Business Environment & Concepts

About this Publication

This publication is intended for the study and preparation of the CPA Exam, and is not intended to offer any legal, accounting, or professional advice. The guidance, opinions, and strategies contained herein make no representations or warranties with respect the accuracy or completeness of the content. The publisher specifically disclaims any express or implied warranties for a particular business, legal, or accounting purpose.
Although every effort is made for accuracy and quality review, the intended purpose of the publication is for knowledge of the CPA exam, and should only be used as such. Neither publisher nor author shall be liable directly or indirectly for any damages. Some of this content is copyrighted by AICPA, and other parties. Redistribution of the content is not allowed without prior written consent from the originator. No part of this publication may be reproduced or electronically transmitted through an unauthorized method. Published by eM Media & Publications, LLC Business, Environment and Concepts Version 1.2013 | Compiled 4-9-2013

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About the Exam

The Uniform Certified Public Accountant Examination is the examination administered to people who wish to become U.S. Certified Public Accountants. The CPA Exam is used by the regulatory bodies of all fifty states plus the District of Columbia. The CPA Exam is developed, maintained and scored by the American Institute of Certified Public Accountants (AICPA) and administered at Prometric test centers in partnership with the National Association of State Boards of Accountancy (NASBA).

About Business Environment & Concepts

The Business Environment and Concepts section tests knowledge and skills necessary to demonstrate an understanding of the general business environment and business concepts. The topics in this section include knowledge of corporate governance; economic concepts essential to understanding the global business environment and its impact on an entitys business strategy and financial risk management; financial management processes; information systems and communications; strategic planning; and operations management. In addition to demonstrating knowledge and understanding of these topics, candidates are required to apply that knowledge in performing audit, attest, financial reporting, tax preparation, and other professional responsibilities as certified public accountants. To demonstrate such knowledge and skills, candidates will be expected to perform the following tasks: Demonstrate an understanding of globalization on the business environment Distinguish between appropriate and inappropriate governance structures within an organization (e.g. tone at the top, policies, steering committees, strategies, oversight, etc.). Assess the impact of business cycles on an entitys industry or business operations. Apply knowledge of changes in the global economic markets in identifying the impact on an entity in determining its business strategy and financial management policies, including managing the

risks of: inflation, deflation, commodity costs, credit defaults, interest rate variations, currency fluctuation, and regulation. Assess the factors influencing a companys capital structure, including risk, leverage, cost of capital, growth rate, profitability, asset structure, and loan covenants. Evaluate assumptions used in financial valuations to determine their reasonableness (e.g. investment return assumptions, discount rates, etc.). Determine the business reasons for and explain the underlying economic substance of transactions and their accounting implications. Identify the information systems within a business that are used to process and accumulate transactional data, as well as provide monitoring and financial reporting information. Distinguish between appropriate and inappropriate internal control systems, including system design, controls over data, transaction flow, wireless technology, and internet transmissions. Evaluate whether there is appropriate segregation of duties, levels of authorization, and data security in an organization to maintain an appropriate internal control structure. Obtain and document information about an organizations strategic planning processes to identify key components of the business strategy and market risks. Develop a time-phased project plan showing required activities, task dependencies, and required resources to achieve a specific deliverable. Identify the business and operational risks inherent in an entitys disaster recovery/business continuity plan. Evaluate business operations and quality control initiatives to understand its use of best practices and the ways to measure and manage performance and costs.

AICPA, American Institute of Certified Public Accountants, Inc.

Content Specification Outline

This book is organized in conjunction with the AICPAs Content Specification Outline of the CPA Examination. The outline below specifies the knowledge in which candidates are required to demonstrate proficiency:
I. Corporate Governance (16% - 20%) A. Rights, Duties, Responsibilities, and Authority of the Board of Directors, Officers, and Other Employees 1. Financial reporting 2. Internal control (including COSO or similar framework) 3. Enterprise risk management (including COSO or similar framework) B. Control Environment 1. Tone at the top establishing control environment 2. Monitoring control effectiveness 3. Change control process II. Economic Concepts and Analysis (16% - 20%) A. Changes in Economic and Business Cycles Economic Measures/Indicators B. Globalization and Local Economies 1. Impacts of globalization on companies 2. Shifts in economic balance of power (e.g. capital) to/from developed from/to emerging markets C. Market Influences on Business Strategies D. Financial Risk Management 1. Market, interest rate, currency, liquidity, credit, price, and other risk 2. Means for mitigating/controlling financial risks

III. Financial Management (19% - 23%) A. Financial Modeling, Projections, and Analysis 1. Forecasting and trends 2. Financial and risk analysis 3. Impact of inflation/deflation B. Financial Decisions 1. Debt, equity, leasing 2. Asset and investment management C. Capital Management, including Working Capital 1. Capital structure 2. Short-term and long-term financing 3. Asset effectiveness and/or efficiency D. Financial Valuations (e.g. Fair Value) 1. Methods for calculating valuations 2. Evaluating assumptions used in valuations E. Financial Transaction Processes and Controls IV. Information Systems and Communications (15% - 19%) A. Organizational Needs Assessment 1. Data capture 2. Processing 3. Reporting 4. Role of information technology in business strategy B. Systems Design and Other Elements 1. Business process design (integrated systems, automated, and manual interfaces) 2. Information Technology (IT) control objectives 3. Role of technology systems in control monitoring 4. Operational effectiveness 5. Segregation of duties 6. Policies C. Security 1. Technologies and security management features 2. Policies D. Internet Implications for Business 1. Electronic commerce 2. Opportunities for business process reengineering 3. Roles of internet evolution on business operations and organization cultures E. Types of Information System and Technology Risks F. Disaster Recovery and Business Continuity V. Strategic Planning (10% 14%) A. Market and Risk Analysis B. Strategy Development, Implementation, and Monitoring C. Planning Techniques 1. Budget and analysis 2. Forecasting and projection 3. Coordinating information from various sources for integrated planning VI. Operations Management (12% - 16%) A. Performance Management and Impact of Measures on Behavior 1. Financial and nonfinancial measures 2. Impact of marketing practices on performance 3. Incentive compensation B. Cost Measurement Methods and Techniques C. Process Management 1. Approaches, techniques, measures, and benefits to process-management-driven businesses

2. Roles of shared services, outsourcing, and off-shore operations, and their implications on business risks and controls 3. Selecting and implementing improvement initiatives 4. Business process reengineering 5. Management philosophies and techniques for performance improvement such as Just in Time (JIT), Quality, Lean, Demand Flow, Theory of Constraints, and Six Sigma D. Project Management 1. Project planning, implementation, and monitoring 2. Roles of project managers, project members, and oversight or steering groups 3. Project risks, including resource, scope, cost, and deliverables

AICPA, American Institute of Certified Public Accountants, Inc.

Business Environment and Concepts 1: Corporate Governance Board of Directors

A board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. Other names include board of governors, board of managers, board of regents, board of trustees, and board of visitors. It is often simply referred to as "the board". A board's activities are determined by the powers, duties, and responsibilities delegated to it or conferred on it by an authority outside itself. These matters are typically detailed in the organization's bylaws. The bylaws commonly also specify the number of members of the board, how they are to be chosen, and when they are to meet. In an organization with voting members, e.g., a professional society, the board acts on behalf of, and is subordinate to, the organization's full assembly, which usually chooses the members of the board. In a stock corporation, the board is elected by the stockholders and is the highest authority in the management of the corporation. In a non-stock corporation with no general voting membership, e.g., a typical university, the board is the supreme governing body of the institution; its members are sometimes chosen by the board itself. Typical duties of boards of directors include:

Governing the organization by establishing broad policies and objectives; Selecting, appointing, supporting and reviewing the performance of the chief executive; Ensuring the availability of adequate financial resources; Approving annual budgets; Accounting to the stakeholders for the organization's performance; Setting the salaries and compensation of company management.

The legal responsibilities of boards and board members vary with the nature of the organization, and with the jurisdiction within which it operates. For public corporations,[clarification needed] these responsibilities are typically much more rigorous and complex than for those of other types. Typically the board chooses one of its members to be the chairman, who holds whatever title is specified in the bylaws.

Business Entities Introduction

The following are the main business designations and types (corporations and non-corporations):

Corp., Inc. (Corporation, Incorporated): used to denote corporations (public or otherwise). These are the only terms universally accepted by all 51 corporation chartering jurisdictions in the United States. However in some states other suffixes may be used to identify a corporation, such as Ltd., Co./Company. Some states that allow the use of "Company" prohibit the use of "and Company", "and Co.", "& Company" or "& Co.". In most states sole proprietorships and partnerships may register a fictitious "doing business as" name with the word "Company" in it. For a full list of allowed designations by state, see the table below. See also Delaware corporation, Nevada corporation,Massachusetts business trust. Doing Business As (DBA): denotes a business name used by a person or entity that is different from the person's or entity's true name. Filing requiments vary and are not permitted for some types of businesses or professional practices. DBAs can be sole proprietorships, or can be used by corporate entities to reserve "brand names", such as those of chain stores owned and operated by a holding company or other "umbrella". General partnership is a partnership in which all the partners are jointly liable for the debts of the partnership. It is typically created by agreement rather than being created by a public filing. LLC, LC, Ltd. Co. (limited liability company): a form of business whose owners enjoy limited liability, but which is not a corporation. Allowable abbreviations vary by state. Note that Ltd. by itself is not a valid abbreviation for an LLC, because in some states (e.g. Texas), it may denote a corporation instead. See also Series LLC. For U.S. federal tax purposes, an LLC with two or more members is treated as a partnership, and an LLC with one member is treated as a sole proprietorship. LLLP (limited liability limited partnership): a combination of LP and LLP, available in some states LLP (limited liability partnership): a partnership where a partner's liability for the debts of the partnership is limited except in the case of liability for acts of professional negligence or malpractice. In some states LLPs may only be formed for purposes of practicing a licensed profession, typically attorneys, accountants and architects. This is often the only form of limited partnership allowed for law firms (as opposed to general partnerships). LP (limited partnership): a partnership where at least one partner has unlimited liability and one or more partners have limited liability PLLC (professional limited liability company): Some states do not allow certain professionals to form an LLC that would limit the liability that results from the services the professionals provide such as doctors, medical care; lawyers, legal advice; and accountants, accounting services, when the company formed offers the services of the professionals. Instead states allow a PLLC or in the LLC statutes, the liability limitation only applies to the business side, such as creditors of the company, as opposed to the service side, the level of medical care, legal services, or accounting provided to clients. This is meant to maintain the higher ethical standards that these professionals have committed themselves to by becoming licensed in their profession and not immune to malpractice suits.

Professional corporations (abbreviated as PC or P.C.) are those corporate entities for which many corporation statutes make special provision, regulating the use of the corporate form by licensed professionals such as attorneys, architects, accountants, and doctors. Sole proprietorship: a business consisting of a single owner, not in a separately recognized business form

Corporate Governance
Corporate governance is the set of processes, customs, policies, laws, and institutions affecting the way a corporation (or company) is directed, administered or controlled. An important theme of corporate governance is the nature and extent of accountability of particular individuals in the organization, and mechanisms that try to reduce or eliminate the principal-agent problem. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. In contemporary business corporations, the main external stakeholder groups are shareholders, debtholders, trade creditors, suppliers, customers and communities affected by the corporation's activities. Internal stakeholders are the board of directors, executives, and other employees. A related but separate thread of discussions focuses on the impact of a corporate governance system on economic efficiency, with a strong emphasis on shareholders' welfare; this aspect is particularly present in contemporary public debates and developments in regulatory policy (see regulation and policy regulation). There has been renewed interest in the corporate governance practices of modern corporations since 2001, particularly due to the high-profile collapses of a number of large corporations, most of which involved accounting fraud. Corporate scandals of various forms have maintained public and political interest in the regulation of corporate governance. In the U.S., these include Enron Corporation andMCI Inc. (formerly WorldCom). Their demise is associated with the U.S. federal government passing the Sarbanes-Oxley Act in 2002, intending to restore public confidence in corporate governance. Comparable failures in Australia (HIH, One.Tel) are associated with the eventual passage of the CLERP 9 reforms. Similar corporate failures in other countries stimulated increased regulatory interest (e.g., Parmalat in Italy). Principles of corporate governance Contemporary discussions of corporate governance tend to refer to principles raised in three documents released since 1990: The Cadbury Report (UK, 1992), the Principals of Corporate Governance (OECD, 1998 and 2004), the Sarbanes-Oxley Act of 2002 (US, 2002). The Cadbury and OECD reports present general principals around which businesses are expected to operate to assure proper governance. The Sarbanes-Oxley Act, informally referred to as Sarbox or Sox, is an attempt by the federal government in the United States to legislate several of the principals recommended in the Cadbury and OECD reports. Rights and equitable treatment of shareholders: Organizations should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by openly and effectively communicating information and by encouraging shareholders to participate in general meetings.

Interests of other stakeholders: Organizations should recognize that they have legal, contractual, social, and market driven obligations to non-shareholder stakeholders, including employees, investors, creditors, suppliers, local communities, customers, and policy makers. Role and responsibilities of the board: The board needs sufficient relevant skills and understanding to review and challenge management performance. It also needs adequate size and appropriate levels of independence and commitment to fulfill its responsibilities and duties. Integrity and ethical behavior: Integrity should be a fundamental requirement in choosing corporate officers and board members. Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. Disclosure and transparency: Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide stakeholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company's financial reporting. Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information. Corporate governance models around the world There are many different models of corporate governance around the world. These differ according to the variety of capitalism in which they are embedded. The Anglo-American "model" tends to emphasize the interests of shareholders. The coordinated or multi-stakeholder model associated with Continental Europe and Japan also recognizes the interests of workers, managers, suppliers, customers, and the community. In the United States, corporations are directly governed by state laws, while the exchange (offering and trading) of securities in corporations (including shares) is governed by federal legislation. Many U.S. states have adopted the Model Business Corporation Act, but the dominant state law for publicly-traded corporations is Delaware, which continues to be the place of incorporation for the majority of publiclytraded corporations. Individual rules for corporations are based upon the corporate charter and, less authoritatively, the corporate bylaws. Shareholders cannot initiate changes in the corporate charter although they can initiate changes to the corporate bylaws. Parties to corporate governance The most influential parties involved in corporate governance include government agencies and authorities, stock exchanges, management (including the board of directors and its chair, the Chief Executive Officer or the equivalent, other executives and line management, shareholders and auditors). Other influential stakeholders may include lenders, suppliers, employees, creditors, customers and the community at large. The agency view of the corporation posits that the shareholder forgoes decision rights (control) and entrusts the manager to act in the shareholders' best (joint) interests. Partly as a result of this separation between the two investors and managers, corporate governance mechanisms include a system of controls intended to help align managers' incentives with those of shareholders. Agency concerns (risk) are necessarily lower for a controlling shareholder. A board of directors is expected to play a key role in corporate governance. The board has the responsibility of\ endorsing the organization's strategy, developing directional policy, appointing, supervising and remunerating senior executives, and ensuring accountability of the organization to its investors and authorities.

All parties to corporate governance have an interest, whether direct or indirect, in the financial performance of the corporation. Directors, workers and management receive salaries, benefits and reputation, while investors expect to receive financial returns. For lenders, it is specified interest payments , while returns to equity investors arise from dividend distributions or capital gains on their stock. Customers are concerned with the certainty of the provision of goods and services of an appropriate quality; suppliers are concerned with compensation for their goods or services, and possible continued trading relationships. These parties provide value to the corporation in the form of financial, physical, human and other forms of capital. Many parties may also be concerned with corporate social performance. A key factor in a party's decision to participate in or engage with a corporation is their confidence that the corporation will deliver the party's expected outcomes. When categories of parties (stakeholders) do not have sufficient confidence that a corporation is being controlled and directed in a manner consistent with their desired outcomes, they are less likely to engage with the corporation. When this becomes an endemic system feature, the loss of confidence and participation in markets may affect many other stakeholders, and increases the likelihood of political action. There is substantial interest in how external systems and institutions, including markets, influence corporate governance. Ownership structures and elements Ownership structure refers to the types and composition of shareholders in a corporation. Researchers often "measure" ownership structures by using some observable measures of ownership concentration or the extent of inside ownership. Some features or types of ownership structure involving corporate groups include pyramids, cross-shareholdings, rings, and webs. Cross-shareholding are an essential feature of keiretsu and chaebol groups). Corporate engagement with shareholders and other stakeholders can differ substantially across different ownership structures. Institutional investors Many years ago, worldwide, investors were typically individuals or families, irrespective of whether or not they acted through a controlled entity. Over time, markets have become largely institutionalized: investors are largely institutions that invest the pooled funds of their intended beneficiaries. These institutional investors include pension funds (also known as superannuation funds), mutual funds,hedge funds, exchangetraded funds, and financial institutions such as insurance companies and banks. In this way, the majority of investment now is described as "institutional investment" even though the vast majority of the funds are for the benefit of individual investors. The significance of institutional investors varies substantially across countries. In developed AngloAmerican countries (Australia, Canada, New Zealand, U.K., U.S.), institutional investors dominate the market for stocks in larger corporations. While the majority of the shares in the Japanese market are held by financial companies and industrial corporations, these are not institutional investors if their holdings are largely with-on group. The largest pools of invested money (such as the mutual fund 'Vanguard 500', or the largest investment management firm for corporations, State Street Corp.) are designed to maximize the benefits of diversified investment by investing in a very large number of different corporations with sufficient liquidity. The idea is this strategy will largely eliminate individual firm financial or other risk and. A consequence of this approach is that these investors have relatively little interest in the governance

of a particular corporation. It is often assumed that, if institutional investors pressing for will likely be costly because of "golden handshakes") or the effort required, they will simply sell out their interest. Mechanisms and controls Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from moral hazard and adverse selection. For example, to monitor managers' behavior, an independent third party (the external auditor) attests the accuracy of information provided by management to investors. An ideal control system should regulate both motivation and ability. Internal corporate governance controls Internal corporate governance controls monitor activities and then take corrective action to accomplish organisational goals. Examples include:

Monitoring by the board of directors: The board of directors, with its legal authority to hire, fire and compensate top management, safeguards invested capital. Regular board meetings allow potential problems to be identified, discussed and avoided. Whilst non-executive directors are thought to be more independent, they may not always result in more effective corporate governance and may not increase performance. Different board structures are optimal for different firms. Moreover, the ability of the board to monitor the firm's executives is a function of its access to information. Executive directors possess superior knowledge of the decision-making process and therefore evaluate top management on the basis of the quality of its decisions that lead to financial performance outcomes, ex ante. It could be argued, therefore, that executive directors look beyond the financial criteria. Internal control procedures and internal auditors: Internal control procedures are policies implemented by an entity's board of directors, audit committee, management, and other personnel to provide reasonable assurance of the entity achieving its objectives related to reliable financial reporting, operating efficiency, and compliance with laws and regulations. Internal auditors are personnel within an organization who test the design and implementation of the entity's internal control procedures and the reliability of its financial reporting Balance of power: The simplest balance of power is very common; require that the President be a different person from the Treasurer. This application of separation of power is further developed in companies where separate divisions check and balance each other's actions. One group may propose company-wide administrative changes, another group review and can veto the changes, and a third group check that the interests of people (customers, shareholders, employees) outside the three groups are being met. Remuneration: Performance-based remuneration is designed to relate some proportion of salary to individual performance. It may be in the form of cash or non-cash payments such as shares andshare options, superannuation or other benefits. Such incentive schemes, however, are reactive in the sense that they provide no mechanism for preventing mistakes or opportunistic behavior, and can elicit myopic behavior.

In publicly-traded U.S. corporations, boards of directors are largely chosen by the President/CEO and the President/CEO often takes the Chair of the Board position for his/herself (which makes it much more

difficult for the institutional owners to "fire" him/her). The practice of the CEO also being the Chair of the Board is known as "duality". While this practice is common in the U.S., it is relatively rare elsewhere. It is illegal in the U.K. External corporate governance controls External corporate governance controls encompass the controls external stakeholders exercise over the organization. Examples include:competition, debt covenants, demand for and assessment of performance information (especially financial statements), government regulations, managerial labour market, media pressure, and takeovers. Financial reporting and the independent auditor The board of directors has primary responsibility for the corporation's external financial reporting functions. The Chief Executive Officer and Chief Financial Officer are crucial participants and boards usually have a high degree of reliance on them for the integrity and supply of accountinginformation. They oversee the internal accounting systems, and are dependent on the corporation'saccountantsand internal auditors. Current accounting rules under International Accounting Standards and U.S. GAAP allow managers some choice in determining the methods of measurement and criteria for recognition of various financial reporting elements. The potential exercise of this choice to improve apparent performance (see creative accountingand earnings management) increases the information risk for users. Financial reporting fraud, including non-disclosure and deliberate falsification of values also contributes to users' information risk. To reduce these risk and to enhance the perceived integrity of financial reports, corporation financial reports must be audited by an independent external auditor who issues a report that accompanies the financial statements (see financial audit). It is One area of concern is whether the auditing firm acts as both the independent auditor and management consultant to the firm they are auditing. This may result in a conflict of interest which places the integrity of financial reports in doubt due to client pressure to appease management. The power of the corporate client to initiate and terminate management consulting services and, more fundamentally, to select and dismiss accounting firms contradicts the concept of an independent auditor. Changes enacted in the United States in the form of the Sarbanes-Oxley Act (following numerous corporate scandals, culminating with the Enron scandal) prohibit accounting firms from providing both auditing and management consulting services. Similar provisions are in place under clause 49 of Standard Listing Agreement in India. Systemic problems of corporate governance 1. Demand for information: In order to influence the directors, the shareholders must combine with others to form a voting group which can pose a real threat of carrying resolutions or appointing directors at a general meeting. 2. Monitoring costs: A barrier to shareholders using good information is the cost of processing it, especially to a small shareholder. The traditional answer to this problem is the efficient market hypothesis (in finance, the efficient market hypothesis (EMH) asserts that financial markets are efficient), which suggests that the small shareholder will free ride on the judgments of larger professional investors. 3. Supply of accounting information: Financial accounts form a crucial link in enabling providers of finance to monitor directors. Imperfections in the financial reporting process will cause

imperfections in the effectiveness of corporate governance. This should, ideally, be corrected by the working of the external auditing process. Executive Remuneration/Compensation Research on the relationship between firm performance and executive compensation does not identify consistent and significant relationships between executives' remuneration and firm performance. Not all firms experience the same levels of agency conflict, and external and internal monitoring devices may be more effective for some than for others. Some researchers have found that the largest CEO performance incentives came from ownership of the firm's shares, while other researchers found that the relationship between share ownership and firm performance was dependent on the level of ownership. The results suggest that increases in ownership above 20% cause management to become more entrenched, and less interested in the welfare of their shareholders. Some argue that firm performance is positively associated with share option plans and that these plans direct managers' energies and extend their decision horizons toward the long-term, rather than the shortterm, performance of the company. However, that point of view came under substantial criticism circa in the wake of various security scandals including mutual fund timing episodes and, in particular, the backdating of option grants as documented by University of Iowa academic Erik Lie and reported by James Blander and Charles Forelle of the Wall Street Journal.

Financial reporting
Summary of Financial Statements A financial statement (or financial report) is a formal record of the financial activities of a business, person, or other entity. For a business enterprise, all the relevant financial information, presented in a structured manner and in a form easy to understand, are called the financial statements. They typically include four basic financial statements, accompanied by a management discussion and analysis:

Statement of Financial Position: also referred to as a balance sheet, reports on a company's assets, liabilities, and ownership equity at a given point in time. Statement of Comprehensive Income: also referred to as Profit and Loss statement (or a "P&L"), reports on a company's income, expenses, and profits over a period of time. A Profit & Loss statement provides information on the operation of the enterprise. These include sale and the various expenses incurred during the processing state. Statement of Changes in Equity: explains the changes of the company's equity throughout the reporting period Statement of cash flows: reports on a company's cash flow activities, particularly its operating, investing and financing activities.

For large corporations, these statements are often complex and may include an extensive set of notes to the financial statements and explanation of financial policies and management discussion and analysis.

The notes typically describe each item on the balance sheet, income statement and cash flow statement in further detail. Notes to financial statements are considered an integral part of the financial statements. SEC Filing An SEC filing is a financial statement or other formal document submitted to the U.S. Securities and Exchange Commission (SEC). Public companies, certain insiders, and broker-dealers are required to make regular SEC filings. Investors and financial professionals rely on these filings for information about companies they are evaluating for investment purposes. Many, but not all SEC filings are available online through the SEC's EDGAR database. Common filing types include:

10-Q: Quarterly report filed pursuant to sections 13 or 15(d). 10-K: Annual report pursuant to section 13 and 15(d). 8-K: Interim report which announces any material events or corporate changes that occur between 10-Q quarterly reports.

Internal Control
What is Internal Control? In accounting and auditing, internal control is defined as a process effected by an organization's structure, work and authority flows, people and management information systems, designed to help the organization accomplish specific goals or objectives. It is a means by which an organization's resources are directed, monitored, and measured. It plays an important role in preventing and detecting fraud and protecting the organization's resources, both physical (e.g., machinery and property) and intangible (e.g., reputation or intellectual property such as trademarks). Definition of Internal Control There are many definitions of internal control, as it affects the various constituencies (stakeholders) of an organization in various ways and at different levels of aggregation. Under the COSO Internal ControlIntegrated Framework, a widely-used framework in not only the United States but around the world, internal control is broadly defined as a process, effected by an entity's board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories: A) Effectiveness and efficiency of operations; B) Reliability of financial reporting; and

C) Compliance with laws and regulations. COSO defines internal control as having five components: Control Environment-sets the tone for the organization, influencing the control consciousness of its people. It is the foundation for all other components of internal control. Risk Assessment-the identification and analysis of relevant risks to the achievement of objectives, forming a basis for how the risks should be managed Information and Communication-systems or processes that support the identification, capture, and exchange of information in a form and time frame that enable people to carry out their responsibilities Control Activities-the policies and procedures that help ensure management directives are carried out. Monitoring-processes used to assess the quality of internal control performance over time. The COSO definition relates to the aggregate control system of the organization, which is composed of many individual control procedures. Discrete control procedures, or controls are defined by the SEC as: "...a specific set of policies, procedures, and activities designed to meet an objective. A control may exist within a designated function or activity in a process. A controls impact...may be entity-wide or specific to an account balance, class of transactions or application. Controls have unique characteristics for example, they can be: automated or manual; reconciliations; segregation of duties; review and approval authorizations; safeguarding and accountability of assets; preventing or detecting error or fraud. Controls within a process may consist of financial reporting controls and operational controls (that is, those designed to achieve operational objectives)." Internal control is defined as "The process designed, implemented and maintained by - (a) those charged with governance, (b) management and (c) other personnel, to provide reasonable assurance about the achievement of an entity's objectives with regard to - (a) reliability of financial reporting, (b) effectiveness and efficiency of operation, (c) safeguarding of assets and (d) compliance with applicable laws and regulations."

Control Environment
Control environment also called "Internal control environment". It is a term of financial audit, internal audit and Enterprise Risk Management. It means the overall attitude, awareness and actions of directors and management (i.e. "those charged with governance") regarding the internal control system and its importance to the entity. They express it in management style, corporate culture,values, philosophy and operating style, the organisational structure, and human resources policies and procedures. Tone at the top establishing control environment "Tone at the top" is a term that originated in the field of accounting and is used to describe an

organization's general ethical climate, as established by its board of directors, audit committee, and senior management. Having a strong tone at the top is believed by business ethics experts to help prevent fraud and other unethical practices. The concept of tone at the top originated in audit firms, where it referred fairly narrowly to the attitude of an organization's senior leadership towards internal financial controls. It was popularized following a series of major corporate accounting scandals such as those affecting Enron, Tyco International, Adelphia, Peregrine Systems and WorldCom, when the concept was strongly emphasized in the SarbanesOxley Act of 2002 as important in the prevention and detection of fraud and other unethical financial practices. Today the term is applied very broadly, including in the fields of general management, information security, law and software development, and is often used to describe the general corporate culture established by an organization's leadership.

The tone at the top is often considered to permeate an entire organization, and good tone at the top is considered a prerequisite for solid corporate governance. It has been said that boards of directors have a dual role: creating codes of conduct, and living by them. Good organizational tone is set through policies, codes of ethics, a commitment to hiring competent employeees, and the development of reward structures that promote good internal controls and effective governance. In an analysis of ethical leadership, KPMG described ethical leaders as those who are receptive to employees' ethical concerns, value ethics and integrity over short-term business goals, and respond appropriately if they become aware of misconduct. Auditors typically interview an organization's leaders as part of the audit fieldwork in order to assess tone at the top, because poor tone is associated with malfeasance. Questions commonly asked include "how is the board compensated," "how active is the audit committee," "what is the nature of the organization's corporate culture," "what pressures are there to make sales and earnings goals," "how is wrong-doing dealt with," "do employees understand their individual responsibilities for controls," "do monitoring controls signal failures in a timely fashion so corrective action can be taken," and "is there evidence that the employee code of ethics is complied with." Important fraud factors include pressure to reach goals, incentives and meeting expectations.

Mission Statement
A mission statement is a statement of the purpose of a company, organization or person, its reason for existing. The mission statement should guide the actions of the organization, spell out its overall goal,

provide a path, and guide decision-making. It provides the framework or context within which the company's strategies are formulated. Effective mission statements start by cogently articulating the organization's purpose. Mission statements often include the following information:

Aim(s) of the organization The organization's primary stakeholders: clients/customers, shareholders, congregation, etc. How the organization provides value to these stakeholders, for example by offering specific types of products and/or services A declaration of an organization's sole core purpose. A mission statement answers the question, "Why do we exist?"

According to Bart, the commercial mission statement consists of 3 essential components: 1. Key market who is your target client/customer? (generalize if needed) 2. Contribution what product or service do you provide to that client? 3. Distinction what makes your product or service unique, so that the client would choose you? Examples of mission statements that clearly include the 3 essential components: For example:

McDonalds - "To provide the fast food customer food prepared in the same high-quality manner world-wide that is tasty, reasonably-priced & delivered consistently in a low-key dcor and friendly atmosphere." o Key Market: The fast food customer world-wide o Contribution: tasty and reasonably-priced food prepared in a high-quality manner o Distinction: delivered consistently (world-wide) in a low-key dcor and friendly atmosphere. Courtyard by Marriott - "To provide economy and quality minded travelers with a premier, moderate priced lodging facility which is consistently perceived as clean, comfortable, wellmaintained, and attractive, staffed by friendly, attentive and efficient people." o Key Market: economy and quality minded travelers o Contribution: moderate priced lodging o Distinction: consistently perceived as clean, comfortable, well-maintained, and attractive, staffed by friendly, attentive and efficient people

The mission statement can be used to resolve trade-offs between different business stakeholders. Stakeholders include: managers & executives, non-management employees, shareholders, board of directors, customers, suppliers, distributors, creditors/bankers, governments (local, state, federal, etc.), labour unions, competitors, NGOs, and the community or general public. By definition, stakeholders affect or are affected by the organization's decisions and activities. According to Vern McGinis, a mission should:

Define what the company is Limited to exclude some ventures Broad enough to allow for creative growth Distinguish the company from all others Serve as framework to evaluate current activities Stated clearly so that it is understood by all

Constitutions A mission statement is a pragmatic, literate statement of enterprise cohesion and future prospect. Magna International is an example of a corporation going beyond the ordinary mission statement to a Corporate Constitution. Where nation states are involved, a mission statement is insufficient, a constitution is required.

BEC 1 (Corporate Governance) Questions

1. Which of the following statements is(are) correct regarding corporate debt and equity securities? I. Both debt and equity security holders have an ownership interest in the corporation. II. Both debt and equity securities have an obligation to pay income. A) I only. B) II only. C) Both I and II. D) Neither I nor II.

2. Which of the following circumstances may permit the piercing of the corporate veil of a closely held corporation and thus may cause its shareholders to be held personally liable? I. The corporation is thinly capitalized. II. The corporation borrows money from a shareholder without giving the shareholder a security interest in corporate assets. A) I only.

B) II only. C) Both I and II. D) Neither I nor II.

3. The principle that protects corporate directors from personal liability for acts performed in good faith on behalf of the corporation is known as A) The clean hands doctrine. B) The full disclosure rule. C) The responsible person doctrine. D) The business judgment rule.

4. Which of the following acts is most likely to cause a court to pierce the corporate veil? A) Failure to designate a registered agent in the articles of incorporation (Charter). B) Retention of excess capital. C) Failure to conduct a significant portion of business in the chartering state. D) Using corporate assets for the owners personal purposes.

5. Which of the following internal control procedures would prevent an employee from being paid an inappropriate hourly wage? A) Having the supervisor of the data entry clerk verify that each employee's hours worked are correctly entered into the system. B) Using real-time posting of payroll so there can be no after-the-fact data manipulation of the payroll register.

C) Giving payroll data entry clerks the ability to change any suspicious hourly pay rates to a reasonable rate. D) Limiting access to employee master files to authorized employees in the personnel department.

6. The Business Judgment Rule is a rule that immunizes corporate A) Management from liability for actions that result in corporate losses or damages if the actions are undertaken in good faith but are not within the power of the corporation or the authority of management to make. B) Management from liability for actions that result in corporate losses or damages if the actions are undertaken in good faith and are within both the power of the corporation and the authority of management to make. C) Shareholders from liability for actions that result in corporate losses or damages if the actions are undertaken in good faith and are within both the power of the corporation and the authority of shareholders to make. D) Shareholders from liability for actions that result in corporate losses or damages if the actions are undertaken in good faith but are not within the power of the corporation or the authority of shareholders to make.

7. The owners of a limited liability company are known as which of the following? A) Partners. B) Members. C) Stockholders. D) Shareholders.

8. Under the Revised Uniform Limited Partnership Act, which of the following is true regarding limited partnerships? A) A limited partnership has no general partners.

B) General partnerships may not be converted to limited liability partnerships because they must be terminated first. C) The limited partners may not participate in the management of the company. D) Official formation is not necessary for a limited partnership other than two or more people carrying on as co-owners of a business for profit.

9. Terry recently started a new business and is trying to decide what type of entity to form. Terry is part owner and is active in running the business. What type of entity would best protect Terry, as one of the owners, from personal liability? A) General partnership. B) Limited partnership. C) Joint venture. D) Limited liability company.

10. Which of the following is a characteristic of a C corporation? A) Includes most privately held businesses. B) Pays taxes on profits after paying dividends to shareholders. c) Subject to double taxation on profits if dividends are paid. D) Must have only one class of stock.

11. Which of the following is considered a corporate equity security? A) A shareholder's preemptive right. B) A shareholder's appraisal right. C) A callable bond.

D) A share of callable preferred stock.

12. Which of the following statements generally is correct regarding a general partner in a general partnership as compared to a general partner in a limited partnership? A) A general partner in a general partnership has greater rights and powers than a general partner in a limited partnership. B) A general partner in a general partnership has greater liability than a general partner in a limited partnership. C) A general partner in a general partnership and a general partner in a limited partnership have the same rights and powers. D) A general partner in a general partnership has rights and powers provided by articles of partnership, while a general partner in a limited partnership has rights and powers provided by statute.

13. Which of the following disqualifies an entity from an S corporation election? A) Seventy-seven individual shareholders (including four married couples). B) An estate shareholder. C) A 501 (c)(3) exempt organization shareholder. D) A nonresident alien shareholder.

14. Davis, an inventor, developed a new product, but lacked money to get the product to the marketplace. Before creating a corporation to raise capital, Davis leased office space and equipment, entered into contracts with third parties, and identified investors. Who has liability for pre-incorporation debts? A) Davis is liable until the corporation assumed the debts in novation. B) Davis is liable until the articles of incorporation were filed. C) If this corporation is never formed, Davis is not liable.

D) If this corporation is never formed, the unpaid third parties must write off the debt because no corporate entity existed at the time debt was incurred.

15. Frey Corp. has 1,000 shares of issued and outstanding common stock. Freys articles of incorporation permit a stockholder who owns 5% or more of the outstanding stock or who has owned the stock for longer than six months to inspect Freys books and records. Ace, who has owned 25 shares of Frey stock for four months, wants to inspect the books and records. Under the Revised Model Business Corporation Act, which of the following statements is correct regarding Aces right to inspect the books and records? A) Ace must wait two months before being allowed to inspect the books and records. B) Ace must purchase an additional 25 shares of Frey stock before being allowed to inspect the books and records. C) Ace may, after giving five days written notice, inspect the books and records to determine the value of Frey stock. D) Ace may, after giving five days written notice, inspect the books and records to provide a list of Frey stockholders to Aces broker.

16. Which of the following corporate shareholder rights is enforceable by means of a derivative suit? A) Compelling payment of properly declared dividends. B) Enforcing access to corporate records. C) Recovering damages from a third party. D) Protecting preemptive rights.

17. Toby invested $25,000 in a limited partnership with Connor and Blair. Toby was a general partner in the limited partnership. The partnership failed to pay Kelly $45,000 for services on behalf of the partnership. Which of the following statements is generally correct regarding Toby's liability under the Revised Uniform Limited Partnership Act? A) Toby was liable for $25,000 because this was a limited partnership.

B) Toby was liable for zero because this was a partnership debt, not a personal debt. C) Toby was liable for $45,000 because Toby was a general partner. D) Toby was liable for $15,000 because this was a limited partnership.

18. According to the Sarbanes-Oxley Act of 2002, which of the following statements is correct regarding an issuer's audit committee financial expert? A) The issuer's current outside CPA firm's audit partner must be the audit committee financial expert. B) If an issuer does not have an audit committee financial expert, the issuer must disclose the reason why the role is not filled. C) The issuer must fill the role with an individual who has experience in the issuer's industry. D) The audit committee financial expert must be the issuer's audit committee chairperson to enhance internal control.

19. According to COSO, which of the following components of enterprise risk management addresses an entity's integrity and ethical values? A) Information and communication. B) Internal environment. C) Risk assessment. D) Control activities.

20. In order to comply with a director's duty of loyalty to a corporation, what action(s) should a director take when presented with a corporate opportunity? A) Reject the opportunity and not offer it to the corporation. B) Accept the opportunity and not offer it to the corporation.

C) Accept the opportunity and disclose the acceptance to the corporation. D) Offer the opportunity to the corporation and accept it if the corporation rejects it.

21. Each of the following is a limitation of enterprise risk management (ERM), except A) ERM deals with risk, which relates to the future and is inherently uncertain. B) ERM operates at different levels with respect to different objectives. C) ERM can provide absolute assurance with respect to objective categories. D) ERM is as effective as the people responsible for its functioning.

22. A manufacturing firm identified that it would have difficulty sourcing raw materials locally, so it decided to relocate its production facilities. According to COSO, this decision represents which of the following responses to the risk? A) Risk reduction. B) Prospect theory. C) Risk sharing. D) Risk acceptance.

23. Which of the following is necessary to be an audit committee financial expert according to the criteria specified in the Sarbanes-Oxley Act of 2002? A) A limited understanding of generally accepted auditing standards. B) Education and experience as a certified financial planner. C) Experience with internal accounting controls. D) Experience in the preparation of tax returns.

