Accounting

for Non-Accountants

Dr. Joyce S. Wendam

Lecturer
 I - Basic Accounting:
Concepts, Techniques
and Conventions
Definition of Accounting

 Accounting is the art of recording,

classifying and summarizing in a
significant manner and in terms of
money, transactions and events which
are, in part at least, of a financial
character and interpreting the results
thereof.
Functions of Accounting

Functions of accounting:
1. Recording of data
2. Classifying of data
3. Summarizing of data
4. Interpreting the results
Major users of accounting
information
 1. owners of the business
 2. management of the business
 3. banks or creditors of the business
 4. the government or its agencies
 5. prospective investors
 6. consumers
 7. employees of the business
 8. the general public
2 – The Elements of
Accounting
The Accounting Elements

 Assets
 Owner’s Equity
 Liabilities
 Revenue
 Expenses
Assets

 Assets are items of worth owned by the

business organization in conducting its
operations.
 Examples: cash, receivables, stock,
land
Types of Assets

1. Current assets – those assets which

are readily converted into cash within a
twelve-month period or within the normal
operating cycle of a business.
 As a guide – non-monetary assets that
are convertible to cash within a year or
the normal operating cycle of a business
are categorized as current assets.
2. Non-current assets - those which are not
readily convertible into cash within a twelve-
month period or within the normal operating
cycle of a business and, thus, it has a long-
term nature. Also known as long-term
assets.
These assets are mostly not intended to be
sold by the business entity. Ex. - land,
building, machinery, motor vehicles,
equipment and furniture.
Liabilities

 Amounts owed by the business entity to

outside parties other than its owner and
as such these are seen as “debts” and
obligations of the business.
 Examples – accounts payable, notes
payable, loans, salaries payable
a. Current Liabilities

 Current Liabilities - debts and

obligations which should be paid within a
twelve-month period or within the normal
operating cycle of a business.
 Examples are creditors, accounts
payable, salaries payable.
b. Non-current Liabilities

 Non-current Liabilities – debts and

obligations which will be paid over more
than a twelve-month period and, thus, it
has a long-term nature. Also known as
long-term liabilities.
 Examples – mortgage loan or long-term
notes payable
Owner’s Equity

 Also known as owner’s contribution,

investment, proprietorship, net worth or
capital to the business.
 Outstanding claim of the owners in the
assets of a business after satisfying the
claims of the creditors.
Revenue & Expenses

 Revenue - amount made or earned by

the business entity as a result of its
operations.
 Expenses – expenditures associated
with earning revenue. These are
generally utilized in the period in which
they incurred.
Profit/Loss calculation
 The primary objective of most business
organizations is to make earnings or profits.
 To calculate a profit or loss, we only need to
subtract expenses from revenues.
 If revenue is greater than expenses, a profit is
made and consequently, a loss is made when
revenue is less than expenses.
 In Accounting, a loss is generally shown with
parentheses around it ( a negative numerical
figure).
Accounting Equation
The Fundamental Accounting Equation:

Assets = Liabilities + Owners’ Equity

The accounting equation may also be

expressed in two other forms:

(1) OWNER’S EQUITY = ASSETS – LIABILITIES

(2) LIABILITIES = ASSETS – OWNER’S EQUITY
Expanded Accounting
Equation

A = L + OE (C + R – E – D)

Where: A = assets
L = liabilities
OE = Owner’s Equity
C = Capital
R = Revenue
E = Expenses
D = Drawings
DOUBLE-ENTRY
BOOKKEEPING

Phases of Accounting
 Recording Phase
 Classifying Phase
 Summarizing Phase
 Interpreting Phase
 Recording Phase –
refers to the procedure of methodically and
chronologically documenting business
transactions in the appropriate accounting books.

 Classifying Phase -
refers to the procedure of sorting accounting
entries and grouping them into same type such
as asset accounts, liability accounts, owner’s
equity accounts, revenue accounts and expense

accounts.
 Summarizing Phase –
refers to the procedure of abridging or
summing up of accounting entries that
were classified in the classifying phase into more
useful financial statements.
 Interpreting Phase –
refers to the procedure of analyzing the financial
statements done in the summarizing phase to
provide answers to major users of financial
information.
Principles of Double-Entry
Bookkeeping System
(1) Each business transaction involves a
worth received and a worth given away;
(2) The balance of the accounting equation
should always be conserved, that is, the
accounting equation should still be
balance after each business
transaction.
Debit and Credit Entry

