PUP SANTA ROSA CAMPUS

SANTA ROSA CITY, LAGUNA

ACCO 20293
BUSINESS MANAGEMENT ACCOUNTING

MARY JOY M. SUMAPID, CPA

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 TABLE OF CONTENTS

UNIT 1: Accounting -Its Importance to Management........................................................................3

Fundamentals of Management..............................................................................................................3
Organizational Structure.........................................................................................................................4
Role of Accounting...................................................................................................................................6
Assessment................................................................................................................................................8

UNIT 2: Financial Statements...............................................................................................................10

Objective of Financial Statements......................................................................................................10
Qualitative Characteristics of Accounting Information..................................................................10
Limitations of Financial Statements..................................................................................................13
Financial Statements............................................................................................................................13
Elements of the Financial Statements..............................................................................................13
Sample Financial Statements.............................................................................................................16.
Assessment............................................................................................................................................22.

UNIT 3: Financial Statement Analysis................................................................................................26

Objective of Financial Statements Analysis.....................................................................................26
Limitations of Financial Statement Analysis....................................................................................27
Horizontal Analysis................................................................................................................................28
Vertical Analysis.....................................................................................................................................29
Ratio Analysis.........................................................................................................................................31
Assessment.............................................................................................................................................37

Midterm Examination

UNIT 4: Cost-Volume-Profit (CVP) Analysis........................................................................................

Assessment................................................................................................................................................

UNIT 5: The Master Budget...................................................................................................................

Assessment................................................................................................................................................
Syllabus.....................................................................................................................................................

Final Examination

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 UNIT 1

ACCOUNTING------ ITS IMPORTANCE TO MANAGEMENT

Objectives
In this course you will learn the following:
1. Definition of Management.
2. The three functions of management.
3. Organizational Chart of a Corporation
4. Function and duties of the Controller and Treasurer
5. Diffentiate Management Accounting from Financial Accounting

Fundamentals of Management
Management is the process of planning, organizing and controlling tasks to realize the
objectives of an organization.

Basic management functions:

1. Planning (budget)
-Setting immediate and long term objectives
-deciding which alternative is best suited to attain the set objectives

2. Organizing (Directing and Staffing)

-Deciding how to utilize available resources as plans are carried out
-tackling activities necessary to achieve objectives such as staffing, subordinating, directing
and motivating

3. Controlling (Actual versus Budget)

-comparing actual performance with set plans or standards
-deciding what corrective actions to take should there be any deviation (variance) between
actual and planned performance

Decision Making function is an inherent function of management; all management

functions would require certain amount of decision making. Decision making is selecting
one alternative from a set of choices.

MANAGEMENT BY OBJECTIVES (MBO) vs. MANAGEMENT BY EXCEPTION (MBE)

MBO - the management process in which a subordinate and a supervisor agree on goals and
the methods of achieving them and develop a plan in accordance with that agreement. The
subordinate is then evaluated with reference to the agreed plan at the end of the period.

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MBE - the management technique of highlighting those which vary significantly from plans
and standards in line with the management principle that executive time should spent be
spent on items that are non-routine and are identified as top priority.

Organizational Structure
An organizational structure is a system that outlines how certain activities are directed in
order to achieve the goals of an organization. These activities can include rules, roles, and
responsibilities.

The organizational structure also determines how information flows between levels within
the company. For example, in a centralized structure, decisions flow from the top down,
while in a decentralized structure, decision-making power is distributed among various
levels of the organization.

STOCKHOLDERS
BOARD OF DIRECTORS

A line position (Give Command)

is a position that has authority and responsibility for achieving the major goals of the
organization. Example: VP for operations over operations manager, A production supervisor
in a manufacturing plant, Store manager of a retail convenience outlet.

A staff position (To Advise)

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is a position whose primary purpose is providing specialized expertise and assistance to
line positions. Example: Human resources manager for an educational institution, Vice
President for Research of a conglomerate firm, Chief Financial Officer of a merchandising
business.

The term “Levels of Management’ refers to a line of demarcation between various

managerial positions in an organization. The number of levels in management increases
when the size of the business and work force increases and vice versa. The level of
management determines a chain of command, the amount of authority & status enjoyed by
any managerial position. The levels of management can be classified in three broad
categories:
1.Top level / Administrative level

2.Middle level / Executory

3.Low level / Supervisory / Operative / First-line managers

Managers at all these levels perform different functions. The role of managers at all the
three levels is discussed below:

Controller vs. Treasurer

To avoid incompatible duties being assigned to a single officer, a controller must not hold at
the same time the position of a treasurer.

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 VP FOR FINANCE AND ACCOUNTING (CHIEF FINANCIAL OFFICER)

INTERNAL AUDIT CONTROLLER/ CHIEF TREASURER (custody

ACCOUNTANT (recording function)
function)
-RELIABILITY AND INTEGRITY OF -FINANCIAL REPORTING -FUND MANAGEMENT
FINANCIAL INFORMATION -COST & MANAGEMENT -CREDITS AND
PROVIDED BY THE ACCOUNTING COLLECTION
CONTROLLER AND TREASURER -ACCOUNTING INFORMATION -FOREIGN EXCHANGE
-INTERNAL CONTROL SYSTEM TRANSACTIONS
-FINANCIAL ANALYSIS & -BANKING AND CUSTODY
SPECIAL STUDIES -DISTRIBUTION OF
-GOVERNMENT TAX EARNINGS TO OWNERS
REPORTING

CONTROLLERSHIP the practice of the established science of control, which is the process by
which management assures itself that company resources are obtained and utilized according to
plans that are in line with the company's set objectives.

CONTROLLER is an officer of an organization who has responsibility for the accounting aspect of
management control. It is a title given to a person holding the position of a chief management
accounting executive of a business enterprise. In many accounting texts and business literatures,
the controller is often referred to as the 'chief accountant.'

The controller primarily exercises a staff functions the controller's office gives advice and service
other departments and to entire organization as a whole; however, in an accounting department
headed by the controller, the controller has a line authority over subordinates within the department.

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THE ROLE OF ACCOUNTING
Accounting is a tool of management by providing for the orderly accumulation, reporting
and interpretation of data pertaining to the financial operations of the business.

MANAGEMENT ACCOUNTING- an application of appropriate techniques and concepts in

processing historical and projected economic data of an entity to assist management in
establishing plan to meet economic objectives and in making rational decisions with a view
toward achieving the objectives. (American Association of Accountants)

Thus, management accounting's role is to provide accounting information to managers who

shall use these pieces of information as basis in making sound, objective and rational
business decisions.

MANAGEMENT ACCOUNTING vs. FINANCIAL ACCOUNTING

Financial Accounting Management Accounting

1 User of information Primarily for external users Exclusively for internal users
(management)
2 Guiding principles Generally Accepted Accounting Management wants and
Principle/ PFRS/PAS/CFAS needs
3 Optional/Mandatory Mandatory (especially for Discretionary or optional
public entities)
4 Type of information Primarily monetary (financial) Monetary and non-monetary
in nature
5 Emphasis of reports Reliability (precision of data) Relevance (timeliness of
data)
6 Purpose/End result Financial reporting and Decision-making
compliance
7 Source of data From company's (internal) info From internal and external
system sources
8 Amount of detail Compressed and simplified extensive and detailed
9 Focus of information Focus mainly on business as a Focus on segments and
whole business as whole
10 Frequency Periodic (annually, quarterly) As frequent as need arises
11 Time orientation Mainly historical (past) data Future-oriented using current
and past data
12 Unifying model Assets = Liabilities + Equity No unifying model or
equation

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 ASSESSMENT
I.
1. Define Management.
2. What are the 3 functions of management?
3. Why decision making function an inherent function of management?
4. Who are the owner of a corporation?
5. Why does the recording function separate from custody function?
6. Why is accounting called a tool of management?

II.
1. The discipline of accounting concerned with providing information to management in
making decisions about business operations. _________________
2. The primary purpose of management accounting is to provide information to _________
users.
3. True or False. Management Accouting is discretionary rather than mandatory. __________
4. True or False. Decision Making is required in planning, organizing and controlling
functions. ____________________
5. A function of management that compares planned results against actual result. _________

III.
Case Study:

I.
What is organizational structure and why do large organizations need continually to
consider the designs of their organization? What may be the consequences of a good or bad
design for a specific organization?

II.
Lorenzo stated that ‘for nearly twenty years we never had an organizational chart’ (she also
stated that they had no systems or procedures, job descriptions or functional departments
like marketing – despite this the company won plenty of awards – these ceased when the
company restructured and formalised aspects of work); she also described the proposed
organizational chart as ‘a Lego set from hell’ ; George suggested that ORGANIZATIONAL
STRUCTURE is more than boxes on a chart – discuss the statements of Lorenzo and George
and consider what organization structure/ design really includes (what are the tools
typically used to structure organizations?).

