Foreign Currency Risk Mr. Roberts said that he is inclined to accept the arrangement however, he is concerned about the Thai firm's proposal that transactions be stated and paid in the Thai currency, the Baht. He asks that you explain in a memorandum what the implications would be if he agrees to accept payment in Baht. Type your communication below the line in the response area below. REMINDER: In CPAexcel, the Written Communications are graded on key words. These are words that need to be included in the message in order to address the subject matter. However, on the exam itself, "Your response will be graded for both technical content and writing skills. Technical content will be evaluated for information that is helpful to the intended reader and clearly relevant to the issue. Writing skills will be evaluated for development, organization, and the appropriate expression of ideas in professional correspondence. Use a standard business memorandum or letter format with a clear beginning, middle, and end. Do not convey information in the form of a table, bullet point list, or other abbreviated presentation." To: Mr. Paul Roberts, CEO, Best Alloy, Inc. From: I.M. Candidate Re: Transactions in Baht
This is to respond to your request for information about the implications if Best Alloy accepts payment in a foreign currency (Thai Baht). When the terms of a business contract provide that transactions will be settled in a currency other than an entity's domestic currency, the transactions are said to be "denominated in a foreign currency." For Best Alloy, agreeing to accept payments from the Thai firm in Baht would result in the transactions being denominated in a foreign currency. A company that has accounts receivable denominated (to be settled) in a foreign currency face a currency exchange risk that does not occur when accounts receivable are collected in the domestic currency of the company. Because the rate at which one currency will exchange for another currency may change continuously, there is the risk that an unfavorable exchange rate change will occur between the time a receivable is established and the time it is collected. For example, assume that the dollar value of a receivable to be satisfied in a foreign currency is $100 when the receivable is recognized. Subsequent to recognizing the receivable, but before it is collected, the exchange rate between the dollar and the foreign currency changes. As a result of the change in exchange rates, at the date the receivable is collected and the foreign currency received, the dollar value of the foreign currency is less than $100. To the extent the dollar value of the foreign currency at the date of collection is less than the dollar value at the date the receivable was recognized (i.e., the date of the sale), a loss has occurred. That loss, which would be reported as a currency exchange loss, would reduce net income from the sale transaction. It also is possible that a favorable change in the exchange rate could occur. In that case, the dollar value of the foreign currency when it is collected would be greater than the dollar value of the original receivable, and a gain would be recognized. Please let me know if you would like additional information or if I can be of further help.
I.M. Candidate
Compensating Balance In a meeting with Ron Jacobs, the manager of your company, he disclosed that the firm is in the early stages of negotiating a $100,000 short-term loan with Block Bank, a local commercial bank with which your firm has no previous relationship. The loan would be used to temporarily increase inventory to meet higher seasonal demand. The bank has offered a one-year, $100,000 loan at 6.00%, with a requirement that 10% of the original loan be maintained as a compensating balance. Mr. Jacobs asks that you explain in a memorandum what a compensating balance is and what effect it would have on the cost or other elements of the proposed borrowing. To: Mr. Ron Jacobs, Manager From: I.M. Candidate Re: Compensating Balances
This is to provide the information you requested concerning the nature of a compensating balance when required by a bank and the implications of such a requirement. A compensating balance is an amount that a borrower is required by the terms of a loan agreement to maintain in a demand deposit account with the lender during the term of the loan. The amount of the compensating balance is usually expressed as a percent of the original loan amount. A requirement to maintain a compensating balance has two primary effects on the borrowing. First, the actual amount of the loan that is available to be used is reduced by the amount of the required compensating balance. Under the terms proposed by Block Bank, only $90,000 of the $100,000 would be available for inventory purchases. The other $10,000 (.10 x $100,000) would continue to be held in our account with Block Bank as a condition of the loan. The second effect on the borrowing is that the effective interest rate would be greater than the 6.00% stated rate. Since only $90,000 of the loan is available to use, the effective cost of the borrowing should be based on $90,000, not $100,000. Thus, under the Block Bank proposal, the annual interest cost of $6,000 ($100,000 x .06) is effectively the cost of borrowing $90,000 and the effective interest rate is 6.67% ($6,000/$90,000), not 6.00%. Please let me know I can provide additional information. I.M. Candidate
