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What is Capital Budgeting? How is it used?

Managerial Accounting technique used to evaluate different investment options

Helps management make decisions

Uses both accounting and non-accounting information

Internal focus

GAAP is not mandatory


What values are used in Capital Budgeting?

Capital Budgeting ONLY uses Present Value tables.

Capital Budgeting NEVER uses Fair Value.


When is the Present Value of $1 table used?

For ONE payment- ONE time.


When is the Present Value of an Annuity Due used?

Multiple payments made over time- where the payments are made at the START of the period.


When is the Present Value of an Ordinary Annuity of $1 (PVOA) used?

Multiple payments over time- where payments are made at the END of the period.

Think A for Arrears.


What is the calculation for the Present Value of $1?

1 / (( 1+i )^n)

i : interest rate
n : number of periods


What is Net Present Value (NPV)?

A preferred method of evaluating profitability.

One of two methods that use the Time Value of Money

: PV of Future Cash Flows - Investment


How is NPV used to calculate future benefit?

NPV : PV Future Cash Flows - Investment

If NPV is Negative- Cost is greater than benefits (bad investment)

If NPV is Positive- Cost is less than benefit (good investment)

If NPV : 0- Cost : Benefit (Management is indifferent)


What is the rate of return on an investment called?

The Discount Rate.


What does the Discount Rate represent?

The rate of return on an investment used.

It represents the minimum rate of return required.


What are the strengths of the Net Present Value system?

Uses the Time Value of Money

Uses all cash flows- not just the cash flows to arrive at Payback

Takes risks into consideration


What are the weaknesses of the Net Present Value system?

Not as simple as the Accounting Rate of Return.


How do Salvage Value and Depreciation affect Net Present Value?

NPV includes Salvage Value because it is a future cash inflow.

NPV does NOT include depreciation because it is non-cash.

Exception - If a CPA Exam question says to include tax considerations- then you have to include depreciation because of income tax savings generated by depreciation.


If multiple potential rates of return are available- which is used to calculate Net Present Value?

The minimum rate of return is used.


What is the Internal Rate of Return (IRR)?

It calculates a project's actual rate of return through the project's expected cash flows.

IRR is the rate of return required for PV of future cash flows to EQUAL the investment.

Investment / After Tax Annual Cash Inflow : PV Factor


Which rate of return is used to re-invest cash flows for Internal Rate of Return?

Cash flows are re-invested at the rate of return earned by the original investment.


How does the rate used for Internal Rate of Return (IRR) compare to that used for Net Present Value (NPV)?

Rate of return for IRR is the rate earned by the investment.

Rate of return for NPV is the minimum rate.


What are the strengths and weaknesses of the Internal Rate of Return system?

Strengths: Uses Time Value of Money- Cash Flow emphasis

Weakness: Uneven cash flows lead to varied IRR


When is NPV on an Investment positive?

When the benefits are greater than the costs.

IRR is greater than the Discount Rate


When is NPV on an Investment Negative?

When Costs are greater than Benefits

IRR is less than the Discount Rate


When is NPV Zero?

When benefits equal the Costs

IRR : Discount Rate


What is the Payback Method? How is it calculated?

It measures an investment in terms of how long it takes to recoup the initial investment via Annual Cash Inflow

Investment / Annual Cash Inflow : Payback Method

Compare to a targeted timeframe; if payback is shorter than target- it's a good investment. If payback is longer than target- it's a bad investment.


What are the strengths of the Payback Method?

Takes risk into consideration

2 year payback is less risky than a 5 year payback


What are the weaknesses of the payback method?

Ignores the Time Value of Money

Exception: Discount payback method

Ignores cash flow after the initial investment is paid back


What is the Accounting Rate of Return?

An approximate rate of return on assets

ARR : Net Income / Average Investment

Compare to a targeted return rate; if ARR greater than target- good investment. If ARR less than target- bad investment.


What are the strengths of the Accounting Rate of Return (ARR)?

Simple to use

People understand easily


What are the weaknesses of the Accounting Rate of Return (ARR)?

Can be skewed based on Depreciation method that is used.

Ignores the Time Value of Money.


What is an Expected Return?

An approximate rate of return on assets.


What is the primary duty of the board of directors?

To monitor management behavior.


What is the responsibility of the Nominating or Corporate Governance Committee of the board of directors?

Oversees the board

Responsible for hiring new CEO


What is the responsibility of the audit committee of the board of directors?

The audit committee appoints and oversees the external auditor.


What is the duty of the compensation committee of the board of directors?

The compensation committee handles the CEO's compensation package.


What does the NYSE and NASDAQ require of the board of directors?

They require the board to be independent.


What is the main goal in an executive compensation package?

The package should ensure that the goals of management should match those of the shareholders.


How can an executive compensation package ensure that goals of management align with those of shareholders?

Executive compensation should create an incentive for management to govern in a shareholder-friendly way that doesn't sacrifice the long-term success of the enterprise for short-term gain.


Which influences help mold the direction that management takes?

They range from internal (Board of Directors- Audit Committee- Internal Control) to external (Creditors- SEC- IRS)

These influences should not be tainted by undue influence from management or have financial ties to management such as compensation-related duties


What is shirking?

When management doesn't act in the best interest of shareholders.

It can be alleviated by tying compensation to stock performance or company profit.


