Review Session

Overview:

  • Comprehensive
  • 2 hours
  • 2 sections
  • Each section will have 6 numbered parts, of which you may skip one. This means that we will drop the worst part from each of the two sections.

Overview:

  • Each part will include information you will use to answer the questions in that part.
  • These questions will be indicated with letters: (a) if there is one, (b) if there is a second, and so forth.
  • The exam is closed book and notes.

Section 1:

  • This will cover the information that was on the mid-term.
  • The original five parts will be repeated with minor edits.
  • There will be one additional question.

Cost functions

  • Average cost, marginal cost, incremental costs.
  • When do they exist, when do they differ, when do the differences matter.

Regression and Plotting

Practice plotting data and adding a trend line using your tool of choice.

Constrained Maximization

  • Be able to set up an objective function.
  • Identify the choice variables.
  • Identify the constraints.
  • Understand what it means for a constraint to bind, or to be slack.
  • Understand shadow price, and explain their real world meaning.
  • The details from this question will come from the Non-linear programming lecture

Multiple Choice questions about taxes.

Key tax concepts:

  1. Assets, investments, and projects all have different pre-tax returns (r).
  2. Tax rates t vary across individuals, jurisdictions, organizations, and assets.
  3. pre-tax returns r correspond to post tax returns r(1−t)
  4. When preferential tax treatment increases demand for a tax favored asset it’s price increases and/or the return to holding it decreases. This price change is an implicit tax.
  5. When tax payers use organizational forms like pensions and insurance policies to avoid taxes it is called organizational form arbitrage.

Key tax concepts:

  1. When high-tax tax payers issue taxable debt to finance the purchase of tax free debt (e.g. municipal bonds in the US) issued by low-tax tax payers (e.g. US non-profit universities) it is called clientele arbitrage.
  2. The depreciation tax shield is the present value of the reduction in tax payments afforded by the depreciation deduction.
  3. The value of the tax shield TS is a function of the investment x, the cash flow it generates k, the risk-free rate of return r, the tax rate t, and the depreciation rate d. TS = f(x,k,t,d,r)
  4. TS is increasing in both d and t.

Data Science work flow

  • Review the “A ‘Data Science’ Workflow” Section of the Cost Estimation Lecture
  • You should have a sense for the flow of the “management accounting” data work flow.

Section 2 - What we’ve covered since the midterm

I will write six questions based on the following topics, you should answer at least six of them.

Economics of agency

  • The following issues will be covered:
    • Separation of ownership and control
    • The nature of the principal agent problem.
    • Risk aversion and incentives

Economics of agency

Section 2 Part 2: Transfer Pricing

  • Vik-Giger
  • Why do we need transfer prices?
    • Overconsumption of common resources.
    • Transmit information and incentives within a decentralized firm.

Cost Allocation

  • The key concept here is that cost allocations (including transfer prices) function as ‘Pigouvian’ taxes
    • Taxes reduce the taxed activity
    • Negative taxes are subsidies, and increase the subsidised activity

Absorption Costing

  • Navisky, Aspen, Kothari problems (don’t worry, I won’t ask all of them)

Activity Based Costing

Conceptual understanding of how activity based costing improves on simple absorption costing.

  1. More granular information leads to more accurate cost allocations.
  2. More accurate allocations provide better information via transfer prices.
  3. More accurate allocations connect incentives (a la Pigou) to the actual costs that the firm incurs.

Budgets/Standard Costs/Variances

The only terms you need are the ones used in the following slides. I will cover these with multiple choice questions.

Variance:

Total Variance = Actual Cost - Standard Cost

Disaggregation of direct cost variances

Direct cost (labor and materials) can be disaggregated into Price and Quantity variances using the flexible budget.

Disaggregation of direct cost variances

Total Variance Actual DM Cost Flexible Budget Standard DM Cost
(Qa×Pa) − (Ps×Qs) Pa × Qa Ps × Qa Ps × Qs
Total Variance Price Variance Quantity Variance
(Qa×Pa) − (Ps×Qs) Pa × Qa − Ps × Qa Ps × Qa − Ps × Qs
[Qa(Pa−Ps)] + [Ps(Qa−Qs)] Qa(Pa−Ps) Ps(Qa−Qs)

Disaggregation of overhead cost variances

Total Overhead Variance = Actual Overhead Costs - Overhead Absorbed AOH − (OHR×SV) = AOH − (OHR×SV)$2,300,000 - $2,291,600 = $8,400

Interpretation:

  • Overhead is ‘Underabsorbed’, if actual > absorbed
  • Overhead is ‘Overabsorbed’, if actual < absorbed

Disaggregation Overhead Variance

Total Overhead Variance = Actual Overhead - Overhead Absorbed

  • Overhead spending variance = Actual overhead - Flexible budget at actual volume
  • OSV = AOH - FB@AV
  • Overhead efficiency variance = Flexible budget at actual volume - Flexible budget at standard volume
  • OEV = FB@AV - FB@SV
  • Overhead volume variance = Flexible budget at standard volume - Overhead Absorbed
  • OVV = FB@SV - OA

Disaggregation Overhead Variance

TOV = AOH - OA
OSV = AOH - FB@AV
OEV = FB@AV - FB@SV
OVV = FB@SV - OA

More detailed definitions:

TOV = AOH - OHR × SV
OSV = AOH - FOH+(VOH×AV)
OEV = FOH+(VOH×AV) - FOH+(VOH×SV)
OVV = FOH+(VOH×SV) - OHR × SV

Disaggregation Overhead Variance

  • Overhead spending variance: OSV = AOH - FB@AV
    • This is the variance due to change in the cost of the overhead itself.
  • Overhead efficiency variance: OEV = FB@AV - FB@SV
    • This is the variance due to differences in how efficiently we used the overhead.
  • Overhead volume variance: OVV = FB@SV - OA
    • This is the variance due to the effect of volume on the overhead allocation.