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Flashcards in BEC NINJA II Deck (100):
1

A checkpoint/restart procedure is primarily designed to recover from:

A. programming errors.

B. data input errors.

C. computer operator errors.

D. hardware failures.

D. hardware failures.

The term “checkpoint-restart procedure” refers to the periodic copying of the results of a program prior to its actual completion (e.g., at 15 minute intervals). The copy is written to secondary storage for use in restarting a program, should there be an interruption in the operation of the hardware devices. Restart is initiated from the most current (recent) checkpoint, rather than at the beginning of the program.

2

Which of the following is not part of the control cycle approach to risk management?

A. Doing a profit test to determine whether a product provides a positive contribution margin

B. Developing the hedges necessary to mitigate interest rate risk

C. Determining, in both quantitative and qualitative terms, an understandable explanation of the differences between expected and actual results

D. Using the feedback loops in the modeling of expected results to update the assumptions and determine what adjustments in reserves might be necessary

B. Developing the hedges necessary to mitigate interest rate risk

Key elements of the control cycle approach to risk management include the following:

-Modeling the expected results using a set of initial assumptions
-Doing a profit test to determine if the product provides a contribution margin
-Measuring the actual results
-Determining, both in quantitative and qualitative terms, an understandable explanation of the differences between expected and actual results
-Determining what actions need to be taken with respect to the product, including possible adjustments to reserves
-Using the findings to strengthen the model and update the assumptions as needed with feedback from the process

3

Which of the following concepts can best be used to understand oligopoly behavior?

A. Concentration ratio

B. Interindustry competition

C. Game theory model

D. Herfindahl index

C. Game theory model

Answer A is incorrect because the concentration ratio measures the market share of the several largest firms in the industry. It doesn’t provide understanding of their behavior.

Answer B is incorrect because inter-industry competition is competition between difference markets, not within a market such as a oligopolistic market.

Answer C is correct because an oligopoly means few firms in the market, each relatively large. Game theory is a useful tool in choosing responses to actions of competitors in such a market.

Answer D is incorrect because this index is a measure of the size of firms in relation to the market, not a way to understand behavior of firms in such a market.

Game theory is mathematical models of conflict and cooperation between rational decision-makers.

Herfindahl index measures the size of firms in an industry and indicates the amount of competition in that industry.

4

Which of the following would not be a successful business strategy resulting from rebalancing due to the shifting balance of power in the international economy?

A. Promoting the same standards of quality throughout the world while maintaining the flexibility to tailor product attributes to the customs and traditions of local markets

B. Enhancing the use of R&D, integrating innovation, and devising new products at lower costs while developing a long-term customer focus

C. Attempting to identify clusters of similar customers across a broad base of international markets to allow building revenue and/or profit streams that would support ongoing capital investment

D. Engaging in specialized production for a significant number of local markets by constructing manufacturing facilities in several locations to ensure that products produced would meet local tastes and preferences

D. Engaging in specialized production for a significant number of local markets by constructing manufacturing facilities in several locations to ensure that products produced would meet local tastes and preferences

The high cost of information technology infrastructure and the need for highly skilled labor in the production process using many of the new technologies requires a market niche that caters to a large global market that requires the firm have the ability to provide mass customization and increased sensitivity to cultural diversity.

Success might take the form of developing clusters of similar customers across multiple domestic and/or international markets that would allow for building revenue and profit streams that would continue to support ongoing capital investment for continuing growth. Success might also come from building operations at local levels of an adequate scale in specific regions and territories by teaming up with very knowledgeable on-the-ground partners for product development, distribution, and market positioning.

5

Bank reserves would be decreased by:

A. an increase in Federal Reserve float.

B. a sale of government securities by the Federal Reserve.

C. a loan to member banks by the Federal Reserve.

D. a purchase of gold by the Federal Reserve.

B. a sale of government securities by the Federal Reserve.

Creation of Money

To understand the manner in which the Federal Reserve can impact the level of economic activity, the process by which financial intermediaries create money needs to first be understood.

a. Financial intermediaries take in deposits and make loans.
b. The Federal Reserve requires financial intermediaries to hold reserves against their deposits. This creates a fractional reserve system in that only a portion of the total money supply must be held as reserve deposits.
1. Reserves = Reserve deposits at the Fed and vault cash.
2. Required reserves = Required reserve ratio (r) × Checkable deposits.

Reserve deposits must be held on deposit with the Federal Reserve Bank or kept within the bank (known as vault cash).
c. Any reserves that the bank has that are more than their required reserves are defined as excess reserves.

Excess reserves = Reserves - Required reserves
d. When a bank makes a loan, it is assumed that the borrower will spend the money, and the funds will then be deposited elsewhere in the financial system.
e. Under these assumptions, a bank can make loans only if it has excess reserves. It is also true that the “banking system” can expand loan balances if, and only if, there are excess reserves somewhere in the banking system.
f. When a bank creates a loan, it generally gives the borrower a demand deposit. Thus, the bank “creates money” by creating an asset in the form of the loan and a liability (debt) in the form of a checkable deposit which is defined as part of the money supply.

6

A key rationale or cause for the changing pattern of investment in agriculture by sovereign wealth funds would be:

A. to create markets for the output of their farmers in the countries where they are investing by attaching conditions to the loans that require those nations to make specific commodity purchases.

B. to ensure food security in the event that crop shortages would cause export bans that might curtail their ability to import crops.

C. to ensure getting the products at lower prices in the event that crop shortages caused price spikes in commodity markets.

D. to support the countries in which they are investing to produce cash crops that can be used for domestic consumption to provide for a better level of food security for the emerging market economy in which the investment took place as part of United Nations efforts to improve world food security.

B. to ensure food security in the event that crop shortages would cause export bans that might curtail their ability to import crops.

A key driver of SWF (sovereign wealth fund) investment in agriculture is to ensure food security for their country in the event worldwide food shortages would curtail the availability of foodstuffs in traditional agricultural markets. Also, many emerging market economies are not well-suited for adequate agricultural production as they lack sufficient arable land and have an inadequate water supply. Thus, they outsource food production by purchasing and/or leasing land and growing the crops elsewhere in the world and having the output exported to the homeland.

Traditional investment in agriculture involved investment to support shifting production from staple crops to those that could be exported to world agricultural markets to earn a profit for the investing country.

7

A company manufactures goods in Esland for sale to consumers in Woostland. Currently, the economy of Esland is booming and imports are rising rapidly. Woostland is experiencing an economic recession, and its imports are declining. How will the Esland currency, $E, react with respect to the Woostland currency, $W?

A. The $E will remain constant with respect to the $W.
B. The $E will increase with respect to the $W.
C. The $E will decline with respect to the $W.
D. Changes in imports and exports will not affect currency changes.

C. The $E will decline with respect to the $W.

Exchange Rate Systems and Practices

a. The exchange rate is simply the price of one currency expressed in terms of another. For example, assume that the exchange rate between the dollar and the yen is expressed as $1 = 120 yen. This could also be expressed as 1 yen = $0.008333 ($1 ÷ 120).
b. Exchange rates are determined by the interaction of supply and demand for the various foreign currencies in foreign exchange markets. If the demand for a nation's currency increases, the price of the currency will appreciate. If a currency appreciates, it increases in value in terms of the other currencies. In this instance, if the yen were to appreciate, it would take fewer yen to buy a dollar. For example, as the yen appreciates, the exchange rate might fall to $1 = 110 yen. This would make Japanese exports more expensive for American consumers. If the supply of the nation's currency increases, the price of the currency will depreciate, or decline in value in terms of other currencies.
c. Exchange rate determinants include:
1. Changes in consumer tastes for the products of a particular country. If consumers wish to buy more products from a country, they will increase the demand for that country's currency.
2. Relative income changes. If, for example, disposable income rises more rapidly in Europe than in the United States, all other things being equal, Europeans will demand more American goods. The demand for dollars will increase, and the supply of Euros that will be required to purchase the additional dollars will increase.
3. Relative interest rates. Suppose that real interest rates rise in the United States while they stay constant in Europe. Europeans will find the U.S. a more attractive place to make financial investments in fixed-income securities and will increase the supply of Euros.
d. Over time flexible exchange rates will adjust and eliminate balance-of-payments surpluses or deficits between two nations. Disadvantages of flexible exchange rate systems include:
1. A flexible exchange rate produces uncertainty in the future price of a foreign currency and reduces the amount of trade.
2. If a country's currency strengthens, it will need to export fewer goods and services to get a specific level of imports from another country. Thus, in this instance, it would be said that the country's terms-of-trade has improved.


Exchange Rate Determinants

a. Changes in demand and/or supply of the currency—As the demand for a currency increases, the exchange rate will also increase. As the supply of a currency increases, the exchange rates will decrease.
b. Changes in consumer tastes—If consumers desire a foreign product, the demand for that product and the resulting increase in demand for the foreign currency will affect exchange rates.
c. Relative income changes—As incomes rise, the demand for imports increases, thus having an effect on exchange rates.
d. Relative price changes—As prices decrease for a particular foreign product relative to domestic prices, the demand for that product will increase, thus having an effect on exchange rates.
e. Relative interest rates—As interest rates increase in a given country, interest in investing in securities in that country rises. As investing activities increase, the supply and demand for those currencies are affected as well as the exchange rates.
f. Relative inflation rates—Changes in inflation can have an effect on international trade activity. The changes in this activity will in turn influence the supply and demand for various currencies, resulting in changes in exchange rates.
g. Government controls—Governments can influence exchange rates by imposing exchange and trade barriers, buying and selling securities in foreign exchange markets, and changing interest rates in their home country.

8

The determination of gross domestic product by the expenditure approach would include:

A. net exports.

B. business profits.

C. compensation to employees.

D. a capital consumption allowance.

A. net exports.

The “expenditure approach” to GDP determination includes personal consumption expenditures (C), gross private domestic investment (Ig), government purchases of goods and services (G), and exports minus imports or net exports (Xn). GDP = C + Ig + G + Xn

Thus, the equation for GDP includes net exports.

Business profits, compensation to employees, and capital consumption allowance (depreciation) are all variables used in the “Income Approach” to GDP determination.

INCOME APPROACH:

The income approach is the method of measuring the market value of all output by adding up the factor payments and claims on the value of all final output, to yield gross national product. It is a method of national income accounting and is used to compute net national income. Income approach analogous to the Expenditure Approach. It is a macroeconomic concept.


GNP = Factor Payments + Other Claims on the Value of Output
= Wages + Rent + Interest + Profits + Capital Consumption Allowance+ Indirect Taxes, Net of Subsidies

9

Primary benefits of globalization for companies would include all of the following except:

A. the growing ability to capture the benefits of global labor arbitrage created as new technologies have allowed production to be shifted geographically to take advantage of low-cost labor.
B. the increased demand for raw materials and infrastructure development that has dramatically increased the demand for many nonrenewable resources.
C. increasing capital flows that transfer savings from countries where the marginal product of capital is low to those where it is high, resulting in increasing world output.
D. the recipients of foreign direct investment now having access to new research, technology, and skills.

B. the increased demand for raw materials and infrastructure development that has dramatically increased the demand for many nonrenewable resources.

The increased demand for products and infrastructure development in the emerging economics has been a mixed blessing in the sense that companies that engage in providing nonrenewable resources have benefited. However, the users of these resources have seen significant increases in their cost of materials that has eroded company profit margins.

Globalization has allowed for new technologies to be effectively utilized in areas where low-cost labor is available; allowed for foreign direct investment to bring new technology and labor market skills to underdeveloped areas; and caused capital to flow to areas where its marginal product is higher, resulting in increased world output.

10

In the modern world economy, balance-of-payments deficits and surpluses can be eliminated:

A. through the market mechanism of flexible exchange rates.

B. if all nations adopt tight monetary policies.

C. when the opportunity costs of production are made the same in all countries.

D. if nations trade inputs instead of outputs.

A. through the market mechanism of flexible exchange rates.

Flexible exchange rates automatically adjust so as to eliminate balance of payments surpluses and deficits. In the case of a deficit, the supply of the home currency and demand for the foreign currency increase. This causes the home currency to depreciate against the foreign currency. Hence the home country's goods become cheaper relative to foreign goods and the country's exports increase and imports decrease, eventually eliminating the deficit.


The exchange rate is the price of one currency in terms of another currency. It is the price of one currency at which another currency, or claims on it, can be bought and sold. Exchange rate is the value of one currency in another currency and can be expressed in both directions: if 2 units of currency A must be traded for 1 unit of currency B, the exchange rate for currency A (in relation to currency B) is 2 and the rate for B in terms of A is 0.5. Exchange rates are a macroeconomic concept.

Factors that affect exchange rates include:

changes in taste (i.e., demand for each nation's goods),
changes in relative income,
changes in relative prices (determined by the respective inflation rates of each nation),
changes in real interest rates, and
speculation.



Interest Rates Differ

a. There is risk that the borrower will not repay the loan in a timely fashion. The greater the likelihood that the borrower will default on the loan, the higher the interest rates will be in order to compensate the lender for bearing that risk.
b. Interest rates tend to be higher for longer-term loans. Borrowers tend to like the certainty of a known fixed expense. Lenders are concerned about the possibility of an increase in their cost of funds over the period of the loan and charge a premium to compensate for this risk.
c. There are fixed and variable costs associated with making loans. There tend to be high administrative and processing costs associated with making loans. The costs tend to be higher per dollar loaned for smaller loans and for loans that require more frequent payments. This causes interest rates on smaller loans to be higher than on larger loans, and interest rates on short-term loans to be higher than on longer-term loans.

11

Which of the following scenarios would encourage a company to use short-term loans to retire its 10-year bonds that have five years until maturity?

A. The company expects interest rates to increase over the next five years.

B. Interest rates have increased over the last five years.

C. Interest rates have declined over the last five years.

D. The company is experiencing cash flow problems.

C. Interest rates have declined over the last five years.

If interest rates have declined, refunding with short-term debt may be appropriate. The bonds pay a higher interest rate than the new short-term debt. Assuming that rates continue to fall, the short-term debt can itself be refunded with debt having a still lower interest charge. The obvious risk is that interest rates may rise, thereby compelling the company to choose between paying off the debt or refunding it at higher rates.

12

Consider a world consisting of only two countries, Canada and Italy. Inflation in Canada in one year was 5%, and in Italy 10%. Which one of the following statements about the Canadian exchange rate (rounded) during that year will be true?

A. The Canadian dollar will appreciate by 5%.

B. The Canadian dollar will depreciate by 5%.

C. The Canadian dollar will depreciate by 15%.

D. The Canadian dollar will appreciate by 15%.

A. The Canadian dollar will appreciate by 5%.

The factors which affect exchange rates are changes in tastes (demand for each other's goods), changes in relative income, changes in relative prices (determined by respective inflation rates), speculation, and changes in real interest rates. In this case, there is a change in relative prices, as the two countries have differing inflation rates. If inflation is higher in Italy, Canadian goods will become relatively cheaper and Italian demand for Canadian goods will rise. This increases demand for the Canadian dollar and supply of the Italian lira, causing the Canadian dollar to appreciate and the Italian lira to depreciate. The difference in inflation rates is 5% (Italy's 10% minus Canada's 5%), so the Canadian dollar appreciates by 5%.

