B6-5/6/7 Flashcards
In a large public corporation, evaluating internal control procedures should be the responsibility of:
a.
Operations management staff who report to the chief operations officer.
b.
Security management staff who report to the chief facilities officer.
c.
Accounting management staff who report to the CFO.
d.
Internal audit staff who report to the board of directors.
Choice “d” is correct. In a large public corporation, evaluating internal control procedures should be the responsibility of an organizationally independent internal audit function that reports to the governing body of the corporation.
Choice “c” is incorrect. Evaluation of the effectiveness of the internal control procedures by accounting management that report to the CFO would likely be subject to bias and lack objectivity since the controls are likely designed and at least partially implemented by that staff. Use of the accounting management that report to the CFO would not be appropriate.
Choice “a” is incorrect. Operations management staff reporting to the chief operations officer would likely lack the depth of knowledge of financial controls that extend beyond operations necessary to evaluate the internal control procedures of a large public corporation. Use of operations management staff would not be appropriate.
Choice “b” is incorrect. Securities management staff reporting to the chief facilities officers would likely lack the expertise necessary to evaluation the internal control procedures in a large public corporation. Use of securities management staff would not be appropriate.
Which of the following types of bonds is most likely to maintain a constant market value?
a.
Zero-coupon.
b.
Floating-rate.
c.
Callable.
d.
Convertible.
Choice “b” is correct. Floating-rate bonds would automatically adjust the return on a financial instrument to produce a constant market value for that instrument. No premium or discount would be required since market changes would be accounted for through the interest rate.
Choice “a” is incorrect. Zero-coupon bonds have, in effect, a fixed stated rate of return that would require assignment of a premium or discount to the underlying security to produce a market rate of interest if that market yield is different from the stated rate.
Choice “c” is incorrect. Callable bonds would fluctuate in value. In fact, one of the advantages to the issuer of callable bonds is the ability to call or, effectively, refinance the bonds if interest rates become favorable.
Choice “d” is incorrect. Convertible bonds would fluctuate in value. In fact, one of the advantages to the investor (and potentially the issuer) in relation to convertible bonds is the ability to convert or, effectively, swap the bonds for equity if market conditions become favorable (equity returns exceed fixed return on debt).
International Standards for the Professional Practice of Internal Auditing include standards for quality of communications. According to the Standard, communications that are free from errors and distortions and are faithful to underlying facts are characterized as:
a.
Complete.
b.
Clear.
c.
Objective.
d.
Accurate.
Choice “d” is correct. Accurate communications are free from errors and distortions and are faithful to the underlying facts.
Choice “c” is incorrect. Communications that are free from errors are characterized as accurate. Objective communications are fair, impartial, unbiased, and are the result of a fair-minded and balanced assessment of all relevant facts and circumstances.
Choice “b” is incorrect. Communications that are free from errors are characterized as accurate. Clear communications are easily understood and logical, avoiding unnecessary technical language and providing all significant and relevant information.
Choice “a” is incorrect. Communications that are free from errors are characterized as accurate. Complete communications lack nothing that is essential to the target audience and include all significant and relevant information and observations to support recommendations and conclusions.
Harken Corporation’s price earnings ratio is 10 and its earnings in the current year is $5 per share but the earnings expected in the coming year is $8 per share. What is the anticipated price of Harken?
a.
$50
b.
$80
c.
$0.80
d.
$0.50
Choice “b” is correct. The price earnings ratio is 10, therefore, the price is equal to the price divided by earning anticipated for the coming year. The P/8 = 10, therefore, P = $80.
Choice “d” is incorrect. The proposed solution anticipates current earnings divided by price.
Choice “c” is incorrect. The proposed solution anticipates projected earnings divided by price.
Choice “a” is incorrect. The proposed solution anticipates price divided by current earnings.
Which of the following statements is true regarding the International Professional Practices Framework Code of Ethics?
a.
The Code of Ethics applies to both individual internal auditors and entities that conduct internal audits.
b.
The Code of Ethics is divided into three sections covering independence, objectivity, and competency.
c.
The Code of Ethics includes a comprehensive and detailed Standards of Conduct document.
d.
The Code of Ethics applies to individual internal auditors only.
Choice “a” is correct. The Code of Ethics issued as part of the IPPF applies to both individuals and entities that provide internal auditing services.
Choice “d” is incorrect. The Code of Ethics issued as part of the IPPF applies to both individuals and entities that provide internal auditing services.
Choice “c” is incorrect. The Code of Ethics issued as part of the IPPF does not have a companion Standards of Conduct document.
