ACCT 3309 Exam 1 Review Part 2 (Chapters 11, 15,18,19,26)

What elements of a control system can be used to safeguard resources? Explain.

Having an audit trail, reliable personnel, separation of duties, proper authorization, adequate documents, proper procedures, physical safeguards, bonding, vacations and rotation of duties, independent checks, and cost-benefit analysis.

What is double taxation?

If a business earns income and pays tax on it, then distributes the profits to the owners of the business and they have to pay tax on those same profits, the income is being subjected to double taxation. You are paying income tax twice on the same income.

What is the COSO opinion concerned with?

It is concerned with the disclosure of the auditor's and management's opinion about the adequacy of the internal controls of the organization being audited.

What is the role of the Certified Public Accountant in the audit process?

It is focused on determining if the financial statements provide a fair representation of the financial status of the organization. Of primary concern to the auditor is arithmetic errors, internal controls and adherence to GAAP.

What is the auditor's management letter focused on and who is it submitted to?

It is focused on providing management with the auditor's view on the organization's internal control procedures. This includes recommendations for improving the internal control procedures. It is submitted to the organization's management team and is not typically made available to the public.

An auditor samples various financial transactions, recordings and examines the organization's internal control process.

True

If payments are not collected promptly, follow-up statements should be sent, often in another color to get the customer's attention.

True

In order for an audit trail to be an effective tool for control, there must be regular use of the trail to identify and examine discrepancies or unusual spending patterns.

True

Internal control systems often rely heavily on standard operating procedures, usually in the form of a procedures manual.

True

Invoices should be issued prompt basis, and they should be accurate in all respects.

True

Management control systems also detect variations from plans and provide managers with information needed to take corrective actions when necessary.

True

One potential problem is that firms still hire their auditors, and if they are in collusion with their auditor to commit fraud, an important oversight protection does not exist.

True

Ordering costs include the cost ofthe employee time to place the order, plus shipping and handling charges.

True

The auditor can issue an adverse opinion if the auditor believes that the financial statements are not presented fairly in accordance with GAAP.

True

What are the characteristics of a well-developed corporate ethics program?

1. A written statement 2. A strong statement of support from top management. 3. Public disclosure of examples of actions management has taken which indicate adherence to, and support of, the policy. 4. Periodic occasions when ethics is discussed in seminars that focus specifically on ethical corporate behavior. 5. Periodic occasions where ethical considerations are discussed in meetings where the primary focus of the meeting was not ethics, so that ethics become a part of the day in and day out business of the organization. 6. A plan for monitoring compliance 7. Clearly stated consequences for failure to adhere to the policies. 8. Policy that is perceived as being attainable within the corporate culture of the organization.

What are the three main approaches for preventing fraud discussed in the chapter?

1. Focus on ethical behavior, educating employees that fraud is wrong, it is not a glamorous thing that is okay if you can get away with it. 2. Enact legislation focusing on fraud, creating severe enough penalties to dissuade individuals from committing fraud. 3. Prevent fraud is for organizations to assure that they have adequate management control systems to discourage and discover frauds.

What are the steps from issuance of a bill until we collect payment from a customer and have access to the funds? What role do managers play, aside from issuing the bill?

1. Issue invoice 2. Invoice received by customer 3. Invoice paid by customer 4. Payment received 5. Payment deposited 6. Payment clears bank

Assume that Executive Corporation is considering investing $5,000 today in a new piece of equipment that will provide a service they can charge for. The annual cash profits from the machine will be $600, $700, $800, $900, $1000, $1100, $1200 for each of the 7 years of its useful life. What is the IRR on the investment?

=IRR(values, guess) =IRR({-5000,600,700,800,900,1000,1100,1200})= 5.5%

Suppose that you have $50,000 available today and can invest it at 7% per year. How long will it be before you have accumulated $500,000 in the investment?

=Nper(rate,pmt,pv,fv,type) =Nper(7%,,-50000,500000)= 34 years

If someone offered to pay you $5,000 a year for 5 years and you could earn 6% per year, how much would that be worth today?

=PV(rate,nper,pmt,fv,type) =PV(6%,5,-5000)=$21,061.82

If you are buying something for $50,000 and are offered terms of 1/10, N/30 should you take the discount if you normally earn a return of 15% on your money?

=Rate(20, , -49500, 50000)= 0.0503% per day. 0503% x 365 = 18.3% The discount is equivalent to earning 18.3%. This is greater than a return of 15%, so you should take the discount.

Suppose that you have $50,000 and need to invest it so that you will have $1,000,000 twenty years from now and repay a debt. What interest rate do you have to earn, assuming monthly compounding?

=Rate(nper, pmt, pv, fv, type, guess) =Rate(20*12,,-50000,1000000)= 1.26% per month or 15.1% per year

What is a management control system?

