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Flashcards in BEC NINJA IV Deck (100):
1

In Belk Co.’s “just in time” production system, costs per setup were reduced from $28 to $2. In the process of reducing inventory levels, Belk found that there were fixed facility and administrative costs that previously had not been included in the carrying cost calculation. The result was an increase from $8 to $32 per unit per year. What were the effects of these changes on Belk’s economic lot size and relevant costs?

A. Lot size, decrease; Relevant Costs, increase

B. Lot size, increase; Relevant Costs, decrease

C. Lot size, increase; Relevant Costs, increase

D. Lot size, decrease; Relevant Costs, decrease

D. Lot size, decrease; Relevant Costs, decrease

Inventory decision models work with opposing costs. Carrying costs increase as the size of the order increases. Setup or ordering costs, however, decrease as the size of the production run or order increases.

Lower setup costs result in decreased lot sizes because it becomes less expensive to produce a smaller lot.

Increased carrying costs also result in decreased lot sizes because the greater the cost of carrying inventory, the fewer the units you will want to produce in a lot.

In a JIT (just in time) production system, each component in a production sequence is produced as it is needed by the next processing step. It is described as “demand-pull” or simply “demand” production. JIT requires a detailed system for integrating the sequential operations of the process. Accurate sales forecasts are needed for effective finished goods planning and production scheduling. If possible, products should be designed to use standardized parts to reduce manufacturing time and per-unit input costs.

An inventory decision model is designed to aid in inventory management, specifically determining order time and quantities. Inventory decision models are designed to answer two basic questions:

What quantity of an item should be ordered (or produced)?
How often should an item be ordered (or produced)?
Inputs for inventory decision models include information about demand, cost, lead-times, and variability.

The most widely known inventory decision model is the Economic Order Quantity (EOQ) model.

2

The working capital financing policy that subjects the firm to the greatest risk of being unable to meet the firm's maturing obligations is the policy that finances:

A. fluctuating current assets with long-term debt.

B. permanent current assets with long-term debt.

C. permanent current assets with short-term debt.

D. fluctuating current assets with short-term debt.

C. permanent current assets with short-term debt.

Of the possible solutions offered, financing permanent current assets with short-term debt places a firm at the greatest risk because of its possible inability to meet its maturing obligations as economic conditions change, forcing the firm to respond to unfavorable refinancing situations to replace the short-term debt.

3

Data access security related to applications may be enforced through all the following, except:

A. user identification and authentication functions incorporated in the application.

B. utility software functions.

C. user identification and authentication functions in access control software.

D. security functions provided by a database management system.

B. utility software functions.

Data access security related to applications cannot be enforced through utility software functions. Utility programs are one of the more serious “holes” in data access security since some of them can actually bypass normal access controls.

Data access security related to applications may be enforced through user identification and authentication functions incorporated in the application. Although there is a migration of control of this type away from applications to other software, most of these controls still reside in application software.
Data access security related to applications may be enforced through user identification and authentication functions in access control software. Access control software has as one of its primary objectives improving data access security for all data on the system.
Data access security related to applications may be enforced through security functions provided by a database management system. In fact, most database management systems provide for improved data access security while they are running.

4

The cost of debt most frequently is measured as:

A. actual interest rate.

B. actual interest rate adjusted for inflation.

C. actual interest rate plus a risk premium.

D. actual interest rate minus tax savings.

D. actual interest rate minus tax savings.

Dividends paid on stock are not deductible in computing taxable income, so there is no income tax savings when dividends are paid. Debt is different. Interest expense is deductible from income to find taxable income, so interest cost incurred reduces income tax.

Because of that, when computing cost of capital, the cost of debt is normally measured using the after-tax cost of interest, which is the interest incurred less the income tax saved because of the interest deduction.

The actual interest rate already includes a component for inflation and other interest rate risks.

5

A compiler is:

A. a procedure-oriented language.

B. a machine that translates the assembler program to machine language.

C. a program that converts high-level programming language into machine language.

D. a program that converts symbolic language to machine language.

C. a program that converts high-level programming language into machine language.


A compiler is a program that transforms source code written in programming languages into object code (or machine language) in order for the CPU to execute the program.

6

Which of the following strategies would the Federal Reserve most likely pursue under an expansionary policy?

A. Purchase federal securities and lower the discount rate

B. Reduce the reserve requirement while raising the discount rate

C. Raise the reserve requirement and lower the discount rate

D. Raise the reserve requirement and raise the discount rate

A. Purchase federal securities and lower the discount rate


When the Federal Reserve buys federal securities, they expand the money supply. The effect on the economy is expansionary. Similarly, lowering the discount rate decreases interest rates paid by banks, which pass lower interest rates along to borrowers. People are more able to afford to borrow to invest, and the result is expansion of the economy.

7

Through the use of decision models, managers thoroughly analyze many alternatives and decide on the “best” alternative for the company. Often the actual results achieved from a particular decision are not what were expected when the decision was made. In addition, an alternative that was not selected may have actually been the best decision for the company. The appropriate technique to analyze the alternatives by using expected inputs and then altering them before a decision is made is:

A. expected value analysis.

B. Program Evaluation Review Technique (PERT).

C. sensitivity analysis.

D. regression analysis.

C. sensitivity analysis.

Sensitivity analysis is any process that measures the impact of a change in a single variable or a combination of variables on profits or on some other decision variable. That is, it is a technique to analyze the alternatives before the decision is made by measuring how changes in the critical assumptions will influence the results. Sensitivity analysis asks “what if?” Expected value analysis is used to determine the mean value of a random variable over an infinite number of outcomes. PERT is a network model used for planning and managing the system with well-defined activities and events (i.e., a start and a finish of activity). Regression analysis is a statistical tool that measures the average amount of change in the dependent variable that is associated with a unit change in the amount of one or more independent variables.

The program evaluation and review technique (PERT) is a procedure for planning a project. It uses network analysis to determine the time estimates for the steps of an activity in each successive time period. Network analysis is a method of planning and scheduling a project such as a construction project or a professional engagement that presents the results in graphic form with a set of “nodes” or connecting “links.” The network analysis is usually performed with computer programs that produce a pictorial representation of the events and processes of the project together with estimated times and costs.

The method determines three possible times for the activity—the optimal time, the most likely time, and the worst time—and makes a prediction of the completion date of the steps and of the activity within a probability range. The method provides the “critical path” that cannot be shortened by accelerating the steps outside the path and provides time estimates for that path. Some users consider PERT and CPM (critical path method) synonymous, while others distinguish PERT from CPM by including cost predictions in PERT.


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.

8

All of the following statements in regard to working capital are correct, except:

A. current liabilities are an important source of financing for many small firms.

B. the hedging approach to financing involves matching maturities of debt with specific financing needs.

C. an aggressive working capital policy focuses on high profitability potential, despite the cost of high risk and low liquidity.

D. financing permanent inventory buildup with long-term debt is an example of an aggressive working capital policy.

D. financing permanent inventory buildup with long-term debt is an example of an aggressive working capital policy.

Working capital consists of the current assets and current liabilities of a firm. An aggressive working capital policy would focus on high profitability potential, despite the cost of high risk and low liquidity. Although financing permanent current asset increases with long-term debt rather than short-term debt is wise, this is not an example of an aggressive working capital policy. An aggressive policy would work to reduce current assets, in relation to current liabilities.

9

A company has daily cash receipts of $150,000. The treasurer of the company has investigated a lockbox service whereby the bank that offers this service will reduce the company's collection time by four days at a monthly fee of $2,500. If money market rates average 4% during the year, the additional annual income (loss) from using the lockbox service would be:

A. $6,000.

B. $(6,000).

C. $12,000.

D. $(12,000).

B. $(6,000).

A lockbox is a method of cash management which expedites collection of receivables. This service, usually offered by a bank, reduces the company's collection time this way: customers send payments to a post office box; for a monthly fee the bank picks up the checks and begins the clearing process even before the company has recorded the payment. The company thus has the use of the payment funds more quickly.

In this question, the daily cash receipts of $150,000 can earn interest for four days at the annual rate of 4%:


Interest = Principal x Rate x Time
= $150,000/day x .04/year x 4 days
= $24,000

The cost to the company is the monthly bank fee of $2,500. Net annual loss is:

$24,000 - ($2,500 × 12) = $24,000 - $30,000 = $(6,000)

10

Aggregate demand is defined as:

A. net investment in plant and equipment designed to move the economy out of a recession.

B. total expenditure on consumption, investment, government spending, and net exports during a given year.

C. a schedule or curve that shows the amount of real GDP or output that buyers collectively desire to buy at every price level.

D. the schedule or curve that shows consumers' willingness and ability to purchase a particular product at various alternative prices at a given moment in time.

C. a schedule or curve that shows the amount of real GDP or output that buyers collectively desire to buy at every price level.

Aggregate demand is the amount of goods and services—the amount of real national income—that will be purchased at each possible price level. There is an inverse relationship between the price level and real GDP (gross domestic product). There are three different price effects that explain this inverse relationship. The real balance effect reduces the purchasing power effectiveness of accumulated public savings balances. Since consumers are now poorer in real terms, they will need to reduce their spending. The interest-rate effect causes consumers to need more money for their purchases as prices increase. The increase in demand for money will drive up interest rates which would reduce business investment and interest-related consumption spending, thus reducing demand. Finally, we have the foreign purchases effect. When prices of domestic goods rise relative to foreign prices, foreign consumers would buy fewer of our goods, and our consumers would buy more foreign goods.

11

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

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


A. II, I, III, V, IV

B. V, II, IV, III, I

C. I, II, III, IV, V

D. III, IV, II, I, V

B. V, II, IV, III, I

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

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

A business management strategy originally developed by Motorola, USA, in 1981, Six Sigma is a systematic method for improving the operational performance of an organization by eliminating variability and waste in manufacturing and business processes. “Sigma” indicates standard deviation from the mean in a normal distribution.

12

During the recessionary phase of a business cycle:


A. the purchasing power of money is likely to decline rapidly.

B. the natural rate of unemployment will increase dramatically.

C. potential national income will exceed actual national income.

D. the real rate of interest will exceed the nominal rate of interest.

C. potential national income will exceed actual national income.


A recession is defined as a period when real output, as measured by real national income, is decreasing. Thus, during a recession, actual real national income falls short of potential real national income, because some resources are unemployed and the economy operations below capacity.

13

During the current year, the following manufacturing activity took place for a company's products:

Beginning work-in-process, 70% complete 10,000 units
Units started into production during the year 150,000 units
Units completed during the year 140,000 units
Ending work-in-process, 25% complete 20,000 units
What was the number of equivalent units produced using the first-in, first-out method?

A. 138,000

B. 140,000

C. 145,000

D. 150,000

A. 138,000

Equivalent units is the number of units that would have been completed had the same production effort been devoted to starting and finishing a smaller number of units (the number of complete units).

On a FIFO (first-in, first-out) method, the equivalent units are calculated as follows:


Units completed during the period XX
Plus equivalent units in-process at end of period XX
Less equivalent units in-process at beginning of period XX
---
Total equivalent units for FIFO method XXX


Units completed during the year = 140,000 units
Equivalent units in-process at end of period = 25% of 20,000
= 5,000 units
Equivalent units in-process at end of period = 70% of 10,000
= 7,000 units

140,000 + 5,000 - 7,000 = 138,000 equivalent units

14

Which of the following types of budgets is the last budget to be produced during the budgeting process?

A. Cash

B. Capital

C. Cost of goods sold

D. Marketing

A. Cash

The steps to prepare a master budget are:

develop a sales forecast,
determine the desired level of finished goods inventory,
prepare a purchases or production budget,
estimate selling, administrative, and other general expenses,
organize the preceding information into an income statement, and
prepare a cash forecast.

15

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 rates are affected by changes in consumer tastes for products produced in various countries, relative changes in income in various countries, differing inflation rates, and differences in real interest rates.

If the demand for a nation's currency increases, the currency will appreciate, and if the supply of the nation's currency decreases, it will appreciate. A slower growth rate in a country compared to that of another country would cause a decline in the country's imports. Since one key source of supply of domestic currency is that made available to purchase foreign currency needed for imports, we would now be supplying less of our currency, and this would cause the domestic currency to appreciate vis-a-vis the foreign currency.

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.

