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
Characteristics of Successful Budgeting
Time Frames for Budgets
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
Cost Standards in Budgeting
Setting Standard Costs
The Standard-Setting Process

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Budget Methodologies .................................................................................................... 23

Annual/Master Budget
The Different Budgets
The Sales Budget
The Production Budget
Direct Labor Budget
Cost of Goods Sold Budget
Other Budgets
The Cash Budget
The Operating and Financial Budgets
The Capital Expenditures Budget
The Master Budget
Flexible Budgets

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Other Types of Budgets .................................................................................................. 31

Project Budgeting
Activity-Based Budgeting
Zero-Base Budgeting

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Continuous (Rolling) Budgets
Budget Reports

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Budgeting Questions ...................................................................................................... 35

Flexible Budgeting Questions
Units to Produce / Purchase Questions
Cash Flow Questions

35
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41

Forecasting Techniques ................................................................................................. 43

Forecasting and Budgeting
Collecting the Data for a Forecast
Time Series Analysis
Using Time Series Analysis in Forecasting
Inflation Adjustment in a Time Series Analysis
Causal Forecasting
Benefits and Limitations of Regression Analysis

43
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62

Learning Curves .............................................................................................................. 64

Cumulative Average vs. Incremental Unit Model
Cumulative Average-Time Learning Model
Incremental Unit-Time Learning Model
Benefits of Learning Curve Analysis
Limitations of Learning Curve Analysis

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68
68

Probability ........................................................................................................................ 70
Two Requirements of Probability
Conditional Probability
Joint 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 Distribution

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76

Risk, Uncertainty and Expected Value .......................................................................... 78

The Mean, Median and Mode
Expected Value in Estimating Future Cash Flows
Statistical Measurements of Cash Flow Variability
Summary of Probability and Expected Value

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82

Sensitivity Analysis ......................................................................................................... 84

Top-Level Planning and Analysis .................................................................................. 85
Pro Forma Financial Statements
Forecasting for Planning
Sales Forecasting
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Forecasting Future Financing Needs

Analysis of Pro Forma Financial Statements
Other Uses of Pro Forma Financial Statements

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Section B Performance Management ......................................................................... 99

Introduction to Variance Analysis and Standard Costs ............................................. 100
Determining the Level of Activity
Sources of Standards
Management by Exception

101
101
102

Variance Analysis Concepts......................................................................................... 103

Static Budget Variances Vs Flexible Budget Variances
Static Budget Variances
Flexible Budget Variances and Sales Volume Variances
Types of Variances

103
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105
106

Manufacturing Input Variances .................................................................................... 107

Direct Materials Variances
The Quantity Variance
The Price Variance
Purchase Price Variance
Accounting for Direct Materials Variances in a Standard Cost System
Direct Labor Variances
The Labor Rate Variance
The 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 Material Quantity or Labor Efficiency Variance of a Weighted Mix
Factory Overhead Variances
Overview of Manufacturing Overhead Variances
Variable Overhead Variances
Fixed Overhead Variances
Two-Way, Three-Way and Four-Way Analysis
Summary Table of Manufacturing Variance Calculations

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Sales Variances ............................................................................................................. 137

Sales Variances for a Single Product Firm
Sales Price Variance for a Single Product Firm (Flexible Budget Variance)
Sales Volume Variance for a Single Product Firm
Sales Variances When MORE THAN ONE Product is Sold
Sales Price Variance (Flexible Budget Variance) for a Multi-Product Firm
Sales Volume Variances for a Multi-Product Firm

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Sales Quantity Variance for a Multi-Product Firm
Sales Mix Variance for a Multi-Product Firm
Total Sales Variance for a Multi-Product Firm
Variances Example Using Contribution Margin

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Market Variances ........................................................................................................... 153

Variance Analysis for a Service Company .................................................................. 153
Responsibility Centers and Reporting Segments ...................................................... 154
Allocation of Common Costs
The Contribution Income Statement Approach to Evaluation
Use of the Contribution Income Statement
Transfer Pricing
Transfer Pricing Objectives
Transfer Pricing Methods

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Performance Measures ................................................................................................. 169

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 These Measures
Performance Measurement in Multinational Companies
Multiple Measures of Performance and the Balanced Scorecard
Customer and Product Profitability Analysis

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Section C Cost Management ..................................................................................... 187

Classifications of Costs ................................................................................................ 188
Costs Based on Level of Production
Production vs. Period Costs
Types of Product Costs
Other Costs and Cost Classifications
Cost of Goods Sold (COGS) and Cost of Goods Manufactured (COGM)

