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Flashcards in BEC NINJA III Deck (100):
1

Which of the following information technology (IT) departmental responsibilities should be delegated to separate individuals?

A. Network maintenance and wireless access

B. Data entry and antivirus management

C. Data entry and application programming

D. Data entry and quality assurance


C. Data entry and application programming

2

Management of a company has a lack of segregation of duties within the application environment, with programmers having access to development and production. The programmers have the ability to implement application code changes into production without monitoring or a quality assurance function. This is considered a deficiency in which of the following areas?

A. Change control

B. Management override

C. Data integrity

D. Computer operations

A. Change control

Change control is the process of modifying application software, including requesting a change, reviewing the effectiveness of the change, approving the change, and implementing the change. Since programmers can implement application code changes without approval, there is a weakness in control over changes to application programs.

Management override refers to management not following controls that are properly designed and in force. Data integrity refers to accuracy of data entered into the program or processing of that data rather than the software itself. Computer operations refer to the management of the computer system running the application rather than the steps programmed into the software.

3

What does the audit committee of the board of directors oversee?

A. Formal job descriptions for employees in an organization
B. The financial reporting process in an organization
C. The responsibilities assigned to employees
D. The creation of standards

B. The financial reporting process in an organization

The audit committee of the board of directors oversees the following:

Financial reporting
Financial disclosure
Compliance with standards

4

Which of the following is most useful when risk is being prioritized?

A. Low- and high-probability exposures

B. Low- and high-degree loss exposures

C. Expected value

D. Uncontrollable risks

C. Expected value
Expected value is the sum of the outcomes (payoff) of each event multiplied by the probability of each event occurring. It combines the likelihood of each outcome with the payoff of that outcome, and so is a way of prioritizing alternatives while considering risk. None of the other answer choices consider both the likelihood and payoff of each alternative course of action.

5

Which one of the following is a sales forecasting technique?

A. Linear programming

B. Exponential smoothing

C. Queuing theory

D. Cost-volume-profit analysis

B. Exponential smoothing

Exponential smoothing is a statistical method that is useful as a sales forecasting technique. This forecasting procedure is a special type of weighted moving average: it is reverse geometric progression in which the effect of past events (in this case sales) is discounted based on some multiple so that the effect which the past event has on current projections decreases as the time since the event increases.

The other methods are not useful in forecasting sales:

Linear programming is a model for the allocation of scarce resources.
Queuing theory relates to the balancing of the cost of waiting with the cost of service; for example, the cost of lost sales resulting from long lines at the cash register versus the cost of opening another cash register.
Cost-volume-profit analysis is a model used to aid decision making relating to product lines, pricing of products, marketing strategy, and utilization of production facilities.

6

The business cycle refers to the continual ebb and flow of economic activity. No two cycles are exactly the same, but most are characterized by changes in the price level and the rate of employment and can be identified by common factors.

The trough of a business cycle is generally characterized by:

A. shortages of essential raw materials and rising costs.

B. rising costs and an unwillingness to risk new investments.

C. unused productive capacity and an unwillingness to risk new investments.

D. declining purchasing power and unused productive capacity.

C. unused productive capacity and an unwillingness to risk new investments.

At a business cycle's trough, a large portion of the nation's productive capacity often goes unused due to the depressed level of demand in the economy. Moreover, firms and individuals are hesitant to make new investments because the expected return is far less than what it would be if the economy were in an expansion. However, the trough of a business cycle is not characterized by any specific sort of behavior with respect to costs and purchasing power.

The Business Cycle Phases

a. The business cycle is characterized by four phases:
1. The “expansion” phase, where more resources become employed and actual output approaches potential output. In the extreme, there may be over-employment as workers work overtime and the utilization rate for plant and equipment exceeds normal levels. However, this cannot be sustained.
2. The “peak,” which is the highest point of output during the cycle. The economy is operating above the long-term growth trend of real GDP.
3. The “contraction” (or recession) phase, where more resources become unemployed and actual output falls below potential output.
4. The “trough,” which is the lowest point of output during the cycle. There are high unemployment rates, a decline in annual income, and overproduction. This is the time at which the real GDP stops declining and starts expanding.
b. A business cycle is measured as the period of time from the peak of one cycle through the four phases to the peak of the next cycle.


Done

7

The rate of unemployment caused by changes in the composition of employment opportunities over time is referred to as the:

A. frictional unemployment rate.
B. cyclical unemployment rate.
C. structural unemployment rate.

D. full employment unemployment rate.

C. structural unemployment rate.

Changes over time in consumer demand, and technology that alters the structure or composition of the demand for labor, both in terms of occupation and geographic opportunities, are referred to as structural unemployment.

Frictional unemployment is due to imperfections in the labor market and relates to workers searching for jobs or waiting to take jobs in the near future. Cyclical unemployment is caused by the recession phase of the business cycle, that is, by a decline in aggregate spending. The full employment unemployment rate is the sum of frictional and structural unemployment. Full employment does not mean zero unemployment.

Full Employment and the Natural Rate of Unemployment

a. Full employment is defined as the level of employment where the actual unemployment rate is equal to the natural rate of unemployment (NRU). At this point the economy would be producing its “potential output” with the economy operating at full capacity. The NRU occurs when the number of job seekers is equal to the number of job vacancies, and actual unemployment would be greater than zero due to frictional unemployment.
b. Cyclical and structural unemployment would cause the unemployment rate to exceed the NRU.
c. The NRU has fluctuated over time. During the 1950s, it was estimated to be in the range of 3.0% to 3.5%. It climbed to approximately 6.5% by the mid-1980s and has declined to the 5.0% range by the end of the 1990s. Key factors explaining the changes were:
1. Demographics—young adults and teenagers spent a larger portion of their time in the labor force looking for jobs, and their percentage of the population rose during the 1970s and then declined in the 1980s and 1990s.
2. Higher rates of imprisonment—the percentage of the male population that was imprisoned almost doubled to 2.3% in the period 1985–1998.
3. The use of temporary help enhanced by IT-based job matching has helped to reduce the NRU.

8

Most large-scale computer systems maintain at least three program libraries: production library (for running programs); source code library (maintains original source coding); and test library (for programs which are being changed). Which of the following statements is correct regarding the implementation of sound controls over computer program libraries?

A. Only programmers should have access to the production library.

B. Users should have access to the test library to determine whether all changes are properly made.

C. Only the program librarian should be allowed to make changes to the production library.

D. The computer operator should have access to both the production library and the source code library to assist in diagnosing computer crashes.

C. Only the program librarian should be allowed to make changes to the production library.

Allowing only the program librarian to make changes to the production library would appropriately restrict access to the program modules that are running.

Good control dictates that programmers cannot make undetected, unrecorded changes to data or programs. Thus, programmers should be restricted from accessing the production library.
Programmers should be responsible for making program changes and users should be responsible for testing the changes. It would be poor control to allow users to have access to the test library. It would decrease accountability, as well as the competence to make the changes.
If the operator had access to both program libraries, the operator would be in a position to make unauthorized and undetected changes to the computer programs.

9

When the economic order quantity (EOQ) model is used for a firm which manufactures its inventory, ordering costs consist primarily of:

A. insurance and taxes.

B. obsolescence and deterioration.

C. storage and handling.

D. production setup.

D. production setup.

The EOQ model formula attempts to minimize costs when faced with the trade-off between the cost to procure and the cost to hold inventory. The formula is the square root of the quotient of two times the annual demand multiplied by the order cost (or setup cost), divided by the annual unit carrying cost.

EOQ = Square root of (2DS/Ci)
Where:

D = Demand per year in units
S = Production setup or ordering cost per order
C = Cost per unit
i = Carrying cost, expressed as a percentage of inventory cost
(C × i is the carrying cost per unit.)
Costs to procure inventory are ordering cost for a reseller and production setup costs for a manufacturer.

10

Contingency planning alternatives can vary by computer processing environment. A company is least likely to use a reciprocal processing agreement for:

A. small systems.

B. large batch operations.

C. online teleprocessing facilities.

D. small batch operations.

C. online teleprocessing facilities.

Online teleprocessing would generally not involve a reciprocal processing agreement.

Reciprocal processing agreements are often used for small systems, large batch operations, and small batch operations.

11

The Internet is made up of a series of networks that include:

A. gateways to allow mainframe computers to connect to personal computers.

B. bridges to direct messages through the optimum data path.

C. repeaters to physically connect separate local area networks (LANs).

D. routers to strengthen data signals between distant computers.

A. gateways to allow mainframe computers to connect to personal computers.

Gateways connect Internet computers of dissimilar networks.

Routers determine the best path for data.
Bridges connect physically separate LAN's.
Repeaters strengthen signal strength.

12

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

13

Adle Supply Company recently installed an integrated order-entry and invoicing system. The basic inputs to the system consist of one record for each line on the customers' orders, the inventory master file, and the customer master file. Individual items ordered by the customer may be rejected at the computer entry audit or when the items are validated by comparing them with data in the inventory master file. Complete orders may be rejected when data from the orders are compared with data in the customer master file. All orders that are found to be valid are posted to the inventory and customer files. For data control personnel to account for all inventory items and customer orders processed, the system should include:

A. echo checks.

B. run-to-run control totals and error lists.

C. manual processing of invalid transactions.

D. printing the status of the master records before and after processing the applications.

B. run-to-run control totals and error lists.

14

The business environment includes several types of business risk. One type of business risk is systemic risk. Systemic risk is also called ________ risk.

A. credit

B. default

C. liquidity

D. market

D. market

Systemic risk is security-related risk that cannot be totally eliminated through diversification. It includes market factors such as inflation, recession and interest rate fluctuations. Another name for systemic risk is market risk.

15

In a process cost system, the application of factory overhead usually would be recorded as an increase in:

A. finished goods inventory control.

B. factory overhead control.

C. cost of goods sold.

D. work-in-process inventory control.

D. work-in-process inventory control.

Process costing is a system of accounting for production in which costs are assigned to units of finished goods indistinguishable from each other and produced in a continuous process.

During the process, raw material cost, direct labor cost, and applied overhead increase the work-in-process inventory account. As units are finished, the cost of those units reduces work-in-process and increases the finished goods account.

"Finished goods inventory control" is incorrect because overhead is applied as work is performed, not when units are finished. "Factory overhead control" is incorrect because the application of overhead to work-in-process would increase work-in-process, not the factory overhead control account. "Cost of goods sold" is incorrect because the application of overhead does not affect cost of goods sold. The overhead applied will be included in work-in-process, which is transferred to finished goods, which is then transferred to cost of goods sold as the goods are sold, but cost of goods sold is not affected when overhead is applied to work-in-process.

16

Which of the following is a technique for assessing the potential effect of risk in a capital budgeting project?

A. Sensitivity analysis

B. Adjusting required rate of return

C. Adjusting estimated future cash inflows

D. All of the answer choices are correct.

D. All of the answer choices are correct.

Sensitivity analysis involves testing the effects of various assumptions. Adjusting the required rate of return involves increasing the rate for more risky projects. Similarly, adjusting estimated future cash flows is to make them more conservative for more risky projects. Thus, all of these are techniques for dealing with risk in capital budgeting projects.

17

The following information is for the Just Made It Company in regard to a ziget used in the production process.


Highest number of units expected to be needed in a day 1,600 units
Lowest number of units expected to be needed in a day 1,000 units
Lead time 5 days
Safety stock 2,000 units
Calculate the replenishment point (order point).

A. 8,000 units

B. 6,500 units

C. 7,000 units

D. 8,500 units

D. 8,500 units


The equation for the replenishment point is as follows:


RP = (Average daily use x Lead time in days) + Safety stock
= (((1,600 + 1,000) / 2) x 5 days) + 2,000
= 8,500 units

18

Bander Co. is determining how to finance some long-term projects. Bander has decided it prefers the benefits of no fixed charges, no fixed maturity date, and an increase in the creditworthiness of the company. Which of the following would best meet Bander's financing requirements?

A. Bonds

B. Common stock

C. Long-term debt

D. Short-term debt

B. Common stock

Long-term debt including bonds has both fixed interest charges and maturity dates. Although short-term debt does not have fixed changes, these amounts have to be repaid within the current period.

Common stock increases the equity position of a company and can provide a basis for increasing debt—or in other words, the issuance of common stock increases the creditworthiness of a company.

19

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.

20

In the definition of fair value as presented in FASB ASC 820, the principal market is considered to be a market where:

A. the holder of the asset or liability could find the greatest volume of asset sales or liability transfers of items similar to the one being valued.

B. the holder of an asset could maximize the price received in an asset sale or minimize the transfer costs in the conveyance of a liability.

C. the buyer and seller are not related parties and both have usual and customary knowledge of the items being transferred.

D. all transfer costs rest solely with either the buyer or the seller.

A. the holder of the asset or liability could find the greatest volume of asset sales or liability transfers of items similar to the one being valued.

Under the fair value assumption as presented in FASB ASC 820, the hypothetical transaction is considered to have occurred in either the principal market for transactions similar to the subject of the valuation or the most advantageous market if a principal market does not exist. The principal market is considered to be one where the holder of the asset or liability being valued could find the greatest volume of similar transfers. The most advantageous market is one where the holder of an asset could maximize the price received in an asset sale or minimize the transfer costs in the conveyance of a liability.

