NC State CPA Exam Review (Business) January 4, 2019 Josh Rosenberg JMRose09@aol

1. NC State CPA Exam Review (Business) January 4, 2019 Josh Rosenberg JMRose09@aol.com

2. Agenda (11:00 – 2:00) • Overview of the Exam • In Detail: B1 – B6 • Subject Areas • Key Points • Selected MCQs and SIMS • Final Tips • Q&A

4. 240 minutes         X X X + 40min + 40min + 80min=240min 40min + 40min

5. 1 2 3 4

6. BEC Exam – Percentage Allocations • Remembering and Understanding(R&U): The perception and comprehension of the significance of an area utilizing knowledge gained. • Application (APP): The use or demonstration of knowledge, concepts, and techniques. • Analysis: The examination and study of the interrelationships of separate areas in order to identify causes and find evidence to support inferences. • Evaluation: The examination or assessment of problems, and use of judgment to draw conclusions. • Remembering and Understanding tasks are in all five areas of the BEC blueprint. • • Application tasks are in all five areas of the BEC blueprint. • • Analysis tasks are in Area II, Area III and Area V of the BEC blueprint.

7. BEC Exam – The Blueprint • Two places to find it: • Back of your Becker BEC Textbook • AICPA Website: https://www.aicpa.org/content/dam/aicpa/becomeacpa/cpaexam/examinationcontent/downloadabledocuments/cpa-exam-blueprints-effective-jan-2019.pdf • (BEC Pages: 32 – 47)

8. B1 Corporate Governance and Financial Risk Management

9. Subject Areas: • Internal Control Frameworks • Enterprise Risk Management Frameworks • Sarbanes Oxley Act of 2002 • Financial Risk Management B1: Corporate Governance and Financial Risk Management

10. B1: Corporate Governance and Financial Risk Management Key Points: • The “Internal Control – Integrated Framework” has three categories of objectives (Operating, Reporting, Compliance) and five integrated components (CRIME): Control Environment, Risk Assessment, Information and Communication, Monitoring, and Existing Control Activities which contain seventeen (17) principles. • To be effective, all components and relevant principles must be both present and functioning. • COSO issued “Enterprise Risk Management – Integrating with Strategy and Performance in 2017” to help entities manage the inevitable risks that they face in the effort to pursue & provide value to stakeholders. • ERM is defined by five interrelated components and is supported by 20 risk management principles. • ERM Components include: (1) Governance and Culture, (2) Strategy and Objective Setting, (3) Performance, (4) Review and Revision, and (5) Information, Communication, and Ongoing Reporting. • ERM Governance and Culture: includes board oversight, commitment to core values, operating structure, capable employees. • ERM Strategy and Objective Setting: formulates business objectives, analyzes context, defines risk appetite. • ERM Performance: Develops portfolio view, identifies, assesses and prioritizes risks, and implements risk responses. • ERM Review & Revision: Assesses substantial change, pursues ERM improvements, reviews risk and performance.

11. B1: Corporate Governance and Financial Risk Management Key Points: • ERM Information, Communication, and Reporting (ongoing): leverages IT, communicates risk information, reports on risk culture and performance. • Sarbanes-Oxley Title III: Requirements for an Audit Committee, representations required by CEO and CFO. • Sarbanes-Oxley Title IV: Enhanced financial disclosures, internal control assessments, code of ethics. • Sarbanes-Oxley Titles VIII, IX, XI: criminal penalties, white collar offenses, and corporate fraud. • Be familiar with diversifiable (unsystematic) risk versus nondiversifiable (systematic) risk, interest rate risk, default risk (creditor bears), credit risk (borrower bears), and liquidity risk. • The rate calculations: Stated rate, effective rate, (effective) annual percentage rate, simple interest, compound interest. • Transaction exposure (economic loss or gain from transaction settlements due to changes in exchange rates), economic exposure (PV of cash flows change due to changes in exchange rates), and translation exposure (financial statement components will change due to changes in exchange rates). • Risk averse: greater returns should accompany greater risks. • Hedging techniques such as futures, forwards, currency options, and money market hedges are used to mitigate transaction risks with receivables or payables.

12. B1: Corporate Governance and Financial Risk Management MCQ # 1: Disposal of the business unit, product line, or segment. Diversifying product lines. Insurance, joint ventures. Tolerating the risk…..self-insuring.