Enterprise-Level Risks Alex Poindexter is the controller of Ensenada Products, a small, publicly held manufacturing company that operates in both the U.S. and Mexico. Ensenada Products Board of Directors concerns about, and interest in, how to better manage enterprise-level risks motivates their request that Alex write a letter that defines enterprise risk management (ERM) and discusses what risks should be considered as a part of ERM. The Board also wants Alex to explain what benefits accrue to an organization that implements an effective system for managing enterprise-level risks. To: Ensenada Products Board of Directors From: Alex Poindexter Re: Enterprise-Level Risks
Enterprise risk management (ERM) concerns the identification and management of events and circumstances that may impact the ability of an entity to achieve its objectives. A number of corporate frauds, including Enron Corp., WorldCom, Adelphia Communications, Tyco International, Global Crossing, and Qwest Communications scandals have increased concern with, and attention to, enterprise risk management. A number of risks should be considered as a part of enterprise risk management. These risks include damage to the organization's reputation, business interruption due to disaster (e.g., flood) or human events (e.g., a labor strike), liability to third parties, distribution or supply chain failure, risk related to the market environment, to regulatory or legislative changes, due to market competition or failure to attract or retain key staff or management, technology failure, failure of a disaster recovery plan, and loss of data. COSO's ERM framework (a cube) includes four objectives, eight components, and three levels of organizational units. The benefits of effectively implementing systems for managing enterprise-level risks include aligning the organization's risk appetite with its strategy such that the organization chooses to assume an appropriate level of risk, rather than assuming an unknown or inappropriately low or high level of risk. Assessment of an organization's risk appetite and strategy also enables the development of mechanisms to better manage risk. Risk management also creates the possibility for improving an organization's risk responses. For example, organizations may choose to avoid, reduce, share, or to accept, risks. Better management of enterprise-level risks also reduces the likelihood of disruptive operational surprises and losses. Enterprise level risk management enables organizations to better identify potential risk events and to establish responses, thereby reducing surprises in the associated costs and losses. Risk management also enables the ability to manage multiple and cross enterprise risks. For example, Ensenada Products has divisions both in the United States and Mexico. The risks related to political instability along the U.S., Mexican border, coupled with risks of smuggling and drug traffic at the border must be assessed jointly to determine whether and how they pose risks and threats to Ensenada's operations. The assessment of enterprise-level risks can also lead to the identification of opportunities to enhance an organization's business prospects. For example, assessing the risks related to online sales and activities may give rise to the realization that additional opportunities exist in online markets that have not been previously considered. Finally, enterprise-level risk assessment can improve capital deployment. Specifically, risk information can allow management to better assess its capital needs and to improve capital allocations among competing projects and alternatives.
In short, enterprise-level risk assessment promises a number of important insights and advantages to Ensenada Products. I look forward to exploring these opportunities further with you. Sincerely, Internal Control Issues related to corporate governance are of increasing concern in capital markets. Write a memorandum to a corporate Board of Directors that considers some of the events that transpired at WorldCom. WorldCom's CEO (Bernard Ebbers) and CFO (Scott Sullivan), authorized, executed, and recorded falsified accounting transactions that inflated revenue by about $11 billion. WorldCom's Board of Directors approved these transactions. This fraud earned Ebbers and Sullivan 25 year and 15 year prison terms, respectively. The specific topics that the board would like you to cover are a definition of internal control and how the events at WorldCom relate to the goal of an appropriate "tone at the top" in relation to an organization's system of accounting control. The board would also like you to discuss what controls might have helped prevent the WorldCom fraud. To: Board of Directors From: Accountant Re: Internal Control at WorldCom
