MCQ Flashcards
Net Present Value Negative
Discount Rate > Internal Rate of Return
Use of Message Encryption Software
Increases system overhead
Translates plain text to ciphertext using key (fixed length string of binary digits) and algorithm combining key and text by blocks
Single key or
asymmetric/public key infrastructure (PKI) using two keys
Does NOT
guarantee secrecy,
reduce need for password changes, or
require manual distribution of keys
decreases bank reserves
Sale of gov’t securities by Federal Reserve
also increases interest rates
decrease in potential money supply
increases in bank reserves
Purchase of gold by the Federal Reserve
decrease in currency held by public
increase in Fed Res float
Fed Res loans to member banks
Short term vs. long term credit
obtained quicker
more flexible
less costly (yield curve) (l/t prepayment penalties are NOT the reason)
riskier (more frequent need to renew)
spontaneous credit
no cost
requirement of compensating balances
increase effective cost of debt
learning curve anaylsis
labor becomes more skilled and efficient
reduces cost
used to mathematically estimate future time to produce units
Calculate residual income
Capital Turnover (4) = Sales (400K) /Invested Capital
Operating Income (40K
Less Imputed Interest on Invested Capital
10% x 100K)
= Residual Income (30K)
3 ways to configure a wide area network (WAN)
Centralized (all devices ink to mainframe)
Decentralized (LAN for each dept)
Distributed Data Processing (DDP) (local processing & corporate mainframe)
Sequential data
can only be accessed after all preceding records passed
impossible to edit in real time (online)
conservative working capital policy
minimize risk
low ratio of current liabilities to long term financing
high current ratio
longer operating cycle
financial leverage
how well the owners of common stock are able to get money from other sources (debt and/or preferred stock) to fund operations
profits made from these resources will be greater than the cost of the financing so that net income attributable to the common stockholders is increased
using other people’s money to make money for owners
extent of debt and preferred stock
DFL = EBIT/(EBIT - Interest-(Pref Div/(1 - TR))
DOTL = DOL X DFL
DFL = Change in NI (after tax)/Change in Operating Income (EBIT)
financial leverage and purchase of treasury stock
decreases SHE
increases debt-to-equity
increases financial leverage
economic exposure
impact of exchange rate fluctuations on firm’s cash flow
running open systems
increase vendors and price competition
scale to precise size
reduce reliance on proprietary components
reduce integration into existing systems
absorption costing
variable and fixed manufacturing costs = product costs
S&A costs = period costs
required by GAAP
variable/direct costing
include only variable manufacturing costs (not fixed)
Advantages of NPV method
TMV (compounding returns)
perfect mkt = correct decision
correct ranking of mutually exclusive projects
absolute value
Disadvantages:
difficult to determine discount rate
cash flow assumptions
deflation
sustained decline in general price level
increased purchasing power of money
increase money supply = decrease exchange rate = decrease demand = increase price = inflation
material efficiency
material usage (quantity) variance
less = favorable more = unfavorable
difference between budgeted cost of materials used and the budgeted cost of materials that should have been used
If someone purchases a call option, he or she expects
prices to rise during the option period.
a put option is purchased if the price is expected to
decrease over the option period.
The excess present value index, or profitability index,
present value of future net cash inflows/
discounted (net) initial investment
NPV/initial invesment + 1
OR
PV benefits/Cost
index number NOT a dollar amount.
the excess present value is particularly useful in evaluating:
different-sized projects when
capital budgeting funds are limited.
project screening not ranking
goal of management in a corporation
maximize shareholder wealth (maximize share price)
NASDAQ market makes it a requirement that all listed companies have audit committees
composed entirely of independent directors
who are also financially literate
COSO
internal control framework
Committee of Sponsoring Organizations of the Treadway Commission.
“COSO is recognized the world over for providing guidance on critical aspects of organizational governance, business ethics, internal control, enterprise risk management, fraud, and financial reporting.”
Risk appetite in an ERM system
refers to the level of risk an entity is willing to accept in reaching its goals
is related to the organization’s overall culture and strategy.
risk tolerance
refers to a specific level or range of variation that is acceptable in reaching particular objectives
Investment risk from investment activity
Price risk refers to the risk that a security or portfolio of securities will decline in value and can be mitigated through diversification and hedging activities.
Credit risk refers to risk of default by a borrower or issuer of a debt security in which the company has invested.
Liquidity risk refers to exposure to loss resulting from the lack of marketability or liquidity of an investment.
An outside director
a member of the board
who is not otherwise employed by or engaged with the organization, and
does not represent any of its stakeholders
contribution margin ratio
contribution margin per unit
/sales revenue per unit
additional sales x contribution margin ratio = additional net sales
less additional S&A (fixed) expenses
= net decrease/increase in pretax profit
calculate $ and % change adjusted for inflation
prior $ X (CPI current/CPI prior)
current $ less adjusted $ (above)
difference (above)/current $ = % change adj for inflation
effective rate of interest and compensating balance
actual interest at stated rate
/available principal (loan proceeds less compensating balance)
annual after tax cost of bonds sold at a discount
stated interest
/discount price
x 1-tax rate
opportunity cost of holding cash balances
average cash balance
x opportunity cost %
Section 302 of the Sarbanes-Oxley Act
requires that CEOs and CFOs
certify that the periodic statutory financial statements
were reviewed before being signed.
Annual percentage rate (APR)
periodic rate times the number of periods per year
requirement established by the New York Stock Exchange for the companies that are officially listed on that exchange
To help ensure that companies operate with some level of moral guidance,
a code of conduct must be adopted.
To help outsiders evaluate the company’s commitment to ethical principles
that code of conduct must be made public.
financial intermediaries include
Commercial bank Savings and loan Mutual savings bank Credit union Mutual fund Pension fund Life insurance company
Stock exchanges
require a physical/tangible location
NYSE and AMEX are national exchanges.
Boston is a regional exchange.
NASDAQ
computer based trading network
lacks a single physical location
NOT an exchange
yield curve
a graph of the relationship between bond yields and maturity
upward sloping curve
provides investors with a higher return to compensate for taking greater risk by investing in longer maturity bonds
Nominal and stated rates
different names for the rate quoted in the contract
APR
periodic rate times the number of periods per year
Effective annual rate (EAR)
annual rate of interest actually being earned or charged
open end fund
often referred to as a mutual fund
size changes based on investor demand
fund where investors buy shares from and sell shares to the fund at the fund’s net asset value (NAV)
Treasury bill
is a short-term debt obligation backed by the U.S. government with a maturity of less than one year
T-bills (as they are often called) are sold in denominations of $1,000 up to a maximum purchase of $5 million.
Treasury note
has a maturity from one to ten years
Treasury bond
has a maturity great than ten years
Spot market
purchase and sale of commodities for current delivery
nominal risk free rate of interest
function of two factors
real rate of interest and
an inflation premium
Money market
market for securities with a maturity of one year or less.
Capital market
is for longer term investment products.
open end fund
often referred to as a mutual fund
fund where investors buy shares from and sell shares to the fund at the fund’s net asset value (NAV)
closed end fund
a fixed number of shares are issued to investors and they trade with each other on the secondary market at prices that often differ from the fund’s NAV
NYSE Specialist
NYSE member acting as a dealer in a small number of securities on the exchange
makes a market in a stock on the NYSE
In the OTC market the same function is provided by market makers.
call option
gives the holder the right to purchase a security at a specified price for a certain period of time (often three months or less)
London Interbank Offered Rate (or LIBOR)
average interbank borrowing rate
derived from quotations provided London banks and calculated by the British Bankers’ Association.
This rate is generally compared to the U.S. Federal fund rate.
nominal risk free rate of interest is a function of two factors
real rate of interest and an inflation premium
Federal Reserve has purchased a large quantity of US government securities
Federal Reserve Bank deposits can be used to buy government securities as a way of raising the supply of money.
When more money is available, it is easier to obtain and interest rates usually fall.
private placement
SEC permitted issuance
allows the sale of securities with only a limited amount of registration and disclosure information which will save the company money
Price risk from investment activity
refers to the risk that a security or portfolio of securities will decline in value.
can be mitigated through diversification and hedging activities
Credit risk from investment activity
refers to risk of default by a borrower or issuer of a debt security in which invested
Translation risk
risk to the firm’s earnings associated with translating its financial statements into functional currencies
Foreign currency transaction (remeasurement) risk
risk of loss associated with effects of changes in currency exchange rates on transactions valued in other currencies
exposes firm to loss if it has a receivable valued in a foreign currency and the value of this currency weakens relative to the U.S. dollar
Transfer pricing
refers to the pricing strategy for products and services bought and sold across international borders between related parties.
closely tied to a firm’s international tax strategy
minimize its overall tax burden by minimizing net income in jurisdictions with higher income tax rates and maximizing its net income in jurisdictions with lower income tax rates
in response, many foreign jurisdictions have implemented tax regulations that are designed to align transfer prices with market prices
money market hedges
firm would borrow a sum of money in a foreign currency at the present time to be repaid by a receivable in that currency to be received at a future date
forward contract hedge
firm will be entitled to purchase and sell
a specific quantity
at a specific future date
of a particular foreign currency, commodity, or financial instrument
currency swap hedge
firm will exchange an obligation to pay cash flows in one currency for an obligation to pay cash flows in another currency.
option contract hedge with European call option
firm will be able to buy, at its option, a certain financial instrument or commodity at a specified date.
foreign currency economic risk
risk associated with the present value of a firm’s cash flows due to changes in foreign currency exchange rates
Foreign currency transaction (remeasurement) risk
risk of loss associated with effects of changes in currency exchange rates on transactions valued in other currencies
Transfer pricing
refers to the pricing strategy for products and services bought and sold across international borders between related parties.
closely tied to a firm’s international tax strategy
minimize its overall tax burden by minimizing net income in jurisdictions with higher income tax rates and maximizing its net income in jurisdictions with lower income tax rates
A rightward shift in the demand curve
means that buyers are willing and able to purchase more of a product at all prices.
Factors that create a shift in the demand curve include: income, prices of related goods, number of buyers, preferences, and expectation of future prices.
four basic categories of normalization adjustments:
Nonoperating adjustments:
Nonrecurring adjustments:
Comparability adjustments:
Discretionary adjustments:
discounted break even period
time required to recover the cash invested in a project.
discount both cash inflows and outflows
break even becomes “the point where discounted cumulative cash inflows on a project equal discounted total cash outflows.”
Structural unemployment
arises because of changes in technology and international competitiveness, which change the skills required to perform jobs and/or change the location of jobs.
Workers laid off due to technological change often find it difficult to obtain jobs without retraining, relocating, or additional education.
IRS Revenue Ruling 68-609 states,
“The 8 percent rate of return and the 15 percent rate of capitalization are applied to tangibles and intangibles, respectively, of businesses with a small risk factor and stable and regular earnings; the 10 percent rate of return and 20 percent rate of capitalization are applied to businesses in which the hazards of business are relatively high.”
However, even the IRS has denounced the use of the treasury method discussed in Revenue Ruling 68-609 as well as a blanket approach to determine discount and capitalization rates.
Frictional unemployment
occurs due to normal labor turnover such as people seeking employment in a higher-paid occupation or another location.
Discount and capitalization rates are not the same.
Capitalization rate is often derived by subtracting a company’s expected long-term annual growth rate from its discount rate;
therefore, a growing company’s capitalization rate is usually lower than its discount rate.
the best set of controls includes
input controls (batch and hash totals, record counts of each run),
preventive controls (proper separation of duties, passwords and user codes), and
recovery methods (backup copies of activity and master files).
Magnetic ink character recognition
is most often used by banks to read the magnetic ink on checks and deposit slips.
prevent the viewing of sensitive data on an unattended data terminal
Automatic log-off of inactive data terminals
Structural unemployment
arises because of changes in technology and international competitiveness, which change the skills required to perform jobs and/or change the location of jobs.
Cyclical unemployment
occurs during declines in the business cycle, and unemployment should be reduced as the economy recovers.
Accounting rate of return
Increase in income ÷ Required investment
Accounting rate of return is a nondiscounted method of computing the rate of return of an investment.
It is based on accrual accounting and has the measurement of profitability as the goal.
