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Business Environment and Concepts (BEC)

ExamTree 2013
This document provides a comprehensive and concise review of all the important concepts that could be potentially tested on
the CPA Exam. Key words are underlined and key topics that will almost certainly be tested are in bold to help with retention as
well as the use of acronyms. Also included are all the general formulas that could be potentially tested as well. The document is
divided into the different sections that the CPA Exam test material itself is in to provide more efficient studying and comprehension.
This document can also be used by students who are currently or planning on enrolling in Accounting, Finance, Economics, or
Management classes as a guideline and study tool for the materials that will be covered in these classes.
I. Corporate Governance (16% - 20%)
The Board of Directors powers are:
1. In charge of appointing an independent audit committee.
2. Responsible for overseeing the daily operations of the company.
3. Hiring/firing of the chief executive officer (CEO).
4. Determine the mission of company.
5. Decide the declaration/payment of dividends.
The shareholders are the primary stakeholder of any corporation and they have certain rights like the following:
1. Right to receive declared dividends.
2. Right to inspect books and records.
3. Right to keep their ownership level in the company the same if new shares are issued (pre-emptive right).
4. Right to sue on companys behalf if a violation of fiduciary duty occurs (officer not exercising care and due diligence).
5. Right to possible cumulative voting rights (stock owner can vote once for each board seat for each share owned).
The primary goal of the management team of a company is to maximize shareholder wealth and the secondary or by-
product goals are to create as much economic value added as possible and to maximize cash inflows. They are also
responsible for maintaining and implementing all internal controls within the organization to maintain the goal of all
transactions being processed according to managements authorization and requirements.
Business judgment rule where a director can not be held liable as long as they exercised care and due diligence.
Duty of loyalty where management of company puts the interest of the company ahead of their own.
The aligning of management and shareholders goals can best be achieved by including a combination of fixed
compensation and bonuses tied to stock price to avoid compliancy as well as them possibly taking too much risk.
Articles of Incorporation of a company usually include the following:
1. Proposed name and address
2. Purpose
3. Powers
4. Name of registered agent
5. Name and address of each incorporator
6. Number of authorized shares
Bylaws of a company usually state when and how officers will be elected, what duties these officers will perform, how
many mandatory meetings will take place, and what will be the agenda at these meetings.
The Audit Committee must have at least one financial or accounting expert within its members and the committee does
the following:
1. Oversees the appointment
2. Determines amount of compensation
3. Oversee the work performed by the external auditor
4. The external auditor must report directly to them and not an officer of the company.
5. Audit committee members must all be independent
6. Have no direct financial or direct family connections with employees of the company.
The audit committee financial expert must have an understanding of:
1. Functions of the audit committee.
2. Internal control and procedures of financial reporting for organizations.
3. Generally accepted accounting principals (GAAP).
If the audit committee does not have a financial expert then it must give an explanation as to why not.
The Nominating/Corporate Governance Committee
1. Oversees board organization.
2. Determines director qualifications and training.
3. Develops corporate governance principles.
4. Oversees CEO succession.
The Compensation Committee
1. Reviews/Approves CEO compensation.
2. Makes recommendations with respect to incentives and equity based compensation.
3. Helps to align top management pay incentives with shareholder objectives and risk appetite.
Sarbanes-Oxley Act makes CEO and CFO attest to the accuracy and truthfulness of the companys financial documents
and applies internal control provisions to all companies who are registered with the Securities and Exchange Commission
Dodd Frank Act of 2010
1. Requires all members of the compensation committee of public companies must be independent.
2. Requires public corporations to disclose why or why not the chairman of the board is also the chief executive officer.
3. Requires a nonbinding vote by shareholders on extreme pay incentives to top executives at least every three years.
4. Rewards may be paid to whistle blowers.
New York Stock Exchange (NYSE) and NASDAQ requirements for corporations
1. Majority of directors must be independent.
2. Provide how each director independence level was determined to its stockholders.
3. Must have an independent audit committee.
4. Must have a code of conduct for all employees made public.
5. Have regularly scheduled executive sessions.
Internal controls three objectives or definition organizations top management supervision and implementation of a
plan that should provide reasonable assurance to the (1) reliability of the companys financial statements, (2) compliance
with all laws, and (3) effectiveness and efficiency of the companys operations. To have an effective internal control
process it is essential to implement and follow each of the above components.
Limitations of Internal Control
1. Human judgment can be faulty.
2. Breakdowns can occur because of human failures such as simple errors or mistakes.
3. Circumvention by collusion.
4. Management override of internal control.
5. Cost constraints (the cost-benefit analysis).
6. There are no absolute deterrents to fraud.
Internal control systems fail because controls:
1. Not designed/implemented properly.
2. Properly designed/ implemented but ineffective because of changes within the organizations environment.
The internal auditor must:
1. Have knowledge of key information technology risks
2. Have knowledge of information technology audit techniques
3. Can evaluate fraud risk.
The purpose of the external auditors is to provide assurance to the general public that the company is not operating
fraudulently and the financials presented do not contain misleading and inaccurate numbers.
Evaluators individuals who are competent and objective that monitor controls within an organization.
Institute of Internal Auditors (IIA) issues International Standards for the Professional Practice of Internal Auditing and
they do the following:
1. Covers assurance and consulting services internal auditors provide.
2. Internal auditors must establish and maintain monitoring of the disposition of audit results.
3. Has three sections and they are performance, implementation, and attribute standards.
4. Internal audit charter should recognize the need to conform to the code of ethics of the company.
5. Internal audit activity must be independent and the auditor themselves must be objective in work performed.
6. Chief audit executive should report to the audit committee and/or the chief executive officer.
Monitoring for change continuum within an organization
1. Control Baseline serves as the starting point.
2. Change identification identification of a change needed from monitoring.
3. Change Management Design and implementation of the changes needed.
4. Control Revalidation/update continually updating and revalidating controls.
Control environment factors/components for a general organization
1. Commitment to competence.
2. Top management and their philosophy/operating style.
3. Delegation of authority/responsibility.
4. H/R policies and procedures.
There are 3 types of internal controls and they are:
1. Preventive designed to stop an error from happening.
2. Detective designed to find an error after it has happened.
3. Corrective designed to repair what has occurred from an error happening.
Five components within internal control structure and they are:
1. Control environment the providing of appropriate surroundings to entice proper structure and policies that will lead
to good internal control.