24. Which of the following positions best describes the nature of the Board of Directors of XYZ Co.'s relationship to the company? A) Agent. B) Executive. C) Fiduciary. D) Representative.

25. According to COSO, the use of ongoing and separate evaluations to identify and address changes in internal control effectiveness can best be accomplished in which of the following stages of the monitoring-for-change continuum? A) Control baseline. B) Change identification. C) Change management. D) Control revalidation/update.

26. Which of the following documents would most likely contain specific rules for the management of a business corporation? A) Articles of incorporation. B) Bylaws. C) Certificate of authority. D) Shareholders' agreement.

27. Following the formation of a corporation, which of the following terms best describes the process by which the promoter is released from, and the corporation is made liable for, pre-incorporation contractual obligations? A) Assignment. B) Novation. C) Delegation. D) Accord and satisfaction.

28. Which of the following parties is liable to repay an illegal distribution to a corporation? A) A director not breaching his or her duty in approving the distribution and the corporation is solvent. B) A director not breaching his or her duty in approving the distribution and the corporation is insolvent. C) A shareholder not knowing of the illegality of the distribution and the corporation is solvent. D) A shareholder not knowing of the illegality of the distribution and the corporation is insolvent.

29. Under the Revised Model Business Corporation Act, which of the following items of information should be included in a corporation's articles of incorporation (charter)? A) Name and address of each preincorporation subscriber. B) Nature and purpose of the corporation's business. C) Name and address of the corporation's promoter. D) Election of either C corporation or S corporation status.

30. Which of the following may not own shares in an S corporation? A) Individuals.

B) Estates. C) Trusts. D) Corporations.

31. If no provisions are made in an agreement, a general partnership allocates profits and losses based on the A) Value of actual contributions made by each partner. B) Number of partners. C) Number of hours each partner worked in the partnership during the year. D) Number of years each partner belonged to the partnership.

32. Which of the following decreases stockholder equity? A) Investments by owners. B) Distributions to owners. C) Issuance of stock. D) Acquisition of assets in a cash transaction.

33. Food Corp. owned a restaurant called The Ambers. The corporation president, T.J. Jones, hired a contractor to make repairs at the restaurant, signing the contract, "T.J. Jones for The Ambers. Two invoices for restaurant repairs were paid by Food Corp. with corporate checks. Upon presenting the final invoice, the contractor was told that it would not be paid. The contractor sued Food Corp. Which of the following statements is correct regarding the liability of Food Corp.? A) It is not liable because Jones is liable. B) It is not liable because the corporation was an undisclosed principal.

C) It is liable because Jones is not liable. D) It is liable because Jones had authority to make the contract.

34. An S corporation must adhere to all of the following conditions except having A) No more than 75 shareholders. B) A nonresident alien as a shareholder. C) An individual as a shareholder. D) One class of stock.

35. Jones, Smith, and Bay wanted to form a company called JSB Co. but were unsure about which type of entity would be most beneficial based on their concerns. They all desired the opportunity to make tax-free contributions and distributions where appropriate. They wanted earnings to accumulate tax-free. They did not want to be subject to personal holding tax and did not want double taxation of income. Bay was going to be the only individual giving management advice to the company and wanted to be a member of JSB through his current company, Channel, Inc. Which of the following would be the most appropriate business structure to meet all of their concerns? A) Proprietorship. B) S corporation. C) C corporation. D) Limited liability partnership.

36. Which of the following statements describes the same characteristic for both an S corporation and a C corporation? A) Both corporations can have more than 75 shareholders. B) Both corporations have the disadvantage of double taxation.

C) Shareholders can contribute property into a corporation without being taxed. D) Shareholders can be either citizens of the United States or foreign countries.

37. Smith was an officer of CCC Corp. As an officer, the business judgment rule applied to Smith in which of the following ways? A) Because Smith is not a director, the rule does not apply. B) If Smith makes, in good faith, a serious but honest mistake in judgment, Smith is generally not liable to CCC for damages caused. C) If Smith makes, in good faith, a serious but honest mistake in judgment, Smith is generally liable to CCC for damages caused, but CCC may elect to reimburse Smith for any damages Smith paid. D) If Smith makes, in good faith, a serious but honest mistake in judgment, Smith is generally liable to CCC for damages caused, and CCC is prohibited from reimbursing Smith for any damages Smith paid.

38. Which of the following parties generally has the most management rights? A) Minority shareholder in a corporation listed on a national stock exchange. B) Limited partner in a general partnership. C) Member of a limited liability company. D) Limited partner in a limited partnership.

39. In which type of business entity is the entire ownership interest most freely transferable? A) General partnership. B) Limited partnership. C) Corporation. D) Limited liability company.

40. Under the Revised Uniform Limited Partnership Act and in the absence of a contrary agreement by the partners, which of the following events is most likely to dissolve a limited partnership? A) A majority vote in favor by the partners. B) A two-thirds vote in favor by the partners. C) A withdrawal of a majority of the limited partners. D) Withdrawal of the only general partner.

41. Which of the following statements is correct regarding both debt and common shares of a corporation? A) Common shares represent an ownership interest in the corporation, but debt holders do not have an ownership interest. B) Common shareholders and debt holders have an ownership interest in the corporation. C) Common shares typically have a fixed maturity date, but debt does not. D) Common shares have a higher priority on liquidation than debt.

42. What term is used to describe a partnership without a specified duration? A) A perpetual partnership. B) A partnership by estoppel. C) An indefinite partnership. D) A partnership at will.

43. In which type of business organization are income taxes always required to be paid by the entity on profits earned as well as by the owners upon distribution thereof?

A) General partnership. B) Limited liability company. C) Subchapter C corporation. D) Subchapter S corporation.

44. Under the Revised Model Business Corporation Act, following what type of corporate acquisition does the acquiring corporation automatically become liable for all obligations of the acquired corporation? A) A leveraged buyout of assets. B) An acquisition of stock for debt securities. C) A cash tender offer. D) A merger.

45. A customer's order was never filled because an order entry clerk transposed the customer identification number while entering the sales transaction into the system. Which of the following controls would most likely have detected the transposition? A) Sequence test. B) Completeness test. C) Validity check. D) Limit test.

46. Which of the following actions is required to ensure the validity of a contract between a corporation and a director of the corporation? A) An independent appraiser must render to the board of directors a fairness opinion on the contract.

B) The director must disclose the interest to the independent members of the board and refrain from voting. C) The shareholders must review and ratify the contract. D) The director must resign from the board of directors.

47. Which of the following statements is correct regarding the declaration of a stock dividend by a corporation having only one class of par value stock? A) A stock dividend has the same legal and practical significance as a stock split. B) A stock dividend increases a stockholder's proportionate share of corporate ownership. C) A stock dividend causes a decrease in the assets of the corporation. D) A stock dividend is a corporation's ratable distribution of additional shares of stock to its stockholders.

48. What is the doctrine under which a corporation is made liable for the torts of its employees, committed within the scope of their employment? A) Respondeat superior. B) Ultra vires. C) Estoppel. D) Ratification.

49. Leslie, Kelly, and Blair wanted to form a business. Which of the following business entities does not require the filing of organization documents with the state? A) Limited partnership. B) Joint venture. C) Limited liability company.

D) Subchapter S corporation.

50. Which of the following partners of a limited liability partnership (LLP) may avoid personal liability when a partner commits a negligent act? A) All the partners. B) The supervisor of the negligent partner. C) All the partners other than the negligent partner. D) All the partners other than the supervisor of, and, the negligent partner.

51. Under the Revised Uniform Partnership Act, which of the following have the right to inspect partnership books and records? A) Employees. B) Former partners. C) Inactive partners. D) Transferees of partners' interests.

52. Berry, Drake, and Flanigan are partners in a general partnership. The partners made capital contributions as follows: Berry, $150,000; Drake, $100,000; and Flanigan, $50,000. Drake made a loan of $50,000 to the partnership. The partnership agreement specifies that Flanigan will receive a 50% share of profits, and Drake and Berry each will receive a 25% share of profits. Under the Revised Uniform Partnership Act and in the absence of any partnership agreement to the contrary, which of the following statements is correct regarding the sharing of losses? A) The partners will share equally in any partnership losses. B) The partners will share in losses on a pro rata basis according to the capital contributions. C) The partners will share in losses on a pro rata basis according to the capital contributions and loans made to the partnership.

D) The partners will share in losses according to the allocation of profits specified in the partnership agreement.

53. Under which of the following circumstances is a shareholder who receives an illegal dividend not obligated to repay the dividend? A) The shareholder was not aware the dividend was improper and the corporation was solvent at the time of payment. B) The shareholder was not aware the dividend was improper and the corporation was insolvent at the time of payment. C) The shareholder was aware the dividend was improper and the corporation was solvent at the time of payment. D) The shareholder was aware the dividend was improper and the corporation was insolvent at the time of payment.

54. Fil and Breed are 50% partners in F&B Cars, a used-car dealership. F&B maintains an average usedcar inventory worth $150,000. On January 5, National Bank obtained a $30,000 judgement against Fil and Fil's child on a loan that Fil had cosigned and on which Fil's child had defaulted. National sued F&B to be allowed to attach $30,000 worth of cars as part of Fil's interest in F&B's inventory. Will National prevail in its suit? A) No, because the judgement was not against the partnership. B) No, because attachment of the cars would dissolve the partnership by operation of law. C) Yes, because National had a valid judgement against Fil. D) Yes, because Fil's interest in the partnership inventory is an asset owned by Fil.

55. Which of the following corporate actions is subject to shareholder approval? A) Election of officers. B) Removal of officers.

C) Declaration of cash dividends. D) Removal of directors.

56. Which of the following is a requirement for a small business corporation to elect S corporation status? A) It has only one class of stock. B) It has at least one partnership as a shareholder. C) It has international ownership. D) It has more than 75 shareholders.

57. The president of a company has signed a $10 million contract with a construction company to build a new corporate office. Which of the following corporate documents sets forth the scope of authority under which this transaction is governed? A) Certificate of Incorporation. B) Charter. C) By-laws. D) Proxy statement.

Answer Key: 1)D 2)A 3)D 4)D 5)D 6)B 7)B 8)C 9)D 10)C 11)D 12)C 13)D 14)A 15)C 16)C 17)C 18)B 19)B 20)D 21)C 22)A 23)C 24)C 25)B 26)B 27)B 28)D 29)B 30)D 31)B 32)B 33)D 34)B 35)D 36)C

Business Environment and Concepts 2: Economic Concepts and Analysis Business Cycle Introduction
The term business cycle (or economic cycle) refers to economy-wide fluctuations in production or economic activity over several months or years. These fluctuations occur around a long-term growth trend, and typically involve shifts over time between periods of relatively rapid economic growth (an expansion or boom), and periods of relative stagnation or decline (a contraction or recession). Business cycles are usually measured by considering the growth rate of real gross domestic product. Despite being termed cycles, these fluctuations in economic activity do not follow a mechanical or predictable periodic pattern. Classification by periods In the mid-20th century, Schumpeter and others proposed a typology of business cycles according to their periodicity, so that a number of particular cycles were named after their discoverers or proposers:

the Kitchin inventory cycle of 35 years (after Joseph Kitchin); the Juglar fixed investment cycle of 711 years (often identified as 'the' business cycle); the Kuznets infrastructural investment cycle of 1525 years (after Simon Kuznets); the Kondratiev wave or long technological cycle of 4560 years (after Nikolai Kondratiev).

Interest in these different typologies of cycles has waned since the development of modern macroeconomics, which gives little support to the idea of regular periodic cycles. Keynesian According to Keynesian economics, fluctuations in aggregate demand cause the economy to come to short run equilibrium at levels that are different from the full employment rate of output. These fluctuations express themselves as the observed business cycles. Keynesian models do not necessarily imply periodic business cycles. However, simple Keynesian models involving the interaction of the Keynesian multiplier and accelerator give rise to cyclical responses to initial shocks. Paul Samuelson's "oscillator model" is supposed to account for business cycles thanks to the multiplier and the accelerator. The amplitude of the variations in economic output depends on the level of the investment, for investment determines the level of aggregate output (multiplier), and is determined by aggregate demand (accelerator). In the Keynesian tradition, Richard Goodwin accounts for cycles in output by the distribution of income between business profits and workers wages. The fluctuations in wages are almost the same as in the level of employment (wage cycle lags one period behind the employment cycle), for when the economy is at high employment, workers are able to demand rises in wages, whereas in periods of high unemployment, wages tend to fall. According to Goodwin, when unemployment and business profits rise, the output rises. In macroeconomics, aggregate demand (AD) is the total demand for final goods and services in the

economy (Y) at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a country when inventory levels are static. It is often called effective demand, though at other times this term is distinguished. It is often cited that the aggregate demand curve is downward sloping because at lower price levels a greater quantity is demanded. While this is correct at the microeconomic, single good level, at the aggregate level this is incorrect. The aggregate demand curve is in fact downward sloping as a result of three distinct effects; Pigou's wealth effect, the Keynes' interest rate effect and the Mundell-Fleming exchange-rate effect. An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for deferring the use of funds and instead lending it to the borrower. Interest rates are normally expressed as a percentage of the principal for a period of one year. Interest rates targets are also a vital tool of monetary policy and are taken into account when dealing with variables like investment, inflation, and unemployment. Reasons for interest rate change

Political short-term gain: Lowering interest rates can give the economy a short-run boost. Under normal conditions, most economists think a cut in interest rates will only give a short term gain in economic activity that will soon be offset by inflation. The quick boost can influence elections. Most economists advocate independent central banks to limit the influence of politics on interest rates. Deferred consumption: When money is loaned the lender delays spending the money on consumption goods. Since according to time preference theory people prefer goods now to goods later, in a free market there will be a positive interest rate. Inflationary expectations: Most economies generally exhibit inflation, meaning a given amount of money buys fewer goods in the future than it will now. The borrower needs to compensate the lender for this. Alternative investments: The lender has a choice between using his money in different investments. If he chooses one, he forgoes the returns from all the others. Different investments effectively compete for funds. Risks of investment: There is always a risk that the borrower will go bankrupt, abscond, die, or otherwise default on the loan. This means that a lender generally charges a risk premium to ensure that, across his investments, he is compensated for those that fail. Liquidity preference: People prefer to have their resources available in a form that can immediately be exchanged, rather than a form that takes time or money to realise. Taxes: Because some of the gains from interest may be subject to taxes, the lender may insist on a higher rate to make up for this loss.

In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time. Inflation's effects on an economy are various and can be simultaneously positive and negative. Negative effects of inflation include a decrease in the real value of money and other monetary items over time, uncertainty over future inflation may discourage investment and savings, and high inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Positive effects include ensuring central banks can adjust nominal interest rates (intended to mitigate recessions), and encouraging investment in non-monetary capital projects. Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. Views on which factors determine low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities, as well as to growth in the money supply. However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth. Today, most mainstream economists favor a low, steady rate of inflation. Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduce the risk that a liquidity trap prevents monetary policy from stabilizing the economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control the size of the money supply through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements. Gross domestic product (GDP) refers to the market value of all final goods and services produced in a country in a given period. GDP per capita is often considered an indicator of a country's standard of living. Determining GDP GDP can be determined in three ways, all of which should, in principle, give the same result. They are the product (or output) approach, the income approach, and the expenditure approach. The most direct of the three is the product approach, which sums the outputs of every class of enterprise to arrive at the total. The expenditure approach works on the principle that all of the product must be bought by somebody, therefore the value of the total product must be equal to people's total expenditures in buying things. The income approach works on the principle that the incomes of the productive factors ("producers," colloquially) must be equal to the value of their product, and determines GDP by finding the sum of all producers' incomes. Example: the expenditure method: GDP = private consumption + gross investment + government spending + (exports imports), or Note: "Gross" means that GDP measures production regardless of the various uses to which that

production can be put. Production can be used for immediate consumption, for investment in new fixed assets or inventories, or for replacing depreciated fixed assets. "Domestic" means that GDP measures production that takes place within the country's borders. In the expenditure-method equation given above, the exports-minus-imports term is necessary in order to null out expenditures on things not produced in the country (imports) and add in things produced but not sold in the country (exports). Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment. Monetary theory provides insight into how to craft optimal monetary policy. It is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values. Monetary policy differs from fiscal policy, which refers to taxation, government spending, and associated borrowing. A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries. In contrast to a commercial bank, a central bank possesses a monopoly on printing the national currency, which usually serves as the nation's legal tender. Examples include the European Central Bank (ECB), the Federal Reserve of the United States, and the People's Bank of China. The primary function of a central bank is to provide the nation's money supply, but more active duties include controlling interest rates (i.e., price fixing), and acting as a lender of last resort to the banking sector during times of financial crisis (e.g., bailouts). It may also have supervisory powers, intended to prevent banks and other financial institutions from reckless or fraudulent behaviour. Central banks in most developed nations are independent in that they operate under rules designed to render them free from political interference. Interest rates By far the most visible and obvious power of many modern central banks is to influence market interest rates; contrary to popular belief, they rarely "set" rates to a fixed number. Although the mechanism differs from country to country, most use a similar mechanism based on a central bank's ability to create as much fiat money as required. The mechanism to move the market towards a 'target rate' (whichever specific rate is used) is generally to lend money or borrow money in theoretically unlimited quantities, until the targeted market rate is sufficiently close to the target. Central banks may do so by lending money to and borrowing money from (taking deposits from) a limited number of qualified banks, or by purchasing and selling bonds. As an example of how this functions, the Bank of Canada sets a target overnight rate, and a band of plus or minus 0.25%. Qualified banks borrow from each other within this band, but never above or below, because the central bank will always lend to them at the top of the band, and take deposits at the bottom of

the band; in principle, the capacity to borrow and lend at the extremes of the band are unlimited. Other central banks use similar mechanisms. It is also notable that the target rates are generally short-term rates. The actual rate that borrowers and lenders receive on the market will depend on (perceived) credit risk, maturity and other factors. For example, a central bank might set a target rate for overnight lending of 4.5%, but rates for (equivalent risk) five-year bonds might be 5%, 4.75%, or, in cases of inverted yield curves, even below the short-term rate. Many central banks have one primary "headline" rate that is quoted as the "central bank rate". In practice, they will have other tools and rates that are used, but only one that is rigorously targeted and enforced. "The rate at which the central bank lends money can indeed be chosen at will by the central bank; this is the rate that makes the financial headlines." Henry C.K. Liu. Liu explains further that "the U.S. centralbank lending rate is known as the Fed funds rate. The Fed sets a target for the Fed funds rate, which its Open Market Committee tries to match by lending or borrowing in the money market ... a fiat money system set by command of the central bank. The Fed is the head of the central-bank because the U.S. dollar is the key reserve currency for international trade. The global money market is a USA dollar market. All other currencies markets revolve around the U.S. dollar market." Accordingly the U.S. situation is not typical of central banks in general. A typical central bank has several interest rates or monetary policy tools it can set to influence markets.

Marginal lending rate (currently 1.75% in the Eurozone) a fixed rate for institutions to borrow money from the central bank. (In the USA this is called the discount rate). Main refinancing rate (1.00% in the Eurozone) the publicly visible interest rate the central bank announces. It is also known as minimum bid rate and serves as a bidding floor for refinancing loans. (In the USA this is called the federal funds rate). Deposit rate (0.25% in the Eurozone) the rate parties receive for deposits at the central bank.

These rates directly affect the rates in the money market, the market for short term loans.

Economic Cost
The economic cost of a decision depends on both the cost of the alternative chosen and the benefit that the best alternative would have provided if chosen. Economic cost differs from accounting cost because it includes opportunity cost. As an example, consider the economic cost of attending college. The accounting cost of attending college includes tuition, room and board, books, food, and other incidental expenditures while there. The opportunity cost of college also includes the salary or wage that otherwise could be earning during the period. So for the two to four years an individual spends in school, the opportunity cost includes the money that one could have been making at the best possible job. The economic cost of college is the accounting cost plus the opportunity cost. Thus, if attending college has a direct cost of $20,000 dollars a year for four years, and the lost wages

from not working during that period equals $25,000 dollars a year, then the total economic cost of going to college would be $180,000 dollars ($20,000 x 4 years + the interest of $20,000 for 4 years + $25,000 x 4 years). Components of Economic Costs

Total cost (TC): Total Cost equal fixed cost plus variable costs. TC = FC + VC. o Variable cost (VC): Variable costs are the costs paid to the variable input. Inputs include labor, capital, materials, power and land and buildings. Variable inputs are inputs whose use vary with output. Conventionally the variable input is assumed to be labor. Total variable cost (TVC) or (VC) total variable costs is the same as variable costs. o Fixed cost (FC) fixed costs are the costs of the fixed assets those that do not vary with production. Total fixed cost (TFC) or (FC) Average cost (AC) average cost are total costs divided by output. AC = FC/q + VC/q o Average fixed cost (AFC) = fixed costs divided by output. AFC = FC/q. The average fixed cost function continuously declines as production increases. o Average variable cost (AVC) = variable costs divided by output. AVC = VC/q. The average variable cost curve is typically U-shaped. It lies below the average cost curve and generally has the same shape - the vertical distance between the average cost curve and average variable cost curve equals average fixed costs. The curve normally starts to the right of the y axis because with zero production Marginal cost (MC) Cost curves

Average cost
In economics, average cost or unit cost is equal to total cost divided by the number of goods produced (the output quantity, Q). It is also equal to the sum of average variable costs (total variable costs divided by Q) plus average fixed costs (total fixed costs divided by Q). Average costs may be dependent on the time period considered (increasing production may be expensive or impossible in the short term, for example). Average costs affect the supply curve and are a fundamental component of supply and demand.

Short-run average cost Average cost is distinct from the price, and depends on the interaction with demand through elasticity of demand and an average cost due to marginal cost pricing.

Short-run average cost will vary in relation to the quantity produced unless fixed costs are zero and variable costs constant. A cost curve can be plotted, with cost on the y-axis and quantity on the x-axis. Marginal costs are often shown on these graphs, with marginal cost representing the cost of the last unit produced at each point; marginal costs are the slope of the cost curve or the first derivative of total or variable costs. A typical average cost curve will have a U-shape, because fixed costs are all incurred before any production takes place and marginal costs are typically increasing, because of diminishing marginal productivity. In this "typical" case, for low levels of production marginal costs are below average costs, so average costs are decreasing as quantity increases. An increasing marginal cost curve will intersect a Ushaped average cost curve at its minimum, after which point the average cost curve begins to slope upward. For further increases in production beyond this minimum, marginal cost is above average costs, so average costs are increasing as quantity increases. An example of this typical case would be a factory designed to produce a specific quantity of widgets per period: below a certain production level, average cost is higher due to under-utilised equipment, while above that level, production bottlenecks increase the average cost. Long-run average cost The long run is a time frame in which the firm can vary the quantities used of all inputs, even physical capital. A long-run average cost curve can be upward sloping, downward sloping, or downward sloping at relatively low levels of output and upward sloping at relatively high levels of output, with an in-between level of output at which the slope of long-run average cost is zero. The typical long-run average cost curve is U-shaped, by definition reflecting increasing returns to scale where negatively sloped and decreasing returns to scale where positively sloped. If the firm is a perfect competitor in all input markets, and thus the per-unit prices of all its inputs are unaffected by how much of the inputs the firm purchases, then it can be shown that at a particular level of output, the firm has economies of scale (i.e., is operating in a downward sloping region of the long-run average cost curve) if and only if it has increasing returns to scale. Likewise, it has diseconomies of scale (is operating in an upward sloping region of the long-run average cost curve) if and only if it has decreasing returns to scale, and has neither economies nor diseconomies of scale if it has constant returns to scale. In this case, with perfect competition in the output market the long-run market equilibrium will involve all firms operating at the minimum point of their long-run average cost curves (i.e., at the borderline between economies and diseconomies of scale). If, however, the firm is not a perfect competitor in the input markets, then the above conclusions are modified. For example, if there are increasing returns to scale in some range of output levels, but the firm is so big in one or more input markets that increasing its purchases of an input drives up the input's perunit cost, then the firm could have diseconomies of scale in that range of output levels. Conversely, if the firm is able to get bulk discounts of an input, then it could have economies of scale in some range of output levels even if it has decreasing returns in production in that output range. In some industries, the LRAC is always declining (economies of scale exist indefinitely). This means that the largest firm tends to have a cost advantage, and the industry tends naturally to become a monopoly,

and hence is called a natural monopoly. Natural monopolies tend to exist in industries with high capital costs in relation to variable costs, such as water supply and electricity supply. Long run average cost is the unit cost of producing a certain output when all inputs are variable. The behavioral assumption is that the firm will choose that combination of inputs that will produce the desired quantity at the lowest possible cost. Relationship to marginal cost When average cost is declining as output increases, marginal cost is less than average cost. When average cost is rising, marginal cost is greater than average cost. When average cost is neither rising nor falling (at a minimum or maximum), marginal cost equals average cost. Other special cases for average cost and marginal cost appear frequently:

Constant marginal cost/high fixed costs: each additional unit of production is produced at constant additional expense per unit. The average cost curve slopes down continuously, approaching marginal cost. An example may be hydroelectric generation, which has no fuel expense, limited maintenance expenses and a high up-front fixed cost (ignoring irregular maintenance costs or useful lifespan). Industries where fixed marginal costs obtain, such as electrical transmission networks, may meet the conditions for a natural monopoly, because once capacity is built, the marginal cost to the incumbent of serving an additional customer is always lower than the average cost for a potential competitor. The high fixed capital costs are a barrier to entry. Minimum efficient scale / maximum efficient scale: marginal or average costs may be nonlinear, or have discontinuities. Average cost curves may therefore only be shown over a limited scale of production for a given technology. For example, a nuclear plant would be extremely inefficient (very high average cost) for production in small quantities; similarly, its maximum output for any given time period may essentially be fixed, and production above that level may be technically impossible, dangerous or extremely costly. The long run elasticity of supply will be higher, as new plants could be built and brought on-line. Zero fixed costs (long-run analysis) / constant marginal cost: since there are no economies of scale, average cost will be equal to the constant marginal cost.

Relationship between AC, AFC, AVC and MC 1. The Average Fixed Cost curve (AFC) starts from a height and goes on declining continuously as production increases. 2. The Average Variable Cost curve, Average Cost curve and the Marginal Cost curve start from a height, reach the minimum points, then rise sharply and continuously. 3. The Average Fixed Cost curve approaches zero asymptotically. The Average Variable Cost curve is never parallel to or as high as the Average Cost curve due to the existence of positive

Average Fixed Costs at all levels of production; but the Average Variable Cost curve asymptotically approaches the Average Cost curve from below. 4. The Marginal Cost curve always passes through the minimum points of the Average Variable Cost and Average Cost curves, though the Average Variable Cost curve attains the minimum point prior to that of the Average Cost curve.

Marginal cost
In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good. If the good being produced is infinitely divisible, so the size of a marginal cost will change with volume, as a non-linear and non-proportional cost function includes the following:

variable terms dependent to volume, constant terms independent to volume and occurring with the respective lot size, jump fix cost increase or decrease dependent to steps of volume increase.

In practice the above definition of marginal cost as the change in total cost as a result of an increase in output of one unit is inconsistent with the differential definition of marginal cost for virtually all nonlinear functions. This is as the definition finds the tangent to the total cost curve at the point q which assumes that costs increase at the same rate as they were at q. A new definition may be useful for marginal unit cost (MUC) using the current definition of the change in total cost as a result of an increase of one unit of output defined as: TC(q+1)-TC(q) and re-defining marginal cost to be the change in total as a result of an infinitesimally small increase in q which is consistent with its use in economic literature and can be calculated differentially. In general terms, marginal cost at each level of production includes any additional costs required to produce the next unit. If producing additional vehicles requires, for example, building a new factory, the marginal cost of those extra vehicles includes the cost of the new factory. In practice, the analysis is segregated into short and long-run cases, and over the longest run, all costs are marginal. At each level of production and time period being considered, marginal costs include all costs that vary with the level of production, and other costs are considered fixed costs.

Opportunity Cost
Opportunity cost is the cost of any activity measured in terms of the value of the next best alternative forgone (that is not chosen). It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the "cost" (as a lost benefit) of the forgone products after making a choice. Opportunity cost is a key concept in

economics, and has been described as expressing "the basic relationship between scarcity and choice". The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently. Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered opportunity costs. Opportunity costs in production Explicit costs Explicit costs are opportunity costs that involve direct monetary payment by producers. The opportunity cost of the factors of production not already owned by a producer is the price that the producer has to pay for them. For instance, a firm spends $100 on electrical power consumed, their opportunity cost is $100. The firm has sacrificed $100, which could have been spent on other factors of production. Implicit costs Implicit costs are the opportunity costs that in factors of production that a producer already owns. They are equivalent to what the factors could earn for the firm in alternative uses, either operated within the firm or rent out to other firms. For example, a firm pays $300 a month all year for rent on a warehouse that only holds product for six months each year. The firm could rent the warehouse out for the unused six months, at any price (assuming a year-long lease requirement), and that would be the cost that could be spent on other factors of production.

Total cost
In economics, and cost accounting, total cost (TC) describes the total economic cost of production and is made up of variable costs, which vary according to the quantity of a good produced and include inputs such as labor and raw materials, plus fixed costs, which are independent of the quantity of a good produced and include inputs (capital) that cannot be varied in the short term, such as buildings and machinery. Total cost in economics includes the total opportunity cost of each factor of production as part of its fixed or variable costs. The rate at which total cost changes as the amount produced changes is called marginal cost. This is also known as the marginal unit variable cost. If one assumes that the unit variable cost is constant, as in cost-volume-profit analysis developed and used in cost accounting by the accountants, then total cost is linear in volume, and given by: total cost = fixed costs + unit variable cost * amount. The total cost of producing a specific level of output is the cost of all the factors of input used. Conventionally economist use models with two inputs capital, K. and labor, L. Capital is assumed to be the fixed input meaning that the amount of capital used does not vary with the level of production. The rental price per unit of capital is denoted r. Thus the total fixed costs equal Kr. Labor is the variable input meaning that the amount of labor used varies with the level of output. In fact in the short run the only way to vary output is by varying the amount of the variable input. Labor is denoted L and the per unit cost or wage rate is denoted w so the total variable costs is Lw. Consequently total cost is fixed costs (FC) plus

variable cost (VC) or TC = FC + VC = Kr +wL. Other economic models have the total variable cost curve (and therefore total cost curve) illustrate the concepts of increasing, and later diminishing,marginal returns.

Variable cost
Variable costs are expenses that change in proportion to the activity of a business. Variable cost is the sum of marginal costs over all units produced. It can also be considered normal costs. Fixed costs and variable costs make up the two components of total cost. Direct Costs, however, are costs that can easily be associated with a particular cost object. However, not all variable costs are direct costs. For example, variable manufacturing overhead costs are variable costs that are indirect costs, not direct costs. Variable costs are sometimes called unit-level costs as they vary with the number of units produced. Direct labor and overhead are often called conversion cost, while direct material and direct labor are often referred to as prime cost. In marketing, it is necessary to know how costs divide between variable and fixed. This distinction is crucial in forecasting the earnings generated by various changes in unit sales and thus the financial impact of proposed marketing campaigns. In a survey of nearly 200 senior marketing managers, 60 percent responded that they found the "variable and fixed costs" metric very useful. Explanation of Variable Costs For example, a firm pays for raw materials. When activity is decreased, less raw material is used, and so the spending for raw materials falls. When activity is increased, more raw material is used and spending therefore rises. Note that the changes in expenses happen with little or no need for managerial intervention. These costs are variable costs. A company will pay for line rental and maintenance fees each period regardless of how much power gets used. And some electrical equipment (air conditioning or lighting) may be kept running even in periods of low activity. These expenses can be regarded as fixed. But beyond this, the company will use electricity to run plant and machinery as required. The busier the company, the more the plant will be run, and so the more electricity gets used. This extra spending can therefore be regarded as variable. In retail the cost of goods is almost entirely a variable cost; this is not true of manufacturing where many fixed costs, such as depreciation, are included in the cost of goods. Although taxation usually varies with profit, which in turn varies with sales volume, it is not normally considered a variable cost. For some employees, salary is paid on monthly rates, independent of how many hours the employees work. This is a fixed cost. On the other hand, the hours of hourly employees can often be varied, so this type of labour cost is a variable cost.

Fixed cost
In economics, fixed costs are business expenses that are not dependent on the level of goods or services produced by the business. They tend to be time-related, such as salaries or rents being paid per month, and are often referred to as overhead costs. This is in contrast to variable costs, which are volume-related (and are paid per quantity produced). In management accounting, fixed costs are defined as expenses that do not change as a function of the activity of a business, within the relevant period. For example, a retailer must pay rent and utility bills irrespective of sales. In marketing, it is necessary to know how costs divide between variable and fixed. This distinction is crucial in forecasting the earnings generated by various changes in unit sales and thus the financial impact of proposed marketing campaigns. In a survey of nearly 200 senior marketing managers, 60 percent responded that they found the "variable and fixed costs" metric very useful.

Globalization
Globalization refers to the increasing unification of the world's economic order through reduction of such barriers to international trade as tariffs, export fees, and import quotas. The goal is to increase material wealth, goods, and services through an international division of labor by efficiencies catalyzed by international relations, specialization and competition. It describes the process by which regional economies, societies, and cultures have become integrated through communication, transportation, and trade. The term is most closely associated with the term economic globalization: the integration of national economies into the international economy through trade, foreign direct investment, capital flows, migration, the spread of technology, and military presence. However, globalization is usually recognized as being driven by a combination of economic, technological, sociocultural, political, and biological factors. The term can also refer to the transnational circulation of ideas, languages, or popular culture through acculturation. An aspect of the world which has gone through the process can be said to be globalized. Against this view, an alternative approach stresses how globalization has actually decreased inter-cultural contacts while increasing the possibility of international and intra-national conflict. Economic globalization refers to increasing economic interdependence of national economies across the world through a rapid increase in cross-border movement of goods, service, technology and capital. Whereas globalization is centered around the diminution of international trade regulations as well as tariffs, taxes, and other impediments that suppresses global trade, economic globalization is the process of increasing economic integration between countries, leading to the emergence of a global marketplace or a single world market. Depending on the paradigm, economic globalization can be viewed as either a positive or a negative phenomenon. Economic globalization comprises the globalization of production, markets, competition, technology, and corporations and industries. While economic globalization has been occurring for the last several hundred years (since the emergence of trans-national trade), it has begun to occur at an increased rate over the last

2030 years. This recent boom has been largely accounted by developed economies integrating with less developed economies, by means of foreign direct investment, the reduction of trade barriers, and in many cases cross border immigration. It can be argued that economic globalization may or may not be an irreversible trend. There are several significant effects of economic globalization. There is statistical evidence for positive financial effects as well as proposals that there is a power imbalance between developing and developed countries in the global economy. Furthermore, economic globalization has an impact on world cultures.

Market Risk
Market risk is the risk of losses in positions arising from movements in market prices. Some market risks include:

Equity risk, the risk that stock or stock indexes (e.g. Euro Stoxx 50, etc. ) prices and/or their implied volatility will change. Interest rate risk, the risk that interest rates (e.g. Libor, Euribor, etc.) and/or their implied volatility will change. Currency risk, the risk that foreign exchange rates (e.g. EUR/USD, EUR/GBP, etc.) and/or their implied volatility will change. Commodity risk, the risk that commodity prices (e.g. corn, copper, crude oil, etc.) and/or their implied volatility will change.

Equity risk is the risk that one's investments will depreciate because of stock market dynamics causing one to lose money. The measure of risk used in the equity markets is typically the standard deviation of a security's price over a number of periods. The standard deviation will delineate the normal fluctuations one can expect in that particular security above and below the mean, or average. However, since most investors would not consider fluctuations above the average return as "risk", some economists prefer other means of measuring it. Interest rate risk is the risk that interest rates will change. Foreign exchange risk (also known as exchange rate risk or currency risk) is a financial risk posed by an exposure to unanticipated changes in the exchange rate between two currencies. Investors and multinational businesses exporting or importing goods and services or making foreign investments throughout the global economy are faced with an exchange rate risk which can have severe financial consequences if not managed appropriately.

Commodity risk refers to the uncertainties of future market values and of the size of the future income, caused by the fluctuation in the prices of commodities. These commodities may be grains, metals, gas, electricity etc. A commodity enterprise needs to deal with the following kinds of risks: Price risk (Risk arising out of adverse movements in the world prices, exchange rates, basis between local and world prices), Quantity risk, Cost risk (Input price risk), and Political risk.

Market Structures
In economics, market structure is the number of firms producing identical products [7] which are homogeneous. The types of market structures include the following:

Monopolistic competition, also called competitive market, where there is a large number of firms, each having a small proportion of the market share and slightly differentiated products. Oligopoly, in which a market is dominated by a small number of firms that together control the majority of the market share. o Duopoly, a special case of an oligopoly with two firms. Monopsony, when there is only one buyer in a market. Oligopsony, a market where many sellers can be present but meet only a few buyers. Monopoly, where there is only one provider of a product or service. o Natural monopoly, a monopoly in which economies of scale cause efficiency to increase continuously with the size of the firm. A firm is a natural monopoly if it is able to serve the entire market demand at a lower cost than any combination of two or more smaller, more specialized firms. Perfect competition, a theoretical market structure that features no barriers to entry, an unlimited number of producers and consumers, and a perfectly elastic demand curve.

The imperfectly competitive structure is quite identical to the realistic market conditions where some monopolistic competitors, monopolists, oligopolists, and duopolists exist and dominate the market conditions. The elements of Market Structure include the number and size distribution of firms, entry conditions, and the extent of differentiation. These somewhat abstract concerns tend to determine some but not all details of a specific concrete market system where buyers and sellers actually meet and commit to trade. Competition is useful because it reveals actual customer demand and induces the seller (operator) to provide service quality levels and price levels that buyers (customers) want, typically subject to the sellers financial need to cover its costs. In other words, competition can align the sellers interests with the buyers interests and can cause the seller to reveal his true costs and other private information. In the absence of perfect competition, three basic approaches can be adopted to deal with problems related to the control of market power and an asymmetry between the government and the operator with respect to objectives and information: (a) subjecting the operator to competitive pressures, (b) gathering information on the operator and the market, and (c) applying incentive regulation.

Monopolistic Competition
Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another as goods but not perfect substitutes [11] (such as from branding, quality, or location). In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms. In a monopolistically competitive market, firms can behave like monopolies in the short run, including by using market power to generate profit. In the long run, however, other firms enter the market and the benefits of differentiation decrease with competition; the market becomes more like a perfectly competitive one where firms cannot gain economic profit. In practice, however, if consumer rationality/innovativeness is low and heuristics are preferred, monopolistic competition can fall into natural monopoly, even in the complete absence of government intervention. In the presence of coercive government, monopolistic competition will fall into government-granted monopoly. Unlike perfect competition, the firm maintains spare capacity. Models of monopolistic competition are often used to model industries. Textbook examples of industries with market structures similar to monopolistic competition include restaurants, cereal [12],clothing, shoes, and service industries in large cities. Monopolistically competitive markets have the following characteristics:

There are many producers and many consumers in the market, and no business has total control over the market price. Consumers perceive that there are non-price differences among the competitors' products. There are few barriers to entry and exit. Producers have a degree of control over price.