The limitation of this method, however, is that it ignores the time value of money.
(Net cash inflow - Depreciation) ÷ Investment or
net income ÷ investment.
There is some controversy about the denominator—the most commonly used amount is the initial cost of the investment, but some advocate the use of an average investment.
Sensitivity analysis in capital budgeting projects.
involves testing the effects of various assumptions.
Adjusting the required rate of return in capital budgeting projects.
involves increasing the rate for more risky projects
adjusting estimated future cash flows in capital budgeting projects.
make them more conservative for more risky projects
Section 302 of the Sarbanes-Oxley Act requires
CEOs and CFOs certify that the periodic statutory financial statements were reviewed before being signed.
Break even units
Total fixed costs / (Selling price per unit - Variable cost per unit)
Manufacturing Cycle Efficiency
Manufacturing or Process Time /Time from Start of Manufacturing to Delivery
Accounting rate of return
Increase in income ÷ Required investment
Sensitivity analysis
involves testing the effects of various assumptions.
The CAPM formula
is E(R) = RF + B [RM-RF]
E(R) = expected return on the security RF = risk free rate of return (4%) RM = the return on the market (10%)
E(R) = 4 + 1.5 [10-4] = 13%
adjusting estimated future cash flows
make them more conservative for more risky projects
Prime cost consists of
direct material and direct labor.
Both of these are variable costs
value or price of stock given annual dividend and required rate of return
dividend divided by the required rate of return
a low discount rate for a cash flow in a quicker period of time
will lead to a high present value
Quarterly compounding requires
one fourth the interest rate and
four times the periods
The CAPM formula
is E(R) = RF + B [RM-RF]
E(R) = expected return on the security RF = risk free rate of return (4%) RM = the return on the market (10%)
E(R) = 4 + 1.5 [10-4] = 13%
statistical measure for two investment alternatives that have different expected returns and standard deviations
Coefficient of variation
When projects have different expected returns, the project with the lower coefficient of variation is preferred.
When two investments have the same expected return,
the project with the lower standard deviation is preferred.
Bond ratings
By firms such as Moody’s or Standard and Poor’s
Measure default risk
Highest rating is AAA.
BBB and above are investment grade.
Below BBB are high yield/junk bonds.
security market line (SML)
graphs the relationship between .
expected return and risk
as measured by the beta coefficient.
The beta coefficient measures systematic risk.
The equation for the SML is the capital asset pricing model (CAPM): E(R) = RF + B [RM-RF]
The internal rate of return (IRR)
Profit rate from the investment.
Specific discount rate that makes the present value of the inflows equal to the net investment and forces the NPV to be equal to zero
IRR needs to be higher than the cost incurred to get the capital that is used to make the investment.
project’s payback period
Initial Investment/Annual Cash Flow
does not adjust for the time value of money
how long in years or months it takes the firm to recoup its initial cost (focus is liquidity, rapid cash recovery)
point where sum of future UNDISCOUNTED cash flows exceeds net investment
depreciation expense is a noncash expense that is subtracted from profit to arrive at net income.
add noncash depreciation back to net income per year
WACC four weighting systems
book values (balance sheet)
market value
optimal/target capital structure weights
marginal weights
(assign capital weights in percentages funds were actually raised, i.e. project funded using only debt,
debt weight 100)
Future value problems can be solved without financial calculators or tables.
The future value of a single sum is
amount times
one plus the interest rate
raised to the power of the number of periods.
FV= current amount x (1 + i)^n
A short cut estimate (very close estimate) for the time it takes for a sum to double in value
Rule of 72
72/interest rate
72/.08* = 9 yrs
*8%
risk premium is comprised of five components:
business risk, financial risk, liquidity risk, currency risk, and country risk
security market line (SML)
graphs the relationship between .
expected return and risk as measured by the beta coefficient.
The beta coefficient measures systematic risk.
The equation for the SML is the capital asset pricing model (CAPM): E(R) = RF + B [RM-RF]
project’s benefit cost (profitability) index
B/C ratio
present value of the cash flows
divided by the net investment.
An index greater than one (or equal to in some cases) means that the project is acceptable.
project’s DISCOUNTED payback period
length of time required for an investment’s DISCOUNTED cash flow to equal its initial cost (net investment)
Modified Internal Rate of Return (MIRR) improves upon the Internal Rate of Return (IRR) technique by addressing what shortcomings of the IRR
MIRR reinvestment rate assumption may be user-modified
IRR assumes reinvestment of each cash flow at the IRR
NPV assumes reinvestment at the cost of capital
.
limitations of IRR (versus a NPV)
Value additivity issue
Multiple roots (answers) issue when cash flow changes from positive to negative
Dealing with mutually exclusive projects
projects the equivalent annual annuity (EAA) technique (sometimes called the equivalent annual cost or EAC) is used to evaluate
calculates present value on an annual basis
allows the analyst to compare projects with different lives
Standard capital budgeting techniques (such as NPV, IRR) are not designed to compare projects with different lives.
times interest is earned
shows how easily an organization can meet its required interest payments
net income for the period less interest and tax divided by the reported interest expense
Earnings before interest exp and taxes/interest expense
EBIT/IE
Projected Profit
Sales - VC* - FC
VC Rate x Sales
opportunity costs
benefits that are passed up
sunk cost
real cost incurred in the past that cannot now be changed
already been spent and cannot be recovered
not considered in the investment decision process
fixed cost
will not increase as production levels increase (within a relevant range)
variable cost
one that will increase as production levels increase
Break even sales
contribution margin (CM) = sales - variable costs ($80,000 - $20,000 = $60,000)
Contribution margin ratio (CMR)
CM/sales revenue
60,000/80,000 = .75
Break even sales:
Fixed costs/CMR
$30,000/.75 = $40,000.
Variable Cost Rate
Variable Costs/Break Even Sales
Projected Profit
Sales - VC - FC
Access time
amount of time it takes for a computer to seek out and find data or, “to retrieve data from memory.”
transmission rate
speed of transmission of data from a remote terminal to a central computer
often measured in baud
Financial leverage
increases when the proportion of fixed payment obligations from interest and preferred dividends increases relative to the “variable” payments to common stockholders.
decrease in preferred dividends increases denominator, so proportionately decreases total FL
Payable-through drafts
legal instruments that look like checks, but they are not drawn on the bank.
drawn on and approved by the issuing company against its demand deposit account.
Concentration banking
company uses a geographically dispersed collection center to speed up the collection process.
For standard variance:
AS QP (ass cupie).
AQAP AQSP SQSP
For overhead variance:
SEV (spending, efficiency, volume)
ABA BSA (aba busy)
two types of business valuation engagements
SSVS 1, Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset:
valuation engagement,
calculation engagement
In a valuation engagement,
valuation analyst is free to employ the use of ANY Valuation Approach or method that is professionally deemed appropriate under the circumstances
Financial leverage
increases when the proportion of fixed payment obligations from interest and preferred dividends increases relative to the “variable” payments to common stockholders.
Common stock dividends
are variable, in the sense that there is no fixed, definite amount of dividends that must be paid each year.
must be paid regardless
interest
preferred dividends
A decrease in preferred stock dividends
decreases financial leverage
The formula for total leverage shows that as preferred dividends decrease (increasing the value of the denominator), total leverage decreases.
simple interest method
principal x interest rate x time
two types of business valuation engagements
SSVS 1, Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset:
valuation engagement,
calculation engagement
In a valuation engagement,
valuation analyst is free to employ the use of ANY Valuation Approach or method that is professionally deemed appropriate under the circumstances
results are expressed in terms of a conclusion of value and can either be a Single Number OR a Range
premise of value can be either a Going Concern OR Liquidation
In a calculation engagement,
the valuation analyst and the client Agree upon the valuation methods AND Approaches to be used, so NOT free to use any approach or method available.
valuation engagement AND calculation engagement
results are expressed in terms of a conclusion of value and can either be a Single Number OR a Range
premise of value can be either a Going Concern OR Liquidation
estimated net realizable value method to allocate joint costs
Product NRV:
Sales price less Separable Costs
Allocate joint costs
Product NRV/Total NRV x Joint Costs
certainty equivalent net present value
no risk (i.e., the cash flows are certain),
the appropriate discount rate is the risk-free rate.
A Mortgage
B Subordinated
C Senior
D Debenture
A. collateralized
B. junior in standing
C. bondholders first in terms of repayment
D. unsecured
reorder point
inventory level at which an order for the inventory item is submitted
Reorder point = (Avg. Daily Use × Lead time) + Safety Stock
10 days are required to order and receive a part
daily demand for part is 1,000 units
Reorder point = 1,000 units x 10 days
Reorder point = 10,000 units
Correlation
refers to the existence of a reliable relationship between two variables (dependent and independent)
measured by the value of the coefficient of correlation, r
The coefficient of correlation, r, is a measure of the relative relationship (not the variance) between the two variables.
dependent variable - values to predict
independent variable - values used in the prediction
Reliable correlation must exist for regression analysis to be valid.
translation exposure
exposure of a multinational corporation’s consolidated financial statements to foreign exchange fluctuations
dividend irrelevance theory
investors are neutral as to whether returns come from dividends or capital gains
direct contrast to Bird in the Hand theory
Return on investment (ROI)
Net Income / AVG Invested Capital
If the invested capital increases (long-term asset purchase), then ROI will decrease.
Residual income
amount of net income in excess of a minimum desired rate of return on invested capital.
Reported net income - (Desired rate of return × Invested capital)
If invested capital increases, the residual income will decrease.
A Mortgage
B Subordinated
C Senior
D Debenture
A. collateralized
B. junior in standing
C. bondholders first in terms of repayment
D. unsecured
A Best efforts basis
B Private placement
C Rights offering
D Underwriting
A. investment bank sells what it can, in exchange for a commission
B. selling securities to institutional investors rather than the public
C. offering the securities to existing owners first
D. investment bank purchases the entire security offering from the issuer and attempts to resell it to the public at a profit
A lease must be classified as a capital lease if any one of four conditions occurs.
A Transfer of ownership occurs
B A bargain purchase plan option exists
C The lease period is greater than or equal to 75% of the assets life
D The present value of the lease payments is greater than or equal to 90% of the asset’s initial value
Bird in the hand theory
firm’s value is maximized by setting a high dividend project ratio
investors are less certain of receiving future capital gains,
investors value a dollar of current dividend more than a dollar of uncertain capital gains
result in a high firm value
dividend irrelevance theory
investors are neutral as to whether returns come from dividends or capital gains
direct conrast to Bird in the Hand theory
Sinking funds
reduce the risk to bondholders by gradually reducing the amount of debt the firm has outstanding.
to enforce the sinking fund provision, the bonds are often used with a call provision
long-term source of funds considered a hybrid security
Preferred stock
features of bonds (a fixed dividend) and
equity (no maturity)
Indenture
legal document that outlines the obligations of the bond issuer
Covenants
provisions within an indenture detailing things the issuer must do (minimum ratios) or cannot do (issue additional debt without permission)
Warrants
long term options attached to bonds.
advantages of issuing the bonds over issuing CS
use the money to increase income by more than the cost of the interest, this leveraging increases net income without any additional funds from the owners.
interest expense is tax deductible so that its cost is reduced significantly (whereas dividend payouts are not tax deductible)
if inflation takes place, the dollars eventually used to repay the bonds are worth less than the ones that were received on the day of issuance—a financial benefit
Disadvantage: Creditors can force a company into bankruptcy and shareholders cannot so debt is viewed as a more risky method to raise funds.
least expensive source of long-term capital
Long term debt is generally cheapest for two reasons:
1) the interest rate on the debt is tax deductible and
2) debt is repaid first so it has less risk
ex-dividend date
first date on which you buy stock without being entitled to receive a declared dividend
chronological:
declaration date, ex-dividend date, date of record, and payment date
Founders shares
are issued to the original owners of the firm.
A put option
allows you to sell at a fixed rate for a fixed period of time
Preemptive right
Common stock owners right to purchase a pro rata share of new issues of common stock to maintain their ownership percentage in the firm.
How often are dividends usually paid by U.S. corporations?