The characteristics of the hypothetical parties to the transaction as being unrelated and having usual and customary knowledge of the items being transferred do not define the principal market involved in the hypothetical transaction.

Fair Value Basics

a. As part of the FASB's Convergence Project working with the IASB (International Accounting Standards Board) as well as other standard-setting bodies to work towards compatible international reporting requirements, the FASB issued Fair Value Measurements and Disclosures (FASB ASC 820) to clarify the definition of fair value as well as to provide guidelines for measuring fair value. Per this statement, fair value is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” (FASB ASC 820-10-35-2)
b. Since the calculation of fair value assumes that the value determination is for a particular asset, liability, or equity ownership, the following items must be taken into consideration (FASB ASC 820-10-35):
(1) Age and condition of the valuation object
(2) Attributes for the valuation object
(3) Ability of the valuation object to stand alone or the need to function as part of a unit
(4) Location of the valuation object
(5) Restriction placed on the use or sale of the valuation object
c. In determining the price under a fair value assumption, the conditions under which the hypothetical sale are assumed to occur would be orderly and not under conditions of liquidation or distress. The seller would be able to take advantage of normal market activities and would have the ability to take enough time prior to the date of measurement to take advantage of normal exposure to the market given the item being valued. (FASB ASC 820-10-35-3)
d. Under fair value assumptions, the hypothetical transaction is considered to have occurred in either the principal market for the subject transaction or, in the absence of such a market, in the most advantageous market for that transaction. The principal market is considered to be where the holder of the transaction asset or liability could locate the greatest volume of similar transfers. The most advantageous market is considered to be where either the sales price for an asset can be maximized or the transfer costs for a liability can be minimized. Note that these hypothetical transfers are considered from the perspective of the holder of the asset or liability. Also, if there is a principal market for the subject item, then the fair value measurement is determined using that market even if the most advantageous market would yield a more beneficial transfer for the holder. (FASB ASC 820-10-35-5)
e. The market participants to be considered when determining fair market value are the actual holder of the asset or liability being valued and the hypothetical buyer in the principal (or most advantageous) market. Characteristics for both the buyer and seller would include (FASB ASC 820-10-35):
(1) Buyer and seller are not related parties (independence).
(2) Both parties are knowledgeable about the item being transferred and have access to usual and customary information.
(3) Both parties have the ability to complete the transaction.
(4) Both parties are willing to complete the transaction but are not being forced to do so.
f. A fair value measurement assumes that the item being valued will be put to the highest and best use resulting in the maximization of value that would be physically possible, legally permissible, and financially feasible. Note that the highest and best use is not determined from the perspective of the current holder but by the hypothetical market participants. (FASB ASC 820-10-35-10)
g. The fair value determination of an asset uses either an in-use or an in-exchange premise. An in-use premise assumes that the maximum value from the purchaser's perspective of the subject asset is when it is used in conjunction with other assets as a group. An in-exchange premise assumes that the maximum value from the purchaser's perspective of the subject asset is when it is used alone. (FASB ASC 820-10-35-10)
h. The fair value determination of a liability assumes that the liability will continue to exist after the transfer and maintain the same risk of nonperformance after the transfer as before. (FASB ASC 820-10-35 and 10-36)

21

Devices that are used only to perform sequential file processing will not permit:

A. data to be edited on a separate computer run.

B. data to be edited in an offline mode.

C. batch processing to be initiated from a terminal.

D. data to be edited on a real-time basis.

D. data to be edited on a real-time basis.

Using a sequential file organization, data is placed in the file using a key or code for sequencing. Sequential data can only be accessed after all preceding data records have been passed.

Hence, it is impossible to edit the data on a real-time basis.

Master files can be updated in three ways:

1. Batch Processing is updating master files periodically to reflect all transactions that occurred during a given time period. The master file is updated at set times (such as hourly or daily) or whenever a manageable number (50 to 100, for example) of transactions are gathered. Transaction data can be entered as a batch or as each transaction occurs (called online batch processing).

The first step in batch processing is to sort the transaction file so it is in the same sequential order as its corresponding master file. For example, before updating the accounts receivable master file, the transaction file containing sale and payment transactions should be sorted so that it is in customer number order. Then the computer:
a. reads a transaction file record and/or an old master file record.
b. when the primary keys match, updates the old master file record.
c. creates a new master file with the updated master file records and the old master file records that are not updated.
d. repeats the update process.


Batch processing is primarily used for applications, like payroll, where all or most records need to be updated. Its advantage is efficiency in processing. Its disadvantages are that the only time the master files are current is immediately after the update and that errors can occur in the processing even when the job completes that might not be apparent to the user.
2. Online, Real-Time Processing
a. Online, real-time processing is where the computer:
(1) captures data electronically, edits it for accuracy and completeness, and updates the master file as each transaction occurs.
(2) processes information requests from users by locating the desired information in the data files and displaying it in the specified format.


Unlike batch processing, transaction file records can be in any order. When a transaction occurs, the computer uses the primary key of the transaction file (such as account number) to search the master file for the desired record. The appropriate record is retrieved, updated, and written back to the master file. Unlike batch processing, which creates a new master file, online processing does not create a new master file—it merely updates the existing master file.
b. Most companies use online, real-time processing for most applications because:
(1) master file information is always current and results in better decision making.
(2) online data entry is more accurate than batch processing because:
(a) the system can refuse incomplete or erroneous entries.
(b) since data is entered as the transaction occurs, errors can be easily corrected.
3. Online Batch Processing is a combination of the above two approaches, where transaction data is entered when the event occurs but processed later in batches.


Done

22

Corporate intranets are typically characterized by ________ as compared to local and wide area networks.

A. higher security risk and higher cost

B. higher security risk and lower cost

C. lower security risk and higher cost

D. lower security risk and lower cost

B. higher security risk and lower cost

Intranets are private networks that behave in much the same manner as the Internet. They are subject to higher security risks but are less costly to operate than local or wide area networks

Internet Technologies

a. The Internet is a worldwide web of interlinked computers and networks. An incredible amount of information and services are available to Internet users. The Internet facilitates e-business and makes it more cost effective by eliminating the need for companies and consumers to use VANs and special telephone lines to exchange information.
b. Internet service providers (ISPs) own and maintain portions of the Internet backbone and provide access to the Internet.
c. Browsers make it possible for users to easily navigate through vast amounts of information found on the Internet.
d. An intranet is a company-specific internal network that is navigated with Internet browser software. Intranets significantly reduce the costs of disseminating and sharing information and increase the effectiveness of operations. These benefits can be magnified by giving suppliers and customers limited access to company intranets.
e. Extranets link the intranets of two or more companies. Access to extranets is typically limited to trusted trading partners.
f. A gateway, often implemented via software, translates between two or more different protocol families and makes connections between dissimilar networks possible.
g. An application service provider (ASP) uses the Internet to rent software programs to its customers.
(1) Using an ASP has several advantages:
(a) Customers significantly reduce the costs associated with purchasing software because the ASP spreads its costs among its many customers.
(b) Customers do not have to purchase expensive hardware to run the latest and greatest software.
(c) Customers can always have the most current software.
(d) Customers can achieve greater security and privacy protection if the ASP uses better and more elaborate controls than does the customer.
(2) The major disadvantages of the ASP model are:
(a) Customers must rely on the ASP for essential business services. If an ASP goes out of business, its customers are in a very precarious position.
(b) Customers face the very real risk that sensitive data can be compromised since ASPs serve many different customers (possibly even direct competitors).


23

A U.S. parent company is reviewing the cash flows from its international subsidiaries. In addition to exchange rate risk, which of the following items would be a primary consideration in the company's cash flow analysis?

A. Repatriation restrictions

B. American depository receipts

C. Default risk premium

D. Foreign trade deficit

A. Repatriation restrictions

American depository receipts is a negotiable security that replaces securities of non-U.S. firms traded on U.S. markets.

Repatriation is converting a foreign currency into the local currency.

24

Zig Corp. provides the following information:

Pretax operating profit $300,000,000
Tax rate 40%
Capital used to generate profits 50% debt, 50% equity $1,200,000,000
Cost of equity 15%
Cost of debt 5%

What of the following represents Zig's year-end economic value added amount?

A. $0

B. $60,000,000

C. $120,000,000

D. $180,000,000

B. $60,000,000

The economic value added amount (EVA) is calculated by multiplying the capital employed at the beginning of the period by the difference between the return on capital employed (RCOE) and the weighted average cost of capital (WACC). Since a company is worth its book value if the RCOE is equal to its WACC, the positive difference between the two would be the percentage by which the value of the business is increased.

EVA is the income earned in excess of the normal rate of return represented by the WACC. Since the debt and equity proportions are each 50%, the WACC is 10% ((15% + 5%) ÷ 2).

Capital $1,200,000,000
WACC x 0.10
Normal return $ 120,000,000
Net income after tax ($300,000,000 x 0.60) 180,000,000
EVA ($180,000,000 - $120,000,000) $ 60,000,000

25

Which of the following Federal Reserve policies would increase money supply?

A. Change the multiplier effect

B. Increase reserve requirements

C. Reduce the discount rate

D. Sell more U.S. Treasury bonds

C. Reduce the discount rate

One of the duties of the Federal Reserve System is to establish monetary policy by influencing monetary and credit conditions in our economy. The Federal Reserve can influence the availability and cost of money and credit through actions that it can take.

There are three basic tools available to the Fed to affect monetary policy:

Purchasing and selling U.S. Treasury and federal agency securities. Purchasing increases the money supply and selling decreases the money supply.
Changing the interest rate charged to commercial banks and other depository institutions on loans they receive from the Fed. Increasing the interest rate decreases the money supply, and decreasing the interest rate increases the money supply.
Changing the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. Increasing the reserve requirement decreases the money supply, and decreasing the reserve requirement increases the money supply.

26

Mig Co., which began operations this year, produces gasoline and a gasoline byproduct. The following information is available pertaining to current-year sales and production:


Total production costs to split-off point $120,000
Gasoline sales 270,000
Byproduct sales 30,000
Gasoline inventory, end of year 15,000
Additional byproduct costs:
Marketing 10,000
Production 15,000
Mig accounts for the byproduct at the time of production. What are Mig's current-year cost of sales for gasoline and the byproduct?

A. Gasoline: $105,000; Byproduct: $25,000

B. Gasoline: $115,000; Byproduct: $0

C. Gasoline: $108,000; Byproduct: $37,000

D. Gasoline: $100,000; Byproduct: $0

D. Gasoline: $100,000; Byproduct: $0

Total production costs to split-off point $120,000
Less:
Byproduct sales $30,000
Marketing costs (10,000)
Additional production costs (15,000)
--------
Cost recovery from byproduct 5,000
--------
Production cost allocated to gasoline 115,000
Less gasoline inventory, end of year 15,000
--------
Cost of sales of gasoline $100,000
========
There is no cost of sales for byproduct because the excess of sales over additional cost related to byproduct is treated as a reduction in cost of the main product, gasoline.

27

Companies today often have bank accounts spread out over several different banks within their operating areas. This presents a problem in monitoring and controlling cash levels. In order to deal with this issue, some companies have cash transferred to a single concentration bank. The device used to accomplish these transfers is:

A. commercial paper.

B. depository transfer checks.

C. e-mail.

D. trade credit.

B. depository transfer checks.

Depository transfer checks, also called official bank checks, are used to transfer funds from local banks to single company accounts at a concentration bank.

Depository Transfer Checks (DTCs) are official bank checks that provide a means of moving funds from one account to another within the banking system. A DTC is payable to a particular account in a particular bank.
1. The payer prepares and mails a DTC.
2. The DTC is deposited by the payee (often through the use of a lockbox).
3. The DTC is sent to a concentration bank that serves as a clearing house for funds within the banking system. Often the lockbox is located at the concentration bank as a means of speeding up the collection process.
4. The concentration bank begins the clearing process by sending the check to the central bank.
5. Ultimately, the funds are deducted from the payer's account when the payer's bank is notified of the funds transfer.
b. Float is the difference between the company's checkbook balance and the bank's balance. It represents the net effect of checks in the process of collection. Checks written by the firm create disbursement float and reduce the book cash. Checks received and deposited by the firm create collection float and increase the book balance. As checks are cleared, the bank cash position is reconciled to the book cash position.


Done

28

Controllable revenue would be included in a performance report for:

A. a profit center.

B. a cost center.

C. both a profit center and a cost center.

D. neither a profit center nor a cost center.

A. a profit center.

The performance report of a profit center would appear as follows:


Controllable revenue XXX
Less Controllable costs XX
---
Profit center income XX
===
Note that controllable revenue does appear in this performance report. On the other hand, only controllable costs appear in the cost center performance report.

Responsibility accounting: Segmented reporting is useful in the management and control of an enterprise. It is consistent with the concept of responsibility accounting. Responsibility accounting breaks the company into responsibility centers according to the ability of individuals to control various activities. Accounting reports are then prepared for each responsibility center consistent with the assignment of responsibility. There are three types of responsibility centers:

1. Cost centers: Subdivisions of a business that are assigned responsibility for the incurrence and proper utilization of costs.
2. Profit centers: Subdivisions responsible for both costs and revenues.
3. Investment centers: Subdivisions responsible for costs, revenues, and profitable utilization of invested capital.