The long-run characteristics of a monopolistically competitive market are almost the same as a perfectly competitive market. Two differences between the two are that monopolistic competition produces heterogeneous products and that monopolistic competition involves a great deal of non-price competition, which is based on subtle product differentiation. A firm making profits in the short run will nonetheless only break even in the long run because demand will decrease and average total cost will increase. This means in the long run, a monopolistically competitive firm will make zero economic profit. This illustrates the amount of influence the firm has over the market; because of brand loyalty, it can raise its prices without losing all of its customers. This means that an individual firm's demand curve is downward sloping, in contrast to perfect competition, which has a perfectly elastic demand schedule. Major characteristics There are six characteristics of monopolistic competition (MC):

Product differentiation Many firms Free entry and exit in the long run

Independent decision making Market Power Buyers and Sellers do not have perfect information (Imperfect Information)

Monopoly
A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity (this contrasts with a monopsony which relates to a single entity's control of a market to purchase a good or service, and with oligopoly which consists of a few entities dominating an industry). Monopolies are thus characterized by a lack of economic competition to produce the good or service and a lack of viable substitute goods. The verb "monopolize" refers to the process by which a company gains the ability to raise prices or exclude competitors. In economics, a monopoly is a single seller. In law, a monopoly is a business entity that has significant market power, that is, the power, to charge high prices. Although monopolies may be big businesses, size is not a characteristic of a monopoly. A small business may still have the power to raise prices in a small industry (or market). A monopoly is distinguished from a monopsony, in which there is only one buyer of a product or service ; a monopoly may also have monopsony control of a sector of a market. Likewise, a monopoly should be distinguished from a cartel (a form of oligopoly), in which several providers act together to coordinate services, prices or sale of goods. Monopolies, monopsonies and oligopolies are all situations such that one or a few of the entities have market power and therefore interact with their customers (monopoly), suppliers (monopsony) and the other companies (oligopoly) in ways that leave market interactions distorted. When not coerced legally to do otherwise, monopolies typically maximize their profit by producing fewer goods and selling them at higher prices than would be the case for perfect competition. Monopolies can be established by a government, form naturally, or form by integration. In many jurisdictions, competition laws restrict monopolies. Holding a dominant position or a monopoly of a market is not illegal in itself, however certain categories of behavior can, when a business is dominant, be considered abusive and therefore incur legal sanctions. A government-granted monopoly or legal monopoly, by contrast, is sanctioned by the state, often to provide an incentive to invest in a risky venture or enrich a domestic interest group. Patents, copyright, and trademarks are sometimes used as examples of government granted monopolies, but they rarely provide market power. The government may also reserve the venture for itself, thus forming a government monopoly. Characteristics

Profit Maximizer: Maximizes profits. Price Maker: Decides the price of the good or product to be sold.

High Barriers to Entry: Other sellers are unable to enter the market of the monopoly. Single seller: In a monopoly, there is one seller of the good that produces all the output. Therefore, the whole market is being served by a single company, and for practical purposes, the company is the same as the industry. Price Discrimination: A monopolist can change the price and quality of the product. He sells more quantities charging less price for the product in a very elastic market and sells less quantities charging high price in a less elastic market.

Sources of monopoly power Monopolies derive their market power from barriers to entry circumstances that prevent or greatly impede a potential competitor's ability to compete in a market. There are three major types of barriers to entry; economic, legal and deliberate.

Economic barriers: Economic barriers include economies of scale, capital requirements, cost advantages and technological superiority. Economies of scale: Monopolies are characterised by decreasing costs for a relatively large range of production. Decreasing costs coupled with large initial costs give monopolies an advantage over would-be competitors. Monopolies are often in a position to reduce prices below a new entrant's operating costs and thereby prevent them from continuing to compete. Furthermore, the size of the industry relative to the minimum efficient scale may limit the number of companies that can effectively compete within the industry. If for example the industry is large enough to support one company of minimum efficient scale then other companies entering the industry will operate at a size that is less than MES, meaning that these companies cannot produce at an average cost that is competitive with the dominant company. Finally, if long-term average cost is constantly decreasing, the least cost method to provide a good or service is by a single company. Capital requirements: Production processes that require large investments of capital, or large research and development costs or substantial sunk costs limit the number of companies in an industry. Large fixed costs also make it difficult for a small company to enter an industry and expand. Technological superiority: A monopoly may be better able to acquire, integrate and use the best possible technology in producing its goods while entrants do not have the size or finances to use the best available technology. One large company can sometimes produce goods cheaper than several small companies. No substitute goods: A monopoly sells a good for which there is no close substitute. The absence of substitutes makes the demand for the good relatively inelastic enabling monopolies to extract positive profits. Control of natural resources: A prime source of monopoly power is the control of resources that are critical to the production of a final good. Network externalities: The use of a product by a person can affect the value of that product to other people. This is the network effect. There is a direct relationship between the proportion of people using a product and the demand for that product. In other words the more people who are using a

product the greater the probability of any individual starting to use the product. This effect accounts for fads and fashion trends. It also can play a crucial role in the development or acquisition of market power. The most famous current example is the market dominance of the Microsoft operating system in personal computers. Legal barriers: Legal rights can provide opportunity to monopolise the market of a good. Intellectual property rights, including patents and copyrights, give a monopolist exclusive control of the production and selling of certain goods. Property rights may give a company exclusive control of the materials necessary to produce a good. Deliberate actions: A company wanting to monopolise a market may engage in various types of deliberate action to exclude competitors or eliminate competition. Such actions include collusion, lobbying governmental authorities, and force (see anti-competitive practices).

In addition to barriers to entry and competition, barriers to exit may be a source of market power. Barriers to exit are market conditions that make it difficult or expensive for a company to end its involvement with a market. Great liquidation costs are a primary barrier for exiting. Market exit and shutdown are separate events. The decision whether to shut down or operate is not affected by exit barriers. A company will shut down if price falls below minimum average variable costs.

Monopoly versus competitive markets While monopoly and perfect competition mark the extremes of market structures there is some similarity. The cost functions are the same. Both monopolies and perfectly competitive companies minimize cost and maximize profit. The shutdown decisions are the same. Both are assumed to have perfectly competitive factors markets. There are distinctions, some of the more important of which are as follows:

Marginal revenue and price: In a perfectly competitive market, price equals marginal cost. In a monopolistic market, however, price is set above marginal cost. Product differentiation: There is zero product differentiation in a perfectly competitive market. Every product is perfectly homogeneous and a perfect substitute for any other. With a monopoly, there is great to absolute product differentiation in the sense that there is no available substitute for a monopolized good. The monopolist is the sole supplier of the good in question. A customer either buys from the monopolizing entity on its terms or does without. Number of competitors: PC markets are populated by an infinite number of buyers and sellers. Monopoly involves a single seller. Barriers to Entry: Barriers to entry are factors and circumstances that prevent entry into market by would-be competitors and limit new companies from operating and expanding within the market. PC markets have free entry and exit. There are no barriers to entry, exit or competition. Monopolies

have relatively high barriers to entry. The barriers must be strong enough to prevent or discourage any potential competitor from entering the market.

Elasticity of Demand: The price elasticity of demand is the percentage change of demand caused by a one percent change of relative price. A successful monopoly would have a relatively inelastic demand curve. A low coefficient of elasticity is indicative of effective barriers to entry. A PC company has a perfectly elastic demand curve. The coefficient of elasticity for a perfectly competitive demand curve is infinite. Excess Profits: Excess or positive profits are profit more than the normal expected return on investment. A PC company can make excess profits in the short term but excess profits attract competitors, which can enter the market freely and decrease prices, eventually reducing excess profits to zero. A monopoly can preserve excess profits because barriers to entry prevent competitors from entering the market. Profit Maximization: A PC company maximizes profits by producing such that price equals marginal costs. A monopoly maximises profits by producing where marginal revenue equals marginal costs. The rules are not equivalent. The demand curve for a PC company is perfectly elastic flat. The demand curve is identical to the average revenue curve and the price line. Since the average revenue curve is constant the marginal revenue curve is also constant and equals the demand curve, Average revenue is the same as price (AR = TR/Q = P x Q/Q = P). Thus the price line is also identical to the demand curve. In sum, D = AR = MR = P. P-Max quantity, price and profit: If a monopolist obtains control of a formerly perfectly competitive industry, the monopolist would increase prices, reduce production, and realise positive economic profits. Supply Curve: in a perfectly competitive market there is a well defined supply function with a one to one relationship between price and quantity supplied. In a monopolistic market no such supply relationship exists. A monopolist cannot trace a short term supply curve because for a given price there is not a unique quantity supplied. As Pindyck and Rubenfeld note a change in demand "can lead to changes in prices with no change in output, changes in output with no change in price or both". Monopolies produce where marginal revenue equals marginal costs. For a specific demand curve the supply "curve" would be the price/quantity combination at the point where marginal revenue equals marginal cost. If the demand curve shifted the marginal revenue curve would shift as well and a new equilibrium and supply "point" would be established. The locus of these points would not be a supply curve in any conventional sense.

The most significant distinction between a PC company and a monopoly is that the monopoly has a downward-sloping demand curve rather than the "perceived" perfectly elastic curve of the PC company. Practically all the variations above mentioned relate to this fact. If there is a downward-sloping demand curve then by necessity there is a distinct marginal revenue curve. The implications of this fact

are best made manifest with a linear demand curve. Assume that the inverse demand curve is of the form x = a by. Then the total revenue curve is TR = ay by2 and the marginal revenue curve is thus MR = a 2by. From this several things are evident. First the marginal revenue curve has the same y intercept as the inverse demand curve. Second the slope of the marginal revenue curve is twice that of the inverse demand curve. Third the x intercept of the marginal revenue curve is half that of the inverse demand curve. What is not quite so evident is that the marginal revenue curve is below the inverse demand curve at all points. Since all companies maximise profits by equating MR and MC it must be the case that at the profit-maximizing quantity MR and MC are less than price, which further implies that a monopoly produces less quantity at a higher price than if the market were perfectly competitive. The fact that a monopoly has a downward-sloping demand curve means that the relationship between total revenue and output for a monopoly is much different than that of competitive companies. Total revenue equals price times quantity. A competitive company has a perfectly elastic demand curve meaning that total revenue is proportional to output. Thus the total revenue curve for a competitive company is a ray with a slope equal to the market price. A competitive company can sell all the output it desires at the market price. For a monopoly to increase sales it must reduce price. Thus the total revenue curve for a monopoly is a parabola that begins at the origin and reaches a maximum value then continuously decreases until total revenue is again zero. Total revenue has its maximum value when the slope of the total revenue function is zero. The slope of the total revenue function is marginal revenue. So the revenue maximizing quantity and price occur when MR = 0. For example assume that the monopolys demand function is P = 50 2Q. The total revenue function would be TR = 50Q 2Q2 and marginal revenue would be 50 4Q. Setting marginal revenue equal to zero we have 1. 50 4Q = 0 2. 4Q = 50 3. Q = 12.5 So the revenue maximizing quantity for the monopoly is 12.5 units and the revenue maximizing price is 25. A company with a monopoly does not experience price pressure from competitors, although it may experience pricing pressure from potential competition. If a company increases prices too much, then others may enter the market if they are able to provide the same good, or a substitute, at a lesser price. The idea that monopolies in markets with easy entry need not be regulated against is known as the "revolution in monopoly theory". A monopolist can extract only one premium, and getting into complementary markets does not pay. That is, the total profits a monopolist could earn if it sought to leverage its monopoly in one market by monopolizing a complementary market are equal to the extra profits it could earn anyway by charging more for the monopoly product itself. However, the one monopoly profit theorem is not true if customers in the monopoly good are stranded or poorly informed, or if the tied good has high fixed costs. A pure monopoly has the same economic rationality of perfectly competitive companies, i.e. to optimise a profit function given some constraints. By the assumptions of increasing marginal costs, exogenous inputs' prices, and control concentrated on a single agent or entrepreneur, the optimal decision is to equate

the marginal cost and marginal revenue of production. Nonetheless, a pure monopoly can unlike a competitive company alter the market price for its own convenience: a decrease of production results in a higher price. In the economics' jargon, it is said that pure monopolies have "a downward-sloping demand". An important consequence of such behaviour is worth noticing: typically a monopoly selects a higher price and lesser quantity of output than a price-taking company; again, less is available at a higher price.

Oligopoly
An oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists). A general lack of competition can lead to higher costs for consumers. Because there are few sellers, each oligopolist is likely to be aware of the actions of the others. The decisions of one firm influence, and are influenced by, the decisions of other firms. Strategic planning by oligopolists needs to take into account the likely responses of the other market participants. Oligopoly is a common market form. As a quantitative description of oligopoly, the four-firm concentration ratio is often utilized. This measure expresses the market share of the four largest firms in an industry as a percentage. For example, as of fourth quarter 2008, Verizon, AT&T, Sprint, and TMobile together control 89% of the US cellular phone market. Oligopolistic competition can give rise to a wide range of different outcomes. In some situations, the firms may employ restrictive trade practices (collusion, market sharing etc.) to raise prices and restrict production in much the same way as a monopoly. Where there is a formal agreement for such collusion, this is known as a cartel. A primary example of such a cartel is OPEC which has a profound influence on the international price of oil. Firms often collude in an attempt to stabilize unstable markets, so as to reduce the risks inherent in these markets for investment and product development. There are legal restrictions on such collusion in most countries. There does not have to be a formal agreement for collusion to take place (although for the act to be illegal there must be actual communication between companies)for example, in some industries there may be an acknowledged market leader which informally sets prices to which other producers respond, known as price leadership. In other situations, competition between sellers in an oligopoly can be fierce, with relatively low prices and high production. This could lead to an efficient outcome approaching perfect competition. The competition in an oligopoly can be greater when there are more firms in an industry than if, for example, the firms were only regionally based and did not compete directly with each other. Thus the welfare analysis of oligopolies is sensitive to the parameter values used to define the market's structure. In particular, the level of dead weight loss is hard to measure. The study of product

differentiation indicates that oligopolies might also create excessive levels of differentiation in order to stifle competition. Oligopoly theory makes heavy use of game theory to model the behavior of oligopolies:

Stackelberg's duopoly. In this model the firms move sequentially (see Stackelberg competition). Cournot's duopoly. In this model the firms simultaneously choose quantities (see Cournot competition). Bertrand's oligopoly. In this model the firms simultaneously choose prices (see Bertrand competition).

Perfect Competition
In economic theory, perfect competition (sometimes called pure competition) describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets. Still, buyers and sellers in some auction-type markets, say for commodities or some financial assets, may approximate the concept. Perfect competition serves as a benchmark against which to measure real-life and imperfectly competitive markets. Basic structural characteristics Generally, a perfectly competitive market exists when every participant is a "price taker", and no participant influences the price of the product it buys or sells. Specific characteristics may include:

Infinite buyers and sellers An infinite number of consumers with the willingness and ability to buy the product at a certain price, and infinite producers with the willingness and ability to supply the product at a certain price. Zero entry and exit barriers A lack of entry and exit barriers makes it extremely easy to enter or exit a perfectly competitive market. Perfect factor mobility In the long run factors of production are perfectly mobile, allowing free long term adjustments to changing market conditions. Perfect information - All consumers and producers are assumed to have perfect knowledge of price, utility, quality and production methods of products. Zero transaction costs - Buyers and sellers do not incur costs in making an exchange of goods in a perfectly competitive market. Profit maximization - Firms are assumed to sell where marginal costs meet marginal revenue, where the most profit is generated.

Homogenous products - The qualities and characteristics of a market good or service do not vary between different suppliers. Non-increasing returns to scale - The lack of increasing returns to scale (or economies of scale) ensures that there will always be a sufficient number of firms in the industry. Property rights - Well defined property rights determine what may be sold, as well as what rights are conferred on the buyer.

In the short run, perfectly-competitive markets are not productively efficient as output will not occur where marginal cost is equal to average cost (MC=AC). They are allocatively efficient, as output will always occur where marginal cost is equal to marginal revenue (MC=MR). In the long run, perfectly competitive markets are both allocatively and productively efficient. In perfect competition, any profit-maximizing producer faces a market price equal to its marginal cost (P=MC). This implies that a factor's price equals the factor's marginal revenue product. It allows for derivation of the supply curve on which the neoclassical approach is based. This is also the reason why "a monopoly does not have a supply curve". The abandonment of price taking creates considerable difficulties for the demonstration of a general equilibrium except under other, very specific conditions such as that of monopolistic competition.

Measures of National Income and Output

A variety of measures of national income and output are used in economics to estimate total economic activity in a country or region, including gross domestic product (GDP), gross national product (GNP), and net national income (NNI). All are specially concerned with counting the total amount of goods and services produced within some "boundary". The boundary is usually defined by geography or citizenship, and may also restrict the goods and services that are counted. For instance, some measures count only goods and services that are exchanged for money, excluding bartered goods, while other measures may attempt to include bartered goods by imputing monetary values to them.

Market value
In order to count a good or service it is necessary to assign some value to it. The value that the measures of national income and output assign to a good or service is its market value the price it fetches when bought or sold. The actual usefulness of a product (its use-value) is not measured assuming the usevalue to be any different from its market value. Three strategies have been used to obtain the market values of all the goods and services produced: the product (or output) method, the expenditure method, and the income method. The product method looks at the economy on an industry-by-industry basis. The total output of the economy is the sum of the outputs of every industry. However, since an output of one industry may be used by another industry and become part of the output of that second industry, to avoid counting the item twice we use not the value output by

each industry, but the value-added; that is, the difference between the value of what it puts out and what it takes in. The total value produced by the economy is the sum of the values-added by every industry. The expenditure method is based on the idea that all products are bought by somebody or some organisation. Therefore we sum up the total amount of money people and organisations spend in buying things. This amount must equal the value of everything produced. Usually expenditures by private individuals, expenditures by businesses, and expenditures by government are calculated separately and then summed to give the total expenditure. Also, a correction term must be introduced to account for imports and exports outside the boundary. The income method works by summing the incomes of all producers within the boundary. Since what they are paid is just the market value of their product, their total income must be the total value of the product. Wages, proprieter's incomes, and corporate profits are the major subdivisions of income.
The output approach

The output approach focuses on finding the total output of a nation by directly finding the total value of all goods and services a nation produces. Because of the complication of the multiple stages in the production of a good or service, only the final value of a good or service is included in total output. This avoids an issue often called 'double counting', wherein the total value of a good is included several times in national output, by counting it repeatedly in several stages of production. In the example of meat production, the value of the good from the farm may be $10, then $30 from the butchers, and then $60 from the supermarket. The value that should be included in final national output should be $60, not the sum of all those numbers, $100. The values added at each stage of production over the previous stage are respectively $10, $20, and $30. Their sum gives an alternative way of calculating the value of final output. Formulae: GDP(gross domestic product) at market price = value of output in an economy in a particular year intermediate consumption NNP at factor cost = GDP at market price - depreciation + NFIA (net factor income from abroad) - net indirect taxes
The income approach

The income approach equates the total output of a nation to the total factor income received by residents or citizens of the nation. The main types of factor income are:

Employee compensation (cost of fringe benefits, including unemployment, health, and retirement benefits); Interest received net of interest paid; Rental income (mainly for the use of real estate) net of expenses of landlords; Royalties paid for the use of intellectual property and extractable natural resources.

All remaining value added generated by firms is called the residual or profit. If a firm has stockholders, they own the residual, some of which they receive as dividends. Profit includes the income of the entrepreneur - the businessman who combines factor inputs to produce a good or service. Formulae: NDP at factor cost = Compensation of employees + Net interest + Rental & royalty income + Profit of incorporated and unincorporated NDP at factor cost
The expenditure approach

The expenditure approach is basically an output accounting method. It focuses on finding the total output of a nation by finding the total amount of money spent. This is acceptable, because like income, the total value of all goods is equal to the total amount of money spent on goods. The basic formula for domestic output takes all the different areas in which money is spent within the region, and then combines them to find the total output.

Where: C = household consumption expenditures / personal consumption expenditures I = gross private domestic investment G = government consumption and gross investment expenditures X = gross exports of goods and services M = gross imports of goods and services Note: (X - M) is often written as XN, which stands for "net exports"

Definitions
The names of the measures consist of one of the words "Gross" or "Net", followed by one of the words "National" or "Domestic", followed by one of the words "Product", "Income", or "Expenditure". All of these terms can be explained separately. "Gross" means total product, regardless of the use to which it is subsequently put.

"Net" means "Gross" minus the amount that must be used to offset depreciation ie., wear-and-tear or obsolescence of the nation's fixed capital assets. "Net" gives an indication of how much product is actually available for consumption or new investment. "Domestic" means the boundary is geographical: we are counting all goods and services produced within the country's borders, regardless of by whom. "National" means the boundary is defined by citizenship (nationality). We count all goods and services produced by the nationals of the country (or businesses owned by them) regardless of where that production physically takes place. The output of a French-owned cotton factory in Senegal counts as part of the Domestic figures for Senegal, but the National figures of France. "Product", "Income", and "Expenditure" refer to the three counting methodologies explained earlier: the product, income, and expenditure approaches. However the terms are used loosely. "Product" is the general term, often used when any of the three approaches was actually used. Sometimes the word "Product" is used and then some additional symbol or phrase to indicate the methodology; so, for instance, we get "Gross Domestic Product by income", "GDP (income)", "GDP(I)", and similar constructions. "Income" specifically means that the income approach was used. "Expenditure" specifically means that the expenditure approach was used. Note that all three counting methods should in theory give the same final figure. However, in practice minor differences are obtained from the three methods for several reasons, including changes in inventory levels and errors in the statistics. One problem for instance is that goods in inventory have been produced (therefore included in Product), but not yet sold (therefore not yet included in Expenditure). Similar timing issues can also cause a slight discrepancy between the value of goods produced (Product) and the payments to the factors that produced the goods (Income), particularly if inputs are purchased on credit, and also because wages are collected often after a period of production.

GDP and GNP

Gross domestic product (GDP) is defined as "the value of all final goods and services produced in a country in 1 year". Gross National Product (GNP) is defined as "the market value of all goods and services produced in one year by labour and property supplied by the residents of a country." As an example, the table below shows some GDP and GNP, and NNI data for the United States:

NDP: Net domestic product is defined as "gross domestic product (GDP) minus depreciation of capital", similar to NNP. GDP per capita: Gross domestic product per capita is the mean value of the output produced per person, which is also the mean income. National income and welfare

GDP per capita (per person) is often used as a measure of a person's welfare. Countries with higher GDP may be more likely to also score highly on other measures of welfare, such as life expectancy. However, there are serious limitations to the usefulness of GDP as a measure of welfare: Because of this, other measures of welfare such as the Human Development Index (HDI), Index of Sustainable Economic Welfare (ISEW), Genuine Progress Indicator (GPI), gross national happiness (GNH), and sustainable national income (SNI) are used. Measures of GDP typically exclude unpaid economic activity, most importantly domestic work such as childcare. This leads to distortions; for example, a paid nanny's income contributes to GDP, but an unpaid parent's time spent caring for children will not, even though they are both carrying out the same economic activity. o GDP takes no account of the inputs used to produce the output. For example, if everyone worked for twice the number of hours, then GDP might roughly double, but this does not necessarily mean that workers are better off as they would have less leisure time. Similarly, the impact of economic activity on the environment is not measured in calculating GDP. o Comparison of GDP from one country to another may be distorted by movements in exchange rates. Measuring national income at purchasing power parity may overcome this problem at the risk of overvaluing basic goods and services, for example subsistence farming. o GDP does not measure factors that affect quality of life, such as the quality of the environment (as distinct from the input value) and security from crime. This leads to distortions - for example, spending on cleaning up an oil spill is included in GDP, but the negative impact of the spill on well-being (e.g. loss of clean beaches) is not measured. o GDP is the mean (average) wealth rather than median (middle-point) wealth. Countries with a skewed income distribution may have a relatively high per-capita GDP while the majority of its citizens have a relatively low level of income, due to concentration of wealth in the hands of a small fraction of the population. See Gini coefficient. Difficulties in Measurement of National Income There are many difficulties when it comes to measuring national income, however these can be grouped into conceptual difficulties and practical difficulties.
o

Conceptual Difficulties

Inclusion of Services: There has been some debate about whether to include services in the counting of national income, and if it counts as output. Marxian economists are of the belief that services should be excluded from national income, most other economists though are in agreement that services should be included. Identifying Intermediate Goods: The basic concept of national income is to only include final goods, intermediate goods are never included, but in reality it is very hard to draw a clear cut line as to what intermediate goods are. Many goods can be justified as intermediate as well as final goods depending on their use.

Identifying Factor Incomes: Separating factor incomes and non factor incomes is also a huge problem. Factor incomes are those paid in exchange for factor services like wages, rent, interest etc. Non factor are sale of shares selling old cars property etc., but these are made to look like factor incomes and hence are mistakenly included in national income. Services of Housewives and other similar services: National income includes those goods and services for which payment has been made, but there are scores of jobs, for which money as such is not paid, also there are jobs which people do themselves like maintain the gardens etc., so if they hired someone else to do this for them, then national income would increase, the argument then is why are these acts not accounted for now, but the bigger issue would be how to keep a track of these activities and include them in national incom

Practical Difficulties

Inclusion of Services: There has been some debate about whether to include services in the counting of national income, and if it counts as output. Marxian economists are of the belief that services should be excluded from national income, most other economists though are in agreement that services should be included. Identifying Intermediate Goods: The basic concept of national income is to only include final goods, intermediate goods are never included, but in reality it is very hard to draw a clear cut line as to what intermediate goods are. Many goods can be justified as intermediate as well as final goods depending on their use. Identifying Factor Incomes: Separating factor incomes and non factor incomes is also a huge problem. Factor incomes are those paid in exchange for factor services like wages, rent, interest etc. Non factor are sale of shares selling old cars property etc., but these are made to look like factor incomes and hence are mistakenly included in national income. Services of Housewives and other similar services: National income includes those goods and services for which payment has been made, but there are scores of jobs, for which money as such is not paid, also there are jobs which people do themselves like maintain the gardens etc., so if they hired someone else to do this for them, then national income would increase, the argument then is why are these acts not accounted for now, but the bigger issue would be how to keep a track of these activities and include them in national income. Unreported Illegal Income: Sometimes, people don't provide all the right information about their incomes to evade taxes so this obviously causes disparities in the counting of national income. Non Monetized Sector: In many developing nations, there is this issue that goods and services are traded through barter, i.e. without any money. Such goods and services should be included in accounting of national income, but the absence of data makes this inclusion difficult.

Price Ceiling
A price ceiling is a government-imposed limit on the price charged for a product. Governments intend price ceilings to protect consumers from conditions that could make necessary commodities unattainable.

However, a price ceiling can cause problems if imposed for a long period without controlled rationing. Price ceilings can produce negative results when the correct solution would have been to increase supply. Misuse occurs when a government misdiagnoses a price as too high when the real problem is that the supply is too low. In an unregulated market economy price ceilings do not exist. Students may incorrectly perceive a price ceiling as being on top of a supply and demand curve when in fact, an effective price ceiling is positioned below the equilibrium position on the graph. Binding versus non-binding A price ceiling can be set above or below the free-market equilibrium price. For a price ceiling to be effective, it must differ from the free market price. In the graph at right, the supply and demand curves intersect to determine the free-market quantity and price. The dashed line represents a price ceiling set above the free-market price, called a non-binding price ceiling. In this case, the ceiling has no practical effect. The government has mandated a maximum price, but the market price is established well below that. In contrast, the solid green line is a price ceiling set below the free market price, called a binding price ceiling. In this case, the price ceiling has a measurable impact on the market. Consequences of binding price ceilings A price ceiling set below the free-market price has several effects. Suppliers find they can't charge what they had been. As a result, some suppliers drop out of the market. This reduces supply. Meanwhile, consumers find they can now buy the product for less, so quantity demanded increases. These two actions cause quantity demanded to exceed quantity supplied, which causes a shortageunless rationing or other consumption controls are enforced. It can also lead to various forms of non-price competition so supply can meet demand. Reduction in quality To supply demand at the legal price, the most obvious approach is to lower costs. However, in most cases, lower costs means lower quality. During World War II, for example, food sellers operating under ceilings reduced portion size and used less expensive ingredients (e.g., more fat, flour, etc.). It can also be seen in decreased maintenance of rent-controlled apartments. Some scholars, however, doubt that price ceilings necessarily drive quality down in the case of an oligopoly. They argued that with few competing firms selling under a price ceiling, a company at the lower end of the market must find ways to achieve better quality without raising price. Black markets If somebody cannot obtain needed goods because a price ceiling reduces the quantity, they may turn to the black market. Those whoby luck or good managementobtain goods in short supply can profit by illegally selling at a higher price than the free market allows. The black market price is higher than the free market price because the quantity is less than in a free market transaction, where more sellers could afford to sell the product. People are sometimes forced to buy at these higher prices when a shortage happens and there is no other place to obtain these.

Discrimination If there is a shortage, sellers may discriminate among customers. In the case of rent control in New York City, landlords have given rent-controlled apartments to celebrities over less-wealthy, non-famous people.

Price Elasticity
Price Elasticity of Demand Price elasticity of demand (PED or Ed) is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price (ceteris paribus, i.e. holding constant all the other determinants of demand, such as income). Price elasticities are almost always negative, although analysts tend to ignore the sign even though this can lead to ambiguity. Only goods which do not conform to the law of demand, such as Veblen and Giffen goods, have a positive PED. In general, the demand for a good is said to be inelastic (or relatively inelastic) when the PED is less than one (in absolute value): that is, changes in price have a relatively small effect on the quantity of the good demanded. The demand for a good is said to be elastic (or relatively elastic) when its PED is greater than one (in absolute value): that is, changes in price have a relatively large effect on the quantity of a good demanded. Revenue is maximized when price is set so that the PED is exactly one. The PED of a good can also be used to predict the incidence (or "burden") of a tax on that good. Various research methods are used to determine price elasticity, including test markets, analysis of historical sales data and conjoint analysis. Perfectly elastic demand A decrease in the price of a good normally results in an increase in the quantity demanded by consumers because of the law of demand [18], and conversely, quantity demanded decreases when price rises. As summarized in the table above, the PED for a good or service is referred to by different descriptive terms depending on whether the elasticity coefficient is greater than, equal to, or less than 1. That is, the demand for a good is called:

relatively inelastic when the percentage change in quantity demanded is less than the percentage change in price (so that Ed > - 1); unit elastic, unit elasticity, unitary elasticity, or unitarily elastic demand when the percentage change in quantity demanded is equal to the percentage change in price (so that Ed = - 1); and relatively elastic when the percentage change in quantity demanded is greater than the percentage change in price (so that Ed < - 1).

As the two accompanying diagrams show, perfectly elastic demand is represented graphically as a horizontal line, and perfectly inelastic demand as a vertical line. These are the only cases in which the PED and the slope of the demand curve (P/Q) are both constant, as well as the only cases in which the PED is determined solely by the slope of the demand curve (or more precisely, by the inverse of that slope). Price Elasticity of Supply Price elasticity of supply (PES or Es) is a measure used in economics to show the responsiveness, or elasticity, of the quantity supplied of a good or service to a change in its price. When the coefficient is less than one, the said good can be described as inelastic; when the coefficient is greater than one, the supply can be described as elastic. An elasticity of zero indicates that quantity supplied does not respond to a price change: it is "fixed" in supply. Such goods often have no labor component or are not produced, limiting the short run prospects of expansion. If the coefficient is exactly one, the good is said to be unitary elastic. The quantity of goods supplied can, in the short term, be different from the amount produced, as manufacturers will have stocks which they can build up or run down. Determinants Availability of raw materials for example, availability may cap the amount of gold that can be produced in a country regardless of price. Likewise, the price of Van Gogh [19] paintings is unlikely to affect their supply. Length and complexity of production Much depends on the complexity of the production process. Textile production is relatively simple. The labor is largely unskilled and production facilities are little more than buildings no special structures are needed. Thus the PES for textiles is elastic. On the other hand, the PES for specific types of motor vehicles is relatively inelastic. Auto manufacture is a multi-stage process that requires specialized equipment, skilled labor, a large suppliers network and large R&D costs. Mobility of factors If the factors of production are easily available and if a producer producing one good can switch their resources and put it towards the creation of a product in demand, then it can be said that the PES is relatively elastic. The inverse applies to this, to make it relatively inelastic. Time to respond The more time a producer has to respond to price changes the more elastic the supply. Supply is normally more elastic in the long run [20] than in the short run [21] for produced goods, since it is generally assumed that in the long run all factors of production can be utilised to increase supply, whereas in the short run only labor can be increased, and even then, changes may be prohibitively costly. For example, a cotton farmer cannot immediately (i.e. in the short run) respond to an increase in the price of soybeans because of the time it would take to procure the necessary land. Excess capacity

A producer who has unused capacity can (and will) quickly respond to price changes in his market assuming that variable factors are readily available. Inventories A producer who has a supply of goods or available storage capacity can quickly increase supply to market. Various research methods are used to calculate price elasticities in real life, including analysis of historic sales data, both public and private, and use of present-day surveys of customers' preferences to build up test markets capable of modelling such changes. Alternatively, conjoint analysis (a ranking of users' preferences which can then be statistically analysed) may be used.

Price Floor
A price floor is a government- or group-imposed limit on how low a price can be charged for a product. A price floor must be greater than the equilibrium price in order to be effective. Effectiveness of price floors A price floor can be set below the free-market equilibrium price. In the first graph at right, the dashed green line represents a price floor set below the free-market price. In this case, the floor has no practical effect. The government has mandated a minimum price, but the market already bears a higher price. By contrast, in the second graph, the dashed green line represents a price floor set above the free-market price. In this case, the price floor has a measurable impact on the market. It ensures prices stay high so that product can continue to be made. Effect on the market A price floor set above the market equilibrium price has several side-effects. Consumers find they must now pay a higher price for the same product. As a result, they reduce their purchases or drop out of the market entirely. Meanwhile, suppliers find they are guaranteed a new, higher price than they were charging before. As a result, they increase production. Taken together, these effects mean there is now an excess supply (known as a "surplus") of the product in the market to maintain the price floor over the long term. The equilibrium price is determined when the quantity demanded is equal to the quantity supplied. Minimum wage A historical (and current) example of a price floor are minimum wage laws; in this case, employees are the suppliers of labor and the company is theconsumer. When the minimum wage is set higher than the

equilibrium market price for unskilled labor, unemployment is created (more people are looking for jobs than there are jobs available). A minimum wage above the equilibrium wage would induce employers to hire fewer workers as well as allow more people to enter the labor market, the result is a surplus in the amount of labor available. The equilibrium wage for a worker would be dependent upon the worker's skill sets along with market conditions.

Supply and Demand

In microeconomics, supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price), resulting in an economic equilibrium for price and quantity. The four basic laws of supply and demand are: 1. If demand increases and supply remains unchanged, a shortage occurs, leading to a higher equilibrium price. 2. If demand decreases and supply remains unchanged, a surplus occurs, leading to a lower equilibrium price. 3. If demand remains unchanged and supply increases, a surplus occurs, leading to a lower equilibrium price. 4. If demand remains unchanged and supply decreases, a shortage occurs, leading to a higher equilibrium price. Supply schedule A supply schedule is a table that shows the relationship between the price of a good and the quantity supplied. A supply curve is a graph that illustrates that relationship between the price of a good and the quantity supplied . Under the assumption of perfect competition, supply is determined by marginal cost. Firms will produce additional output while the cost of producing an extra unit of output is less than the price they would receive. By its very nature, conceptualizing a supply curve requires the firm to be a perfect competitor, namely requires the firm to have no influence over the market price. This is true because each a point on the supply curve is the answer to the question "If this firm is faced with this potential price, how much output will it be able to and willing to sell?" If a firm has market power, its decision of how much output to provide to the market influences the market price, then the firm is not "faced with" any price, and the question is meaningless. Economists distinguish between the supply curve of an individual firm and between the market supply curve. The market supply curve is obtained by summing the quantities supplied by all suppliers at each potential price. Thus, in the graph of the supply curve, individual firms' supply curves are added horizontally to obtain the market supply curve. Economists also distinguish the short-run market supply curve from the long-run market supply curve. In

this context, two things are assumed constant by definition of the short run: the availability of one or more fixed inputs (typically physical capital), and the number of firms in the industry. In the long run, firms have a chance to adjust their holdings of physical capital, enabling them to better adjust their quantity supplied at any given price. Furthermore, in the long run potential competitors can enter or exit the industry in response to market conditions. For both of these reasons, long-run market supply curves are flatter than their short-run counterparts. The determinants of supply are: 1. 2. 3. 4. 5. Production costs, how much a good costs to be produced The technology used in production, and/or technological advances A good's own price Firms' expectations about future prices Number of suppliers

Demand schedule A demand schedule, depicted graphically as the demand curve, represents the amount of some good that buyers are willing and able to purchase at various prices, assuming all determinants of demand other than the price of the good in question, such as income, tastes and preferences, the price of substitute goods, and the price of complementary goods, remain the same. Following the law of demand, the demand curve is almost always represented as downward-sloping, meaning that as price decreases, consumers will buy more of the good. Just like the supply curves reflect marginal cost curves, demand curves are determined by marginal utility curves. Consumers will be willing to buy a given quantity of a good, at a given price, if the marginal utility of additional consumption is equal to the opportunity cost determined by the price, that is, the marginal utility of alternative consumption choices. The demand schedule is defined as the willingness and ability of a consumer to purchase a given product in a given frame of time. It is aforementioned, that the demand curve is generally downward-sloping, there may be rare examples of goods that have upward-sloping demand curves. Two different hypothetical types of goods with upwardsloping demand curves are Giffen goods (an inferior but staple good) and Veblen goods (goods made more fashionable by a higher price). By its very nature, conceptualizing a demand curve requires that the purchaser be a perfect competitor that is, that the purchaser has no influence over the market price. This is true because each point on the demand curve is the answer to the question "If this buyer is faced with this potential price, how much of the product will it purchase?" If a buyer has market power, so its decision of how much to buy influences the market price, then the buyer is not "faced with" any price, and the question is meaningless. Like with supply curves, economists distinguish between the demand curve of an individual and the market demand curve. The market demand curve is obtained by summing the quantities demanded by all consumers at each potential price. Thus, in the graph of the demand curve, individuals' demand curves are added horizontally to obtain the market demand curve. The determinants of demand are: 1. Income

2. 3. 4. 5.