Quarterly
advantages of issuing the bonds over issuing CS
use the money to increase income by more than the cost of the interest, this leveraging increases net income without any additional funds from the owners.
interest expense is tax deductible so that its cost is reduced significantly (whereas dividend payouts are not tax deductible)
if inflation takes place, the dollars eventually used to repay the bonds are worth less than the ones that were received on the day of issuance—a financial benefit
Disadvantage: debt raises the risk of company bankruptcy.
cost of issuing common stock ignoring any transactions costs
cost of common stock is next period’s dividend divided by the net proceeds (market price less any transaction or flotation costs to sell).
The resulting percentage is added to the forecasted growth rate percentage.
ex-dividend date
first date on which you buy stock without being entitled to receive a declared dividend
leveraged buyout
transaction mostly financed by taking on debt with little money being contributed by the owners.
pooling of interests
old accounting term no longer used for new acquisitions.
congeneric merger
merger where two companies operate in related industries but do not offer the same products.
reverse acquisition
private company acquires a public firm to bypass the complex and costly process of going public
more common in recent years due to foreign firms wanting to enter the U.S. capital markets
degree of financial leverage
reflects how well a company uses borrowed money to increase the income applicable to the owners of common stock.
It is calculated by:
% increase EPS/% increase EBIT
Money market securities
have a maturity of one year or less.
Treasury bills
Commercial paper
Bankers acceptance
Negotiable certificate of deposit
four reasons to hold cash
transactions (to meet day to day cash outflows) compensating balances (required by banks) precautionary balances (to meet unexpected events) speculative balances (to take advantage of opportunities)
Cash Conversion Cycle CCC
Days it takes to buy inventory, pay for it, sell it and collect on sales.
Time inventory takes to be sold plus the time the accounts receivable takes to be collected shortened by the length of time accounts payable take to be paid.
Inventory (conversion period/age)
+ Receivables (collection period/age)
- Payables (deferral period/age)
Credit policy has 4 components.
(1) Credit period–when the payment is due;
(2) Credit standards–criteria as to which customers are granted credit;
(3) Collection policy–enforcement of the collection process
(4) Discount–reductions offered to speed up payments.
Aging schedule is not part of the credit policy but a listing of accounts by their age.
A bankers’ acceptance
a promissory note
backed by a letter of credit
that has become a money market security
A letter of credit
states that the bank will guarantee payment
if the customer defaults
credit terms of 2/10 net 30
cost of not taking the discount and paying on the 30th day
Extra Cost x Annualized Cost
.0204081 x 18.25 = .3724 = 37.24%
Discount/(1 - Discount) = Extra cost
.02/.98 = .0204081
Annualized Cost = 365/#days saved
365/20 = 18.25
*% as decimal or
cents per dollar saved/cents per dollar spent
Just In Time (JIT)
inventory strategy implemented to improve return on investment by
reducing in-process inventory and
lowering inventory carrying costs
introduced by the Japanese automobile industry
Instead of holding inventories, the manufacturer subcontracts with suppliers to provide the necessary inputs for that day’s or week’s expected production.
Economic Order Quantity points (EOQ)
Annual Demand = 1,600
Fixed Cost per order = $50
Variable Cost of carrying inventory units for a year (calculated on avg inventory balance) = $1
how many to order at one time
square root of:
2 times annual demand x cost of placing an order/
cost of carrying a unit for a year
(2 x 1,600 x 50)/1 = 160,000.
Square root of 160,000 = 400 units per order
1600/400 = 4 orders per year
Reorder Point (parts)
Operates 365 days per year
Produce 3,650 per year
5 days to delivery (lead time)
In the absence of a safety stock:
RP = Daily Usage x Delivery (Lead) Time
3,650/365 = 10 x 5 (days to deliver/lead time) = 50
three forms of short term secured loans used to purchase inventory
Blanket (Broad Form) Lien - covers an entire group of usually low cost homogeneous items
Trust Receipt - lender holds title and borrower has possession of collateral
Warehouse Receipts - lender controls title and possession of collateral
Operating Cycle
Average age of inventory (inventory period)
+ Average age of accounts receivable (receivables period)
Subtract average age of accounts payable to calculate Cash Conversion Cycle (CCC)
Factoring
Factors are businesses that buy accounts receivable from firms at a discounted price.
Provides the seller with immediate cash.
Usually transfer the costs associated with collection to factor.
The sale is referred to as factoring.
number of days sales in inventory
number of days it takes to sell an item
Avg Inventory/Daily Avg COGS
Avg Inventory = (Beg Inventory + End Inventory)/2
COGS =
Beginning Inventory
+ Purchases
- Ending Inventory
Daily Avg COGS = COGS/365 (or 360)
average time to collect accounts receivable
Avg AR/ Avg Daily Credit Sales
Avg Daily Credit Sales = Credit Sales/ 365 days
Avg AR = (Beg AR + End AR)/2
Concentration Banking
Companies have payments sent by customers directed to local banks around the country that can electronically forward the money to the company which speeds up cash collection by several days.
In managing cash, companies like to receive payments from customers as quickly as possible.
Mail sent over a long distance can take several days to arrive.
forward exchange contract
fluctuation of currency values is always a concern
it can be managed through this hedge
company has a payable, so establishes a receivable
Company pays more for receivable than the current value of the payable which is the cost of establishing the hedge.
futures contract
contract to buy or sell
a specified commodity
at a certain date in the future,
at a market-determined (futures) price
Commercial paper
unsecured obligation issued by a corporation or bank
to finance short-term credit needs.
maturities typically up to 270 days,
wide range of denominations,
either discounted or interest-bearing,
usually limited or nonexistent secondary market,
typically issued by companies with high credit ratings, so the investment is viewed as having relatively low risk
Acid-test Ratio
evaluate ability to pay current liabilities if they immediately come due
(Cash + AR + ST investments)*/Current Liabilities
*Exclude Inventory (less liquid)
Inventory Turnover (Ratio)
used to measure the speed at which a company is able to sell its inventory
COGS/Avg Inventory
how many times during the year that the reporting company sells an amount equal to its average inventory
average age accounts receivable balance
End AR/ Avg Daily Credit Sales
Avg Daily Credit Sales = Credit Sales/ 365 days
Net operating income
difference between revenues and operating expenses.
Net income
difference between revenues (and gains) and expenses (and losses)
Gross margin (also called gross profit)
difference between revenue and cost of goods sold
Contribution margin
difference between revenue and variable expenses
Sales - Variable Costs
Contribution Margin = 600 & 30% of Sales
Net Income = 420
Find Break Even Sales
Sales - Variable Costs = Contribution Margin
100% Sales - X% Sales = 30% Sales
VC = 70% Sales
Contribution Margin* - Fixed Costs = Net Income
600 - FC = 420
FC = 180
*(Sales - Variable Costs) - Fixed Costs = Net Income Break Even Net Income = 0 Break Even Sales - 70% Sales - 180 = 0 30% BE Sales = 180 BE Sales = 600
Cost Volume Profit (CVP) underlying assumptions
1) selling price does not change with activity level,
2) sales mix remains constant,
3) cost can be separated into fixed and variable elements,
4) TOTAL fixed cost are constant,
5) variable costs PER UNIT are constant
Equipment Purchase = $1,000 Expected Life = 5 years Depreciation - S/L, 0 salvage value Revenue Increase Year 1 = $300 Income tax rate = 35%
Calculate after-tax cash flow of purchase Year 1.
Change in Revenue - Change in Expense (Depreciation) = Change in Operating Income
300 - 200 = 100
Change in Operating Income x Tax Rate = Change in Income Tax Expense
100 x 35% = 35
Net Change in CF = Change in Revenue - Change in Income Tax Expense
300 - 35 = 265 OR
Change in Operating Income - Change in Income Tax Expense = Change in Net Income
100 - 35 = 65
Net Change in CF = Change in Net Income + Change in Noncash Expense (Depreciation)
65 + 200 = 265
consider when estimating cash flow from a potential investment
Opportunity cost
Cannibalization (erosion in cash flow to existing projects)
Impact of the project on net working capital requirements
NOT Sunk costs
cash flow attributable to a potential investment project
Increase Cash Flow:
Increase Salvage Value (increase CR at project end) Increase Depreciation (decrease taxable income)
Decrease Tax Rate (decrease income tax paid)
Decrease Interest Rate (decrease interest expense)
Decrease Cash Flow:
Decrease Salvage Value (decrease CF at project end) Decrease Depreciation (increase taxable income)
Increase Tax Rate (increase income tax paid)
Increase Interest Rate (increase interest expense)
target # of units to sell
target profit/contribution margin per unit
variable cost per unit
Decreases
Increases contribution margin ( sales price-variable cost) Decreases break even point (easier to get to)
Increases margin of safety (greater difference between sales and break even point)
Increases
Decreases contribution margin (sales price-variable cost) Increases break even point (harder to get to)
Decreases margin of safety (lesser difference between sales and break even point)
Three transfer pricing strategies
Full Cost - includes transferring a product from one division to another at the first division’s full absorption cost, which includes fixed costs. This method can lead to reduced morale and rejection of otherwise viable special projects.
Market Price - should be reduced to reflect costs savings from not transferring the product to an outside customer
Dual transfer pricing - allows the transferring division to record one price, and the receiving division to record another, which can reduce issues related to morale and unnecessary rejection of special orders.
transfer pricing strategies
Choose between a cost-based, market price, or negotiated price approach to transfer pricing.
Design to encourage divisional managers to maximize the profits of the company as a whole not within their individual divisions.
Base on opportunity cost plus any outlay required to transfer the product to another division.
If a division has idle capacity, there is no opportunity cost involved with providing a product to another division within a firm.
Floor and Ceiling in a transfer pricing decision
Floor - opportunity cost plus costs of outlay to transfer the product to another division within the firm
Ceiling should be the market price.
Actual transfer price should fall between these two prices.
marginal analysis applied to an outsourcing decision
compare the costs
fixed costs are unavoidable, so not relevant
cost of producing in house = variable costs (direct materials, direct labor, variable overhead) + opportunity cost
Cost-plus pricing strategy
bases prices upon a certain level of mark-up over costs or
at a target return on investment for stakeholders.
Cost-plus pricing is NOT a strategy limited to the public sector.
Short-term pricing strategy
often determined using a contribution margin approach
can be for special orders
Target pricing strategy
sets prices based on what a firm believes customers will be willing to pay
based on the product’s perceived value
sets a target cost to achieve a desired level of profit.
Three general categories of Business Forecasting methods
- Observed Relationships - regression analysis, ranging from a simple high-low method to multiple regression analysis
- Historical Data - Moving average calculates average sales for a rolling number of periods, exponential smoothing method adjusts moving average to place more weight on recent, relevant periods, trend analysis utilizes regression techniques to create a trend line of historical data in a time series
- Predictions of Customer Behavior - Markov techniques and polling
For All:
Consider factors such as cyclicality, seasonality and sensitivity . Sensitivity analysis can provide foresight into the effects of differences between forecasted amounts and actual results.
NOT Probability Analysis - uses the probability of various outcomes to predict the expected value of an investment during capital budgeting risk analysis
Economic value added
a firm’s residual wealth
Net Operating Profit (adjusted for taxes)
- Cost of Capital
financial value created beyond the cost of capital
popularly used as a component of executive compensation
an example of value-based management
Using EVA alone as the basis for incentive pay does not capture all elements of value creation in an organization.
DuPont analysis
breaks the ROI metric into the product of
Return on Sales x Asset Turnover Ratios
helps break ROI into meaningful components
Return on investment (ROI)
ROI = Net Income/Total Assets*
*AVG Invested Capital
ROI = Profit Margin** x Capital Employed Turnover Rate**
**Net Income/Sales x **Sales/Invested Capital
value-based management (VBM)
increase pay when value is added to the firm
VBM is most effective when long-term growth strategies and a range of financial and non-financial measures are incorporated into measures of performance.
Using any single metric alone as the basis for incentive pay does not capture all elements of value creation in an organization.