What requirements are imposed on a public company under Sarbanes-Oxley?

Management must submit a report on the effectiveness of Internal Control in the 10K.

Management must disclose significant Internal Control deficiencies.

CEO/CFO must certify that the financial statements comply with securities laws and fairly present the financial condition of the company.


What characteristics are promoted by the COSO framework on Internal Control?

Reliable financial reporting

Effective and efficient operations



What are the elements of the control environment?

Integrity & Ethics
The Board of Directors & Audit Committee
Management's Operating Style
Organizational Structure
Authority & Roles of Responsibilities
HR Policies


What are control activities?

A component of Internal Control that includes actions being taken to promote the control environment.


What are the basic elements of Internal Control?

Control Environment
Risk Assessment
Control Activities
Information and Communication


What is the significance of the Information and Communication aspect of Internal Control?

Management must have access to relevant and timely information to make good decisions.


How does Monitoring affect Internal Control?

Internal Control activities must be constantly monitored and evaluated for effectiveness.


What activities does the COSO framework for enterprise risk management include?

Identifies Risk Factors
Promotes Risk Response Decisions
Compares Management Risk vs. Shareholder Goals
Aids in evaluating opportunities
Promotes Quicker Capital movement

Does NOT eliminate all risk


What are possible responses to risk under the COSO framework for enterprise risk management?

Avoid or Reduce

Share or Accept


What is Cost Accounting?

Cost Accounting is a component of GAAP that records Ending Inventory on the Balance Sheet for
o Direct Materials
o Direct Labor
o Work in Process
o Finished Goods

Cost Accounting also records for the Income Statement


What is the difference between Cost Accounting and Managerial Accounting?

Cost Accounting - External Focus- GAAP

Managerial Accounting - Internal Focus- Not GAAP


What are Product Costs (aka Inventory Costs)?

Prime Costs

Conversion Costs


What are included in Prime Costs?

Direct Material USED - Have become part of the product or had a direct impact on the product

Direct Labor Used - Employees who worked on product and had direct impact


What is Factory Overhead?

All factory costs except for DM and DL used in production- including Spoilage (except for abnormal spoilage- which is a period cost and not included in OH).


What is included in Fixed Factory Overhead?

FFO : Estimated Costs / Normal Capacity

Uses Normal Activity

Examples of Fixed Factory OH: Depreciation (SL)- Utilities- Taxes

Under/Over-applied Fixed OH always goes to COGS


What is included in Variable Overhead?

VO : Estimated Activity / Actual Activity

Uses Actual Activity

Examples of Variable Factory OH: Deprecation (Units of Prod)- Indirect materials (supplies & insignificant items)- Indirect labor (factory foreman- janitors- machine maintenance)


Where is Under/Over-applied Variable OH recorded?

If Immaterial - Goes to COGS

If Material - Goes to WIP- Finished Goods- or COGS- based on their Ending Balance


Where is Under/Over-applied Fixed OH recorded?

It always goes to COGS


What is indicated by a Debit balance in Actual Factory Overhead? How is it corrected?

Under-applied overhead.

If it's Fixed OH- under-applied goes to COGS.

If it's Variable OH- under-applied goes to COGS if immaterial- but is allocated to WIP- FG or COGS based on ending balances.


What is indicated by a Credit balance in Applied Factory Overhead? How is it corrected?

A credit balance indicates over-applied overhead.

If Fixed overhead- it is corrected from COGS.

If Variable overhead- it is corrected through COGS if immaterial- but if material overage is allocated to WIP- FG or COGS based on ending balances.


Which variables are used to calculate Direct Material balances?

Beginning Balance
DR Net purchases (plus freight-in)
CR Direct Materials Used
: Ending balance (goes to BS)


What variables are used to calculated Work in Process (WIP)?

Beginning Balance (End Bal of Previous WIP)
DR Direct Materials Used
DR Direct Labor Used (Conversion Cost)
DR Factory Overhead Applied (Conversion Cost)
: Ending Balance (Goes to BS)


What variables are included in Finished Goods calculations?

Beginning Balance
: COGAS (Cost of Goods Avail for Sale)
: Ending Balance (Goes to BS)


How does Freight In affect Cost Accounting calculations?

Inventory (Product) Cost

Part of DM Purchases


How does Freight Out affect Cost Accounting?

Selling (Period) Cost

Not part of inventory


When is Job-Order Costing used?

Used when costs are easily connected to a specific product or product line

Can also be applied to services

Calculation is the same as normal cost accounting - just use your T Accounts
- DM to WIP to FG to COGS
- You're likely going to be solving for the last job in the queue


What is the Direct Method for allocating service department costs?

No services allocated between service departments- even if they serve each other. Only allocate to product(s)


What is the Step Method for allocating service department costs?

Services can be allocated to both other service departments and the product(s)


Under process costing- how are the units shipped calculated?

Beginning Inventory
+ Units Started
- Ending Inventory
: No. Units Shipped


Which two inventory methods are used under Process Costing?


Weighted Average


What is another name for Process Costing?

Equivalent Units of Production


How will Equivalent Finished Units under FIFO compare to EFU under the Weighted Average method?

EFU FIFO will always be LESS than EFU Weighted Avg (unless Beginning Inventory is Zero)


How are Direct Materials calculated under the Weighted Average Method?