Tastes and preferences Prices of related goods and services Consumers' expectations about future prices and incomes that can be checked Number of potential consumers

Equilibrium Equilibrium is defined to be the price-quantity pair where the quantity demanded is equal to the quantity supplied, represented by the intersection of the demand and supply curves. Market Equilibrium: A situation in a market when the price is such that the quantity that consumers wish to demand is correctly balanced by the quantity that firms wish to supply. Comparative static analysis: Examines the likely effect on the equilibrium of a change in the external conditions affecting the market. Changes in market equilibrium:- Practical uses of supply and demand analysis often center on the different variables that change equilibrium price and quantity, represented as shifts in the respective curves. Comparative statics of such a shift traces the effects from the initial equilibrium to the new equilibrium. Demand curve shifts: When consumers increase the quantity demanded at a given price, it is referred to as an increase in demand. Increased demand can be represented on the graph as the curve being shifted to the right. At each price point, a greater quantity is demanded, as from the initial curve D1 to the new curve D2. In the diagram, this raises the equilibrium price from P1 to the higher P2. This raises the equilibrium quantity from Q1 to the higher Q2. A movement along the curve is described as a "change in the quantity demanded" to distinguish it from a "change in demand," that is, a shift of the curve. there has been an increase in demand which has caused an increase in (equilibrium) quantity. The increase in demand could also come from changing tastes and fashions, incomes, price changes in complementary and substitute goods, market expectations, and number of buyers. This would cause the entire demand curve to shift changing the equilibrium price and quantity. Note in the diagram that the shift of the demand curve, by causing a new equilibrium price to emerge, resulted in movement along the supply curve from the point (Q1, P1) to the point Q2, P2). If the demand decreases, then the opposite happens: a shift of the curve to the left. If the demand starts at D2, and decreases to D1, the equilibrium price will decrease, and the equilibrium quantity will also decrease. The quantity supplied at each price is the same as before the demand shift, reflecting the fact that the supply curve has not shifted; but the equilibrium quantity and price are different as a result of the change (shift) in demand. The movement of the demand curve in response to a change in a non-price determinant of demand is caused by a change in the x-intercept, the constant term of the demand equation. Supply curve shifts: When technological progress occurs, the supply curve shifts. For example, assume that someone invents a

better way of growing wheat so that the cost of growing a given quantity of wheat decreases. Otherwise stated, producers will be willing to supply more wheat at every price and this shifts the supply curve S1 outward, to S2an increase in supply. This increase in supply causes the equilibrium price to decrease from P1 to P2. The equilibrium quantity increases from Q1 to Q2 as consumers move along the demand curve to the new lower price. As a result of a supply curve shift, the price and the quantity move in opposite directions. If the quantity supplied decreases, the opposite happens. If the supply curve starts at S2, and shifts leftward to S1, the equilibrium price will increase and the equilibrium quantity will decrease as consumers move along the demand curve to the new higher price and associated lower quantity demanded. The quantity demanded at each price is the same as before the supply shift, reflecting the fact that the demand curve has not shifted. But due to the change (shift) in supply, the equilibrium quantity and price have changed. The movement of the supply curve in response to a change in a non-price determinant of supply is caused by a change in the y-intercept, the constant term of the supply equation. The supply curve shifts up and down the y axis as non-price determinants of demand change.

Demand Curve
In economics, the demand curve is the graph depicting the relationship between the price of a certain commodity and the amount of it that consumers are willing and able to purchase at that given price. It is a graphic representation of a demand schedule. The demand curve for all consumers together follows from the demand curve of every individual consumer: the individual demands at each price are added together. Demand curves are used to estimate behaviors in competitive markets, and are often combined with supply curves to estimate the equilibrium price (the price at which sellers together are willing to sell the same amount as buyers together are willing to buy, also known as market clearing price) and the equilibrium quantity (the amount of that good or service that will be produced and bought without surplus/excess supply or shortage/excess demand) of that market. In a monopolistic market, the demand curve facing the monopolist is simply the market demand curve. Characteristics According to convention, the demand curve is drawn with price on the vertical (y) axis and quantity on the horizontal (x) axis. The function actually plotted is the inverse demand function. The demand curve usually slopes downwards from left to right; that is, it has a negative association (for two theoretical exceptions, see Veblen good and Giffen good). The negative slope is often referred to as the "law of demand", which means people will buy more of a service, product, or resource as its price falls. The demand curve is related to the marginal utility curve, since the price one is willing to pay depends on the utility. However, the demand directly depends on the income of an individual while the utility does not. Thus it may change indirectly due to change in demand for other commodities.

Linear demand curve The demand curve is often graphed as a straight line of the form Q = a - bP where a and b are parameters. The constant a embodies the effects of all factors other than price that affect demand. If income were to change, for example, the effect of the change would be represented by a change in the value of a and be reflected graphically as a shift of the demand curve. The constant b is the slope of the demand curve and shows how the price of the good affects the quantity demanded. The graph of the demand curve uses the inverse demand function in which price is expressed as a function of quantity. The standard form of the demand equation can be converted to the inverse equation by solving for P or P = a/b - Q/b. More plainly, in the equation P = a - bQ, "a" is the intercept where quantity demanded is zero (where the demand curve intercepts the Y axis), "b" is the slope of the demand curve, "Q" is quantity and "P" is price. Shift of a demand curve The shift of a demand curve takes place when there is a change in any non-price determinant of demand, resulting in a new demand curve. Non-price determinants of demand are those things that will cause demand to change even if prices remain the samein other words, the things whose changes might cause a consumer to buy more or less of a good even if the good's own price remained unchanged. Some of the more important factors are the prices of related goods (both substitutes and complements), income, population, and expectations. However, demand is the willingness and ability of a consumer to purchase a good under the prevailing circumstances; so, any circumstance that affects the consumer's willingness or ability to buy the good or service in question can be a non-price determinant of demand. As an example, weather could be a factor in the demand for beer at a baseball game. When income rises, the demand curve for normal goods shifts outward as more will be demanded at all prices, while the demand curve for inferior goods shifts inward due to the increased attainability of superior substitutes. With respect to related goods, when the price of a good (e.g. a hamburger) rises, the demand curve for substitute goods (e.g. chicken) shifts out, while the demand curve for complementary goods (e.g. tomato sauce) shifts in (i.e. there is more demand for substitute goods as they become more attractive in terms of value for money, while demand for complementary goods contracts in response to the contraction of quantity demanded of the underlying good). Demand shifters

Changes in disposable income Changes in tastes and preferences - tastes and preferences are assumed to be fixed in the short-run. This assumption of fixed preferences is a necessary condition for aggregation of individual demand curves to derive market demand. Changes in expectations. Changes in the prices of related goods (substitutes and complements) Population size and composition

Changes that decrease demand Circumstances which can cause the demand curve to shift include:

decrease in price of a substitute increase in price of a complement decrease in consumer income if the good is a normal good increase in consumer income if the good is an inferior good

Factors affecting market demand Market or aggregate demand is the summation of individual demand curves. In addition to the factors which can affect individual demand there are three factors that can affect market demand (cause the market demand curve to shift):

a change in the number of consumers, a change in the distribution of tastes among consumers, a change in the distribution of income among consumers with different tastes.

Some circumstances which can cause the demand curve to shift in include:

decrease in price of a substitute increase in price of a complement decrease in income if good is normal good increase in income if good is inferior good

Movement along a demand curve There is movement along a demand curve when a change in price causes the quantity demanded to change. It is important to distinguish between movement along a demand curve, and a shift in a demand curve. Movements along a demand curve happen only when the price of the good changes. When a nonprice determinant of demand changes the curve shifts. These "other variables" are part of the demand function. They are "merely lumped into intercept term of a simple linear demand function." Thus a change in a non-price determinant of demand is reflected in a change in the x-intercept causing the curve to shift along the x axis.

BEC 2 (Economic Concepts and Analysis) Questions

1. What type of business organization may generally be formed without filing an organizational document or certificate with a state government agency or office? A) A corporation. B) A limited liability company. C) A general partnership.

D) A limited partnership.

2. What business entity can be voluntarily dissolved and terminated without filing a dissolution document with the state of organization? A) A corporation. B) A general partnership. C) A limited liability limited partnership. D) A limited partnership.

3. Hughes and Brody start a business as a closely-held corporation. Hughes owns 51 of the 100 shares of stock issued by the firm and Brody owns 49. One year later, the corporation decides to sell another 200 shares. Which of the following types of rights would give Hughes and Brody a preference over other purchasers to buy shares to maintain control of the firm? A) Shareholder derivative rights. B) Pre-emptive rights. C) Cumulative voting rights. D) Inspection rights.

4. If the dollar price of the euro rises, which of the following will occur? A) The dollar depreciates against the euro. B) The euro depreciates against the dollar. C) The euro will buy fewer European goods. D) The euro will buy fewer U.S. goods.

5. An economy is at the peak of the business cycle. Which of the following policy packages is the most effective way to dampen the economy and prevent inflation? A) Increase government spending, reduce taxes, increase money supply, and reduce interest rates. B) Reduce government spending, increase taxes, increase money supply, and increase interest rates. C) Reduce government spending, increase taxes, reduce money supply, and increase interest rates. D) Reduce government spending, reduce taxes, reduce money supply, and reduce interest rates.

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.

7. Which of the following economic terms describes a general decline in prices for goods and services and in the level of interest rates? A) Expansion. B) Inflation. C) Deflation. D) Recession.

8. The primary purpose of the consumer price index (CPI) is to A) Establish a cost-of-living index.

B) Identify the strength of an economic recovery. C) Help determine the Federal Reserve Bank's discount rate. D) Compare relative price changes over time.

9. Which of the following is an assumption in a perfectly competitive financial market? A) No single trader or traders can have a significant impact on market prices. B) Some traders can impact market prices more than others. C) Trading prices vary based on supply only. D) Information about borrowing/lending activities is only available to those willing to pay market prices.

10. A country's currency conversion value has recently changed from 1.5 to the U.S. dollar to 1.7 to the U.S. dollar. Which of the following statements about the country is correct? A) Its exports are less expensive for the United States. B) Its currency has appreciated. C) Its imports of U.S. goods are more affordable. D) Its purchases of the U.S. dollar will cost less.

11. Farrow Co. is applying for a loan in which the bank requires a quick ratio of at least 1. Farrow's quick ratio is 0.8. Which of the following actions would increase Farrow's quick ratio? A) Purchasing inventory through the issuance of a long-term note. B) Implementing stronger procedures to collect accounts receivable at a faster rate. C) Paying an existing account payable. D) Selling obsolete inventory at a loss.

12. Variations between business cycles most likely are attributable to which of the following factors? A) The law of diminishing returns. B) Comparative advantage. C) Duration and intensity. D) Opportunity costs.

13. Which of the following types of risk can be reduced by diversification? A) High interest rates. B) Inflation. C) Labor strikes. D) Recessions.

14. A company has a policy of frequently cutting prices to increase sales. Product demand is significantly elastic. What impact would this have on the company's situation? A) Quantity increases proportionally more than the price declines. B) Quantity increases proportionally less than the price declines. C) Price increases proportionally more than the quantity declines. D) Price increases proportionally less than the quantity declines

15. Which of the following types of unemployment typically results from technological advances? A) Cyclical.

B) Frictional. C) Structural. D) Short-term.

16. Which of the following indicates that the economy is in a recessionary phase? A) The rate of unemployment decreases. B) The purchasing power of money declines rapidly. C) Potential national income exceeds actual national income. D) There is a shortage of essential raw materials and costs are rising.

17. To address the problem of a recession, the Federal Reserve Bank most likely would take which of the following actions? A) Lower the discount rate it charges to banks for loans. B) Sell U.S. government bonds in open-market transactions. C) Increase the federal funds rate charged by banks when they borrow from one another. D) Increase the level of funds a bank is legally required to hold in reserve.

18. Which of the following actions is the acknowledged preventive measure for a period of deflation? A) Increasing interest rates. B) Increasing the money supply. C) Decreasing interest rates. D) Decreasing the money supply.

19. Under which of the following conditions is the supplier most able to influence or control buyers? A) When the supplier's products are not differentiated. B) When the supplier does not face the threat of substitute products. C) When the industry is controlled by a large number of companies. D) When the purchasing industry is an important customer to the supplying industry.

20. An auditor is required to obtain an understanding of the entity's business, including business cycles and reasons for business fluctuations. What is the audit purpose most directly served by obtaining this understanding? A) To enable the auditor to accurately identify reportable conditions. B) To assist the auditor to accurately interpret information obtained during an audit. C) To allow the auditor to more accurately perform tests of controls. D) To decide whether it will be necessary to perform analytical procedures.

21. Which of the following segments of the economy will be least affected by the business cycle? A) Commercial construction industry. B) Machinery and equipment industry. C) Residential construction industry. D) Healthcare industry.

22. All of the following are components of the formula used to calculate gross domestic product except A) Household income.

B) Foreign net export spending. C) Government spending. D) Gross investment.

23. Gross domestic product includes which of the following measures? A) The size of a population that must share a given output within one year. B) The negative externalities of the production process of a nation within one year. C) The total monetary value of all final goods and services produced within a nation in one year. D) The total monetary value of goods and services including barter transactions within a nation in one year.

24. The CPA reviewed the minutes of a board of director's meeting of LQR Corp., an audit client. An order for widget handles was outsourced to SDT Corp. because LQR couldn't fill the order. By having SDT produce the order, LQR was able to realize $100,000 in sales profits that otherwise would have been lost. The outsourcing added a cost of $10,000, but LQR was ahead by $90,000 when the order was completed. Which of the following statements is correct regarding LQR's action? A) The use of resource markets outside of LQR involves opportunity cost. B) Accounting profit is total revenue minus explicit costs and implicit costs. C) Implicit costs are not opportunity costs because they are internal costs. D) Explicit costs are opportunity costs from purchasing widget handles from resource

25. An American importer expects to pay a British supplier 500,000 British pounds in three months. Which of the following hedges is best for the importer to fix the price in dollars? A) Buying British pound call options. B) Buying British pound put options.

C) Selling British pound put options. D) Selling British pound call options.

26. Which of the following statements is correct if there is an increase in the resources available within an economy? A) More goods and services will be produced in the economy. B) The economy will be capable of producing more goods and services. C) The standard of living in the economy will rise. D) The technological efficiency of the economy will improve.

27. Which of the following is correct regarding the consumer price index (CPI) for measuring the estimated decrease in a company's buying power? A) The CPI is measured only once every 10 years. B) The products a company buys should differ from what a consumer buys. C) The CPI measures what consumers will pay for items. D) The CPI is skewed by foreign currency translations.

28. A city ordinance that freezes rent prices may cause A) The demand curve for rental space to fall. B) The supply curve for rental space to rise. C) Demand for rental space to exceed supply. D) Supply of rental space to exceed demand.

Answer Key: 1)C 2)B 3)B 4)A 5)C 6)A 7)C 8)D 9)A 10)A 11)D 12)C 13)C 14)A 15)C 16)C 17)A 18)B 19)B 20)B 21)D 22)A 23)C 24)A 25)A 26)B 27)B 28)C

Business Environment and Concepts 3: Financial Management Business Valuation Methods

Businesses or fractional interests in businesses may be valued for various purposes such as mergers and acquisitions, sale of securities, and taxable events. An accurate valuation of privately owned companies largely depends on the reliability of the firm's historic financial information. Public company financial statements are audited by Certified Public Accountants (US), Chartered Certified Accountants (ACCA) or Chartered Accountants (UK and Canada) and overseen by a government regulator. Alternatively, private firms do not have government oversightunless operating in a regulated industryand are usually not required to have their financial statements audited. Moreover, managers of private firms often prepare their financial statements to minimize profits and, therefore, taxes. Alternatively, managers of public firms tend to want higher profits to increase their stock price. Therefore, a firm's historic financial information may not be accurate and can lead to over- and undervaluation. In an acquisition, a buyer often performs due diligence to verify the seller's information. Financial statements prepared in accordance with generally accepted accounting principles (GAAP) show many assets based on their historic costs rather than at their current market values. For instance, a firm's balance sheet will usually show the value of land it owns at what the firm paid for it rather than at its current market value. But under GAAP requirements, a firm must show the fair values (which usually approximates market value) of some types of assets such as financial instruments that are held for sale rather than at their original cost. When a firm is required to show some of its assets at fair value, some call this process "mark-to-market." But reporting asset values on financial statements at fair values gives managers ample opportunity to slant asset values upward to artificially increase profits and their stock prices. Managers may be motivated to alter earnings upward so they can earn bonuses. Despite the risk of manager bias, equity investors and creditors prefer to know the market values of a firm's assetsrather than their historical costsbecause current values give them better information to make decisions. This method estimates the value of an asset based on its expected future cash flows, which are discounted to the present (i.e., the present value). This concept of discounting future money is commonly known as the time value of money. For instance, an asset that matures and pays $1 in one year is worth less than $1 today. The size of the discount is based on an opportunity cost of capital and it is expressed as a percentage. Some people call this percentage a discount rate. The idea of opportunity cost can be illustrated in an example. A person with only $100 to invest can make just one $100 investment even when presented with two or more investment choices. If this person is later offered an alternative investment choice, the investor has lost the opportunity to make that second investment since the $100 is spent to buy the first opportunity. This example illustrates that money is limited and people make choices in how to spend it. By making a choice, they give up other opportunities. In finance theory, the amount of the opportunity cost is based on a relation between the risk and return of

some sort of investment. Classic economic theory maintains that people are rational and averse to risk. They, therefore, need an incentive to accept risk. The incentive in finance comes in the form of higher expected returns after buying a risky asset. In other words, the more risky the investment, the more return investors want from that investment. Using the same example as above, assume the first investment opportunity is a government bond that will pay interest of 5% per year and the principal and interest payments are guaranteed by the government. Alternatively, the second investment opportunity is a bond issued by small company and that bond also pays annual interest of 5%. If given a choice between the two bonds, virtually all investors would buy the government bond rather than the small-firm bond because the first is less risky while paying the same interest rate as the riskier second bond. In this case, an investor has no incentive to buy the riskier second bond. Furthermore, in order to attract capital from investors, the small firm issuing the second bond must pay an interest rate higher than 5% that the government bond pays. Otherwise, no investor is likely to buy that bond and, therefore, the firm will be unable to raise capital. But by offering to pay an interest rate more than 5% the firm gives investors an incentive to buy a riskier bond. For a valuation using the discounted cash flow method, one first estimates the future cash flows from the investment and then estimates a reasonable discount rate after considering the riskiness of those cash flows and interest rates in the capital markets. Next, one makes a calculation to compute the present value of the future cash flows. Guideline companies method This method determines the value of a firm by observing the prices of similar companies (guideline companies) that sold in the market. Those sales could be shares of stock or sales of entire firms. The observed prices serve as valuation benchmarks. From the prices, one calculates price multiples such as the price-to-earnings or price-to-book value ratios. Next, one or more price multiples are used to value the firm. For example, the average price-to-earnings multiple of the guideline companies is applied to the subject firm's earnings to estimate its value. Many price multiples can be calculated. Most are based on a financial statement element such as a firm's earnings (price-to-earnings) or book value (price-to-book value) but multiples can be based on other factors such as price-per-subscriber. Net asset value method The third common method of estimating the value of a company looks to the assets and liabilities of the business. At a minimum, a solvent company could shut down operations, sell off the assets, and pay the creditors. Any cash that would remain establishes a floor value for the company. This method is known as the net asset value or cost method. Normally, the discounted cash flows of a well-performing company exceed this floor value. However, some companies are "worth more dead than alive", such as weakly performing companies that own many tangible assets. This method can also be used to value heterogeneous portfolios of investments, as well as non-profit companies for which discounted cash flow analysis is not relevant. The valuation premise normally used is that of an orderly liquidation of the assets, although some valuation scenarios (e.g. purchase price allocation) imply an "in-use" valuation such as depreciated replacement cost new. An alternative approach to the net asset value method is the excess earnings method. This method was first described in ARM34, and later refined by the U.S. Internal Revenue Service's Revenue Ruling 68-

609. The excess earnings method has the appraiser identify the value of tangible assets, estimate an appropriate return on those tangible assets, and subtract that return from the total return for the business, leaving the "excess" return, which is presumed to come from the intangible assets. An appropriate capitalization rate is applied to the excess return, resulting in the value of those intangible assets. That value is added to the value of the tangible assets and any non-operating assets, and the total is the value estimate for the business as a whole.

Capital Structure
In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20 billion in equity and $80 billion in debt is said to be 20% equity-financed and 80% debt-financed. The firm's ratio of debt to total financing, 80% in this example, is referred to as the firm's leverage. In reality, capital structure may be highly complex and include dozens of sources. Gearing Ratio is the proportion of the capital employed of the firm which come from outside of the business finance, e.g. by taking a short term loan etc. The Modigliani-Miller theorem, proposed by Franco Modigliani and Merton Miller, forms the basis for modern thinking on capital structure, though it is generally viewed as a purely theoretical result since it disregards many important factors in the capital structure decision. The theorem states that, in a perfect market, how a firm is financed is irrelevant to its value. This result provides the base with which to examine real world reasons why capital structure isrelevant, that is, a company's value is affected by the capital structure it employs. Some other reasons include bankruptcy costs, agency costs, taxes, andinformation asymmetry. This analysis can then be extended to look at whether there is in fact an optimal capital structure: the one which maximizes the value of the firm. Capital structure in a perfect market Consider a perfect capital market (no transaction or bankruptcy costs; perfect information); firms and individuals can borrow at the same interest rate; no taxes; and investment decisions are not affected by financing decisions. Modigliani and Miller made two findings under these conditions. Their first 'proposition' was that the value of a company is independent of its capital structure. Their second 'proposition' stated that the cost of equity for a leveraged firm is equal to the cost of equity for an unleveraged firm, plus an added premium for financial risk. That is, as leverage increases, while the burden of individual risks is shifted between different investor classes, total risk is conserved and hence no extra value created. Their analysis was extended to include the effect of taxes and risky debt. Under a classical tax system, the tax deductibility of interest makes debt financing valuable; that is, the cost of capital decreases as the proportion of debt in the capital structure increases. The optimal structure, then would be to have virtually no equity at all, i.e. a capital structure consisting of 99.99% debt.

Capital structure in the real world If capital structure is irrelevant in a perfect market, then imperfections which exist in the real world must be the cause of its relevance. The theories below try to address some of these imperfections, by relaxing assumptions made in the M&M model. Trade-off theory Main article: Trade-off theory of capital structure Trade-off theory allows the bankruptcy cost to exist. It states that there is an advantage to financing with debt (namely, the tax benefits of debt) and that there is a cost of financing with debt (the bankruptcy costs and the financial distress costs of debt). The marginal benefit of further increases in debt declines as debt increases, while the marginal cost increases, so that a firm that is optimizing its overall value will focus on this trade-off when choosing how much debt and equity to use for financing. Empirically, this theory may explain differences in D/E ratios between industries, but it doesn't explain differences within the same industry. Pecking order theory Pecking Order theory tries to capture the costs of asymmetric information. It states that companies prioritize their sources of financing (from internal financing to equity) according to the law of least effort, or of least resistance, preferring to raise equity as a financing means of last resort. Hence: internal financing is used first; when that is depleted, then debt is issued; and when it is no longer sensible to issue any more debt, equity is issued. This theory maintains that businesses adhere to a hierarchy of financing sources and prefer internal financing when available, and debt is preferred over equity if external financing is required (equity would mean issuing shares which meant 'bringing external ownership' into the company). Thus, the form of debt a firm chooses can act as a signal of its need for external finance. The pecking order theory is popularized by Myers (1984) when he argues that equity is a less preferred means to raise capital because when managers (who are assumed to know better about true condition of the firm than investors) issue new equity, investors believe that managers think that the firm is overvalued and managers are taking advantage of this over-valuation. As a result, investors will place a lower value to the new equity issuance. Agency Costs There are three types of agency costs which can help explain the relevance of capital structure.

Asset substitution effect: As D/E increases, management has an increased incentive to undertake risky (even negative NPV) projects. This is because if the project is successful, share holders get all the upside, whereas if it is unsuccessful, debt holders get all the downside. If the projects are

undertaken, there is a chance of firm value decreasing and a wealth transfer from debt holders to share holders. Underinvestment problem (or Debt overhang problem): If debt is risky (e.g., in a growth company), the gain from the project will accrue to debtholders rather than shareholders. Thus, management have an incentive to reject positive NPV projects, even though they have the potential to increase firm value. Free cash flow: unless free cash flow is given back to investors, management has an incentive to destroy firm value through empire building and perks etc. Increasing leverage imposes financial discipline on management.

Structural Corporate Finance An active area of research in finance is that which tries to translate the models above as well as others into a decision theoretic setups that are time-consistent and that have a dynamic structure similar to the one that can be observed in the real world. Managerial contracts, debt contracts, equity contracts, investment decisions, all have long lived, multi-period implications. Therefore it is hard to think through what the implications of the basic models above are for the real world if they are not embedded in a dynamic structure that approximates reality. A similar type of research is performed under the guise of Credit Risk research in which the modeling of the likelihood of default and its pricing is undertaken under different assumptions about investors and about the incentives of management, shareholders and debt holders. Examples of research in this area are Goldstein, Ju, Leland (1998) and Hennessy and Whited (2004). Capital gearing ratio Capital gearing ratio = (Capital Bearing Risk) : (Capital not bearing risk) Capital bearing risk includes debentures(risk is to pay interest) and preference capital (risk to pay dividend at fixed rate). Capital not bearing risk includes equity share capital. Therefore we can also say, Capital gearing ratio= (Debentures+Preference share capital) : (Equity shareholders' funds)

Financial Modeling
Financial modeling is the task of building an abstract representation (a model) of a financial decision making situation. This is a mathematical model designed to represent (a simplified version of) the performance of a financial asset or portfolio of a business, project, or any other investment. Financial

modeling is a general term that means different things to different users; the reference usually relates either to accounting and corporate finance applications, or to quantitative finance applications. While there has been some debate in the industry as to the nature of financial modeling - whether it is a tradecraft, such as welding, or a science - the task of financial modeling has been gaining acceptance and rigor over the years. Typically, financial modelling is understood to mean an exercise in either asset pricing or corporate finance, of a quantitative nature. In other words, financial modelling is about translating a set of hypotheses about the behavior of markets or agents into numerical predictions; for example, a firm's decisions about investments (the firm will invest 20% of assets), or investment returns (returns on "stock A" will, on average, be 10% higher than the market's returns). In corporate finance, investment banking and the accounting profession financial modeling is largely synonymous with cash flow forecasting. This usually involves the preparation of detailed company specific models used for decision making purposes and financial analysis. Applications include:

Business valuation, especially discounted cash flow, but including other valuation problems Scenario planning and management decision making ("what is"; "what if"; "what has to be done") Capital budgeting Cost of capital (i.e. WACC) calculations Financial statement analysis (including of operating- and finance leases, and R&D) Project finance.

To generalize as to the nature of these models: firstly, as they are built around financial statements, calculations and outputs are monthly, quarterly or annual; secondly, the inputs take the form of assumptions, where the analyst specifies the values that will apply in each period for external / global variables (exchange rates, tax percentage, etc.) and internal / company specific variables (wages, unit costs, etc.). Correspondingly, both characteristics are reflected (at least implicitly) in the mathematical form of these models: firstly, the models are in discrete time; secondly, they are deterministic.[citation needed] For discussion of the issues that may arise, see below; for discussion as to more sophisticated approaches sometimes employed, see Corporate finance: Quantifying uncertainty. Modellers are sometimes referred to (tongue in cheek) as "number crunchers", and are often designated "financial analyst". Typically, the modeller will have completed an MBA or MSF with (optional) coursework in "financial modeling". Accounting qualifications and finance certifications such as the CIIA and CFA generally do not provide direct or explicit training in modeling. At the same time, numerous commercial training courses are offered, both through universities and privately. Although purpose built software does exist, the vast proportion of the market is spreadsheet-based - this is largely since the models are almost always company specific. Microsoft Excel now has by far the dominant position, having overtaken Lotus 1-2-3 in the 1990s. Spreadsheet-based modelling can have its own problems, and several standardizations and "best practices" have been proposed. "Spreadsheet risk" is increasingly studied and managed.

One critique here, is that model outputs, i.e. line items, often incorporate unrealistic implicit assumptions and internal inconsistencies (for example, a forecast for growth in revenue but without corresponding increases in working capital, fixed assets and the associated financing, may imbed unrealistic assumptions about asset turnover, leverage and / or equity financing). What is required, but often lacking, is that all key elements are explicitly and consistently forecasted. An extension of this is that modellers often additionally "fail to identify crucial assumptions" relating to inputs, "and to explore what can go wrong". Here, in general, modellers "use point values and simple arithmetic instead of probability distributions and statistical measures" - i.e., as mentioned, the problems are treated as deterministic in nature - and thus calculate a single value for the asset or project, but without providing information on the range, variance and sensitivity of outcomes. Other critiques discuss the lack of adequate spreadsheet design skills, and of basic computer programming concepts. More serious criticism, in fact, relates to the nature of budgeting itself, and its impact on the organization.

Foreign Exchange
The foreign exchange market (forex, FX, or currency market) is a form of exchange [31] for the global decentralized trading of international currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. There is no unified or centrally cleared market for the majority of trades, and there is very little crossborder regulation. Due to the over-the-counter (OTC) nature of currency markets, there are rather a number of interconnected marketplaces, where different currencies instruments are traded. This implies that there is not a single exchange rate but rather a number of different rates (prices), depending on what bank or market maker is trading, and where it is. Fluctuations in exchange rates are usually caused by actual monetary flows as well as by expectations of changes in monetary flows caused by changes in gross domestic product (GDP) growth, inflation (purchasing power parity theory), interest rates (interest rate parity, Domestic Fisher effect, International Fisher effect), budget and trade deficits or surpluses, large cross-border M&A deals and other macroeconomic conditions. Major news is released publicly, often on scheduled dates, so many people have access to the same news at the same time. However, the large banks have an important advantage; they can see their customers' order flow. Determinants of exchange rates These include: (a) economic policy, disseminated by government agencies and central banks, (b) economic conditions, generally revealed through economic reports, and other economic indicators. Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a government's central bank influences the supply and "cost" of money, which is reflected by the level of interest rates).

Government budget deficits or surpluses: The market usually reacts negatively to widening government budget deficits, and positively to narrowing budget deficits. The impact is reflected in the value of a country's currency. Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country's currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation's economy. For example, trade deficits may have a negative impact on a nation's currency. Inflation levels and trends: Typically a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power, thus demand, for that particular currency. However, a currency may sometimes strengthen when inflation rises because of expectations that the central bank will raise short-term interest rates to combat rising inflation. Economic growth and health: Reports such as GDP, employment levels, retail sales, capacity utilization and others, detail the levels of a country's economic growth and health. Generally, the more healthy and robust a country's economy, the better its currency will perform, and the more demand for it there will be. Productivity of an economy: Increasing productivity in an economy should positively influence the value of its currency. Its effects are more prominent if the increase is in the traded sector.

Impact of Deflation
The effects of deflation are: 1. 2. 3. 4. Decreasing nominal prices for goods and services Increasing buying power of cash money and all assets denominated in cash terms May decrease investment and lending if cash holdings are seen as preferable (aka hoarding) Benefits recipients of fixed incomes

Deflation was present during most economic depressions in US history Deflation is generally regarded negatively, as it causes a transfer of wealth from borrowers and holders of illiquid assets, to the benefit of savers and of holders of liquid assets and currency, and because confused pricing signals cause malinvestment, in the form of under-investment. In this sense it is the opposite of the more usual scenario of inflation, whose effect is to tax currency holders and lenders (savers) and use the proceeds to subsidize borrowers, including governments, and to cause malinvestment as overinvestment. Thus inflation encourages short term consumption and can similarly over-stimulate investment in projects that may not be worthwhile in real terms (for example the housing or dot.com bubbles), while deflation retards investment even when there is a real-world demand not being met. In modern economies, deflation is usually caused by a drop in aggregate demand, and is associated with economic depression, as occurred in the Great Depression and the Long Depression.

While an increase in the purchasing power of one's money benefits some, it amplifies the sting of debt for others: after a period of deflation, the payments to service a debt represent a larger amount of purchasing power than they did when the debt was first incurred. Consequently, deflation can be thought of as an effective increase in a loan's interest rate. If, as during the Great Depression in the United States, deflation averages 10% per year, even an interest-free loan is unattractive as it must be repaid with money worth 10% more each year. Under normal conditions, the Fed and most other central banks implement policy by setting a target for a short-term interest rate the overnight federal funds rate in the US and enforcing that target by buying and selling securities in open capital markets. When the short-term interest rate hits zero, the central bank can no longer ease policy by lowering its usual interest-rate target. With interest rates near zero, debt relief becomes an increasingly important tool in managing deflation.

Impact of Inflation
An increase in the general level of prices implies a decrease in the purchasing power of the currency. That is, when the general level of prices rises, each monetary unit buys fewer goods and services. The effect of inflation is not distributed evenly in the economy, and as a consequence there are hidden costs to some and benefits to others from this decrease in the purchasing power of money. For example, with inflation, lenders or depositors who are paid a fixed rate of interest on loans or deposits will lose purchasing power from their interest earnings, while their borrowers benefit. Individuals or institutions with cash assets will experience a decline in the purchasing power of their holdings. Increases in payments to workers and pensioners often lag behind inflation, especially for those with fixed payments. Increases in the price level (inflation) erode the real value of money (the functional currency) and other items with an underlying monetary nature. Negative High or unpredictable inflation rates are regarded as harmful to an overall economy. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation. Uncertainty about the future purchasing power of money discourages investment and saving. And inflation can impose hidden tax increases, as inflated earnings push taxpayers into higher income tax rates unless the tax brackets are indexed to inflation. With high inflation, purchasing power is redistributed from those on fixed nominal incomes, such as some pensioners whose pensions are not indexed to the price level, towards those with variable incomes whose earnings may better keep pace with the inflation. This redistribution of purchasing power will also occur between international trading partners. Where fixed exchange rates are imposed, higher inflation in one economy than another will cause the first economy's exports to become more expensive and affect the balance of trade. There can also be negative impacts to trade from an increased instability in currency exchange prices caused by unpredictable inflation. Positive

Labor-market adjustments Nominal wages are slow to adjust downwards. This can lead to prolonged disequilibrium and high unemployment in the labor market. Since inflation allows real wages to fall even if nominal wages are kept constant, moderate inflation enables labor markets to reach equilibrium faster. Room to maneuver The primary tools for controlling the money supply are the ability to set the discount rate, the rate at which banks can borrow from the central bank, and open market operations, which are the central bank's interventions into the bonds market with the aim of affecting the nominal interest rate. If an economy finds itself in a recession with already low, or even zero, nominal interest rates, then the bank cannot cut these rates further (since negative nominal interest rates are impossible) in order to stimulate the economy this situation is known as a liquidity trap. A moderate level of inflation tends to ensure that nominal interest rates stay sufficiently above zero so that if the need arises the bank can cut the nominal interest rate. MundellTobin effect The Nobel laureate Robert Mundell noted that moderate inflation would induce savers to substitute lending for some money holding as a means to finance future spending. That substitution would cause market clearing real interest rates to fall. The lower real rate of interest would induce more borrowing to finance investment. In a similar vein, Nobel laureate James Tobin noted that such inflation would cause businesses to substitute investment in physical capital (plant, equipment, and inventories) for money balances in their asset portfolios. That substitution would mean choosing the making of investments with lower rates of real return. (The rates of return are lower because the investments with higher rates of return were already being made before.) The two related effects are known as the MundellTobin effect. Unless the economy is already overinvesting according to models of economic growth theory, that extra investment resulting from the effect would be seen as positive. Instability with Deflation Economist S.C. Tsaing noted that once substantial deflation is expected, two important effects will appear; both a result of money holding substituting for lending as a vehicle for saving. The first was that continually falling prices and the resulting incentive to hoard money will cause instability resulting from the likely increasing fear, while money hoards grow in value, that the value of those hoards are at risk, as people realize that a movement to trade those money hoards for real goods and assets will quickly drive those prices up. Any movement to spend those hoards "once started would become a tremendous avalanche, which could rampage for a long time before it would spend itself." Thus, a regime of long-term deflation is likely to be interrupted by periodic spikes of rapid inflation and consequent real economic disruptions. Moderate and stable inflation would avoid such a seesawing of price movements. Financial Market Inefficiency with Deflation The second effect noted by Tsaing is that when savers have substituted money holding for lending on financial markets, the role of those markets in channeling savings into investment is undermined. With nominal interest rates driven to zero, or near zero, from the competition with a high return money asset, there would be no price mechanism in whatever is left of those markets.

With financial markets effectively euthanized, the remaining goods and physical asset prices would move in perverse directions. For example, an increased desire to save could not push interest rates further down (and thereby stimulate investment) but would instead cause additional money hoarding, driving consumer prices further down and making investment in consumer goods production thereby less attractive. Moderate inflation, once its expectation is incorporated into nominal interest rates, would give those interest rates room to go both up and down in response to shifting investment opportunities, or savers' preferences, and thus allow financial markets to function in a more normal fashion.

Long-term liabilities
Long-term liabilities are liabilities with a future benefit over one year, such as notes payable that mature longer than one year. In accounting, the long-term liabilities are shown on the right wing of the balance-sheet representing the sources of funds, which are generally bounded in form of capital assets. Examples of long-term liabilities are debentures, bonds, mortgage loans and other bank loans. (Note: Not all bank loans are long term as not all are paid over a period greater than a year, an example of this is a bridging loan.) By convention, the portion of long-term liabilities that must be paid in the coming 12-month period are classified as current liabilities. For example, a loan for which two payments of $1000 are due, one in the next twelve months and the other after that date, would be 'split' into two: the first $1000 would be classified as a current liability, and the second $1000 as a long-term liability (note this example is simplified, and does not take into account any interest or discounting effects, which may be required depending on the accounting rules). Also "long-term liabilities" are a way to show that you have to pay something off in a time period longer than one year. Bonds In finance, a bond is an instrument of indebtedness of the bond issuer to the holders. It is a debt security, under which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest (the coupon) and/or to repay the principal at a later date, termed the maturity. Interest is usually payable at fixed intervals (semiannual, annual, sometimes monthly). Very often the bond is negotiable, i.e. the ownership of the instrument can be transferred in the secondary market. Thus a bond is a form of loan or IOU: the holder of the bond is the lender (creditor), the issuer of the bond is the borrower (debtor), and the coupon is the interest. Bonds provide the borrower with external funds to finance long-term investments, or, in the case of government bonds, to finance current expenditure. Certificates of deposit (CDs) or short term commercial paper are considered to be money market instruments and not bonds: the main difference is in the length of the term of the instrument.

