5.

Income Elasticity of Demand

EI
Where
EI
EI

=dfsd
% Δ in Quantity Demanded
% Δ in Income
for normal
goods
for
inferior
goods

ED =
No Δ
No Δ

Revenue
Increases
gssuantity demanded for X versus the Δ in Price for Y)
EXY

Wher EX > 0
Y
e
EX = 0
EX < 0
Y

% Δ in Quantity Demanded of X
% Δ in Price of Y
for substitutes
for unrelated goods
for complements

7. Consumption Function
C

c0

c1 Y D

Where C = Consumption for the period

YD = Disposable income for the period
c0 = The constant
c1 = The slope of the consumption function
And = MPC, the marginal propensity to consume
c1
8. Relationship between Marginal Propensity to Save (MPS) and
Marginal Propensity to Consume (MPC)
MPS + MPC = 1
9. Elasticity of Supply
ES

% Δ in Quantity Supplied
% Δ in Price

9A. Interpretation of ES, Supply Elasticity Coefficient

If ES > 1, then
1, then
If ES = elastic
1, then
If ES < unitary
inelastic
B. Macroeconomics
10. GDP Gap
GDP Gap = Potential GDP — Real GDP
A Positive [+] Gap means that there are unemployed
resources; may lead to unemployment.
A Negative [–] Gap means that the economy is running above normal
capacity; may lead to rising prices.
11. Income Approach (Output Approach) Calculation of GDP
+
+
+
+
=
+
–
=
+
=
+
–
=

Compensation to Employees
Corporate Profits
Net Interest
Proprietor's Income
Rental Income of Persons
National Income
Indirect Taxes
Other, Including Statutory Discrepancy
Net National Product
Consumption of Fixed Capital
Gross National Product
Payments of Factor Income to Other Countries
Receipts of Labor Income from Other Countries
Gross Domestic Product

11. A Net Domestic

Product (NDP)
Gross Domestic Product
– Depreciation [also called Capital Cost Allowance]
= Net Domestic Product
12. Expenditure Approach (Input Approach) Calculation of GDP
Personal Consumption
Expenditures
+ Gross Private Domestic Fixed Investment (Business &
Residential)
+ Government Purchases (Federal, State, & Local)
+ Net Exports [may be a (+) or (–) number]
+ Changes in Business Inventories [may be a (+) or (–) number]
= Gross Domestic Product
13. The Multiplier, the Δ in Equilibrium GDP
Where

MPS + MPC = 1

Δ in Equilibrium GDP =
MPS

Δ in Spending

14. Disposable Income

Personal
Income
– Personal Taxes
= Disposable Income
15. Money Measures: M1, M2, and M3
+
=
+
+
=
+
=

Currency
Demand Deposits
M1
Savings Accounts
Small Time Deposits (< $100,000)
M2
Large Time Deposits (≥ $100,000)
M3
Financial Risk Management, Formula Sheet
1. Coefficient of Variation (a measurement of risk, where a lower # is less risky)
= Standard
Deviation / Expected Return
2. Effective
Stated Annual Interest Rate
Compounding Frequency
Annual
=
1 +
Interest Rate
Compounding Frequency
– 1
3. Compound Interest and Present Value Tables
a. Future Value of $1: Multiply amount invested x FACTOR to get accumulation
b. Present Value of $1: Multiply amount desired x FACTOR to get the amount you have
to invest
NOW. This is the reciprocal of FV of $1.
c. Future Value of an Ordinary Annuity: Multiply payment x FACTOR to get
accumulated amount.
Payments are at the END
of the period.
d. Present Value of an Ordinary Annuity: Multiply payment x FACTOR to get the
amount which
must be invested NOW to provide those payments.
Ordinary Annuity or Annuity in Arrears means the payments are made at the
END of the period. Annuity Due or Annuity in Advance means the payments are
made at the BEGINNING of the period. To change from an Ordinary Annuity to
an Annuity Due FACTOR:
(OA FACTOR)(1 + i) = AD FACTOR
To change from an Annuity Due to an Ordinary
Annuity FACTOR: AD FACTOR = OA FACTOR
(1 + i)
Capital Budgeting, Formula Sheet
1. Payback Period. The number of years to recoup the investment in cash.
Payback Period =
Investment
Where: Annual Cash Inflow (Before
Depn/Amort & Taxes) Annual Cash Inflow
–
Depn/Amort Expense
=
NIBT
–
Taxes
=
NIAT
+ Depn/Amort Expense
= Annual Cash Inflow (Net of Taxes)
2. Accounting Rate of Return. The percentage of return on investment each year.
Accounting Rate of Return = Net Income
Investment
BOTH THE PAYBACK PERIOD AND ACCOUNTING RATE OF RETURN TECHNIQUES IGNORE THE
TIME VALUE OF MONEY.
3. Net Present Value. Uses present value tables.
If:
PV of the
>
PV of the Benefits from the Investment, then NPV is
Investment
negative and this is a poor investment.
If:
PV of the
<
PV of the Benefits from the Investment, then NPV is
Investment
positive
this
is
a goodand
investment.
If:
PV of the
=
PV of the Benefits from the Investment, then NPV is zero
Investment
and
management would be indifferent.
4. Internal Rate of Return. Uses present value tables. The interest rate that would
make
PV of the Investment
=
PV of the Benefits from the Investment
The annuity factor that would make these equal is the same number as the payback
period.
Financial Management, Formula Sheet
A. Working Capital Management
1. Cash Conversion Cycle
Cash
Conversion
Cycle