Duncan (1979) suggested that organizational structure is more than boxes on a chart. It is a pattern of interactions and co-ordination linking technology, tasks and human components of the organization to ensure the organization accomplishes its purpose. The tools used to add structure include: Organizational chart - a diagram of formal relations which the company
intends should prevail within it. Job definitions - the task requirements of a particular job in the organization. Span of control - the number of subordinates who report directly to a single manager or supervisor. The principle of span of control states that administrative efficiency is increased by limiting the span of control of a leader to no more than five or six
subordinates whose work interlocks. Authority - the right to guide or direct the actions of others. Responsibility - an obligation placed on a person, who occupies a certain position in the organization structure, to perform a task, function or assignment. Accountability - responsibility for some activity. When establishing the structure, designers typically start by defining
larger groups and then decompose them into smaller units. Departmentalization is a process of grouping together employees who share a common supervisor and resources, who are jointly responsible for performance and who tend to identify and collaborate with each other. The organizational chart usually shows the departments within an organization. The chart
also shows relationships between departmental staff in the organization which can be Line (direct relationship between superior and subordinate); Lateral (relationship between different departments on the same hierarchical level), Staff and functional. At a high level, designers distinguish between different categories of employee. For example Staff employees are

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workers who are in advisory positions and who use their specialized expertise to support the efforts of line employees. Employees may be related to one another in a variety of ways. A Line relationship is a formal relationship between individual positions within an organisation where authority flows vertically down through the structure; a Functional relationship is
where staff department specialists have the authority to insist that line managers implement their instructions concerning a particular issue and Lateral relationships are formal relationships which exist between individuals in different departments or sections, especially between individuals on the same level. In many large companies the organization chart can be
large and incredibly complicated and is therefore sometimes broken down into smaller charts for each individual department within the organization. There are several limitations with organizational charts. Firstly, they only show 'formal relationships'. Secondly they do not show anything about the managerial style adopted (e.g. Autocratic or democratic)

III.
A management accountant discovers that his/ her company is violating environmental
regulations. If immediate supervisor is involved, the appropriate action is to

Present the matter to the next higher managerial lever

IV.
If a management accountant has a problem in identifying unethical behavior or resolving an
ethical conflict, then the first action to take should be

Discuss the problem with immediate supervisor

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 UNIT 2
FINANCIAL STATEMENTS

Objectives
In this course you will learn the following:
1. Objective of Financial Statements
2. The users of financial statements and the types of information they need
3. Four qualitative characterictics of accounting
4. Four principal financial statements
5. Examples of Assets, Liabilities, Revenue, Expense and Equity

Objective of Financial Statements

Financial statements are a central feature of accounting because they are the primary
means of communicating important accounting information to users. It is helpful to think of
these statements as models of the business enterprise, because they are attempts to show
the business in financial terms. As is true of all models, however, financial statements are
not perfect pictures of the real thing but rather the accountant’s best effort to represent
what is real.

The main objective of financial statements is to provide information about the entity's
financial position, performance and changes in financial position that is useful to many
users in making important economic decisions. Users of financial statements are the
investors, lenders, suppliers, creditors, customers, governments and their agencies and the
general public. These users are called external users because they do not have direct access
to financial information of an entity and therefore, rely heavily on financial statements.

Information presented in the financial statements, are primarily quantitative in nature and
serve as the basis to help users make informed judgments and better decisions.

Example of users and the type of information they need are:

a. Investors are interested mainly in returns from dividends and in the market prices of
their investment
b. Creditors want to know if the business can repay a Ioan according to its terms.
c. Government and their agencies want to determine if the entity is complying with
government rules and regulations
d. Employees want to know if the entity is stable for their security of tenure
e. Customers and the general public are interested if the entity could provide them with
their needs for better products.

Qualitative Characteristics of Accounting Information

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Qualitative characteristics are standards for judging the information that accountants give
to decision maker. They are the attributes that make the information provided in the
financial statements useful to users. The four principal qualitative characteristics are:

1. Relevance
2. Reliability/ Faithful Representation
3. Understandability
4. Comparability

Relevance and reliability refer to the content of financial statements, understandability and
comparability refer to the way financial statements are presented

Relevance

An information is relevant if knowledge of the information will affect the evaluation or

decision of the users. To be relevant the Information must be related to the needs of the
users or decision makers. A relevant information has the following attributes:

1. Predictive value----------an Information is relevant if it has a predictive value, that it helps

in predicting an entity's activities in the future periods. Example is the preparation of a
company’s budget for the year 2021. One of the relevant sources of information for making
the budget of 2021 would be prior periods financial statements.

2. Confirmatory value---------to be relevant, information must provide feedback. For

example, the income statement provides information about how a company did in the past
year. It shows the results of operations in the past year whether it is gain or a loss. This
makes the financrai statements historical in nature.

3. Materiality---------- information is material if its omission or misstatement could influence

the economic decisions of users taken on the basis of the financial statements. The
materiality of an item is normally determined by relating its peso value to parts of the
financial statements. Thus P 5,000 may be material if compared to P 10,000 but it may be
considered immaterial if compared to several millions of pesos.

Reliability/ Faithful Representation

In addition to being relevant, accounting information must have reliability. In other words,
the users must be able to depend on the information. It must represent what it is meant to
represent. It must be regarded as credible or verifiable by independent parties using the
same methods of measuring. It must be neutral or objective. Accounting should convey
business activity as faithfully as possible without coloring the picture being presented in
order to influence anyone in a certain direction.

A reliable information has the following attributes:

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1. Faithful representation----- an information that is representationally faithful is truthful
and reports what actually takes place. Thus if sales in 2020 amount to P 500,000, reliable
financial statements should show this amount as part of its 2020 income statement.

2. Substance over form----- if an accounting information presents the actual Intention of the
parties to a transaction and not only its legal basis, then, it applies substance over form.

Example: Land owned by Lorenzo Company was sold to George Company on installment
basis. Title is to be retained by Lorenzo Company (seller) until all installment payments have
been received from George Company (buyer). From a legal Lorenzo Company is the owner
of the land (because Lorenzo Company still holds the title). From an accounting viewpoint,
George Company is already the owner (because the economic substance of the transaction
transfers control of the land to George Company). Lorenzo only retains title as a security
not because it is still the owner of the land.

3. Neutrality------ the quality of accounting information to be fair, neutral or free from bias.
Income statement should reflect correct revenue and expenses. T'he balance sheet, on the
other hand, should contain the correct assets, liabilities and capital.

4. Prudence------- is the inclusion of a degree of caution in the exercise of judgment needed

in making the estimates required under conditions of uncertainty, such that assets or
income are not overstated and liabilities or expenses are not understated. Prudence
requires being careful, so as not to encourage undue optimism on the part of the users.

5. Completeness--------- refers to the degree to which information is free from omissions. An

omission can cause ap accounting data to be false misleading and therefore unreliable.

Understandability

Financial data should be expressed in forms or terminologies adapted to the users' range of
understanding. For this purpose, users are assumed to have a reasonable knowledge of
business activities and must have a willingness to study the information with reasonable
diligence.

Comparability

Accounting users must be able to compare the financial statements of a business entity for
different accounting periods. This is called intracomparability. Example: Financial
Statements of ABC Company for 2020 can be compared to its financial statements for 2019
and other prior periods to determine if there is improvement in operating performance as
well as in financial position.

The other type of companson is inter-comparability where accounting users compare the
financial statements of different business enterprise in order to evaluate their
performances, financial positions and cash flows.

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Limitations of Financial Statements

The various concepts and principles that govern the presentation of financial statements
have imposed limitations on these statements. Some of the limitations are

1. Financial statements are not based entirely on absolute truths; much of the information
are estimates based on experience, customs and existing regulations and practices;

2. Personal Judgment is often exercised by accountant in the methods used in the

accounting process; and

3. The financial statements only include quantitative information about a business. They do
not reflect qualitative data needed for decision making purposes.

Financial Statements

The principal financial statements of a proprietorship are the income statement, the
statement of owner's equity, the statement of financial position, and the statement of cash
flows.

1. Income statement------- A summary of the revenue and expenses for a specific period of
time, such as a month or a year.

2. Statement of Owner's Equity-------- A summary of the changes in the owner's equity that
have occurred during a specific period of time, such as a month or a year.

3. Statement of Financial Position ---------A list of the assets, liabilities, and owner's equity as
of a specific date, usually at the close of the last day of a month or a year. Also called the
balance sheet.

4. Statement of Cash Flows------------ A summary of the cash receipts and cash payments for a
specific period of time, such as a month or a year.

Elements of the Financial Statements

1. Statement of Financial Position

Assets---------- An asset is a resource controlled by the enterprise a result of past events

and from which future economic benefits are expected to flow to the enterprise.

Examples:

Cash- is any medium of exchange that the bank will accept at face value. It includes coins
and currencies. Checks, money orders, bank drafts, and bank deposits.

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Accounts receivable- are claims against debtors or customers arising from the provision of
services or delivery of goods on credit,

Notes Receivable- These are claims against debtors or customers evidenced by a written
promise to pay called a promissory note.

Inventories- These are assets are (a) held for sale in the ordinary course of business; (b) in
the process of production for such sale; or (c) in the form of materials or supplies to be
consumed in the production process or in the rendering of services.

Prepaid Expenses- These are expenses paid for by the business in advance. Examples are
Office Supplies, Store Supplies, Prepaid Rent, Prepaid Insurance and Prepaid Interest.

Property, Plant and Equipment- These are tangible assets held by a business for use in the
production of goods or services, or for rental to others, or for administrative purposes and
which are expected to be used during more than one accounting periods. Examples are:
Land, Building, Equipment, Truck, Automobile, Furniture and Fixtures.

Liabilities --------is a present obligation of the enterprise arising from past events, the
settlement of which is expected to result in an outflow from the enterprise of resources
embodying economic benefits.

Examples:

Accounts Payable- These are amounts due to creditors arising from the purchase of
merchandise or services on account.

Notes Payable- these are amounts due to creditors evidenced by a written promise to pay

Accrued Liabilities- These are amounts owed to others for unpaid expenses. Examples are
Salaries Payable, Taxes Payable, Interest Payable and Utilities Payable.

Unearned Revenues- These are revenues collected by the business in advance. When a
business receives payments before providing services to customers, there is an obligation
created on the part of the business to provide services. Once the business provides the
services, the advance collections from customers will become earned and will be recorded
as income.

Mortgage Payable- These are long-term debts secured by certain assets as collateral.

Owner's Equity ------Interest in the assets of the enterprise

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Capital- This is used to record the initial or original investments of the owner. Any additional
investments are also recorded in the Capital account. Net Income increases Capital while
net loss decreases Capital. Examples are Juan Cruz, Capital; Jose Santos, Capital

Withdrawals- Another term is Drawing or Personal. This is used to record any withdrawal of
cash or other assets of the business by the owner intended for any personal or non-business
use. Examples are: Juan Cruz, Drawing; Jose Santos, Drawing

2. Income Statement

Income----- Refers to increases in economic benefits during the accounting period in the
form of inflows or enhancements of assets or decreases of liabilities that result in increase
in equity, other than those relating to contributions from equity participants.

