April 25, 2016

Accounting: The Language of Business - Review Notes

Review of chapter of Horngren (Introduction to Financial Accounting) to be posted

Accounting is the information system that measures business activity, processes the data into reports,
and communicates the results to decision makers. Accounting is “the language of business.” The better you understand the language of business, the better you can manage your own business.

A key product of accounting is a set of reports called financial statements. Financial statements report on a business in monetary terms.

We can divide accounting into two fields—financial accounting and managerial accounting.
Financial accounting provides information for external decision makers, such as outside investors and lenders. Financial accounting provides data for outsiders.

Managerial accounting focuses on information for internal decision makers, such as the company’s managers. Managerial accounting provides data for insiders.

A business can be organized as one of the following:
● Proprietorship
● Partnership
● Corporation
● Limited-liability partnership (LLP) and limited-liability company (LLC)
● Not-for-profit

Accounts are maintained for each of them.

Accounting Concepts and Principles
The Entity Concept
The Faithful Representation Principle
The Cost Principle
The Going-Concern Concept
The Stable Monetary Unit Concept

The Accounting Equation
The basic tool of accounting is the accounting equation. It measures the resources of
a business and the claims to those resources.

Definition of  Accounting

Accounting is the process of analyzing, recording, classifying, summarizing and communicating the results of the economic events of an organization.  The economic events must be measurable in dollars, and are called transactions.

Transaction is an economic event that is a measured in dollars. Accounting is based on actual transactions, not opinions or desires. A transaction is any event that affects the financial position of the business and can be measured reliably. Transactions affect what the company owns, owes, or its net worth.

The Accounting Cycle

1.  Analyze each transaction (Decide which account is to debited and which account is to be credited)
2.  Record each transaction in a journal (ordered by date).
3.  Transfer each transaction to the accounts affected in the ledger.
     (The ledger is a set of accounts ordered by account number.)
4.  Summarize the transactions in the form of statements to help in taking decisions.

5. The overall performance of the organization is summarized in financial statements of the organization
     a.  Income Statement:  Shows the net income (profit) of the company.
     b.  Owner's Equity Statement:  Shows the owner's claim in the business.
     c.  Balance Sheet:  Shows the financial position of the company.
     d.  Cash Flow Statement:  Shows where cash came from and where it went during the period.

Similar statements can be prepared for various profit centers of the organization also.

Introduction to Financial Accounting
Professor Alexander Sannella

Rutgers Digital Accounting Web

Review notes - Very good detailed notes

Presentation slides


Related chapter



Foundation lecture for accounting course - PPT

Book chapter from Pearson

Updated 25 Apr 2016,  12 Apr 2016,
8 Dec 2011

Accrual Accounting and Financial Statements - Review Notes

Review of chapter of Horngren (Introduction to Financial Accounting)

The first objective in this article  is to understand the types of adjustments typically made to the accounts, and why those adjustments need to be made.

Accrual Accounting

A simple definition of accrual accounting is:  "record all revenues in the period we earn them; record all expenses in the period we incur them."  It can also be explained as recording a business transaction as it happens without waiting for the cash payment or receipt.  For revenues, the basic approach is to determine when the revenue was earned. If  a service is performed, the revenue is accounted as earned during the period.

Expenses work in a similar way.  If an advertisement is run in the newspaper in a  month, the accounting transaction is entered in the journal, even though cash payment is done by the firm after two months,. The incurrence of the expense is recognized, rather than the timing of the cash payment.

Facts about Adjustments

Every adjustment affects one income statement account and one balance sheet account.  The income statement account will be a revenue or an expense.

Adjustments are only done at the end of an accounting period.  We will assume that the entire accounting cycle takes place in one month's time.  Therefore, the adjustments would be recorded at the end of each month.

The accountant has to  use good judgment in deciding if an adjustment is necessary.

Accrual accounting requires that adjustments be made to properly reflect periodic revenues and expenses.

There are two principles of accounting that are satisfied by the adjusting process. First, we want to make sure we record all revenues that were earned this period. This is called the revenue recognition principle. The revenue recognition principle says that "we must record all revenues in the period they were earned, regardless of whether the cash has been received."

Second, we want to match all expenses that we incurred this period to the revenues earned this period. This is called the matching principle. Some expenses such as rent expense involve paying cash for the expense. However, using up supplies is also an expense, one in which an asset other than cash is being consumed. Similarly, using up insurance and equipment are considered expenses in the adjusting process.

As the revenues and expenses come together on the income statement, these two principles are the foundation for computing net income according to accrual accounting rules.

Adjusting entries, unearned/accrued, revenue/expense
Rutgers Accounting Web


Adjusting the accounts - Review notes


Presentation slides


Flash card exercise



More flashcards and educational activitites at StudyStack.com

Updated 25 Apr 2016, 12 March 2016, 8 Dec 2011

April 24, 2016

Process Costing - Review Notes

In processes output can not be separated and accounted for as in discrete product manufacture. The production process is continuous. Therefore period costs are accumulated and they are charged to the output in a period. In the process there is work-in-progress. So at the start of a period there is beginning inventory and at the end of the period there is ending inventory. During the period, there is input of costs. From these three figures cost of production of a period is calculated and charged to the number of units produced during the period.

Process Costing Illustration
Assembly Department

Physical Units for Dec 2015

Work in progress, beginning inventory  (Dec 1)             0 units
Started during December                                                30 units
Completed and transferred to FG Stores                         30
WIP Ending                                                                       0

Total Costs for Dec 2015

Direct materials                                                               $12,000
Conversion Cost incurred in the process                           24,000
Total assembly department costs Dec 2015                       36,000

Hence assembly cost per unit of output is $36,000/30  =  $1200, itemized as:

Direct material cost     $400
Conversion cost             800
Total cost                    $1200


Detailed explanation of Process Costing and normal and abnormal losses in process

Process Costing


Rutgers Accounting Web

Updated  24 Apr 2016,  8 Dec 2011

April 4th Week - MBA Management Knowledge Revision


22 April to 26 April 2016

Statement of Cash Flows - Review Notes

Financial Statement Analysis - Review Notes

Cost Accounting

23 April 2016
Role of Costing and Cost Accounting in the Organizations
Introduction to Cost Terms - Review Notes

Traditional Cost Objectives and Their Utility
Job Costing - Review Notes

Activity-Based Costing and Activity-Based Budgeting
Process Costing - Review Notes

Cost Center Reports and Analysis
Cost of Sales Account Analysis

April 23, 2016

Data Analytics - Driving Digital Transformation of Organization

Digital Transformation
Issues                                                      -                  Outcomes

Shrinking Market Share                         -             Expanding Market Share

Pricing Pressures                                                   Enhanced Cost and Cash Advantage

Customer Defection                                              Customer Loyalty

Fragmentation and Complexity                             Speed to Insights

Inefficient Operations                                            Operational Excellence

Aged Platforms and Systems                                 Leading Edge Platforms

Employee Engagement                                          Winning the War for Talent

Fraud and Noncompliance                                      Reduced Risk and Fraud


Advanced Data Analysis from an Elementary Point of View

by Cosma Rohilla Shalizi, CMU
E-Book will be permanently available even after print Book is published by Cambridge University Press.