Beginning Inventory + Current Costs / EFU WA


How are Conversion Costs calculated under Weighted Average Method?

Beginning Inventory + Current Costs / EFU WA


How are Equivalent Finished Units calculated for Direct Materials?

Units Shipped
+ EI x % Complete DM
: EFU (Weighted Average Method)

- Beginning Inventory x % Complete


How are Equivalent Finished Units calculated for Conversion Costs?

Units Shipped
+ EI x % Complete CC
: EFU (Weighted Average)

- Beginning Inventory x % Complete


How are Direct Materials calculated under the FIFO method?

Current Costs / EFU FIFO

Note: FIFO method uses Current Period costs only and ignores Beginning Inventory


How are Conversion Costs calculated under the FIFO method?

Current Costs / EFU FIFO

FIFO method uses Current Period costs only and ignores Beginning Inventory


How is WIP calculated?

Beginning balance (DM- DL- OH)
+ Current Costs (DM- DL- OH)
- COGM (Goes to Finished Goods)
+ DM EFU x Cost per DM EFU
+ CC EFU x Cost per CC EFU
: Ending WIP


How do period costs and product costs relate to net sales- gross margin and operating income?

Net Sales
- Product Costs
: Gross Margin
- Period Costs
: Operating Income


What is the focus of Activity Based Costing (ABC)?

Focuses on eliminating non-value-added activities for poor quality and inventory and things customers don't want or don't care about

Inventory is expensive to store and storing something is not a value-added expenditure

Uses Cost Pools - Different departments can have different OH rates

Uses Several OH rates based on Activity - Cost Pool / Cost Driver


How do Cost Pools and Allocations compare under ABC versus traditional costing system?

Cost Pools and Allocations increase compared to a traditional costing system


What is Backflush Costing?

Connected to Just-in-Time Production- which is part of Activity-Based Costing and Total Quality Management (TQM)

- Works backward to flush out COGS
- Mostly GAAP


What are the characteristics of By-Products?

Usually immaterial and common costs aren't allocated to them
Low Market Value
Can be valued at NRV
Can be treated as a contra expense and netted against COGS - Can be treated as a contra sale and netted against Sales
Recognition rules are very flexible with valuing and classifying by-products


What are Cost Functions?

Measure how costs change relative to activity levels

High-Low Method

Change in Cost (High-Low pts) / Change in Activity (High-Low pts)


How does a price increase affect supply?

When the prices of an item increases supply increases- because more sellers are willing to sell.


What is a supply curve shift?

When supply changes due to something other than price.


What are the characteristics of a positive supply curve shift (shift right)?

Supply increases at each price point

Higher Equilibrium GDP

Number of sellers increases - market can get flooded

Examples: Government subsidies or technology improvements that decrease costs for suppliers


What are the characteristics of a negative supply curve shift (shift left)?

Supply decreases at each price point

Lower Equilibrium GDP

Cost of producing item increases

Examples: Shortage of gold- so less gold watches are made; wars or crises in rice-producing countries means there is less rice on the market


How does price affect the demand for an item?

When the prices of an item increases- demand for it decreases.


What is a Demand Curve Shift?

When demand changes due to something other than price.


What is a Positive Demand Curve Shift (Shift Right)?

When demand increases at each price point

Price of substitutes go up - price of beef rises- so people buy more chicken

Future price increase is expected - War in Middle East- people go out and buy gas

Market expands - i.e. people get new free health care plan- demand at clinic rises

Expansion - more spending increases equilibrium GDP


What is a Negative Demand Curve Shift (Shift Left)?

Demand decreases at each price point.

Price of complement goes up - price of beef goes up- less demand for ketchup

Boycott - Company commits social blunder- consumers boycott

Consumer income rises - Demand for inferior goods drops as people have more money to spend

Consumer tastes change

Contraction - less spending decreases equilibrium GDP


What is the Marginal Propensity to Consume?

How much you spend when your income increases

Calculate: Change in Spending / Change in Income


What is the Marginal Propensity to Save?

How much you save when income increases

Calculate: Change in Savings / Change in Income

Also equals 1 - Marginal Propensity to Consume


How is the multiplier effect calculated?

(1 / 1-MPC) x Change in Spending


How does increased spending by consumers and the government affect the demand curve?

As spending by consumers or the government increases- the demand curve increases (shifts right).


How does spending change due to the multiplier effect?

The increase in demand ends up being larger than the amount of additional income spent in the economy due to the multiplier effect.

One consumer spends money- which:
*Increases the income of a business
*Increases the income of a vendor
*Increases income of employees
*Increases tax revenue


How is Price Elasticity of Demand calculated?

% Change in Quantity Demand / % Change in Price


Under elastic demand- how does price affect revenues?

Price increases- Revenue decreases

Price decreases- Revenue increases


What conditions would indicate Elastic Demand?

Many substitutes (luxury items)
Considered elastic if elasticity is greater than 1
10% drop in demand / 8% increase in price : 1.25 (Elastic)

Price increases- Revenue decreases
Price decreases- Revenue increases


How does revenue react to price under Inelastic Demand?

Price increases- Revenue increases

Price decreases- Revenue decreases


What conditions would indicate Inelastic Demand?

Few substitutes (groceries- gasoline)
Considered inelastic if coefficient of elasticity is less than 1
5% drop in demand / 10% increase in price : .5 (inelastic)

Price increases- Revenue increases
Price decreases- Revenue decreases


What is Unitary Demand?

