Cat Financial Ratios

Caterpillar Inc. Financial Ratios
Short-Term Solvency/Liquidity Ratios
Current Ratio	Current Assets			1.15
	Current Liabilities
Quick Ratio	Current Assets – Inventory			0.82
	Current Liabilities
Cash Ratio	Cash			0.05
	Current Liabilities
Long-Term Solvency/Financial Leverage Ratios
Total Debt Ratio	Total Assets – Total Equity			0.84
	Total Assets
Debt-Equity Ratio	Total Debt			2.01
	Total Equity
Equity Multiplier	Total Assets			6.32
	Total Equity
Times Interest Earned Ratio	EBIT			-17.09
	Interest
Cash Coverage Ratio	EBIT + Depreciation			14.90
	Interest
Asset Utilization/Turnover Ratios
Inventory Turnover	Cost of Goods Sold			4.53
	Inventory
Days’ Sales in Inventory	365 Days			80.59
	Inventory Turnover
Receivables Turnover	Sales			2.66
	Accounts Receivable
Days’ Sales in Receivables	365 Days			137.02
	Receivables Turnover
Total Asset Turnover	Sales			0.75
	Total Assets
Capital Intensity	Total Sales			0.75
	Assets
Profitability Ratios
Profit Margin	Net Income			0.12
	Sales
Return on Assets (ROA)	Net Income			0.09
	Total Assets
Return on Equity (ROE)	Net Income			0.55
	Total Equity
Market Value Ratios
Price-Earnings Ratio (P/E)	Price per Share			6.96
	Earnings per Share
Market-to-Book Ratio	Market Value per Share			2.84
	Book Value per Share
DuPont Identity
ROE	Net Income x	Sales x	Assets	0.40
(Net Income/Total Equity)	Sales	Assets	Equity
	Net Income x	Assets
	Assets	Total Equity
ROE	ROA x EM
	ROA x (1+Debt-Equity Ratio)			0.26
ROE	Sales x	Net Income x	Assets
	Sales	Assets	Total Equity
	ROA
	Profit Margin x	Total Asset Turnover x	Equity Multiplier
	(Operating Efficiency)	(Asset Use Efficiency)	(Financial Leverage)
ROA	PM x Total Asset Turnover			0.09
(Net Income/Total Assets)
Long-Term Financial Planning
Construct Pro Forma Income Statement and Balance Sheets
Develop Based on Percentage of Sales Approach
Dividend Payout Ratio (d)	Cash Dividends			0.06
	Net Income
Addition to R/E to Net Income	Addition to RE			4.91
	Net Income
Retention/Plowback Ratio (b)	1 – Dividend Payout Ratio			0.94
Capital Intensity Ratio	Total Assets
	Sales
External Financing Needed	Assets x	Change in Sales -	Spontaneous Liabilities x
	Sales		Sales
	Change in Sales – PM x	Projected Sales x	x (1 – d)
Financial Policy and Growth
Internal Growth Rate	ROA x b			0.10
	1 – ROA x b
Sustainable Growth Rate	ROE x b			0.60
	1 – ROE x b

“MCS Design Within Its Organizational Context: Findings from Contingency-Based Research and Directions for the Future” (Chenhall) Summary

Here are the original notes that I meant to post the weekend after we discussed it in ACC 509.  I’m not sure if the notes make any more (or less) sense than the article itself, but it helped for me to put it into an outline form and summarize it.  I apologize for it taking this long.

Management Control Systems (MCS) Design Within Its Organizational Context: Findings from Contingency-Based Research and Directions for the Future

 

Robert H. Chenhall (Monash U., Australia)

 

1. Introduction

 

Three purposes:

·        Provide a review of empirical, contingency-based research as it has developed since the early 1980s

·        To critically evaluate this work

·        Consider a variety of theoretical foundations that may assist in developing future research

 

Also:

·        Meaning of MCS

·        Outcomes of MCS

·        Contextual variables:  see below

 

1. An organizational framework for contingency-based MCS research

 

·        Theorists focused on impact of environment and technology on organizational structure

·        Early accounting researchers drew on this work, added size

·        Recent studies – environment, technologies, structural arrangements

·        Important new stream of literature – role of strategy

·        TQM, JIT, FM

·        New structural arrangements (teams) draw on HRM (performance and evaluation)

·        National culture – Multi-nationals, Globalization

·        Conventional, functionalist contingency-based research – “MCS are adopted to assist managers achieve some desired organizational outcomes or organizational goals”.

·        Short-comings in Contingency-based research

 

1. The meaning of MCS

 

MA – Management Accounting (budgeting, product costing)

MAS – Management Accounting Systems (use of MA to achieve goals)

MCS – Management Control Systems (MAS + other controls e.g. clan)

OC – Organizational Controls (controls built into activities, processes, JIT)

 

·        Moved from financially quantifiable to broader scope of information

·        Conventionally, considered passive tools that assist managers

·        Now seen as more active (contingency follows conventional view)

·        May include:

o       Participation

o       Importance of meeting budgets

o       Formality of communications and systems

o       Links to reward systems

o       Budget slack

o       Post completion audits

o       Variance analysis

o       ABC/ABM NEW

o       Non-financial performance measures NEW

o       Economic value analysis NEW

o       Balanced scorecards / Target Costing NEW

 

1.  
   1. Critical evaluation

 

·        Build on existing area or identify emerging?

·        Replications studies to accumulate findings – consistency needed

o       What is accounting and non-accounting?

·        Studies need to maintain relevancy

·        Accounting controls only form part of the MCS

·        Control taxonomies:  Mechanistic or Organic?