Internal control is a set of processes that are designed to provide reasonable assurance regarding the achievement of objectives related to the effectiveness and efficiency of operations, reliability of financial reporting, and compliance with applicable laws and regulations. Internal control is primarily the responsibility of management and the entity's Board of Directors. An organization desiring an effective internal control must have top management that is ethical and pro-active in establishing this tone and culture. That this tone was lacking at WorldCom, is evidenced by the events described above. Positive strategies for creating an ethical culture include management emphasizing the critical role of ethics and integrity to organizational success, and, emphasizing the role of mission statements and codes of conduct in promoting integrity. In addition, managements' actions, as well as their words, must embody a culture of integrity and ethical conduct. Controls that might have helped prevent the fraud that occurred at WorldCom include the segregation of duties between the accounting functions that authorized, executed, and recorded the falsified accounting transactions is one important (absent) control in this scenario. In addition, the WorldCom Board of Directors did not appear to be independent of management and did not effectively execute its oversight function. Hence a stronger, independent Board of Directors likely would've helped prevent the WorldCom fraud. Finally, a similarly strong, independent, professional WorldCom Audit Committee might also have lessened the likelihood or success of the WorldCom fraud. In short, the WorldCom case illustrates the hazards of an unethical management "tone at the top", inadequate segregation of duties, and a Board of Directors that failed its fiduciary responsibility of management oversight. Sincerely,
Credit Card Processing and Encryption Melanie Hogsbath has started a successful pet lodging, grooming, care and entertainment, e.g., dog walking, business, Hogsbath's PetPoria. Many of Melanie's transactions are executed by credit card at her website. A customer of Melanie's recently expressed concerns regarding entering credit card information into Melanie's website. Melanie has called you to ask about the possibility of providing her with a more secure credit card processing system. More specifically, she has recently read an article about "encryption" and asks your opinion of its value to her business. Please write Ms. Hogsbath a memo that discusses encryption - what it is and how it may be useful to her business. Explain what system risks it may help her address. Briefly describe symmetric versus asymmetric encryption and the implications to Melanie for implementing either type of encryption for credit card information at her website. To: Ms. Hogsbath From: Accountant Re: The role and importance of "encryption" in credit card processing
Encryption is the process of transforming information using an algorithm to make it unreadable to anyone except those possessing special knowledge, usually referred to as a key (source: Wikipedia). Encryption technology uses a mathematical algorithm to translate cleartext (plaintext) - text that can be read and understood into ciphertext (text which has been mathematically scrambled so that its meaning cannot be determined). A key is then required to translate the ciphertext back into plaintext. An effective implementation of encryption can guard against risks to privacy, i.e., the protection of data-in-transit against unauthorized access, and authentication, i.e., user identification. Hence, well designed and implemented encryption lessens the likelihood of the theft of credit card numbers and personal information from her website. Symmetric encryption -- also called Single-key encryption or private-key encryption uses a single algorithm to encrypt and decrypt the text. The sender uses the encryption algorithm to create the ciphertext and sends the encrypted text to the recipient; the sender must also let the recipient know which algorithm was used to encrypt the text; the recipient then uses the same algorithm (essentially running it in reverse) to decrypt the text. Asymmetric encryption -- also called public/private-key encryption and private-key encryption uses two paired encryption algorithms to encrypt and decrypt the text. If the public key is used to encrypt the text, the private key must be used to decrypt the text; conversely, if the private key is used to encrypt the text, the public key must be used to decrypt the text. To acquire a public/private key pair, the user applies to a certificate authority (CA); the CA registers the public key on its server and sends the private key to the user; when someone wants to communicate securely with the user, they access the public key from the CA server, encrypt the message and send it to the user; the user then uses the private key to decrypt the message. Although the ciphertext created with symmetric encryption can be very secure, the symmetric encryption methodology itself is inherently insecure because the sender must always find a way to let the recipient know which encryption algorithm to use. Hence, symmetric encryption is most commonly used with "data-at-rest," i.e., data that is stored in an archive or data warehouse.