Effects of Deflation and Inflation
Deflation - more damaging than inflation (discourages business investment as companies are reluctant to invest in equipment in a period of declining prices)
High rates of inflation - associated with economic contraction and a redistribution of wealth
internal controls over significant financial transactions
Financial controls and processes must be in place (due to the significant company funds involved) to ensure that:
- transactions are properly recorded,
- management’s assumptions are documented, evaluated for reasonableness, and results are assessed
- approvals are received and documented
value of preferred stock
A preferred stock is perpetuity.
The value of perpetuity is
Annual Cash Flow/Required Rate of Return
When interest rates increase, bond prices
decrease
lower bond price = higher current yields and eventual capital gains (which increases the bond’s YTM)
Dividend Discount Model
value of a share of stock
= Dividend per share/(discount rate less the dividend growth rate)
Increasing the dividend growth
decreases the denominator
so the resulting value is higher
internal growth rate (G) in earnings
Return on Equity x Retention Rate*
Retention Rate (percentage kept of each dollar earned) Dividends per share/ EPS = payout rate *1 - payout rate = retention rate
taxable equivalent yield
municipal bond rate/1 - tax rate
techniques to value stock
multiples of: Earnings Cash flow Book value Sales Commissions
EBITDA
Super Normal DDM (stock must pay a dividend )
dividend payout ratio
dividend per share/earnings per share
percentage of the reported income that goes to the owners in the form of dividends
CPU
Central Processing Unit
primary hardware component where the actual processing of data occurs
contains: Primary storage (temporary main memory that holds program, data and results during processing, RAM (Random Access Memory) and ROM (Read Only Memory)), Control unit (reading or interpreting the program instructions and directing execution) and Arithmetic/logic unit (circuitry that performs these operations)
bus
circuitry connecting the CPU to the primary memory and to peripheral devices
Input and output devices
transfer data in and out of the CPU
keyboard, monitor, scanner, printer, mouse, modem, joystick, touchpad, bar code reader, etc.
Peripheral equipment
any device that is not a part of the CPU but can be accessed by the CPU.
secondary storage and any input or output device
Secondary storage
consists of devices external to the CPU consisting of disks, flash drives, hard drives etc.
secondary storage is more permanent
Machine language
binary (on/off) language
interpreted by the computer hardware
lowest level or first generation language
machine dependent
writing programs in machine language is difficult and prone to error
a compiler is required to translate higher level languages into machine language
Assembly language
second generation language that requires an assembler to translate assembly language into machine language
machine dependent language utilizing short commands for repetitive tasks
easier to write programs in assembly language than machine language
Procedural languages
third generation language that allows programmers to concentrate on the procedures and functions of the programs
programmer writes the program in source code which is then converted or translated into object code
source code is more similar to English while the object code is the machine language for a particular type of computer
FORTRAN, COBOL and BASIC all forms of procedural languages
third generation languages
must be converted from source code to object or machine code
FORTRAN (FORMula TRANslation) - designed for scientific purposes
COBOL (Common Business Oriented Language) - designed for business operations
BASIC (Beginner All purpose Symbolic Instruction Code) -designed for educational purposes
Fourth generation languages (4GL)
have many routine commands and procedure pre-programmed.
often associated with a dataBase management system and are relatively easy for programmers to use.
designed to reduce programming effort and improve the process of software development.
efficiency can come at the cost of computer resources.
GUI
Graphical User Interface
allows the user to navigate the system and access programs though a series of graphical icons, visual indicators, scroll bars, pictorial and graphical symbols.
can eliminate the need for a user to learn a complex set of commands
A patch
change or modification to an existing program.
to correct an error in programming or as a result of a change in requirements.
may also be added for fraudulent purposes.
Operating System (O/S)
manages and schedules application programs and system functions.
tracks, coordinates and allocates memory, inputs, outputs and performs security functions.
Windows, Unix and Linus, MVS and DOS
Job Control Language or JCL
command language that initiates programs,
specifies processing priorities, running sequences, databases used and files used
virtual storage/memory
saves time and money
operating system divides a program into pages or segments and brings only the pages of the program required for execution into memory.
unneeded portions of the program remain in less expensive secondary memory
applications program
designed to perform a specific process or series of tasks.
artificial intelligence (AI)
software designed to help humans make decisions.
attempt to mimic the human thought process.
deals with processes that involve a structured or predicable approach.
using a computer to reach the same conclusion as a human
an expert system is a form of AI
reaches a conclusion much faster than an human
Computer hardware is extremely reliable, primarily due to
chip technology
self diagnostics
provided by the manufacturer and activated when the system is booted up;
boundary protection - maintains separate areas of processing so that multiple programs can run simultaneously;
echo check - used in transmissions where the receiving hardware sends back the data received as a confirmation;
parity check - one bit is added to a block of bits so that the ones in the block always add up to either an odd or even number;
periodic or preventative maintenance - the systems is serviced regularly to ensure that it is operating as intended. -
Enterprise resource planning (ERP)
an enterprise-wide information system
designed to coordinate all the resources, information, and activities needed to complete business processes
supports most of the business system that maintains - in a single database
the data needed for a variety of business functions such as manufacturing, supply chain management, financials, projects, human resources and customer relationship management
A local area network (LAN)
privately owned network that allows people within a small geographical region (possibly a single building) so that the employees of a company can perform specified operating activities
XBRL
eXtensibleBusiness Reporting Language
a freely available and global standard for exchanging business information between business systems
Data should be restricted at what level
field level
flexible budget
provides budgeted numbers for any activity level within the relevant range
compare actual results to expected results given a specific level of activity achieved during a given period
part of the control function of management
Variances based on a flexible budget are generally more meaningful, because they can be changed to reflect actual production volume levels.
primary source for sovereign wealth funds
earnings from
commodity based exports
trade surpluses driven by
export of manufactured goods
Gross Margin Ratio
Gross Margin*/Net Sales Revenue
- (Unit Price - Unit Cost) x # Units
- Sales - COGS
detailed anaylsis only by management not external parties
Income and Employment Equilibrium
Aggregate Supply = Aggregate Demand
Intended Savings = Intended Investment
Balance of Trade
difference between export (sale) and import (purchase)
theoretically official reserves offset to net zero
If demand is elastic
reducing prices
increases total revenue
quantity SOLD increases proportionately MORE
than price decreases
% increase in qty > % decrease in price
A disaster recovery and business continuity plan should allow the firm to
Minimize the extent of Disruption, damage and loss,
Resume normal Operations as quickly as possible,
Train and familiarize Personnel to perform Emergency Operations,
Establish an Alternate (temporary) method for processing information.
Relocation to another location may not be necessary.
Valid backup approaches
Checkpoint Copies - at certain points, copies are made of the database and stored in a secure location,
Grandfather-Father-Son Batch system - backup files created based on updating a master file with the day’s transactions (creates a new generation),
Rollback Recovery - removes the effects of updates until it reaches a point where the system was processing accurately
Reciprocal Agreement
mutual aid pact
between at least two organizations with comparable computing requirements
agreeing to assist each other in the event of a disaster
An internal site
another data processing center within the organization or intranet
generally only available for fairly large organizations
A disaster recovery and business continuity plan should include
Priorities (which applications are the most critical)
Insurance
Backup approach
Specific Assignments (familiar with plan/responsibilities)
Period Testing/Updating
Documentation
best backup facility option
combination of hot site, cold site, reciprocal agreement and internal site
complete backup of the entire system to become fully operational
Activity-based costing (ABC)
accumulates costs in cost pools related to separately identified activities that are allocated based on cost drivers.
Advantages:
Enhanced control of overhead costs
Elimination of arbitrary assignment of overhead costs
Limitations:
Higher cost of determining pools and drivers
NPV
determines whether the present value of the estimated net future cash inflows at a desired rate of return will be greater or less than the cost of the proposed investment
present value of the net cash inflows is calculated and compared to the initial investment
investment proposal is desirable if the net present value is positive (exceeds initial investment)
Sarbanes-Oxley Act of 2002, regarding an issuer’s audit committee financial expert
issuer should have an audit committee,
at least one of its members should be an individual with significant financial reporting expertise
If the firm does not have an audit committee financial expert, the issuer must disclose the reason why the role is not filled.
Physical access controls
prevent unauthorized users from physically using the computer equipment
separate unauthorized individuals from computer resources
prevent damage or other loss including theft, acts of war, weather, disgruntled employees, or others
locks on doors, security guards, alarms, and monitoring systems
Logical access controls
protect systems from infiltration electronically
authentication (only authorized users can have access through a user ID or a digital signature on a message)
authorization (controlled by passwords)
If variable costs per unit are constant .
total cost line is a straight line
If revenue line (that starts at the origin) is also a straight line, revenue per unit is constant.
At any point, variable costs divided by sales revenue will be the same, so variable costs (that rise proportionately with volume) are the same percentage of sales revenue regardless of volume.
Dividing fixed costs (a constant) by a smaller sales revenue gives fixed costs a greater percentage of revenue at a lower volume of sales.
when byproduct inventory is recorded at net realizable value
no profit is recognized
BP Inventory DR NRV (Selling Price - Selling Cost)
WIP Inventory NRV
Cash DR Selling Price
BP Inventory CR NRV
Cash CR Selling Costs
Treating dividends as the residual part of a financing decision assumes that:
earnings should be retained and reinvested as long as profitable projects are available
dividends can be problematic for both the company (dividends are not tax deductible) and the stockholder (dividends are taxable)
transaction and other costs of financing by selling additional stock
younger firms will invest more and older firms will pay more dividends since profitable investment opportunities will be smaller relative to funds available
normal profit
(zero economic profit)
revenue equal to total explicit plus implicit costs
Economic profit and accounting profit
EP is generally lower (never higher) than AP
implicit costs are included in economic profits.
The discount rate set by the Federal Reserve System
rate that the central bank charges for loans to commercial banks.
The federal funds rate
rate paid by commercial banks when borrowing excess reserves from other institutions in the Fed Funds market.
The prime rate
base rate that banks use in pricing short maturity loans to their best, or most creditworthy, customers
Key elements of a management information system (MIS)
timeliness, accuracy, consistency, and relevance (usefulness is reduced if any elements are compromised)
use of decision models to organize data
management of data in an organized database
users do not have to be computer experts to benefit
not based on computers,
consists of an organized federation of subsystems rather than a single, highly integrated system.
“sketchy” structure and new technology introduce risk
new technology is riskier than existing technology.
Discounts are
price adjustments, not cost outlays
effect revenue level per unit (not expenses)
Method 1:
Sales Discounts Not Taken - financing income on IS
(receivable and sales recorded at net)
Method 2:
Sales Discounts - contra Sales on IS
(receivable and sales recorded at gross)
Gross domestic product (GDP)
measure of the market (monetary) value of all final goods and services produced in an economy during a year using either domestic- or foreign-supplied resources
excludes intermediate goods, (purchased for resale or further processing/manufacturing) and nonproductive transactions (have nothing to do with the production of final goods and services)
GDP = C Personal consumption expenditures \+ Ig Gross private domestic investment \+ G Government purchases \+ Xn Net exports
Gross domestic product (GDP)
the price of all goods and services produced by a domestic economy for a year at current market prices
measure of the market (monetary) value of all final goods and services produced in an economy during a year using either domestic- or foreign-supplied resources
includes all goods and services produced within the borders of the country, regardless of the nationality of the producer.
excludes intermediate goods, (purchased for resale or further processing/manufacturing) and nonproductive transactions (have nothing to do with the production of final goods and services)
New homes purchases are included in GDP, but purchases of common stock are not a good or service.
GDP = C Personal consumption expenditures \+ Ig Gross private domestic investment \+ G Government purchases \+ Xn Net exports
three groups of inputs used when developing fair value:
Level 1: directly observable inputs of identical items, such as quoted active market prices
Level 2: directly or indirectly observable inputs of similar items
Level 3: unobservable inputs
a question as to the similarity of the conditions between the subject asset and the comparable asset may be significant enough to lower to Level 3.
FASB ASC 820:
expects more observable than unobservable inputs
requires only the use of information that is available without undue cost or effort.
Control precision
alignment between a risk and the control activity designed to mitigate that risk
control activity that has a direct influence on the achievement of a stated objective is considered to be more precise than one that only has an indirect influence
Control sufficiency
group of controls with a variety of degrees of precision necessary to achieve a control objective
a number of control activities to protect all incoming receivable payments from theft or fraud
A best-cost producer can gain a competitive advantage:
by delivering a superior product
at a lower price than the competition.