2. Control activities makes sure all policies and procedures of management are undertaken appropriately and are
done according to the organizations guidelines.
3. Information and Communication makes sure all information and communication finds it way to the appropriate
levels of the organizations employees in a timely manner.
4. Monitoring the implemented Controls continually checking to make sure controls are working properly.
5. Risk Assessment the process management uses to identify, analyze, and respond to internal or external risks.
Enterprise risk management (ERM) Committee of sponsoring organization (COSO)uses procedures to identify, access,
control, and manages organizational governance by providing guidance. It also helps to align the stakeholders of the
company risk appetite with that of management.
Eight topics within Enterprise Risk Management and they are:
1. Internal control environmentsame as stated in internal control structure above.
2. Objective settingmission statement stating the goals of the organization in terms of its internal control.
3. Event Identificationcontrols and potential risks of breaking controls can be identified.
4. Risk assessmentorganizational employer can identify risks to internal control. Examples are inherent and residual.
5. Risk Responsesorganizational employees know what to do when risks to internal control are present.
6. Control activitiessame as stated in internal control structure above.
7. Flow of Information and Communicationsame as stated in internal control structure above.
8. Monitoring same as stated in internal control structure above.
Risk appetite amount of risk that is acceptable and the company can still achieve its goals
Risk tolerance the acceptable amount of change in a risk or risks that the company is willing to allow.
Risk averse where an entity or person will choose between two investments the investment with the less risk.
Risk response examples are
1. Avoidance reduction of risk by avoiding the situation altogether or exiting the situation.
2. Reduction reduction of risk by implementing safeguards to minimize the likelihood/effects of an adverse reaction.
3. Sharing reduction of risk by transferring or spreading out the risks.
4. Acceptance reduction of risk is not possible and the company accepts it.
The following are advantages of using the ERM framework:
1. Improves risk response decisions
2. Reduces the operational surprises and losses
3. Organization can seize opportunities more easily.
4. Deploy capital more easily.
Some limitations of the ERM framework are the potential for management override, collusion among employees, and
there always being an uncertain future for businesses.
Monitoring is the most important aspect of the COSO ERM Model and has three steps to ensure proper monitoring of
internal control is performed and they are:
1. Structuring organization so employees are assigned job duties according to their capability, objectivity, and authority.
2. Design and Implement monitoring controls to get the most output from the controls with the least input.
3. Evaluate and Report monitoring controls to proper authorities so that needed actions can take place.
II. Economic Concepts and Analysis (16% - 20%)
Demand Curve as the price of a product increases, the quantity demanded by consumers decreases and vice versa.
If some other variable besides price affects the quantity demanded then it will shift the entire demand curve(causes a
change in demand, not quantity demanded) to either the right (if it is positive and increases demand) or to the left (if it is
negative and decreases demand).
Factors or variables that may shift the demand curve are
1. Price of substitute goods
2. Price of complement goods
3. Consumer income and wealth
4. Consumer tastes change
5. The size of the market
Aggregate demand and supply these two functions in the same manner as a normal demand and supply curve except
that the price level affects aggregate demand inversely and in the supply curve the price should remain constant at least
up to some point.
Normal goods where goods are usually consumed during the course of normal business.
Substitute goods where one good can take the place of another without a loss of quality.
Inferior goods where one good can take the place of another but there would be a loss of quality.
Complement goods where one good is needed or usually consumed in conjunction with another good.
Price elasticity of demand the lowest end of the spectrum is goods or products considered a necessity and are not very
price sensitive while the higher end of the spectrum is a good or product considered a luxury or has many substitutes and
can be very price sensitive.
When the price of soda increases, the demand for water (a substitute good) increases or vice versa.
When the price of soda increases causing less demand, the demand for cups to hold the soda (a complement good)
would decrease as well or vice versa.
Cross Elasticity of demand measures the change in demand for a good when the price of a related or competing
product is changed.
Marginal utility (or sometimes called Marginal Return) the value or satisfaction to a consumer of the next dollar they
would spend on a certain product.
Law of Diminishing Returns- the more a consumer purchases (consumes) of a product the less valuable they will deem
the next purchased unit of that product.
Marginal propensity to Consume The % of the next dollar of disposable income the consumer would be willing to spend
to purchase another unit.
Marginal propensity to Save The % of the next dollar of disposable income the consumer would be willing to save
rather than purchase another unit.
Supply Curve as the price of a certain product increases, the quantity supplied increases. If some other variable
besides price affects the quantity supplied then it will shift the entire supply curve either to the right (if it is positive
and increases supply) or to the left (if it is negative and decreases supply).Factors with a positive effect on supply curve:
number of producers, government subsidies, price expectations. Factors with a negative effect on supply curve: changes
in production costs and prices of other goods.
Market Equilibrium price the price at which quantity demanded equals quantity supplied intersect on the graph. An
example would be a decrease in input prices would result in increased quantity supplied at any price resulting in potentially
lower market equilibrium or vice versa.
Price ceilings setting price below equilibrium (results in a shortage or quantity demanded exceeding quantity supplied
or a shortage). Gives consumers a lower price than what they normally would receive from producers.
Price floors setting price above equilibrium (results in a surplus or quantity supplied exceeding quantity demanded).
Gives producers a higher price than what they normally would receive for their products.
Marginal costs the increase in costs that will result from an increase of one unit in production.
Marginal revenue the increase in revenue received by the company due to the sale of one additional unit of production.
In the long run, fixed costs become variable costs and will increase because of diseconomies of scale (increased efficiency
that results from producing more units will only happen for so long before added production costs of producing more
units will overtake the added benefits).
Return to scale increase in units produced (output) that results from an increase in production costs (input).
Economic Rent is the difference of the initial amount paid for something and what the next potential bidder would pay.
Perfect (Pure) Competition - composed of a large number of sellers, the products of each seller are very similar or
standardized, the products price must stay within the industry average, and there are very few barriers to entry/exit.
Perfect Monopoly usually only has one producer (seller), the product does not have any close substitutes and there
are very few restrictions on entering the market. The Demand curve for a perfect monopoly has a negative slope and the
only way to increase profits from where they are currently is to advertise more or decrease production costs. Usually not
found in United States but can exist because of:
1. Increasing returns to scale
2. Control over the materials supply
3. Patents
4. Government franchises (e.g. Russia or China).
Monopolistic Competition usually includes lots of producers (sellers), products are differentiated but can be
interchanged (substituted) and easy for a firm to enter or leave the market.