Asymmetric encryption is more complicated, cumbersome, and secure. With asymmetric encryption the transmission is more secure because only the private key can decrypt the message and only the user has access to the private key. Hence, well designed asymmetric encryption offers a higher level of security but (also adds a bit of complexity to the system). In addition, as computing moves towards ubiquitous or mobile computing (e.g., m-commerce), asymmetric encryption can create compatibility problems since the certificate authority system may not yet be adapted to the latest technology platforms. To summarize, your online customers may desire the level and type of assurance that is provided by encryption. Specifically, encryption can be useful in reducing consumer concerns about credit card number and identity theft in online transactions. A number of alternatives exist for implementing encryption technology into online transactions. The best alternative for your business would depend of the level of security that you desire and the corresponding costs (and potential complexities) associated with that level of encryption. Business Continuity Plan Willie Dixon, the President and CEO of "The Back Door Man" has a growing and successful business repairing and replacing screen doors, entry doors, and garage doors. His business includes about 1000 employees at a headquarters and 23 branch offices. The business does not have business continuity (BCPs) or disaster recovery plans (DRPs). President Dixon has requested that you draft a letter suggesting the motivation, and a process, for creating a BCP. To: President Willie Dixon From: Accountant Re: Business Continuity Plan
A business continuity plan (BCP) is critical to enabling your business to recover in the event of a natural or human-based disaster, or a disruption of services. Creating a BCP is one element of organizational risk management. Hence, developing a BCP should be part of a broader strategy and approach to addressing significant strategic and business threats and risks. The following six steps present one model of the process for developing a BCP. Create a business continuity policy and program -- Create a framework and structure for the BCM, based in an overall risk management strategy. Identify the scope of the plan, its key roles, and assign individuals to roles. Understand and evaluate organizational risks -- Identify key organizational activities and processes to determine the activities, and their costs, that are needed to prevent their interruption, and, ensure their restoration in the event of interruption. Identify the maximum tolerable interruption periods by function and organizational activity. Choose business continuity strategies -- Define alternative methods to ensure sustainable delivery of products and services. Key decisions will likely include desired recovery times, distance to recovery facilities, required personnel, supporting technologies, and impact on stakeholders. Develop and complete a BCP response -- Document and formalize the BCP plan. Define protocols for defining and handling crisis incidents. Create, assign roles to, and train the incidence response team(s).
Exercise, maintain and review the plan -- -- Test the required technology and implement all proposed recovery processes. Update the plan as business processes and risks evolve. Embed the plan in the organization's culture -- Design and deliver education, training and awareness materials to enable effective responses to identified risks. Manage change processes to ensure that the BCP integrates into the organization's culture. Following these steps should enable the creation of a BCP that greatly reduces the threat of key organizational risks disrupting future business success. Biometric Security System GenghisKhan.Com Airlines is considering ways to enhance the physical security of its data center, which is located in a suburb of New York City, consists of 10,000 ft. 2, and is regularly used by about 30 employees. Currently, access to the data center requires a proximity card; individual employees receive cards. The company is considering implementing a biometric fingerprint scanner to increase security. Please define each of the following security risks, and comment on the effectiveness of the proposed biometric security in addressing them: (1) Piggybacking; (2) Phishing; (3) Sharing access cards; (4) Packet sniffing. To: GenghisKhan.Com Airlines From: Accountant Re: Proposed biometric security system
Biometric scanning technologies authenticate identity using an individual's unique body features, such as voice, retina, fingerprint, or signature. The cost of biometric identification technologies are dropping and such systems are increasingly reliable and valid. In considering such systems, GenghisKhan.Com should consider an integrated system that combines multi-factor identification, potentially including by knowledge (e.g., password), by device (e.g., a keycard) and by body (e.g., voice print or fingerprint). The proposed biometric fingerprint scanning technology would relate to the security risks as follows: In piggybacking, an unauthorized user gains entry into a restricted area by following an authorized user, using the authorized user's entry credentials to gain access. The level of piggybacking might be reduced by the proposed biometric system, but a better (though perhaps more expensive) control over this risk would be hiring security guards or installing video systems to monitor entry stations. Phishing attempts are requests for information delivered via email or text messaging (when sent by text message, these are called smishing). This risk would be unaffected by the use of biometric identification technologies. Sharing access cards. The proposed biometric systems would eliminate this risk. Employees could not share access cards in a system that included biometric identification. Packet sniffing programs capture packets of data as they move across a computer network. This risk would be unaffected by the use of biometric identification technologies.