Total revenue will remain the same if price is increased

Considered unitary if coefficient of elasticity : 1


How is Income Elasticity of Demand calculated?

% Change Quantity Demanded / % Change in Income

Normal goods greater than 1 (demand increases more than income)

Inferior goods less than 1 (demand increases less than income)


What conditions occur under periods of inflation?

Interest rates increase
Reduced demand for loans
Reduced demand for houses- autos- etc.
Value of bonds and fixed income securities decrease
Inferior good demand to increase
Foreign goods more affordable than domestic
Demand for domestic goods decrease


What happens under Demand-Pull inflation?

Overall spending increases

Demand increases (shifts right)

Market equilibrium price increases


What happens under Cost-Push inflation?

Overall production costs increase
Supply decreases (shifts left)
Market equilibrium price increases

Note: Demand-Pull and Cost-Push Inflation BOTH result in market equilibrium price to increase


What is the Equilibrium Price?

The price where Quantity Supplied : Quantity Demanded


What is Optimal Production?

When Marginal Revenue : Marginal Cost


What is the result of a Price Floor?

Causes a surplus if above equilibrium price.


What is GDP (Gross Domestic Product)?

The annual value of all goods and services produced domestically at current prices by consumers- businesses- the government- and foreign companies with domestic interests

Included: Foreign company has US Factory

Not included: US company has foreign factory


What is included under the income approach for calculating GDP?

Sole Proprietor and Corp Income
Passive Income
Employee Salaries
Foreign Income Adjustments


What is included under the Expenditure Approach for calculating GDP?

Individual Consumption

Private Investment

Government Purchases

Net Exports


What is Nominal GDP?

Measures goods/services in current prices.


For what is a GDP Deflator used?

Used to convert GDP to Real GDP


What is Real GDP?

Nominal GDP / GDP Deflator x 100


What is Gross National Product (GNP)?

Like GDP; Swaps foreign production. US Firms overseas are included- Foreign firms domestically are not included


What is the Consumer Price Index (CPI)? How is it applied?

Price of goods relative to an earlier period of time- which is the benchmark. Year 1 : 1.0

((CPI Current - CPI Last) / CPI Last) * 100


How is disposable income calculated?

Personal Income - Personal Taxes


How is Return to Scale calculated?

% Increase in output / % Increase in input

Greater than 1 : Increasing returns to scale

Less than 1 : Decreasing returns to scale


When is the economy in Recession?

When GDP growth is negative for two consecutive quarters.


What is a Depression?

A prolonged- severe recession with high unemployment rates

No requisite period of time for the economy to officially be in a depression


What are the stages of the Economic Cycle?

Peak (highest)
Recession (decreasing)
Trough (lowest)
Recover (increasing)
Expansion (higher again)


What are leading indicators?

Conditions that occur before a recession or before a recovery

Example: Stock Market or New Housing Starts


What are lagging indicators?

Conditions that occur after a recession or after a recovery

Examples: Prime Interest Rates- Unemployment


What are coincident indicators?

Conditions that occur during a recession or during a recovery

Example: Manufacturing output


Which people are included in the calculation of unemployment?

Only people looking for jobs


What is Cyclical Unemployment?

GDP doesn't grow fast enough to employ all people who are looking for work

Example: People are unemployed in 2010 because there aren't enough jobs available due to the economy


What is Frictional Unemployment?

People are changing jobs or entering the work force. This is a normal aspect of full employment.

Example: A recent college graduate is looking for a job


What is Structural Unemployment?

A worker's job skills do not match those necessary to get a job so they need education or training

Example: A construction worker wants to work in an office- so they quit their job and get computer training


How does inflation relate to unemployment?

High Unemployment : Low Inflation (Vice Versa)


What is the Discount Rate?

The rate a bank pays to borrow from the Fed.


What is the Prime Rate?

The rate a bank charges their best customers on short-term borrowings.


What is the Real Interest Rate?

Inflation-adjusted interest rate


What is the Nominal Rate?

Rate that uses current prices


What is the Risk-Free Rate?

Rate for a loan with 100% certainty of payback.

Usually results in a lower rate.

US Treasuries are an example.


What is included in the M1 money supply?

Currency- Coins- and Deposits


What is included in the M2 money supply?

Highly liquid assets other than currency- coins or deposits


What is Deficit Spending?

Increased spending levels without increased tax revenue.

Lower taxes without decrease in spending

Gamble that the multiplier effect will take over and boost economy


How can the Fed control the money supply?

By buying and selling the government's securities.


How does the Fed control economy-wide interest rates?

By adjusting the discount rate charged to banks


What is a Tariff?

A tax on imported goods


What is a quota?

A limit on the number of goods that can be imported


How do international trade restrictions affect domestic producers?

They are good for domestic producers.

Demand curve shifts right

Fewer substitutes

They can charge higher prices


How to international trade restrictions affect foreign producers?

They are bad for foreign producers

Demand curve shifts left

Fewer buyers

They must charge lower prices


How do international trade restrictions affect foreign consumers?

They are good for foreign consumers

Supply curve shifts right

Goods purchased at lower prices in the foreign markets


How do international trade restrictions affect domestic consumers?

They are bad for domestic consumers

Supply curve shifts left

Fewer goods bought due to higher prices


What is Accounting Cost?