Bonds and stocks are both securities, but the major difference between the two is that (capital) stockholders have an equity stake in the company (i.e. they are owners), whereas bondholders have a creditor stake in the company (i.e. they are lenders). Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely. An exception is an irredeemable bond, such as Consols, which is a perpetuity, i.e. a bond with no maturity. Bonds are issued by public authorities, credit institutions, companies and supranational institutions in the primary markets. The most common process for issuing bonds is through underwriting. When a bond issue is underwritten, one or more securities firms or banks, forming a syndicate, buy the entire issue of bonds from the issuer and re-sell them to investors. The security firm takes the risk of being unable to sell on the issue to end investors. Primary issuance is arranged by bookrunners who arrange the bond issue, have direct contact with investors and act as advisers to the bond issuer in terms of timing and price of the bond issue. The bookrunners' willingness to underwrite must be discussed prior to any decision on the terms of the bond issue as there may be limited demand for the bonds. In contrast, government bonds are usually issued in an auction. In some cases both members of the public and banks may bid for bonds. In other cases only market makers may bid for bonds. The overall rate of return on the bond depends on both the terms of the bond and the price paid. The terms of the bond, such as the coupon, are fixed in advance and the price is determined by the market. In the case of an underwritten bond, the underwriters will charge a fee for underwriting. An alternative process for bond issuance, which is commonly used for smaller issues and avoids this cost, is the private placement bond. Bonds are sold directly to buyers and may not be tradeable in the bond market. Historically an alternative practice of issuance was for the borrowing government authority to issue bonds over a period of time, usually at a fixed price, with volumes sold on a particular day dependent on market conditions. This was called a tap issue or bond tap. Principal Nominal, principal, par or face amount the amount on which the issuer pays interest, and which, most commonly, has to be repaid at the end of the term. Some structured bonds can have a redemption amount which is different from the face amount and can be linked to performance of particular assets such as a stock or commodity index, foreign exchange rate or a fund. This can result in an investor receiving less or more than his original investment at maturity. Maturity The issuer has to repay the nominal amount on the maturity date. As long as all due payments have been made, the issuer has no further obligations to the bond holders after the maturity date. The length of time until the maturity date is often referred to as the term or tenor or maturity of a bond. The maturity can be any length of time, although debt securities with a term of less than one year are generally designated

money market instruments rather than bonds. Most bonds have a term of up to 30 years. Some bonds have been issued with terms of 50 years or more, and historically there have been some issues with no maturity date (irredeemables). In the market for United States Treasury securities, there are three categories of bond maturities:

short term (bills): maturities between one to five year; (instruments with maturities less than one year are called Money Market Instruments) medium term (notes): maturities between six to twelve years; long term (bonds): maturities greater than twelve years.

Coupon The coupon is the interest rate that the issuer pays to the bond holders. Usually this rate is fixed throughout the life of the bond. It can also vary with a money market index, such as LIBOR, or it can be even more exotic. The name "coupon" arose because in the past, paper bond certificates were issued which had coupons attached to them, one for each interest payment. On the due dates the bondholder would hand in the coupon to a bank in exchange for the interest payment. Interest can be paid at different frequencies: generally semi-annual, i.e. every 6 months, or annual. Yield The yield is the rate of return received from investing in the bond. It usually refers either to the current yield, or running yield, which is simply the annual interest payment divided by the current market price of the bond (often the clean price), or to the yield to maturity or redemption yield, which is a more useful measure of the return of the bond, taking into account the current market price, and the amount and timing of all remaining coupon payments and of the repayment due on maturity. It is equivalent to the internal rate of return of a bond. Credit Quality The "quality" of the issue refers to the probability that the bondholders will receive the amounts promised at the due dates. This will depend on a wide range of factors. High-yield bonds are bonds that are rated below investment grade by the credit rating agencies. As these bonds are more risky than investment grade bonds, investors expect to earn a higher yield. These bonds are also called junk bonds. Market Price The market price of a tradeable bond will be influenced amongst other things by the amounts, currency and timing of the interest payments and capital repayment due, the quality of the bond, and the available redemption yield of other comparable bonds which can be traded in the markets.

The price can be quoted as clean or dirty. ("Clean" refers to the actual price to be paid; "Dirty" includes an adjustment for accrued interest.) The issue price at which investors buy the bonds when they are first issued will typically be approximately equal to the nominal amount. The net proceeds that the issuer receives are thus the issue price, less issuance fees. The market price of the bond will vary over its life: it may trade at a premium (above par, usually because market interest rates have fallen since issue), or at a discount (price below par, if market rates have risen or there is a high probability of default on the bond).

Marketable Securities
A security or financial instrument is a tradable asset of any kind. Securities are broadly categorized into:

debt securities (such as banknotes, bonds and debentures), equity securities, e.g., common stocks; and, derivative contracts, such as forwards, futures, options and swaps.

The company or other entity issuing the security is called the issuer. A country's regulatory structure determines what qualifies as a security. For example, private investment pools may have some features of securities, but they may not be registered or regulated as such if they meet various restrictions. Securities may be represented by a certificate or, more typically, "non-certificated", that is in electronic or "book entry" only form. Certificates may be bearer, meaning they entitle the holder to rights under the security merely by holding the security, or registered, meaning they entitle the holder to rights only if he appears on a security register maintained by the issuer or an intermediary. They include shares of corporate stock or mutual funds, bonds issued by corporations or governmental agencies, stock options or other options, limited partnership units, and various other formal investment instruments that are negotiable and fungible. Securities are traditionally divided into debt securities and equities The securities markets (Equity) Primary and secondary market Public securities markets are either primary or secondary markets. In the primary market, the money for the securities is received by the issuer of the securities from investors, typically in an initial public offering (IPO). In the secondary market, the securities are simply assets held by one investor selling them to another investor, with the money going from one investor to the other.

An initial public offering is when a company issues public stock newly to investors, called an "IPO" for short. A company can later issue more new shares, or issue shares that have been previously registered in a shelf registration. These later new issues are also sold in the primary market, but they are not considered to be an IPO but are often called a "secondary offering". Issuers usually retain investment banks to assist them in administering the IPO, obtaining SEC (or other regulatory body) approval of the offering filing, and selling the new issue. When the investment bank buys the entire new issue from the issuer at a discount to resell it at a markup, it is called a firm commitment underwriting. However, if the investment bank considers the risk too great for an underwriting, it may only assent to a best effort agreement, where the investment bank will simply do its best to sell the new issue. For the primary market to thrive, there must be a secondary market, or aftermarket that provides liquidity for the investment securitywhere holders of securities can sell them to other investors for cash. Otherwise, few people would purchase primary issues, and, thus, companies and governments would be restricted in raising equity capital (money) for their operations. Organized exchanges constitute the main secondary markets. Many smaller issues and most debt securities trade in the decentralized, dealer-based over-the-counter markets. Public offer and private placement In the primary markets, securities may be offered to the public in a public offer. Alternatively, they may be offered privately to a limited number of qualified persons in a private placement. Sometimes a combination of the two is used. The distinction between the two is important to securities regulation and company law. Privately placed securities are not publicly tradable and may only be bought and sold by sophisticated qualified investors. As a result, the secondary market is not nearly as liquid as it is for public (registered) securities. Listing and OTC dealing Securities are often listed in a stock exchange, an organized and officially recognized market on which securities can be bought and sold. Issuers may seek listings for their securities to attract investors, by ensuring there is a liquid and regulated market that investors can buy and sell securities in. Growth in informal electronic trading systems has challenged the traditional business of stock exchanges. Large volumes of securities are also bought and sold "over the counter" (OTC). OTC dealing involves buyers and sellers dealing with each other by telephone or electronically on the basis of prices that are displayed electronically, usually by commercial information vendors such as SuperDerivatives, Reuters and Bloomberg. There are also eurosecurities, which are securities that are issued outside their domestic market into more than one jurisdiction. They are generally listed on the Luxembourg Stock Exchange or admitted to listing in London. The reasons for listing eurobonds include regulatory and tax considerations, as well as the investment restrictions.

Debt Debt securities may be called debentures, bonds, deposits, notes or commercial paper depending on their maturity and certain other characteristics. The holder of a debt security is typically entitled to the payment of principal and interest, together with other contractual rights under the terms of the issue, such as the right to receive certain information. Debt securities are generally issued for a fixed term and redeemable by the issuer at the end of that term. Debt securities may be protected by collateral or may be unsecured, and, if they are unsecured, may be contractually "senior" to other unsecured debt meaning their holders would have a priority in a bankruptcy of the issuer. Debt that is not senior is "subordinated". Corporate bonds represent the debt of commercial or industrial entities. Debentures have a long maturity, typically at least ten years, whereas notes have a shorter maturity. Commercial paper is a simple form of debt security that essentially represents a post-dated check with a maturity of not more than 270 days. Money market instruments are short term debt instruments that may have characteristics of deposit accounts, such as certificates of deposit, Accelerated Return Notes (ARN), and certain bills of exchange. They are highly liquid and are sometimes referred to as "near cash". Commercial paper is also often highly liquid. Euro debt securities are securities issued internationally outside their domestic market in a denomination different from that of the issuer's domicile. They include eurobonds and euronotes. Eurobonds are characteristically underwritten, and not secured, and interest is paid gross. A euronote may take the form of euro-commercial paper (ECP) or euro-certificates of deposit. Government bonds are medium or long term debt securities issued by sovereign governments or their agencies. Typically they carry a lower rate of interest than corporate bonds, and serve as a source of finance for governments. U.S. federal government bonds are called treasuries. Because of their liquidity and perceived low risk, treasuries are used to manage the money supply in the open market operations of non-US central banks. Sub-sovereign government bonds, known in the U.S. as municipal bonds, represent the debt of state, provincial, territorial, municipal or other governmental units other than sovereign governments. Supranational bonds represent the debt of international organizations such as the World Bank, the International Monetary Fund, regional multilateral development banks and others.

Net Present Value

In finance, the net present value (NPV) or net present worth (NPW) of a time series of cash flows, both incoming and outgoing, is defined as the sum of the present values (PVs) of the individual cash flows of the same entity.

In the case when all future cash flows are incoming (such as coupons and principal of a bond) and the only outflow of cash is the purchase price, the NPV is simply the PV of future cash flows minus the purchase price (which is its own PV). NPV is a central tool in discounted cash flow (DCF) analysis and is a standard method for using the time value of money to appraise long-term projects. Used for capital budgeting and widely used throughout economics, finance, and accounting, it measures the excess or shortfall of cash flows, in present value terms, once financing charges are met. NPV can be described as the difference amount between the sums of discounted: cash inflows and cash outflows. It compares the present value of money today to the present value of money in future, taking inflation and returns into account The NPV of a sequence of cash flows takes as input the cash flows and a discount rate or discount curve and outputs a price; the converse process in DCF analysis taking a sequence of cash flows and a price as input and inferring as output a discount rate (the discount rate which would yield the given price as NPV) is called the yield and is more widely used in bond trading.

Formula
Each cash inflow/outflow is discounted back to its present value (PV). Then they are summed. Therefore NPV is the sum of all terms,

where - the time of the cash flow - the discount rate (the rate of return that could be earned on an investment in the financial markets with similar risk.); the opportunity cost of capital - the net cash flow i.e. cash inflow cash outflow, at time t . For educational purposes, is commonly placed to the left of the sum to emphasize its role as (minus) the investment. The result of this formula is multiplied with the Annual Net cash in-flows and reduced by Initial Cash outlay the present value but in cases where the cash flows are not equal in amount, then the previous formula will be used to determine the present value of each cash flow separately. Any cash flow within 12 months will not be discounted for NPV purpose, nevertheless the usual initial investments during the first year R0 are summed up a negative cash flow.

The discount rate

The rate used to discount future cash flows to the present value is a key variable of this process.

A firm's weighted average cost of capital (after tax) is often used, but many people believe that it is appropriate to use higher discount rates to adjust for risk or other factors. A variable discount rate with higher rates applied to cash flows occurring further along the time span might be used to reflect the yield curve premium for long-term debt. Another approach to choosing the discount rate factor is to decide the rate which the capital needed for the project could return if invested in an alternative venture. If, for example, the capital required for Project A can earn 5% elsewhere, use this discount rate in the NPV calculation to allow a direct comparison to be made between Project A and the alternative. Related to this concept is to use the firm's reinvestment rate. Reinvestment rate can be defined as the rate of return for the firm's investments on average. When analyzing projects in a capital constrained environment, it may be appropriate to use the reinvestment rate rather than the firm's weighted average cost of capital as the discount factor. It reflects opportunity cost of investment, rather than the possibly lower cost of capital. An NPV calculated using variable discount rates (if they are known for the duration of the investment) better reflects the situation than one calculated from a constant discount rate for the entire investment duration. Refer to the tutorial article written by Samuel Baker for more detailed relationship between the NPV value and the discount rate. For some professional investors, their investment funds are committed to target a specified rate of return. In such cases, that rate of return should be selected as the discount rate for the NPV calculation. In this way, a direct comparison can be made between the profitability of the project and the desired rate of return. To some extent, the selection of the discount rate is dependent on the use to which it will be put. If the intent is simply to determine whether a project will add value to the company, using the firm's weighted average cost of capital may be appropriate. If trying to decide between alternative investments in order to maximize the value of the firm, the corporate reinvestment rate would probably be a better choice.

Use in decision making

NPV is an indicator of how much value an investment or project adds to the firm. With a particular project, if is a positive value, the project is in the status of positive cash inflow in the time oft. If is a negative value, the project is in the status of discounted cash outflow in the time of t. Appropriately risked projects with a positive NPV could be accepted. This does not necessarily mean that they should be undertaken since NPV at the cost of capital may not account for opportunity cost, i.e., comparison with other available investments. In financial theory, if there is a choice between two mutually exclusive alternatives, the one yielding the higher NPV should be selected.

Risk Analysis

Risk analysis is a technique to identify and assess factors that may jeopardize the success of a project or achieving a goal. This technique also helps to define preventive measures to reduce the probability of these factors from occurring and identify countermeasures to successfully deal with these constraints when they develop to avert possible negative effects on the competitiveness of the company. Reference class forecasting was developed by professor Bent Flyvbjerg, University of Oxford, to increase accuracy in risk analysis. Daniel Kahneman, Nobel Prize winner in economics, calls Flyvbjerg's counsel to use reference class forecasting to de-bias forecasts of risk, "the single most important piece of advice regarding how to increase accuracy in forecasting, including forecasts of risk. One of the more popular methods to perform a risk analysis in the computer field is called facilitated risk analysis process (FRAP). Facilitated risk analysis process FRAP analyzes one system, application or segment of business processes at time. FRAP assumes that additional efforts to develop precisely quantified risks are not cost effective because:

Such estimates are time consuming Risk documentation becomes too voluminous for practical use Specific loss estimates are generally not needed to determine if controls are needed. Without assumptions there is little risk analysis

After identifying and categorizing risks, a team identifies the controls that could mitigate the risk. The decision for what controls are needed lies with the business manager. The team's conclusions as to what risks exists and what controls needed are documented along with a related action plan for control implementation. Three of the most important risks a software company faces are: unexpected changes in revenue, unexpected changes in costs from those budgeted and the amount of specialization of the software planned. Risks that affect revenues can be: unanticipated competition, privacy, intellectual property right problems, and unit sales that are less than forecast. Unexpected development costs also create risk that can be in the form of more rework than anticipated, security holes, and privacy invasions. Narrow specialization of software with a large amount of research and development expenditures can lead to both business and technological risks since specialization does not

necessarily lead to lower unit costs of software. Combined with the decrease in the potential customer base, specialization risk can be significant for a software firm. After probabilities of scenarios have been calculated with risk analysis, the process of risk management can be applied to help manage the risk. Methods like applied information economics add to and improve on risk analysis methods by introducing procedures to adjust subjective probabilities, compute the value of additional information and to use the results in part of a larger portfolio management problem.

Short Term Financing

As money became a commodity, the money market became a component of the financial markets for assets involved in short-term borrowing, lending, buying and selling with original maturities of one year or less. Trading in the money markets is done over the counter, is wholesale. Various instruments exist, such as Treasury bills, commercial paper, bankers' acceptances, deposits, certificates of deposit, bills of exchange, repurchase agreements, federal funds, and short-lived mortgage-, and asset-backed securities. It provides liquidity funding for the global financial system. Money markets and capital markets are parts of financial markets. The instruments bear differing maturities, currencies, credit risks, and structure. Therefore they may be used to distribute the exposure. Common money market instruments for short term financing:

Certificate of deposit - Time deposit, commonly offered to consumers by banks, thrift institutions, and credit unions. Repurchase agreements - Short-term loansnormally for less than two weeks and frequently for one dayarranged by selling securities to an investor with an agreement to repurchase them at a fixed price on a fixed date. Commercial paper - Unsecured promissory notes with a fixed maturity of one to 270 days; usually sold at a discount from face value. Eurodollar deposit - Deposits made in U.S. dollars at a bank or bank branch located outside the United States. Federal agency short-term securities - (in the U.S.). Short-term securities issued by government sponsored enterprises such as the Farm Credit System, the Federal Home Loan Banks and the Federal National Mortgage Association. Federal funds - (in the U.S.). Interest-bearing deposits held by banks and other depository institutions at the Federal Reserve; these are immediately available funds that institutions borrow or lend, usually on an overnight basis. They are lent for the federal funds rate. Municipal notes - (in the U.S.). Short-term notes issued by municipalities in anticipation of tax receipts or other revenues.

Treasury bills - Short-term debt obligations of a national government that are issued to mature in three to twelve months. Money funds - Pooled short maturity, high quality investments which buy money market securities on behalf of retail or institutional investors. Foreign Exchange Swaps - Exchanging a set of currencies in spot date and the reversal of the exchange of currencies at a predetermined time in the future.

Valuation
In finance, valuation is the process of estimating what something is worth. Items that are usually valued are a financial asset or liability. Valuations can be done on assets (for example, investments in marketable securities such as stocks, options, business enterprises, or intangible assets such as patents and trademarks) or on liabilities (e.g., bonds issued by a company). Valuations are needed for many reasons such as investment analysis, capital budgeting, merger and acquisition transactions, financial reporting, taxable events to determine the proper tax liability, and in litigation. Valuation of financial assets is done using one or more of these types of models: 1. Absolute value models that determine the present value of an asset's expected future cash flows. These kinds of models take two general forms: multi-period models such as discounted cash flow models or single-period models such as the Gordon model. These models rely on mathematics rather than price observation. 2. Relative value models determine value based on the observation of market prices of similar assets. 3. Option pricing models are used for certain types of financial assets (e.g., warrants, put options, call options, employee stock options, investments with embedded options such as a callable bond) and are a complex present value model. The most common option pricing models are the BlackScholes-Merton models and lattice models. Common terms for the value of an asset or liability are market value, fair value, and intrinsic value. The meanings of these terms differ. For instance, when an analyst believes a stock's intrinsic value is greater (less) than its market price, an analyst makes a "buy" ("sell") recommendation. Moreover, an asset's intrinsic value may be subject to personal opinion and vary among analysts. The International Valuation Standards include definitions for common bases of value and generally accepted practice procedures for valuing assets of all types.

BEC 3 (Financial Management) Questions

1. Which of the following is usually a benefit of using electronic funds transfer for international cash transactions? A) Creation of multilingual disaster recovery plans. B) Reduction in the frequency of data entry errors. C) Off-site storage of foreign source documents. D) Improvement in the audit trail for cash transactions.

2. JacKue Co. plans to produce 200,000 pairs of roller skates during January of next year. Planned production for February is 250,000 pairs. Sales are forecasted at 180,000 pairs for January and 240,000 pairs for February. Each pair of roller skates has eight wheels. JacKue's policy is to maintain 10% of the next month's production in inventory at the end of a month. How many wheels should JacKue purchase during January? A) 195,000 B) 205,000 C) 1,560,000 D) 1,640,000

3. Which of the following decision-making models equates the initial investment with the present value of the future cash inflows? A) Accounting rate of return. B) Payback period. C) Internal rate of return. D) Cost-benefit ratio.

4. Which of the following statements is correct regarding financial decision making? A) Opportunity cost is recorded as a normal business expense. B) The accounting rate of return considers the time value of money. C) A strength of the payback method is that it is based on profitability. D) Capital budgeting is based on predictions of an uncertain future.

5. 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.

6. Which of the following events would decrease the internal rate of return of a proposed asset purchase? A) Decrease tax credits on the asset. B) Decrease related working capital requirements. C) Shorten the payback period. D) Use accelerated, instead of straight-line depreciation.

7. Which of the following changes would result in the highest present value? A) A $100 decrease in taxes each year for four years. B) A $100 decrease in the cash outflow each year for three years.

C) A $100 increase in disposal value at the end of four years. D) A $100 increase in cash inflow each year for three years.

8. A lender and a borrower signed a contract for a $1,000 loan for one year. The lender asked the borrower to pay 3% interest. Inflation occurred and prices rose by 2% over the next year. The borrower repaid $1,030. What is the amount worth in real terms, after inflation? A) $1,060.90 B) $1,050.60 C) $1,019.80 D) $1,009.80

9. Which of the following is an advantage of net present value modeling? A) It is measured in time, not dollars. B) It uses accrual basis, not cash basis accounting for a project. C) It uses the accounting rate of return. D) It accounts for compounding of returns.

10. Which of the following individuals would be most hurt by an unanticipated increase in inflation? A) A retiree living on a fixed income. B) A borrower whose debt has a fixed interest rate. C) A union worker whose contract includes a provision for regular cost-of-living adjustments.

D) A saver whose savings was placed in a variable rate savings account.

11. A client wants to know how many years it will take before the accumulated cash flows from an investment exceed the initial investment, without taking the time value of money into account. Which of the following financial models should be used? A) Payback period. B) Discounted payback period. C) Internal rate of return. D) Net present value.

12. The calculation of depreciation is used in the determination of the net present value of an investment for which of the following reasons? A) The decline in the value of the investment should be reflected in the determination of net present value. B) Depreciation adjusts the book value of the investment. C) Depreciation represents cash outflow that must be added back to net income. D) Depreciation increases cash flow by reducing income taxes.

13. Wilson and Thomas are partners. Wilson contributed $150,000 to the partnership, and Thomas contributed $50,000. Wilson does 40% of the work, and Thomas does 60%. They do not have a partnership agreement that addresses the sharing of profits and losses. By the end of the year, the partnership has earned a profit of $200,000. What is Wilson's share of the profit under the Revised Uniform Partnership Act? A) $80,000 B) $100,000 C) $115,000

D) $150,000

14. ABC Co. had debt with a market value of $1 million and an after-tax cost of financing of 8%. ABC also had equity with a market value of $2 million and a cost of equity capital of 9%. ABC's weighted-average cost of capital would be A) 8.0% B) 8.5% C) 8.7% D) 9.0%

15. Carter Co. paid $1,000,000 for land three years ago. Carter estimates it can sell the land for $1,200,000, net of selling costs. If the land is not sold, Carter plans to develop the land at a cost of $1,500,000. Carter estimates net cash flow from the development in the first year of operations would be $500,000. What is Carter's opportunity cost of the development? A) $1,500,000 B) $1,200,000 C) $1,000,000 D) $500,000

16. What is the formula for calculating the profitability index of a project? A) Subtract actual after-tax net income from the minimum required return in dollars. B) Divide the present value of the annual after-tax cash flows by the original cash invested in the project. C) Divide the initial investment for the project by the net annual cash inflow.

D) Multiply net profit margin by asset turnover.

17. Which of the following statements is correct regarding the weighted-average cost of capital (WACC)? A) One of a company's objectives is to minimize the WACC. B) A company with a high WACC is attractive to potential shareholders. C) An increase in the WACC increases the value of the company. D) WACC is always equal to the company's borrowing rate.

18. An increase in which of the following should cause management to reduce the average inventory? A) The cost of placing an order. B) The cost of carrying inventory. C) The annual demand for the product. D) The lead time needed to acquire inventory.

19. Which of the following ratios would most likely be used by management to evaluate short-term liquidity? A) Return on total assets. B) Sales to cash. C) Accounts receivable turnover. D) Acid test ratio.

20. Which of the following ratios would be used to evaluate a company's profitability? A) Current ratio. B) Inventory turnover ratio. C) Debt to total assets ratio. D) Gross margin ratio.

21. Salem Co. is considering a project that yields annual net cash inflows of $420,000 for years 1 through 5, and a net cash inflow of $100,000 in year 6. The project will require an initial investment of $1,800,000. Salems cost of capital is 10%. Present value information is presented below: Present value of $1 for 5 years at 10% is .62. Present value of $1 for 6 years at 10% is .56. Present value of an annuity of $1 for 5 years at 10% is 3.79. What was Salems expected net present value for this project? A) $ 83,000 B) ($108,200) C) ($152,200) D) ($442,000)

22. Egan Co. owns land that could be developed in the future. Egan estimates it can sell the land for $1,200,000, net of all selling costs. If it is not sold, Egan will continue with its plans to develop the land. As Egan evaluates its options for development or sale of the property, what type of cost would the potential selling price represent in Egan's decision? A) Sunk. B) Opportunity.

C) Future. D) Variable.

23. Which of the following statements is correct regarding the payback method as a capital budgeting technique? A) The payback method considers the time value of money. B) An advantage of the payback method is that it indicates if an investment will be profitable. C) The payback method provides the years needed to recoup the investment in a project. D) Payback is calculated by dividing the annual cash inflows by the net investment.

24. Larson Corp. issued $20 million of long-term debt in the current year. What is a major advantage to Larson with the debt issuance? A) The reduced earnings per share possible through financial leverage. B) The relatively low after-tax cost due to the interest deduction. C) The increased financial risk resulting from the use of the debt. D) The reduction of Larsons control over the company.

25. Green, Inc., a financial investment-consulting firm, was engaged by Maple Corp. to provide technical support for making investment decisions. Maple, a manufacturer of ceramic tiles, was in the process of buying Bay, Inc., its prime competitor. Green's financial analyst made an independent detailed analysis of Bay's average collection period to determine which of the following? A) Financing. B) Return on equity.

C) Liquidity. D) Operating profitability.

26. A corporation is considering purchasing a machine that costs $100,000 and has a $20,000 salvage value. The machine will provide net annual cash inflows of $25,000 per year and has a six-year life. The corporation uses a discount rate of 10%. The discount factor for the present value of a single sum six years in the future is 0.564. The discount factor for the present value of an annuity for six years is 4.355. What is the net present value of the machine? A) ($2,405) B) $8,875 C) $20,155 D) $28,875

27. Which of the following is a limitation of the profitability index? A) It uses free cash flows. B) It ignores the time value of money. C) It is inconsistent with the goal of shareholder wealth maximization. D) It requires detailed long-term forecasts of the project's cash flows.

28. Which of the following metrics equates the present value of a project's expected cash inflows to the present value of the project's expected costs? A) Net present value. B) Return on assets. C) Internal rate of return.

D) Economic value-added.

29. A company recently issued 9% preferred stock. The preferred stock sold for $40 a share with a par of $20. The cost of issuing the stock was $5 a share. What is the company's cost of preferred stock? A) 4.5% B) 5.1% C) 9.0% D) 10.3%

30. The ABC Company is trying to decide between keeping an existing machine and replacing it with a new machine. The old machine was purchased just two years ago for $50,000 and had an expected life of 10 years. It now costs $1,000 a month for maintenance and repairs due to a mechanical problem. A new machine is being considered to replace it at a cost of $60,000. The new machine is more efficient and it will only cost $200 a month for maintenance and repairs. The new machine has an expected life of 10 years. In deciding to replace the old machine, which of the following factors, ignoring income taxes, should ABC not consider? A) Any estimated salvage value on the old machine. B) The original cost of the old machine. C) The estimated useful life of the new machine. D) The lower maintenance cost on the new machine.

31. Yarrow Co. is considering the purchase of a new machine that costs $450,000. The new machine will generate net cash flow of $150,000 per year and net income of $100,000 per year for five years. Yarrow's desired rate of return is 6%. The present value factor for a fiveyear annuity of $1, discounted at 6%, is 4.212. The present value factor of $1, at compound interest of 6% due in five years, is 0.7473. What is the new machine's net present value?

A) $450,000 B) $373,650 C) $181,800 D) $110,475

32. A corporation obtains a loan of $200,000 at an annual rate of 12%. The corporation must keep a compensating balance of 20% of any amount borrowed on deposit at the bank, but normally does not have a cash balance account with the bank. What is the effective cost of the loan? A) 12.0% B) 13.3% C) 15.0% D) 16.0%

33. Each of the following periods is included when computing a firm's target cash conversion cycle, except the A) Inventory conversion period. B) Payables deferral period. C) Average collection period. D) Cash discount period.

34. The profitability index is a variation on which of the following capital budgeting models? A) Internal rate of return.

B) Economic value-added. C) Net present value. D) Discounted payback.

35. A multiperiod project has a positive net present value. Which of the following statements is correct regarding its required rate of return? A) Less than the company's weighted average cost of capital. B) Less than the project's internal rate of return. C) Greater than the company's weighted average cost of capital. D) Greater than the project's internal rate of return.

36. Which of the following statements is true regarding the payback method? A) It does not consider the time value of money. B) It is the time required to recover the investment and earn a profit. C) It is a measure of how profitable one investment project is compared to another. D) The salvage value of old equipment is ignored in the event of equipment replacement.

37. The capital structure of a firm includes bonds with a coupon rate of 12% and an effective interest rate is 14%. The corporate tax rate is 30%. What is the firm's net cost of debt? A) 8.4%. B) 9.8%. C) 12.0%.

D) 14.0%.

38. What is the primary disadvantage of using return on investment (ROI) rather than residual income (RI) to evaluate the performance of investment center managers? A) ROI is a percentage, while RI is a dollar amount. B) ROI may lead to rejecting projects that yield positive cash flows. C) ROI does not necessarily reflect the company's cost of capital. D) ROI does not reflect all economic gains.

39. The benefits of debt financing over equity financing are likely to be highest in which of the following situations? A) High marginal tax rates and few noninterest tax benefits. B) Low marginal tax rates and few noninterest tax benefits. C) High marginal tax rates and many noninterest tax benefits. D) Low marginal tax rates and many noninterest tax benefits.

40. Amicable Wireless, Inc. offers credit terms of 2/10, net 30 for its customers. Sixty percent of Amicable's customers take the 2% discount and pay on day 10. The remainder of Amicable's customers pay on day 30. How many days' sales are in Amicable's accounts receivable? A) 06 B) 12 C) 18 D) 20

41. What would be the primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt? A) To cause the price of the company's stock to rise. B) To lower the company's bond rating. C) To reduce the risk for existing bondholders. D) To reduce the interest rate on the bonds being sold.

42. At the beginning of year 1, $10,000 is invested at 8% interest, compounded annually. What amount of interest is earned for year 2? A) $800.00 B) $806.40 C) $864.00 D) $933.12

43. 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.

44. The optimal capitalization for an organization usually can be determined by the

A) Maximum degree of financial leverage (DFL). B) Maximum degree of total leverage (DTL). C) Lowest total weighted-average cost of capital (WACC). D) Intersection of the marginal cost of capital and the marginal efficiency of investment.

45. Super Sets, Inc. manufactures and sells television sets. All sales are finalized on credit with terms of 2/10, n/30. Seventy percent of Super Set customers take discounts and pay on day 10, while the remaining 30% pay on day 30. What is the average collection period in days? A) 10 B) 16 C) 24 D) 40

46. Net present value as used in investment decision-making is stated in terms of which of the following options? A) Net income. B) Earnings before interest, taxes, and depreciation. C) Earnings before interest and taxes. D) Cash flow.

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

A) Bonds. B) Common stock. C) Long-term debt. D) Short-term debt.

48. Which of the following terms represents the residual income that remains after the cost of all capital, including equity capital, has been deducted? A) Free cash flow. B) Market value-added. C) Economic value-added. D) Net operating capital.

49. Which of the following formulas should be used to calculate the economic rate of return on common stock? A) (Dividends + change in price) divided by beginning price. B) (Net income - preferred dividend) divided by common shares outstanding. C) Market price per share divided by earnings per share. D) Dividends per share divided by market price per share.

50. Which of the following factors is inherent in a firm's operations if it utilizes only equity financing? A) Financial risk. B) Business risk.

C) Interest rate risk. D) Marginal risk.

51. The CFO of a company is concerned about the company's accounts receivable turnover ratio. The company currently offers customers terms of 3/10, net 30. Which of the following strategies would most likely improve the company's accounts receivable turnover ratio? A) Pledging the accounts receivable to a finance company. B) Changing customer terms to 1/10, net 30. C) Entering into a factoring agreement with a finance company. D) Changing customer terms to 3/20, net 30.

52. A project has an initial outlay of $1,000. The projected cash inflows are: Year 1 $200 Year 2 $200 Year 3 $400 Year 4 $400 What is the investment's payback period? A) 4.0 years. B) 3.5 years. C) 3.4 years. D) 3.0 years.

53. Which of the following effects would a lockbox most likely provide for receivables management? A) Minimized collection float. B) Maximized collection float. C) Minimized disbursement float. D) Maximized disbursement float.

Answer Key: 1)B 2)D 3)C 4)D 5)D 6)A 7)A 8)D 9)D 10)A 11)A 12)D 13)B 14)C 15)B 16)B 17)A 18)B 19)D 20)D 21)C 22)B 23)C 24)B 25)C 26)C 27)D 28)C 29)B 30)B 31)C 32)C 33)D 34)C 35)B 36)A 37)B 38)B 39)A 40)C 41)D 42)C 43)A 44)C 45)B 46)D 47)B 48)C 49)A 50)B 51)C 52)B 53)A

Business Environment and Concepts 4: Information Systems and Communications Computer Networks
A computer network, or simply a network, is a collection of computers and other hardware interconnected by communication channels that allow sharing of resources and information. Where at least one process in one device is able to send/receive data to/from at least one process residing in a remote device, then the two devices are said to be in a network. A network is a group of devices connected to each other. Networks may be classified into a wide variety of characteristics, such as the medium used to transport the data, communications protocol used, scale, topology, benefit, and organizational scope. Networks are often classified by their physical or organizational extent or their purpose. Usage, trust level, and access rights differ between these types of networks. Local area network A local area network (LAN) is a network that connects computers and devices in a limited geographical area such as home, school, computer laboratory, office building, or closely positioned group of buildings. Each computer or device on the network is a node. Current wired LANs are most likely to be based on Ethernet technology, although new standards like ITU-T G.hn also provide a way to create a wired LAN using existing home wires (coaxial cables, phone lines and power lines). Wide area network A wide area network (WAN) is a computer network that covers a large geographic area such as a city, country, or spans even intercontinental distances, using a communications channel that combines many types of media such as telephone lines, cables, and air waves. A WAN often uses transmission facilities provided by common carriers, such as telephone companies. WAN technologies generally function at the lower three layers of the OSI reference model: the physical layer, the data link layer, and the network layer. Backbone network A backbone network is part of a computer network infrastructure that interconnects various pieces of network, providing a path for the exchange of information between different LANs or subnetworks. A backbone can tie together diverse networks in the same building, in different buildings in a campus environment, or over wide areas. Normally, the backbone's capacity is greater than that of the networks connected to it.

A large corporation which has many locations may have a backbone network that ties all of these locations together, for example, if a server cluster needs to be accessed by different departments of a company which are located at different geographical locations. The equipment which ties these departments together constitute the network backbone. Network performance management including network congestion are critical parameters taken into account when designing a network backbone. A specific case of a backbone network is the Internet backbone, which is the set of wide-area network connections and core routers that interconnect all networks connected to the Internet. Internet The Internet is a global system of interconnected governmental, academic, corporate, public, and private computer networks. It is based on the networking technologies of the Internet Protocol Suite.The Internet is also the communications backbone underlying the World Wide Web (WWW).

Database Management Systems

A Database Management System (DBMS) is a set of programs that enables you to store, modify, and extract information from a database, it also provides users with tools to add, delete, access, modify, and analyze data stored in one location. A group can access the data by using query and reporting tools that are part of the DBMS or by using application programs specifically written to access the data. DBMSs also provide the method for maintaining the integrity of stored data, running security and users access, and recovering information if the system fails. The information from a database can be presented in a variety of formats. Most DBMSs include a report writer program that enables you to output data in the form of a report. Many DBMSs also include a graphics component that enables you to output information in the form of graphs and charts. Database and database management system are essential to all areas of business, they must be carefully managed. There are many different types of DBMSs, ranging from small systems that run on personal computers to huge systems that run on mainframes. The following are examples of database applications: computerized library systems, flight reservation systems, and computerized parts inventory systems. It typically supports query languages, which are in fact high-level programming languages, dedicated database languages that considerably simplify writing database application programs. Database languages also simplify the database organization as well as retrieving and presenting information from it. A DBMS provides facilities for controlling data access, enforcing data integrity, managing concurrency control, and recovering the database after failures and restoring it from backup files, as well as maintaining database security.

Information Security

Information security means protecting information and information systems from unauthorized access, use, disclosure, disruption, modification, perusal, inspection, recording or destruction. The terms information security, computer security and information assurance are frequently used interchangeably. These fields are interrelated often and share the common goals of protecting the confidentiality, integrity and availability of information; however, there are some subtle differences between them. These differences lie primarily in the approach to the subject, the methodologies used, and the areas of concentration. Information security is concerned with the confidentiality, integrity and availability of data regardless of the form the data may take: electronic, print, or other forms. Computer security can focus on ensuring the availability and correct operation of a computer system without concern for the information stored or processed by the computer. Information assurance focuses on the reasons for assurance that information is protected, and is thus reasoning about information security. Should confidential information about a business' customers or finances or new product line fall into the hands of a competitor, such a breach of security could lead to negative consequences. Protecting confidential information is a business requirement, and in many cases also an ethical and legal requirement. The field of information security has grown and evolved significantly in recent years. There are many ways of gaining entry into the field as a career. It offers many areas for specialization including: securing network(s) and allied infrastructure, securing applications and databases, security testing, information systems auditing, business continuity planning and digital forensics science, etc. Key concepts The CIA triad (confidentiality, integrity and availability) is one of the core principles of information security. There is continuous debate about extending this classic trio.[citation needed] Other principles such as Accountability have sometimes been proposed for addition it has been pointed out[citation needed] that issues such as Non-Repudiation do not fit well within the three core concepts, and as regulation of computer systems has increased (particularly amongst the Western nations) Legality is becoming a key consideration for practical security installations. In 1992 and revised in 2002 the OECD's Guidelines for the Security of Information Systems and Networks proposed the nine generally accepted principles: Awareness, Responsibility, Response, Ethics, Democracy, Risk Assessment, Security Design and Implementation, Security Management, and Reassessment. Building upon those, in 2004 the NIST's Engineering Principles for Information Technology Security proposed 33 principles. From each of these derived guidelines and practices. In 2002, Donn Parker proposed an alternative model for the classic CIA triad that he called the six atomic elements of information. The elements are confidentiality, possession, integrity, authenticity, availability, and utility. The merits of the Parkerian hexad are a subject of debate amongst security professionals.

Confidentiality Confidentiality is the term used to prevent the disclosure of information to unauthorized individuals or systems. For example, a credit card transaction on the Internet requires the credit card number to be transmitted from the buyer to the merchant and from the merchant to a transaction processing network. The system attempts to enforce confidentiality by encrypting the card number during transmission, by limiting the places where it might appear (in databases, log files, backups, printed receipts, and so on), and by restricting access to the places where it is stored. If an unauthorized party obtains the card number in any way, a breach of confidentiality has occurred. Confidentiality is necessary (but not sufficient) for maintaining the privacy of the people whose personal information a system holds. Integrity In information security, integrity means that data cannot be modified undetectably. This is not the same thing as referential integrity in databases, although it can be viewed as a special case of Consistency as understood in the classic ACID model of transaction processing. Integrity is violated when a message is actively modified in transit. Information security systems typically provide message integrity in addition to data confidentiality. Availability For any information system to serve its purpose, the information must be available when it is needed. This means that the computing systems used to store and process the information, the security controls used to protect it, and the communication channels used to access it must be functioning correctly. High availability systems aim to remain available at all times, preventing service disruptions due to power outages, hardware failures, and system upgrades. Ensuring availability also involves preventing denial-ofservice attacks. Authenticity In computing, e-Business, and information security, it is necessary to ensure that the data, transactions, communications or documents (electronic or physical) are genuine. It is also important for authenticity to validate that both parties involved are who they claim to be. Non-repudiation In law, non-repudiation implies one's intention to fulfill their obligations to a contract. It also implies that one party of a transaction cannot deny having received a transaction nor can the other party deny having sent a transaction.