Control Procedures Roger Johnson, a CPA, worked as a volunteer at the International Commonwealth Track and Field Games (ICTFG). Each day of the six-day games, about $100,000 in cash and $2 million in credit card revenues came into the accounting office. Roger's volunteer duties included counting cash each evening and reconciling the credit card receipts and credit card fee payments to the cash receipts journal and general ledger. Control procedures required at least two individuals to be present in the accounting office at all times. However, Melanie Smurf, the other volunteer who was to work with Roger on Thursday evening, had a six-year-old daughter who was ill. Hence, Melanie requested that Roger count the cash and perform the reconciliations for this day by himself, since she could not fulfill her volunteer duties that evening. Please write a memo discussing the role of monitoring of internal control in improving corporate governance and how the monitoring of internal control is relevant to the issue identified in this question. Memo:
Over time, controls deteriorate. This deterioration is called "entropy." Control monitoring is important because people forget, quit jobs, get lazy, get distracted, or, come to work drunk, stoned, or hung over; in addition, machines fail and technology changes. Monitoring is the core, foundational component in the COSO ERM model. Its position, i.e., as the foundation of risk management, is intentional. Monitoring is essential to achieving strong internal control and effective risk management. With good control monitoring control problems are identified, and identified more quickly. Decision makers receive better, more timely information. Certifications of internal control are easier and more timely, and organizations are more efficient and have lower costs. Effective cash control requires segregation of duties. Monitoring the control requirement, i.e., that at least two individuals be present for cash counts, would reveal that a backup, additional individual is needed in the system, to ensure that no individual ever counts cash alone. Hence, monitoring is useful, as in this case, in revealing that the specified control procedures are infeasible or inadequate. In short, the situation at ICTFG suggests a control deficiency that should be identified by effective monitoring and corrected through proper segregation of duties. Sincerely, Accountant
Enterprise Resource Planning System he Cup-O-Cake Company (COCC) manufactures cupcakes, wedding cakes, and other baked desserts which are delivered through grocery stores, caterers, and restaurants. COCC has recently begun a complex IT project, built around an enterprise resource planning system, to replace accounting, customer relations management, supply chain management, and inventory control systems. Although the system is built around SAP, management decided to customize many of the SAP modules to ensure a better fit with existing organizational processes. Unfortunately, the implementation is not going well. Implemented modules, after initial testing, are evidencing difficulties, including transactions failing to execute, and data errors emerging in the enterprise-wide databases. Please write a memo to the head of the IT steering committee that considers: 1. the major roles of each of the following in resolving the above issues and problems: the IT steering committee, the lead systems analyst, applications programmers, and end-users, 2. what processes, within the systems development lifecycle, may have led to the above failures. Type your communication below the line in the response area below. To: IT Steering Committee Chair From: Accountant Re: Resolving SAP implementation issues at COCC
Question #1: In relation to the issues that are emerging in the SAP implementation at COCC, the roles of the following parties should be: The IT steering committee: bears primary responsibility for approving and prioritizing information technology projects. Their responsibility in relation to implementation failures would depend upon how their role was defined in relation to the project. Hence, it is not clear from the case what the role of the IT steering committee would be in resolving these issues. The lead systems analyst: Responsible for developing overall programming logic and functionality. Failures of the system may be an indicator of problems in this responsibility. Should be interviewed regarding why the implementation is not proceeding smoothly. Applications programmers: Given that considerable customization is occurring in the implementation, pinpointing the causes of these failures will be a critical diagnostic activity. Hence, interview applications programmers to help determine why these implementation failures are occurring, particularly in relation to customized programming. End-users: Gathering additional information about when, why and how the system is failing to operate as promised will be an additional critical diagnostic activity. Hence, interviewing end users as to these issues should be informative in resolving them, by allowing for more precise diagnosis of the nature of the failures. Question #2: Failures at the implementation stage may be traced back to one of several possible failures earlier in the systems development process. For example:
Feasibility may have been mis-assessed in the planning and feasibility assessment stage. Hence, the system, as conceived and implemented, may be infeasible. The assessment of system requirements may have been poorly executed, meaning that actual system requirements do not match those proposed in the system planning documents. Failure at the design stage would lead to an improper specification of the technical system architecture or the definition of the interfaces between modules and subsystems. This could also explain the system failure. Failure at the development stage could result in inadequate hardware and IT infrastructure for the system. This would mean that the hardware and other IT (for example network) resources may be inadequate to the demands of the system. A failure at the testing stage may result from inadequate testing at normal operational loads, meaning that the system may work in a test environment but may fail in the more demanding, actual environment within which the system must work. A failure at the implementation stage may result from inadequate training of users in the new system or in insufficient time to allow users to gain a complete working knowledge of the new system. Sincerely, Accountant Segregation of Duties Skyview, Inc., a small start-up company, has hired you as a consultant to assess its financial systems and related processes. During your review, you learned that the company accountant is responsible for providing general ledger access to others in the company, processing of transactions in the general ledger, and printing checks. The president of the company must authorize write-offs in the system, but the accountant has access to the president's user name and password. Prepare a memorandum to Skyview's president assessing these responsibilities in the context of segregation of duties. Also assess the possibility of the accountant committing fraud. To: Skyview President Re: Redemption Treatment You have requested that an independent assessment of Skyview's financial systems and related processes. In a properly controlled financial system the duties of authorization of transactions, approval of transactions, custody of assets, and record keeping should all be segregated. In other words, these functions should all be performed by different individuals. Your current financial system and processes do not include this proper segregation of duties. Skyview's accountant has incompatible duties that would allow him to make an error or perpetrate a fraud and prevent its detection. He processes transactions and has access to assets (printed checks). As an example, he could process fictitious purchase transactions to his own shell companies and cause payments to be made for goods or services that were not received by Skyview.
