Corporate Governance Corporate responsibility to Audit committee and CEO/CFO Public Companies / \ Enhanced financial disclosures internal controls

s controls in place to mitigate RMM or omission of material fact or some type of fraud Corporate responsibility Public company audit committees Auditor reports directly to audit committee (by pass mgmt) Audit committee resolves disputes between auditor and mgmt Audit committee - members of BOD, need be independent, Auditor not since hired by and paid by AC - May not accept compensation from issuer for consulting or advisory svcs - May not be an affiliated person of issuer CEO and CFO make certain representations Reviewed the reports Does not contain untrue statements FS in conformity with GAAP Assumed responsibility for IC are designed, evaluated and give report on conclusions to effectiveness of IC Less effective of IC => GREATER RISK of RMM or omission of material fact or fraud No compliance = no bonus Disclosures in Periodic Reports material entries, off B/S transactions (operating leases vs. capital leases) Conflict of Interest provisions prohibited from making personal loans to directors or executive officers Principal stockholder >= 10% of any class of stock Code of Ethics - Issuers must disclose senior financial officers subject to code of conduct - Honest and ethical - Full, fair, accurate, timely disclosures - Compliance w laws and regs Disclosure of AC Financial Expert At least one member of AC s/b financial expert Financial reports MUST DISCLOSE the EXISTENCE of Financial expert on the committee OR Reasons why committee does not have a member that is financial expert Financial expert understanding of GAAP and FS, assess of the application of acctg principles, experience with IC, audit committee functions No need to have PhD, MBA, CPA

ving wrong info) or (commiting a theft) INTERNAL CONTROLS COSO Committee on Sponsoring Organizations to help businesses assess IC over financial reporting Issues Internal Control Integrated Framework to assist organizations in developing comprehensive assessments of internal control effectiveness. The COSOs framework is widely regarded as an appropriate and comprehensive basis to document the assessment of IC over financial reporting Known as Treadway commission Promotes Reliable Financial Reporting Effective and Efficient Operations Compliance

Each objective above is interrelated

Control Activities A component of Internal Control Are actions being taken to promote the Control Environment?

Control activities s/b designed to mitigate risk Risk Assessment - Financial reporting objectives i.e. leases, depreciation, interest rates, evaluation of transactions Financial reporting risks cash and disbursements present F/S in accordance with GAAP o Mgmt needs to consider process and personnel Fraud Risk incentives and pressures

Management must have a system of risk assessment

Information and Communication internal control information Management must have access to relevant and timely information to make good decisions

Principles of Information and Communication Financial reporting info IC info Internal communication External communication assessment of IC Monitoring reporting deficiencies Internal Control activities must be constantly monitored and evaluated
Control Environment - The Foundation of Internal Control

Integrity & Ethics Competence BOD & Audit Committee Management's Operating Style Organizational Structure Authority & Roles of Responsibilities HR Policies

Integrity and Ethical Values - Clearly articulated

Board of Directors supervising officers Actively involved oversight responsibility related to both financial reporting and IC Attributes Operates independently Monitors risk Appoints an audit committee and at least one member of the committee is a financial expert Oversees quality and reliability Appoints audit committee oversees audit activities Management Philosophy and operating style Emphasize RELIABLE financial reporting Mgmts attitude supports an objective selection of acctg principles i.e. choosing LIFO vs. FIFO, capital lease vs. operating lease GAAP compliance Organizational Structure Designs appropriate financial reporting structures provides relevant info at appropriate functional and business unit levels Approaches to applying principle Organizational charts Aligning roles to process Job descriptions Organizational structure no more than 3 layers existed b/n CFO and individuals involved in financial reporting Financial Reporting Competencies Individuals who possess the necessary competencies for financial reporting are hired for that purpose Approaches to applying principle training is provided in house Are BOD or AC reviewing competency of CFO? Authority and Responsibility Authority of AC Authority of mgmt = IC