29

To avoid invalid data input, a bank added an extra number at the end of each account number and subjected the new number to an algorithm. This technique is known as:

A. optical character recognition.

B. a check digit.

C. a dependency check.

D. a format check.

B. a check digit.

A check digit is an extra reference number that follows an identification code and bears a mathematical relationship to the other digits. This extra digit is input with the data. The identification code can be subjected to an algorithm and compared to the check digit.

30

In calculating the breakeven point for a multiproduct company, which of the following assumptions are commonly made when variable costing is used?

Sales volume equals production volume.
Variable costs are constant per unit.
A given sales mix is maintained for all volume changes.

A. I and II

B. I and III

C. II and III

D. I, II, and III

C. II and III

When performing cost-volume-profit (CVP) analysis, a standard assumption is that variable costs are constant per unit. In addition, if multiple products are involved, it becomes necessary to assume that the sales product mix will remain constant. Thus II, variable costs are constant per unit, and III, a given sales mix is maintained for all volume changes, must occur. There is no reason that sales volume must equal production volume (I).

The inherent simplifying assumptions used in CVP analysis are the following:

Costs and revenues are predictable and are linear over the relevant range.
Total variable costs change proportionally with the activity level. Variable costs per unit are constant.
Changes in inventory are insignificant.
Total fixed costs are constant over the relevant range of volume.
Production equals sales or units produced equals units sold.
The product mix is constant, or the firm has only one product.
A relevant range exists in which the various relationships are true.
All costs are either fixed or variable; i.e., costs can be separated into fixed and variable elements.
Productivity and efficiency are constant.
The sales mix remains constant.
Selling prices and unit variable costs are constant. Selling price does not change with the activity level.
The breakeven point is directly related to costs and indirectly related to the budgeted margin of safety and the contribution margin.
Breakeven analysis is based upon several simplified assumptions. Included in these assumptions is that variable costs are constant per unit and, for a multiproduct company, that a given sales mix is maintained for all volume changes. When absorption costing is used, operating income is a function of both production volume and sales volume. This is because an increase in inventory levels causes fixed costs to be held in inventory while a decrease in inventory levels causes fixed costs to be charged to cost of goods sold. These fluctuations can dramatically affect income and the breakeven point. On the other hand, when variable costing is used, the same amount of fixed costs will be deducted from income whether or not inventory levels fluctuate. As a result, the breakeven point will be the same even if production does not equal sales. Hence, operating income under variable costing is a function only of sales, and assumption I is incorrect.

31

Canseco Enterprises uses 84,000 units of Part No. 256 in manufacturing activities over a 300-day work year. The usual lead time for the part is six days; occasionally, the lead time has gone as high as eight days. The company now wants to implement a safety stock policy (it presently has none). The safety stock size, the likely effect on stockout costs, and the likely effect on carrying costs, respectively, would be:

A. 560 units, decrease, increase.

B. 560 units, decrease, decrease.

C. 1,680 units, decrease, increase.

D. 1,680 units, increase, no change.

A. 560 units, decrease, increase.


84,000
Daily usage = -------- = 280 units
300 days

Safety Maximum Usual Daily
stock = (lead time - lead time) x usage

= (8 days - 6 days) x 280 units
= 560 units
As a result of the two days' safety stock the likelihood of a stockout and incurrence of stockout costs will decrease.

However, because of the additional 560 units carried in inventory, inventory carrying costs will increase.

32

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.

33

If a database has integrity, this means that the:

A. software was implemented after extensive acceptance testing.

B. database has only consistent data.

C. database is secure from accidental entry.

D. incidence of failure for the database was within statistically acceptable limits.

B. database has only consistent data.

Integrity is the protection of data from unauthorized tampering. The system accomplishes its objectives in an unimpaired manner: processing is complete, accurate, timely, and free from unauthorized or inadvertent system manipulation.

34

Which of the following is correct?

A. Short-term credit can be obtained more quickly than long-term credit, but long-term credit is more flexible.

B. Short-term credit is generally less costly than long-term credit due to the prepayment penalties associated with long-term credit.

C. The shape of the yield curve implies that interest costs will generally be higher using long-term credit than short-term credit.

D. Short-term credit can generally be obtained quicker than long-term credit; however, short-term credit holds more risk due to the need to renew more often.

D. Short-term credit can generally be obtained quicker than long-term credit; however, short-term credit holds more risk due to the need to renew more often.

Short-term credit can generally be obtained quicker than long-term credit.
Generally short-term credit is more flexible than long-term credit.
Short-term credit is generally less costly than long-term credit as shown by the yield curve.
Prepayment penalties are generally associated with long-term credit, but these penalties are not the basic reasons for a higher cost for long-term credit.
Short-term credit holds more risk than long-term credit due to the need to renew more often.

35

What is the effect on prices of U.S. imports and exports when the dollar depreciates?

A. Import prices and export prices will decrease.

B. Import prices will decrease and export prices will increase.

C. Import prices will increase and export prices will decrease.

D. Import prices and export prices will increase.

C. Import prices will increase and export prices will decrease.

As the dollar depreciates, the demand for the dollar decreases. This means that its value decreases in terms of the value of other currencies. It takes more dollars to buy the same amount of foreign currency and foreign goods. This means that the prices of imports increase. In the same manner, prices of U.S. exports decrease as the dollar depreciates.

36

Edwards Manufacturing Corporation uses the standard economic order quantity (EOQ) model. If the EOQ for Product A is 200 units and Edwards maintains a 50-unit safety stock for the item, what is the average inventory of Product A?

A. 250 units

B. 150 units

C. 100 units

D. 50 units

B. 150 units

Economic Order Quantity

a. The economic order quantity is the least amount of inventory that should be ordered given the various costs involved. The Economic Order Quantity Model (EOQ) provides a formula for determining the quantity of a particular inventory item that should be ordered in order to minimize inventory costs.
EOQ = Square root of (2DS/Ci)
b. Relevant items in determining the economic order quantity:

D = The demand per year in units

S = Setup or ordering cost per order or batch

C = The cost per unit

i = The carrying costs expressed as a percentage of inventory cost
c. Inventory decision models contain costs that move in opposite directions. Carrying costs increase as the size of the order increases. Set-up or ordering costs, however, decrease as the size of the production run or order increases. The EOQ model seeks to minimize the combined total of these two costs.
d. Assuming that there is constant demand and no change in lead time, the reorder point is equal to the sum of expected units of demand during the lead time plus any required safety stock.

The formula for the reorder point (RP) is:
RP = D + SS
LT

D = the average demand during the lead time period. This can
LT be calculated by determining the demand per day and
multiplying that result by the number of days in the
lead time.

SS = the safety stock required
e. Illustration: Use the following data to compute the economic order quantity and reorder point assuming 300 business days per year.
Demand (D) 40,000 units per year
Unit Cost (C) $50
Carrying Cost Rate (i) 20% per year
Order Cost (S) $115 per order
Lead Time (LT) 3 days
Safety Stock (SS) 500 units

Solution:
EOQ = Square root of (2DS/Ci)

= Square root of ((2 x 40,000 x $115) / ($50 x 20%))
= 960 units

RP = D + SS
LT

= ((40,000 units / 300 days) x 3 days) + 500 = 900 units

37

What is the effect when a foreign competitor's currency becomes weaker compared to the U.S. dollar?

A. The foreign company will have an advantage in the U.S. market.

B. The foreign company will be disadvantaged in the U.S. market.

C. The fluctuation in the foreign currency's exchange rate has no effect on the U.S. company's sales or cost of goods sold.

D. It is better for the U.S. company when the value of the U.S. dollar strengthens.

A. The foreign company will have an advantage in the U.S. market.

As a foreign competitor's home currency becomes weaker compared to the U.S. dollar, the competitor's product becomes less expensive for American consumers, providing the firm with an advantage since more of a particular product will be purchased as it becomes relatively cheaper for the consumer.

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.


38

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.

39

Which of the following actions is the acknowledged preventive measure for a period of deflation?

A. Increasing interest rates

B. Increasing the money supply

C. Decreasing interest rates

D. Decreasing the money supply

B. Increasing the money supply

Deflation, or negative inflation, occurs when prices fall because the supply of goods is higher than the demand for those goods. This is usually due to a reduction in money, credit, or consumer spending. Deflation can occur as a result of a combination of four factors: the supply of money goes down; the supply of other goods goes up; demand for money goes up; or demand for other goods goes down.

To prevent deflation, the opposite actions (i.e., inflationary actions) must take place: increase the money supply; decrease the supply of other goods; decrease the demand for money; or increase the demand for other goods.

The only correct answer choice is increasing the money supply. When the Federal Reserve (the Fed) takes action to increase the money supply, it begins a cycle whereby interest rates decrease and the demand for goods and services increases. Eventually this creates inflationary pressure on the economy, and the Fed then begins to implement deflationary policies.

40

Using a real options approach in capital investments planning helps managers in dealing with which of the following?

A. Competitors

B. Prolonged strikes

C. Tax issues

D. Uncertainty

D. Uncertainty

41

Which one of the following statements concerning cash flow determination for capital budgeting purposes is incorrect?

A. Tax depreciation must be considered since it affects cash payments for taxes.

B. Book depreciation is relevant since it affects net income.

C. Sunk costs are not incremental flows and should not be included.

D. Net working capital changes should be included in cash flow forecasts.

B. Book depreciation is relevant since it affects net income.

Depreciation itself is not a cash outflow. Depreciation is relevant for capital budgeting purposes only because it affects the income upon which taxes must be assessed. Taxes are a cash outflow. Therefore, only tax depreciation is relevant. Book depreciation is not relevant despite its effect on net income.

42

Kode Co. manufactures a major product that gives rise to a byproduct called May. May's only separable cost is a $1 selling cost when a unit is sold for $4. Kode accounts for May's sales by deducting the $3 net amount from the cost of goods sold of the major product. There are no inventories. If Kode were to change its method of accounting for May from a byproduct to a joint product, what would be the effect on Kode's overall gross margin?

A. No effect

B. Gross margin increases by $1 for each unit of May sold

C. Gross margin increases by $3 for each unit of May sold

D. Gross margin increases by $4 for each unit of May sold

B. Gross margin increases by $1 for each unit of May sold

When May is treated as a byproduct, its $3 net realizable value (i.e., $4 - $1) is subtracted from the main product cost so only that $3 is included in the computation of gross profit for the main product.

However, when May is treated as a joint product the entire $4 selling price enters into the computation of gross margin. The $1 is not subtracted in computing gross margin. This $1 shows up in selling costs which appear after the computation of gross margin.

The effect of a change from byproduct to joint product status is a $1 increase in gross margin. It should be noted that bottom line net income does not change, however.

43

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

Using absorption costing, what is Augusta’s budgeted income for the period?

A. $95,000

B. $140,000

C. $305,000

D. $350,000

A. $95,000

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 inventoriable costs and are expensed through cost of goods sold when the units are sold.

-Dividing 70,000 units to be produced into $210,000 of manufacturing fixed costs gives $3 per unit produced.
-Production costs include materials of $3, other variable costs of $2, and fixed costs of $3, for a total of $8 per unit.
-Selling 70,000 units at $11 each results in revenue of $770,000.
-Cost of sales is 70,000 units at $8, or $560,000.
This leaves a gross profit of $210,000 ($770,000 − $560,000).
-Selling and administrative costs include the variable costs of 70,000 units at $1 each, or $70,000, plus fixed costs of $45,000, for a total of $115,000.
-Subtracting $115,000 of selling and administrative costs from gross profit of $210,000 leaves a net profit of $95,000.

44

Carol and Jane were sitting in the local coffee shop discussing Jane's possible strategies for constructing her investment portfolio. Carol suggested that Jane spend time reviewing the financial information for stocks she might consider purchasing and do some ratio analysis once she had obtained the information, but at the same time, it probably wouldn't be a good idea for Jane to attempt to predict the future movements of the markets. Jane said that she would think about these suggestions, but that she had come to believe the best approach would be for her to do her analysis using charts based on the historic market data using price and trading volume to predict the future movement of stock prices. Someone overhearing this conversation would believe that Jane wanted to use ________ and did not believe in the ________.

A. passive management techniques; strong form of the efficient market hypothesis

B. beta; fundamental analysis

C. technical analysis; weak form of the efficient market hypothesis

D. asset allocation techniques; fundamental analysis

C. technical analysis; weak form of the efficient market hypothesis

Technical analysis involves analyzing past market data of price and volume movements to attempt to determine future price movements of individual securities. The weak form of the efficient market hypothesis suggests that information about past prices would not be of use in predicting future performance, and therefore technical analysis would not be a viable technique to use.

Fundamental analysis uses factors specific to a firm, such as financial statements, ratio analysis, projected earnings growth, and dividend yield in an attempt to find undervalued securities.

45

Which of the following indicates that the economy is in a recessionary phase?

