MGAB03 Midterm Analysis

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University of Toronto Scarborough
Financial Accounting
Liang Chen

Midterm Analysis – L. Chen Course Introduction + Some Personal Suggestion: The majority of this intro to managerial accounting course covers cost accounting, a significant branch of managerial accounting. Cost accounting is important in financial management because net income is essentially a function of 2 things: revenue and expenses/costs. Effective cost accounting lays out a clear picture of the company’s costs, the breakdown of the costs, and the categorization of the costs so that managers can make better cost-related decisions on improving net income in the long run. If you have good managerial thinking and good organization, this course should be pretty intuitive for you. If not, this course will help you develop the essential and crucial concepts needed in basic financial management. This course is one of the most important and useful courses you will take in UTSC. While the concepts in this course are basic, the applications (midterm and exam questions) can be very difficult with complex situations that involve the integrated use of multiple concepts. In order to get an 85+ you must understand all concepts inside-out, and practice all materials you have so that your SPEED is fast. The exams are all about speed. If everyone is given 10 hours to complete the 2 hour exam, everyone will get 80+, but the truth is, you only have 2 hours. Chapter 1: Introduction of Managerial Accounting Concepts:  Financial Accounting vs. Managerial Accounting: Financial accounting’s main goal is to communicate financial information of the organization. It is heavily regulated with rules (ASPE and IFRS), because it needs to be consistent and reliable so that users of financial information will not be misled. Managerial accounting on the other hand, focuses mainly on analyzing financial information for internal decision making. It is not regulated at all – you may do whatever you want in your analysis if you think it will help you make better decisions. The techniques learnt in this course are common techniques that most (if not all) organizations perform on a regular basis to ensure they are making the right financial decisions. Chapter 2: Cost Object and Cost Driver Concepts:  Cost Object: a product/service, department, or project for which costs are accumulated  Cost Classification:  Cost Driver: anything (activity) that causes costs to incur.  Cost Function: a mathematical function that describes cost behavior pattern – how costs change with changes in the cost drivers. A very simple example: total cost = fixed cost + number of units x variable cost per unit.  Cost Estimation Approaches: Chapter 3: Cost-Volume-Profit (CVP) Analysis The basic form of CVP analysis is to calculate the breakeven point – how many units do I need to sell so that at least I have no net loss? What are my revenue and costs going to be (of course in this case revenue and costs will be the same)? In more advanced application, CVP analysis can help you breakdown the criteria you have to meet in order to reach a specific profit target – how many units do I need to sell to reach my target operating income of $100,000? What are my revenue and costs going to be now? Terms/Concepts:  Contribution Margin: the amount for which sales revenue exceeds variable costs. Sales Revenue - Variable Costs. Can be in the form of “total contribution margin” or “contribution margin per unit”.  Contribution Margin Ratio/Percentage: total contribution margin / total sales, or, unit contribution margin / unit selling price  Gross Profit (also called Gross Margin): the amount for which sales revenue exceeds cost of goods sold. Sales Revenue - COGS.  Margin of Safety: the amount for which total projected sales revenue exceeds the breakeven sales revenue. It can be expressed in absolute dollar amount; it can be expressed in percentages: margin of safety in sales / total sales; it can also be expressed in units of goods sold.  Degree of Operating Leverage: the extent to which the cost function is made up of fixed cost. High degree of operating leverage means there is a high proportion of fixed costs. Companies with high degree of operating leverage face faster falling profits when sales drop, but enjoy profits that rise more quickly when sales increase. % increase in sales revenue x DOL = % increase in net operating income. Degree of operating leverage can be calculated 3 ways: o Contribution Margin / Net Operating Income o (Fixed Costs / Earnings Before Tax) + 1 o 1 / Margin of Safety Percentage Chapter 4: Relevant Costs for Decision Making The main goal of this chapter is to teach you to identify what costs are relevant and should be taken into consideration when making decisions/choosing between alternatives. Irrelevant costs are therefore excluded in the consideration. After you have identified the relevant costs, this chapter will also show you how to prepare analyses for various decision situations. Terms/Concepts  Relevant Revenue/Costs: expected future revenue/costs that differ across alternatives  Irrelevant Revenue/Costs: expected future revenue/costs that will not differ across alternatives  Sunk Costs: costs that have fully incurred in the past. When we evaluate between alternatives (i.e. whether we should discontinue or continue a line of products), sunk costs should not be a consideration because they have already fully incurred and will not affect the future. A related misconception held by a lot of people is “we should continue the operation because we’ve already spent so much on it”. This argument is invalid and this logic fallacy is called “escalation of commitment”. Typical Decision Making Situations  One-time-only special order (usually the decision is to determine the price) o Consider only
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