CMA Formula Part 1 Final
CMA Formula Part 1 Final
Direct
Labor Price
Variance
Calculation
Actual
Calculation Results
for Average Calculation for
Annual Growth
! ! $ the Static
Rate (AAGR)? % Budget
X
÷ =
*
*
+/-
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To your success,
Stephanie Ng
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COMPONENTS
• Net Income (Loss): The amount of profit or loss after expenses and
losses are subtracted from revenues and gains.
• Preferred Dividends: A dividend that is accrued and paid on a
company’s preferred shares.
• Weighted Average Number of Common Shares: The number of
shares of a company calculated after adjusting for changes in the
share capital over a reporting period. Generally, it can be easily
calculated using the following formula: (Beginning Outstanding
Shares + Ending Outstanding Shares) ÷ 2
DESCRIPTION
Earnings per share is a measure of how much profit a company has generated for
each outstanding share of its common stock. Because preferred dividends are meant
for preferred shareholders and not common shareholders, this is why preferred
dividends are subtracted from net income when calculating basic earnings per share.
Using earnings per share as a measurement of a company’s health has its limitations
because companies can buy back their own shares, which increases the amount
of earnings per share. Stock buybacks reduce the shares outstanding without
increasing the net income; this allows companies to manipulate the earnings per
share to make it seem like they are doing better than they actually are.
Additionally, the earnings per share calculation does not consider two other
important factors: a company’s outstanding debt, and the capital needed to generate
the earnings in question.
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HIGH/LOW ANALYSIS
If a company has a high earnings per share, the company has more money available
to reinvest in the business or distribute to stockholders in the form of dividend
payments.
Also, a higher earnings per share ratio will often make the stock price of a company
rise.
Conversely, a low earning per share could indicate that the company is experiencing
trouble with profitability and could reduce the future stock price.
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COMPONENTS
• Operating Activities: Functions of a business directly related to the
day-to-day operations used to provide its goods and/or services to
the market; generally, activities related to net income.
• Examples of Cash Inflows:
• Sales of goods or services
• Interest received from loans
• Dividends received from investments
• Examples of Cash Outflows:
• Merchandise purchased from suppliers
• Materials used to manufacture products
• Income tax expense
• Interest expense
• Payroll expense
• Investing Activities: Functions of a business related to buying
and selling longer-term assets and other investments; generally
associated with long-term balance sheet items.
• Examples of Cash Inflows:
• Sale of long-term investments (e.g., bonds and other company’s stock)
• Sale of property, plant, and equipment
• Collection of principle for loans made to other entities
• Examples of Cash Outflows:
• Purchase of long-term investments (e.g., bonds and other company’s
stock)
• Purchase of property, plant, and equipment
• Loans made to other entities
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DESCRIPTION
First and foremost, it is essential to note that cash flow isn’t the same as profit.
Simply put, the cash flow calculation exists to help track the movement of money in
and out of a business. The amount of available cash dictates how a company makes
many significant business decisions, including whether or not to expand, develop
new products, buy back stock, pay dividends, or reduce debt.
Cash flow is also indicative of a company’s liquidity, flexibility, and overall financial
performance. When cash flow is positive, a company’s liquid assets increase,
enabling it to settle debts, reinvest in its business, return money to shareholders, or
pay expenses.
If a company has a lower level of liquidity due to profits being tied up in accounts
receivable and inventory or spending too much on capital expenditures, then there is
a chance the company may fail.
However, a large amount of cash available doesn’t always mean that a company
will be successful since the money could have been acquired by taking on an
unsustainable debt level.
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COMPONENTS
• Current Book Value: The value at which a company carries an asset
on its balance sheet. It is calculated by subtracting accumulated
depreciation from the cost of an asset.
• Accelerated Depreciation % Rate: Straight-Line Depreciation Rate
x Specific Percentage (e.g., 150% or 200%)
• Straight-Line Depreciation Rate: 1 ÷ Useful Life of the Asset
• Annual Depreciation Expense: The portion of a depreciable asset
deemed to have been consumed or expired during a specific
accounting period.
DESCRIPTION
The declining balance method is a form of accelerated depreciation that utilizes a
percentage of the straight-line depreciation rate to calculate depreciation expense.
