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CPA Exam 2017 > BEC 1 > Flashcards

BEC 1 Flashcards

1
Q

Internal Control

What are the 3 components of the COSO CUBE of internal controls?

A

O
R
C

Operations
Reporting
Compliance

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2
Q

ERM

The 4 objectives of Enterprise Risk Management (ERM)

SORC

A

Strategic
Operations
Reporting
Compliance

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3
Q

ERM

The 8 components of Enterprise Risk Management (ERM)

IS
EAR
AIM

A 
Internal environment (Control environment) = (EBOCA)
Setting objectives = S+ORC
Event Identification (SAFR)
Assess risk (SAFR)
Risk response (SAFR)
control Activities (CATP)
Information & Communication (OIE)
Monitoring (SOD)
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4
Q

ERM

e-A-r
Assessment of Risk
&
Assessment Technique

A

1) Likelihood
2 )Severity (Impact)

1) Benchmarking
2) Prob models - Statistics
3) Non-prob - Opinions

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5
Q

ERM

e-a-R
Risk response
ARSA

A

Avoid/terminate
Reduce - invest
Share - buy insurance
Accept

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6
Q

Event Inventory

A

When management uses listings of potential events common to a specific industry as a means of identifying risks or opportunities

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7
Q

Residual risk

A

The risk that remains after management responds to the risk

The risk that an organization incurs after management takes whatever actions are needed to mitigate the adverse impact of a given event

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8
Q

The 4 stages of the change continuum

A
  1. Control Baseline
  2. Change Identification
  3. Change Management
  4. Control Validation/Update
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9
Q

Internal Controls

5 internal control components

CRIME
C
R
I
M
E
A 
C - Control environment (EBOCA)
R - Risk assessment (SAFR)
I - Information & Communication (OIE)
M - Monitoring (SOD)
E - Existing control activities (CATP)
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10
Q

EBOCA (Control Environment)

A 
E - Ethical values
B - Board independence & oversight
O - Organizational structure
C - Commitment to competence
A - Accountability
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11
Q

SOD (Monitoring)

A

Separate & Ongoing evaluations

Deficiencies

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12
Q

OIE (Information & Communication)

A

O -Obtain and use information
I - Internal communication
E - External communication

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13
Q

SAFR (Risk Assessment)

A

S - Specify objectives
A - Asses changes
F - Fraud
R - Risk assessment

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14
Q

CATP (Control Activities)

A

C - Control Activities
A
T - Technology
P - Policies & procedures

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15
Q

Interest Rate goes up = Value of fixed income goes down

A

Fixed coupon / (1+r) = Value

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16
Q

Market Risk (systematic / nondiversifiable)

A

fluctuation in value as a result of operating within an economy (war, inflation, international incidents, political events)

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17
Q

Diversifiable risk (Unsystematic / Firm-Specific)

A

the portion of a firm’s or industry’s risk that is associated with random causes and can be eliminated through diversification (Strikes, lawsuits, regulatory actions, loss of a key account)

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18
Q

2 Broad categories of risk

A
  1. D - Diversifiable risk
    U - Unsystematic risk
  2. N - Nondiversifiable risk
    S - Systematic risk
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19
Q

Credit Risk (affects borrowers)

A

Credit risk goes up = cost of borrowing goes up

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20
Q

Default Risk (affects lenders)

A

the extent that it is possible that debtors/borrowers may not repay the principal or interest due on their indebtedness on a timely basis

21
Q

Liquidity Risk (General Rule - not publicly traded)

A

When investors/lenders can’t sell something in a timely manner or when material price concessions have to be made.

22
Q

Price Risk (affects investor)

A

Decline in value of individual securities or portfolios

*diversifiable

23
Q

Computation of Return = Yield

State Annual Interest Rate (SAR)

A

The rate of interest charged before any adjustments for compounding or market factors

24
Q

Effective Interest Rate (Periodic rate)

EF>SAR

A

Interest paid “per period” / NET proceeds of loan

Interest paid per period = (P * SAR)/ # periods

25
Q

Effective Interest Rate (definition)

A

the actual finance charge associated with a borrowing after reducing loan proceeds for charges and fees related to a loan origination

26
Q

Annual Percentage Rate (APR)

A

Effective (periodic rate) * # periods in year

27
Q

Effective Annualized Rate (EAR)

Raise

A

(1 + effective periodic rate)^ # of periods - 1

28
Q

Simple Interest (amount)

A

Total interest over life of loan = P * SAR * # years

29
Q

Compounded Interest (Amount)

