Accounting and Finance

Accounting and Finance

1. Types of accounting (collect, analyse, communicate -> decision-making

   • Financial accounting (external,)
     • Nat. / Intern. acc. stanards
       • Financial well-being at part. point
         • Past financial performance, historical
           • General / broad
             • Rep. annual
   • Management accounting (internal)
     • Managers and decision-making
       • To achieve firm's goals
         • No optimum package
           • Specific purpose, past & future info
             • Rep. as required by managers
     • Aspects
       • Organizational planning
         • Organizational control
           • Organizational performance

2. Cost terminology and cost management

   • Cost terminology
     • Cost (resource sacrificed / forgone for obj.)
       • Cost object (cost measurem.)
         • Classifications
           • Indirect (non-traced)
             • e.g. marketing
           • Direct (traced)
             • e.g. direct labour
           • Can be both!
       • Manufacturing costs (direct lab. direct mat. manuf. overhead)
       • Prime costs (direct lab. direct mat.)
       • Conversion cost (direct lab. manuf. overhead)
       • Non-manufacturing costs (marketing, administration)
       • Cost behaviour (how cost responds to change in business activity)
         • Classifications
           • Fixed
             • Do not (in total) vary with level of output
           • Variable
             • Vary (in total) with level of output)
   • Cost management
     • Cost accounting (managers, planning / dec. m., IFRS)
       • Cost system (capt. cost data -> basis for cost info)
         • Two stages
           • Cost accumulation (group=
           • Cost assignment (object)
       • Cost allocation (cost obj. usage of indirect costs)
       • Cost Volume Profit (CVP Analysis)
         • Contribution margin (unit of product -> fixed expenses)
           • Operating leverage (sensitivity of net profit to changes in sales)
             • High: Small change in CM -> larger percentage increase in net profit
         • Useful for managers, acc. business owners -> short term!
           • Rel. between cost, volume, output & profit
             • How much do I need to sell to cover my costs?
               • Assumptions
                 • Cost & revenues linear
                 • Costs distinguished as fixed or var.
                 • Costs and revenues are constant
                   • Unlikely! Managers + acc. to be knowledgable of underlying costs -> how risky firm's cost structure is + conduct 'what if' analysis
                     • Sensitivity analysis (what-if technique)
                       • How outcome changes if original prediction changes)
                         • Broadens managers' perspective
                           • Spreadsheets
                   • Sales mix (prop in which company's products are sold)
                     • CVP assumed this is constant (short-term)
                       • BP multiple products:
                         • assume known + constant sales mix
                           • BP number of bundles
                             • By knowing sales mix, volume of ind. product sales can be determined
                 • All units prod. are sold
                 • All prices and costs known with certainty
         • Breakeven point: Where total costs = total revenues
           • Purpose (planning prod. + pricing)
             • How much do I need to sell to cover costs?
             • How much do I need to sell to reach desired level of profit? (Target profit)
             • + and - with firm's cost structure
         • Margin of safety (how much loss (sales) before loss (profit))
         • Cost structure (prop. of fixed & variable)
           • Some freedom - e.g. automatation (less direct costs)
             • Cost estimation
               • Estimation tech. aggregate data + mixed costs (e.g. telephone)
                 • Mixed costs = linear -> TC = FC + vcu (q)
                   • Methods of isolating fixed / variable costs)
                     • Inspection of accounts (each item classified) SImple but not precise
                     • High-low method
                       • Historical data (levels of output + ass. costs)
                         • Separation of fixed / variable costs
                           • Conc. on highest-lowest observations of cost data
                             • Simultaneous equation or VC = change in cost / change in output
                               • Easy to use / inexpensive
                               • Can complement direct inspection methods
                               • No way to know if there is rel. between highest activity / lowest cost & vice versa
                                 • Ignores all other observation except high / low, which could be extremes
                     • Least-square regression analysis
           • FIxed to total cost ratio
             • High: Fast profit increase when sales expand (VARIABILITY
             • Low: Fast increase in losses when sales fall (RISK)

