...On Accounting Flows and Systematic Risk Neil Garrod University of Glasgow Dusan Mramor University of Ljubljana Address for correspondence: Neil Garrod, Department of Accounting and Finance, University of Glasgow, 65-71, Southpark Avenue, Glasgow G12 8LE, Scotland, U.K. Tel: 00-44-141-330-5426 e-mail: n.garrod@accfin.gla.ac.uk On Accounting Flows and Systematic Risk Abstract The body of work that relates accounting numbers to market measures of systematic equity risk was largely undertaken in the 1970s and early 1980s. More recent proposals on changes in accounting disclosure of risk mean that a rigorous theoretical model of the relationship between accounting measures and market measures of risk is timely. In this paper such a model is developed. In addition, the assumptions required to develop the model are explicitly identified. By so doing it becomes possible to identify the potential cross-sectional differences which drive the empirical relationship between accounting and market based measures of risk. The model developed highlights a clear relationship between accounting and market measures of risk which can be exploited in situations where accounting data alone is available. It also provides a framework within which the environmental factors leading to cross-sectional differences between companies can be further explored. On Accounting Flows and Systematic...
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...Discussion Week 3: Read Exercise 4-1 (Note: This is will not be done as a group assignment). Answer end of exercise question and post answer in discussion board. Operating Leverage: John Diaz owns Pacific Electric, a large electrical contracting firm that provides services to building construction projects. The company has 2,000 employees and operates in three western states. Recently the company experienced large losses due to a downturn in the economy and a slowdown in construction. John thinks the losses were particularly large because his company has too much fixed cost. Required: a. Expand on John’s thought. How are the large losses related to fixed costs? In management accounting, fixed costs are defined as expenses that do not change as a function of the activity of a business, within the relevant period. For example, a retailer must pay rent and utility bills irrespective of sales. In John’s case, I will assume that he will have a Cost-Volume-Profit Analysis performed. I would hope also that this analysis would be performed on each of his businesses in the three states that he operates within and at a corporate level. No company should go on gut feelings when it comes to saving their business and this could be the situation for John. Cost-Volume-profit (CVP), in managerial economics is a form of cost accounting. It is a simplified model, useful for elementary instruction and for short-run decisions. Cost-volume-profit (CVP) analysis expands the use of information...
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...Bureaucratic Control People do not like change. In fact, even when change leads to job improvement, such as making one’s job easier or more efficient, people will initially resist it. In the company overview, Jack and Jenny can outline what the employee can expect of the company and what the company in turn expects from them. If employers evolve as their workers evolve, the end result will be a more dynamic and competitive organization where knowledge is shared, action is taken quickly and new possibilities are opened. The performance of an employee cannot be measured effectively unless a standard has been set against which to measure the employee's daily performance. When you are setting performance standards, it is helpful to clearly state, “Here is what meeting expectations looks like and here is what exceeding expectations would look like.” Clear expectations provide a solid foundation on which to provide recognition and reinforcement as well as guidance and corrective feedback. It's not fair to hit people with corrective feedback or a bad review if you have not made your expectations clear. An employee handbook can help managers and workers know how to deal with difficult situations. Employee performance can be improved just as much if not more by general management practices that recognize the individual. The best way managers can measure performance is to be as open as possible about how they make decisions, and to have a clear...
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...Operating Leverage What Does Operating Leverage Mean? A measurement of the degree to which a firm or project incurs a combination of fixed and variable costs. (1) A business thathas limited sales, with each sale providing a very high gross margin, is said to be highly leveraged. A business that makesmany sales, with each sale contributing a very low margin, is said to be less leveraged. As the volume of sales in a businessincreases, each new sale contributes less to fixed costs and more to profitability. (2) A business that has a higher proportion offixed costs and a lower proportion of variable costs is said to use more operating leverage. Conversely, businesses with lowerfixed costs and higher variable costs are said to employ less operating leverage. Investopedia explains Operating Leverage The higher the degree of operating leverage, the greater the potential danger for inaccurately forecasting risk. That is, if arelatively small error is made in forecasting sales, it can be magnified into large errors in projections of cash flow. The oppositeis true for businesses that are less leveraged. A business that sells millions of products a year, with each contributing slightlyto paying for fixed costs, is not as dependent on each individual sale. For example, convenience stores are significantly lessleveraged than are high-end car dealershipsoperating leverage The extent to which fixed operating costs magnify changes in sales or revenues into even greater proportionate changesin operating income...