Double-entry bookkeeping system always

records a transaction using two entries:
 Debit entry deals with the worth received
(things-of-value received) by the business
entity.
 Credit entry deals with the worth given
away (things-of-value given away) by the
business entity.
 For you to understand further the double-entry
bookkeeping system, study the following business
transactions:
1. The business purchase a motor vehicle for P500,000
from David Car Sales paid in cash.
worth received: motor vehicle worth P500,000
worth given away: cash of P500,000
What is the accounting entry?
Debit entry – transportation equipment worth
P500,000
Credit entry – cash-on-hand of P500,000
Rules of Debit and Credit
 Rule 1: An asset is increased by a debit entry.
 Rule 2: An asset is decreased by a credit
entry.
 Rule 3: A liability is increased by a credit entry.
 Rule 4: A liability is decreased by a debit
entry.
 Rule 5: An owner’s equity is increased by a
credit entry.
 Rule 6: An owner’s equity is decreased by a
debit entry.
 Rule 7: A revenue is increased by a credit
entry.
 Rule 8: A revenue is decreased by a debit
entry.
 Rule 9: An expense is increased by a debit
entry.
 Rule 10: An expense is decreased by a credit
entry.
3. FINANCIAL ACCOUNTING

REPORTS
Financial Statements
 Summarized reports of accounting transactions
 Two-fold purpose: to communicate to users:
- the effect of operating activities during a
specified period of time; and,
- the business’ financial position at the end of
the period
 Types of financial statements:
Income Statement
Balance Sheet
Statement of Cash Flow
Balance Sheet

 Reports the financial position of a

business at a specific point in time
 Often called the “statement of financial
position”
 Equation: Assets = Liabilities + Owners’
Equity
Balance Sheet
 Assets – economic resources that are
expected to benefit future activities
 Equities – claims against, or interests in, the
assets
 Liabilities – entity’s economic obligations to
non-owners
 Owners’ equity – excess of the assets over the
liabilities
For a corporation, the owners’ equity is called
the stockholders’ equity.
 Pro Forma Balance Sheet
XYZ Co.
Balance Sheet
December 31, 20xx

ASSETS
Current Assets
Cash xxx
Marketable Securities xxx
Accounts Receivable xxx
Merchandise Inventory xxx
Other Current Assets xxx .
Total Current Assets xxx

Fixed Assets
Land xxx
Building xxx
 Furniture & Fixture xxx
Office Equipment xxx .
Total xxx
Less: Accumulated Depreciation xxx .
Total Fixed Assets xxx .
TOTAL ASSETS xxx
.
LIABILITIES & STOCKHOLDERS’ EQUITY
LIABILITIES
Current Liabilities:
Notes and Accounts Payable xxx
Taxes Payable xxx
Other Current Liabilities xxx .
Total Current Liabilities xxx
Long-term Liabilities xxx .
Total Liabilities xxx
.
STOCKHOLDERS’ EQUITY
Capital Stock xxx
Retained Earnings xxx .
Total Stockholders’ Equity xxx .
TOTAL LIABILITIES & STOCKHOLDERS’
EQUITY xxx
.
Income Statement

 Measures the operating performance of

the corporation by matching its
accomplishments (revenue from
customers, which is usually called sales)
and its efforts (cost of goods sold and
expenses).
 Measures performance for a span of time
 Also known as Profit and Loss Statement
 Revenues - inflows of assets either from the
sale of goods or the performance of services
 Expenses - outflows or other uses of assets to
produce revenues over expenses
 Net income (sometimes referred to as earnings
or profit) is the excess of revenues over
expenses, including tax expense
 ABC Corporation
Income Statements
For Year Ended December 31, 2008
(in thousands of pesos)

Sales 3,280
Less: Cost of Sales 2,120
Gross Income 1,160
Less: Operating Expenses
Selling 350
Administrative 420
Total Operating Expenses 770
Income from Operations 390
Less: Interest Expense 30
Income before tax 360
Less: Income Tax 126
Net Income 234
====
Statement of Cash Flows
 Prepared by analyzing changes in balance
sheet amounts and the data in the income and
retained earnings statements.
 The financing (i.e. obtaining financial
resources) and investing (i.e. using financial
resources) activities of a company are of
considerable interest to users of financial
information because those activities change
the financial position of the business
C. Pro forma Cash Flow Statement

