CMA Part 1 Financial Decision Making Introduction to the CMA Exam and Essays on the Exam Ronald Schmidt, CMA, CFM Ethics for Management Jim Clemons, CMA Introduction to the CMA Prep-course • • • • Schedule of classes and topics Instructional mode/format Instructors Resources outside of the lectures – Instructor/mentor – Study material The ICMA Requirements for the CMA Designation • Become a member, pref. choosing your local chapter • Request to take the exam, and register for an exam 12 months after being admitted to the Certification Program • Pass both parts in 3 years • Satisfy the education requirements • Satisfy the experience requirement • Comply with the IMA’s Statement of Ethical Professional Practice • Once you are a CMA – Beginning the calendar year after successful completion of the CMA exam, 30 hours of CPE must be completed – This course can help you achieve that CMA Exam Prep • • • • • • • • • • Read the Study Units to be lectured on next Take the two multiple-choice quizzes Identify if missed questions were do to concept or strategy Re-read the concepts missed Share with us what you are having trouble with by no later than the Wednesday prior to the lecture Attend lecture and ask questions Prepare a 20 question quiz on the lectured material using Gleim’s test bank Identify any concepts still not clear and contact Instructor/Mentor to review Practice Essays as much as possible throughout the course, completing ideally one per week until the end of the course Keep track of concepts which still seem difficulty or unclear and convey those to us prior to the Cram Session Exam • It is recommended that you register for the exam as early as possible. – Exams are given at Prometrics Testing Centers • Class (cram session) will conclude on Feb. 14th, which will give you 2 weeks to take the exam • DO NOT(!) plan a strategy that you will plan any “catchup” studying after our cram session – You should progress through the course in an “even” a manner possible – plan for a consistent study plan Exam format • 3 hrs - 100 multiple choice questions = approx. 1.8 (we recommend 1.5) minutes per question (on average). – – – – – Find ways to “bank” time Look for short-cuts You will find that you most question do not seem “easy”, don’t get discouraged You “earn” points for each question answered correctly Some questions are “test” questions that carry no point value. You will not know which ones they are – Extra time can be carried forward to the Essay portion • 1 hr - 2 Essay scenarios with up to 10 sub-parts – You can’t go back to multiple-choice part once you enter this portion of the exam – Whatever you have typed on the screen will be saved as your answer, irrespective if the timer runs out on you Exam format Part 2 – Financial Decision Making 4 hours, 100 multiple-choice questions and two 30-minute essay scenarios • Exam Content Specific Outline (CSO) includes: • • • • • Financial Statement Analysis (25%) Corporate Finance (25%) Decision Analysis (25%) Investment Decisions (20%) Professional ethics (5%) If you find you have weaknesses in any topic ref. Appendix C for ref. the appropriate sub –units Exam Structure & Feedback • Exam structure – 3 hours of multiple choice questions ~ 75% of score – 1 hour of essay questions ~ 25% of score • Must earn at least 50% on multiple choice section in order to advance to essay section • Cannot return to the multiple choice section once you’ve advanced to the essay section of the exam Exam Strategy • • • • • To pass the exam, you need: Knowledge Confidence Effective Time Management Commitment! Day of the Exam Relax - “NO ONE HAS DIED FROM FAILING THE CMA EXAM”, there is life beyond and we will help you pass it!!!! Test Stategy • Multiple Choice questions – – – – – Answer in consecutive order Try to ignore the answer choices (don’t get tricked) Read the question carefully (sometimes before the scenario/data) Determine the correct answer Read the answer choices carefully and completely (most common wrong answers are the alternative choices) – Chose the best answer (there are correct and “more” answers) – Guess if you have to (either educated, what you think the ICMA is testing, or if you have not idea the same letter) Most common reasons for missing questions 1. Misreading the requirement (stem) – Read the question first 2. Not understanding what is required 3. Making a math error – Try to not do calculations of paper first, with the idea of “transferring” to the exam later. If you know how to use your memory button(s) well on your calculator, use it (i.e. save sub-calculations in your calculator). 4. Applying the wrong rule or concept 5. Being distracted by one or more of the answers – the most common wrong answers are the incorrect alternatives Most common reasons for missing questions 6. Incorrectly eliminating answers from considerations – read all answers first, some are more correct or complete then others 7. Not having any knowledge of the topic tested – don’t agonize over it. If possible try to make an educated guess by eliminating obvious wrong answers. If you guess, use the same letter each time. 8. Employing bad intuition when guessing The essays • Remember, 2 essay questions with 3 to 6 parts each! • This section provides a great opportunity to earn partial credit – Be sure to show your work and assumptions – You can scroll between questions and scenarios within the essay section of the exam • Helps to determine how much time you will need for responses Essay Questions • Pay close attention to verbs – E.g., if it says compare or contrast, don’t define something • Read the entire question to understand all requirements – You may have more than one requirement, for example: “Define abc and interpret its applicability to xyz.” • Grammar and writing