Explicit (Actual) cost of operating a business

Implicit costs are opportunity costs


What is Accounting Profit?

Revenue - Accounting Cost


What is Economic Cost?

Explicit + Implicit Cost


What is Economic Profit?

Revenue - Economic Cost


What is the primary focus of working capital management?

Managing inventory & receivables (current assets & liabilities)


How is Net Working Capital calculated?

NWC : Current Assets - Current Liabilities


What are the characteristics of effective Working Capital Management?

Shorten the cash conversion cycle

Don't negatively impact operations


What is the Inventory Conversion Period?

Average time needed to convert materials into finished goods and sell them

Average Inventory : (BI + E) / 2

Inventory Conversion Period : Average Inventory / Sales Per Day


What is the Receivables Collection Period?

Average time needed to collect A/R

RCP : Average Receivables / Credit Sales Per Day


What is the Payables Deferral Period?

Average time between materials and labor purchase and their A/P payment

Average Payables : (BP + EP) / 2

Payables Deferral Period : Average Payables / (COGS/365)


What is the Cash Conversion Cycle?

Amount of time it takes to receive a cash inflow (Customers) after making a cash outflow (Vendors)

Inventory Conversion Period
+ Receivables Collection Period
- Payables Deferral Period
: Cash Conversion Cycle

(Inventory Really (-Pays) Cash)


What traits should Cash and Short-Term Investments have?




For what are Letters of Credit used?

Used for importing goods.

Issued by importer's bank.


What is the advantage of using Trade Credit?

No interest cost if paid timely.


What is a Lockbox System? What are the advantages?

Customer Payments are sent to a bank-managed PO box.

Employees don't have access to cash.
Deposits are more timely.
Interest income from deposits should pay for the Lockbox fees (if they don't- lockbox is not beneficial)


What is float?

Time it takes to mail a payment and have it clear your bank account

Maximize float on cash payments

Minimize float on cash receipts


What are Zero Balance Accounts?

Regional bank sends enough cash to cover daily checks

Checks take longer to clear -more float
Low amounts of cash tied up for compensating (minimum) balances


What is the difference between Treasury Bills- Notes and Bonds?

Treasury Bills: Short term (less than one year) Think: $1 Bill

Treasury Notes: Medium term (less than 10 years- more than 1)

Treasury Bonds: Long term (greater than 10 years) Think: government is in long-term bondage to you; they owe you money


What is commercial paper?

Similar to T-Bill- but issued by corporations instead of Government

Greater than 9 Months Maturity


Issued by large firms


What are the advantages and disadvantages of Commercial Paper?

Advantages: Financing at less than Prime. No compensating balances required.

Disadvantages: Unpredictability of markets. Credit crisis emerges and large insurance/investment companies aren't lending.


What is Economic Order Quantity?

The order quantity that minimizes inventory costs.

EOQ : Square Root of (2DO/C)

D : Unit Demand (Annual)
O : Order Cost
C : Cost of Inventory


What is Carrying Cost?

The cost of keeping inventory.


What is Order Cost?

Cost of executing an order and starting product production.


What is inventory reorder point?

How low inventory should get before it should be re-ordered.

IOP : Average Daily Demand x Average Lead Time


What is a Just In Time (JIT) system?

Orders inventory so that you get it just in time for when it's needed

JIT is valuable when Order Cost is low and Cost of Carrying Inventory is high


What is Factoring of receivables?

Receivables are sold to a financing company where they pay less than the value of the receivables due to a discount related to risk of non-collection


What is a Trade Discount?

Buyer saves if paid early

Example: 1/10 Net 30

1% Discount if paid within 10 days

If not- bill is still due in 30 days


What is the cost of forgoing a discount?

(Discount % x 365) / ((100% - Discount) x (Pay Period - Discount Period))


What is the Prime Rate?

A benchmark used for lending only to the best customers

Most customers will be charged Prime + 3%- for example

If the lending institution and the customer are not in the same country- the LIBOR rate is often used


What is the Nominal (Face- Coupon- Stated) Rate?

Interest rate stated on the face of a bond.


How is Current Yield calculated?

CY : Interest Payment / Bond Price


What is the Effective (YTM- Market) Rate?

PV of Principle + Interest : Bond Price


What is a Zero Coupon Bond?

No interest payments made

Bond sold at a discount

Interest reflected when Bond matures


What are the characteristics of a Junk Bond?

High interest rate

High default risk


What are debenture bonds?

Bonds unsecured by collateral


What are subordinated debentures?

Debenture Bonds that will be repaid if any assets are left after liquidation of a company


What are Redeemable Bonds?

Provision in Bond contract allows demand of Bond payment under certain circumstances


What is a Callable Bond?

Borrower can pay off debt early


What is a Convertible Bond?

Lender can demand payment via company stock instead of money


What is a Sinking Fund?

Borrower deposits regular sums into an account that will eventually pay off the debt


What is the disadvantage of Common Stock in comparison to bonds?

Common Stock is more expensive to issue than debt.

Why? Investors demand a greater ROI than debtors (bondholders)


What is the advantage of Preferred Stock?

Hold dividend priority over common stock


What is Weighted Average Cost of Capital?