XYZ Enterprise
Cash Flow Projections
For the Period Ending _________

Opening Balance xxx

Cash Receipts xxx
Collection of Receivables xxx
Cash Sales xxx
Sale of Temporary Investments xxx
Sale of Equity xxx
Short-Term Borrowing xxx
Long-Term Borrowing xxx
Investments xxx .
Total Receipts xxx
Cash Disbursements
Payments for Raw Materials Purchases xxx
Payments for Labor xxx
Manufacturing Overhead and Expenses xxx
Selling Expenses xxx
General and Administrative Expense xxx
Payment for Fixed Assets xxx
Interest Payments xxx
Loan Repayments xxx
Payments on Real Estate Mortgage xxx
Payment on Income Taxes xxx
Other Taxes and Assessments xxx .
Total Disbursements (xxx) .

End Balance xxx

=======
MANAGEMENT ACCOUNTING
 II - INTRODUCTION
Management Accounting -
 Management Accounting – the application of appropriate techniques and concepts in
processing the historical and projected economic data of an entity to assist
management in establishing a plan for reasonable economic objectives and in the
making of rational decisions with a view towards achieving these objectives.

 Management Accounting defies attempts at comprehensive, concise definition; it changes

constantly to adapt to technological changes, changes in manager’s needs, and new
approaches to other functional areas of business – marketing, production, finance,
organizational behavior, and corporate strategy.

 An indispensable part of the system that provides information to managers – the people whose
decisions and actions determine the success or failure of an organization.
Definition of Management
Accounting
 Management Accounting includes the methods
and concepts necessary for effective planning,
for choosing alternative business actions and
for control through the valuation and
interpretation of performance (The
American Accounting Association).
 The essential aim of management accountant
is to assist management in decision making
and control (Brown and Howard).
Financial Accounting and Managerial Accounting

Major Differences:

1. They serve different audiences

- Financial Accounting – serves persons outside the firm such as
creditors, customers,
government units and investors.
- Managerial - insiders

2. Differ in source and nature

- Financial Accounting reports are developed from
the basic accounting system , which captures
data about completed transactions.
Financial Accounting and Managerial Accounting
- Managerial - reports incorporate information that is not found in
the financial accounting system; such information might
relate to expected future transactions (such as budgeted sales
and costs) or alternatives to past transactions (such as
showing what income would have been if we had sold more
units at a lower price)

3. As to purpose
- Financial accounting reports are general purpose.

- Managerial accounting reports are specifically

designed for a particular user or a particular decision.
 Financial Accounting and Managerial Accounting

4. Financial accounting reports concentrate on the

results of past decisions.

Managerial accounting reports often concentrate on

what is likely to happen in the future.

5. Managerial accounting has no external restrictions

such as the generally accepted accounting principles
(GAAP) while financial accounting has to adhere to
GAAP.
 Managerial Functions and their
Relationship to Accounting

1. planning – setting goals and developing strategies and

tactics to achieve them

2. decision making - use of analytical techniques

3. control - determining whether goals are being met, and if

not, what can be done.

4. performance evaluation - how well operations are being

controlled
Objectives of Management
Accounting
 Main objective – to supply the required data to perform the internal management
functions.
The ff. are some of the functions:
- Collection of data – for preparation of plans
- Evaluation of plans – ascertaining the defects if any and brought to the notice of
the managers immediately.
- Observing the performance – comparing the actual with the standards
- Observing the reports – analyzing the uses of various types of statements in the
organization and suggesting for their improvement.
- Coordination among persons – showing organizational relaitons among people
- Financial analysis
- Timely decisions
- Peaceful atmosphere
- Coordination
- Submission of reports – for performance evaluation
Role of Managerial Accounting within an Organization

 Boeing – “ Less transactional and more decision-support type of

work. More analytical, more . . . option analysis”

 US West – “ From a historical role to a much more collaborative

business partner, doing a lot more analysis, saying here’s what
we need to do in the business. A business partner. It’s how do
we run the business and what are the financial impacts of doing
that.”

 Caterpillar - “Accountants evolve to become more of a team

player and being involved in major projects and being looked to as
a business advisor or consultant to help leverage our expertise on
profitability of certain products or outsourcing decisions and then
helping the team develop strategy and focus the team all the way
through recommendation and implementation.”
Source: Counting More , Counting Less: Transformation in the Mangament Accosunting Profession, Institute of Managmeent Accosutning, 1999.
Activities of Managerial Accountants

 Assist in the design of the organization’s

information system
 Ensuring that the system performs
adequately
 Periodically reporting information to
interested managers
 Undertaking special analyses
 III - Profit Planning

 Cost-Volume-Profit Analysis – a systematic examination of the

relationships among costs, activity levels or volume, and profit.