The definition of income encompasses both revenue and gains. Revenue arises in the course
of the ordinary activities of an enterprise and is referred to by a variety of different names
including sales, fees, interest, dividends, royalties and rent. Gain represents other items
that meet the definition of income and may, or may not, arise in the course of the ordinary
activities of an enterprise.

Examples:

Service Income, Fees Income – These are revenues earned by rendering services to
customers or clients.

Sales- There are revenues earned by selling merchandise to customers.

Expenses---------Refer to decreases in economic benefits during the accounting period in

the form of outflows or depletion of assets or increases of liabilities that result in decrease
in equity other than those relating to distributions to equity participants.

The definition of expenses encompasses losses as well as those expenses that arise in the
course of the ordinary activities of the enterprise. Losses represent other items that meet
the definition of expenses and may, or may not, arise in the course of the ordinary activities
of the enterprise.

Examples:

Rent Expense- This is used to record expense for leased office spaces, building or other
assets.

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Supplies Expense- This is used to record supplies used by the business.

Depreciation Expense- This is used to record portion of the cost of a tangible asset like
building allocated as expense during an accounting period.

Interest Expense- This is used to record an expense for using borrowed funds

Uncollectible Accounts Expense- Other terms are Provision for Doubtful Accounts, Bad
Debts Expense or Doubtful Accounts Expense. This is used to record the amount of
receivables estimated to be uncollectible and charged to expense during an accounting
period.

ASSESSMENT
I.
Questions:
1. What is the main objective of financial statements? Explain.
2. Who are the external users of accounting information and what are the types of
information they need?
3. What is the importance of qualitative characterictics of accounting information?
4. What is the difference of inter comparability and intra comparability?
5. Give some limitations of financial statements.

II.
Identification
Write A if the acccout is a statement of financial position account and B if the account is an
income statement account.

1 Arman, Capital 6 Cash 11 Retained Earnings

2 Share Capital 7 Fees Earned 12 Prepaid Rent
3 Gain on Sale of 8 Depreciation Expense 13 Accumulated
Equipment Depreciation
4 Sales Discount 9 Rent Expense 14 Unearned Revenue
5 Accounts Payable 10 Merchandise Inventory 15 Interest Expense

Problem Solving. No solution. No point.

1. The following alphabetical list represents the accounts and balances for ABC Company on
December 31, 2020. All accounts have normal balances.

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Accounts Payable 5,000 Accounts Receivable 5,100
Accumulated Depreciation 1,000 Advertising Expense 900
Cash 6,000 Equipment 10,000
Prepaid Insurance 1,000 Rent Expense 5,000
Revenue from commissions 40,000 ABC, Capital, Beg 13,550
ABC, Drawing 11,000 Supplies 550
Salaries Expense 18,000 Supplies Expense 2,000

Prepare the (1) Income Statement (2) Statement of changes in equity (3) Statement of
financial position

2. Selected items from the Income Statement columns of the December 31, 2020 worksheet
of the JKL Company for the year ended December 31, 2020 appear below:

Income Statement
Account title Debit Credit
Sales 100,000
Sales returns and allowances 5,000
Sales discount 2,400
Purchases 50,000
Purchase Discount 1,000
Purchase returns and allowances 500
Income Summary 1,000 1,500
Freight In 5,000
Selling Expense 8,000
Administrative Expense 9,000

Prepare an income statement for the year end December 31, 2020.

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 UNIT 3
Financial Statement Analysis

Objective
In this unit you will learn the following:
1. Understand the objectives of financial statement analysis, and its limitations.
2. Use the analytical techniques in financial statements analysis:
a. Horizontal analysis
b. Trend analysis
c. Vertical analysis
d. Ratio analysis
3. Prepare and interpret common- size financial statements.
4. Compute the various financial ratios, turnover and their interpretations and how to use
them for profit planning.

Objective of Financial Statements Analysis

Financial Statement Analysis--- is a process of evaluating and interpreting an entity’s

financial statements to assess its financial health for the purpose of making better
economic decisions.

Depending on the objective of the analysis, a financial statement analysis may involve
analyzing one or more of the following:

1. Industry and economic trend-----

This involves the analysis of the economic environment where the business operates. This is
necessary because the ability of a business to thrive is affected by various external factors
such as economic climate, competition, demand and supply, market rates government
regulations, technological changes, and the like.

For example, when analyzing a hotel business, one would need to analyze also the general
condition of the economy, the current state of the hotel industry, the demand and supply,
and the like. If the hotel industry is generally declining, there is a possibility that the future
earnings of the business will also decline. On the other hand, if the hotel industry is
generally booming, there is a good chance that the business will also prosper.

The financial statements of a business do not provide all the necessary information needed
in analyzing the industry and economic trend. Other information from external sources is
needed, for example, published industry averages, current events, statistical data, research
papers, financial data from key players in the industry, and the like. The financial statements
of the business are only one of the many inputs needed in this analysis.

2. Solvency and Capital structure-----------

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Solvency refers to the ability of the business to pay its debts and remain as a going concern.
Solvency can be short-term (liquidity) or long-term (solvency).

Capital structure refers to how a business efficiently finances its operations using different
sources of funds, such as debt or equity. Solvency and capital structure relates to the
stability of a business.

A= L + C
100%= ? + ?
3. Operational efficiency-------------

Operational efficiency refers to how well a business is managing its resources to maximize
earnings.

4. Profitability---------------

Profitability refers to the ability of the business to generate profit.

Limitations of Financial Statement Analysis

Financial statements and the financial ratios derived from them are but a single source of
information about a company. Like any management accounting information, financial
ratios serve only as an attention-directing device. The ratios raise questions more often
than they answer them. An analyst must follow up the financial statement analysis with in-
depth research on a company's management styles, its history and trends, the industry, and
the national and international economies in which the firm operates.

Further, as financial statements are historical costs, inflation could badly distort balance
sheets particularly depreciation charges and inventory costs which affect profit. Thus, a
ratio analysis for one firm for several periods or different companies of different ages must
be interpreted with extra care and judgement.

Several factors make financial analysis difficult. One of them is variations in accounting
methods among firms. As in the case of different methods of inventory valuations and
depreciation can lead to differences in reported profits for identical firms, and a good
financial analyst must be able to adjust for these differences so that he or she can make
valid comparisons among companies. Again, analysis will be more meaningful if we make
comparisons.

Another is timing. An action is taken at one point in time, but its full effects cannot be
accurately measured until some later period. As the cash account is the steering wheel of
every firm, the effects of the cash flow cycle could be accurately measured at a different
time. Cash could be depleted as a result of acquisition of fixed assets to boost production

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and sales activities and net income was recognized at the same period though collection of
cash again could be done at a later period.

As such, at that same period, current asset ratio may seem not good, but profit seems
better. It is also difficult to generalize whether a particular ratio is “good” or “bad”. For
instance, a high current ratio may indicate strong liquidity position which in fact illiquid
since most of its current asset is in the form of non-moving inventory or in the form of aged
accounts receivable. Even excessive cash is not good as cash itself is a non-earning asset.

Therefore, financial statement analysis must be interpreted as a whole, co-relating its

weaknesses and strengths rather individual ratios.

Methods of Financial Statement Analysis

The two methods used in analyzing financial statements are as follows:

1. Horizontal, Trend and Vertical Analyses

2. Financial ratio analysis

Horizontal Analysis

Horizontal analysis is the comparison of financial information over two or more reporting
periods. The purpose is to analyze if changes in amounts are unusually high or low, which
may entail investigation of the reason for the unusual change.

Steps in Horizontal Analysis

2020 2021
Compute for the change in the amounts in a baseline year (earlier period) and a later
period.

Divide the change by the amount in the baseline year.

Percentage Change = Most recent value – Base period value x 100

Base Period Value
Ratio= Most recent value/
Base period value
Illustration: Horizontal Analysis ex. 50,000/40,000=1.25
Base year Change
2020 2019 Amount Percentage Ratio
a Cash 50,000 40,000 10,000 25% 1.25
b Service Income 30,000 40,000 -10,000 -25% 0.75
c Accounts Payable 0 40,000 -40,000 -100% -
d Accounts Receivable -20,000 40,000 -60,000 -150% -

20 SUMAPID
e Salaries Payable -40,000 0 -40,000 - (error) - (error)
f Prepaid Expense (abnormal) -40,000 -30,000 -10,000 - -

Amount= (-40,000)- (-30,000)

= -40,000 + 30,000
=-10,000

Vertical Analysis

Vertical analysis involves the analysis of the financial statements of one reporting period. It
is a proportional analysis whereby each amount in the financial statements is shown as a
percentage of another item.

For example, each amount in the balance sheet is stated as a percentage of total assets;
each amount in the income statement is stated as a percentage of net sales. Financial
statements state( in this manner are also called "common-size financial statements. “

ABC Company
Common Size Statement of Financial Position
As of December 31, 2020

Assets
Cash P100,000 40%
Accounts Receivable 70,000 28%
Supplies 1,000 0.4%
Total Current Asset P171,000 68.4%

Office Equipment-net P79,000 31.6%

Total Assets (base amount) P250,000 100%

Liabilities
Current Liabilities
Accounts Payable P29,000 11.6%
Income Tax Payable 8,000 3.2%
Total Current Liabilities P37,000 14.8%

21 SUMAPID
Capital
ABC, Capital 213,000 85.2%

Total Liabilities and Capital (base amount) P250,000 100%

ABC Company
Common Size Income Statement
For the year ended December 31, 2020

Gross Sales P78,780 101%

Less: Sales Discount 780 1%
Net Sales (base amount) P78,000 100%
Less Cost of goods sold 31,200 40%
Gross Profit P46,800 60%
Less: Selling Expenses P15,600 20%
Administrative Expenses 23,400 30%
Total Operating Expenses 39,000 50%
Earning before interest and taxes P7,800 10%
Interest expense 1,560 2%
Earning before tax P6,240 8%
Tax Expense 1,248 1.6%
Net Income P4,992 6.4%

Trend Analysis

An extended horizontal analysis could be developed as the so-called "Trend Analysis". Trend
percentages state several years’ financial data in terms of a base year, which equals 100
percent.