16

A financial lease:

A. may normally be canceled by the lessee on 30 days' notice.

B. has a duration that corresponds to the useful life of the asset and payments that amortize the cost of the asset while providing the lessor an interest return.

C. is only available through a bank.

D. is only available on assets whose economic life exceeds 20 years.

B. has a duration that corresponds to the useful life of the asset and payments that amortize the cost of the asset while providing the lessor an interest return.


Financial leases are financing-type leases. They typically are noncancelable and extend over the life of the leased asset with title transferring to lessee at the end of the lease term. Lease payments “pay for” the asset while providing the lessor with interest income.

17

Why would a firm generally choose to finance temporary assets with short-term debt?

A. Matching the maturities of assets and liabilities reduces risk.

B. Short-term interest rates have traditionally been more stable than long-term interest rates.

C. A firm that borrows heavily long term is more apt to be unable to repay the debt than a firm that borrows heavily short term.

D. Financing requirements remain constant.

A. Matching the maturities of assets and liabilities reduces risk.

Temporary assets are often represented by temporary working capital—that is, the working capital that supports the company's operations above a minimal level and does not need to be maintained throughout the annual business cycle. The maturity matching concept states that the maturity date of the financing for an asset or project should match the maturity of the related asset. This means that the loan will be repaid at approximately the same time that cash becomes available at the end of a project or sale (or collection) of the asset. This situation is considered to be self-liquidating since the funds that become available at the end of the temporary period will be used to repay the short-term loan. The risk is considered to be lower for such a loan since the funds that will be used to repay the short-term loan are definite (reduction in working capital) as opposed to being dependent upon the general profitability of the organization.

18

Change management control policies should contain which of the following elements?

A. Require IT management to review, monitor, and approve all change requests

B. Assess what impact each change will have on system availability, security, maintainability, and integrity

C. Ensure proper testing of changes before the changes are implemented in a production environment

D. All of the answer choices are correct.

D. All of the answer choices are correct.

Change management control policies put into place the proper processes and approval channels to make changes to an organization's systems. At a minimum, they should include the following elements:

Formalized channels for requesting and approving changes to any of the organization's information systems
Preventing unauthorized changes from occurring
Ensuring that any changes made do not impair or negatively impact the other functions of the system
Ensuring that the viability of the system as a whole is not impaired
Requiring appropriate testing of all changes before implementation to production environments occurs

19

A 15,000-employee multinational company that produces and distributes retail products for home use has moved financial consolidation and reporting off its large mainframe computer system at headquarters to local area networks (LANs) with file servers. The mainframe system was doing the job of processing 200,000 transactions a month, but its batch processing was cumbersome and time consuming. It also did not have automatic interfaces to all the subsidiaries, especially those in other countries, due to software and hardware incompatibilities.

The risk of some or all of one month's general ledger transaction being processed again the following month is less if there is:

A. separate subsidiary balancing.

B. inadequate testing.

C. floppy booting.

D. range checking.

D. range checking.

Range checking would reduce the risk of reprocessing ledger transactions of an earlier month. Range checking involves checking a number in a transaction (such as the date) to determine whether that number falls within a specified range. For example, when March transactions were being processed, the date of each transaction would be checked and any transaction date falling outside the range March 1 through March 31 would not be processed.

20

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

A. interprets variances in terms of the independent variable.

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

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

D. is positive only for downward sloping regression lines.

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

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

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

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

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

Linear regression is a statistical technique (least squares) for fitting relationships between one or several independent variable(s) and a dependent variable. A linear regression model is one in which the theoretical mean value of the observation (yi) is a linear combination of independent variables:

Y = a + b1X1 + b2X2 + …… + bnXn + Error Variable (ε)
…where n X-or independent variables are included in the model. The multiples of b are the parameters of the model and the quantities to be estimated by the model—the regression coefficients. Y is the dependent variable and is the intercept or constant term in the model. The error term or residual recognizes measurement errors and other factors not included.

21

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

I. Sales volume equals production volume.
II. Variable costs are constant per unit.
III. 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.

Cost/volume/profit analysis helps a manager to understand the interrelationships between cost, volume, and profit by focusing on how changes in the following items can affect profit:

Selling price of the product
Volume of sales
Variable costs per unit
Total fixed costs
Product mix
The CVP Formula:

Profit = Sales - Variable Costs - Fixed Costs
Sales = Number of units sold times sales price per unit
Variable costs = Number of units sold times variable costs per unit
The breakeven point is a special case of CVP analysis where the profits equal zero. In other words, sales revenue equals total costs.

CVP analysis has several assumptions built into it:

Cost can be classified as either fixed or variable.
Variable costs per unit remain unchanged as activity changes.
Total fixed costs remain unchanged over the relevant range.
Sales price does not change with changes in volume.
There is only one product or if there are multiple products, the sales mix remains constant.
Productive efficiency does not change.
Inventories are kept constant or at zero.
Volume is the only relevant factor affecting costs.

22

One of the changes that has occurred as a result of recent globalization has been a shifting pattern in foreign direct investment (FDI). The current pattern of FDI may be described as having:

A. investment flow from emerging market economies to other emerging market economies and more developed economies, as many of these emerging economies capture an increasing amount of foreign exchange earnings either from the sale of raw materials or rising trade surpluses from the export of manufactured goods.

B. investment flow from developed nations to the emerging market economies to take advantage of the higher rates of return that are available on investments in those nations.

C. Central Banks increase their use of official reserves to ensure that the emerging market economies maintain a weak currency to support continued export growth.

D. developed countries provide loans to emerging market economies to allow them to develop infrastructure that will then provide the necessary environment for manufacturing development.

A. investment flow from emerging market economies to other emerging market economies and more developed economies, as many of these emerging economies capture an increasing amount of foreign exchange earnings either from the sale of raw materials or rising trade surpluses from the export of manufactured goods.

A foreign direct investment is an investment in which a resident of one country obtains a lasting interest in, and a degree of control over, management of a business enterprise in another country.

Traditional patterns of foreign direct investment (FDI) saw funds flow from slower-growing, rich, developed economies to emerging market economies. There has been a dramatic shift in FDI such that today major flows go from emerging market economies to more developed economies.

The lack of well-functioning capital markets coupled with a lack of sufficient local investment opportunities has created a pool of funds available for investment. Some of the goals pursued when using SWFs (sovereign wealth funds) to invest these funds would be to acquire technologies, brands, resources, and better access to international markets while using technology to enhance productivity and gain Western management skills.

23

Given that demand exceeds capacity, that there is no spoilage or waste, and that there is full utilization of a constant number of assembly hours, the number of components needed for an assembly operation with an 80% learning curve should:

i. increase for successive periods.
II. decrease per unit of output.


A. I only

B. II only

C. Both I and II

D. Neither I nor II

A. I only

The learning curve is a graphical description of the learning process that shows the impacts of learning over a number of practice opportunities on work behaviors. The learning curve usually shows increases in work performance as an employee integrates learning experiences (classes, on-the-job training, etc.) into work practices. A basic assumption of the learning curve model is that the direct labor required for the n + 1st unit will always be less than the labor required for the n unit.

Since demand exceeds supply, the company will keep increasing production with a constant number of assembly hours. Increased production requires more units of raw material (components).

24

EDP accounting control procedures are referred to as general controls or application controls. The primary objective of application controls in a computer environment is to:

A. ensure that the computer system operates efficiently.

B. maintain the accuracy of the inputs, files, and outputs for specific applications.

C. ensure the separation of incompatible functions in the data processing department.

D. provide controls over the electronic functioning of the hardware.

B. maintain the accuracy of the inputs, files, and outputs for specific applications.

“Application controls” refers to the transactions and data relating to each computer-based application system and are, therefore, specific to each such application. The objectives of application controls, which may be manual or programmed, are to ensure the completeness and accuracy of the records and the validity of the entries made therein. Application controls consist of input controls, processing controls, and output controls.

25

A fundamental purpose of a database management system is to:

A. store all data for an organization in multiple files.

B. reduce data redundancy.

C. change the manner in which application programs access individual data elements.

D. reduce the overall complexity of matters that relate to electronic data processing.

B. reduce data redundancy.

Reduction of data redundancy and associated costs is a prime objective of database utilization.

Storage of data will occur in multiple files regardless of whether or not a database is used. Minimizing the occurrences of data elements within the files is the key to data organization.
By using a logical view of data, access differences by application programs should be transparent to the programs and programmers.
Utilization of a database will increase complexity of data processing.

26

How does inflation distort reported income?

A. Wages are not reflective of current labor rates.

B. Sales are not reflective of current product prices.

C. Depreciation is not reflective of current fixed-asset replacement costs.

D. Interest expense is not reflective of current borrowing rates.

C. Depreciation is not reflective of current fixed-asset replacement costs.

As time passes during a period of inflation, the replacement cost of fixed assets increases while the historical cost remains unchanged. Depreciation based on replacement cost would lower net income more than historical cost depreciation; so historical cost depreciation does not reflect current fixed-asset replacement costs.

The other answer choices are incorrect because wages, sales revenue, and interest expense are measured in current dollars rather than the historical currency. Therefore, they do not distort reported income.

27

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

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

B. innovations in industrial technology.

C. changes in the level of national income.

D. a decrease in the minimum lending rate.

C. changes in the level of national income.

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

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

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

28

Controllable revenues would be included in the performance reports of which of the following types of responsibility centers?

A. Cost centers

B. Investment centers

C. Both cost centers and investment centers

D. Neither cost centers nor investment centers

B. Investment centers

A cost center is a subdivision (unit, section, department, or segment) of the business responsible for the incurrence and proper utilization (control) of costs.

An investment center adds revenues and investments to subdivision reports.

Revenue is not reported for cost center performance reports since they are not controllable by the center manager. Revenue is reported for investment centers since the manager controls costs, revenues, and investments.

29

Which of the following standard cost variances used in a standard cost system would be least controllable by a production supervisor?

A. Overhead volume

B. Overhead efficiency

C. Labor efficiency

D. Material usage

A. Overhead volume

The labor efficiency variance is the difference between the standard quantity of direct labor hours budgeted and the actual quantity used (per employee time sheets).

Direct labor efficiency variance = Standard wage × (Standard hours - Actual hours)
If Actual Hours is less than Standard Hours, variance is favorable; if Actual Hours is greater than Standard Hours, variance is unfavorable.

Direct labor efficiency variance is usually recorded at the end of the accounting period when the total hours worked in the period is known (it may also be recorded when it is used). The variance is assigned to Production or Manufacturing, since it is that department that has the responsibility for approving the actual hours worked.

Since labor efficiency variance is designed to measure labor efficiency, other factors such as downtime, rework, and vacations are not included. The standard should make reasonable allowance for fatigue, rest time, and faulty materials.



Note these three factors related to overhead volume:

The overhead volume variance is related to fixed overhead only. There is no volume variance for variable overhead.
The fixed overhead rate is a function of estimated volume.
Overhead volume variance occurs when actual production volume differs from estimated volume.
The production supervisor has little, if any, control over the overhead volume variance. Efficiency or usage variances relate quantities used against standard quantities. The production supervisor should have control over quantities used.

30

The “true” rate of interest is the same as the ________ rate.

A. tax

B. stated

C. nominal

D. effective

D. effective

The effective interest is computed considering the principal amount, stated or nominal rate and the compounding period(s). It is, therefore, the equivalent of the true rate of interest on a loan.

31

Kore Industries is analyzing a capital investment proposal for new equipment to produce a product over the next eight years. The analyst is attempting to determine the appropriate “end-of-life” cash flows for the analysis. At the end of eight years, the equipment must be removed from the plant and will have a net book value of zero, a tax basis of $75,000, a cost to remove of $40,000, and scrap salvage value of $10,000. Kore's effective tax rate is 40%. What is the appropriate “end-of-life” cash flow related to these items that should be used in the analysis?

A. $27,000

B. $12,000

C. $(18,000)

D. $(30,000)

B. $12,000

The key to solving this problem is separating the cash flow items from the noncash items. The $40,000 cost to remove the asset is a cash outflow. The scrap salvage value of $10,000 is a cash inflow. Both of these items are also part of the net income upon which tax must be computed. The $75,000 loss that will result from the disposal is also part of the net income upon which tax must be computed. However, the loss is not a cash outflow. What is a cash flow is the tax or tax savings in the net income or loss. The “end-of-life” cash flow may be calculated as follows:


Outflow: Cost to remove ($ 40,000)
Inflow: Salvage value $ 10,000
Inflow: Tax savings from
net loss $ 42,000 *
----------
Net cash inflow $ 12,000
* The tax savings is calculated on a net loss of $105,000. The loss is a result of the $65,000 tax loss on the asset disposal ($75,000 tax basis offset by $10,000 scrap value) and the $40,000 cost to remove the asset.