Approach clear job descriptions, AC review of key finance personnel, employee positions aligned with appropriate authority Human Resources Approach maintain job descriptions and HR procedures screen job applicants through ref checks and resume reviews establish a review and appraisal process design and review compensation plans

evaluate competency of personnel Monitoring Control Effectiveness Ongoing and Separate Evalulations and reporting deficiencies Integrated with companys operations Mgmt receives Feedback on IC over financial reporting **Scope & frequency of evaluations varies based on the significance of risk being controlled - Easier to steal cash or inventory vs. PP&E - Controls over petty cash or inventory Approach metrics compare current performance to target performance - internal Audit performs ongoing and separate evals of controls and report to both mgmt and AC Reporting deficiencies in IC Deficiencies in IC design or operation s/b reported to appropriate leadership in timely manner Approach alternate reporting channels hotline for whistle blowers All deficiencies in IC s/b reported to responsible mgr and one supervisory level above mgr

COSO FRAMEWORK - ENTERPRISE RISK MGMT balance risk & return, take on risk or be conservative

*** ERM is to allow mgmt to effectively deal uncertainty, evaluate risk acceptance and build value *** COSO defines ERM designed to identify potential events that may affect the entity and manage risk to be w/I its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives
Identifies Risk Factors Promotes Risk Response Decisions Compares Management Risk vs. Shareholder Goals Aids in evaluating opportunities Promotes Quicker Capital movement Does NOT eliminate all risk ~ Possible responses to Risk: o Avoid response to risk involving disposal of business unit, product line or geographical segment o Reduce response to risk involves diversification of product offerings rather than elimination of product offerings o Share insuring against losses or entering into joint ventures to address risk (BUY DOWN) o Accept self insuring or tolerating full exposure to risk Objectives of ERM SORC Strategic high level goals designed to achieve the mission (shareholder value ) Operations Achievement objectives through the effective and efficient use of resources ROIC > COST

PASS KEY - ENTERPRISE RISK MANAGEMENT FRAMEWORK

Reporting IS EAR AIM Achievement of reliable reporting (internal managerial acctg, external financial reporting) I Complianceenvironment compliance with laws and regulations Internal Ensuring E Event Identification A Activities (control)

S Setting objectives R Risk response

A Assessment of risk M Monitoring

I Information and Communication

F ERM (similar to control environment of COSO)

Human Resource standards orting competencies) responsibility

OPERATIONS MANAGEMENT Financial and Non-Financial Measures - provide feedback to motivate mgmt Financial measures Profit Return on Investment ROI is expressed as a % of profit to investment ROI provides an outstanding tool for measuring performance, it can inappropriately motivate managers to delay or avoid increasing investment base thereby making ROI targets easier ROI does not balance ST & LT issues Variance analysis budget vs. actual Balanced scorecard FECH CRITICAL SUCCESS FACTORS integrate financial with non-financial measures of performance
F Financial (measuring financial results) E Business process (measuring efficiency and effectiveness of business process) C Customer (measuring the effort that adds to customer satisfaction) H Learning and growth (leveraging human resources capabilities) Non-financial measures Best viewed as attention directors -> tying incentives to mgrs individual effort mgr can control outcome less risk to them Benchmarking can be used to develop non-financial measures and is the process used to indentify standards that define or quantify critical success factors. Benchmarks used for comparison to actual performance, gaps in performance, implementation of improvements Internally developed or externally researched EXTERNALLY = best practice External benchmarks variance analysis Productivity measure of the ratio of outputs achieved to the inputs into production Measurement objectives determine whether more inputs have been used than necessary to obtain the actual output (unfavorable analysis) Total Productivity Ratios (TPR) all output -> all input Consider all inputs simultaneously as well as prices of the inputs Partial Productivity Ratios (PPR) all output -> some input not all Concerned only with quantity of single input (DM or DL) and do not consider price of input Benchmarking Techniques and best practices Control chart - determine zero defects, shows quality performance trends, measuring goalpost performance Keep deviations within acceptable range (within goal posts) Pareto diagrams (histogram) - used to determine frequency of quality control issues, display most to least frequent Most frequent control issues requires GREATEST ATTENTION!! Cause and effect (fishbone) - analyze the source and location of a problem of processes

