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IB Year 2 Quarter 2 Financial and management Decisisons Summary
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A short but handy summary of the topics/chapters for the upcoming financial and management desicisions exam.
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Financial and management decisions summary (Y2Q2)Chapter 3 (104-123)
Measurement of cost behaviour: Understanding and quantifying how activities of an organization
affect its levels of cost
Linear-cost behaviour: Activity that can be graphed with a straight line because costs are assumed
to be either fixed or variable
Capacity cost: The fixed costs of being able to achieve a desired level of production or to provide a
desired level of service while maintaining product or service attributes, such as quality.
Committed fixed costs: Costs arising from the possession of facilities, equipment, and a basic
organization
Discretionary fixed costs: Costs determined by management as part of the periodic planning process
in order to meet the organization’s goals. They have no obvious relationship with levels of capacity or
output activity.
Cost measurement: estimating or predicting costs as a function of appropriate cost drivers
Cost function: An algebraic equation used by managers to describe the relationship between a cost
an its cost drivers.
Monthly facilities maintenance department costs = monthly fixed maintenance cost + monthly variable
maintenance cost
“ = monthly fixed maintenance cost + ( variable cost per patient day x number of patient days in the
month)
Y = F + VX
Y = monthly facilities maintenance department cost
F= monthly fixed maintenance cost
V = variable costs per patient day
X = cost-driver activity in number of patient days per month
Activity analysis: The process of identifying appropriate cost drivers and their effects on the cot of
making a product or providing a service.
Methods of measuring cost functions:
1. Engineering analysis: The systematic review of materials, supplies, labour, support
services, and facilities
2. Account analysis: Classifying each account as a variable cost or as a fixed cost with respect
to a selected cost driver
3. High-low method; A simple method for measuring a linear-cost function from past cost data,
focussing on the highest-activity and lowest activity points, and fitting a line through these two
points
4. Visual-fit method: A method in which the cost analyst visually fits a straight line thoh a plot of
all the available data
5. Least-squares regression (regression analysis): Measuring a cost function objectively by
using statistics to fit a cost function to all the data
- Coefficient of determination (R2): A measurement of how much of the fluctuation of a
cost is explained by changes in the cost driver
Chapter 7
, The word budget primarily with limitations on spending. However, budgeting can play a much more
important role than simply limiting spending. Well-managed organizations make budgeting an integral
part of the formulation and execution of their strategy.
We define budgeting as a quantitative expression of a plan of action. Sometimes plans are informal,
perhaps even unwritten, and informal plans sometimes work in a small organization. However, as an
organization grows, seat-of-the-pants planning is not enough. Budget impose the formal structure (a
budgetary system) that is needed for all but the smallest organizations. There are numerous
examples of healthy businesses that failed because managers did not bother to construct budgets
that would have identified problems in advance or they failed to monitor and adjust budgets to
changing conditions. Despite this there will always be a debate about costs and benefits of budgeting,
as indicated in the Business First box (page 290), the vast majority of managers continue to use
budgeting as an effective cost-management tool.
Advantages of Budgeting
Budgeting is the process of formulating an organization’s plans. We will discuss four major
advantages of effective budgeting:
1. Budgeting compels managers to think ahead by formulating their responsibilities for planning
2. Budgeting provides an opportunity for managers to re-evaluate existing activities and evaluate
possible new activities
3. Budgeting aids managers in communicating objectives and coordinating actions across the
organization
4. Budgeting provides benchmarks to evaluate subsequent performance
Formalization of planning
budgeting forces managers to devote time to planning. As a manager, on a day-to-day basis it is
mostly about the problems at the moment and leaves no time to think about the future. As a result,
planning takes a backseat to, or is obliterated by, daily pressure. The budgeting process formalizes
the need to anticipate ad prepare for changing conditions.
To prepare a budget, a manager should set objectives and establish policies to aid their achievement.
The objectives are the destination point, and budgets are the road maps guiding us in those
destinations. In absence of goals and objectives, results are difficult to interpret, managers do not
foresee problems, and company operations lack direction
Evaluation of activities
budgeting typically uses the current activities of the organization as a starting point for planning, but
how managers use this starting pint varies widely.
- At one extreme, the budget process automatically assumes that activities for the new budget
period will be the same as the activities for the previous period.
- At the other extreme some organizations use a form of zero-base budget (a budget that
requires justification of expenditures for every activity, including continuing activities), which starts with
the assumption that current activities will not automatically be continued. The advantages of using a
zero base system is that managers re-evaluate all activities each new budget (including whether
existing activities should be continued.
In practice, budgeting for most organizations falls somewhere between those extremes. An effective
budget process encourages managers to think carefully about whether to continue current activities
and methods, whether there are opportunities to modify activities, and whether to add new activities to
help the organizations better achieve its goals in response to changing conditions. Used in this way
encourages managers to review whether a particular plan allocates resources optimally among the
firm’s various activities.
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