13. B1: Corporate Governance and Financial Risk Management MCQ # 2: Risk to a lender that a borrower will fail to repay interest or principal. Risk to a borrower associated with trying to obtain credit. A.K.A. Inflation Premium…..risk that price levels will rise and asset value and purchasing power will suffer. Risk associated with lending money (and not having access to your funds) for longer period.

14. B1: Corporate Governance and Financial Risk Management MCQ # 3: Current Price: $0.60 Strike Price: $0.61 Price in 90 days: $0.63 You locked in lower rate = EXERCISE! Gain = 500,000 x ($0.63 – ($0.61 + $0.005)) Call Option Goal: Lock in lower price in case what you need to buy goes UP $7,500

15. B1: Corporate Governance and Financial Risk Management SIM # 1: Written Question advice: Read the question twice before you even think of starting your answer. Introduction, Body, Conclusion 3. When writing your answer, keep these grading tips in mind: -Spelling counts -Grammar counts -Punctuation counts -Write in complete sentences and paragraphs, no bulleted or numbered lists -Do not use an abbreviation unless you define it first, for example: Do not use SEC unless you first type Securities Exchange Commission (SEC) Once you define the abbreviation SEC, you can use it after that.

16. B1: Corporate Governance and Financial Risk Management SIM # 1: Introduction Body Body Conclusion

17. B2 Financial Management

18. Subject Areas: • Capital Structure • Working Capital Metrics • Working Capital Management • Financial Valuation Methods • Financial Decision Models B2: Financial Management

19. Key Points: • A firm's weighted-average cost of capital (WACC) is calculated using the weighted proportion of the entity's after-tax cost of debt, preferred stock, and common equity. Equity cost may be the cost of internal retained earnings or issuing new common stock. WACC is often used as a "hurdle" rate in capital investment decisions. The optimal capital structure is the one that produces the lowest WACC for the firm. • While a firm’s capital structure relates to the debt and equity components of its balance sheet, the asset structure relates to the composition of assets on its balance sheet. • Working capital policy and working capital management involve managing cash so that a company can meet its short-term obligations. • The current ratio demonstrates a firm’s ability to generate cash to meet its short-term obligations. The quick (acid-test) ratio is a more rigorous test of liquidity than the current ratio because inventory and prepaids are excluded from current assets. • The cash conversion cycle (CCC) measures the time from cash outlay to cash collection in days. The CCC period can be shortened by increasing inventory turnover, collecting receivables more quickly or deferring remittances on payables for a longer period. (The candidate should be able to calculate the CCC using the formula which includes inventory turnover, AR turnover, and AP turnover, converted to a 365-days basis.) B2: Financial Management

20. Key Points: • Working Capital Management involves managing current assets (especially cash) and current liabilities so that a company can meet its current obligations in an efficient manner. • Inventory management attempts to balance the costs of carrying inventory against the costs of "stocking out." Inventory turnover and the number of days' sales in inventory are two key ratios used in analysis. • Accounts receivable management involves effectively balancing credit and collection policies to optimize the average collection period and number of days' sales in receivables. • Absolute value models assign an intrinsic value to an asset on the present value of its future cash flows. • Relative valuation models use the value of comparable stocks to determine the value of similar stocks. Price multiples are useful metrics in relative valuation. • An option is a contract that entitles the owner (holder) to buy (call option) or sell (put options) a stock (or some other asset) at a given price within a stated period of time. • The value of a bond is equal to the present value of its future cash flows. The cash flows may be discounted using a single interest rate or multiple interest rates aligned with the degree of risk for each cash flow. B2: Financial Management

21. Key Points: • After-tax cash flows over the life of the project, both direct and indirect, are analyzed in the capital budgeting process. • Stages of cash flows in a capital investment project include the inception of the project (at time period zero), the ongoing periodic cash flows generated by the project, and the terminal value associated with the disposal or winding down of a project. • DCF valuation methods determine the present value of all expected future cash flows using a predetermined discount rate (e.g., WACC, required rate of return). • The net present value (NPV) method compares the PV of future cash flows to the initial investment. If NPV is positive, the investment should be made. If NPV is negative, the investment should not be made. • Capital rationing attempts to spend limited (rationed) funds in the most efficient manner in order to select the combination of projects that will maximize net present value. The profitability index (PI) divides the PV of the net future cash flows by the initial investment. • The internal rate of return (IRR) method determines the present value factor (and related interest rate) that yields an NPV equal to zero. Only projects with an IRR greater than the hurdle rate should be accepted. • The payback period method calculates the time it will take to recover the initial investment, disregarding time value of money. The discounted payback period method use PV factors to discount the expected cash flows. B2: Financial Management