Electronic commerce uses technology such as digital signatures and public key encryption to establish authenticity and non-repudiation.

Management Information Systems

A management information system (MIS) provides information that is needed to manage organizations efficiently and effectively. Management information systems are not only computer systems - these systems encompass three primary components: technology, people (individuals, groups, or organizations), and data/information for decision making. Management information systems are distinct from other information systems in that they are designed to be used to analyze and facilitate strategic and operational activities in the organization. Academically, the term is commonly used to refer to the study of how individuals, groups, and organizations evaluate, design, implement, manage, and utilize systems to generate information to improve efficiency and effectiveness of decision making, including systems termed decision support systems, expert systems, and executive information systems. Most business schools (or colleges of business administration within universities) have an MIS department, alongside departments of accounting, finance, management, marketing, and sometimes others, and grant degrees (at undergrad, masters, and PhD levels) in MIS. A management information system gives the business managers the information that they need to take decisions. Early business computers were used for simple operations such as tracking inventory, billing, sales, or payroll data, with little detail or structure. Over time, these computer applications became more complex, hardware [32] storage capacities grew, and technologies improved for connecting previously isolated applications. As more data was stored and linked, managers sought greater abstraction as well as greater detail with the aim of creating significant management reports from the raw, stored data. Originally, the term "MIS" described applications providing managers with information about sales, inventories, and other data that would help in managing the enterprise. Over time, the term broadened to include: decision support systems, resource management and human resource management, enterprise resource planning (ERP), enterprise performance management (EPM), supply chain management (SCM), customer relationship management (CRM), project management and database retrieval applications. An MIS supports a business' long range plans, providing reports based upon performance analysis in areas critical to those plans, with feedback loops that improve guidance for every aspect of the enterprise, including recruitment and training. MIS not only indicates how various aspects of a business are performing, but also why and where. MIS reports include near-real-time performance of cost centers and projects with detail sufficient for individual accountability.

Network Devices
The following are major hardware network devices:

Gateway: device sitting at a network node for interfacing with another network that uses different protocols. Works on OSI layers 4 to 7. Router: a specialized network device that determines the next network point to which it can forward a data packet towards the destination of the packet. Unlike a gateway, it cannot interface different protocols. Works on OSI layer 3. Switch: a device that allocates traffic from one network segment to certain lines (intended destination(s)) which connect the segment to another network segment. So unlike a hub a switch splits the network traffic and sends it to different destinations rather than to all systems on the network. Works on OSI layer 2. Bridge: a device that connects multiple network segments along the data link layer. Works on OSI layer 2. Hub: connects multiple Ethernet segments together making them act as a single segment. When using a hub, every attached device shares the same broadcast domain and the same collision domain. Therefore, only one computer connected to the hub is able to transmit at a time. Depending on the network topology, the hub provides a basic level 1 OSI model connection among the network objects (workstations, servers, etc.). It provides bandwidth which is shared among all the objects, compared to switches, which provide a connection between individual nodes. Works on OSI layer 1. Repeater: device to amplify or regenerate digital signals received while sending them from one part of a network into another. Works on OSI layer 1. Firewalls: A firewall is an important aspect of a network with respect to security. It typically rejects access requests from unsafe sources while allowing actions from recognized ones.

Personal Computer Hardware

Personal computer hardware are the component devices that are the building blocks of personal computers. These are typically installed into a computer case, or attached to it by a cable or through a port. In the latter case, they are also referred to asperipherals. The motherboard is the main component inside the case. It is a large rectangular board with integrated circuitry that connects the other parts of the computer including the CPU, the RAM, the disk drives (CD, DVD, hard disk, or any others) as well as any peripherals connected via the ports or the expansion slots. Components directly attached to the motherboard include:

The CPU (Central Processing Unit) performs most of the calculations which enable a computer to function, and is sometimes referred to as the "brain" of the computer. It is usually cooled by a heat sink and fan. Most newer CPUs include an on-die Graphics Processing Unit (GPU). The Chipset, which includes the north bridge, mediates communication between the CPU and the other components of the system, including main memory. The Random-Access Memory (RAM) stores the code and data that are being actively accessed by the CPU. The Read-Only Memory (ROM) stores the BIOS that runs when the computer is powered on or otherwise begins execution, a process known as Bootstrapping, or "booting" or "booting up". The BIOS (Basic Input Output System) includes boot firmware and power management firmware. Newer motherboards use Unified Extensible Firmware Interface (UEFI) instead of BIOS. Buses connect the CPU to various internal components and to expansion cards for graphics and sound.
o

PCI Express: for expansion cards such as graphics, sound, network interfaces, TV tuners, etc. PCI: for other expansion cards. SATA: for disk drives. Ports for external peripherals. These ports may be controlled directly by the south bridge [33] I/O controller or provided by expansion cards attached to the motherboard. o USB o Memory Card o FireWire o eSATA o SCSI

Fixed media

Hard disk drives: a hard disk drive (HDD; also hard drive, hard disk, or disk drive)[2] is a device for storing and retrieving digital information, primarily computer data. It consists of one or more rigid (hence "hard") rapidly rotating discs (often referred to as platters), coated with magnetic material and with magnetic heads arranged to write data to the surfaces and read it from them. Solid-state drives: a solid-state drive (SSD), sometimes called a solid-state disk or electronic disk, is a data storage device that uses solid-state memory to store persistent data with the intention of providing access in the same manner of a traditional block I/O hard disk drive. SSDs are distinguished from traditional magnetic disks such as hard disk drives (HDDs) or floppy disk, which are electromechanical devices containing spinning disks and movable read/write heads. RAID array controller - a device to manage several internal or external hard disks and optionally some peripherals in order to achieve performance or reliability improvement in what is called a RAID array.

Removable media

Optical Disc Drives for reading from and writing to various kinds of optical media, including Compact Discs such as CD-ROMs, DVDs, DVD-RAMs and Blu-ray Discs. Optical discs are the most common way of transferring digital video, and are popular for data storage as well. Floppy disk drives for reading and writing to floppy disks, an outdated storage media consisting of a thin disk of a flexible magnetic storage medium. These were once standard on most computers but are no longer in common use. Floppies are used today mainly for loading device drivers not included with an operating system release (for example, RAID drivers). Zip drives, an outdated medium-capacity removable disk storage system, for reading from and writing to Zip disks, was first introduced by Iomega in 1994. USB flash drive plug into a USB port and do not require a separate drive. USB flash drive is a typically small, lightweight, removable, and rewritable flash memory data storage device integrated with a USB interface. Capacities vary, from hundreds of megabytes (in the same range as CDs) to tens of gigabytes (surpassing Blu-ray discs but also costing significantly more). Memory card readers for reading from and writing to Memory cards, a flash memory data storage device used to store digital information. Memory cards are typically used on mobile devices. They are thinner, smaller and lighter than USB flash drives. Common types of memory cards are SD and MS. Tape drives read and write data on a magnetic tape, and are used for long term storage and backups.

Risk Management
Risk management is the process of identifying vulnerabilities and threats to the information resources used by an organization in achieving business objectives, and deciding what countermeasures, if any, to take in reducing risk to an acceptable level, based on the value of the information resource to the organization. There are two things in this definition that may need some clarification. First, the process of risk management is an ongoing, iterative process. It must be repeated indefinitely. The business environment is constantly changing and new threats and vulnerability emerge every day. Second, the choice of countermeasures (controls) used to manage risks must strike a balance between productivity, cost, effectiveness of the countermeasure, and the value of the informational asset being protected. Risk analysis and risk evaluation processes have their limitations since, when security incidents occur, they emerge in a context, and their rarity and even their uniqueness give rise to unpredictable threats. The analysis of these phenomena which are characterized by breakdowns, surprises and side-effects, requires a theoretical approach which is able to examine and interpret subjectively the detail of each incident. Risk is the likelihood that something bad will happen that causes harm to an informational asset (or the loss of the asset). A vulnerability is a weakness that could be used to endanger or cause harm to an informational asset. A threat is anything (manmade or act of nature) that has the potential to cause harm. The likelihood that a threat will use a vulnerability to cause harm creates a risk. When a threat does use a vulnerability to inflict harm, it has an impact. In the context of information security, the impact is a loss of

availability, integrity, and confidentiality, and possibly other losses (lost income, loss of life, loss of real property). It should be pointed out that it is not possible to identify all risks, nor is it possible to eliminate all risk. The remaining risk is called "residual risk". A risk assessment is carried out by a team of people who have knowledge of specific areas of the business. Membership of the team may vary over time as different parts of the business are assessed. The assessment may use a subjective qualitative analysis based on informed opinion, or where reliable dollar figures and historical information is available, the analysis may usequantitative analysis. The research has shown that the most vulnerable point in most information systems is the human user, operator, designer, or other human The ISO/IEC 27002:2005 Code of practice for information security management recommends the following be examined during a risk assessment:

security policy, organization of information security, asset management, human resources security, physical and environmental security, communications and operations management, access control, information systems acquisition, development and maintenance, information security incident management, business continuity management, and regulatory compliance.

In broad terms, the risk management process consists of: 1. Identification of assets and estimating their value. Include: people, buildings, hardware, software, data (electronic, print, other), supplies. 2. Conduct a threat assessment. Include: Acts of nature, acts of war, accidents, malicious acts originating from inside or outside the organization. 3. Conduct a vulnerability assessment, and for each vulnerability, calculate the probability that it will be exploited. Evaluate policies, procedures, standards, training, physical security, quality control, technical security. 4. Calculate the impact that each threat would have on each asset. Use qualitative analysis or quantitative analysis. 5. Identify, select and implement appropriate controls. Provide a proportional response. Consider productivity, cost effectiveness, and value of the asset. 6. Evaluate the effectiveness of the control measures. Ensure the controls provide the required cost effective protection without discernible loss of productivity. For any given risk, management can choose to accept the risk based upon the relative low value of the asset, the relative low frequency of occurrence, and the relative low impact on the business. Or, leadership may choose to mitigate the risk by selecting and implementing appropriate control measures to reduce the

risk. In some cases, the risk can be transferred to another business by buying insurance or outsourcing to another business. The reality of some risks may be disputed. In such cases leadership may choose to deny the risk.

Roles in the Information Technology Industry

Information technology (IT) is the use of computers and telecommunications equipment to store, retrieve, transmit and manipulate data. The term is commonly used as a synonym for computers and computer networks. A web developer is a programmer who specializes in, or is specifically engaged in, the development of World Wide Web applications, or distributed network applications that are run over HTTP from a web server to a web browser. A Network Engineer is involved in the design and maintenance of both the hardware and software necessary for a computer network. They are high level technical analysts with a specialty in Local Area Networks (LANs) or Wide Area Networks (WANs). A Network Administrator is a professional in charge of the maintenance of the computer hardware and software systems that make up a computer network. A Programmer, computer programmer, developer, or coder is a person who writes computer software. The term computer programmer can refer to a specialist in one area of computer programming or to a generalist who writes code for many kinds of software. System Administrators are responsible for maintaining the computer systems of a company. Server management is a primary responsibility, and a System Administrator would be responsible for installing, maintaining and upgrading servers. Database Administrators use database software to store and manage information. They will often set up database systems and are responsible for making sure those systems operate efficiently. A Project Manager is responsible for managing the resources of large projects. In the IT industry, this can mean managing large Software Development projects, Networking projects, IT installations or conversions, or any other function where business and technology needs have to be managed and resources have to be coordinated for a project. A Chief Technology Officer or chief technical officer (CTO) is an executive-level position in a company or other entity whose occupant is focused on scientific and technological issues within an organization.

The Chief Information Officer (CIO) is a job title for the head of information technology within an organization.

Security Controls
Security controls are safeguards or countermeasures to avoid, counteract or minimize security risks. To help review or design security controls, they can be classified by several criteria, for example according to the time that they act, relative to a security incident:

Before the event, preventive controls are intended to prevent an incident from occurring e.g. by locking out unauthorized intruders; During the event, detective controls are intended to identify and characterize an incident in progress e.g. by sounding the intruder alarm and alerting the security guards or police; After the event, corrective controls are intended to limit the extent of any damage caused by the incident e.g. by recovering the organization to normal working status as efficiently as possible.

(Some security professionals would add further categories such as deterrent controls and compensation. Others argue that these are subsidiary categories. This is simply a matter of semantics.) Security controls can also be categorized according to their nature, for example:

Physical controls e.g. fences, doors, locks and fire extinguishers; Procedural controls e.g. incident response processes, management oversight, security awareness and training; Technical controls e.g. user authentication (login) and logical access controls, antivirus software, firewalls; Legal and regulatory or compliance controls e.g. privacy laws, policies and clauses.

A similar categorization distinguishes control involving people, technology and operations/processes. Information security controls protect the confidentiality, integrity and/or availability of information (the so-called CIA Triad). Again, some would add further categories such as non-repudiation and accountability, depending on how narrowly or broadly the CIA Triad is defined. Risk-aware organizations may choose proactively to specify, design, implement, operate and maintain their security controls, usually by assessing the risks and implementing a comprehensive security management framework such as ISO/IEC 27002, the Information Security Forum's Standard of Good Practice for Information Security and NIST SP 800-53 (more below). Organizations may also opt to demonstrate the adequacy of their information security controls by being independently assessed against certification standards such as ISO/IEC 27001. In telecommunications, security controls are defined as Security services as part of OSI Reference model by ITU-T X.800 Recommendation. X.800 and ISO ISO 7498-2 (Information processing systems

Open systems interconnection Basic Reference Model Part 2: Security architecture are technically aligned.

Segregation of duties
Separation of duties is the concept of having more than one person required to complete a task. In business the separation by sharing of more than one individual in one single task shall prevent from fraud and error. The concept is alternatively called segregation of duties or, in thepolitical realm, separation of powers. In democracies, the separation of legislation from administration shall serve for unbiased government. The concept is addressed in technical systems and in information technology equivalently and generally addressed as redundancy. Application in General Business and Accoutning The term SoD is already well known in financial accounting systems. Companies in all sizes understand not to combine roles such as receiving checks (payment on account) and approving write-offs, depositing cash and reconciling bank statements, approving time cards and have custody of pay checks, etc. SoD is fairly new to most Information Technology (IT) departments, but a high percentage of SarbanesOxley internal audit issues come from IT. In information systems, segregation of duties helps reduce the potential damage from the actions of one person. IS or end-user department should be organized in a way to achieve adequate separation of duties. According to ISACA's Segregation of Duties Control matrix, some duties should not be combined into one position. This matrix is not an industry standard, just a general guideline suggesting which positions should be separated and which require compensating controls when combined. Depending on a company's size, functions and designations may vary. When duties cannot be separated, compensating controls should be in place. Compensating controls are internal controls that are intended to reduce the risk of an existing or potential control weakness. If a single person can carry out and conceal errors and/or irregularities in the course of performing their day-to-day activities, they have been assigned SoD incompatible duties. There are several control mechanisms that can help to enforce the segregation of duties: 1. Audit trails enable IT managers or Auditors to recreate the actual transaction flow from the point of origination to its existence on an updated file. Good audit trails should be enabled to provide information on who initiated the transaction, the time of day and date of entry, the type of entry, what fields of information it contained, and what files it updated. 2. Reconciliation of applications and an independent verification process is ultimately the responsibility of users, which can be used to increase the level of confidence that an application ran successfully. 3. Exception reports are handled at supervisory level, backed up by evidence noting that exceptions are handled properly and in timely fashion. A signature of the person who prepares the report is normally required.

4. Manual or automated system or application transaction logs should be maintained, which record all processed system commands or application transactions. 5. Supervisory review should be performed through observation and inquiry. 6. To compensate mistakes or intentional failures by following a prescribed procedure, independent reviews are recommended. Such reviews can help detect errors and irregularities. Application in information systems The accounting profession has invested significantly in separation of duties because of the understood risks accumulated over hundreds of years of accounting practice. By contrast, many corporations in the United States found that an unexpectedly high proportion of their Sarbanes-Oxley internal control issues came from IT. Separation of duties is commonly used in large IT organizations so that no single person is in a position to introduce fraudulent or malicious code or data without detection. Role based access control is frequently used in IT systems where SoD is required. Strict control of software and data changes will require that the same person or organizations performs only one of the following roles:

Identification of a requirement (or change request); e.g. a business person Authorization and approval; e.g. an IT governance board or manager Design and development; e.g. a developer Review, inspection and approval; e.g. another developer or architect. Implementation in production; typically a software change or system administrator.

This is not an exhaustive presentation of the software development life cycle, but a list of critical development functions applicable to separation of duties. To successfully implement separation of duties in information systems a number of concerns need to be addressed:

The process used to ensure a person's authorization rights in the system is in line with his role in the organization. The authentication method used such as knowledge of a password, possession of an object (key, token) or a biometrical characteristic. Circumvention of rights in the system can occur through database administration access, user administration access, tools which provide back-door access or supplier installed user accounts. Specific controls such as a review of an activity log may be required to address this specific concern.

BEC 4 (Information Systems and Communications) Questions

1. An accounts payable clerk is accused of making unauthorized changes to previous payments to a vendor. Proof could be uncovered in which of the following places? A) Transaction logs. B) Error reports. C) Error files. D) Validated data file.

2. 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.

3. Which of the following best describes a hot site? A) Location within the company that is most vulnerable to a disaster. B) Location where a company can install data processing equipment on short notice. C) Location that is equipped with a redundant hardware and software configuration. D) Location that is considered too close to a potential disaster area.

4. Compared to online real-time processing, batch processing has which of the following disadvantages? A) A greater level of control is necessary. B) Additional computing resources are required.

C) Additional personnel are required. D) Stored data are current only after the update process.

5. Which of the following represents the procedure managers use to identify whether the company has information that unauthorized individuals want, how these individuals could obtain the information, the value of the information, and the probability of unauthorized access occurring? A) Disaster recovery plan assessment. B) Systems assessment. C) Risk assessment. D) Test of controls.

6. A value-added network (VAN) is a privately owned network that performs which of the following functions? A) Route data transactions between trading partners. B) Route data within a company's multiple networks. C) Provide additional accuracy for data transmissions. D) Provide services to send marketing data to customers.

7. Which of the following is a key difference in controls when changing from a manual system to a computer system? A) Internal control principles change. B) Internal control objectives differ. C) Control objectives are more difficult to achieve. D) Methodologies for implementing controls change.

8. When a client's accounts payable computer system was relocated, the administrator provided support through a dial-up connection to a server. Subsequently, the administrator left the company. No changes were made to the accounts payable system at that time. Which of the following situations represents the greatest security risk? A) User passwords are not required to be in alpha-numeric format. B) Management procedures for user accounts are not documented. C) User accounts are not removed upon termination of employees. D) Security logs are not periodically reviewed for violations.

9. An entity doing business on the Internet most likely could use any of the following methods to prevent unauthorized intruders from accessing proprietary information except A) Password management. B) Data encryption. C) Digital certificates. D) Batch processing.

10.Which of the following information technology (IT) departmental responsibilities should be delegated to separate individuals? A) Network maintenance and wireless access. B) Data entry and antivirus management. C) Data entry and application programming. D) Data entry and quality assurance.

11. Which of the following transaction processing modes provides the most accurate and complete information for decision making? A) Batch. B) Distributed. C) Online. D) Application.

12. Which of the following is considered an application input control? A) Run control total. B) Edit check. C) Report distribution log. D) Exception report.

13. Which of the following terms refers to a site that has been identified and maintained by the organization as a data processing disaster recovery site but has not been stocked with equipment? A) Hot. B) Cold. C) Warm. D) Flying start.

14. Which of the following items would be most critical to include in a systems specification document for a financial report? A) Cost-benefit analysis.

B) Data elements needed. C) Training requirements. D) Communication change management considerations.

15. An enterprise resource planning (ERP) system has which of the following advantages over multiple independent functional systems? A) Modifications can be made to each module without affecting other modules. B) Increased responsiveness and flexibility while aiding in the decision-making process. C) Increased amount of data redundancy since more than one module contains the same information. D) Reduction in costs for implementation and training.

16. Which of the following structures refers to the collection of data for all vendors in a relational data base? A) Record. B) Field. C) File. D) Byte.

17. During the annual audit, it was learned from an interview with the controller that the accounting system was programmed to use a batch processing method and a detailed posting type. This would mean that individual transactions were A) Posted upon entry, and each transaction had its own line entry in the appropriate ledger. B) Assigned to groups before posting, and each transaction had its own line entry in the appropriate ledger.

C) Posted upon entry, and each transaction group had a cumulative entry total in the appropriate ledger. D) Assigned to groups before posting, and each transaction group had a cumulative entry total in the appropriate ledger.

18. A company has a significant e-commerce presence and self-hosts its web site. To assure continuity in the event of a natural disaster, the firm should adopt which of the following strategies? A) Backup the server database daily. B) Store records off-site. C) Purchase and implement RAID technology. D) Establish off-site mirrored web server.

19. Which of the following is the primary advantage of using a value-added network (VAN)? A) It provides confidentiality for data transmitted over the Internet. B) It provides increased security for data transmissions. C) It is more cost effective for the company than transmitting data over the Internet. D) It enables the company to obtain trend information on data transmissions.

20. 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.

21. Which of the following technologies is specifically designed to exchange financial information over the World Wide Web? A) Hypertext markup language (HTML). B) Extensible business reporting language (XBRL). C) Hypertext transfer protocol (HTTP). D) Transmission control program/internet protocol (TCP/IP).

22. Which of the following solutions creates an encrypted communication tunnel across the Internet for the purpose of allowing a remote user secure access into the network? A) Packet-switched network. B) Digital encryption. C) Authority certificate. D) Virtual private network.

23. What is the correct ascending hierarchy of data in a system? A) Character, record, file, field. B) Field, character, file, record. C) Character, field, record, file. D) Field, record, file, character.

24. In a large firm, custody of an entity's data is most appropriately maintained by which of the following personnel? A) Data librarian. B) Systems analyst. C) Computer operator. D) Computer programmer.

25. An enterprise resource planning system is designed to A) Allow nonexperts to make decisions about a particular problem. B) Help with the decision-making process. C) Integrate data from all aspects of an organization's activities. D) Present executives with the information needed to make strategic plans.

26. Which of the following statements is correct concerning the security of messages in an electronic data interchange (EDI) system? A) Removable drives that can be locked up at night provide adequate security when the confidentiality of data is the primary risk. B) Message authentication in EDI systems performs the same function as segregation of duties in other information systems. C) Encryption performed by a physically secure hardware device is more secure than encryption performed by software. D) Security at the transaction phase in EDI systems is not necessary because problems at that level will be identified by the service provider.

27. 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.

28. The computer operating system performs scheduling, resource allocation, and data retrieval functions based on a set of instructions provided by the A) Multiplexer. B) Peripheral processors. C) Concentrator. D) Job control language.

29. Which of the following types of control plans is particular to a specific process or subsystem, rather than related to the timing of its occurrence? A) Preventive. B) Corrective. C) Application. D) Detective.

30. Which of the following procedures should be included in the disaster recovery plan for an Information Technology department? A) Replacement personal computers for user departments. B) Identification of critical applications.

C) Physical security of warehouse facilities. D) Cross-training of operating personnel.

31. A digital signature is used primarily to determine that a message is A) Unaltered in transmission. B) Not intercepted en route. C) Received by the intended recipient. D) Sent to the correct address.

32. 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.

33. In an accounting information system, which of the following types of computer files most likely would be a master file? A) Inventory subsidiary. B) Cash disbursements. C) Cash receipts. D) Payroll transactions.

34. Which of the following is an advantage of a computer-based system for transaction processing over a manual system? A computer-based system A) Does not require as stringent a set of internal controls. B) Will produce a more accurate set of financial statements. C) Will be more efficient at producing financial statements. D) Eliminates the need to reconcile control accounts and subsidiary ledgers.

35. Which of the following risks can be minimized by requiring all employees accessing the information system to use passwords? A) Collusion. B) Data entry errors. C) Failure of server duplicating function. D) Firewall vulnerability.

36. Which of the following areas of responsibility are normally assigned to a systems programmer in a computer system environment? A) Systems analysis and applications programming. B) Data communications hardware and software. C) Operating systems and compilers. D) Computer operations.

37. Most client/server applications operate on a three-tiered architecture consisting of which of the following layers? A) Desktop client, application, and database.

B) Desktop client, software, and hardware. C) Desktop server, application, and database. D) Desktop server, software, and hardware.

38. Which of the following is a computer program that appears to be legitimate but performs an illicit activity when it is run? A) Redundant verification. B) Parallel count. C) Web crawler. D) Trojan horse.

39. Which of the following input controls would prevent an incorrect state abbreviation from being accepted as legitimate data? A) Reasonableness test. B) Field check. C) Digit verification check. D) Validity check.

40. Compared to batch processing, real-time processing has which of the following advantages? A) Ease of auditing. B) Ease of implementation. C) Timeliness of information. D) Efficiency of processing.

41. Which of the following is a critical success factor in data mining a large data store? A) Pattern recognition. B) Effective search engines. C) Image processing systems. D) Accurate universal resource locater (URL).

42.In which of the following locations should a copy of the accounting system data backup of year-end information be stored? A) Secure off-site location. B) Data backup server in the network room. C) Fireproof cabinet in the data network room. D) Locked file cabinet in the accounting department.

43. A manufacturing company that wanted to be able to place material orders more efficiently most likely would utilize which of the following? A) Electronic check presentment. B) Electronic data interchange. C) Automated clearinghouse. D) Electronic funds transfer.

44. Which of the following statements best characterizes the function of a physical access control? A) Protects systems from the transmission of Trojan horses.

B) Provides authentication of users attempting to log into the system. C) Separates unauthorized individuals from computer resources. D) Minimizes the risk of incurring a power or hardware failure.

45. In business information systems, the term "stakeholder" refers to which of the following parties? A) The management team responsible for the security of the documents and data stored on the computers or networks. B) Information technology personnel responsible for creating the documents and data stored on the computers or networks. C) Authorized users who are granted access rights to the documents and data stored on the computers or networks. D) Anyone in the organization who has a role in creating or using the documents and data stored on the computers or networks.

46. Which of the following cycles does not have accounting information that recorded into the general ledger reporting system? A) Expenditure. B) Production. C) Planning. D) Revenue.

47. An organization relied heavily on e-commerce for its transactions. Evidence of the organization's security awareness manual would be an example of which of the following types of controls? A) Preventative. B) Detective.

C) Corrective. D) Compliance

48. An auditor was examining a client's network and discovered that the users did not have any password protection. Which of the following would be the best example of the type of network password the users should have? A) trjunpqs. B) 34787761. C) tr34ju78. D) tR34ju78.

49. In which of the following phases of computer system development would training occur? A) Planning phase. B) Analysis phase. C) Design phase. D) Implementation phase.

50. Which of the following is usually a benefit of transmitting transactions in an electronic data interchange (EDI) environment? A) Elimination of the need to continuously update antivirus software. B) Assurance of the thoroughness of transaction data because of standardized controls. C) Automatic protection of information that has electronically left the entity. D) Elimination of the need to verify the receipt of goods before making payment.

51. Which of the following is an electronic device that separates or isolates a network segment from the main network while maintaining the connection between networks? A) Query program. B) Firewall. C) Image browser. D) Keyword.

52. A distributed processing environment would be most beneficial in which of the following situations? A) Large volumes of data are generated at many locations and fast access is required. B) Large volumes of data are generated centrally and fast access is not required. C) Small volumes of data are generated at many locations, fast access is required, and summaries of the data are needed promptly at a central site. D) Small volumes of data are generated centrally, fast access is required, and summaries are needed monthly at many locations.

53. To prevent interrupted information systems operation, which of the following controls are typically included in an organizations disaster recovery plan? A) Backup and data transmission controls. B) Data input and downtime controls. C) Backup and downtime controls. D) Disaster recovery and data processing controls.

54. Which of the following statements is true regarding Transmission Control Protocol and Internet Protocol (TCP/IP) ? A) Every TCP/IP-supported transmission is an exchange of funds. B) TCP/IP networks are limited to large mainframe computers. C) Every site connected to a TCP/IP network has a unique address. D) The actual physical connections among the various networks are limited to TCP/IP ports.

55. Which of the following configurations of elements represents the most complete disaster recovery plan? A) Vendor contract for alternate processing site, backup procedures, names of persons on the disaster recovery team. B) Alternate processing site, backup and off-site storage procedures, identification of critical applications, test of the plan. C) Off-site storage procedures, identification of critical applications, test of the plan. D) Vendor contract for alternate processing site, names of persons on the disaster recovery team, off-site storage procedures.

56. What type of computerized data processing system would be most appropriate for a company that is opening a new retail location? A) Batch processing. B) Real-time processing. C) Sequential-file processing. D) Direct-access processing.

57. What should be examined to determine if an information system is operating according to prescribed procedures? A) System capacity. B) System control. C) System complexity. D) Accessibility to system information.

58. What is the effect when a foreign competitor's currency becomes weaker compared to the U.S. dollar? A) The foreign company will have an advantage in the U.S. market. B) The foreign company will be disadvantaged in the U.S. market. C) The fluctuation in the foreign currencys exchange rate has no effect on the U.S. company's sales or cost of goods sold. D) It is better for the U.S. company when the value of the U.S. dollar strengthens.

59. Which of the following artificial intelligence information systems cannot learn from experience? A) Neural networks. B) Case-based reasoning systems. C) Rule-based expert systems. D) Intelligent agents.

60. Which of the following allows customers to pay for goods or services from a web site while maintaining financial privacy? A) Credit card.

B) Site draft. C) E-cash. D) Electronic check.

Answer Key: 1)A 2)A 3)C 4)D 5)C 6)A 7)D 8)C 9)D 10)C 11)C 12)B 13)B 14)B 15)B 16)C 17)B 18)D 19)B 20)B 21)B 22)D 23)C 24)A 25)C 26)C 27)D 28)D 29)C 30)B 31)A 32)A 33)A 34)C 35)D 36)C 37)A 38)D 39)D 40)C 41)A 42)A 43)B 44)C 45)D 46)C 47)A 48)D 49)D 50)B 51)B 52)A 53)C 54)C 55)B 56)B 57)B 58)A 59)C 60)C

Business Environment and Concepts 5: Strategic Planning Balanced Scorecard

The balanced scorecard (BSC) is a strategy performance management tool - a semi-standard structured report, supported by design methods and automation tools, that can be used by managers to keep track of the execution of activities by the staff within their control and to monitor the consequences arising from these actions. It is perhaps the best known of several such frameworks (it is the most widely adopted performance management framework reported in the annual survey of management tools undertaken by Bain & Company, and has been widely adopted in English-speaking western countries. Characteristics The characteristic of the balanced scorecard and its derivatives is the presentation of a mixture of financial and non-financial measures each compared to a 'target' value within a single concise report. The report is not meant to be a replacement for traditional financial or operational reports but a succinct summary that captures the information most relevant to those reading it. It is the method by which this 'most relevant' information is determined (i.e., the design processes used to select the content) that most differentiates the various versions of the tool in circulation. The balanced scorecard also gives light to the company's vision and mission. These two elements must always be referred to when preparing a balance scorecard. As a model of performance, the balanced scorecard is effective in that "it articulates the links between leading inputs (human and physical), processes, and lagging outcomes and focuses on the importance of managing these components to achieve the organization's strategic priorities." The first versions of balanced scorecard asserted that relevance should derive from the corporate strategy, and proposed design methods that focused on choosing measures and targets associated with the main activities required to implement the strategy. As the initial audience for this were the readers of the Harvard Business Review, the proposal was translated into a form that made sense to a typical reader of that journal - one relevant to a mid-sized US business. Accordingly, initial designs were encouraged to measure three categories of non-financial measure in addition to financial outputs - those of "customer," "internal business processes" and "learning and growth." Clearly these categories were not so relevant to non-profits or units within complex organizations (which might have high degrees of internal specialization), and much of the early literature on balanced scorecard focused on suggestions of alternative 'perspectives' that might have more relevance to these groups. Modern balanced scorecard thinking has evolved considerably since the initial ideas proposed in the late 1980s and early 1990s, and the modern performance management tools including Balanced Scorecard are significantly improved - being more flexible (to suit a wider range of organisational types) and more effective (as design methods have evolved to make them easier to design, and use).

Design Design of a balanced scorecard ultimately is about the identification of a small number of financial and non-financial measures and attaching targets to them, so that when they are reviewed it is possible to determine whether current performance 'meets expectations'. The idea behind this is that by alerting managers to areas where performance deviates from expectations, they can be encouraged to focus their attention on these areas, and hopefully as a result trigger improved performance within the part of the organization they lead. The original thinking behind a balanced scorecard was for it to be focused on information relating to the implementation of a strategy, and, perhaps unsurprisingly, over time there has been a blurring of the boundaries between conventional strategic planning and control activities and those required to design a Balanced Scorecard. This is illustrated well by the four steps required to design a balanced scorecard included in Kaplan & Norton's writing on the subject in the late 1990s, where they assert four steps as being part of the Balanced Scorecard design process: 1. 2. 3. 4. Translating the vision into operational goals; Communicating the vision and link it to individual performance; Business planning; index setting Feedback and learning, and adjusting the strategy accordingly.

These steps go far beyond the simple task of identifying a small number of financial and non-financial measures, but illustrate the requirement for whatever design process is used to fit within broader thinking about how the resulting Balanced Scorecard will integrate with the wider business management process. This is also illustrated by books and articles referring to Balanced Scorecards confusing the design process elements and the balanced scorecard itself. In particular, it is common for people to refer to a "strategic linkage model" or "strategy map" as being a balanced scorecard. Although it helps focus managers' attention on strategic issues and the management of the implementation of strategy, it is important to remember that the Balanced Scorecard itself has no role in the formation of strategy. In fact, balanced scorecards can comfortably co-exist with strategic planning systems and other tools. The four perspectives The 1st generation design method proposed by Kaplan and Norton was based on the use of three nonfinancial topic areas as prompts to aid the identification of non-financial measures in addition to one looking at financial. Four "perspectives" were proposed:

Financial: encourages the identification of a few relevant high-level financial measures. In particular, designers were encouraged to choose measures that helped inform the answer to the question "How do we look to shareholders?" Customer: encourages the identification of measures that answer the question "How do customers see us?" Internal business processes: encourages the identification of measures that answer the question "What must we excel at?"

Learning and growth: encourages the identification of measures that answer the question "How can we continue to improve and create value?".

These 'prompt questions' illustrate that Kaplan and Norton were thinking about the needs of small to medium sized commercial organizations in the USA (the target demographic for the Harvard Business Review) when choosing these topic areas. They are not very helpful to other kinds of organizations, and much of what has been written on balanced scorecard since has, in one way or another, focused on the identification of alternative headings more suited to a broader range of organizations. Measures The balanced scorecard is ultimately about choosing measures and targets. The various design methods proposed are intended to help in the identification of these measures and targets, usually by a process of abstraction that narrows the search space for a measure (e.g. find a measure to inform about a particular 'objective' within the customer perspective, rather than simply finding a measure for 'customer'). Although lists of general and industry-specific measure definitions can be found in the case studies and methodological articles and books presented in the references section. In general measure catalogs and suggestions from books are only helpful 'after the event' - in the same way that a Dictionary can help you confirm the spelling (and usage) of a word, but only once you have decided to use it proficiently.

Budget Introduction
A budget is a financial plan and a list of all planned expenses and revenues. It is a plan for saving, borrowing and spending. A budget is an important concept in microeconomics, which uses a budget line to illustrate the trade-offs between two or more goods. In other terms, a budget is an organizational plan stated in monetary terms. In summary, the purpose of budgeting is to: 1. Provide a forecast of revenues and expenditures, that is, construct a model of how our business might perform financially if certain strategies, events and plans are carried out. 2. Enable the actual financial operation of the business to be measured against the forecast. 3. Establish the cost constraint for a project, program, or operation. Why do we produce budgets? Budget helps to aid the planning of actual operations by forcing managers to consider how the conditions might change and what steps should be taken now and by encouraging managers to consider problems before they arise. It also helps co-ordinate the activities of the organization by compelling managers to examine relationships between their own operation and those of other departments. Other essentials of budget include:

To control resources To communicate plans to various responsibility center managers. To motivate managers to strive to achieve budget goals. To evaluate the performance of managers To provide visibility into the company's performance

Business start-up budget The process of calculating the costs of starting a small business begins with a list of all necessary purchases including tangible assets (for example, equipment, inventory) and services (for example, remodeling, insurance), working capital, sources and collateral. The budget should contain a narrative explaining how you decided on the amount of this reserve and a description of the expected financial results of business activities. The assets should be valued with each and every cost. All other expenses are like labour factory overhead all freshmen expenses are also included into business budgeting. Corporate budget The budget of a company is often compiled annually, but may not be. A finished budget, usually requiring considerable effort, is a plan for the short-term future, typically one year. While traditionally the Finance department compiles the company's budget, modern software allows hundreds or even thousands of people in various departments (operations, human resources, IT, etc.) to list their expected revenues and expenses in the final budget. If the actual figures delivered through the budget period come close to the budget, this suggests that the managers understand their business and have been successfully driving it in the intended direction. On the other hand, if the figures diverge wildly from the budget, this sends an 'out of control' signal, and the share price could suffer as a result. Budget types

Sales budget an estimate of future sales, often broken down into both units and currency. It is used to create company sales goals. Production budget an estimate of the number of units that must be manufactured to meet the sales goals. The production budget also estimates the various costs involved with manufacturing those units, including labor and material. Created by product oriented companies. Capital budget - used to determine whether an organization's long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing. Cash flow/cash budget a prediction of future cash receipts and expenditures for a particular time period. It usually covers a period in the short term future. The cash flow budget helps the business determine when income will be sufficient to cover expenses and when the company will need to seek outside financing. Marketing budget an estimate of the funds needed for promotion, advertising, and public relations in order to market the product or service.

Project budget a prediction of the costs associated with a particular company project. These costs include labour, materials, and other related expenses. The project budget is often broken down into specific tasks, with task budgets assigned to each. A cost estimate is used to establish a project budget. Revenue budget consists of revenue receipts of government and the expenditure met from these revenues. Tax revenues are made up of taxes and other duties that the government levies. Expenditure budget includes spending data items.