·        Distinction between adoption and implementation

·        How combinations of controls can be combined to suit organization

 

1. Outcomes of MCS

 

·        Use or usefulness, behavioral and organizational outcomes

·        Broad leaps in logic from useful MCS to enhanced org performance

·        Considerations:

o       Extent to which systems provide info

o       The degree of use

o       Usefulness of the info

o       Beneficial nature of the MCS

o       Importance in making operational decisions

o       Importance to product development

o       Helpful to the organization

o       Satisfaction with the systems

·        Examine effects on job satisfaction?  (Only on stress!, implicated in association with performance)

·        Little work relating MCS to share price changes

o       No significant association found, effects are felt when first adopted, but then significantly drop off

o       Difficult to extract MCS from other share price effecting factors

1.  
   1. Critical evaluation

                                                               i.      MCS as dependent or independent variable?

                                                             ii.      Outcome variable some dimension of org performance

                                                            iii.      Good fit vs. poor fit?

                                                           iv.      MCS use and usefulness used as outcome variable

                                                             v.      First establish adoption and use of MCS, then examine how used to enhance decision quality, then org performance

                                                           vi.      May not directly affect org performance (whether considered useful or not)

                                                          vii.      Interference of broader controls

                                                        viii.      Care in theory construction is required

                                                           ix.      What constitutes org performance?

                                                             x.      Dynamic approach examining goal formation process

                                                           xi.      Aligning actions of employees with strategy – New MCS

                                                          xii.      Unplanned discovery of new technology – New MCS

                                                        xiii.      MCS affects goal achievement by establishing benchmarks

1.      Cannot be too hard or too easy – right amt of challenge

2.      Sufficient stretch

3.      Continuous improvement, difficult goals may be req’d

                                                        xiv.      Need to satisfy multiple/competing goals

                                                         xv.      Mission statements

                                                        xvi.      Aligning operative goals with official goals – important!

                                                      xvii.      Evaluate MCS used for reporting goals on basis of:

1.      Considering multiple stakeholders

2.      Measuring efficiency, effectiveness and equity

3.      Capture financial/non-financial outcomes

4.      Provide vertical links between strategy + ops

5.      Provide horizontal links across value chain

6.      Provide info on how that org relates to its external environment – its ability to adapt

1. Contextual variables and MCS

 

·        Necessary to identify specific attributes of environment to prescribe MCS

·        Risk = situation in which probabilities can be attached to particular events occurring

·        Uncertainty = probabilities cannot be attached, elements of environment may not be predictable

·        Environmental variables:

o       Turbulence (risky, unpredictable, fluctuating, ambiguous)

o       Hostility (stressful, dominating, restrictive)

o       Diversity (variety in products, inputs, customers)

o       Complexity (rapidly developing technologies)

o       Complexity vs. Dynamism

o       Simple-Complex vs. Static-Dynamic

o       Controllable vs. Uncontrollable

o       Ambiguity

o       Equivocality

1.  
   1. The external environment

                                                               i.      Findings: external environment and MCS

1.      Accounting – uncertainty related to usefulness of broad-scope and timely info

2.      Performance evaluation characterized by more subjective style

3.      Less reliance on incentive-based pay

4.      Non-accounting style of performance evaluation

5.      Participative budgeting

6.      Functional area + budgetary participation enhance performance

7.      Combinations of traditional budgetary controls + interpersonal/flexible controls used in environmental uncertainty

8.      Accounting has a planning role + substantial interaction to adapt to changing conditions

9.      Environmental hostility > strong emphasis on meeting budgets, reliance on formal controls, and sophisticated accounting production and statistical control

10.  Uncertainty assoc. w/ need for more open, externally focused, non-financial style of MCS

11.  Extreme pressure = first tight controls (short-term), then adopt more organic controls

12.  Use blend of tight and loose?

                                                             ii.      Critical evaluation

1.      Formal>incomplete info in uncertain conditions

2.      Must have MCS more flexible

3.      Uncertainty = Elements of change, Unknown outcomes

4.      Should involve top managers’ perceptions of ext. environment

5.      Single valid, reliable measure of ext. environment needed

6.      Increased social pressure – environmental ecology, social wellbeing of employees and society

7.      Tendency to mimic successful practices

1.  
   1. Generic concepts of technology

·        Way tasks transform inputs to outputs

·        Hardware, materials, people, software, knowledge

·        Complexity, Task Uncertainty, Interdependence

·        Highly specialized, non-standard, differentiated products

o       Low analyzability, many exceptions, low measurability of outputs

o       Traditional, mechanistic MCS not good fit

·        Standard, automated, mass production

o       Highly analyzable, few exceptions, interdependencies moderate

o       Traditional, formal, financial MCS good fit

                                                               i.      Findings: standardized-automated processes and MCS

1.      High budgetary slack provides buffer against low predictability w/in processes

                                                             ii.      Task uncertainty and MCS

1.      Marketing dept.’s faced more task uncertainty, used broad scope information to enhance performance

2.      High participation/high task difficulty provided a fit irrespective of budget emphasis

3.      High participation/high budget emphasis enhanced performance in low task difficulty situations

4.      Linking high task uncertainty w/ more informal, open MCS

1.  
   1. Interdependence and MCS

                                                               i.      Low levels of interdependence > budgets, op procedures, statistical reports

                                                             ii.      High levels of interdependence > statistical reports used for planning, informal coordination, customization strategies

                                                            iii.      Complex situations (reciprocal interdependencies) > less emphasis on budgets, more freq. superior/subordinate interaction

1.  
   1. Contemporary technologies

·        JIT, TQM, FM (Flexible manufacturing)

·        Consider tech changes w/in organizational context

·        JIT is best-suited to open, informal, organic MCS (continuous improvement)

·        TQM, FM – high variability, low analyzability, management of interdependencies (relationships w/ customers, suppliers), provide effective links across value chain

·        Appropriate MCS should be open, informal, broad scope info, benchmark, performance measures that link strategy to ops (balanced scorecards, strategic interactive controls)

                                                               i.      Findings: advanced technologies and MCS

1.      Product focused TQM > timely problem solving info, flexible revisions to reward systems

2.      Customer, quality performance higher in TQM + JIT where there were customer, quality-related performance goals + incentive pay           