A. The rate of unemployment decreases.

B. The purchasing power of money declines rapidly.

C. Potential national income exceeds actual national income.

D. There is a shortage of essential raw materials and costs are rising.

C. Potential national income exceeds actual national income.

Net national income is the sum of the four components of factor income: wages, rent, interest, and profits. It is factor incomes generated by the production of final output. Net national income is a measure of national income computed by the income approach to national income accounting. It is a component of GNP and a macroeconomic concept.

NI = the sum of factor income = Wages + Rent + Interest + Profits.

Addition of indirect taxes less government subsidies gives NNP (net national product) at market prices.


GNP at market prices
- Capital consumption allowance (depreciation)
= NNP (at market prices)
- Indirect taxes, net of subsidies
= NI (at factor cost)
- Retained earnings and business taxes
+ Transfer payments to households
= Personal income
- Personal income taxes
= Disposable income

Potential national income is the amount of output that would be produced if all productive resources were fully employed; i.e., there is frictional unemployment and some structural unemployment as workers transition to new skills and geographic locations. It also assumes that factories and equipment are being used at normal (not maximum) capacity (factories are operating at approximately 85%–87% capacity). Potential national income is very difficult to measure because it cannot be measured directly. It is independent of the price level and is compared to actual real national income to determine the GNP gap. It is macroeconomic concept.

Increases in potential income/potential GNP result from economic growth.

46

Managers of local offices of an international consulting firm need better access to human resource data for their offices' employees than they have now from the consolidated database at the firm's headquarters. A distributed database, in which data about individuals would reside on computers at local offices but would be accessible to managers worldwide, has been proposed. A risk of the proposed arrangement is that:

A. segregation of incompatible duties might not be maintained at the firm's headquarters.

B. the data might not be updated as quickly as with the centralized system.

C. database integrity might not be preserved during a network or computer failure.

D. the data are more vulnerable to outsiders than with the centralized system.

C. database integrity might not be preserved during a network or computer failure.





Database integrity might not be preserved during a network or computer failure because of the complexity of updates, the time delays when multiple sites are involved, and the number of nodes to be coordinated.

Segregation of incompatible duties at the headquarters is independent of and imposes no risk on distributing the database.
Since the database would be distributed to the local offices, it is likely that data would be updated more quickly than before.
Both the centralized and distributed systems permitted access to all data, so if access security is maintained at the same levels, there should be no difference in the vulnerability of the database to outsiders.

47

Client/server architecture may potentially involve a variety of hardware, systems software, and application software from many vendors. The best way to protect a client/server system from unauthorized access is through:

A. a combination of application and general access control techniques.

B. use of a commercially available authentication system.

C. encryption of all network traffic.

D. thorough testing and evaluation of remote procedure calls.

A. a combination of application and general access control techniques.

ince there is no “perfect solution,” a combination of application and general access control techniques is the best way to protect a client/server system from unauthorized access.

Authentication systems, such as Kerberos, are only a part of the solution.
Encryption of all network traffic only affects general access control techniques.
Testing and evaluation of remote procedure calls (RPCs) may be a small part of an overall security review.

Application controls:

a. are designed to prevent, detect, and correct transaction errors;
b. ensure the integrity of a specific application's inputs, stored data, programs, data transmissions, and outputs; and
c. are much more effective when there are good general controls.

When application controls are weak, the information system is more likely to produce information that contains errors and leads to poor management decisions. This can negatively affect relationships with customers, suppliers, and other external parties.

The following six categories of controls can improve system integrity:

1. Source data controls
2. Input validation routines
3. Online data entry controls
4. Data processing and storage controls
5. Output controls
6. Data transmission controls

48

Which of the following statements is true regarding opportunity cost?

A. Opportunity cost is recorded in the accounts of an organization that has a full costing system.

B. The potential benefit is not sacrificed when selecting an alternative.

C. Idle space that has no alternative use has an opportunity cost of zero.

D. Opportunity cost is representative of actual dollar outlay.

C. Idle space that has no alternative use has an opportunity cost of zero.


An opportunity cost is the lost inflow of the next best alternative that is forgone as the result of a decision. Although opportunity costs are important in the decision-making process, they are not included as actual costs in financial statements.

For example, a company has idle space that could be used for the production of a new product or could be rented to a third party. If the production of a new product is considered, then the lost rental income would be an opportunity cost that would have to be considered during the decision-making process. If idle space has no alternative use, it has an opportunity cost of zero.

Relevant Costs for Decision Making

a. The function of decision making is to select future courses of action that will achieve maximum profits (highest net revenue) for the firm in the future. The analysis can be based on an individual project approach or an incremental cost or revenue approach. Under the individual project approach, the total costs or revenues of each project are first computed, and the project with the lowest cost or highest revenue is selected. When the incremental approach is used, the incremental or added costs to move to the alternative proposal are subtracted from the incremental revenue provided by it. If the result is positive, it is considered a desirable alternative.
b. Critical in management decision making is the understanding that sunk (past) costs are irrelevant. Relevant costs for decision making are expected future costs that will differ among alternatives available to the firm. Historical costs are useful only as they help predict the future.
1. The book value of old equipment is not relevant since it is an historic cost. Nothing can change what has already been spent.
2. The current disposal price of old equipment is relevant since expected future cash flows will differ among alternatives. (Replacing vs. Keeping)
3. The gain or loss on sale (or disposal) of equipment is irrelevant to decision making since this is merely an algebraic difference between book value and disposal price. Note, however, that any tax consequences resulting from the gain or loss from the sale would be relevant.
4. The cost of new equipment is relevant since expected cash outflows will differ between alternatives.
5. Fixed costs that will not change among alternatives are irrelevant. Fixed costs that will be eliminated or added due to the project under consideration are relevant.
6. Variable costs are relevant if they differ among alternatives (per unit cost) or if production volume is changed (change in total cost).
7. The timing of expected future costs and revenues is relevant to decision making due to the time value of money. The use of discounted cash flow methods will take timing issues into consideration.
8. Illustration: An uninsured machine costing $50,000 is destroyed the first day. There are two alternatives—(a) dispose of it for $5,000 and replace it with another machine for $51,000 or (b) rebuild it to original state for $45,000. Which alternative should be selected?

Solution: Rebuild, based on the following analysis. The $50,000 original cost is a sunk cost and irrelevant.
(a) New $51,000 (b) Rebuild $45,000
Less Salvage 5,000 =======
-------
New Cost $46,000
=======

In this situation, it would cost less to rebuild the equipment than replace it.
c. Steps to use in the decision-making process:
1. Define the problem. Replace equipment, make or buy a component part, expand or contract, accept a special order, etc.
2. Determine possible alternatives and compare each to the firm's goals for congruence.
3. Prepare estimates of costs/revenues, benefits, and risks for each alternative that is complementary to the firm's goals.
4. Identify and estimate possible constraints such as availability of funds, capacity, availability of raw materials, and skilled labor.
5. Select the alternative that will most likely maximize the present value of the company's future cash flows without violating any of the constraints.
d. Since cash is the most important aspect of running a business, decision making leans toward defining cost and benefits in terms of cash flows—positive, negative, or both. Since the choice of one action will potentially prevent another from being taken, the decision should be based on perceived differences among the alternatives being considered—the incremental approach. When future cash is affected, the PV of the incremental cash flows should be used.
e. An opportunity cost is a net cash inflow that will be lost if the course of action under consideration is pursued. An action that eliminates a cash inflow is equivalent to an action that produces a cash outflow.

Illustration: An overstock of 5,000 widgets could be sold as a special promotion at $100 each. If the action is rejected, the incremental cash inflow of ($500,000) represents the opportunity cost of not selling the widgets.
f. Any past cash outflow (or committed future cash outflow) that is not affected by the decision to pursue the course of action under consideration is a sunk cost to the decision at hand. In the example used above, the cost of the widgets would be a sunk cost.

Some managers would choose not to replace an old machine with current depreciable book value greater than zero due to the fact that they do not want to recognize a loss on disposal. “Depreciation expense” over the next few years is often considered to be more appealing than a “loss on disposal.” For many, there appears to be a psychological issue regarding the appearance of “loss on disposal” on the income statement even though it would be in the best interest of the organization to replace current production assets with new ones.
g. Pitfalls of relevant costing:
1. Assuming that all variable costs are relevant. For example, normal variable marketing costs may not be relevant for a special order, or there might be incremental marketing costs associated with the proposed alternative.
2. Assuming that all fixed costs are irrelevant. If a proposal would require operating outside the relevant range, fixed costs could increase or decrease. When purchasing new equipment, fixed costs are likely to change.
3. The use of unit costs can be misleading. Original unit costs could contain a combination of both relevant and irrelevant costs.


Done

49

Which of the following types of bonds is most likely to maintain a constant market value?

A. Zero coupon

B. Floating rate

C. Callable

D. Convertible

B. Floating rate

With most bonds, interest rates are fixed, resulting in an identical interest payment for each payment period over the life of the bonds. As current market interest rates rise, the market value of the bonds will go down since that value is based upon the present value of the future cash flows related to the current market rate; therefore, most bonds expose the holder to interest rate risk.

Floating-rate bonds eliminate interest rate risk since the interest rate paid for a given payment period is based upon the prevailing rates in the current bond market; therefore, if interest rates rise, the interest payment will also increase. Since the market value of bonds is based upon the present value of future cash flows, the market value of floating-rate bonds will remain relatively constant.

50

Residual income of an investment center is the center’s:

A. income plus the imputed interest on its invested capital.

B. income less the imputed interest on its invested capital.

C. contribution margin plus the imputed interest on its invested capital.

D. contribution margin less the imputed interest on its invested capital.

B. income less the imputed interest on its invested capital.

Residual income is the amount of net income in excess of the imputed interest on its invested capital, so "income less the imputed interest on its invested capital" is correct. The imputed interest on investment is a rate determined by corporate headquarters to encourage the investment center managers to invest in projects that would return more than that rate since residual income will be increased.

"Income plus the imputed interest on its invested capital" is incorrect because the imputed interest is subtracted from income rather than added.

"Contribution margin plus [or less] the imputed interest on its invested capital" is incorrect because the contribution margin is not used in the computation of residual income.

51

Embedded audit modules:

A. identify unexpected computer code.

B. aid in debugging application systems.

C. analyze the efficiency of programming.

D. enable continuous monitoring of transaction processing.

D. enable continuous monitoring of transaction processing.

Embedded audit modules enable continuous monitoring of transaction processing.

Identifying unexpected computer code is a characteristic of snapshot.
Aiding in debugging application systems is a characteristic of tracing.
Analyzing the efficiency of programming is a characteristic of mapping.

52

Gartshore, Inc., is a mail-order book company. The company recently changed its credit policy in an attempt to increase sales. Gartshore's variable cost ratio for obtaining credit is 70% and its required rate of return is 12%. The company projects that annual sales will increase from the current level of $360,000 to $432,000, but the average collection period on receivables will go from 30 to 40 days. Ignoring any tax implications, what is the cost of carrying additional investment in accounts receivable, using a 360-day year?

A. $168

B. $1,512

C. $2,000

D. $2,160

B. $1,512

Cost of holding accounts receivable before credit policy change: $360,000 sales ÷ 360 days = $1,000 average daily sales:

30 days average collection period = $30,000 average A/R balance
12% required rate of return = $3,600 annual interest
Cost of holding accounts receivable after credit policy change: $432,000 sales ÷ 360 days = $1,200 average daily sales:

40 days average collection period = $48,000 average A/R balance
12% required rate of return = $5,760 annual interest
$5,760 - $3,600 = $2,160 additional annual interest on holding A/R balance.

However, by stating the variable cost ratio, the problem implies it expects a distinction made between actual investment in A/R and margin earned. The actual investment by Gartshore is its variable cost, which for a mail-order book company represents cost of goods purchased for sale. That is, there is no change in fixed costs. Consequently, the $2,160 needs to be reduced to represent only the interest on the variable cost portion: $2,160 × 70% variable cost = $1,512.

53

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

Section 404 of the Sarbanes-Oxley Act requires issuers of annual reports to use an internal control framework that meets all of the SEC’s requirements (such as COSO). This section was created to provide investors with reasonable assurance that material unauthorized transactions or the improper use of assets will be prevented or detected in a timely manner. Issuers must include the scope and capabilities of the internal control system and include procedures for financial reporting in their annual reports.

54

If consumer income increases and as a result the demand for housing increases, we can conclude that housing is:

A. a complementary good.

B. an inferior good.

C. a necessary good.

D. a normal good.

D. a normal good.

A normal good is one for which demand increases as income increases.


Go to Next QuestionGuess and Mark WrongOpen CalculatorPrint QuestionEnd Session
If consumer income increases and as a result the demand for housing increases, we can conclude that housing is:

Incorrect A.
a complementary good.