Forecasting Techniques

The fact that firms must make decisions that can be impacted by exchange rate movements suggests that they either explicitly or implicitly make forecasts about exchange rate movements in the decision-making process. If the firm engages in explicit forecasts, the basic techniques for forecasting include:

a. Technical forecasting involves the use of historical exchange rate data to predict future values. This type of forecasting is generally limited to forecasting the near future, which is often not effective for developing corporate policies. This type of forecasting is generally more relevant for speculators who are concerned with day-to-day exchange rate movements.
b. Fundamental forecasting is based on the presumed relationship between exchange rates and economic variables. This forecasting methodology is subject to a series of limitations, including:
1. The precise timing of the relationships predicted by the regression model cannot be determined.
2. Some of the data for which relationships have been determined cannot be obtained in a timely manner so that it would be usable for current forecasts.
3. The probability of many events that have an impact cannot be readily quantified.
4. Regression coefficients that are obtained from the forecasting model are often not constant over time.
c. Market-based forecasting starts from the premise that financial markets provide an unbiased estimate of future events, and uses either the spot rate or the forward rate.
1. Illustration: For example, if the current spot rate shows that the Japanese yen is expected to appreciate against the dollar in the very near future, this should encourage speculators to buy the yen with U.S. dollars today in anticipation of its appreciation. These purchases would tend to drive the yen's value up at once, and therefore, the current value of the yen should reflect its expected value in the very near term.
2. The forward rate that is quoted for a specific date in the future is commonly used as a proxy for the forecasted future spot rate on that date. An example would be as follows: if speculators expect the spot rate on the Japanese yen in 60 days to be $1 = 122 yen and the 60-day forward rate is $1 = 119 yen, they might simply buy yen 60-days forward at $1 = 119 yen, and then sell them when they are received at the spot rate. If this is the common speculator strategy, then the forward purchases of yen will cause the forward rate to increase until the speculative demand runs its course. Thus, the forward rate reflects the market's expectations of the spot rate at the end of the period. To the degree that the forward rate is shown to be an unbiased estimate of the future spot rate, then corporations can monitor the forward rate as they develop their exchange rate expectations. Arbitrage activity would tend to eliminate any differential.


Done

13

A company obtained a short-term bank loan of $250,000 at an annual interest rate of 6%. As a condition of the loan, the company is required to maintain a compensating balance of $50,000 in its checking account. The company's checking account earns interest at an annual rate of 2%. Ordinarily, the company maintains a balance of $25,000 in its checking account for transaction purposes. What is the effective interest rate of the loan?

A. 6.00%

B. 6.44%

C. 6.66%

D. 7.11%

B. 6.44%

If a firm borrows $250,000 but is required to maintain $50,000 as a minimum compensating balance, then the firm only has use of $200,000, but is paying 6% interest on the entire $250,000. To determine the effective interest rate, the interest in dollars ($250,000 × 6%, or $15,000) should be divided by the amount of the loan available to the borrower, the effective loan amount, which is only $200,000. However, there are two issues that further complicate this problem. This company ordinarily maintains a $25,000 balance in its checking account. Therefore, the company will only be out $25,000 ($50,000 - $25,000). This means the effective loan amount is $225,000 ($250,000 - $25,000), not $250,000. Also, the company earns checking account interest which partially offsets the loan interest. The applicable amount on which to determine interest is only the part that pertains to this borrowing, the additional $25,000. The interest on this is $500 (2% × $25,000). The effective interest dollar amount for this borrowing is $14,500 ($15,000 - $500). The effective interest rate is now calculated as:

$14,500 ÷ $225,000 = .0644, or 6.44% effective interest rate

14

One of the measures economists and economic policy makers use to gauge a nation's economic growth is to calculate the change in the:

A. money supply.

B. total wages.

C. general price level.

D. real per capita output.

D. real per capita output.

A nation's economic growth is measured by gauging changes in the production of physical output per capita. Output indices such as the Federal Reserve Board's Index of Industrial Production are used in quantifying the amount of the change. Money supply, total wages, and general price levels are not good growth indicators because of their sensitivity to inflation and other factors.

15

Which of the following set of economic variables or factors would not be characteristic of emerging market economies?

A. Low-cost labor and high savings rates

B. Large currency reserves and high investment in infrastructure

C. High debt-to-GDP (gross domestic product) ratios and decreasing trade among and between emerging market countries

D. Significant growth in the number of middle-class consumers and improving supply-chain effectiveness

C. High debt-to-GDP (gross domestic product) ratios and decreasing trade among and between emerging market countries

Some of the key characteristics of emerging market economies include low debt-to-GDP ratios, a significant increase in trade among and between emerging market economies, low-cost labor, high savings rates, large currency reserves, and high investment in infrastructure.

In addition, most emerging market economies are experiencing rapid growth in the number of middle-class consumers while many are improving supply-chain linkages in an attempt to capture more of value-added costs during the production process.

16

Globalization is a process by which nations of the world become integrated through global networks of communication. Its current success is tied to a number of socioeconomic effects, with one of the key effects being:

A. an understanding that the success of the emerging economies is more than simply the cost advantage they have due to having relatively low-cost labor.

B. the relatively large labor force in emerging markets and declining birth rates that have historically been associated with dynamic positive economic change.

C. an undervalued currency in emerging economies that would stimulate exports and strong investment in infrastructure.

D. the fact that innovation blowbacks as the low-priced, high-quality products developed for the emerging economics now will be effectively marketed and sold in the developed world.

B. the relatively large labor force in emerging markets and declining birth rates that have historically been associated with dynamic positive economic change.

ocioeconomic effects are the social and economic experiences and realities that help mold one's personality, attitudes, and lifestyle. Declining birth rates reduce the dependency ratio, and the large labor force tends to keep wages low as economic activity expands. Most of the world's currently developed economies were in this phase of the demographic cycle when they began their economic expansion.

The dependency ratio is arbitrarily defined as the ratio of the elderly (those 65 years and over) plus the young (those under 15 years of age) to the population in the “working ages” (those 15–64 years of age).

Innovation blowback is the idea that countries from developed markets that attempt to sell in emerging markets may in fact find themselves under attack in their home markets by companies who are more aggressive in realizing the potential for innovation in emerging markets.

17

All of the following are characteristics of the strategic planning process except the:

A. emphasis on both the short and long run.

B. analysis of external economic factors.

C. review of the attributes and behavior of the organization's competition.

D. analysis and review of departmental budgets.

D. analysis and review of departmental budgets.

Strategic planning focuses on goals and objectives of the overall organization and is long-run in nature, covering 3 to 10 years normally. All of the characteristics listed relate to strategic planning except analysis and review of operating budgets, which is more closely identified with short-term operational planning, more like 1–3 years. This is not related to financial accounting that defines everything short-term as less than one year.

18

The economic order quantity formula assumes that:

A. purchase costs per unit differ due to quantity discounts.

B. costs of placing an order vary with quantity ordered.

C. periodic demand for the good is known.

D. erratic usage rates are cushioned by safety stocks.

C. periodic demand for the good is known.

Economic order quantity seeks to identify an optimum order quantity by equating order cost with carrying cost. In order to do this, the following values must be known or assumed:

Cost of placing an order
Cost of carrying inventory
Periodic demand for product

19

A company has a 10% cost of borrowing and incurs fixed costs of $500 for obtaining a loan. It has stable, predictable cash flows and the estimated total amount of net new cash needed for transactions for the year is $175,000. The company does not hold safety stocks of cash.

If the average cash balance for the company during the year is $20,916.50, then the opportunity cost of holding cash for the year will be:

A. $2,091.65.

B. $4,183.30.

C. $8,750.00.

D. $17,500.00.

A. $2,091.65.

The opportunity cost of holding cash balances for the year is calculated as the average cash balance multiplied by the opportunity cost percentage. In this case, the opportunity cost of holding cash balances is best indicated by the cost of borrowing money since this is the only interest rate given in the problem.


Opportunity cost = Average cash balance x Opportunity cost percentage
= 20,916.50 x .10 = 2,091.65

Opportunity cost is a central concept of economics. It is the cost of a foregone alternative, the result of scarcity and choice. Whenever a choice is made to use scarce resources in one way, other uses are “foregone”; opportunity cost is the benefit given up by not using resources in the alternative way. In a choice between “this” and “that,” the opportunity cost is the cost of giving up “this” to get another unit of “that.” Opportunity cost may be thought of as the commodities that could have been obtained instead of the ones actually chosen. It is a microeconomic concept.

Opportunity cost is the foregone return from alternative choices that are not selected. It is the maximum alternative contribution that might have been obtained if resources had been applied to an alternative use, but which was foregone by using limited resources in a particular different way. It is the foregone contribution from rejecting the next best alternative.

20

The coefficient of determination, r squared, in a multiple regression equation is the:

A. percentage of variation in the independent variables explained by the variation in the dependent variable.

B. percentage of variation in the dependent variable explained by the variation in the independent variables.

C. measure of the proximity of actual data points to the estimated data points.

D. coefficient of the independent variable divided by the standard error of regression coefficient.

B. percentage of variation in the dependent variable explained by the variation in the independent variables.

The coefficient of determination is a ratio that indicates the proportion of variance in the dependent variable determined by the independent variable using the regression equation.

Coefficient of Determination (R2): A ratio that indicates the proportion of variance in the dependent variable that is statistically explained (determined) by the independent variable using the regression equation. The total variation of the dependent variable y from its mean can be divided into the part explained by the regression equation and the part that is not explained, but is produced by chance. The values range from 0 (no explanation) to 1 (all explained). It can also be expressed as a percentage, as in “x explains 70% of the variation in y.”

21

Which of the following is assigned to goods that were either purchased or manufactured for resale?

A. Relevant cost

B. Period cost

C. Opportunity cost

D. Product cost

D. Product cost

Product costs are “attached” or assigned to units produced in a manufacturing process. Product costs are direct materials, direct labor, and manufacturing overhead.

Relevant costs are those expected to differ among alternative future courses of action. They are also known as incremental costs or differential costs.
Period costs are not associated with the manufacturing process. They are expensed in the period incurred. Period costs are selling, general, or administrative expenses.
Opportunity costs are those revenues that will be lost if one action is chosen over another.

Product cost is costs associated with the manufacturing process that are capitalized in inventory; generally, they are the costs that add value to the units produced. Costs are accounted for as if they are “absorbed” by the units and stay with them through work-in-process and finished goods inventory (as the value of the units in inventory) and into cost of goods sold when the unit is sold. Product cost includes Direct labor + Direct materials + Manufacturing overhead.

22

The standard direct labor cost to produce one pound of output for a company is presented below. Related data regarding the planned and actual production activities for the current month for the company are also given below.

(Note: DLH = Direct Labor Hours)


Direct Labor Standard:
.40 DLH at $12.00 per DLH = $4.80
Planned production 15,000 pounds
Actual production 15,500 pounds
Actual direct labor costs (6,250 DLH) $75,250
The company's direct labor efficiency variance for the current month would be:

A. $600 unfavorable.

B. $602 unfavorable.

C. $2,400 unfavorable.

D. $3,000 unfavorable.

A. $600 unfavorable.

$600 unfavorable derives from the difference between the direct labor hours allowed for the output achieved (15,500 × .4 = 6,200) and the actual hours worked (6,250) times the standard direct labor rate ($12.00). Calculation: ((6,200 - 6,250) × $12).

$602 unfavorable derives from the difference between the direct labor hours allowed for the output achieved (15,500 × .4 = 6,200) and the actual hours worked (6,250) times the actual direct labor rate ($75,250 ÷ 6,250 = $12.04). Calculation: ((6,200 - 6,250) × $12.04).
$2,400 unfavorable derives from the difference between the direct labor hours allowed for the planned production (15,000 × .4 = 6,000) and the direct labor hours allowed for the output achieved (15,500 × .4 = 6,200) times the standard direct labor rate ($12.00). Calculation: ((6,000 - 6,200) × $12).
$3,000 unfavorable derives from the difference between the direct labor hours allowed for the planned production (15,000 × .4 = 6,000) and the actual hours worked (6,250) times the standard direct labor rate ($12.00). Calculation: ((6,000 - 6,250) × $12).

23

Everything else being equal, the internal rate of return (IRR) of an investment project will be lower if:

A. the investment cost is lower.

B. cash inflows are received later in the life of the project.

C. cash inflows are larger.

D. the project has a shorter payback period.

B. cash inflows are received later in the life of the project.

Later cash inflows have a lower present value than earlier cash inflows, since the present value of a dollar is higher the sooner it is received. Projects with later cash flows will have lower net present values, for any given discount rate, than will projects with earlier cash flows, everything else being equal. Hence, projects with later cash flows will have a lower internal rate of return (IRR).

The IRR is the discount rate that sets the net present value (NPV) of a project equal to zero. NPV is calculated as follows: NPV = Present value of cash inflows - Investment cost. If the discount rate is higher, the present value of the cash inflows is lower. If the investment cost is lower, then a higher discount rate will be required to set the net present value to zero.
The larger the cash inflows, the higher the IRR.
Projects with shorter payback periods have higher cash inflows early in the life of the project, which means a higher IRR.

24

Based on potential sales of 500 units per year, a new product has estimated traceable costs of $990,000. What is the target price per unit to obtain a 15% profit margin on sales using the traditional markup calculation?

A. $2,329

B. $2,277

C. $1,980

D. $1,935

traceable costs per unit = $990,000 / 500 = $1,980


This $1,980 represents 85% (i.e., 100% - 15%) of the target price.


Target price per unit = $1,980 / .85 = $2,329.41

25

Which of the following is a disadvantage of participative budgeting?

A. It is more time consuming.

B. It decreases motivation.

C. It decreases acceptance.

D. It is less accurate.

A. It is more time consuming.

Participative budgeting is a bottom-up budgeting process where budgets are developed after lower-level managers have provided input in the development of the numbers. The thought is that lower-level managers will feel an ownership of the budget if they have had a hand in developing the budget, and this ownership is hoped to lead to a greater motivation and goal congruence. Some of the disadvantages are the fact that the numbers provided by the lower-level managers often contain budgetary slack, leading to negative motivation and the fact that it is more time consuming to involve additional people in the budgeting process.

Participative budgeting is a budgeting process that has key employees in various departments providing input into the budgetary process. This process is considered to be motivational since people who participate in this budgetary process are often considered to be more motivated to obtain budget goals that they helped set.

A budget is a plan of action expressed in dollars. It is a formal quantitative expression of the plans of the enterprise—a plan for the coordination of revenues and expenditures or the amount of money that is available for, required for, or assigned to a particular purpose. A budget is a method of providing control and evaluating performance. It is an expression of policy and financial intent of a governmental entity. In governmental funds, the budget is formally integrated in the records using memorandum accounts called “budgetary accounts.”

GASB 1700

Budgets are also used as an internal planning tool in private not-for-profit and for-profit organizations, and are usually thought to be an expression of the organization's strategic plan in monetary terms. Such budgets are not integrated into the formal accounting records as is done in the governmental sector.

A complete budget is called the master budget. A master budget is composed of smaller budgets, including:

operating budget (budgeted income statement),
sales budget (sales forecast),
production budget,
direct materials budget,
direct labor budget,
direct overhead budget,
cost of goods sold budget,
selling and administrative expense budget,
financial budget,
cash forecast (cash receipts and disbursements),
budgeted balance sheet,
special budgets,
performance budgets,
capital budgets,
pro forma financial statements,
pro forma statement of activities,
pro forma statement of financial position, and
pro forma statement of cash flows.

26

In using regression analysis, which measure indicates the extent to which a change in the independent variable explains a change in the dependent variable?

A. p-value

B. r-squared

C. Standard error

D. t-statistic

B. r-squared

The coefficient of determination (r2) is a ratio that indicates the proportion of variance in the dependent variable determineCoefficient of Determination (R2): A ratio that indicates the proportion of variance in the dependent variable that is statistically explained (determined) by the independent variable using the regression equation. The total variation of the dependent variable y from its mean can be divided into the part explained by the regression equation and the part that is not explained, but is produced by chance. The values range from 0 (no explanation) to 1 (all explained). It can also be expressed as a percentage, as in “x explains 70% of the variation in y.”d by the independent variable using the regression equation.

27

A static budget contains which of the following amounts?

A. Actual costs for actual output

B. Actual costs for budgeted output

C. Budgeted costs for actual output

D. Budgeted costs for budgeted output

D. Budgeted costs for budgeted output

A static budget is set for one anticipated volume. It is not adjusted to the actual output attained. Therefore, it represents the budgeted costs of the budgeted output. A flexible budget is adjusted to the actual output .“Actual costs for actual output” and “actual costs for budgeted output” are wrong because budgets contain budgeted costs rather than actual costs.