Inventor
Receivabl
Payabl
= y
+ es
– es
Conversi
Conversio
Deferr
on Period
n Period
al
[Shorten
[Shorten
[Shorten
[Lengthe
]
]
]
n]
[Lengthe
[Lengthe
[Lengthe
[Shorten
n]
n]
] Sales in Inventory)
1A. Inventory Conversion
Period n]
(Number of Days
Inventory
Conversio =
n
Period

Avg Inventory
COGS per Day or Sales per Day

1B. Receivables Conversion Period or Receivables Collection Period

(Number of Days
Sales Outstanding)
Receivabl
es
= Avg Accounts Receivable
Conversio
Period
Credit Sales per Day
1C. Payables Deferral Period
Payables
Deferral
Period
=

Avg Accounts Payable

Purchases per Day or COGS per Day

2. Economic Order Quantity (EOQ)

EOQ =

2aD
Where a =
ordering cost per order k D = Annual Demand
k = carrying cost for 1 unit for
1 year
3. Reorder Point
Reorder
Point

= # of Units Sold per x Purchase Lead

Time
Day
in days
4. Nominal Rate for Discount Period
Nominal Rate =
Discount
for
%
Discount
1 – Discount
B. Capital Structure

360 or 365
days
Payment Period – Discount

5. Degree of Operating Leverage (DOL)

DOL

% Δ in Operating Income
% Δ in Unit Volume

6. Degree of Financing Leverage (DFL)

DFL

% Δ in Earnings per Share [Basic]

% Δ in Earnings before Interest and Taxes

7A. Cost of Debt (After‐tax)

Cost of Debt (After‐tax)

Interest Rate x (1 – Tax Rate)

7B. Cost of Debt (Before‐tax)

Cost of Debt (Before‐tax)

=
Interest Payment
Debt Price – Floatation
Cost

8. Cost of Preferred Equity

Cost of Preferred Equity

+ Safety
Stock
=
Preferred Dividend
Preferred Stock Issue
Price
9. Capital Asset Pricing Model (CAPM)
ks

kRF

(km – kRF) bi

Where ks = cost of
existing common equity kRF =
risk‐free rate
km = expected market
return bi = stock's
beta coefficient

10. Bond‐Yield‐Plus Approach

ks

Long‐term Debt Interest Rate

(3% to

5% Risk Premium) Where ks = cost of existing common

equity
11. Dividend‐Yield‐Plus‐Growth‐Rate Approach
ks =

D1

Expected g

P0

Wher ks = cost of existing common

e
D equity
= next expected dividend
1
P0 = current stock price
g = growth rate in earnings

12. Cost of New Common Stock

ks =

D1
P0 –
F

+
Expected g

Wher ks = cost of new common

e
D equity
= next expected dividend
1
P0 = current stock price
= floatation
growth rate
in earnings
g
F =
cost
per share
COST MEASUREMENT
Primary Objective of the Cost Accountant: To compute the cost per unit for
financial statement
presentation of COGS on the income statement and Ending Inventories on the balance
sheet.
3 Components of Manufacturing Costs: (1) Direct Materials
Materials which
become part of the product. (2) Direct Labor
Employees who work on the product.
(3) Factory Overhead
All other MANUFACTURING costs,
(3a) Variable OH
including
normal spoilage. (3b) Fixed OH
Prime Costs:
DM Used and DL Used
Conversion Costs: DL Used and Variable & Fixed OH Applied
FLOW OF
COSTS
Direct Materials or
Raw Materials
Beg. Bal.
COGP
Available
for use

WIP

FGI

Beg. Bal.

Beg. Bal.

||

DM Used

COGM

||

End. Bal.

OH Appl

COGAS

To a/c for

COGM

End. Bal.

End. Bal.

