UNIT 1 - BEC
A company has a capital project with the before-tax cash inflows in real dollars that are expected to be 200,000 within 2 years. The inflation rate is expected to be 6% each year during that period. What is the before-tax cash inflow expressed in nominal dollars?
$200,000 × 1.06 × 1.06 = $224,720. Nominal dollars are equal to the inflation rate applied to real dollars. If $200,000 is the amount expected in two years expressed in real dollars, the inflation rate of 6 percent needs to be applied each year for the next two years to derive the nominal amount.
A company has an outstanding 1 year bank loan of 500,000 at a stated interest rate of 8%. The company is required to maintain a 20% compensating balance in its checking account. The company would maintain a zero balance inthis account if the requirement did not exist. What is the effective interest rate of the loan?
10% The effective rate of interest rate is 10 percent. The effective interest rate represents the actual finance charges associated with a borrowing after reducing loan proceeds for charges and fees. The above scenario indicates that finance charges are $40,000 ($500,000 x 8%), and the net proceeds or amount available under the loan is $400,000 (the face value of $500,000 net of the 20 percent compensating balance of $100,000 [$500,000 x 20%]). The effective rate of interest is the finance charge of $40,000 divided by the net proceeds of $400,000:
Management has carefully evaluated the likelihood and impact of events on its foreign operations. In the event o fa 3 percent variation in exchange rate, the impact is estimated at 10 million without any action taken by management and 4 million if the company purchases a hedge instrument. The impact of the residual risk of changes in foreign currency exchange on achieving the company's business objective is:
4 million the $4-million risk exposure, after management purchases the hedge, is the residual risk. Residual risk is the risk that remains after management responds to the risk. Inherent risk is the risk to an entity in the absence of any actions management might take to alter either the risk's likelihood or impact. The $10-million exposure identified in the problem is the risk exposure without management's intervention.
Elan corporation is considering borrowing 100,000 from a bank for one year at a stated interest rate o f9%. What is the effective interest rate to Elan if this borrowing is in the form of a a discounted note?
9.89% Step 1: Loan principal 100,000 Less 9% interest discounted in advance (9,000) Cash proceeds 91,000 Step 2: Interest charged $9,000 Divided by cash proceeds $91,000 = 9.89%
A manufacturer actively monitors a foreign country's political events whenever a supply chain disruption occurs within the country that exceeds 90 days. According to COSO Enterprise Risk Management principles, the manufacturer is following which risk response strategy?
Accept If a manufacturer is only monitoring political events without taking any actions, it is simply choosing to accept the risk.
In evaluating the impact of relative inflation rates on the demand for a foreign currency, what is true?
As inflation associated with a foreign economy increases in relation to a domestic economy, demand for the foreign currency fails.
The Sarbanes-Oxley Act of 2002 requires that the members of the audit committee be independent with regard to the issuer. Within the meaning of the law, which of the following corporate officers would be considered independent? Board Member: Yes or No? Independent Auditor: Yes or No?
Board Member: Yes Independent Auditor: No Rule: Audit committee members are to be members of the issuer's Board of Directors but also must be otherwise independent. Independence criteria are as follows: Audit committee members may not accept compensation from the issuer for consulting or advisory services. Audit committee members may not be an affiliated person of the issuer (affiliation means a person has the ability to influence financial decisions). Board membership does not impair independence for purposes of audit committee membership (in fact, being a board member is a requirement). The independent auditor is hired and paid by the audit committee and thus is not independent, per the rule above.
Which of the following factors is inherent in a firm's operations if it utilizes only equity financing? a) financial risk b) business risk c) inherent rate risk d) marginal risk
Business risk Represents risk associated with the unique circumstances of a particular company as they might affect the shareholder value of that company.
The COCO Cube is used to illustrate the relationship between:
Categories of objectives, internal control components, and entity organizational levels. The COSO Cube shows the three categories of objectives as columns, the five internal control components as rows, and the four levels of an entity's organization as the third dimension.
What element is unique to the governance and culture component within the Enterprise Risk Management framework and not a part of the control environment within the internal control - integrated framework?
Definition of the desired culture Definition of the desired culture reflects the shared beliefs and attitudes of management and the entity's leadership. This element is a part of the governance and culture component within ERM but is not a part of the control environment within the Integrated Framework.