A static budget is prepared for a single target level of activity. A static budget does not change, although actual or possible levels of activity might vary. Static budgets are often very detailed; master budgets are usually prepared as static budgets. A static budget contrasts with a Flexible Budget. While flexible budgets are easily modified for different activity levels, they usually do not present as much detail as a static budget. Flexible budgets may be prepared retroactively for actual levels of activity achieved or prospectively for possible potential levels of activity.

A flexible budget is a budget prepared for several possible levels of production or adjusted for the level of production actually achieved. It is also referred to as an incremental budget.

28

Black Co.'s breakeven sales were $780,000. Variable expenses averaged 60% of sales, and the margin of safety was $130,000. What was Black's contribution margin?

A. $364,000

B. $546,000

C. $910,000

D. $1,300,000

C. $910,000

Margin of safety is sales above the breakeven sales, so sales were $910,000 (breakeven sales of $780,000 plus the margin of safety of $130,000). Since variable expenses were 60% of sales, the variable expenses were $546,000 ($910,000 × 0.60). Contribution margin equals sales ($910,000) less variable expenses ($546,000), or $364,000.

Since contribution margin is sales minus variable costs, this answer could also be calculated as the remaining 40% of the $910,000 in sales.

VP Analysis/Margin of Safety

a. In the context of capital budgeting, Cost/Volume/Profit analysis (CVP) is often used to determine the margin of safety for a project. In other words, how much could projected sales fall and still not fall below the breakeven point?
b. The CVP formula:
• Profit = Sales - Variable costs - Fixed costs
• Sales = Number of units sold times sales price per unit
• Variable costs = Number of units sold times variable costs per unit
• Fixed costs = Total fixed costs for anticipated range


The breakeven point is a special case of CVP analysis where the profit equals zero. In other words, sales revenue equals total costs.

Illustration: Product A sells for $5 per unit. Variable production costs are $3 per unit and fixed costs per period are $50,000. What will the profit be if 100,000 units are produced and sold? What is the breakeven point?
Solution:

Profit = Sales - Variable costs - Fixed costs
= ($5 x 100,000) - ($3 x 100,000) - $50,000
= $150,000

Breakeven in units:

0 = $5x - $3x - $50,000
x = 25,000 units
c. Margin of safety is the excess sales over the breakeven sales point. This can be important when looking at projects with projected sales. The methods used to evaluate capital budgeting decisions use projected sales (savings). If, however, the projections are incorrect, then there could be significant changes in the calculations of the payback period, NPV, and IRR. When evaluating a project, the likelihood that the sales/production projected will be achieved needs to assessed.

Illustration: Using the above illustration, calculate the margin of safety:
Margin of safety = 100,000 projected units - 25,000 breakeven units
= 75,000 units

This could also be expressed in term of dollars. The margin of safety for sales is $375,000 ($5 per unit × 75,000 units). In this case, sales could fall significantly (by 75%), and there would still be a profit.


29

Which of the following options lists the correct sequence for preparing budgets?

A. Cost of goods sold budget, sales budget, budgeted income statement, budgeted balance sheet

B. Material purchases budget, production budget, cost of goods sold budget, cash receipts budget

C. Sales budget, production budget, budgeted balance sheet, budgeted income statement

D. Production budget, material purchases budget, budgeted income statement, budgeted balance sheet

D. Production budget, material purchases budget, budgeted income statement, budgeted balance sheet

Answer A is incorrect because you can’t determine the cost of goods sold until you know your budgeted sales level.

Answer B is incorrect because you can’t determine your material purchases until you know your expected production.

Answer C is incorrect because your budgeted income statement amounts are combined with the prior balance sheet to give the budgeted balance sheet.

Answer D is correct because you can’t budget material purchases until you know the expected production. Once you have the production and material purchases budget you can prepare the budgeted income statement, which leads to the budgeted balance sheet.

The following steps summarize the preparation of a master budget:

a. Develop a sales forecast. A sales forecast is the starting point for most companies because sales is the limiting factor. Expected sales are based on sales of prior years and the firm's percentage of the market adjusted for expected changes in economic conditions.
b. Determine the desired level of finished goods inventory.
c. Determine the amount of finished goods that must be produced or purchased. This is done by adjusting sales for a net increase (decrease) in the finished goods inventory (Production = Sales - Beginning inventory + Ending inventory).
d. Prepare a purchases or production budget. If the units are produced, the manufacturing costs (including direct material, direct labor, and overhead) required to produce the desired number of units are summarized in a statement of cost of goods manufactured. When a standard cost system is used, the standard costs per unit are used.
e. Estimate selling, administrative, and other general expenses.
f. Organize the preceding information into an income statement.
g. Prepare a cash forecast. This is usually done on a month-to-month or quarter-to-quarter basis to highlight cash flows and pinpoint times during the year when additional financing is required. For each month or quarter, a forecast is developed showing the beginning balance, plus the expected cash receipts, less expected cash disbursements for an ending balance. The company's experience in collecting cash from sales and collecting payments on accounts receivable and the company's policy regarding paying expenses and paying accounts payable are critical in developing accurate cash forecasts. Accountants need to anticipate that companies often deal with different collection and payment schedules, based on different arrangements for each account.
h. Organize the preceding information into a balance sheet and statement of cash flows.

30

How many levels of interdependence are included in integrated planning?

A. Three levels

B. One level

C. Five levels

D. Ten levels

A. Three levels

There are three levels of interdependence in integrated planning:

Pooled
Sequential
Reciprocal

Interdependence is the level to which work groups are organized. There are three levels of interdependence to take into consideration:

a. Pooled interdependence: There is a common source of resource, but no interrelationship between the work groups.
b. Sequential Interdependence: The work groups coordinate the flow of information, tasks, or resources from one group to another.
c. Reciprocal Interdependence: Information, tasks, and resources are passed back and forth between the groups.

31

A company manufactures a product using one material per unit. The following information for the upcoming budget year is available:

Number of units sold 14,500
Budgeted beginning finished goods inventory units 1,500
Budgeted ending finished goods inventory units 3,000
Budgeted beginning direct materials inventory units 2,000
Budgeted ending direct materials inventory units 1,500
Direct manufacturing material cost per unit $5
What amount is the total direct materials purchasing budget?

A. $67,500

B. $72,500

C. $77,500

D. $80,000

C. $77,500

The company would produce 16,000 finished units, 14,500 to sell and 1,500 more to increase the finished goods inventory from 1,500 to 3,000 units. They would have to purchase 16,000 units of material, except that the raw material inventory declines by 500 units, from 2,000 units to 1,500 units therefore they will only purchase 15,500 units. At a cost of $5 per unit the 15,500 units will cost $77,500.

32

Asta, Inc., is a medical laboratory that performs tests for physicians. Asta anticipates performing between 5,000 and 12,000 tests during the month of April. Compared to industry averages, at the low range of activity Asta has a lower sales price per test, higher fixed costs, and the same breakeven point in number of tests performed. At the high range of activity, Asta’s sales price per test and fixed costs are the same as industry averages, and Asta’s variable costs are lower. At the low range of activity (0 to 4,999 tests performed) fixed costs are $160,000. At the high range of activity (5,000 to 14,999 tests performed) fixed costs are $200,000.

Sales price per test $60
Variable costs per test 20

Are Asta’s contribution margin and variable costs greater or lower than the industry average at the low activity range?

A. Contribution margin, greater; Variable costs, greater

B. Contribution margin, greater; Variable costs, lower

C. Contribution margin, lower; Variable costs, greater

D. Contribution margin, lower; Variable costs, lower

B. Contribution margin, greater; Variable costs, lower

Compared to industry averages, at the low range of activity Asta has a lower sales price per test, higher fixed costs, and the same breakeven point in number of tests performed.

If Asta has the same breakeven point as the averages but with higher fixed costs, it must have a greater contribution margin per unit to cover those higher fixed costs.

If Asta has the same breakeven point as the averages but with a lower sales price per test, it must have lower variable costs to generate that higher contribution margin to cover the higher fixed costs.

33

Typical product-costing systems synchronize the recording of accounting-system entries with the physical sequence of purchases and production. The alternative of delaying journal entries until after the physical sequences have occurred (which is normally used in high-speed automated environments) is referred to as:

A. backflush costing.

B. direct costing.

C. operation costing.

D. process costing.

A. backflush costing.

The alternative (which is normally used in high-speed automated environments) of delaying journal entries until after the physical sequences have occurred is referred to as backflush costing.

Direct costing is an inappropriate response because direct or variable costing is a method of inventory costing in which all variable product costs are treated as inventoriable costs and fixed manufacturing overhead is treated as a period cost.
Operation costing is an inappropriate response because operation costing refers to a hybrid costing system that blends characteristics of both job-order and process-costing systems. Operation costing is usually applied to batches of similar products where each batch of product is a variation of a single design and requires a sequence of selected operations/activities. An operation costing system would track work-in-process inventory.
Process costing is an inappropriate response because process costing is a sequential costing system in which the cost of a product/service is obtained by assigning costs to masses of similar units as they are produced and then computing unit costs on an average basis. There would be a tracking of work-in-process inventory with a process costing system.

34

A standard cost system may be used in:

A. neither process costing nor job order costing.

B. process costing but not job order costing.

C. either job order costing or process costing.

D. job order costing but not process costing.

C. either job order costing or process costing.

Standard cost is a predetermined quantity or cost of inputs (direct material, direct labor, and manufacturing overhead) that should be required to produce one unit of output. It is the per-unit planned amount; the target, quantity, or cost that should be needed. It serves as the basis for budgeting and control (feedback) and serves as the plan against which actual results are compared.

Standard cost is used with both job order costing and process costing.

35

Probability (risk) analysis is:

A. used only for situations involving five or fewer possible outcomes.

B. used only for situations in which the summation of probability weights is greater than one.

C. an extension of sensitivity analysis.

D. incompatible with sensitivity analysis.

C. an extension of sensitivity analysis.

Sensitivity analysis determines how the results will change if the original data or the underlying assumptions change. It is the process of identifying the data changes that alter optimal solutions and the decisions made based on that solution. Probability analysis combines the likelihood of various outcomes with sensitivity analysis.

Probability analysis can be used with an infinite number of outcomes, and 1.00 is the largest possible probability. It is helpful to combine probability analysis with sensitivity analysis to evaluate the sensitivity of various outcomes to risk.

Not all capital budgeting projects will have the same level of risk to the company. For example, replacing a machine is not the same as entering a new market. Various methods are available to adjust for the levels of risk in different types of projects. The procedures include the following:

a. Different Discount Rates: establish different discount rates.
b. Shorten Payback Period: shorten the required payback period.
c. Reduce Cash Flows Estimate: reduce the estimated future cash flows.
d. Sensitivity Analysis: perform sensitivity analysis, which evaluates how outcomes are expected to vary with changes in assumptions. Sensitivity analysis should focus on areas having the greatest uncertainty and/or largest expected impact.
e. Probability Distributions: develop probability distributions for the future cash flows.
f. Certainty Equivalent: the certain amount that would be acceptable in lieu of the uncertain payoffs from the capital project. To compensate for risk, the certainty equivalent should be greater than the expected value of the capital budget payoffs.

36

A put is an option that gives its owner the right to do which of the following?

A. Sell a specific security at fixed conditions of price and time

B. Sell a specific security at a fixed price for an indefinite time period

C. Buy a specific security at fixed conditions of price and time

D. Buy a specific security at a fixed price for an indefinite time period

A. Sell a specific security at fixed conditions of price and time

Options are contracts that give the buyer the right (but not the obligation) to buy (if it is a call option) or sell (if it is a put option) an asset like shares of stock at a set price prior to a set expiration date.

The answer choices to buy or sell a specific security at a fixed price for an indefinite time period are incorrect because the time period of a put option is not indefinite. Buying a specific security at fixed conditions of price and time is incorrect because a put is an option to sell, not to buy. An option to buy is a call option.

Introduction to Interest Rates

a. Interest rate risk arises from differences between the timing of interest rate changes and the timing of cash flows (re-pricing risk); the risk that changes in interest rates will re-price interest-incurring liabilities differently from re-pricing the interest-earning assets, thus causing an asset-liability mismatch (basis risk); from changing rate relationship across the spectrum of maturities (yield curve risk); and from interest rate-related options embedded in a financial institution's products (option risk).
b. An evaluation of interest rate risk must consider the impact of complex, illiquid hedging strategies or products, and also the potential impact on fee income that is sensitive to changing interest rates.
c. Re-pricing risk is the most common form of interest rate risk and some firms make a bet on the typical upward-sloping nature of the yield curve and deliberately mismatch the portfolio by holding longer-duration assets when compared to liabilities in an attempt to enhance earnings.
d. Basis risk may be seen in the following example. A retail bank generally funds loans from customer deposits. Thus, since loan rates tend to adjust upward more rapidly than deposit rates, there is a tendency for interest margins to increase spontaneously when rates are rising. However, as rates stabilize, the improvement may disappear as deposit rates catch up, and then interest margins would fall when rates began to decline.
e. Yield curve risk arises from variations in interest rate moves along the yield curve, such as different changes for the 90-day T-bill and a 10-year Treasury bond. The yield curve flattens, steepens, or becomes inverted during an interest rate cycle. These types of changes tend to accentuate the possible impact of any asset-liability mismatches held by the firm.
f. Option risk arises from legal rights to engage in a future transaction at a predetermined price (puts and calls). The owner of a put option has the right, but not the obligation, to sell a given quantity of an underlying asset at a specified strike price during a specified period to the seller of the put if the option is exercised. These protect against the risk of a decline in market value of the underlying asset. For example, a farmer is concerned that the market price of a growing crop may decline before harvest. The farmer can buy a put option to guarantee a minimum price. If the price declines below that price the option is exercised and the crop sold for that minimum price. Of course, if after harvest the price is above the floor, the farmer has no obligation to sell the crop at the floor and will happily sell it for the higher market price. The owner of a call option has the right, but not the obligation, to buy a given quantity of an underlying asset from the seller of the option during a specified period for a specific strike price. The seller of the option is obliged to sell the underlying asset if the option is exercised. For example, an airline has sold a number of tickets for future flights assuming the cost of jet fuel stays constant, but a large increase in the cost of jet fuel would make those future flights uneconcomic. The airline can buy a call option on the price of jet fuel in the future, giving the airline the right to buy the fuel at a maximum price. If the price of fuel rises the airline will exercise the option, buying the fuel at the strike (maximum) price. If future jet fuel prices remain below the maximum price the airline is not obligated to buy the fuel at that strike price. Instead, the airline will buy the fuel at the lower market price, saving the difference in cost.

37

Information related to the economic activity for a country is given as follows with values stated in billions of dollars.


-- Gross domestic product (GDP) $4,000
-- Transfer payments 500
-- Corporate income taxes 50
-- Social Security contributions 200
-- Indirect business taxes 210
-- Personal income taxes 250
-- Undistributed corporate profits 25
-- Depreciation 500
-- Net income earned abroad for the country 0
National income is:

A. $3,500.

B. $3,290.

C. $3,515.

D. $3,265.

B. $3,290.

National income (NI) is defined as net domestic product (NDP), plus net income earned abroad, minus indirect business taxes (e.g., sales taxes). NDP is gross domestic product ($4,000) minus depreciation ($500), or $3,500. Thus, national income is $3,290 ($3,500 NDP + $0 net income earned abroad - $210 indirect business taxes).


Net domestic product $3,500
Net income earned abroad 0
Indirect business taxes (210)
------
National income $3,290
======

$3,500 is the NDP. Recall that NDP = Gross domestic product (GDP) - depreciation.
$3,515 equals personal income (PI). Recall that PI = NI - corporate income taxes and undistributed profits - Social Security contributions + transfer payments (public and private). PI = NI ($3,290) - corporate income taxes ($50) - undistributed corporate profits ($25) - Social Security contributions ($200) + transfer payments ($500) = $3,515.
$3,265 equals disposable income (DI). Recall that DU = PI - personal income taxes. DI = PI ($3,515) - personal income taxes ($250) = $3,265.