Terms

32

In a microcomputer system, the place where parts of the operating system program and language translator program are permanently stored is:

A. read only memory (ROM).

B. magnetic disk drive.

C. random access memory (RAM).

D. magnetic tape drive.

A. read only memory (ROM).

The operating system and language translator programs are permanently stored in the read only memory (ROM). ROM may only be read from to prevent these important programs from being accidentally altered or deleted.

33

Company A has numerous personal computers (PCs) with full processing capabilities linked into an integrated local area network with a file server which in turn is fully connected to the central mainframe computer. Data entry, comprehensive processing, and inquiry routines are possible at all nodes in the network.

A control feature designed to negate the use of utility programs to read files which contain all authorized access user codes for the network is:

A. internally encrypted passwords.

B. a password hierarchy.

C. log-on passwords.

D. a peer-to-peer network.

A. internally encrypted passwords.

Internally encrypted passwords are a form of access control designed to prevent unauthorized access by use of a utility program to identify passwords.

Password hierarchy is a system of passwords designed in such a manner as to allow differing degrees of access to file manipulation activities.
Log-on passwords are the familiar passwords commonly used to gain initial access to a system or network.
A peer-to-peer network has all processing done at the same level (by PCs in this case) with no dedicated file server or mainframe.

Encryption is transforming data, called plaintext, into unreadable gibberish, called ciphertext. Decryption reverses this process, transforming ciphertext back into plaintext.

a. Both a key and an algorithm are use to encrypt plaintext into ciphertext and to decrypt ciphertext back into plaintext.
(1) The key is a fixed length string of binary digits (a 128-bit key has 128 0s and 1s). The longer the key, the less likely it is that someone can break the encryption code.
(2) The algorithm is a formula that combines the key and the text. A strong algorithm that has been rigorously tested is difficult, if not impossible, to break by using brute-force guessing techniques.
b. To encrypt a document:
(1) The data to be encrypted is divided into blocks the same length as the key.
(2) The formula is applied to each block of data, producing a ciphertext version of the data that is the same size as the original.
c. To decrypt a document, the computer divides the ciphertext into 128-bit blocks and then applies the decryption key to each block.
d. Data is encrypted using one of the following encryption systems:
(1) A symmetric, or single key system, uses the same key to encrypt and decrypt a message.
(2) An asymmetric, or public key infrastructure (PKI), system uses two keys. The public key, as the name implies, is publicly available. The private key is kept secret and only the owner of that pair of keys knows what it is. Either key can be used to encode a message, but only the other key can be used to decode it.
e. A symmetric key is simple, fast, and efficient but has the following disadvantages:
(1) Since the sender provides the recipient with the secret key, the two parties need to have some method for securely exchanging the key. System effectiveness depends on controlling who knows the secret key.
(2) It requires a secret key for each different party with whom the company communicates.
(3) Since both parties have the same secret key, there is no way to prove who created a specific document and therefore no way to create legally binding agreements.
f. The PKI approach has the following advantages over single key systems:
(1) It eliminates problems with exchanging keys, and companies only need one key.
(2) It is more secure, because two different keys are used to encode and decode a message.
(3) Anyone can use the organization's public key to encrypt a message, but only the organization can use its private key to decode the message.
(4) Data can be encrypted with the private key and decrypted with the public key. Since this makes it possible to prove who created a document, legally binding electronic agreements can be created.
(5) This main drawback to asymmetric encryption systems is that it is much slower than single key systems—too slow to be used to exchange large amounts of data over the Internet.

34

Which of the following inputs would be most beneficial to consider when management is developing the capital budget?

A. Supply/demand for the company's products

B. Current product sales prices and costs

C. Wage trends

D. Profit center equipment requests

D. Profit center equipment requests

Capital budgeting involves management making decisions about spending money on long-term assets. In order to make these decisions, management must first know what each profit center's equipment needs are.

Supply and demand for the company's products, current sales prices and costs, and wage trends would be helpful in order to determine future cash flows as they relate to implementing various capital projects, but these are not the best answers.

35

Which one of the following statements best describes material requirements planning (MRP)?

A. A planning system that is used to determine the amount and timing of the optimal inventory level

B. A software tool that is used to forecast the ordering quantities of inventories that tend to be subject to a variable and continual demand

C. A planning system that is used to determine the amount and timing of inventories that are dependent on the demand for finished goods

D. A software tool that is used to forecast the schedule of material purchases that tend to be subject to a variable and continual demand

C. A planning system that is used to determine the amount and timing of inventories that are dependent on the demand for finished goods

Of the answer choices provided, the best description of material requirements planning (MRP) is a planning system that is used to determine the amount and timing of inventories that are dependent on the demand for finished goods. This description emphasizes the characteristic that sales demand drives the required inventories all the way from finished goods, through work-in-process, back down to the requirements of individual commodities needed for production. All of the other answer choices are incomplete or partial descriptions of aspects of a MRP system.

Material Resource Planning (MRP): The acronym MRP refers to “material resource planning” or to “material requisition planning.” MRP refers to the use of a computerized information system to schedule and order inventories of raw materials and other components used in manufacturing. A sales forecast or specific customer's order for completed product units specifies a given requirement date. The system then uses a bill of material and master production schedule to identify the type and quantity of components needed and determines the amount and timing of orders to be placed for the needed components. Orders may be placed through electronic data interchange (EDI) or a more traditional ordering system. In recent years, MRP has evolved to include both materials and financing—the planning of cash requirements to pay for inventory purchases.

36

All activity related to a particular application in a manual system is recorded in a journal. The name of the corresponding item in a computerized system is a:

A. master file.

B. year-to-date file.

C. transaction file.

D. current balance file.

C. transaction file.

A transaction file is the file of original entry and hence, corresponds to manual journal.

A master file is a list of all accounts and required information (records) for an application. This is similar to a ledger in a manual system.
A year-to-date file is an accumulated transaction file from the beginning of a fiscal year.
A current balance file shows some account information including and focusing on the current balance.

37

Morton Company needs to pay a supplier's invoice of $50,000 and wants to take a cash discount of 2/10, net 40. The firm can borrow the money for 30 days at 12% per annum plus a 10% compensating balance.

The amount Morton Company must borrow to pay the supplier within the discount period and cover the compensating balance is:

A. $55,000.

B. $55,056.

C. $55,556.

D. $54,444.

D. $54,444.

The total amount of the loan must be the amount due the supplier less the 2% discount plus the compensating balance of 10% of the total loan, or:


$50,000(1.00 - 0.02) + 0.10(Loan) = Loan
$49,000 + 0.10X = X
$49,000 = X - 0.10X
$49,000 = 0.90X
$54,444 = X

38

Jackson Distributors sells to retail stores on credit terms of 2/10, net 30. Daily sales average 150 units at a price of $300 each. Assuming that all sales are on credit and 60% of customers take the discount and pay on Day 10 while the rest of the customers pay on Day 30, the amount of Jackson's accounts receivable is:

A. $1,350,000.

B. $990,000.

C. $900,000.

D. $810,000.

D. $810,000.

Daily sales average $45,000 (150 units × $300/unit). Sixty percent (60%) of Jackson's customers pay in 10 days and 40% pay in 30 days. Using the collection ratio (accounts receivable divided by average daily sales) and treating the accounts receivable as if it were two different accounts receivable (one for those who pay in 10 days and one for those who pay in 30 days), one can arrive at the amount of Jackson's accounts receivable. We know the collection ratio for the 10-day accounts receivable is 10 days and the collection ratio for the 30-day accounts receivable is 30 days.

10-Day Accounts Receivable:


Collection Ratio = 10 = Accounts receivable / Average daily sales
10 = Accounts receivable / ($45,000 x 60%)
solve for A/R: Accounts receivable = $270,000
30-Day Accounts Receivable:


30-day Accounts Receivable:
Collection ratio = 30 = Accounts receivable / Average daily sales
30 = Accounts receivable / ($45,000 x 40%)
solve for A/R: Accounts receivable $540,000
--------
Total Accounts Receivable: $810,000

39

The relevance of a particular cost to a decision is determined by the:

A. riskiness of the decision.

B. number of decision variables.

C. amount of the cost.

D. potential effect on the decision.

D. potential effect on the decision.

Relevant costs are the only costs considered in decision making. Relevant costs are those costs that are affected by the decision being made. All other costs are considered constant and consequently have no effect on the decision. Therefore, the relevance of a particular cost to a decision is determined by the potential effect on the decision.

40

Many companies and government organizations would like to convert to open systems in order to:

A. get volume discounts from equipment vendors.

B. achieve more economies of scale for equipment.

C. use less expensive computing equipment.

D. facilitate the integration of proprietary components.

C. use less expensive computing equipment.

Converting to open systems increases the number of vendors from which substitutable components could be acquired, which increases price competition for equipment.

In general, running open systems:

tends to increase the number of vendors, which decreases the amount of the average purchase from any one vendor, thereby decreasing the opportunities for volume discounts from vendors.
allows organizations to scale their computing facilities to a precise size, which may be inconsistent with attempting to achieve economies of scale due to larger volumes concentrated in fewer sites.
reduces an organization's reliance on proprietary components, which reduces the need for their integration into existing systems.

41

The resource base figures prominently in performance measures such as return on investment, residual income, and economic value added. The theoretically superior (not necessarily the one most widely used) investment base would be:

A. book value.

B. historical cost.

C. replacement value.

D. All of the answer choices are correct.

C. replacement value.

Replacement cost is a measure of current value. Since revenue and most expenses are also stated in terms of current value, a more consistent performance measure (i.e., return on investment or residual income) will result when all variables are stated in current dollars. Use of replacement or current values assures that a more relevant performance result will be obtained.

42

The dominant reason why countries devalue their currencies is to:

A. improve the balance of trade.

B. discourage exports without having to impose controls.

C. curb inflation by increasing imports.

D. slow what is regarded as too rapid an accumulation of international reserves.

A. improve the balance of trade.

Countries devalue their currencies so as to lower the prices of their domestic goods relative to those of foreign imports. Devaluation of one's currency makes foreign goods more expensive, and demand for the goods denominated in the devalued currency become more attractive. Exports for these goods increase, and this improves the balance of trade, which is the difference between the dollar value of exports and imports in a given year.

43

The overall cost of capital is the:

A. rate of return on assets that covers the costs associated with the funds employed.

B. average rate of return a firm earns on its assets.

C. minimum rate a firm must earn on high risk projects.

D. maximum rate of return on assets.

A. rate of return on assets that covers the costs associated with the funds employed.

The overall cost of capital is the rate of return on assets that covers the costs associated with the funds employed.

A firm's overall cost of capital is a weighted average of the costs of the different sources of funds that the firm uses to finance its assets. These sources are usually some combination of debt and equity. Cost of capital usually refers to the cost of long-term sources of funds, such as long-term debt, preferred stock, and common stock. A firm must pay a return to the suppliers of all of these sources of funds. Theoretically, the minimum return that a firm must earn to keep the value of its stock from declining is equal to the weighted average cost of capital. If a firm earns less than this on its total assets, then there are not enough earnings to pay the suppliers of funds what they expect to receive. Since interest costs are fixed and must be paid first, common stockholders are the ones who will usually suffer a shortfall in returns. If common stockholders do not receive at least the minimum return they require for the risk they are taking by holding common stock, then the value of their investment decreases and the value of their stock falls.

44

When performing a fair value valuation, John CPA has found a quoted market price for a similar asset to the one held by the reporting organization. There are some questions, however, related to the condition of the asset being valued in comparison to the similar asset. John should:

A. consider this a Level 1 fair value measurement since a current market price was available for an asset similar to the one being valued.

B. consider this a Level 2 fair value measurement since a current market price was available for an asset similar to the one being valued.

C. consider this a Level 3 fair value measurement if the potential adjustments necessary due to the condition of the assets being valued merit the classification of an unobservable input.

D. make all possible efforts to find another input that will be a closer comparison to the subject asset.

C. consider this a Level 3 fair value measurement if the potential adjustments necessary due to the condition of the assets being valued merit the classification of an unobservable input.

