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HOCK CMA - TOCs

CMA Part 1

Table of Contents

Table of Contents
Introduction to CMA Part 1 ............................................................................................... 1
Section A Planning, Budgeting and Forecasting ......................................................... 3
Planning and Budgeting Concepts .................................................................................. 4
Planning in Order to Achieve Superior Performance
The Role of Management in Attaining Profitable Growth
The External Environment in Planning and Budgeting
Setting Objectives and Goals
Types of Plans and General Principles
Budgeting
The Relationship Among Planning, Budgeting, and Performance Evaluation
Advantages of Budgets
Time Frames for Budgets
Methods of Developing the Budget
Who Should Participate in the Budgeting Process?
The Budget Development Process
Best Practice Guidelines for the Budget Process
Budgetary Slack and Its Impact on Goal Congruence
Responsibility Centers and Controllable Costs
Standard Costs Used in Budgeting
Setting Standard Costs

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Budget Methodologies .................................................................................................... 28


The Budgeting Cycle
Budget/Profit Planning Manual
The Annual/Master Budget or Profit Plan
The Master Budget
Development of the Master Budget
The Capital Expenditures Budget
The Operating Budget
The Financial Budget
The Master Budget Financial Statements
Flexible Budgets

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Other Types of Budgets .................................................................................................. 50


Project Budgeting
Activity-Based Budgeting (ABB)
Zero-Based Budgeting
Continuous (Rolling) Budgets

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55

Ongoing Budget Reports ................................................................................................ 56


Answering Budgeting Exam Questions ........................................................................ 57
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CMA Part 1

Flexible Budgeting Questions


Units to Produce / Purchase Questions
Cash Flow Questions

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Forecasting Techniques ................................................................................................. 66


Forecasting and Budgeting
Collecting the Data for a Forecast
1. Time Series Analysis
2. Causal Forecasting
Multiple Regression Analysis in Causal Forecasting
Benefits and Limitations of Regression Analysis

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90
100
103

Learning Curves ............................................................................................................ 105


1) Cumulative Average-Time Learning Model
2) Incremental Unit-Time Learning Model
Using a Financial Calculator with the Incremental Unit-Time Learning Model
Answering Learning Curve Questions on the CMA Exam
Summary of and Observations About the Two Models
Benefits of Learning Curve Analysis
Limitations of Learning Curve Analysis

106
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114
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116

Probability ...................................................................................................................... 118


Two Requirements of Probability
Independent Events and Joint Probability
Mutually Exclusive Events
Dependent Events and Conditional Probability
Three Methods of Assigning Probable Values
Discrete and Continuous Random Variables
Discrete Random Variable Probability Distributions
Expected Value
Variance and Standard Deviation
Continuous Random Variable Probability Distributions
Normal Probability Distributions
Properties of Normal Distributions
Use of Normal Distributions in Forecasting Returns on Investments

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Risk, Uncertainty, and Expected Value ....................................................................... 138


Expected Value (or Expected Return)
Expected Value in Estimating Future Cash Flows
Statistical Measurements of Cash Flow Variability
Standard Deviation as a Measure of Risk
The Coefficient of Variation (Risk Per Unit of Return) as a Measure of Relative Risk
The Expected Value of Perfect Information
The Opportunity Loss, or Regret, Table as a Decision-Making Tool
Summary of Probability, Risk and Expected Value
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Table of Contents

Dispersion and Standard Deviation Summary

148

Sensitivity Analysis ....................................................................................................... 150


Top-Level Planning and Analysis ................................................................................ 153
Pro Forma Financial Statements
Forecasting for Planning
Sales Forecasting
Forecasting Future Financing Needs
Analysis of Pro Forma Financial Statements
Other Uses of Pro Forma Financial Statements

153
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165
167

Section B Performance Management ....................................................................... 168


Cost and Variance Measures ........................................................................................ 169
Determining the Level of Activity for Standard Costs
Sources of Standards

170
170

Variance Analysis Concepts......................................................................................... 172


Levels in Variance Analysis
Static Budget Variances vs. Flexible Budget Variances
Level 1 Variances: Static Budget Variances
Level 2 Variances: Flexible Budget Variances and Sales Volume Variances
Level 3 Variances: Manufacturing Input and Sales Quantity and Sales Mix Variances

172
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178

Manufacturing Input Variances .................................................................................... 179


The Difference Between Sales Variances and Production Variances
What Causes Manufacturing Input Variances?
Direct Materials Variances
The Quantity Variance
The Price Variance
Direct Labor Variances
The Direct Labor Rate Variance
The Direct Labor Efficiency Variance
Accounting for Direct Labor Variances in a Standard Cost System
More than One Material Input or One Labor Class
Total Variance of a Weighted Mix
Materials Price Variance (or Labor Rate Variance) of a Weighted Mix
Total Materials Quantity or Labor Efficiency Variance of a Weighted Mix
Factory Overhead Variances
Overview of Total Manufacturing Overhead Variances
Variable Overhead (VOH) Variances
Fixed Overhead Variances
Two-Way, Three-Way, and Four-Way Analysis of Overhead
Summary Table of Manufacturing Variance Calculations

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Sales Variances ............................................................................................................. 219


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Sales Variances for a Single Product Firm


Flexible Budget Variances for a Single Product Firm
Sales Volume Variances for a Single Product Firm
Sales Variances When More than One Product is Sold
Flexible Budget Variance for a Multiple-Product Firm
Sales Volume Variances for a Multiple-Product Firm
Sales Quantity Variance for a Multiple-Product Firm (Sales Volume Sub-variance #1)
Sales Mix Variance for a Multiple-Product Firm (Sales Volume Sub-variance #2)
Total Sales Variance for a Multiple-Product Firm
Variances Example Using Contribution Margin