38

Debt-servicing problems of less developed countries that primarily sell raw materials to the United States would be eased by:

A. a recession in the United States with declines in interest rates.

B. an expanding United States economy with stable money supply growth.

C. an expansion of the lending authority of the World Bank.

D. a significant increase in the level of U.S. tariffs.

B. an expanding United States economy with stable money supply growth.

An expanding United States economy with stable money supply growth would maintain a steady demand for raw materials of less developed countries. The moneys earned from the sale of raw materials will aid in servicing the debt of less developed nations.

Money supply is the total stock of money in an economy, the sum of cash in circulation plus various types of deposits. It is a macroeconomic concept.

Various measures of the money supply depend upon which types of deposits are included:

M1: cash in circulation plus all checkable deposits in commercial banks, thrift institutions, and credit unions.
M2: a broader definition; includes M1 plus highly liquid near-monies such as savings and smaller time deposits (including money market deposit accounts and money market mutual funds).
M3: the broadest definition; includes M2 plus large denomination time deposits, generally business certificates of deposit.
M2 and M3 add highly liquid assets that serve as a store-of-value and can be readily converted into cash or some other medium of exchange at a known rate.


39

A country’s currency conversion value has recently changed from 1.5 to the U.S. dollar to 1.7 to the U.S. dollar. Which of the following statements about the country is correct?

A. Its exports are less expensive for the United States.

B. Its currency has appreciated.

C. Its imports of U.S. goods are more affordable.

D. Its purchases of the U.S. dollar will cost less.

A. Its exports are less expensive for the United States.

A foreign exchange rate is the ratio between a unit of one currency and the amount of another currency for which that unit can be exchanged at a particular date.

Assume that you are buying an item from Tunisia and paying 15 dinars for it. It would cost you $10 to buy the 15 dinars at a rate of 1.5 dinars per dollar. What would the item cost you in dollars if the rate went to 1.7 dinars per dollar? Now you would be able to buy the item with your $10 and have 2 dinars left over—that 2 dinars is a gain on a foreign currency exchange rate fluctuation. That export from Tunisia is less expensive to you in the United States.

The answer choice "its currency has appreciated" is incorrect because the dinar has declined in value relative to the dollar, not appreciated. "Its imports of U.S. goods are more affordable" is incorrect because people in Tunisia who pay in dinars would need to spend more dinars to buy U.S. goods—their imports would be less affordable, not more affordable. "Its purchases of the U.S. dollar will cost less" is incorrect because people in Tunisia will pay more in dinars, not less, for purchases of U.S. goods.

40

Which of the following variables is not one of the variables traditionally found in national income calculations?

A. Disposable income

B. Gross domestic product

C. Net domestic product

D. Real per capita gross domestic product

D. Real per capita gross domestic product

Real per capita gross domestic product is gross domestic product for a particular year adjusted for inflation compared to a base year using a price index. This adjusted number is then divided by population to derive real per capita GDP (gross domestic product). This measure is often used as an estimate of changes in well-being in a society over time, but it is not one of the variables one would traditionally see in national income calculations.

41

The primary sources of funds for sovereign wealth funds would be:

A. the export earnings that are driven by government policies designed to have a strong currency.

B. the Central Bank in an attempt to sterilize the inflationary impact of the inflow of foreign exchange reserves on the money supply of the country.

C. earnings from commodity-based exports and trade surpluses driven by the export of manufactured goods.

D. foreign direct investment attracted by donor governments that hope to gain political leverage by making such investments.

C. earnings from commodity-based exports and trade surpluses driven by the export of manufactured goods.

The primary sources of funds for sovereign wealth funds are export earnings from commodity (energy)-based exports and the trade surplus generated by the export of manufactured goods. The trade surplus is often tied to the country having a weak currency that causes a country's goods and services to be priced lower in terms of a foreign currency.

Additionally, increases in commodity prices have shifted the terms-of-trade in favor of nations exporting goods from extractive- and commodity-based industries.

Sovereign wealth funds are pools of money accumulated from a country's reserves that are provided for investment purposes that will benefit the country's economy and citizens.

42

When implicit costs are greater than zero and economic profits in an industry equal zero:

A. resources will be unproductive if they remain in the industry.

B. there will be no production in the short run.

C. resources will move to other industries

D. accounting profits will be greater than zero.

D. accounting profits will be greater than zero.

A firm that earns a normal profit (zero economic profit) has revenue equal to total cost (explicit plus implicit costs). Economic profit is generally lower (never higher) than accounting profit due to the fact that implicit costs are included in the calculation of in economic profits.

43

If the central bank of a country raises interest rates sharply, the country's currency will most likely:

A. increase in relative value.

B. remain unchanged in value.

C. decrease in relative value.

D. decrease sharply in value at first and then return to its initial value.

A. increase in relative value.

If the central bank of a country raises interest rates sharply, the country's currency will most likely increase in relative value. This is because as interest rates increase, the currency offers a higher return through the interests. The currency will become more desirable as an investment because the return is relatively higher. The currency “costs” more, so its value increases. (The demand for currency correspondingly decreases.)

44

The following transactions were noted for an economy whose currency is denominated in pesetas (Pta).


Amount in Pesetas
-----------------
Imports of goods 20,300
Exports of goods 15,760
Domestic purchases of assets in foreign
countries 6,300
Foreign purchases of assets in the country 1,400
Net investment income (3,700)
Gifts received from abroad (net transfers) 1,240
When calculating the current account balance for this economy:

A. the current account has a surplus of Pta 7,000.
B. the capital account has a surplus of Pta 4,000.
C. the capital account has a deficit of Pta 7,700.
D. the current account has a deficit of Pta 7,000.

D. the current account has a deficit of Pta 7,000.

The balance of trade is calculated by subtracting merchandise imports from merchandise exports (15,760 Ptas. - 20,300 Ptas.) which shows a balance of trade deficit of 4,540 Ptas. The negative net investment income (3,700 Ptas.) is added to this balance, and it would be reduced by the positive inflow of transfers (1,240 Ptas.) leaving a current account deficit balance of 7,000 Ptas.

The two accounts dealing with the purchase of assets are part of the capital account and therefore are not relevant for this calculation. If there were any exports or imports or services, they would have been included in the calculation.

45

Information related to the financial transactions for a country is given as follows with values stated in billions of dollars.


-- Gross domestic product (GDP) $4,000
-- Transfer payments 500
-- Corporate income taxes 50
-- Social Security contributions 200
-- Indirect business taxes 210
-- Personal income taxes 250
-- Undistributed corporate profits 25
-- Depreciation 500
-- Net income earned abroad for the country 0
Personal income is:

A. $3,500.

B. $3,290.

C. $3,265.

D. $3,515.

D. $3,515.

Personal income is all income received by individuals whether earned or unearned and is computed before any deductions for personal income taxes. National income (NI) includes all income by American-used resources whether used/invested at home or abroad. Since all income earned is not received, we must adjust NI by deducting Social Security contributions, corporate income taxes and undistributed corporate taxes. Also, some income received is not earned and so we must add in transfer payments received by individuals, including such things as Social Security payments received, unemployment compensation, and welfare payments.


Gross domestic product (GDP) $4,000
- Depreciation (500)
-------
= Net domestic product (NDP)(at mkt cost)

$3,500
- Indirect business taxes (210)
-------
= Net national income (NNI) (at factor cost) $3,290
- Corporate income taxes ( 50)
- Undistributed corporate profits ( 25)
- Social Security contributions (200)
+ Transfer payments 500
-------
= PERSONAL INCOME $3,515
=======

46

Suppose a firm borrows $100,000 for one year at 9% with interest being paid on a discount basis. The effective rate on the loan would be:

A. 8.0%.

B. 9.2%.

C. 9.9%.

D. 10.2%.

C. 9.9%.


Effective rate
of interest = Interest paid / Usable funds
= (9% x $100,000) / ($100,000 - (9% x $100,000))
= $9,000 / $91,000
= .0989 or 9.9%
Usable funds = Loan amount - Discounted interest - Compensating balance

47

There will be a national election in 15 months. Your planning team believes that the current administration in Washington will actively seek to follow the basic tenets of the political business cycle. Given that fact, as you develop your 2-year forecast, you are more likely to:

A. increase your sales forecast for the near term and plan to access the debt markets earlier than you had otherwise anticipated.

B. make no changes to your plans since the actions of politicians prior to an election have no impact on the economy.

C. reduce your sales forecast for the near term and postpone a planned bond issue until after the election.

D. reduce inventories and loosen your credit policies.

A. increase your sales forecast for the near term and plan to access the debt markets earlier than you had otherwise anticipated.

According to the political business cycle theory, politicians want the economy to be “pointed in the right direction” as the election approaches with the unemployment rate and the inflation rate falling. Thus, there would be relatively expansionary fiscal policy prior to the election, followed by more restrictive fiscal policy soon after the election, often placing the blame for the reversal on the previous administration if there were a change.

48

A vendor offered Wyatt Co. $25,000 compensation for losses resulting from faulty raw materials. Alter­nately, a lawyer offered to represent Wyatt in a lawsuit against the vendor for a $12,000 retainer and 50% of any award over $35,000. Possible court awards with their associated probabilities are as follows:

Award Probability
------- -----------
$75,000 0.6
0 0.4

Compared to accepting the vendor's offer, the expected value for Wyatt to litigate the matter to verdict provides a:

A. $4,000 loss.

B. $18,200 gain.

C. $21,000 gain.

D. $38,000 gain.

A. $4,000 loss.


Here there are two possible outcomes: collecting $25,000, or accepting the lawyer’s offer to represent Wyatt in the lawsuit. We will need to compare the expected value of $25,000 (fixed at $25,000) with the expected value if the lawsuit alternative is chosen.

If the lawsuit is chosen, Wyatt will lose the $12,000 retainer, but have a 60% probability of winning $75,000 less the lawyer’s contingent fee of 50% of the award above $35,000. The contingent fee would be 50% times ($75,000 − $35,000) which is 0.50 × $40,000, or $20,000.

The value of winning the lawsuit is $75,000 less the contingent fee of $20,000, or $55,000. The expected value of winning the lawsuit is the probability of winning (60%) multiplied by the value of winning ($55,000), or $33,000. However, Wyatt will have to pay the retainer of $12,000, leaving a net expected value of $21,000.

Comparing a gain of $25,000 from accepting the vendor’s offer with an expected value of $21,000 of filing the lawsuit leaves a loss of $4,000 to file the lawsuit, as compared to accepting the vendor’s offer.

49

The following information is taken from Wampler Co.'s contribution income statement:

Sales $200,000
Contribution margin 120,000
Fixed costs 90,000
Income taxes 12,000

What was Wampler's margin of safety?

A. $50,000

B. $150,000

C. $168,000

D. $182,000

A. $50,000

Margin of safety is the excess of actual or budgeted sales over breakeven point sales. It is the amount by which sales could decrease before losses occur. At breakeven there would be no income tax, so we can ignore the income tax information.

To find breakeven sales, first find the contribution margin ratio (contribution margin divided by sales) of $120,000 ÷ $200,000, or 60%. Then divide fixed costs by the contribution margin ratio ($90,000 ÷ 0.6 = $150,000 breakeven sales).

The margin of safety is the current sales ($200,000) less breakeven sales ($150,000), or $50,000.

50

Jago Co. has two products that use the same manufacturing facilities and cannot be subcontracted. Each product has sufficient orders to utilize the entire manufacturing capacity. For short-run profit maximization, Jago should manufacture the product with the:

A. lower total manufacturing costs for the manufacturing capacity.

B. lower total variable manufacturing costs for the manufacturing capacity.

C. greater gross profit per hour of manufacturing capacity.

D. greater contribution margin per hour of manufacturing capacity.

D. greater contribution margin per hour of manufacturing capacity.

In a full utilization situation, manufacturing capacity represents a scarce resource, or constraint. The question of importance is how to most profitably utilize this resource.

Contribution margin (price minus variable cost) indicates profitability potential per unit of product. When this value is multiplied times the number of units that can be produced per hour, we can determine profit potential per hour for various products that might be produced.

Thus, contribution margin per hour of manufacturing capacity is very relevant in a short-run situation in which the entire manufacturing capacity is expected to be utilized.

51

Which of the following is a characteristic of a flexible budget?

A. Provides budgeted numbers for various activity levels

B. Allows for modification during the budgeted period

C. Isolates the impact of variable costs on the overall budget

D. Can be utilized by several product divisions

A. Provides budgeted numbers for various activity levels

A flexible budget is developed using the static budget standards for any activity level within the relevant range. Amounts are calculated using the actual output level based on the standard cost and usage per unit for variable items, and the identical dollar amounts for the fixed costs in the static budget are used in the flexible budget. A flexible budget prepared outside the relevant range would not necessarily be accurate.

52

In computing the reorder point for an item of inventory, which of the following is used?

I. Cost
II. Usage per day
III. Lead time

A. I and II

B. II and III

C. I and III

D. I, II, and III

B. II and III

The reorder point is the inventory level at which an order for the inventory item is submitted. The formula is:

Reorder point = Usage per day × Lead time
For example, if 10 days are required to order and receive Part J94Y and the daily demand for this part is 1,000 units, the formula is:


Reorder point = 1,000 units x 10 days
Reorder point = 10,000 units

Note that both usage per day and lead time are used in this calculation.

53

Which of the following listings correctly describes the order in which the four types of budgets must be prepared?

A. Production, direct materials purchases, sales, cash disbursements

B. Sales, production, direct materials purchases, cash disbursements

C. Cash disbursements, direct materials purchases, production, sales

D. Sales, direct materials purchases, production, cash disbursements

B. Sales, production, direct materials purchases, cash disbursements

The master budget is a set of separate but interrelated budgets. The sales budget is key to the entire budgeting process since all other parts of the master budget depend on the sales budget. The sales budget will determine how many units to produce. The production budget will determine the quantity of raw materials to purchase. The purchases will determine the timing of cash disbursements.

The order of the master budget would be as follows:

Sales budget
Production budget
Direct materials, direct labor, and manufacturing overhead budgets
Selling and administrative budgets
Budgeted income statement
Cash budget
Budgeted balance sheet

54

A company's controller is adjusting next year's budget to reflect the impact of an expected 5% inflation rate. Listed below are selected items from next year's budget before the adjustment:


Total salaries expense $250,000
Health costs 100,000
Depreciation expense 65,000
Interest expense on 10-year, fixed-rate notes 37,750
After adjusting for the 5% inflation rate, what is the company's total budget for the selected items before taxes for next year?

A. $470,250

B. $472,138

C. $473,500

D. $475,388

A. $470,250


The expected inflation rate of 5% will affect items where the costs are being incurred due to activities taking place during the year, as opposed to being related to past actions or decisions. For example, the depreciation expense is based upon the systematic expensing of prior capital purchases. The interest expense is based upon a contract entered into sometime in the past.

The total budget before taxes for the items listed would be as follows:


Total salaries expense ($250,000 x 1.05 (105%))

$262,500
Health costs ($100,000 x 1.05) 105,000
Depreciation expense 65,000
Interest expense on 10-year, fixed-rate notes 37,750
--------
Adjusted budget $470,250
========

55

The coefficient of determination, r squared, in a multiple regression equation is the:

A. percentage of variation in the independent variables explained by the variation in the dependent variable.

B. percentage of variation in the dependent variable explained by the variation in the independent variables.

C. measure of the proximity of actual data points to the estimated data points.

D. coefficient of the independent variable divided by the standard error of regression coefficient.

B. percentage of variation in the dependent variable explained by the variation in the independent variables.
The coefficient of determination is a ratio that indicates the proportion of variance in the dependent variable determined by the independent variable using the regression equation.