B.
an inferior good.

C.
a necessary good.

D.
a normal good.

a. Complementary goods are goods and services that are used in conjunction with each other. When the price of one good falls and the quantity demanded of that good rises, the demand for the other good rises. The cross-elasticity of demand of complementary goods is negative since as the price of product A declines, the more of product B will be purchased at any price. For example, if the price of hot dogs falls, consumers will purchase more hot dogs, and they will also purchase more hot dog buns, a complementary good.
b. Inferior goods are goods or services whose demand decreases as a consumer's income increases, assuming prices remain constant. The “inferiority” being described has nothing to do with the actual quality of the item but with the consumer's ability to purchase needed items. For example, when consumers have limited incomes, canned vegetables will often be purchased rather than fresh vegetables; however, as incomes rise, less canned vegetables will be purchased as the consumer substitutes fresh vegetables for the “inferior product” that was purchased only because of the consumer's limited income. Inferior goods have a negative income elasticity of demand.
c. Normal goods are good or services whose demand increases as consumer's income increases, assuming prices remain constant. Normal goods have a positive income elasticity of demand.
d. Substitute goods are goods and services that can be used in place of each other in at least some of their uses. When the price of one good falls, the quantity demanded of that good increases and the demand for the other good without a price decrease falls. If goods are perfect substitutes, the consumer is indifferent as to which product to purchase and will purchase the one with the lower price. If goods are imperfect substitutes, the purchase decision would be based on the price change of one good relative to trade-offs being made such as differences in quality between the two goods. For example, a consumer may believe a Ford truck is of better quality that a Toyota truck, but at some difference in price, some consumers would substitute the Toyota truck. A substitute good is the opposite of a complementary good.
e. Law of diminishing marginal utility is a proposition that describes how an individual's satisfaction (or marginal utility) derived from the consumption of each additional unit of the good or service declines as consumption of that good or service increases. For example, a guest may desire a piece of pie at the end of dinner on Thursday evening and derives a level of “satisfaction” from consuming it. The host offers the guest a second piece of pie and the “satisfaction” the guest receives from consuming that piece of pie is less than that received from consuming the first.

55

The amount of inventory that a company would tend to hold in stock would increase as the:

A. sales level falls to a permanently lower level.

B. cost of carrying inventory decreases.

C. cost of running out of stock decreases.

D. length of time that goods are in transit decreases.

B. cost of carrying inventory decreases.

The EOQ model formula attempts to minimize costs when faced with the trade-off between the cost to procure and the cost to hold inventory. The formula is the square root of the quotient of two times the annual demand multiplied by the order cost (or setup cost), divided by the annual unit carrying cost.

EOQ = Square root of 2DS/Ci
Where:

D = Demand per year in units
S = Setup or ordering cost per order
C = Cost per unit
i = Carrying cost, expressed as a percentage of inventory cost
(C × i is the carrying cost per unit.)
For this formula, if carrying costs are decreased, then the EOQ will increase. As the EOQ increases, the amount of inventory that a company would tend to hold also increases.

56

Which of the following is correct in stating a similarity between firms in a perfectly competitive industry and a monopolistically competitive industry?

A. Firms in either industry structure produce standardized products.

B. Firms operating in either industry structure engage in non-price competition

C. There are no significant barriers to entry in either market structure.

D. Firms in either market structure face a perfectly elastic demand curve.

C. There are no significant barriers to entry in either market structure.

Firms in a monopolistically competitive industry produce differentiated products, engage in non-price competition, and face a downward sloping demand curve. Firms in a perfectly competitive industry produce a standardized product, find non-price competition ineffective, and face a perfectly elastic demand curve. There are no significant barriers to entry in either market structure.

57

According to COSO, the use of ongoing and separate evaluations to identify and address changes in internal control effectiveness can best be accomplished in which of the following stages of the monitoring-for-change continuum?

A. Control baseline

B. Change identification

C. Change management

D. Control revalidation/update

B. Change identification

The baseline understanding of internal control effectiveness is the starting point. Monitoring identifies changes in the environment or internal control system and the entity's ability to manage those changes. To “identify and address changes” is part of change identification.

The control baseline is limited to the controls in effect before the change is identified. Change management is the process of implementing needed changes, not identifying them. Control revalidation is a later part of the process after the need for control changes has been identified.

58

Financial statements were being prepared for the ABC Company, and among its long-term investments were 1,000 shares of XYZ common stock, a publicly held company traded on a major market. At the close of the day related to the date of the financial statements, the XYZ stock had a quoted market price of $65 per share; however, at approximately 4:30 p.m., after the close of the market, it was announced that a major fire had destroyed the only production plant held by XYZ Company. As a result of this new information, the quoted market price for the XYZ common stock fell to $25 per share on the following day. When considering all of this information, ABC Company should value the investment of the XYZ common stock at:

A. $65 per share since there is valid Level 1 input available for the date of the valuation.

B. $25 per share due to the new information; however, the input level would be dropped to Level 2.

C. $65 per share since there is valid Level 1 input available for the date of the valuation; however, the slide to $25 per share should be disclosed in the notes to the financial statements.

D. $45 (an average of $65 and $25) and drop the input level to Level 2.

B. $25 per share due to the new information; however, the input level would be dropped to Level 2.

As a general rule, if observable inputs such as quoted market prices for identical assets are available, the subject asset should be used in determining value, since this would represent a Level 1 input in the fair value hierarchy. However, if a company announces negative information that has a negative impact on the market price shortly after the close of the market, the fair value valuation should employ the use of the new information and list the value of the subject asset at the lower price. This would also drop the input level to Level 2.

a. FASB ASC 820 has grouped possible inputs used to determine value fair into three groups (hierarchies) in an attempt to achieve consistency and comparability. Note that it is the inputs that are classified as to the preferred usage and not the methods or techniques used to determine fair value. In determining fair value of a particular asset or liability when inputs from two or more levels are used, then the fair value measurement will be classified at the lowest input level that is significant to those measurements. For example, if significant inputs from both Level 2 and Level 3 are used to determine fair value, then the fair value measurement will be considered to be based upon Level 3. (FASB ASC 820-10-35-37)
b. Observable inputs are the most desirable ones to use when determining fair value. Observable inputs are those that reflect the assumptions based on market data obtained from sources independent of the reporting entity used in pricing an asset or liability. When possible, it is expected that more observable inputs will be used than unobservable. (FASB ASC 820-10-35-36)
c. Unobservable inputs are the least desirable ones to use when determining fair value. Unobservable inputs are those based upon assumptions developed using the best information available in the circumstances reflecting the reporting entity's own speculations used in pricing assets or liabilities. (FASB ASC 820-10-35-37)
d. Level 1 inputs are observable and considered to be the highest level and most desirable when determining fair value. Level 1 inputs would include unadjusted quoted active market prices of identical assets. An active market is where there is adequate trading to provide constant market data. (FASB ASC 820-10-35-37)
(1) Generally accepted business valuation techniques often apply a blockage discount to the quoted market price when valuing a large block of stock, since it is assumed that the market price would drop if a large block of stock was put on the market on a particular date. FASB ASC 820 specifically disallows the use of such a blockage discount. (FASB ASC 820-10-35-45)
(2) It is not unusual for a company to announce information that will have a negative impact on market price at the end of the day or shortly after the close of the market. If the quoted market price is adjusted for the new information, then the fair value should be listed at the lower price. (FASB ASC 820-10-35-45)
e. Level 2 inputs are considered to be the middle level when determining fair value, and include such items as prices of assets or liabilities that can be either directly or indirectly observed but do not include the Level 1 quoted market prices. Often market values of similar assets or liabilities (as opposed to identical) are used to determine fair value. In such cases, the degree of comparability must be determined, and often adjustment must be made when determining fair value. A higher degree of adjustment could cause the fair value measure to fall to a Level 3 category. Level 2 items would include such items as the following (FASB ASC 820-10-35-48):
(1) Active market prices for similar assets or liabilities
(2) Available market prices for identical or similar assets or liabilities when markets are not active
(3) Inputs such as interest rates, default rates, yield curves, and credit risks
(4) Other market-corroborated inputs
f. Level 3 inputs are unobservable and considered to be the lowest and least desirable level when determining fair value. (FASB ASC 820-10-35-37)
(1) Level 3 inputs should be used to develop an exit price to represent fair value from the perspective of the reporting entity.
(2) Level 3 inputs should reflect the reporting entity's market assumptions.
(3) Level 3 inputs should be based upon the best available information that can be obtained without undue cost and effort.

59

Wexford Co. has a subunit that reported the following data for Year 1:

Asset (investment) turnover: 1.5 times
Sales: $750,000
Return on sales: 8%
The imputed interest rate is 12%. What is the division residual income for Year 1?

A. $60,000

B. $30,000

C. $20,000

D. $0

D. $0

The profit margin on sales is a profitability ratio that measures the profit generated from each dollar of sales. Profit margin on sales can be computed for gross profit, operating profit, or net income. Return on sales is net income divided by net sales revenue.

Wexford has a return of 8% on sales revenue of $750,000, so net income is $60,000.

Asset turnover is a measure of how effectively a business unit uses its assets. It equals sales revenue divided by average total assets. If the turnover is 1.5 times, the revenue of $750,000 can be divided by the turnover of 1.5 to find that total assets equal $500,000.

Residual income is operating income less the imputed interest on the assets used to generate the income. The imputed income at 12% multiplied by assets of $500,000 is $60,000. Subtracting imputed income of $60,000 from net income of $60,000 leaves residual income of zero.

60

Spotech Co.'s budgeted sales and budgeted cost of sales for the coming year are $212,000,000 and $132,500,000, respectively. Short-term interest rates are expected to average 5%. If Spotech could increase inventory turnover from its current eight times per year to 10 times per year, its expected cost savings in the current year would be:

A. $331,250.

B. $250,000.

C. $165,625.

D. $81,812.

C. $165,625.

The key to this problem is to determine how much inventory is reduced by the increased inventory turnover and the resulting savings in interest costs due to reduced working capital requirements. A company must either borrow funds to acquire working capital or give up the next best investment opportunity to fund working capital requirements (opportunity cost). Either way, it costs a company to hold inventory. Any reduction in inventory levels reduces that cost.

The formula for inventory turns is annual cost of sales divided by inventory. Solve for inventory by dividing annual cost of sales by inventory turns. Initially, Spotech has an inventory level of $16,562,500 ($132,500,000 divided by 8 turns). Spotech hopes to decrease the level to $13,250,000 by increasing inventory turns to 10 ($132,500,000 divided by 10 turns). Working capital is reduced by this change in inventory ($16,562,500 - $13,250,000 = $3,312,500). The interest avoided on the $3,312,500 represents a savings of $165,625 ($3,312,500 × 5%).

61

Which of the following terms represents the residual income that remains after the cost of all capital, includ­ing equity capital, has been deducted?

A. Free cash flow

B. Market value-added

C. Economic value-added

D. Net operating capital

C. Economic value-added

Economic value added (EVA) is after-tax operating income less the weighted average cost of capital.

Free cash flow is a measure of financial performance calculated as operating cash flow minus capital expenditures, not a measure of income.

Market value added is the difference between the current market value of a firm measured by the price of stock on the stock exchange and the capital contributed by investors, not the income remaining after cost of capital is deducted.

Net operating capital is a term used to describe working capital (current assets less current liabilities), not the cost of capital.

Projecting Free Cash Flow

a. Free cash flow is the cash flow actually available for distribution to investors after the firm has made all necessary investments in fixed assets and working capital required to support the on-going operations. For a growth company, there may be a negative free cash flow. This is not necessarily bad, providing that growth can ultimately provide value for the investors as well as the cash flow necessary to service the long-term debt.
b. Since the income statement uses accrual accounting, income must be converted to the cash basis. Investors include debt holders as well as stockholders; therefore, income needs to be calculated as if there no were debt by calculating NOPAT (net operating profit after taxes):

NOPAT = EBIT (1 - Tax rate)

NOPAT still includes items that did not use cash; therefore, non-cash items must be added back in order to arrive at operating cash flow:

Operating cash flow = NOPAT + Depreciation and amortization
c. The information found on the balance sheets provides us with the data necessary to compute the net investment for the period (ending net &PPE; less beginning &PPE;); however, annual depreciation is also included in the change in the beginning and ending net &PPE; figures. Gross investment in operating for a period can be summarized as follows:

Gross Investment in Operating Capital = Net Investment for the period + Depreciation and amortization
d. Free cash flow can be expressed in an equation form as follows:

Free Cash Flow = Operating Cash Flow - Gross Investment in Operating Capital

If Operating Cash Flow and Gross Investment in Operating Capital equations are substituted in the above formula, the result is:

Free Cash Flow = NOPAT - Net Investment in Operating Capital
e. When planning, the calculation of Free Cash Flow can be an important analytical tool. With the planned level of capital expenditures for expansion, will there be enough cash available for debt and equity investors? The results for a single year are not important in isolation. This is an equation that draws importance over time and allows a firm to answer the question as to whether an expansion today can be expected to provide the cash flow necessary to satisfy investors in the future.

62

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.

63

Ribbonwood Corporation, a defense contractor, spent June completing Job CC818 for a government space contract. Information about Job CC818, other June costs, and relevant annual estimates follows:


Material issued:
(60% for direct use on Job CC818 and 40%
for indirect factory use through June) $ 4,000

Labor:
Direct labor for Job CC818
(200 direct labor hours at $15 per hour) 3,000
Indirect factory labor for June 850

Other June Costs:
Depreciation (50% factory, 50% administrative) 600
Other (60% factory and 40% administrative) 1,000
Cost driver is Direct Labor Hours
Estimated annual overhead 323,000
Estimated annual direct labor hours 4,000
Mark-up as a percent of costs 150%
What is Ribbonwood's actual overhead for June?