skills – Focus is on use of standard English, organization and clarity – Graders are looking for effective writing skills Essay Questions • Be brief and to the point – It’s ok to use bullet points!!! • Do not leave a questions blank – If short on time, at least write an outline of your main points • Graders are looking to give you points, not take them away – Make it as easy as possible for graders to give you points! Essay Questions • Type your responses into a text box – Similar to MS Word, but with more simple functionality – Effective January 2013, the spreadsheet tool is no longer being used on the CMA exam • Be sure to use all of the time available to you Essay • • • • • There is a sample grading rubric for essay portion enclosed in slide presentation. This is interesting because this shows that the graders only give points for correct answers. They don't deduct for wrong answers. Notice on rubric for the second sample essay, there are multiple points that could be earned for each question, but the total points for each question is less than the sum for all the possible answers. This means that there is more than one correct answer. Once you get the maximum points for this part, the grader moves on. You don't get more points for embellishing. Don't embellish. Be direct. Be simple. Use bullet points. Show your work, including calculations. Use proper grammar and English. Then move on to the next question. Practice answering essays online. This will get you used to how to type calculations and make bullet points. Use ALL the time you have on your essay questions, even if you pull time from your multiple choice section. The more you study, the better you will do. It is as simple as that. Sample Essay Question #1 A City owns and operates a community swimming pool. The pool is open each year for 90 days during the summer months of June, July, and August. A daily admission is charged to patrons of the pool. By law, 10% of all recreational and sporting fees must be remitted to a state tourism promotion fund. The City Manager has set a goal that pool admission revenue, after subtracting the state fee and variable costs, must be sufficient to cover the fixed costs. Variable costs are assumed to be 15% of gross revenue. Fixed costs for the three-month period total $33,000. The following budget for the pool has been prepared for the current year. Adult admissions: 30 per day x 90 days x $5.00 $ 13,500 Student admissions: 120 per day x 90 days x $2.50 27,000 Total revenue 40,500 State tourism fee 4,050 Net revenue 36,450 Variable costs 6,075 Fixed costs 33,000 Expected deficit $ (2,625) The City Manager is trying to determine what admission mix is necessary to break even and what actions could be taken to eliminate the expected deficit. Essay Requirements (partial) 1. Given the anticipated mix of adult and student admissions, how many total admissions must the pool have in order to break even for the season? 2. Regardless of the admissions mix, what is the highest number of admissions that would be necessary to break even for the season? Sample Essay Response Question 1: Given the anticipated mix of adult and student admissions, how many total admissions must the pool have in order to break even for the season? Sample Response: The contribution margin is 75% or $3.75 per adult admission, and $1.875 per student admission. The mix is 20% adult (30 ÷ 150) and 80% student (120 ÷ 150). – – – – Calculate the weighted average contribution margin (WACM) WACM = 0.20 ($3.75) + 0.80 ($1.875) = $2.25 The breakeven point in units is calculated as follows: Fixed costs ÷ WACM • • • Fixed costs = $33,000 WACM = $2.25 $33,000 ÷ $2.25 = 14,667 admissions per season Sample Essay Response Question 2: Regardless of the admissions mix, what is the highest number of admissions that would be necessary to break even for the season? Sample Response: To calculate the highest number of admissions to break even, you would assume that all admissions are students. That’s because the student admission price is the lowest of all admission prices. – The breakeven point in units is calculated as follows: • Fixed costs ÷ Contribution margin for students – Fixed costs = $33,000 – Contribution margin for students = $1.875 – $33,000 ÷ $1.875 = 17,600 admissions per season Ethics - Overview CMA candidates need to be prepared to answer ethics questions that will be integrated with any of the other topics, which can be tested at all three levels of difficulty, requiring you: • Recall aspects of the Foreign Corrupt Practices Act and the IMA Statement of Management Accounting • Evaluate and apply the different aspects as they relate to typical business situations • Memorize IMA’s Statement of Ethical Professional Practice Ethics - Overview cont. • Questions can come in either multiple choice questions or in essay format • And require you not only to identify the nature of the ethical dilemma but how to resolve it • Tested from the perspective of both the individual and organization in Part 2. SU 1.1 - IMA’s Statement of Ethical Professional Practice • HFOR – The four overarching principles – Honesty – Fairness – Objectivity – Responsibility SU 1.1 - IMA’s Statement of Ethical Professional Practice • CCIC – The statement contains four specific standards – Competence – Confidentiality – Integrity – Credibility SU 1.1 - IMA’s Statement of Ethical Professional Practice • Conflict of Interest – Mitigate actual, and to avoid apparent, conflict of interest – Examples – financial interest in suppliers, privileged info. – Methods to control conflict of interest include: • • • • • Code of Conduct Full Financial disclosure Prohibit financial ties to distributors Adherence to strong ethical behavior Etc… SU 1.1 - IMA’s Statement of Ethical Professional