In addition, the fact that the accountant has access to your user name and password allows him to circumvent the control provided by your being the only individual authorized to write off accounts. This would allow the accountant to process an unauthorized sales transaction to his own shell company and use your user name and password to write off the account. I recommend that you purchase or develop a new financial accounting system that would include appropriate segregation of duties to ensure that no individual in the organization has the ability to perpetrate errors or fraud without it being detected in the normal course of operations. In addition, you should establish polices regarding the maintenance and confidentiality of user names and passwords to ensure that the controls cannot be circumvented. While such actions will, in the short-term increase the costs of the accounting system, they will help to prevent the potentially disastrous occurrence of a major fraud at Skyview. If you have any questions, please contact me. Enterprise Risk Management Assume that you are acting as a consultant for Winston Co. The president of the company is considering implementing an enterprise risk management system. To evaluate whether to go forward with the project, the president has asked you to describe the limitations of an enterprise risk management system. Prepare a memorandum to Winston's president describing the purpose and limitations of an enterprise risk management system. To: Winston Co. President Re: Limitations of an enterprise risk management system
You have requested that I provide you with information about an enterprise risk management system. You are particularly concerned with the limitations of such a system. The primary purpose of an enterprise risk management system is to provide processes to identify potential risks to achieving a company's objectives, and, to manage those risks to be within the company's risk appetite. In considering implementation of an enterprise risk management system, it is important to recognize that these systems have limitations. All enterprise risk management systems rely on judgments about future events that may or may not occur. Also, while an enterprise risk management system provides information about risks to achieving the company's objectives, it does not provide complete assurance that the objectives will be achieved. Finally, as with all control systems, an enterprise risk management system can break down for a number of reasons, including bad judgments about risks and their impact, collusion among two or more individuals, or override by management. Also, due to cost-benefit constraints, no enterprise risk management system can be perfect. Adopting a structured plan for assessing the need for and developing a high-quality ERM system can mitigate these risks. If you have any additional questions about enterprise risk management systems, please contact me.
Real-time Processing Tintco, Inc. is a distributor of auto supplies. Currently, the corporation has a batch processing system for processing all transactions and maintaining its inventory records. Batches are processed monthly. George Wilson, the chief information officer for the corporation, is considering adopting an online, real-time processing system. He has asked you (a consultant) to prepare a memorandum describing the advantages of adopting such a system for the corporation. To: Mr. George Wilson, CIO Tintco, Inc. From: CPA Candidate
As you requested, this memorandum describes the advantages of implementing an online, real-time processing system for inventory. As you are aware, Tintco, Inc. currently uses a batch processing system that processes transactions monthly. The primary advantage of an online, real-time processing system is that it provides more timely (and therefore more accurate) information for decisions. In a batch system, inventory data are only accurate when the records are updated (i.e., each month). Therefore, decisions about ordering inventory, inventory value, and company profitability are not based on timely information. As a result, management cannot do a very good job of managing inventory. If the company implements an online, realtime system, information about inventory levels, inventory investment, and cost of goods sold would be available on a continuous basis. As a result, business decisions will be based on accurate and timely information. This should result in much better decisions and better financial performance. It is clear that an online, real-time inventory system is superior to your current batch processing system. If you would like to have additional information about implementation of a new inventory processing system, please contact me. Payback and Accounting Rate of Return Methods Yeager Company is considering several alternative capital investments. In evaluating the investments, management of the company has used the payback and accounting rate of return methods. Prepare a memorandum to Linda Gordon, the chief financial officer, describing the limitations of these two methods for evaluating investments and suggesting other methods that might be more appropriate. To: Ms. Linda Gordon, CFO Yeager Company From: CPA Candidate
You have requested that I provide an evaluation of the two methods that Yeager Company uses for capital budgeting: the payback and the accounting rate of return methods. As you know, the payback method evaluates investments based on the length of time it takes to recapture the initial investment. The payback method has two major limitations. First, it ignores the overall profitability of the investment. Second, it does not take into account the time value of money. These are major limitations which can result in selecting investments that are not consistent with maximization of the company's return on investment.