2020 2019 2018 (Base year)

Sales 87,200 82,400 80,000

22 SUMAPID
 2020 2019 2018 (Base year)
Sales 109% 103% 100%

Ratio Analysis

Many related items in the balance sheet help the analyst develop his interpretation as to
the company's financial strengths and operation’s performance. Financial statements report
both the firm’s position as of a certain period and on its operations for a certain period. As
mentioned earlier, the real value of financial statements is in the fact that they can be used
to help predict the firm’s future earnings and dividends, thus, an analysis of the firm’s ratios
is generally the first step in a financial analysis. The ratios are designed to show
relationships between financial statement accounts. For instance, Company X might have
a debt of P5 million and interest charges of P400 thousand, while Company Y might have
debt of P50 million and interest charges of P4 million. Which company is stronger? The true
burden of these debts, and the companies’ ability to repay them can be ascertained.

(1) by comparing each firm’s debt to its assets and (2) by comparing the interest it must pay
to the income it has available for payment of interest. Such comparisons are what we called
ratio analysis.

The three major areas that concern the users of financial statements are:
1. Stability
2. Solvency or liquidity, and
3. Profitability.

Analyzing ratios as a whole could be more meaningful, even though they are computed
individually; the totality of it could give the final interpretation about the company's
financial and operating conditions. The following are the most common ratios used by
financial analysts:

Basic Rule
BS Amount, 12-31-20 IS Amount, 12-31-20
BS Amount, 12-31-20 IS Amount, 12-31-20

IS Amount, 12-31-20
(BS Amount, 1-1-20 + BS Amount, 12-31-20) / 2

Sales and purchase---not stated if made in cash or on credit, assumption

-Turnover (on Credit)
-Cash flow ratio (in Cash)

Operating year (360 days unless specified otherwise)

23 SUMAPID
Analyzing the Balance Sheet
Liquidity

Liquidity - will indicate whether the firm can meet its maturing obligations

1. Current Ratio= Current Assets 10= 2.0 10=0.50

Current Liabilities 5 20

This is the basic test of liquidity of the firm. This will determine the adequacy of working capital or the
ability to meet current obligations.

2. Quick/Acid Test Ratio= Quick Assets (Cash, Current Receivable and marketable securities)
Current Liabilities

Quick or acid test ratio is a more stringent test of ability to pay current obligations as they come due.
Quick assets are: Cash and cash equivalents, marketable securities, short-term notes and accounts
receivables. In this regard, inventory and prepaid expenses are not included in the computation of quick
asset ratio as inventories are typically least liquid among the current assets, while, prepaid expenses are
not convertible to cash.

3. Working Capital = Current Assets- Current Liabilities

This is the excess of current assets over current liabilities. Net Credit Sales
Given= Beginning, A.R.
Ending, A. R. (10+20)/2=15 Gross Sales- Sales Discount-
Sales returns & allowances= Net
Sales
Given= Ending, A.R. = Average Efficiency (working capital)----Asset Management
A.R. 18=18 Given= Cash 20% Credit 80%
Net Sales= 1,000,000
1. Receivable Turnover= Net Credit Sales 1000/20=50 times Net Credit Sales= 800,000

Average Receivables Not Given

Net Credit Sales= 1,000,000

This will measure the efficiency of collections. How fast collections are being made.

2. Average age of Receivables= 360 days or Average Receivable *

360/50=7.2 days Receivable Turnover (Net Credit Sales/ 360 days)
Credit terms: 30 to pay + discount--------> 1/10,n/30------ 100,000 x 0.01=1,000= 99,000

*20/ (1,000/360)= 20/ 2.78=7.2 days

This is to measure the number of days the firm invests in accounts receivable.

24 SUMAPID
3. Inventory Turnover= Cost of goods sold Beginning Inventory + Net Purchases= Total Cost of goods
available for sale- Ending inventory= Cost of goods sold
Average Inventory
Average Inventory= (Beg. Inventory + End. Inventory)/2
Similar with accounts receivable, inventory turnovers are used to determine how fast inventory were
converted into sales.

4. Average age of Inventory=360 days or Average Inventory

Inventory Turnover (Cost of goods sold/ 360 days)

This determines the number of days’ in inventory is held as stock before it will be sold. The shorter the
number of days it is held on stock, the better it will be as it means more number times it is reinvested
by the firm.

5. Normal Operating Cycle= Average age of Receivables + Average age of Inventory

cash-inventory-receivable-cash
6. Trade Payables Turnover= Net Credit Purchases
Average Trade Payables

7. Average age of Trade Payables= 360 days or Average Trade Payable

Trade Payables Turnover (Net Credit Purchases/ 360 days)

8. Cash Conversion Cycle= Average age of Receivables + Average age of Inventory - Average age of Trade Payables

Solvency and Leverage

Solvency is the ability of a company to meet its long-term debts and financial obligations.

Leverage is any technique involving using debt (borrowed funds) rather than fresh equity in
the purchase of an asset, with the expectation that the after-tax profit to equity holders from
the transaction will exceed the borrowing cost.

1. Debt Ratio= Liabilities/ Asset

25 SUMAPID
It measures up to what extent that portion of the total assets provided by the creditors

2. Equity Ratio= Equity/ Asset

It measures tobwhat extent that portion of the total assets provided by the owners. It measures the
resources provided by the owners in the business.

3. Debt to Equity= Liabilities/ Capital 40/60 67%

It provides information on the equivalent amount provided by creditors for every P1 provided by the
owners.

4. Times interest earned= EBIT/ Interest Expense

This measures the ability of the firm to meet its annual interest payments.

Net Sales- Cost Of Goods Sold= Gross Profit- Adminitrative expense- Selling expense=EBIT- Interest
Expense= EBT- Tax Expense= Net Income
ex. 50/5= 10x

Analyzing the Income Statement

Profitability

Profitability -is a measurement of efficiency – and ultimately its success or failure.

-is the ability of a company to generate income from operations.

1. Return on Sales= Income/ Net Sales (vertical analysis)

2. Return on Assets= Income/ Average Assets

3. Return on Equity= Income/ Average Equity

4. Earnings per share (EPS) = Net Income- Preferred Dividends

Weighted Average Common Outstanding Shares

Dupont model

1 10 5 1
x x =

26 SUMAPID
 10 5 2 2 or 0.5

Analyzing the Retained Earnings

Retained Earnings (RE) are the accumulated portion of a business’s profits that are not distributed
as dividends to shareholders but instead are reserved for reinvestment
back into the business.

A dividend is a distribution of profits by a corporation to its shareholders

Marketability

Marketability - is a measure of whether a product will appeal to buyers and sell at a certain price
range to generate a profit.

1. Price earnings= Price per share/ EPS

This ratio shows the peso amount investors will pay for every P1 of current earnings.

2. Dividend Yield= Dividend per share/ Price per share

This ratio measures the rate of return on actual dividend distribution to common stockholders.

3. Dividend Payout= Dividend per share/ EPS 2/10=20%

This measures the amount of dividend paid for every P1 earnings or the percentage of distributed
earnings in relation to EPS.

4. Retention Ratio= EPS- DPS 10-2/10 8/10=80%

EPS

Example:

27 SUMAPID
Given

January 1, December 31, December 31, December 31,

2020 2020 2019 2020
Cash 100,000 194,000 Sales 1,000,000 1,300,000
Marketable 20,000 20,000 Cost of Goods 400,000 520,000
securities Sold
Accounts 15,000 35,000 Gross Profit 600,000 780,000
Receivable
Inventory 60,000 68,000 Operating 500,000 660,000
Expenses
Prepayments 5,000 3,000 EBIT 100,000 130,000
Total Current 200,000 320,000 Interest 5,000 5,000
Assets Expense
Total Assets 400,000 500,000 EBT 95,000 125,000
Trade 60,000 80,000 Tax Expense 19,000 25,000
payables
Total Current 150,000 220,000 Net Income 76,000 100,000
liabilities
Total 248,000 248,000 Additional data:
Liabilities
Total Equity, 152,000 252,000 Dividend declared and paid P35,000
10,000 shares Market price of Stock P12/share
outstanding

Computation year 2020

Ratio Formula Computation Result

1. Current Ratio Current Asset / Current Liabilities 320,000/220,000 1.45
2. Quick Ratio Quick Assets/Current Liabilities 249,000/220,000 1.13
3. Net Working Capital Current Asset -Current Liabilities 320,000-220,000 100,000
4. Receivable Turnover Net Credit sales/Average 1,300,000/25,000 52 x
Receivable
5. Average age of 360/ Receivable turnover 360/52 6.9 days
Receivables
6. Inventory turnover Cost of goods sold/ Average 520,000/64,000 8.13 x
Inventory

28 SUMAPID
7. Average age of 360/ Inventory turnover 360/8.13 44.28
inventory days
8. Normal operating Average age of Receivables + 6.9 days + 44.28 days 51.18
cycle Average age of inventory days
9. Trade payables Net credit purchases/Average 528,000*/70,000 7.54 x
turnover trade payables
*cost of goods sold
+ end Inventory –
beg Inventory
10. Average age of 360/ Trade payables turnover 360/7.54 47.74
Payables days
11. Cash Conversion Average age of Receivables + 6.9 days + 44.28 days 3.44
Cycle Average age of inventory - – 47.74 days days
Average age of Payables
12. Debt ratio Liabilities/ Assets 248,000/500,000 49.6%
13. equity ratio Equity/ Assets 252,000/500,000 50.4%
14. debt to equity ratio Liabilities/ Equity 248,000/252,000 98.41%
15. Times interest EBIT/ Interest Expense 130,000/5,000 26 x
earned ratio
16.Return on sales Income/ net sales 100,000/1,300,000 7.69%
17.Return on Asset Income/ Average Asset 100,000/450,000 22.22%
18.Return on Equity Income / Average Equity 100,000/202,000 49.5%
19. EPS Income/ weighted average shares 100,000/10,000sh 10
outstanding
20. Price earnings Price per share/ Earnings per 12/10 1.2
Ratio share
21. Dividend yield ratio Dividend per share/ price per 3.5/12 0.29
share
22. Dividend payout Dividend per share/ Earnings per 3.5/10 0.35
share
23. Retention ratio Earnings per share- dividend per 6.5/10 0.65
share divided by Earnings per
share

29 SUMAPID
 Asessment
I.
TRUE-FALSE STATEMENTS. Write “True” if the statement is true and write “False” if the
statement is false.