A company uses this to determine the true cost of their capital

Debt costs 5%; 40% of Cap.
Equity costs 12%; 60% of Cap.
(5% x 40%) + (12% x 60%)
WACC : 9.2%


What is CAPM?

A stock's expected performance is based on its beta (risk) compared to that of the stock market.

More risk : more expected return.


How is Cost of Debt calculated?

(Interest Expense - Tax Benefit) / Carrying Value of Debt


What is a Static Budget?

Budget targeted for a specific segment of a company.


What is a Maser Budget?

Budget targeted for the company as a whole

Includes budgets for Operations and Cash Flows

Includes set of budgeted Financial Statements


How do Fixed Costs affect budgeting?

Costs independent of the level activity within the relevant range

Property Tax is the same whether you produce 100-000 units or zero units

However - Fixed Costs per unit vary given the amount of activity

If you produce fewer units- fixed costs per unit will be greater than if you produce more units - i.e. less units to spread the cost over


How do Variable Costs affect budgeting?

The more Direct Materials or Direct Labor used- the more Variable Costs per unit

However - Variable Costs per unit don't change with the level of activity like Fixed Costs per unit


How are Material Variances calculated?


Standard Material Costs
- Actual Material Costs
= Material Variance


How are Labor Variances calculated?


Standard Labor Costs
- Actual Labor Costs
= Labor Variance


How are Overhead Variances calculated?


Overhead Applied
- Actual Overhead Cost
= Total Overhead Variance


How does Absorption Costing compare to Variable Costing?

Absorption Costing - External Use- Cost of Sales- Gross Profit- SG&A

Variable Costing - Internal Use- Variable Costs- Contribution Margin- Fixed Costs


How is Contribution Margin calculated?

Sales Price (per unit)
- Variable Cost (per unit)
= Contribution Margin (per unit)


How is Break-even Point (per unit) calculated?

Total Fixed Costs / Contribution Margin (per unit)
= Break-even Point Per Unit

Assumption: Total Costs & Total Revenues are LINEAR


What is the focus in a Cost Center?

Management is concerned only with costs


What is the focus in a Profit Center?

Management is concerned with both costs and profits


What is the focus in an Investment Center?

Management is concerned with costs- profits- and assets


What is the Delphi technique?

Forecasting technique where Data is collected and analyzed

Requires judgement/consensus


What is Regression Analysis?

A forecasting technique where Sales is the dependent variable.

Simple Regression - One independent variable

Multiple Regression - Multiple independent variables


What are Econometric Models?

Forecast sales using Economic Data


What are Naive Forecasting Models?

Very Simplistic
- Eyeball past trends and make an estimate


How does a Moving Average compare to Exponential Smoothing?

Both project estimates using average trends from recent periods

Difference: Exponential Smoothing weighs recent data more heavily


What are the characteristics of Short-term Cost Analysis?

Uses Relevant Costs Only

Ignore Sunk Costs

Opportunity Cost is a Must


Which IT personnel roles should always be segregated?





What are the duties of a systems analyst?

Designs or purchases IT system

Responsible for flowcharts

Liaison between Users and Programmers

Note: Think IT Manager


What is the primary duty of a Systems Administrator?

A Systems Administrator controls database access.


What are the duties of a Systems Programmer?

Writes- Updates- Maintains- & Tests software- systems- and compilers


Which duties should a Systems Programmer NOT have?

In order to maximize internal control- a Systems Programmer should NOT have application programming duties/abilities or be an Operator on the system.


What are the duties of a Systems Operator?

Schedules and Monitors Jobs

Runs IT Help Desk


What duties should a System Operator NOT have?

For internal control purposes- they should not be a Programmer on the system.


If it is not possible to segregate duties in an IT System- what actions should be taken to compensate for internal control purposes?

Include Computer Logs.

Control Group should review the logs.


What is the purpose of a Management Information System (MIS)?

To assist with decision making.


What is an Accounting Information System (AIS)?

A type of Management Information System (MIS) that processes accounting transactions.


What are the characteristics of an Executive Information System (EIS)?

Specialized for Company Executive needs

Assists with Strategy Only

No Decision-Making Capabilities


What are the characteristics of an Expert System (ES)?

Computer uses reasoning


No human interpretation needed


What are the characteristics of a Decision Support System (DSS)?

Computer provides data

Gives Interactive Support

Human interpretation needed


What are the characteristics of an Ad Hoc computer report?

User initiates the report.

The report is created upon demand.


When are Exception reports generated?

Exception reports are produced when Edit Tests- Check Digits- or Self-Checking Digits identify a problem


What is a query?

A type of Ad Hoc report- initiated by a user.


What is End-User Computing?

The User develops and executes their own application.


What is the primary benefit of E-commerce?

E-commerce makes business transactions easier.


What are the risks of E-commerce?

Compromised data or theft.

Less paper trail for auditors.


What are the benefits of Electronic Data Interchange?

Uses globally-accepted standards



What is a File Server?

A file server stores shared programs and documents.


What is the purpose of a Database?

Located on a File Server- a Database allows users to share documents.


What is the purpose of a LAN (Local Area Network)?

It connects computers in close proximity.


What is the purpose of a WAN (Wide Area Network)?

It connects computers that are far apart.


What are the characteristics of a VAN (Value-Added Network)?

Privately-owned Network

Serves as 3rd Party Between 2 Companies

Routes EDI Transactions

Accepts wide range of Protocols

Very Costly


What is the purpose of a Firewall?