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...Fundamentals of Cost Accounting Week 5 Assignments Chapters 8 and 9 Questions Chapter 8 6. Discuss the sequence in which the major components of the master budget are prepared. Why is it necessary to prepare the components in such a sequence? The Sequence for a master budget is as follows: A production budget, purchases budget, personnel budget, direct labor budget, overhead budget, selling and administrative budget, capital budget, and budgeted financial statements. Using this sequence to create a master budget a manager has assistance to align activities and resources allocations with organizational goals; it’s a vehicle to promote employee participation, cooperation, and department coordination. It's also a tool to enhance conduct of the managerial functions of planning, controlling, problems solving; basis on which to sharpen management's responsiveness to changes in both internal and external factors; and model that provides a rigorous view of future performance of a business in time to consider alternative measures. 7. Why is a firm’s production budget influenced by the finished goods inventory policy? The production budget follows from the sales budget and is based on information about the type, quantity, and timing of units to be sold. (A retail or service company would not prepare a production budget.) Sales information is combines with beginning and ending Finished Goods (FG) Inventory information so that managers can schedule necessary production. 8. Assume...
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...LOOK AT CHAPTER 6 SLIDES Budget project: How many units do you need to break even. Also a cost volume profit graph. ON EXAM Mixed Costs Total Cost= Total fixed cost + Variable per unit * units ON EXAM: High-Low Method Ex: High hours of maintenance – Low hours / High Total Maintenance cost – Low Total Maintenance cost Predict Costs: 1) Account Analysis 2) High-Low Method Contribution Margin: Sales -Variable Costs = Contribution Margin -Fixed Costs =Net Operating Income Used for external reporting Used by management Sensitivity analysis: if sales are down 10% or If sales are up by 10% what’s your income. Can be checked by CM Contribution Margin Ratio: Total CM/ Total Sales In terms of Units: CM Ratio: Unit CM/ Unit SP Break even point in Units Sold: FC/ CM per Unit Break even point in total sales dollars: FC / CM Ratio Operating Leverage: Degree of Operating Leverage = Contribution Margin/ Net Operating Income 1) 2) Variable Cost: Fixed Cost: Mixed Cost: with Variable and Fixed: cell phone bill which is $50 a month and additional 20 cents per message. Chapter 6: Cost Behavior: Analysis and Use LOOK AT CHAPTER 6 SLIDES Budget project: How many units do you need to break even. Also a cost volume profit graph. ON EXAM Mixed Costs Total Cost= Total fixed cost + Variable per unit * units ON EXAM: High-Low Method Ex: High hours of maintenance – Low hours /...
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...have sales totaling $17,142,857. Pittman Company Contribution Income statement For the month of Total Cm Ratio Sales $17,142,857 100% Less: Variable expense $11,142,857 65% Contribution margins $6,000,000 35% Less: Fixed cost $4,800,000 Net operating income $1,200,000 3 If the company wanted to generate the same net income as contained in the budgeted income statement, while paying no commission and hire no sales force, they would have to generate sales of $10,909,091 to generate a profit of $1,200,000. Pittman Company Contribution Income statement For the month of Total Cm Ratio Sales $10,909,091 100% Less: Variable expense $4,909,091 45% Contribution margins $6,000,000 55% Less: Fixed cost $4,800,000 Net operating income $1,200,000 4. A. Operating leverage is 4 B Operating leverage is 7 C. Operating leverage is 19 5 If the company decides to stay the course and continue to pay a commission of 15% this will allow them to operate with the lowest possible break even point. While a 20% commission will put the break-even point at the highest level of the three scenarios. However if the company decides to stay the course they will have a relatively low operating leverage and will need a substantial increase in sales to increase profit. The best choice is for the company to drop the outside sales force and hire an internal sales team. An internal sales team would have a break-even point higher than the status quo but lower than...