Practice • Ethics on the exam – You should essentially memorize the entire content of the IMA Statement of Ethical Professional Practice as shown on page 13 of the book, including the section on Resolution of Ethical Conflict on page 14 SU 1.5 – Practice Question 1 In accordance with IMA’s Statement of Ethical Professional Practice, a member who fails to perform professional duties in accordance with relevant standards is acting contrary to which one of the following standards? A Competence. B Confidentiality. C Integrity. D Credibility. SU 1.5 – Practice Question 2 Answer Correct Answer: A One of the responsibilities of an IMA member under the competence standard is to “maintain an appropriate level of professional expertise by continually developing knowledge and skills.” (S)he must also “perform professional duties in accordance with relevant laws, regulations, and technical standards.” The third requirement under this standard is to “provide decision support information and recommendations that are accurate, clear, concise, and timely.” Incorrect Answers: B The confidentiality standard concerns an IMA member’s responsibility not to disclose or use the firm’s confidential information. C The integrity standard pertains to conflicts of interest, avoidance of acts discreditable to the profession, and refraining from activities that prejudice the ability to carry out duties ethically. D Credibility is the fourth standard of IMA’s Statement of Ethical Professional Practice. It requires that information be communicated “fairly and objectively,” and that all information that could reasonably influence users be disclosed. SU 1.5 – Practice Question 2 If an IMA member discovers unethical conduct in his or her organization and fails to act, (s)he will be in violation of which of IMA’s ethical standard(s)? A “Refrain from engaging in any conduct that would prejudice carrying out duties correctly.” B “Communicate information fairly and objectively.” C “Disclose all relevant information that could reasonably be expected to influence an intended user’s understanding of reporting analyses or recommendations.” D All of the answers are correct. SU 1.5 – Practice Question 2 Answer Correct Answer: D An IMA member displays his or her competence and credibility and maintains integrity by taking the appropriate action within the organization to resolve an ethical problem. All of these activities should be a part of an IMA member’s normal job processes. Incorrect Answers: A Each standard is violated by an IMA member who fails to act upon discovering unethical conduct. B Each standard is violated by an IMA member who fails to act upon discovering unethical conduct. C Each standard is violated by an IMA member who fails to act upon discovering unethical conduct. SU 1.5 – Practice Question 3 In which situation is an IMA member permitted to communicate confidential information to individuals or authorities outside the firm? A There is an ethical conflict and the board has refused to take action. B Such communication is legally prescribed. C The IMA member knowingly communicates the information indirectly through a subordinate. D An officer at the IMA member’s bank has requested information on a transaction that could influence the firm’s stock price. SU 1.5 – Practice Question 3 Answer Correct Answer: B According to IMA’s Statement of Ethical Professional Practice, members are responsible for observing the standard of confidentiality. Thus, the IMA member should “refrain from disclosing confidential information acquired in the course of his or her work except when authorized, unless legally obligated to do so.” Incorrect Answers: A IMA’s Statement of Ethical Professional Practice states that “each member has a responsibility to keep information confidential except when disclosure is authorized or legally required.” C The IMA member should “inform all relevant parties regarding appropriate use of confidential information. Monitor subordinates’ activities to ensure compliance.” D The IMA member is required to “refrain from using confidential information for unethical or illegal advantage.” Study Tip • Try to explain out loud a concept you are trying to learn as though you are trying to teach it to someone. A good place to do this is in your car or in front of a mirror. SU 1.2 - Corporate Ethics and Legislation • The Foreign Corrupt Practices Act of 1977 (FCPA) contains two sets of provisions: – Accounting • Books and Records • Internal Control – Anti-Bribery SU 1.2 - Corporate Ethics and Legislation • Foreign Corrupt Practices Act of 1977 (FCPA) – All public companies must comply • Payments to foreign officials / politicians –Prohibited • Payment to foreign business owners / corporate officers – Not addressed • Corrupt payments – For the purpose of inducing someone to act or refrain to obtain or retain business. – Prohibits a mere offer or promise –even if not consummated. Only minims gifts are acceptable. – Known / should have known – influence of official. • Violations subject to fines and imprisonment. – Fines have to be paid by the person involved, Not 3rd party – Grease payments are allowed but not to Politicians. Sarbanes-Oxley Act of 2002 • See “Backgrount to Sarbanes-Oxley Act” on page 16 (Enron, Arthur Andersen…) • Extensive responsibilities on issuers / auditors of publicly traded securities. – Sec 406(a) Senior financial officers Code of Ethics • Reasonably necessary to promote – Honest and ethical conduct – Full, fair, accurate, timely, and understandable disclosure – Compliance with governmental rules and regulations • SOX does not define ethics. 