A

P * (1 + Effective Periodic)^total #periods

Total #periods = #years * #periods per year

30
Q

Required Rate of Return

Lender’s required return = Borrower’s cost of borrowing

A

Step 1 = Nominal RF = Real RF + Expected rate of inflation

Step 2 = Nominal RF + Risk Premiums = Required Return

31
Q

2 ways to mitigate interest rate risk

  1. Floating rate debt securities
  2. Forward Rate Agreements (FRAs) / Interest swaps
A

If investor believes rates are going up

SWAP = Rec variable and pay fixed
or
Buy FRA = Rec variable & pay fixed

32
Q

Mitigating risk

1.
2.
3. Unsystematic risk
4. Credit risk
5. Default risk
6. Liquidity
7. Price
A
  1. 2.
  2. Diversification (uncorrelated or inversely correlated)
  3. Ratio analysis
  4. Higher rate charged or only lend to those with low risk of default
  5. allocate a greater percentage of capital to investments that trade on active markets
  6. Diversification or short selling
33
Q

Mitigating risk

  1. Market
  2. Unsystematic risk
  3. Credit risk
  4. Default risk
  5. Liquidity
  6. Price
A
  1. Diversification or short selling (hedge).
  2. Diversification (uncorrelated or inversely correlated)
  3. Ratio analysis
  4. Higher rate charged or only lend to those with low risk of default
  5. allocate a greater percentage of capital to investments that trade on active markets
  6. Diversification or short selling (hedge)
34
Q

2 factors influencing exchange rates

A
  1. Trade

2. Financial

35
Q

Trade Factor

  1. relative inflation rates
  2. Relative income levels
  3. Government controls (vs. freely fluctuating equilibrium)
  4. Relative interest rates and capital flows
A
  1. Currency with higher inflation loses value
    Thus demand for that currency value goes down
  2. As demand goes up value goes up
  3. government barriers or enhancements to artificially suppress or increase demand
  4. Currency with higher int. rate attracts investment thus demand and currency value goes up
36
Q

Risk Exposure Categories

A
  1. (Export) AR denominated in FC goes down resulting in AR loss
  2. (Import) AP denominated in FC goes up resulting in AP loss
37
Q

Transaction Exposure - G/L

A

Transaction exposure is defined as the potential that an organization could suffer economic loss or experience economic gain upon settlement of individual transactions as a result of changes in the exchange rates

38
Q

Transaction exposure is generally done in two steps

A
  1. Project currency inflows (AR) and foreign currency (AP) outflows - calculate “net” asset or liability
  2. Estimate the variability (risk)associated with the foreign currency
39
Q

Economic exposure

A

the potential that the present value of an organization’s cash flow could increase/decrease as a result of changes in the exchange rates

40
Q

Effect of Currency Appreciation

A

Thus FC going down

  1. AR down = PV cash inflow goes down (economic) = loss (transaction)
  2. AP down = PV cash outflow goes down (economic) = gain (transaction)
41
Q

Effect of Currency Depreciation

A

Thus FC goes up

  1. AR up = Cash inflow up = gain
  2. AP up = cash outflow up = loss
42
Q

Translation Exposure (foreign subs)

A

risk that assets, liabilities, equity, or income of a consolidated organization that includes foreign subsidiaries will change as a result of changes in exchange rates

43
Q

Break even point on

  1. Call option
  2. Put option
A
  1. X + cost (strike price plus cost)

2. X - cost (strike price minus cost)

44
Q

Explain how exchange rates effect gain/loss when the FC appreciates/depreciates in a FC transaction with Net inflows vs net outflows

1A) FC appreciates

1B) FC depreciates

A

1A) When FC appreciates the $ depreciates (FC buys more $ / $ buy less FC)

1B) when FC depreciates the $ appreciates (FC buys less $ / $ buy more FC)

  1. In situation 1A, if you have a net inflow of FC the FC will buy more $ resulting in gain whereas if you have a net outflow of FC you will have to spend more $ resulting in loss
    3) In situation 1B, if you have a net inflow of FC the FC will buy less $ resulting in loss whereas if you have a net outflow of FC you will spend less $ resulting in gain
45
Q

Currency with higher IR (Interest Rate) attracts investment and thus….

A

Demand goes up —> Value of the currency goes up

46
Q

Futures Contract (Hedge)

A
  • liquid investment (traded on the exchange)
  • entitles its holder to either purchase or sell a particular number of currency units of an identified currency for a negotiated price on a stated date
  • denominated in standardized amounts and mostly used for smaller transactions
47
Q

Accounts Payable application

Mitigate the risk that FC goes up and thus causes the liability to go up (loss)

A
  1. buy a call option
  2. buy futures contract

If FC goes up you can use the profit on the der. to offset the loss.

48
Q

AR application

Mitigate the risk that the FC goes down in value thus the asset goes down in value (loss)

A
  1. buy put options
  2. sell futures contracts

If FC goes down in value use profit on deriv. to offset loss.

49
Q

Forwards contract

A
  • customized
  • private
  • used in larger transactions

CPA Exam 2017 (1 decks)

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