3.      Organic MCS more effective JIT systems

4.      Relying on non-financial in TQM provides interactive strategic control

5.      Broadly-based MCS enhanced org performance in JIT setting

6.      Customer focused manufacturing + AMT assoc. w/ non-financial

7.      FMS – performance measures focused on time, quality, operating efficiency, and flexibility, de-emphasis of efficiency-based measures

·        Control derived from integrating liaison devices

·        CAD/CAM – generic notion of tech emphasizing strategy of flexible response, customization

8.      Link performance w/ combinations of controls w/ range of strategies + manufacturing practices

                                                             ii.      Critical evaluation

1.      More flexible, interactive MCS required to encourage learning, adaptation in managers

·        Activity-based accounting, non-financial manufacturing performance measures and supplier networks

2.      Task difficulty, not task variability, moderate the effects of budget behaviors on performance

3.      Complimentarities > ways multiple aspects of manufacturing can be optimally combined

4.      Best practices – manufacturing

5.      Interactive IT systems – SAP R/3 – need to be studied

6.      Target costing many help alleviate risks of short product life cycles

7.      Role of formal systems through new firm formation, early growth, maturity and decline

8.      Most MCS contingency-based research on large manufacturing firms – need some in service and government sectors

1.  
   1. Organizational structure

·        Formal specification of different roles for organizational members (tasks for groups) to ensure organizational activities are performed

·        Help shape:

o       Efficiency of work

o       Motivation of individuals

o       Information flows

o       Control systems

·        Outcomes of structure vs. Structural mechanisms

·        “…the way in which the organization is differentiated and integrated.”

o       Differentiated – sub-unit managers = entrepreneurs

o       Integration – rules, op procedures, committees

·        Centralization, standardization, formalization, configuration

·        Bureaucratic vs. Non-bureaucratic

·        MCS to be consistent with the intent of the org structure

·        Organic MCS may require sophisticated liaison mechanisms rather than rules

·        Strategy might follow structure – influence info flows

·        Links between technology and structure and strategy and MCS

·        Socio-technical approaches required to ensure improved org performance

·        Learning curves

                                                               i.      Findings: organizational structure and MCS

1.      Large firm, sophisticated tech., decentralized > formal MCS

2.      Large firm, diverse, decentralized > administrative controls (budgets, formal patterns of communication)

3.      Factors related to internal ops, ext. conditions, interdependencies depend on the functional nature of depts.

4.      R&D better suited to participative budgeting?

5.      Improvements in MCS valued for pricing, customer mix, sales force/promotions and product mix

6.      Few studies consider fit between organic structures and MCS

·        Best served by broad scope, future-oriented info?

·        -In turn, does this serve activity-based accounting?

·        ABC assoc. w/ centralization, formalization

·        Activity analysis, activity-cost analyst w/ organic structure

7.      Teams > High task complexity, financial/non-financial comprehensive performance measures (formulated participatively)

8.      Teams > ABC, rewards based on group incentives > cooperative innovations, lower costs, higher profits

                                                             ii.      Critical evaluation

1.      Conventional thinking = decentralization should be combined w/ profit center responsibility accounting systems vs. complex liaison mechanisms to achieve integration

2.      Closer inspection = both used (sophisticated controls + participation, HR approaches)

3.      Further research – as employees become more autonomous and empowered

4.      Take care when selecting measurement instruments related to structure:  Measured in terms of:

·        Decentralization of authority?

·        Structuring of activities?

·        Interdependence?

·        Organic-mechanistic orientation?

5.      Seamless org structures still retain hierarchical structures (profit centers, responsibility accounting) instead of organic MCS

6.      Research = MCS and HRM links

1.  
   1. Size

·        Specialization and division of labor

·        Mass production, economies of scale

·        Greater amounts of info to handle and analyze, more complexity

·        Blurred due to close associations with suppliers / customers

·        Global ops, mergers, takeovers, licensing

                                                               i.      Findings: size and MCS

1.      Few studies

2.      Large org mostly – use formal MCS

3.      In combination w/ tech., product diversity

4.      Made more use of sophisticated controls, forecasting, marketing research

5.      Large firms = administrative, Small firms = personal

6.      Managers perceived budgets as limiting innovation / flexibility

                                                             ii.      Critical evaluation

1.      Not considered size variation in larger entities

2.      Size/Administration relationship – increases with size, but at a declining rate

3.      Combinative MCS may be used in large orgs.

4.      Must investigate small- and medium-sized orgs.

5.      Substitution of capital for labor’s effect on MCS

6.      How to est. size? (Profits, sales volume, employees, assets, etc.)

7.      Employee numbers correlate with net assets?

8.      Forecast sales may be best indicator?  Other factors?

1.  
   1. Strategy

·        Not a contextual element per se – means for managers to influence

·        Managers have ‘strategic choice’

·        Entrepreneurial-Conservative (best served by: Flexible MCS)

·        Prospectors-Analyzers-Defenders (Flexible)

·        Build-Hold-Harvest (Centralized control, Formal)

·        Product Differentiation-Cost Leadership (Centralized control, Formal)

·        Four MCS link to strategy:

o       Belief systems to communicate/reinforce basic values, missions

o       Boundary systems to est. limits, rules to be respected

o       Diagnostic controls to monitor outcomes, correct deviations

o       Interactive controls to supervisor/subordinate dialog, force learning

                                                               i.      Findings: strategy and MCS

1.      Suggest links between strategy > cost control > formality of performance evaluation

2.      Strategic BU rather than corp. or functional levels

3.      Little sense of urgency about creating vision, no interactive cntls.

4.      Tight cntls still found in entrepreneurial strategies (to curb excess innovation?, uncertain environments?)

5.      Entrepreneurial also had organic elements working w/ tight cntls.

6.      Product differentiation > less rigid budget control

7.      Competitor-focused accounting (prospector companies)

8.      Integrated, aggregated, timely info > customization strategies

                                                             ii.      Critical evaluation

1.      Few studies addressed MCS implicated in implementation and monitoring of strategies, providing learning/info feedback used interactively to formulate strategy

2.      Studies done in 1970s, 80s – relevance is decreasing

3.      Need to see how strategic change affects MCS

4.      Both evolutionary and revolutionary

5.      How to measure strategy?

1.  
   1. Culture

·        Moving into more sociological concerns

·        National identity and culture

·        Multi-national corporations

·        Transfer domestic MCS overseas or redesign?