Competitive Advantage
Competitive advantage is defined as the strategic advantage one business entity has over its rival entities within its competitive industry. Achieving competitive advantage strengthens and positions a business better within the business environment. Resource-based view perspective Competitive advantage occurs when an organization acquires or develops an attribute or combination of attributes that allows it to outperform its competitors. These attributes can include access to natural resources, such as high grade ores or inexpensive power, or access to highly trained and skilled personnel human resources. New technologies such as robotics and information technology can provide competitive advantage, whether as a part of the product itself, as an advantage to the making of the product, or as a competitive aid in the business process (for example, better identification and understanding of customers). The term competitive advantage is described as the ability gained through attributes and resources to perform at a higher level than others in the same industry or market. Competitive advantage as the ability to stay ahead of present or potential competition, thus superior performance reached through competitive advantage will ensure market leadership. Also it provides the understanding that resources held by a firm and the business strategy will have a profound impact on generating competitive advantage. Business author Powell views business strategy as the tool that manipulates the resources and create competitive advantage, hence, viable business strategy may not be adequate unless it possess control over unique resources that has the ability to create such a unique advantage. Summarizing the view points, competitive advantage is a key determinant of superior performance and it will ensure survival and prominent placing in the market. Superior performance being the ultimate desired goal of a firm, competitive advantage becomes the foundation highlighting the significant importance to develop same. Competitive Strategies Cost Leadership Strategy The goal of Cost Leadership Strategy is to offer products or services at the lowest cost in the industry. The challenge of this strategy is to earn a suitable profit for the company, rather than operating at a loss and draining profitability from all market players. Companies such as Walmart succeed with this strategy by

featuring low prices on key items on which customers are price-aware, while selling other merchandise at less aggressive discounts. Differentiation Strategy The goal of Differentiation Strategy is to provide products that stand out from competitive offerings. An example is Southwest Airlines, which promotes its no-fee baggage handling as unique from other airlines. Innovation Strategy The goal of Innovation Strategy is to leapfrog other market players via the introduction of completely new or notably better products or services. This strategy is typical of technology start-up companies, who often intend to "disrupt" the existing marketplace, obsoleting the current market entries with a breakthrough product offering. It is harder for more established companies to pursue this strategy, once their product offering has achieved market acceptance. Apple has been a notable example of this strategy, for example, with its introduction of iPod personal music players, and iPad tablet computers. Operational Effectiveness Strategy The goal of Operational Effectiveness as a strategy is to perform internal business activities better than competitors, making the company easier or more pleasurable to do business with than other market choices. State Farm Insurance pursues this strategy by promoting their agents as "good neighbors" who actively help customers.

Market Analysis
A market analysis studies the attractiveness and the dynamics of a special market within a special industry. It is part of the industry analysis and this in turn of the global environmental analysis. Through all of these analyses the opportunities, strengths, weaknesses and threats of a company can be identified. Finally, with the help of a SWOT analysis, adequate business strategies of a company will be defined. The market analysis is also known as a documented investigation of a market that is used to inform a firm's planning activities, particularly around decisions of inventory, purchase, work force expansion/contraction, facility expansion, purchases of capital equipment, promotional activities, and many other aspects of a company. Dimensions of market analysis The goal of a market analysis is to determine the attractiveness of a market, both now and in the future. Organizations evaluate the future attractiveness of a market by gaining an understanding of evolving opportunities and threats as they relate to that organization's own strengths and weaknesses. The folowing are the dimenstions of a market:

Market size (current and future) Market Trend

Market growth rate Market profitability Industry cost structure Distribution channels Key success factors Key success Details

Elements Market size The market size is defined through the market volume and the market potential. The market volume exhibits the totality of all realized sales volume of a special market. The volume is therefore dependant on the quantity of consumers and their ordinary demand. Furthermore, the market volume is either measured in quantities or qualities. The quantities can be given in technical terms, like GW for power capacities, or in numbers of items. Qualitative measuring mostly uses the sales turnover as an indicator. That means that the market price and the quantity are taken into account. Besides the market volume, the market potential is of equal importance. It defines the upper limit of the total demand and takes potential clients into consideration. Although the market potential is rather fictitious, it offers good values of orientation. The relation of market volume to market potential provides information about the chances of market growth. The following are examples of information sources for determining market size:

Government data Trade association data Financial data from major players Customer surveys

Market Trends Market trends are the upward or downward movement of a market, during a period of time. The market size is more difficult to estimate if one is starting with something completely new. In this case, you will have to derive the figures from the number of potential customers, or customer segments. Besides information about the target market, one also needs information about one's competitors, customers, products, etc. Lastly, you need to measure marketing effectiveness. A few techniques are:

Customer analysis Choice modelling Competitor analysis Risk analysis Product research Advertising the research Marketing mix modeling Simulated Test Marketing

Changes in the market are important because they often are the source of new opportunities and threats. Moreover, they have the potential to dramatically affect the market size. Examples include changes in economic, social, regulatory, legal, and political conditions and in available technology, price sensitivity, demand for variety, and level of emphasis on service and support. Market growth rate A simple means of forecasting the market growth rate is to extrapolate historical data into the future. While this method may provide a first-order estimate, it does not predict important turning points. A better method is to study market trends [37] and sales growth in complementary products. Such drivers serve as leading indicators that are more accurate than simply extrapolating historical data. Important inflection points in the market growth rate sometimes can be predicted by constructing a product diffusion curve [38]. The shape of the curve can be estimated by studying the characteristics of the adoption rate of a similar product in the past. Ultimately, many markets mature and decline. Some leading indicators of a market's decline include market saturation, the emergence of substitute products, and/or the absence of growth drivers. Market opportunity A market opportunity product or a service, based on either one technology or several, fulfills the need(s) of a (preferably increasing) market better than the competition and better than substitution-technologies within the given environmental frame (e.g. society, politics, legislation, etc.). Market profitability While different organizations in a market will have different levels of profitability, they are all similar to different market conditions. Michael Porter devised a useful framework for evaluating the attractiveness of an industry or market. This framework, known as Porter five forces analysis, identifies five factors that influence the market profitability:

Buyer power Supplier power Barriers to entry Threat of substitute products

Industry cost structure The cost structure is important for identifying key factors for success. To this end, Porter's value chain model is useful for determining where value is added and for isolating the costs. The cost structure also is helpful for formulating strategies to develop a competitive advantage. For example, in some environments the experience curve effect can be used to develop a cost advantage over competitors. Distribution channels help with a market analysis:

Existing distribution channels - can be described by how direct they are to the customer. Trends and emerging channels - new channels can offer the opportunity to develop a competitive advantage. Channel power structure - for example, in the case of a product having little brand equity, retailers have negotiating power over manufacturers and cannot capture more margin.

Success factors The key success factors are those elements that are necessary in order for the firm to achieve its marketing objectives. A few examples of such factors include:

Access to essential unique resources Ability to achieve economies of scale Access to distribution channels Technological progress

It is important to consider that key success factors may change over time, especially as the product progresses through its life cycle.

Pricing Strategies
Pricing strategies for products or services encompass three main ways to improve profits. These are that the business owner can cut costs or sell more, or find more profit with a better pricing strategy. When costs are already at their lowest and sales are hard to find, adopting a better pricing strategy is a key option to stay viable. Cost-plus pricing Cost-plus pricing is the simplest pricing method. The firm calculates the cost of producing the product and adds on a percentage (profit) to that price to give the selling price. This method although simple has two flaws; it takes no account of demand and there is no way of determining if potential customers will purchase the product at the calculated price. Creaming or skimming In most skimming, goods are sold at higher prices so that fewer sales are needed to break even. Selling a product at a high price, sacrificing high sales to gain a high profit is therefore "skimming" the market. Skimming is usually employed to reimburse the cost of investment of the original research into the product: commonly used in electronic markets when a new range, such as DVD players, are firstly dispatched into the market at a high price. This strategy is often used to target "early adopters" of a product or service. Early adopters generally have a relatively lower price-sensitivity - this can be attributed to: their need for the product outweighing their need to economise; a greater understanding of

the product's value; or simply having a higher disposable income. Limit pricing A limit price is the price set by a monopolist to discourage economic entry into a market, and is illegal in many countries. The limit price is the price that the entrant would face upon entering as long as the incumbent firm did not decrease output. The limit price is often lower than the average cost of production or just low enough to make entering not profitable. The quantity produced by the incumbent firm to act as a deterrent to entry is usually larger than would be optimal for a monopolist, but might still produce higher economic profits than would be earned under perfect competition. The problem with limit pricing as a strategy is that once the entrant has entered the market, the quantity used as a threat to deter entry is no longer the incumbent firm's best response. This means that for limit pricing to be an effective deterrent to entry, the threat must in some way be made credible. A way to achieve this is for the incumbent firm to constrain itself to produce a certain quantity whether entry occurs or not. An example of this would be if the firm signed a union contract to employ a certain (high) level of labor for a long period of time. In this strategy price of the product become limit according to budget. . Loss leader A loss leader or leader is a product sold at a low price (i.e. at cost or below cost) to stimulate other profitable sales. This would help the companies to expand its market share as a whole. Market-oriented pricing Setting a price based upon analysis and research compiled from the target market. This means that marketers will set prices depending on the results from the research. For instance if the competitors are pricing their products at a lower price, then it's up to them to either price their goods at an above price or below, depending on what the company wants to achieve . Penetration pricing Penetration pricing includes setting the price low with the goals of attracting customers and gaining market share. The price will be raised later once this market share is gained. Price discrimination Price discrimination is the practice of setting a different price for the same product in different segments to the market. For example, this can be for different classes, such as ages, or for different opening times. Premium pricing Premium pricing is the practice of keeping the price of a product or service artificially high in order to encourage favorable perceptions among buyers, based solely on the price. The practice is intended to exploit the (not necessarily justifiable) tendency for buyers to assume that expensive items enjoy an exceptional reputation, are more reliable or desirable, or represent exceptional quality and distinction. Predatory pricing

Predatory pricing, also known as aggressive pricing (also known as "undercutting"), intended to drive out competitors from a market. It is illegal in some countries. Contribution margin-based pricing Contribution margin-based pricing maximizes the profit derived from an individual product, based on the difference between the product's price and variable costs (the product's contribution margin per unit), and on ones assumptions regarding the relationship between the products price and the number of units that can be sold at that price. The product's contribution to total firm profit (i.e. to operating income) is maximized when a price is chosen that maximizes the following: (contribution margin per unit) X (number of units sold).. Psychological pricing Pricing designed to have a positive psychological impact. For example, selling a product at $3.95 or $3.99, rather than $4.00. Dynamic pricing A flexible pricing mechanism made possible by advances in information technology, and employed mostly by Internet based companies. By responding to market fluctuations or large amounts of data gathered from customers - ranging from where they live to what they buy to how much they have spent on past purchases - dynamic pricing allows online companies to adjust the prices of identical goods to correspond to a customers willingness to pay. The airline industry is often cited as a dynamic pricing success story. In fact, it employs the technique so artfully that most of the passengers on any given airplane have paid different ticket prices for the same flight. Price leadership An observation made of oligopolistic business behavior in which one company, usually the dominant competitor among several, leads the way in determining prices, the others soon following. The context is a state of limited competition, in which a market is shared by a small number of producers or sellers. Target pricing Pricing method whereby the selling price of a product is calculated to produce a particular rate of return on investment for a specific volume of production. The target pricing method is used most often by public utilities, like electric and gas companies, and companies whose capital investment is high, like automobile manufacturers. Target pricing is not useful for companies whose capital investment is low because, according to this formula, the selling price will be understated. Also the target pricing method is not keyed to the demand for the product, and if the entire volume is not sold, a company might sustain an overall budgetary loss on the product. Absorption pricing

Method of pricing in which all costs are recovered. The price of the product includes the variable cost of each item plus a proportionate amount of the fixed costs and is a form of cost-plus pricing High-low pricing Method of pricing for an organization where the goods or services offered by the organization are regularly priced higher than competitors, but through promotions, advertisements, and or coupons, lower prices are offered on key items. The lower promotional prices are designed to bring customers to the organization where the customer is offered the promotional product as well as the regular higher priced products. Marginal-cost pricing In business, the practice of setting the price of a product to equal the extra cost of producing an extra unit of output. By this policy, a producer charges, for each product unit sold, only the addition to total cost resulting from materials and direct labor. Businesses often set prices close to marginal cost during periods of poor sales. If, for example, an item has a marginal cost of $1.00 and a normal selling price is $2.00, the firm selling the item might wish to lower the price to $1.10 if demand has waned. The business would choose this approach because the incremental profit of 10 cents from the transaction is better than no sale at all. Value-based pricing Pricing a product based on the value the product has for the customer and not on its costs of production or any other factor. This pricing strategy is frequently used where the value to the customer is many times the cost of producing the item or service. For instance, the cost of producing a software CD is about the same independent of the software on it, but the prices vary with the perceived value the customers are expected to have. The perceived value will depend on the alternatives open to the customer. In business these alternatives are using competitors software, using a manual work around, or not doing an activity. In order to employ value-based pricing you have to know your customer's business, his business costs, and his perceived alternatives. Freemium Freemium is a business model that works by offering a product or service free of charge (typically digital offerings such as software, content, games, web services or other) while charging a premium for advanced features, functionality, or related products and services. The word "freemium" is a portmanteau combining the two aspects of the business model: "free" and "premium". It has become a highly popular model, with notable success.

SWOT Analysis

SWOT analysis (alternatively SWOT Matrix) is a structured planning method used to evaluate the Strengths, Weaknesses, Opportunities, and Threats involved in a project or in a business venture. A SWOT analysis can be carried out for a product, place or person. It involves specifying the objective of the business venture or project and identifying the internal and external factors that are favorable and unfavorable to achieving that objective. SWOT analysis, with its four elements in a 2x2 matrix. Setting the objective should be done after the SWOT analysis has been performed. This would allow achievable goals or objectives to be set for the organization.

Strengths: characteristics of the business or project that give it an advantage over others Weaknesses: are characteristics that place the team at a disadvantage relative to others Opportunities: external elements that the project could exploit to its advantage Threats: external elements in the environment that could cause trouble for the business or project

Identification of SWOTs is important because they can inform later steps in planning to achieve the objective. First, the decision makers should consider whether the objective is attainable, given the SWOTs. If the objective is not attainable a different objective must be selected and the process repeated. Users of SWOT analysis need to ask and answer questions that generate meaningful information for each category (strengths, weaknesses, opportunities, and threats) to make the analysis useful and find their competitive advantage. Internal and external factors The aim of any SWOT analysis is to identify the key internal and external factors that are important to achieving the objective. These come from within the company's unique value chain. SWOT analysis groups key pieces of information into two main categories:

Internal factors The strengths and weaknesses internal to the organization. External factors The opportunities and threats presented by the external environment to the organization.

The internal factors may be viewed as strengths or weaknesses depending upon their effect on the organization's objectives. What may represent strengths with respect to one objective may be weaknesses for another objective. The factors may include all of the 4Ps; as well as personnel, finance, manufacturing capabilities, and so on. The external factors may include macroeconomic matters, technological change, legislation, and socio-cultural changes, as well as changes in the marketplace or competitive position. The results are often presented in the form of a matrix. SWOT analysis is just one method of categorization and has its own weaknesses. For example, it may tend to persuade its users to compile lists rather than to think about what is actually important in achieving objectives. It also presents the resulting lists uncritically and without clear prioritization so that, for example, weak opportunities may appear to balance strong threats.

It is prudent not to eliminate too quickly any candidate SWOT entry. The importance of individual SWOTs will be revealed by the value of the strategies it generates. A SWOT item that produces valuable strategies is important. A SWOT item that generates no strategies is not important.

Strategic Management
Strategic management analyzes the major initiatives taken by a company's top management on behalf of owners, involving resources and performance in external environments. It entails specifying the organization's mission, vision and objectives, developing policies and plans, often in terms of projects and programs, which are designed to achieve these objectives, and then allocating resources to implement the policies and plans, projects and programs. A balanced scorecard is often used to evaluate the overall performance of the business and its progress towards objectives. Recent studies and leading management theorists have advocated that strategy needs to start with stakeholders expectations and use a modified balanced scorecard which includes all stakeholders. Resource-based view perspective Competitive advantage seeks to address some of the criticisms of comparative advantage. Michael Porter proposed the theory in 1985. Competitive advantage theory suggests that states and businesses should pursue policies that create high-quality goods to sell at high prices in the market. Porter emphasizes productivity growth as the focus of national strategies. Competitive advantage rests on the notion that cheap labor is ubiquitous and natural resources are not necessary for a good economy. The other theory, comparative advantage, can lead countries to specialize in exporting primary goods and raw materials that trap countries in low-wage economies due to terms of trade. Competitive advantage attempts to correct for this issue by stressing maximizing scale economies in goods and services that garner premium prices. Competitive advantage occurs when an organization acquires or develops an attribute or combination of attributes that allows it to outperform its competitors. These attributes can include access to natural resources, such as high grade ores or inexpensive power, or access to highly trained and skilled personnel human resources. New technologies such as robotics and information technology can provide competitive advantage, whether as a part of the product itself, as an advantage to the making of the product, or as a competitive aid in the business process (for example, better identification and understanding of customers). The term competitive advantage is the ability gained through attributes and resources to perform at a higher level than others in the same industry or market. The study of such advantage has attracted profound research interest due to contemporary issues regarding superior performance levels of firms in the present competitive market conditions. "A firm is said to have a competitive advantage when it is implementing a value creating strategy not simultaneously being implemented by any current or potential player". Successfully implemented strategies will lift a firm to superior performance by facilitating the firm with competitive advantage to outperform current or potential players. To gain competitive advantage a business strategy of a firm manipulates the various resources over which it has direct control

and these resources have the ability to generate competitive advantage. Superior performance outcomes and superiority in production resources reflects competitive advantage. Competitive Strategies Cost Leadership Strategy The goal of Cost Leadership Strategy is to offer products or services at the lowest cost in the industry. The challenge of this strategy is to earn a suitable profit for the company, rather than operating at a loss and draining profitability from all market players. Companies such as Walmart succeed with this strategy by featuring low prices on key items on which customers are price-aware, while selling other merchandise at less aggressive discounts. Differentiation Strategy The goal of Differentiation Strategy is to provide products that stand out from competitive offerings. An example is Southwest Airlines, which promotes its no-fee baggage handling as unique from other airlines. Innovation Strategy The goal of Innovation Strategy is to leapfrog other market players via the introduction of completely new or notably better products or services. This strategy is typical of technology start-up companies, who often intend to "disrupt" the existing marketplace, obsoleting the current market entries with a breakthrough product offering. It is harder for more established companies to pursue this strategy, once their product offering has achieved market acceptance. Apple has been a notable example of this strategy, for example, with its introduction of iPod personal music players, and iPad tablet computers. Operational Effectiveness Strategy The goal of Operational Effectiveness as a strategy is to perform internal business activities better than competitors, making the company easier or more pleasurable to do business with than other market choices. State Farm Insurance pursues this strategy by promoting their agents as "good neighbors" who actively help customers.

Strategic Planning
Strategic planning is an organization's process of defining its strategy, or direction, and making decisions on allocating its resources to pursue this strategy. In order to determine the direction of the organization, it is necessary to understand its current position and the possible avenues through which it can pursue a particular course of action. Generally, strategic planning deals with at least one of three key questions: 1. "What do we do?" 2. "For whom do we do it?" 3. "How do we excel?"

In many organizations, this is viewed as a process for determining where an organization is going over the next year ormore typically3 to 5 years (long term), although some extend their vision to 20 years. Key components The key components of 'strategic planning' include an understanding of the firm's vision, mission, values and strategies. (Often a "Vision Statement" and a "Mission Statement" may encapsulate the vision and mission).

Vision: outlines what the organization wants to be, or how it wants the world in which it operates to be (an "idealised" view of the world). It is a long-term view and concentrates on the future. It can be emotive and is a source of inspiration. For example, a charity working with the poor might have a vision statement which reads "A World without Poverty." Mission: Defines the fundamental purpose of an organization or an enterprise, succinctly describing why it exists and what it does to achieve its vision. For example, the charity above might have a mission statement as "providing jobs for the homeless and unemployed". Values: Beliefs that are shared among the stakeholders of an organization. Values drive an organization's culture and priorities and provide a framework in which decisions are made. For example, "Knowledge and skills are the keys to success" or "give a man bread and feed him for a day, but teach him to farm and feed him for life". These example maxims may set the priorities of self-sufficiency over shelter. Strategy: Strategy, narrowly defined, means "the art of the general". - a combination of the ends (goals) for which the firm is striving and the means (policies) by which it is seeking to get there. A strategy is sometimes called a roadmap - which is the path chosen to plow towards the end vision. The most important part of implementing the strategy is ensuring the company is going in the right direction which is towards the end vision.

Organizations sometimes summarize goals and objectives into a mission statement and/or a vision statement. Others begin with a vision and mission and use them to formulate goals and objectives. Many people mistake the vision statement for the mission statement, and sometimes one is simply used as a longer term version of the other. However they are distinct; with the vision being a descriptive picture of a desired future state; and the mission being a statement of a rationale, applicable now as well as in the future. The mission is therefore the means of successfully achieving the vision. For an organisation's vision and mission to be effective, they must become assimilated into the organization's culture. Strategic planning process There are many approaches to strategic planning but typically one of the following approaches is used: Situation-Target-Proposal

Situation - evaluate the current situation and how it came about. Target - define goals and/or objectives (sometimes called ideal state) Path / Proposal - map a possible route to the goals/objectives

Draw-See-Think-Plan

Draw - what is the ideal image or the desired end state? See - what is today's situation? What is the gap from ideal and why? Think - what specific actions must be taken to close the gap between today's situation and the ideal state? Plan - what resources are required to execute the activities

Among the most useful tools for strategic planning is SWOT analysis (Strengths, Weaknesses, Opportunities, and Threats), and a Balanced Scorecard.

Strategy Map
A strategy map is a diagram that is used to document the primary strategic goals being pursued by an organization or management team. It is an element of the documentation associated with the Balanced Scorecard, and in particular is characteristic of the second generation of Balanced Scorecard designs that first appeared during the mid 1990s. The first diagrams of this type appeared in the early 1990s, and the idea of using this type of diagram to help document Balanced Scorecard was discussed in a paper by Kaplan & Norton in 1996. The strategy map idea featured in several books and articles during the late 1990 by Kaplan & Norton and others, including most notably Olve and Wetter in their 1998/9 book Performance Drivers. Across these broad range of articles, there are only a few common attributes. Strategy maps show:

Each objective as text appearing within a shape (usually an oval or rectangle) Relatively few objectives (usually less than 20) Objectives are arrayed across two or more horizontal bands on the strategy map, with each band representing a 'perspective' Broad causal relationships between objectives shown with arrows that either join objectives together, or placed in a way not linked with specific objectives but to provide general euphemistic indications of where causality lies.

The purpose of the strategy map in Balanced Scorecard design, and its emergence as a design aid, is discussed in some detail in a research paper on the evolution of Balanced Scorecard designs during the 1990s by Lawrie & Cobbold.

Origin of strategy maps The Balanced Scorecard is a framework that is used to help in the design and implementation of strategic performance management tools within organisations. The Balanced Scorecard provides a simple structure for representing the strategy to be implemented, and has become associated with a wide selection of design tools that facilitate the identification of measures and targets that can inform on the progress the organisation is making in implementing the strategy selected ("activities"), and also provide feedback on whether the strategy is having the kind of impact on organisational performance that was hoped for ("outcomes"). By providing managers with this direct feedback on whether the required actions are being carried out, and whether they are working, the Balanced Scorecard is thought to help managers focus their attention more closely on the interventions necessary to ensure the strategy is effectively and efficiently executed. One of the big challenges faced in the design of Balanced Scorecard based performance management systems is deciding what activities and outcomes to monitor. By providing a simple visual representation of the strategic objectives to be focused on, along with additional visual cues in the form of the perspectives and causal arrows, the strategy map has been found useful in enabling discussion within a management team about what objectives to choose, and subsequently to support discussion of the actual performance achieved. Perspectives Early Balanced Scorecard articles by Kaplan & Norton proposed a simple design method for choosing the content of the Balanced Scorecard based on answers to four generic questions about the strategy to be pursued by the organization. These four questions, one about finances, one about marketing, one about processes, and one about organizational development evolved quickly into a standard set of "perspectives" ("Financial", "Customer", "Internal Business Processes", "Learning & Growth"). Design of a Balanced Scorecard became a process of selecting a small number of objectives in each perspective, and then choosing measures and targets to inform on progress against this objective. But very quickly it was realised that the perspective headings chosen only worked for specific organisations (small to medium sized firms in North America - the target market of the Harvard Business Review), and during the mid to late 1990s papers began to be published arguing that other sets of headings would make more sense for specific organization types, and that some organisations would benefit from using more or less than four headings. Despite these concerns, the 'standard' set of perspectives remains the most common, and traditionally is arrayed on the strategy map in the sequence (from bottom to top) "Learning & Growth", "Internal Business Processes", "Customer", "Financial" with causal arrows tending to flow "up" the page. Links between the strategy map and strategy development The strategy map is a device used to communicate context and illustrate the basis managers have used for choosing a subset of the available measures to report on an organisation's progress in implementing a strategy. As a device, it is not very helpful or appropriate as a strategy development tool. However over the years many have suggested that it could be used as a simple strategy development tool - including

Kaplan & Norton in their book "The Strategy Focused Organisation" who argue that organisations could adopt 'industry standard' templates (basically a set of pre-determined strategic objectives) if the managers can't work out a strategy for themselves. This type of approach is fraught with problems (e.g. what is the competitive advantage arising from a strategy developed in this way?).

Value Chain
A value chain is a chain of activities that a firm operating in a specific industry performs in order to deliver something valuable (product or service). A business unit is appropriate level for construction of a value chain, not divisional or corporate level. Products pass through activities of a chain in order, and at each activity the product gains some value. Chain of activities gives the product more added value than sum of the independent activities' values. A diamond cutter, as a profession, can be used to illustrate the difference of cost and the value chain. The cutting activity may have a low cost, but the activity adds much of the value to the end product, since a rough diamond is significantly less valuable than a cut diamond. Typically, the described value chain and the documentation of processes, assessment and auditing of adherence to the process routines are at the core of the quality certification of the business, e.g. ISO 9001. Popular Visualization A Value Reference Model (VRM) developed by the trade consortium Value Chain Group offers an open source semantic dictionary for value chain management encompassing one unified reference framework representing the process domains of product development, customer relations and supply networks. The integrated process framework guides the modeling, design, and measurement of business performance by uniquely encompassing the plan, govern and execute requirements for the design, product, and customer aspects of business. The Value Chain Group claims VRM to be next generation Business Process Management that enables value reference modeling of all business processes and provides product excellence, operations excellence, and customer excellence. Six business functions of the Value Chain:

Research and Development Design of Products, Services, or Processes Production Marketing & Sales Distribution Customer Service

This guide to the right provides the levels 1-3 basic building blocks for value chain configurations. All Level 3 processes in VRM have input/output dependencies, metrics and practices. The VRM can be extended to levels 4-6 via the Extensible Reference Model schema.

Variance
In budgeting (or management accounting in general), a variance is the difference between a budgeted, planned or standard amount and the actual amount incurred/sold. Variances can be computed for both costs and revenues. The concept of variance is intrinsically connected with planned and actual results and effects of the difference between those two on the performance of the entity or company. Types of variances Variances can be divided according to their effect or nature of the underlying amounts. When effect of variance is concerned, there are two types of variances:

When actual results are better than expected results given variance is described as favorable variance. In common use favorable variance is denoted by the letter F - usually in parentheses (F). When actual results are worse than expected results given variance is described as adverse variance, or unfavourable variance. In common use adverse variance is denoted by the letter U or the letter A - usually in parentheses (A).

The second typology (according to the nature of the underlying amount) is determined by the needs of users of the variance information and may include e.g.:

Variable cost variances o Direct material variances o Direct labour variances o Variable production overhead variances Fixed production overhead variances Sales variances

Variance analysis, in budgeting (or management accounting in general), is a tool of budgetary control by evaluation of performance by means of variances between budgeted amount, planned amount or standard amount and the actual amount incurred/sold. Variance analysis can be carried out for both costs and revenues.

BEC 5 (Strategic Planning) Questions

1. Which of the following listings correctly describes the order in which the four types of budgets must be prepared? A) Production, direct materials purchases, sales, cash disbursements. B) Sales, production, direct materials purchases, cash disbursements. C) Cash disbursements, direct materials purchases, production, sales. D) Sales, direct materials purchases, production, cash disbursements.

2. For the current period production levels, Woodwork Co. budgeted 11,000 board feet of production and purchased 15,000 board feet. The material cost was budgeted at $7 per foot. The actual cost for the period was $8.50 per foot. What was Woodwork's material price variance for the period? A) $6,000 unfavorable. B) $16,500 unfavorable. C) $19,500 unfavorable. D) $22,500 unfavorable.

3. Which of the following is a characteristic of a flexible budget? A) Provides budgeted numbers for various activity levels. B) Allows for modification during the budgeted period. C) Isolates the impact of variable costs on the overall budget. D) Can be utilized by several product divisions.

4. Which of the following attributes of a management report has the greatest impact on management's ability to make effective decisions? A) Summarization.

B) Exception orientation. C) Relevance. D) Conciseness.

5. A company's controller is adjusting next year's budget to reflect the impact of an expected 5% inflation rate. Listed below are selected items from next year's budget before the adjustment: Total salaries expense $250,000 Health costs 100,000 Depreciation expense 65,000 Interest expense on 10-year fixed-rate notes 7,750 After adjusting for the 5% inflation rate, what is the company's total budget for the selected items before taxes for next year? A) $470,250 B) $472,138 C) $473,500 D) $475,388

6. Relevant information for material A follows: Actual quantity purchased 6,500 lbs. Standard quantity allowed 6,000 lbs. Actual price $3.80 Standard price $4.00 What was the direct material quantity variance for material A?

A) $2,000 favorable. B) $1,900 favorable. C) $1,900 unfavorable. D) $2,000 unfavorable.

7. An increase in production levels within a relevant range most likely would result in A) Increasing the total cost. B) Increasing the variable cost per unit. C) Decreasing the total fixed cost. D) Decreasing the variable cost per unit.

8. A CPA would recommend implementing an activity-based costing system under which of the following circumstances? A) The client is a single-product manufacturer. B) Most of the client's costs currently are classified as direct costs. C) The client produced products that heterogeneously consume resources. D) The client produced many different products that homogeneously consume resources.

9. A company that produces 10,000 units has fixed costs of $300,000, variable costs of $50 per unit, and a sales price of $85 per unit. After learning that its variable costs will increase by 20%, the company is considering an increase in production to 12,000 units. Which of the following statements is correct regarding the company's next steps? A) If production is increased to 12,000 units, profits will increase by $50,000. B) If production is increased to 12,000 units, profits will increase by $100,000.

C) If production remains at 10,000 units, profits will decrease by $50,000. D) If production remains at 10,000 units, profits will decrease by $100,000.

10. A delivery company is implementing a system to compare the costs of purchasing and operating different vehicles in its fleet. Truck 415 is driven 125,000 miles per year at a variable cost of $0.13 per mile. Truck 415 has a capacity of 28,000 pounds and delivers 250 full loads per year. What amount is the truck's delivery cost per pound? A) $0.00163 per pound. B) $0.00232 per pound. C) $0.58036 per pound. D) $1.72000 per pound.

11. Wexford Co. has a subunit that reported the following data for year 1: Asset (investment) turnover 1.5 times Sales $750,000 Return on sales 8% The imputed interest rate is 12%. What is the division residual income for year 1? A) $60,000 B) $30,000 C) $20,000 D) $0

12. The target capital structure of Traggle Co. is 50% debt, 10% preferred equity, and 40% common equity. The interest rate on debt is 6%, the yield on the preferred is 7%, the cost of common equity is

11.5%, and the tax rate is 40%. Traggle does not anticipate issuing any new stock. What is Traggle's weighted-average cost of capital? A) 6.50% B) 6.77% C) 7.10% D) 8.30%

13. Galax, Inc. had operating income of $5,000,000 before interest and taxes. Galax's net book value of plant assets at January 1 and December 31 were $22,000,000 and $18,000,000, respectively. Galax achieved a 25 percent return on investment for the year, with an investment turnover of 2.5. What were Galax's sales for the year? A) $55,000,000 B) $50,000,000 C) $45,000,000 D) $20,000,000

14. 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.

15. A company is offered a one-time special order for its product and has the capacity to take this order without losing current business. Variable costs per unit and fixed costs in total will be the same. The gross

profit for the special order will be 10%, which is 15% less than the usual gross profit. What impact will this order have on total fixed costs and operating income? A) Total fixed costs increase, and operating income increases. B) Total fixed costs do not change, and operating income increases. C) Total fixed costs do not change, and operating income does not change. D) Total fixed costs increase, and operating income decreases.

16. Which of the following types of variances would a purchasing manager most likely influence? A) Direct materials price. B) Direct materials quantity. C) Direct labor rate. D) Direct labor efficiency.

17. A company has gathered the following information from a recent production run: Standard variable overhead rate $10 Actual variable overhead rate 8 Standard process hours 20 Actual process hours 25 What is the company's variable overhead spending variance? A) $50 unfavorable. B) $50 favorable. C) $40 unfavorable.

D) $40 favorable.

18. A company produces and sells two products. The first product accounts for 75% of sales and the second product accounts for the remaining 25% of sales. The first product has a selling price of $10 per unit, variable costs of $6 per unit, and allocated fixed costs of $100,000. The second product has a selling price of $25 per unit, variable costs of $13 per unit, and allocated fixed costs of $212,000. At the breakeven point, what number of units of the first product will have been sold? A) 52,000 B) 39,000 C) 25,000 D) 14,625

19. Which of the following is one of the four perspectives of a balanced scorecard? A) Just in time. B) Innovation. C) Benchmarking. D) Activity-based costing.

20. The following information data pertains to a manufacturing company: Total sales $80,000 Total variable costs 20,000 Total fixed costs 30,000 What is the break-even level in sales dollars? A) $30,000

B) $40,000 C) $50,000 D) $80,000

21. Which of the following is one of the four perspectives of a balanced scorecard? A) Just in time. B) Innovation. C) Benchmarking. D) Activity-based costing.

22. The following information data pertains to a manufacturing company: Total sales $80,000 Total variable costs 20,000 Total fixed costs 30,000 What is the break-even level in sales dollars? A) $30,000 B) $40,000 C) $50,000 D) $80,000

23. Jackson Co. is considering a project that will use 2,000 square feet of storage space at one of its facilities to store used equipment. What will determine Jacksons opportunity cost?

A) The net present value of the project. B) The internal rate of return of the project. C) The value of the next best use of the space. D) The depreciation expense on the space.

24. Jones Corp. had an opportunity to use its capacity to produce an extra 5,000 units with a contribution margin of $5 per unit, or to rent out the space for $10,000. What was the opportunity cost of using the capacity? A) $35,000 B) $25,000 C) $15,000 D) $10,000

25. In the past, four direct labor hours were required to produce each unit of product Y. Material costs were $200 per unit, the direct labor rate was $20 per hour, and factory overhead was three times direct labor cost. In budgeting for next year, management is planning to outsource some manufacturing activities and to further automate others. Management estimates these plans will reduce labor hours by 25%, increase the factory overhead rate to 3.6 times direct labor costs, and increase material costs by $30 per unit. Management plans to manufacture 10,000 units. What amount should management budget for cost of goods manufactured? A) $4,820,000 B) $5,060,000 C) $5,200,000 D) $6,500,000

26. 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.

27. Which of the following steps in the strategic planning process should be completed first? A) Translate objectives into goals. B) Determine actions to achieve goals. C) Develop performance measures. D) Create a mission statement.

28. Which of the following forecasting methods relies mostly on judgment? A) Time series models. B) Econometric models. C) Delphi. D) Regression.

29. Which of the following inputs would be most beneficial to consider when management is developing the capital budget? A) Supply/demand for the companys products. B) Current product sales prices and costs.

C) Wage trends. D) Profit center equipment requests.

30. Which of the following would be most impacted by the use of the percentage of sales forecasting method for budgeting purposes? A) Accounts payable. B) Mortgages payable. C) Bonds payable. D) Common stock.

31. A company produces widgets with budgeted standard direct materials of 2 pounds per widget at $5 per pound. Standard direct labor was budgeted at 0.5 hour per widget at $15 per hour. The actual usage in the current year was 25,000 pounds and 3,000 hours to produce 10,000 widgets. What was the direct labor usage variance? A) $25,000 favorable. B) $25,000 unfavorable. C) $30,000 favorable. D) $30,000 unfavorable.

32. Which of the following balanced scorecard perspectives examines a company's success in targeted market segments? A) Financial. B) Customer. C) Internal business process.

D) Learning and growth.

33) To meet its monthly budgeted production goals, Acme Mfg. Co. planned a need for 10,000 widgets at a price of $20 per widget. Acme's actual units were 11,200 at a price of $18.50 per widget. What amount reflected Acme's price variance? A) $7,200 unfavorable. B) $15,000 favorable. C) $16,800 favorable. D) $24,000 unfavorable.

34. Spring Co. had two divisions, A and B. Division A created Product X, which could be sold on the outside market for $25 and used variable costs of $15. Division B could take Product X and apply additional variable costs of $40 to create Product Y, which could be sold for $100. Division B received a special order for a large amount of Product Y. If Division A were operating at full capacity, which of the following prices should Division A charge Division B for the Product X needed to fill the special order? A) $15 B) $20 C) $25 D) $40

35. Which of the following is a disadvantage of participative budgeting? A) It is more time consuming. B) It decreases motivation. C) It decreases acceptance. D) It is less accurate.

36. Which of the following budgets provides information for preparation of the owner's equity section of a budgeted balance sheet? A) Sales budget. B) Cash budget. C) Capital expenditures budget. D) Budgeted income statement.

37. Fargo, Mfg., a small business, is developing a budget for next year. Which of the following steps should Fargo perform first? A) Forecast Fargo's sales volume. B) Determine the price of Fargo's products. C) Identify costs of Fargo's forecasted sales volume. D) Compute the dollar amount of Fargos forecasted sales.

38. What is strategic planning? A) It establishes the general direction of the organization. B) It establishes the resources that the plan will require. C) It establishes the budget for the organization. D) It consists of decisions to use parts of the organization's resources in specified ways.

39. On June 30, 2003, a company is preparing the cash budget for the third quarter. The collection pattern for credit sales has been 60% in the month of sale, 30% in the first month after sale, and the rest in the second month after sales. Uncollectible accounts are negligible. There are cash sales each month equal to

25% of total sales. The total sales for the quarter are estimated as follows: July, $30,000; August, $15,000; September, $35,000. Accounts receivable on June 30, 2003, were $10,000. What amount would be the projected cash collections for September? A) $21,375 B) $28,500 C) $30,125 D) $37,250

40. Quick Co. was analyzing variances for one of its operations. The initial budget forecast 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.