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Market Variances ........................................................................................................... 237


Variance Analysis for a Service Company .................................................................. 240
Responsibility Centers and Reporting Segments ...................................................... 241
Evaluating the Manager vs. Evaluating the Business Unit
Allocation of Common Costs
Stand Alone Allocation vs. Incremental Allocation
The Contribution Income Statement Approach to Evaluation
Use of the Contribution Income Statement
Transfer Pricing
Transfer Pricing Objectives
Methods to Set the Transfer Price

242
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Performance Measures ................................................................................................. 261


Strategic Issues in Performance Measurement
Timing of Feedback
Performance Measures Should be Related to Cost and Revenue Drivers
Performance Measurement
Return on Investment (ROI)
Effect of Accounting Policies on ROI
Residual Income (RI)
Using ROI and RI
Performance Measurement in Multinational Companies
Multiple Measures of Performance and the Balanced Scorecard
Customer and Product Profitability Analysis

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272
273
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278

Appendix A: Incremental Unit-Time Learning Model for Financial Calculators ............ 279
Logarithm Basics
279
Calculating the Time Required to Produce Any Unit Using a Financial Calculator and the Incremental
Unit-Time Learning Model
280

Appendix B: Variance Report for a Company Selling Two Products........................ 284


Answers to Questions................................................................................................... 288

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CMA Part 1

Table of Contents

Table of Contents
Section C Cost Management ......................................................................................... 1
Classifications of Costs .................................................................................................... 2
The Difference Between Costs and Expenses
Direct Versus Indirect Costs
Costs Based on Level of Production (Fixed, Variable and Mixed Costs)
Production vs. Period Costs
Types of Product Costs
Other Costs and Cost Classifications
Cost of Goods Sold (COGS) and Cost of Goods Manufactured (COGM)

2
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11

Introduction to Cost Accumulation Systems ................................................................ 13


The Flow of Manufacturing Costs .................................................................................. 14
1. Materials Inventory
2. Payroll
3. Factory Overhead Control
4. Work-in-Process Inventory
5. Finished Goods Inventory
6. Cost of Goods Sold

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Costing Systems ............................................................................................................. 18


1. Standard Costing
2. Normal Costing
3. Extended Normal Costing
4. Actual Costing
Benefits and Limitations of Each Costing System

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19
21

Accounting for Direct Manufacturing Inputs in Standard Costing .............................. 23


Overhead Allocation ........................................................................................................ 27
Manufacturing Overhead Allocation
Traditional (Standard) Allocation Method
Determining the Basis of Allocation
Calculating the Manufacturing Overhead Allocation Rate
Determining the Level of Activity
Allocating Manufacturing Overhead to the Units
The Process of Accounting for Factory Overhead
Over-Applied and Under-Applied Manufacturing Overhead
Comprehensive Example of Accounting for Fixed Overhead and FOH Variances

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Process Costing .............................................................................................................. 45


Steps in Process Costing
1. Determine the Physical Flow of Goods
2. Calculate the Number of Units Started and Completed
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3. Determine When the Materials Are Added to the Process
4. Calculate the Equivalent Units of Production (EUP)
5. Calculation of Costs Incurred During the Period
6. Calculation of the Cost per EUP
7. Allocation of the Costs to the Products
Process Costing Diagram FIFO
Process Costing Diagram Weighted Average
Process Costing Summary
Process Costing Examples
Spoilage in Process Costing
1. How Many Units Were Spoiled
2. How are the spoiled units classified as normal or abnormal?
3. Calculating the Costs Allocated to Each Spoiled Unit
4. What is Done with the Costs Allocated to the Spoiled Units?

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Job-Order Costing ........................................................................................................... 70


Operation Costing ........................................................................................................... 72
Activity-Based Costing ................................................................................................... 73
Traditional Costing versus ABC
ABC and External Financial and Tax Reporting
The ABC Process
Benefits and Limitations of Activity-Based Costing

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Life-Cycle Costing ........................................................................................................... 82


Customer Life-Cycle Costing ......................................................................................... 84
Joint Products and Byproducts ..................................................................................... 85
Methods of Allocating Costs to Joint Products
1. Relative Sales Value at Splitoff Method (or Gross Market Value Method)
2. Estimated Net Realizable Value (NRV) Method
3. Physical Measure and Average Cost Methods
4. Constant Gross Profit (Gross-Margin) Percentage Method
Accounting for Byproducts
The Production Method: Inventory the Byproduct Costs
The Sales Method: Revenue from the Byproduct
Comprehensive Example of Joint and Byproduct Costing

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Variable and Absorption Costing ................................................................................. 101


Fixed Factory Overheads Under Absorption Costing
Fixed Factory Overheads Under Variable Costing
Effects of Changing Inventory Levels
Income Statement Presentation
The Income Statement under Absorption Costing
The Income Statement under Variable (Direct) Costing
Absorption Costing versus Variable Costing: Benefits and Limitations
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Table of Contents

Answer to the Variable/Absorption Costing Example


What if the Number of Units is Not Known or is Not Meaningful?