April 22, 2016

April - Management Knowledge Revision



1 April to 5 April 2016

Material Requirements Planning - Review Notes
Operations Scheduling - Review Notes

Financial Analysis - Review Notes
Operations Technology - Review Notes

Supply Chain Management

 3rd April 2016

Understanding the Supply Chain
Supply Chain Performance: Achieving Strategic Fit

Supply Chain Drivers and Obstacles - Review Notes
Designing the Distribution Network in a Supply Chain

Facility Decisions: Network Design in the Supply Chain
Network Design in an Uncertain Environment

2nd Week

8 April to 12 April 2016

Demand Forecasting in a Supply Chain
Aggregate Planning in the Supply Chain - Review Notes

Planning Supply and Demand in the Supply Chain
Managing Economies of Scale in the Supply Chain

Managing Uncertainty in the Supply Chain: Safety Inventory
Determining Optimal Level of Product Availability

Sourcing Decisions in a Supply Chain
Transportation in the Supply Chain - Chopra and Meindl

Pricing and Revenue Management in the Supply Chain
Coordination in the Supply Chain - Review Notes

3rd Week

15 April to 19 April 

Information Technology and the Supply Chain
e-business and the Supply Chain

Financial Accounting

Accounting: The Language of Business
Recording Transactions - Review Notes

Accrual Accounting  - Revision
Measuring Income to Assess Performance and Balance Sheet - Review Notes

Detailed Accounting Procedures

Accounting for Sales - Review Notes
Inventories and Cost of Goods Sold - Review Notes

Long-Lived Assets and Depreciation - Review Notes
Liabilities and Interest - Review Notes

4th Week

22 April to 26 April 2016

Statement of Cash Flows - Review Notes
Financial Statement Analysis - Review Notes

Cost Accounting

23 April 2016
Role of Costing and Cost Accounting in the Organizations
Introduction to Cost Terms - Review Notes

Traditional Cost Objectives and Their Utility
Job Costing - Review Notes

Activity-Based Costing and Activity-Based Budgeting
Process Costing - Review Notes

29 April

Operations Management - Subject Update 2016
Supply Chain Management - Subject Update 2016

To May - Management Knowledge Revision

One Year MBA Knowledge Revision Plan

January  - February  - March  - April  - May   -   June

July  - August     - September  - October  - November  - December

Included in the A to Z Blogging Challenge Posts

Birthdays of Management Scholars and Executives in April

1 - Prof Maike Andresen (1971) - Chair for HRM
2 - Jan Jantsch (1960)
3 - Mark Albion (1951)
4 - Charles Buxton Going (1863)  - Principles of Industrial Engineering - Book in 1911
6 - Armand V. Feigenbaum (1920) - Total Quality Control
      Clayton Christensen (1952) - Disruptive innovations
10 - Joseph Pulitzer (1847), Perry Sink Marshall (1969)
11 - Charles Eugene Bedaux (1886) - Check?  26 October
12 - Elwood S. Buffa (1923)  - Modern Production Management, Operations Management
13 - W. Charles Redding (1914), -
        Michael Hammer (1948) - Business Process Reengineering
14-  Eric Brynjolfsson (1962)
15 - Glen L. Urban (1940)
17 - J.P. Morgan (1837)
18 - Frederick Herzberg (1923),   Hygiene factors - Motivation factors model
       Bengt R. Holmstrom (1949),
       Niall Ferguson (1964),
       Robert Allen Phillips (1968)

19- James J. Heckman (Economics Nobel Prize Winner, 1944), James B. Orlin (1953), Peter Bowman Scott-Morgan (1958)
21- Max Weber (1864)  http://www.britannica.com/EBchecked/topic/638565/Max-Weber
Alan Cerf
29 - Dan Ariely (1967)

January  - February  - March  - April  - May   -   June

July  - August     - September  - October  - November  - December

Included in the A to Z Blogging Challenge Posts

Last Year Plan Items

Cost Information for Pricing Decisions

Cost Behavior Analysis and Relevant Costs

Costing for Strategic Profitability Analysis

Cost Information for Customer Profitability Analysis

Costing for Spoilage, Rework and Scrap

Costing for Quality, Time and the Theory of Constraints

Costing for Inventory Management, JIT and Backflush

February 19 - 25

Cost Information and Analysis for Capital Budgeting

Cost Information for Management Control and Performance Control

Cost Information for Transfer Pricing

Managerial Accounting or Management Accounting - Review Notes

Relevant Information and Decision Making - Marketing Decisions

Relevant Information and Decision Making - Production

Relevant Information and Decision Making - HR

The Master Budget - Accounting Information

Flexible Budgets and Variance Analysis - Review Notes

Responsibility Accounting for Management Control

February 26 to March 4

Accounting Information for Management Control in Divisionalized Companies

Capital Budgeting - Accounting and Cost Information

To May - Management Knowledge Revision

One Year MBA Knowledge Revision Plan

Management of Training Programmes - Training Function

Managing Change in Improvement Projects

Manufacturing Management - Introduction

Mergers and Acquisitions - Introduction

Engineering Economy or Engineering Economics:

Introduction to Engineering Economics

April 23 - 29

Present-Worth Comparisons

Required Rate of Return for Investment or Expenditure

Rate-of-Return Calculations

Equivalent Annual-Worth Comparisons

Machine Selection Problem

Sensitivity Analysis - Engineering  Economics

Structural Analysis of Alternatives

Peter Drucker on Scientific Management - Industrial Engineering,

To May - Management Knowledge Revision

One Year MBA Knowledge Revision Plan

January  - February  - March  - April  - May   -   June

July  - August     - September  - October  - November  - December

Included in the A to Z Blogging Challenge Posts

Cost Center Reports and Analysis

Cost Center Reports and Analysis

Any activity can be analysed by its costs and the ’output’ it generates. A business might want to know the
cost of running a production line compared to other production lines or ways of producing things.
Similarly, a firm might want to look at the total cost of running training courses (salary, rents, training materials, utilities and so on) compared to the number of people actually trained.

