Principles of Accounting: Chapter Twenty-Four

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Chapter Summary

Chapter 24 examines analytical methods and reasoning that are applicable to management decision-making activities. The chapter begins with a presentation of cost characteristics, including emphasis on the concepts of relevant and sunk costs. This is followed by the construction of a general frame of reference for decision making, which is then illustrated with examples related to outsourcing, special orders, and discontinuance of products/departments.

The chapter then turns to consideration of the evaluation of capital expenditures. Such decisions are heavily dependent upon a number of intrinsic calculations related to future and present value concepts, and the chapter provides in-depth coverage of each. Next, the chapter shows how these considerations are utilized in net present value calculations and internal rate of return calculations. Alternative capital investment evaluation tools, like the accounting rate of return and payback method, are also examined.

Exercises

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Key Terms

Key Terms: Chapter Twenty-Four

accounting rate of return

A project evaluation tool that focuses on accounting income rather than cash flows; average annual increase in income by the amount of initial investment.

annuity

Level streams of payments; with each payment being the same, and occurring at a regular interval

annuity due

Also known as an annuity in advance; involves a level stream of payments, with the payments being made at the beginning of each time period

capital expenditure decision

Also known as capital budgeting; planning and decision making related to longer term projects and expenditures

future value

Or "compound interest;" amount that a current payment (or stream of payments) will grow in time; includes interest on previous interest based on frequency of compounding

internal rate of return

Also known as time-adjusted rate of return or IRR; discount rate causing present value of cash inflows to equal present value of the cash outflows

net present value

Or NPV, a method of evaluating capital projects that uses a predetermined interest rate to determine the present value of an investment's net cash inflows and outflows

opportunity cost

The cost of a foregone alternative; may include lost revenue

ordinary annuity

Also known as an annuity in arrears; involves a level stream of payments, with the payments being made at the end of each time period

outsourcing

Utilization of independent parties to manufacture products (sometimes known as make-or-buy) or manage data processing, tech support, payroll services, etc.

payback

Easy method for evaluating capital projects; calculated by dividing the initial investment by the annual cash inflow

present value

Also known as discounting; determines the current worth of cash to be received in the future

relevant cost

Items where future costs and revenues are expected to differ for the alternative decisions under consideration

special order

A customer order that is outside of the normal pricing and terms

sunk cost

Historical amount expended on a project or object; not relevant to current decisions or future actions

time value of money

Conceptual notion holding that money to be received sooner is worth more than money to be received later