BUS105: Managerial Accounting

Read section 1.2. Good managers are always planning for the future and assessing the present. The functions that enable management to continually plan for the future and assess implementation are called planning and control. Planning is the process of establishing goals and communicating these goals to employees of the organization. The control function is the process of evaluating whether the organization’s plans were implemented effectively.

Read section 1.4. Mark Twain told us that there are three types of lies, “lies, damned lies and statistics.” Management accountants produce many statistics! As a management accountant you need to be aware of ethical issues and avoid practices that mislead and misdirect those who will use your information.

Selection of a computer system for a company is more than a software or hardware decision—it is a complex problem that usually requires scrupulous research and a full rethinking of the organization's culture and reporting relationships. Today, most companies have a computerized financial system that creates financial and management accounting reports. Read more in section 1.5.

Read section 1.6. Classifying costs and revenue correctly is critical to consistent financial reporting. A consistent report has uniform meaning within the company. In this section you will learn some of the basic terminology used to classify costs. This section of the textbook is important to your success in this course, so be sure to complete the exercises at the end of the section before you move on.

Costs are associated with, and accumulated in, broad accounts out of necessity. In section 1.7, you will learn how costs are assigned to those accounts and how those costs can "flow" through another cost account. Be sure to complete the exercises at the end of this section before you move on.

Companies who manufacture products report different accounts on their income statements than other types of companies, such as service or merchandising companies. In section 1.8, you will review the income statements of manufacturing companies.

Many of us could use a refresher from our high school math courses! The following videos review some basic math skills that you will apply to accounting.

Watch this series of four videos that give several good examples of job order costing.

Read section 2.2 to learn how to assign direct material and direct labor costs. Companies are careful to track both direct and indirect materials and labor, but only the direct resources are assigned immediately to production costs.

Indirect materials and indirect labor are part of manufacturing overhead costs, but so are lots of other costs associated with a manufacturing operation. Read section 2.3 to learn about applying overhead to the cost of production with a pre-determined factory overhead rate.

Read section 2.4. Service organizatons have similar objectives to manufacturing companies when it comes to tracking expenses. Certainly, they may rely less on direct materials for their product, but it's crucial for a service organization to track labor and overhead to be sure they're charging their customers appropriately!

Read section 2.5, and apply what you've learned so far to Custom Furniture's business. Review the financial statements and determine whether or not they're profitable. Will you see where they have room for improvement? Note that the end of chapter exercises are optional.

Read the Chapter 3 introduction, and then click "Next Section" to read section 3.1. Like Custom Furniture Company, SailRite Company, a maker of fine sail boats, is earning less profit than expected. Because SailRite makes many boats but only two models, job costing is not an appropriate costing system. Activity-based costing (ABC) is another method to allocate costs.

Direct labor and direct materials are allocated the same regardless of which system is used. Manufacturing overhead, however, which is an indirect manufacturing cost, can be allocated a number of different ways. Each way results in different total cost for the same product. the goal is to find a system of allocation that best approximates the amount of overhead costs required for each product.

ABC allocates overhead based on the activities that are driving the costs. The four steps to apply ABC are relatively straightforward. The key is to determine the appropriate cost driver for each activity. Note that job costing, process costing, and ABC use the same pool of costs. They are just three different ways of analyzing and allocating the cost pool. 

At the end of "3.3: Using Activity-Based Costing to Allocate Overhead Costs", which you'll read soon, be sure to find out what is going wrong at SailRite and what two management actions or decisions could remedy the lower-than-expected profit. 

Read section 3.2. Overhead costs are a significant part of production costs. Managers try to assign overhead costs (including indirect materials, indirect labor, rent, utilities, ect) to jobs as closely as possible to the dollar amount of resources these jobs consume. Managers might choose from the plant-wide allocation, department allocation, or the activity-based allocation. 

Read section 3.3. There are five steps to the activity-based method of allocating overhead costs. Practice the steps until you're comfortable with them!