Oligopoly usually has only a few producers (sellers), products can be similar or non-similar and the market has
high restrictions for entry and exit. Usually members of this economy try to avoid changing prices too much to avoid
potential price wars between each other.
None of the above three are assured of making a profit in the short run.
Gross domestic product (GDP) the price of all goods and services produced by a domestic economy during the year for
sale only in that country, not in another.
Gross national product (GNP) includes all goods and services, whether for sale or produced within its boundaries or in
another country.
Interest rate effect where price inflation causes interest rates to rise and decreases the potential borrowing by consumers.
Wealth effect price inflation causes the value of fixed income investments to decrease, causing people to have less wealth
and reducing their potential consumption of normal goods.
Consumer Price Index measures price of certain goods and services that a typical consumer would probably consume
and/or purchase in relation to the price paid for the same goods and services in an earlier period.
Producer Price Index measures price of certain goods and services at the wholesale cost to dealers, does not include any
purchases made by consumers.
Point A Point B Point C Point D Point E Point F
Example of an expansionary economy is from point A to point B.
Example of a peek in the economy is point B itself.
Example of a recession in the economy is from point B to point D.
Example of a trough happening in the economy is from Point C to E.
Leading indicator starts moving up months before an actual recovery begins. Examples are unemployment rate and
housing starts.
Coincidence indicator moves up and down simultaneously with economic recoveries and recessions. Example is personal
income as it will move as the economy moves.
Lagging indicator starts moving up months after a recovery has begun, and starts declining months after a recession has
begun. Example is a consumer price index.
Frictional unemployment unemployed who are changing jobs or just entering the work force.
Structural unemployment unemployed whose job skills do not match the wants of employers.
Cyclical unemployment caused by changes in the business cycle or economy.
There can be what is considered full employment and frictional unemployment still exist.
Phillips Curve as unemployment decreases, interest rates rise or vice versa.
Effective Annual Rate rate of annual interest actually being charged or earned.
Nominal interest rate rate valued in relation to a nations currency or real risk free rate plus inflation.
Real interest rate rate adjusted for inflation.
Risk free interest rate rate charged to someone who would without doubt repay their loan.
Discount rate rate the Federal Reserve Bank charges banks for loans made to them.
Prime Rate rate banks charge customers on short term loans who have excellent credit.
Absolute advantage when a country can produce a good or service at a lower cost than another country.
Comparative advantage when the opportunity costs of producing a certain good or service relative to the opportunity
cost of producing other goods is lower in one country than it is in another.
Tariffs (taxes on the importing of goods) and quotas (limits on the quantity that may be imported).They both have direct
effects on producers and users and they are;
Domestic Producers and Foreign Users Positive.
Domestic Users and Foreign Producers Negative.
Current account flow of goods, services, interest, and dividends during a period.
Capital account flow of investments in fixed and financial assets.
Inflation rate of increase in the price level of goods and services.
Deflation rate of decrease in the price levels.
High levels of deflation and inflation can be detrimental to the economies of a country by causing contractions in
Monetary policy where the Federal Reserve central bank of the United States borrows money given to them to hold by
depositors and loaned out to individuals and others for spending purposes.
The Federal Reserve can influence the interest rates or monetary policy of the country by
1. Increasing the reserve requirements of banks (decreases the money supply and increases the interest rates).
2. Decreasing the reserve requirements of banks (increases the money supply and decreases the interest rates).
3. Purchase more government securities (increases the money supply and decreases the interest rates).
4. Sell more government securities (decreases the money supply and increases the interest rates).
Fiscal policy where the federal government takes actions such as taxes levied, subsidies paid out, and other
government spending programs to promote a stable economy.
The federal government can influence the economy and how strong it is by
1. Increasing taxes (decreases the money supply to the general public and generally contracts the economy).
2. Decreasing taxes (increases the money supply to the general public and generally expands the economy).
3. Increase spending (increases the money supply to the general public and generally expands the economy).
4. Decrease spending (decreases the money supply to the general public and generally contracts the economy).
Factors that affect foreign exchange rates:
Inflation a nations currency with a higher inflation rate will decrease in value relative to a country with lower inflation.
Interest rate a nations currency with higher interest rates will increase in value relative to a country with low interest.
Balance of payments currency in a nation that buys more goods than it sells (net importer) will decrease in value
because of less demand for its currency. Currency in a nation that sells more goods than it buys (net exporter) will
increase in value because of more demand for its currency.
Government intervention currency in nation buying its own currency will increase in value and currency in nation that
is selling its own currency will decrease in value.
Currency Exchange Examples
When $1.25 equals 1 Euro instead of it taking $1.30 to equal 1 Euro it means a stronger dollar and you are able to buy
more with it.
When $1.50 equals1 Euro instead of it taking $1.45 to equal 1 Euro it means a weaker dollar and you will be able to buy
less with it.
World Bank usually lends money to countries for development and building infrastructure.
International Monetary Fund usually provides money to countries in financial crisis.
Options contracts that allow the buyer (holder) to either buy (call) or sell (put) whatever the contract states. Usually
involves a commodity like a farm crop or a stock.
Warrant contract attached to a bond that allows the buyer to buy (call) stock in a company.
Spot rate- rate for currencies or contract for something that will be exchanged immediately (current delivery or market).
Forward rate rate at which two parties agree to exchange currencies or contract for something at a future date (future
delivery or market). These trade on the open market as futures.
III. Financial Management (19% - 23%)
Sunk costs capital that has been spent and cannot be recovered.
Opportunity costs capital that is lost because of the choosing of one alternative over another.
Differential costs costs that change from one alternative to another.
Relevant costs future costs that will change as a result of a specific decision.
Transfer Pricing Strategy where a product is transferred from one division to another and the costs of the product are
transferred as well by full absorption costing, market price, or dual transfer pricing.
Full Absorption Costing where a product is transferred from one division to another and the full cost is absorbed by the
receiving department.
Short-term pricing Strategy strategy for one time or limited quantity products or services and usually use the contribution
margin of the product to determine the price point.
Cost-Plus Pricing Strategy usually used where products or services are done at high standards and a given profit margin is
added to the total costs to determine the price point.