Cost centre analysis tries to attribute all costs involved in a particular activity to one ’location’ or ’cost centre’. To calculate costs involved in a particular activity it is necessary to calculate the cost of:

All materials used directly  and materials used indirectly (for instance packaging).

All labour costs directly involved and the proportionate cost of any supporting labour (for instance
administrative staff).

Sales And Marketing Costs
Regular, on-going costs of advertising and promotion of that activity’s product or service.

Proportionate costs of regular expenses associated with that activity such as rent, rates, power, interest repayments, other charges.

Additional Costs
Other costs solely attributable to the activity (for instance higher insurance costs for a new machine).

ABC Novelties company  management want to know the real cost of manufacturing toys. Materials used cost $2,000 per year. Production involves 5 trainees paid $500 expenses each per year. The single machine
used is used for toy production 20% of the time and full depreciation is valued at $1,000 per year. Electricity costs $600 a year and toy production takes up half of a workshop costing $2,000 in rent, rates and repairs
per year. The paid administration worker calculates that he spends 30% of his time on book-keeping, sales and marketing toys. He is paid $8,000 per year. The total income of the project is $25,000 per year
and sales of toys contribute $5,000 to this. 

Its total costs are $24,500 per year.

Cost Centre Analysis
Materials            =    $2000
Labour (5 x $500) =   2500
Depreciation ($1,000 x 20%)   =  200
Electricity ($600 x 20%)   =  120
Rent ($2,000 / 2) =           1000
Administration ($8,000 x 30%) = 2400
Total                 =   8220
From these figures we can calculate the following:
Toy making is responsible for 34% of all costs ($8,220 / $24,500 x 100)
Toy making generates only 20% of all income ($5,000 / $25,000 x 100) 

April 17, 2016

Inventories and Cost of Goods Sold - Review Notes

Determining Cost (Accounting Value) of Inventory

Specific unit cost
 Mandated by AASB when inventory items differ (e.g. motor vehicles, jewellery)
 Average cost
 First-In, First-Out (FIFO)
 Oldest units sold first
 Last-In, First-Out (LIFO):

Calculate periodic inventory amounts under
FIFO, LIFO and average cost.

Journal Entry for Purchase of Inventory
Purchases (not inventory) 400
Accounts Payable (Cash) 400


Beginning Inventory (1 @ 40)  = $40
Purchases (6 @ 45 + 7 @ 50)  = 620
Cost of goods available for sale (14 numbers)   =  660
Less: Ending Inventory (2 @ 50)   =   (100)
Cost of Sales  =  $560

Beginning Inventory (1 @ 40)  =  $40
Purchases (6 @ 45 + 7 @ 50)   =  620
Cost of goods available for sale (14)  =  660

Cost of goods available for sale (14) =  660
Less: Ending Inventory  (1 @ 40 + 1 @ 45)  =  (85)
Cost of Sales  =   $575

Weighted Average
Beginning Inventory (1 @ 40)   =  $40
Purchases (6 @ 45 + 7 @ 50)  = 620
Cost of goods available for sale (14 @ 47 14) =  660 (14 @ 47.14)
Less: Ending Inventory (2 @ 47.14)  =  (94)
Cost of Sales  =   $566

Accounting Principles and Inventories

Several accounting principles affect inventories. Among them are consistency, disclosure, materiality, and accounting conservatism.

Consistency Principle

The consistency principle states that businesses should use the same accounting
methods from period to period. Consistency helps investors compare a company’s
financial statements from one period to the next.

Disclosure Principle

The disclosure principle holds that a company should report enough information
for outsiders to make wise decisions about the company. In short, the company
should report relevant, reliable, and comparable information about itself. This
includes disclosing the method being used to account for inventories. All major
accounting decisions are described in the footnotes to the financial statements.

Materiality Concept

The materiality concept states that a company must perform strictly proper accounting
only for significant items. Information is significant—or, in accounting terms, material—
when it would cause someone to change a decision. The materiality concept frees
accountants from having to report every last item in strict accordance with GAAP. For
example, $1,000 is material to a small business with annual sales of $100,000.
However, $1,000 isn’t material to a large company like Apple.

Accounting Conservatism

Conservatism in accounting means exercising caution in reporting items in the financial statements. Conservatism says,

● “Anticipate no gains, but provide for all probable losses.”
● “If in doubt, record an asset at the lowest reasonable amount and a liability at the highest reasonable amount.”
● “When there’s a question, record an expense rather than an asset.”
● “When you are faced with a decision between two options, you must choose the option that undervalues, rather than overvalues, your business.”

The goal of conservatism is to report realistic figures.

Lower-of-Cost-or-Market Rule
In addition to the FIFO, LIFO, and average costing methods, accounts must use the  the lower-of-cost-or-market rule (abbreviated as LCM).

LCM shows accounting conservatism in action and requires that inventory be reported in the financial statements at whichever is lower—
● the historical cost of the inventory, or
● the market value of the inventory.

For inventories, market value generally means the current replacement cost (that is, the cost to replace the inventory on hand). If the replacement cost of inventory is less than its historical cost, the business must adjust the inventory value. By adjusting the inventory down (crediting Inventory), the balance sheet value of the asset, Inventory, is at its correct value (market) rather than its overstated accounting value (cost).

Review Notes
Inventory Accounting

Presentation slides


Updated 17 Apr 2016
8 Dec 2011

April 3rd Week - MBA Management Knowledge Revision

Long-Lived Assets and Depreciation - Review Notes

Measuring the Cost of a Plant Asset
The cost principle says to carry an asset at its historical cost—the amount paid for
the asset. The rule for measuring cost is as follows:
Measure the cost of a plant asset

Cost of an asset =
Sum of all the costs incurred to bring the asset
to its intended purpose, net of all discounts

Land and Land Improvements
The cost of land is not depreciated. It includes the following costs paid by the purchaser:
● Purchase price
● Brokerage commission
● Survey and legal fees
● Property taxes in arrears
● Taxes assessed to transfer the ownership (title) on the land
● Cost of clearing the land and removing unwanted buildings
The cost of land does not include the following costs:
● Fencing
● Paving
● Sprinkler systems
● Lighting
● Signs
These separate plant assets—called land improvements—are subject to

Measuring the Cost of Land
Purchase price of land ......................
Add related costs:
Property taxes in arrears...........
Transfer taxes...........................
Removal of building .................
Survey fee .................................
Total cost of land .............................

The cost of a plant asset is its purchase price plus taxes, purchase commissions, and
all other amounts paid to ready the asset for its intended use.