Read section 3.4. Don't let the terms confuse you! Activity-based management is simply a management technique that requires an analysis of activity-based costing for decision making.

Read section 3.5. Service organizations benefit from activity-management, as well!

This series of three videos covers the concepts that underlie activity-based costing. They consider Zannon Corporation, which, like SailRite, is experiencing sales growth but worryingly shrinking profits. Work through each video, pencil in hand, or create your own spreadsheets to follow along.

Read the Chapter 4 Introduction, and then click "Next Section" to read section 4.1. In this section, you'll read about the example of Desk Products Inc., which mass produces wood desks. It maintains an advantage over its competitors by producing one desk in large quantities: 4,000 to 8,000 desks each month. Changes in the market are causing the CEO to be diligent about keeping costs as low as possible. The most efficient method to respond to this concern is to use process costing. As you read this chapter, pay attention to how department costs are allocated based on the concept of equivalent units. Pay close attention to the production cost report and the information it gives the CEO. How does this improve her management decision making?

Read section 4.2. Much like job costing, process costing requires companies to assign the cost of direct materials, direct labor, and factory overhead. The nature of manufacturing a product that flows through a process of departments necessitates a different method of applying those costs.

Read section 4.3. As you can imagine, products manufactured in a process cost system will have varying degrees of completion with respect to its use of direct materials, direct labor, and overhead as the product flows through production. Accountants rely on the degree of completion to calculate equivalent units for the purpose of assigning those production costs at all stages.

Read section 4.4. To determine an average cost per unit, some companies rely on the weighted average method of assigning production costs to its inventory. This simple method simply averages the prior costs with current manufacturing costs to determine its average cost.

Read section 4.5. Using the four steps of assigning costs in a process costing system, managers ultimately determine the cost of the finished goods transferred out of production as well as the value of the partially completed product. This information is summarized nicely in a standard format with the production cost report.

Watch this series of three videos on process costing. In the first video, Tony Bell explains process costing for Smith, Inc. In the remaining two videos, he works through an example of applying process costing. Take special note of how WIP is accounted for in the examples.

Read the Chapter 5 introduction, and then click on "Next Section" to read section 5.1. Bikes Unlimited is planning its monthly sales. They have recently concluded a successful advertising campaign and expect that sales will increase 10 to 20%. They need to know what happens if they adjust manufacturing to meet the predicted increase in sales and their predictions of sales are, in fact, true. How will increased sales volumes impact profit? First, you have to identify how costs behave with changes in sales and production—behavior depends upon whether the costs are variable, fixed, or mixed. Once you have classified the costs, you can set up an income statement in a "contribution-margin" format, that will give management a major tool in their decision making. 

Variable Costs The key to understanding and being able to classify a variable cost is to remember that you are thinking about how costs behave relative to production. Variable costs will fluctuate based on how much product is sold. The cost of purchasing chrome tubing for Bikes Unlimited is an obvious variable cost, some variable costs are not so obvious. Fixed Costs 

Fixed costs are incurred whether Bikes Unlimited sells zero units or a billion units. The payment of the annual lease on Bikes Unlimited's factory/warehouse is a good example of a fixed cost; even if Bikes Unlimited chooses to make no bikes, it would have to continue to pay its lease. There are two kinds of fixed costs: some are "committed," those that must happen, such as the lease payment stated above, and others that are discretionary, such as advertising or research and development. Both of these activities could be suspended in the short term. 

Mixed Costs Bikes Unlimited also has mixed costs which have both fixed and variable components. Bikes Unlimited pays its sales staff a base salary plus a commission based on units sold and, finally, a year-end bonus based on overall profitability, which demonstrates all three cost behavior patterns.

These two videos supplement and reinforce what we learned earlier. The first video explores the actual behavior of costs and how you might normalize that behavior and use the costs in developing management decision tools. The second video extends the graphic model to explain cost behavior. Follow along with paper/pencil or your own spreadsheet program.