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108

Service Cost Allocation ................................................................................................ 116


Allocating Costs of A Single (One) Service or Support Department to Multiple Users
Allocating Costs of Multiple Service or Support Departments
The Direct Method
The Step-Down Method
The Reciprocal Method
Comprehensive Example of Direct, Step and Reciprocal Methods

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Estimating Fixed and Variable Costs ........................................................................... 125


High-Low Points Method
Regression Analysis
Forecasting Total Costs

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Operational Efficiency ................................................................................................... 130


Just-in-Time (JIT) Inventory Management Systems
Kanban
Materials Requirements or Material Resource Planning (MRP)
MRP and Making Calculations in Manufacturing
Outsourcing
Theory of Constraints (TOC)
Drum-Buffer-Rope
Calculating Throughput Contribution Margin
Capacity Level and Management Decisions
Capacity Level and its Effect on Financial Statements

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148

Business Process Performance ................................................................................... 155


The Value Chain
Primary Value Chain Activities
Steps in Value Chain Analysis
Process Analysis
Business Process Reengineering
Benchmarking Process Performance
Activity-Based Management (ABM)
The Concept of Kaizen
The Costs of Quality
Calculating the Costs of Quality
Total Quality Management (TQM)
Total Quality Management and Activity-Based Management
ISO 9000
Quality Management and Productivity
Other Quality Related Issues

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CMA Part 1

Section D Internal Controls ....................................................................................... 174


Risk Assessment, Controls and Risk Management ................................................... 175
Corporate Governance

175

Internal Control .............................................................................................................. 178


Internal Control Definition and Objectives
Who Is Responsible for Internal Control?
Components of Internal Control
The Relationship Between the Objectives and the Components of Internal Control
Component 1: The Control Environment
Component 2: Risk Assessment
Component 3: Control Activities
Component 4: Information and Communication
Component 5: Monitoring
Segregation of Duties
Responsibilities of the Board of Directors
Responsibilities of the Full Board
Audit Committee Requirements, Responsibilities and Authority
Foreign Corrupt Practices Act (FCPA)
Sarbanes-Oxley Act
Title I - Public Company Accounting Oversight Board (PCAOB)
Title II Auditor Independence
Title III Corporate Responsibility
Title IV Enhanced Financial Disclosures
SEC Release 33-8810 Guidance for Management
PCAOB Auditing Standard No. 5 Guidance for External Auditors
Top-Down Approach Versus Bottom-Up Approach
What Internal Control Can and Cannot Do

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Internal Auditing ............................................................................................................ 218


Definition of Internal Auditing
The Internal Audit Charter
Independence and Objectivity in Internal Auditing
Requirement for Internal Auditor Proficiency
Responsibilities and Limit of Responsibilities
The Organizational Status of the Internal Audit Function
The Difference Between Internal Auditors and External Auditors
Types of Engagements
Differences Between Assurance Services and Consulting Services
Assurance Services
Consulting Services
Quality Auditing
Quality Assurance Reviews of the Internal Audit Function
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Table of Contents

The Auditing Process


Determining Which Engagements to Conduct
Planning the Audit
Understanding Internal Controls in the Planning of the Audit
The Internal Audit Program
Audit Evidence
Audits of Financial Controls
Types of Controls
Accounting Controls Versus Administrative Controls
Objectives of an Audit of Controls
Testing Compliance with Controls
Control Breakdowns
Detection and Prevention of Fraud
Consideration of Fraud in the Planning of a Financial Statement Audit
Internal Audit Reports
Oral Reports and Interim Reports
Preparing the Final Written Internal Audit Report
Contents of the Final Report
Summary Reports
Report Review and Distribution
Types of Incidents That Should Be Reported
Auditor Follow Up
Computerized Audit Techniques

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Systems Controls and Security Measures .................................................................. 261


Introduction to Systems Controls
Threats to Information Systems
The Classification of Controls
General Controls
Organization and operation of the computer facilities
General Operating Procedures
Equipment Controls
Equipment Access and Data Access Controls
Segregation of Duties
System and Program Development and Change Controls
Physical Access Controls
Hardware Controls for Networks
File Security and Storage Controls
Application Controls
Input Controls
Processing Controls
Output Controls
Controls Classified as Preventive, Detective and Corrective
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Controls Classified as Feedback, Feedforward and Preventive

CMA Part 1
282

Internet Security ............................................................................................................ 284


Viruses, Trojan Horses and Worms
Cybercrime
Defenses Against Cybercrime
Encryption

285
286
288
289

Contingency Planning................................................................................................... 290


Disaster Recovery

292

Section E Professional Ethics ................................................................................... 294


Introduction to Ethics
Business Ethics
Statement of Ethical Professional Practice

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294
297

Answers to Questions................................................................................................... 301

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HOCK CMA - TOCs

CMA Part 2

Table of Contents

Table of Contents
Introduction to CMA Part 2 ............................................................................................... 1
Section A Financial Statement Analysis....................................................................... 3
Introduction to the Financial Statement Analysis Section

Basic Financial Statement Analysis ................................................................................ 4


Users of Financial Information
The Financial Statements
Format of the Statement of Cash Flows
Limitations of Financial Statements in General

4
4
15
18

Comparative Financial Statement Analysis .................................................................. 19


Vertical Common-Size Financial Statements
Horizontal Index-Number Trend Series Analysis

19
21

Financial Performance Metrics Financial Ratios ....................................................... 23


Liquidity Ratios................................................................................................................ 24
Net Working Capital
Liquidity Ratios

24
26

Leverage, Capital Structure and Solvency .................................................................... 29


Financial Leverage
Operating Leverage
Capital Structure and Solvency Ratios

30
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35

Asset Coverage Ratios ................................................................................................... 36


Fixed Assets to Equity Capital
Net Tangible Assets to Long-Term Debt
Total Liabilities to Net Tangible Assets

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36

Earnings Coverage Ratios .............................................................................................. 37


Interest Coverage (Times Interest Earned) Ratio
Fixed Charge Coverage (Earnings to Fixed Charges) Ratio
Cash Flow to Fixed Charges Ratio

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39

Activity Ratios.................................................................................................................. 41
Accounts Receivable Activity Ratios
Inventory Activity Ratios
Accounts Payable Turnover Ratio
Days Purchases in Accounts Payable and the Cash Cycle
Total Asset Turnover Ratio
Fixed Asset Turnover Ratio