Commonly, the straight-line rate will be applied at a 150% or 200% accelerated
depreciation rate.
Unlike other depreciation methods, the salvage value is not deducted from the
asset’s cost under this method. The accelerated depreciation rate is applied to the
book value of the asset at the beginning of the period, and the book value of the asset
decreases year by year. When the book value of the asset is reduced to its salvage, no
more depreciation is applied.
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1. Calculate the Straight-Line Depreciation Rate: 1 ÷ 5 (Useful Life of the Asset) = 20%
2. Accelerated Depreciation Rate: 20% Straight – Line Depreciation Rate x 1.5 (150%
acceleration) = 30%
3. $35,000 Year 1 Book Value x 30% Accelerated Depreciation Rate = $10,500 Depreciation
Expense
There is a variation of the declining balance method called the Variable Declining Balance
method that handles the final year of depreciation in a slightly different way. The book value of
the equipment at the beginning of year 5 is $8,403, of which 30% is $2,521.
If this depreciation is used, the book value of the equipment at the end of year 5 will be $5,882
($8,403 – $2,521), which is more than the salvage value.
Under the Variable Declining Balance method, the asset is fully depreciated to the salvage
value over its useful life, so the depreciation expense in year 5 would be $3,403 ($8,403 –
$5,000).
1. Calculate the Straight-Line Depreciation Rate: 1 ÷ 5 (Useful Life of the Asset) = 20%
3. $35,000 Year 1 Book Value x 40% Accelerated Depreciation Rate = $14,000 Depreciation
Expense
The book value of the equipment at the beginning of year 4 is $7,560, of which 40% is $3,024.
If this depreciation is used, the book value of the equipment at the end of year 4 will be $4,536
($7,560 – $3,024), which is less than the salvage value.
As stated earlier, the asset is depreciated only to its salvage value under the declining balance
method. Therefore, the depreciation in year 4 is calculated as follows:
$7,560 Book value (Beg. Year 4) – $5,000 Salvage value = $2,560 Year 4 Depreciation Expense
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COMPONENTS
• Acquisition Cost of Asset: The purchase price of an asset plus the
cost incurred to put the asset into service. Additional costs may
include sales tax, customs duties, freight charges, installation fees,
and testing costs.
• Salvage Value of Asset: The estimated resale value of an asset at
the end of its useful life.
• Depreciable Base: The value of the asset to be written off over time.
DESCRIPTION
Typically, the computation of the depreciable base is the first step
used to calculate depreciation expense regardless of the chosen
method of depreciation. The depreciable base represents the asset’s
value that must be allocated as an expense based on the useful life of
the asset or estimated production capability.
It should be noted that some companies use assets and scrap them as
opposed to reselling them at a salvage value; in these instances, the
depreciable base of the asset is the same as its cost.
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DESCRIPTION
The gross profit figure can be used to assess a company’s efficiency at using its labor and
supplies in producing goods or services. However, it is essential to note that the metric only
considers variable costs, such as materials and direct labor. These expenses vary based on the
output level while excluding fixed costs, such as rent and insurance, that are the same amount
regardless of output level.
By reviewing the gross margin, management and investors can analyze how profitable an
organization’s core business activities or products are without considering the indirect costs.
One of the most useful purposes for calculating gross profit is to use the metric to further
calculate the gross profit margin:
The gross profit margin is a popular metric among analysts and management because it
allows for a better comparison with competitors within the same industry or sector. Also, it
indicates how much gross profit a company is earning for every dollar of revenue.
Companies with high gross profit margins generally have more efficient processes and
more effective operations, and they are a safer long-term investment than their competitors.
Typically, an organization’s gross profit margin should be stable over time; substantial
fluctuations could indicate several issues, including declines in business, mismanagement of
resources, or fraud.
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COMPONENTS
• Expected Selling Price: The value of an asset that can be realized
upon the sale of the asset.
• Total Production and Selling Costs: The estimate of costs
associated with either the completion, sale, or disposal of the asset
in question.
• Net Realizable Value: The selling price of an asset minus the costs
associated with the completion, sale, or disposal of the asset.
COMPONENTS
• Accounts Receivable Balance: The amount of money owed to a
company by its debtors.