Chapter 5, Section 2 of your textbook continues the story of Bikes Unlimited. You consider the four principle cost estimation methods to estimate fixed and variable costs. Each method has its advantages and disadvantages. The choice of a method will depend on the situation at hand. Experienced employees may be able to effectively estimate fixed and variable costs by using the account analysis approach. If a quick estimate is needed, the high-low method may be appropriate. The scatter-graph method can be used to identify any unusual data points which can be thrown out when estimating costs. Finally, regression analysis can be run using computer software and its precise results will provide more accurate cost estimates.

Section 5.3 considers the contribution margin income statement, which shows fixed and variable components of cost information. Revenue minus variable costs equals the contribution margin. The contribution margin minus fixed costs equals operating profit . This statement provides a clearer picture of which costs change and which costs remain the same with changes in levels of activity.

In Chapter 5, Section 4 of the textbook, you again consider the relevant range. Along with the assumption of linearity, the relevant range must be considered when estimating costs using the methods described in this unit. When costs are estimated for a specific level of activity, the assumption is that the activity level is within the relevant range. Costs are estimated assuming that they are linear. Both assumptions are reasonable as long as the relevant range is clearly identified, and the linearity assumption does not significantly distort the resulting cost estimate.

This video demonstrates how the high-low method can be applied to Danny Office Supplies to estimate shipping costs next month. Account analysis is a cost analysis method that requires a review of accounts by experienced employees to determine whether the costs in each account are fixed or variable. This approach is perhaps the most common starting point for estimating fixed and variable costs. The high-low method starts with the highest and lowest activity levels and uses four steps to estimate fixed and variable costs.

This video demonstrates how the scattergraph method is applied to Danny Office Supplies to estimate the next month's shipping costs. The scattergraph method has five steps and starts with plotting all points on a graph and fitting a line through the points. This line represents costs throughout a range of activity levels and is used to estimate fixed and variable costs. The scattergraph is also used to identify any outlying or unusual data points.

Regression analysis forms a mathematically determined line that best fits the data points. Software packages like Excel are available to perform regression analysis. This method is also called the Least Squares Regression. In the following video, Bell demonstrates how regression analysis is applied to Danny Office Supplies to estimate the next month's shipping costs. Bell does this by using Microsoft Excel where regression analysis is a built-in function. See the optional appendix to Chapter 5 if you would like to learn how to use this Excel function.

Section 5.5 is optional because it specifically addresses Microsoft Excel software, which you are not required to have in order to take this course. Regardless, regression analysis is an important part of managerial accounting. It provides the best fit between independent variables and allows the best estimations to be made, through extrapolation. The following section provides students with a guide to performing regression analysis with Microsoft Excel. Most spreadsheet programs provide this function.

Read the Chapter 6 introduction, and then click on "Next Section" to read Section 6.1. In this unit, Snowboard Company uses CVP analysis to determine its break-even point and what additional volumes it would need to sell to achieve a decent profit. CVP assumes that the selling price per unit is the same throughout the relevant range. Cost-volume-profit analysis involves finding the break-even point and target profit point in units and in sales dollars. The key formulas for an organization with a single product are developed and explained in the reading.

Read section 6.2. By expanding the equation taught in Section 1, a company who manufactures more than one product can still determine their break-even point with the same basic variables.

This video walks through an example of applying CVP analysis.

Seldom are financial predictions exactly correct; there is a natural variance in predictions. As a result of this natural variance, managers should always be aware of how sensitive their predictions are to fluctuations in the model’s variables. Sensitivity analysis shows how the cost-volume-profit model will change with changes in any of its variables. Although the focus is typically on how changes in variables affect profit, accountants often analyze the impact of uncertainty on the break-even point and target profit as well. Read section 6.3. to learn more.