 Cost – refers to amount of resources given up in exchange for

some goods or services

 Classification of cost
1. fixed – remain the same in total over a wide range of volume

2. variable – change in total in direct proportion to changes in

volume
Profit Planning

Example:

Exeter Company

Selling price of backpacks P20.00

Cost of backpacks from manufacturers P10.00
Variable cost to pack and ship 1.00
Sales commission at 5% of P20.00 1.00
Total Variable Cost P12.00
Fixed Costs (rent, salaries, insurance, etc.) P40,000
Contribution Margin

Contribution Margin – the difference between selling price per

unit and variable cost per unit

Contribution margin percentage – per-unit contribution margin

divided by selling price
CM/unit
CM percentage = ___________
Selling Price

a) In our example, how much is the contribution margin per unit

and what is the contribution margin percentage?
b) What is the total cost?

Total costs = fixed costs + (variable cost per unit x unit

volume)
(Assume units sold, 6000 units)
c) Determine profit:

Profit = (selling price x unit sales) - total variable

costs – total fixed costs
 Achieving Target Profits

 Break-Even Point
– the point at which profits are zero because
total revenues equal total costs

BEP = Total sales = Total costs = 0 Profit

Finding the BEP

A. In units
Total Fixed Costs
Q (break even sales, in units) = --------------------------
CM per unit
= P40,000
-----------------
P20 – 12
= P 40,000
---------------
8
= 5,000 backpacks
Finding the BEP

B. In Pesos
Total Fixed Costs + P 0
Break-even sales = -------------------------------
CM %

= P40,000
-----------------
40%

= P100,000
Target Profit

At the BEP, total contribution margin equals total fixed costs. We can
therefore find the volume required to achieve a target profit by finding
the sales required to earn total contribution margin equal to the sum
of total fixed costs and the target profit.
Formula:
Fixed costs + target profit
Sales in units to achieve target profit = ---------------------------------------
Contribution margin per unit
Problem:
Suppose Exeter wishes to earn a profit of P5,000 per month.
How many backpacks must it sell?
= P40,000 + 5,000
-------------------------
20 – 12

= 45,000
------------
8

= 5,625 units
B. Sales, in pesos, to achieve target profit

total fixed costs + target profit

Sales, in pesos, to achieve = ------------------------------------------------
target profit contribution margin percentage

P40,000 + 5,000
= ---------------------------
40%

= P112,500
Target Return on Sales (ROS)

Formula:
fixed costs
Sales, in pesos to = __________________________
achieve target ROS CM percentage – target ROS

Problem:
Suppose that Exeter wishes to earn a 15% ROS.
P40,000
= _________________
40% - 15%

P40,000
= _______________ = P160,000
25%
To check:

Pesos Percentages

Sales 160,000 100%

Variable costs (60% of sales) 96,000 60%
CM 64,000 40%
Fixed costs 40,000 25%
Income 24,000 15%
====== ======
Target Selling Prices

Formula:
total fixed costs + target profit
Price = ___________________________ + unit variable cost
unit volume

Problem:
Exeter’s target is P10,000 per month and it expects to sell 6,000
backpacks per month. Remember that Exeter’s variable costs
are P10.00 to purchase a backpack and P1.00 for packing and
shipping and a 5% sales commission. Thus, per unit variable cost
is P11.00 plus 5% of selling price.
Target Selling Prices

P40,000 + P10,000
Price = _____________________ + P11.00 + (5% x price)
6,000

= P8.33 + P11.00 + 5%Price

95% Price = P8.33 + P11.00

= P19.33/.95

Price = P20.35 rounded

Target Costing

 Some companies use a planning technique called target costing

to help decide whether to enter a new market or bring out a new
product.

 The essence of target costing is to determine how much the

company can spend to manufacture and market a product, given
a target profit

 The price and volume are estimated first, then the costs

 Target costing is useful especially in deciding whether to enter an

established market where selling prices are relatively stable.
Target Costing

For instance, if the managers agree on a target profit of P300,000

and that unit volume of 100,000 is achievable at a P20.00 price, the
total allowable cost is:

Revenue (100,000 x P20 ) P2,000,000

Target profit 300,000
Total allowable cost P1,700,000

If managers expect total fixed costs to be P1,200,000, total variable

costs can be P500,000 or P5.00 per unit. The P5.00 along with the
P1,200,000 fixed cost, becomes an objective for the managers
responsible for designing and manufacturing the product.
Uses of Target Costing

To illustrate, consider Cruz Co. Its managers decide to

introduce a new product. They expect to sell 20,000
units at P10.00. They can make the product in either
two manufacturing processes:

Process A uses a great deal of labor and has

variable cost of P7.00 per unit and annual fixed costs
of P40,000.00.