• Allowance for Doubtful Accounts: The dollar amount of invoices
that the company labels bad debt (uncollectible).
• Net Realizable Value: The amount of money owed to a company by
its debtors less the estimated value of bad debt.
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COMPONENTS
• Depreciable Base: The value of the asset to be written off over time.
• Useful Life of the Asset: The period of time for which the asset will
be economically feasible for use in a business.
• Annual Depreciation Expense: The portion of a depreciable asset
deemed to have been consumed or expired during a specific
accounting period.
DESCRIPTION
Straight-line depreciation is the most commonly used and easiest to compute
method for calculating depreciation because it results in the same depreciation
expense for every accounting period. As a result, the asset’s carrying amount on the
balance sheet reduces by the same amount every accounting period.
In some cases, the straight-line depreciation method does not accurately reflect
the asset’s usage and may not be the best method depending on the specific asset.
For example, computers may not be efficiently depreciated using the straight-line
depreciation method due to rapid technological advancements.
EXAMPLE A car rental company purchases a new vehicle for $35,000. The company expects the vehicle
to last for 5 years, after which the vehicle will be sold for a salvage value of $5,000. Calculate
depreciation expense over the life of the asset using the straight-line method of depreciation.
1. Calculate the Depreciable Base: $35,000 (Cost of Asset) – $5,000 (Salvage Value of Asset)
= $30,000 Depreciable Base
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8 Sum-of-the-Years’-Digits
Depreciation Calculation
COMPONENTS
• Remaining Useful Life of the Asset: The remainder of the period
of time for which the asset will be economically feasible for use in a
business.
• Sum-of-the-Years’ digits: The sum of remaining asset life every
year in the asset’s useful life.
• Depreciable Base: The value of the asset to be written off over time.
• Annual Depreciation Expense: The portion of a depreciable asset
deemed to have been consumed or expired during a specific
accounting period.
DESCRIPTION
The sum-of-the-year’ digits depreciation method is an accelerated method of depreciation,
which means that a higher amount of depreciation expense is charged in the early years of an
asset’s useful life since this is when the asset is most productive.
One problem with this and other accelerated depreciation methods is that it artificially
reduces the business’s reported profit over the near term. The outcome is excessively low
profits in the near term, followed by excessively high profits in later accounting periods.
EXAMPLE A car rental company purchases a new vehicle for $35,000. The company expects the vehicle
to last for 5 years, after which the vehicle will be sold for a salvage value of $5,000. Calculate
depreciation expense over the life of the asset using the Sum-of-the-Years’ Digits method of
depreciation.
1. Calculate the Depreciable Base: $35,000 (Cost of Asset) – $5,000 (Salvage Value of Asset)
= $30,000 Depreciable Base
2. Remaining Useful Life of the Asset: 5 years (Year 1); 4 years (Year 2); 3 years (Year 3); 2
years (Year 4); and 1 year (Year 5)
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9 Units-of-Output Depreciation
Calculation
COMPONENTS
• Depreciable Base: The value of the asset to be written off over time.
• Estimate Production Capability: The total number of hours of
usage of an asset or the total number of units to be produced by an
asset over its useful life.
• Units Per Year: The actual number of units produced or numbers of
hours of usage by an asset for an accounting period.
• Annual Depreciation Expense: The portion of a depreciable asset
deemed to have been consumed or expired during a specific
accounting period.
DESCRIPTION
The direct relationship between asset usage and expense in the units-of-output
method makes it the most accurate depreciation method. While most depreciation
methods base depreciation expense on the passage of time, the units-of-output
method is unique because the amount of depreciation expense is directly
proportional to the amount of asset usage in the accounting period.
Typically, this depreciation method is reserved for more expensive assets because it
requires that the company track asset usage, resulting in additional costs. Another
limiting factor for this method is that one must be able to estimate the total usage
over the life of an asset for this process to be applicable.
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9 Units-of-Output Depreciation
Calculation
EXAMPLE A car rental company purchases a new vehicle for $35,000 with an estimated
capacity to be driven 200,000 miles during its 5-year life. Miles driven for each of the
five years are as follows: Year 1: 75,000 miles; year 2: 50,000 miles; year 3: 30,000;
year 4: 25,000 miles; year 5: 20,000 miles. The expected salvage value of the vehicle
is $5,000. Calculate depreciation expense over the life of the asset using the Units-
of-Output method of depreciation.