Answer Key: 1)B 2)D 3)A 4)C 5)A 6)D 7)A 8)C 9)D 10)B 11)D 12)C 13)B 14)B 15)B 16)A 17)B 18)B 19)B 20)B 21)B 22)B 23)C 24)D 25)B 26)C 27)D 28)C 29)D 30)A 31)C 32)B 33)C 34)C 35)A 36)D 37)A 38)A 39)C 40)D

Business Environment and Concepts 6: Operations Management Benchmarking

Benchmarking is the process of comparing one's business processes and performance metrics to industry bests or best practices from other industries. Dimensions typically measured are quality, time and cost. In the process of benchmarking, management identifies the best firms in their industry, or in another industry where similar processes exist, and compare the results and processes of those studied (the "targets") to one's own results and processes. In this way, they learn how well the targets perform and, more importantly, the business processes that explain why these firms are successful. Benchmarking is used to measure performance using a specific indicator (cost per unit of measure, productivity per unit of measure, cycle time of x per unit of measure or defects per unit of measure) resulting in a metric of performance that is then compared to others. Also referred to as "best practice benchmarking" or "process benchmarking", this process is used in management and particularly strategic management, in which organizations evaluate various aspects of their processes in relation to best practice companies' processes, usually within a peer group defined for the purposes of comparison. This then allows organizations to develop plans on how to make improvements or adapt specific best practices, usually with the aim of increasing some aspect of performance. Benchmarking may be a one-off event, but is often treated as a continuous process in which organizations continually seek to improve their practices. Procedure There is no single benchmarking process that has been universally adopted. The wide appeal and acceptance of benchmarking has led to the emergence of benchmarking methodologies. The first book on benchmarking developed a 12-stage approach to benchmarking. The 12 stage methodology consists of: 1. 2. 3. 4. 5. 6. 7. 8. Select subject Define the process Identify potential partners Identify data sources Collect data and select partners Determine the gap Establish process differences Target future performance

9. Communicate 10. Adjust goal 11. Implement 12. Review and recalibrate The following is an example of a typical benchmarking methodology:

Identify problem areas: Because benchmarking can be applied to any business process or function, a range of research techniques may be required. They include informal conversations with customers, employees, or suppliers; exploratory research techniques such as focus groups; or indepth marketing research, quantitative research, surveys, questionnaires, re-engineering analysis, process mapping, quality control variance reports, financial ratio analysis, or simply reviewing cycle times or other performance indicators. Before embarking on comparison with other organizations it is essential to know the organization's function and processes; base lining performance provides a point against which improvement effort can be measured. Identify other industries that have similar processes: For instance, if one were interested in improving hand-offs in addiction treatment one would identify other fields that also have hand-off challenges. These could include air traffic control, cell phone switching between towers, transfer of patients from surgery to recovery rooms. Identify organizations that are leaders in these areas: Look for the very best in any industry and in any country. Consult customers, suppliers, financial analysts, trade associations, and magazines to determine which companies are worthy of study. Survey companies for measures and practices: Companies target specific business processes using detailed surveys of measures and practices used to identify business process alternatives and leading companies. Surveys are typically masked to protect confidential data by neutral associations and consultants. Visit the "best practice" companies to identify leading edge practices: Companies typically agree to mutually exchange information beneficial to all parties in a benchmarking group and share the results within the group. Implement new and improved business practices: Take the leading edge practices and develop implementation plans which include identification of specific opportunities, funding the project and selling the ideas to the organization for the purpose of gaining demonstrated value from the process.

Types

Process benchmarking - the initiating firm focuses its observation and investigation of business processes with a goal of identifying and observing the best practices from one or more benchmark firms. Activity analysis will be required where the objective is to benchmark cost and efficiency; increasingly applied to back-office processes where outsourcing may be a consideration. Financial benchmarking - performing a financial analysis and comparing the results in an effort to assess your overall competitiveness and productivity.

Benchmarking from an investor perspective- extending the benchmarking universe to also compare to peer companies that can be considered alternative investment opportunities from the perspective of an investor. Performance benchmarking - allows the initiator firm to assess their competitive position by comparing products and services with those of target firms. Product benchmarking - the process of designing new products or upgrades to current ones. This process can sometimes involve reverse engineering which is taking apart competitors products to find strengths and weaknesses. Strategic benchmarking - involves observing how others compete. This type is usually not industry specific, meaning it is best to look at other industries. Functional benchmarking - a company will focus its benchmarking on a single function to improve the operation of that particular function. Complex functions such as Human Resources, Finance and Accounting and Information and Communication Technology are unlikely to be directly comparable in cost and efficiency terms and may need to be disaggregated into processes to make valid comparison. Best-in-class benchmarking - involves studying the leading competitor or the company that best carries out a specific function. Operational benchmarking - embraces everything from staffing and productivity to office flow and analysis of procedures performed. Energy benchmarking - process of collecting, analysing and relating energy performance data of comparable activities with the purpose of evaluating and comparing performance between or within entities. Entities can include processes, buildings or companies. Benchmarking may be internal between entities within a single organization, or - subject to confidentiality restrictions - external between competing entities.

Break-Even Point
In cost accounting, the break-even point (BEP) is the point at which cost or expenses and revenue are equal: there is no net loss or gain, and one has "broken even". A profit or a loss has not been made, although opportunity costs have been "paid", and capital has received the risk-adjusted, expected return. For example, if a business sells fewer than 200 tables each month, it will make a loss, if it sells more, it will be a profit. With this information, the business managers will then need to see if they expect to be able to make and sell 200 tables per month. If they think they cannot sell that many, to ensure viability they could: 1. Try to reduce the fixed costs (by renegotiating rent for example, or keeping better control of telephone bills or other costs)

2. Try to reduce variable costs (the price it pays for the tables by finding a new supplier) 3. Increase the selling price of their tables. Any of these would reduce the break even point. In other words, the business would not need to sell so many tables to make sure it could pay its fixed costs. The Break-Even Point can alternatively be computed as the point where Contribution equals Fixed Costs.

Equation
the break-even point can be more simply computed as the point where Total Contribution = Total Fixed Cost:

In currency units (sales proceeds) to reach break-even, one can use the above calculation and multiply by Price, or equivalently use the Contribution Margin Ratio (Unit Contribution Margin over Price) to compute it as: Where C is cost incurred (i.e. Fixed costs + Variable Costs), and P is Unit sales price.

Cost Accounting Introduction

Cost accounting information is designed for managers. Since managers are making decisions only for their own organization, there is no need for the information to be comparable to similar information from other organizations. Instead, the important criterion is that the information must be relevant for decisions that managers operating in a particular environment of business including strategy make. Cost accounting information is commonly used in financial accounting information, but first we are concentrating in its use by managers to make decisions. The accountants who handle the cost accounting information add value by providing good information to managers who are making decisions. Among the better decisions, the better performance of one's organization, regardless if it is a manufacturing company, a bank, a non-profit organization, a government agency, a school club or even a business school. The cost-accounting system is the result of decisions made by managers of an organization and the environment in which they make them. Cost accounting is regarded as the process of collecting, analyzing, summarizing and evaluating various alternative courses of action involving costs and advising the management on the most appropriate course of action based on the cost efficiency and capability of the management.

The organizations and managers are most of the time interested in and worried about costs. The control of the costs of the past, present, and future is part of the job of all the managers in a company. In the companies that try to have profits, the control of costs directly affects them. Knowing the costs of the products is essential for decision-making regarding price and mix assignation of products and services. The cost accounting systems can be important sources of information for the managers of a company. For this reason, the managers understand the strengths and weaknesses of the cost accounting systems and participate in the evaluation and evolution of the cost measurement and administration systems. Unlike the accounting systems that help in the preparation of financial reports periodically, the cost accounting systems and reports are not subject to rules and standards like the Generally Accepted Accounting Principles. As a result, there is wide variety in the cost accounting systems of the different companies and sometimes even in different parts of the same company or organization. The following are different cost accounting approaches:

standardized or standard cost accounting lean accounting activity-based costing resource consumption accounting throughput accounting marginal costing/cost-volume-profit analysis

Classical cost elements are: 1. Raw materials 2. Labor 3. Indirect expenses/overhead Elements of cost

Material (Material is a very important part of business) o Direct material Labor o Direct labor Overhead (Variable/Fixed) o Indirect material o Indirect labor o Maintenance & Repair o Supplies o Utilities o Other Variable Expenses

o o o o

Salaries Occupancy (Rent) Depreciation Other Fixed Expenses

(In some companies, machine cost is segregated from overhead and reported as a separate element) They are grouped further based on their functions as,

Production or works overheads Administration overheads Selling overheads Distribution overheads

Classification of costs Classification of cost means, the grouping of costs according to their common characteristics. The important ways of classification of costs are:

By nature or element: materials, labor, expenses By functions: production, selling, distribution, administration, R&D, development, By traceability: direct and indirect By variability: fixed, variable, semi-variable By controllability: controllable, uncontrollable By normality: normal, abnormal By Decision making Costs Time of Occupation

Standard cost accounting In modern cost accounting, the concept of recording historical costs was taken further, by allocating the company's fixed costs over a given period of time to the items produced during that period, and recording the result as the total cost of production. This allowed the full cost of products that were not sold in the period they were produced to be recorded in inventory using a variety of complex accounting methods, which was consistent with the principles of GAAP (Generally Accepted Accounting Principles). It also essentially enabled managers to ignore the fixed costs, and look at the results of each period in relation to the "standard cost" for any given product. For example: if the railway coach company normally produced 40 coaches per month, and the fixed costs were still $1000/month, then each coach could be said to incur an overhead of $25 =($1000 / 40). Adding this to the variable costs of $300 per coach produced a full cost of $325 per coach. This method tended to slightly distort the resulting unit cost, but in mass-production industries that made one product line, and where the fixed costs were relatively low, the distortion was very minor.

For example: if the railway coach company made 100 coaches one month, then the unit cost would become $310 per coach ($300 + ($1000 / 100)). If the next month the company made 50 coaches, then the unit cost = $320 per coach ($300 + ($1000 / 50)), a relatively minor difference. An important part of standard cost accounting is a variance analysis, which breaks down the variation between actual cost and standard costs into various components (volume variation, material cost variation, labor cost variation, etc.) so managers can understand why costs were different from what was planned and take appropriate action to correct the situation. Cost Allocation Cost allocation is a process of providing relief to shared service organization's cost centers that provide a product or service. In turn, the associated expense is assigned to internal clients' cost centers that consume the products and services. For example, the CIO may provide all IT services within the company and assign the costs back to the business units that consume each offering. The core components of a cost allocation system consist of a way to track which organizations provides a product and/or service, the organizations that consume the products and/or services, and a list of portfolio offerings (e.g. service catalog). Depending on the operating structure within a company, the cost allocation data may generate an internal invoice or feed an ERP system's chargeback module. Accessing the data via an invoice or chargeback module are the typical methods that drive personnel behavior. In return, the consumption data becomes a great source of quantitative information to make better business decisions. Cost Driver A cost driver is the unit of an activity that causes the change of an activity cost. The Activity Based Costing (ABC) approach relates indirect cost to the activities that drive them to be incurred. In traditional costing the cost driver to allocate indirect cost to cost objects was volume of output. With the change in business structures, technology and thereby cost structures it was found that the volume of output was not the only cost driver. Some examples of indirect costs and their drivers are: indirect costs for maintenance, with the possible driver of this cost being the number of machine hours; or, the indirect cost of handling raw-material cost, which may be driven by the number of orders received; or, inspection costs that are driven by the number of inspections or the hours of inspection or production runs. Generally, the cost driver for short term indirect variable costs may be the volume of output/activity; but for long term indirect variable costs, the cost drivers will not be related to volume of output/activity.

John Shank and Vijay Govindarajan list cost drivers into two categories: Structural cost drivers that are derived from the business strategic choices about its underlying economic structure such as scale and scope of operations, complexity of products, use of technology, etc., and Executional cost drivers that are derived from the execution of the business activities such as capacity utilization, plant layout, work-force involvement, etc. To carry out a value chain analysis, ABC is a necessary tool. To carry out ABC, it is necessary that cost drivers are established for different cost pools. "Cost drivers are the structural determinants of the cost of an activity, reflecting any linkages or interrelationships that affect it" (M. Porter), therefore we could assume that the cost drivers determine the cost behavior within the activities, reflecting the links that these have with other activities and relationships that affect them. Activity-Based Costing Activity-based costing (ABC) is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. This model assigns more indirect costs (overhead) into direct costs compared to conventional costing models. Aims of model With ABC, an organization can soundly estimate the cost elements of entire products and services. That may help inform a company's decision to either:

Identify and eliminate those products and services that are unprofitable and lower the prices of those that are overpriced (product and service portfolio aim) Or identify and eliminate production or service processes that are ineffective and allocate processing concepts that lead to the very same product at a better yield (process re-engineering aim).

In a business organization, the ABC methodology assigns an organization's resource costs through activities to the products and services provided to its customers. ABC is generally used as a tool for understanding product and customer cost and profitability based on the production or performing processes. As such, ABC has predominantly been used to support strategic decisions such as pricing, outsourcing, identification and measurement of process improvement initiatives. Methodology Methodology of ABC focuses on cost allocation in operational management. ABC helps to segregate

Fixed cost Variable cost Overhead cost

The split of cost helps to identify cost drivers, if achieved. Direct labor and materials are relatively easy to trace directly to products, but it is more difficult to directly allocate indirect costs to products. Where products use common resources differently, some sort of weighting is needed in the cost allocation process. The cost driver is a factor that creates or drives the cost of the activity. For example, the cost of the activity of bank tellers can be ascribed to each product by measuring how long each product's transactions (cost driver) takes at the counter and then by measuring the number of each type of transaction. For the activity of running machinery, the driver is likely to be machine operating hours. That is, machine operating hours drive labour, maintenance, and power cost during the running machinery activity. Cost of Goods Sold Cost of goods sold (COGS) refer to the inventory costs of those goods a business has sold during a particular period. Costs are associated with particular goods using one of several formulas, including specific identification, first-in first-out (FIFO), or average cost. Costs include all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Costs of goods made by the business include material, labor, and allocated overhead. The costs of those goods not yet sold are deferred as costs of inventory until the inventory is sold or written down in value. Overview Many businesses sell goods that they have bought or produced. When the goods are bought or produced, the costs associated with such goods are capitalized as part of inventory (or stock) of goods. These costs are treated as an expense in the period the business recognizes income from sale of the goods. Determining costs requires keeping records of goods or materials purchased and any discounts on such purchase. In addition, if the goods are modified, the business must determine the costs incurred in modifying the goods. Such modification costs include labor, supplies or additional material, supervision, quality control, use of equipment, and other overhead costs. Principles for determining costs may be easily stated, but application in practice is often difficult due to a variety of considerations in the allocation of costs. Cost of goods sold may also reflect adjustments. Among the potential adjustments are decline in value of the goods (i.e., lower market value than cost), obsolescence, damage, etc. When multiple goods are bought or made, it may be necessary to identify which costs relate to which particular goods sold. This may be done using an identification convention, such as specific identification of the goods, first-in-first-out (FIFO), or average cost. Alternative systems may be used in some countries, such as last-in-first-out (LIFO), gross profit method, retail method, or combinations of these. Cost of goods sold may be the same or different for accounting and tax purposes, depending on the rules of the particular jurisdiction. Importance of inventories nventories have a significant effect on profits. A business that makes or buys goods to sell must keep

track of inventories of goods under all accounting and income tax rules. An example illustrates why. Fred buys auto parts and resells them. In 2008, Fred buys $100 worth of parts. He sells parts for $80 that he bought for $30, and has $70 worth of parts left. In 2009, he sells the remainder of the parts for $180. If he keeps track of inventory, his profit in 2008 is $50, and his profit in 2009 is $110, or $160 in total. If he deducted all the costs in 2008, he would have a loss of $20 in 2008 and a profit of $180 in 2009. The total is the same, but the timing is much different. Most countries' accounting and income tax rules (if the country has an income tax) require the use of inventories for all businesses that regularly sell goods they have made or bought. Cost of goods made by the business The cost of goods produced in the business should include all costs of production. The key components of cost generally include:

Parts, raw materials and supplies used, Labor, including associated costs such as payroll taxes and benefits, and Overhead of the business allocable to production.

Most businesses make more than one of a particular item. Thus, costs are incurred for multiple items rather than a particular item sold. Determining how much of each of these components to allocate to particular goods requires either tracking the particular costs or making some allocations of costs. Parts and raw materials are often tracked to particular sets (e.g., batches or production runs) of goods, then allocated to each item. Labor costs include direct labor and indirect labor. Direct labor costs are the wages paid to those employees who spend all their time working directly on the product being manufactured. Indirect labor costs are the wages paid to other factory employees involved in production. Costs of payroll taxes and fringe benefits are generally included in labor costs, but may be treated as overhead costs. Labor costs may be allocated to an item or set of items based on timekeeping records. Materials and labor may be allocated based on past experience, or standard costs. Where materials or labor costs for a period exceed the expected amount of standard costs, a variance. Such variances are then allocated among cost of goods sold and remaining inventory at the end of the period. Identification conventions In some cases, the cost of goods sold may be identified with the item sold. Ordinarily, however, the identity of goods is lost between the time of purchase or manufacture and the time of sale. Determining which goods have been sold, and the cost of those goods, requires either identifying the goods or using a convention to assume which goods were sold. This may be referred to as a cost flow assumption or inventory identification assumption or convention. The following methods are available in many jurisdictions for associating costs with goods sold and goods still on hand:

Specific identification. Under this method, particular items are identified, and costs are tracked with respect to each item. This may require considerable recordkeeping. This method cannot be used where the goods or items are indistinguishable or fungible.

Average cost. The average cost method relies on average unit cost to calculate cost of units sold and ending inventory. Several variations on the calculation may be used, including weighted average and moving average. First-In First-Out (FIFO) assumes that the items purchased or produced first are sold first. Costs of inventory per unit or item are determined at the time made or acquired. The oldest cost (i.e., the first in) is then matched against revenue and assigned to cost of goods sold. Last-In First-Out (LIFO) is the reverse of FIFO. Some systems permit determining the costs of goods at the time acquired or made, but assigning costs to goods sold under the assumption that the goods made or acquired last are sold first. Costs of specific goods acquired or made are added to a pool of costs for the type of goods. Under this system, the business may maintain costs under FIFO but track an offset in the form of a LIFO reserve. Such reserve (an asset or contra-asset) represents the difference in cost of inventory under the FIFO and LIFO assumptions. Such amount may be different for financial reporting and tax purposes in the United States. Dollar Value LIFO. Under this variation of LIFO, increases or decreases in the LIFO reserve are determined based on dollar values rather than quantities. Retail inventory method. Resellers of goods may use this method to simplify recordkeeping. The calculated cost of goods on hand at the end of a period is the ratio of cost of goods acquired to the retail value of the goods times the retail value of goods on hand. Cost of goods acquired includes beginning inventory as previously valued plus purchases. Cost of goods sold is then beginning inventory plus purchases less the calculated cost of goods on hand at the end of the period.

Example Jane owns a business that resells machines. At the start of 2009, she has no machines or parts on hand. She buys machines A and B for 10 each, and later buys machines C and D for 12 each. All the machines are the same, but they have serial numbers. Jane sells machines A and C for 20 each. Her cost of goods sold depends on her inventory method. Under specific identification, the cost of goods sold is 10 + 12, the particular costs of machines A and C. If she uses FIFO, her costs are 20 (10+10). If she uses average cost, her costs are 22 ( (10+10+12+12)/4 x 2). If she uses LIFO, her costs are 24 (12+12). Thus, her profit for accounting and tax purposes may be 20, 18, or 16, depending on her inventory method. After the sales, her inventory values are either 20, 22 or 24. After year end, Jane decides she can make more money by improving machines B and D. She buys and uses 10 of parts and supplies, and it takes 6 hours at 2 per hour to make the improvements to each machine. Jane has overhead, including rent and electricity. She calculates that the overhead adds 0.5 per hour to her costs. Thus, Jane has spent 20 to improve each machine (10/2 + 12 + (6 x 0.5) ). She sells machine D for 45. Her cost for that machine depends on her inventory method. If she used FIFO, the cost of machine D is 12 plus 20 she spent improving it, for a profit of 13. Remember, she used up the two 10 cost items already under FIFO. If she uses average cost, it is 11 plus 20, for a profit of 14. If she used LIFO, the cost would be 10 plus 20 for a profit of 15. In year 3, Jane sells the last machine for 38 and quits the business. She recovers the last of her costs.

Her total profits for the three years are the same under all inventory methods. Only the timing of income and the balance of inventory differ.

CostVolumeProfit Analysis
Costvolumeprofit (CVP), in managerial economics, is a form of cost accounting. It is a simplified model, useful for elementary instruction and for short-run decisions. CVP analysis expands the use of information provided by breakeven analysis. A critical part of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs). At this break-even point, a company will experience no income or loss. This break-even point can be an initial examination that precedes more detailed CVP analysis. CVP analysis employs the same basic assumptions as in breakeven analysis. The assumptions underlying CVP analysis are:

The behavior of both costs and revenues is linear throughout the relevant range of activity. (This assumption precludes the concept of volume discounts on either purchased materials or sales.) Costs can be classified accurately as either fixed or variable. Changes in activity are the only factors that affect costs. All units produced are sold (there is no ending finished goods inventory). When a company sells more than one type of product, the sales mix (the ratio of each product to total sales) will remain constant.

The components of CVP analysis are:

Level or volume of activity Unit selling prices Variable cost per unit Total fixed costs Sales mix

Assumptions CVP assumes the following:

Constant sales price; Constant variable cost per unit;

Constant total fixed cost; Constant sales mix; Units sold equal units produced.

These are simplifying, largely linearizing assumptions, which are often implicitly assumed in elementary discussions of costs and profits. In more advanced treatments and practice, costs and revenue are nonlinear and the analysis is more complicated, but the intuition afforded by linear CVP remains basic and useful. One of the main methods of calculating CVP is profitvolume ratio which is (contribution /sales)*100 = this gives us profitvolume ratio.

contribution stands for sales minus variable costs.

Therefore it gives us the profit added per unit of variable costs. The assumptions of the CVP model yield the following linear equations for total costs and total revenue (sales): ) These are linear because of the assumptions of constant costs and prices, and there is no distinction between units produced and units sold, as these are assumed to be equal. Note that when such a chart is drawn, the linear CVP model is assumed, often implicitly. where

TC = Total costs TFC = Total fixed costs V = Unit variable cost (variable cost per unit) X = Number of units TR = S = Total revenue = Sales P = (Unit) sales price

Profit is computed as TR-TC; it is a profit if positive, a loss if negative. In symbols: Break Down of Costs Costs and sales can be broken down, which provide further insight into operations. One can decompose total costs as fixed costs plus variable costs: One can decompose sales as contribution plus variable costs, where contribution is "what's left after deducting variable costs". One can think of contribution as "the marginal contribution of a unit to the profit", or "contribution towards offsetting fixed costs". Decomposing sales as contribution plus variable costs

Financial Ratios
A financial ratio (or accounting ratio) is a relative magnitude of two selected numerical values taken from an enterprise's financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization. Financial ratios may be used by managers within a firm, by current and potential shareholders (owners) of a firm, and by a firm's creditors. Financial analysts use financial ratios to compare the strengths and weaknesses in various companies. If shares in a company are traded in a financial market, the market price of the shares is used in certain financial ratios. Ratios can be expressed as a decimal value, such as 0.10, or given as an equivalent percent value, such as 10%. Some ratios are usually quoted as percentages, especially ratios that are usually or always less than 1, such as earnings yield, while others are usually quoted as decimal numbers, especially ratios that are usually more than 1, such as P/E ratio; these latter are also called multiples. Given any ratio, one can take its reciprocal; if the ratio was above 1, the reciprocal will be below 1, and conversely. The reciprocal expresses the same information, but may be more understandable: for instance, the earnings yield can be compared with bond yields, while the P/E ratio cannot be: for example, a P/E ratio of 20 corresponds to an earnings yield of 5%.

Sources of data for financial ratios

Values used in calculating financial ratios are taken from the balance sheet, income statement, statement of cash flows or (sometimes) the statement of retained earnings. These comprise the firm's "accounting statements" or financial statements. The statements' data is based on the accounting method and accounting standards used by the organization.

Purpose and types of ratios

Financial ratios quantify many aspects of a business and are an integral part of the financial statement analysis. Financial ratios are categorized according to the financial aspect of the business which the ratio measures. Liquidity ratios measure the availability of cash to pay debt. Activity ratios measure how quickly a firm converts non-cash assets to cash assets. Debt ratios measure the firm's ability to repay long-term debt. Profitability ratios measure the firm's use of its assets and control of its expenses to generate an acceptable rate of return. Market ratiosmeasure investor response to owning a company's stock and also the cost of issuing stock. These are concerned with the return on investment forshareholders, and with the relationship between return and the value of an investment in companys shares. Financial ratios allow for comparisons

between companies

between industries between different time periods for one company between a single company and its industry average Ratios generally are not useful unless they are benchmarked against something else, like past performance or another company. Thus, the ratios of firms in different industries, which face different risks, capital requirements, and competition are usually hard to compare.

Accounting methods and principles

Financial ratios may not be directly comparable between companies that use different accounting methods or follow various standard accounting practices. Most public companies are required by law to use generally accepted accounting principles for their home countries, but private companies,partnerships and sole proprietorships may not use accrual basis accounting. Large multinational corporations may use International Financial Reporting Standards to produce their financial statements, or they may use the generally accepted accounting principles of their home country. There is no international standard for calculating the summary data presented in all financial statements, and the terminology is not always consistent between companies, industries, countries and time periods.

Abbreviations and terminology

Various abbreviations may be used in financial statements, especially financial statements summarized on the Internet [41]. Sales reported by a firm are usually net sales, which deduct returns, allowances, and early payment discounts from the charge on an invoice [42]. Net income is always the amountafter taxes, depreciation, amortization, and interest, unless otherwise stated. Otherwise, the amount would be EBIT, or EBITDA (see below). Companies that are primarily involved in providing services with labour do not generally report "Sales" based on hours. These companies tend to report "revenue" based on the monetary value of income that the services provide. Note that Shareholders' Equity and Owner's Equity are not the same thing, Shareholder's Equity represents the total number of shares in the company multiplied by each share's book value; Owner's Equity represents the total number of shares that an individual shareholder owns (usually the owner with controlling interest), multiplied by each share's book value. It is important to make this distinction when calculating ratios.
Other abbreviations

(Note: These are not ratios, but values in currency.)

COGS = Cost of goods sold, or cost of sales. EBIT = Earnings before interest and taxes EBITDA = Earnings before interest, taxes, depreciation, and amortization EPS = Earnings per share

Ratios
Profitability ratios

Profitability ratios measure the company's use of its assets and control of its expenses to generate an acceptable rate of return Gross margin, Gross profit margin or Gross Profit Rate

OR

Operating margin, Operating Income Margin, Operating profit margin or Return on sales (ROS)

Note: Operating income is the difference between operating revenues and operating expenses, but it is also sometimes used as a synonym for EBIT and operating profit. This is true if the firm has no non-operating income. Profit margin, net margin or net profit margin

Return on equity (ROE)

Return on assets (ROA ratio or Du Pont Ratio)

Return on assets (ROA)

Return on net assets (RONA)

Return on capital (ROC)

Cash flow return on investment (CFROI)

Efficiency ratio

Net gearing

Basic Earnings Power Ratio

Liquidity ratios

Liquidity ratios measure the availability of cash to pay debt. Current ratio (Working Capital Ratio)

Acid-test ratio (Quick ratio)

Cash ratio

Operation cash flow ratio

Activity ratios (Efficiency Ratios)

Activity ratios measure the effectiveness of the firms use of resources. Average collection period

Degree of Operating Leverage (DOL)

DSO Ratio [43].

Average payment period

Asset turnover [44]

Stock turnover ratio

Receivables Turnover Ratio

Inventory conversion ratio

Debt ratios (leveraging ratios)

Debt ratios quantify the firm's ability to repay long-term debt. Debt ratios measure financial leverage. Debt ratio

Debt to equity ratio

Long-term Debt to equity (LT Debt to Equity)

Capital budgeting ratios

In addition to assisting management and owners in diagnosing the financial health of their company, ratios can also help managers make decisions about investments or projects that the company is considering to take, such as acquisitions, or expansion. Many formal methods are used in capital budgeting, including the techniques such as

Net present value Profitability index Internal rate of return Modified internal rate of return Equivalent annuity

Performance Management
Performance management (PM) includes activities which ensure that goals are consistently being met in an effective and efficient manner. Performance management can focus on the performance of an organization, a department, employee, or even the processes to build a product of service, as well as many other areas.PM is also known as a process by which organizations align their resources, systems and employees to strategic objectives and priorities. Application This is used most often in the workplace, can apply wherever people interact schools, churches, community meetings, sports teams, health setting, governmental agencies,social events and even political settings - anywhere in the world people interact with their environments to produce desired effects. Armstrong and Baron (1998) defined it as a strategic and integrated approach to increase the effectiveness of companies by improving the performance of the people who work in them and by developing the capabilities of teams and individual contributors. It may be possible to get all employees to reconcile personal goals with organizational goals and increase productivity and profitability of an organization using this process. It can be applied by organizations or a single department or section inside an organization, as well as an individual person. The performance process is appropriately named the self-propelled performance process (SPPP). First, a commitment analysis must be done where a job mission statement is drawn up for each job. The job mission statement is a job definition in terms of purpose, customers, product and scope. The aim with this analysis is to determine the continuous key objectives and performance standards for each job position. Following the commitment analysis is the work analysis of a particular job in terms of the reporting structure and job description. If a job description is not available, then a systems analysis can be done

to draw up a job description. The aim with this analysis is to determine the continuous critical objectives and performance standards for each job. Benefits Managing employee or system performance facilitates the effective delivery of strategic and operational goals. There is a clear and immediate correlation between using performance management programs or software and improved business and organizational results. For employee performance management, using integrated software, rather than a spreadsheet based recording system, may deliver a significant return on investment through a range of direct and indirect sales benefits, operational efficiency benefits and by unlocking the latent potential in every employees work day (i.e. the time they spend not actually doing their job). Benefits may include: Direct financial gain

Grow sales Reduce costs in the organization Stop project overruns Aligns the organization directly behind the CEO's goals Decreases the time it takes to create strategic or operational changes by communicating the changes through a new set of goals Motivated workforce

Optimizes incentive plans to specific goals for over achievement, not just business as usual Improves employee engagement because everyone understands how they are directly contributing to the organizations high level goals Create transparency in achievement of goals High confidence in bonus payment process Professional development programs are better aligned directly to achieving business level goals Improved management control

Flexible, responsive to management needs Displays data relationships Helps audit / comply with legislative requirement Simplifies communication of strategic goals scenario planning Provides well documented and communicated process documentation

Organizational Development In organizational development (OD), performance can be thought of as Actual Results vs Desired Results. Any discrepancy, where Actual is less than Desired, could constitute the performance improvement zone. Performance management and improvement can be thought of as a cycle:

1. Performance planning where goals and objectives are established 2. Performance coaching where a manager intervenes to give feedback and adjust performance 3. Performance appraisal where individual performance is formally documented and feedback delivered A performance problem is any gap between Desired Results and Actual Results. Performance improvement is any effort targeted at closing the gap between Actual Results and Desired Results. Other organizational development definitions are slightly different. The U.S. Office of Personnel Management (OPM) indicates that Performance Management consists of a system or process whereby: 1. 2. 3. 4. 5. Work is planned and expectations are set Performance of work is monitored Staff ability to perform is developed and enhanced Performance is rated or measured and the ratings summarized Top performance is rewarded

BEC 6 (Operations Management) Questions

1. Selected information concerning the operations of a company for the year ended December 31 is as follows: Units produced 20,000 Units sold 18,000 Direct materials used $80,000 Direct labor incurred $40,000 Fixed factory overhead $50,000 Variable factory overhead $24,000 Fixed selling and administrative expenses $60,000 Variable selling and administrative expenses $9,000 Work-in-process inventories at the beginning and end of the year were zero. What was the company's finished goods inventory cost at December 31 under the variable (direct) costing method?

A) $23,900 B) $19,400 C) $17,000 D) $14,400

2. Which of the following statement(s) is(are) true regarding the relationship between absorption costing net income and variable costing income? I. When production exceeds sales, variable costing income exceeds absorption costing net income. II. When sales exceeds production, absorption costing income exceeds variable costing net income. A) I only. B) II only. C) Both I and II. D) Neither I nor II.

3. Snyder Co. manufactures fans with direct material costs of $10 per unit and direct labor of $7 per unit. A local carrier charges Snyder $5 per unit to make deliveries. Sales commissions are paid at 10% of the selling price. Fans are sold for $100 each. Indirect factory costs and administrative costs are $6,800 and $37,200 per month, respectively. How many fans must Snyder produce to break even? A) 1,375 B) 648 C) 564 D) 530

4. The difference between standard hours at standard wage rates and actual hours at standard wage rates is referred to as which of the following types of variances? A) Labor rate. B) Labor usage. C) Direct labor spending. D) Indirect labor spending.

5. A company uses a standard costing system. At the end of the current year, the company provides the following overhead information: Actual overhead incurred Variable $90,000 Fixed $62,000 Budgeted fixed overhead $65,000 Variable overhead rate (per direct labor hour) $8 Standard hours allowed for actual production 12,000 Actual labor hours used 11,000 What amount is the variable overhead efficiency variance? A) $8,000 favorable. B) $8,000 unfavorable. C) $6,000 favorable. D) $2,000 unfavorable.

6. Relevant information for material A follows:

Quantity purchased 6,500 lbs. Standard quantity allowed 6,000 lbs. Actual price $3.80 Standard price $4.00 What was the direct material price variance for material A? A) $1,300 favorable. B) $1,200 favorable. C) $1,200 unfavorable. D) $1,300 unfavorable.

7. Relevant information for product A follows: Actual variable overhead cost per hour $8.00 Standard variable overhead cost per hour $7.50 Actual hours 4,500 Standard hours 5,000 What was the variable overhead spending variance for product A? A) $2,250 favorable. B) $4,000 favorable. C) $2,250 unfavorable. D) $4,000 unfavorable. REG 6, C

8. Black Co.'s breakeven point was $780,000. Variable expenses averaged 60% of sales, and the margin of safety was $130,000. What was Black's contribution margin? A) $364,000 B) $546,000 C) $910,000 D) $1,300,000

9. Limitations of an activity-based costing system include which of the following? A) Control of overhead costs is enhanced. B) Activity-based costing systems are less reliable. C) The expense of obtaining cost data is relatively high. D) It eliminates arbitrary assignment of overhead costs.

10. Which of the following costing methods will yield the lowest inventory value? A) Absorption. B) Hybrid. C) Process. D) Variable.

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

what amount of the joint costs would be allocated to the white breast meat on a relative sales value basis? A) $120,000 B) $200,000 C) $400,000 D) $480,000

12. Black, Inc. employs a weighted average method in its process costing system. Black's work in process inventory on June 30 consists of 40,000 units. These units are 100% complete with respect to materials and 60% complete with respect to conversion costs. The equivalent unit costs are $5.00 for materials and $7.00 for conversion costs. What is the total cost of the June 30 work in process inventory ? A) $200,000 B) $288,000 C) $368,000 D) $480,000

13. Virgil Corp. uses a standard cost system. In May, Virgil purchased and used 17,500 pounds of materials at a cost of $70,000. The materials usage variance was $2,500 unfavorable and the standard materials allowed for May production was 17,000 pounds. What was the materials price variance for May? A) $17,500 favorable. B) $17,500 unfavorable. C) $15,000 favorable. D) $15,000 unfavorable.

14. 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 a value of $322,897 when X equals zero. B) X has a 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.

15. At the end of a company's first year of operations, 2,000 units of inventory are on hand. Variable costs are $100 per unit, and fixed manufacturing costs are $30 per unit. The use of absorption costing, rather than variable costing, would result in a higher net income of what amount? A) $ 60,000 B) $140,000 C) $200,000 D) $260,000

16. A divisional manager receives a bonus based on 20% of the residual income from the division. The results of the division include: Divisional revenues, $1,000,000; divisional expenses, $500,000; divisional assets, $2,000,000; and the required rate of return is 15%. What amount represents the manager's bonus? A) $200,000 B) $140,000 C) $100,000 D) $40,000

17. Which of the following types of costs are prime costs? A) Direct materials and direct labor. B) Direct materials and overhead. C) Direct labor and overhead. D) Direct materials, direct labor, and overhead.

18. Which of the following inventory management approaches orders at the point where carrying costs equate nearest to restocking costs in order to minimize total inventory cost? A) Economic order quantity. B) Just-in-time. C) Materials requirements planning. D) ABC.

19. A company has two divisions. Division A has operating income of $500 and total assets of $1,000. Division B has operating income of $400 and total assets of $1,600. The required rate of return for the company is 10%. The company's residual income would be which of the following amounts? A) $0 B) $260 C) $640 D) $900

20. Central Winery manufactured two products, A and B. Estimated demand for product A was 10,000 bottles and for product B was 30,000 bottles. The estimated sales price per bottle for A was $6.00 and for B was $8.00. Actual demand for product A was 8,000 bottles and for product B was

33,000 bottles. The actual price per bottle for A was $6.20 and for B was $7.70. What amount would be the total selling price variance for Central Winery? A) $3,700 unfavorable. B) $8,300 unfavorable. C) $3,700 favorable. D) $14,100 favorable.

21. Which of the following ratios is appropriate for the evaluation of accounts receivable? A) Days sales outstanding. B) Return on total assets. C) Collection to debt ratio. D) Current ratio.

22. Which of the following is assigned to goods that were either purchased or manufactured for resale? A) Relevant cost. B) Period cost. C) Opportunity cost. D) Product cost.

23. A company manufactures two products, X and Y, through a joint process. The joint (common) costs incurred are $500,000 for a standard production run that generates 240,000 gallons of X and 160,000 gallons of Y. X sells for $4.00 per gallon, while Y sells for $6.50 per gallon. If there are no additional processing costs incurred after the split-off point, what is the amount of joint cost for each production run allocated to X on a physical-quantity basis?

A) $200,000 B) $240,000 C) $260,000 D) $300,000

24. Pinecrest Co. had variable costs of 25% of sales, and fixed costs of $30,000. Pinecrest's breakeven point in sales dollars was A) $24,000 B) $30,000 C) $40,000 D) $120,000

25. What is the cost of ending inventory given the following factors? Beginning inventory $5,000 Total production costs $60,000 Cost of goods sold $55,000 Direct labor $40,000 A) $5,000 B) $10,000 C) $45,000 D) $50,000

26. The following is selected information from the records of Ray, Inc.: Purchases of raw materials $6,000 Raw materials, beginning $500 Raw materials, ending $800 Work-in-process, beginning $0 Work-in-process, ending $0 Cost of goods sold $12,000 Finished goods, beginning $1,200 Finished goods, ending $1,400 What is the total amount of conversion costs? A) $5,500 B) $5,900 C) $6,100 D) $6,500

27. Which of the following costing methods provide(s) the added benefit of usefulness for external reporting purposes? I. Variable. II. Absorption. A) I only. B) II only. C) Both I and II.

D) Neither I nor II.

28. Which of the following nonvalue-added costs associated with manufactured work in process inventory is most significant? A) The cost of materials that cannot be traced to any individual product. B) The cost of labor that cannot be traced to any individual product. C) The cost of moving, handling, and storing any individual product. D) The cost of additional resources consumed to produce any individual product.

Answer Key: 1)D 2)D 3)B 4)B 5)A 6)A 7)C 8)A 9)C 10)D 11)D 12)C 13)A 14)A 15)A 16)D 17)A 18)A 19)C 20)B 21)A 22)D 23)D 24)C 25)B 26)D 27)B 28)C