Target Pricing Strategy strategy where a price point or target is set according to the estimated value of the product or
service and the profit the firm wants to make.
Payback period method determines number of years needed to payback initial investment only and ignores time value of
money, any cash flows after payback period is met, and does not take into account the maximization of shareholder value.
Can be considered the same as the Accounting rate of return (computes rate of return but does not consider the time
value of money like the payback period method. It is simple and easy to compute but the disadvantages are the results are
affected by the depreciation method used and make no adjustment for the projects risk potential).
Discounted payback period method same as normal payback period but includes the time value of money.
Net present value advantages include answer is in dollars and adjusted for the time value of money as well as it
considers the total profits for the project. Disadvantages of net present value are that it can be cumbersome to solve for
and it does not evaluate managements decisions when undertaking a project.
Internal rate of return includes the time value of money which makes it more advantageous to use than the regular
payback method. Some drawbacks are that some projects will have very uneven cash flows making it very hard to
calculate the IRR and there could be instances where it is also hard to find a real discount rate.
Lease vs. Buy decisions where management decides whether to lease/buy when purchasing usually large equipment.
Advantages of leasing -
1. Tax advantages.
2. Can require less initial investment than a loan (also less capital restrictions due to loan covenants).
3. Some leases are not capitalized (no debt recognized on balance sheet).
Standard deviation measures the volatility of a potential investment and used when choosing among investments with the
same expected return.
Coefficient of variation used when choosing among investments having different expected returns or standard deviations.
Covariance or correlation measures the amount of change an investment will encounter in terms of another investment.
Covariance of 1.00 is when one investment goes up, the other will move upwards as well and vice versa.
Covariance of 0 is where no relationship exists and when one investment changes the other might change or it might not.
Covariance of -1.00 is when one investment goes up, the other will move downwards or vice versa.
Hedging decrease of risk by having more than one kind of an investment, e.g., having more than one egg in the basket.
Speculation profit from changes in price of the investment.
Un-systemic risk risks that can be eliminated from an investment.
Systemic risk risks that cannot be eliminated from an investment no matter what.
Credit risk potential that a borrower will default on a loan or the interest owed on the loan.
Price risk potential that a security or group of securitys prices will decline in value.
Business sector risk risk a certain industry segment declines across all companies represented in that industry segment.
Market risk potential that a bond or loan will lose value because of the economy deteriorating.
Interest rate risk potential that a bond or loan will lose value because of increasing interest rates.
Floating amount of time between a check being written out until it is reflected in financial records.
Zero Balance accounts- company transfers only the amount of funds needed to pay for current bills received and ends
the business day with a zero as the account balance. Maximizes float of cash disbursements.
Lockbox system where payments are sent directly to a bank and stored in a locked box. Increases internal control over
cash accounts and is cost effective in terms of interest savings due to more timely deposits of cash.
Concentration banking where payments are sent to local branch offices of bank instead of the main office.
Electronic funds transfers where customers pay electronically (e.g., a credit or debit card).
Treasury Bills short term obligations that trade at a discount and have maturities less than one year.
Treasury Notes obligations with maturities of 1 to 10 years with semiannual interest.
Treasury Bonds obligations with maturities greater than 10 years with semiannual interest.
Commercial Paper obligations from large and credit worthy corporations with maturities usually up to only 9 months.
Line of credit bank states the maximum amount they will lend to a customer.
Letter of credit bank states they will lend the agreed upon amount when the deal is finalized.
Other types of bonds include the serial (paid off in installments and can choose the maturity date) zero-coupon, floating
rate, junk, euro, and foreign bonds, conversion, subordinated, and debenture (not secured).
Supply chain management total management of goods from point of origin all the way to the final consumer and then
back to the point of origin. Used to help provide the best possible use of inventory to keep costs as low as possible.
Economic order quantity total quantity of inventory to order to reduce the ordering/carrying costs to the minimum.
Just in Time inventory (JIT) where inventory is either produced or ordered just before the customer needs and
purchases it. Advantages of JIT inventory systems are
1. Lowers investment in inventory and storage space that is needed.
2. Lowers inventory carrying and handling costs.
3. Less chance of defective and obsolete inventory carried past warranty/return date.
Debt financing advantages
1. Interest is tax deductible
2. Fixed interest and principal payments
3. No control of ownership is relinquished
4. Debt is less costly than equity (stock issued) and will maximize earnings per share.
Debt financing disadvantages
1. Interest and principal must be paid no matter how economically stable the firm is.
2. Restrains the company from possibly issuing future debt.
3. Excessive debt can increase the likelihood that stakeholders of the firm could lose their interest in it.
Capital vs. Operating leases capital leases are those that meet any one of the four conditions below while operating
leases are any that do not.
1. Has clause where ownership of leased item transfers from lessee to lessor at end of lease term.
2. Has a bargain purchase option that can be exercise at end of lease term.
3. Lease term itself is equal to 75% or more of the estimated life of the leased item.
4. Present value of minimum payments equals 90% or more of the fair value of the leased item at lease commencement.
Cost of Capital the weighted average cost of an entitys debt and equity financing components.
Optimal capital structure is the mix of debt, preferred stock, and common stock that maximizes a companys stock
price. The use of more debt will usually increase the return on equity but increases the risks incurred.
Common Stock
1. Less costly in the long run than borrowing but the initial issuance costs are expensive (in terms of additional capital).
2. Issuing common stock results in sharing more control and ownership with the new purchasers of the new shares.
3. Interest payments resulting from borrowing from a lender can be deducted.
4. Dividend payments to stock holders can not be deducted.
Preferred Stock
1. Usually have no voting rights but given first priority over common stockholders if a company files for bankruptcy.
2. Generally lower costs than a common stock issue
3. Dividends typically expected as they usually receive a certain pre-stated dividend amount.
4. There can be more than one class of stock.
Chronological calendar order of the dividend payout process is declaration date, ex-dividend date, date of record and the
payout date.
Dividend Payouts the use of dividends and stock splits to distribute earnings to stockholders and to help entice more
stock purchases. An advantage of dividend payout use is it does not reduce shareholders equity in the company.
Leveraged Buyout where investors buy a company using small amount of their own money and instead borrow the
majority of the capital needed.
Operating leverage how much fixed costs are carried by a company the higher the fixed cost, the higher the risk of
trouble the company faces if performance declines.