1. Companies with relatively high rates of return on equity generally sell at higher multiples
of book value than those with low returns.

2. If the firm’s liquidity, asset management, debt management and profitability ratios are all
good, then, its market value ratios will be high, and its stock price is expected to be as high
it can be.

3. A high current asset ratio is always an indication of strong liquidity position.

4. In trend analysis, percentage figures are usually computed by using the most recent year
as a base.

5. Common-size statements are statements of companies of similar size and operations.

6. An extremely high current ratio may be an indication that receivables and inventories are
excessive.

7. Trend percentages in financial statements would be an example of vertical analysis.

8. A common-size statement is one that shows the separate items appearing on it in

percentage form, with each item stated as a percentage of some total of which that item is
a part.

9. If earnings remain unchanged and the price/earnings ratio goes up, then, one would
expect the market price of a stock to go down.

10. Investors seeking capital gains would like the dividend pay-out ratio to be high.

11. Dividing the market price of share of stock by the dividends per share gives the
price/earnings ratio.

12. In computing the dividend yield ratio, the investor should use the current market price
for the stock, rather than the price that he or she paid for it.

13. The inventory turnover is computed by dividing sales by average inventory.

30 SUMAPID
14. If a company’s return on total assets is substantially higher than its cost of borrowing,
then, the common stockholders would normally want the company to have a high
debt/equity ratio.

15. Comparisons within a company are often useful to detect changes in financial
relationships and significant trends.

16. Comparisons with other companies provide insight into a company’s competitive
position.

17. Comparisons with industry averages provide information about a company’s relative
position within the industry.

18. Horizontal analysis is a technique for evaluating financial statement data that expresses
each item in a financial statement as a percent of a base amount.

19. Comparisons of company data with industry averages provide information about a
company's relative position within the industry.

20. Horizontal, vertical, and ratio analyses are the basic tools of financial statement analysis.

21. Horizontal analysis is a technique for evaluating a financial statement item in the
current year with other items in the current year.

22. If a company has sales of P110 in 2020 and P154 in 2019, the percentage increase in
sales from 2019 to 2020 is 140%.

23. In horizontal analysis, if an item has a negative amount in the base year, and a positive
amount in the following year, no percentage change for that item can be computed.

24. A primary purpose of vertical analysis is to observe trends over a three-year period.

25. Vertical analysis is a technique for evaluating a series of financial statement data over a
period to determine the increase (decrease) that has taken place.

26. Using vertical analysis of the income statement, a company's net income as a
percentage of net sales is 10%; therefore, the cost of goods sold as a percentage of sales
must be 90%.

27. Liquidity ratios measure the ability of the enterprise to survive over a long period of
time.

28. A solvency ratio measures the income or operating success of an enterprise for a given
period.

31 SUMAPID
29. Receivable turnover is useful in assessing the profitability of receivables.

30. The inventory turnover ratio measures the number of times on average the inventory
was sold during the period.

Problem Solving:
1.From the given data, calculate the following ratios for the Salvacion Corporation for 2020.
a. current ratio (125,000+75,000+60,000+90,000)/
(74,000+40,000)=350k/114k=3.07
b. quick ratio (125,000+75,000+60,000)/(74,000+40,000)=260k/114k=2.28
c. debt to total assets ratio 185,000/469,000=0.39 or 39.45%
d. profit margin ratio 31,500/240,000=0.13 or 13.13%
CR=3.07
QR=2.28
Accounts payable P74,000
Accounts receivable 75,000
Cash 125,000
Inventory 90,000
Short-term investments 60,000
Short-term notes payable 40,000
Notes payable (due in 2022) 50,000 X
Total assets 469,000 X
Total liabilities 185,000 X
Net sales 240,000 X
Net income 31,500 X

2. Comparative information taken from the 7RS Company financial statements

is shown below:
2020 2019
(a) Accounts receivable 175,000 140,000 a. 35,000 increase 25%
(b) Retained earnings 30,000 (40,000) b. 70,000 increase -----
(c) Sales 855,000 750,000 c. 105,000 increase 14%
(d) Operating expenses 170,000 200,000 d. 30,000 decrease -15%
(e) Income taxes payable 22,000 20,000 e. 2,000 increase 10%

percentage change= (most recent value- base period value) x 100

base period value

1. Calculate the peso changes for each item and indicate whether the change is increase of
decrease
2. Calculate the percentage change from 2019 to 2020 with 2019 as the base year.

32 SUMAPID
3.
AR----- Allowance for Doubtful account------->
Gross AR 100,000 (debit)
ADA 10,000 (credit)
AR (Net) 90,000 debit
Selected information from the comparative financial statements of UrTurn Company for the
year ended December 31 appears below: 2020 2019

Instructions: Answer the following questions relating to the year ended December 31, 2020
Show computations.

1.The inventory turnover ratio for 2020 is __________. CGS/Ave.Inv=600k/140k=4.29x

Average age of Inventory= 360 days/ Inv. TO=360/4.29= 84 days or 83.92 days
2.The number of times interest earned ratio in 2020 is __________. EBIT/IE=250k/40k=6.25x
3.The receivables turnover ratio for 2020 is __________. NCS/Ave. AR=800k/187.5k=4.27x
Average age of Receivable= 360 days/ AR TO=360/4.27= 84.375 days or 84.31 days
4.The return on assets ratio for 2020 is __________. Income/Ave asset=150k/950k=15.79%
5. The current cash debt coverage ratio for 2020 is __________.

4.
The following ratios have been computed for the RMO Company for 2018.
Profit margin ratio 20%
Times interest earned 12 times
Receivable turnover ratio 5 times
Acid-test ratio 1.4:1
Current ratio 2.5:1
Debt to total assets ratio 24%

33 SUMAPID
The 2018 financial statements of the company with missing information was presented on
the next page: Use the above ratios and information from RMO Company financial
statements to fill in the missing information on the financial statements. Follow the
sequence indicated. Show computations that support your answers.

34 SUMAPID
 UNIT 4

COST-VOLUME-PROFIT ANALYSIS

Objectives
In this unit, you will learn the following:
1. Define Cost, Cost behavior Analysis
2. Segregating Mixed Cost using High Low Method
3. Differentiate Absorption method and Variable method
4. Definition the Contribution margin Income Statement
5. Differentiate Gross profit from Contribution margin
6. Define the interrelationship between cost, volume and profit
7. Computation of Break even point and margin of safety

COST - the monetary amount of the resources given up or sacrificed to attain some objective such as
acquiring goods and services. When notified by a term that defines the purpose, cost becomes
operational (e.g., acquisition cost; production cost; cost of goods sold).

COST BEHAVIOR ANALYSIS

Cost behavior is the relationship between cost and activity-------- as to how costs react to changes in an
activity like production. As production increases, some costs remain the same (i.e., fixed) while some
costs increase or decrease (i.e., variable). Consider the following (assuming activity is based on
production):
COST TOTAL amount PER UNIT amount
1. FIXED (Rent Expense) Constant (P20,000) P20,000/ 1,000 units= P20 per unit
(Depreciation Expense)
(Monthly Salary) P20,000/ 2,000 units= P10 per unit
Advertising Expense)
Decreases as production increases (
Inverse relationship)

2. VARIABLE (Raw Materials) Increases as production Constant

(Direct Labor) increases (direct relationship)
(Commission Expenses) P100 pesos Raw Materials per unit
(Indirect Materials) 10,000 raw mats x P100= 2 hours per unit at P47 per hour
(Utilities Expense) P1,000,000 5% of sales

12,000 raw mats x P100=

P1,200,000
3. MIXED (Semi- variable) Increases less proportionately Decreases less proportionately (vs
(vs Total variable costs) as unit fixed costs) as production

35 SUMAPID
 production increases increases

Fixed costs are merely allocated to products, while variable costs are traced to products.
Fixed costs are costs that have been or will be incurred regardless of volume of production.

Example:
(A) Fixed Cost P1M, 500,000 units produced, Fixed cost will be allocated to 500,000 units,
therefor fixed cost per unit is P2.00

(B) Fixed Cost P1M, 1,000,000 units produced, Fixed cost will be allocated to 1,000,000
units, therefor fixed cost per unit is P1.00

On the other hand, variable cost are incurred specifically because there is activity. When
products are produced , manufacturing costs are incurred. Had there been no activity, these
costs would not have been incurred. Thus these costs that have been incurred are
associated with the products that were created because these costs were incurred. These is
the concept of tracing. Usually the costs of making and selling a product are already
standardized, and thus, variable cost per product remain constant.

Example:
Manufacturing cost per unit is P100
(A) If a company produced 100,000 units, Manufacturing costs is P10,000,000
(B) If a company produced 50,000 units, Manufacturing costs is P5,000,000.