As part of the information and communication component of the Integrated Framework, a company must:
Ensure that external auditors are aware of significant internal control issues
The Enterprise Risk Management Integrated Framework states that an organization must identify events, both positive and negative, as part of its risk management program. What is true with regard to events?
Event identification occurs after the development of objectives Events can only be identified after the organizational objectives are identified. Events will either favorably or unfavorably impact the achievement of objectives. Risks (negative events) are only identifiable within the context of the objectives that they might impede.
What position best describes the nature of the Board of Directors of XYZ Co.'s relationship to the company? a) executive b) agent c) representative d) fiduciary
Fiduciary The board of directors has a fiduciary responsibility to act on behalf of and in the best interest of the corporation.
According to the Committee of Sponsoring Organizations (COSO) of the Treadway Commission, what component of enterprise risk management addresses an entity's commitment to core values?
Governance and Culture
Hedgehog International has numerous foreign exchange transactions. Management has elected to hedge transactions as a means of mitigating transaction exposure to exchange rate risk. What is the most effective means that Hedgehog International can use to avoid overhedging?
Hedgehog should acquire the minimum amount required to hedge known transactions Parallel loans represent a swap contract for hedging long-term transaction exposure and are not specifically designed to mitigate the risk of overhedging. Cross hedging involves techniques related to currencies that do have hedge instruments available to mitigate risk and are not specifically designed to avoid overhedging.
An importing partnership has experienced a dramatic surge in its exporting business and is looking for ways to minimize its risks from foreign currency fluctuations. The partnership's imports and exports to European Union countries are at similar levels. What method most effectively minimizes risk?
Hold payables and receivables due in the same currency and amount.
Which of the following assessment techniques may be used to assess risk? I. Benchmark data from comparable organizations II. Objective statistical data with estimated probabilities III. Subjective assumptions which take into account impact without probabilities.
I, II and III
Which of the following is/are inherent risk(s) of conducting international business? I. Exchange rate fluctuation II. Foreign economies III. Political risk
I, II, and III
The performance component of COSO's Enterprise Risk Management framework is supported by which of the following principals?
Identifies risk The performance component of the framework is supported by five principles summarized by the VAPIR mnemonic. Those five principles include: develops portfolio View, Assesses severity of risk, Prioritizes risk, Identifies risks, and implements risk Responses.
In a large public corporation, evaluating internal control procedures should be the responsibility of:
Internal audit staff who report to the BOD
What statement is most accurate regarding the Enterprise Risk Management Framework?
It aids management in balancing risks/uncertainty with the need to increase value/returns.
The event identification component of enterprise risk management most closely aligns with which component of the Enterprise Risk Management - Integrated Framework?
Performance Identifying both positive and negative events is most closely aligned with
According to COSO, which of the following identifies the group directly responsible for the implementation and development of the Enterprise Risk Management framework?
Management It is incumbent on management to determine how the inevitable risks that an entity faces must be balanced with the desire to grow stakeholder value. Management is responsible for developing and implementing the enterprise risk management framework and process.
A US based company decides to invest capital in an emerging market operation that has a lower expected return rate compared to the expected return for an alternative domestic operation. What statement supports this decision?
Management expects the US dollar to decline in value relative to the foreign location's currency.
The Gotham Corporation regularly produces budget vs. actual data for its managers. The company is particularly sensitive to personnel costs, and division variances of greater than 5% for any period are promptly investigated to determine if budgeted positions have not been filled or if there has been extraordinary overtime. Timely exception resolution of this character illustrates the information and communications principles typically associated with:
Obtain and Use information The principle of obtain and use information is applied when the organization obtains or generates and uses relevant, high-quality information to support the functioning of the control. In this case, management is using the exception report (information) to support the control of monitoring overtime costs.
The event identification component of enterprise risk management most closely aligns with which component of the Enterprise Risk Management - Integrated Framework?
Performance Identifying both positive and negative events is most closely aligned with the principles associated with the performance component within the Enterprise Risk Management—Integrated Framework.
Conflict of interest provisions of the Sarbanes Oxley Act of 2002 generally prohibit the directors or executive offers of an issuer from:
Receiving a personal loan from the issuer not in the ordinary course of business
A manufacturing firm identified that it would have difficult sourcing raw materials locally, so it decided to relocate its production facilities. According to COSO, this decision represents what response to the risk?