1.2 - Corporate Ethics and Legislation – Question 1 The Foreign Corrupt Practices Act prohibits A. B. Bribes to all foreigners. Small bribes to foreign officials that serve as facilitating or grease payments. C. Bribery only by corporations and their representatives. D. Bribes to foreign officials to influence official acts. 1.2 - Corporate Ethics and Legislation – Question 1 Answer Correct Answer: D The Foreign Corrupt Practices Act (FCPA) prohibits any U.S. firm from making bribes to foreign officials to influence official acts. The businesses subject to the FCPA include corporations, partnerships, limited partnerships, business trusts, and unincorporated organizations. Violations of the FCPA are federal felonies. The penalties are up to 5 years in prison or up to a $100,000 fine or both for an officer, director, or shareholder who helps make the bribe. Incorrect Answers: A: Bribes to all foreigners is not covered by the provisions in the FCPA. B: Small bribes to foreign officials that serve as facilitating or grease payments is not covered by the provisions in the FCPA. C: All U.S. firms are subject to the anti-bribery provisions. 1.2 - Corporate Ethics and Legislation – Question 2 Firms subject to the reporting requirements of the Securities Exchange Act of 1934 are required by the Foreign Corrupt Practices Act of 1977 to maintain satisfactory internal control. The role of the independent auditor relative to this Act is to A. Report clients with unsatisfactory internal control to the SEC. B. Provide assurances to users as part of the traditional audit attest function that the client is in compliance with the present legislation. C. Express an opinion on the sufficiency of the client’s internal control to meet the requirements of the Act. D. Attest to the financial statements. 1.2 - Corporate Ethics and Legislation – Question 2 Answer Correct Answer: D Whether a client is in conformity with the Foreign Corrupt Practices Act is a legal question. Auditors cannot be expected to provide clients or users of the financial statements with legal advice. The role of the auditor is to assess control risk in the course of an engagement to attest to the fair presentation of the financial statements. Incorrect Answers: A: The auditor is not required to report violations of the Act to the SEC, although a duty to disclose outside the client may exist in some circumstances; e.g., the client’s failure to take remedial action regarding an illegal act may constitute a disagreement that it must report on Form 8-K (AU 317). B: The traditional attest function does not involve compliance auditing. C: The FCPA contains no requirement that an auditor express an opinion on internal control. Study Tip • Try to find a little time every day to study, whether it is reading or practicing quiz questions. 1 hour per day M – F and the 4 hour lecture = 10 hrs. per week • Passing the exam is a marathon not a sprint! 1.3 - Corporate Responsibility for Ethical Behavior • The organization has a responsibility to foster a sense of ethics • A pervasive sense of ethical values can benefit and organization • A sense of ethics requires an ability to distinguish between ethical and merely legal behavior • “Leadership by example”, or tone at the top plays an important role 1.3 - Corporate Responsibility for Ethical Behavior • “Human capital” concept is an important component to creating the right climate of “doing the right thing” • Organizations culture • Employee training • Monitoring ethical compliance – Human performance feedback loop – Survey tools – Reviews, 360’s, KPI’s 1.3 - Corporate Responsibility for Ethical Behavior • Whistleblowing framework – Confidential and independent • Special challenges with international companies or trade • Ethical behavior as a prerequisite to internal control • Three tools to identify process controls related to ethical and behavioral issues: – Business Process Reengineering (BPR) – Quality Management – Continual Process Improvement (CPI) 1.3 - Corporate Responsibility for Ethical Behavior • “Values and Ethics: From Inception to Practice” • Have a comprehensive framework – CEO & CFO “Get out of Jail card” • Responsible to : Foster a sense of ethics – Written code of Conduct and ethical behavior • Pervasive sense of ethical values has benefits. – White space vs. Gray area. • Ethical and merely legal behavior 1.3 - Corporate Responsibility for Ethical Behavior – Question 1 Which one of the following is a true statement regarding organizational ethics? A. As long as officer and employee behavior meet the requirements of the law, the organization can be considered to have a functioning system of ethical behavior. B. A strong sense of ethics on the part of employees who are in the best position to appropriate cash and other assets is the most vital part of a functioning system of ethical behavior. C. If an organization has a strong code of ethical conduct in place, the role of employee training can be downplayed. D. Paying attention to “whistleblowers” plays a significant role in maintaining an effective ethical atmosphere. 