COGS

Labor
B A L A N C E

||
||
||
||
||
||

DL Used
S H E E T

Variable & Fixed

Factory Overhead
Actual
OH

COGS

DL Used
DM Used

COGS

Direct

||

||
||
||
||

INCOME
STATEMENT

||

Applied
OH

Where:
Gross Purchases
– Purchase Discounts
– Purchase Returns and Allowances
= Net Purchases
+ Freight‐In or Transportation‐in
= Cost of Goods Purchased (COGP)

||
||
||

Acronyms:
COGP = Cost of Goods Purchased
COGM = Cost of Goods Manufactured
COGAS = Cost of Goods Available for Sale
COGS = Cost of Goods Sold
WIP = Work‐in‐Process or Work‐in‐Progress
FGI = Finished Goods Inventory

PROCESS COSTING ‐‐ EQUIVALENT UNITS OF PRODUCTION (EUPs) or

EQUIVALENT FINISHED
UNITS (EFUs)
Four Steps: (1) Calculate the number shipped (in
whole units). (2) Calculate the
equivalent finished units.
(3) Calculate the cost
per EFU.
(4) Complete the WIP T account.
Step 1. Calculate the number shipped (in whole units).
Beginning Inventory
+ Units Started
Units to be accounted for
– Ending Inventory
= Units shipped
PROCESS COSTING ‐‐ EUPs or EFUs (Continued)
Step 2. Calculate the equivalent finished units.
A. FIFO
B. Weighted‐Average
DM
CC
DM
Units shipped
CC Units shipped
+ End. Inv. (EFUs)
+ End. Inv. (EFUs)
– Beg. Inv. (EFUs)
= W/A EFUs
= FIFO EFUs
Step 3. Calculate the cost
per EFU A. FIFO
Cost per EFU = Current Costs
Only
EFUs

B. Weighted‐Average
Cost per EFU = Beg. Inv. + Current
Costs
EFUs

Step 4. Complete the WIP T account. Using the number of Ending Inventory EFUs from
Step 2 and
Cost per EFU in Step 3, calculate the $ value of ending inventory in WIP and plug
COGM.
Lost Units: (1) Abnormal Spoilage is a PERIOD COST; do not include it in WIP.
(2) Normal Spoilage is a PRODUCT COST; the costs of all units are spread over
the good units; usually part of OH.
COST MEASUREMENT
BACKFLUSH COSTING
Traditional Cost Flows
Direct
Materials
|
Direct
Labor
|
Var &| Fixed
OH
|

WIP
|
|
|

COGM

FGI
|
|
|

COGS
|
COGS
|

Backflush Costing Method I ‐‐ JIT Inventory Methods with Vendors/Suppliers: Combine

DM and WIP,
Combine DL and OH
Materials & In‐
Process
|
Conversion Cost
Control
|

FGI
|
|
|

COGS|
|
|

Backflush Costing Method II ‐‐ JIT Inventory Methods with Vendors/Suppliers &

Customers: Same as
Method I, but also no
FGI.
Materials & In‐
Process
|
COGS
|
| Conversion Cost Control
|
|
|
|
BACKFLUSH COSTING (Continued)

Traditio
nal
1. Purchase raw materials.

Backflush
Method I ‐‐
JIT Inventory
Methods with

Materials
DR
Materials & In‐Process DR
A/P
A/P
CR
CR
2. Issue materials to production.
WIP
DR
Materials
CR
3. Incur direct labor costs.
WIP
DR
Payroll
CR
4. Incur overhead costs.

See next entry.

Conversion Cost Ctrl DR

Payroll
CR
A/P, etc.

Variable OH Control
DR Fixed OH Control
DR
A/P, etc.
5. Apply overhead.
WIP
DR
Variable OH Control
CR
Fixed OH Control
6. Complete goods.
FGI
WIP
CR

None

DR

7. Sell goods.

None
FGI
DR
Conversion Cost Ctrl
CR
Materials & In‐Process

Backflush
Method II ‐‐
JIT Inventory
Methods with
Same as
I.
None

See next entry.

Same as
I.
None

COGS
DR
Conversion Cost Ctrl
CR
Materials & In‐Process
CR

COGS
DR
Same as Traditional.
FGI
CR
8. Recognize overhead variance (underapplied).
COGS
Overhead Control
CR

DR

COGS
DR
Conversion Cost Ctrl
CR

Same as
I.
PLANNING, CONTROL, AND ANALYSIS STANDARDS AND VARIANCES
SALES, DM, DL, and 4‐WAY OVERHEAD
VARIANCE ANALYSIS
Direct Material, Direct Labor, and Variable OH Variances (and Sales Variances). Use
the following
matrix:
* * * Sales Price Variance * * *
AQPurchased/Used
*
Variance; DM Price Variance

AP

AQPurchased/Used
|
|

SP

DM Purchase Price

DL Rate Variance
(1) Variable OH Spending Variance

=
DM Quantity/Usage Variance
DL Efficiency/Usage Variance

SQAllowed
Efficiency Variance
(Based on Units Produced)
Variance * * *

SP

(2) Variable OH
* * * Sales Volume

For DM, DL, and VOH variances, as you go UP the matrix, if the numbers are going UP
(increasing),
then the variances are
UNFAVORABLE.
* * * For sales variances, as you go UP the matrix, if the numbers are going UP
(increasing), then the
variances are
FAVORABLE. Remember that these are REVENUES and not COSTS. * * *
Fixed OH Variances.
AQ
*
|
=