Process B uses more machinery, with unit variable

costs of P4.00 and annual fixed costs of P95,000.00.
Income Statement

 Process A Process B
Sales (20,000 x 10) P200,000 P200,000
Variable cost at P7 & P4 140,000 80,000
Contribution margin at
P3 and P6 60,000 120,000
Fixed costs 40,000 95,000
Profit 20,000 25,000
======== ========
Given the above income statements, what will
you choose? Process A or Process B? Why?
1. Finding the BEP

BEP = Fixed Costs/CM per unit

Process A = P40,000/3 = 13,333 units

Process B = P40,000/6 = 15,833 units

The higher the break-even, the riskier. Managers

often express risk by referring to the Margin of
Safety (MOS).
2. Margin of Safety

= the decline in volume from the expected

level of sales to the break-even point
is called the margin of safety (MOS).

Formula:

MOS = Expected level of sales - BE (units)

Finding the MOS

Process A
MOS = 20,000 units (expected) –13,333 units (BE)
= 6,667 units or P66,670 (6,667 x P10.00)
or 33.33% (6,667/20,000)

Process B
MOS = 20,000 units (expected) –15,833 units (BE)
= 4,167 units or P41,670 (4,167 x P10.00)
or 20.8% (4,167/20,000)
Generally the higher the MOS, the lower the risk.
3. Indifference Point

= the level of volume at which total costs and,

hence profits, are the same under both
structures.

= at unit volumes below the indifference point, the

alternative with the lower fixed cost gives higher profits;
at volumes above the indifference point, the alternative
with the higher fixed cost is more profitable.
Formula for Indifference Point

Total Cost for Process A = Total Cost for Process B

Fixed Cost + Variable Cost = Fixed Cost + Variable Cost
P40,000 + P7Q = P95,000 + P4Q
P3Q = P55,000
Q = 18,333 rounded

At volume below 18,333 units, Process A gives lower total

costs (and higher profits); above 18,333 units, Process B
gives higher profits.
 Cruz’s managers have no correct answer in their
choice of cost structure. Analytical tools such as the
indifference point, margin of safety, and CVP graph help
them evaluate alternatives, but the decision depends of
their attitudes about risk and return.
 If they want to avoid risk, they will choose Process A
foregoing the potential for higher profits from Process B.
If they are venturesome, they probably will be willing to
take some risk for the potentially higher returns and
choose Process B.
Assumptions and Limitations of CVP Analysis

Assumptions:
First:
 The company sells only one product or
 The sales of each product in a multiproduct company
are a constant percentage of total sales.
Second:
 Relevant only to manufacturing companies,not to
merchandising and service companies.
 Assumptions and Limitations
Underlying CVP Analysis

 All costs are classifiable as either fixed or variable.

 Fixed costs remain constant within the relevant range.
 The behavior of total revenues and total costs will be linear over
the relevant range i.e. will appear as a straight line on the BE
chart.
 In case of multiple-product companies, the selling prices, costs
and proportion of units, (sales mix) sold will not change.
 There is no significant change in the inventory levels during the
period under review.
 Unit selling prices will remain constant
 Unit variable cost will not change
 There will be no change inefficiency and productivity
 The design of the product will not change
 Uses of Cost-Volume-Profit Analysis

 - Planning – CVP Analysis is useful tool for planning

future operations.

 - Control – CVP Analysis may be used to control

operations. Actual results are studied, analyzed and
compared with the projected or planned data.

 - Analysis – both projected and actual data may be

analyzed using CVP relationships.
 IV - Short-Term Decisions and
Accounting Information

Making decisions is choosing among alternatives. Should

we raise the price of our product, lower it, or leave it
alone? Should we drop a product (or product line) or
keep it? Should we add a new product? Should we
make a component of our product in our factory or buy it
from another company?

Managers continually evaluate such sets of alternatives.

 The Criterion for Short-Term Decisions

The economic criterion for making a short-term decision

is simple. Take the action that you expect will give
the organization the highest income (or lowest
loss).