22. MCQ # 1: B2: Financial Management DEBT: (.50)(.06)(1 - .40) = .018, or 1.8% 1.8% + 0.7% + 4.6% = 7.1% + PREF. EQUITY: (.10)(.07) = .007, or 0.7% + COMMON EQUITY: (.40)(.115) = .046, or 4.6%

23. MCQ # 2: B2: Financial Management Higher is better (all else equal)!

24. MCQ # 3: B2: Financial Management

25. MCQ # 4: B2: Financial Management

26. MCQ # 5: B2: Financial Management Outflow: ($20,000) Inflow: $4,000 x 4.62288 = $18,491.52 NPV: ($1,508.48)

27. B3 Operations Management: Cost Accounting and Performance Management

28. Subject Areas: • Cost Accounting • Performance Management B3: Operations Management: Cost Accounting and Performance Management

29. B3: Operations Management: Cost Accounting and Performance Management Key Points: • Product costs are all costs associated with manufacturing a product. Product costs are "inventoriable" while period costs (SG&A) are expensed in the period incurred. • The "cost of goods manufactured statement" accumulates all costs of production, adjusts for changes in work in process, to determine (present) cost of goods manufactured for a period. The "cost of goods sold statement" is similar except its purpose is to determine cost of goods sold for a given period. • An equivalent unit of direct material, direct labor, or conversion costs (direct labor plus factory overhead) is equal to the amount of direct material, direct labor, or conversion costs necessary to complete one unit of production. Cost per equivalent unit can be calculated using FIFO or the weighted-average inventory costing methods. • Activity-based costing (ABC) refines traditional costing methods and assumes that the resource-consuming activities (tasks, units of work, etc.) with specific purposes cause costs. ABC assumes that the best way to assign indirect costs to products (cost objects) is based on the product's demand for resource-consuming activities (i.e., costs are assigned based on the consumption of resources). Application of activity-based costing techniques attempts to improve cost allocation by emphasizing long-term product analysis. • Joint and by-product costing attempts to allocate the joint costs of two or more separate products using unit volume relationships or net realizable value. Under this allocation method, common or joint costs relate to multiple products that cannot be separately identified. • Financial performance measures include profit, return on investment, variance analysis, and balanced scorecard.

30. B3: Operations Management: Cost Accounting and Performance Management Key Points: • Nonfinancial measures include external benchmarks, such as total factor productivity ratios (TFPs) and partial productivity ratios (PPRs), and internal benchmarks, such as control charts, Pareto diagrams, and cause-and-effect (fishbone) diagrams. • Responsibility segments or strategic business units (SBUs) are classified by four financial measures for which managers may be held accountable: cost SBU, revenue SBU, profit SBU, and investment SBU. • The balanced scorecard gathers information on multiple dimensions of an organization’s performance defined by critical success factors. Critical success factors are classified as financial, internal business processes, customer satisfaction, and advancement of innovation and human resource development. • Return on equity (ROE) can be further analyzed using the DuPont model. The three-step DuPont model breaks down ROE into three ratios, including the net profit margin, asset turnover, and financial leverage. The extended DuPont model adds a tax burden and interest burden to the ROE calculation. • The residual income method measures the excess of actual income earned by an investment over the required (target or hurdle) return required by the company. While ROI provides a percentage measurement, residual income provides an amount. • The Economic Value Added ™ (EVA) method of performance evaluation is similar to the residual income method. EVA measures the excess of income after taxes earned by an investment over the return defined by the company’s overall cost of capital (WACC).

31. B3: Operations Management: Cost Accounting and Performance Management MCQ # 1: FIFO – take credit just for work done in this period. Units completed in May = 92,000 Less portion of those units started prior to May = 16,000 x 60% = (9,600) Plus portion of units started in May but not finished = 24,000 x 90% = 21,600 FIFO Equivalent Units = 104,000 Current Costs = $468,000 Equivalent Cost Per Unit = $468,000/104,000 or $4.50

32. B3: Operations Management: Cost Accounting and Performance Management MCQ # 2: Wall Mirrors  5 out of 20 material moves per product line. 5/20 = 25%. $50,000 x 25% = $12,500 in materials handling costs allocated to Wall Mirrors. $12,500 across 25 units = $500 per unit.