1.3 - Corporate Responsibility for Ethical Behavior – Question 1 Answer Correct Answer: D “Values and Ethics: From Inception to Practice” states, in part, “A whistleblowing framework (e.g., an ethics helpline) is an important component in maintaining an ethical organizational culture. An effective feedback system includes having a confidential framework for employees to report possible violations of the organization’s code of ethics and to receive advice on the ethical aspects of challenging decisions. Statistics show that a large number of occupational fraud cases are detected through an employee “hotline” or other reporting method ... ” (IX. Measuring and Improving Ethical Compliance.) Continued 1.3 - Corporate Responsibility for Ethical Behavior – Question 1 Answer (continued) Incorrect Answers: A: A sense of ethics requires an ability to distinguish between ethical and merely legal behavior. “Values and Ethics: From Inception to Practice” states, in part, “Many individuals at the center of corporate scandals [of the late 20th and early 21st Century] have professed the belief that they were innocent of any wrongdoing, including Kenneth Lay of Enron or Conrad Black of Hollinger. The problem is that these individuals did not define their behavior by what most of society would see as ‘reasonable,’ but rather they followed their own particular code – in some cases, limiting the definition of ethical behavior to require compliance with the law and nothing more.” (II. Introduction.) B: “Values and Ethics: From Inception to Practice” states, in part, “Ethical behavior is not something that applies to someone else – every single individual is responsible for behaving ethically. Nowhere is this more important than the demonstration of ethical behavior that managers and supervisors exhibit in the way they execute their day-to-day work...” This phenomenon is referred to as the “tone at the top.” (VI. Leadership by Example.) C: Employee training is important to maintaining an ethical organizational culture. “Values and Ethics: From Inception to Practice” states, in part, “Every existing member of staff should receive ongoing training, starting at the board level and cascading down throughout the organization ... Ethics training for employees should focus on covering ethical concepts, the organization’s code, and compliance. To achieve this, training should include: ethical concepts and thinking: What is ‘behind’ the issue of ethical action?; [and] the organization’s code of ethics and any supporting ‘rules.’” (VIII. Practical Application: Converting Intent into Operational Reality.) 1.3 - Corporate Responsibility for Ethical Behavior – Question 2 IMA’s Statement on Management Accounting, “Values and Ethics: From Inception to Practice,” recommends a defined code of conduct and ethical behavior for all organizations. One advantage of having such a code is that it A. Provides employees with guidance for handling unfamiliar situations. B. Ensures ethical behavior by all employees. C. Shields the organization from liability in cases of loss of stockholder value due to fraud. D. Eases the investigative process performed by police and prosecutors in cases of suspected fraud. 1.3 - Corporate Responsibility for Ethical Behavior – Question 2 Answer Correct Answer: A “Values and Ethics: From Inception to Practice” states, in part, “... what does an employee do when unplanned events occur? What reference does an individual look to for help in making decisions? ... This is why it is important to have a defined set of organizational values and code of ethics – they create the “touchstone” against which every unanticipated decision must be judged. Failure to have every individual in the organization know and understand these values and ethical code leads to inconsistency and, in the worst cases, unethical or fraudulent behavior.” (IV. Values, Ethics, and Accounting.) Incorrect Answers: B: A code of conduct cannot guarantee ethical behavior by employees. C: A code of conduct cannot guarantee that an organization will be shielded from liability in cases of fraud. D: A code of conduct does not ease law enforcement’s investigative process. Study Tip • You need to achieve an 80% on the quizzes you attempt. If you have taken the quizzes twice and still not achieved an 80%, create another 20 question quiz from the test bank available, focusing (selecting) on material that you are having difficulty with. In different words “practice” what you don’t know rather than what you do know. SU 1.4 – Fraud and the Fraud Risk Model • Types of Fraud – Fraudulent Financial Reporting • Mostly done by management • Focus of external auditors, the PCAOB and the SEC – Misappropriating of Assets • Mostly done by employees (theft, embezzlement or defalcation) • Cause more internal problems then external problems The Fraud Risk Model (Fraud Triangle) SU 1.4 - The Fraud Risk Model (Fraud Triangle) • Opportunity – ability of a person not only to commit and also conceal the fraud – Absence of oversight, inadequate controls, lack of enforcement – The only thing that can be controlled by management SU 1.4 - The Fraud Risk Model (Fraud Triangle) • Rationalization – ability to justify actions as consistent with his or her personal code of ethics – Principles and integrity vary among individuals – Rationalizations include: • • • • • Being underpaid or overworked Everyone else is doing it Rank has its privileges See revenge Nobody will get hurt SU 1.4 - The Fraud Risk Model (Fraud Triangle) • Rationalization – most difficult to appraise – Difficulty to get insight into another persons ethical principles – Believe that the perpetrator was an honest person SU 1.4 - The Fraud Risk Model (Fraud Triangle) • Pressures (motivations) – Need for cash – Fraud and reward is not always so direct • Maybe other than monetary • Pressure to manipulate financial reporting if compensation is tied to financial results • Other include debt covenants, meeting budgets/earnings targets/analyst forecast The Fraud Risk Model (Fraud Triangle) – Pressures Fraud Model as overlapping circles and where you find the greatest risk SU 1.4 – Fraud and the Fraud Risk Model • Red Flags or Risk Factors indicating potential fraud include: – – – – – – Missing documents Large amounts of cash on hand Unexplained budget variances Unwillingness to take vacation Poor supervision Complaints by customers SU 1.4 – Fraud and the Fraud Risk Model • Investigative Resources and Techniques – Documents • Search for evidence-related documents including other locations such as trash bins, shredders, etc. • Alert to alternate documents via erasure