Midterm Review: Managerial Accounting

University of Washington – ACCT 225 – Intro Managerial Accounting

Midterm 2 Study Guide Below is a list of some of the things you should definitely be familiar with for Midterm 2. It is not intended to be a complete list. Rather, this should be used a supplement to the studying you were otherwise doing. Chapter 7 Under variable costing, only those manufacturing costs that vary with production quantity (output) are included as product costs. This would typically include direct materials, direct labor, and the variable portion of manufacturing overhead (V-MOH). Unlike in absorption costing (i.e., everything we did in Midterm 1), fixed manufacturing overhead (F-MOH) is treated as a period expense that goes straight to the income statement rather
than flow into WIP, FG, and COGS. You should have a very clear understanding of the differences in these costing systems. You should be able to do the following: separate total manufacturing cost into it's V-MOH and F-MOH components (recall: y = a + bx). We did this on the last midterm too. calculate unit costs under both variable and absorption costing prepare a contribution margin income statement under variable costing and a regular income statement using absorption costing o Remember, under variable costing we have all variable costs (inventory related and variable S&A expense) "above the line" and both fixed S&A expense as well as fixed inventory costs "below the line." The “line” is the contribution margin. o Total sales (revenue) will be the same in both income statements o NET INCOME MAY NOT BE THE SAME UNDER VARIABLE AND ABSORPTION COSTING  If production > sales: inventories increase and absorption costing net income is higher  If production = sales: inventory levels stay the same and both net income figures are the same  If production < sales: inventories decrease and variable costing net income is higher Reconcile absorption costing net income to that under variable costing (the difference is the difference in unit prices multiplied by the difference in

 Ed deHaan 2009

University of Washington – ACCT 225 – Intro Managerial Accounting

production over sales; this difference is stored in the inventory account under absorption costing) Explain the advantages of variable costing over absorption costing. Why, then, do we use absorption costing for external reporting (under GAAP)?

Chapter 9 Terms to know: - master budget - planning & control - responsibility accounting - continuous or perpetual budget A “master budget” consists of a set of sub-budgets for each core function of the company. Preparation of the master budget starts with estimating sales and ends with a full budgeted balance sheet and income statement. Once you have budgeted sales, you can use other assumptions and data to figure out everything else you need to know. The key thing to keep in mind is that cash in/outflows to not necessarily occur at the same time as the related purchase, sale or expense. Each budget is essentially a three-step process. First, you figure out what quantities are involved. Then you figure out how much cash is involved. Lastly, you figure out when the related cash will be paid or received. 1) Sales Budget – predicts how many units you think you’ll sell and then calculates the expected revenue from those sales (quantity x price). Revenues are partially collected in the month of sale and partially in future months. For example, a company may collect 50% of revenues in the month of the sale (month “t”), 35% in the following month (month “t + 1”), and 15% in the next month (month “t + 2”). With this information, you can figure out how much cash you expect to collect each month. In turn, you can then figure out your expected ending Accounts Receivable balance for each month. 2) Production Budget – shows you how many units of inventory you’ll need to produce in order to accommodate your Sales Budget. At the end of each month, you also need to make sure you have sufficient inventory on-hand to cover your sales at the beginning of the following month. For example, a company may have a policy that they want ending finished goods inventory to equal 30% of the following month’s expected sales. The Production Budget formula is fairly straight-forward (all in units): Estimated monthly sales + desired ending inventory balance... (e.g. 30% of next month’s sales) = Inventory requirement