Per FASB ASC 820, there are three groups of inputs used when developing fair value:

Level 1: directly observable inputs of identical items, such as quoted active market prices
Level 2: directly or indirectly observable inputs of similar items
Level 3: unobservable inputs
In John's valuation situation, the quoted market price is for the allegedly similar asset; therefore, this can be no more than a Level 2 fair value measurement. However, since there is a question as to the similarity of the conditions between the subject asset and the comparable, John will need to consider whether these questions related to the condition of the subject asset are significant enough to lower the fair value measurement to a Level 3.

Although FASB ASC 820 expects that the CPA will attempt to use more observable than unobservable inputs when doing a fair value valuation, it only requires the use of information that is available without undue cost or effort.

45

Kane Corp. estimates that it would incur a $100,000 cost to prepare a bid proposal. Kane estimates also that there would be an 80% chance of being awarded the contract if the bid is low enough to result in a net profit of $250,000. What is the expected value of the payoff?

A. $0

B. $150,000

C. $180,000

D. $220,000

C. $180,000

Expected value is the mean or average value of a random variable over the possible outcomes. It is calculated by weighting the value of each possible outcome by its probability and summing over all values.

Here there are two possible outcomes:

$250,000 profit with an 80% probability gives an expected value of 0.8 × $250,000, or $200,000.
Zero profit with a 20% probability gives an expected value of -$100,000 (the cost of preparing the bid) for an expected value of -$20,000.
Summing an expected value of $200,000 with an expected loss of $20,000 gives a net expected value of $180,000.

We would not want to subtract the $100,000 cost of preparing the bid from the $250,000 profit because profit means revenue minus expenses. Therefore, the $250,000 profit is the amount after the $100,000 cost of preparing the bid has been subtracted from revenue.

46

Supply chain metrics are created to measure the performance of the supply chain. If a firm developed metrics to measure things such as fill rates and on-time delivery, we would assume that they are trying to measure:

A. manufacturing flexibility.

B. supplier relationships.

C. customer service.

D. the flexibility the firm has to respond to environmental changes.

C. customer service.

One key element of customer service management is to provide customers with real-time information as to product availability and delivery and customer satisfaction could be measured by metrics such as fill-rates and on-time delivery.

47

What is the primary objective of data security controls?

A. To establish a framework for controlling the design, security, and use of computer programs throughout an organization

B. To ensure that storage media are subject to authorization prior to access, change, or destruction

C. To formalize standards, rules, and procedures to ensure the organization's controls are properly executed

D. To monitor the use of system software to prevent unauthorized access to system software and computer programs

B. To ensure that storage media are subject to authorization prior to access, change, or destruction

Data processing and storage controls ensure all transactions are processed as authorized, no authorized transactions were omitted, and no unauthorized transactions were added; the controls also safeguard stored data. Only the answer choice “to ensure that storage media are subject to authorization prior to access, change, or destruction” refers to controlling the data.

The answer choice “To establish a framework for controlling the design, security, and use of computer programs throughout an organization” is incorrect because it describes controls over computer software, not data security. “To formalize standards, rules, and procedures to ensure the organization's controls are properly executed” describes the monitoring of internal controls, not data security. “To monitor the use of system software to prevent unauthorized access to system software and computer programs” describes access controls to the system, not data security controls.

48

The four components of time series data are secular trend, cyclical variation, seasonality, and random variation. The seasonality in the data can be removed by:

A. multiplying the data by a seasonality factor.

B. taking the weighted average over four time periods.

C. subtracting a seasonality factor from the data.

D. adding a seasonality factor to the data.

B. taking the weighted average over four time periods.

Seasonality in data may be removed by calculating a weighted average of the data for the four seasonal (quarterly) time periods. This provides a representative annual value which is free of seasonal influence.

49

According to COSO, the position or internal entity that is best suited, as part of the enterprise risk management process, to devise and execute risk procedures for a particular department is:

A. the internal audit department.

B. the chief executive officer.

C. a manager within the department.

D. the audit committee.

C. a manager within the department.

50

Under the balanced scorecard concept developed by Kaplan and Norton, employee satisfaction and retention are measures used under which of the following perspectives?

A. Customer

B. Internal business

C. Learning and growth

D. Financial

C. Learning and growth

The balanced scorecard concept is a management tool detailed in the book of the same name by Robert Kaplan and David Norton. The back cover of Kaplan and Norton's book states: “The Balanced Scorecard is a management system that can channel the energies, abilities, and specific knowledge held by people throughout the organization toward achieving long-term strategic goals. Kaplan and Norton demonstrate how senior executives in industries such as banking, oil, insurance, and retailing are using the Balanced Scorecard both to guide current performance and to target future performance. They show how to use measures in four categories—financial performance, customer knowledge, internal business processes, and learning and growth—to align individual, organizational, and cross-departmental initiatives and to identify entirely new processes for meeting customer and shareholder objectives.”

Kaplan and Norton's book (p. 44) provides these general guidelines for the four perspectives of the balanced scorecard concept:

Perspective: Generic measures
Financial: Return on investment and economic value added
Customer: Satisfaction, retention, market, and account share
Internal: Quality, response time, cost, and new product introductions
Learning and Growth: Employee satisfaction and information system availability

51

Which of the following statements is true?

A. Liquid assets yield a return higher than the return on other assets.

B. A greater margin of safety would be provided by having more current liabilities and fewer current assets.

C. For current assets, the higher the proportion of liquid assets to total assets, the greater the return on investment.

D. Over an extended period of time, interest on long-term debt costs more than interest on short-term debt for the same amount of money borrowed.

D. Over an extended period of time, interest on long-term debt costs more than interest on short-term debt for the same amount of money borrowed.

As a general rule, interest on long-term debt costs more than interest on short-term debt because of risk associated with longer maturity dates.

If the exact dollar amounts needed over time and the short-term interest rates were known, needs could be met with only short-term debt. However, since short-term rates fluctuate widely, it is usually advantageous to avoid the risk of such fluctuation by borrowing long term. The amount borrowed will tend to be greater for long-term borrowing than would be true if such borrowing could be short term (refinanced periodically) and for only the minimum amount needed.

Why Interest Rates Differ

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

Advantages of Short-Term Debt

a. A short-term loan can generally be obtained quickly.
b. Cost of obtaining short-term debt is generally low since the lender tends to only do a minimal financial examination of the firm applying for funds.
c. There are generally no prepayment penalties.
d. Short-term debt generally has few restrictions.
e. Since the yield curve is typically upward sloping, short-term interest rates are generally lower than long-term interest rates.
f. Interest expense is tax deductible and, therefore, provides financial leverage.
g. Accounts payable is a primary source of short-term debt and it is spontaneously created when inventory is purchased.

Disadvantages of Short-Term Debt

a. Short-term interest rates can vary widely over time, subjecting the firm to refinancing risk.
b. An unexpected need for cash during a recession could cause cash flows to be insufficient to meet the short-term obligations.
c. Due to changing financial conditions, short-term debt may not be renewable and thus, depending upon the level of short-term debt, may put a firm in an illiquid position that could lead to bankruptcy.

Advantages of Long-Term Debt

a. A firm's interest cost is fixed for the maturity of the loan, thus protecting the firm from interest rate changes (or within a limited range for a variable interest rate).
b. Interest expense is tax deductible and, therefore, provides financial leverage.
c. The yield required by providers of long-term debt is lower than required by providers of equity due to the fact that the risk is lower.
d. The control of the firm is not shared by long-term debt holder.

Disadvantages of Long-Term Debt

a. Long-term debt frequently has various restrictive covenants that can dramatically limit choices available to management. Examples include setting dividends, obtaining additional debt, holding compensation balances, maintaining levels of liquidity and/or solvency ratios, and prepayment penalties.
b. If interest rates fall, a firm could be locked into a high interest rate.
c. If profits (cash flows) fall, interest expenses still have to be paid.
d. Long-term debt has a maturity date at which time the principal needs to be repaid.
e. A firm generally has a limit as to the amount of funds that can be raised through the issuance of long-term debt.

52

The correlation coefficient that indicates the weakest linear association between two variables is:

A. - 0.73.

B. - 0.11.

C. 0.12.

D. 0.35.

B. - 0.11.

The correlation coefficient is a measure of the closeness of data points to the regression line. The closer to zero, the poorer the fit. Hence, - 0.11 is the closest to zero and thus the weakest association to the regression line. (Note: Correlation can be positive or negative. Thus, the best answer choice is the smallest absolute number.)

53

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

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

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

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

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

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

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

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

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

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

a. Working Capital is short-term assets such as cash, receivables, and inventory. Net Working Capital is current assets less current liabilities. Working capital is tied to the cash conversion cycle where inventory is purchased or produced and then sold on account, and payments are made. It focuses on the difference between the cash collection period and cash payment period.
1. The inventory conversion period is the average time that inventory is held in days before being sold. (Average inventory ÷ Average sales per day)
2. The receivables collection period is the average time that receivables are outstanding before they are turned into cash. (Average accounts receivable ÷ Average sales per day)
3. The payables deferral period is the average time that short-term obligations related to the purchase/production of inventory are outstanding. (Average payables ÷ Average purchases per day)
4. The cash conversion cycle is the inventory conversion period and the receivable collection period less the payables deferral period. It represents the amount of time that funds are tied up in non-cash current assets.


Illustration: If the inventory conversion period is 45 days, the receivable collection period is 35 days, and the payable deferral period is 30 days, what is the cash conversion cycle?

Solution: The cash conversion cycle is simply:
Inventory conversion period + Receivable collection period
- Payable deferral period = 45 days + 35 days - 30 days = 50 days

Thus cash is tied up in non-cash current items for 50 days. This represents a permanent financing need.
b. As long as the cash conversion cycle can be shortened without encroaching on sales or increasing costs, a firm should attempt to do so since that will mean that a lower amount of permanent financing will be necessary, and there is a cost to any financing. This can be done by:
1. Selling products more quickly
2. Collecting receivable more quickly
3. Slowing down payments (See the discussion on discounts in section 5333.10.)


Illustration: Using the above example, if $25,000 of obligations related to the purchase/production of inventory are created each day, the necessary working financing needs would be $1,250,000 given the cash conversion cycle of 50 days ($25,000 × 50 days). If products could be sold on average 2 days earlier, receivables collected on average 3 days earlier, and payments on payables delayed on average 1 day more, then the conversion cycle would be decreased by 6 days. That translates into a decrease of $150,000 tied up in non-cash current assets. If the cost of borrowing is 6%, that would mean that the organization would save $9,000 per year ($150,000 × 6%).
c. The concept of zero working capital is when inventories + receivables - payables equal zero. This equation can be translated as the use of payables for the sole source of financing for inventories and receivables. If a company moves to zero working capital, there are two results:
1. There is a one-time infusion of cash as either inventory and/or receivables are decreased or payables increased.
2. Income is permanently increased on an annual basis due to the fact that financing is no longer needed to support working capital (higher level of inventory and receivables including the costs of carrying inventory and receivables). The costs of financing operating assets are shifted to suppliers. Inventory reductions can often be accomplished through the use of JIT (Just-in-Time).
d. If working capital is reduced, the amount of financing decreases; thus, EVA (economic value added) will increase since the after-tax dollar cost of operating capital will decrease.


54

Tam Co. is negotiating for the purchase of equipment that would cost $100,000, with the expectation that $20,000 per year could be saved in after-tax cash costs if the equipment were acquired. The equipment's estimated useful life is 10 years, with no residual value, and would be depreciated by the straight-line method. Tam's predetermined minimum desired rate of return is 12%. Present value of an annuity of 1 at 12% for 10 periods is 5.65. Present value of 1 due in 10 periods at 12% is .322.

In estimating the internal rate of return, the factors in the table of present values of an annuity should be taken from the columns closest to:

A. 65.


B. 1.30.

C. 5.00.

D. 5.65.

C. 5.00.

The payback period serves as a fair approximation of the annuity factor value from the table of present values of an annuity.

Using the data given:


Payback = Investment / Annual saving
= $100,000 / $20,000
= 5.00
Thus, internal rate of return can be obtained as a percentage rate from an annuity table for 10 periods nearest the annuity factor of 5.00.