The cost of a building depends on whether the company is constructing the building
itself or is buying an existing one. These costs include the following:

Constructing a Building
Architectural fees
Building permits
Contractor charges
Payments for material, labor, and overhead
Capitalized interest cost, if self-constructed

Purchasing an Existing Building

Purchase price
Costs to renovate the building to
ready the building for use, which
may include any of the charges listed
under “Constructing a Building”

Machinery and Equipment
The cost of machinery and equipment includes its
● purchase price (less any discounts),
● transportation charges,
● insurance while in transit,
● sales tax and other taxes,
● purchase commission,
● installation costs, and
● the cost of testing the asset before it is used.

After the asset is up and running, the company no longer debits the cost of insurance,
taxes, ordinary repairs, and maintenance to the Equipment account. From that
point on, insurance, taxes, repairs, and maintenance costs are recorded as expenses.

Furniture and Fixtures
Furniture and fixtures include desks, chairs, file cabinets, display racks, shelving,
and so forth. The cost of furniture and fixtures includes the basic cost of each asset
(less any discounts), plus all other costs to ready the asset for its intended use. For
example, for a desk, this may include the costs to ship the desk to the business and
the cost paid to a laborer to assemble the desk.

Capital Expenditures
Accountants divide spending made on plant assets into two categories:
● Capital expenditures
● Expenses
Capital expenditures are debited to an asset account because they
● increase the asset’s capacity or efficiency, or
● extend the asset’s useful life.
Examples of capital expenditures include the purchase price plus all the other costs
to bring an asset to its intended use, as discussed in the preceding sections. Also, an
extraordinary repair is a capital expenditure because it extends the asset’s capacity or
useful life.


depreciation is the allocation of a plant asset’s cost
to expense over its useful life. Depreciation distributes the asset’s cost over the time
(life) the asset is used. Depreciation matches the expense against the revenue generated
from using the asset to measure net income.

Measuring Depreciation
Depreciation of a plant asset is based on three main factors:
1. Capitalized cost
2. Estimated useful life
3. Estimated residual value
Capitalized cost is a known cost and, as mentioned earlier in this chapter,
includes all items spent for the asset to perform its intended function. The other two
factors are estimates.

Depreciation Methods
There are many depreciation methods for plant assets, but three are used most
● Straight-line
● Units-of-production
● Declining-balance

Accounting for Research and Development
Research and development (R&D) costs are the lifeblood of companies such as Procter & Gamble, General Electric, Intel, and Boeing. In general, companies do not
report R&D assets on their balance sheets because GAAP requires companies to expense R&D costs as they are incurred.

Presentation slides


HBS Alumni excel tool on Depreciation methods

Updated  17 Apr 2016

8 Dec 2011

Financial Accounting - Cost Accounting Revision Articles with Links

April Third Week (16 April 2016 - 19 April 2016)

Financial Accounting

Accounting: The Language of Business: http://nraomtr.blogspot.in/2011/12/accounting-language-of-business-review.html
Measuring Income to Assess Performance - Review Notes: http://nraomtr.blogspot.in/2011/12/measuring-income-to-assess-performance.html

Recording Transactions - Review Notes: http://nraomtr.blogspot.in/2011/12/recording-transactions-review-notes.html
Accrual Accounting and Financial Statements - Revision: http://nraomtr.blogspot.in/2011/12/accrual-accounting-and-financial_08.html

Accounting for Sales - Review Notes: http://nraomtr.blogspot.in/2011/12/accounting-for-sales-review-notes.html
Inventories and Cost of Goods Sold - Review Notes: http://nraomtr.blogspot.in/2011/12/inventories-and-cost-of-goods-sold.html

Long-Lived Assets and Depreciation - Review Notes: http://nraomtr.blogspot.in/2011/12/long-lived-assets-and-depreciation.html
Liabilities and Interest - Review Notes: http://nraomtr.blogspot.in/2011/12/liabilities-and-interest-review-notes.html

4th Week

22 April to 26 April 2016

Statement of Cash Flows - Review Notes: http://nraomtr.blogspot.in/2011/12/statement-of-cash-flows-review-notes.html

Financial Statement Analysis - Review Notes: http://nraomtr.blogspot.in/2011/12/financial-statement-analysis-review.html

Cost Accounting

21 April 2015
Role of Costing and Cost Accounting in the Organizations: http://nraomtr.blogspot.in/2011/12/role-of-costing-and-cost-accounting-in.html

Introduction to Cost Terms - Review Notes: http://nraomtr.blogspot.in/2011/12/introduction-to-cost-terms-review-notes.html
Traditional Cost Objectives and Their Utility: http://nraomtr.blogspot.in/2011/12/traditional-cost-objectives-and-their.html

Job Costing - Review Notes:http://nraomtr.blogspot.in/2011/12/job-costing-review-notes.html
Cost Allocation: Joint Products and By Products: http://nraomtr.blogspot.in/2011/12/cost-allocation-joint-products-and-by.html

Activity-Based Costing and Activity-Based Budgeting:http://nraomtr.blogspot.in/2011/12/activity-based-costing-and-activity.html
Process Costing - Review Notes: http://nraomtr.blogspot.in/2011/12/process-costing-review-notes.html

First Week  4 May to 8 May 2015

Cost Information for Pricing Decisions
Cost Behavior Analysis and Relevant Costs

Costing for Strategic Profitability Analysis
Cost Information for Customer Profitability Analysis

Costing for Spoilage, Rework and Scrap
Costing for Quality, Time and the Theory of Constraints

Costing for Inventory Management, JIT and Backflush
Cost Information and Analysis for Capital Budgeting

Cost Information for Management Control and Performance Control
Cost Information for Transfer Pricing

Second Week 11 May to 15 May 2015

Managerial Accounting or Management Accounting - Review Notes
Relevant Information and Decision Making - Marketing Decisions

Relevant Information and Decision Making - Production
Relevant Information and Decision Making - HR

The Master Budget - Accounting Information
Flexible Budgets and Variance Analysis - Review Notes

Responsibility Accounting for Management Control
Accounting Information for Management Control in Divisionalized Companies

Capital Budgeting - Accounting and Cost Information

Accounting for Sales - Review Notes

Revenue Recognition
•The timing of revenue recognition is important since itis critical to the measurement of income.