Financial leverage how much debt outstanding is carried by a company the more, the higher the risk of trouble the
company faces if performance declines. The more debt financing a company uses the more financial leverage they have.
Mortgages are collateralized while an unsecured bond is a debenture. Indenture is the legal documentation of the bond and
exists to protect the bond holder. Sinking funds refer to where a certain percentage of the outstanding balance owed of a
bond must be repaid each year.
Underwriting where an investment firm or bank buys the entire amount of security offering and then resells them to the
public at a profit.
IV. Information Systems and Communications (15% - 19%)
Central Processing Unit (CPU) main hardware that processes programs
System software programs that run the computer system and support operations.
Application software user programs such as word processors and spreadsheets.
Hardware the physical equipment of a computer system.
Primary storage the RAM (random access memory) an ROM (read-only memory) of a CPU.
Secondary storage storage devices like flash drives, dvds, and cds.
Electronic data interchange the transmission of data using computer systems from one companys computer to another
companys computer, no paper is used, and where controls being in place are essential.
Benefits of EDI
1. Quick reaction/access to information
2. Costs reduced (due to reduced paperwork, errors and error-correction costs).
3. More efficient communications and customer service
4. Can become necessary in some technology laden fields for entity to remain competitive
Weaknesses of EDI
1. Dependence on computer systems.
2. Dependence on third parties.
3. Increased chance of loss of sensitive data.
4. Increased chance for theft/fraud.
5. More potential for errors.
Enterprise Resource Planning systems (ERPs) includes all data and processes of an organization as an almost complete
information system for medium and large organizations and it eliminates some of the errors that might occur within a
diversified organization with many different departments or divisions. Disadvantages of an ERP system are the costs and
complexity that it can add to an organization.
Data Manipulation Language (DML) used to change records by adding, updating, or deleting.
Data Definition Language (DDL) used to add, update, or delete tables, fields, or databases.
Decision Support System (DSS) uses models and data to assist in management decisions.
Extensible Markup Language (XBRL) encodes and tags business information such as account information for a
customer. Another example is Extensive Markup Language (XML).
Hypertext Markup Language (HTML) used primarily for creating webpages.
Hypertext Transfer Protocol (HTTP) language used to connect different computers by the internet over the internet.
Management Information systems provides necessary information for management to make appropriate decisions.
Local Area Networks (LAN) used where computers are all centrally located close together.
Virtual Private Network (VPN) secured way of connecting from an offsite location to a LAN network.
Wide Area Network (WAN) used where computers are going to be connected from long distances by the use of fiber
optic cables or satellites.
Value Added Network (VAN) privately owned network that transmits EDI information between business partners.
Advantages of VAN include
1. Reduces scheduling problems.
2. Provides more security than normal transaction channels.
3. Business to business partners have direct communication lines open at all times (thereby reducing problems).
Disadvantages of VAN include
1. Can be costly.
2. Entity can become dependent on the security that VAN offers.
3. Can be a loss of confidential data.
Server computer sending data.
Client computer receiving data.
Upload data sent from the client to the server.
Download data sent from the server to the client.
Data is organized in the following order so that all computers can process and read it.
Remember the acronym BBC FRF
Bit either a (1) or (0).
Byte group of bits, usually 8 representing a character.
Character letter, number, or special character.
Field group of characters representing a number or word.
Record group of fields representing such things as a list of certain businesses in a segment of an industry.
File group of records representing such things as the whole list of businesses in an industry.
Seven step process of systems design and process improvement and it is as follows:
1. Plan
2. Analyze
3. Design
4. Develop
5. Test
6. Implement
7. Maintain
Batch data collected and held until processed in a lump sum. Provides more internal control.
Online data collected and processed as it is collected. Provides less internal control.
Batch totals sum of a certain section or field within a collection of data. Used to check for controls of total amount.
Financial totals sum of a financial total such as checks, cash, or coins. Used to check for controls of total amount.
Hash totals sum of a certain field that is meaningless such as the amount of total accounts receivable for a certain hour of
business. Used to check for controls of total amount.
Record totals sum of a certain field such as number of accounts receivable. Used to check for controls of total amount.
Data warehouse collection of data needed to make management decisions (data mart is like this but smaller in scope).
Data mining manipulating data.
Primary storage consists of RAM (random access memory for internal storage of data and programs) and ROM (read only
memory for storage and fast retrieval of data).
Digital Signature where a sender of data encrypts its own data by it not being altered in transmission.
Digital Certificate where a third party encrypts the senders data and certifies its authenticity.
IT department staff includes the following:
Remember Acronym SAD SS
1. System analyst designs the information system environment.
2. Application programmer writes, tests, and debugs programs such as payroll or accounts receivable applications.
3. Database administrator overlooks database to assure appropriate users have access to the databases information.
4. Systems Programmer updates and maintains the computer system such as the operating system.
5. System Administrator secures and oversees the computer system as a whole.
6. Librarians maintains custody of removable media items and for maintenance of program/system documentation.
Electronic funds transfer making cash payments from one entity or person to another by the use of electronic means.
Advantages are it is faster and easier but has a higher risk of unauthorized access and risk of fraudulent fund transfers.
Does help to provide for the reduction in the frequency of data entry errors.
Control Objectives for Information and Related Technology (COBIT) developed by the Information Systems Audit and
Control Association (ISACA) to help entities achieve their set objectives with the use of enterprise IT.
Echo Check used in technology transactions of data to keep entities from sending incorrect data by resending the data
received back to the sender to verify and any data sent incorrectly is resent.
Limit Check a control that tests data for reasonableness by using a given upper and/or lower limit.
Field check a control that limits the types of characters accepted into a certain field.
Validity check a control that allows only valid transactions or data to be entered into the system.
Check digit a control that adds an extra digit added to detect certain types of data transmission errors.
Advantages of database systems
1. Data independence
2. Minimal duplication of data
3. Data sharing performed easier
4. Reduces system maintenance
Disadvantages of database systems
1. Need for expert personnel.
2. Installation/Conversion costs
3. Continuous backup/recovery measures are necessary.
Controls needed for telecommunications
1. Data entry
2. Encryptions
3. Data transmission accuracy and completeness
4. Physical security
5. Remote site
Disaster recovery plan helps management to prepare for possibility of a long term effecting disaster and minimize its
costs and effects. It should do the following:
1. Minimize the disaster effects.
2. Have an alternate information processing system
3. Provide for normal operations to begin again as quick as possible.
4. Provide disaster recovery training so everyone employee can be as knowledgeable as possible.
Hot site allows for immediate use because it has a system that is just like the one the company regularly uses.