1. Calculate the Depreciable Base: $35,000 (Cost of Asset) – $5,000 (Salvage Value
of Asset) = $30,000 Depreciable Base
2. Calculate Cost Per Unit: $30,000 (Depreciable Base) ÷ 200,000 miles = $0.15 per
mile
3. Calculate Annual Depreciation Expense: $0.15 per mile x 75,000 miles (Year 1) =
$11,250
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COMPONENTS:
• Cost of Goods Available for Sale: The beginning value of inventory
plus the cost of goods purchased in the accounting period.
• Number of Units Available for Sale: The total number of units in
inventory, or the number of units a company can sell.
• Weighted Average Cost per Unit: The figure used to determine the
cost of goods sold and ending inventory amounts at the end of an
accounting period.
DESCRIPTION
The weighted-average cost method of inventory valuation uses a weighted average to
determine the amounts for cost of goods sold and ending inventory as opposed to both LIFO
and FIFO, which focus on the timing and order of when goods are added to inventory.
Two common situations in which the weighted average cost method is utilized are when
inventory items are intermixed to a point where it is impossible to assign a specific cost to an
individual unit, and a company’s accounting system isn’t advanced enough to track LIFO or
FIFO.
Because tracking inventory is not necessary for the weighted-average cost method, it is
considered the simplest way to track inventory. There are, however, some disadvantages
associated with this method when inventory prices vary by a large amount.
Weighted-average cost assumes that all units are identical, which may not always be the case
due to product upgrades or additional features of newer batches. Ideally, a company will make
up for any loss from selling the most expensive units when selling the less expensive units.
Still, if there is a decline in sales, inventory may be discontinued without ever recovering the
losses associated with the sale of the expensive units.
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COMPONENTS:
• Revenues: Income generated from sales of goods or services
associated with the main operations before any costs or expenses
are deducted.
• Gains: Any economic benefit that is outside the normal operations
of a business. Common examples include the excess of money
or fair value when an asset is sold or exchanged for more than its
purchase price.
• Expenses: Costs incurred to generate revenue. Commons examples
include the cost of goods sold, operating expenses, sales, general,
and administrative expenses, and amortization/depreciation
expense.
• Losses: A decrease in net income outside the normal operations
of the business. Common examples include the sale of an asset for
less than its carrying value, the write-down of assets, or a loss from
lawsuits.
• Net Income (Loss): The amount of profit or loss after expenses and
losses are subtracted from revenues and gains.
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HIGH/LOW ANALYSIS:
• A higher net income could result from an increase in sales volume,
an increase in the sales price, or an increase in investment
income. A decrease in expenses, such as cost of goods sold and
sales, general, and administrative expenses, will also result in an
increased level of net income.
• Conversely, a decrease in revenue caused by reduced sales prices
or low sales volume can result in less, or negative, net income.
Likewise, an increase in the cost of goods sold and other sales,
general, and administrative expenses will cause net income to
decrease.
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COMPONENTS:
• Beginning Inventory: The value of goods that a company has for its
use or sale at the start of an inventory accounting period.
• Purchases During the Period: The value of goods purchased
during the period.
• Ending Inventory: The value of goods that a company has on hand
at the end of the reporting period.
• Cost of Goods Sold: The accumulated total of all costs used to
create a product or service that has been sold.
DESCRIPTION
Cost of goods sold is an indication of operational efficiency, and an organization
should aim to keep the metric as low as possible. An organization’s understanding
of its cost of goods sold is vital because it allows the organization to set prices that
result in a healthy profit margin and aids the organization in determining when to
increase prices for a particular product.
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HIGH/LOW ANALYSIS
The inventory costing methodology used by an organization to calculate the cost of
ending inventory can significantly impact the measure of cost of goods sold.
1. First in, first out method (FIFO): Assumes that the first inventory added is the
first inventory used. When prices are increasing in an inflationary environment,
lower-cost goods are used first, resulting in a lower cost of goods sold and higher
net income.
2. Last in, first out method (LIFO): Assumes that the last inventory added is the
first inventory used. When prices are increasing, higher-cost goods are used first,
resulting in a higher cost of goods sold and lower net income.