Work backwards, trace back to source

Elements of manufacturing process include: Machinery Method Materials Manpower

NOT MOH = allocated cost Effective performance measures Promote achievement of goals Relate to goals of organization Balance long and short term issues Are under the control or influence of the employee Are objective and easily measured Marketing Practices on Performance Transaction marketing single sale (lowest price) Interaction-based Relationship marketing repeat business, sales serves for future sales Database marketing info gathered on customers and used to segment customers into target mkts for more effective selling effort segment by age, demographic E-marketing - Internet Network marketing relationships and referrals Incentive Compensation Fixed salary guaranteed payment Bonuses based on profit or incentives
EXECUTIVE COMPENSATION ~ Goals of management should match those of shareholders ~ To accomplish this, executive compensation should creative incentive for management to govern in a shareholder-friendly way that doesn't sacrifice the long-term success of the enterprise for short-term gain ~ Influences that help mold the direction that management takes range from internal (Board of Directors, Audit Committee, Internal Control) to external (Creditors, SEC, IRS)

o These influences should not be tainted by undue influence from management or have financial ties to management such as compensation-related duties

~ "Shirking" o When management doesn't act in the best interest of the shareholders o Can be alleviated by tying compensation to stock performance or company profit

Cost Measurement and Cost Measurement Concepts Cost measurement concepts is associated with managerial accounting and internal reporting. Future orientation and usefulness characterize managerial accounting Meant for internal users Cost drivers (a factor that has the ability to change total costs) may be based on Volume (output) Activity (value added) - other Types of theoretical cost drivers Executional (short-term) - cost drivers that are helpful to the firm in managing short term costs (relationship with suppliers, improvements to the production process) Structural (long-term) - cost drivers that have long term effect on cost (experience, available technology, complexity) Types of operational cost drivers Volume based - associated with traditional cost acctg systems. Based on aggregate volume output (# of direct labor hours used, # of production units) Activity based - associated with contemporary cost acctg systems. Based on an activity that adds value to output (packaging, inspection) Cost objects - resources or activities that serve as the basis for management decisions. Cost objects require separate cost measurement and may be products, product lines, departments, geographic locations, or any other classification that aids in decision making. A single cost object can have more than one measurement. Inventory (product) costs for financial statements are usually different than costs reported for tax purposes. These costs differ than the inventory (product) costs that management uses to make decisions Prime costs (direct costs) = DM + DL Conversion costs = DL + Factory overhead Product costs = DM + DL + Mfg OH applied. These costs are not expensed until the product is sold (inventoriable) Period costs = non mfg costs (SG&A). Are expensed in the period they are incurred and are not inventoriable. Cost accounting systems are designed to meet the goal of measuring cost objects or objectives. The most frequent objectives include: Product costing (inventory and COGS) Efficiency measurements (comparisons to standards)

 Income determination (profitability) Examples of indirect costs - not easily traceable to a cost pool or cost object (B5-7) Indirect costs are allocated to a single cost pool called overhead, i.e. manufacturing overhead Indirect costs in mfg OH consist of both fixed and variable components (such as rent and indirect materials). Total overhead cost is a mixed cost because it includes both fixed and variable costs Depreciation is a fixed cost Joint product costs - costs incurred in production up to the split-off point. Only allocated to the main products. By-products do not receive an allocation of joint costs.