The answer choices “the percentage of variation in the independent variables explained by the variation in the dependent variable” and “the coefficient of the independent variable divided by the standard error of regression coefficient” are incorrect because the coefficient is not a percentage of variation in the independent variable, but in the dependent variable. “The measure of the proximity of actual data points to the estimated data points” is incorrect because the coefficient does not indicate the proximity of data points, but the portion of variance.

56

A company that produces 10,000 units has fixed costs of $300,000, variable costs of $50 per unit, and a sales price of $85 per unit. After learning that its variable costs will increase by 20%, the company is considering an increase in production to 12,000 units. Which of the following statements is correct regarding the company’s next steps?

A. If production is increased to 12,000 units, profits will increase by $50,000.

B. If production is increased to 12,000 units, profits will increase by $100,000.
C. If production remains at 10,000 units, profits will decrease by $50,000.

D. If production remains at 10,000 units, profits will decrease by $100,000.

D. If production remains at 10,000 units, profits will decrease by $100,000.
The new contribution margin will be sales price less variable cost, or $85 − (120% × $50) = $25 per unit.

If production increases to 12,000 units, the contribution margin will be 12,000 × $25, or $300,000. Subtracting fixed costs of $300,000 from a contribution margin of $300,000 leaves no profit.

If production remains at 10,000 units, the contribution margin will be 10,000 × $25, or $250,000. Before the increase in variable costs, the contribution margin was 10,000 × $35 ($85 − $50), or $350,000. With no change in fixed costs, a decrease in the contribution margin from $350,000 to $250,000 will reduce profits by $100,000.

57

Which of the following is not an integrating mechanism?

A. General personnel systems

B. General management systems

C. Increasing coordination potential

D. Reducing the need for coordination

A. General personnel systems

Integrating mechanisms connect the information, tasks, and resources with the work groups in the organization. The major integrating mechanisms include:

general management systems,
increasing coordination potential, and
reducing the need for coordination.

58

Which of the following may be used to estimate how inventory warehouse costs are affected by both the number of shipments and the weight of materials handled?

A. Economic order quantity analysis

B. Probability analysis

C. Correlation analysis

D. Multiple regression analysis

D. Multiple regression analysis

The purpose of regression analysis is to use an independent variable to predict the value of another variable. Multiple regression involves the analysis of more than two variables. In this situation, we can use multiple regression analysis with the number of shipments and the weight of materials as the independent variables to predict inventory warehouse costs.

Economic order quantity (EOQ) is the quantity of inventory that should be ordered at one time in order to minimize the associated costs of carrying and ordering inventory, such as purchase-order processing, transportation, and insurance. EOQ is an inventory decision model that reflects a fixed quantity system. It would not provide a method to predict warehouse costs.

Probability theory is a branch of mathematics that studies the likelihood of occurrence of random events in order to predict behavior. Probability is the measure of how likely an event is. It would not allow us to predict warehouse costs based on weight and number of orders.

Correlation analysis is a measure of the extent to which the independent variable accounts for the variation of the dependent variable (i.e., the amount of variation in y that is explained by x). It is the measure of how well the regression line fits the actual data points. It would not permit the prediction of warehouse costs from independent variables, although it could be used to measure how good the predictions are.

59

Which of the following is a disadvantage of participative budgeting?
A. It is more time consuming.

B. It decreases motivation.

C. It decreases acceptance.

D. It is less accurate.

A. It is more time consuming.

Participative budgeting is a bottom-up budgeting process where budgets are developed after lower-level managers have provided input in the development of the numbers. The thought is that lower-level managers will feel an ownership of the budget if they have had a hand in developing the budget, and this ownership is hoped to lead to a greater motivation and goal congruence. Some of the disadvantages are the fact that the numbers provided by the lower-level managers often contain budgetary slack, leading to negative motivation and the fact that it is more time consuming to involve additional people in the budgeting process.

60

The forecasting technique most relevant for analyzing data prior to creation of a flexible budget is:

A. exponential smoothing.

B. learning curves.

C. regression analysis.

D. time series analysis.

C. regression analysis.
Flexible budgets are prepared (or can be prepared) for different levels of activity. In doing this, it is necessary to identify and separate variable costs and fixed costs.

Regression analysis can be used to develop simple regression equations of the type y = a + b(x), where a represents the constant (i.e., fixed) cost and b represents the variable rate. This is what is needed for preparation of flexible budgets.

Regression analysis, often utilizing the least-squares method, is used to estimate the relationship between a dependent variable and one or more independent variables. It is often used as a method to estimate a cost function, i.e., to use historical relationships to predict future costs.

Exponential smoothing is a prediction technique that uses weighted averaging applied to time series observations adjusted so that most recent observations heavily influence the results and prior random variation is minimized.

61

Which tool would most likely be used to determine the best course of action under conditions of uncertainty?

A. Cost-volume-profit analysis

B. Expected value (EV)

C. Program evaluation and review technique (PERT)

D. Scattergraph method

B. Expected value (EV)

Cost-volume-profit (CVP) analysis uses sales price and cost numbers that are assumed to be known in the short run.

Program evaluation and review technique (PERT) is used to plan and control the resources consumed in completing large and complex projects. PERT does use a probabilistic approach in identifying a “critical path,” but it is not applicable in situations other than those involving critical path identification.

The scattergraph approach is a graphical method for separating fixed and variable costs. Historical cost data is used as input in this process.

Expected value (EV) applies estimated percentages of occurrence to estimated values such as sales or costs. For example, assume that in preparing next month's sales budget we think that there is a 60% chance that sales will be $200,000 and a 40% chance that sales will be $160,000. The expected value of sales is computed:

62

A best-cost producer can gain a competitive advantage:

A. by delivering a superior product at a lower price than the competition.

B. when buyers are more concerned about price than value.

C. when they can do a better job of controlling cost driver activities.

D. when they can concentrate on low-cost alternatives that provide product differentiation.

A. by delivering a superior product at a lower price than the competition.

The best cost provider attempts to provide a product with superior quality, features, durability, service, etc. at the lowest cost. In other words, they are trying to give the buyer more value for their money.

a. The Best-Cost Provider attempts to provide a product with superior quality, features, durability, service, etc. at a low price. In other words, the strategy is to give consumers more value for their money. This is done by matching or beating the competition's product attributes while being able to produce the product at a lower cost.
b. The firm that successfully competes using the best-cost provider strategy needs to be able to incorporate upscale product attributes while still aggressively controlling costs. The most successful firms using this strategy have unique proficiencies and abilities that allow them to produce high-caliber products while controlling costs at the same time. The better a firm does at successfully balancing these two important aspects of production, the more advantage it has over competitors.

63

Induced investment is the investment made in an economy in response to:

A. a decrease in the short-term interest rate.

B. innovations in industrial technology.

C. changes in the level of national income.

D. a decrease in the minimum lending rate.

C. changes in the level of national income.

The accelerator principle says that small changes in consumer spending can cause big percentage changes in investment. It plays a role in many business-cycle theories and is still used today to explain some of the fluctuation in investment.

In a very simple form, the accelerator principle assumes that the ratio of capital to output tends to remain constant. Suppose, for example, that normally it takes $1,000 worth of equipment to manufacture $1,000 worth of shoes each year. Suppose further that each year one-tenth of the equipment wears out. If there is no growth or decline, total investment each year will be $100, all for replacement.

Now suppose that the sales of shoes jump by 5%, to $1,050 each year. The new desired amount of equipment will also rise by 5%, to $1,050. However, to obtain this new level, investment will have to increase by 50%, to $150. Thus, if firms desire a constant capital-to-output ratio, a small percentage change (either an increase or decrease) in final sales, can lead to a big percentage change in investment.

Theories Explaining Business Cycles

a. There are several competing theories that economists have developed that try to explain the causes for the business cycle. While there is no universal agreement as to the exact combination of factors that cause business cycles, a brief review of some of the more accepted theories helps to potentially explain how changes at the firm level might affect the economy at the macroeconomic level.
b. The real business cycle model is based on the premise that fluctuations in output and employment result from real supply shocks that periodically hit the economy, and that markets adjust rapidly to the shock and always remain in equilibrium.
1. Monetary policy is assumed to have no real effect on the business cycle.
2. Toward the end of the expansionary phase of the business cycle, employment is high and jobs are easy to find. The supply of labor is highly elastic with respect to temporary changes in wages as workers are very willing to substitute work for leisure on a short-term basis because wages are high.
3. The most important shock that can impact the economy is a productivity shock that often results from technological change and leads to an increased level of output from the given amount of inputs. Workers will be willing to work more hours to take advantage of the higher wages caused by the higher productivity.
4. In the absence of an increase in aggregate demand, the necessary level of output could be produced by a smaller level of inputs, thus increasing unemployment until aggregate expenditures increase. Rising productivity also increases the incentive for business investment.
5. Illustration: Assume that productivity declines significantly because of a supply shock that raises the price of crude oil. This would lead to a dramatic increase in the cost of energy. This in turn would lead to an increase in operating costs for most firms. The cost increases would reduce society's ability to produce real output. At the same time, the increased cost of energy would reduce consumer purchasing power and expenditures on consumer goods. This would further reduce the incentive for businesses to invest.
c. The political business cycle model explains the business cycle as resulting from interactions between economic policy decisions and political decisions designed to influence voter behavior.
1. Economic policy choices often represent trade-offs between unemployment and inflation.
2. Surveys indicate the voters are worried about both issues and perceive rising unemployment to be a problem. Voters are also concerned about the rate of inflation, the rate of increase in the inflation rate, and the effect that inflation could have on their buying power.
3. Politicians desire to have the economy “moving in the right direction” as an election approaches.
4. Politicians tend to run restrictive fiscal policies early in their terms and to blame the previous administration for current economic problems.
5. Fiscal policy tends to become more expansionary as an election year approaches.
6. There is little doubt that most administrations tend to pursue certain policies; however, it is very difficult for any administration to “fine-tune” fiscal policy since the executive branch does not control the major policy tools. Monetary policy is controlled by the Federal Reserve and fiscal policy measures are enacted by the legislative branch.
d. The insufficient aggregate expenditure model is based on the premise that a business cycle is caused by inadequate spending. The key components of aggregate expenditure are personal consumption (C), business investment (I), government expenditures (G), and the net difference between exports (X) and imports (M). It is represented by the formula:
GDP = C + I + G + (X - M)

Each of these expenditure categories is assumed to be a function of other economic variables:
1. The level of personal consumption depends primarily on consumer disposable income and wealth. In addition, the demand for consumer durable goods such as housing and automobiles is influenced by the impact of interest rate changes on monthly payments.
2. Business investment depends primarily on the level of interest rates and business expectations concerning the net present value of the cash flows from potential projects. (See section 5312 on capital budgeting.)
3. Government expenditures are determined by the fiscal policy that is developed by the executive and legislative branches of government.
4. Exports are driven by consumer income and wealth in foreign nations as well as foreigners' tastes and preferences for foreign (in this case U.S.) goods. The demand for imports depends primarily on the same factors as personal consumption plus the tastes and preferences U.S. citizens have for foreign goods.
e. The accelerator model assumes that the business cycle is caused by the volatility of investment spending.
1. Expenditures on capital goods and investment in inventory are related to the rate of change in GDP.
2. It assumes that a given level of capital goods is required to produce a given level of output. Also, firms desire a given level of inventory at a given level of demand.
3. If the economy is operating at full capacity and there is an increase in aggregate demand, then there would be an increase in the demand for capital goods, which stimulates increases in aggregate demand, causing a secondary increase in the demand for capital goods.
4. With the increase in aggregate demand, inventory levels will fall below desired levels and firms will increase their investment in inventory which will cause an increase in production and employment at the wholesale level.


64

Sovereign wealth funds (SWFs) are:

A. government investments funded by official currency reserves that are managed to make monetary policy more effective.

B. government-controlled entities that seek to attract funds from foreign countries to fund foreign direct investment in the country.

C. government investments funded by foreign currency reserves that are managed separately from official currency reserves and invested for profit.

D. entities that are an offshoot of state capitalism where the state manipulates its official currency reserves for political purposes.

C. government investments funded by foreign currency reserves that are managed separately from official currency reserves and invested for profit.

65

Currently, the U.S. tax code requires that transfer prices for multinational corporations are “arms length transactions.” Methods that are prescribed by the IRS for setting arm's length prices for tangible goods include all of the following except:

A. the comparable uncontrolled price. This method is based on the philosophy that what is a reasonable price for one customer is reasonable for another customer.

B. the resale price. This method assumes that the price at which the items can be resold by the distribution affiliate less an amount to cover overhead head costs and a reasonable profit is a realistic transfer price.

C. the cost-plus approach. This method entails adding an appropriate profit to the costs of the manufacturing affiliate in order to achieve a reasonable transfer price.

D. the target revenue approach. This method starts at a target selling price for the distribution affiliate that allows for a reasonable profit less the transfer price and any additional costs to cover overhead costs.

D. the target revenue approach. This method starts at a target selling price for the distribution affiliate that allows for a reasonable profit less the transfer price and any additional costs to cover overhead costs.

The comparable uncontrolled price, the resale price, and the cost-plus approach to set transfer prices are all methods allowed by the IRS in an attempt to control transfer pricing manipulation.

International Issues and Transfer Pricing

a. Many multinational corporations (MNCs) have international sales among the components of the organization. That means that transfer prices must be set between divisions and/or subsidiaries that reside in different countries. The MNCs have the same basic transfer pricing issues just discussed; however, there is an additional issue of taxes. Not all governments have identical tax rates; therefore, it is in the best interest of an MNC to use transfer pricing to shift the profit to subsidiaries in countries with lower tax rates when possible.
b. The flexibility to shift profit through the use of transfer pricing may be limited due to the fact that some host governments restrict such transfers when the intent is to avoid taxes. In other words, sales/purchases between subsidiaries of a firm are expected to use the principle of an arm's-length transaction when setting prices. There is still, however, a bit of flexibility in setting transfer prices without violating laws or regulations. Even though there is a limited range for setting transfer prices, subsidiaries often can shift costs for technology, research and development, etc. to subsidiaries in countries with high tax rates.
c. Currently, the U.S. tax code requires that transfer prices are “arm's-length transactions.” On March 12, 2003, the Pacific Association of Tax Administrators (PATA) reached an agreement for a final Transfer Pricing Documentation Package. The result is the PATA members have agreed to certain principles that allow taxpayers to prepare one set of documentation to meet the transfer pricing documentation provisions of each country. If a taxpayer complies with the provisions under the agreement, the taxpayer is shielded from transfer documentation penalties that might otherwise apply in each of the four jurisdictions (Australia, Canada, Japan, and the United States). The IRS extended the tax code to include transfer pricing of services as well as products in 2004.

66

Immunizing a portfolio from interest rate risk by matching the duration of assets to the duration of liabilities might be ineffective and/or inappropriate because:

A. conventional duration strategies assume an upward-sloping yield curve.

B. immunization models are highly sensitive to adjustments for inflation.

C. duration matching is effective in immunizing portfolios from parallel shifts in the yield curve.

D. All of the answer choices are correct.

C. duration matching is effective in immunizing portfolios from parallel shifts in the yield curve.

Mitigating Risks Related to Changing Interest Rates

a. Interest rate risk is the risk of holding fixed interest-bearing instruments such as a bond when interest rates are changing. The price of long-term securities is more sensitive to changes in interest rates than the price of short-term securities. There is an inverse relationship between the direction of the change in interest rates and the price of the fixed interest-bearing security.
b. Although a nonfinancial firm will usually report its bonds on issue in financial statements at their market value at the time of issuance less premium or discount amortization, early redemptions must be done at the market value. These amounts may be significantly different as interest rates will change the value of fixed-rate debt. This risk is not commonly considered by most nonfinancial firms.
c. This risk could be mitigated by hedging or acquiring an offsetting exposure, which could be a derivative such as an option, a futures contract, or a swap, or by acquiring an offsetting asset or liability.
d. The main reasons for hedging include reducing the volatility in cash flow, avoiding financial distress, or providing predictability. Financial distress could be as simple as a liquidity crunch with an inability to meet short-term demands on cash, which could ultimately result in bankruptcy. A hedge would reduce the probability of the outcome.
e. A firm is concerned about the uncertainty of cash flows related to asset and liability structure caused by changes in interest rates that impact the value of the assets and liabilities.
f. A firm is concerned about the changes in market value of fixed-rate assets as market interest rates change.
g. There is a flow risk that relates to the sensitivity of interest rate changes that could be hedged with fair value hedges or a risk on the ability to make interest payments that may be covered by developing a cash flow hedge (a hedge that is the result of the exposure to the variability of cash flow attributable to a particular risk associated with a recognized asset or liability (IAS 39.86)).

