Chartered Global Management Accountant (CGMA) Performance Pillar: Cost, Decision-Making, and Risk Management Flashcards

24 sample cards from the Performance Pillar: Cost, Decision-Making, and Risk Management deck

Sampled from the end of the deck, so these are different cards from the ones shown on the syllabus page.

1. What is interdependence of variances? Give an example.

   It is when one variance is causally linked to another, so they should be interpreted together rather than in isolation. Example: buying cheaper, lower-quality material gives a favorable price variance but causes more wastage (adverse usage) and slower work (adverse labor efficiency).

2. Define a relevant cost for decision-making and name its three core characteristics.

   A relevant cost is a cost relevant to a specific decision. It must be: (1) future (not yet incurred), (2) incremental/differential (changes as a result of the decision), and (3) a cash flow. Sunk costs, committed costs, and non-cash items are irrelevant.

3. What is an opportunity cost and is it a relevant cost?

   An opportunity cost is the value of the next-best alternative forgone when a resource is used for a particular purpose. It is a relevant cost in decision-making even though it is not a recorded accounting cost.

4. State the relevant cost rules for materials already in inventory.

   If the material is regularly used, relevant cost = current replacement (purchase) cost. If not in regular use: relevant cost = the higher of its net realizable (scrap/resale) value or its value in alternative use; if it must be specially bought, relevant cost = purchase price.

5. What is the contribution per unit, and what is the CVP break-even point in units?

   $$\text{Contribution per unit} = \text{Selling price} - \text{Variable cost per unit}$$ $$\text{Break-even (units)} = \frac{\text{Fixed costs}}{\text{Contribution per unit}}$$

6. How are the contribution/sales (C/S) ratio and break-even revenue calculated?

   $$\text{C/S ratio} = \frac{\text{Contribution per unit}}{\text{Selling price per unit}} = \frac{\text{Total contribution}}{\text{Total sales}}$$ $$\text{Break-even revenue} = \frac{\text{Fixed costs}}{\text{C/S ratio}}$$

7. Give the formula for the number of units needed to achieve a target profit, and define the margin of safety.

   $$\text{Units for target profit} = \frac{\text{Fixed costs} + \text{Target profit}}{\text{Contribution per unit}}$$ Margin of safety = Budgeted (or actual) sales $-$ Break-even sales, often expressed as a percentage of budgeted sales; it shows how far sales can fall before a loss occurs.

8. In a multi-product CVP setting, how is the weighted-average break-even handled, and what does the gradient of a multi-product P/V chart show?

   Break-even is found using the weighted-average C/S ratio based on the standard sales mix: $$\text{BE revenue} = \frac{\text{Fixed costs}}{\text{Weighted-average C/S ratio}}$$ On a multi-product P/V chart, plotting products in order of decreasing C/S ratio gives a curved line whose steeper initial slope indicates the most profitable products are sold first.

9. In a make-or-buy decision with no scarce resources, what is the decision rule?

   Compare the relevant (incremental) cost to make in-house with the external purchase price. Make internally if the variable/incremental cost of making is less than the buy-in price; buy externally if the purchase price is lower. Avoidable fixed costs are relevant; unavoidable fixed costs are not.

10. For a one-off limiting factor (single scarce resource) decision, how do you rank products?

    Rank products by contribution per unit of the scarce resource (e.g., contribution per machine hour or per kg), then allocate the limited resource to the highest-ranked products first until it is exhausted.

11. What is a shutdown decision and the key relevant factor?

    A decision on whether to close a product line/segment/factory. Continue in the short run if the segment generates positive contribution toward unavoidable fixed costs; consider closure if it makes a negative contribution or if avoidable fixed cost savings exceed the lost contribution, also weighing qualitative factors.

12. In a further-processing (sell-or-process-further) decision for joint products, what costs are relevant?

    Joint (pre-separation) costs are sunk and irrelevant. Process further only if the incremental revenue from further processing exceeds the incremental (further) processing cost incurred after the split-off point.

13. Describe cost-plus (full-cost and marginal-cost) pricing and a key limitation.

    Cost-plus pricing adds a profit markup to cost: full cost-plus uses total cost per unit; marginal cost-plus adds a markup to variable cost. Limitation: it ignores market demand, competitors' prices, and price elasticity, and full cost-plus depends on the overhead absorption and the assumed volume.

14. Contrast market skimming and penetration pricing strategies.

    Market skimming sets a high initial price to maximize margin from early adopters of a novel product, then lowers it over time. Penetration pricing sets a low initial price to gain rapid market share and discourage competitors, useful when demand is elastic and economies of scale exist.

15. What is the profit-maximizing rule using marginal revenue and marginal cost, and the optimal price/output condition?

    Profit is maximized where marginal revenue equals marginal cost: $$MR = MC$$ Output is set at that quantity, and price is read off the demand curve at that quantity.

16. Given the demand function $P = a - bQ$, what are the marginal revenue function and the gradient $b$?

    $$MR = a - 2bQ$$ and $$b = \frac{\text{change in price}}{\text{change in quantity}}$$ (the absolute fall in price per unit increase in demand). Setting $MR = MC$ and solving for $Q$ gives the profit-maximizing output.

17. Distinguish risk from uncertainty in decision-making.

    Risk exists when the range of possible outcomes and their probabilities can be quantified (objective or estimated probabilities). Uncertainty exists when outcomes are known but probabilities cannot be reliably assigned, so probability-based techniques cannot be applied.

18. How is an expected value (EV) calculated and what is its main limitation?

    $$EV = \sum (p \times x)$$ where $p$ is the probability and $x$ the outcome. Limitations: it is a long-run average that may never actually occur, it ignores the decision-maker's risk attitude (variability/spread), and it depends on the accuracy of subjective probabilities.

19. Describe the maximax, maximin, and minimax regret decision rules.

    Maximax (optimist): choose the option with the highest possible payoff. Maximin (pessimist): choose the option whose worst outcome is the best of the worst. Minimax regret: build a regret (opportunity loss) table and choose the option that minimizes the maximum possible regret.

20. What is the value of perfect information, and how is the value of perfect information calculated?

    It is the maximum amount worth paying for information that removes uncertainty. $$\text{Value of perfect information} = (\text{EV of decision with perfect information}) - (\text{EV of best decision without it})$$ It represents the expected gain from always choosing the optimal action for each known outcome.

21. What is a decision tree and how is it evaluated?

    A diagram mapping sequential decisions (square nodes) and uncertain outcomes (circular/chance nodes) with probabilities and payoffs. It is evaluated by 'rolling back' (backward induction) from right to left, computing expected values at chance nodes and selecting the highest-value branch at decision nodes.

22. Define the four broad categories used to classify business risk.

    Common categories: strategic risk, operational risk, financial risk, and compliance/hazard risk. (Other frameworks add reputational and environmental.) Risks are also split into systematic (market-wide, non-diversifiable) and unsystematic (specific, diversifiable) risk.

23. What are the steps of the risk management process and the four main risk responses (TARA)?

    Process: identify, assess (likelihood $\times$ impact), respond, and monitor/report risks. The TARA responses are Transfer (e.g., insure/outsource), Avoid (cease the activity), Reduce (mitigate/control), and Accept (retain the risk).

24. How does a risk map (heat map) guide the choice of TARA response?

    A risk map plots each risk by likelihood (axis) against impact (axis). High likelihood/high impact = Avoid; low likelihood/high impact = Transfer; high likelihood/low impact = Reduce; low likelihood/low impact = Accept.

What this deck covers

Performance Pillar: Cost, Decision-Making, and Risk Management flashcards FAQ