• Cash-basis
 –revenues are recognized when cash iscollected for goods or services.
• Accrual basis
 –recognition of revenue occurs at the point of sale
. Both IFRS and U.S. GAAP require the following two criteria be met for revenue recognition:
 –Revenue is earned–goods or services must bedelivered to the customer –Revenue is realized–cash or an asset virtually assuredto be converted into cash is received

Revenue Recognition
• Percentage of Completion Method
 –recognizes revenue on long term contracts as production occursand assigns the associated expenses to abide by thematching principle.
•US GAAP considers the usage of the methodappropriate only if:
 –the progress measures are dependable –contract obligations are explicit –both seller and the buyer are expected to meet their obligations.
•IFRS is not that specific with these requirements

Cash and Credit Sales Revenue
•Revenue is recorded at the present cash value of the asset received.

Sales Returns
• Sales Returns
-previously purchasedmerchandise returned to the seller for any reason

Sales Allowances
• Sales Allowance
 –reduction of the originalselling price mostly to settle customercomplaints

Cash and Trade Discounts
• Trade discounts
 –reductions to the gross salesprice for a particular class of customers or fordiffering order sizes.
• Cash discounts
 –reductions of invoice pricesfor prompt payment; rewards extended to thecustomers

Some Cash Discount Terms
• n/30
 –The full billed price (net price) due in 30days after the invoice date.•
15 E.O.M
. –The full price is due within 15 daysafter the end of the month of sale.•
 –2% off invoice price, if paid within 10days of invoice date; net amount due in 30 daysafter invoice date.

Uncollectible Accounts
•Two methods to measure uncollectible accounts
Specific Write-off Method
: assumes all receivablesare collectable until proven otherwise; is used bycompanies that rarely experience bad debts; writes-off the specific receivable when it is apparent that itwill not be collected.
•Pros: less costly, Cons: violates the matchingprinciple. –
Allowance method
: estimates the amount ofuncollectible accounts at year end; net income andreceivables are reduced to reflect potentialuncollectible accounts.
•Pros: better matching, Cons: prone tomanipulations

Assessing Accounts Receivable
•Cash sales produce cash instantly
•Credit sales generally cause sales to increasebut they also delay cash receipts.
 –Major credit cards
•Just a few days before credit card companytransfers cash to the company
•Some treat these receivables as cash equivalents –Company credit cards –using last year’s data
•How long did it take to collect receivables
•Is that length of time acceptable?

Review Notes  -  Merchandising Operations (Sales)

Presentation slides


Updated 17 Apr 2016
8 Dec 2011

April 16, 2016

Recording Transactions - Review Notes

The basic summary device of accounting is the account. An account is the detailed record of all the changes that have occurred in an individual asset, liability, or owners’ (or stockholders’) equity during a specified period. Business transactions cause the changes in accounts.

Accountants record transactions first in a journal, which is the chronological record of transactions. Accountants then post the data to the book of accounts called the ledger.  One can describe it as copying the journal post in the ledger. A list of all the ledger accounts and their balances is
called a trial balance.

The ledger (book of accounts0 contains the accounts grouped under these headings:

● Assets, Liabilities, and Stockholders’ Equity
● Revenues and Expenses

Companies prepare a chart of accounts to show the list of all their accounts along with the account numbers.

Charts of accounts vary from business to business, though many account names are common to all companies’ charts of accounts.

Accounting is based on transaction data. Each transaction represents exchange of value and it has two sides: The receiving side and  The giving side.

Accounting uses the double-entry system, which means that we record the dual effects of each transaction. As a result, every transaction affects at least two accounts. It would be incomplete to record only the giving side, or only the receiving side, of a transaction.

The T-Account
A shortened form of the general ledger account is called the T-account because it takes the form of the capital letter T. The vertical line divides the account into its left and right sides, with the title at the top. For example, the Cash account appears as follows.

Debit Side                   Credit Side

Increases and Decreases in the Accounts

The account category (asset, liability, equity) governs how we record increases and decreases. For any given account, increases are recorded on one side, and decreases are recorded on the opposite side.

Whether an account is increased or decreased by a debit or a credit depends on the type of account. Debits are not “good” or “bad.” Neither are credits. Debits are not always increases or always
decreases—neither are credits.

The words debit and credit abbreviate the Latin terms debitum and creditum. Luca Pacioli, the Italian
monk who wrote about accounting in the fifteenth century, popularized these terms.

The amount remaining in an account is called its balance.

List the Steps of the Transaction Recording Process

In practice, accountants record transactions in a journal. The journalizing process has three steps:

1. Identify each account affected and its type (asset, liability, or stockholders’ equity).
2. Determine whether each account is increased or decreased. Use the rules of debit and credit.
3. Record the transaction in the journal, including a brief explanation. The debit side of the entry is entered first. The credit side is indented. Total debits should always equal total credits. This step is also called “making the journal entry” or “journalizing the transaction.”

Posting (Copying Information) from the Journal to the Ledger

Journalizing a transaction records the data only in the journal—but not in the ledger. The data must also be copied to the ledger. The process of copying from the journal to the ledger is called posting. We post from the journal to the ledger. Debits in the journal are posted as debits in the ledger and credits as credits

Assets = Liabilities + Stockholders’ equity

DR    CR
+         -

–        +

DR      CR
–           +

DR    CR
–        +

DR     CR    
–           +

+       -

The Normal Balance of an Account

An account’s normal balance appears on the side—either debit or credit—where we record an increase (+) in the account’s balance. For example, assets normally have a debit balance, so assets are debit-balance accounts. Liabilities and equity accounts normally have the opposite balance, so they are credit-balance accounts. Expenses are equity accounts that have debit balances—unlike the other equity accounts. They have debit balances because they decrease equity. Revenues increase equity, so a revenue’s normal balance is a credit.

Preparing the Trial Balance from the T-Accounts
As noted earlier, a trial balance summarizes the ledger (T-accounts) by listing all the accounts with their balances—assets first, followed by liabilities, and then stockholders’ equity. In a manual accounting system, the trial balance provides an accuracy check by showing whether total debits equal total credits. In all types of systems, the trial balance is a useful summary of the accounts and their balances because it shows the balances on a specific date for all accounts in a company’s accounting system.

Accounting Terms

The detailed record of all the changes that have occurred in a particular asset, liability,
or owners’ equity (stockholders’ equity) during a period. The basic summary device of

Accrued Liability
A liability for which the business knows the amount owed but the bill has not
been paid.

Chart of Accounts
A list of all a company’s accounts with their account numbers.

Credit side
The right side of an account.

Debit side
The left side of an account.

Double-Entry System
A system of accounting where every transaction affects at least two accounts.

The chronological accounting record of an entity’s transactions.

The record holding all the accounts and amounts.

Normal Balance
The balance that appears on the side of an account—debit or credit—where we
record increases.

Note Receivable
A written promise for future collection of cash.