3. Short-term decision making (1 year or less)

   • Contribution as a basis
     • Short-term profitability
       • Special order (below market price, one-off)
         • Key factors
           • Additional revenues / costs
           • Producton capacity
             • Decision rule
               • Capacity + positive contr. -> accept
               • No capacity -> contr. higher than contr. forgone from existing orders
                 • Other: Customer reactions, intentions + hidden costs?
       • Limiting factor / scarce resource (multiple products with shortage / binding constraint)
         • Decision -rule
           • Production plan based on availability of scarce resource
           • Contribution per limiting factor
             • Steps: Is mat. x a limiting factor? -> contr / limiting factor (higher contr. higher rank) -> optimal prod. plan based on limiting factor
     • Profitability and asset structure
       • Product discontinuation
         • Straight-line depreciation (same decrease every year)
         • Decision of org
           • Keys for decision
             • Positive contribution?
             • Fixed costs? (remain, avoid?)
             • Impact on other business areas, use of freed up capacity
       • Asset (resource) replacement
         • Cost-revenue relevance: Comp. 2+ alt
           • Relevant comp. of 'relevant' costs / rev.
             • Decision-rules
               • Eliminate costs / revenues that do not differ + sunk costs
                 • Sunk costs (past costs, can't be altered)
                   • Sunk cost fallacy
                   • Concorde fallacy
                   • FA and sunk costs
               • Make decision between rem. alts.
               • Choose most conv. option

4. Long-term decision making (more than 1 year)

   • Capital investment appraisal
     • Quant. info on how to invest long term funds
       • Assump.: no taxes, no infl, predictive certainty
     • Investment appraisal techniques
       • No time value for money
         • Payback period
           • Length of time to recover initial cost using cash flows (in years)
             • Only when net annual cash flow is same each year
               • Investment required/net annual cash flow
                 • Evaluate
                   • Pros
                     • Screening tool (which proposals to consider further)
                     • 'Cash poor' companies may benefit (how to recoup cash quickly)
                     • Cautious approach
                     • Industries where products become obsolete quickly -> recoup cash quickly
                   • Cons
                     • No time value for money, or depreciation
                       • Discounted payback method
                         • Same aim as PP but considers time value of money
                           • Ignores cash flows after payback period
                     • Does not consider interest
         • Simple Rate of Return
           • No focus on cash flows -> Profit & depreciation
             • inc.r. rev - incr. exp. incl. depreciation / initial investm.
               • Evaluate
                 • Pros
                   • Easy to calculate
                   • Based on familiar acc. meas. of profit
                   • All profits taken into account (ass. with project)
                 • Cons
                   • Does not cons. time value of money
                   • Subject to acc. policies -> vary from one org. to another, can be manipulated
         • Since investment decisions are being made at the beginning of the period, future cash flows must be converted to their equivalent value now
           • Discounting: Analysis fo future cash flows in today's worth
             • Discount rate (at which fut. CF disc.)
               • How to determine: Risk-free rate of inter., risk premium of proj., risk of inflation
                 • Annuity: Stream of equal periodic payments for 'n' periods
       • Time value for money
         • Net Present Value
           • Disc. value of fut. cash flows - initial investm.
             • Assumptions: All cash flows received at start of year
               • Calc pres. vaue of cash outfl. - pres. value of cash infl.
                 • If the NPV is...
                   • Pos: Acceptable (return > required rate of ret.
                   • 0: (Less) acceptable (return = required RoR)
                   • Neg: Not acceptable (return < required RoR)
                 • Evaluate
                   • Pros
                     • Simpler to use
                     • Assumption: Cash flows can be reinvested at discount rate
                   • Cons
                     • Cannot be compared to NPV of other project
         • Internal Rate of Return
           • Return promised by an investment period over its useful life
             • Find discount rate to cause NPV = 0
               • Works if cash flows for project identical each year (if not, use trial-error process)
                 • Evaluate
                   • Pros
                     • Ind. RELATIVE return: Good for comparison
                     • Preference rule: Higher -> more des.
                   • Cons
                     • Assumes all cash flows are reinvested at project's constant IRR
       • Screening tool or establishing preference
         • Identify investments -> gather data, -> perform fin. analysis -> present in bus. prop. -> sel & appr. bus. prop -> implement
   • Cash flow associated to proj.
     • Initial investm.
     • Operations
     • Terminal disposal