36 SUMAPID
Mixed costs= is a cost with Variable cost and fixed costs components.

37 SUMAPID
Example:
AAA Company manufactures and sells a Single product. A partially completed schedule of the
company's total and per unit costs over a relevant range of 60 to 100 units produced each year is given
below:

Units Produced
(I) 60 units (II) 80 units (III) 100 units
TOTAL COSTS
(A) Variable Costs P120 P ? 160 <1> P? 200 <3> P2x100U
(B) Fixed Costs ? P600 <2> P600 ? P600 <1>
(C) TOTAL COSTS P? 720 <4> P? 760 <2> P? 800 <5>

PER UNIT COSTS

(D) Variable Costs ? P2=P120/60U <1> P2 ? 2 <2>
(E) Fixed Costs ? 10=P600/60U <3> ? 7.5 <3> ? 6 <4> P600/100U
REQUIRED:
1. Determine the correct amounts of those with (?) mark.
2. Which two (2) specific costs remain constant over the relevant range? TFC and VC/U
3. Which two (2) specific costs are directly related with production? TVC and TC
4. Which specific cost is inversely related with production? FC/U
5. Express the cost formula based on the line equation form 'Y =a + bX.'
Y=600 + 2(X)
6. If the company produces 90 units, then how much is the expected total costs?
Y= P600 + P2x
Y= P600 + P2 (90)
Y= P600 + P180
Y= P780

COST BEHAVIOR ASSUMPTIONS and LIMITATIONS

1. RELEVANT RANGE Assumption

Relevant range refers to the range of activity within which the cost behavior patterns are valid. Any
level of activity outside this range (outlier) may show a different cost behavior pattern.

2. TIME Assumption

The cost behavior patterns identified are true only over a specified period of time. Beyond this, the
cost may show a different cost behavior pattern.

38 SUMAPID
3. LINEARITY Assumption

The cost is assumed to manifest a linear relationship over a relevant range despite its tendency to
show otherwise over the long run.

COST ESTIMATION: SEGREGATING VARIABLE AND FIXED COSTS

1. HIGH-LOW POINTS Method

The fixed and variable portions of the mixed costs are computed from two sampled data points the
highest and lowest points based on activity or cost driver.

Variable cost per unit (b) = Change in Cost% (YH -YL)

Change In Activity (XH - XL)

Example:
The controller of BBB Hospital would like to come up with a cost formula that links Admitting
Department cost to the number of patients admitted during a month. The Admitting Department's costs
and the number of patients admitted during the past nine months follow:
MONTH NUMBER OF PATIENTS COST
April 18 15,600
May 19 (Highest point) 15,200
June 17 13,700
July 15 14,600
August 15 14,300
September 11 13,200
October 11 (Lowest Point) 12,800
November 48 (deviant/Outlier) X 72,500
December 16 14,000

REQUIRED: Using the high-low method, determine:

1.Variable cost per unit P300

Variable cost per unit (b)= 15,200 – 12,800 =2,400 =P300

19-11 8

2. Annual fixed costs P114,000=P9,500 x 12 months

15,200=A + P300(19)= P9,500 12,800= A + P300(11)= P9,500

39 SUMAPID
3. Monthly cost function y= 9,500 + P300x
4. Department's estimated cost assuming 14 patients will be admitted next month.

y=P9,500 + P300 (14)

y= P9,500 + P4,200
y= P13,700

40 SUMAPID
 ABSORPTION & VARIABLE COSTING

Absorption Costing - is a costing method that includes all manufacturing costs-----direct

(Full costing) materials, direct labor, variable and fixed factory overhead---in the cost of
a unit of product. It treats fixed factory overhead (FFOH) as a product
cost.

Variable Costing - is a method that includes only variable manufacturing costs-------direct

(Direct costing) materials, direct labor, and variable overhead-----in the cost of a unit of
product. It treats FFOH as a period cost.

PRODUCT vs. PERIOD cost

A product cost is an inventoriable cost that is subject to allocation between sold and unsold units.
Current income is reduced only by the amount allocated to the sold units. Consider the following
allocation:

Unsold units (asset--- Inventory)

Product Cost Sold units ( Expense----- cost of goods sold)

A period cost is a cost that is charged as expense against income, regardless of sales performance. No
Allocation is necessary; current income is reduced by the full amount of the period cost.

Fully Expensed in the period incurred, regardless

Period Cost of sales

EXAMPLE:
1. AAA Company makes state-of-the- art toy car. Each toy car sells for P 1,000 each. Data for 2020's
operations are as follows:

Units: Variable Costs:

Beginning Inventory 5 Direct Materials 18,000
Production 60
Sold units 50 units Direct labor 12,000
Ending Inventory 15 Factory Overhead 6,000
Selling and Administrative 2,000
Fixed Costs:
Factory Overhead 15,000
Selling and Administrative 1,000
REQUIRED:

41 SUMAPID
1. Determine the inventory cost per unit under:
Product Cost=
A) Absorption costing
Inventory Cost
B) Variable costing
Total Cost Absorption cost per unit Variable cost per unit
DM 18,000/60 u 300 300
DL 12,000/ 60 u 200 200
VFOH 6,000/ 60 u 100 100
FFOH 15,000/ 60 u 250 -
TOTAL 51,000 850 600
2. Determine the total cost of ending inventory under:
A) Absorption costing 850 x 15 units = P12,750

B) Variable costing 600 x 15 units = P9,000

3. Prepare income statements under

A) Absorption costing

B) Variable costing

Absorption Costing Variable Costing

Sales 50u x P1,000 50,000 Sales 50,000
Cost of sales 50u xP850 -42,500 Variable Cost (50 xP600= -32,000
P30,000) + P2,000
Gross Profit 7,500 Contribution Margin 18,000
Operating Expenses -3,000 Fixed Cost -16,000
Net Income 4,500 Profit 2,000

4. how much is the difference in income between the 2 costing methods

4,500 – 2,000= 2,500

- 1,250 (beg) -3,750 (end) = 2,500

een the 2 costing methods?

CVP analysis is useful for profit planning by way of a systematic analysis of the profit's
relationship with various costs and volume of sales.

FACTORS AFFECTING PROFIT

42 SUMAPID
 If there is an increase in.... Then Profit tends to.......
1. Selling price Increase
2. Unit Variable cost Decrease
3. Fixed cost Decrease
4. Volume (Unit Sales) Increase

In multi-product companies, a change in sales mix may also affect company profit.

LIMITATIONS and ASSUMPTIONS of CVP analysis

1. Relevant range, time and linearity assumptions COST BEHAVIOR ANALYSIS are also assumed in
CVP analysis.
2. Unless indicated otherwise, unit selling price is constant even if sales volume changes.
3. Inventories do not change significantly from period to period.
4. In case of a multi-product company, sales mix is constant.
5. Labor productivity, production technology and market conditions remain stable.

TERMINOLOGIES USED IN CVP ANALYSIS

1. Contribution Margin (CM) is the difference between sales and variable cost. It is otherwise known as
marginal income, profit contribution, contribution to fixed cost or incremental contribution.

CM Ratio = CM / Sales = Unit CM/ Unit SP= change in CM/ Change in Sales

Sales 100% 100

Less: Variable Cost 40/100=0.40 or 40% -40
Contribution margin 60/100=0.60 or 60% 60
Less: Fixed Cost -20
Net Income before interest and taxes 40

2. Break-Even Point (BEP) - a level of activity, in units (break-even volume) or in pesos (break-even
sales), at which total revenues equal total costs. At the break-even point, there is neither a profit nor a
loss.

1A. BEP units = Total Fixed Costs / CM per unit

2A. BEP peso sales= Total Fixed Costs / CM Ratio

1B. Unit Sales With Target Profit = (Fixed Costs + Profit* ) / CM per Unit
2B. Peso Sales with Target Return on Sales = Fixed Costs/ (CM Ratio- Return on Sales)

* Profit must be expressed before tax: Profit after tax/ (100% - tax rate)

43 SUMAPID
3. Margin of Safety (MOS)- the difference between actual sales and break-even sales. It indicates the
maximum amount by which sales could decline without incurring a loss.

Margin of Safety = Sales — Breakeven Sales

Margin of Safety Ratio= Margin of Safety / Sales

4. Indifference Point — the level of volume at which two alternatives being analyzed would yield equal
amount of total costs or profits.

Alternative A Alternative B

1. (Unit CM x Q) - Fixed Cost = (Unit CM x Q) - Fixed Cost

2. Fixed Cost + (Unit VC x Q) = Fixed Cost + (Unit VC x Q)

NOTE: Q number of units (indifference point)

5. Sales Mix- the relative combination of quantities of sales of various products that make up the total
sales of a company

Over-all BEP in units = Fixed Costs / Weighted Average CM per unit

Over-all BEP peso sales= Fixed Costs / Weighted Average CM Ratio

6. Degree of Operating Leverage (DOL)- measures how a percentage change in sales will affect
company profits. It indicates how sensitive the company if sales volume increases and decreases. It is
also known as operating leverage factor.