A complete set of policies and procedures designed to keep operations going according to plan.

How much will $8,000 invested at 3% simple interest be worth in 3 years? What will it be worth if the interest rate is 5%?

A. $8,000 at 3% simple interest for 3 years: $8,000 x 3% = $240 $240 x 3 years = $720 $8,000 + $720 = $8,720 B. $8,000 at 5% simple interest for 3 years: $8,000 x 5% = $400 $400 x 3 years = $1,200 $8,000 + $1,200 = $9,200

Why do we need to distinguish capital gains separately from other income?

Because the gains earned on many types of investments are referred to as capital gains, and are subject to a lower tax rate than you would pay on normal earned income.

Why would you want to keep inventory levels low?

Because the less inventory on hand, the less you have paid to suppliers, and the greater the amount of money in your own interest-bearing accounts. Lower inventory tends to also result in less waste through breakage, obsolescence and theft, and also lower storage costs.

Why are Generally Accepted Accounting Principles needed and what organization established them?

Because the only way for accountants to obtain consistency in the treatment of financial records across different organizations is to agree on some rules. The Financial Accounting Standards Board (FASB)or the Governmental Accounting Standards Board (GASB) created these set of rules.

What are the most common types of short-term investments?

Cash, marketable securities, accounts receivable, and inventory.

Tax base

Defines what is subject to tax.

Do you think the SOX legislation was adequate to prevent fraud such as the Madoff Scandal?

No, because the Madoff scandal was not even discovered until long after the passage of SOX.

Does the auditor attempt to identify all accounting errors?

No, the auditor cannot identify all errors that might have taken place within the accounting system of the organization.

What are some issues that must be considered regarding payroll policy?

Organizations have to decide on policies such as the number of holidays, sick days, and vacation days. Will sick days roll over to the following year if not used? Can employees take a cash payout for unused days? How frequently will employees be paid? Weekly? Biweekly? Monthly? What fringe benefits such as health insurance and retirement payments will be made?

In addition to the types of fraud common to a lay person, what are the four main classes of fraud that take place in businesses? Focus on the financial reporting if the firm.

Overstating revenue, understating expense, overstating assets, and understating liabilities.

Proponents of a flat tax support what type of tax system?

Proportional

Audit

Refers to the ability to trace each transaction in an accounting system back to its source.

Compounding

Refers to the fact that when money is invested going forward in time, at some point the interest earned on the money starts to earn interest itself.

What is working capital management?

Refers to the techniques and approaches designed to maximize the benefit of short-term resources and minimize the cost of short-term obligations.

Specific authorization

Requires an individual to get written permission to override the general authorization policies.

General authorization

Standing approval of certain spending. Items under a certain dollar limit or for certain purposes may fall under that type of authorization

What are some examples of the greater level of responsibility that the SOX legislation imposes on senior executives?

The CEO and CFO of organizations required to comply with SOX have to certify that they have reviewed the annual financial report, that it does not contain any untrue statement of a material fact, and that the statements fairly present the financial condition of the organization. Furthermore, the CEO and CFO will have to certify that internal control systems are in place to ensure awareness of material misinformation, and that any known deficiencies in control, or any known frauds involving key personnel, have been disclosed to both the outside auditors and to the audit committee.

How much will $8,000 invested at 3% interest be worth in 3 years if it is compounded annually? Quarterly? How much if the interest rate is 5%?

The Excel solutions would be:=FV(rate,nper, pmt, pv, type) A. 3% Annual Compounding =FV(rate,nper,pmt,pv,type) =FV(3%,3,,-8000)=$8,741.82 B. 3% Quarterly Compounding =FV(rate,nper,pmt,pv,type) =FV(.75%,12,,-8000)=$8,750.46 C. 5% Annual Compounding =FV(rate,nper,pmt,pv,type) =FV(5%,3,,-8000)=$9,261.00 D. 5% Quarterly Compounding =FV(rate,nper,pmt,pv,type) =FV(1.25%,12,,-8000)=$9,286.04

What event precipitated the establishment of the Securities and Exchange Commission and the requirement for publicly traded companies to issue audited financial statements to stockholders?

The Stock Market Crash of 1929.

Tax rate

The percentage that is multiplied by the tax base to calculate the tax.

What is the primary limitation of an S-corp?

The profits of this type of corp are taxed to the owners, even if the firm does not distribute cash dividend which can create a situation where the owners are obligated to pay tax on income but don't have a source of cash to use to pay the taxes. These corps are also limited in that all owners have to agree to a certain treatment for taxes, and there are restrictions on who can own a stock for this type of corp(no partnerships, corporations or foreign investors).