and forgery – Handwritten signatures – Photocopies – Torn, smudged, faded documents SU 1.4 – Fraud and the Fraud Risk Model • Investigative Resources and Techniques – Documents (cont.) • Public searches of information – Public records – Social media – Privacy concerns • Commercial online services SU 1.4 – Fraud and the Fraud Risk Model • Investigative Resources and Techniques – Documents (cont.) • Electronic evidence • Interview – Care should be taken when drawing conclusions SU 1.4 – Practice Question 1 High risk of employee fraud is most likely when there is pressure, rationalization, and A Opportunity. B Internal control. C Personal integrity. D Limited responsibility. SU 1.4 – Practice Question 1 Answer Correct Answer: A Opportunity creates risk of employee fraud. Incorrect Answers: B Internal control mitigates the risk of employee fraud. C Personal integrity mitigates the risk of employee fraud. D Limited employee responsibility mitigates the risk of employee fraud. SU 1.4 – Practice Question 2 Rationalization of a fraud by an employee may be in the form of all the following except A Pressure from one’s spouse. B Feelings of being underpaid. C Belief in being overworked. D Belief that rank has its privileges. SU 1.4 – Practice Question 2 Answer Correct Answer: A Pressure from one’s spouse is a motive for the misappropriation of assets. Incorrect Answers: B Feelings of being underpaid may be used by an employee to justify or rationalize stealing. C Belief in being overworked may be used by an employee to justify or rationalize stealing. D Belief that rank has its privileges may be used by an employee to justify or rationalize stealing. SU 1.4 – Practice Question 3 Fraudulent financial reporting is most often committed by A Management to deceive financial statement users. B An auditor while performing an audit. C Employees stealing assets. D Customers. SU 1.4 – Practice Question 3 Answer Correct Answer: A Fraudulent financial reporting is committed by management in an attempt to deceive financial statement users. Incorrect Answers: B Auditors are not responsible for financial reporting. C Misappropriation of assets is most often committed by employees. D Managers, not customers, are responsible for financial reporting. SU 1.4 – Practice Question 4 What is the most likely reason for management to overstate expenses? A To minimize tax liability. B To earn a bonus. C To maximize net income. D To maximize cash on hand. SU 1.4 – Practice Question 4 Answer Correct Answer: A The most likely reason for management to understate income by overstating expenses is to minimize tax liability. Incorrect Answers: B Management may understate expenses to earn a bonus. C Management may understate expenses to maximize net income. D Understating expenses has no direct effect on cash. Study Tip • Try to explain out loud a concept you are trying to learn as though you are trying to teach it to someone. A good place to do this is in your car or in front of a mirror. SU 1.5 – Addressing Fraud and Error • Types of Controls – Primary Controls • • • • Preventive Controls Detective Controls Corrective Controls Directive Controls SU 1.5 – Addressing Fraud and Error • Types of Controls – Secondary Controls • Compensatory (mitigative) controls may reduce risk (i.e. segregation of duties) • Complementary controls with other controls may reduce risk to an acceptable level SU 1.5 – Addressing Fraud and Error • Segregation of Duties • Independent checks and verification – A Reconciliation between recorded amounts and assets must be performed by • someone unconnected with original transaction or • without custody of the assets • Safeguarding Controls – Limiting access to assets to only authorized personnel (i.e. lockbox system) SU 1.5 – Practice Question The frequency of the comparison of recorded accountability with assets (for the purpose of safeguarding assets) should be determined by A The amount of assets independent of the cost of the comparison. B The nature and amount of the asset and the cost of making the comparison. C The cost of the comparison and whether the susceptibility to loss results from errors or fraud. D The auditor in consultation with client management. SU 1.5 – Practice Question 1 Answer Correct Answer: B Assets should be compared with the recorded accountability as frequently as the nature and amount of the assets require, within the limits of acceptable costs of comparison. The costs of safeguarding assets should not exceed the expected benefits. Incorrect Answers: A The costs of controls should be considered when making the comparison. C Whether the susceptibility to loss arises from errors or fraud should have little bearing on the frequency of the comparison. D Management, not the auditor, has responsibility for internal control. SU 1.5 – Practice Question 2 Internal controls may be preventive, detective, corrective, or directive. Which of the following is preventive? A Requiring two persons to open mail. B Reconciling the accounts receivable subsidiary file with the control account. C Using batch totals. D Preparing bank reconciliations. SU 1.5 – Practice Question 2 Answer Correct Answer: A Preventive controls are designed to prevent an error or an irregularity. Detective and corrective controls attempt to identify and correct errors or irregularities that have already occurred. Preventive controls are usually more cost beneficial than detective or corrective controls. Assigning two individuals to open mail is an attempt to prevent misstatement of cash receipts. Incorrect Answers: B Reconciling the subsidiary file with the master file may detect and lead to the correction of errors, but the control does not prevent errors. C The use of batch totals may detect a missing or lost document but will not