B1 Flashcards
The treadway commission was established by
Private Sponsoring Organizations
COSO prepared
the Internal Control Integrated Framework to help businesses assess internal controls.
A public corporation, evaluating internal control procedures is done by
internal audit staff who reports to the board of directors which are responsible for the internal controls of company
According the COSO, the proper tone at the top helps a company
promote a willingness to seek assistance, navigate gray areas, create a compliance supporting culture
Conduct that will communicate the “tone at the top” includes
limits on situations that can cause conflict of interest ( what is this) / gifts and descriptions of their commitment to keeping information confidential
Board of Directors is
Fiduciary which is acting on the behalf of or best interest of another
The Board of Directors exercises
oversight responsibility to financial reporting and related internal control
Control Environment represents
A company has established and communicated baseline expectations ( example code of conduct) for performance to all employees
Risk Assessment includes
principles such as specifying objectives of risk and financial reporting, asses changes to leaders, Fraud, Risks analyzed
According to COSO, the first step in evaluating the effectiveness of an internal control system is to
establish a Control Baseline
The compliance program that included both Ethics training and hotline for anonymous reporting is evidence of
development of ethical values and the values are understood: Control Environment
Periodic acknowledgement is
the development of ethical values and that ethical values are understood
Define Control Environment
the baseline set by management expectations for employees.
Monitoring internal controls is to
make sure control effectively manages Risks.
Establishing a control baseline is
the first ongoing monitoring step in evaluating the effectiveness of an internal control.
Internal audit manager requests information of training that IT department received showing a
commitment to retain competent individuals which is part of Control Environment
The financial reporting principle suggests
stronger controls and encourages the company to retain qualified personnel.
The definition of Obtain and use information
obtains relevant, high quality information to support a control
Ongoing monitoring activities are
comparison of information, periodic analysis, follow up customer and vendor complaints. (Monitoring COSO)
Monitoring internal control involves
establishing a foundation, designing and executing procedures, assessing and reporting the results & following up corrective action
Monitoring is
assessing the design and operation of controls in a timely manner & taking corrective actions
The fraud triangle is
incentive to commit fraud from motivation and pressure, opportunity stems from weak internal controls, rationalization is justification of actions by fraud perpetrator.
Prioritizing findings is
included in the assess and report phase of an effective approach to monitoring
Committee on Sponsoring Organizations (COSO) are associated with
Institute of Auditors (IIA), Institute of Management Accountants (IMA), American Institute of Certified Public Accountants (AICPA)
The COSO cube is used to illustrate categories of objectives
(Operating, Reporting, Compliance), internal control components, and entity organizational levels.
Controls Provide:
Controls only provide “inherent limitations”. Setting up internal controls does not provide “assurance” (confidence or certainty) that controls will not be overridden.
In order to have effective internal controls
components operate together, the components and associated principles are present and functioning as designed.
Information and communication ensure
the internal and external auditors are aware of significant internal control issues
What are principals of existing control activities
Policies/ Procedure and Technology
Strategy and Objective setting component of
Enterprise Risk Management framework is supported by the principle of analyzing business Objective setting in GO PRO (Strategies, Objectives, Analyzes business context, Risk Appetite)
Regular evaluation of employees for their competence in financial reporting is a link between
human resources policy and financial reporting objectives.
Attracting and retaining capable employees is a principle that
supports the governance and culture in Enterprise Management
Governance and culture components is
is supported by the principles of oversight of board, commitment to values, desired culture
Enterprise Risk Management states
that event identification occurs after the development of objectives. (Events will either favorably or unfavorably impact the achievement of objectives)
Enterprise Risk Management helps improves
risk response decisions, Improving division of capital, seizing good opportunities for companies
Organizational sustainability is
the ability to withstand the impact of large scale events
The core values of an entity most closely correlate with
culture
What makes up Enterprise Risk Management framework
Objectives are reached, achieve financial and Performance targets, assess Risks continuously
Risk appetite is
likelihood of fraud occurring significantly exceed residual risks.
Information must be provided in a
timely manner, relevant to the appropriate user, readily accessible to those who need it. (Information and communication component) (OIE)
Risk assessment use
Objective statistical data with estimated probabilities, subjective assumptions which accounts impact all of these assessment
Enters into a contract with conflict of interest
contract is voidable unless the director makes the full disclosure to the disinterested directors/ shareholders who then can approve it before hand
Control Environment is
code of conduct that encouraging teamwork in pursuit for entity’s objectives
Sarbanes- Oxley Act requires that
members of the audit committee be a financial expert and that the financial reports disclose the existence of financial experts does not require CPA
Qualifications to be financial expert is
a judgment issue made by the Board of Directors and Sarbnes- Oxley provides guidance
SEC proposed standards for codes of ethics to include
both internal reporting & accountability
Sarbanes-Oxley States
issuer must disclose whether or not it has adopted a code of ethics for the issuers senior financial officers but not for other employees
A code of conduct should be
in writing and available to employees but does not need to be displayed in public.