3. Average method: Uses the average price of all the goods in stock, regardless
of purchase date. This method keeps the cost of goods sold at a more balanced
level than the FIFO and LIFO methods because it prevents cost of goods sold from
being highly impacted by extreme costs of one or more purchases.
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COMPONENTS:
• Beginning Retained Earnings: The amount of retained earnings
from the previous accounting period.
• Net Income (Loss) During Period: The amount of profit or loss after
expenses and losses are subtracted from revenues and gains from
the current period.
• Dividends Paid During Period: The portion of a company’s
earnings paid to investors during the period.
• Retained Earnings: The profits that a company has earned to date,
less any dividends or other distributions paid to investors.
DESCRIPTION
Retained earnings is the profit amount of a business that has not been distributed to
investors and are retained by the business to, among other things, invest in working
capital or pay down outstanding liabilities.
It is important to note that retained earnings does not represent surplus cash or the
amount of cash left over after the distribution of dividends. Instead, it explains what
a company did with its profits. Since all profits and losses flow through retained
earnings, the balance is constantly changing because any income statement activity
will directly impact the net income part of the retained earnings calculation.
Growing industries and industries that rely on large amounts of capital tend to retain
more of their earnings to invest in more assets needed to operate the business; it is
also common for older companies to report higher retained earnings than similar
younger companies due to the amount of earnings accumulated over time.
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ALT NAME: NA
TERMS:
• Upper Limit (Ceiling): Net Realizable Value (NRV) of Inventory
• Replacement Cost of Inventory
• Lower Limit (Floor): Net Realizable Value (NRV) – Normal Profit
Margin on the Inventory
COMPONENTS:
• Net Realizable Value (NRV): The expected selling price of an item
minus any selling costs or costs to complete the item.
• Replacement Cost: The market value of an item; may be expressed
in the form of purchase cost or manufacturing cost.
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DESCRIPTION
The lower of cost or market (LCM) is an accounting rule used to value
inventory. The LCM rule dictates that a business must record the cost
of inventory at whichever cost is lower: (a) the historical cost or (b) its
current market value.
The current market value in LCM is the current replacement cost not
exceeding the ceiling of net realizable value (NRV) and not below the
floor of NRV adjusted for a normal profit margin (NRV – normal profit
margin).
At the end of the fiscal year, the remaining inventory items are
compared to the current market value. If the current market value
is less than the historical cost, the items are adjusted down to the
current market price to account for the lost value. However, if the
current market value is greater than the historical cost, the items
remain at historical cost.
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COMPONENTS:
• Sales Forecast: The projection of achievable sales revenue based
on historical sales data and an analysis of market surveys and
trends.
• Percentage of Historical Warranty Cost based on Sales: The
percentage of revenues used to pay for warrantied repairs and
replacements from historical periods.
DESCRIPTION
If a company issues a warranty on a product it sells, the company must record a
liability to reflect the estimated costs of repairing or replacing the item under warranty.
The estimated warranty liability should be recorded in the same period as the sale, and
the warranty liability account is reduced as the company pays for warrantied repairs.
Typically, a company will compare historical sales and warranty claim data to forecast
the amount of future sales and warranty expense; if historical data is not available, the
company will use industry averages.
Depending on the warranty’s length, the warranty liability account may need to be
split between the current (payable within a year) and long-term (not payable for over a
year) liability sections of the balance sheet.
The initial recording of accrued warranty liability should be a debit to the warranty
expense account and a credit to the accrued warranty liability account; redemption of
a warranty would result in a debit to the accrued warranty liability account and a credit
to the inventory/cash account.
Companies with a minimal history of warranty expenditures may choose not to record
a liability in advance of actual warranty expense since the forecast would be that
warranty expense is immaterial. The concept of warranty liability is least common for
service companies since it is more difficult to determine what qualifies as a warranty
liability, as most services are customized.
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DESCRIPTION
An asset’s carrying value represents the original amount reflected on the company’s
balance sheet, minus the accumulated depreciation of the asset and any asset
impairments.
For physical assets, such as computers and machinery, the carrying value can be
computed by subtracting accumulated depreciation from the asset’s original cost.