67

Suppose that a monopolist calculates that at the current level of sales and output, marginal costs is $3 and marginal revenue is $5. Under these conditions, profits could be increased by:

A. increasing output and decreasing price.

B. decreasing output and increasing price.

C. leaving output unchanged and decreasing price.

D. decreasing output and leaving price unchanged.

A. increasing output and decreasing price.

The monopoly can increase profits by increasing output and decreasing price as long as MR > MC (marginal revenue is greater than marginal costs). The firm will maximize profits by continuing to the point where at the given output MC = MR.

Profit Maximizing Rule (MR = MC)

Marginal cost represents the change in total cost associated with producing one additional unit. Marginal revenue represents the change in total revenue derived from selling one more unit. If the marginal revenue from selling one more unit is greater than the marginal cost of producing the unit, it makes sense to produce and sell the unit as doing so will increase the firm's profit.

If marginal revenue is greater than marginal costs, then producing more will increase profits. However, if marginal revenue is less than marginal cost, then producing more will lower profit. Thus, profit is at a maximum when marginal revenue equals marginal cost: MR = MC.

68

Assume that a firm is able to issue 20-year fixed rate bonds at an attractive rate. When looking at their balance sheet and cash flow position, management finds that the key interest rate risk the firm is facing is related to movements in short-term interest rates. Management decides that the rate on the 20-year bond is too attractive to pass up. They issue the bond and then choose to develop ________ to offset their interest rate risk.

A. an interest rate swap transaction

B. a collateralized debt transaction secured by subprime mortgages

C. a forward hedge

D. a technical forecast model

A. an interest rate swap transaction

An interest rate swap in its usual form would transform one interest stream into another. In this instance, the firm has the ability to issue a bond with a fixed-rate payment stream at an attractive interest rate; however, management needs to deal with a floating-rate interest rate risk problem. To deal with this problem, the firm would work with a counterparty such as a bank to find a firm that has a floating-rate stream that is less costly than one they could obtain themselves and who desired access to a fixed-rate stream. The two firms would enter into a swap where one party pays fixed and receives floating, and the other firm pays floating and receives fixed.

A forward hedge is designed to deal with foreign exchange transactions and is a customized transaction that is usually written by a bank for a specific client.

A collateralized debt obligation (CDO) is a structured asset-based security where the value and payment stream is derived from a portfolio of fixed-income assets.

69

Processing data through the use of simulated files provides an auditor with information about the operat­ing effectiveness of control policies and procedures. One of the techniques involved in this approach makes use of:

A. controlled reprocessing.

B. an integrated test facility.

C. input validation.

D. program code checking.

B. an integrated test facility.

An integrated test facility allows an auditor to introduce test data (simulated files) into an actual processing run to test the processing of that data. This provides evidence about operating effectiveness of the software.

"Controlled reprocessing" is incorrect because reprocessing the same data again with the same software provides no new information. "Input validation" is incorrect because input validation is a control that improves the accuracy of data entry, but does not provide information about control effectiveness. "Program code checking" is incorrect because manual program code checking in a complex system is a difficult task, sometimes impossible, which is more efficiently done by using test data in an integrated test facility.

A company may process most of its business transactions through an electronic data processing (EDP) system. In such case, the controls over the processing must be adequate to safeguard assets and provide reliability in the output produced. One of the methods of testing the controls over the processing is with an integrated test facility.

In an integrated test facility, test data is developed and integrated into the live processing of actual data resulting from business transactions. By assessing the results of the test data at the same time this data is processed with actual data, the auditor can help ensure that the data processed was reliable.


Done

70

An American importer expects to pay a British supplier 500,000 British pounds in three months. Which of the following hedges is best for the importer to fix the price in dollars?

A. Buying British pound call options

B. Buying British pound put options

C. Selling British pound put options

D. Selling British pound call options

A. Buying British pound call options

If someone purchases a call option, he or she expects prices to rise during the option period.

Conversely, a put option is purchased if the price is expected to decrease over the option period.

An American importer who will pay a British supplier in the future is concerned about the value of the British pound increasing against the U.S. dollar. If this happens, it will take more dollars to repay the loan. The importer would hedge against a rise in British pounds by purchasing a British pound call option. This option is the right to purchase British pounds at a future date. If and when the price of British pounds rises, the importer would exercise the option and then sell the futures contract at a profit. The profit made would offset the cost of paying more in U.S. dollars to the British supplier.

71

Employee numbers have all numeric characters. To prevent the input of alphabetic characters, what technique should be used?

A. Check digit

B. Existence check

C. Dependency check

D. Field check

D. Field check

Input Validation Routines

Input validation routines, called edit programs, test input data as it is entered into a system to make sure it is accurate and valid. These tests are called edit checks. In online processing, edit checks are performed during the source data entry process, and incorrect data is not accepted until corrected. In batch processing, a separate program performs the edit checks on the input data before it is processed.

a. The following edit checks are used in input validation routines.
(1) Capacity checks, to test whether data will fit into a field.
(2) Field checks, to test whether characters are the proper type. A field check on a numerical field would indicate an error if it contains blanks or alphabetic characters.
(3) Limit checks, to make sure a numerical amount does not exceed an upper or lower limit.
(4) Range checks, to test for both an upper and a lower limit.
(5) Reasonableness test, to make sure data makes sense when compared to other data.
(6) Redundant data checks, to determine whether two identifiers in a transaction record match.
(7) Sequence checks, to test whether input data is in the proper numerical or alphabetical sequence.
(8) Sign checks, to test data for the appropriate arithmetic sign. (An inventory balance should never possess a negative sign.)
(9) Validity checks, or existence checks, to compare ID numbers or transaction codes to those stored in the system. When vendor 12612 is entered, the computer locates that vendor in its database to confirm that vendor is valid.
(10) Hash total: a set of nonfinancial numbers not normally totaled (e.g., invoice numbers) are totaled by the system after input and are compared to the total generated by the documents themselves.
b. Companies also need to establish procedures to record, correct, and report all input validation errors.
(1) Enter all error data (date occurred, cause, date corrected, date resubmitted) in an error log.
(2) Investigate, correct, and resubmit errors on a timely basis.
(3) Use the normal input validation routine to reedit the corrected transactions.
(4) Review the log periodically to make sure all errors were corrected.
(5) Summarize errors by record type, error type, cause, date, and disposition in an error report sent to management.

72

Which of the following allows customers to pay for goods or services from a website while maintaining financial privacy?

A. Credit card

B. Site draft

C. E-cash

D. Electronic check

C. E-cash

E-cash currencies, such as bitcoins, are anonymous and allow payment for purchases from websites.

A credit card, a sight draft (one that promises immediate payment to the holder of the draft), and an electronic check (such as created when a debit card is used for a purchase) are not anonymous.

There are two principal forms of e-business:

1. Business-to-consumer (B2C), where individuals purchase items (books, music, airline tickets) on the Internet.
a. Most B2C transactions are straightforward and do not involve a great deal of money.
(1) A consumer visits a company website, decides what to purchase, places an order, and pays using a credit card.
(2) The seller ships the goods to complete the transaction.
b. Trust and confidence are important in B2C transactions because the parties do not have long-term relationships; they usually have not done business with each other before. Consumers need confidence that:
(1) a company's website represents a legitimate electronic “storefront.”
(2) their orders will be filled correctly.
(3) the vendor can and will keep the personal information they provide private.


Services such as WebTrust (developed by the AICPA) have been designed to provide these assurances.
c. In B2C e-commerce, payments are made using:
(1) credit cards.
(2) electronic bill payments, which are electronic checks that function like paper checks, but are less costly to process.
(3) electronic cash, which is stored as tokens in an electronic wallet or on a smart card. It avoids credit card and electronic check fees.
2. Business-to-business (B2B), where organizations do business with one another.
a. Most B2B transactions occur between organizations with established relationships so there is less need for third-party assurance services.
b. In B2B transactions, large dollar amounts are usually involved.
(1) The selling organization extends credit to customers.
(2) Partial payments on accounts are permitted, which makes accounting for and controlling sales and customer payments more challenging.

73

The use of message encryption software:

A. guarantees the secrecy of data.

B. requires manual distribution of keys.

C. increases system overhead.

D. reduces the need for periodic password changes.

C. increases system overhead.

The machine instructions necessary to encrypt and decrypt data constitute system overhead, which means that processing may be slowed down.

No encryption approach absolutely guarantees the secrecy of data in transmission although encryption approaches are considered to be less amenable to being broken than others.
Keys may be distributed manually, but they may also be distributed electronically via secure key transporters.
Using encryption software does not reduce the need for periodic password changes because passwords are the typical means of validating users' access to unencrypted data.

74

Which of the following is responsible for authorizing and recording transactions and for correcting errors?

A. Data control group

B. Computer operators

C. Security management

D. Users

D. Users

Users authorize and record transactions, use system output, and are responsible for correcting errors.

-The data control group logs data inputs, processing, and outputs, and makes sure that transactions have been authorized. They do not authorize or record transactions themselves.
-Computer operators maintain and run daily computer operations.
-Security management is responsible for preventing unauthorized physical and logical access to the system.

Users:

a. authorize and record transactions,
b. use system output, and
c. are responsible for correcting errors.

75

Which of the following would best be considered an example of the use of decision support system (DSS)?

A. A manager uses a PC-based simulation model to determine whether one of the company's ships would be able to satisfy a particular delivery schedule.

B. An auditor uses a generalized audit software package to retrieve several purchase orders for detailed vouching.

C. A manager uses the query language feature of a database management system (DBMS) to compile a report showing customers whose average purchase exceeds $2,500.

D. An auditor uses a PC-based word-processing software package to modify an internal control questionnaire for a specific audit engagement.

A. A manager uses a PC-based simulation model to determine whether one of the company's ships would be able to satisfy a particular delivery schedule.

The PC-based simulation model is being used to provide interactive problem-solving (e.g., scheduling) assistance, the distinguishing feature of a DSS.

The generalized audit software package does not provide interactive problem-solving assistance in retrieving the purchase orders, and thus is not a DSS.
The query feature of a database management system does not provide interactive problem-solving assistance in compiling the report, and thus is not a DSS.
The word-processing software package does not provide interactive problem-solving assistance to the auditor, and thus is not a DSS.

A decision support system (DSS) is an information processing system providing interactive capabilities, including modeling and database access, within a decision-making system. The system differs from other information systems in its emphasis on synergism between the computer and the user, and its application to underspecified or loosely structured decision-making problems.

76

The operational effectiveness of controls can be improved through the application of a methodology such as Six Sigma or total quality management (TQM). In general, in order to improve the operating effectiveness of processes and their associated controls, the following series of steps needs to be followed in what sequence?

Implement monitoring and control capabilities
Collecting information about the problem or issue
Remediating causes of ineffectiveness or inefficiencies
Determine the root cause of the issue
Define the problem, issue, and/or goal of the process

A. II, I, III, V, IV

B. V, II, IV, III, I

C. I, II, III, IV, V

D. III, IV, II, I, V

B. V, II, IV, III, I

While the various process improvement methodologies (Six Sigma, total quality management, lean manufacturing, and others) all vary in the exact way in which they identify issues and improve their operational effectiveness, in general they all follow the same basic steps. These steps are essentially as follows:

Identify what the issue is
Understand more about the issue
Determine what is causing the issue
Remediate the issue
Put into place monitoring and control capabilities to either ensure the issue never occurs again, or to inform the organization if/when the issue does occur again

77

All of the following actions are tools of monetary policy that the Federal Reserve Bank uses to control the supply of money (M1), except:

A. selling government securities.

B. changing the reserve ratio.

C. raising or lowering the discount rate.

D. printing money when the level of M1 appears low.

D. printing money when the level of M1 appears low.

Since the money supply consists of currency plus different types of deposits, money can be created in several different ways. The Federal Reserve Bank uses all of the following actions to control the supply of money:

Selling government securities
Changing the reserve ratio
Raising or lowering the discount rate
The actual printing of currency is controlled by the U.S. Treasury. This is not a tool of monetary policy.

M1 is the most narrowly defined component of the money supply. It consists of coins and currency in the hands of the public and the checkable deposits held in commercial banks and thrift institutions.

78

How does a change in net investment affect the level of income?

A. An increase in net investment will be offset directly by a decrease in the level of income.

B. A decrease in net investment will be offset directly by an increase in the level of income.

C. A decrease in net investment will cause a more than proportional decrease in the level of income.

D. An increase in net investment will cause a more than proportional decrease in the level of income.

C. A decrease in net investment will cause a more than proportional decrease in the level of income.


In macroeconomics, equilibrium national income is affected by changes in autonomous consumption, net investment, and government expenditures.

The actual impact on national income will be multiplied, positively or negatively, by some multiple of the initial change. This is due to the “multiplier effect,” which magnifies small changes in C, In, or G into larger overall changes to national income.

Thus, a decrease in net investment (In) will decrease national income by a larger amount than the original decline in investment.

Autonomous expenditure (AE) is independent of other variables. Specifically, AE is spending that is not dependent upon changes in national income, interest rates, or other variables. It is a variable that is explained by variables outside the model. AE is spending determined by factors or forces other than the variables of national income accounting theory. It is a macroeconomic concept.

Compare to Induced Expenditure.

AE may be expressed as the combination of autonomous expenditure and induced expenditure (from the basic national income equations), as the aggregate expenditure function, relating desired expenditure to income:


AE = Autonomous expenditure + Induced expenditure
= (a + I + G + X) + (bh - m)Y

The consumption expenditure is spending for all goods and services produced and sold to households during the year (except for residential housing, which is counted as an investment expenditure). It is the largest component of gross national expenditure (GNE)—representing approximately two-thirds of GNE—and aggregate expenditure. It may be actual or it may be desired, planned, or intended. Most consumption expenditure is induced, i.e., related to the available disposable income and, therefore, national income. Some may be autonomous and not related to disposable income. Consumption expenditure is explained by the consumption function and is a macroeconomic concept.

Changes in consumption expenditure result from changes in tastes, expectations, interest rates, taxes, and transfer payments and result in fluctuations in the business cycle (in income and employment).

Consumption expenditure plus savings equal disposable income: C + S = Yd.

The consumption function is C = a + bYd = a + bhY, where b = MPC.

Also see Government Expenditure, Investment Expenditure, and Net Exports.

Government expenditure is all spending by all governmental units except transfer payments. (Note that government spending on investment goods is considered governmental expenditure rather than investment expenditure.) Government expenditure is a component of gross national expenditure (representing approximately 20% of GDP) and aggregate expenditure. It may be actual or it may be desired, planned, or intended. Transfer payments by governmental units are not included in the computation of national income. Government expenditure is a macroeconomic concept.

See also Consumption Expenditure, Investment Expenditure, and Net Exports.

79

Relevant information for Product A follows:


Actual variable overhead cost per hour $8.00
Standard variable overhead cost per hour $7.50
Actual hours 4,500
Standard hours 5,000
What was the variable overhead spending variance for Product A?