Risk reduction There are four methods to responding to risk: 1) Risk avoidance techniques might involve discontinuing the product that uses the raw materials all together or replacing the raw materials with a locally available product. 2) Risk acceptance is typically associated is typically associated with doing nothing 3) Risk sharing is often associated with purchasing insurance, however, in this instance, the company might choose to share risk by buying purchase options to ensure raw material availability commitments from local suppliers 4) Risk reduction by relocating its production facilities
If an investor's certainty equivalent is greater than the expected value of an investment alternative, the investor is said to be:
Risk seeking If an investor's certainty equivalent, the point at which the investor is indifferent to risk, exceeds the expected return on an investment, then the investor is actually seeking lower return for higher risk. This behavior represents risk seeking behavior.
The Carlton Corporation publishes an Employee Handbook that contains employee responsibilities for moral behavior including a code of conduct. Each year, employees must acknowledge their receipt of the handbook, their understanding of the code, and if they have an awareness of non-compliance within the company. The policies would indicate:
Sound integrity and ethical values are developed and understood and set the standard of conduct for financial reporting.
As an organization defines its risk appetite, it is supporting what component of COSO's Enterprise Risk Management framework?
Strategy and objective setting The strategy and objective-setting component of the framework is supported by four principles summarized by the SOAR mnemonic. Those four principles include: evaluates alternative Strategies, formulates business Objectives, Analyzes business context, and defines Risk appetite.
Investment managers develop portfolios of different investments to combine, offset, and thereby reduce overall risk. Not all risks can be eliminated by development of a portfolio. Risks that cannot be eliminated through a portfolio are called:
Systematic risks Portfolio theory is concerned with construction of an investment portfolio that efficiently balances its risk with its rate of return. Risk is often reduced by diversification, the process of mixing investments of different or offsetting risks. The broad categories of risk are summarized in the following mnemonic to get us DUNS. Diversifiable Unsystematic (non-market/firm-specific) Non-diversifiable Systematic (market) Non-diversifiable risk is also referred to as market or systematic risk. Diversifiable risks are also termed non-market risk. Diversifiable risks are also termed firm-specific risk. Diversifiable risks are also termed unsystematic risk.
The SOX of 2002 requires that one or more members of the audit committee be a financial expert and that the financial reports disclose:
The existence of financial experts on the audit committee or the reasons why the audit committee does not have a financial expert
Generally, an organization will not operate beyond the limits of its risk appetite. Risk appetite has generally been exceeded when:
The likelihood and impact of negative events significantly exceed residual risks Residual risk represents the risk that remains after management has taken actions to mitigate negative events. If the likelihood and impact of those negative events significantly exceed the residual risk, the operation is likely to exceed the organization's risk appetite.
According to the COSO Enterprise Risk Management Integrated Framework, uncertainty in enterprise risk management refers to:
The state of not knowing how or if potential events may manifest
Universal Industries limits its operations to exports to foreign countries. What can be said about Universal's exposures to exchange rate risk?
Universal is subject to potential transaction, and economic exposures to exchange rate risk. No translation exposure exists since there is no foreign investment or subsidiary.
As an organization commits to attracting, developing, and retaining capable individuals, it is supporting which of the following component of COSO's Enterprise Risk Management framework? a) governance and culture b) strategy and objective setting c) performance d) review and revision
a) governance and culture The governance and culture component of the framework is supported by 5 principles (DOVES): Desired culture Oversight, demonstrates commitment to core Values, attracts capable Employees, and establishes operating Structure
The Internal Control - Integrated Framework contains objectives that cover each of the following, except: a) high-level goals established by leadership to develop to the entity's mission b) ensuring all applicable laws and regulations are followed c) the safeguarding of the entity's assets against potential losses d) the transparency of internal and external financial reporting
a) high-level goals established by leadership to develop to the entity's mission
Which of the following statements is most accurate regarding the Enterprise Risk Management Framework? a) it aids management in balancing risks/uncertainty with the need to increase value/returns b) it is required by the SEC to be put in place for all public companies c) it was developed prior to the Internal Control - Integrated Framework d) the purpose of the framework is to help organizations eliminate risk
a) it aids management in balancing risks/uncertainty with the need to increase value/returns The ERM Framework was first published by COSO in 2004, 12 years after the Internal Control—Integrated Framework was first published. Organizations are not necessarily trying to eliminate risk, as that is often unrealistic; they are trying to manage risk while still earning strong returns and maximizing value for their stakeholders.