Prevents unauthorized access to a network.


What are the characteristics of a virus?

Takes over a computer

Needs a host program to run


What are the characteristics of a computer worm?

Takes over multiple computers

Doesn't need a host program to run


What is the purpose of Automated Equipment Controls?

They prevent and detect hardware errors.


What is RAM?

Random Access Memory.

Internal memory in the computer used during immediate processing.


What is a CPU?

Computer Processing Unit

It processes commands within a computer.


What is Job Control Language?

It schedules and allocates system resources.


What are examples of input devices?

Magnetic Ink Reader
Magnetic Tape Reader
Point of Sale Scanner


What are examples of Output Devices?





What are the characteristics of Magnetic Tape storage?

Sequential Access - Sorts data in order

Slower data retrieval

Header Label prevents Operator error by loading wrong tape

External Labels prevent accidental destruction by operator


What are the characteristics of Magnetic Disks?

Random Access - Finds data in random spots

Faster data retrieval

Uses Boundary Protection for data


What is a Gateway?

Connects one network to another

Note: the Internet is connected by Gateways


What are Parity Checks?

A control that detects internal data errors.

A bit is added to each character- it checks to see if a bit was lost.


What is an Echo Check?

Transmitted data is returned to the sender for verification (it echoes back to the sender)


What is a Change Control?

It authorizes program changes and approves program test results.


What is security software?

Software that controls access to IT systems.

Note: Don't confuse this with anti-virus software


What is the purpose of a Digital Signature?

It confirms a message has not been altered.


List the types of computers from smallest to largest


Microcomputer - PC- Laptop (cost-effective)

Minicomputer - Like a Mainframe- but smaller

Mainframe - Large computer with terminals attached

Supercomputer - Very powerful and very big


What are the units of computer data from smallest to largest?

Bit - 1 (on) and 0 (off)
Byte - 8 bits to a byte/character
Field - group of related characters/bytes (i.e. Name- Zip Code- Serial #)
Record - Group of related fields (i.e. Member name- address- phone number)
File - Group of related records (i.e. Membership directory)


What is the duty of a design engineer?

Determine language used for a specific computer- on a computer-to-computer basis


What are object programs?

Programs written in base computer language- not similar to English.


How can source programs be recognized?

They are written in a language close to English.


What is the purpose of a Compiler?

Takes Source language (English) and converts to Object (Computer) Language


How does Online Analytical Processing work?

It uses a Data Warehouse to support management decision making.


What is Data Mining?

Using artificial intelligence and pattern recognition to analyze data stores within a Data Warehouse.


What is the purpose of online transaction processing?

To process a company's routine transactions.


What are the characteristics of batch processing?

Data held- updates multiple files all at once

Leaves a better audit trail

Uses Grandfather-Father-Son backup (3 levels of backup kept in 3 locations)


What does an output control check for?

Checks to see if output data is valid- distributed and used in an authorized manner.


What does a processing control check?

Checks if data processing produced proper output


What is a hash total?

An input control number- a meaningless sum of values included in the input.

Example would be summing a list of SSNs to make sure the data is the same once entered as it was prior to input into the system.


What is a validity check?

Checks to see if data in existing tables or files belongs in the set

For example- is there a # in an alpha-only field or a letter in a numeric-only field


What is a limit check?

Checks to see if numbers surpass a certain limit- i.e. in an age field is the number greater than 110.


What is a check digit?

An input control that adds an identification number to a set of
digits - usually at the end


What is a field check?

An input check that prevents invalid characters- i.e. checks for alphabetic letters in a SSN field


What is a Hot Site?

A disaster recovery system where if the main system goes down- a Hot Site is ready to take over immediately.


What is a Cold Site?

If a main system goes down- a Cold Site will take time to get set up and running.


What is the most common database language?

SQL - Standard Query Language


What is a Data Definition Language?

Defines SQL Database

Controls SQL Tables


What is a Data Manipulation Language?

Queries SQL Database tables


What is a Data Control Language?

Controls Access to SQL Database


What are the characteristics of a Relational Database?

Logical structure

Uses rows and columns similar to spreadsheet


What are the characteristics of a Hierarchical Database?

Has various levels

Uses trees to store data


What are the advantages of a database?

Data is more accessible

Reduced redundancy


What are the disadvantages of a database?

Cost of installation

Skilled personnel required to maintain


What are the components of a database?

Desktop client

Application Server

Database Server

Think: Your desktop computer runs applications and saves to a database


What four perspectives are included in Balanced Scorecard?

Financial / Customer / Internal Business Processes / Learning and Growth


Why was Balanced Scorecard created?

To measure Performance.


What are Strategy Maps?

Diagrams of Strategic Cause and Effect Relationships.


What is a Strategic Initiative?

A plan to achieve goals.


What measures are used under Value-Based Management?

Return on Investment
Residual Income
Economic Value Added
Free Cash Flow


How is Return on Investment (ROI) calculated?

ROI : Return / Investment

Example: You Invest $100 to buy a machine that generates $60 in Operating Income

$60 / $100 : 60% ROI


How is Residual Income calculated?

Operating Income - (Required Rate of Return x Invested Capital) : Residual Income


What is another name for Required Rate of Return (RROR)?