·        “Culture is composed of patterned and interrelated traditions, transmitted over time/space by non-biological mechanisms based on man’s uniquely developed linguistic and no-linguistic symbolizing capabilities.”

·        Knowledge, belief, art, morals, law, custom

·        Power distance, individualism vs. collectivism, uncertainty avoidance, masculinity vs. femininity, Confucian dynamism

                                                               i.      Findings: culture and MCS

1.      Few areas where consensus can be drawn

2.      Singapore mgrs. (low individualism, high power distance), reliance on accounting performance measures > low job related tension, high job satisfaction

3.      Use of long-term incentives was more important in Taiwanese firms then US firms

4.      US vs. Japan – More explicit controls vs. more implicit controls

5.      Less formal MCS in US than Japan

6.      Only ambiguous findings

                                                             ii.      Critical evaluation

1.      Assumes different values have same intensity w/in a culture

2.      Studies don’t consider all of Hofstede’s values

3.      Assume countries differ on values (chk for assumed values 1^st)

4.      Hofstede = restricted view on culture

5.      Advanced tech adoption works more eff  in collectivism culture

6.      More research = Org culture and MCS

1.  
   1. Continuing relevance of traditional elements of context

                                                               i.      Environmental concerns

                                                             ii.      Employee empowerment

                                                            iii.      Technology increasingly complex

                                                           iv.      More hostile, uncertain, complex business environment

                                                             v.      Enlarging organizations

1. Issues related to theory development

·        Selection

o       Examine contextual factors’ relation to MCS w/ no attempt to assess if this is linked to performance

·        Interaction

o       Examine how organizational context moderated relationship between MCS and organizational performance

·        Systems

o       Examine multiple aspects of MCS and dimensions of context and how they enhance performance

1.  
   1. Structural relationships between variables

                                                               i.      Linear additive models – elements of MCS and outcomes

1.      Simple correlations, linear regression, direct / indirect effects

1.  
   1. Causality

                                                               i.      Survey based in the main – Limits scope

                                                             ii.      Unidirectional and bi-directional relationships

1.  
   1. Levels of analysis

                                                               i.      Important to theory construction in contingency-based research

                                                             ii.      Individual or Sub-unit level?  Choose one and stay on that level

                                                            iii.       

1. Alternate theories and contingency-based research
   1. True only under specified conditions
   2. No contingency theory – Variety of theories used to explain + predict conditions where MCS is found
   3. Much can be gained – contemporary elements (environment, tech, structure) relationship to design and implementation of MCS
   4. Using/relating to theories from economics, psychology, sociology, organizational theory
   5. Agency theory – incentive schemes to gain from employees commitment to organization goals prescribed by principals (organizational justice)
   6. Population-ecology theory – fit is attained by a process of natural selection
   7. Psychology – how personality/cognitive style affect individual reaction to MCS
   8. Person-environment and Person-organization fit
   9. Behavioral economics – Limited info processing capability, selective perception, bounded rationality
   10. Contingency-based research has relied to much on functionalist theories, not applying interpretive and critical views
   11. Conflict between individuals and groups
   12. Use case studies for novel approaches to MCS and their relationships

                                                               i.      This can lead to less generalization, limits causal inference

1.  
   1. Alternate theories combined w/ traditional – Develop convergence cautiously
2. Conclusion
   1. “Contingency-based research has approached the study of MCS assuming that managers act w/ an intent to adapter their organizations to changes in contingencies in order to attain fit and enhances performance.”
   2. Potential strength of method – “uncover generalizable findings to enhance desired organizational outcomes”

E.U. Summit – IMF, Regulation, Global Accounting Standards

E.U. summit to push global regulation

I think that it’s interesting to note that Stephen mentions how European countries formed some of the financial structure on a Wall Street / U.S. model.  Now that our system is starting to crack, E.U. knows that it must scrutinize its own financial systems in order to avoid the type of crises that are occurring in the U.S.  Previously, I mentioned (search GAAP in my blog) about the SEC looking to move away from U.S. Generally Accepted Accounting Principles (GAAP) and more toward the International Financial Reporting Standards (IFRS) from an announcement earlier this year.

Another topic of the summit is the role of the International Monetary Fund (IMF) in the current crisis.   Here is a quote from the IMF website on one of their current roles:

“The IMF also lends to countries with balance of payments difficulties, to provide temporary financing and to support policies aimed at correcting the underlying problems; loans to low-income countries are also aimed especially at poverty reduction.”

It will be interested to see how the IMF responds in this situation.  Since it was formed in 1945 (after WWII to help the European recovery from that war), I don’t think that the IMF has really been tested in such a manner as today’s economic crisis.  Also, keep in mind that as opposed to the $700 Billion U.S. bailout package, the IMF’s reserves are approximately $255 Billion (see below table from their website – ignore all links in the table).