Cold site area where the company can set up to run its system but will take some time.
Input controls checks for validity, accuracy and completeness of data entered into the computer system.
Processing Controls ensure data used appropriately to provide the most benefit.
Output Controls checks to make sure data is produced accurately and given to the right employees.
Physical Access Controls physical barriers to prevent damage from disgruntled employees, weather, theft, or acts of war.
An example could be where user accounts requiring passwords helps to prevent access to restricted data, automated key
cards, and manual key locks.
Master Files keeps a record of transactions by account. These records are an example of permanent files and contain
detail files as well.
Intranets access granted to only organization members.
Extranets access granted to only organization associates or business partners.
End-User Computing - end user is responsible for the advancement and execution of computer applications and the data
Control Implications of End-User computing are
1. Physical access controls
2. User passwords and IDs,
3. Record all database information accessed by each user.
4. Use of incorrect versions of data files or programs.
5. File backup or recovery system.
6. Applications controls
Even the best internal control procedures can incur failures due to human error, faulty judgment, collusion, and
management override. Backing the computer system up is good as long as it does not create redundant work.
Programs and data access controls can be accomplished by hardware, software, segregation, and physical controls.
Since IT decreases segregation of duties, the objective of internal controls should be:
Remember acronym CAVATI
1. Completeness
2. Accuracy
3. Validity
4. Authorization
5. Timeliness
6. Integrity
Encryption coding of information so that only selected users with correct decoding key can access the coded material
Virus unwanted program that attaches itself to the users files and usually will cause them damage.
Worm usually function like a virus but can replicate each other easily and spread throughout without needing a host.
Trojan Horse harmful program/file that enters the users network unknowingly and secretively to the users attention.
V. Strategic Planning (10% 14%)
Strategic planning the identification of a companys goals and objectives and then determining the best approaches on
how to achieve them.
Product differentiation business strategy the process of making a companys products different from all competitors
products to make consumers purchase it instead of the competition. Can be done by changing the physical, perceived,
and support service differences. Usually more of a custom order business.
Cost Leadership business strategy focus on lowest cost instead of quality, must be able to produce at a very low unit
cost to succeed. Usually involves process reengineering, lean manufacturing, supply chain management, strategic
alliances, or outsourcing.
Supply chain management the management of the supply chain from start to finish of a product to improve the
product and how it is supplied. Can involve some risks or problems and they are the refusal of some companies to share
all information, failure of suppliers and/or customers to meet obligations, and information system problems.
Cost Volume Profit Analysis (Breakeven analysis) used to maximize profits by determining the most efficient output
quantity and any other variables that might affect profits. Must remember that when this is conducted it is assumed
that the selling price remains constant, sales mix remains constant, total fixed costs remains constant, variable costs per
unit remains constant, and costs can be separated into fixed and variable.
Assumptions of CVP Analysis
1. There are fixed and variable costs.
2. Variable costs remain constant.
3. Total fixed costs remain constant as well.
4. Efficiency remains constant.
5. Productivity remains constant and equals the number of units sold.
6. Selling price is not tied to activity level changes.
7. Sales mix remains constant.
The variable costing treats fixed manufacturing overhead as expensed whereas under absorption costing it is treated as
a product cost and inventoried. The relationship between variable costing income and absorption costing income is as
Sales = production (no change in inventory) No difference in income
Sales > production (inventory decreases) VC income greater than AC income
Sales< Production (inventory increases) VC income less than AC income
Financial Planning Process includes:
1) Evaluating the different financing alternatives available
2) Determining the consequences of each of these alternatives
3) Choosing one of the alternatives to accept
4) Evaluating the results against the goals of the alternative accepted.
Process Improvement Steps includes:
Remember acronym D MEMO.
1. Design
2. Modeling
3. Execution
4. Monitoring
5. Optimization
Master Budget includes financial and operating budgets for a future period.
Flexible Budget adjustable due to changes in the activity levels or changes in volume and allows a manager to be able
to account for differences in budgeted and actual production levels by using standard unit costs.
Operating budgets consist of the following: sales, production, direct materials, direct labor, overhead, research and
development, and selling, general, and administrative expense budgets. The sales budget is the most important and must
be done first before the other budgets are done.
Financial Budgets consist of the following: capital expenditures budget, cash budget, budgeted balance sheet, and the
budgeted statement of cash flows. Best way to remember this is to know components of financial budgets and then
know that everything else is a component of operating budgets.
Capital Budget displays the financial effects of purchases and retirements of long-lived assets. This information is needed
to budget the cash and financing needs of the firm. Because of the need to plan for purchases of long-lived assets, capital
budgets tend to span several years.
Preparing a budget 4 step process
1. Develop a sales forecast
2. Develop a production schedule (Calculating production costs and costs of goods sold).
3. Estimate any other potential expenses or revenues
4. Prepare the pro forma financial statements and budgets.
Managers or lower level employees have more control over material usage, labor, and overhead efficiency variances while
having less control over material price variances because they would have little control over the purchase prices of the
Direct materials all material costs that can be traced to the production of a finished product.
Indirect materials all material costs that can not be traced to the production of a finished product and is grouped within
factory overhead.
Direct labor all labor costs that can be traced to the production of a finished product.
Indirect labor all labor costs that can not be traced to the production of a finished product. Grouped in factory overhead.
Factory overhead all indirect materials, labor, and any other costs that can not be traced to the production of a finished
Manufacturing costs cost of direct materials, direct labor, and factory overhead.
Marketing costs costs of promoting and advertising the product or service.
Administrative costs costs of management and staff support in the operation of the company.
Financing costs costs of receiving funds such as loans or costs of providing customer credit.
Period costs sometimes called selling and administration costs incurred in period of goods produced but cannot be tied
directly to one certain product.
Product costs also called manufacturing costs it is the cost of converting goods and can be tied directly to a specific
Cost of Quality - 4 types of costs associated with this and they are:
Remember acronym IPED.
1. Internal failure
2. Prevention
3. External failure
4. Detection
Cost centers does not add profits to the company but only costs them money.
