturing overhead
costs for manufacturers. Product costs include the cost of purchasing a
product from a supplier for retailers like Walmart or Target, which generally
do not manufacture their own products in company-owned manufacturing
plants.

Period costs are recorded and reported immediately on the income

statement in the period they are incurred. Period costs are non-
manufacturing, non-product related costs and include administrative
costs; sales and marketing costs; and research and development costs
and expenses.

4. How are product costs handled by a manufacturing business, a

merchandising business, and a service business?

TYPE OF BUSINESS COST INCURRED

 Direct Labor
 Plant and Equipment
Manufacturing Business
 Manufacturing Overhead
 Raw Materials
 Lease on Retail Space
Merchandising Business  Merchandise Inventory
 Retail Sales Staff
 Billing and Collections
Service Business  Computer Network Equipment
 Professional Staff
 5. Identify indirect materials and indirect labor and how they are handled in a
manufacturing business.
Indirect Materials: materials used in a manufacturing process that cannot
be traced to an individual product or job. These materials, while consumed
as part of the production process, are usually in small amounts on a per-
product basis and purchase in mass quantities.

Indirect Labor: cost of any labor that supports the production process, but
which is not directly involved in the active conversion of materials into
finished products. Example: production supervisor, purchasing staff, material
handling staff.
6. Describe the flow of product costs for a manufacturing business, a
merchandising business, and a service business.

MODULE 9: COST BEHAVIOR AND COST-VOLUME-PROFIT ANALYSIS

1. Explain what a fixed cost is and why it is important to the Cost-Volume-Profit
(C-V-P) Analysis?
Fixed Costs are costs that remain constant in total, regardless of activity
level, over a certain range of activity. Fixed Costs are a component of the C-
V-P formula to find the profit.
Estimated Manufacturing Overhead: amount of overhead costs
that management has budgeted for the upcoming production period.
 Created by dividing estimated manufacturing overhead by estimate
expected level of activity (direct labor hours) to be used to allocate
overhead during the year.
Actual Manufacturing Overhead: manufacturing costs other than
direct materials and direct labor. Indirect manufacturing costs that are
not assigned to specific products. Recorded as costs are incurred.
Applied Manufacturing Overhead: amount of manufacturing
overhead that is assigned to the goods produced. Entered as
production takes place and are applied to work-in-process on the basis
of a predetermined overhead rate.

2. Explain what a variable cost is and why it is important to the C-V-P Analysis?
Variable Costs are costs that change in total in direct proportion to
changes in activity level. Variable Costs are a component of the C-V-P
formula to find the profit.

3. What are stepped costs?

Stepped Costs are costs that change in total in a stair-step fashion (in
large amounts) with changes in volume of activity.

4. What are mixed costs?

Mixed Costs are costs that contain both variable and fixed cost
components.

5. How are overhead expenses accumulated?

Accumulated separately in Overhead Control and assigned to Work-In-
Process Inventory at the end of a period or at completion of production.

6. What is overapplied and underapplied overhead and how is it accounted for?

Underapplied Manufacturing Overhead: amount of actual overhead
expenses incurred during the period exceeded the amount of overhead
applied during the period.
Overapplied Manufacturing Overhead: amount of actual overhead
expenses incurred during the period was less than the amount of overhead
applied during the period. Impacts profitability of company and associated
products during the period
7. What is the C-V-P equation?
SALES REVENUE – VARIABLE COSTS – FIXED COSTS = PROFIT

(SALES PRICE x UNITS) – (VARIABLE COST x UNITS) – FIXED COSTS =

PROFIT
 8. What is contribution margin and how is it calculated?
Contribution Margin: difference between total sales and variable costs; the
portion of sales revenue available to cover fixed costs and provide a profit.

CONTRIBUTION MARGIN = SALES REVENUE – VARIABLE COSTS

9. What is the contribution margin ratio and how is it calculated?

Contribution Margin Ratio: percentage of net sales revenue left after
variable costs are deducted; the contribution margin divided by net sales
revenue.

CONTRIBUTION MARGIN RATIO = TOTAL SALES REVENUE – COST TO

MAKE PRODUCT / TOTAL SALES REVENUE

10. Explain break-even in sales dollars and in units and how they are
calculated.
Break-Even Point: volume of activity at which total revenues equal
total costs, or where profit is zero. Volume of activity which the
contribution margin equals the fixed costs.
BREAK-EVEN IN UNITS = TOTAL FIXED COSTS/CONTRIBUTION MARGIN
PER UNIT

BREAK-EVEN IN SALES $ = TOTAL FIXED COSTS/CONTRIBUTION MARGIN

RATION (DECIMAL FORM)
11. Explain target net income and how it works with C-V-P.
Target Income: amount of income that will enable management to
reach its objectives. Expressed in percentage of revenues or a fixed
amount.

12. What are sunk costs?

Sunk Costs: costs that are past costs and do not change as a result of
a future decision.

13. What are differential costs?

Differential Costs: future costs that change as a result of a decision;
also called incremental or relevant costs.