A. $2,250 favorable

B. $4,000 favorable

C. $2,250 unfavorable

D. $4,000 unfavorable

C. $2,250 unfavorable

The variable overhead spending variance (VOHSV) is the comparison of what was actually spent with what was expected to have been spent for the actual amount used:

VOHSV = (Actual price - Standard price) × Actual quantity
Remember that for overhead variances, the “quantity” refers to the cost driver usage. So, for our example:


VOHSV = ($8.00 - $7.50) x 4,500 hours
= $0.50 x 4,500 hours
= $2,250 U

The variance is unfavorable (U) since more was spent than expected for the given activity level.

80

Financial risk management is a component of enterprise risk management (ERM). ERM encompasses the methods and procedures used by an organization to control risks and grasp opportunities to help a firm achieve their identified objectives. Included under the heading of financial risks would be such items as:

A. business risk.

B. hazard risk.

C. catastrophic risk.

D. strategic risk.

A. business risk.

Financial risk management is one component of the concept of enterprise risk management of the firm, which would include risks such as the following:

Business risk (uncertainty associated with the ability to forecast EBIT due to factors such as sales variability and operating leverage)
Operations risk (risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events)
Supply-chain risk (potential disruptions to continued manufacturing production and thereby commercial financial exposure)
Product liability risk (responsibility of the firm or vendor of goods to compensate for injury caused by defective merchandise that it has provided for sale)
Political and economic risk (risk that a government buyer or a country prevents a transaction from being completed, or fails to meets its payment obligations; and/or the risk associated with the overall health of the economy)

81

Sensitivity analysis in an investment project proposal:

A. calculates the change in the result due to a potential change in the project's cash flows.

B. provides management with a linear equation of trend information from the projected cash flows.

C. develops probabilities for a variety of results.

D. develops the discount rate to be used in project evaluation.

A. calculates the change in the result due to a potential change in the project's cash flows.

Sensitivity analysis is a “what if?” technique that asks how a result will change if the original predicted data changes or if an underlying assumption changes. Estimates and predictions are subject to varying degrees of uncertainty (defined here as the possibility that an actual amount will deviate from an expected amount). In investment projects, cash flows and interest rates are particularly subject to change.

82

For purposes of allocating joint costs to joint products, the sales price at point of sale, reduced by cost to complete after split-off, is assumed to be equal to the:

A. joint costs.

B. total costs.

C. net sales value at split-off.

D. sales price less a normal profit margin at point of sale.

C. net sales value at split-off.

When allocating joint costs to joint products using a sales value or market value approach, the “sales or market value” of each joint product must be derived in a similar fashion. If all products can be sold at split-off and the respective prices are known, there is no problem. But, what if one or more of the joint products requires some cost to complete (such as special packaging) after split-off? It is generally assumed that cost to complete can be subtracted from the final product sales price to arrive at net sales value at split-off and further, that this value is comparable to sales values at split-off of product(s) which require no completion cost beyond split-off.

Allocation methods: Four methods are commonly used for allocating joint costs:

1. Relative sales value at split-off
2. Physical output
3. Net realizable value (NRV)
4. Constant gross margin NRV

Relative sales value at split-off: Split-off is the point at which separately identifiable main products emerge from the joint processing phase. Where sales values at split-off are known, they are usually used to determine the allocation percentage of joint costs to each product. This method cannot be used in cases where no market exists for one of more products at the split-off point (i.e., some products require further processing before they are marketable).

83

Asta, Inc., is a medical laboratory that performs tests for physicians. Asta anticipates performing between 5,000 and 12,000 tests during the month of April. Compared to industry averages, at the low range of activity Asta has a lower sales price per test, higher fixed costs, and the same breakeven point in number of tests performed. At the high range of activity, Asta’s sales price per test and fixed costs are the same as industry averages, and Asta’s variable costs are lower. At the low range of activity (0 to 4,999 tests performed) fixed costs are $160,000. At the high range of activity (5,000 to 14,999 tests performed) fixed costs are $200,000.

Sales price per test $60
Variable costs per test 20

How is the cost of the binders in which test results are given to physicians categorized?

A. Direct material cost

B. Fixed cost

C. Overhead cost for testing

D. General and administrative cost

A. Direct material cost

Since more binders are used for more tests, this is a cost of material used directly in production, a variable direct material cost. "Fixed cost" is incorrect because this cost varies as production increases.

"Overhead cost for testing" is incorrect because the binders are a direct part of the product produced, not overhead. "General and administrative cost" is incorrect because this is a cost of production, not a cost of administration.

84

What does business process re-engineering do within an organization?

A. Only analyzes design workflows

B. Only designs work processes

C. Analyzes and designs workflows and processes

D. Tests and implements processes

C. Analyzes and designs workflows and processes

Business process re-engineering (BPR) identifies processes and workflows, analyzes processes and workflows, and designs processes and workflows

Business process re-engineering (BPR) is the search for, and implementation of, radical change in business processes to achieve breakthrough results. It reexamines how a company performs basic business processes in fundamentally different ways to radically improve efficiency. Most change efforts start with what exists and fixes it. Re-engineering starts with the future and works backwards, unconstrained by existing methods, people, or departments.

85

A lower than average inventory turnover ratio could be the result of any or all of the following except:

A. past outages of popular products has led to overstocking.

B. sales in the last half of the year were less than expected.

C. several inventory categories contain obsolete goods.

D. stronger than expected demand for most products.

D. stronger than expected demand for most products.

Stronger than expected sales would produce higher cost of goods sold and lower end-of-year inventories than planned.

Since inventory turnover is computed as cost of goods sold divided by average inventory, the overall effect is a higher turnover ratio.

Each of the other conditions mentioned affects cost of goods sold and/or average inventory in a negative manner, causing a lower than expected inventory turnover.

Inventory Turnover Ratio

a. The Inventory Turnover Ratio measures the speed with which inventory can be converted into sales. In other words, the control that management has over inventory is assessed. The quality of the inventory is determined by the company's ability to use and dispose of inventory without a loss.
Cost of Goods Sold
Inventory Turnover = ------------------
Average Inventory
b. Since inventories are purchased or produced for the purpose of obtaining a return, it is extremely important to determine if corrective action needs to be taken. A low turnover can be caused by a variety of factors, some of which are anticipated and based upon management's actions, and others that are unanticipated and require corrective action. These factors include:
1. Obsolete items
2. Unanticipated weak demand
3. Build-up to meet expected future demand or firm commitments
4. Build-up to avoid future price increases
5. Build-up in anticipation for a strike or material shortages
c. Excessive inventories can lead to:
1. high storage and insurance costs.
2. a greater risk of obsolescence, physical deterioration, or theft.
3. tying up funds that could be used in a more productive fashion, thus leading to decreased profitability.
d. A high turnover may be an indication that:
1. the firm is managing its inventory well and thereby achieving higher productivity.
2. the inventory that is held is highly marketable.
3. obsolete inventory does not appear to be a problem.


However, an extremely high turnover suggests a higher probability of stockouts.
e. Different inventory cost flow assumptions (FIFO vs. LIFO) can produce widely different inventory valuations and thus turnover ratios. This can make comparisons between organizations difficult.
f. For seasonal businesses, it is best to use a monthly average inventory figure in the calculation of this ratio, since that is generally more representative of what has actually occurred.


86

Correlation is a term frequently used in conjunction with regression analysis, and is measured by the value of the coefficient of correlation, r. The best explanation of the value r is that it:

A. interprets variances in terms of the independent variable.

B. ranges in size from negative infinity to positive infinity.

C. is a measure of the relative relationship between two variables.

D. is positive only for downward sloping regression lines.

C. is a measure of the relative relationship between two variables.

Correlation refers to the existence of a reliable relationship between two variables:

The dependent variable, the values that we would like to predict
The independent variable, the values that we would like to use in the prediction process
Reliable correlation must exist for regression analysis to be valid.

The coefficient of correlation, r, is a measure of the relative relationship (not the variance) between the two variables.

Coefficient of determination is a measure of the extent to which the independent variable accounts for the variation of the dependent variable (i.e., the amount of variation in y that is explained by x). It is the measure of how well the regression line fits the actual data points. The symbol for the correlation coefficient is r and the coefficient of determination is r squared (r2). Values of r range between -1 and 1. The closer the value is to 1, the greater the association (correlation) between the two variables.

87

The government has a number of policy options designed to stabilize the level of aggregate demand. If policy makers expected a recession, it might be expected that the government would pursue:

A. an expansionary monetary policy and an expansionary fiscal policy.

B. an expansionary monetary policy and a contractionary fiscal policy.

C. an expansionary fiscal policy and a contractionary monetary policy.

D. a contractionary monetary policy and a contractionary fiscal policy.

A. an expansionary monetary policy and an expansionary fiscal policy.

During a recession there is insufficient aggregate demand. An expansionary fiscal policy would increase government spending or cut taxes, both of which would increase the level of aggregate demand. An expansionary monetary policy would attempt to decrease interest rates to stimulate business investment and the consumption of durable goods.

Impact of Monetary Policy on Economic Aggregates

a. Monetary policy is one of the key policy tools that is available to attempt to influence the real GDP and the price level. Monetary policy works through the following process:
1. Money Market—Nominal interest rates are determined by the interaction of the supply and demand for money in financial markets. Monetary policy can impact the supply of money and therefore nominal short-term interest rates.
2. Business Investment—Increasing interest rates makes business investment less attractive by increasing a firm's weighted-average cost of capital, thereby reducing the net present value of a project's future cash flows.
3. Equilibrium GDP—If business investment is reduced, then real GDP will decline by some multiple of the decline in investment (multiplier effect).
b. Monetary Policy to Contain Inflation
1. The Fed would have a restrictive monetary policy and sell bonds.
2. Excess reserves would fall, and the money supply would fall.
3. Interest rates would rise, and business investment would decline.
4. Aggregate demand would fall, and the inflation rate would decline.
c. Monetary Policy to Deal with Deflation
1. With nominal interest rates near zero, the Fed can no longer use traditional monetary policy tools to deal with deflation.
2. The Fed can act in a preventative mode by preserving a “buffer zone” for inflation in the 1%–3% range to reduce the probability that a large and expected drop in aggregate demand will drive the economy to a level that will drive nominal interest rates to zero.
3. The Fed should act more preemptively and more aggressively in cutting interest rates when signs of potential deflation occur.
4. The Fed would need to reduce the value of the dollar in terms of purchasing power (that is, aggressively promote inflation), which is the equivalent of raising the price in dollars of goods and services.
5. The Fed would need to expand the level of asset purchases and expand the menu of the assets it is willing to purchase.
(a) Use existing authority to purchase agency debt such as mortgage-backed securities.
(b) Buy foreign government debt, but with concern about the impact on exchange rates.
6. The Fed would act to lower interest rates out further along the yield curve by purchasing assets with longer maturities and provide a commitment to keep short-term interest rates near zero for a specified period of time.
d. Monetary Policy to Deal with Unemployment
1. The Fed would have an expansionary monetary policy and would buy bonds.
2. Excess reserves would increase, and the money supply would increase.
3. Interest rates would fall and business investment would increase. There is a potential problem here since it is possible firms would not have viable projects at the trough of a business cycle as a decline in the NPV of expected future cash flows might more than offset the positive effect of a lower WACC. Also, banks might have raised their credit standards and not be willing to lend to firms that have had a poor financial performance during the recession.
4. Aggregate demand would increase, and real GDP would climb by some multiple of the increase in investment.

88

If you know a nation's net domestic product (NDP), you can compute national income (NI) by:

A. subtracting the capital consumption allowance.

B. adding corporate income taxes and transfer payments.

C. subtracting net foreign factor income earned in the United States and indirect business taxes.

D. adding corporate income taxes and indirect business taxes.

C. subtracting net foreign factor income earned in the United States and indirect business taxes.

Gross Domestic Product

a. Gross Domestic Product is a measure of the market value of all final goods and services produced in an economy during a year. It is a monetary measure to value the nation's output. It excludes intermediate goods, which are goods that are purchased for resale or for further processing or manufacturing. This is done to prevent double counting. It also excludes non-productive transactions that have nothing to do with the production of final goods and services such as:
1. Public transfer payments such as Social Security, welfare, and veteran's payments.
2. Transfers such as inter-family gifts and immigrant remittances.
3. Buying and selling of stocks and bonds and other financial assets in the financial markets.
4. Secondhand sales.
b. The Expenditure Approach for calculating GDP can be summarized as:
GDP = C + I + G + X
G n
1. Personal Consumption Expenditures (C) are the personal consumption expenditures on durable consumer goods, nondurable consumer goods, and services. Primary determinants of personal consumption are disposable income, consumer wealth, and interest rates on consumer credit. Personal consumption accounts for approximately two-thirds of GDP.
2. Gross Private Domestic Investment (Ig) are all final purchases of machinery and equipment, all construction, all changes in inventory, and purchases of new residential housing. This can be summarized as:

Net Investment = Gross Investment - Capital Consumption Allowance

Primary determinants of investment spending are interest rates, capacity utilization rates, and a firm's ability to develop projects with a positive net present value.
3. Government Purchases (G) are the spending for goods and services used in providing government services including spending on social capital such as buildings and highways.
4. Net Exports (Xn) is equal to exports minus imports or (X - M). Primary determinants for exports are similar to those for consumption, and those for exports would include similar measures for citizens of foreign nations.
c. The Income Approach for calculating GDP deals with the income derived or created to produce the output. National Income (NI) is the sum of all payments to factors of production. However, since all the expenditures noted above do not flow directly to factors of production in the form of income, it is necessary to make certain adjustments to (NI) to derive GDP. The process is as follows:
1. National Income (NI) = Compensation of employees + rental income + interest income + proprietor's income + corporate profits
2. GDP = NI + indirect business taxes + capital consumption allowance + net foreign factor income
d. There are several other national accounts that provide useful information concerning the economy's performance. Key among them are:
1. Net Domestic Product (NDP) = Gross Domestic Product - Capital Consumption Allowance
2. National Income (NI) = NDP - Net Foreign Factor Income - Indirect Business Taxes
3. Personal Income (PI) = NI - Social Security contributions - corporate income tax - undistributed corporate profits + transfer payments
4. Disposable Income (DI) = PI - personal taxes

89

Which of the following input controls would prevent an incorrect state abbreviation from being accepted as legitimate data?

A. Reasonableness test

B. Field check

C. Digit verification check

D. Validity check

D. Validity check

A validity check is an edit test in which an identification number or transaction code is compared with a table of valid identification numbers or codes maintained in computer memory. As an example, the system would compare an incorrect state abbreviation of “PS” with all possible valid state abbreviations and determine that it is not an abbreviation for one of the 50 states.

A reasonableness check or test would compare the data entry to the database to make sure that the input was logically correct, not valid. In other words, does the entry make sense in light of the data required?
A field check makes sure that the entry is the correct type for the field (numeric or alphanumeric). Any letters would satisfy this requirement, whether or not they were a valid state abbreviation.
A check digit verification uses redundant digits to detect errors in data transcription. This check would not prevent an incorrect state abbreviation from being accepted as legitimate data.

Input Validation Routines

Input validation routines, called edit programs, test input data as it is entered into a system to make sure it is accurate and valid. These tests are called edit checks. In online processing, edit checks are performed during the source data entry process, and incorrect data is not accepted until corrected. In batch processing, a separate program performs the edit checks on the input data before it is processed.

a. The following edit checks are used in input validation routines.
(1) Capacity checks, to test whether data will fit into a field.
(2) Field checks, to test whether characters are the proper type. A field check on a numerical field would indicate an error if it contains blanks or alphabetic characters.
(3) Limit checks, to make sure a numerical amount does not exceed an upper or lower limit.
(4) Range checks, to test for both an upper and a lower limit.
(5) Reasonableness test, to make sure data makes sense when compared to other data.
(6) Redundant data checks, to determine whether two identifiers in a transaction record match.
(7) Sequence checks, to test whether input data is in the proper numerical or alphabetical sequence.
(8) Sign checks, to test data for the appropriate arithmetic sign. (An inventory balance should never possess a negative sign.)
(9) Validity checks, or existence checks, to compare ID numbers or transaction codes to those stored in the system. When vendor 12612 is entered, the computer locates that vendor in its database to confirm that vendor is valid.
(10) Hash total: a set of nonfinancial numbers not normally totaled (e.g., invoice numbers) are totaled by the system after input and are compared to the total generated by the documents themselves.
b. Companies also need to establish procedures to record, correct, and report all input validation errors.
(1) Enter all error data (date occurred, cause, date corrected, date resubmitted) in an error log.
(2) Investigate, correct, and resubmit errors on a timely basis.
(3) Use the normal input validation routine to reedit the corrected transactions.
(4) Review the log periodically to make sure all errors were corrected.
(5) Summarize errors by record type, error type, cause, date, and disposition in an error report sent to management.