A. $1,750

B. $3,350

C. $16,150

D. $26,917

B. $3,350



$1,600 (Indirect materials: $4,000 × 40%) + $850 (Indirect labor: $850) + $300 (factory depreciation: $600 × 50%) + $600 (Other factory costs: $1,000 × 60%) = $3,350

64

A company uses a standard costing system. At the end of the current year, the company provides the following overhead information:


Actual overhead incurred:
Variable $90,000
Fixed $62,000
Budgeted fixed overhead $65,000
Variable overhead rate (per direct labor hour (DLH)) $8
Standard hours allowed for actual production 12,000
Actual labor hours used 11,000
What amount is the variable overhead efficiency variance?

A. $8,000 favorable

B. $8,000 unfavorable

C. $6,000 favorable

D. $2,000 unfavorable

A. $8,000 favorable

Variable overhead efficiency variance (VOHEV) = (Actual quantity × Standard price) - (Standard quantity × Standard price)

Remember that for overhead variances, the “quantity” refers to the cost driver usage. So, for the problem:


VOHEV = (11,000 DLH x $8 per hour) - (12,000 DLH x $8 per hour)
= $88,000 - $96,000
= $8,000 F

The variance is favorable (F) since less cost driver activity than expected was used for the units produced.

65

A company manufactures several lines of automobiles including basic family passenger cars, recreational vehicles, sports cars, small trucks, and luxury cars. As part of its annual planning process, managers of each product line are required to submit estimates for the next five years for sales; changes in staffing levels; radio, television, and newspaper advertising requirements; equipment and building replacements; and new equipment and building needs.

Which of the following are you most likely to use to help you estimate the price at which goods might be sold in future years?

A. CPM (critical path method)

B. PERT (program evaluation review method)

C. Current CPI

D. Current PPI

C. Current CPI

Although the consumer price index (CPI) does not have any forecasting capability itself, a forecast of price levels is a necessary component of any business plan. Extrapolating the CPI is often used as an estimate of future prices since it is more stable than the PPI (producer price index).

66

Which of the following definitions best characterizes benchmarking?

A. A technique that examines product and process attributes to identify areas for improvements

B. The comparison of existing activities with the best levels of performance in other, similar organizations

C. The development of the most effective methods of completing tasks in a particular industry

D. The complete redesign of a process within an organization

B. The comparison of existing activities with the best levels of performance in other, similar organizations

Benchmarking is a tool for improving business processes by comparison with performance leaders.

"A technique that examines product and process attributes to identify areas for improvements" is incorrect because it does not mention comparisons with similar organizations. "The development of the most effective methods of completing tasks in a particular industry" is incorrect because benchmarking is not the development of effective methods; it is emulating the best methods of others. "The complete redesign of a process within an organization" is incorrect because benchmarking does not necessarily involve complete redesign of a process but merely improvements to bring it up to the best performance of similar organizations.

67

Erroneous management decisions might be the result of incomplete information. The best control to detect a failure to process all valid transactions is:

A. periodic user submission of test data.

B. user review of selected output and transactions rejected by edit checks.

C. controlled output distribution.

D. decollation of output.

B. user review of selected output and transactions rejected by edit checks.

Review of selected output, with selection being made by use of appropriate edit checks, may provide reasonable assurance that only accurate data is processed and reported.

Although user submission of test data may detect invalid transactions and failure to process valid transactions, this technique would not be routinely used.
Controlled output distribution will not prevent or detect incorrect output.
Decollation of output is simply the separation of output copies.

68

An online database management system for sales and receivables was recently expanded to include credit approval transactions. An evaluation of controls was not performed prior to implementation.

If certain data elements were not defined in the expansion, the following problem could result:

A. Unlimited access to data and transactions

B. Incomplete transaction processing

C. Unauthorized program execution

D. Manipulation of the database contents by an application program

B. Incomplete transaction processing


Failure to completely define the program specification blocks (PSB) prevents the application program from accessing or changing data, resulting in incomplete processing.

Data element definition allows application programs to access or change data; therefore, if they are not defined, no access takes place.
Without the program specification blocks, the application program cannot access data and cannot execute.
The desired manipulation of the database contents by an application program cannot take place if program specification blocks are not defined.

69

All of the following are computer input devices, except a:

A. plotter.

B. mouse.

C. magnetic ink character recognition device.

D. light pen.

A. plotter.

Today, as much business activity data as possible is recorded directly into computers, often through a computer data entry screen that retains the same name as the paper source document it replaced. Computer input devices allow data to be entered into the computer. Examples of input devices include the following:

a. Keyboard
b. Image scanner
c. Magnetic ink character recognition (MICR)
d. Pointing device (graphics tablet, joystick, light pen, mouse, touchpad, touchscreen)

Additionally, software can be combined with input devices to capture data. One example is optical character recognition (OCR) software, which can be used to convert images of paper documents as read by a scanning device into text document computer files.

70

Many entities use the Internet as a network to transmit electronic data interchange (EDI) transactions. An advantage of using the Internet for electronic commerce rather than a traditional value-added network (VAN) is that the Internet:

A. permits EDI transactions to be sent to trading partners as transactions occur.

B. automatically batches EDI transactions to multiple trading partners.

C. possesses superior characteristics regarding disaster recovery.

D. converts EDI transactions to a standard format without translation software.

A. permits EDI transactions to be sent to trading partners as transactions occur.


Value-added networks transmit data to trading partners with additional conversion and auditing steps. Using the Internet directly allows a business to send transactions immediately to trading partners without the delay inherent in the additional VAN steps.

"Automatically batches EDI transactions to multiple trading partners" is incorrect because the Internet does not automatically batch transactions. "Possesses superior characteristics regarding disaster recovery" is incorrect because disaster recovery using a VAN is likely to be improved compared to the Internet since the VAN designs disaster recovery into the network. "Converts EDI transactions to a standard format without translation software" is incorrect because the Internet does not automatically use translation software.

71

In the short-run, average variable cost for a firm is rising; therefore:

A. average variable cost is below average fixed cost.

B. average fixed cost is constant.

C. average total cost is at a minimum.

D. marginal cost is above average variable cost.

D. marginal cost is above average variable cost.

The average-marginal rule states that when the marginal magnitude is above the average magnitude, the average magnitude rises; therefore, since average variable cost is rising, marginal cost must be higher than average variable cost.

a. Average Fixed Cost (AFC) declines as output increases. It is defined as Fixed Costs ÷ Quantity.
b. Average Variable Cost (AVC) is a U-shaped curve. It reflects the operation of the Law of Diminishing Returns. Since the marginal returns of adding variable resources initially increase, the variable costs per unit decrease. At some point, as diminishing returns require more units of the variable factor for each additional unit of output, AVC begins to rise. It is defined as Variable Costs ÷ Quantity.
c. Average Total Cost (ATC) is AFC + AVC. It is also U-shaped but turns up at a slower rate than AVC since, for some number of units, AFC will decline by more than AVC increases. It is defined as Total Cost ÷ Quantity.
d. Marginal Cost is the change in total costs associated with producing one more unit of output. Marginal costs are the costs that the firm can control directly; for example, the firm cannot incur them simply by choosing not to produce the last unit of output. (Note: Only variable costs are relevant when marginal cost is calculated.)
e. Illustration: A relationship exists between MC, AVC, and ATC. The marginal cost curve always intersects the AVC and the ATC at their minimum points. For example, a basketball player has 23.4 points per game (PPG) average. When she plays an additional (marginal) game, if she scores more than 23.4 points, her (PPG) average will rise. If the marginal is greater than the average, then the average rises. If the marginal is less than the average, then the average falls. Therefore, if the average is neither rising nor falling, the marginal equals the average.
f. Cost curves will shift if the firm is faced with increased resource costs or if the firm changes its technology.

72

The use of activity-based costing normally results in:

A. substantially greater unit costs for low-volume products than is reported by traditional product costing.

B. substantially lower unit costs for low-volume products than is reported by traditional product costing.

C. decreased set-up costs being charged to low-volume products.

D. equalizing set-up costs for all product lines.

A. substantially greater unit costs for low-volume products than is reported by traditional product costing.

In the past, conventional costing techniques assigned indirect manufacturing costs to a single (or few) cost pool(s) and allocated those costs based on a single (or few) allocation base(s). The result was that both high and low volume products received the same unit “dosage” of indirect costs.

Activity-based costing (ABC) utilizes multiple cost pools for accumulating indirect costs. These costs are then allocated to products in proportion to the respective products' consumption of those resources. Thus, low volume products which consume more resources (such as set-up costs) receive substantially greater unit costs than they would receive under traditional costing.

Activity-based costing (ABC) addresses several of the concerns about traditional overhead costing systems. Instead of using a small number of overhead cost pools and arbitrary allocation bases, overhead costs are accumulated in cost pools related to separately identified activities that are allocated based on cost drivers.

73

The purpose of a software monitor is to:

A. test for controls in computer programs.

B. collect data on the use of various hardware components during a computer run.

C. help application programmers to write error-free code.

D. provide self-documenting modules.

B. collect data on the use of various hardware components during a computer run.

The purpose of a software monitor is to collect data on the use of various hardware components during a computer run.

Tests for controls are the responsibility of the auditor who usually develops them. The other answer choices are not functions of software monitors. These functions can be performed by other utility-like software.

74

A project's net present value, ignoring income tax considerations, is normally affected by the:

A. proceeds from the sale of the asset to be replaced.

B. carrying amount of the asset to be replaced by the project.

C. amount of annual depreciation on the asset to be replaced.

D. amount of annual depreciation on fixed assets used directly on the project.

A. proceeds from the sale of the asset to be replaced.

Calculation of a project's net present value is accomplished by:

computing the discounted (present) value of all future cash inflows and outflows of the proposed project.
subtracting the present value of outflows from inflows to arrive at the net present value.
Past costs used to calculate the carrying value and depreciation on the asset(s) to be replaced or used on the project are not used in the present value computation. In addition, depreciation is not a cash flow. Expected proceeds from the sale of the asset to be replaced are a future cash inflow, which will affect the proposed project's net present value.

75

Information systems steering committees:

A. should consist of systems specialists and end users who plan and direct projects through the system's life cycle.

B. should consist of systems management, the controller, and other management personnel, and should establish policies with regard to an organization's information system.

C. are found in organizations that have had a history of information system problems, with the focus of the committee being the overseeing of information systems development.

D. consist of a top management team that oversees the information systems department.

B. should consist of systems management, the controller, and other management personnel, and should establish policies with regard to an organization's information system.

An information systems steering committee is a managing or directing committee and, as such, should establish overall policy and direction for an organization's information system. Such a committee should not be involved in the actual design, development, coordination, and direction of projects, or the resolution of specific operational problems within the information system. Consequently, the steering committee should consist of systems management, the controller, and other management personnel.

An information system is a collection of methods, practices, algorithms, and methodologies that transform data into information and knowledge desired and useful for individual and group users in organizations and other entities. It can involve a combination of work practices, information, people, and technologies organized to accomplish goals in an organization.

76

Which of the following would normally be the functions of security software?

A. Authenticates user identification and controls access to information resources

B. Logs the activity of the computer system including the time each program is started and when each file is accessed

C. Displays the data typed into a terminal keyboard

D. Records and monitors changes to program source code and object code files

A. Authenticates user identification and controls access to information resources

Authentication and subsequent access to computer resources are the primary functions of security software.

Activities of the computer are recorded on the operating system log and include when each program is started, the files it accesses, and when the programs terminate execution.
Hardware monitors (CRTs) display the data typed onto terminal keyboards.
Monitoring and recording changes to program source and object code are the functions of source code library maintenance software.

77

Creditors of a corporation should monitor that corporation's:

A. debt to equity ratio.

B. times interest earned number.

C. debt to equity ratio and times interest earned number.

D. None of the answer choices are correct.

C. debt to equity ratio and times interest earned number.

The debt to equity ratio is computed by dividing total debt by total stockholders' equity. A higher ratio indicates existence of significant debt which could entail higher interest expense and creditor risk in a liquidation situation.

Times interest earned indicates the “cushion” related to a firm's ability to pay interest on debt. It is computed by dividing income before interest and taxes by interest expense.

Therefore, creditors are affected by and should monitor both of these measures.

Times Interest Earned

a. The Times Interest Earned Ratio measures a firm's ability to cover interest charges. This is important since, at minimum, a company would need to pay current interest charges in a given period. This is also known as the Interest Coverage Ratio.
Net Income Before Tax + Interest Expense
Times Interest Earned = ----------------------------------------
Interest Expense
b. A higher ratio is associated with greater solvency and demonstrates a greater margin of safety for meeting fixed interest payments.
c. This ratio measures the ability to add new debt in the future.
d. A concern is that accrual income is not necessarily representative of the cash available to pay the interest obligations.
e. Since interest is tax deductible, both interest and taxes are added back to net income indicating the amount available to cover the fixed interest payments.