Read section 6.4, which explores the effects that various loads of fixed costs have on CVP analysis. The amount of fixed costs (cost structure) that a company carries is often established by the type of industry it operates in. The cost structure of a firm describes the proportion of fixed and variable costs to total costs. Operating leverage refers to the level of fixed costs within an organization. The term "high operating leverage" is used to describe companies with relatively high fixed costs. Firms with high operating leverage tend to profit more from increasing sales, and lose more from decreasing sales, than a similar firm with low operating leverage

In section 6.5, you will examine the case of Kayaks-For-Fun, which has limited amounts of labor. How do they manage those constrained units of labor to maximize profits? Many organizations operate with limited resources in areas such as labor hours, machine hours, facilities, or materials. The contribution margin per unit of constraint is a helpful measure in determining how constrained resources should be allocated.

The target profit for a company required to pay income taxes should consider the effect of those taxes on their analysis. Step 1 requires the calculation of a new after-tax target amount. Step 2 converts the after-tax profit to a before-tax target amount. Finally, step 3 calculates the target profit in dollars or units for the desired profit calculated in step 2. Learn more about these 3 steps in Section 6.6.

The accounting treatment for variable and fixed costs is slightly different with a variable costing approach. Only the overhead account receives different treatment as the overhead costs are divided into fixed costs and variable costs. Read Section 6.7 to learn a new approach for recording those costs. Note that the end of chapter exercises are optional.

These videos continue our discussion on CVP analysis. Watch them to see additional real-world applications of CVP analysis. They continues the ABC Company's project that we discussed earlier.

Read the Chapter 7 introduction, then click "Next Section" to read Section 7.1. Best Boards will use differential revenues and costs to show the difference in revenues and costs among alternative courses of action. Differential analysis is useful in making managerial decisions related to making or buying products, keeping or dropping product lines, keeping or dropping customers, and accepting or rejecting special customer orders. Later in this unit, you will examine each of these four scenarios for which differential analysis can be used to assist managers' decision-making.

Read section 7.2. Best Board's decision is whether or not to make its own wakeboards or buy them from a supplier. Differential analysis requires the identification of all revenues and costs that differ from one alternative to another. In general, managers select the alternative with the highest profit. If the only difference between the alternatives is cost (as in the make-or-buy decision for Best Boards), decision-makers would select the alternative with the lowest cost.

This video examines a make-or-buy decision that Snazzy Jazzi Footwear is trying to make and how differential analysis can be used to assist with that snappy decision.

Managers often use differential analysis to determine whether to keep or drop a product line. Direct fixed costs are typically eliminated if a product line is eliminated and are, therefore, considered differential costs. Allocated fixed costs, however, are typically not eliminated if a product line is eliminated. Managers compare sales revenue and costs for each alternative (keep or drop) and select the alternative with the highest profit. Read section 7.3. to learn more.

This video considers Jen's Sweaters, which has been experiencing losses and is considering eliminating a product line. Be sure to follow along in your notes.

Read section 7.4. Managers use differential analysis to determine whether to keep or drop a customer. The format is similar to the differential analysis format used for making product line decisions. However, sales revenue, variable costs, and fixed costs are traced directly to customers rather than to product lines.

Before learning about special orders in the next section, let's do a quick review of the terminology!

Tony's T-shirts makes shirts for local sports teams, and occasionally Tony will receive special orders that involve additional costs. How does Tony go about deciding whether or not to accept these special orders? Managers often use differential analysis to decide whether to accept a special one-time order made by a customer. Managers compare sales revenue and costs for each alternative (accept or reject the special order) and select the alternative with the highest profit. Organizations must be careful to consider the long-run implications of reducing prices for special orders. Read section 7.6 to learn more.

Kaatz is the only producer of Ting. Kaatz has received a special order for 5,000 units. How can Kaatz make a sound financial decision? Watch the video to find out!

In this section, you will explore other pricing systems and why companies may use them. Cost-plus pricing starts with an estimate of the costs incurred to build a product, and a certain profit percentage is added to establish the price. Companies often use this method when it is difficult to determine a reasonable market price. Target costing integrates the product design, desired price, desired profit, and desired cost into one process beginning at the product development stage.