14. What are opportunity costs?

Opportunity Costs: benefits lost or forfeited as a result of selecting
one alternative course of action over another.
 15. What are out of pocket costs?
Out-of-Pocket-Costs: costs that require an outlay of cash or other
resources.

NOTES
Capital Budgeting: process that a business uses to determine which proposed
fixed asset purchases it should accept, and which should be declined. Used to
create quantitative view of each proposed fixed asset investment, thereby giving
a rational basis for making a judgement.
Production Prioritizing: determining how to best use those committed
resources to maximize the return on their capital investment.
Operational Budgeting: also known as profit plans. Set of actions taken to
achieve a targeted profit level. Used by managers to establish and communicate
daily, weekly, and monthly goals (standards) for the organization.
Managerial Accounting: is internal decision making such as product costs,
break even analysis, budgeting, performance evaluation, and outsource
production.
Financial Accounting: is external decision making such as investors and
creditors. Credit analysis estimate value of company.
Direct Costs: costs that can be physically traced to a business unit or segment
being analyzed.
Segment: component of business that generates its own revenues and creates
its own product, product lines, or service offerings.
Indirect Costs: common costs or joint costs that are normally incurred for the
benefit of several segments. Either fixed or variable, although they are nearly
always fixed.
Cost-Volume-Profit Analysis (C-V-P): technique for determining how changes
in revenues, costs, and level of activity affect the profitability of a company, as
reflected in the company’s operating profit. Management tool primarily used in
planning process for an organization.
Target Income: amount of income that will enable management to reach its
objectives. Expressed in percentage of revenues or a fixed amount.

Three Functions of Managerial Accounting

1. PLANNING: involves a process of recognizing problems or opportunities,
identifying alternatives, analyzing alternatives, then choosing and
implementing the best alternative(s). There are two basic types of planning:
 Long- Run Planning (3-5 years):
o Strategic Planning
o Capital Budgeting
 Short-Run Planning:
o Production and Process Prioritizing
o Operational Budgeting

2. EVALUATING: involves analyzing results, providing feedback, and

identifying problems.

3. CONTROLLING: involves the process of tracking actual performance. This

data is used in evaluation process to compare against the budgets and
measure deviations from the original goals or standards. Deviations from
standards are called variances. Controlling also involves the real-time, day-
to-day management of all of a company’s business processes.

 Product costs are divided into three components:

o Direct Materials
o Direct Labor
o Manufacturing Overhead

 Cost Flows in a manufacturing business and service business are similar, the
important difference is that manufacturing business used significant
amounts of raw materials, whereas a service business uses none or very
little.

 Cost Flows in a merchandising business is inventory that comes in from

suppliers and then goes out, as cost of goods sold, to customers.

 The following are steps required to handle the accounting overhead costs:
Step 1: Before the year begins, budget the estimated manufacturing
overhead, estimate the allocation activity, and establish the
predetermined overhead rate.
Step 2: During the year, as costs are incurred, record actual
manufacturing overhead as debits, or additions, to the manufacturing
overhead account.
 Step 3: During the year, as activity takes place, record applied
manufacturing overhead as credits to, or subtractions from, the
overhead manufacturing account and debits, or additions, to the work-
in-process.
Step 4: At the end of the year, compare actual and applied overhead
balances and close out the difference in the manufacturing overhead
account.
 Over a reasonable range of expected sales or production activity (called
the relevant range), a variable cost remains the same per unit. The cost of a
single loaf of bread is the same for the 10th loaf as it is for the 100th loaf.
Over that same reasonable range of expected sales, a fixed cost remains the
same in total. The rent for the bakery location is the same whether 10
loaves of bread or 100 loaves of bread are sold.

 A mixed cost is a cost that has a fixed component and a variable

component. For example, monthly rent for office space might be a minimum
of $2,000 plus an additional 4% of sales.

 A stepped fixed cost is one that remains the same for a substantial volume
of activity and then increases sharply when an activity threshold is reached.
For example, a retail store can be operated with one salesclerk until the
number of customers overwhelms that one person and a second salesclerk
must be hired.

 Direct costs are costs that can be obviously and physically traced to a
business unit or segment being analyzed.

 Indirect costs are costs that are normally incurred for the benefit of several
segments within an organization.

 Estimated manufacturing overhead is used to calculate a predetermined

overhead rate. Actual manufacturing costs are the manufacturing costs
other than direct materials and direct labor. The predetermined overhead
rate is used to apply overhead costs to the goods produced.

 Business begins on the first day of the period. On that day, a company must
be prepared to systematically assign overhead costs to all products or
processes or customers for that period. But as of that first day, actual
overhead costs are not known. Accordingly, overhead costs must be
assigned based on estimated data that are available as of the first day of
the period. These estimated data items are used to compute a
predetermined overhead rate. In this way, a company can be sure it is
incorporating overhead costs in setting prices and in evaluating the
profitability of its products, processes, and customers.
 D196 Study Guide Answers & Notes
University : Western Governors University
Course : Managerial and Financial Accounting (D196)