A time-adjusted rate of return is also called an internal rate of return. It is a method used when the cost of the investment and annual cash flows are known and the rate of return is to be determined. The time-adjusted rate of return is the rate that equates the present value of the projected future net cash flows with the cost of the investment. Investments with a rate of return greater than the firm's desired rate of return are desirable. Those with a return less than the desired rate of return should be rejected.

55

A profit-maximizing firm operating in a competitive market in the short run will increase output:

A. until marginal cost begins to rise.

B. until total revenue equals total costs

C. as long as marginal revenue is greater than marginal costs.

D. as long as marginal costs are greater than marginal revenue.

C. as long as marginal revenue is greater than marginal costs.


In pure competition, a firm will continue to produce until marginal costs = marginal revenue; therefore, as long as marginal revenue is greater than marginal costs, the firm will continue to increase output.

56

Wong Company utilizes both strategic planning and operational budgeting. Which one of the following items would normally be considered in a strategic plan?

A. Setting a target of 12% return on sales

B. Maintaining the image of the company as the industry leader

C. Setting a market price per share of stock outstanding

D. Distributing monthly reports for departmental variance analysis

B. Maintaining the image of the company as the industry leader

Strategic planning is the general planning done by top management that charts a company's course through its operating environment. Maintaining the image of a company as an industry leader is therefore a strategic goal.

The other answer choices, listed below, are all operational or budgetary goals:

Setting a target of 12% return on sales
Setting a market price per share of stock outstanding
Distributing monthly reports for departmental variance analysis

57

What is an internal rate of return?

A. A net present value

B. An accounting rate of return

C. A payback period expected from an investment

D. A time-adjusted rate of return from an investment

D. A time-adjusted rate of return from an investment

The internal rate of return (IRR) can be referred to as the yield (return) expected over the life of a project. It is computed by equating the initial investment with the present value of the cash flows over the life of the project. IRR is the discount rate that results in the net present value of all cash flows equal to zero. Due to the fact that present values of all cash flows are used in the determination of IRR, it is a time-adjusted rate of return related to the project being considered.

58

A company is very conscious of the sensitive nature of company information. Because company data are valuable, the most important thing that the security administrator should monitor is:

A. multiple access to data by data owners.

B. management authorization of modified access.

C. access to operational data by privileged users.

D. data owner specification of access privileges.

C. access to operational data by privileged users.

The security administrator should report access to data or resources by privileged users so that the access can be monitored for appropriate and authorized usage.

Multiple access to data by data owners, the individuals responsible for creating and maintaining specific data, is a normal occurrence.
Management authorization of modified access is expected as needs or conditions change and is not an event typically reported.
Data owner specification of access privileges is normal and is typically maintained by the system and need not be reported by the security administrator.

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.


59

The market approach to determining the fair value of a small company is based upon the theory that:

A. an organization with newer assets will be worth more than one with older and possibly obsolete assets.

B. an investor will require that an investment will not only cover the cost of the initial investment but also provide a return necessary to compensate for the riskiness of that investment.

C. companies within the industry that have similar performance records and structure will have similar value.

D. the economic substitution principle provides a basis to develop a value that takes into consideration the functional obsolescence and physical deterioration of the assets employed in the company.

C. companies within the industry that have similar performance records and structure will have similar value.


There are three basic valuation approaches:

The cost approach
The market approach
The income approach
The market approach to determining fair value uses market comparisons of identical or comparable items. A comparable item is one that has reasonable and justifiable similarity to the item being valued, be that a single asset or an entire business.

The cost approach to determining fair value is an example of the economic substitution principle. In other words, what would it cost to replace the item in question with an asset of like function and capacity?

The income approach to determining fair value focuses on the company's ability to create earnings or some other benefit stream, such as cash inflows, and the risk related to that investment. An investor will approach any investment from the perspective of the expected future benefit streams, and the requirement that those future benefit streams need to cover not only the cost of the initial investment but also a return commensurate with its risk.

60

It is important to maintain proper segregation of duties in a computer environment. Which of the following access setups is appropriate?

A. Users have update access for production data

B. Users have update access for production data and application programmers have update access for production programs

C. Application programmers have update access for production data and users have update access for production programs

D. Users have update access for production data and application programmers have update access for both production data and programs

A. Users have update access for production data


Users need to update data through applications programs.

Application programmers should not be able to change production programs. They should submit changes to the change control unit.

Application programmers should never have update access to production data. Users have no need to change production programs.

61

Under which one of the following conditions is the internal rate of return method less reliable than the net present value technique?

A. When the net present value of the project is equal to zero

B. When income taxes are considered in the analysis

C. When both benefits and costs are included, but each is separately discounted to the present

D. When there are net cash inflows of sizable amounts early in the project

D. When there are net cash inflows of sizable amounts early in the project

The real issue here is the reinvestment assumption applied to “recovered funds.” Net present value (NPV) assumes reinvestment at the cost of capital whereas internal rate of return (IRR) assumes reinvestment at the IRR.

NPV makes the more realistic assumption about the rate of return that can be earned on cash flows from the project.

Profitability Index (Excess Present Value Index)

a. The Profitability Index takes both the size of the original investment and the value of the discounted cash flows into account. This is calculated by dividing the present values of the cash flows after the initial investment by that investment.
Present Value of Cash Flows
Not Including the Initial Investment
------------------------------------ = Profitability Index
Initial Investment

This allows for the comparison of various projects with differing initial investment amounts. Note that any project with a positive NPV will, by definition, have a Profitability Index greater than 1. The Present Value of Cash Flows Not Including the Initial Investment equals the NPV of that project plus the initial investment.
b. The Profitability Index is often used to compare two or more mutually exclusive projects. Potential projects might be mutually exclusive in that they represent viable options to accomplish the same task. Other constraints might include a limited capital budget or lack of adequate resources to accomplish multiple projects. The alternative project with the highest profitability index is the most desirable.
c. Example: Assume that the information is available on two mutually exclusive projects:
Project 1 Project 2
--------- ---------
Initial Investment $50,000 $75,000
NPV $20,250 $25,000

Calculate the Profitability Index:
Project 1: $20,250 + $50,000
----------------- = 1.41
$50,000


Project 2: $25,000 + $75,000
----------------- = 1.33
$75,000

Assuming that funds are available, the most desirable project based upon the Profitability Index would be Project 1. Note that the profitability index uses the PV of the cash flows and not the NPV; therefore the initial investment amount must be added back to the NPV.
d. The Profitability Index is also known as the Benefit-Cost Ratio.
e. An alternative formula used to calculate the profitability index is:
Net Present Value of the Project
-------------------------------- + 1 = Profitability Index
Initial Investment

Using this alternative formula and the above data for Project 1, the profitability index would be calculated as:
$20,250
------- + 1 = 0.41 + 1 = 1.41
$50,000
f. The Project Profitability Index is an additional variation of the profitability index. When an organization with limited funds is considering projects that require different initial investments, the NPV of one project cannot be directly compared to the NPV of another potential project. If the NPV of each project is divided by the required investment of that project, the project profitabilities can then be compared. The project with the highest project profitability index would be the most desirable project.
Net Present Value of the Project
Project Profitability Index = --------------------------------
Investment Required
g. Example: Look at the following information regarding two possible investment opportunities:
Project 1 Project 2
--------- ---------
NPV of Proposed Projects (a) $8,000 $4,500
Investment Required (b) $10,000 $5,000
Project Profitability Index (a/b) 0.80 0.90

Since the project profitability index is higher for Project 2 than Project 1, Project 2 is the more desirable choice.
h. An additional variation of the profitability index is used when there is a constrained resource that can be used to produce incremental profits in multiple segments. Here the profitability index formula is:
Incremental Profit from the Segment
Profitability Index = --------------------------------------------
Constrained Resource Required by the Segment

If machine hours were the constraint (bottleneck) and multiple segments of the organization could use the limited machine hours to produce incremental profits, then by determining the profitability of one unit of the constraint, management can determine the most profitable way to use the constraint.

This formula is really the basis for the formula shown in section (a) to be used for projects of a more long-term nature. For that formula, the incremental profits from the segment are defined as the positive net present values of the cash flows after the initial investment, and the amount of the constrained resource is defined as the investment required by the project.
i. Example: The following information is available regarding incremental profits that could be produced by two different segments using a constrained resource (machine hours).
Product 1 Product 2
--------- ---------
Incremental profit possible $250,000 $400,000
Amount of machine hours
necessary to produce the
incremental profit 100 hours 200 hours

Segment 2 may appear to be more attractive since an additional $400,000 of profit is possible; however, more machine hours (constraint) are necessary for each dollar of profit; therefore, the constraint of machine hours can be best utilized in producing Product 1 than Product 2.
Product 1 Product 2
-------------- --------------
Incremental profit possible (a) $250,000 $400,000
Amount of machine hours
necessary (constraint) (b) 100 hours 200 hours
Profitability index (a/b) $2.50 per hour $2.00 per hour

62

Commercial banks and other financial intermediaries provide a variety of services to their retail customers in a very competitive market. Most institutions provide mortgage loans that allow the customer to refinance the loan at any time without a prepayment penalty. The type of interest-rate risk these institutions would be incurring is:

A. option risk.

B. re-pricing risk.

C. basis risk.

D. yield curve risk.

A. option risk.

Option risk occurs when a firm gives the customer the right (but not the obligation) to change the stream from assets, liabilities, or off-balance sheet items. Allowing a customer to prepay a mortgage without a prepayment penalty gives the customer a call option, i.e., the right to pay the mortgage in full at any time during the mortgage term, thus changing the cash flow stream the firm receives from the mortgage.

Re-pricing risk occurs when a firm deliberately mismatches in an upsloping yield curve environment by holding assets with a longer duration than that of the liabilities used to fund them.
An example of basis risk would be found in the situation where a bank's interest margins are generally spontaneously enhanced in a period of rising interest rates as loan rates tend to adjust upward more rapidly than the rates on deposits. However, at some point, as interest rate increases peak and rates begin to decline, this process reverses itself and there would be increasing pressure on interest rate margins.
Yield curve risk arises when the underlying shape of the yield curve changes (e.g., steepens, flattens, becomes inverted). These changes tend to accentuate any asset-liability mismatches the firm has.

63

A zero-balance account is:

A. a checking account that substitutes drafts for regular checks so that management does not have to keep funds in the account for check clearing.

B. a checking account that moves funds from a local bank to a concentration bank; therefore, the balance maintained in the account is zero.

C. a checking account that maintains a zero-balance since funds only sufficient to cover the checks presented are transferred from another account.

D. None of the answer choices are correct.

C. a checking account that maintains a zero-balance since funds only sufficient to cover the checks presented are transferred from another account.

A zero-balance account is one that maintains a zero-balance since funds only sufficient to cover the checks presented are transferred from another account.

Payable-through drafts are legal instruments that look like checks, but they are not drawn on the bank. Payable-through drafts are drawn on and approved by the issuing company against its demand deposit account.

Concentration banking is when a company uses a geographically dispersed collection center to speed up the collection process.

Zero Balance Accounts (Sweep Accounts)

a. Zero Balance Accounts are held at zero until a claim is made against the account. At that time, the holding bank transfers sufficient funds from an interest-bearing account to the zero balance account. The firm must have at least one additional account with the bank, and there is generally a small fee associated with transfers.
b. A zero balance account can be effectively used by an organization when the interest earned in the interest-bearing account is greater than the fees associated with the transfers of funds. Operationally, it reduces the need for the firm to monitor daily fund flows.
c. A hybrid of the zero balance account is a payroll account where funds necessary to cover payroll are transferred automatically as the payroll checks are being issued.

64

In an activity-based costing system, what should be used to assign a department's manufacturing overhead costs to products produced in varying lot sizes?

A. A single cause and effect relationship

B. Multiple cause and effect relationships

C. Relative net sales values of the products

D. A product's ability to bear cost allocations

B. Multiple cause and effect relationships

Under conventional costing, all of a department's overhead would be accumulated in a single overhead account (or cost pool). This overhead would then be applied to product based on a single driver such as labor hours or machine hours.

Activity-based costing systems identify several activities and the resources (i.e., overhead costs) related to those activities. Then, appropriate cost drivers are identified and activity costs calculated. These activity costs are then assigned to products based on the products' consumption of activities.

The use of multiple activities results in multiple cause and effect relationships in activity-based costing in contrast to a single cause and effect relationship used in conventional costing.