Title IV of sarbanes- oxley disclosures found in
an issuers financial statements include usage of special purpose entities, relationships with subs that are not consolidated, GAAP basis financials
SEC place the lowest priority on
reviewing common stock because they have the lowest value
Picking Ticket is a
list of items on an order, authorizes the warehouse to send goods to the shipping department
Three-way match of expenditure process is
purchase order, receiving report, supplier invoice.
Packing Slip list of items included in package, is a
common document found in the revenue process
Voucher is paper that
entitles the holder to a discount, a common document found in the expenditure process
Product design and engineering and Manufacturing forecasting scheduling, are part of
manufacturing process
Earnings Statement is a
common document found in the human resources and payroll process
Bill of Materials list
of raw materials owned by company is found in the manufacturing process
Detective control are designed to
find errors that has already occurred (EX: Reconciliation of changes)
Validity check helps
prevent error of item not being on a master file but is online for sale
Hiring guidelines is a
supervisory and monitoring control part of control environment
Flowcharts both visualize the
logical flow of data through a process and physical aspects of that flow like showing is processes are manual or automated
Data flow diagrams is
logical flow of data opposed to physical flow
Unsystematic Risk reduces
risk through a combined portfolio of different investments because unsystematic is diversifiable
Labor Strikes can be reduced through
diversification
Business Risk is the risk
shareholders value of the company might be affected
Required rate of return is computed by
default risk lenders demand compensation for taking risk that issuer will fail to pay, liquidity risk compensation lender demands for taking risk that investment could not be sold in a short period without big concession on price, maturity risk lenders demand for exposure to inherent risk over time, purchasing risk compensation investor requires for bearing risk of price levels changing and affecting asset values
Liquidity Risk is ability to
sell investment in short period of time without a big price reduction (mitigate by proper management of cash flow which is improving spending habits)
Put option gives it owner the right to
sell specific security at fixed price and time
Minimize risk from foreign currency fluctuation by
hold payables and receivables in same currency
When domestic currency appreciates is becomes
more expensive compared to FC. Exports become more expensive to purchasers overseas, Imports are less expensive
The company expects the US dollar to decline if
When a company decides to invest in an emerging market operation with a lower rate of return than the domestic market
When exporting goods to foreign countries it subject to
transaction (G/L on AP/AR) and economic risk (CF). Not translation because no foreign investment or subsidiary (no assets).
Foreign competitor currency becomes weaker results in
advantage in the US market
Avoid over-hedging by
minimizing amount of hedge contracts needed to offset transaction
LT financing, credit risk will decrease bc company is
less likely to seek refinancing. ST financing result in lower interest rates but higher interest rate risk bc rates will fluctuate more.
Declining local currency implies
the dollar is less expensive relative to foreign currency
How to find cross rate to euros per pound
Price of the Pound/ Euro
Cash inflow in nominal dollars
Cash Inflows x Inflation rate x number of years
how to mitigate if you do not have AR to offset
When domestic currency falls, payables in foreign currency is the biggest exchange rate risk this can be mitigated by hedging through futures contract or currency swap
What mitigates long term transaction exchange rate risk
Currency swaps, parallel loans and long term forward contracts
How to find Effective Interest Rate
Actual Interest = ( P x Rate x Time)
Net Interest Cost = Actual Interest - Interest Earned
Effective Interest Rate= Net Interest Cost/ Loan Proceeds - Additional Balance
What is the formula effective Interest Rate in form of a discounted note
Cash Proceeds = Loan Principal - Interest discounted in advance
Effective Interest Rate = Interest Charged/ Cash Proceeds Of discounted note
What is the Effective annualized percentage cost of financing
(Face Value - Original Issue Discount ) = x
X + Transaction costs = Y
(Y/ Original Issue Discount) x number of years = Answer
The bond will sell at a premium when
the stated coupon rate on the bond is greater than the market interest rate on the bond at a given date
Commercial paper
generally does not have an active secondary market, it usually sold to the money markets by high creditworthy companies
Commercial paper avoids
the expense of maintaining compensating balance with commercial bank, Provide a broad distribution for borrowing, borrowers name becomes more widely known
Cost of Capital aka hurdle rate is
the minimum return a company must achieve in order to make an investment financially feasible, which can be calculated using
The overall cost of capital is rate of return required to cover
the cost of resources employed
The optimal capitalization for an organization usually can be determined by
lowest total weighted average cost of capital (WACC)
WAAC
Weight x Rate x ( 1- Tax Rate)
When the mean return is greater than the standard deviation that means
there is a greater reward/ risk ratio.
Debt is a
cheaper source of financing than equity, bonds will be the cheapest form of financing. In addition issuing bonds receives a tax deduction for interest paid which further reduces cost
In the CAPM (Capital Asset Pricing Model) formula the beta coeffienctent measures
the volatilityor risk inhenrent investment by % change in stock price
Manager have met the responsibility if
the return on capital investment exceeds the rate of return associated with the firms beta factor
CAPM model is calculated by taking the
= Risk free rate + {Risk premium aka Beta * (Market Rate return - Risk Free Rate)}
Calculate Market rate of interest on a one year US treasury bill
= Risk free rate of interest + Inflation Premium
When determining the risk premium
length of maturity, relative liquidity, and relative security is relevant
calculate cost of capital
R= (D1/Po) + g
Current dividends per share (D)
Expected growth rate in dividends (g)
Current Market Price per share of common stock (P)
An example of operating leverage is a
firm cost structure includes a higher degree of operating fixed costs than variable costs by electing to pay salaries instead of commission.