 Ed deHaan 2009

University of Washington – ACCT 225 – Intro Managerial Accounting

- (beginning inventory balance)… (that is, the inventory you already have) = how many units you need to produce 3) Inventory & COGS budget – once you know how many units you’ll need to produce, you can then figure out how much raw materials you’ll need to make that many goods.
Like in the Production Budget, you’ll also need to make sure you have sufficient raw materials on hand to use in the beginning of the following month. The formula is essentially the same as the Production Budget formula. Once you’ve calculated your raw materials purchases, you also need to figure out how much cash you’ll be paying for these purchases. Similar to cash receipts from sales, cash payments may also be spread out over several months. The question should specify what portion you pay this month, in the next month, etc. You can also use this information to figure out your end “Accounts Payable – Inventory” for the period, which you’ll need later to complete your budgeted Balance Sheet. After raw materials, you may also be asked to estimate your Direct Labor & MOH costs. Lastly, you can calculate your expected COGS. This is just your total estimated unit cost times unit sales (from the Sales Budget). 4) S&A Expense Budget – this is just your estimated S&A Expenses based on your budgeted sales and production. The calculations will probably involved fixed and variable components. Like your raw materials purchases, these expenses will also likely be paid over several months. However, there are two
key differences with S&A payments: 1) be on the lookout for prepaid expense balances (these will affect your cash payments for expenses incurred), and 2) depreciation expense is not paid in cash. You may also need to calculate your “Accounts Payable – S&A expenses” balance for the end of the period (for use later in the Budgeted Balance Sheet). 5) Cash Budget: this just combines your cash in/outflows calculated above and determines your ending cash balance: Beginning Cash Balance (usually given to you) + cash collections (from step 1) - (payments for inventory purchases) (from step 3) - (payments of S&A expenses) (from step 4) = ending cash balance FILL IN BORROWINGS & INTEREST IF NECESSARY 6) Budgeted Income Statement – just combine your sales (step 1), COGS (step 3), and S&A Expense (step 4) into the usual income statement format.

 Ed deHaan 2009

University of Washington – ACCT 225 – Intro Managerial Accounting

7) Budgeted Balance Sheet – really, the relevant pieces are just cash, A/R, inventory, and A/P, the ending balances of which were calculated in the above steps.
Also be on the lookout for prepaid expense accounts or any other balance sheet account that is slipped into the question somewhere. Chapter 10: Terms to know: - management by exception - ideal vs practical standards - standard price per unit (for direct materials) - standard rate per hour (for direct labor) - standard hours (of direct labor) per unit - standard MOH cost per unit - standard quantity (of direct materials) or hours (direct labor or MOH) allowed - materials quantity variance - materials price variance - labor rate variance - labor efficiency (quantity) variance - variable overhead spending (price) variance - variable overhead efficiency (quantity) variance - balanced score card – generally know what this is, but there shouldn’t be any detailed questions about it on the exam. You should know it for the “real world,” though. The general variance composition is price/rate variance {(AQ x AP) – (AQ x SP)} plus quantity/efficiency variance {(AQ x SP) – (SQ x SP)}. You should be able to compute each of these, determine whether it is favorable or unfavorable, and explain what each means. A very likely question format will be to provide you a few, disparate pieces of information and ask you to fill in all the rest of the balances and calculations (like the example we did in section). The trick is to draw your
“prongs,” write out the formulas, and then plug in the information you are given. Then, think logically and “plug and chug” until you figure the whole thing out. You will be given enough information to answer the question. Remember that if your Direct Materials purchases do not equal usage, you will have two different (AQ x SP) figures: one for actual quantity purchased times standard price, and a second for actual quantity used times standard price. I.e. the “middle prong” will have two calculations. The price variance will be calculated based on purchases, while the quantity variance will be based on usage. You won’t have this problem for labor and MOH as you don’t really “purchase” these in advance. You’ll also need to be able to record the related journal entries. A few tips: - when applicable, always start with cash paid. Cash paid is always actual x actual.

 Ed deHaan 2009

University of Washington – ACCT 225 – Intro Managerial Accounting

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then hit your inventory-related account. Inventory accounts are recorded using standard costs and quantities, except for Raw Materials which is calculated based on Actual Quantity and Standard Cost. Raw materials will involve two journal entries: one for the purchase and a second one for usage Favorable variances are always credited Unfavorable variances are always debited

 Ed deHaan 2009