RROR is also called 'Cost of Capital'


What is Weighted Average Cost of Capital (WACC)? How is it calculated?

Cost of Capital is the weighted average of the interest rates you pay for your Capital.

Includes Debt and the Rate of Return your Equity Shareholders expect

Example: 45% of your Capital is supported by debt and has an interest rate of 9%. 55% of your Capital is supported by equity and shareholders expect a ROR of 12%

Your Cost of Capital is: (.45 x .09) + (.55 x .12) : 10.65%


How is Spread calculated?

Spread : ROI - Cost of Capital


What is the primary point of Economic Value Added? How is it calculated?

Investments should exceed costs- with an emphasis on stockholder value.

Economic Value Added : Operating Income After Tax - (Net Assets x WACC)


How is Free Cash Flow calculated?

Operating Income After Tax
+ Depreciation & Amortization
- Capital Expenditures
- Change in Net Working Capital
: Free Cash Flow


What is measured by Six Sigma?

It measures a product versus its quality goal.


What is the Asset Turnover Ratio?

Sales / Average Assets


What does the Current Ratio tell us? How is it calculated?

Can the company pay their short-term liabilities?

Current Ratio : Current Assets / Current Liabilities


What does the Debt to Equity Ratio tell us? How is it calculated?

How is the company financing its capital?

Debt to Equity Ratio : Total Debt / Total Equity


What does the Debt to Total Assets ratio tell us? How is it calculated?

What proportions of the company's assets are encumbered with debt?

Debt to Total Assets : Total Liabilities / Total Assets


What does Gross Margin % tell us? How is it calculated?

How profitable is the product after COGS?

Gross Margin : Gross Profit / Net Sales


What does Operating Profit Margin tell us? How is it calculated?

How profitable is the product after all expenses (except interest and taxes)?

Operating Profit Margin : Operating Profit / Net Sales


How is Times Interest Earned calculated and what does it mean?

Can the company make their interest payments?

Times Interest Earned : Earnings Before Tax & Interest / Interest Expense


What does Return on Assets tell us? How is it calculated?

What % return are the assets generating?

Return on Assets : Net Income (net of interest & taxes) / Average Total Assets


How is Market/Book ratio calculated?

Market Value of Common Stock / Book Value of Common Stock


What is Inventory Turnover and how is it calculated?

How quickly does inventory get sold?

Inventory Turnover : COGS / Average Inventory


What is the Quick Ratio and how is it calculated?

It measures short-term liquidity- and only includes assets that are quickly available (i.e. not inventory)

Quick Ratio : (Current Assets - Inventory) / Current Liabilities


What is Average Collection Period- and how is it calculated?

How many days does it take the company to collect payment on A/R?

Average Collection Period : Average AR / Average Sales Per Day


What is an Internal Failure?

Products have quality defects- but are caught BEFORE they leave the warehouse.


What is an External Failure?

Product reaches the customer- but they are not satisfied with the quality of the product.

This includes recalls.


What is Appraisal Cost?

Quality control- testing & inspection costs.


Define Market Risk

The risk that a sluggish economy will affect the value of a debt instrument


Define Sector Risk

The risk that an event in the investment's business sector will harm the investment

For example- the banking sector is sluggish- so even stocks of healthy banks suffer


Define Credit/Default Risk

The risk that a debtor will be unable to make loan payments or pay back the principal


Define Interest Rate Risk

The risk that a change in interest rates will adversely affect the value of the note

Example: Bond is for 10% but prevailing market rate is now 12%. If bondholder wants to sell it- they will have to sell it at a discount.


What does Standard Deviation measure?

It measures the volatility of an investment.


What is Systematic Risk?

Risk that impacts the entire market and can't be avoided or reduced through diversification

Example: Wars


What is Unsystematic Risk?

Relates to a particular industry or company

Example: You own stocks in ethanol plants and an untimely freeze kills all of the corn in the Midwest


What does Beta measure?

Beta measures how volatile the investment is relative to the rest of the market.

In other words- how quickly (and in what amount) does the value of the stock change when the market sways?


What is Variance?

It compares volatility of an investment to the market average.

Factors include both Systematic and Unsystematic Risk.


What is a Derivative?

An asset whose value is DERIVED from the value of another asset.

Derivatives are measured at Fair Value.


How is an Option used?

Gives the buyer the option to buy or sell a financial derivative at a certain price

Traders use them to speculate where they think the price will be at a certain point and make a profit

Hedgers use them to offset risk


What is a Future?

A Forward Contract with a future value.

They are sold and traded on the futures market.


What is an Interest Rate Swap?

Forward Contract to swap payment agreements

They are highly liquid and often valued using the Zero-Coupon method.

Example: Steve pays Sally a fixed payment with a fixed interest rate. Sally pays Steve a variable payment tied to a benchmark such as LIBOR


What is Legal Risk?

Risk that a law or regulation will void the derivative


What is a Fair Value Hedge?

Hedge that protects against the value of an asset or liability changing.

Changes in value are reported in earnings.


What is a Cash Flow Hedge?

A hedge that protects against a set of future cash flows changing.

Changes in value are reported in OCI.


What is a Foreign Currency Hedge?

A hedge that protects against the value of a foreign currency changing.

For example- a foreign currency hedge might be used to protect against the following: If you have receivables denominated in a foreign currency and that currency dips in value - your receivables are worth less than before.