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45

Profitability Ratios ........................................................................................................... 46


Gross Profit Margin Percentage
Operating Profit Margin Percentage

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Net Profit Margin Percentage
EBITDA Margin Percentage
Return on Invested Capital

CMA Part 2
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Market Ratios ................................................................................................................... 49


Book Value Per Share
Market/Book Ratio
Earnings Per Share
Price/Earnings (P/E) Ratio
Price/EBITDA Ratio
Earnings Yield
Dividend Yield
Dividend Payout Ratio
Shareholder Return

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Profitability Analysis ....................................................................................................... 69


Return on Assets and The DuPont Equation
Return on Equity and The DuPont Equation
Disaggregation of Return on Common Equity
Factors that Contribute to Inconsistent Definitions in ROA and ROE
Sustainable Equity Growth Rate

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Summary and Example ................................................................................................... 77


Example Financial Statements
Ratios for the Example
Interpretation of Ratios in the Example

77
81
84

Limitations of Ratio Analysis ......................................................................................... 87


Analytical Issues in Financial Accounting .................................................................... 89
Statement of Cash Flows
Cash Flows from Operating Activities Under the Indirect Method
Preparing the SCF Under the Indirect Method
Cash Flows from Investing Activities
Cash Flows from Financing Activities
Noncash Investing and Financing Activities
Cash Equivalents and Foreign Currencies
Factors to be Considered in Measuring Income
Impact of Foreign Exchange Fluctuations
The impact of inflation on financial statements and financial ratios
Fair Value Accounting

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103
116
128
131

Financial Analysis and Differences Between U.S. GAAP and IFRS .......................... 133
General Background Information Regarding IFRS
Important Considerations about IFRS Financial Analysis Compared to U.S. GAAP
Why the Differences Between IFRS and U.S. GAAP Are Important
Specific Primary Differences Between IFRS and U.S. GAAP

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Table of Contents

1) Inventories (Costing Methods, Valuation and Write-downs)


2) Revenue Recognition (Sales, Deferred Receipts and Construction Contracts)
3) Expense Recognition (Share-based Payments and Employee Benefits)
4) Intangible Assets (Development Costs and Revaluation)
5) Leases (Leases of Land and Buildings)
6) Long-lived Assets (Revaluation, Depreciation, and Capitalization of Borrowing Costs)
7) Impairment of Assets (Determination, Calculation and Reversal of Loss)
8) Financial Statement Presentation (Extraordinary Events and Changes in Equity)

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144
150
153
156
160
163

Section B Corporate Finance .................................................................................... 165


Introduction to the Corporate Finance Section

165

Risk and Return ............................................................................................................. 167


Return
Risk
Types of Risk
The Relationship Between Risk and Return

167
168
169
172

Measurement of Risk in Investments .......................................................................... 173


Absolute Measurement of Risk
Expected Return
Variance (2)
Standard Deviation of Returns ()
Interpreting the Standard Deviation of Investment Returns
Relative Measurement of Risk
Capital Asset Pricing Model (CAPM)
Arbitrage Pricing Theory (APT)
Fama-French Three-Factor Model

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176
177
180
181
188
189

Measuring and Managing Business and Financial Risk ............................................ 190


Business Risk
Financial Risk

190
193

Portfolio Risk and Return ............................................................................................. 198


Portfolio Theory Liquid Securities
Managing Portfolio Risk and Return - Businesses and Capital Investments
Hedging Risk

198
206
207

Financial Instruments ................................................................................................... 209


Capital Structure
Debt Financing Bonds
Yield Curve Theories
The Bond Itself
The Selling Price of the Bond
Characteristics of Bonds
Types of Bonds

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Equity
Common Stock
Preferred Stock
The Price of a Share of Stock
Additional Equity Related Sources of Financing

CMA Part 2
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228
231
232

Derivatives ..................................................................................................................... 237


Hedging Risk
Hedging to Manage Interest Rate Risk
Options
Hedging Strategies
Put-Call Parity Theorem

237
240
251
259
263

Cost of Capital ............................................................................................................... 265


Weighted Average Cost of Capital (WACC)
Cost of Debt
Cost of Common Equity
Capital Structure Decisions
The Marginal Cost of Capital

265
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268
273
273

Managing Current Assets ............................................................................................. 279


Working Capital
Marketable Securities Management
Accounts Receivable Management
Inventory Management
Short-Term Financing
Factoring of Receivables
Other Sources of Financing
Maturity Matching Approach to Working Capital Management

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297
301
307
312
314
317

Raising Capital............................................................................................................... 318


Financial Markets
Market Efficiency and the Efficient Market Hypothesis
Insider Trading
Raising the Capital
Ratings Agencies
Cash Dividends
Dividend Policy
Treasury Stock
Lease Financing

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339
339

Corporate Restructuring ............................................................................................... 343


Types of Business Combinations
Reasons for Business Combinations
Takeover Strategies and Defenses

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Divestitures .................................................................................................................... 351


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Voluntary Corporate Liquidation
Partial Sell-Off of Assets
Corporate Spin-Off
Equity Carve-Out
Tracking Stock
Effects of Divestitures on Shareholder Value

Table of Contents
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352
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352

Ownership Restructuring.............................................................................................. 352


Going Private

352

Bankruptcy ..................................................................................................................... 354


Voluntary Settlements
Bankruptcy

354
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International Finance .................................................................................................... 358


Direct Foreign Investment
Benefits of International Diversification
International Buying and Selling
Foreign Currency Cross Rates
Managing Exchange Rate Risk
Use of Foreign Financing to Reduce Costs
Financing for International Trade Transactions
Transfer Pricing