DOL = Contribution margin / Profit before tax

change in % of sales x DOL = change in % profit before tax

Example 1:
AAA Company manufactures and sells a single product. The company's sales and expenses for a recent
month follows:
per unit
Sales (1,500 units) P 37,500 25 100%
Less: Variable Costs 15,000 -10 40% (10/25x100)
Contribution Margin P 22,500 /1,500 u= P15 15 60% (15/25 x100)
Less: Fixed Costs 15,000
Profit P 7,500

REQUIRED:
1. Determine the following:
A.Unit selling price 37,500/1,500=P25

44 SUMAPID
B. Unit variable cost 15,000/1,500=P10
C. Contribution margin ratio (CMR) 22,500/37,500 =0.60 x 100=60% or 15/25=0.60 x 100= 60%

2. For profit planning purposes, compute the following:

A) Break-even point in units = Total Fixed Cost/ CM per unit=15,000/15=1,000 units x P25= P25,000
B) Break-even point in peso sales = Total Fixed Cost/ CM ratio= 15,000/0.60=P25,000

3. What unit sales are required to earn P 6,000 profit for the month?
Unit Sales With Target Profit = (Fixed Costs + Profit* ) / CM per Unit
(15,000 + 6,000)/15= 1,400 units

4. What peso sales are required to earn an after-tax profit of P 3,750 (assuming tax rate is 25%)?
Peso Sales With Target Profit = (Fixed Costs + Profit* ) / CM ratio
P15,000 + (P3,750/.75) / 0.60 = P33,333
P5,000
100%-25% tax
To prove:
rate= 75%
Before Tax Income P5,000
Less: Tax 25% x P5,000 -1,250
After Tax Income P3,750
---------------------------------------------------------
Sales 100% P33,333
Less: Variable cost 40% -13,333
Contribution Margin 60% P20,000
Less: Fixed Cost -15,000
Net Income before tax P5,000
Less: Tax 25% x 5,000 -1,250
After Tax Net Income P3,750

5. Assume that AAA is currently selling 800 units per month and that the company president believes
that sales would increase if advertising were increased by P 6,000. How many units should sales
increase to give AAA the same profit or loss that it is currently earning?
Breakeven Point in units= Fixed costs/ CM per unit= P6,000/15=400 units

to prove: (SRP, VC per unit, CM per unit, Total Fixed cost, Sales mix---->Constant)

Sales P25x 400 u= P10,000

VC 10x400 u= - 4,000
CM = 6,000
FC - 6,000
Ni/Nl 0

6. What is the margin of safety at its present sales of P 37,500?

Margin of safety= Actual sales- Breakeven sales= 37,500-25,000= P12,500

45 SUMAPID
To prove: Break even Margin of safety
Sales 100% P25,000 (1,000 units) 12,500
Variable cost 40% (10 x 1,000u),(10 x 500u) -10,000 -5,000
Contribution margin 60% 15,000 7,500
Fixed cost -15,000 0
Net income 0 7,500

7. AAA currently pays its salespeople a monthly salary of P 4,000 per month without any commission.
However, the company considers a plan whereby the salespeople would receive a 10% commission, but
the monthly salary would fall to P 2,500. What sales level will the company be indifferent between the
two compensation plans?

---->Monthly fixed cost will decrease by P 1,500 under the proposal (P 4,000 ----> P 2,500).
15,000-1,500=13,500
---->Unit variable cost increases by P 2.50 =(10% of P 25) ---10+2.5= 12.50 unit VC

Based on cost function "Y = a + bX"

Costs (old) = Costs (new)
1 15,000 + 10x = 13,500 +12.5x
15,000-13,500= 12.5x -10x
1,500= 2.5x
1,500/2.5= x
x = 600 units

Based on Income Statement format CM- FC= Net Income

2 15X-15,000=12.5x-13,500
15x-12.5x=15,000-13,500
2.5x=1,500
x=600 units

To proved:
4,000= 2,500 + (600ux25x10%)
4,000= 2,500 + 1,500
4,000=4,000

PROVING:

Contribution margin ratio x Margin of safety ratio= Net profit ratio

Where:
CMR= CM/Sales
MOSR= MOS/Sales

46 SUMAPID
 NPR= Profit /Sales

Example 2:
BBB's break-even sales are P 528,000. The variable cost ratio is 60% while the profit ratio is 8%.

REQUIRED: Determine the following:

1. Fixed Costs 528,000 x 0.40= P211,200
2. Sales
Peso Sales with Target Return on Sales = Fixed Costs/ (CM Ratio- Return on Sales)
211,200/ 40%-8%= 211,200/ 0.32= P660,000
3. Profit P660,000 x 8%= 52,800
4. Margin of Safety P660,000-528,000= P132,000
5. Margin of Safety Ratio P132k/ P660k= 20% or
Contribution margin ratio x Margin of safety ratio= Net profit ratio
CMR x MOSR= NPR
40% x MOSR = 8%
MOSR= 8%/40%
MOSR= 20%

Break even Margin of safety

Sales 100% 660,000-528,000 528,000 132,000
Variable cost 60% -316,800 (2) -79,200
Contribution margin 40% (1) 211,200 (3) 52,800
Fixed cost 211,200 (4, equal to CM) 0
Net income 8% 0 52,800

Example 3:
CCC Company produces two products, tables and chairs. Following is next month's income budget:
Chairs Tables Total
Unit Sales (sales mix) 60 u 80% 15 u 20% 75 u 100%
Sales P1,200 P187.50 P1,387.50
Variable Cost 1,050 112.5 1,162.50
Contribution margin P150/60 u=2.5 P75/15=5 P225
Fixed costs 90
Profit P135

47 SUMAPID
REQUIRED:
A. How many units of chairs should be sold next month to breakeven?

Chairs Tables
CM/unit 2.50 5.00
Sales mix x80% x20%
Weighted average CM/ unit P3.00 2 1

Over-all BEP in units = Fixed Costs / Weighted Average CM per unit= P90/ 3= 30 units

Chairs 80% x 30 units= 24 chairs

Tables 20% x 30 units= 6 tables

B. How many units of tables should be sold to earn a profit of P 180?

Units with desired profit= (Fixed Costs + Profit) / Weighted Average CM per unit= (P90 + P180)/ 3=90
units
Chairs 80% x 90 units= 72 chairs
Tables 20% x 90 units= 18 tables

Example 4:
DDD has recently opened the G n G Fitness Gym being offered exclusively for malnourished
millennials.

The income statement for its first year of operations

Sales P 250,000
Variable Costs (100,000)
Contribution Margin P 150,000
Fixed Costs (120,000)
Profit P 30,000

DDD is unhappy about the results of his gym’s first year of operations. He observed that despite the
high contribution margin, profit was still low because of the high fixed costs. He concludes that an
increase in sales would not yield a satisfactory increase in profit.
REQUIRED:
A. Explain to DDD that his conclusion is not right by computing the operating leverage factor.
DOL = CM/ Profit before tax
=150,000/ 30,000
=5 times

B. If sales increase by 10%, then how many percent would profit increase?
change in % of sales x DOL = change in % profit before tax
10% x 5 = 50%

To prove:

48 SUMAPID
 100% +10%
Sales, VC & Sales 250,000 275,000
CM =Direct
relationship Variable Cost -100,000 -110,000
in volume
Contribution Margin 150,000 165,000
Fixed cost -120,000 -120,000
Profit 30,000 45,000

45,000- 30,000= 15,000

Percentage change= 15,000/ 30,000 x 100= 50%

Example 5:
Star Company plans to sell 400,000 unit. The fixed costs are P600,000 and variable costs is 60% of the
selling price. If the company wants to realize a profit of 120,000. How much would be the selling price
per unit?

600,000 + 120,000 / 0.40 =P1,800,000 / 400,000 units= P4.50 selling price per unit

OR

Sales 100% (3) 720,000/40% (4) P1,800,000 /400,000 units= P4.50

-Variable Cost 60% (5) 1,080,000
Contribution margin (1) 600k + 120K (2) 100%-60%= 40% 720,000
-Fixed cost -600,000
Net Income 120,000

49 SUMAPID
ASSESSMENT

True or False
1. The breakeven point in pesos can be determined by multiplying break even in units by the selling
price.
2. Decreasing the selling price decreases the break-even point
3. The margin of safety is computed by subtracting fixed costs from sales.
4. Break-even point in units is computed by dividing the total fixed costs by the contribution margin
ratio.
5. Contribution margin and gross profit are synonymous.
6. The break-even point is the volume of sales at which total revenues equal total expenses,
resulting in neither profit nor loss.
7. It is impossible to obtain a break-even point with a negative contribution margin.
8. Sales less variable costs equals profit.
9. If the contribution margin is equal to fixed cost, the result is breakeven point.
10. In break-even point, there is neither profit nor loss.
11. If the contribution margin is greater than fixed costs; the result is a loss.
12 Contribution margin per unit is equal to selling price per unit less variable cost per unit. .
13. If the contribution margin is less than fixed costs, the result is profit.
14. Contribution margin ratio is contribution margin divided by sales.
15. Fixed cost is fixed in total but variable per unit.
16. Variable cost is variable in total but fixed per unit.
17. Variable cost ratio is variable cost divided by sales.
18. Break-even point in units can be obtained by dividing break-even point in pesos by the variable
cost per unit.
19. Variable costs are constant in total within the relevant range.
20. Fixed costs change proportionately with volume within the relevant range.

Problem Solving. No solution, No point.

1. AAA Company is planning to market a new product. The company estimates that it can sell 9,000
units for the first year of operation. Unit selling price is P50 with variable cost estimated as 60% of
the sales price. Estimated total fixed cost is P40,000.

Required: Compute the following:

1. break even point in units

2. break even point in peso sales

2. BBB Company produces and sells a single product. The selling price is P25 and the variable costs is
P15 per unit. The corporation’s fixed costs amounted to P100,000 per month. Average monthly sales
is 11,000 units.

Required: Compute th following:

1. Contribution margin per unit
2. Contribution margin ratio
3. Break even point in units
4. Break even point in peso sales
5. Sales in pesos to earn a profit of P20,000 before tax

50 SUMAPID
6. Sales in units to earn a profit a P2 per unit
7. Margin of safety in pesos
8. Margin of safety in units
9. Compute the Operating Leverage
10. If sales increase by 10%, then how many percent would profit increase?

3. A company sells two products, A and B. Three units of Product A are sold for every two unts of
Product B. Fixed costs amounted to P234,000 per year. Product A is sold for P20 per unit, and the
variable costs identified with the production and sale of each unit os the product amounts to P14.
Product B is sold for P240 per unit, and the variable costs identified with the production and sale of
the product amounts to P20. Compute the break even point in pesos and in units of Product A and
B.