Two subrules are often helpful:

1. The only revenues and costs that are relevant in
making decisions are the expected future revenues
and costs that will differ among the available choices
(differential revenues and costs)
2. Revenues and costs that have already been earned or
incurred are irrelevant in making decisions.
Sunk cost – one that has already been incurred
and therefore will be the same no matter which
alternative a manager selects.

Opportunity cost – the benefit lost by taking one

action as opposed to another.
 Example:

Compu Sales recently manufactured 100

specialized workstation monitors for a customer
that has since gone bankrupt. A rival company
has offered to buy the monitors for P12,000. The
cost to manufacture the monitors was P17,000.
The President says he’d rather throw them away
than sell them at a loss of P5,000. Is his
reasoning sound?
Make or Buy Decisions
Suppose XYZ Co now makes a component for its major
product. A manager has prepared the following
estimates of costs at the normal volume of 20,000 units.

Materials at P2/unit P40,000

Direct labor at P5/unit 100,000
Variable overhead at P3/unit 60,000
Allocated indirect fixed costs (building
depreciation, heat and light, etc. 120,000
Total cost P320,000
An outside supplier offers to supply the component at P14/unit
or P280,000 for 20,000 units. Should XYZ accept the offer?
Make or Buy Decision

Decisions
Make Buy

Materials 40,000 -0-

Direct labor 100,000 -0-
Variable overhead 60,000 -0-
Purchase price -0- 280,000
Total 200,000 280,000
======= ======
 Temporary Shut Down

 Mr Rene Yap operates a snack counter selling sandwiches and

softdrinks. Each unit sale is composed of a sandwich and a cup
of softdrinks which is sold at a lot price of P15.00. Variable cost
amounts to P8.00 per unit. Under normal conditions, Mr. Yap
sells an average of 3,000 units per month, during which he incurs
the following fixed costs:
 Rent - P3,000
 Allocated cost of utilities - 2,000
 Salary of sales clerk 1,500
 Janitor’s salary 1,000
 Security agency’s billing 2,500
 Total P10,000
 A joint strike of teachers and students decreased the sales of Mr.
Yap to only 800 units. Accordingly the strike would last for a
month. Mr. Yap is considering of shutting down his business for a
month to avoid incurring losses due to the reduced sales volume.
He noted that if he shut down his operations, cost of allocated
utilities would be reduced to P500.00 and he could avoid incurring
salary of the sales clerk who would be asked to take a forced
leave without pay while the snack counter is closed. All the other
fixed costs would be incurred despite of the discontinuance of
operations.
Should the snack counter be shut down for one month?
 Solutions:
Continue:
Unit sales price P15.00
Less Variable cost 8.00
CM /unit 7.00
X Sales in units 800.00
Total CM 5,600.00
Less: Fixed Costs 10,000.00
Loss under continued
operations P 4,400.00
 Shut Down:
CM P -
Less: Shut down costs:
Rent P3,000
Cost of utilities 500
Janitor’s salary 1,000
Security agency’s
billing 2,500 7,000
Loss if operations were
shut down P7,000
 V - Budgeting

Budget - a plan, expressed in quantitative terms, on how to acquire and use

the resources of an entity during a certain future period of time.

Uses/Advantages of Budgeting
 Budgeting compels periodic planning.
 Budgeting enhances coordination, cooperation, and communication.
 Forces quantification of plans and proposals
 Provides a framework for performance evaluation
 Enables members of the organization to be aware of business costs
 Satisfies some legal and contractual requirements
 Directs the firm’s activities toward the achievement of organizational
goals.
Comprehensive Budgets

 A comprehensive budget or a master

budget is a set of financial statements and
other schedules showing budgeted,
expected, or pro forma results for a future
period.
 Represents the overall plan of the organization for a
given budget period.

 Normally contains an income statement, a balance

sheet, a cash budget (statement of cash receipts and
disbursements), and schedules of production,
purchases, and fixed-asset acquisitions.
Two Major Parts of the Master Budget

 Operating Budget – budgeted income statement for a

certain budget period

 Financial budget – includes the budgeted balance

sheet as of the end of a certain budget period,
budgeted statement of changes in financial position,
capital expenditure budget, and all other budgets
required in financial management.
 Sales Forecasting

 Sales forecast is the foundation for the comprehensive budget.