Traditional patterns of foreign direct investment (FDI) and recent shift
funds flow from slower-growing, rich, developed economies to emerging market economies.
Dramatic shift in FDI - today major flows go from emerging market economies to more developed economies.
lack of well-functioning capital markets coupled with a lack of sufficient local investment opportunities has created a pool of funds available for investment
goals pursued when using SWFs (sovereign wealth funds) to invest these funds - to acquire technologies, brands, resources, and better access to international markets while using technology to enhance productivity and gain Western management skills
Economic order quantity (EOQ)
identify an optimum order quantity
by equating order cost with carrying cost.
Periodic demand for product is known
Total carrying costs vary with quantity ordered.
Costs of placing an order are unaffected by quantity ordered.
Purchase costs per unit are not affected by quantity discounts.
When the cost of capital is zero, the NPV is
the sum of a project’s undiscounted cash flows: NPV = Cash inflows - Initial outlay
principal market and most advantageous market
principal - where the holder of the asset or liability being valued could find the greatest volume of similar transfers
most advantageous - where the holder of an asset could maximize the price received in an asset sale or minimize the transfer costs in the conveyance of a liability
Under FASB ASC 820, the hypothetical transaction is considered to have occurred in the principal market for transactions similar or the most advantageous market if a principal market does not exist.
Technical analysis
involves ANALYZING PAST market data of price and volume movements to attempt to DETERMINE FUTURE price movements of individual securities.
The WEAK form of the efficient market hypothesis
suggests that information about PAST PRICES would NOT be OF USE in predicting future performance, and therefore technical analysis would not be a viable technique to use.
Fundamental analysis
uses factors specific to a firm, such as financial statements, ratio analysis, projected earnings growth, and dividend yield in an attempt to find undervalued securities.
overhead rate
Estimated annual overhead ÷ Estimated annual direct labor = Overhead Rate
Overhead Rate is applied to actual direct labor cost
Distributed data processing
network of interdependent computers where certain functions are centralized and other functions are decentralized and processing is shared among two or more computers
each computer can also process its own data
Distributed data processing is an alternative to both centralization and decentralization.
three factors related to overhead volume:
overhead volume variance is related to fixed overhead only
There is no volume variance for variable overhead.
The fixed overhead rate is a function of estimated volume.
Overhead volume variance occurs when actual production volume differs from estimated volume.
Production supervisor has no control over the overhead volume variance. Efficiency or usage variances relate quantities used against standard quantities. The production supervisor should have control over quantities used.
Information systems
process data and transactions
Processing data
Controlling the process and data
Collecting and entering transactions and data
Providing users with the information needed
NOT validation and comparison of system generated reports to input data (manual process)
Two general types of computer processing systems
Transaction processing systems - high volume of simple transactions
Management reporting systems - provide management with information needed to make informed decisions (MRS)
Management information systems (MIS)
MRS
provide information for planning, organizing, and controlling the operations of the business
Expert systems
MRS
apply specific models to data to provide a specific type of recommendation for a problem or question
utilizes expert knowledge programmed into a systematic approach
guides the decision making process and provides decisions comparable to those of an expert
a form of AI
widely used in many industries
Decision support systems
MRS
combine data and models in order to resolve problems
On-line transaction processing
supports day to day processing
on-line analytical processing
allows for day to day data to be analyzed
On-line real time and direct access processing
interchangeable
data warehouse
integrated collection of data
used for reporting and analysis
to support management decisions
Data is periodically downloaded from databases into a data warehouse.
data mart
limited version of a data warehouse
Data mining
using complicated statistical and graphical processes and structured approaches to manipulate data
uses statistics and Artificial Intelligence
accesses data warehouses and data marts
useful in analyzing situations and potential problems
used by all levels of the organization
centralized processing
occurs at one location
traditional model used with mainframe computers
still in use, often combined with decentralized or distributed processing
decentralized processing
collection of independent databases rather than an integrated system
processing occurs at multiple locations
not generally networked
do not share data
networked and access a single database
a single database is updated utilizing both on-line and batch transactions
bit
binary digit (0 or 1) smallest storage unit in a computer
byte
sequence of bits
usually 8 bits equals one byte
master file
contains data that is relatively static
detail file
may be associated with master files
information systems department
two distinct functions:
systems development
data processing
Segregation of controls
segregate functions between information departments and user departments
do not allow information systems departments to initiate and authorize transactions.
segregate programming, operations and the library function within the information systems department
database administration typically falls under systems development
data preparation typically falls under data processing
systems development and data processing should be separate functions reporting to a single manager
functions under system development
systems analysis,
systems programming,
applications programming
database administration
functions under data processing
data preparation, operations, data library and data control
systems programmer
implementing, modifying and debugging the software required to interface with the hardware
function generally responsible for preparing data to be entered into the system
end-users or user departments
Operator
responsible for the daily computer operations of both the hardware and software
mounts tapes
supervises operations on a console
accepts inputs
distributes outputs
has documentation available to run programs
Help Desks responsibility to assist end users with system problems and technical support
NOT responsible for detailed program information
Control Group
liaison between end-users and the processing center
records input data in a control log, f
follows the progress of processing,
distributes output,
ensures compliance with control totals
Webmaster
provides expertise and leadership
in the development of a website,
including but not limited to
architecture, design, analysis, security, maintenance, content development, and updates
size of a computer system
may affect the accounting systems because a firm may
purchase software for small systems
but may have to
develop its own software for larger systems
“in-house” developed software
Software developed by a company’s own personnel
quality will vary depending on the care and expertise of the people doing that development
may be easier to audit smaller systems
firm may purchase software for small systems but develop their own software for larger systems
familiar with the purchased software
“exception reports” may be standard and well tested.
may not be familiar with “in house” developed software and although exception reports may exist, controls should be tested to a greater extent
Three main types of system documentation used by auditors and analysts are:
(a) Data Flow Diagrams (DFDs) - -the system components and functions, data flows among the components and sources, destinations and storage of the data;
(b) System Flowcharts - informational processes (such as logic flows, inputs, outputs, data storage), operational processes (such as physical flows)
(c) Entity Relationship Diagrams - key entities and the relationships among those entities.
Auditors and analysts document information systems to understand, explain, and improve complex business processes and operations.
value-added network
can support communications among firms with different hardware and software configurations
high cost to maintain proprietary lines, but security benefits may outweigh such costs
security risk
Risk associated with access by unauthorized parties
availability risk
risk that the e-commerce system will not be available when needed
needs assessment
data capture,
processes,
information, and reporting
gap analysis
performed during the analysis phase of system design,
performed to determine differences between the system in place and the system to be implemented
NOT a component of needs assessment.
ERP systems design
provides many opportunities to reexamine business processes,
enterprise-wide computerized system that connects all areas within an organization
designing or improving provides a firm with an opportunity to align IT processes with business strategy at a high level and throughout the organization
Database Administrator (DBA)
database design, operation, security
Database Management System (DBMS)
create and modify the database
Reorder Point
Usage per day x Lead time
Payback Method
Initial Investment/Annual Cash Flow
does not adjust for the time value of money
Three basic measurements used by the Theory of Constraints (TOC)
Throughput (contribution)
Inventory (investments)
Operational Expense
used to identify the bottleneck
aggressive working capital policy
reduce current assets in relation to current liabilities
high profit potential but high risk and low liquidity
may include hedging approach
cost of retained earnings
Gordon model
Cost, in percentage, of using equity in the form of retained earnings
krm = (D1*/PO) + g
- estimated dividend to be paid next year
- *current market price of stock
- **estimated annual growth rate in dividends (%)
3 basic valuation approaches
cost - economic substitution (cost to replace assets with assets of like function and capacity)
market - market comparison (identical or comparable) by asset or business
income - ability to create benefit (earnings) commensurate with risk
fair market value vs. fair value
fmv -
implies “willing” buyer/seller
“hypothetical” seller (not specific)
“unrestricted” market (not principal or most advantageous)
4 categories of normalization adjustments in valuation
nonoperating - removal of items not part of normal ops
nonrecurring - removal of unusual, unexpected items
comparability - match GAAP choices
discretionary - include/remove items not part of normal ops like excessive wages paid to relatives
2 alternate premises of valuation
going concern
liquidation
SOX 404 TDRA
top-down risk assessment
id and asses:
financial reporting elements
related risks
IC procedures to limit risks
financial transaction control
discover/prevent
errors, misappropriations, noncompliance
allows for the financial resources’ proper:
use
monitoring
measurement
as interest rates get higher, factors
become smaller
Discount rate is increased in NPV calculation
PV of future CF decreases
NPV decreases
Relevance to NPV
Relevant: changes in net working capital tax depreciation (affects tax expense to arrive at NI)
NOT relevant:
book depreciation (noncash)
sunk costs
ARR
Accounting Rate of Return
Net Income*/Investment
Cash Flow + Depreciation
3 techniques for assessing risk in capital budgeting
sensitivity analysis
adjusting required rate or return
adjusting estimated cash flows
Lower setup costs
decrease lot sizes
Increased carrying costs
decrease lot sizes
Barcode tracking of the physical location of small computers
is not required
three procedures to control possible software piracy
establishing a corporate software policy,
maintaining a log of all software purchases
auditing individual computers to identify installed software
small computer security issue
EUC risks
End User Computing
inappropriate management review of applications’ results
personnel lack of understanding of control concepts
inadequate applications testing before implementation
physical access controls
clamps/chains to prevent removal of hard disks or internal boards
key pads and ID scanners to prevent unauthorized access to restricted areas
control over access from outside to prevent unauthorized individuals from sensitive areas
Methods to control access to appropriate users
passwords and user IDs,
menus for end-user computing access databases, independent review of transactions,
restricting user ability to load data,
requirement of appropriate validation,
authorization and reporting control when the end user uploads data
recording access to company databases by EUC app
control implications
require applications to be adequately tested before use, backup of files,
controlling access to appropriate users,
adequate documentation,
application controls
Software piracy risk and mitigation
Software is copyrighted, and violation of copyright laws may result in litigation against the company is true.
Software piracy may be avoided by maintaining software purchase logs.
Computers should be audited to identify installed software.
A corporate software policy should be established.
Verification of processing
Should be performed periodically
Prevents the system from being used for personal projects
Prevents errors from going undetected and assure accuracy of in-house developed spreadsheets and databases
A reliable system
operates without
material, error, fault or failure
during a specified period in a specified environment
generates error logs related to software and data problems
AICPA’s Trust Services (PACOS)
provide assurance on information systems
Processing Integrity - system processing is complete, accurate, timely and authorized
Availability - of the system for operations and uses as committed/agreed to in conformity with entity policies
Confidentiality - information protected as committed/agreed.
On-line Privacy personal information obtained as a result of e-commerce is collected, used, disclosed and retained as agreed/committed
Security - protect against unauthorized access (both physical and logical).
Seven factors of the control environmentpuf
ICHAMBO:
I - Integrity and ethical values
C - Commitment to competence
H - Human resource policies and practices
A - Assignment of authority and responsibility
M - Management’s philosophy and operating style
B - Board of director’s or audit committee participation
O - Organization
Responsible of overseeing the development, planning and the implementation of a website.
Web Administrator / Web Developer
Responsible for creating the visual content of the website.
Web Designer
Responsible for the daily operations of the website
Web Coordinator
Responsible for writing programs for commercial use.
Internet Developer
Similar to a software engineer or a systems programmer.
Responsible for writing programs based on the needs of the company.
Intranet/Extranet Developer
main information systems risks
Financial risk
Information risk
Strategy risk
Internal control systems should be designed to achieve
process objectives
operations and information process goals
Operations process goals should ensure three things:
(1) effectiveness of operations - strives to ensure that an intended process is fulfilling its intended purpose (such as proper management authorization for overrides)
(2) efficient resources - to have enough resources to ensure benefits of controls exceed the costs of those controls
(3) security of resources - protect all tangible and intangible resources
Information process control goals should ensure five things:
(1) input validity - where input data be approved and reflect accurate economic events
(2) input completeness - all valid events are captured
(3) input accuracy - all events are captured correctly
(4) update completeness - all events are reflected in respective master files
(5) update accuracy - all events are reflected correctly within master file
Control plans
policies and procedures that assist in accomplishing control goals
No control plan is 100% effective.