Read the Chapter 8 introduction, then click "Next Section" to read Section 8.1. You'll read about the example of Jackson's Quality Copies, a store that makes photocopies for its customers. The store wants to evaluate the purchase of an expensive new copier that costs $50,000, but with the potential to reduce expenses, increase productivity, and increase profits. The company president has to make the decision if the new copier is actually a good or bad addition. Managerial accounting methods can give her several tools to evaluate this investment. You use two methods to evaluate long-term investments, both of which consider the time value of money. The first is called the net present value (NPV) method, and the second is called the internal rate of return method. Before you start to consider the two methods, let's discuss the time value of money (present value) concept first.

NPV combines the present value of all cash flows associated with an investment, both positive (for example, from sales) and negative (from expenses), into one suitable figure for management decision-making. The term discounted cash flows is also used to describe the NPV method. One critical factor in determining the NPV is the discount rate: what time value (forgone interest rate) is associated with future receipts of money.

Using the internal rate of return (IRR) to evaluate investments is similar to using the net present value (NPV) in that both methods consider the time value of money. The IRR represents the time-adjusted rate of return for the investment being considered. The IRR decision rule states that if the IRR is greater than or equal to the company's required rate of return (recall that this is often called the hurdle rate), the investment is accepted; otherwise, the investment is rejected. This method ensures that any capital investments the company makes are at least equal to the existing rate of return on capital or exceed it. The hurdle rate will vary from company to company.

Julie Jackson's life would be easier if all she had to do was find a number and use it to make a decision. It would be easy to agree to buy a new copier if the NPV and IRR say yes. Unfortunately, life is seldom as easy as following a formula. Other factors affect what Julie should do. In this section, we will consider some of those factors.

You hear people talk about the payback period, as in:

The payback period, typically stated in years, is the time it takes to generate enough cash receipts from an investment to cover the cash outflows from the investment. The method uses a simple sum of future earnings/savings over an arbitrary time period to evaluate capital improvements. It is a quick way to look at an investment and sort potential investments, but the payback method is somewhat lacking in rigor.

Read section 8.6 to learn why it's somewhat problematic when investments involve cash outflows at irregular times throughout the project. Evaluations using NPV, IRR, and the payback period must consider those scenarios.

Income taxes are a significant factor in capital budgeting decisions. Don't overlook them! Read Section 8.7 to learn how to account for their impact.

Companies, much like people, should plan for expenses both big and small. An operating budget assists with planning for the daily activities of running a company with the goal to increase sales and reduce expenses. What does that look like on paper? Read the Chapter 9 introduction, then click "Next Section" to read section 9.1.

Jerry's Ice Cream knows that a good budget is the result of consulting with all levels of the company and having a well-rounded budget committee to prepare the master budget. As a planning document, it is essential that all levels of the company share in the creation of the master budget and are prepared to fully implement it. Budgeting is vital to the planning and controlling phases of the management cycle. For a company that ends its fiscal year on December 31, the budgeting process may start as early as August. Read section 9.2 to learn more.

Read section 9.3. The master budget for Jerry's Ice Cream includes separate budget schedules for sales, production, direct materials, direct labor, manufacturing overhead, selling and administrative, the income statement, capital expenditures, cash, and the balance sheet. The sales budget is most important because sales projections drive the other budgets. To get the most out of this unit, you should attempt to recreate your own master budget for Jerry's Ice Cream using Microsoft Excel or other spreadsheet software.

The examples we have used so far to describe a master budget have been limited to manufacturing companies. Manufacturing companies tend to have comprehensive operating budgets and therefore serve as a good starting point in learning how to develop a master budget. However, all types of organizations use operating budgets. This section describes operating budgets for merchandising, service, and not-for-profit organizations.