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370
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381

Appendix A U.S. GAAP to IFRS Transition Example ............................................... 386


Answers to Questions ................................................................................................... 398

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Table of Contents

Table of Contents
Section C Decision Analysis and Risk Management ................................................... 1
Introduction to the Decision Analysis and Risk Management Section

The Decision-Making Process .......................................................................................... 2


Marginal Analysis .............................................................................................................. 3
Relevant Information
Decision-making About Production Using Economics Concepts
Average Cost
Costs and Cost Objects
Cost Behavior Patterns

3
6
10
10
12

Marginal Analysis Applications...................................................................................... 14


Make-or-Buy Decisions
Special Order Decisions
Sell or Process Further Decisions
Disinvestment Decisions

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17
21
23

Pricing .............................................................................................................................. 26
Impact of Market Structure on Pricing
Impact of Supply and Demand on Pricing
Short-Run Equilibrium Pricing

26
27
32

Pricing Strategy ............................................................................................................... 37


Internal Factors Affecting Pricing Decisions
External Factors Affecting Pricing Decisions
Summary of Factors Affecting Pricing Decisions
Short-Run and Long-Run Pricing Decisions
Cost-Plus and Target Pricing Used Together
Product Life-Cycle Pricing and Costing
Product Life-Cycle (PLC) Strategies
Other Considerations in Price Setting
Illegal Pricing

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38
38
43
47
47
47
51
52

Cost-Volume-Profit (CVP) Analysis ............................................................................... 53


Contribution Margin Income Statement
Breakeven Analysis
Profit Requirement
Using Breakeven Analysis in Decision-Making

55
56
59
66

Breakeven Analysis when More than One Product Is Sold ......................................... 68


Sales Quantity Mix (Dollar Amount of Contribution per Basket)
Sales Revenue Mix (Contribution Margin Ratio for the Basket)
Effect of Changes in Sales Mix
Choosing Between Two Cost Options

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Choosing Between Production Options
Fixed Versus Variable Cost Inputs
Product-Mix Decisions Under Constraints

CMA Part 2
75
77
80

CVP and Conditions of Risk and Uncertainty ............................................................... 81


The Use of Sensitivity Analysis With CVP Analysis
Expected Value
Deterministic Approach

81
83
83

High-Low Points Method ................................................................................................ 85


Risk Assessment ............................................................................................................. 88
Four Categories of Risk
Risk Assessment: Assessing Exposure to Risk
Assessing Risk to Financial Assets
Responses to Risk
Inherent Risk and Residual Risk
Benefits of Risk Management
The Steps in the Risk Management Process
Managing Operational Risk
Financial Risk Management Methods
Qualitative Risk Assessment Tools
Quantitative Risk Assessment Tools

88
89
92
92
93
94
94
95
95
96
97

Enterprise Risk Management (ERM) .............................................................................. 97


Cost-Benefit Analysis In Risk Assessment and Decision Making
Risk Measurement in Banks

101
101

Section D Investment Decisions ............................................................................... 103


Introduction to the Investment Decisions Section

103

Capital Budgeting Process ........................................................................................... 104


The Stages in Capital Budgeting.................................................................................. 105
Terms Used in Capital Budgeting

106

Identifying and Calculating the Relevant Cash Flows................................................ 107


Depreciation for Tax Purposes
Other Tax Considerations
Example of Calculation of After-Tax Relevant Cash Flows

113
114
115

Capital Budgeting Methods .......................................................................................... 117


Payback Method
Discounted Payback Method
Bailout Payback

117
119
121

Discounted Cash Flow Methods .................................................................................. 124


Net Present Value (NPV) Method
Using NPV

125
125

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Table of Contents

Internal Rate-of-Return (IRR)


The Accounting Rate of Return
The Profitability (or Excess Present Value) Index
Use of the Profitability Index

133
140
141
143

Mathematical Relationships Between and Among Different Methods ...................... 144


Incremental Analysis: A New Machine Replacing an Old Machine ........................... 144
Additional Investment Made During Project ............................................................... 146
Payback Method with a Subsequent Investment:
Discounted Cash Flow Methods with a Subsequent Investment:

148
148

Difficulties With the Different Capital Budgeting Methods ........................................ 149


Capital Rationing in Capital Budgeting ....................................................................... 151
Internal Capital Markets as an Alternative Solution to Capital Funding Limitations

152

Capital Budgeting and Inflation.................................................................................... 158


Summary and Review of Relevant Cash Flows .......................................................... 162
Risk in Capital Budgeting ............................................................................................. 164
Types of Risk
Analysis of Risk
Adjustments to the Discount Rate for Risk or Inflation

164
165
174

Real Options in Capital Budgeting ............................................................................... 177


Decision Trees and Valuing Real Options
Other Methods of Valuing Real Options

180
186

The Qualitative Factor in Capital Budgeting Decisions ............................................. 187


Valuation ........................................................................................................................ 188
Valuation of Stock
Valuing Businesses, Business Segments, and Business Combinations
Addressing Risk in Business Valuation

188
193
201

Section E Professional Ethics ................................................................................... 205


Ethical Considerations for the Organization ............................................................... 205
Appendix A Time Value of Money (Present/Future Value) ...................................... 215
Simple Interest
Compound Interest
Present Value
Future Value

215
216
217
222

Appendix B Example of IRR ...................................................................................... 227


Answers to Questions ................................................................................................... 230

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CMA Part 2

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Table of Contents

Table of Contents
Introduction to the CMA Assumed Knowledge Book ..................................................... 4
Chapter 1 Microeconomics ............................................................................................ 5
Microeconomics ................................................................................................................ 6
Demand .............................................................................................................................. 7
Determinants of Demand
Elasticity of Demand