Similarly, the carrying value of patents and other intellectual property can be
calculated by subtracting amortization expense from the asset’s original cost.
Upon acquisition of an asset, its carrying value is exactly the same as its purchase
price. Because the original cost can be traced to a purchase document, such as a
receipt, accounting guidelines dictate that the original cost should be used to record
assets on the balance sheet instead of market value.
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DESCRIPTION
Fair value represents the actual value of an asset that is agreed upon
by both the seller and the buyer, hence the usage of the term fair.
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ALT NAME: NA
CALCULATION: Carrying Value of Bonds at Beginning of Period x
Effective – Interest Rate
COMPONENTS:
• Carrying Value of Bonds at Beginning of Period: The face amount
minus any unamortized discounts or plus any unamortized
premium, also known as book value.
• Effective-Interest Rate: The interest rate that is actually earned
or paid on an investment due to the result of compounding over a
given time period.
DESCRIPTION
The face value of a bond is the amount paid to the owner at maturity.
If bonds sell for less than face value, then they sell at a discount.
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If bonds sell for more than face value, then they sell at a premium.
When a bond is sold at a premium, the amount of the bond premium
must be amortized to interest expense over the bond’s life.
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CALCULATION: y = bx + a
COMPONENTS:
• y = The value being forecast (dependent variable)
• b = The slope of the regression line
• x = The value of the independent variable
• a = The value of y (dependent variable) if the value of x
(independent variable) is 0
DESCRIPTION
Linear regression models are used to show or predict the relationship
between two variables.
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COMPONENTS:
• Growth Rate: The amount by which a variable increases over
a given period of time as a percentage of its previous value;
calculated as “(Ending Value – Beginning Value) ÷ Beginning Value.”
• Number of Periods: The number of accounting periods for which
there is a separate value for growth rate.
DESCRIPTION
The average annual growth rate (AAGR) is the average increase in the
value of an individual investment or asset over the period of a year.
The periods used to calculate the AAGR should all be of equal length
for the result to be accurate.
Also, AAGR can be calculated for any investment but will not consider
any information about an investment’s risk level caused by price
volatility.
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COMPONENTS:
• Budgeted Quantity (BQ): The estimated number of units to be
manufactured during the accounting period.
• Budgeted Price (BP): The estimated selling price for one
manufactured unit during the accounting period.
• Static Budget: An amount representing the estimated number
of units manufactured at the estimated selling price for the
accounting period.
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COMPONENTS:
• Actual Quantity (AQ): The actual number of units manufactured
during the accounting period.
• Actual Price (AP): The actual selling price for one manufactured
unit during the accounting period.
• Actual Results: An amount representing the actual number of units
manufactured at the actual selling price for the accounting period.
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COMPONENTS:
• Actual Quantity (AQ): The actual number of units manufactured
during the accounting period.
• Budgeted Price (BP): The estimated selling price for one
manufactured unit during the accounting period.
• Flexible Budget: An amount representing the actual number
of units manufactured at the estimated selling price for the
accounting period.
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COMPONENTS:
• Flexible Budget Amount: Actual Quantity (AQ) x Budgeted Price
(BP)
• Actual Results for Static Budget: Actual Quantity (AQ) x Actual
Price (AP)
• Flexible Budget Variance: The difference between the actual and
estimated selling price for the actual number of units manufactured
during the accounting period.
DESCRIPTION
In contrast to a static budget, a flexible budget adjusts in response to
changes in volume or activity. In a business environment where costs
are closely related to the level of business activity, the budget will flex
because it will include a variable rate per unit of activity instead of one
fixed total amount.
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Similarly, if the actual number of units sold has been recorded in the
flexible budget, then the variances could be between both standard
and actual revenue per unit and budgeted and actual expenses.
Generally, the flexible budget variance should be smaller than the
static budget variance since the unit volume or revenue level is
adjusted to match actual results. However, an unusually large flexible
budget variance may indicate that the budget formulas need to be
modified.
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COMPONENTS:
• Static Budget Amount: Budgeted Quantity (BQ) x Budgeted Price (BP)
• Flexible Budget Amount: Actual Quantity (AQ) x Budgeted Price (BP)
• Sales-Volume Variance: The difference between the actual and
estimated number of units manufactured during the accounting
period at the estimated selling price.
