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ExamTree 2013
Introduction
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.
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.
1.
2.
3.
4.
5.
6.
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.
If the audit committee does not have a financial expert then it must give an explanation
as to why not.
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 (SEC).
New York Stock Exchange (NYSE) and NASDAQ requirements for corporations
1.
2.
3.
4.
5.
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.
Commitment to competence.
Top management and their philosophy/operating style.
Delegation of authority/responsibility.
H/R policies and procedures.
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.
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.
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.
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 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 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.
2.
3.
4.
Oligopoly usually has only a few producers (sellers), products can be similar or nonsimilar 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.
100
80
60
40
20
0
Point A
Example
Example
Example
Example
Point B
of
of
of
of
Point C
Point D
Point E
Point F
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.
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.
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.
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;
Current account flow of goods, services, interest, and dividends during a period.
High levels of deflation and inflation can be detrimental to the economies of a country
by causing contractions in spending.
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).
When
dollar
When
dollar
$1.25 equals 1 Euro instead of it taking $1.30 to equal 1 Euro it means a stronger
and you are able to buy more with it.
$1.50 equals1 Euro instead of it taking $1.45 to equal 1 Euro it means a weaker
and you will be able to buy less with it.
World Bank usually lends money to countries for development and building infrastructure.
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.
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.
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
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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.
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.
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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 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.
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.
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.
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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.
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System software programs that run the computer system and support operations.
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.
2.
3.
4.
5.
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 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).
Local Area Networks (LAN) used where computers are all centrally located close
together.
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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.
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.
2.
3.
4.
5.
6.
7.
Plan
Analyze
Design
Develop
Test
Implement
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.
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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).
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.
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.
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Data independence
Minimal duplication of data
Data sharing performed easier
Reduces system maintenance
Data entry
Encryptions
Data transmission accuracy and completeness
Physical security
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.
End-User Computing - end user is responsible for the advancement and execution of
computer applications and the data generated.
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2.
3.
4.
5.
6.
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.
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.
Strategic planning the identification of a companys goals and objectives and then
determining the best approaches on how to achieve them.
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.
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variable costs per unit remains constant, and costs can be separated into fixed and
variable.
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 follows
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
Design
Modeling
Execution
Monitoring
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.
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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 materials.
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 product.
Manufacturing costs cost of direct materials, direct labor, and factory overhead.
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 product.
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.
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.
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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.
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 hours.
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.
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
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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.
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.
Pareto Principle theory that 80% of all problems come from only 20% of all causes.
Six Sigma Statistical measuring to see if the companys products meet the necessary
requirements to meet customers demands.
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Kaizen Continuous improvement emphasizing identification of small problems and fixing them
before they become larger
SWOT analysis
1.
2.
3.
4.
Strengths
Weaknesses
Opportunities
Threats
Materials Inventory
Work in Process
Finished Goods
Cost of Goods Sold
Manufacturing Overhead can not be traced directly to the finished product or goods.
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.
FORMULAS
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.
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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
Dividend Payout Ratio = cash dividend per share / Earnings per share
Economic Value Added = net operating profit after taxes (NOPAT) cost of financing
Number of Days Sales in Inventory = # of days in year (usually 365 or 360) / Inventory Turnover
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
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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 period.
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
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)]
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Some of the below formulas are likely to be tested on the exam but should appear, at
most, only time.
Average accounts receivable collection period = sales on credit / average accounts receivable
Book value per share = common stock equity / common stock shares outstanding
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.
Discounted Payback Period = multiply by Present Value factor until initial invested amount reached.
Disregard salvage value
Financial leverage= % change in earnings per share / % change in earnings before interest and
taxes
Internal Rate of Return = Initial Investment + Cash Flow in Period n/ (1 + Discount Rate) to the nth
power (# of periods).
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
Price/Earning (PE) Ratio = common stock price per share / Earning per share
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Receivables Collection Period = Average Accounts Receivable / Credit Sales per day
Safety Stock= (Max. Daily demand * Max. Lead time) reorder point
Written Responses
The written responses will require at a minimum of five paragraphs double spaced between each
paragraph.
2nd thru 3rd states the advantages and disadvantages of the topic or goes into detail answering the
question asked of you.
5th 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.
Conclusion
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