Notes Payable
Represents debts the business owes because it signed promissory notes to borrow
money or to purchase something.

Copying amounts from the journal to the ledger.

Prepaid Expenses
Expenses paid in advance of their use.

Summary device that is shaped like a capital “T” with debits posted on the left side of
the vertical line and credits on the right side of the vertical line. A “shorthand” version of
a ledger.

Trial Balance
A list of all the ledger accounts with their balances at a point in time.

Review notes - Good Notes

Presentation slide

An excel tool on HBA alumni site

Notes on Analyzing Transactions

From Financial and Management Accounting
Book Referred

Updated 16 Apr 2016
8 Dec 2011

Measuring Income to Assess Performance - Review Notes

Measuring Income

Income is a measure of the increase in the “wealth” of an entity over a period of time.

Accountants have agreed on a common set of rules for measuring income and wealth.

Income is generated primarily through the operating cycle.

Operating cycle –average time taken by a firm in converting merchandize or raw material back into cash

•Income –key measure of performance and value; measure of increase in wealth over a
period of time

 –Calendar year vs. Fiscal year Operating cycle –average time taken by a firm inconverting merchandize or raw material back intocash

About 40% of large companies use a fiscal year that differs from a calendar year

Interim reports

Companies also prepare financial statements for interim periods
Interim periods may be for a month or a quarter (3-month period)

Measuring Income

 –are increases in assets received inexchange for the delivery of goods or services to customers. Revenues increase owners' equity.•
 –are decreases in assets as a result of goods or services being delivered to customers. Expenses decrease owners' equity.

(profit, earnings) – excess of revenues over expenses in a reporting period.

Retained Earnings
 –total cumulative owners’equity generated by income or profits

Measuring Income

Cash Basis
 –revenues are recognized when a company receives cash and expenses are recognized when a company pays cash.
 –Ignores activities that increase or decrease assets other than cash

Accrual Basis
 –revenues are recorded as they are earned and expenses are recorded as they are incurred, regardless whether cash changes hands.
 –Ignores that a company can go bankrupt if it does not manage its cash properly, no matter how well it seems to be doing according to the other financial statements

Revenues Recognition
•Criteria to recognize revenues:
Revenues must be earned -
All (or substantially all)of the goods or services the customer wants have been delivered to and accepted by customers –
Revenues must be realized or realizable -
Cash or a formal promise by the customer to pay cash hasbeen received for the goods or services delivered


 –the process of recognizing and recording expenses in the same period the related revenues are recognized.

• Product costs
 –are linked with productrevenues earned in that period (e.g. cost ofgoods, commissions, etc).•

Period costs
 –are linked to a period of timeitself and are recorded in the period incurred(e.g. rent, admin. salaries, etc.)

Depreciation is the systematic allocation of the acquisition cost of long-lived assets to the periods that benefit from the use of the assets.

Land is not subject to depreciation because it does not deteriorate over time

Expanded Balance Sheet Equation

(1) Assets    =    Liabilities   +   Stockholders’ Equity

(2) Assets    =    Liabilities   +   Paid-in Capital  +  Retained Earnings

(3) Assets    =    Liabilities   +   Paid-in Capital  +  Revenues - Expenses

Review Notes


Presentation slides


Updated  16 April 2016

Statement of Cash Flows - Review Notes

The statement of cash flows reports cash flows—cash receipts and cash payments. It
● shows where cash came from (receipts) and how cash was spent (payments).
● reports why cash increased or decreased during the period.
● covers a span of time and is dated the same as the income statement

The statement of cash flows explains why net income as reported on the income statement does not equal the change in the cash balance. In essence, the cash flow statement is the communicating link between the accrual based income statement and the cash reported on the balance sheet.

The statement of cash flows helps
1. predict future cash flows. Past cash receipts and payments help predict future cash flows.
2. evaluate management decisions. Wise investment decisions help the business prosper, while unwise decisions cause the business to have problems. Investors and creditors use cash flow information to evaluate managers’ decisions.
3. predict ability to pay debts and dividends. Lenders want to know whether they will collect on their loans. Stockholders want dividends on their investments. The statement of cash flows helps make these predictions.

Cash Equivalents

On a statement of cash flows, Cash means cash on hand and cash in the bank, and  cash equivalents, which are highly liquid investments that can be converted into cash in three months or less. As the name implies, cash equivalents are so close to cash that they are treated as “equals.” Examples of cash equivalents are money-market accounts and investments in U.S. government securities.

Operating, Investing, and Financing Activities

There are three basic types of cash flow activities, and the statement of cash flows has a section for each:

● Operating activities
● Investing activities
● Financing activities

Each section reports cash flows coming into the company and cash flows going out of the company based on these three divisions.

Operating Activities
● Is the most important category of cash flows because it reflects the day-to-day operations that determine the future of an organization
● Generate revenues, expenses, gains, and losses
● Affect net income on the income statement
● Affect current assets and current liabilities on the balance sheet Investing Activities
● Increase and decrease long-term assets, such as computers, software, land, buildings, and equipment
● Include purchases and sales of these assets, plus long-term loans receivable from others (non-trade) and collections of those loans
● Include purchases and sales of long-term investments

Financing Activities
● Increase and decrease long-term liabilities and equity
● Include issuing stock, paying dividends, and buying and selling treasury stock
● Include borrowing money and paying off loans

Two Formats for Operating Activities

There are two ways to format operating activities on the statement of cash flows:
● The indirect method starts with net income and adjusts it to net cash provided by
operating activities.
● The direct method restates the income statement in terms of cash. The direct method shows all the cash receipts and all the cash payments from operating activities.

The indirect and direct methods
● use different computations but produce the same amount of cash flow from operations.
● present investing activities and financing activities in exactly the same format. Only the operating activities section is presented differently between the two methods.

Cash Flows from Operating Activities - Indirect Method

Operating cash flows begin with net income, taken from the income statement.

A. Net Income

The statement of cash flows—indirect method—begins with net income (or net loss) because revenues and expenses, which affect net income, produce cash receipts and cash payments. Revenues bring in cash receipts, and expenses must be paid. But net income as shown on the income statement is accrual based and the cash flows (cash basis net income) do not always equal the accrual basis revenues and expenses. For example, sales on account generate revenues that increase net income, but the company has not yet collected cash from those sales. Accrued expenses decrease net income, but the company has not paid cash if the expenses are accrued.

To go from net income to cash flow from operations, we must make some adjustments to net income on the statement of cash flows. These additions and subtractions follow net income and are labeled Adjustments to reconcile net income to net cash provided by operating activities.