DESCRIPTION
The sales-volume variance is used to measure the change in profit due to the
difference between actual and budgeted sales quantity. The variance measures the
amount of revenue earned when the product is sold based on actual sales volume
compared to the amount of revenue a company expected to bring in based on
projected sales volume.
A favorable sales-volume variance indicates that the actual quantity of units sold was
more than the budgeted quantity of units sold; thus, actual revenues are higher than
budgeted revenues, which typically leads to higher profit.
1. An increase in competition
2. An increase in product prices
3. A decrease in product demand
4. A governmental restriction on exports
5. Inaccurate budgeting
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COMPONENTS:
• Actual Cost of Direct Materials: Actual Price (AP) x Actual Quantity
(AQ)
• Actual Quantity of Direct Materials at Standard Price: Standard
Price (SP) x Actual Quantity (AQ)
• Direct Materials Price Variance: The difference between the actual
amount spent on direct materials purchased and the amount that
would have been spent had the material been purchased at the
standard price (standard prices are estimated and are used for
budgeting).
DESCRIPTION
The direct materials price variance is used to monitor the costs
incurred to produce goods and determine the purchasing
department’s efficiency in obtaining direct material at a low cost.
Keeping in mind the current market prices and anticipated changes in
material costs in the near future, companies set standard amounts for
direct materials prices.
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If the actual price paid for materials is more than the standard price,
an unfavorable materials price variance occurs. Some of the reasons
for an unfavorable variance include an overall hike in the market
price of materials, the purchase of materials of higher quality than
the standard, an increase in the bargaining power of suppliers, the
loss of purchase discounts due to smaller order sizes, and inefficient
purchasing by the procurement staff.
Conversely, if the actual price paid for materials is less than the
standard price, a favorable materials price variance occurs. The
basis for a favorable variance may include an overall decrease in
the market price level, the purchase of materials of lower quality
than the standard, better price negotiation by the procurement staff,
implementation of improved procurement practices (e.g., soliciting
price quotes from multiple suppliers), and purchase discounts on large
orders.
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COMPONENTS:
• Actual Quantity of Direct Materials at Standard Price: Actual
Quantity (AQ) x Standard Price (SP)
• Standard Quantity of Direct Materials Allowed: Standard Quantity
(SQ) x Standard Price (SP)
• Direct Materials Quantity Variance: The difference between the
actual number of materials used in the production process and the
amount that was expected to be used, multiplied by the standard
price.
DESCRIPTION
Direct materials quantity variance is used to determine a production
department’s efficiency in converting raw materials into finished
goods. The main way to improve efficiency for this production stage is
to reduce the amount of raw material waste.
If the actual quantity of direct materials used is less than the standard
quantity, the variance is favorable because the company could save
money on materials. A few contributing factors of a favorable direct
materials quantity variance are reduced spoilage due to higher quality
materials, advanced employee training about the efficient use of
materials, and improved maintenance of production equipment that
reduces material waste.
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COMPONENTS:
• Actual Cost of Direct Labor: Actual Rate (AR) x Actual Hours Worked
(AH)
• Actual Hours of Direct Labor at Standard Rate: Standard Rate (SR)
x Actual Hours Worked (AH)
• Direct Labor Price Variance: The difference between the actual
cost of direct labor and the standard cost of direct labor for the
number of hours worked.
DESCRIPTION
The direct labor price variance is used to gauge the human resources
department’s performance in negotiating lower wage rates with
employees and labor unions. An unfavorable direct labor price
variance indicates higher labor costs incurred during a period
compared to standard costs.
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COMPONENTS:
• Actual Hours of Direct Labor at Standard Rate: Standard Rate (SR) x
Actual Hours Worked (AH)
• Standard Cost of Direct Labor: Standard Rate (SR) x Total Standard
Hours (SR)
• Direct Labor Efficiency Variance: The difference between the actual
number of hours used to manufacture a certain number of units
and the number of hours allowed by standards to manufacture that
number of units multiplied by the standard direct labor rate.
DESCRIPTION
The direct labor efficiency variance is calculated in order to measure
the performance of a production department in utilizing the abilities of
its workers.
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