10
13

Determining What the Consumer will Buy .................................................................... 21


Utility Theory The Benefit Derived by the Consumer
The Indifference Curve What the Consumer WANTS to Buy
Budget Constraints What the Consumer is ABLE to Purchase

21
23
24

Supply .............................................................................................................................. 33
Elasticity of Supply

35

Market Equilibrium and Pricing ...................................................................................... 37


Production Costs of Economic Resources ................................................................... 45
Resource Planning .......................................................................................................... 52
Production Costs in the Short Run
Decision-making about Production
Marginal Resource Cost
Optimal Combination of Resources

52
54
57
60

Market Structure .............................................................................................................. 66


Governmental Intervention ............................................................................................. 84
Antitrust Policy
Antitrust Regulations
Mergers
Antitrust Violation Penalties
Industrial Regulation by Government of Natural Monopolies

84
85
87
90
92

Chapter 2 Macroeconomics ......................................................................................... 95


Macroeconomics ............................................................................................................. 96
National Income Accounting .......................................................................................... 96
Methods of Calculating GDP

98

Inflation and the Economy ............................................................................................ 105


Costs of Inflation
Redistribution Effects of Inflation

105
106

Measurements of Inflation ............................................................................................ 106


Aggregation of the National Economy ........................................................................ 108
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Economic Growth .......................................................................................................... 116


Investment Expenditure in the Economy .................................................................... 118
Business Cycles ............................................................................................................ 119
Economic Indicators

122

Money and the Economy .............................................................................................. 126


Definitions of Money
The Liquidity Preference Function
Equilibrium Interest Rate
Banks and Deposit Creation

126
128
128
129

Monetary Policy in the U.S. ....................................................................................... 132


Structure of the Fed ...................................................................................................... 132
Board of Governors
Federal Reserve Banks
Federal Open Market Committee

132
132
132

Functions of the Fed ..................................................................................................... 133


Controlling the Nations Money Supply and Short-Term Interest Rates
Banker for Commercial Banks
Banker for the Federal Government
Issuing Currency
Other Functions

133
137
139
139
139

Unemployment and the Economy ................................................................................ 140


Types of Unemployment
Costs of Unemployment
Full Employment and the Natural Rate of Unemployment
Inflation vs. Unemployment

140
141
141
142

Government and the Economy..................................................................................... 143


Demand-Side Fiscal Policy
Government Funding
Classifications of Taxes

143
149
150

Macroeconomic Theories ............................................................................................. 153


Summary of Economic Theories .................................................................................. 153
Classical Theory
Keynesian Economics
Other Schools of Economics

153
154
157

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Table of Contents

Chapter 3 Quantitative Methods ................................................................................ 158


Decision-Making and Quantitative Methods ............................................................... 159
Probability ...................................................................................................................... 161
Two Requirements of Probability
Conditional Probability
Joint Probability

161
161
161

Discrete and Continuous Random Variables .............................................................. 162


Discrete Random Variable Probability Distributions
Expected Value
Continuous Random Variable Probability Distributions

163
164
165

Risk, Uncertainty and Expected Value ........................................................................ 165


Summary of Probability and Expected Value

165

Answers to Questions ................................................................................................... 166

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Table of Contents

Table of Contents
Introduction to the CMA Assumed Knowledge Book ................................................... 10
Financial Accounting ...................................................................................................... 11
Environmental Assumptions
The Financial Statements
The Balance Sheet
The Income Statement
The Statement of Cash Flows (SCF)
Statement of Comprehensive Income

11
13
13
17
19
20

U.S. Accounting Regulations ......................................................................................... 21


Users of Financial Information
History of the Accounting Standard Setting Process

21
22

The IASB (International Accounting Standards Board) ............................................... 23


Statements of Financial Accounting Concepts ............................................................ 25
SFAC 1 Objectives of Financial Reporting
SFAC 2 Qualitative Characteristics of Accounting Information
SFAC 5 Recognition and Measurement Concepts
SFAC 6 Elements of the Financial Statements

25
26
28
30

Limitations of Financial Statements .............................................................................. 31


Cash.................................................................................................................................. 32
Cash Equivalents

34

Accounts Receivable ...................................................................................................... 35


Discounts and Initial Recording of the A/R
Trade Discounts
Cash Discounts
Sales Returns
Immaterial Amount of Returns
Material Amount of Returns
Customer Deposits
Determining the Receivable Amount and Valuing the Receivable
Percentage-of-Sales Method
Percentage-of-Outstanding-Receivables Method

35
35
35
38
38
38
38
39
43
44

Receivables as an Immediate Source of Cash .............................................................. 48


Notes Receivable ............................................................................................................. 52
Presentation on the Balance Sheet
Valuation of Short-Term Notes Receivable
Long-Term Notes Receivable With Reasonable Interest Rate
Unreasonable Interest Rate Long-Term Notes Receivable
Non Interest Bearing Notes Receivable

52
53
53
53
54
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Calculation of Interest Revenue


Calculation of Interest Receivable
Amortization of the of Premium or Discount
Calculating the Gain or Loss on Sale of the Asset
Impairment of Long-Term Notes Receivable

54
54
54
54
56

Investments in Marketable Securities............................................................................ 58


Classification of Securities
Determination of Cost
Subsequent Changes in Market Value of Trading and Available-for-Sale Securities
Realized Gain or Loss on Sale of Security
Transferring Securities between Categories
Marketable Securities Summary

58
58
58
60
63
63

Financial Instruments and Derivatives .......................................................................... 64