What is most accurate regarding event identification within enterprise risk management? a) technology is often an internal and an external event b) the political environment is primarily an internal event c) positive events are more critical to the organization than negative events d) a negative event represents a potential opportunity to achieve established objectives
a) technology is often an internal and an external event Technology is something that can be a risk (negative event) and an opportunity (positive event). In addition, the effect of a technology event can come from within as well as from outside of an organization. The political environment is primarily an external event. Positive events (opportunities) and negative events (risks) are equally critical to an organization. A negative event represents a potential risk to being able to achieve established objectives.
The Sarbanes-Oxley Act of 2002 was enacted in response to corporate scandals that largely centered on the quality of corporate financial disclosure and highlighted the inadequate oversight of management, auditors, and the BOD. SOX addresses the problems related to inadequate board oversight by requiring public companies to have:
an audit committee
Under Title IV of the SOX, disclosures found in an issuer's annual financial statements will likely include all of the following, except: a) the usage of special purpose entities (SEPs) b) all correcting adjustments identified y external auditors c) relationships with subsidiary entities that are not consolidated in the parent's financials d) reconciliation of pro forma financials with GAAP basis financial statements
b) all correcting adjustments identified y external auditors The requirement is that all material correcting adjustments identified by the auditor be reflected in the financial statements. Immaterial adjustments are not required.
According to the SOX, the assertions on financial reports that the CEO and the CFO must make regarding internal controls include all of the following, except: a) conclusions as to the effectiveness of the controls per their evaluation b) any identified internal control weaknesses will be rectified within 60 days after the report is issued c) the assurance that the controls were set up to ensure that material information is available d) the controls have been evaluated for effectiveness within 90 days prior to the report issuance
b) any identified internal control weaknesses will be rectified within 60 days after the report is issued SOX does not require an assertion that any identified internal control weaknesses will be rectified within 60 days after the report is issued.
Which of the following is necessary to be an audit committee financial expert, according to the criteria specified in the Sarbanes-Oxley Act of 2002? a) education and experience as a CFP b) experience with internal accounting controls c) experience in the preparation of returns d) a limited understanding of GAAS
b) experience with internal accounting controls
All of the following fundamental concepts are reflected in the definition of internal control, except that controls are: a) adaptable to the structure of the entity b) geared toward achieving strategic, operations, and compliance objectives c) established to provide reasonable (not absolute) assurance d) affected by people and their actions
b) geared toward achieving strategic, operations, and compliance objectives Internal controls are geared toward the achievement of operations, reporting, and compliance objectives. Strategic objectives are established as part of the enterprise risk management process.
According to COSO, an effective approach to monitoring internal control involves each of the following steps, except: a) assessing and reporting the results, including following up corrective action where necessary b) increasing the reliability of financial reporting and compliance with applicable laws and regulations c) designing and executing monitoring procedures that are prioritized based on risks to achieve organizational objectives d) establishing a foundation for monitoring
b) increasing the reliability of financial reporting and compliance with applicable laws and regulations
Internal controls are likely to fail for any of the following reasons, except: a) they are designed and implemented properly, but their operation changes income way b) they are designed and implemented properly, and their design changes as processes change c) they are designed and implemented properly as static controls, but the environment in which they operate changes d) they are not designed and implemented properly as the outset
b) they are designed and implemented properly, and their design changes as processes change
All of the following penalties under the Sarbanes-Oxley act are correct, except a maximum imprisonment of: a) 10 years of retaliating against an informant (whistle blower) b) 10 years for an auditor failing to retain workpapers for 7 years c) 10 years for altering a document with the intent to influence an investigation d) 20 years for the willful certification of a statement knowing that it fails to comply with SEC requirements
c) 10 years for altering a document with the intent to influence an investigation The maximum is 20 years for this.
