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# Week 14 notes Acct 3323

UTEP

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This 5 page Class Notes was uploaded by Laura Notetaker on Thursday November 26, 2015. The Class Notes belongs to Acct 3323 at University of Texas at El Paso taught by Marjorie A Marinovic in Fall 2015. Since its upload, it has received 26 views. For similar materials see Cost Accounting in Accounting at University of Texas at El Paso.

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Date Created: 11/26/15

Week 14 notes Chapter 10: LO 3: understand the various methods of cost estimation. 1. Industrial Engineering Method: Also called work-measurement method. Estimates cost functions by analyzing the relationship between inputs and outputs in physical terms. It is a very thorough and detailed when there is physical relationship between inputs and outputs, but it can be costly and time consuming. Time and motion studies analyze the time required to perform the various operations to produce something. 2. Conference method Estimated the cost function on the basis of analysis and opinion about costs and their drivers gathered from various departments of a company. It pools expert knowledge, increasing credibility. Reliance opinions makes this method subjective, but is faster and less expensive. 3. Accounting analysis method Estimates the cost functions by classifying various cost accounts as variable, fixed or mixed with respect to the identified level of activity. Managers use qualitative rather than quantitative analysis when making these cost-classification decisions. It is widely used because it is accurate, cost-effective and easy to use, but it is subjective. 4. Quantitative analysis method Use formal mathematical method to fit cost functions to past data observations. The results from it can be objective. It is a rigorous approach to estimate costs. It requires more detailed information about costs, cost drivers, and cost functions and is time consuming. LO 4: Outline the six steps in estimating a cost function using quantitative analysis. 1 Choose the dependent variable 2 Identify the independent variable 3 Collect data on the dependent variable and the cost driver Week 14 notes 4 Plot the data to observe the general relationship 5 Estimate the cost function using two common forms of quantitative analysis: the high-low method or regression analysis. 6 Evaluate the cost driver of the estimated cost function. LO 5: Describe three criteria used to evaluate and choose cost drivers. 1 Economic plausibility 2 Goodness of fit 3 Significance of the independent variable Chapter 11: LO 3: Explain the concept of opportunity cost and why managers should consider it when making insourcing versus outsourcing decisions. Opportunity costs are the contribution to operating income forgone by not using a limited resource in its next-best alternative use. Opportunity costs are not recorded in financial accounting systems because historical record keeping is limited to transactions involving alternatives that managers actually selected rather than alternatives that they rejected. One type of opportunity cost is the carrying cost of inventory: operating income forgone by tying up money in inventory and not investing it elsewhere. LO 4: Know how to choose which products to produce when there are capacity constraints. Product- mix decisions are decisions managers make about which products to sell and in what quantities. Decisions rule: Choose the product that produces the highest contribution margin per unit of the constraining resource, not the highest contribution margin per unit of the product. Chapter 21: LO 2: Use and evaluate the two main discounted cash flow (DCF) methods: the net present value method and the internal rate of return method. Discounted cash flow methods measure all expected future cash inflows and outflows of a project discounted back to the present point in time. The key feature of DCF methods is that the time value of money, which is that a dollar received today is worth more than a dollar received at any future time. Week 14 notes The time value of money is the opportunity cost from not having the money today. DCF methods use the required rate of return (RRR), which is the minimum acceptable annual rate of return on an investment. RRR is internally set, usually by upper management, and typically represents the return that an organization could expect to receive elsewhere for an investment of comparable risk. RRR is also called the discount rate, hurdle rate, cost of capital, or opportunity cost of capital. Net present value method: The NPV method calculates the expected monetary gain or loss from a project by discounting all expected future cash inflows and outflows back to the present point in time, using the RRR. Based on financial factors alone, only projects with a zero or positive NPV are acceptable. Internal rate of return: The IRR Method calculates the discount rate at which an investment’s present value of all expected cash inflows equals the present value of its expected cash outflows. We are looking here for the rate of return that makes NPV = 0. A project is accepted only if the IRR equals or exceeds the RRR. LO 3: Use and evaluate the payback and discounted payback methods. The Payback method measures the time it will take to recoup, in the form of expected future cash flows, the net initial investment in a project. Like the NPV and IRR methods, the payback method does not distinguish among the sources of cash flows. Shorter payback period are preferable. Organizations choose an acceptable project payback period. Generally, the greater the risk, the shorter the payback period should be. The payback method is easy to understand. LO 4: Use and evaluate the accrual accounting method rate of return method. The AARR method divides the average annual [accrual accounting] income of a project by a measure of the investment in it. Week 14 notes That “measure of the investment” in the project can vary company by company. Also called the accounting rate of return. The AARR method is similar to the IRR method in that both calculate a rate- of-return percentage; however, the IRR method is generally regarded as better than the AARR. LO 5: Identify relevant cash inflows and outflows for capital budgeting decisions. One of the biggest challenges in capital budgeting, particularly DCF analysis, is determining which cash flows are relevant in making an investment selection. Relevant cash flows are the differences in expected future cash flows as a result of making the investment. A capital investment project typically has three categories of cash flows: 1 Net initial investment 2 After-tax cash flow from operations 3 After-tax cash flow from terminal disposal of an asset and recovery of working capital Three components of net-initial investment cash flows: 1 Initial machine investment 2 Initial working capital investment 3 After-tax cash flow from current disposal of old machine Two components of cash flow from operations: 1 Annual after-tax cash flow from operations (excluding the depreciation effect) 2 Income tax cash savings from annual depreciation deductions The disposal of an investment generally increases cash inflow of a project at its termination. Two components of Terminal Disposal of Investment: 1 After-tax cash flow from terminal disposal of asset (investment) Week 14 notes 2 After-tax cash flow from recovery of working capital (liquidating receivables and inventory that was needed to support the project)

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