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...% Sales Variable expenses Contribution Margin Fixed Expenses Net operating income $ 20,000.00 $ 12,000.00 $ 8,000.00 $ 6,000.00 $ 2,000.00 per unit $ 100% $ 20.00 60% $ 12.00 40% $ 8.00 1. Total contribution margin Total units sold Contribution margin per unit $ $ 8,000.00 1,000 units 8.00 per unit 2. Total contribution margin Total sales Contribution margin ratio $ 8,000.00 $ 20,000.00 40% 3 Total variable expenses Total sales Variable expense ratio $ 12,000.00 $ 20,000.00 60.00% 4 Contribution margin per unit Increase in unit sales Increase in net operating income Units 900 $ $ 8.00 per unit 1 unit 8.00 Per unit $ 20.00 $ 12.00 $ 8.00 5. Sales Variable expenses Contribution margin Fixed expenses Net operating income 6. Sales Variable expenses Contribution margin Fixed expenses Net operating income $ 18,000.00 $ 10,800.00 $ 7,200.00 $ 6,000.00 $ 1,200.00 Units 900 Per unit $ 16,200.00 $ 18.00 $ 9,720.00 $ 10.80 $ 6,480.00 $ 7.20 $ 6,000.00 $ 480.00 7 Sales Variable expenses Contribution margin Fixed expenses Net operating income 1250 $ 25,000.00 $ 16,250.00 $ 8,750.00 $ 7,500.00 $ 1,250.00 $ $ $ 20.00 13.00 7.00 8 Profit $6,000.00 $8.00 = = = = = = Unit CM X Q - Fixed expenses 750 units 9. Profit $6,000.00 40.00% = = = = = CM ration X Sales - Fixed Expenses $15,000 10 Profit $5000+$6000 $8 11 Sales Break-even sales at units Margin of safety (in dollars) Margin of safety (in dollars) Sales Margin of safety percentage = = = = = = Unit...
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...Margin | | $ 8,000.00 | 40% | $ 8.00 | | | | | | Fixed Expenses | | $ 6,000.00 | | | | | | | | Net operating income | | $ 2,000.00 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 1. | Total contribution margin | | $ 8,000.00 | | | | | | | | Total units sold | | 1,000 | units | | | | | | | Contribution margin per unit | | $ 8.00 | per unit | | | | | | | | | | | | | | | | | | | | | | | | | | 2. | Total contribution margin | | $ 8,000.00 | | | | | | | | Total sales | | $ 20,000.00 | | | | | | | | Contribution margin ratio | | 40% | | | | | | | | | | | | | | | | | | | | | | | | | | | 3 | Total variable expenses | | $ 12,000.00 | | | | | | | | Total sales | | $ 20,000.00 | | | | | | | | Variable expense ratio | | $ 0.60 | | | | | | | | | | | | | | | | | | | | | | | | | | | 4 | Contribution margin per unit | | $ 8.00 | per unit | | | | | | | Increase in unit sales | | 1 | unit | | | | | | | Increase in net operating income | $ 8.00 | | | | | | | | | | | | | | | | | 5. | | Units | | Per unit | | | | | | | Sales | 900...
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...Pioneer Petroleum is a multinational corporation that is in position to capitalize on investments all around the World. Within the industry Pioneer’s gasoline are among the cleanest burning fuels. They are better position than most to meet strict environmental guidelines as they currently have clean efficient running plants positioned to capitalize on less polluted products. Also Pioneer Petroleum is heavily involved in exploration and devilment. From 1924 to the present, pioneer has been able to expand both vertically and diversify horizontally. With such resources and capital, the company has to oversee so many opportunities and ventures. Presently the company is at odds over whether they should use a company wide cut off rate based on the overall weighted average cost of capital or if Pioneer should use multiple rates that reflect risk-profit characteristics of the several businesses or economic sectors. At first we must decide if the methodology used in computing the company’s overall weighted average cost of capital is just. Second, we should decide in which terms Pioneer adheres to future investments. Should they adjust discount rates for different divisions and projects and stay away from a universal cutoff rate? Third, the capital budgeting criteria must be set for different projects across Pioneer’s divisions. What distinctions among projects need to be noted and how the standards should be determined are all questions that arise from judging how to proceed forward...
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...00 40% $8.00 Fixed Expenses $6,000.00 Net operating income $2,000.00 1. Total contribution margin $8,000.00 Total units sold 1,000 units Contribution margin per unit $8.00 per unit 2. Total contribution margin $8,000.00 Total sales $20,000.00 Contribution margin ratio 40% 3 Total variable expenses $12,000.00 Total sales $20,000.00 Variable expense ratio 60% 4 Contribution margin per unit $8.00 per unit Increase in unit sales 1001 unit Increase in net operating income $8.00 5. Units Per unit Sales 900 $18,000.00 $20.00 Variable expenses $10,800.00 $12.00 Contribution margin $7,200.00 $8.00 Fixed expenses $6,000.00 Net operating income $1,200.00 6. Units Per unit Sales 900 $19,800.00 $22.00 Variable expenses $11,800.00 $13.20 Contribution margin $8,000.00 $8.80 Fixed expenses $6,000.00 Net operating income $2,000.00 7 Sales 1250 $26,250.00 $21.00 Variable expenses $15,750.00 $12.60 Contribution margin $10,500.00 $8.40 Fixed expenses $7,500.00 Net operating income $3,000.00 8...