90

Augusta, Inc., expects manufacturing and sales of 70,000 units of product Maggie, its only product, to occur evenly over a 10-week period. Augusta pays for materials in the week following use. The balance of accounts payable for materials at the beginning of the 10-week period is $40,000. There are no beginning inventories. The fol­lowing information pertains to product Maggie for the 10-week period:

Sales price $11 per unit
Materials $3 per unit
Manufacturing conversion costs—Fixed $210,000
Variable $2 per unit
Selling and administrative costs—Fixed $45,000
Variable $1 per unit

Actual results are as budgeted, except that 60,000 of the 70,000 units produced were sold. Using absorp­tion costing, what is the difference between the reported income and the budgeted net income?

A. $10,000

B. $20,000

C. $75,000

D. $95,000

B. $20,000

Absorption costing is a method of costing in which manufacturing fixed costs are treated as product costs and assigned to the units produced. Fixed costs follow the units through work-in-process and finished goods as an inventoriable cost and are expensed through cost of goods sold (COGS) when the units are sold.

Unit sales 60,000 70,000

Revenue $660,000 $770,000
Less COGS 480,000 560,000
-------- --------
Gross profit $180,000 $210,000
Less Fixed selling/admn. 45,000 45,000
Less Variable selling/admn. 60,000 70,000
-------- --------
Net profit $ 75,000 $ 95,000

The difference is pre-tax net income of $20,000 ($95,000 − $75,000).

91

Marsh, Inc., is experiencing a sharp increase in credit sales activity and has, therefore, had a steady increase in production. Management has also adopted an aggressive working capital policy by decreasing the inventory conversion period and holding the receivables collection period and the payables deferral period constant. Original inventory levels were higher than accounts receivable. Therefore, the company's current level of net working capital:

A. would most likely be lower than under other business conditions in order that the company can maximize profits while minimizing working capital investment.

B. would most likely be higher than under other business conditions so that there will be sufficient funds to replenish assets.

C. can be financed most economically through the sale of common stock.

D. would most likely be higher than under other business conditions as the company's profits are increasing.

A. would most likely be lower than under other business conditions in order that the company can maximize profits while minimizing working capital investment.

Net working capital is current assets minus current liabilities. As sales increase, accounts receivable, a component of current assets, will increase providing the receivable collection period (average accounts receivable/average sales per day) remains constant. If credit sales increase by 10%, receivables would be expected to increase by 10%, thus increasing working capital.

If the inventory conversion period (average inventory/average sales per day) is decreased, this means that inventory would be held for a shorter amount of time; therefore, in this situation, production has increased in order to accommodate increase sales; however, since the inventory conversion period has decreased, this means that inventory would have decreased or increased slower than sales.

As sales and production increase, accounts payable and accrued production costs will increase providing the payables deferral period (average payables/average purchases per day) remains constant. If purchases and production increase by 10%, accounts payable and payables related to variable production costs would be expected to increase by 10% thus decreasing working capital. (This is assuming that unit variable costs of production remain unchanged).

If the original balances of accounts receivable were less than the original inventory balances, it would be expected that working capital would decrease since the increase in accounts receivable would be less than the increases in payables related to the increased sales production.

92

Gross domestic product can be measured using ________ approach.

A. an expenditure or outlay

B. an income or expenditure

C. an income or revenue

D. a revenue or sales

B. an income or expenditure

Calculation of gross domestic product can take either an income or expenditure approach. Done correctly, the same result should occur.

The income approach sums items such as wages, rental income, dividends, and other similar items. In contrast, the expenditure approach sums personal consumption, investment, net exports, and governmental acquisitions.

93

An auditor has completed an inventory count in a warehouse where she has identified a large discrepancy in the inventory count. She must now communicate her findings to her audit client, who may not receive this information favorably and who may become confrontative.

When communicating with auditees, there are both situational factors and message characteristics that can damage the communication process. An auditor has only limited control over situational factors but has substantial control over message characteristics.

The behavioral science literature identifies diffusion as an effective approach to resolving conflict. An auditor effectively using diffusion in working with a confrontative auditee would:

A. set aside critical issues temporarily and try to reach agreement on less controversial issues first.

B. emphasize differences between the parties.

C. avoid the conflict situation.

D. identify the sources of conflict and address them directly.

A. set aside critical issues temporarily and try to reach agreement on less controversial issues first.

Control Environment

Demonstrates Commitment to Integrity and Ethical Values. To accomplish this, management should:

a. foster an organizational culture based on integrity and ethical values.
b. make integrity a basic operating principle by consistently encouraging and rewarding honesty and articulating the distinction between honest and dishonest behavior. Punishing or rewarding honesty without identifying or explaining it or using an inconsistent standard of honesty will result in inconsistent moral behavior.
c. actively teach and practice integrity.
d. establish policies that clearly and explicitly describe honest and dishonest behaviors, especially for uncertain or unclear issues such as conflicts of interest and accepting gifts.
e. thoroughly investigate all dishonest acts.
f. dismiss employees found guilty of dishonesty and prosecute employees when it is warranted so that the remaining employees understand that dishonesty is not tolerated and will be punished.
g. require employees to report any incidents of dishonest, illegal, or unethical acts and discipline employees who knowingly fail to report violations.
h. make a commitment to competence, which begins with having competent employees. Competence is a factor of knowledge, experience, training, and skills.

94

The CFO of a company is concerned about the company's accounts receivable turnover ratio. The company currently offers customers terms of 3/10, net 30. Which of the following strategies would most likely improve the company's accounts receivable turnover ratio?

A. Pledging the accounts receivable to a finance company

B. Changing customer terms to 1/10, net 30

C. Entering into a factoring agreement with a finance company

D. Changing customer terms to 3/20, net 30

C. Entering into a factoring agreement with a finance company

The accounts receivable turnover ratio measures how quickly these receivables are collected. The quicker that they are collected, the less financing that is needed to support receivables. One method of speeding up the collection process is to offer discounts for quick payment, such as 3/10. (The customer can take a 3% discount if the invoice is paid within 10 days.) By reducing the discount to 1/10 or 3/20, the customers are less likely to pay quickly, resulting in a deterioration of the accounts receivable turnover ratio.

Pledging is using the accounts receivable balance to secure a loan. This would have no effect on the accounts receivable turnover ratio.

Factoring is a situation where a company sells its accounts receivable at a discount, thus resulting in an immediate receipt of cash related to the receivables sold. This situation would likely improve the company's accounts receivable turnover.

95

A hospital is comparing last year's emergency rescue services expenditures to those from 10 years ago. Last year's expenditures were $100,500. Ten years ago, the expenditures were $72,800. The CPI for last year is 168.5 as compared to 121.3 10 years ago. After adjusting for inflation, what percentage change occurred in expenditures for emergency rescue services?

A. 38.0% increase

B. 13.8% increase

C. 0.6% decrease

D. 18.1% decrease

C. 0.6% decrease

To convert a dollar amount from one price level to another, multiply it by the ratio of the price level you are converting to divided by the price level you are going from. So, the 10-year-old expenses of $72,800 are multiplied by the fraction 168.5/121.3, which gives expenses converted to current dollars of $101,128.

Subtracting last year's expenditures of $100,500 from the previous period price-level adjusted prior expenditures of $101,128 gives a reduction in expenditures of $628. Dividing this $628 reduction by the previous period price-level expenditures of $101,128 gives a decrease of 0.6%.

96

Capital budgeting is generally most accurate when the method used considers the cost of capital, as in the net present value method. The cost of capital used in this analysis should be ________ weighted average cost of capital.

A. historic

B. industry-wide

C. marginal

D. total

C. marginal

The cost of capital used should be the weighted average cost of capital in a marginal sense rather than a historical sense. In other words, the cost of capital should be determined in terms of the cost to issue debt and equity in the current market environment and not based on book value. The weights should be based on the expected capital structure of the funds to be raised.

Weighted-Average Cost of Capital

a. The cost of capital is an important element in making investment decisions, as projects with a higher rate of return than the firm's cost of capital will increase the value of the firm. The relevant cost of capital is the firm's long-term cost of capital, since we are evaluating long-term projects or investments.
b. The Weighted-Average Cost of Capital is the weighted average of the cost of debt and the various equity components of the firm's capital structure. It is preferable to use weights based on the market value of the items or the firm's target capital structure.
(1) The cost of debt for the issuing firm is based upon the required rate of return for debt holders and the marginal tax rate for the issuing company. Due to the tax shield associated with interest-bearing debt, the effective cost of the debt is lower than the interest rate paid due to the reduction in the taxes paid.

Cost of debt = kd (1 - T)

Where:
• kd = Cost of debt
• T = Marginal tax rate
(2) Preferred stock provides the investor with a constant stream of dividends; however, these dividends do not provide a tax shield since they are not a deductible expense for the issuing company. The cost of preferred stock to the issuing company can be calculated by dividing the annual return (interest payment) by the net issuance price for the preferred stock.
D
p
k = ------
p P
p

Where:
• kp = Cost of preferred stock
• Dp = Preferred dividend
• Pp = Price of preferred stock


Generally, however, when looking at the cost of issuing new preferred stock, the company would have to pay flotation costs to an investment house; thus, the proceeds received by the company would be less than the issue price. This would increase the cost of this form of financing. Taking flotation costs into consideration, the formula to calculate the cost of preferred stock to the issuing company would be:
D
p
k = ----------
p (1 - f) P
p

Where:
• kp = Cost of preferred stock
• Dp = Preferred dividend
• Pp = Price of preferred stock
• f = Flotation costs
(3) The cost of retained earnings is the opportunity cost that stockholders of a firm could earn elsewhere if they made investments of comparable risk. This figure would need to be imputed.
(4) The cost of equity (ke) is more expensive than the cost of debt since stockholders are subject to more risk than debt holders. There are a number of ways to estimate the cost of equity, and one commonly used method to obtain the estimate is the dividend growth model. The formula used is:
k = (D / (P (1 - F))) + g
e 1 o

This formula assumes that the firm pays a dividend equal to D1, would issue new stock at price Po, and would pay a flotation cost (F) that is equal to some percentage of the value of the stock being issued. It is assumed that the firm's dividend will grow at a constant rate (g). The result is the cost of using internally generated equity. If new stock is going to be issued, the cost of new equity would be the result obtained for internally generated equity divided (1 - Percent of flotation costs).

Illustration: The firm's dividend was $1.50 and is expected to grow 6% per year. They expect to be able to sell new stock at a price $30 per share and flotation costs are expected to be 10% of the value of the stock issue. What is the firm's cost of equity?
k = ($1.50 / ($30(1 - 0.10))) + 6.0%
e
= ($1.50 / $27.00) + 6.0%
= 5.56% + 6.0%
= 11.56%
c. Most analysts use the CAPM (Capital Asset Pricing Model) to estimate the required return on a firm's cost of equity. The basic equation for estimating the required return on equity (Ri) is:
R = R + Beta (R - R )
i F i m F

The beta coefficient is the amount of risk that an individual stock contributes to the market portfolio and is a measure of the correlation between the volatility of the price of the individual stock and the volatility of the stock market. The market risk premium (Rm - RF) is the premium that common stocks have returned over time in excess of the risk-free rate (RF). Generally the current Treasury bill rate is used as the risk-free rate. Some analysts would use the 10-year Treasury Bond rate for the risk-free rate when evaluating long-term capital projects.
d. The primary conclusion of the capital-asset pricing model (CAPM) is that the relevant risk on any security is its contribution to the risk of a well-diversified portfolio. A commonly used benchmark portfolio for the market portfolio is the S & P 500.
e. Illustration: Assume that the current T-bill rate is 3.35% and the market risk premium is 7% for a diversified market portfolio.
R = R + Beta (R - R )
i F i m F

= 3.35% +1.0(7.0%)
= 10.35%

Under this scenario, investors would expect to earn 10.35% on a diversified market portfolio. (Note: The beta coefficient for the diversified market portfolio is 1.0.)

Given the information in the example above and assuming that the beta coefficient for an individual security is 1.4, what return would investors require to hold this security?

Solution: Using the formula from (c) above, that is, Ri = RF + Beta i (Rm - RF), the return required by investors would be 13.15%. Again, this is the cost of internally generated equity. The cost of issuing new stock would be the cost of internally generated equity divided by (1 - Percentage of flotation costs).
R = R + Beta (R - R )
i F i m F

= 3.35% +1.4(7.0%)
= 13.15%
f. The weighted-average cost of capital can be computed as follows:
WACC = (wt x k ) + (wt x k ) + (wt x k )
d d pf pf e e

Example: Assume that the firm can issue new debt at 5% and that the marginal tax rate is 40%. The firm has $1,000 par preferred stock that pays a dividend of 4%. Using the CAPM, it is estimated that investors require a 16% return on equity investments. The firm has a target capital structure of 30% debt, 10% preferred stock, and 60% equity. What is the firm's WACC?

Solution:
WACC = (.30 x (.05 x (1 - .40))) + (.10 x .04) + (.60 x .16)
= .009 + .004 + .096
= .109 or 10.9%

97

The Sarbanes-Oxley Act requires financial issuers to publish what kind of information?

A. The immaterial condition of the company

B. Internal control performance relative to industry best practice benchmarks

C. Only positive impacts on internal controls

D. The scope and capabilities of the internal control structure

D. The scope and capabilities of the internal control structure

98

Which of the following security controls would best prevent unauthorized access to sensitive data via an unattended data terminal directly connected to a mainframe?

A. Use of a screen saver with a password

B. Prevention of booting from a diskette by removing the diskette drive

C. Encryption of data files

D. Automatic log-off of inactive users

D. Automatic log-off of inactive users

Automatic log-off of inactive data terminals may prevent the viewing of sensitive data on an unattended data terminal.

Screen savers do not prevent the viewing of data on an unattended data terminal.
Data terminals do not have diskette drives.
Encryption of data files will not prevent the viewing of data on an unattended data terminal.

99

Freely fluctuating exchange rates perform which of the following functions?

A. They automatically correct a lack of equilibrium in the balance of payments.

B. They make imports cheaper and exports more expensive.

C. They impose constraints on the domestic economy.

D. They eliminate the need for foreign currency hedging.

A. They automatically correct a lack of equilibrium in the balance of payments.

A floating (freely fluctuating) exchange rate is an exchange rate where a currency's value is determined on the foreign exchange markets without interference. Flexible exchange rates are considered to allow free, unhampered foreign trade by lessening the impact of foreign business cycles and eliminating balance-of-payment surpluses or deficits.

100

Product Cott has sales of $200,000, a contribution margin of 20%, and a margin of safety of $80,000. What is Cott's fixed cost?

A. $16,000

B. $24,000

C. $80,000

D. $96,000

B. $24,000

The contribution margin is sales revenue minus all variable costs. Fixed costs are not considered in calculating contribution margin.

Margin of safety is the excess of actual or budgeted sales over breakeven point sales. It is the amount by which sales could decrease before losses occur.

At sales of $200,000, Cott has a margin of safety of $80,000. Sales would be $120,000 at breakeven.

With sales of $120,000, the contribution margin toward fixed costs and profit is 20% of $120,000, or $24,000. However, there is zero profit at breakeven, so the contribution margin exactly equals fixed costs, which must be $24,000.