Inventory .......................................................................................................................... 67
Classifications of Inventory
Valuing the Inventory When It Is Purchased
What Goods Are Included in Inventory
Determining Which Item Is Sold
First in First Out (FIFO)
Last in First Out (LIFO)
Weighted Average
Effect of the Different Methods
The Frequency of Determining Inventory Balances
Periodic System
Perpetual System
Errors in Inventory

67
67
68
70
71
71
72
73
73
73
74
78

The Physical Inventory Count ........................................................................................ 79


Gross Profit Calculation
Dollar-value LIFO
The DVLIFO Calculations
Recognizing Permanent Declines through the Lower of Cost or Market (LCM)
LIFO and LCM
Estimating Inventory
Gross Profit Method
Retail Method
Other Inventory Items

80
82
83
88
89
90
90
91
104

Property, Plant and Equipment .................................................................................... 106


Measurement at Acquisition
Method of Payment at Acquisition
Internally Constructed Assets - The Capitalization of Interest
Qualifying Assets

106
107
108
108

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When Can Interest Be Capitalized
Calculating the Interest to Capitalize
Depreciation
Calculation of Depreciation
Depreciation Methods
Depreciation in the Year of Acquisition and Disposal
Subsequent Expenditures
Disposals of Fixed Assets
Involuntary Disposals
Disposal by Donation
Acquisition and Disposals by Exchange
Accounting for Exchanges that Have Commercial Substance
Accounting for Exchanges That Lack Commercial Substance
Recognition of the Loss from a Noncommercial Exchange
Summary
Impairment of Property, Plant and Equipment

Table of Contents
109
109
112
113
113
116
118
119
119
120
121
122
122
123
127
130

Intangible and Other Assets ......................................................................................... 131


Impairment of Intangible Assets
Research and Development (R&D)
Prepaid Expenses
Computer Software
Capitalize
Expense
Inventory

133
134
136
136
137
137
137

Bonds ............................................................................................................................. 138


Issuance of the Bonds Calculating the Selling Price
Recording the Sale of the Bond in the Books
How the Premium or Discount Is Created
Amortizing the Premium or Discount
Amortization of a Bond Discount
Example
Amortization of a Bond Premium
Financial Statements Issued on Dates Other Than Interest Payment Dates
A Bond Paying Interest Semi-Annually
Journal Entry to Record Issuance
Straight-line Amortization of Bond Premium or Discount
Investments in Bonds
Example
Bonds Issued or Purchased Between Interest Payment Dates
Bond Issue Costs
Early Extinguishment of Debt (Bonds Payable)
Convertible Bonds

139
142
142
144
144
145
146
147
148
149
151
153
154
155
158
159
162
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Book Value Method


Market Value Method
Types of Bonds
Term Bonds vs. Serial Bonds
Debenture Bonds vs. Guaranteed Bonds
Registered Bonds vs. Coupon Bonds
Callable, Convertible and Other Bonds
Bond Disclosures for Issuer of Bonds
One-page Summary of Bonds

162
162
164
164
164
164
165
166
168

Leases ............................................................................................................................ 169


Two Types of Leases
Operating Leases
Capital Leases

169
169
169

Pensions ........................................................................................................................ 171


Accounting for Income Taxes ...................................................................................... 173
Presentation of Taxes on the Income Statement
Temporary Timing Differences The Cause of Deferred Taxes

174
174

Other Liabilities ............................................................................................................. 175


Current Liabilities
Definitely Determinable Liabilities
Accounts Payable (A/P)
Short-Term Notes Payable (N/P)
Zero Interest Bearing Notes
Current Maturities of Long-Term Debt
Dividends Payable
Unearned Revenue

175
175
175
175
176
176
177
177

Estimated Liabilities ...................................................................................................... 177


Compensated Absences
Contingencies
Contingent Liabilities
Warranties
Premiums or Coupons
Refinancing of Short-Term Obligations
Troubled Debt Restructurings

177
178
178
181
183
185
186

Owners Equity .............................................................................................................. 190


Corporate Shareholders Equity

191

Common Stock .............................................................................................................. 192


Rights and Expectations of Common Shareholders
Issuing Common Stock

192
193

Common Stock Dividends ............................................................................................ 196


Stock Dividends

199

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Stock Splits

Table of Contents
200

Preferred Stock .............................................................................................................. 201


Preferred Dividends
Share Issuance Costs

202
203

Treasury Stock............................................................................................................... 204


Classification of Shares
Authorized Shares
Issued Shares
Outstanding Shares
Accounting for Treasury Stock
Recognition of Gain or Loss on Share Transactions
The Cost Method
The Par Value Method
Retirement of Shares

204
204
204
204
205
205
206
207
212

Stock Rights................................................................................................................... 214


Employees and Share-Based Payment Plans ............................................................. 215
(formerly Stock Compensation Plans)
Classified as Liabilities or Equity?
Accounting for Grants Classified as Equity

215
215
216

Retained Earnings ......................................................................................................... 219


Accounting for Appropriated Retained Earnings

219

Accumulated Other Comprehensive Income .............................................................. 220


Statement of Stockholders Equity

221

The Income Statement .................................................................................................. 224


Income from Continuing Operations
Classification of Expenses

224
226

Revenue Recognition .................................................................................................... 228


Goods in Transit
Unearned Revenue
Revenue Recognized at the Completion of Production
Installment Method of Profit Recognition
Presentation of Deferred Gross Profit in the Financial Statements
Cost Recovery Method of Profit Recognition
The Deposit Method
Revenue Recognition When the Right of Return Exists
Consignment Sales
Accounting for the Consignor
Accounting for the Consignee
Royalties
Long-Term Contracts
Completed Contract Method

228
228
229
231
231
236
238
238
239
239
240
240
241
241
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Percentage-of-Completion Method