33. B3: Operations Management: Cost Accounting and Performance Management MCQ # 3: DuPont ROE = Net Profit Margin x Asset Turnover x Financial Leverage 1,500,000 Debt Ratio of 0.40 means debt is 40% of assets. 40% of 2,500,000 = 1,000,000. A = L + E. 2,500,000 = 1,000,000 + E. E = 1,500,000

34. B3: Operations Management: Cost Accounting and Performance Management SIM # 1: Watson Inc. is a manufacturing company operating in the southeastern United States. The company has three primary product lines, as well as several "secondary" lines. The company's controller is in the process of preparing the annual financial statements and will need to classify the following cost objects as either product costs or period costs. For each of these costs, determine the amounts that will be considered product costs versus the amounts that will be considered period costs and enter them into the appropriate column. 2,500,000 3,600,000 9,415,200 5,100,000 7,200,000 5,900,000 $55,000 x 50 x 1.15 = $3,162,500. 3,162,500 $30,000 x 15 x 1.25 = $562,500. 562,500

35. B4 Operations Management: Planning Techniques

36. Subject Areas: • Projection and Forecasting Techniques • Ratio Analysis of Forecasts and Projections • Marginal Analysis • Budgeting • Variance Analysis B4: Operations Management: Planning Techniques

37. B4: Operations Management: Planning Techniques Key Points: • Cost-volume-profit (CVP) analysis is used to determine the breakeven point when fixed costs are "covered" by contribution margin (sales less variable costs). Under CVP, managers can forecast profits using different levels of sales and production volume. • The contribution and absorption approaches differ in the treatment of fixed overhead costs. Under the contribution approach, fixed factory overhead is treated as a period cost and is expensed in the period incurred. Under the absorption approach, fixed factory overhead is a product cost and is included in inventory values. • Know the various breakeven formulas, including the breakeven point in units, contribution margin ratio (per unit), and the required sales volume (dollars) to derive a target profit. • Ratios are a quick and easy way to evaluate a company’s past, current, and future performance and financial standing. The results of forecasts and projections can be analyzed using ratio analysis and by looking for correlations to and variations from key financial ratios. • Marginal analysis is used when analyzing business decisions such as accepting or rejecting special orders, making or buying a product or service, selling or processing further, and adding or dropping a segment. Marginal analysis focuses on the relevant revenues and costs that are associated with a decision. • Costs and revenues are relevant if they change as a result of selecting different alternatives. Relevant costs include incremental costs (the additional costs incurred to produce an additional unit of output) and opportunity costs (the costs of foregoing the next best alternative when making a decision).

38. B4: Operations Management: Planning Techniques Key Points: • Costs which are not different among alternatives are irrelevant and should be ignored in marginal cost analysis. Sunk costs are not relevant costs. • Budgets frequently revolve around the development of standards. Standards have been referred to as per-unit budgets and are integral to the development of flexible budgets. • A flexible budget is a financial plan that allows for adjustments for changes in production or sales and accurately reflects expected costs for the adjusted output. Analysis focuses on substantive variances from standards rather than simple changes in volume or activity. Flexible budgets are adjustable economic models that are designed to predict outcomes and accommodate changes in actual activity. • For direct materials and direct labor, two variances are typically calculated: a price (or rate) variance and a quantity (or efficiency) variance. • The overall manufacturing overhead variance can be broken down into variable and fixed overhead variances. The variable overhead variance can be further broken into a rate (spending) variance and an efficiency (usage) variance. The fixed overhead variance can be divided into a budget (spending) variance and a volume variance.