Separable costs - costs incurred on a product after the split-off point. 3 methods to allocate joint product costs Method 1: Volume allocation (Volume product A Total volume) * joint costs = portion of product A joint costs Method 2: Net realizable value (value at split-off point), used for inventory costing only (Sales value of product A at split-off Total sales value at split-off) * joint costs = portion of product A joint costs Method 3: Sales value not available at split-off, subtract separable costs from final selling price to find net realizable value at split-off Final sales value of product A - Separable costs = sales value of product A at split-off (Sales value of product A at split-off Total sales value at split-off) * joint costs = portion of product A joint costs *subtract value of byproduct from joint costs when allocating. Because proceeds from by-product reduce costs. The lowest unit price acceptable is the variable cost of the product (DL + DM + Var mfg OH) plus the contribution margin of the alternative use for the production capacity. Accumulating and assigning costs Full absorption costing - treats fixed manufacturing costs as product costs, while variable costing expenses these as period costs. Job costing -custom orders Process costing - mass produced homogeneous product Operations costing - uses components of both job order costing and process costing Back flush costing - accounts for certain costs as the end of the process Life cycle costing - monitors costs throughout the products life cycle and expand on the traditional costing systems. Beg materials + net purchases = available for use Available for use - ending materials = materials used Beg WIP + total mfg costs [DL + DM used + mfg OH applied] - ending WIP = COGM

Application of overhead Overhead rate = Budgeted overhead costs Estimated cost driver [such as labor hrs or costs, machine hrs] Overhead applied = Actual cost driver * overhead rate [based on actual production] Overhead applied consists of both variable overhead and fixed overhead. The calculation is as follows (with direct labour hours as the cost driver): Variable overhead rate = budgeted variable mfg OH / budgeted direct labor hours Fixed overhead rate = Budgeted fixed mfg OH / budgeted direct labor hours Total overhead rate = Variable overhead rate + Fixed overhead rate Overhead applied to the job = Total overhead rate x actual direct labor hours = $5,625

Normal spoilage is an inventory cost and is included in the standard cost of the manufactured product Abnormal normal spoilage is a period expense and is charged against income of the period as separate component of cost of goods sold. Weighted Avg method to find equivalent units Equivalent units = Units completed + (Ending WIP * % completed ) Weighted average = (beginning cost + current cost) equivalent units FIFO method to find equivalent units Equivalent units = (Beginning WIP * % to be completed) + (units completed beginning WIP) + (ending WIP * % completed) FIFO = current costs only equivalent units Activity based costing (ABC) uses multiple OH rates to assign indirect costs to products (cost objects) based on the resources a product consumes. An ABC system will apply high amounts of overhead to a product that places high demands on expensive resources Factors affecting productions costs Factors contributing to economies of scale include: Labor specialization Managerial specialization Utilization of by products (or joint products) Efficient use of capital equipment Volume discount purchasing Financial models used for operating decisions Revenue Less: Variable Costs (DM + DL + Variable OH + Variable SG&A) Contribution Margin Less: Fixed Costs (Fixed OH + fixed SG&A) Net Income Absorption approach (GAAP) Revenue Less: COGS (DM + DL + Variable OH + Fixed OH) Gross Margin Less: Operating Expenses (Fixed SG&A, Variable SG&A) Net Income Variable costing and absorption costing are the same except that all fixed mfg costs are treated as period costs Under the contribution approach (variable costing), all fixed mfg OH is treated as a period cost and expensed immediately. i.e. COGS includes only variable mfg costs. Not GAAP Under the absorption approach (absorption costing), all fixed mfg OH is treated as a product cost and included in inventory values. i.e. COGS includes both fixed and variable costs. GAAP Net income effect between variable and absorption costing

No change in inventory: absorption NI = Variable NI Increase in inventory: Absorption NI > Variable NI [because less fixed OH expensed under absorption] Decrease in inventory: Absorption NI < Variable NI [because more fixed OH expensed under absorption] Contribution margin ratio = contribution margin revenue Breakeven in units = total fixed costs contribution margin per unit Break even in dollars = total fixed costs contribution margin ratio Break even in dollars = unit price * break even point in units Required sales volume for target profit Sales = (Fixed cost + target profit) contribution margin ratio Target profit before tax = target profit after tax (1 - tax rate) Margin of safety = total sales in dollars - breakeven in dollars Margin of safety % = margin of safety in dollars total sales Target costing - the selling price of the product determines the production costs allowed Economic value added (EVA) - measures the excess of income after taxes earned by an investment over the return rate defined by the company's cost of capital. Investment * cost of capital = required rate of return Income after taxes - required return = economic value added
When considering alternatives, such as discontinuation of a product line, management should consider relevant costs. Relevant costs are those costs that will change under different alternatives.