78

Which of the following items is one of the eight components of COSO's enterprise risk management framework?

A. Operations

B. Reporting

C. Monitoring

D. Compliance

C. Monitoring

There are eight components of COSO's ERM framework:

1. Internal environment. The people in a business and the environment in which they operate are the foundation for all other ERM components.
2. Objective setting. Management must put into place a process to formulate objectives in order to help the company assess and respond to risks.
3. Event identification. Certain events can affect the company's ability to implement its strategy and achieve its objectives. Management must identify these events and determine whether they represent risks or opportunities.
4. Risk assessment. Identified risks are evaluated to determine how they affect the company's ability to achieve its objectives and how to manage them. Both qualitative and quantitative methods are used to assess risks.
5. Risk response. Management can choose to avoid, reduce, share, or accept risks after careful analysis.
6. Control activities. To ensure that management's risk responses are effectively carried out, policies and procedures should be implemented.
7. Information and communication. Information about ERM components needs to be communicated through all levels of the company and with external parties.
8. Monitoring. ERM processes must be monitored, deficiencies reported to management, and modifications performed when required.


The eight components of COSO's ERM framework are internal environment, objective setting, event identification, risk assessment, risk response, control activities, information and communication, and monitoring. ERM processes must be monitored, deficiencies reported to management, and modifications performed when required.

79

Which of the following tasks is least likely to be undertaken in the implementation phase of an accounting software application?

A. Obtain and install hardware.

B. Enter and verify test data.

C. Identify inputs and outputs.

D. Document user procedures.

C. Identify inputs and outputs.

The implementation phase of an accounting software application would include obtaining and installing hardware, documenting user procedures, training users, and entering and verifying test data.

Identifying inputs and outputs would occur in the systems design and development phase, preceding implementation.

Implementation is the process of installing a computer. It includes selecting and installing the equipment, training personnel, establishing operating policies, and getting the software onto the system and functioning properly.

Implementation and conversion. During this phase all physical design components are assembled and the system is put into place.

a. An implementation and conversion plan is created and implemented.
b. Hardware and software are installed and tested.
c. Employees are hired and existing employees are relocated.
d. Employees are trained.
e. Processing procedures are developed and tested.
f. Standards and controls are established and implemented.
g. System documentation is completed.
h. The organization converts to the new system and discontinues the old system.
i. Fine-tuning adjustments are made.
j. A post-implementation review is conducted to detect and correct any design deficiencies.
k. The new system is complete when the operational system is delivered to the organization.
l. The steering committee is sent a final report.


80

Technology is constantly changing. An improvement in production techniques that allows for a larger output for a given amount of inputs would result in:

A. a shift of the supply curve to the right resulting in more of the product being offered at each price.

B. movement along the supply curve resulting in a lower equilibrium quantity and price given the current level of demand for that product.

C. a shift of the supply curve to the left resulting in fewer units offered for sale at each price.

D. no change in the supply curve but a decrease in price along with an increase in quantity supplied.

A. a shift of the supply curve to the right resulting in more of the product being offered at each price.

A shift in the supply curve to the right indicates that a larger quantity of the product is supplied at each price. Things that shift the supply curve are technology, prices of resources, expectation of future prices, number of sellers, taxes and other government restriction or subsidies.


Change in Supply

a. A change in quantity supplied relates to a movement along a given supply curve when all supply determinants other than the price of the good are held constant. The movement from point A to point B on the supply curve would represent a change in quantity supplied.
b. A change in supply is caused by a change in one of the supply determinants other than the price of the good. Examples of supply determinants are:
1. The price of the resources needed to produce the product.
2. Technology.
3. Taxes and subsidies.
4. Prices of other goods.
5. Future price expectations.
6. The number of sellers in the market.


Done

81

Which of the following covenants obliges the borrower to repay the bonds if a large quantity of common stock is held by a single investor and the bond rating is downgraded?

A. Poison put clause

B. Cross-default clause

C. Affirmative covenant

D. Negative pledge clause

A. Poison put clause

A poison put clause is a covenant that obliges the borrower to repay the bonds if a large quantity of common stock is held by a single investor and the bond rating is downgraded. This type of bond covenant is used as a defensive strategy to prevent hostile takeovers.

82

A partial set of standard characteristics of a real-time system is:

A. batched input, online files, and an extensive communication network.

B. reliance upon sequential files, prompt input from users, and interactive programs.

C. online files, prompt input from users, and an extensive communication network.

D. the use of a high-level language and the major need being for historical reports.

C. online files, prompt input from users, and an extensive communication network.

A real time system is characterized by online files, prompt input from users, an extensive communication network, random access and immediate update. The language in the communications process is usually low-level.

83

A company employing an online computer system has CRT terminals located in all operating departments for inquiry and updating purposes. Many of the company's employees have access to and are required to use the CRT terminals. A control the company would incorporate to prevent an employee from making an unauthorized change to computer records unrelated to that employee's job would be to:

A. restrict the physical access to terminals.

B. establish user codes and passwords.

C. use validity checks.

D. apply a compatibility test to transactions or inquiries entered by the user.

D. apply a compatibility test to transactions or inquiries entered by the user.

Use of a compatibility test for users would assure that an employee used a CRT only for purposes related to that employee's job description. For example, an accounts receivable clerk would not be allowed access to inventory or fixed asset records since those records would not be compatible with the duties of an accounts receivable clerk.

None of the control measures mentioned in the other answers would specifically prevent an employee from making an unauthorized change in computer records unrelated to that employee's job.

Authorization controls are implemented using compatibility tests and access control matrices.

a. Compatibility tests. Companies should classify data based on how its loss or unauthorized use would impact it and determine the data and program access privileges of employees and outsiders. When users request access to data or programs or try to operate the system, a compatibility test can determine if the user is authorized to perform the desired action. This prevents unintentional errors and deliberate attempts to manipulate the system. Several confidentiality levels are defined and used:
(1) Some data does not need to be restricted and is put on a website.
(2) Some data is restricted to employees.
(3) Confidential data is restricted to owners and appropriate top management and employees.
(4) No one should be able to read, add, delete, and change data without authorization of their activities.
b. Access control matrix. Compatibility tests use an access control matrix, which is:
(1) a list of authorized user ID numbers and passwords and
(2) a list of all files, data, and programs and the access each user has to them.


Done

84

Spring Co. had two divisions, A and B. Division A created Product X, which could be sold on the outside market for $25 and used variable costs of $15. Division B could take Product X and apply additional variable costs of $40 to create Product Y, which could be sold for $100. Division B received a special order for a large amount of Product Y. If Division A were operating at full capacity, which of the following prices should Division A charge Division B for the Product X needed to fill the special order?

A. $15

B. $20

C. $25

D. $40

C. $25

At full operating capacity, Division A would be losing sales to the outside market if it chose to sell Product X to Division B. Therefore, the transfer pricing should be equal to Product X's market price of $25.

At less than full operating capacity, Division A may choose to sell Product X to Division B for less than the market price, since Division B can further process that product into Product Y and create a profit for Spring Co.

Division A would not charge more than market price to Division B, since they are the same company.

Transfer pricing is assigning a monetary value to goods and services exchanged between internal units of an organization. Often the exchanged goods and services are the same as those that can be exchanged with external entities.

There is no single rule for setting transfer prices. Transfer prices can be cost-based, market-based, or negotiated. In general, the transfer price should be a combination of (1) the additional outlay costs incurred to the point of transfer (approximately the variable costs associated with the production and transfer of the goods) plus (2) opportunity costs for the firm as a whole (e.g., foregone external sales so that internal needs may be met). Factors that influence transfer pricing decisions include the availability of the goods or services from an external supplier and the availability of an external market for the idle capacity.

Transfer pricing must be evaluated in relation to its impact on (1) goal congruency (economic analysis and decisions of the firm as a whole), (2) performance evaluation (of both the supplying and receiving units), and (3) subunit autonomy.


Done

85

Assuming that exchange rates are allowed to fluctuate freely, which one of the following factors would likely cause a nation's currency to appreciate on the foreign exchange market?

A. A relatively rapid rate of growth in income relative to other countries that stimulates imports and depresses exports

B. A high rate of inflation relative to other countries

C. A slower rate of growth in income relative to other countries, which causes imports to lag behind exports

D. Foreign real interest rates that are higher than domestic real interest rates

C. A slower rate of growth in income relative to other countries, which causes imports to lag behind exports

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.


Done

86

Letters of credit are often used to facilitate international trade. The basic purpose of the letter of credit is to reduce risk to the:

A. bank.


B. exporter.

C. final customer.

D. importer.

B. exporter.

Unsecured Bank Loans

a. Unsecured loans are not backed by any collateral and come in a variety of forms.
b. A line of credit is an agreement with a bank to have up to a specific amount of funds available as a short-term loan during a particular period. If the line of credit is for $100,000, a firm can borrow $20,000 in January, borrow an additional $35,000 in May, repay $40,000 in July, and borrow $50,000 in September, etc. As long as the total amount borrowed at a given point in time remains under $100,000 during the period of the agreement, the firm will continue to have access to additional funds. Interest is usually paid monthly and calculated on the average outstanding balance during the period. This method of financing allows a firm to smooth out its cash flow cycle as well as to have funds available for possibly both precautionary and speculative needs.

The use of the line of credit affects both current assets and current liabilities equally. They increase and decrease in a parallel fashion. However, as long as the current ratio is greater than one, an increase in a line of credit (increase to cash and an increase to current liabilities) will decrease the current ratio.

Illustration: A firm has $100,000 of current assets, $50,000 of current liabilities, and a current ratio of 2 to 1 ($100,000 ÷ $50,000). If $25,000 is borrowed on the line of credit, current assets will increase to $125,000, current liabilities to $75,000, and the current ratio will become 1.7 to 1 ($125,000 ÷ $75,000).
c. A variation on the line of credit is the revolving credit agreement that is generally used by large corporations. This is an agreement by a bank to extend credit to a company over a specified period of time; however, if the firm does not make use of the revolving credit, there still is an annual commitment fee. For example, the approved revolving credit could be for three years to allow a corporation to borrow up to $50 million. Even if the company does not use any of the credit during the year, it will still have to pay a significant commitment fee expressed in terms of a percent (for example, a quarter of 1% or $125,000 annually in the above illustration). If the corporation borrows $25 million on the revolving credit agreement, the commitment fee would drop to a percent of the unused portion of the agreement ($62,500 in this illustration), and the corporation would pay interest on the outstanding borrowed balance as well. The biggest difference between a line of credit and a revolving credit agreement is that there is a legal obligation with a revolving credit agreement that does not exist with a simple line of credit. This legal obligation guarantees the company access to the funds over the life of the agreement.
d. A letter of credit is an international financing tool that guarantees payment to an international supplier upon the safe arrival of the goods by issuing a loan to the purchaser. A letter of credit can be irrevocable (not subject to cancellation if the specific conditions are met) or revocable.
e. Commercial paper is an unsecured promissory note that is issued by large banks and big corporations to meet short-term cash needs. It is a promise to repay the borrowed funds at a future given date—with a maturity of no more than 270 days. Rates for these loans are normally lower than for bank loans. This financing option is considered to be quite safe due to the short time frame and the strength of the borrowing companies; however, there is no flexibility in the repayment date as might be received with a bank loan.

87

Which of the following would normally be the functions of security software?

A. Authenticates user identification and controls access to information resources

B. Logs the activity of the computer system including the time each program is started and when each file is accessed

C. Displays the data typed into a terminal keyboard

D. Records and monitors changes to program source code and object code files

A. Authenticates user identification and controls access to information resources

Authentication and subsequent access to computer resources are the primary functions of security software.

Activities of the computer are recorded on the operating system log and include when each program is started, the files it accesses, and when the programs terminate execution.
Hardware monitors (CRTs) display the data typed onto terminal keyboards.
Monitoring and recording changes to program source and object code are the functions of source code library maintenance software.

88

Garo Company, a retail store, is considering foregoing sales discounts in order to delay using its cash. Supplier credit terms are 2/10, net 30. Assuming a 360-day year, what is the annual cost of credit if the cash discount is not taken and Garo pays net 30?

A. 20.0%

B. 24.0%

C. 24.5%

D. 36.7%

D. 36.7%

The annual cost of credit if the cash discount is not taken and Garo pays net 30 is calculated as follows. The lost discount of holding onto money for an additional 20 days (2/10 means 2% discount if paid in 10 days) is 2% for those 20 days; however, the trick is to realize that the principal upon which the 2% is compared is really gross less 2%; e.g., if a $100 invoice is paid in 10 days with terms of 2/10, the amount paid is $98. The 2% discount ($2) is really potential interest that could be charged on the principal amount of $98. This results in an interest rate that is really 2/98 or 2.041% for 20 days. The 30 in “2/10 net 30” means the total amount of the invoice must be paid in 30 days. If the discount is not taken, the cash is held onto for an additional 20 days (30 - 10 = 20). In a 360-day year, 20 days represents 18 periods. 18 × 2.041% = 36.738%, or 36.7%.

a. If payment is not made on trade credit within the discount period, the discount is lost, and the full amount of the credit is paid within 30 days. The results of this lost discount are:
1. The savings of the discount are lost.
2. The size of trade credit increases, thus increasing the debt load.
b. Illustration: A firm purchases $2 million of merchandise throughout the year (assuming a 360-day year) and is offered a 2% discount on all invoices paid within 10 days. If all invoices are paid within the discount period, the full amount paid will be $1,960,000 ($2 million × 98%). This results in a savings of $40,000 per year.