242

Other Income Statement Items After Continuing Operations ................................. 250


Discontinued Operations .............................................................................................. 251
Extraordinary Events .................................................................................................... 255
Insurance and Extraordinary Events
Reporting of Other Events in Retained Earnings
Accounting Changes and Corrections
Three Methods of Accounting for Changes or Corrections
Accounting for Changes in Accounting Principles Retrospective Adjustment
Accounting for a Change in Reporting Entity Retrospective Adjustment
Correction of Errors Restatement
Accounting for Changes in Accounting Estimates Prospective Adjustment
A Change in Accounting Estimate Effected by a Change in Accounting Principle
Required Disclosures When a Change in Accounting Principle is Made

255
257
257
257
258
259
259
261
261
262

Earnings Per Share ....................................................................................................... 263


Income Available to Common Shareholders (IAC)
The Impact of Dividends on IAC
Weighted Average Number of Common Shares Outstanding (WANCSO)
Basic EPS
Diluted EPS
1) Calculate BEPS
2) Calculate the Impact of Warrants and Options
3) Calculate the EPS Effect of Convertible Bonds or Convertible Preferred Shares
4) Add in the EPS Effects of Convertible Bonds or Convertible Preferred Shares
5) Calculate the Final DEPS
Table for the Calculation of the EPS Effects

263
263
264
266
268
268
268
270
271
271
272

EPS Disclosure Notes ................................................................................................... 273


The Statement of Cash Flows....................................................................................... 276
Classification of Items within the Statement of Cash Flows
Operating Activities
Investing Activities
Financing Activities
Noncash Investing and Financing Activities
Cash Equivalents and Foreign Currencies

276
277
277
277
278
279

Preparing the Statement of Cash Flows ...................................................................... 280


Format of the Statement of Cash Flows

281

The Direct Method ......................................................................................................... 282


Cash Flows From Operating Activities Under the Direct Method
Cash Collected from Customers
Items Recognized as Revenue but Not Collected: Receivables
Items Collected, but Not Recognized as Revenue: Unearned Revenue

282
282
283
283

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Accounts Receivable Written Off
Cash Paid to Suppliers
Cash Paid for Operating Expenses
Gains and Losses
Deferred Taxes
Amortization of Bond Premium or Discount
Other Revenue or Expense Items

Table of Contents
284
284
286
287
287
288
289

The Indirect Method ...................................................................................................... 290


Cash Flows from Operating Activities Under the Indirect Method
Elimination of Noncash Income Statement Items
Elimination of Non-Operating Activity Events
Individual Account Adjustments
Rule for Increases and Decreases in Asset and Liability Accounts
Preparing the SCF Under the Indirect Method

290
290
291
291
292
293

Calculation of Investing Activities ............................................................................... 296


Calculation of Financing Activities .............................................................................. 298
Large SCF Question ...................................................................................................... 299
Accounting for Foreign Operations ............................................................................. 301
Restatement of Non-U.S. GAAP Financial Statements into U.S. GAAP
Translation of Foreign Currency Financial Statements
Remeasurement
Translation

301
301
303
304

Foreign Currency Transactions ................................................................................... 307


Foreign Currency Hedges
Table of Gains and Losses Calculations

310
310

Accounting for Investments ......................................................................................... 312


Chain of Investment
The Cost Method
Acquisition of the Investment
Change in Fair Value of the Investment
Dividends Received
Income of the Investee Company
Intercompany Receivables and Payables
Disposal of the Investment
The Equity Method
Post Acquisition Events
Investees Earnings
Cash Dividends
Stock Dividends and Stock Splits
Intercompany Profits and Losses
Intercompany Receivables and Payables

312
313
313
313
313
314
314
314
316
316
316
316
316
317
317
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Goodwill
Specific Investee Assets
Deferred Income Taxes
Losses in Excess of Carrying Value of an Equity Method Investment
Changing Levels of Investments to Different Classifications

317
317
318
318
321

Business Combinations ................................................................................................ 324


Recording Assets and Liabilities
Recording Equity
Goodwill
Negative Goodwill

324
324
325
325

Consolidation of Financial Statements ....................................................................... 327


The Elimination of Intercompany Receivables and Payables
The Elimination of the Effect of Intercompany Sales of Inventory
The Elimination of the Effect of Intercompany Sales of Fixed Assets
Elimination of the Parents Investment Account
Noncontrolling Interests
Other Eliminations

327
327
328
328
328
328

Other Topics .................................................................................................................. 329


Segment Reporting ....................................................................................................... 329
Accounting for Natural Resources .............................................................................. 332
Development Stage Enterprises (DSE) ........................................................................ 333
Accounting Legislation in the United States............................................................... 334
The Securities Act of 1933
The Securities Exchange Act of 1934

334
335

The Annual Report ........................................................................................................ 336


The Financial Statements
The Notes to the Financial Statements
Auditors Reports
The Report of Management
The Letter to Shareholders
The Management Discussion and Analysis
The Statement on Social Responsibility

336
336
337
339
339
339
341

The SEC and Its Reporting Requirements .................................................................. 341


The Integrated Disclosure System
The Basic Information Package (BIP)
Registration (Filing) Requirements
Shelf Registration
Filing Procedures
Reporting Requirements
Proxy Solicitations
Shareholder Proposals

342
342
343
344
344
345
346
347

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Sarbanes-Oxley Act of 2002 ......................................................................................... 348


Audit Committee Requirements, Responsibilities and Authority
Requirements for Audit Committee and Audit Committee members
Responsibilities of the Audit Committee:
Authority of the Audit Committee

351
351
352
353

Answers to Questions ................................................................................................... 354

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