Atlas Worldwide Industries conducts business in a number of different countries and is trying to evaluate its economic exposure to exchange rate risk. Which of the following statements is not correct? a) Atlas will enjoy an economic gain in the event it has net cash outflows of a foreign currency and the foreign currency depreciates b) Atlas will suffer an economic loss in the event it has net cash outflows of a foreign currency and the foreign currency appreciates c) Atlas will suffer an economic loss in the event it has net cash inflows of a foreign currency and the foreign currency appreciates a) Atlas will suffer an economic loss in the event it has net cash inflows of a foreign currency and the foreign currency depreciates
c) Atlas will suffer an economic loss in the event it has net cash inflows of a foreign currency and the foreign currency appreciates
Which of the following statements is most accurate regarding public company audit committees? a) the auditor report directly to the company's CEO and indirectly to the audit committee b) audit committee members cannot serve as members of the board of directors c) the audit committee is charged with overseeing the work of the external auditor hired by the issuer d) resolving disputes between management and external auditors is outside of audit committee scope
c) the audit committee is charged with overseeing the work of the external auditor hired by the issuer
Each of the following instruments is a derivative, except: a) a contract to purchase a commodity in 6 months at a price determined today b) an agreement to buy a piece of equipment in 6 months at a price determined today c) interest rate futures d) a fixed interest, 5-year note payable
d) a fixed interest, 5-year note payable A derivative is a financial contract which derives its value from the performance of another asset or financial contract (interest rate, stock, asset, etc.). A fixed interest, five-year note payable is a debt instrument whose changes in value drive its own performance.
Kamp Sporting Goods seeks to establish a code of conduct that will communicate the "tone at the top" to all employees. The contents of the code will likely include all of the following, except: a) prohibitions against conflicts of interest and self dealing b) prohibitions or limits on gifts and gratuities or establishes required reporting c) descriptions of the organization's commitment to compliance and confidentiality d) definitions of common sense approaches to software piracy to ensure that the company is competitive
d) definitions of common sense approaches to software piracy to ensure that the company is competitive Codes of conduct likely will not condone exceptions to ethical behavior or the law in the name of competition.
When purchasing temporary investments, which of the following best desrcribes the risk associated with the ability to sell the investment risk in a short period of time without significant price concessions? a) financial risk b) interest rate risk c) purchasing power risk d) liquidity risk
d) liquidity risk Financial risk is a general category of risk that includes: Interest rate risk Market risk Purchasing power risk Liquidity risk Default risk Interest rate risk is the fluctuation in the value of a "financial asset" when interest rates change Purchasing power risk is the risk that price levels will change and affect asset values (mostly real estate).
SOX seeks to improve investor confidence by providing greater transparency for all of the following issues except: a) competency of audit committees b) compliance of senior officers with a code of ethics c) adequacy of internal controls d) means and methods for balancing risk and growth
d) means and methods for balancing risk and growth
According to COSO, establishing, maintaining, and monitoring an effective internal control system can do each of the following except: a) help an entity achieve performance targets b) provide protection for an entity's resources c) ensure an entity's financial survival d) promote an entity's compliance with laws and regulations
d) promote an entity's compliance with laws and regulations An internal control system serves many purposes, including the promotion of compliance with laws and regulations, helping to achieve performance objectives, and safeguarding resources. But no matter how effective an internal control system is, there will always be limitations and no internal control system can absolutely ensure financial survival.
According to the COSO, the presence of a written code of conduct provides for a control environment that can:
encourage teamwork in the pursuit of an entity's objectives
Due to 50% store growth year after year, monitoring internal controls at a national retail chain has come under tremendous pressure. According to COSO, what response would be appropriate under the circumstances to help restore effective monitoring?
shifting most of the monitoring responsibility to store managers and district managers When the size of an organization grows substantially, it becomes more difficult to effectively monitor from only the top level. An effective strategy to ensure that monitoring is done across the organization is to shift monitoring responsibility to all of the store and district managers—essentially transferring the responsibility to the local rather than the central level.
Th emission and vision of an organization most closely correlate with an entity's:
strategy an organization's mission represents the purpose of an entity, and its vision represents the organization's aspirations and what it hopes to achieve over time. Culture is most closely correlated with core values.
What is the effect when a foreign competitor's currency becomes weaker compared with the U.S. dollar?
the foreign company will have an advantage in the U.S. market As a foreign competitor's currency becomes weaker compared with the U.S. dollar, the product becomes less expensive in U.S. dollars. The less expensive product will increase demand and result in an advantage in the U.S. market.