Liquidity Table

					Aug. 2008
			2006	2007	SDRs	US$
I.	224.2		224.6	224.2	352
		Members’ currencies	209.0	209.6	210.0	330
		SDR holdings	2.8	2.6	1.9	3
		Gold holdings	5.9	5.9	5.9	9
		Other assets	6.6	6.6	6.5	10
		Available under GAB/NAB activation	-	-	-	-
II.	Less:Non-usable resources		63.0	59.3	60.8	96
		Of which: Credit outstanding	9.8	6.0	7.7	12
III.	Equals:Usable resources		161.2	165.4	163.4	257
IV.	Less:Undrawn balances under GRA arrangements		3.9	3.1	0.8	1
V.	Equals:Uncommitted usable resources		157.3	162.3	162.6	255
VI.	Plus:Repurchases one-year forward		2.8	0.3	0.2	0
VII.	Less:Prudential balance		34.8	34.9	34.9	55
VIII.	Equals:One-year forward commitment capacity (FCC)		125.4	127.7	128.0	201
	Memorandum items:
		Potential GAB/NAB borrowing	34.0	34.0	34.0	53
		Quotas of members that finance IMF transactions (see Financial Transactions - http://www.imf.org/cgi-shl/create_x.pl?ftp )	173.8	174.4	174.4	274
		Liquid liabilities	17.5	13.7	15.0	24
		US$ per SDR	1.50440	1.58025	1.56988

Week 5 Portfolio Intro (Edited – Moved Some to Week 6)

This week, I’ve been doing a lot of reading and not much posting here. I was deliberately waiting for the bailout plan to reach some sort of resolution before posting my thoughts on it (I should’ve known better! – as there is as of yesterday night no such resolution). I’ve spent more time this week on accountancy, watching “Money As Debt“, staying on top of the bailout plan as well as the banking situation daily through articles/reports on WSJ, CNN and NPR, some Fannie and Freddie research in regards to their federal takeover, and reading all of the articles everyone’s been posting. Over the next few days, I’ll organize my thoughts on these topics, assemble the articles I’ve read in a logical fashion, and try to break it up into some posts. In addition, I’ve also found some things interesting this week about financial gurus, philanthropists, and entertainment moguls. The organization may be as follows:

• MA – The Accountant’s Role in the Organization
• MA – An Introduction to Cost Terms and Purposes
• MA – Cost-Volume-Profit Analysis
• MA – Determining How Costs Behave (Week 6)
• MA – Master Budget and Responsibility Accounting
• MA – Flexible Budgets, Direct-Cost Variances, and Management Control
• MA – Flexible Budgets, Overhead Cost Variances, and Management Control
• Bailout TImeline – What’s Next? (Week 6)
• Bank Mergers and Acquisitions Summary – Who’s Left? (Week 6)
• Forbes Magazine 400 Richest Americans / One Philanthropist
• Myspace Music Player Update as Part of Deal with Major Label Cos.

MA – Flexible Budgets, Overhead Cost Variances, and Management Control

TERMS

 

Denominator level  The denominator in the budgeted fixed overhead rate computation.

 

Denominator-level variance  (also production-volume variance)  The difference between budgeted fixed overhead and fixed overhead allocated on the basis of actual output produced.

 

Fixed overhead flexible-budget variance  The difference between actual fixed overhead costs and fixed overhead costs in the flexible budget.

 

Fixed overhead spending variance  Same as fixed overhead flexible-budget variance.  The difference between actual fixed overhead costs and fixed overhead costs in the flexible budget.

 

Production-denominator level  The denominator in the budgeted manufacturing fixed overhead rate computation.

 

Standard costing  Costing system that traces direct costs to output produced by multiplying the standard prices or rates by the standard quantities of inputs allowed for actual outputs produced and allocates overhead costs on the basis of the standard overhead cost rates times the standard quantities of the allocation bases allowed for the actual outputs produced.

 

Total-overhead variance  The sum of the flexible-budget variance and the production-volume (PV) variance.

 

Variable overhead efficiency variance  The difference between the actual quantity of variable overhead cost-allocation base used and budgeted quantity of variable overhead cost-allocation base that should have been used to produce actual output, multiplied by actual quantity of variable overhead cost-allocation base used for actual output.

 

Variable overhead flexible-budget variance  The difference between actual variable overhead costs incurred and flexible-budget variable overhead amounts.

 

Variable overhead spending variance  The difference between actual variable overhead cost per unit and budgeted variable overhead cost per unit of the cost-allocation base, multiplied by actual quantity of variable overhead cost-allocation base used for actual output.

 

NOTES

 

Developing budgeted variable overhead cost rates:

1. Choose the Period to Be Used for the Budget
2. Select the Cost-Allocation Bases to Use in Allocating Variable Overhead Costs to Output Produced
3. Identify the Variable Overhead Costs Associated with Each Cost-Allocation Base
4. Compute the Rate per Unit of Each Cost-Allocation Base Used to Allocate Variable Overhead Costs to Output Produced

 

Journal Entries – Variable Overhead Costs and Variances:

 

Variable Overhead Control 

            A/P (etc.)    

Work-in-Process Control        

            Variable Overhead Allocated     

Variable Overhead Allocated

Variable Overhead Efficiency Variance

            Variable Overhead Control  

            Variable Overhead Spending Variance 

Cost of Goods Sold   

Variable Overhead Spending Variance 

            Variable Overhead Efficiency Variance

 

Developing budgeted fixed overhead rates:

1. Choose the Period to Use for the Budget
2. Select the Cost-Allocation Bases to Use in Allocating Fixed Overhead Costs to Output Produced
3. Identify the Fixed Overhead Costs Associated with Each Cost-Allocation Base
4. Compute the Rate per Unit of Each Cost-Allocation Base Used to Allocate Fixed Overhead Costs to Output Produced 

Journal Entries – Fixed Overhead Costs and Variances:

 

Fixed Overhead Control

            Salaries Payable, Acc. Deprec., etc.