The accounting rate of return method evaluates investment alternatives based on their rate of accounting return. Like the payback method, the accounting rate of return method ignores the time value of money. As a result, it too can result in choosing investments that may not result in maximization of the company's return on investment. The most effective capital budgeting techniques are those that consider the time value of money. As an example, the net present value method evaluates investment alternatives based on the present values of the future cash flows of the investments. It considers both the total profitability of the investment and the time value of money. Another technique, the internal rate of return method, evaluates investment alternatives based on their time-adjusted rates of return. This technique also considers the total profitability of the investment and adjusts for the time value of money. I would suggest that you consider replacing your current techniques for capital budgeting with a technique or techniques that are superior, such as the present value and the internal rate of return techniques. If you have any other questions about capital budgeting, please contact me. Advantages and Disadvantages of Going Public Talon, Inc. is a privately held manufacturing company. Management of the company is considering taking the company public through the issuance of common stock. Terry Savage, the president of the company, has asked you prepare a memorandum describing the advantages and disadvantages of going public. To: Mr. Terry Savage, President Talon, Inc. From: CPA Candidate
As you requested, this memorandum describes the advantages and disadvantages of taking your company, Talon, Inc., public. A primary advantage of going public is that Talon will have access to a much larger pool of equity capital. The company's stock will trade on an organized market. Therefore, the company can more easily issue additional stock. Because the stock of the company is publicly traded, it can be used for business acquisitions, and the company can offer stock-based compensation to Talon's employees. Finally, the owners of Talon are afforded the opportunity to readily sell all, or a portion, of their investment in the company. Therefore, the owners' investments become liquid. The primary disadvantage of going public is the cost. There are significant costs involved in the initial public offering of stock, and the continuing costs of compliance with SEC laws and regulations, including the Sarbanes-Oxley Act. Being a public company necessarily causes management to focus on maximizing stock price, which may not be in the best long-term interest of Talon. Finally, public companies must disclose significant amounts of information that becomes available to competitors, customers, and potential corporate raiders. Because of these significant costs and benefits, it is important that the board of directors of Talon carefully evaluate the decision about whether or not to go public. If you need any additional information, please contact me.
Balanced Scorecard The management of Hewitt Company is considering adopting a balanced scorecard to measure performance. Karen Wells, the chief financial officer for the company, has asked you to prepare a memorandum describing a balanced scorecard and the advantages of adopting such a system. To: Ms. Karen Wells, CFO Hewitt Company From: CPA Candidate
I understand that you are considering implementing a balanced scorecard performance measurement system at Hewitt Company. This memorandum explains the nature and benefits of such a system. The balanced scorecard is a performance measurement system that includes both financial and nonfinancial measures. It includes measures in the four perspectives of financial, customer, internal business processes, and learning and growth. By measuring performance with multiple measures across these four perspectives, a balanced scorecard is more strategic than other systems that rely primarily on financial measures. It aids in communicating the company's strategy to all members of the organization and helps insure that they work to achieve the organization's strategic goals. I suggest that you continue with your plan to implement a balanced scorecard system because I believe that it is superior to other single-dimensional systems. If you have any questions, please contact me. Performance Measures The management of Taylor Corporation is attempting to adopt new performance measures. Henry Warren, the chief executive officer, has asked you to prepare a memorandum describing how management should choose between alternative measures. To: Mr. Henry Warren, CEO Taylor Corporation From: CPA Candidate
This memorandum is designed to assist you in deciding how to select among different performance measures for Taylor Corporation. Selecting among different performance measures requires an understanding how the measures will be used. Possible uses include for compensation, resource allocation, and business unit performance. Different measures are more appropriate for different purposes. It is important that all performance measures reflect the strategy of the company. Measures that are strategic communicate the goals of the organization and motivate management to pursue those goals. Performance measures must also represent economic reality. They should provide a clear and accurate measure of relative performance. Finally, if the measures are used to evaluate and compensate