65

As it relates to accounts receivable, a mathematical relationship that can define the optimal credit level is:

A. Carrying costs = Cost of capital.

B. Carrying costs = Opportunity costs.

C. Total costs = Opportunity costs.

D. Total costs = Cost of capital.

B. Carrying costs = Opportunity costs.

Accounts receivable are at the optimal level when Carrying costs = Opportunity costs.

Carrying costs are costs that are associated with the granting of credit (such as bad debts), the costs of managing that credit, and the delay in receiving cash.

Opportunity costs are sales that are lost from refusing to offer credit.

Introduction to Accounts Receivable Management

a. Firms extend credit on sales in order to increase revenues. Since the objective of increased sales is to increase profit, a firm will theoretically extend credit until the cost of offering additional credit equals the costs incurred in generating those sales (incremental analysis).
b. The value of the trade accounts receivable at any given time is directly tied to sales volume, which in turn is influenced by factors, some of which management has control of, such as product price and quality and advertising. Another major controllable factor influencing sales is the firm's credit policy that consists of:
1. Credit period—the length of time the customer is given to pay for the purchases. For example, credit terms of “3/10, net 30” allow buyers to take up to 30 days to pay without incurring interest charges.
2. Discounts—the credit terms “3/10, net 30” allow customers to take a 3% discount if the payment is received within 10 days of the invoice. The full amount would be due in 30 days if the discount opportunity was not taken.
3. Credit Standards—the required financial strength of acceptable customers. Relaxing the standards is likely to boost sales, but also to increase bad debt losses.
4. Collection Policy— how tough or lax the firm is in terms of attempting to collect slow-paying accounts. Again, there is a trade-off between attempting to speed up the collection of an account and possibly losing a customer.
c. The credit manager is generally responsible for administering a firm's credit policy. However, credit policy is generally set at an administrative level within the firm.
d. A change in credit policy involves the interaction between several variables. Below are some of the issues management would need to analyze when considering a change in the credit policy.
1. Sales—What is the projected increase in the level of gross sales that would result from the change?
2. Account Receivable—There is generally a proportional relationship between an increase in sales and an increase in accounts receivable. An increase in accounts receivable would mean that additional funds would be tied up until collection. Increasing accounts receivable would require increasing funding (debt or equity) with a possible increase in interest costs.
3. Discounts and Bad Debt Losses—What proportion of customers would be expected to take the discount? What proportion of the additional receivables would become bad debts?
4. Costs of Running a Collection Department—Would more staff (higher costs) be needed to run collection department due to higher volume? Would there be fixed costs associated with the expansion of the credit collection efforts?
5. Management would have to compare the increased revenues expected with the increased costs to determine whether the firm would be better off on an incremental profit basis.
e. A firm's credit policy includes the credit standards, credit period, available discounts, and collection procedures.
f. The quality of credit is defined as the ability to collect receivables in full and in a timely manner.
g. A firm's credit policy is often dictated or strongly influenced by competitors since unless the firm's policies are competitive, sales will often be lost.


66

A management accountant performs a linear regression of maintenance cost vs. production using a computer spreadsheet. The regression output shows an “intercept” value of $322,897. How should the accountant interpret this information?

A. Y has an estimated value of $322,897 when X equals zero.

B. X has an estimated value of $322,897 when Y equals zero.

C. The residual error of the regression is $322,897.

D. Maintenance cost has an average value of $322,897.

A. Y has an estimated value of $322,897 when X equals zero.

A linear relationship between two variables means that it can be graphed as a straight line. On a graph, the vertical axis is the Y axis, and the horizontal axis is the X axis. The intercept value is where the line crosses the Y axis. At the Y axis, the X value is zero. Therefore, Y has an estimated value of $322,897 when X equals zero.

67

Which one of the following input validation routines is not likely to be appropriate in a real-time operation?

A. Field check

B. Sign check

C. Sequence check

D. Redundant data check

C. Sequence check

In real-time operations, transactions are processed as they occur, without regard to any particular sequence. Therefore, a sequence check would not be an appropriate input validation routine.

The other responses represent input validation checks or controls that should be performed.

68

An accounting system that collects financial and operating data on the basis of the underlying nature and extent of the cost drivers is:

A. direct costing.

B. activity-based costing.

C. target costing.

D. cycle-time costing.

B. activity-based costing.

Activity-based costing (ABC) collects financial and operating data based on the underlying nature and extent of the cost drivers. Activity-based costing:

identifies activities and cost of performing those activities.
identifies appropriate cost drivers for all activities.
develops activity costs per unit of cost driver.
assigns costs to products/services based on consumption of activity costs.
The cost drivers are clearly very important in the process of collecting financial and operating data.

69

What does integrated planning accomplish?

A. Participation of stakeholders and affected departments

B. The creation of strategic planning

C. Electronic commerce

D. Business process design

A. Participation of stakeholders and affected departments

Integrated planning provides for the participation of stakeholders with affected departments within an organization. This participation helps the organization to examine costs and benefits of a plan of action.

In the process of strategic planning, the organization must consider integrated planning. Integrated planning ensures communication between all stakeholders and affected departments (work groups) participating in the project.

70

Which of the following responses is not an advantage to a corporation that uses the commercial paper market for short-term financing?

A. This market provides more funds at lower rates than other methods provide.

B. The borrower avoids the expense of maintaining a compensating balance with a commercial bank.

C. There are no restrictions as to the type of corporation that can enter into this market.

D. This market provides a broad distribution for borrowing.

C. There are no restrictions as to the type of corporation that can enter into this market.

Commercial paper is a short-term note payable which is unsecured and usually discounted. It is issued in large denominations with maturities ranging from 2 to 270 days. There are several advantages to a corporation using commercial paper for short-term financing. The commercial paper market provides more funds at lower rates than other methods available. There is no required compensating balance at a lending bank. There is a broad and efficient distribution and the borrower's name becomes more widely known through this market. What is not an advantage to a corporation that uses the commercial paper market is the statement “there are no restrictions as to the type of corporation that can enter into this market.” This is false. Commercial paper is issued in denominations of $100,000 or more and is almost always backed by bank lines of credit. This limits the access to this market to large corporations only. Plus, commercial paper is rated by Standard & Poor's and Moody's and, consequently, only top-rated corporations with high credit ratings can enter this market.

Commercial Paper

a. Commercial Paper is short-term, unsecured notes that are offered by stable companies. These are in large amounts with short-term maturities generally ranging from one month to a maximum of 270 days. Access to the market for commercial paper is limited to a small number of companies that are exceptionally good credit risks. The interest rates on commercial paper tend to be somewhat below the prime rate.
b. The advantages of commercial paper include:
1. Providing the firm an additional source for funds that is readily accessible once the firm's paper has been rated.
2. Lower rates than are available with traditional bank loans—generally ranging from 1-1/2 to 3-1/2 percentage points below the prime rate.
3. Absence of costly financing arrangements and the need for potential compensating balances.
4. The repeated issuance of successful commercial paper improves a borrower's reputation in the financial markets.
c. The primary disadvantage of commercial paper is that if a firm is facing temporary financial difficulties, it would not be able to utilize this source of funding.

71

To reduce security exposure when transmitting proprietary data over communication lines, a company should use:

A. asynchronous modems.

B. authentication techniques.

C. call-back procedures.

D. cryptographic devices.

D. cryptographic devices.

Cryptographic devices protect data in transmission over communication lines.

Asynchronous modems handle data streams from peripheral devices to a central processor. Authentication techniques confirm that valid users have access to the system. Call-back procedures are used to ensure incoming calls are from authorized locations.

72

The market approach is one of the three basic methodologies available to the valuator. When determining whether this approach can be employed in a particular engagement (whether guideline companies are available), the valuator must keep all of the following in mind except:

A. the normalized statements of the subject of the valuation need to use similar GAAP choices, such as LIFO and FIFO, as the guideline companies.

B. one company does not make a comparable.

C. the guideline companies will need to be identical to the subject of the valuation.

D.
a guideline company needs to produce (supply) similar products, serve similar markets, and be within a similar size range as the subject company.

C. the guideline companies will need to be identical to the subject of the valuation.

Finding guideline companies when performing a business valuation is often difficult. When developing a list of potential guideline companies, the business valuator assesses items such as whether the potential guideline company:

uses similar GAAP choices as the subject company.
has a similar product diversification as the subject company.
serves similar markets as the subject company.
has a similar geographic diversification as the subject company.
is of a similar size as the subject company.
has similar financial and operating leverage as the subject company.
has similar liquidity, solvency, growth, and profitability as the subject company.
It is important to note that a business valuation cannot be based upon one guideline organization, nor is a comparable expected to be identical to the subject of the valuation in any manner.

73

When calculating a company's cost of common stock, an analyst evaluates the following four components: risk-free rate, stock's beta coefficient, rate of return on the market portfolio, and required rate of return on the company's stock. Which of the following measurement models is being used?

A. Constant growth

B. Weighted marginal cost of capital

C. Capital asset pricing

D. Overall cost of capital



C. Capital asset pricing

Answer A is incorrect because constant growth is an assumption that dividends increase at a constant rate in perpetuity.

Answer B is incorrect because the weighted marginal cost of capital combines the rates on all sources of capital. This question asks about only one security, common stock.

Answer C is correct because the Capital Asset Pricing Model uses the beta coefficient, the market risk premium and the risk-free rate.

Answer D is incorrect because the overall cost of capital combines the rates on all sources of capital. This question asks about only one security, common stock.

74

In relation to the role of capital in mitigating financial risk, it has been strongly suggested that in the new regulatory environment, regulators treat capital:

A. as a necessary component of risk margin reserves that should be held to deal with black swan events.

B. as being inadequate on a prima facie basis and require that regulators mandate significantly higher levels of capital that would be fixed in nature to convince investors that the institutions could absorb risk.

C. as being inadequate and thus causing regulators to need to monitor and regulate compensation packages so that the incentive structure does not distort the proper evaluation of risk and cause management not to make appropriate contributions to capital.

D. as a shock absorber and allow firms to draw down capital during periods of market stress that would be expected to be replenished when market conditions improve.

D. as a shock absorber and allow firms to draw down capital during periods of market stress that would be expected to be replenished when market conditions improve.

Regulators are looking to be more proactive in dealing with potential bubbles in financial markets and, as a result, are looking at primary capital to serve as a “shock absorber” as early warning signs that a bubble might occur.

Regulators are concerned about the need to increase capital requirements for any market participant where remuneration and incentives focus excessively on short-term results. However, that is not the focus of this question. Risk margin capital is designed to be available in the event of high uncertainty or the occurrence of “black swan” events.

75

A computer system that converts the inputs into data that allows management to make unstructured decisions concerning the company's future is:

A. a transaction processing system.

B. an office automation system.

C. a strategic information system.

D. a decision support system.

C. a strategic information system.

Strategic Information System (SIS): An SIS provides information that may allow an organization to make strategic, competitive decisions.

A strategic information system provides information that may allow an organization to make strategic, competitive decisions.

Transaction processing systems support basic routine business functions.
An office automation system is used by clerical personnel to process existing information.
Decision support systems process semi-structured and unstructured problems.

76

A firm has just received the proceeds from a $5 million bond issue that is earmarked for plant expansion. Work on the project is not expected to begin for several weeks. The firm will invest the funds in marketable securities. The firm is primarily concerned with ensuring they will receive all the funds they have invested in a timely manner. Thus, they are primarily concerned with the ________ of the securities they purchase.

A. marketability and maturity

B. default risk and taxability

C. marketability and default risk

D. maturity and default risk

C. marketability and default risk

A firm that wishes to ensure that it receives the entire proceeds of an investment is concerned about marketability (the ability to sell a security for its face market value quickly and in large amounts) and its default risk (the probability of receiving principal and interest payments in a timely manner).

The maturity of the security is important for determining the time period over which interest and principal payments will be received and is related to interest rate risk that demonstrates that the prices of longer-term securities will fluctuate more that those of shorter-maturity securities when interest rates change. Taxability relates to the fact that some securities have a degree of tax exemption which might make them attractive to a particular class of investors.

77

An edit of individual transactions in a direct access file processing system usually:

A. takes place in a separate computer run.

B. takes place in an online mode as transactions are entered.

C. takes place during a backup procedure.

D. is not necessary.

B. takes place in an online mode as transactions are entered.

During data entry in an online system, the input data is compared with its expected format. Error messages indicate if the entry is invalid. This is the edit process of individual transactions in a direct access file processing system.