B. Depreciation, Depletion, and Amortization Expenses

These expenses are added back to net income to reconcile from net income to cash flow from operations.

Depreciation does not affect cash because there is no Cash account in the journal entry. Depreciation is a noncash expense. However, depreciation, like all the other expenses, decreases net income. Therefore, to go from net income to cash flows, we must remove depreciation by adding it back to net income.

C. Gains and Losses on the Sale of Assets

Sales of long-term assets such as land and buildings are investing activities, and these sales usually create a gain or a loss. The gain or loss is included in net income, which is already in the operating section of the cash flow statement. The gain or loss must be removed from net income on the statement of cash flows so the total cash from the sale of the asset can be shown in the investing section.

A loss on the sale of plant assets would make net income smaller, so it would be added back to net income.

Changes in the Current Assets and the Current Liabilities

Most current assets and current liabilities result from operating activities. For example,
● accounts receivable result from sales,
● inventory relates to cost of goods sold, and so on.

Changes in the current accounts create adjustments to net income on the cash flow statement, as follows:
1. An increase in a current asset other than cash causes a decrease in cash. If Accounts receivable, Inventory, or Prepaid expenses increased, then cash decreased. Therefore, we subtract the increase in the current asset from net income to get cash flow from operations.

Cash Flows from Investing Activities

Investing activities affect long-term assets, such as Plant assets and Investments.

Cash Flows from Financing Activities

Financing activities affect the liability and owners’ equity accounts, such as Longterm
notes payable, Bonds payable, Common stock, and Retained earnings.

Computing Issuances and Payments of Long-Term Notes Payable

The beginning and ending balances of Notes payable or Bonds payable are taken
from the balance sheet. If either the amount of new issuances or payments is known,
the other amount can be computed.

Computing Issuances of Stock and Purchases of Treasury Stock

Cash flows for these financing activities can be determined by analyzing the stock
accounts. For example, the amount of a new issuance of common stock is determined
by analyzing the Common stock account.

Computing Dividend Payments

The amount of dividend payments can be computed by analyzing the Retained earnings

Excerpts from
Financial and Management Accounting,

Review Notes

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Slides of the chapter from another source

Updated  16 April 2016
8 Dec 2011

April 10, 2016

Sourcing Decisions in a Supply Chain - Summary of the Chapter

Chopra and Meindl's book, Supply Chain Management: Strategy, Planning, and Operation, is a comprehensive introduction on supply chain management.

Sourcing Decisions in Supply Chain

Learning Objectives

1. Understand the role of sourcing in supply chain
2. Understand the factors that determine whether a component or service is outsourced or not.
3. Identify dimensions of supplier performance that affect total cost.
4. Structure successful auctions and negotiations.
5. Understand the impact of risk sharing arrangement with suppliers or distributors.
6. Design a tailored supplier portfolio.

Purchasing: Also called the procurement, is the process by which companies acquire raw materials, components, product, services or other resources from suppliers to execute their operations.

Sourcing: The entire set of business process required to purchase goods and services.

Benefits of effective sourcing

Better economies of scale can be achieved by aggregating orders with in a firm.
Reduction in the overall cost of purchasing (for items with large number of low value transaction).
Design collaboration can result in products that are easier to manufacture and distribute, resulting in lower overall costs. ( for products that contribute a significant amount to product cost and value)
Coordination with the supplier to improve forecasting and planning.
Appropriate supplier contracts can allow for the sharing of risk, resulting in higher profits for both the
supplier and the buyer.
Firms can achieve a lower purchase price by increasing competition through the use of auctions.

In-house or Outsource

A firm should consider outsourcing if the growth in supply chain surplus is large with a small increase in risk.
Performing the function in-house is preferable if the growth in surplus is small or the increase in risk is large.

How Do Third Parties Increase The Supply Chain Surplus

Third parties increase the supply chain surplus if they either increase value for the customer or decrease the supply chain cost relative to a firm performing the task in-house. Three important factors that affect the increase in surplus that a third party provides: scale, uncertainty, and the specificity of assets.

1. Capacity aggregation: Surplus can be created by firms specialising in a component or service by  aggregating demand across multiple firms and gaining production economies of scale that no single firm can on its own.
 The growth in surplus from outsourcing is highest when the needs of the firm are significantly lower than the volumes required to gain economies of scale.
2. Inventory aggregation: Surplus can be created by aggregating inventories across a large number of customers.
Aggregation allows them to significantly lower overall uncertainty and provide higher level of service with lower inventories.
 The third party performing inventory aggregation adds most to the supply chain surplus when demand from customers is fragmented and uncertain.
3. Transportation aggregation by transportation intermediaries: Surplus can be created by aggregating the transportation function to a higher level than any shipper can on its own. The transportation intermediary aggregates shipments across multiple shippers, thus lowering the cost of each shipment below what could be achieved by the shipper alone.
 This is particularly true if the shipper's transportation flows are highly unbalanced, with the quantity coming into a region very different from the quantity leaving the region.
4. Transportation aggregation by storage intermediaries: Surplus can be created by aggregating in bound and out bound transportation.
 This form of aggregation is most effective if the intermediary stocks products from many suppliers and serves many customers, each ordering in small quantities.
5. Warehousing aggregation: Surplus can be created by aggregating warehousing needs over several customers. (in terms of lower real estate cost and lower processing cost).
 Savings through warehousing aggregation arise if a supplier's warehousing needs are small or if its needs fluctuate over time
6. Procurement aggregation: Surplus can be created if a third party if it aggregates procurement for many small players and facilitates economies of scale in production and inbound transportation.
 Procurement aggregation is most effective across many small buyers.
7. Information aggregation: Supply chain surplus can be increased by aggregating information to a higher level than can be achieved by a firm performing the function in-house. This information aggregation reduces search costs for customers.
 Information aggregation increases the surplus if both buyers and sellers are fragmented and buying is sporadic.
8. Receivables aggregation: Supply Chain surplus cab be increase if third party can aggregate the receivables risk to a higher level than the firm or it has a lower collection cost than the firm. Collecting receivables from each retail outlet is a very expensive proposition for a manufacturer.
 Receivables aggregation is likely to increase the supply chain surplus if retail outlets are small and
numerous and each outlet stocks products from many manufacturers that are all served by the same
9. Lower costs and higher quality: A third party can increase the supply chain surplus if it provides lower cost or higher quality relative to the firm. If these benefits come from specialization and learning, they are likely to be sustainable over the longer term. A specialized third party that is further along the learning curve for some supply chain activity is likely to maintain its advantage over the long term.
A firm gains the most by outsourcing to a third party if its needs are small, highly uncertain and shared by other firms sourcing from the same third party.