Profit Center adds profits and costs to the company.
Investment Center adds profits, costs, and investments to the company.
Cost drivers any variable that influences cost.
Moving average uses the average of totals for the most recent periods to predict the next periods totals.
Exponential smoothing similar to moving average but the more recent totals are weighted more heavily than older totals
in computing the forecast.
Delphi technique series of structured questionnaires.
Regression Analysis measures a dependent variable and at least one independent variable.
Where y = mx +b and
y = the dependent variable
m = slope of regression line (sometimes referred to as letter b).
x = the independent variable
b = the y intercept or constant value (sometimes referred to as letter a).
A major assumption of regression analysis is the relationship is linear within the relevant range.
Sell or process further the decision of whether joint products should sold at split-off or processed further. Ignore any joint
costs in the decision making process and only process further if incremental revenue exceeds incremental costs.
Special order decision of whether to accept a special order to manufacture as long as there is idle capacity. Entity will
normally accept as long as regular sales are not affected and revenue from order is greater than production costs.
Make or buy where entity decided to either make or buy a part. Usually will choose the lower cost option unless the
entity is trying to avoid something like the loss of quality.
Normal spoilage a product cost spoilage that usually cannot be avoided.
Abnormal spoilage a period cost spoilage that can be avoided.
Scrap a cost of goods manufactured leftover material from the processing another job.
Activity Based Costing method that assigns only the costs of each activity to all products and services according to
actual costs incurred. Usually used to allocate overhead costs to appropriate products by breaking down the costs from a
very involved process into smaller process and assigning the costs to each of them individually.
Involves two principles and they are that activities consume resources and these resources are then consumed by
products or services the firm offers. It can also help managers to identify non value adding activities.
Allocation bases where a business allocates overhead costs to the appropriate levels in terms such as labor or machine
Predetermined Overhead Rate calculated before period and is used for applying manufacturing overhead to work in
process inventory.
Variable overhead overhead amount that changes as more/less units are produced.
VI. Operations Management (12% - 16%)
Job Order Costing where costs are assigned to a product that can be easily identified and is unique from any other
product and the costs associated with it.
Process Costing where costs are assigned to a product that is mass produced and the costs can not be easily identified
from one product to another because the products are all the same.
Just in Time Costing where costs are assigned to a product that is currently being produced and will not incur any other
costs that were or will be incurred in another period.
Accounting for overhead if overhead can not be directly traced to the final product then overhead must be applied, rather
than directly charged, to goods produced. the overhead application process is described as
Over-applied overhead occurs because
1. Overhead costs were overestimated
2. Actual activity was greater than normal capacity
3. Actual overhead costs were less than expected
Under-applied overhead occurs because
1. Overhead costs were underestimated
2. Actual activity was less than normal capacity
3. Actual overhead costs were more than expected.
Balance Scorecard
1. Financial performance ratings relating to the financial performance of the company.
2. Customer performance ratings relating to the customer and the market as a whole.
3. Internal Business Processes performance ratings relating to the internal operations.
4. Learning and Growth performance ratings relating to skills, training, and work environment of entitys employees.
Value Chain where a product or service is receiving value added inputs along its path to the customer. Another way of
stating this is the company is creating value as it produces its service or product.
Internal Business Processes include all processes that happen or will happen within the company and its production line,
not anything that happens outside like customer feedback or profit potential of the item.
Outsourcing sending a job or jobs to another company, usually in another country, to complete to usually save money,
improve quality, or give the firm more time to focus on other jobs or duties. Risks involved are potential loss of quality, loss
of control over the manufacturing of the product or service, and public relations issues.
Theory of Constraints elimination of obstacles to production such as bottlenecks to maximize production.
Lean Manufacturingelimination of non value adding jobs or activities to increase efficiency in production.
Quality Control Costs it is usually more economical to try and prevent failures than to fix them after they happen. Rework
and Spoilage are internal failure costs.
The four categories of cost of quality are:
1. Prevention
2. Internal failure costs
3. External failure costs
4. Appraisal costs
Benchmarking measuring the performance of a company or segment of a company against expected performance.
Pareto Principle theory that 80% of all problems come from only 20% of all causes.
Control Chart measures variations from standard processing.
Six Sigma Statistical measuring to see if the companys products meet the necessary requirements to meet customers
Kaizen Continuous improvement emphasizing identification of small problems and fixing them before they become larger
SWOT analysis
1. Strengths
2. Weaknesses
3. Opportunities
4. Threats
Porters Five Forces analysis
1. Threat of new entries
2. Threat of substitute goods
3. Bargaining power of suppliers
4. Competition
5. Bargaining power of consumers.
System Costs flows thru an organization in the following order:
1. Materials Inventory
2. Work in Process
3. Finished Goods
4. Cost of Goods Sold
Manufacturing Overhead can not be traced directly to the finished product or goods.
Prime Costs includes direct materials and direct labor.
Conversion Costs costs incurred to convert raw materials into final products. Includes direct labor and materials overhead.
Fixed costs do not change with the level of output along the relevant range but fixed unit costs decreases as the level of
output increase along the relevant range or vice versa.
Variable costs costs that change with the level of output along the relevant range and variable unit costs do not change
with the level of output along the relevant range.
The following gives an example of what happens when production rates
change along the relevant range or where fixed costs will remain
The following gives an example of what happens when the
amount of receivables or payables are changed.
Unit Costs Total costs
Fixed Costs Change Constant
Variable Costs Constant Change
Total costs Change Change
Receivables Payables
Decrease Increase of Cash Decrease of Cash
Increase Decrease of Cash Increase of Cash
The below group of formulas are more likely to be tested on every test given than the others and problems should be
worked using these formulas to help with the retention and how to apply them.
APR (annual percentage return) = Effective Interest Rate * # of periods in year
Asset turnover = Sales / Total Assets
Breakeven Point in terms of units = fixed costs / Contribution Margin
Breakeven Point in terms of dollars = fixed costs / contribution margin ratio
Bond valuations divide the current market interest rate by the number of payments per year and multiply by
corresponding present value factor of (number of years times number of periods in a year). Then take the corresponding
bond value amount and multiply it by the corresponding present value factor of ordinary annuity.
Capital Asset Pricing Model (CAPM) = [( Beta * (expected rate of return risk free rate of return)] + risk free rate of return
Includes both time value of money and risk.