Work-in-Process Control

            Fixed Overhead Allocated

Fixed Overhead Allocated

Fixed Overhead Spending Variance

Fixed Overhead Production-Volume Variance 

            Fixed Overhead Control 

Cost of Goods Sold 

            Fixed Overhead Spending Variance

 

Flexible Budget and Variance Analysis for variable Setup Overhead Costs:

1. Using Budgeted Batch Size, Calculate the Number of Batches That Should Have Been Used to Produce Actual Output
2. Using Budgeted Setup-Hours per Batch, Calculate the Number of Setup-Hours That Should Have Been Used
3. Using Budgeted Variable Cost per Setup-Hour, Calculate the Flexible Budget for Variable Setup Overhead Costs

Flexible Budget and Variance Analysis for Fixed Setup Overhead Costs:

1. Choose the Period to Use for the Budget
2. Select the Cost-Allocation base to Use in Allocating Fixed Overhead Costs to Output Produced
3. Identify the Fixed Overhead Costs Associated with the Cost-Allocation Base
4. Compute the Rate per Unit of the Cost-Allocation Base Used to Allocate Fixed Overhead Costs to Output Produced

Flexible budgets in ABC systems can be used to give insight into why variance occurs in overhead activity costs.

MA – Flexible Budgets, Direct-Cost Variances, and Management Control

TERMS

 

Benchmarking  The continuous process of comparing the levels of performance in producing products and services and executing activities against the best levels of performance in competing companies or in companies having similar processes.

 

Budgeted performance  Expected performance or a point of reference to compare actual results.

 

Effectiveness  The degree to which a predetermined objective or target is met.

 

Efficiency  The relative amount of inputs used to achieve a given output level.

 

Efficiency variance (also usage variance)  The difference between actual input quantity used and budgeted input quantity allowed for actual output, multiplied by budgeted price.

 

Favorable variance  Variance that has the effect of increasing operating income relative to the budgeted amount.  Denoted “F”.

 

Flexible budget  Budget developed using budgeted revenues and budgeted costs based on the actual output in the budget period.

 

Flexible-budget variance  The difference between an actual result and the corresponding flexible-budget amount based on the actual output level in the budget period.

 

Input-price variance  (also price variance, rate variance)  The difference between actual price and budgeted price multiplied by actual quantity of input.

 

Management by exception  Practice of focusing management attention on areas not operating as expected and giving less attention to areas operating as expected.

 

Sales-volume variance  The difference between a flexible-budget amount and the corresponding static-budget amount.

 

Selling-price variance  The difference between the actual selling price and the budgeted selling price multiplied by the actual units sold.

 

Standard  A carefully determined price, cost, or quantity that is used as a benchmark for judging performance.  It is usually expressed on a per unit basis.

 

Standard cost  A carefully determined cost of a unit of output.

 

Standard input  A carefully determined quantity of input required for one unit of output.

 

Standard price  A carefully determined price that a company expects to pay for a unit of input.

 

Static budget  Budget based on the level of output planned at the start of the budget period.

 

Static-budget variance  Difference between an actual result and the corresponding budgeted amount in the static budget.

 

Unfavorable variance  Variance that has the effect of decreasing operating income relative to the budgeted amount.  Denoted “U”.

 

Variance  The difference between the actual result and expected performance.

 

NOTES

 

Flexible budgets help managers gain more insight on why variances have occurred than static budgets.

 

Three steps to develop a flexible budget:

1. Identify the Actual Quantity of Output
2. Calculate the Flexible Budget for Revenues Based on Budgeted Selling Price and Actual Quantity of Output
3. Calculate the Flexible Budget for Costs Based on budgeted Variable Cost per Output Unit, Actual Quantity of Output, and Budgeted Fixed Costs

 

Levels 1, 2, 3 Variance Analysis:

 

Static-budget variance for operating income (1)

Flexible-budget variance for operating income (2)

                                    Selling price variance (Line Item-2)

                                    Direct materials variance (Line Item-2)

                                                Direct materials price variance (3)

                                                Direct materials efficiency variance (3)

                                    Direct manufacturing labor variance (Line Item-2)

                                                Direct manufacturing labor price variance (3)

                                                Direct manufacturing labor efficiency variance (3)

                                    Variable manufacturing overhead variance (Line Item-2)

                                    Fixed manufacturing overhead variance (Line Item-2)

                          Sales-volume variance for operating income (2)

 

Journal Entries – Standard Costs:

 

Direct Materials Control                       

            Direct Materials Price Variance

            Accounts Payable Control

Work-in-Process Control

Direct Materials Efficiency Variance

            Direct Materials Control

 

Work-in-Process Control

Direct Mfg. Labor Price Variance

Direct Mfg. Labor Efficiency Variance

            Wages Payable Control 

 

Cost of Goods Sold

Direct Materials Price Variance

            Direct Materials Efficiency Variance

            Direct Mfg. Labor Price Variance

            Direct Mfg. Labor Efficiency Variance

 

 

MA – Master Budget and Responsibility Accounting

TERMS

Activity based budgeting (ABB)  Budgeting approach that focuses on the budgeted cost of the activities necessary to produce and sell products and services.

Budgetary slack  The practice of underestimating budgeted revenues, or overestimating budgeted costs, to make budgeted targets more easily achievable.

Cash budget  Schedule of expected cash receipts and disbursements.

Controllability  Degree of influence that a specific manager has over costs, revenues, or related items for which he or she is responsible.

Controllable cost  Any cost that is primarily subject to the influence of a given responsibility center manager for a given period.

Cost center  Responsibility center where the manager is accountable for costs only.

Financial budget  Part of the master budget that focuses on how operations and planned capital outlays affect cash.  It is made up of the capital expenditures budget, the cash budget, the budgeted balance sheet, and the budgeted statement of cash flows.

Financial planning models  Mathematical representations of the relationships among operating activities, financial activities, and other factors that affect the master budget.

Investment center  Responsibility center where the manager is accountable for investments, revenues, and costs.

Kaizen budgeting  Budgetary approach that explicitly incorporates continuous improvement anticipated during the budget period into the budget numbers.