This section considers the inherent conflict that can exist between the planning and control phases of budgeting. During the planning phase, organizations are most concerned about getting accurate estimates that lead to positive results. The control phase requires evaluating the performance of CEOs, managers, and employees by comparing actual results to the operating budget. CEOs, managers, and employees often must decide between doing what is best for them and what is best for the organization.

Rarely will the assumptions of the master budget be completely accurate. As a result, organizations use a modified budget called a flexible budget. A flexible budget is a revised master budget based on the actual activity levels. The flexible budget represents what costs should be – based on the actual levels of sales/activity. In this unit, the text assumes beginning and ending finished goods inventory are the same and, therefore, the number of units produced and sold will be the same. Read the Chapter 10 Introduction, and then click "Next Section" to read Section 10.1. As you read, follow along with how Jerry's Ice Cream handles a doubling of expected sales – sweet news!

These videos give two examples of how flexible budgets may be prepared and used. Work along with them. If you use an Excel file, you will have a more permanent record. The first video provides a general discussion of flexible budgets and their use. The second solves a typical exam question about flexible budgets.

In this section, you will see what happens when the master budget plan deviates significantly from the assumptions used to develop it. When a deviation from the master budget becomes apparent, one of the possible causes is that actual costs were not known when the master budget was developed and standard costs were used. Standard costs are those costs that management expects to incur to provide a good or service and are typically stated as a cost per unit. Standard cost is based on the combination of price (or rate) and quantity (or hours). They serve as the "standard" by which performance will be evaluated and are used to produce the master budget.

Follow along and document how Jerry's Ice Cream used standard costs to develop a master budget and how that contributes to variance from the actual results. You should note that a standard cost is a per-unit cost, while a master budget cost is the total cost at a given standard level of activity/standard quantity of units.

Jerry’s Ice Cream is concerned about cost overruns of direct materials. This section examines the "causation" of direct materials variance. The master budget amount allocated to direct materials is made up of two estimated parts, the quantity (Q) of materials included and the price (P) of those materials. Any variance in this cost category from the master budget can be accounted for by an increase or decrease in P and/or Q. Attribution of the variance to its cause(s) is critical to management decisions.

This video gives examples from Steve's Sausages, using a diagrammatic method to calculate direct materials variance. The diagram integrates standard and actual measures of price and quantity. By following this method, you will be able to break down variance into those factors associated with quantity changes and price changes.

Jerry's Ice Cream wants to know why there are cost overruns for direct labor. This section considers another significant factor of variance: direct labor. Like direct material variance, direct labor variance has two possible causes: labor rate variance and labor efficiency variance. As with materials, any variance in this cost category from the master budget can be accounted for. Attribution of the variance to its cause(s) is critical to management decisions.

This video demonstrates a diagrammatic method of separating causes of variance and their attribution using the case of Frank's Bikes. Frank has fixed amounts of labor, which is a slight twist on the case of Jerry's Ice Cream, which had a variable amount of labor. Small and large companies differ in how they manage their labor supply, as do companies with one product compared to companies with many products.

The final piece of the puzzle for Jerry's Ice Cream is variable manufacturing overhead variance. Variable manufacturing overhead variance has two distinct variances. When you calculate both variances, one is favorable and the other is not. The two variances are the spending variance and efficiency variance. The variable overhead spending variance is the difference between actual costs for variable overhead and budgeted costs based on the standards.

This video demonstrates a diagrammatic method of finding the variances. The client, Widgets R Us, has unfavorable variances, and the video explores reasons why this could happen.

At Jerry's Ice Cream or any other company, each budget line item could have an associated variance. The question becomes which variances should be investigated. As a decision-maker, you have limited resources, and you should allocate them to their most productive use. Every investigation consumes resources and has a direct expense associated with it. All managers must be judicious in selecting and investigating variances. Let's return to Jerry's Ice Cream to determine which variance you would track and examine.