Choice “b” is incorrect. The Code of Ethics issued as part of the IPPF provides principles and rules of conduct under four headings: integrity, objectivity, confidentiality, and competency.
Investors are likely to view a high price earnings (P/E) ratio as an indication that:
a.
Earnings have growth potential
b.
Earnings have peaked and will likely fall
c.
There is no logical conclusion to reach about the relationship between price and earnings
d.
Earnings have peaked and will remain flat
Choice “a” is correct. The P/E ratio measures the amount that investors are willing to pay for each dollar of earnings per share. Higher P/E ratios generally indicate that investors are anticipating more growth and are bidding up the price of the shares in advance of performance.
Choice “d” is incorrect. High P/E ratios generally indicate investor confidence in earnings growth, not performance that has peaked.
Choice “b” is incorrect. High P/E ratios generally indicate investor confidence in earnings growth, not that performance will fall.
Choice “c” is incorrect. High P/E ratios give some insight into investor confidence of earnings growth.
Karl Kravitz, chief audit executive of the Carbon Corporation, applies internal audit procedures to the company’s system of controls over accidental pollution and concludes that the likelihood and impact of accidental carbon pollution exceeds the company’s risk appetite. If Carbon Corporation has adopted International Standards for the Professional Practice of Internal Auditing, how should Kravitz report his finding that residual risk exceeds risk appetite?
a.
Report the finding only to senior management.
b.
Report the finding directly to the board of directors.
c.
Report the risk exposure to senior management and, if unresolved, report the matter to the board of directors.
d.
Report the risk exposure directly to the Environmental Protection Agency (EPA) or other appropriate regulatory body.
Choice “c” is correct. When the chief audit executive believes that senior management has accepted a level of residual risk that may be unacceptable to the organization, the chief audit executive must discuss the matter with senior management. If the decision regarding residual risk is not resolved, the chief audit executive must report the matter to the board for resolution.
Choice “a” is incorrect. The chief audit executive should initially report his judgment that residual risks exceed risk appetite to senior management and would pursue the matter with the board in the event that the issue cannot not be resolved with senior management.
Choice “b” is incorrect. The chief audit executive would not directly report his judgement to the board of directors that residual risks exceed risk appetite without first trying to resolve the issue with senior management.
Choice “d” is incorrect. The chief audit executive is not required to report findings to external parties in this instance.
An analyst is reviewing a start up company with no net earnings. If the analyst wants to use a price multiples approach to valuation rather than a discounted cash flow method, the analyst would most likely select:
a.
P/E ratio projections
b.
Price-sales ratio projection
c.
Return on residual P/E ratio
d.
PEG ratio projections
Choice “b” is correct. Price-sales ratio projection approaches can provide meaningful information in the event that net earnings data is not available.
Choice “a” is incorrect. P/E ratios are not meaningful if earnings are either extremely small or a loss.
Choice “d” is incorrect. PEG ratios are based on the P/E ratio which is not meaningful when the analyzed company is either experiencing losses or has small earnings.
Choice “c” is incorrect. This is a distracter. There is no “return on residual P/E ratio” methodology.
According to the Performance standards included in the International Standards for the Professional Practice of Internal Auditing, effective management of internal audit activities is characterized in part by:
a.
Objective and relevant assurance.
b.
Contributions to the effectiveness and efficiency of governance.
c.
Conformity to the Standards and Code of Ethics.
d.
Consultation of practice aids.
According to the Performance standards included in the International Standards for the Professional Practice of Internal Auditing, effective management of internal audit activities is characterized in part by:
a.
Objective and relevant assurance.
b.
Contributions to the effectiveness and efficiency of governance.
c.
Conformity to the Standards and Code of Ethics.
d.
Consultation of practice aids.
Bander Co. is determining how to finance some long-term projects. Bander has decided it prefers the benefits of no fixed charges, no fixed maturity date and an increase in the credit-worthiness of the company. Which of the following would best meet Bander’s financing requirements?
a.
Common stock.
b.
Bonds.
c.
Short-term debt.
d.
Long-term debt.
Choice “a” is correct. Common stock is an equity security that conveys ownership. Common stock does not require any payment, it does not mature and, because it increases equity while having no effect on debt, it decreases the debt equity ratio and increases the credit-worthiness of the firm.
Choice “b” is incorrect. Bonds are debt instruments that require specific fixed payments, mature at a specific time and increase debt. Immediately after issue, increases in debt increase the debt equity ratio and decrease credit worthiness.
Choice “d” is incorrect. Long-term debt requires specific fixed payments, includes maturity at a specific time and (by definition), increases debt. Immediately after issue, increases in debt increase the debt equity ratio and decrease credit worthiness.