Risks of using a Third Party
 The process is broken
 Underestimation of the cost of coordination: The cost of the effort required to coordinate activities across multiple entities performing supply chain tasks.
 Reduced customer/supplier contact: The loss of customer contact is particularly significant for firms that sell directly to consumers but decide to use a third party to either collect incoming orders or deliver outgoing product.
 Loss of internal capability and growth in third-party power
 Leakage of sensitive data and information.
 Ineffective contracts: Contracts with performance metrics that distort the third party's incentives often significantly reduce any gains from outsourcing

Supplier Scoring and Assessment (Total Cost Approach)

When scoring and assessing suppliers, the following factors other than quoted price must be considered:
 Replenishment lead time: dictates the amount of inventory required
 On-time performance: affects the variability of the lead time and hence the safety stock
 Supply flexibility(variation in order quantity): less flexible the supplier, more lead-time variability it will display as order quantities change .
 Delivery frequency/minimum lot size: affect the size of each replenishment lot ordered by a firm - cycle and safety inventory
 Supply quality: Quality affects the lead time taken by the supplier order and also the variability of this lead time because follow-up orders often need to be fulfilled to replace defective products.
 Inbound transportation cost: The distance, mode of transportation, and delivery frequency affect the inbound transportation cost
 Pricing terms: allowable time delay before payment has to be made and any quantity discounts offered by the supplier- affects the working capital required.
 Information coordination capability: affects the ability of a firm to match supply and demand- reduces bull whip effect.
 Design collaboration capability: Given that a large part of product cost is fixed at design, collaboration capability of a supplier is significant
 Exchange rates, taxes, and duties

Contracts and Supply Chain Performance

Contracts for Product Availability

To improve overall profits, the supplier must design a contract that encourages the buyer to purchase more and increase the level of product availability. This requires the supplier to share in some of the buyer's demand uncertainty. Three contracts that increase overall profits by making the supplier share some of the buyer's demand uncertainty are as follows:

Buyback or returns contracts: A buy-back or returns clause in a contract allows a retailer to return unsold inventory up to a specified amount, at an agreed-upon price.

In some instances, manufacturers use holding-cost subsidies or price protection to encourage retailers to order more. In the high-tech industry, in which products lose value rapidly, manufacturers share the risk of product becoming obsolete by providing price support to retailers.
 A downside to the buy-back clause (or any equivalent practice such as holding cost subsidy or price support) is that it leads to surplus inventory that must be salvaged or disposed. The task of returning unsold product increases supply chain costs. The cost of returns can be eliminated if the manufacturer gives the retailer a markdown allowance and allows it to sell the product at a significant discount.

Revenue-Sharing Contracts: In revenue-sharing contracts, the manufacturer charges the retailer a low wholesale price c, and shares a fraction f of the retailer's revenue. Even if no returns are allowed, the lower wholesale price decreases the cost to the retailer in case of an overstock. The retailer thus increases the level of product availability resulting in higher profits for both the manufacturer and the retailer. If the production cost v, retail price p, salvage value is sR , optimal order quantity
O*, where the cost of under stacking is Cu = (1 - f)p - c and the cost of overstocking is Cu = c - sR. We thus obtain
Expected manufacturer's profits = (c - v) o* + fp( o* - expected overstock at retailer)
Expected retailer profit = (1 - f)p( O* - expected overstock at retailer)+ SR * expected overstock at retailer - cO*
One advantage of revenue-sharing contracts over buy-back contracts is that no product needs to be returned, thus eliminating the cost of returns. Revenue sharing contracts are best suited for products with low variable cost and a high cost of return.
 Revenue sharing contracts counter double marginalization by decreasing the cost per unit charged to the retailer thus decreasing the cost of over stocking. They increase information distortion and lead to lower retailer effort in case of over stocking, just as but back contracts do.
Quantity Flexibility Contracts: Under quantity flexibility contracts, the manufacturer allows the retailer to change the quantity ordered after observing demand. If a retailer orders 0 units, the manufacturer commits to providing Q = (1 + α)O units, whereas
the retailer is committed to buying at least q = (1 - β )O units. Both α and β are between 0 and 1.
Expected Manufacturer Profit = O*
* (c - v) - (b - sM) * expected overstock at retailer
Quantity flexibility contracts are common for components in the electronics and computer industry. If the supplier has flexible capacity, a quantity flexibility contract increases profits for the entire supply chain and also each party. The quantity flexibility contract requires either inventory or excess flexible capacity to be available at the supplier. If the supplier is selling to multiple retailers with independent demand, the aggregation of inventory leads to a smaller surplus inventory with a quantity flexibility contract compared to either a buy-back or revenue-sharing contract.
Relative to buy-back and revenue-sharing contracts, quantity flexibility contracts have less information distortion.
 Quantity flexible contracts counter double marginalization by giving the retailer the ability to modify the order based on improved forecasts closer to the point of sale. They result in lower information distortion than buy back or revenue contacts when a supplier sells to multiple buyers or supplier has excess flexible capacity.

The Procurement Process
There are two main categories of purchased goods: direct and indirect materials. Direct materials are components used to make finished goods. For example, hard drives, and CD drives. Indirect materials are goods used to support the operations of a firm. For eg: PCs. The procurement process for direct material should be focussed on improving visibility and coordination with the supplier. For indirect materials, the process should focus on decreasing the transaction cost for each order. The procurement process in both the cases should consolidate orders to take advantage of the economies of scale and quantity discounts.

Based on the value and criticality of the product, they are classified into four groups:
1. General Items: Low value, Low Criticality. Mostly Indirect Items. Aim: Lower the cost of acquisition.
2. Bulk purchase items: High value, Low Criticality. Method: well-designed auctions.
3. Strategic Items: Low value, High Criticality. Components with long lead times. Aim: ensure availability
4. Critical Items: High value, High Criticality. Aim: Long term buyer-supplier relationship

Risk Management in Sourcing

 Supply Disruption: Developing multiple sources especially for products with high demand.
 Delay from suppliers: Carry inventory(low value items) or develop backup source(high value items).
 Higher procurement costs: have a portfolio of long- and short-term contracts
 Exchange-rate risk: Financial hedging can be done so that purchase price in local currency becomes fixed.
 Intellectual Property risk: keeping sensitive production in-house. maintain ownership of part of the equipment

Making Sourcing Decisions in Practice

Use multifunctional teams
Ensure appropriate coordination across regions and business units.
Always evaluate the total cost of ownership
Build long-term relationships with key suppliers

Updated 10 Apr 2016
9 Dec 2011