If a company uses ABC (activity-based costing), like Jerry's Ice Cream, it cannot establish one standard variable overhead rate and standard quantity based on one cost driver. ABC companies must establish several standard variable overhead rates and quantities, each having its own cost driver. Regardless of whether a company uses the traditional costing approach or an activity-based costing approach, the process of performing variance analysis is consistent. Suppose Jerry's Ice Cream identified three significant activities. Let's see how ABC can be used with variance analysis!

Fixed overhead in the master budget is the same as fixed overhead in the flexible budget because fixed costs do not change with changes in units produced. Fixed manufacturing overhead variance analysis involves two separate variances, the spending variance and the production volume variance. This unit applies this management measure to Jerry's Ice Cream. Calculating the two variances informs management if they are applying enough overhead to the operation.

Read the Chapter 11 Introduction, then click on "Next Section" to read Section 11.1. You'll read about Game Products, Inc., which has experienced significant growth in volume, market area and products. The company is now operating internationally and has three broad product lines: board games, computer game making, and sporting goods. Along with its three distinct product lines are three distinct marketing areas. Management decided to decentralize its operation, and needed to revamp its management information system to provide relevant and timely information about its different product lines in its different locations. Decentralization has both pros and cons, which you will read about here.

Responsibility centers can be based on attributes such as sales regions, product lines, or services offered. In the case of Game Products Inc., there are three responsibility centers based on three product lines. The purpose of establishing responsibility centers within organizations is to hold managers responsible for only the assets, revenues, and costs they can control. The level of control a manager has will help determine the type of responsibility center used for each manager.

With this approach, responsibility centers are allocated budgets, and their revenues and costs (variable and fixed) are tracked. Each center has a responsibility income statement. Responsibility center expenses are allocated to direct variable costs and direct fixed costs. The responsibility center contribution margin is determined by reducing revenue by variable costs. Subtracting allocated fixed costs from the contribution margin yields the responsibility margin.

Read section 11.3. Games Inc. President's starting point for evaluating investment centers is with reviewing segmented income for each investment center (or division). Segmented income is segment revenues minus segment expenses. She is interested in the level of profit that each of the three divisions generates, and segmented income gives her this information. You will see, however, that there are limitations to using this method exclusively.

Games Products Inc. will also consider the return on investment (ROI) generated by each division as an evaluative metric. ROI is one of the most common measures of performance for managers responsible for investment centers. ROI is a basic measure, but the way it is calculated can vary between organizations.

Residual income is another evaluative metric that Games Products Inc. can use. Residual income (RI) provides a measure of income that is available to the whole organization. A manager's goal is to increase her RI from year to year. Most organizations that use RI also use ROI. Using both measures has the benefit of comparing one division to another by using ROI and minimizes the conflict between company goals and division goals by using RI.

Read Section 11.6 to learn about the EVA method of evaluating a company's performance. By the time you're finished reading, you'll be able to explain the differences and similarities of EVA to the Residual Income approach.

Mandy Dwyer, the president of Games Products Inc., meets with her management accountant and goes over his work. They choose three metrics to control their decentralized divisional operation: net income, profit margin ratio, and ROI. Their final step is to integrate these performance measures with a compensation plan for their operations managers.

Read the Chapter 12 Introduction, then click "Next Section" to read Section 12.1. The CEO of Home Store wants to know “where has the money gone?" Home Store is profitable but there is no money in the bank. You will soon see a possible explanation. The statement of cash flow provides cash receipt and cash payment information and reconciles the change in beginning cash and ending cash over a period of time.

This video provides a rationale for cash flow statements and introduces basic terms.

Cash flow is essential. Because of this, it takes many forms and can be measured in numerous ways. This section considers the usual methods of describing cash flow.

Operating activities include cash activities related to net income (revenues and expenses are included in net income).

Investing includes cash activities related to noncurrent assets. Noncurrent assets include (1) long-term investments; (2) property, plant, and equipment; and (3) the principal amount of loans made to other entities.