 Factors Considered in Making a Sales Forecast

- company’s past sales volume
- economic and political conditions
- conditions in the industry to which the company belongs
- competition
- market research studies
- pricing policies of the firm as well as those of the competitors
- government control and regulations affecting the company
- company’s own sales force and its planned advertising and promotional
activities
- company’s productive capacity and other limitations affecting production
- change in demand for the product due to seasonal variations
 Expense Budget

 Each manager in an organization is

responsible for specific tasks and their
costs. So managers should have budget
allowances, or expense budgets, stating
the limits for costs they may incur in
accomplishing their tasks.
 Budgeting in Not-For-Profit Entities

Not-for-profit (NFP) entities, especially governmental

units, use budgets in different ways from profit-seeking
companies.
- NFPs are likely to budget only for cash flows (receipts
and expenditures), not for revenues and expenses
- the process is more likely to begin with expenditures
rather than receipts
Zero-Based Budgeting

 Zero-based budgeting – starts with the assumption

that zero will be spent on each activity.

 Tries to help management answer the question,

“Supposing we are to start our business from scratch,
on what activities would we spend our money and to
what activities would we give the highest priority?”
 Advantages of Zero Base Budgeting:
1. Not based on incremental approach, so it promotes operational
efficiency because it requires managers to review and justify
their activities or the funds requested.
2. Most appropriate for the staff and support areas
3. Considers alternative ways of performing the same job
4. Focuses management process on analysis and decision
making
5. Helpful to the management in making optimum allocation of
scarce resources
6.
Program Budgeting

 Program budgeting – requires that a

budget indicate not only how the
requested funds are to be spent,
but also why the funds are to be spent in
those ways.
VI - Analysis of Financial
Statements
Horizontal Analysis

- Involves comparing figures shown in the

financial statements of two or more
consecutive periods. The difference
between the figures of the two periods is
calculated, and the percentage change
from one period to the next is computed,
using the earlier period as the base.
Horizontal Analysis
Compare Corporation
Income Statements
For Years Ended December 31
(in thousands of pesos)

2008 2007 Increase (Decrease)

Amount Percent
Sales 3,280 2,950 330 11%
Less: Cost of Sales 2,120 1,917 203 11
Gross Income 1,160 1,033 127 12
Less: Operating Expenses
Selling 350 100 250 250
Administrative 420 480 ( 60) (13)
Total Operating Expenses 770 580 190 33
Income from Operations 390 453 (63) (14)
Less: Interest Expense 30 25 5 20
Income before tax 360 428 (68) (16)
Less: Income Tax 126 149.8 (23.8) (16)
Net Income 234 278.2 (44.20) (16)
==== ===== ====== ====
Horizontal Analysis

Formula for Percentage Change:

Percentage = Most Recent Value - Base Period Value

Change Base Period Value

= 3,280 – 2950
2,950

= .11 or 11%
Vertical Analysis

- process of comparing figures in the financial statements

of a single period.
- involves converting the figures in the statements to a
common base.
- accomplished by expressing all the figures in the
statements as a percentage of an important item, such
as total assets (in the balance sheet) and total or net
sales (in the income statement).
- all the figures in the statements would be expressed not
in peso but in percentage terms.
- these converted statements are called common-size
statements, 100 percent statements or component
statements.
 Compare Corporation
Income Statements
For Years Ended December 31
(in thousands of pesos)

2008 Percent 2007

Sales 3,280 100.0% 2,950

Less: Cost of Sales 2,120 64.6% 1,917
Gross Income 1,160 35.4% 1,033
Less: Operating Expenses
Selling 350 10.7% 100
Administrative 420 12.8% 480
Total Operating Expenses 770 23.5% 580
Income from Operations 390 11.9 453
Less: Interest Expense 30 1.0 25
Income before tax 360 10.9% 428
Less: Income Tax 126 3.8% 149.8
Net Income 234 7.1 278.2
==== =====
Ratio Analysis
Ratios are categorized based on their uses:
1. Tests of liquidity
- Current ratio
- Acid test ratio
- Turnovers
2. Tests of Solvency
- Number of times interest earned ratio
- Debt-equity ratio
- Debt ratio
- Equity ratio
Ratio Analysis

3. Tests of Profitability
- Return on sales
- Return on total assets
- Return on owner’s equity
- Earnings per share
4. Market Tests
- Price-earnings ratio
- Dividend yield
- Dividend payout
Tests of Liquidity