78

Which of the following is not a test to determine if an organization is using business process re-engineering (BPR)?

A. The effort focused on critical business processes

B. The receptiveness of senior management.

C. The desired improvement's ambition

D. The effort focused on project management

D. The effort focused on project management

There are three questions that need to be answered to see if an organization is implementing BPR:

Is the effort focused on critical business processes that, if they are changed, can have a major impact on performance?
How ambitious is the desired improvement?
How receptive is senior management to change?

79

A U.S firm sold $3 million in finished goods to a firm in Thailand for delivery in six months with the contract to be invoiced in dollars. In the ensuing period, the value of the bhat declined by 80%, which meant that Thai firm could not afford to purchase the dollars necessary to fulfill the contract. This is an example of:

A. translation exposure.

B. economic exposure.

C. purchasing power risk.

D. transactions risk.

B. economic exposure.

Economic exposure represents any impact of exchange rate fluctuations on a firm's future cash flow. In this instance, the firm had attempted to protect itself from transactions exposure by invoicing the goods in dollars, but the foreign crisis make it impossible for foreign firms to afford to buy the dollars necessary to fulfill the contract. The firm could have protected itself somewhat from this exposure if some of their expenses had been denominated in bhat.

The rationale for forecasting foreign exchange rates is to help the firm make decisions as to whether they should remain exposed to exchange rate fluctuations or if they should attempt to hedge their foreign exchange positions. Forecasting methodologies can be evaluated over time by comparing the actual values of the currencies to those predicted by the forecast over long periods of time.

80

Quick Co. was analyzing variances for one of its operations. The initial budget forecasted production of 20,000 units during the year with a variable manufacturing overhead rate of $10 per unit. Quick produced 19,000 units during the year. Actual variable manufacturing costs were $210,000. What amount would be Quick's flexible budget variance for the year?

A. $10,000 favorable

B. $20,000 favorable

C. $10,000 unfavorable

D. $20,000 unfavorable

D. $20,000 unfavorable

Flexible budget variance = Actual cost compared to Flexible budget cost
= $210,000 - ($10 x 19,000 units)
= $210,000 - $190,000
= $20,000 unfavorable

The flexible budget variance is the difference between an actual amount and the expected amount at the production level achieved (flexible budget amount). The flexible budget variance can also be thought of as the price plus the efficiency variances.

81

Which of the following management practices involves concentrating on areas that deserve attention and placing less attention on areas operating as expected?

A. Management by objectives

B. Responsibility accounting

C. Benchmarking

D. Management by exception

D. Management by exception

Management by exception involves concentrating on areas that deserve attention and paying less attention to areas operating as expected.

Management-by-objectives (MBO) involves having manager and subordinate jointly develop objectives and plans.
Responsibility accounting is a method whereby responsibility is identified and related to managers. Then, managerial performance is monitored and evaluated based on this identification.
Benchmarking involves identifying “best in class” performance or other measure(s), then comparing the company's performance to that benchmark or standard.

82

The Sarbanes-Oxley Act of 2002 (SOX) requires that all publicly traded firms establish internal controls related to financial reporting that are documented, tested, and maintained for the purpose of preventing fraud. Per SOX, a company needs to do all of the following except:

A. develop documentation of existing internal controls and procedures associated with financial reporting.

B. test the effectiveness of the existing internal controls and procedures.

C. provide information on deficiencies in the controls and/or documentation of those controls.

D. include all areas of potential risk to the misstatement of the financial statements in this documentation, testing, and reporting process.

D. include all areas of potential risk to the misstatement of the financial statements in this documentation, testing, and reporting process.

Section 404 of the Sarbanes-Oxley Act of 2002 (SOX) requires that all publicly traded firms establish internal controls related to financial reporting that are documented, tested, and maintained. The purpose of these controls is to reduce the probabilities of corporate fraud. In order to be in compliance with SOX 404, a company needs to:

develop documentation of existing internal controls and procedures associated with financial reporting,
test the effectiveness of those controls and procedures, and
provide details on any deficiencies in the controls and/or documentation.
Although the initial response to SOX was to document, test, and report on both high- and low-risk areas related to financial reporting, the Public Company Accounting Oversight Board (PCAOB) developed Auditing Standard 5 (An Audit of Internal Control Over Financial Reporting That Is Integrated with an Audit of Financial Statements), approved by the SEC, that limits such activities. This standard takes a risk-based approach related to internal control documentation and testing, thus limiting the compliance measures necessary under SOX. SOX was never meant to create unnecessary compliance burdens on a company, but rather to protect shareholders' investment from fraud.

83

When estimating cash flow for use in capital budgeting, depreciation is:

A. included as a cash or other cost.

B. excluded for all purposes in the computation.

C. utilized to estimate the salvage value of an investment.

D. utilized in determining the tax costs or benefit.

D. utilized in determining the tax costs or benefit.

The only effect depreciation expense has on cash flows is the determination of income tax. Depreciation expense is subtracted from income to find taxable income. Therefore, while depreciation is not a cash flow directly, it does affect income tax cash flows.

“Included as a cash or other cost” is incorrect because depreciation is not a cash flow. “Excluded for all purposes in the computation” is incorrect because depreciation is considered in determining cash flows for income taxes. “Utilized to estimate the salvage value of an investment” is incorrect because the salvage value is the cash value of the asset at the end of its useful life, which is not related to the book value remaining after deducting annual depreciation expense.

Capital Budgeting Basics

a. Capital Budgeting is the analysis of investment decisions that have a useful life longer than one year. Management uses capital budgeting to allocate resources to investment opportunities in an attempt to obtain the maximum value for the firm. Investment decisions are project-oriented. Poor capital budgeting decisions can often be difficult to reverse. Questions such as the following are addressed:
1. Should machinery be replaced by more expensive but more efficient models?
2. Should a new product or market be added?
3. Should existing debt be extinguished or refinanced?
4. How can a constrained resource best be used?
b. The relevant data in capital budgeting is cash-flow–oriented. Regardless of the approach used, the following items are essential:
1. Initial investment
2. Future net cash inflows or net savings in cash outflows
c. Data for capital budgeting is relevant only if it affects the cash flows. Some data accumulated for financial reporting is either not useful or must be adjusted to be useful for capital budgeting purposes. Financial accounting is primarily concerned with computing periodic earnings using the accrual basis of accounting for the firm or a reportable segment of the firm. Accrual accounting is not relevant in capital budgeting. The decision is project-oriented, and relevant data includes the expected cash flows associated with that project. Items such as the depreciation expense are sunk costs as they relate to capital decisions, and only become relevant as they relate to tax consequences.
d. Because capital budgeting is long-term–oriented, the time value of money is very important. Some approaches to capital budgeting account for the time value of money and some do not. Those that account for it are considered preferable because of the difference between a $1 investment today and a $1 return sometime in the future. Inflation that persists and the opportunity cost of having money sit idle make present and future earnings unequal. Present-value techniques are useful in adjusting dollar amounts received or paid at different points in time to a common point in time.
e. There are several techniques for capital budgeting. These approaches are often used, first to screen project possibilities, and second to rank existing choices. Those commonly used techniques include:
1. Payback Method
2. Discounted Payback
3. Accounting Rate of Return
4. Net Present Value
5. Internal Rate of Return
6. Profitability Index
7. CVP Analysis/Margin of Safety

84

A value-added network (VAN) is a privately owned network that performs which of the following functions?

A. Routes data transactions between trading partners

B. Routes data within a company's multiple networks

C. Provides additional accuracy for data transmissions

D. Provides services to send marketing data to customers

A. Routes data transactions between trading partners

A value-added network (VAN) provides specialized hardware, software, and long-distance communications to private networks so that they can exchange data. A VAN adds value to the basic data communications process by handling the difficult task of interfacing with multiple types of hardware and software used by different parties.

85

All of the following are characteristic of computer machine language, except:

A. internal binary code.

B. hexadecimal code.

C. assembly language.

D. on/off electrical switches.

C. assembly language.


All of the answer choices except assembly language are characteristic of computer machine language.

Assembly language is a programming language in which each machine language instruction is represented by mnemonic characters; it is a symbolic language, an English-like and understandable alternative to basic machine language.

Machine language is the binary code (the on/off electrical switches: zero and one) that can be interpreted by the internal circuitry of the CPU. The binary code is usually arranged as a hexadecimal (base 16) code. It is a very time-consuming, error-prone programming process.

86

An update program for bank account balances calculates check digits for account numbers. This is an example of:

A. an input control.

B. a file management control.

C. access control.

D. an output control.

B. a file management control.

Check digit verification is an example of an input control. The check digit is a number calculated based on a calculation using all but the last digit, which is the check digit. If the calculation returns the check digit, the number is accepted as valid. If the calculation returns a number other than the check digit, the input is rejected as invalid.

87

An online data entry technique that can be employed when inexperienced personnel input data is the use of:

A. prompting.

B. written job descriptions.

C. compatibility tests.

D. checkpoints.

C. compatibility tests.

Some software assists users in data entry by prompting (the use of questions and predetermined input formats). Prompting is very helpful in avoiding input errors by inexperienced personnel.

88

John Maynard Keynes talks about the reasons for holding cash and concludes that there are three major motives. The three major motives for holding cash are:

A. transactional, psychological, and social purposes.

B. speculative, fiduciary, and transactional purposes.

C. speculative, social, and precautionary purposes.

D. transactional, precautionary, and speculative purposes.

D. transactional, precautionary, and speculative purposes.

J.M. Keynes actually had four reasons for holding cash (money-demand):

The “Income-motive”
The “Business-motive”
The “Precautionary-motive”
The “Speculative-motive”
The first two however, refer to individuals and businesses having cash on hand to purchase goals and services in between the intervals of the receipt of income and its disbursement.

These are therefore generally referred to as the “Transactional-motive” for holding money.

The “Precautionary-motive” refers to having money on hand to provide for emergencies where a sudden expenditure is required.

The “Speculative-motive” for holding money refers to a situation where the alternative return on assets is so low that the yield on money (given changing prices and interest rates) is greater than the yields on other assets (stock, bonds, etc.).

89

A fast-growing service company is developing its information technology internally. What is the first step in the company's systems development life cycle?

A. Analysis

B. Implementation

C. Testing

D. Design

A. Analysis

System analysis is the first step in the system development life cycle. This is where the information necessary to decide whether to purchase or develop a system is gathered. Common sense would also suggest that analysis would come before the other steps in the process, which include conceptual design, physical design, implementation and conversion, and operation and maintenance.

90

Management has reviewed the standard cost variance analysis and is trying to explain an unfavorable labor efficiency variance of $8,000. Which of the following is the most likely cause of the variance?

A. The new labor contract increased wages.

B. The maintenance of machinery has been inadequate for the last few months.

C. The department manager has chosen to use highly skilled workers.

D. The quality of raw materials has improved greatly.

B. The maintenance of machinery has been inadequate for the last few months.

The labor efficiency variance is the difference between the standard quantity of direct labor hours budgeted and the actual quantity used (per employee time sheets).

Direct labor efficiency variance = Standard wage × (Standard hours - Actual hours)
If Actual Hours is less than Standard Hours, variance is favorable; if Actual Hours is greater than Standard Hours, variance is unfavorable.

Direct labor efficiency variance is usually recorded at the end of the accounting period when the total hours worked in the period is known (it may also be recorded when it is used). The variance is assigned to Production or Manufacturing, since it is that department that has the responsibility for approving the actual hours worked.

Since labor efficiency variance is designed to measure labor efficiency, other factors such as downtime, rework, and vacations are not included. The standard should make reasonable allowance for fatigue, rest time, and faulty materials.
The labor efficiency (usage) variance is the difference between standard cost of actual hours and the standard cost of the budgeted labor hours.

The labor efficiency variance is caused by direct labor employees working more hours than standard for the actual output attained. This could be due to improper machinery maintenance, resulting in extra hours worked to rework products that do not meet quality standards.

"The new labor contract increased wages" is incorrect because the labor rate per hour does not affect the labor efficiency variance.

"The department manager has chosen to use highly skilled workers" is incorrect because highly skilled workers should work fewer hours than standard, not more.

"The quality of raw materials has improved greatly" is incorrect because improved raw material quality should result in fewer defective units that need to be reworked, and therefore decreasing, not increasing, direct labor hours.