Marginal tax rates

The rate that will be paid on the next dollar of income earned. This may be higher than the average rate which is the total tax paid divided by the tax base.

Discounting

The reversal of the compounding process as we go backward in time.

Suppose that two projects each cost $10,000. The first project returns $3,000 a year for 7 years. The second project returns $5,000 a year for two years. Which has a better payback period? Is that the better project to invest in?

The second project has the better payback because you get your entire investment back in two years. However, the first project is probably the better one to invest in because you make a $11,000 profit after a return of $21,000 in that 7 year time period, whereas that first second project yields no profit.

Explain the following Generally Accepted Accounting Principles: Cost

The value of what was given up to acquire the item.

What is the primary benefit of an S-corp?

This is a corporation that is taxed as if it were a partnership which avoids double taxation.

Explain the following Generally Accepted Accounting Principles: Consistency

To avoid misleading users of financial reports, organizations should generally use the same accounting methods from period to period.

Capital cost is usually interest, while out-of-pocket includes rent on space, insurance, taxes, the cost of counting inventory, damage loss and theft.

True

Carrying costs include both capital cost and out-of-pocket costs.

True

Credit policies should be used to determine who to extend credit to.

True

If necessary phone calls or even legal action or use of a collection agency to collect the dues.

True

What are the variables that have to be considered in the EOQ system for inventory?

We need to know the carrying or holding costs and the ordering costs.

If possible electronic billing and collections should NOT be used

False

Account payable are sometimes referred to as _____________.

trade credit

Explain the following Generally Accepted Accounting Principles: Materiality

An error is material if any individual would make a different decision based on the incorrect information resulting from the error than if he or she possessed the correct information.

Fraud

An intentional deception for the purpose of a financial gain.

Suppose that you need 5,000 units of inventory over the course of a year. Each unit costs $1. The costs related to placing each order are $20. Your cost of capital is 8%. Other carrying costs are estimated to be $0.10 per unit. What is the EOQ for this inventory?

EOQ = √2ON/C = √2×20×5000/(.10+.08)= 1,054

Why does the investment analysis focus us cash flow rather than revenue?

Even if net income were a perfect measure of profitability, it doesn't consider the time value of money. We need to know when we actually receive or spend cash. This is important becausewe only earn interest on cash we actually have, or pay interest on money we need tomorrow. You can't deposit revenues in a bank. You must actually have cash.

Explain the following Generally Accepted Accounting Principles: Matching

Expenses should be recorded in the same accounting period as the revenues that they were responsible for generating.

Managers shouldn't use an aging schedule to track collections.

False

Explain the following Generally Accepted Accounting Principles: Objective Evidence

Financial report should be based on such evidence as reasonable individuals could all agree upon within relatively narrow bounds.

Explain the following Generally Accepted Accounting Principles: Full Disclosure

Financial reports should disclose any information needed to ensure that the reports are a fair presentation.

Explain the following Generally Accepted Accounting Principles: Going Concern

Financial statements are prepared based on the assumption that the organization will remain in business for the foreseeable future. If that is not likely to be the case, it must be disclosed.

What is the period of time from which you write a check until it clears your bank account called?

Float

What are the three principal reasons that organizations keep cash?

For daily transactions, as a safety margin for emergencies, and to have available if attractive opportunities arise.

Average tax rate

Found if you divide the amount of tax by the total amount of taxable income.

Effective tax rate

Found if you divide the tax by the total income, including non-taxable income.

When cash is invested to earn a higher return than a bank savings account, what are the two primary tradeoffs?

In exchange for a higher rate of return you incur more risk, and/or sacrifice liquidity.

Explain the following Generally Accepted Accounting Principles: Conservatism

In reporting the financial position of the organization, sufficient consideration should be given to the various risks the organization faces.

Coffin Corporation wants to buy a new hearse for $60,000. It will last for 5 years. They expect to make 100 trips per year. Coffin uses a discount rate of 6%. If they charge $150 per trip, will they have a positive net present value for the investment?

Initial Outlay = ($60,000) Compare cost to PV of PMT = 100*$150 = $15,000 Rate = 6% Nper = 5 =PV(rate, nper, pmt, fv, type) =PV(6%,5,-15000)= $63,185.46 The inflows from using the hearse are worth $63,185 in today's dollars. The hearse will cost less than the value of the cash we will receive. But the hearse.$63,185.46 -$60,000 = $3,185.46 NPV

What is net working capital or simply working capital?

Is defined as current assets less current liabilities.

What is the opinion letter and what are the different opinions that can be rendered?

It is.a letter from the CPA that relates to the scope and results of the audit.

When the auditor believes that the financial statements are a fair representation of the organization's financial status and the financial statements conform to GAAP the auditor issues what is called a _____________.

clean opinion