Financing includes cash activities related to noncurrent liabilities and owners' equity. Noncurrent liabilities and owners' equity items include (1) the principal amount of long-term debt, (2) stock sales and repurchases, and (3) dividend payments.

The statement of cash flows is based on cash only, and when used for accrual accounting based companies, adjustments must be made to convert accrual basis information to a cash basis. In addition to reconciling the three statement activities (the income statement, balance sheet, and statement of owners' equity), cash flows need to have certain adjustments made to them. One of the main ones is adjusting the statement for non-cash transactions like depreciation. There are four steps to creating a cash flow statement.

We now look at Home Store and the CEO's question. Where's the money? The information needed to prepare Home Store's statement of cash flows includes the balance sheet, income statement, and other selected data.

This video explains how to prepare the investing and financing sections of a cash flow statement.

Investing activities focus on the effect that changes in noncurrent assets have on cash. Noncurrent asset balances found on the balance sheet, coupled with other information (like cash proceeds from the sale of equipment), are used to perform this step. The financing activities section focuses on the effect changes in noncurrent liabilities and owners' equity have on cash. Noncurrent liabilities and owners' equity balances found on the balance sheet, coupled with other information (like cash dividends paid), are used to perform this step.

This video finishes the cash flow work on Turner Inc. by doing a rudimentary analysis of the company's cash flow statements.

The same four steps apply to preparing a statement of cash flows in both the direct and indirect methods. The only difference is how the operating activities section is presented in step one; all other steps are the same. Although the presentation of the operating activities section differs with each method, the result is the same.

This video finishes the cash flow work on Turner Inc. by doing a rudimentary analysis of the company's cash flow statements.

Financial stability is an important attribute of how your company is perceived by customers and competitors. Similarly, your company will be evaluated by others: customers, suppliers and stakeholders. All publicly traded corporations publish annual financial information; even privately held corporation can be and often are asked for their financials. The principles of managerial accounting are used to determine trends and ratios to evaluate the strength of each company’s income statement and balance sheet. Trends and "common size analysis" and ratio analysis are all used to make intra- and inter- comparisons of performance. This unit should give you a better idea about how financial stability is determined and used for any company. Read the Chapter 13 Introduction, then click "Next Section" to read Section 13.1.

Watch this horizontal/trend analysis for Elky Co.

Financial analysis is an important skill set that integrates everything we have discussed so far in this course. Think about your own skills. Can you do what this video is talking about?

Read section 13.2. When you are dealing with many numbers of comparatively large magnitudes, it becomes difficult to distinguish important features or attributes of those numbers. With common size analysis, you reduce numbers to percentages and then compare percent difference. For example if you have a company that has $450,000 in profit on sales of $2,220,000, while another has profit of only $375,000 on sales of $1,500,000, how do you compare these numbers? This is the strength of common size analysis, which is also known as vertical analysis.

This video shows how a client can compare his financial statements to another company's statements with vertical analysis.

The most robust type of analysis is ratio analysis. A ratio is a comparison of two numbers and normally takes the form of a fraction, decimal, or percentage. A ratio can be specific to a company, to companies within a region, to an industry, or to a stock exchange. Ratios are versatile and powerful. This section will show you how to use ratios to explain and compare companies to other companies or industries as a whole.

There are four basic types of ratios, which are used to measure profitability, short-term liquidity, long-term solvency, and market valuation.

These videos examine the financial statements for Squirrel Co. and give several examples of useful ratios.

Before you read the final sections of Chapter 13 regarding Chicken Deluxe, go back to the beginning of this chapter and review their problem. Review the analysis that the management accountants at Chicken Deluxe produced and note the use of all the elements you have been reading about in this unit. In coming to a management decision, seldom will numbers provide an answer on their own. A good CEO and a good team will also consider nonfinancial performance measures in coming to a decision. This process of considering nonfinancial performance measures is considered and you will note how similar the methodology is to those we have discussed above for financial performance measures. Read section 13.4 and 13.5. The end of chapter exercises are optional.