Choice “c” is incorrect. Short-term debt requires specific fixed payments, includes maturity at a specific time and, by definition, increase debt. Immediately after issue, increases in debt increase the debt equity ratio and decrease credit worthiness.
According to the Independence and Objectivity standards included in the International Standards for the Professional Practice of Internal Auditing, the chief internal audit officer should confirm his independence to the board of directors:
a.
Annually.
b.
Quarterly.
c.
Every three years.
d.
Biannually.
Choice “a” is correct. The chief internal audit officer should confirm his independence to the board of directors annually according to the Independence and Objectivity standards included in the International Standards for the Professional Practice of Internal Auditing.
Choice “c” is incorrect. The chief internal audit officer should confirm his independence to the board of directors annually, not every three years, according to the Independence and Objectivity standards included in the International Standards for the Professional Practice of Internal Auditing.
Choice “d” is incorrect. The chief internal audit officer should confirm his independence to the board of directors annually, not biannually, according to the Independence and Objectivity standards included in the International Standards for the Professional Practice of Internal Auditing.
Choice “b” is incorrect. The chief internal audit officer should confirm his independence to the board of directors annually, not quarterly, according to the Independence and Objectivity standards included in the International Standards for the Professional Practice of Internal Auditing.
Which of the following statements is (are) correct regarding corporate debt and equity securities?
I.
Both debt and equity security holders have an ownership interest in the corporation.
II.
Both debt and equity securities have an obligation to pay income.
a.
Neither I nor II.
b.
II only.
c.
Both I and II.
d.
I only.
Choice “a” is correct. Neither I nor II is correct. Equity security holders have ownership interest while debt holders do not. Debt obligations require a periodic interest payment while equity securities only pay income to their holders when dividends are declared at the discretion of the Board of Directors.
Choice “d” is incorrect. Equity security holders have ownership interest while debt holders do not.
Choice “b” is incorrect. Debt obligations require a periodic interest payment while equity securities only pay income to their holders when dividends are declared at the discretion of the Board of Directors.
Choice “c” is incorrect. “Both I and II” is not correct. See explanations above.
A financial manager believes that his actions will cause earnings to increase and market prices to stay in proportion to increased earnings. The manager’s behavior illustrates:
a.
Confirmation bias.
b.
Excessive optimism.
c.
Overconfidence.
d.
Illusion of control.
Choice “d” is correct. A manager that believes their actions will have unerring impact on the market place is suffering from an illusion of control.
Choice “c” is incorrect. Overconfidence is purely a belief that judgments are correct.
Choice “b” is incorrect. Excessive optimism anticipates more favorable than unfavorable results.
Choice “a” is incorrect. Confirmation bias seeks data that supports a position without regard to evidence that contradicts the position or supports an opposing point of view.
Which of the following formulas should be used to calculate the economic rate of return on common stock?
a.
Market price per share divided by earnings per share.
b.
Dividends per share divided by market price per share.
c.
(Dividends + change in price) divided by beginning price.
d.
(Net income − preferred dividend) divided by common shares outstanding.
Choice “c” is correct. The economic rate of return on common stock measures the dividend income and capital growth in relation to the initial investment, the beginning price of the stock.
Choice “d” is incorrect. The proposed solution is earnings per share, a ratio generally computed as the earnings available to common shareholders (net income after payment of preferred shares) divided by the common shares outstanding.
Choice “a” is incorrect. Market price per share divided by earnings per share is the price/earnings or P/E ratio, not the economic rate of return on common stock.
Choice “b” is incorrect. The dividends per share divided by the market price per share does not represent the economic rate of return on common stock, the ratio includes change in stock value in the denominator rather than the numerator of the equation.
The Institute of Internal Auditors defines internal auditing in their International Standards for the Professional Practice of Internal Auditing as an:
a.
Institutional improvement system.
b.
Interdependent attestation service.
c.
Independent objective assurance and consulting activity.
d.
Integrated program evaluation function.
Choice “c” is correct. The IIA defines internal auditing as an independent objective assurance and consulting activity designed to add value and improve an organization’s operations.
Choice “b” is incorrect. The IIA defines internal auditing as an independent rather than interdependent activity. The definition does not characterize internal auditing as an attest function.
Choice “d” is incorrect. Program audits or evaluations may be part of an internal auditor’s work; however, the definition provided by the IIA characterizes internal auditing as an independent objective assurance and consulting activity.
Choice “a” is incorrect. Although the adding value and, by extension, institutional improvement, is a purpose of internal auditing, the IIA definition characterizes internal auditing as an independent objective assurance and consulting activity.