AP

=
(3) Fixed OH Spending/Budget
Variance

| BUDGET
|

(4) Production/Volume Variance [Not

Controllable]

SQAllowed
*
SP
|
| (Based on Units Produced)

4‐Way OH Variance Analysis:

(1)
Variable OH Spending Variance
(2)
Variable OH Efficiency Variance
(3)
Fixed OH Spending/Budget Variance
(4)
Production/Volume Variance [NOT CONTROLLABLE]
3‐Way OH Variance Analysis:
(a)
(1) + (3) above together are the OH Spending Variance
(b)
(2) above becomes the OH Efficiency Variance (drop
the word Variable) (c)
(4) above is the Production/Volume
Variance [NOT CONTROLLABLE]
2‐Way OH Variance Analysis:
(a)
(1) + (2) + (3) above together are the Controllable Variance
(b)
(4) above is the Production/Volume Variance [NOT CONTROLLABLE]
3‐WAY and 2‐WAY OVERHEAD VARIANCE ANALYSIS
AQ

FOH
BUDGET
FOH
BUDGET

+
+

AP
VAR (AQ *
SP)
VAR (SQ *
SP)

OH Spending/Budget
Variance
OH Efficiency Variance
Production/Volume
Variance [Not

Controlla
ble
Variance
Controllabl
e]
SQAllowed
*
(Based on Units Produced)

SP

|
Standards and Variances (Continued)
Flexible Budget Formula:
Budgeted OH
Rate/HR)

Total Fixed Costs

(# HRs)(Variable OH

Sample Problem on DM Variances.

The Universal Company's direct materials data for February
201X is as follows: Actual Quantity Purchased
36,000 pounds
Actual Purchase Price Per Pound
Direct Materials Purchase Price Variance
Standard Quantity Allowed for Actual Production
Actual Quantity Used

$3.60 per pound

$7,200 Unfavorable
32,000 pounds
30,000 pounds

For February 201X, what was Universal's favorable direct materials

usage variance? [A] $6,800

[B] $6,000

[C] $6,720

[D] $7,600
Correct Answer: [A] $6,800 favorable is the DM usage variance. Hints: First use the
DM Purchase
Price Variance to
calculate SP, then remember AQPurchased ≠ AQUsed and AQUsed is used for the DM
usage variance.
Also, $6,000 unfavorable is the DM price variance and uses AQUsed. The $7,200
unfavorable DM
purchase price variance given in the problem uses AQPurchased.
PLANNING, CONTROL, AND ANALYSIS
DIRECT COSTING/VARIABLE COSTING vs. ABSORPTION
COSTING/FULL COSTING
Direct or Variable Costing
Absorption or Full Costing
Not GAAP
GAAP
Used for internal decision making.
Used for external
financial reporting. Treats FMOH as a PERIOD cost.
Treats FMOH as a PRODUCT cost.
Income Statement:
Income Statement: Sales
Sales
– Variable COGS (DM, DL, VMOH)
= Manufacturing Contribution Margin
– Variable Period Costs
= Contribution Margin
– Fixed Costs (FMOH as Period Cost)
= Net Income

– COGS (DM, DL, VMOH, FMOH)

= Gross Profit or Gross Margin
– Period Costs (Fixed & Variable)
= Net Income

If Production > Sales, then Ending Inventory

Increases: Lower NI
Higher NI
If Production < Sales, then Ending Inventory
Decreases: Higher NI
Lower NI
If Production = Sales, then Ending Inventory does
not change: Same NI for both
To calculate the difference in the net income between the
two methods: Difference in NI = (Change in ending
inventory)(FMOH/unit)
COST‐VOLUME‐PROFIT (BREAK‐EVEN POINT) ANALYSIS
Formula
s:
CM = SP – VC
CMR
=
SP –
VC
SP
Use only when they mention profit
BEPUnits = Total Fixed
CM/unit
Costs

or

BEPUnits = Total Fixed Costs + Before

CM/unit
Tax Profit

BEPSales $ = Total Fixed

CMR
Costs

or

BEPSales $ = Total Fixed Costs + Before

CMR
Tax Profit

After Tax Profit = (Before Tax Profit) (1 – Tax Rate)

Before Tax Profit = After Tax Profit
(1 – Tax Rate)
Margin of Safety (in units or $) = Current Sales Level (in units or $) –
BEP (in units or $) CM/unit = Net Income
Margin of Safety in
Units
CMR = Net Income
Margin of Safety in $