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...Healthy Foods, Inc., sells 50- pound bags of grapes to the military for $10 a bag. The fixed costs of this operation are $80,000, while the variable costs of the grapes are $.10 per pound. a. what is the break-even point in bags b. calculate the profit of loss on 12,000 bags and on 25,000 bags. c. what is the degree of operating leverage change as the quantity sold increases? d. If healthy foods has an annual interest expense of $10,000, calculate the degree of financial leverage at both 20,000 and 25,000 bags e. what is the degree of combined leverage at both sales levels. A. What is the break even point in bags. The break even point in bags will equal the fixed cost divided by the unit contribution margin, which the unit contribution margin will equal the selling price per unit subtracted by the variable cost per unit. Therefore my equation is $10-(50*0.10) will equal 10-5 which equal $5. So, the break even point will equal the operation fixed cost which is 80,000 and I divide that by 5(80,000/5) will equal 16,000. B. Calculate the profit of loss on 12,000 bags and 25,000 bags. The desired sales in the unit will equal the fixed cost plus the desired profit divided by the unit contribution margin. So, 12,000 will equal the operation fixed cost which is 80,000 plus the desired profit divided by 5. Therefore, 80,000 plus the desired profit will equal 60,000. The desired profit/loss will equal 80,000-60,000 which will give us the net loss of 20,000. The next equation...
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...expenses + Profits BREAKEVEN ANALYSIS - CONTRIBUTION MARGIN METHOD Break-even quantity = Fixed Expenses CM/u To calculate the breakeven point in sales dollars, substitute ratios as a percent of sales for dollars. Or, calculate the breakeven point in units and multiply by the selling price/unit. MARGIN OF SAFETY The margin of safety is the excess of budgeted (or actual) sales over the break-even sales. The margin of safety can be expressed either in dollar or percentage form. The formulas are: [pic] [pic] OPERATING LEVERAGE Operating leverage measures how a given percentage change in sales affects net operating income. It is a measure of volatility in net income caused by high fixed expenses relative to variable expenses. [pic] Use the income statements for Company X and Y to compute: a. Breakeven point in units and sales dollars. b. Margin of safety. c. Degree of operating leverage. d. The change in net income caused by a 10% increase in sales. | |Company X |Company Y | |Sales (5,000 units) |$500,000 |100% |$500,000 |100% | |Less variable expenses |...
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...Research and Application 6-34, page 278 1. From looking at the income statement presented on page 50, is prepared using an absorption format. Then on page 33 it is prepared using a contribution format. The annual report says that the contribution format income statement shown on page 33 is used for internal reporting purposes; but, Benetton has chosen to include it in the annual report anyway. The contribution format income statement treats all cost of sales as variable costs. The selling, general and administrative expenses shown on the absorption income statement have been broken down into variable and fixed components in the contribution format income statement. It appears the Distribution and Transport expenses and the Sales Commissions have been reclassified as variable selling costs on the contribution format income statement. The sum of these two expenses according to the absorption income statement on page 50 is €103,561 and €114,309 in 2004 and 2003, respectively. If these numbers are rounded to the nearest thousand, they agree with the variable selling costs shown in the contribution format income statements on page 33. 2. The cost of sales is included in the computation of contribution margin because the Benetton Group primarily designs, markets, and sells apparel. The manufacturing of the products is outsourced to various suppliers. While Benetton’s cost of sales may include some fixed costs, the majority of the costs are variable, as one would...
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...S. Truett Cathy was a successful entrepreneur almost from birth. He started by selling Coca-Cola door to door, then magazines and newspapers, before finally entering the restaurant business. Several successful years later, he began working on a chicken sandwich for his restaurants and customer response was so great that Cathy knew he was on to something special. Cathy initially wanted to license the sales of the product to other restaurants, but saw that it could created quality control issues and damage to the Chick-fil-A brand. Therefore, Cathy developed a unique franchise opportunity that he deployed first to malls and then to stand alone stores based on his core values of conservatism, encouraging corporate social responsibility, and entrepreneurship (Cathy, 2013). It allowed others to cover the majority of the variable costs of running a restaurant, while he assumed much of the fixed costs of building the restaurant so he could retain more control than competitors. Unique Franchise Model After making it through a strenuous interview process, a person can become a Chick-fil-a franchisee or “Operator” for only $5,000 which is substantially lower than the industry average (Cathy, 2013).What Chick-fil-A gives up in terms of initial fees, it makes up for in other areas. In general, Chick-fil-A requires operators to cover between $250,000 and $900,000 for the location's variable costs such as inventory, as well as fixed costs such as equipment rental, insurance, location leasing...
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