necessarily prevent a document from becoming lost. D Bank reconciliations disclose errors in the accounts but have no preventive effect. SU 1.5 – Practice Question 3 Segregation of duties is a fundamental concept in an effective system of internal control. Nevertheless, the internal auditor must be aware that this safeguard can be compromised through A Lack of training of employees. B Collusion among employees. C Irregular employee reviews. D Absence of internal auditing. SU 1.5 – Practice Question 3 Answer Correct Answer: B By segregating duties, organizations make it more difficult for one person to perpetrate a fraud. When custody of the asset and recordkeeping for the asset are invested in different persons, a fraud generally cannot be executed by one of the two parties. However, if they collude, the internal control aspect of the segregation is nullified. Incorrect Answers: A Lack of training by itself cannot negate effective separation of duties. C Irregular employee reviews may affect employee job performance, but they alone cannot negate effective separation of duties. D While the absence of an internal audit activity may lessen the chances that an organization will maintain effective internal control over the long run, by itself it cannot negate effective segregation of duties. Study Tip • Always prepare for the next lecture first, as opposed to catching up on material you are behind on. There are plenty of weekends with no classes that will allow you to catch up past material. This way you are always prepared for the next class and have identified (and conveyed) what areas you need help with. Essays cont. Essay Question #2 SmallParts is a manufacturer of metal washers, screws, and other parts required in the manufacture of various handmade craft and novelty items. The firm has the ability to custom make virtually any small part, provided the client is able to provide SmallParts with the dimensions and tolerance required of the product. Because of its niche in the market, SmallParts has over 1,000 clients. Unfortunately, many of its small business clients eventually merge or cease operations. One of the company’s biggest challenges is the return of shipped product. Usually, this is because the small business client has ceased operations. While most of the product is custom made, SmallParts has found that much of it can be sold to other clients for adapted use. The company’s accountant is reviewing the company’s internal controls and financial accounting procedures, in particular, with respect to inventory. Essay Question #2 Currently, SmallParts has one salesperson responsible for marketing returned product. This salesperson has exclusive and total control over the returned product including arranging of sales terms, billing, and collection. The salesperson receives the returned product and attempts to find a client who may be able to adapt the product for the client’s use. The inventory of returned product is not entered in the accounting records, under the logic that the cost is sunk. Revenue generated from its sale is classified as other revenue on the SmallParts income statement. Sample Essay Requirements (partial) 1. 2. 3. 4. Identify and describe the three objectives of a system of internal control. Identify and explain three ways that the procedure for handling returned product violates the internal control system of segregation of duties. Identify and describe three ways that SmallParts can provide for better internal control over its inventory of returned product. The company accountant is concerned about SmallParts’ current procedure for accounting for returned product and has turned to IMA’s Statement of Ethical Professional Practice for guidance. Assume the company’s accountant identifies a possible conflict of interest on the part of the salesperson responsible for the returned product. a)Identify the ethical principles that should guide the work of a management accountant. b)Identify and describe the standards that relate to this situation and explain how they apply. Sample Essay Response Question 1: Identify and describe the three objectives of a system of internal control. Sample Response: A good system of internal control is designed to provide reasonable assurance regarding achievement of an entity’s objectives involving effectiveness and efficiency of operations, reliability of financial reporting, and compliance with applicable laws and regulations. Sample Essay Response Question 2: Identify and explain three ways that the procedure for handling returned product violates the internal control system of segregation of duties. Sample Response: Segregation of duties requires that no one person have control over the physical custody of an asset and the accounting for it. There is no evidence to suggest SmallParts makes any effort to account for the value of returned product, which may indeed be significant. The one salesperson seems to be in charge of all aspects related to returned product, including authorizing the returns, crediting the customers, receiving the returns, handling the physical custody, finding new customers, concluding sales, shipping, billing, and collecting. Most of these rules should be separated. Sample Essay Question #2 Information relative to answering #2 of Question 2 has been circled in red. SmallParts is a manufacturer of metal washers, screws, and other parts required in the manufacture of various handmade craft and novelty items. The firm has the ability to custom make virtually any small part, provided the client is able to provide SmallParts with the dimensions and tolerance required of the product. Because of its niche in the market, SmallParts has over 1,000 clients. Unfortunately, many of its small business clients eventually merge or