A combination of plans must be used to maximize effectiveness.
Three levels of control plans
control environment (top level),
pervasive control plans (mid-level)
application control plans (detail level)
Control plans is in relation to the timing of their occurrence.
Preventive control plans - stop problems from occurring
Detective control plans - discover problems that have already occurred
Corrective control plans - correct problems that have already occurred
COBIT
Control Objectives for Information and Related Technology
developed by the Information Systems Audit and Control Foundation (ISACA)
provide guidance on best practices for management and information technology
groups IT control processes into four domains:
1) Plan and Organize PLAN
2) Acquire and Implement BUILD
3) Deliver and Support RUN
4) Monitor and Evaluate MONITOR
audit trail
is a record left by the accounting information system of movements in individual transaction data
in the form of references to the processing of the data
trail of the processing of transactions and other events entered into by the entity
some provide a visible and complete audit trail, while others provide an invisible and/or incomplete trail
may start from the moment data about the event is first captured within the system to the time of its ultimate disposition in the financial statements
should allow for a means to trace back to individual business events from the general ledger
auditor may follow the audit trail of a transaction as part of a systems “walkthrough”
actions required when changing an existing program or system
change should be
reviewed (manager)
tested
documented
approved
methods to control access to programs and data
segregation
physical access
hardware and software access
methods to control computer operations
segregation backup and recovery contingency processing file protection rings internal and external labels
input validation or edit controls
preprinted forms, check digits, control totals., batch and proof totals, hash totals, record counts limit or reasonable tests, menu driven input, field and validity checks, missing data and field size checks, logic checks, redundant data checks, closed loop verification
user control activities
checks of computer output against source documents
control totals or other input
reviewing computer logs
policies and procedures that document authorized users and receipients of data
COBIT framework’s four categories of IT resources:
information
applications - include systems and manual procedures to process information;
infrastructure - includes hardware, equipment, and operating systems needed to process information
people
NOT Design
seven criteria set forth in the COBIT framework are:
1) integrity,
2) confidentiality,
3) effectiveness,
4) reliability,
5) availability,
6) compliance,
7) efficiency
ICE RACE
NOT Security
Gateways
connect internet computers of dissimilar networks
translates between two or more protocol families
allow mainframe to connect to PC’s
Routers
determine best path for data
Bridges
connect physically separate LANs
Repeaters
strengthen signal strength
B2B & EDI
reduce purchasing costs
increase market efficiency (increases market intelligence)
Option risk
firm gives the customer the right (but not the obligation) to change the stream
from assets, liabilities, or off-balance sheet items
prepay a mortgage without a prepayment penalty = call option
Re-pricing risk
firm deliberately mismatches in an upsloping yield curve environment
holding assets with a longer duration than that of the liabilities used to fund them
basis risk
bank’s interest margins are spontaneously enhanced in a period of rising interest rates as loan rates tend to adjust upward more rapidly than the rates on deposits.
as interest rate increases peak and rates begin to decline, this process reverses itself and there would be increasing pressure on interest rate margins.
Yield curve risk
the underlying shape of the yield curve changes
(e.g., steepens, flattens, becomes inverted).
accentuates any asset-liability mismatches the firm has
Real $
Actual $/(1 + inflation rate) to the n*
n* = # of periods
The higher the perceived risk involved in a particular investment,
the greater the return that an investor would demand on that investment;
therefore, the higher the discount rate used, the lower the present value.
NPV vs. IRR
reinvestment assumption applied to “recovered funds.”
Net present value (NPV) assumes reinvestment at the cost of capital*
Internal rate of return (IRR) assumes reinvestment at the IRR.
*more realistic assumption about the rate of return that can be earned on cash flows from the project
real options approach in capital investments
investment is considered similar to acquisition of stock using options
exercised only if investment appears profitable.
potential loss minimized
Expected value
average value of a random variable over the possible outcomes
weight value of each possible outcome by probability
sum values.
$250,000 profit x 80% probability
expected value = 0.8 × $250,000 = $200,000
$-100,000 profit x 20% probability
expected value = 0.2 x -$100,000 = -$20,000
$200,000 - $20,000 = $180,000
Human resources policies and procedures
should include the following:
Hire employees based on the written job requirements
Verify resumes and perform background checks
Promote on both merit and performance
Train members of the organization on many aspects
Contribution margin per unit
Change in revenue/Change in volume
Break even units
$ FC/CMPU*
*Contribution Margin per unit (Unit Sales Price - Unit Variable Cost)
Return on Assets
Income/Assets
Profit Margin on Sales* x Asset Turnover**
*(Income/Sales) x **(Sales/Assets)
Sales cancels out
market value added (MVA)
market value of the firm minus the book value of the capital investment in the firm
economic value added (EVA)
net operating profit after taxes minus the firm’s cost of capital in dollar terms
NOPAT - (capital investment x WACC)
ROA
net income divided by total assets
ROE
net income divided by total equity
Net profit margin
net income divided by net sales
ROIC
net income plus interest divided by average total invested capital.
Invested capital is equal to interest bearing debt plus shareholders equity.
balance scorecard
performance measurement does not rely solely on financial measures (ratio analysis, changes in balance sheet figures)
Four general perspectives - FICL: Financial Internal business processes Customer Learning/growth
strategic objectives (what each strategy is to achieve and critical factors)
performance measures (WHY each and HOW tracked),
baseline (current) performance,
targets, and
strategic initiatives (how targets will be achieved)
BS performance measures
establish:
Baseline Performance,
Targets, and
Strategic Initiatives
BS value chaing
the sequential set of primary and support activities that an enterprise performs to turn inputs into value-added outputs for its external customers
sequence of business processes which add usefulness to a product from inception to satisfactory use by a customer
DuPont ROI
NI/Total Assets
return on sales (net income/sales) x asset turnover (sales/total assets)
return on sales and asset turnover are two basic ways to improve profits
- by increasing the amount of profit for each dollar or sales
- by making better use of assets to generate more sales
Free cash flow
NOPAT*
+ Depreciation & Noncash
- Capital Expenditures
- WC (increasing working capital requirements)
operating profit margin
measures sales-generated operating profit
Operating Profit/Net Sales
A/R Turnover
net credit sales for a period (after returns and allowances) divided by the average accounts receivable balance for the period
Credit Sales/ avg AR*
(Beg AR + End AR)/2
benchmarking in product manufacturing
best practices for each activity
achieve efficiency by comparing its own operations to those benchmarks in hopes of adapting where necessary
Types of share-based compensation with long-term focus to align management’s interests with the firm’s long-term financial success.
Vesting periods
Stock appreciation rights - give management access to the appreciation over a period of time
Restricted shares - restricted from being resold for a certain period of time or until the company reaches certain financial targets
Single-productivity ratios (SPR)
Partial productivity ratio (PPR)
Total productivity ratio (TPR)
SPR - finding the ratio of her company’s total outputs to one input
PPR - to less than all inputs
TPR - all outputs to all inputs
Management by exception
concentrating on areas that deserve attention and paying less attention to areas operating as expected
Management-by-objectives (MBO)
manager and subordinate jointly develop objectives and plans
Responsibility accounting
responsibility is identified and related to managers
managerial performance is monitored and evaluated based on this identification
Benchmarking
identify “best in class” performance or other measure(s),
compare performance to that standard
Variations between business cycles
the economy as a whole
due to many factors that result in fluctuations in business activity over time
measured by duration (from peak to peak) and intensity (the peaks and troughs in the cycle)
The law of diminishing returns
applies to an individual firm
the intensity of its use of fixed costs
Comparative advantage
internal factors within one company
strengths in comparison to other firms
Opportunity costs
lost income when a firm chooses to use a resource in one area instead of another
does not apply to the economy as a whole
Production costs up to the split-off point
joint costs sometimes assigned to the products based upon a physical measure such as weight (physical measure often bears no relationship to sales value of products)
Sales methods to assign joint costs to individual products in proportion to:
Relative sales value - sales value of each product relative to the sales value of all products at the split-off point.
Net realizable value method: net realizable value of the joint products as of the split-off point (defined the final sale price less all costs to complete the product in its final form)
theory of constraints uses three measurements:
throughput contribution, investments, and operating costs.
Financial Planning
1) analyzing the investment and financing alternatives available to a firm,
2) forecasting the future consequences for each of the alternatives,
3) deciding which alternatives to undertake,
4) measuring subsequent performance against established goals.
business process improvements initiatives
reduce (do not eliminate) costs of quality,
greater efficiency,
higher product quality,
alignment of processes with customer needs
steps to process improvement
1) design,
2) modeling (which involves simulation of the process),
3) execution (training of personnel/testing process),
4) monitoring, and
5) optimization
D’MEMO
outsourcing or off-shoring a business process
improve quality when this process falls outside the firm’s area of strength or expertise
Cost reduction
freed resources to focus on core competencies are two common benefits of outsourcing, off-shoring, or sharing services.
Tax savings can also play a role, as outsourcing may provide for less capital investment and greater expense related to the outsourced services.
Process reengineering
consider interconnected and cross-functional processes
benchmarking best practices,
should be in line with the firm’s overall strategy
Just-in-time manufacturing
efficiency by eliminating inventories and having both supplies and end products when needed to satisfy actual customer demand.
Lean manufacturing
seeks to eliminate non-value added activities from a system.
Six Sigma
statistical process controls to achieve six-sigma quality of 3.4 defects per million products.
Demand flow theory
customer demand drives a flow of processes in a manufacturing system.
ISO 9000
certification for environmental activities (awarded by the International Organization for Standardization) for meeting certain quality standards.
Kaizen
quality initiative that seeks continuous improvement.
Total Quality Management (TQM)
apply quality principles across its functions and operations
The Baldridge award
recognizes total quality management and was established by Congress in 1987.
The Deming Prize
named after the quality pioneer who was instrumental in revolutionizing quality in Japanese manufacturing during the mid-20th Century.
European Quality Award
most prestigious award for quality for European companies
quality control costs
cost of failure far exceeds the cost of prevention
cost of quality can be divided into four categories: prevention cost, appraisal cost (inspection/testing), internal failure cost, and external failure cost
cost of internal failure includes costs such as rework and spoilage (discovered before product reaches customers)
costs to prevent a failure include quality improvement projects and statistical process control activities
generic benchmarking
benchmark across other industries
Competitive benchmarking
benchmarking the practices of competing firms
Internal benchmarking
benchmarking against other processes within a firm.
Functional (or industry) benchmarking
benchmarking against the performance of other firms within a firm’s own industry (specialized characteristics)
Pareto chart
bar chart or histogram that ranks the causes of variations in a process from most to least frequent, which is intended to indicate their effects on quality.
control chart
measures deviations from process standards,
Ishikawa (fishbone) diagram
identifies causes of defects and their effects.
steps in project management
initiation, planning, execution, monitoring and control, and closure
Project crashing
adding additional resources to a project in order to shorten its timeline
Gantt chart
bar chart that shows the actual and predicted amounts of time for completing certain aspects of a project.
ABC analysis in the context of project management
categorizes activities in a project as being
A) urgent and important;
B) important, but not urgent; and
C) neither important nor urgent
Program Evaluation and Review Technique (PERT) analysis
finding the critical path to completion of the project.
milestone chart
tool for keeping track of major project milestones over the project’s duration.
critical path method (CPM)
similar to PERT, but focusing on one time estimate;
line of balance chart
illustrate related project activities;uf
network diagramming
illustrate the path of a project and its required activities
graphical evaluation and review technique (GERT)
expands on PERT by allowing interconnection between elements of the critical path
project manager
responsible for managing timelines and costs of the project, and project scope
facilitate coordination and communication between members of an interdisciplinary team
project steering committee
decision-making power over business issues related to the project, such as budget strategy
Project risk management
identifying, quantifying, prioritizing, and developing a response to risks.
may include shifting a portion of risk to another party
types of risks:
Time and cost overruns
inappropriate or unreasonable project scope (too broad or narrow)
deliverables that are unsatisfactory (internal or external)
check digit
input control,
single digit at the end of an identification code
computed from the other digits in a field.