Net working capital is the
difference between current assets and current liabilities
Determine the appropriate level of working capital requires
offsetting the benefit of current assets and current liabilities against liabilities rising at a faster rate than assets
As a company becomes more conservative in its working capital it
increases in the ratio of current assets to units of output
Net Working Capital
Cash + Accounts Receivable + Inventory - Accounts Payable = Net Working Capital
Refinancing a short term note payable with a two year note payable would
increase the working capital of the firm
The working capital financing policy that finances
permanent current assets with short term debt subjects the firm to the greatest risk of being unable to meet maturity
Working Capital Formula
Current Assets - Current Liabilities
The current ratio is measure current assets by current liabilities which will increase if
you receive payment on accounts payable but the ratio will stay unchanged if cash is received from a receivable bc that cash already was included in assets just moved to a different category
Refinancing of accounts payable
with a two year note payable would increase capital of a firm
Cash Conversion Cycle
Inventory + Receivables - Payables
Account Receivable Turnover
Sales / Average AR
When a long term debt instead of short term debt is used to finance inventory purchases
current ratio and total debt ratio both increase
Increase inventory Turnover
lowers cash conversion cycle
Accounts Receivable Days
Ending AR / (Sales / 365)
Net realizable value method
recognize the price at which the inventory could be sold less any costs associated with shipping inventory
Examples of inventory carrying costs are
insurance, opportunity cost on inventory investment, obsolescence and spoilage
Safety stock is the
minimum level on inventory that a firm keeps on hand, which depends on sales forecast, customer dissatisfaction for back orders, lead time for stock shipments
The optimal level of inventory would be affected by
cost per unit of inventory, cost of placing an order for merchandise, lead time to receive merchandise ordered.
The economic order quantity formula (EOQ) assumes
the periodic demand is known
When the Economic order quantity (EOQ) model is used for a firm
manufactures inventory ordering costs consist of production set up
Economic Order Quantity
is when Inventory Management approaches orders at the point where carrying costs equate nearest to restocking costs in order to minimize total inventory
SCOR model says
when key management processes does assess the ability of suppliers to suply resources falls under “Plan”
Supply Chain Operations Reference (SCOR) says a company would
include determining demand requirements, assessing capacity concerns and capabilities, making make/ buy decisions in its planning
Potential Problems for a company with just in time inventory are
actual lead time for materials order could be longer than expected, loss of quantity discounts more than the cost of handling and purchasing larger lots of inventory, low quantity inventory. Seasonal fluctuations should not be a problem bc manufactures and suppliers should expect it and coordinate
Primary benefit of just in time inventory system for raw materials
is eliminates non value added operations
Materials requirements planning
has a set of procedures to determine inventory levels for demand dependent inventory types such as work in process and raw materials
Supply Chain Operations Reference (SCOR) says key management processes
does managing accounts receivable and collections from customers falls into Deliver
Supply Chain Operations Reference (SCOR) says key management processes does
collecting and processing vendor payments falls into Source
Trade Credit provides
the largest source of short term credit for small firms
Accounts Payable provides
a spontaneous source of financing for a firm
Trade credit is subject to
risk of buyer default
A firm best delay disbursements through
the use of Drafts
Trade credit should still be used if
cost of alternative short term financing is more
If a seller extends credit to a purchaser for a longer period of time than operating cycle it in effect
financing more than just the purchaser’s inventory needs
If a seller extends the payback period on a customer it affects
cost of funds, impact on current customer base of extending terms for certain customers, bank loan covenants on days sales outstanding. No affect on current bad debt.
examples of methods of converting accounts receivable to cash
Cash discounts, collection agencies, and electronic funds transfers
A change in credit policy has caused an
increase in sales, increase in discounts taken, decrease in the amount of bad debt, decrease in accounts receivable means the average collection period decreased
If a business sells a product and they receive 55% of it by check and 45% by credit card after they receive the invoice all of it goes to
accounts receivable bc they aren’t paying it until they receive an invoice not immediate payment
Formula for Average Gross Receivables
Average daily sales x Average Collection Period
Concentration banking is
when company establishes a single bank as its central depository
Lockbox System accelerated
accounts receivable because its systems of mailboxes in many locations where customers send payments. Company checks mailboxes and immediately deposits checks
A lockbox most likely provides
for receivable management a minimized collection float because its expedites cash inflows
The primary reason for a company to agree to debt covenant limiting the percentage of its LT debt is to
reduce the coupon rate on the bonds being sold
Stock price will grow at the same rate as
the dividend if the company uses a constant growth dividend discount model to forecasted the value of share of common stock
Price sales ratio is
a valuation of estimation technique that can be adapted to start up companies and other situations where earnings are very low
Company Free Cash Flow
Net Income + Non Cash Expenses - Increase in Working Capital - Capital Expenditures