cease operations. One of the company’s biggest challenges is the return of shipped product. Usually, this is because the small business client has ceased operations. While most of the product is custom made, SmallParts has found that much of it can be sold to other clients for adapted use. The company’s accountant is reviewing the company’s internal controls and financial accounting procedures, in particular, with respect to inventory. Currently, SmallParts has one salesperson responsible for marketing returned product. This salesperson has exclusive and total control over the returned product including arranging of sales terms, billing, and collection. The salesperson receives the returned product and attempts to find a client who may be able to adapt the product for the client’s use. The inventory of returned product is not entered in the accounting records, under the logic that the cost is sunk. Revenue generated from its sale is classified as other revenue on the SmallParts income statement. Sample Essay Response Question 3: Identify and describe three ways that SmallParts can provide for better internal control over its inventory of returned product. Sample Response: Separate responsibilities and duties. While the salesman may be assigned to work with customers who return products, and find other customers for these products, other staff should post credits to customer accounts following written policy. The products should be received, inventoried, booked and shipped just like regular products. Sample Essay Response Question 4: (Summarized) a) Identify the ethical principles that should guide the work of a management accountant. b) Identify and describe the standards that relate to this situation and explain how they apply. Sample Response: a)The Statement lists the following four ethical principles: – Honesty, Fairness, Objectivity, Responsibility b)Several standards from the Statement apply. – Credibility: “Each practitioner has a responsibility to disclose deficiencies in internal controls.” – Competence: duty to maintain an appropriate level of professional expertise relative to standard procedure commonly used in the accounting of firms dealing with returned product – Confidentiality: refrain from using this confidential information for unethical advantage, by not informing firms of the lax controls and availability of steep discounts on returned product – Integrity: mitigating any conflict of interest. Small Parts Question Item Description Question 1 Reasonable Assurance Effectiveness of operations Efficiency of operationsi Reliability of financial reporting Other Subtotal Question 2 1 person should not control custody & acctg. Salesperson in charge of everything No accounting for returned product No tracking or returned product Other Subtotal Maximum Points 2 1/2 1/2 1/2 1/2 1/2 % Correct Score 0 0 0 0 0 0.00 2 1/2 1/2 1/2 1/2 1/2 0 0 0 0 0 0.00 Small Parts Question (continued) Item Description Question 3 Separate resp./segregation of duties 4 different ind. for ret. Prod. duties Authority, recording, custody, reco. Other Subtotal Maximum Points 2 1/2 1/2 1/2 1/2 % Correct Score 0 0 0 0 0.00 SmallParts Question (continued) Item Description Question #4 a. Principles: max = 1 Honesty, Fairness, Objectivity, Responsibility Two correct identifications Four correct identifications b. Standards max = 5 Competence maintain appropriate level of prof competence prepare complete & clear reports perform in accord with laws, regs & tech stds Confidentiality refrain from disclosing confidential info refrain from using info unethically Integrity refrain from activity discrediting the profession avoid actual or apparent conflicts of interest refrain fr activity prejudice ability to carry out duties refrain fr activity subverting attn of org objectives Credibility/Objectivity communicate info fairly and objectively disclose fully all relevant info other TOTAL FOR ALL QUESTIONS: Maximum Points 6 % correct Score 1/2 1 0 0 1/2 1/2 1/2 1/2 1/2 1/2 1 1/2 1 1 1/2 1/2 1/2 1/2 1/2 1/2 12 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0.00 Remember! • The CMA exam uses essays to reflect a more "real-world" environment in which candidates must apply the knowledge they have acquired. Essays are graded on both writing skills and subject matter. Partial credit IS available for essays that have some correct and some incorrect points. Finally, it is important to remember that essays are not intended to test typing ability, so the time you allocated for essay response is adequate to complete the questions even if you do not have the best typing skills. • Answering multiple-choice questions is an effective method to study the material for both the multiple-choice and essay sections of the exam. They are an excellent diagnostic tool that will allow you to quickly identify your weak areas. Also, think about what your answer would be if the question were not multiple-choice. When reviewing the correct and incorrect answer explanations, your "essay answers" should be somewhat equivalent to the detailed answer explanations. Essay • Roughly 75% of points come from multiple choice. Essay only accounts for 25% of points. • There are two essay questions for each section of the CMA exam. Each question will have 43-6 parts that must be answered. • Be sure you skim all essay parts before begin answering. This will help you survey how much time to spend on each question from the beginning. Some will be easy, just asking for a definition. Some will require calculations. Show all your work. Even if your answer is wrong, showing your work will give you partial credit. • Be sure to answer the question correctly. If the question asks you to compare or contrast something, don't define it. That is not what they are looking for.