51 SUMAPID
 UNIT V

MASTER BUDGET

Objectives
In this unit, you will learn the following:
1. Definition of Budget
2. Advantage and Limitations of Budgeting
3. Differentiate Operating and Financial Budget
4. Preparation of Master Budget

BUDGET - is a detailed plan, expressed in quantitative terms, about business operations for a
specific period;

- a budget is a useful tool for planning and controlling company expenses, cash
flows and earnings.

- The term budgeting is used to denote the process of coming up with budgets.

ADVANTAGES & LIMITATIONS OF BUDGETING

Uses/ Advantages of Budgeting

1. It forces managers to plan for the future.
2. It provides a means of communicating management's plans throughout the entity.
3. It directs the activities toward the achievement of organizational goals.
4. It coordinates the activities of the entire entity by integrating plans of various parts.
5. It provides a means of allocating resources to segments efficiently and effectively.
6. It defines goals that serve as benchmarks for evaluating subsequent performance.

Limitations of Budgeting
1. Considerable time and costs are required
2. Budgets are merely estimates that require judgement and might be modified or revised if necessary
3. A successful budgetary system requires cooperation of all members of the organization
4. Budgets sometimes restrict the flexibility of the decision-making process
5. The budget program is merely a guide, not a substitute for good management ability

THE MASTER BUDGET - is a comprehensive budget that consolidates the overall plan of the
(pro forma budget organization for a specific period.
, planning budget,
forecast budget, - is composed of (1) operating budgets and (2) financial budgets
master profit plan)

52 SUMAPID
 MASTER BUDGET
OPERATING BUDGET FINANCIAL BUDGET
1. Sales Budget 1. Cash budget
2. Production budget 2. Budgeted Balance Sheet
-Direct materials budget 3. Budgeted Cash Flows statement
-Direct labor budget 4. Capital expenditure budget
-Factory overhead budget 5. Working capital budget
3. Budgeted cost of goods sold
4. Budgeted operating expenses
5. Budgeted net income
6. Budgeted income statement
TERMINOLOGIES USED IN BUDGETING

FIXED BUDGET - A budget prepared for a one level of activity within a certain
period. (other term: static budget)

FLEXIBLE BUDGET - A budget prepared for different levels of activity within a certain
period. (other terms: variable budget, sliding scale budget)

CONTINUOUS - A 12-month budget that rolls forward one month as the current
BUDGET month is completed

ZERO-BASED - A method of budgeting in which managers are required to justify

BUDGETING all costs as if the programs involved were being proposed for the
first time

IMPOSED - A process wherein budgets are prepared by top management with

BUDGETING little or no inputs from operating personnel

PARTICIPATORY - A process wherein budgets are developed through joint decisions

BUDGETING by top management and operating personnel

BUDGET COMMITTE - A group of key management person responsible for over-all

policy matters relating to the budget program and for coordinating
the budget preparation

BUDGET MANUAL - this describe how a budget is prepared and includes a planning
calendar and distribution instructions for all budget schedules

EXAMPLE 1:

53 SUMAPID
AAA Company has budgeted sales at P 100,000 and expects a profit of 10% of the sales. Expenses are
as follows: selling is 10% of sales; administrative is 15% of sales. Labor is expected to be 40% of the
total manufacturing costs. Factory overhead is to be applied at 75% of direct labor costs. Inventories
are to be as follows:

January 1 December 31
Materials P 4,000 + ? 19,250 P 1,500 + 21,750
Work-in-process 2,500 + TMC 72,500 5,000 + FG 70,000
Finished goods 3,000 +? 70,000 8,000 +65,000

REQUIRED: Determine the following:

1. Cost of goods sold 65,000=100,000- (10,000+15,000+10,000)

Sales – Gross Profit= COGS

Sales – COGS= Gross profit-Opex= NI
GP=NI + OPEX
GP= 10,000 + 25,000
GP=35,000
Sales-COGS=GP
100,000-COGS=35,000
COGS=100,000-35,000
COGS= 65,000

Beg Inv + Net Purchases=Total good available for sale- End Inv. = COGS

2. Total manufacturing cost 72,500=65,000+8,000-3,000+5,000-2,500

TMC= CGS + Ending Inv of FG - Beg Inv of FG + End Inv of WIP – Beg Inv of WIP

3. Factory overhead 21,750=72,500*.4*.75

Direct Labor=29,000= 72,500 X 40%

Direct Materials= 72,500-21,750-29,000=21,750

4. Materials purchases 19,250=72,500-29,000-21,750+1,500-4,000

Example 2:
Past collections experienced by BBB Company indicate that 60% of the net sales billed in a month are
collected during the month of sales, 30% are collected in the following month, and 10% are collected in
the second following month. A record of monthly net sales of previous months is as follows:

54 SUMAPID
2018 November P450,000 2019 March P500,000
December P460,000 April P550,000
2019 January P480,000 May P600,000
February P420,000 June P700,000

On January 1, 2019, the accounts receivable balance showed P 229,000.

REQUIRED: Determine the following:

A. Cash collections on account receivable during:
1. January 2019
November P450,000 X 10% P 45,000
December P460,000 X 30% 138,000
January P480,000 X 60% 288,000
Total Collection P471,000

2. March 2019
January P480,000 X 10% P 48,000
February P420,000 X 30% 126,000
March P500,000 X 60% 300,000
Total Collection P474,000

3. May 2019

March P500,000 X 10% P 50,000

April P550,000 X 30% 165,000
May P600,000 X 60% 360,000
Total Collection P575,000

B. Accounts Receivable balance at the end of:

4. February 2019
5. April 2019
6. June 2019

55 SUMAPID
 January February March April May June
AR, beginning P229,000 P238,000 P216,000 P242,000 P270,000 P295,000
+ net sales 480,000 420,000 500,000 550,000 600,000 700,000
- collections -471,000 -442,000 -474,000 -522,000 -575,000 -655,000
AR, ending P238,000 P216,000 P242,000 P270,000 P295,000 P340,000

Example 3:
The sales manager of CCC Company has budgeted the following sales for the 3rd quarter of 2019:
July P 123,500 /1.3 = 95,000 + 28,500 mark up (30%)
August 156,000 /1.3 = 120,000 + 36,000 mark-up (30%)
September 208,000 /1.3 = 160,000 + 48,000 mark up (30%)

Other budgeted estimates are:

*All merchandises are to sell at its invoice cost plus 30% mark-up.
*Beginning inventories of each month are budgeted at 40% of that particular month's projected cost of
goods sold.

REQUIRED: Determine the following:

1. Projected merchandise purchases for the month of July.

Ending Inventory (156,000/1.3 x40%) P48,000

COGS-July( 123,500/1.3) + 95,000
Less: Beg Inventory (123,500/1.3x40%) -38,000
Purchases-July P105,000

Beg Inv + Net Purchases=Total good available for sale- End Inv. = COGS
Net Purchases= End Inv + COGS – Beg Inv

2. Projected merchandise purchases for the month of August.

Ending Inventory (208,000/1.3 x40%) P64,000

COGS-August ( 156,000/1.3) 120,000
Less: Beg Inventory (156,000/1.3x40%) -48,000
Purchases-August P136,000

Example 4:
The following information taken from DDD Corporation's accounting records for the recent year. These
data would be used as the basis for the next year's cash budget,

56 SUMAPID
A. Customer sales receipts for P 870,000
B. Purchased machinery and equipment for P 125,000 cash.
C. Settled income taxes of P 110,000
D. Sold investment securities for P 500,000
E. Paid dividends of P 600,000
F. Received rentals of P105,000
G.Issued 500 shares of common stock for P 250,000
H. Paid a sum of P 100,000 due to suppliers and payroll to employees.
I. Purchased real estate for P 550,000 cash that was borrowed from a bank.
J. Paid P 450,000 for treasury shares.

REQUIRED: Determine the following:

1. Net cash provided by operating activities. 765,000= 870,000-110,000+105,000-100,000
2. Net cash used in investing activities. -175,000 = -125,000+ 500,000 – 550,000
3. Net cash used in financing activities. -250,00 0 = -600,000 +250,000 +550,000 – 450,000
4. Net cash increase or decrease. +340,000

57 SUMAPID
 Assessment

1. The Starting point in preparing a comprehensive budget is the

a. sales forecast b. cash budget
c. budgeted income statement d. flexible expense budget

2. Budgets are related to which of the following management functions?

a. Planning b. Control
c. Performance evaluation d. All of the above

3. Which of the following is not an operating budget?

a. sales budget b. production budget
c. purchases budget d. capital budget

4. The master budget usually includes

a. an operating budget b. a capital budget
c. pro forma financial statements d. All of the above

5. The following are forecasts of sales and purchases for a company.

Sales Purchases
April P 80,000 P30,000
May 90,000 40,000
June 85,000 30,000

All sales are on credit. Records show that 70 percent of the customers pay the month of the sale,
20percentpaythe month after the sale, and the remaining 10 percent pay the second month after
the sale.Purchasesareallpaidthefollowing monthat a 2 percent discount. Cash disbursements for
operating expenses in June were P5,000.

Instructions: Prepare a schedule of cash receipts and disbursements for June.

6. AAA Company desires an ending inventory of P 120,000, It expects sales of P 240,000 and has a
beginning inventory of P 80.000. Cost of sales is 60% of sales. Budgeted purchases are __________

7. BBB Company budgeted purchases of P 200,000, Cost of sales was P 240,000 and the desired
ending inventory was P84,000. The beginning inventory was _________________

58 SUMAPID
8. CCC Company budgeted purchases of 20,000 units. The budgeted beginning inventory was 4,800
units and the budgeted ending inventory was 6,000 units. Budgeted sales were_______________

9. DDD Company budgeted sales of 18,000 units. - The budgeted beginning inventory was 3,000
units and the budgeted ending inventory was 5,000 units ... Budgeted purchases are__________

10. Pilar Company desires an ending inventory of P 70,000. . It expects sales of P 400,000 and has a
beginning inventory of P 65.000. Cost of sales is 65% of sales, Budgeted purchases are___________

59 SUMAPID