91

Wolk Corporation is a highly automated manufacturing firm. The vice president of finance has decided that traditional standards are inappropriate for performance measures in an automated environment. Labor is insignificant in terms of the total cost of production and tends to be fixed, material quality is considered more important than minimizing material cost, and customer satisfaction is the number one priority. As a result, delivery performance measures have been chosen to evaluate performance. The following information is considered typical of the time involved to complete orders.

Wait time:
From order being placed to start of production 10.0 days
From start of production to completion 5.0 days
Inspection time 1.5 days
Process time 3.0 days
Move time 2.5 days
What is the manufacturing cycle efficiency for this order?

A. 25.0%

B. 13.6%

C. 37.5%

D. 69.2%

A. 25.0%


Manufacturing Cycle = Manufacturing or Process Time /
Efficiency Time from Start of Manufacturing to Delivery
= 3 days / (5 days +1.5 days + 3 days + 2.5 days)
= 3 days / 12 days
= 25.0%

92

Well-developed disaster recovery plans include provisions for:

A. minimizing disruptions and loss from a disaster.

B. minimizing system downtime.

C. providing insurance to replace equipment and compensate for business interruptions.

D. minimizing disruptions and loss from a disaster as well as providing insurance to replace equipment and compensate for business interruptions.

D. minimizing disruptions and loss from a disaster as well as providing insurance to replace equipment and compensate for business interruptions.

A disaster recovery plan should establish procedures to minimize disruptions from disaster and should provide insurance to replace equipment and compensate for business loss. However, minimizing system downtime is a system reliability concept and does not relate to disaster recovery.

Disaster recovery plans should contain the following:

a. Recovery priorities. The plan should identify and prioritize:
(1) hardware, software, applications, and data necessary to sustain the most critical applications.
(2) sequence and timing of all recovery activities.
b. Insurance to:
(1) replace equipment lost in the disaster.
(2) compensate for business interruptions.
c. Specific assignments. A plan coordinator should:
(1) be responsible for implementing the recovery plan.
(2) assign individuals and teams specific recovery responsibilities such as finding new physical facilities, operating the system, installing software, setting up data communications linkages, recovering data, and procuring forms and supplies.
d. Backup computer and telecommunications facilities, which can be arranged by:
(1) establishing reciprocal agreements with companies with compatible facilities so each company can use the other's computers if an emergency occurs.
(2) signing a contract for a contingent site. A hot site is configured to meet user requirements. A cold site has everything needed (power, air conditioning, and support systems) to quickly install a computer. Cold site users rely on their computer vendors for prompt delivery of equipment and software if an emergency occurs.
(3) fail-soft distributing processing capacity in a multilocation organization so other facilities can take over if one location is damaged or destroyed.
(4) investing in duplicate hardware, software, or data storage devices for critical applications.
e. Periodic testing and revision. A recovery plan must be:
(1) regularly tested with a simulated disaster, with each disaster recovery team carrying out its assigned activities.
(2) constantly improved, since most plans fail their initial test and tested plans rarely anticipate and deal with all real-life disaster problems.
(3) reviewed to make sure it reflects current computer application changes, equipment configurations, and new personnel assignments.
f. Complete documentation of all aspects of the system.
(1) Copies of the documentation should be stored securely at multiple locations.
(2) One copy should be some distance from the system.

93

A rise in price levels may result when costs of raw materials or labor increase. This type of price increase is called ________ inflation.

A. cost-push

B. demand-pull

C. intrinsic

D. structural

A. cost-push

Types of Inflation

a. Demand-Pull Inflation is caused by an excess in total spending relative to the economy's current capacity to produce goods and services. It is an excess of demand relative to output at the current price level. This is often referred to by the phrase, “too much money chasing too few goods,” and will continue as long as there is excess total spending.
b. Cost-Push Inflation occurs when rising prices result from an increase in resource costs and thus a rise in per-unit costs of production. Rising per-unit production costs squeeze profits and reduce a firm's willingness and ability to produce goods and services. Examples of factors that might cause cost-push inflation include negotiated increases in wage rates, and supply shocks such as the rapid rise in energy prices during the 1970s and early 1980s as OPEC reduced production. Each of these factors increased the cost of producing and transporting most products, and created a period of rapid cost-push inflation. This type of inflation tends to be self-limiting since the rising prices will cause firms to reduce output, and this leads to an increase in unemployment and a reduction in demand.
c. Hyperinflation is an extremely rapid rate of inflation that usually has a devastating impact on real output and employment. Creditors avoid debtors to prevent being repaid with cheap money, and money eventually becomes worthless. Examples include Germany where prices increased by 322% per month from late 1922 to late 1923, culminating with a monthly price increase of 32,000% in October 1923. Argentina, Brazil, Bolivia, Nicaragua, Peru, Poland, and the Congo Democratic Republic each had a 1000% inflation rate (an average of 22% per month) in at least one year during the 1980s and 1990s.
d. Deflation is a sustained decline in the general price level. Creditors gain at the expense of debtors. Japan has been experiencing deflation on an irregular basis for more than 20 years.


94

Jansen, Inc., pays bonuses to its managers based on operating income. The company uses absorption costing, and overhead is applied on the basis of direct labor hours. In order to increase bonuses, Jansen's managers may do all of the following, except:

A. defer expenses such as maintenance to a future period.

B. increase production schedules independent of customer demands.

C. decrease production of those items requiring the most direct labor.

D. decrease production of those items requiring the least direct labor.

C. decrease production of those items requiring the most direct labor.

Absorption costing treats fixed costs as product cost and assigns the fixed costs to the units produced. Fixed costs follow the units through work-in-process and finished goods as an inventoriable cost. Non-production costs are recognized when they are incurred. With absorption costing, a manager's organization will show a higher operating income if some of the goods produced are inventoried since the inventoried goods will carry with them some of the fixed overhead costs that were incurred during the period.

Managers will show lower operating income if they decrease production of those items requiring the most direct labor. The lower operating income results from the fact that a decrease in the production of items that require the most direct labor hours means that each of the items that is produced will have more fixed costs associated with it. The increase in fixed costs per item will reduce operating income.

95

Which of the following performance measures may lead a manager of an investment center to forgo investments that could benefit the company as a whole?

A. Return on investment

B. Residual income

C. Profitability index

D. Economic value added


A. Return on investment

Return on investment (ROI) is net income divided by invested capital. It does not consider profitability to the company as a whole because it does not use the corporate cost of capital. A division manager may decide to forego an investment that has an ROI below the division ROI even though it is above the overall corporation cost of capital.

Residual income (RI) is net income above a minimum desired rate of return on invested capital. The minimum desired net income is found by multiplying the desired rate of return by invested capital. Division managers would desire to accept projects that exceed the overall corporate cost of capital.

The profitability index is an analysis of investment alternatives rather than a performance measurement. It is calculated as the present value of the cash flows not counting the initial investment divided by the amount of that investment.

Economic value-added (EVA) is the earnings above the required cost of capital for shareholders; this measure is similar to residual income, but it is applied by external investors rather than the company's management.

96

If you were to see the formula (Portfolio return - Risk-free rate) ÷ Standard deviation, you would be dealing with:

A. the Jensen measure.

B. the Sharpe measure.

C. the Treynor index.

D. a swap transaction.

B. the Sharpe measure.

The formula for the Sharpe measure for portfolio performance is (Portfolio return - Risk-free rate) ÷ Standard deviation.

The formula for the Treynor index for portfolio performance is (Portfolio return - Risk-free rate) ÷ Beta. The formula for the Jensen measure of portfolio performance measure of return on portfolio is Risk-free rate + ((Return on market index - Risk-free rate) × Beta).

97

Which of the following assumptions is associated with the economic order quantity formula?

A. The carrying cost per unit will vary with quantity ordered.

B. The cost of placing an order will vary with quantity ordered.

C. Periodic demand is known.

D. The purchase cost per unit will vary based on quantity discounts.

C. Periodic demand is known.

Assumptions of economic order quantity analysis include the following:

Periodic demand for the good is known.
Total carrying costs vary with quantity ordered.
Costs of placing an order are unaffected by quantity ordered.
Purchase costs per unit are not affected by quantity discounts.

98

Which of the following activities would most likely detect computer-related fraud?

A. Using data encryption

B. Performing validity checks

C. Conducting fraud-awareness training

D. Reviewing the systems-access log


D. Reviewing the systems-access log


The question asks about fraud detection, not fraud prevention. Data encryption and fraud-awareness training are preventive measures. Validity checks ensure that data entry input is correct (for instance, that a general ledger account exists for each journal entry account number). Validity checks, while an important internal control over financial reporting, are not a method to detect fraud. Of all the answers, reviewing the systems-access log is the best choice. It would help discover if unauthorized access to the system has been allowed.

99

In traditional information systems, computer operators are generally responsible for backing up software and data files on a regular basis. In distributed or cooperative systems, ensuring that adequate backups are taken is the responsibility of:

A. user management.

B. systems programmers.

C. data entry clerks.

D. tape librarians.

A. user management.


In distributed or cooperative systems, the responsibility for ensuring that adequate backups are taken is the responsibility of user management because the systems are under the control of users.

In distributed environments, there will be no systems programmers comparable to those at central sites for traditional systems, there may be no data entry clerks because users are typically performing their own data entry, and there are no tape librarians.

100

What is a major disadvantage to using a private key to encrypt data?

A. Both sender and receiver must have the private key before this encryption method will work.

B. The private key cannot be broken into fragments and distributed to the receiver.

C. The private key is used by the sender for encryption but not by the receiver for decryption.

D. The private key is used by the receiver for decryption but not by the sender for encryption.

A. Both sender and receiver must have the private key before this encryption method will work.

Encryption is transforming data, called plaintext, into unreadable gibberish, called ciphertext. Decryption reverses this process, transforming ciphertext back into plaintext.

a. Both a key and an algorithm are use to encrypt plaintext into ciphertext and to decrypt ciphertext back into plaintext.
(1) The key is a fixed length string of binary digits (a 128-bit key has 128 0s and 1s). The longer the key, the less likely it is that someone can break the encryption code.
(2) The algorithm is a formula that combines the key and the text. A strong algorithm that has been rigorously tested is difficult, if not impossible, to break by using brute-force guessing techniques.
b. To encrypt a document:
(1) The data to be encrypted is divided into blocks the same length as the key.
(2) The formula is applied to each block of data, producing a ciphertext version of the data that is the same size as the original.
c. To decrypt a document, the computer divides the ciphertext into 128-bit blocks and then applies the decryption key to each block.
d. Data is encrypted using one of the following encryption systems:
(1) A symmetric, or single key system, uses the same key to encrypt and decrypt a message.
(2) An asymmetric, or public key infrastructure (PKI), system uses two keys. The public key, as the name implies, is publicly available. The private key is kept secret and only the owner of that pair of keys knows what it is. Either key can be used to encode a message, but only the other key can be used to decode it.
e. A symmetric key is simple, fast, and efficient but has the following disadvantages:
(1) Since the sender provides the recipient with the secret key, the two parties need to have some method for securely exchanging the key. System effectiveness depends on controlling who knows the secret key.
(2) It requires a secret key for each different party with whom the company communicates.
(3) Since both parties have the same secret key, there is no way to prove who created a specific document and therefore no way to create legally binding agreements.
f. The PKI approach has the following advantages over single key systems:
(1) It eliminates problems with exchanging keys, and companies only need one key.
(2) It is more secure, because two different keys are used to encode and decode a message.
(3) Anyone can use the organization's public key to encrypt a message, but only the organization can use its private key to decode the message.
(4) Data can be encrypted with the private key and decrypted with the public key. Since this makes it possible to prove who created a document, legally binding electronic agreements can be created.
(5) This main drawback to asymmetric encryption systems is that it is much slower than single key systems—too slow to be used to exchange large amounts of data over the Internet.

A major disadvantage of private key encryption is that both the sender and receiver must have the same (private) key, and this must be securely transmitted to avoid interception and decryption of the message by others.

"The private key cannot be broken into fragments and distributed to the receiver" is incorrect because the private key can be transmitted in distinct fragments. "The private key is used by the sender for encryption but not by the receiver for decryption" and "the private key is used by the receiver for decryption but not by the sender for encryption" are both incorrect because both the sender and receiver use the same key.