PIPFA Management Accounting Flashcards

24 sample cards from the Management Accounting deck

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

1. Distinguish between a mark-up and a margin in pricing.

   A mark-up expresses profit as a percentage of cost (Profit / Cost). A margin expresses profit as a percentage of selling price (Profit / Selling price). For example, a 25% mark-up on cost equals a 20% margin on selling price.

2. What are the main advantages and disadvantages of full cost-plus pricing?

   Advantages: simple to apply, ensures all costs and a profit are covered, useful when costs are stable. Disadvantages: ignores demand and price elasticity, relies on overhead absorption assumptions, may set prices uncompetitively, and circular (price affects volume which affects unit fixed cost).

3. What is target costing and how is the target cost derived?

   Target costing starts from a market-driven target selling price and a required profit margin, then derives the maximum allowable cost. Target cost = Target selling price - Required profit margin. The aim is to design the product to be made within this target cost.

4. What is a cost gap in target costing and how can it be closed?

   A cost gap is the excess of the estimated (current) cost over the target cost. Cost gap = Estimated cost - Target cost. It is closed through value engineering, redesigning the product, eliminating non-value-added activities, negotiating cheaper materials, and improving process efficiency.

5. How does target costing fundamentally differ from cost-plus pricing in approach?

   Cost-plus pricing starts with cost and adds a margin to set the price (cost-led). Target costing starts with the market price the customer will pay and works backwards to a required cost (price-led / market-driven). Target costing makes cost the variable to be managed, not the price.

6. What is transfer pricing and why does it matter for divisional performance?

   A transfer price is the price at which goods or services are transferred between divisions of the same organisation. It matters because it affects each division's reported profit, performance evaluation, and managers' decisions; it should promote goal congruence, divisional autonomy and fair performance measurement.

7. What is the general economic rule for setting a minimum transfer price?

   Minimum transfer price = Marginal (variable) cost of the transferring division + Opportunity cost of making the internal transfer. When there is spare capacity, opportunity cost is zero, so the minimum is just marginal cost; when at full capacity, it includes the lost external contribution.

8. What are the common bases for setting transfer prices?

   Common bases are: market-based price (external market price), cost-based prices (marginal cost, full cost, or cost-plus), and negotiated transfer prices agreed between divisional managers. Market price is often preferred when a competitive external market exists.

9. What is the payback period and what is its main decision rule?

   The payback period is the time taken for a project's cumulative net cash inflows to recover the initial investment. Decision rule: accept projects with a payback period within the company's target maximum; when ranking, prefer the project with the shortest payback.

10. What are the main advantages and disadvantages of the payback method?

    Advantages: simple, easy to understand, emphasises liquidity and early cash flows, reduces risk exposure. Disadvantages: ignores the time value of money (in its basic form), ignores cash flows after the payback period, and does not measure overall profitability.

11. What is the Accounting Rate of Return (ARR) and its formula?

    ARR (also called return on capital employed) measures average accounting profit as a percentage of investment. ARR = (Average annual accounting profit / Average investment) x 100, where Average investment = (Initial investment + Scrap value) / 2. It uses profits, not cash flows, and ignores the time value of money.

12. What is the decision rule for ARR, and what is one key weakness?

    Decision rule: accept a project if its ARR exceeds a predetermined target rate; rank by highest ARR. A key weakness is that ARR ignores the time value of money and is based on accounting profits (after depreciation) rather than cash flows.

13. What is Net Present Value (NPV) and what does a positive NPV indicate?

    NPV is the sum of the present values of all a project's future cash flows, discounted at the cost of capital, less the initial investment. A positive NPV indicates the project earns more than the required return and increases shareholder wealth, so it should be accepted.

14. What is the present value formula and the role of the discount factor?

    PV = Future cash flow x Discount factor, where Discount factor = 1 / (1 + r)^n (r = discount rate, n = number of years). The discount factor converts a future cash flow into its equivalent value today, reflecting the time value of money.

15. In NPV analysis, how is the discount rate chosen and what is the NPV decision rule?

    The discount rate is normally the company's cost of capital (required rate of return). Decision rule: accept a project if NPV is positive (or zero); reject if NPV is negative. For mutually exclusive projects, choose the one with the highest positive NPV.

16. What is the Internal Rate of Return (IRR)?

    The IRR is the discount rate at which a project's NPV equals zero, i.e. the rate at which the present value of inflows equals the present value of outflows. It represents the project's effective yield or breakeven cost of capital.

17. What is the IRR decision rule, and how does it relate to NPV?

    Decision rule: accept a project if its IRR is greater than the cost of capital; reject if IRR is below it. This is consistent with NPV because an IRR above the cost of capital generally corresponds to a positive NPV.

18. What is the interpolation formula used to estimate the IRR?

    IRR is approx = L + [NPV_L / (NPV_L - NPV_H)] x (H - L), where L = lower discount rate, H = higher discount rate, NPV_L = NPV at the lower rate (positive), and NPV_H = NPV at the higher rate (negative). It linearly interpolates between the two rates to find where NPV = 0.

19. Why may NPV and IRR give conflicting rankings for mutually exclusive projects, and which is preferred?

    They can conflict due to differences in project scale or the timing/pattern of cash flows and the reinvestment assumption. NPV is generally preferred because it measures the absolute increase in shareholder wealth and assumes reinvestment at the cost of capital, whereas IRR assumes reinvestment at the IRR.

20. What is the objective of cash management in working capital management?

    The objective is to hold enough cash to meet day-to-day obligations and avoid liquidity problems, while not holding so much idle cash that profitability suffers. It balances the transactions, precautionary and speculative motives for holding cash against the opportunity cost of idle funds.

21. What are the three motives for holding cash identified by Keynes?

    (1) Transactions motive - to meet regular day-to-day payments; (2) Precautionary motive - to provide a buffer against unexpected needs or uncertain cash flows; (3) Speculative motive - to take advantage of profitable opportunities (e.g. bargain purchases or investments) as they arise.

22. What is the objective of receivables (debtors) management?

    To set and operate a credit policy that maximises the benefit of offering credit (increased sales) while minimising the costs and risks of credit (financing cost of receivables, bad debts, and administration). It involves setting credit terms, assessing creditworthiness, and collecting debts efficiently.

23. How is the average collection period (debtor days) calculated and what does it indicate?

    Average collection period = (Trade receivables / Credit sales) x 365 days. It indicates the average number of days customers take to pay. A rising figure may signal weaker credit control or collection problems; comparing it to the credit period granted shows policy effectiveness.

24. What is the typical cost-benefit basis for deciding whether to offer a cash (settlement) discount to receivables?

    Compare the cost of the discount (discount % x affected sales) against the benefits: reduced financing cost from faster collection of receivables, lower bad debts, and possibly increased sales. Offer the discount only if the savings/benefits exceed the cost of giving the discount.

What this deck covers

Management Accounting flashcards FAQ