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190
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194

Variable and Absorption Costing ................................................................................. 196

Fixed Factory Overheads Under Variable Costing
Fixed Factory Overheads Under Absorption Costing
Effects of Changing Inventory Levels
Income Statement Presentation
The Income Statement under Absorption Costing
The Income Statement under Variable (Direct) Costing
Answer to the Variable/Absorption Costing Example
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Joint Products and Byproducts ................................................................................... 207

Methods of Allocating Costs to Joint Products and Byproducts
Accounting for Byproducts
Comprehensive Example of Joint and Byproduct Costing Under Both Methods
Scenario #1 The Production Method
Scenario #2 The Sales Method

207
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213
213
214

Process Costing ............................................................................................................ 217

Steps in Process Costing
1. Determine the Physical Flow of Goods
2. Calculate the Number of Units Started and Completed
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
EUP for Spoilage for Conversion Costs
EUP for Spoilage for Materials
Allocation of Costs to the Spoiled Units
Transferring the Costs of Spoiled Units
Normal Spoilage
Abnormal Spoilage
Additional Classifications of Spoilage

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Overhead Allocation ...................................................................................................... 239

Manufacturing Overhead Allocation
Standard (Traditional) Allocation Method
Determining the Basis of Allocation
Calculating the Manufacturing Overhead Allocation Rate
Determining the Level of Activity
Allocating Manufacturing Overhead to the Units
Costing System Methods
Benefits and Limitations of Each Costing Method
The Process of Accounting for Factory Overhead
Over-Applied and Under-Applied Manufacturing Overhead
Comprehensive Example of Accounting for Fixed Overhead and FOH Variances
Activity-Based Costing

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Job-Order Costing ......................................................................................................... 262

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Life-Cycle Costing ......................................................................................................... 263

Customer Life-Cycle Costing ....................................................................................... 264
Service Cost Allocation ................................................................................................ 265
Allocating Costs of One Service or Support Department to Multiple Users
Allocating Costs of Multiple Service or Support Departments
The Direct Method
The Step Method
The Reciprocal Method
Comprehensive Example of Direct, Step and Reciprocal Methods

265
268
269
269
270
270

Estimating Fixed Costs ................................................................................................. 273

High-Low Points Method
Regression Analysis
Forecasting Total Costs

273
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278

Operational Efficiency................................................................................................... 279

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

279
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282
282
283
286
286
289
292
293

Business Process Performance ................................................................................... 300

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
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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Section D Internal Controls ....................................................................................... 314

Risk Assessment, Controls and Risk Management ................................................... 315
Internal Control Definition and Objectives
Who Is Responsible for Internal Control?
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
Audit Committee Requirements, Responsibilities and Authority
Requirements for Audit Committee and Audit Committee members:
Responsibilities of the Audit Committee:
Authority of the Audit Committee:
Legislative Initiatives on Internal Control
Foreign Corrupt Practices Act (FCPA)
Sarbanes-Oxley Act
Public Company Accounting Oversight Board (PCAOB)
Major Internal Control Provisions of Sarbanes-Oxley
PCAOB Preferred Approach to Auditing Internal Controls in Auditing Standard No. 5
PCAOB Auditing Standard 5: Steps to a Top-Down Approach
SEC Release 33-8810
Top-Down Approach Versus Bottom-Up Approach
What Internal Control Can and Cannot Do

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345

Internal Auditing ............................................................................................................ 346

Definition of Internal Auditing
Responsibilities of the Internal Auditing Function
The Difference Between Internal Auditors and External Auditors
Coordination of Work Between Internal and External Auditors
Types of Engagements
Assurance Services
Consulting Services
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

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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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378

Systems Controls and Security Measures .................................................................. 381

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
Controls Classified as Feedback, Feedforward and Preventive

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401
402
402

Internet Security ............................................................................................................ 404

Viruses, Trojan Horses and Worms
Cybercrime
Defenses Against Cybercrime
Encryption

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409

Contingency Planning................................................................................................... 410

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Disaster Recovery

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Section E Professional Ethics ................................................................................... 414

Introduction to Ethics
Business Ethics
Statement of Ethical Professional Practice

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Appendix A - Variance Report for a Company Selling TWO PRODUCTS ................. 421
Answers to Questions ................................................................................................... 425

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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

36
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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

37
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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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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

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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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75

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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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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175
176
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

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

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

237
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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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301
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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

343
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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

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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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381

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

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

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CMA Part 2

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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
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10
10
12

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

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

14
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

37
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43
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51
52

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

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

55
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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

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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

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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
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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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