Master budget (also pro forma statements)  Expression of management’s operating and financial plans for a specified period (usually a fiscal year) and includes a set of budgeted financial statements.

Operating budget  Budgeted income statement and its supporting budget schedules.

Organization structure  Arrangement of lines of responsibility within the organization.

Profit center  Responsibility center where the manager is accountable for revenues and costs.

Responsibility accounting  System that measures the plans, budgets, actions, and actual results of each responsibility center.

Responsibility center  Part, segment, or subunit of an organization whose manager is accountable for a specifies set of activities.

Revenue center  Responsibility center where the manager is accountable for revenues only.

Rolling budget (also continuous budget)  Budget or plan that is always available for a specified future period by adding a period (month, quarter, or year) to the period that just ended.

NOTES

Operating decisions deal with how to best use the limited resources of an organization.

Financing decisions deal with how to obtain the funds to acquire those resources.

Advantages of budgets:

1. Promote coordination and communication among subunits within the company
2. Provide a framework for judging performance and facilitating learning
3. Motivate managers and other employees

Operating budget steps:

1. Prepare the Revenues Budget
2. Prepare the Production Budget (in units)
3. Prepare the Direct Material Usage Budget and Direct Material Purchases Budget
4. Prepare the Direct Manufacturing Labor Costs Budget
5. Prepare the Manufacturing Overhead Costs Budget
6. Prepare the Ending Inventories Budget
7. Prepare the Cost of Goods Sold Budget
8. Prepare the Nonmanufacturing Costs Budget
9. Prepare the Budgeted Income Statement

MA – Cost-Volume-Profit Analysis

TERMS

Breakeven point (BEP)  Quantity of output sold at which total revenues equal total costs, that is, where operating income is zero.

Choice criterion  Objective that can be quantified in a decision model.

Contribution income statement  Income statement that groups costs into variable costs and fixed costs to highlight the contribution margin.

Contribution margin  Total revenues minus the variable cost per unit.

Contribution margin per unit  Selling price minus total variable costs.

Contribution margin percentage/ratio  Contribution margin per unit divided by selling price.

Cost-volume-profit (CVP) analysis  Examines the behavior of total revenues, total costs, and operating income as changes occur in the units sold, the selling price, the variable cost per unit, or the fixed costs of a product.

Decision table  Summary of the alternative actions, events, outcomes, and probabilities of events in a decision model.

Degree of operating leverage  Contribution margin divided by operating income at any given level of sales.

Event  A possible relevant occurrence in a decision model.

Expected (monetary) value  Weighted average of the outcomes of a decision with the probability of each outcome serving as the weight.

Gross margin percentage  Gross margin (revenues – COGS) divided by revenues.

Margin of safety  Amount by which budgeted (or actual) revenues exceed breakeven revenues.

Net income  Operating income plus nonoperating revenues (such as interest revenue) minus nonoperating costs (such as interest cost) minus income taxes.

Operating leverage  Effects that fixed costs have on changes in operating income as changes occur in units sold and hence in contribution margin.

Outcomes  Predicted economic results of the various possible combinations of actions and events in a decision model.

Probability  Likelihood or chance that an event will occur.

Probability distribution  Describes the likelihood (or the probability) that each of the mutually exclusive and collectively exhaustive set of events will occur.

PV graph  Shows how changes in the quantity of units (Volume) sold affect operating income (Profit).

Revenue driver  A variable, such as volume, that casually affects revenues.

Sales mix  Quantities of various products/services that constitute total unit sales.

Sensitivity analysis  A “What If?” technique that managers use to examine how an outcome will change if the original predicted data are not achieved or if an underlying assumption changes.

Uncertainty  The possibility that an actual amount will deviate from an expected amount.

NOTES

Three methods for computering BEP or targeted operating (or net) income:

1. Equation method
2. Contribution margin method
3. Graph method

A. Decision Model Steps:

1. Identify a choice criterion
2. Identify the set of alternative actions to be considered
3. Identify the set of events that can occur
4. Assign a probability to each even that can occur
5. Identify the set of possible outcomes

B. Implementation of chosen action

C. Outcome of chosen action

D. Performance evaluation

Continuous feedback is necessary as the cycle repeats.

MA – An Introduction to Cost Terms and Purposes

TERMS

Actual cost  Cost incurred (a historical or past cost), as distinguished from a budgeted or forecasted cost.

Budgeted cost  Predicted or forecasted cost (future cost), as distinguished from an actual or historical cost.

Conversion costs  All manufacturing costs other than direct material costs.

Cost  Resource sacrificed or forgone to achieve a specific objective.

Cost accumulation  Collection of cost data in some organized way by means of an accounting system.

Cost allocation  Assignment or indirect costs to a particular cost object.

Cost assignment  General term that encompasses both tracing accumulated costs that have a direct relationship to a cost object and allocating accumulated costs that have an indirect relationship to a cost object.

Cost driver  A variable, such as the level of activity or volume, that causally affects costs over a given time span.

Cost object  Anything for which a measurement of costs is desired.

Cost of goods manufactured  Cost of goods brought to completion, whether they were started before or during the current accounting period.

Cost tracing  Describes the assignment of direct costs to a particular cost object.

Direct costs of a cost object  Costs related to the particular cost object that can be traced to that object in an economically feasible (cost-effective) way.

Direct manufacturing labor costs  Include the compensation of all manufacturing labor that can be traced to the cost object (work in process and then finished goods) in an economically feasible way.

Direct material costs  Acquisition costs of all materials that eventually become part of the cost object (work in process and then finished goods), and that can be traced to the cost object in an economically feasible way.

Direct materials inventory  Direct materials in stock and awaiting use in the manufacturing process.

Finished goods inventory  Goods completed but not yet sold.

Fixed cost  Cost that remains unchanged in total for a given time period, despite wide changes in the related level of total activity or volume.