39. B4: Operations Management: Planning Techniques MCQ # 1: Fixed Costs $180,000/Production of 100,000 units = $1.80 per unit Absorption Costing Fixed Factory Overhead remains in Inventory until items are sold. Variable Costing Fixed Factory Overhead hits the income statement in period incurred. 20,000 units remain in inventory x $1.80 per unit = $36,000

40. B4: Operations Management: Planning Techniques MCQ # 2: Rental Income = 24,000 Net Loss = (6,000) TOTAL Increase in Operating Income 18,000 Net loss of 6,000

41. B4: Operations Management: Planning Techniques MCQ # 3: Collections in June = 80% of sales from June (month of sale) = 40,000 x 80% = 32,000. 20% of sales from May (month following sale) = 42,000 x 20% = 8,400 32,000 + 8,400 = 40,400

42. B4: Operations Management: Planning Techniques MCQ # 4: Budgeted VOH based on Standard Hours Budgeted VOH based on Actual Hours VS. Actual Frames = 19,000 DLH Budget = 0.1 hours per frame. DLH budgeted for 19,000 frames = 1,900 Actual DLH = 2,100 VOH per DLH = $2.00 VOH per DLH = $2.00 Actual VOH = 4,200 Budgeted VOH = 3,800 $400 unfavorable

43. B4: Operations Management: Planning Techniques You are right about everything EXCEPT sales units What ACTUALLY happened What you THOUGHT would happen SIM # 1: 37,500 37,500 36,000 $487,500 $450,000 $432,000 ($405,000) ($362,880) ($378,000) $72,000 $82,500 $69,120 ($36,500) ($28,000) ($28,000) $41,120 $44,000 $46,000 Favorable $4,880 Favorable $2,880 Favorable $2,000

44. B5 Economic Concepts and Analysis

45. Subject Areas: • Economic and Business Cycles • Economic Measures and Indicators • The Economic Marketplace • The Impact of Market Influences • The Impact of Globalization • The Economic Effect of Significant Transactions B5: Economic Concepts and Analysis

46. Key Points: • Gross Domestic Product (GDP) represents the total market value of all final goods and services produced within the borders of a nation in a given period. Real GDP is nominal GDP adjusted for changing prices. • Fluctuations in economic activity are known as business cycles and include an expansionary phase, peak, contractionary phase, trough, and recovery phase. • Aggregate demand and aggregate supply curves can be used to illustrate the relationship between a country’s output (real GDP) and price level (the GDP deflator). • Know the factors that shift the aggregate demand curve and shift the short-run aggregate supply curve. For each factor, know the direction of the shift and the corresponding impact on the price level and output. • The unemployment rate measures the ratio of the number of unemployed to the total labor force. As this rate rises, GDP tends to contract - and vice versa. Know the types (causes) of unemployment, including frictional, structural, seasonal, and cyclical unemployment. • Know the definitions of money (e.g., M1, M2, and M3) and how the Federal Reserve controls the U.S. monetary supply through open market operations, changing the discount rate for short-term loans to member banks, or changing the required reserve ratio on bank deposit reserves. • Government spending and taxes are the main tools of fiscal policy. Budget surpluses and deficits are important indicators of the "health" of the economy. B5: Economic Concepts and Analysis

47. Key Points: • Demand for a product is said to be elastic if an increase in the price of the product will reduce total revenue, while a price decrease will increase total revenue. If the price of such a product increases, consumers will shift to substitute products. Price elastic means the absolute price elasticity of demand is greater than 1.0. • Cross elasticity of demand (or supply) measures the percentage change in the quantity demanded (or supplied) of one good caused by the price change of another. Positive cross elasticity = Substitute. Negative cross elasticity = Complementary. • Income elasticity of demand measures the percentage change in quantity demanded for a product caused by a change in income. Positive income elasticity = Normal. Negative income elasticity = Inferior. • The four types of market structure are perfect (pure) competition, monopolistic competition, oligopolies, and monopolies. The Market Structure Table summarizes the characteristics of these market structures. Know the characteristics of each market structure for the exam. • Be familiar with Michael Porter’s five forces (Porter model) that affect the competitive environment and ultimately the profitability of a firm. The five forces include barriers to entry, market competitiveness, existence of substitute products, bargaining power of customers, and bargaining power of suppliers. • The primary competitive strategies are cost leadership, product differentiation, best cost, and focus/niche strategy. Know when each competitive strategy works and doesn’t work well. B5: Economic Concepts and Analysis

48. MCQ # 1: B5: Economic Concepts and Analysis AD left, SRAS left AD right, SRAS right AD right and left AD right and left Real GDP increases when: AD curve moves to the right SRAS curve moves to the right

49. MCQ # 2: B5: Economic Concepts and Analysis

50. MCQ # 3: B5: Economic Concepts and Analysis