If the identification code is mis-keyed, a formula or algorithm will reveal that the check digit is not correct, and the field will not accept the entry.
Hash totals
nonsense totals
used to verify processing (or output) compared to input.
not an input control
parity check (bit)
extra bit added to a string of bits as a hardware control
control over the accuracy of data transmission,
hardware control, not an input control
encryption
data is processed through a formula that substitutes other characters for the original characters
transmitted between computers to prevent interception of the data or
store data so that others cannot read it
The central assumption in the multiplier effect
an increase in autonomous expenditure,
will result in a greater increase in national income
(and subsequently national product).
Simple/mulitple regression
relationship between one dependent variable and
S - one independent variable
M - two or more independent variables
COGS (Finished Goods)
Beg FG + Cost of Goods Manufactured - End FG
Raw Materials Used
Beg RM + Purchases - End RM
Cost of Goods Manufactured (WIP)
Beg WIP + RM Used + DL + OHA - End WIP
Marginal Propensity to Consume
Change in Consumption/Change in Income
PV
Payment/(1+r) to the n
3000 over 5 years @ 10% discount rate
3000/1.1 \+3000/(1.1*1.1) \+3000/(1.1*1.1*1.1) \+3000/(1.1*1.1*1.1*1.1) \+3000/(1.1*1.1*1.1*1.1*1.1) =11372
conversion costs
cost to convert materials into finished products
include direct labor and factory overhead
level of activity increases within the relevant range
Variable Cost PER UNIT will remain same
Total Variable Cost will increase
Fixed Cost PER UNIT will decrease
Total Fixed Cost will remain the same
Total cost will increase
Product costs
“inventoriable” costs (such as direct material and direct labor)
directly associated with the production of a good
capitalized, or added to the cost of those items
Period costs
not directly associated with the production of a good
expensed as incurred rather than being capitalized
Abnormal losses incurred during production are period costs
cost management system
a planning and control system
identifies activities
measures cost of significant activities,
identifies non value-added cost
Mixed costs
semi variable costs
have both a fixed and variable component
fixed cost does not vary with the level of activity
variable cost varies proportionally in total with the level of activity
Relevant range
level of activity where fixed costs remain fixed (e.g. do not vary)
nonlinear cost function
cost not described by a straight line over the relevant range
fixed cost does not vary with the level of activity while a variable cost does vary proportionally in total with the level of activity but both can be represented by a straight line
Joint costs
common to multiple products
can be fixed or variable
Materials available for use
listed on a cost of goods manufactured statement
as Direct Materials
cost of goods manufactured
transfer from Work-in-Process to Finished Goods
flows through to cost of goods sold
on the Income Statement
manufacturing costs flow
Materials Inventory,
Work in Process,
Finished Goods (balance sheet)
Cost of Goods Sold (Income Statement)
Overhead
all costs other than direct labor and direct materials
cannot be traced directly to the product
activity bases
causal relationship to the incurrence of the overhead costs
Labor hours, labor costs and machine hours
Theoretical capacity
state in which output is produced efficiently 100% of the time
Practical capacity
adjusts theoretical capacity for non-production time such as holidays and maintenance shutdowns
Normal volume
adjusts theoretical capacity for long run product demand over a multiple year period
Expected annual capacity
adjusts theoretical capacity for the expected output for the current year only
Most firms use the expected annual capacity approach to the application of overhead.
overapplied overhead
estimated overhead is higher than the actual overhead
or
estimated activity level is lower than the actual activity level
Overhead is applied
based on a calculated rate per unit
estimated overhead costs/estimated activity level
Variable costing
account for fixed manufacturing overhead
all fixed costs of manufacturing overhead are expensed immediately as period costs, so these costs are never included in inventory
often used for managerial accounting purposes (internal decision-making)
more representative of actual performance during the period when inventories are high
Methods such as variable and throughput costing
often used for managerial accounting purposes,
more representative of actual performance during the period when inventories are high
Full absorption costing
account for fixed manufacturing overhead
required under GAAP (external reporting)
includes overhead as product costs added to inventory
until products are sold.
When inventory increases, variable costing income is less than absorption costing income
linked list
has a pointer field which displays the address of the next record in the list
activity based-costing (ABC) is based upon two principles.
- activities consume resources
- resources are consumed by products, services, or other cost objectives (output)
allocates overhead costs to products on the basis of the resources consumed by each activities cost driver
( match all costs to their drivers)
Overhead is assigned one time for each separate activity
Traditional process, job order, and standard cost accounting focus exclusively on manufacturing process (raw materials, labor, factory overhead)
assigns costs at product, batch, process levels, etc.
superior method because it attempts to allocate costs to their actual drivers in a system
eliminating non-value added activities is one of the primary benefits
ABC includes all value-adding activities (such as design)
Job order costing
allocating costs to groups of unique products made to customer specifications.
Each job is material in natural and accounted for separately.
Weighted Average System
determines the equivalent finished units (EFU) of work done based on the total that has been accomplished by the end of the period.
During period, 120,000 units completed
(120,000 units of material & 120,000 units conversion costs)
+ 10,000 units partially complete
(10,000 times 60 percent or 6,000 units of material)
(10,000 times 10 percent or 1,000 units conversion costs)
WAS Total EFU Material = 126,000 units
(120,000 plus 6,000)
WAS Total EFU CC = 121,000 units
(120,000 plus 1,000)
First-in, First-out System
does not include any work done prior to the period
amount of work on the beginning work in process is removed
WAS Total EFU Material = 126,000 units
WAS Total EFU CC = 121,000 units
Remove WAS 30,000 units already in beginning WIP (30,000 units 80 percent complete = 24,000 units material) (30,000 units 30 percent complete = 9000 units conversion costs)
FIFO total EFU Material = 102,000
(WAS 126,000 less 24,000)
FIFO Total EFU CC = 112,000
(WAS 121,000 less 9,000)
standard costing system
Primary purpose is to identify what is driving variances between actual costs and those based on standard per unit costs for products
focuses on target costs that are attainable when a system is operating efficiently (but not under ideal conditions)
foundation for variance analysis that identifies variances in overhead, labor, and material costs
not acceptable method for U.S. GAAP
Cost-volume-profit analysis
flexible budgeting
performed by companies to determine
output quantity and
other variables
that should be used to maximize profits.
different inputs and outputs can be factored in
allowing management to determine the number of units to produce to increase net income
given desired gross profit percentage, calculate sales prices
SP* – CPU** = %AD*** x SP
(1 - %AD) SP = CPU
SP = CPU/(1 - AD%)
- Sales Price
- *Cost Per Unit
- ** % as decimal
Top-down budget
alignment with the company’s strategic plan
Advantages:
faster preparation time
clearer communication of top management’s objectives
Participative budgeting
driven by lower-level management and employees
still requires approval by top management and
alignment with the company’s strategic plan
Advantage: improved morale and wider acceptance
Disadvantage: possible budget slack being built in by area managers
operating budget
focuses on the budgeted income statement and its supporting schedules
sales, production, direct materials, direct labor, overhead, research and development, and selling, general, and administrative expense budgets,
starting point is sales forecast
financial budgets
capital expenditures budget,
cash budget,
budgeted balance sheet,
budgeted statement of cash flows
sales forecast
basis for sales budget
determines elements of the production budget,
which flow to the other operating budgets,
including the production expense budgets
(direct material, direct labor, and manufacturing overhead) and other budgets
needed to prepare the budgeted income statement.
The financial budgets cannot be completed without preparation of the budgeted income statement.
Therefore, the sales budget is the most critical budget in the master budget process.
Lean manufacturing,
production practice and methodology that focuses on reduction of the seven wastes in manufacturing products
(overproduction, waiting time, transportation, processing, inventory, motion, and scrap)
Sharpe measure
SD
formula for portfolio performance
(Portfolio return - Risk-free rate) ÷ Standard deviation
SD
Treynor index
TB
formula for portfolio performance
portfolio return per unit of risk
risk = market/individual stock flux
(Portfolio return - Risk-free rate) ÷ Beta.
BETA
Jensen measure
JR
formula for portfolio performance
measure of return on portfolio
Risk-free rate + ((Return on market index - Risk-free rate) × Beta)
ROMI
The eight components of COSO’s ERM framework
Internal Environment, Objective Setting*, Event identification*, Risk Assessment, risk Response*, Control Activities, Information and communication, and Monitoring
IS EAR AIM
CRIME + ORE*
ERM processes must be monitored, deficiencies reported to management, and modifications performed when required.
Electronic vaulting
process of electronically transmitting and storing backups of programs and data
at a remote data storage facility.
An inferior good
consumers buy more
when income falls
A normal good
consumers buy more
as their income rises
When demand is elastic, an increase in price
makes the total revenue smaller
A price floor
minimum price that is only binding if it is set higher than the market price
surpluses develop (QS > QD)
more non-price competition among sellers
reduces price competition
reduction in quantity demanded by consumers
Starting with an equilibrium, a shift of the supply curve to the left and a shift of the demand curve to the left
new equilibrium with a lower level of output
change in price depends on magnitude of shift in supply relative to the shift in demand
Price may go up, go down, or stay the same (indeterminate)
price freeze
shortage - excess quantity demanded for gasoline
relative to quantity supplied of gasoline at the pump
artificial price for gasoline lower than market price
not a shift of demand supply
luxury good
buy more as income gets higher
ratio above 1.0 (elastic)
purchasing is primarily at higher levels of income
Optimal consumption
subject to the budget constraint
requires knowing consumer preferences
ratio of the price equals
ratio of the marginal utility of consumption
marginal utility of consumption/ price of each are equal
Diminishing marginal utility
the addition to total utility of the last unit of a good consumed is less than the addition to total utility of the consumption of the prior unit of a good
For complements, when the price of one good goes up,
quantity demanded for that good reduced
change in price also reduces the demand for complement
a negative percentage change in the demand for product Y in response to a positive percentage increase in the price of X
cross-elasticity of demand is negative for complements
in the long run
there are no fixed costs
In the short run, fixed costs
decline as the firm produces more output,
since the fixed cost is spread out over more units.
average total cost and marginal costs
When the marginal cost is above the average total cost, the average total cost must be increasing (the last increments are higher than the average so the average rises).
The average reaches its minimum when it is equal to the marginal cost.
As the marginal cost continues to increase and rises above the average total cost the average total cost must begin to increase,
Marginal costs decline in the early stages of production but increase as the law of diminishing returns sets in.
The inefficiencies of putting more variable inputs to work with the same fixed inputs will eventually make marginal costs higher.
Average total costs decline as long as they are above marginal costs (incremental costs are less so the average comes down).
law of diminishing returns
due to inefficiencies in production relevant only in the short run where some inputs are fixed
inefficiencies and lower productivity caused by adding too many variable inputs to fixed amount of inputs
decreasing returns to scale
due to inefficiencies in production in the long run where there are no fixed costs
allows for changes in production capacity but diseconomies of scale set in to produce inefficiencies
The long run average cost curve
falls, reaches a flat segment, and then rises
Pattern:
increasing returns to scale (economies of scale and falling average costs),
constant returns to scale (constant or flat average costs), and
decreasing returns to scale (rising average costs due to diseconomies of scale)
Marginal revenue
addition to total revenue from the sale of one additional unit of product
Marginal cost
addition to total cost from producing one more unit of product
Marginal product
additional output obtained from employing one additional unit of a resource or input
marginal revenue product
change in total revenue from employing one more unit of a resource or input
economic rent
input is purchased for a more than the next highest bidder would pay
potential risks of globalization
challenges due to cultural differences,
political risk due to unstable political systems in developing nations,
shift in the economic balance of power to emerging markets,
supply chain management risks
quadrants in SWOT matrix
strength-opportunity strategies,
strength-threat strategies,
weakness-opportunity strategies, and
weakness-threat strategies
monopolistic competition:
several independent producers,
low barriers to entry, and
differentiated products.
oligopoly
small number of powerful firms
perfect competition
several producers identical/standardized product, non-price competition ineffective perfectly elastic demand curve no significant barriers to entry
cartel
small number of producers that collude to set market prices
Classical economics - three factors of production
natural resources (or land), labor, and capital stock (or means of production - equipment and other man made items used in the production of other goods and services
Intellectual capital (or entrepreneurship) has only more recently been suggested as a factor of production.
production possibility frontier (PPF)
In an economy with scarce factors of production (labor, capital, and natural resources), the curve depicting the maximum output possibilities for two of more goods competing for these factors.