1. Current Ratio – also called the working

capital ratio or banker’s ratio, measures
the number of times that the current
liabilities could be paid with the
available current assets.
Current Assets
CURRENT RATIO = Current Liabilities
Standard – 1.5:1 - the higher, the better
2. Acid Test Ratio

- Also called as quick ratio; only those

assets that are cash or “near cash” (or
assets that can be converted to cash
quickly) are included so that the resulting
ratio can indicate the firm’s paying liability
in the very, very near term.
- Similar to the current ratio except that the
inventories and prepayments are
excluded from the numerator.
Acid test ratio

Quick Assets
Quick Ratio = Current Liabilities

or
= Cash + Marketable Securities+ Receivables
Current Liabilities

Standard = 1:1 - the higher, the better

Illustration:
Let us first compute Compare
Corporation’s quick or liquid assets:
1989 1990
Cash 120 150
Marketable securities 45 15
Accounts receivable (net) 210 180
Total Quick Assets 375 345
=== ===
 Current Liabilities:
1989 1990
Notes & Accounts Payable - P125 169
Taxes Payable 85 107
Other Current Liabilities 82 -
Total CL P292 276
===== ====
Solution:

Acid Test Ratio = Quick Assets

Current Liabilities
2007 = 375
292 = 1.28 to 1
2008 = 345
276 = 1.25 to 1
Working Capital Activity
Ratios
Both the current ratio and acid test ratio fail to
provide answers to the following questions:
1. How long can the firm expect to realize cash
from its receivables and inventories?
2. When should the firm pay its various current
liabilities?
To answer these 2 important questions, analysts
can use the 3 working capital activity ratios:
accounts receivable turnover, inventory
turnover and accounts payable turnover.
Receivables Turnover

 - the time required to complete one

collection cycle – from the time
receivables are recorded, then collected,
to the time new receivables are recorded
again; the faster the cycle is completed,
the more quickly receivables are
converted into cash.
Formula for Receivables
Turnover

Receivables = Net Sales

Turnover Average Receivables

Average
Receivables = Beg. Balance + Ending Balance
2
Standard: 20 – 60 days - the lower, the better
Inventory Turnover
 Measures the number of times that inventory is
replaced during the period.

Inventory = Cost of Goods Sold

Turnover Ave. Merchandise
Inventory
Ave Mdse Invty - Beg Bal + Ending Bal
2
Standard – 180 days - the lower the better
Net Working Capital

 Net Working Capital =

Current Assets - Current Liabilities

Standard = Positive
Remarks = Positive
Tests of Solvency
 Solvency refers to the company’s ability
to pay all its debts, whether such liabilities
are current or noncurrent.
Net Income before
Interest Expense
Times Interest Earned = -----------------------
Interest Expense
Standard - 2x - the higher, the better
Debt Ratio

- indicates the percentage of total assets

provided by creditors.

Total Liabilities
Debt Ratio = --------------------- x 100
Total Assets
Standard - 50% - the lower, the better
Debt-Equity Ratio

Debt-Equity = Total Liabilities

Equity

Standard = 4:1 - the lower, the better

Tests of Profitability
Gross Profit Margin

 Gross Profit Margin = Gross Profit

Net Sales
Standard = 10 – 15%
The higher, the better
Net Profit Margin

 Net Profit Margin = Net Profit

Net Sales
Standard = 2 – 20%
The higher, the better
Return on Equity

Return on Equity = Net Profit

Equity
Standard = 5 – 25%
The higher, the better
Return on Total Assets

Return on Total Assets = Net Profit

Total Assets

Standard = 10%
The higher, the better
Return on Investment

 Rate of Return
or = Income
Return on Investment Investment

= Higher than interest rate

Payback Period

Payback Period = Total Project Cost

Net Income
= shall not exceed term of loan
Chapter VII – Management
Audit
Definition
 Management Audit – systematic and
dispassionate examination, analysis and
appraisal of management overall performance.
 Signifies critical assessment of management of
the enterprise from the broadest possible point
of view
 Thrust of this audit is on evaluation with
appropriate analysis for improvement on
contribution towards industrial development.
References
 Manual on Project Evaluation, Seminar
Workshop of Field Personnel on Credit
Evaluation, Loan Documentation and
Collection, 2003.
 Matz, Adolph, Milton, Usry F., Macuja, Estela
F., Cost Accounting, Planning and Control,
1984
 Mejorada, Nenita D., Management Services
Part II, 1985
 Reddy, Jayaprakash R., Management
Accounting, 2004.
 Happy Schooling!