Cash conversion cycle = inventory conversion period + receivables collection period - payables deferrable period
Current ratio = current assets / current liabilities
Contribution Margin = revenue variable costs
or = sales variable costs
Cost of Goods Sold = Beg. Inventory + Inv. Purchases End. Inventory
Dividend Payout Ratio = cash dividend per share / Earnings per share
Economic Value Added = net operating profit after taxes (NOPAT) cost of financing
Effective Interest Rate = (principle * rate * time) / principle
(Principle includes only usable portion, in case of compensating balances)
(Time is = 1 year is 1, less would be .5 for 6 months or so on)
Gross Margin = revenue cost of goods sold (or gross profit)
Inventory conversion period = Average Inventory / Cost of sales per day
Average inventory = (Beginning inventory + Ending inventory) / 2
Make sure to use 365 days per year unless stated otherwise
Inventory Turnover = cost of goods sold / average inventory
Marginal propensity to consume = change in spending / change in disposable income
Marginal propensity to save = change in savings / change in income
Number of Days Sales in Inventory = # of days in year (usually 365 or 360) / Inventory Turnover
Payback Method = Initial investment / cash inflows
If the payback period is less than the targeted time period then the investment is acceptable
If the payback period is more than the targeted time period then the investment is not acceptable.
Present value, Net Present value, and Future value Calculation Tips to solving exam questions
The exam will include future, present, and net present value factors that will be need to be used to solve the problems
instead of using a financial calculator like most people learn when they take finance classes in college. After reading the
problem, you must choose the corresponding factor to be able to solve the problem based on the following:
1. Ordinary Annuity where payments are made at the end of the period
2. Annuity Due where payments are made at the beginning of the period
3. Present Value of $1 received in a certain number of years where a certain payment is made in full at a certain time or
Price Elasticity = % change in quantity demanded / % change in price.
Elasticity > 1 = demand is elastic and total demand (revenue) will decline if the price is increased.
Elasticity = 1 = demand is unitary and total demand (revenue) will remain the same if price is increased.
Elasticity < 1 = demand is inelastic and total demand (revenue) will increase if price is increased.
Quick Ratio = Quick assets (cash, marketable securities, and A/R) / current liabilities
Residual Income (RI) = operating profit interest on investment (or required rate of return)
Times interest Earned Ratio = earning before interest and taxes / interest expense
Total costs = fixed costs + variable costs or y = mx + b, where m = slope, x = variable value, and b = y intercept
Variances plug in the corresponding units:
1. Labor Efficiency SR * (SH AH). Actual Quantity Purchased/Consumed *(standard price per unit actual price per unit)
2. Labor Rate AH * (SR AR). Standard price per unit * (standard quantity used actual quantity used)
3. Material Price AQ * (SP AP). Actual Quantity Purchased/Consumed *(standard price per unit actual price per unit)
4. Material Efficiency SP * (SQ AQ). Standard price per unit * (standard quantity used actual quantity used)
In any of the above four formulas or the two located below, if the answer is negative then the variance will be unfavorable
or favorable if the opposite occurs. Also, some problems might require you to solve for one of the variables located within
the parenthesis.
1. Fixed overhead spending (budgeted-standard fixed overhead to incur actual fixed overhead incurred)
2. Fixed overhead volume (budgeted-standard fixed overhead to incur ((actual production * standard labor hours)
*(budgeted-standard fixed overhead to incur/budgeted labor hours))
Weighted Average Cost of Capital = [(cost of capital A / Total Amount)(rate of cost)(1-Tax Rate)] + [(cost of capital B / Total
cost amount)(rate of cost)]
Work in process = Direct Material used + Direct Labor + Manufacturing Overhead
Some of the below formulas are likely to be tested on the exam but should appear, at most, only time.
Average accounts receivable = (Beg. A/R + End. A/R) / 2
Average accounts receivable collection period = sales on credit / average accounts receivable
Average total assets = (Beginning total assets + Ending total assets) / 2
Book value per share = common stock equity / common stock shares outstanding
Common stockholders equity = stockholders equity preferred stock liquidation value
Contribution Margin Ratio = (sales variable costs) / sales
Cost of financing= (Total assets current liabilities) * Weighted average cost of capital
Cross-Elasticity = % change in demand for certain product A / % change in price of certain product B.
Debt to equity = Total debt / total equity
Debt to total assets = total liabilities / total assets
Discounted Payback Period = multiply by Present Value factor until initial invested amount reached. Disregard salvage value
DuPont ROI= Return on Sales * Asset turnover
Equivalent Units = Number of partially Completed Units % of Completion
Financial leverage= % change in earnings per share / % change in earnings before interest and taxes
Fixed asset turnover = sales / average net fixed assets
Gross Profit = revenue cost of goods sold
Income Elasticity = % change in quantity demanded / % change in income
Internal Rate of Return = Initial Investment + Cash Flow in Period n/ (1 + Discount Rate) to the nth power (# of periods).
Marginal utility = change in total utility / change in quantity
Market/Book Ratio = common stock price per share (or market value)/ book value per share
Market Capitalization = Common stock price per share * common stock shares outstanding
Operating leverage= % change in operating income / % change in unit volume
Operating Profit Margin = Operating profit / net sales
Preferred Stock Valuation dividend per share / required rate of return
Price/Earning (PE) Ratio = common stock price per share / Earning per share
Profitability Index = project net present value / cost of project
Receivables Collection Period = Average Accounts Receivable / Credit Sales per day
Receivable Turnover = Net credit sales / average accounts receivable
Reorder Point= delivery time of stock + safety stock or could be stated as = average daily demand * average lead time
Return on Assets (ROA) = net income / average total assets
Return on Equity (ROE) = net income / Average common stockholders equity
Return on Investment (ROI) = Net Income / Total Assets
Return on sales (ROS) = net income / Sales
Safety Stock= (Max. Daily demand * Max. Lead time) reorder point
Total asset turnover = sales / average total assets
Written Responses
The written responses will require at a minimum of five paragraphs double spaced between each paragraph.
paragraph states what the memo will talk about.
thru 3
states the advantages and disadvantages of the topic or goes into detail answering the question asked of you.
paragraph restates what the memo covered.
states that you are available for further discussion or something to that effect.
Lastly, double space and type sincerely yours or something to that effect and then double space and type your name.
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