Points along the curve represent points at which production of the goods is most efficient.
Points under the curve represent points at which resources are not being used efficiently
Points above the curve are unattainable given the resources or inputs available.
The supply curve
defined in classical economics
depicts the relationship between price and quantity supplied of a good or service
value chain components:
inbound logistics, operations, outbound logistics, marketing and sales, and service to customers.
analysis focuses these value-creating activities
to maximize a firm’s competitive advantage
Gross Domestic Product (GDP)
total market value of goods and services produced WITHIN a country,
not necessarily with the resources of that country
Gross Domestic Product (GDP)
total market value of goods and services produced WITHIN a country, not necessarily with the resources of that country
Input (expenditure) approach: Consumption \+ Investment \+ Government Spending \+ Net Exports CIGN
Output (income and cost) approach: Wages \+ Interest \+ Rent \+ Profits \+ Depreciation \+ Indirect business WIRDI
Gross National Product (GNP)
appropriate measure of the total market value of all goods and services produced with a country’s resources
price of all goods and services produced by labor and property supplied by the nation’s residents
(not necessarily within its borders)
National Income
National income is the net domestic product plus income earned abroad minus indirect business taxes.
GDP Price Deflator
uses a factor based on all production in the economy at prices used in the GDP calculation.
Wholesale Price Index
uses the price of items in a typical cart of wholesale quantities to a base value.
Consumer Price Index
based on a comparison of the prices of items in a “typical” shopping cart to a base value
Full employment
occurs when all workers willing to work at market wages are employed using their skills
When the unemployment rate falls, the inflation rate
increases at an increasing rate
Phillips curve - shape is convex to the origin.
Slope gets steeper as unemployment falls and
flatter as unemployment increases
Absolute advantage
occurs when a country can produce more of everything
Comparative advantage
occurs when a product can be produced cheaper
Several control strategies to create barriers to free trade
Quota - limit on the quantity of goods and services imported
Substitution - develops substitute goods for imports
Tariff - tax on imports
Shift of consumer preferences - encourages consumers to buy domestic products.
Four control strategies to create barriers to free trade
Quota - limit on the quantity of goods and services imported
Substitution - develops substitute goods for imports
Tariff - tax on imports
Shift of consumer preferences - encourages consumers to buy domestic products.
When the $/euro increases
euro is worth more
dollar is worth less
dollar has depreciated.
U.S. exports to Europe are less expensive
European exports to the U.S. in euros are more expensive
Interest and dividends received in the U.S. from investments abroad
represents a credit
recorded in the current account
Producer Price Index (PPI)
calculated by the government to determine changes in prices of commodities when they are first sold
measures the average change over time in the selling prices received by domestic producers for their output.
prices included are from the first commercial transaction for many products and some services
International Monetary Fund (IMF)
promotes international monetary cooperation
exchange rate stability
facilitates the balanced growth of international trade
provides resources to help members in balance of payments difficulties or to assist with poverty reduction]
Economic profit
any profit earned in excess of a normal profit
additional competition will be drawn to areas where an economic profit can be earned
in the long run, it will be eliminated by the added competition
“excess profits”
leading economic indicators
orders for consumer goods, consumer expectations, and issuance of building permits average weekly manufacturing hours new claims for unemployment insurance
aid in predicting recovery or a deeper recession
lagging economic indicator
Continued unemployment
prime rate of interest
ratio of personal installment credit to personal income
Investment spending
as a component of GDP refers to business investment in plant and equipment and inventory, as well as residential construction.
Fiscal and monetary policy both influence this type of spending as they influence consumer spending.
Expectations about profitability are the most important factor in determining business investment spending.
Real GDP
GDP adjusted for changes in price levels.
When the difference between real GDP and potential GDP (or, the GDP gap) is negative, this indicates that the economy is operating above capacity and price levels should begin to rise.
Real GDP in excess of potential GDP is often associated with demand-pull inflation.
If potential GDP exceeds real GDP, this means that there are underutilized resources in the economy
monetary policy example (rather than fiscal)
increase the supply of money by:
Purchasing in the open market,
decreasing the reserve ratio,
decreasing the margin requirement
decrease the money supply by:
increasing the discount rate which would reduce lending
selling government securities
fiscal policy
government spending
consumer taxe rates
possible explanations for increased inflation
cost-push inflation - increased cost of producing goods and services.
demand-pull inflation - faster economic growth due to stimulated investment and expansion.
aggregate demand in excess of its potential ability to produce goods and services, leading to higher prices.
Real GDP in excess of potential GDP is often associated with demand-pull inflation.
Deflation
discourages borrowing (undesirable to borrow money and then have to repay it with money that has more purchasing power)
generally considered more damaging to the economy than inflation
discourages business investment as companies are reluctant to invest in equipment in a period of declining prices
High rates of inflation
economic contraction and
redistribution of wealth
recession
period of temporary economic decline
during which trade and industrial activity are reduced
reflected by a fall in GDP for two consecutive quarters
Nominal GDP
price of all goods and services
produced by a domestic economy
at current prices
Real GDP
price of all goods and services
produced by a domestic economy
at price-level adjusted prices
Potential GDP
maximum amount of production
that could take place in an economy
without putting pressure on the general level of prices
accelerator principle
small changes in consumer spending can cause big percentage changes in investment
Reserve ratio
Reserves / Total Demand Deposits
best cost provider
provide a product with superior quality, features, durability, service, etc.
at the lowest cost
give the buyer more value for their money
If controls add to the efficiency,
weigh the benefit of reducing loss
or inefficiency
against cost of the controls.
Monopolistic Competition
many small firms produce differentiated products
downward-sloping demand curve
marginal revenue is less than price
competing on quality, price, and marketing
entry will continue until economic profit disappears
some degree of control over product price
significant use of advertising as a non-price competition to shift the firm’s demand curve to the right and to make demand less elastic (make consumers less responsive to price changes)
economic profit in the short-run provides incentive to enter the industry, shifting the industry supply curve to the right
assumptions:
large number of independent/small buyers and sellers
free entry into and exit
differentiated product (materials, design,workmanship, customer service, location, packaging, image)
average-marginal rule
when the marginal magnitude is above the average magnitude, the average magnitude rises;
if average variable cost is rising, marginal cost must be higher than average variable cost.
differences between fair market value and fair value:
Fair market value
willing buyer and seller,
seller is hypothetical,
unrestricted market
Fair value:
buyer and seller not necessarily willing,
specific seller
principal or most advantageous market
variable costs per unit (given two volumes and total cost of each find costs at third volume)
change in cost/change in volume
remaining costs are fixed costs.
Section 404 of the Sarbanes-Oxley Act requires issuers of annual reports to include
scope and capabilities of the internal control system
procedures for financial reporting
levels of interdependence in integrated planning:
Three:
Pooled - common source of resource, but no interrelationship between the work groups.
Sequential Interdependence - work groups coordinate the flow of information, tasks, or resources from one group to another
Reciprocal Interdependence - information, tasks, and resources are passed back and forth between the groups.
Assembly language
programming language
machine language instruction is represented by mnemonic characters;
symbolic language,
an English-like and understandable alternative to basic machine language.
Machine language
binary code (on/off electrical switches: zero and one)
can be interpreted by the internal circuitry of the CPU
binary code is usually arranged as a hexadecimal (base 16) code
very time-consuming, error-prone programming process.
The formula to convert actual dollars to real dollars
Real$n = Actual$n ÷ (1 + f)n (n = Number of periods; f = Inflation rate)
For 1 period:
Actual $/(1 + inflation rate% as decimal)
levels of interdependence in integrated planning:
3
Pooled
Sequential
Reciprocal
in-exchange fair value
max value when item is used alone
in-use fair value
max value when item used in conjunction with assets as a group
Price
observed exchange price that occurs in the marketplace
Worth
advantages of ownership
based upon perceived benefits
at a particular time
for a particular use
Value
received in exchange two willing parties arms-length transaction in marketplace with knowledge and prudence without compulsion
Cost
paid for an asset in the marketplace
Business Process Management is supported by (3)
approaches
techniques
measures
NOT systems
Business process modeling tools
case diagrams - overview by driver
activity diagrams - step by step workflow
BP modeling notation - graphical rep of processes
extended business modeling language - who, what , when, where, which
unified modeling language - gen purpose/standard
Transfer pricing per IRS
comparable uncontrolled price
resale price
cost-plus approach
NOT target revenue approach
three basic valuation approaches:
market approach - market comparisons of identical or comparable items (reasonable and justifiable similarity to single asset or entire business)
cost approach - economic substitution principle (what would it cost to replace the item with an asset of like function and capacity)
income approach - company’s ability to create earnings or some other benefit, and the related risk
relational databases
store data in tables
ad hoc queries
maintained on direct access devices
dual-rate allocation method
variable and fixed costs are allocated to departments in a two-step process,
variable costs on current use
fixed costs on a long-term, maximum capacity basis
may not recognize any reciprocity of services among service departments
a refinement of either the direct or step-down methods
direct allocation method
allocates the cost of service departments directly to the production departments without any intermediate allocations to other service departments
does not recognize any reciprocity of services among service departments
.
step-down allocation method
allocates service department costs to other service departments and production departments usually starting with the service department that provides the most service to other service departments.
allows for partial recognition of reciprocity of services among service departments
linear algebra
reciprocal allocation method
recognizes reciprocity among service department by explicitly including the mutual services rendered among support departments
check digit
input control,
single digit at the end of an identification code that is computed from the other digits in a field
If the identification code is mis-keyed, a formula or algorithm will reveal that the check digit is not correct, and the field will not accept the entry.
Hash totals
output control
used to verify processing
nonsense totals
parity check
hardware control
extra bit added to a string of bits
control over the accuracy of data transmission
encryption
data is processed through a formula that substitutes other characters for the original characters
applied overhead
Overhead Rate* x Actual Direct Labor Cost = Applied Overhead
*Estimated annual overhead ÷ Estimated annual direct labor = Overhead Rate (percent)
Calculate DI (GDP to NDP to NI to PI to DI)
GDP - Capital consumption allowance (depreciation) ------------------------------- NDP - Net foreign factor income - Indirect business taxes ---------------------------- NI - Social Security contribution - corporate income taxes - undistributed corporate profits \+ transfer payments ------------------------------- PI - personal taxes ------------------------------- DI
Knowledge-based systems
use symbolic processing based on heuristics*
*rules-of-thumb
Algorithms
defined procedures
characteristic of typical computer programs
Deterministic procedures
permit no uncertainty in outcomes
implemented in computer programs,
Simulations
prepare results as if a set of assumptions were true
computer programs
fail-soft protection
capability to continue processing at all sites except a nonfunctioning one
an advantage of distributed systems
average gross receivable balance
Average daily sales x average collection period
Because the average collection period is the time it takes to collect on a sale (indicated in days, this is the average age of a receivable in accounts receivable), multiplying this by average daily sales would give you the average gross receivable balance.
average collection period
average gross receivable / average daily sales gives you the .
store data in trees
hierarchical databases
store data in tables
relational databases
ROM
Read Only Memory
permanent storage of operating system and language translator
cryptographic devices
protect data in transmission over communication lines
benefit of EDI
compressed business cycle with lower year-end receivables
Statement on Standards for Valuation Services (SSVS 1), issued by the AICPA in 2008. Valid comparisons of two types of engagements
Valuation engagement - valuator is free to use any valuation approach of method deemed to be professional appropriate
Calculation engagement - valuator and the client agree upon specific valuation methods used
Expected value
sum of the outcomes (payoff) of each event
multiplied by the probability of each event occurring
Combines the likelihood of each outcome
with the payoff of that outcome
a way of prioritizing alternatives while considering risk