managers, they should be sensitive to factors that are in the manager's control and not sensitive to factors beyond the manager's control. The measures should be clearly controllable by the manager being evaluated. As you can see, selection of appropriate performance measures is a complex process. If you would like to discuss your selection of measures in more detail, please contact me. Cost System The controller of Tennyson, Inc., Howard Lester, is concerned that the company's costing system is not providing good information about product costs. As a result, he fears that the company is not making good sales or production decisions. Currently, the company uses a simple job order costing system and allocates service department costs on the direct method. Prepare a memorandum to Mr. Lester describing the importance of having good cost information and ways in which the existing system may be improved. To: Mr. Howard Lester, Controller Tennyson, Inc. From: CPA Candidate
At your request, this memorandum provides information about the importance of a good cost system and the manner in which Tennyson's system may be improved. It is essential that a company's cost system reflect accurately the costs of production. Product cost information is a very important input into a number of business decisions, including those involving product pricing, inventory levels, and allocation of productive resources. Historically, the company has allocated service department costs on the direct method. This method simply allocates the costs of each service department to production departments based on the relative level of use. The direct method can result in inaccurate costing when service departments provide significant amounts of services to other service departments. Two methods of cost allocation are superior to the direct method: the step method and the reciprocal method. The step method allocates service department costs to other service departments as well as the production departments, starting with the service departments that provide the most services to other service departments. The reciprocal method uses simultaneous equations to allocate costs to production departments, resulting in the most accurate allocation of costs when service departments provide services to other service departments. Because of the importance of developing accurate cost information, I encourage you to evaluate your current system of costing. As described, the step and the reciprocal methods of allocation of service department costs are superior to the direct method which is currently being used by the firm.
Enterprise Resource Management System Assume that you are a consultant providing services for Webster Corp. Webster is performing a significant project based implementation of a new enterprise resource system. The company
is concerned about the difficulties in performing the project. Compose a memorandum to management describing the risks involved in executing a project that is cross-functional in nature. To: Webster Corp. President Re: ERP project management From: CPA Candidate
You have requested that we provide information about the issues involved in executing a project to implement an enterprise resource management system. In particular, you are concerned that the cross-functional nature of the project will be difficult to manage. You should understand that the cross-functional nature of this project creates additional risk of failure that must be controlled. The most important requirement for success of a cross-functional project is full support by top management. The team must have this support to get adequate cooperation from the various functional managers of the organization. This also means that the relationships between the project manager and various functional managers must be clearly defined to avoid conflict. Finally, senior management must support the project manager's decisions, recognizing that these decisions must be made quickly and with limited information to ensure that the project remains on schedule. If senior management recognizes and resolves these issues, the risk of failure will be significantly reduced. If you have any additional questions about the issues regarding completing the project, please contact me. Responsibility Accounting System Tom Miller, the controller of Winston Corporation, is considering establishing a responsibility accounting system for the corporation. Tom would like you to prepare a memorandum describing a responsibility accounting system and its advantages over a typical budgeting and reporting systems. To: Mr. Tom Miller, Controller Winston Corporation From: CPA Candidate
As we discussed, Winston Corporation is considering implementing a responsibility accounting system. A responsibility accounting system is one that evaluates center managers based on reports that include only revenues and costs that a particular manager can control. If the manager is responsible for both revenues and costs, the center is referred to as a profit center. A cost center is one in which the manager is only responsible for costs. The primary advantage of a responsibility accounting system is that managers are rewarded based on factors that are within their control, creating a direct relationship between their performance and their performance evaluation. When being evaluated with a responsibility accounting system, managers are not frustrated by receiving performance evaluations that are influenced significantly by external factors. Also they are not rewarded for performance that results from factors outside of their control. Therefore, from a management evaluation
standpoint, a responsibility accounting system has a significant advantage over traditional accounting systems. If you need any additional information about such systems, please contact me.