If all discounts are taken, payables at any given time will average $54,444 (($1,960,000 ÷ 360 days) × 10 days). If the discounts are not taken and payment is made within the 30-day period, then average accounts payable will increase to $163,333 (($1,960,000 ÷ 360 days) × 30 days). That is an additional $108,889 of trade credit that is being used.

There is a cost to this additional credit—the lost $40,000 in discounts. The lost discounts represent increased cost for the merchandise; therefore the price of the additional $108,889 of trade credit is $40,000. The cost of this credit is computed as follows:
Loan Discount $40,000
-------------------------- = -------- = 36.7%
Additional Credit Supplied $108,889
c. If a firm can borrow funds at an interest rate lower than the cost of the foregone discount, then the funds should be borrowed and the discounts taken. If the firm above can borrow $108,889 at 10% for an annual interest cost of $10,889, then $29,111 would be saved on an annual basis ($40,000 - $10,889).
d. The return on taking discount can also be calculated using the following formula:
360 Percentage of Discount
------------------------------------- x -----------------------------
Total Credit Period - Discount Period 100% - Percentage of Discount

Using the above illustration, the return can be calculated:
360 2%
----------------- x --------- = 36.7%
30 days - 10 days 100% - 2%
e. Payment of trade credit beyond the normal credit terms will likely result in interest charges, thus increasing the cost of credit as well as hurting relations with the supplier. Firms that do not take advantage of discounts are generally in a weaker financial position with poor cash flow and/or limited access to other sources of funds.

89

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.

90

When economists are concerned about the liquidity preference function they are interested in:

A. the relationship of the demand for money and the rate of interest.

B. the proportion of liquid (cash) reserves maintained by commercial banks.

C. the preference for a currency backed by gold.

D. a bank's desire for accounts receivable as collateral.

A. the relationship of the demand for money and the rate of interest.


The demand for money varies inversely with the rate of interest. The liquidity preference (LP) function relates money demand to the rate of interest. As interest rates fall, the quantity of money demanded increases. As rates rise, the quantity of money demanded decreases.

91

The Internet is made up of a series of networks that include:

A. gateways to allow mainframe computers to connect to personal computers.

B. bridges to direct messages through the optimum data path.

C. repeaters to physically connect separate local area networks (LANs).

D. routers to strengthen data signals between distant computers.

A. gateways to allow mainframe computers to connect to personal computers.

Gateways connect Internet computers of dissimilar networks.

Routers determine the best path for data.
Bridges connect physically separate LAN's.
Repeaters strengthen signal strength.

92

Mighty, Inc., processes chickens for distribution to major grocery chains. The two major products resulting from the production process are white breast meat and legs. Joint costs of $600,000 are incurred during standard production runs each month, which produce a total of 100,000 pounds of white breast meat and 50,000 pounds of legs. Each pound of white breast meat sells for $2 and each pound of legs sells for $1. If there are no further processing costs incurred after the split-off point, what amount of the joint costs would be allocated to the white breast meat on a relative sales value basis?

A. $120,000

B. $200,000

C. $400,000

D. $480,000

D. $480,000

The joint costs should be allocated between the breast meat and legs according to the relative sales value of each.

Sales value of breast meat = 100,000 pounds × $2 per pound = $200,000
Sales value of legs = 50,000 pounds × $1 per pound = $50,000
Total sales value = $200,000 + $50,000 = $250,000
Breast meat has 80% of the sales value ($200,000 ÷ $250,000).
80% × $600,000 (total joint costs) = $480,000 of joint costs allocated to breast meat

93

The full-employment gross domestic product is $1.3 trillion, and the actual gross domestic product is $1.2 trillion. The marginal propensity to consume is 0.8. When inflation is ignored, what increase in government expenditures is necessary to produce full employment?

A. $100 billion

B. $80 billion

C. $20 billion

D. $10 billion

C. $20 billion

The proportion of the disposable income that individuals spend on consumption is the propensity to consume. The marginal propensity to consume (MPC) is the proportion of additional income that an individual will spend. The marginal propensity to save (MPS) is 1 - MPC.

The multiplier is the combined effect of the additional spending once it ripples through the economy (if the MPC is 0.8, then each person is assumed to spend 80% of additional income received and save the other 20%). The multiplier equals 1/MPS; in this question, 1/0.2 = 5. Increasing government expenditures by $20 billion, when multiplied by the multiplier of 5, equals the desired increase in GDP of $100 billion ($0.1 trillion).

Marginal propensity to consume is defined as the change in consumption divided by the change in disposable income. It is the slope of the consumption function. Marginal propensity to consume is a macroeconomic concept.


Change in consumption
Marginal Propensity = MPC = -----------------------------
to Consume Change in disposable income

Change in C
= -------------- = z = Slope of
Change in Yd consumption
function

MPC is always positive. MPC is greater than zero but less than unity for all levels of income: 0

94

Which of the following risks is more likely to be encountered in an end-user computing (EUC) environment as compared to a mainframe computer system?

A. Inability to afford adequate uninterruptible power supply systems

B. User input screens without a graphical user interface (GUI)

C. Applications that are difficult to integrate with other information systems

D. Lack of adequate utility programs

C. Applications that are difficult to integrate with other information systems

Applications that are difficult to integrate with other information systems are a risk that is considered unique to end-user computer (EUC) system development.

The inability to afford adequate uninterruptible power supply systems and user input screens without graphical user interfaces (GUIs) are risks that relate to traditional information systems and end-user computing (EUC) environments. Lack of adequate utility programs is a risk that relates to all computing environments.

Personal computers (PCs) and networks are more vulnerable than mainframes because:

a. Physical access is more difficult to control:
(1) PCs are everywhere, and many people are familiar with their use and operation.
(2) Networks have many PCs connected to them that must be controlled, and this increases the risk that a network can be attacked.
b. PC users are usually not as security and control conscious as mainframe users.
c. It is difficult to segregate duties in a PC and network environment, and one person may be responsible for both developing and operating a PC system.
d. End-user computing (EUC) allows user to develop their own information systems. These systems are often difficult to integrate with the organizational information system.
e. Networks can be remotely accessed from almost anywhere using modems and phone lines, the Internet, and EDI.
f. PCs and laptops are portable and subject to theft.


95

Newman Products has received proposals from several banks to establish a lockbox system to speed up receipts. Newman receives an average of 700 checks per day averaging $1,800 each, and its cost of short-term funds is 7% per year. Assuming that all proposals will produce equivalent processing results and using a 360-day year, which one of the following proposals is optimal for Newman?

A. A $0.50 fee per check

B. A flat fee of $125,000 per year

C. A fee of 0.03% of the amount collected

D. A compensating balance of $1,750,000

D. A compensating balance of $1,750,000

Considering that each proposal will produce equivalent processing results, the optimal proposal for Newman will be the lowest cost proposal. Consequently, to solve this problem, the costs of each of the proposals must be calculated.

700 checks × $0.50 × 360 days = $126,000 per year
$125,000 per year
$1,800 per check × 700 checks × 360 days × 0.03% = $136,080
$1,750,000 × 7% = $122,500

A compensating balance is a cash balance left on account with the bank in exchange for a loan. It is usually a specified percentage of the amount of the loan, and is often required as collateral or to secure a more desirable stated interest rate. The actual effect is to decrease the actual balance borrowed and to increase the effective interest rate (the cost to the borrower). The compensating balance must be disclosed.

96

A basic assumption of activity-based costing (ABC) is that:

A. all manufacturing costs vary directly with units of production.

B. products or services require the performance of activities, and activities consume resources.

C. only costs that respond to unit-level drivers are product costs.

D. only variable costs are included in activity cost pools.

B. products or services require the performance of activities, and activities consume resources.

Activity-based costing (1) identifies activities (i.e., things that are done), (2) determines the cost of those activities, and (3) assigns costs to products/services based on their consumption of activities. In order for ABC to be used, therefore, those “products or services require the performance of activities, and activities consume resources.”

Activity-based costing (ABC) addresses several of the concerns about traditional overhead costing systems. Instead of using a small number of overhead cost pools and arbitrary allocation bases, overhead costs are accumulated in cost pools related to separately identified activities that are allocated based on cost drivers.

97

Data processed by a computer system are usually transferred to some form of output medium for storage. However, the presence of computerized output does not, in and of itself, assure the output's accuracy, completeness, or authenticity. For this assurance, various controls are needed. The major types of controls for this area include:

A. activity listings, echo checks, and pre-numbered forms.

B. tape and disk output controls and printed output controls.

C. input controls, processing/storage controls, and output controls.

D. processing controls, tape and disk output controls, and printed output controls.

C. input controls, processing/storage controls, and output controls.

In order to assure the accuracy of computerized output, it is necessary to have controls related to each of the following three categories: input, processing/storage, and output.

98

A company purchases inventory on terms of net 30 days and resells to its customers on terms of net 15 days. The inventory conversion period averages 60 days. What is the company's cash conversion cycle?

A. 15 days

B. 45 days

C. 75 days

D. 105 days

B. 45 days

The cash conversion cycle is the time between the investment of cash in inventory and the return of cash after the sale and collection of the related account receivable. In this case, cash is not invested in the inventory until 30 days into the 60-day inventory conversion cycle. The remaining 30 days of the inventory conversion cycle plus the 15-day receivable collection period results in a 45-day cash conversion cycle.

99

Clauson, Inc., grants credit terms of 1/15, net 30 and projects gross sales for next year of $2 million. The credit manager estimates that 40% of their customers pay on the discount date, 40% on the net due date, and 20% pay 15 days after the net due date. Assuming uniform sales and a 360-day year, what is the projected days sales outstanding (rounded to the nearest whole day)?

A. 20 days

B. 24 days

C. 27 days

D. 30 days

C. 27 days

Days sales outstanding (DSO) is a relationship between accounts receivable and sales and is an indication of how quickly accounts receivable turns over as a function of sales. It is calculated by dividing annual sales by 360 days and then dividing the accounts receivable balance by the sales per day amount. This represents how many “days of sales” exist in your accounts receivable. For this problem we've been given three kinds of sales, which represent three kinds of accounts receivable balances, each remaining an accounts receivable balance for a particular length of time. The problem gives you the weights of each of these kinds of sales, so all you have to do is arrive at the weighted average of each of the lengths of time these sales remain as an accounts receivable balance. 40% of 15 days = 6 days; 40% of 30 days = 12 days; and 20% of 45 days = 9 days. The sum of these is 6 days + 12 days + 9 days, which equals 27 days.

100

Inflation may be measured using each of the following measures, except:

A. consumer price index.

B. gross domestic product deflator.

C. gross domestic product inflator.

D. wholesale price index.

C. gross domestic product inflator.

All of the items listed can be used to measure inflation except the gross domestic product inflator. It is not a technique for measurement of inflation. In contrast, the gross domestic product deflator does measure inflation.

Inflation

a. Inflation is a sustained increase in the average level of prices and is measured by using a fixed-weight price index. In measuring the consumer price index (CPI), consumers are assumed to buy a specified group of goods and services—a “market basket of goods.” The items in the market basket are “weighted” based on their relative importance in terms of consumer spending. The rate at which the weighted-average price for these goods increases is the inflation rate.
b. The inflation rate is determined by comparing the prices paid for the market basket of goods in one period to that paid in another. The CPI is reported by the government every month and is used to adjust Social Security benefits annually and to adjust income tax brackets for inflation.
c. Biases in the CPI calculation include:
1. New goods bias. New goods constantly replace old goods, and the index does not compare both the price and quality between the old and new goods. This problem is handled by periodically revising the market basket of goods used to calculate the CPI. This factor creates an upward bias in the CPI.
2. Quality change bias. The quality of many items improves each year, and the improvement must be compared to the increase in price of the good. This factor generally creates an upward bias in the CPI.
3. Commodity substitution bias. Consumers have a tendency to cut back on the consumption of relatively more expensive goods and substitute relatively cheaper goods as prices rise. This factor tends to have increases in the CPI overstate the overall rate of inflation.
4. Outlet substitution bias. As prices increase, there is a tendency for more people to shop at discount stores, and in recent years, online shopping has allowed consumers to search for lower prices for many products.
d. Other commonly reported measures of inflation include the producer price index (PPI) that measures the rate of increase in wholesale prices and the GDP deflator that measures the price changes for all goods and serviced included in GDP. It is used when calculating real GDP.

Gross domestic product is a measure of the market value of all final goods and services produced in an economy during a year using either domestic- or foreign-supplied resources. 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. It also excludes nonproductive transactions that have nothing to do with the production of final goods and services.

GDP = C + Ig + G + Xn

Where:

C = Personal consumption expenditures
Ig = Gross private domestic investment
G = Government purchases
Xn = Net exports