Idle time  Wages paid for unproductive time caused by lack of orders, machine breakdowns, material shortages, poor scheduling, etc.

Indirect costs of a cost object  Costs related to the particular cost object that cannot be traced to that object in an economically feasible (cost-effective) way.

Indirect manufacturing costs (also factory overhead costs, manufacturing overhead costs)  All manufacturing costs that are related to the cost object (work in process and then finished goods) but that cannot be traced to that cost object in an economically feasible way.

Inventoriable costs  All costs of a product that are considered as assets in the balance sheet when they are incurred and that become cost of goods sold only when the product is sold.

Manufacturing-sector companies  Companies that purchase materials/components and convert them into various finished goods.

Merchandising-sector companies  Companies that purchase and then sell tangible products without changing their basic form.

Operating income  Total revenues from operations minus cost of goods sold and operating costs (excluding interest expense and income taxes).

Overtime premium  Wage rate paid to workers (for both direct labor and indirect labor) in excess of their straight-time wage rates.

Period costs  All costs in the income statement other than cost of goods sold.

Prime costs  All direct manufacturing costs. (labor and materials)

Product cost  Sum of the costs assigned to a product for a specific purpose.

Relevant range  Band of normal activity level or volume in which there is a specific relationship between the level of activity or volume and the cost in question.

Revenues  Inflows of assets (usually cash or A/R) received for products/services provided to customers.

Service-sector companies  Companies that provide services or intangible products to their customers.

Unit cost (also average cost)  Cost computed by dividing total cost by number of units.

Variable cost  Cost that changes in total in proportion to changes in the related level of total activity or volume.

Work-in-process inventory (also work in progress)  Goods partially worked on but not yet completed.

NOTES

Cost object examples:

• Products
• Services
• Project
• Customer
• Brand category
• Activity
• Department

Focus on total costs.

Inventoriable costs regarded as an asset in the accounting period they are incurred.

Period costs are expensed in the account period they are incurred.

Features of cost accounting and cost management:

1. Calculating the cost of products, services and other cost objects
2. Obtaining information for planning, control, and performance evaluation
3. Analyzing the relevant information for making decisions

Product costs for different purposes:

1. Pricing and product-mix decisions (All)
2. Contracting with government agencies (Part of R&D, Design, Production)
3. Preparing financial statements for external reporting under GAAP (Production)

Direct Material Inventory (Balance Sheet)

to

Work-in-process Inventory (Balance Sheet)

to

Finished Goods Inventory (Balance Sheet)

to

Cost of Goods Sold (Income Statement)

MA – The Accountant’s Role in the Organization

TERMS

Budget  Quantitative expression of a proposed plan of action by management for a specified period and an aid to coordinating what needs to be done to implement that plan.

CFM  Certifies that the holder has met the admission criteria and demonstrated the competency of technical knowledge in financial management required by the IMA.

CMA  Certifies that the holder has met the admission criteria and demonstrated the competency of technical knowledge in management accounting required by the IMA.

CFO  Executive responsible for overseeing the financial operations of an organization.  Also called the finance director.

Control  Taking actions that implement the planning decisions, deciding how to evaluate performance, and providing feedback and learning that will help future decision making.

Controller  The financial executive primarily responsible for management and financial accounting.  Also called the chief accounting officer.

Cost accounting  Measures, analyzes, and reports financial and nonfinancial information relating to the costs of acquiring or using resources in an organization.  It provides information for both management and financial accounting.

Cost-benefit approach  Approach to decision making and resource allocation based on a comparison of the expect benefits from attaining company goals and the expected costs.

Cost management  The approaches and activities of managers to use resources to increase value to customers and to achieve organizational goals.

Customer service  Providing after-sale support to customers.

Design of products, services or processes  The detailed planning and engineering of products, services or processes.

Distribution  Delivering products or services to customers.

Financial accounting  Measures and records business transactions and provides financial statements that are based on GAAP.  It focuses on reporting to external parties such as investors and banks.

IMA  Institute of Management Accountants

Learning  Involves managers examining past performance and systematically exploring alternative ways to make better-informed decisions and plans in the future.

Line management  Managers (in production, marketing, distribution, etc.) who are directly responsible for attaining the goals of the organization.

Management accounting  Measures, analyzes, and reports financial and nonfinancial information that helps managers make decisions to fulfill the goals of an organization.  It focuses on internal reporting.

Marketing  Promoting/selling products or services to customers/prospective customers.

Planning  Selecting organizational goals, predicting results under various alternative ways of achieving those goals, deciding how to attain the desired goals, and communicating the goals and how to attain them to the entire organization.

Production  Acquiring, coordinating, and assembling resources to produce a product or deliver a service.

R&D  Generating and experimenting with ideas related ot new products, services, or processes.

Staff management  Staff (such as MA and HR managers) who provide advice and assistance to line management.

Strategic cost management  Describes cost management that specifically focuses on strategic issues.

Strategy  Specifies how an organization matches its own capabilities with the opportunities in the marketplace to accomplish its objectives.

Supply chain  Describes the flow of goods, services, and information from the initial sources of materials and services to the delivery of products to consumers, regardless of whether those activities occur in the same organization or in other organizations. Examples: Suppliers of materials, independent distributors.

Value chain  The sequence of business functions in which customer usefulness is added to products or services of a company.  Examples: R&D; design of products, services, or processes; marketing; distribution; customer service.

IDEAS

Five-Step Decision-Making Process:

1. Identify the problem and uncertainties (Planning)
2. Obtain information (Planning)
3. Make predictions about the future (Planning)
4. Make decisions by choosing among alternatives (Planning)
5. Implement the decision, evaluate performance, and learn. (Control)

Three MA Guidelines:

1. Employ a cost-benefit approach
2. Recognize behavioral as well as technical considerations
3. Identify different costs for different purposes

Controller reports to CFO in most organizations.

Ethical responsibilities defined by IMA and similar professional organizations.