Forecasting and projection techniques Regression analysis - statistical model that can estimate the dependent cost variable based on changes in the independent variable. Learning curve analysis - used to determine increases in efficiency or production as experience is gained. Both products have long production runs, making learning curve analysis the best method for estimating the cost of the competitive bid. Attainable standards are used with flexible budgets Authoritative standards are set exclusively by management, while participative standards are set by both managers and employees

Planning/budgeting overview and planning/budget techniques A master budget - an overall budget, consisting of many smaller budgets, that is based on one specific level of production (usually begins with sales budget) A flexible budget - a series of budgets based on different activity levels within the relevant range. The production budget - begins with sales budget and then adds in the effect of any changes in inventory levels

Budget Variance Analysis DM price variance = actual quantity purchased * (actual price - standard price) DM quantity variance = standard price * (actual quantity used - standard quantity allowed) DL rate variance = actual hours works * (actual rate standard rate) DL efficiency variance = standard rate * (actual hours worked - standard hours allowed) Standard quantity allowed (SQA) = actual output * standard allowed output B5-63 variance chart Sales volume variance = (actual units sold - budgeted unit sales) * standard contribution margin per unit Sales mix variance = (actual product sales mix ratio - budgeted product sales mix ratio) * actual sold units * budgeted contribution margin per unit of that product Sales quantity variance = (actual units sold - budgeted unit sales) * budgeted sales mix ratio * budgeted contribution margin per unit Market size variance = (actual market size in units - expected market size in units) * budgeted market share * budgeted contribution margin per unit weighted avg Market share variance (actual market share - budgeted market share) * actual industry units * budgeted contribution margin per unit weighted avg Selling price variance = (actual SP per unit - budgeted selling price per unit) * actual units sold Variable overhead efficiency variance - computed as budgeted variable overhead based on standard hours minus budgeted variable overhead based on actual hours. Budgeted variable OH = standard direct labor hours allowed x standard variable overhead rate Budgeted variable OH = actual direct labor hours x standard variable overhead rate Production volume variance component for overhead variances is computed as applied overhead minus budgeted overhead based on standard hours
Applied Overhead (Std Var OH Rate x Std DLH Allowed) + (Std Fixed OH Rate x Actual Production) Budgeted overhead based on standard hours (Std Var OH Rate x Std DLH Allowed) + (Std Fixed OH Rate x Standard Production) The fixed overhead rate is $5 per machine hour [$1,200,000 / 240,000 = $5]. The amount of FIXED manufacturing overhead planned for November is $100,000. Therefore, the standard production for FIXED overhead is 20,000 machine hours [$100,000/$5 = 20,000.]

Organizational performance measures Strategic business units (SBU), are generally classified around 4 financial measures -Cost SBU -Revenue SBU -Profit SBU -Investment SBU (most like and independent business) (highest level)

BEC - Notes Chapter 5http://www.cpa-cfa.org

Critical success factors to accomplish a firm strategy are FICA: - Financial - Internal business processes - Customer Satisfaction - Advancement of innovation and human resource development Conformance costs - costs to ensure products conform to quality standards -Prevention costs - incurred to prevent production of defects (employee training, engineering) -Appraisal costs - remove defects before they reach customer (testing, inspections) Nonconformance costs - costs that result from lost sales or reputation damage -Internal failure - cost of defective parts or lost production time (scrap, rework) -External failure - cost of returns and lost customer loyalty (warranty, liability)