CMA Part 1 - Financial Planning, Performance and Analytics

What do the financial statements comprise of?

1. Balance Sheet, or Statement of Financial Position

2. The Income Statement

3. Statement of Cash Flows

4. Statement of Comprehensive Income

5. Statement of Changes in Shareholders’ Equity

What is an asset?

An asset is a probable future economic benefit that is obtained or controlled by an entity as a result of a past transaction or event.

• Arises from a past transaction or event

• Is presently owned by the company

• Will cause probable future economic benefit for the company

What is a liability?

A liability is a probable future sacrifice of economic benefit owed by the entity as a result of a past transaction or event.

• Arises from a past transaction

• Is presently owed by the company

• Will lead to a probable future sacrifice of economic benefit by the company

What is a current asset?

A current asset is cash and other assets or resources that are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business.

What does the balance sheet help its users assess?

1. Liquidity

2. Financial Flexibility

3. Solvency

4. Risk

List the different kinds of current assets

1. Cash

2. Cash Equivalents

3. Contract assets classified as current assets

4. Marketable Securities classified as current assets

5. Receivables

6. Funds that are restricted for current purposes

7. Inventory

8. Prepaid Expenses

9. Short-term notes receivables

When a fixed asset is purchased, how is it recorded on the balance sheet?

It’s recorded at its cost, including shipping and installation costs needed to bring it to usable condition

How is the cost recorded for a fixed asset expensed?

It is expensed over the life of the asset through depreciation, amortization or depletion

What are current liabilities?

Current liabilities are obligations that will be settled through the use of current assets or the creation of other current liabilities.

What are the elements of a corporation’s entity?

1. Capital stock

2. Additional paid-in capital

3. Accumulated OCI items

4. Retained earning

5. Non-controlling interest

6. Treasury stock

What is fair value?

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

According to the revenue recognition principle, when should revenue be recognized?

Revenue should be recognized in the accounting period in which the performance obligation satisfied

What is the structure of a multiple-step income statement?

1. Revenue

2. Cost of goods sold

3. Gross Profit

4. Selling, General and Administrative expenses

5. Operating Income

6. Interest and dividend income

7. Non-operating gains/(losses)

8. Interest expenses

9. Income from continuing operations before taxes

10. Provision for income tax on continuing operations

11. Income from continuing operations

Discontinued Operations:

12. Gain/(loss) from operations of discontinued operations

13. Income tax benefit or income tax expense

14. Income/ (loss) on discontinued operations

15. NET INCOME

What are gains?

Gains are increases in equity resulting from transactions that are not part of the company’s central operations and do not result from revenues or investments by the owners of the equity.

According to the expense recognition principle, when should you recognize an expense?

An expense should be recognized when the work or product contributes to revenue.

What is the mission of the International Integrated Reporting Council (IIRC)?`

To establish integrated reporting and thinking within mainstream business practice as the norm in the public and private sectors

What is the vision of the IIRC?

To align capital allocation and corporate behaviour to wider goals of financial stability and sustainable development through the cycle of integrated reporting and thinking.

What is the IIRC’s objective?

To change the corporate reporting system so that integrated reporting becomes the global norm

What are the 6 capitals as per International IR Framework?

1. Financial capital

2. Manufactured physical capital

3. Intellectual capital

4. Human capital

5. Social and relationship capital

6. Natural capital

What are the content elements of an Integrated Report?

1. Organisational Overview and External Environment

2. Governance

3. Risks and Opportunities

4. Strategy and Resource Allocation

5. Business Model

6. Performance

7. Outlook

8. Basis of Presentation

What are the 7 guiding principles for preparing an integrated report?

1. Strategic focus and future orientation

2. Connectivity of information

3. Stakeholder relationships

4. Materiality

5. Conciseness

6. Reliability and completeness

7. Consistency and comparability

What are the primary means by which shareholder value increases?

High profitability and sustainable profit growth

What are the four generic distinctive competencies?

1. Superior efficiency

2. Superior quality

3. Superior innovation

4. Customer responsiveness

Strategic Planning Process

1. Determine the company’s mission, vision, values and goals

2. Analyse the external environment to identify threats and opportunities

3. Analyse the internal environment to identify strengths and weaknesses

4. Formulate strategies that align with organisational goals and leverage strengths and correct weaknesses and maximise opportunities and limit threats

5. Develop and implement the chosen strategies

Distinctive competencies arise from?

Resources and capacity

Four components of a company’s mission statement

1. Statement of company’s mission, or ‘reason to be’

2. Statement of vision, or ‘future desired state’

3. Company values

4. Company goals

What questions should be answered in the company’s statement of mission?

1. What customer groups are being served?

2. What customer needs are being served?

3. By what means are customer needs being served?

Porter’s five forces model

1. Risk of entry by potential competitors

2. Intensity of rivalry among competitors

3. Bargaining power of buyers

4. Bargaining power of suppliers

5. Closeness of substitutes to an industry’s products

How is value created?

Utlity of the product - Cost of producing the product

What is consumer surplus?

The excess utility derived from a product wrt to its price

What are the three factors that impact durability of competitive advantage?

1. Barriers to imitation

2. Capability of competitors’ to imitate, competitors prior strategic commitments, competitors absorptive capacity

3. Dynamism of the industry environment

Collection period for accounts receivable

365/ receivables turnover

Receivables turnover = net credit sales/ average accounts receivables

When can you account for a contract?

When the contract meets ALL the following criteria:

1. Creates enforceable rights and obligations

2. All parties approve the contract and are committed to satisfying their performance obligations

3. The rights of each party can be identified

4. The payment terms can be identified

5. The contract has commercial substance

6. There is a positive assessment of collectability

Advantages of budgets

1. Coordination and communication

2. Framework for measuring performance

3. Motivation

4. Efficient allocation of organisational resources

5. Controlling operations

6. Check on progress

What benefits does a strong internal control system provide to a company?

1. Lower external audit costs

2. Better control over the assets of the company

3. Reliable information for use in decision-making

Corporate governance

All the means by which businesses are directed and controlled. It spells out the rules and procedures to be followed in making decisions for the corporation.

An organisation’s governance is a byproduct of

1. Values

2. Strategies

3. Policies

4. Procedures

Principles of Good Governance

1. Board Purpose - promote and protect interests of shareholders

2. Board Responsibilities - monitor management, oversee strategies and processes, monitor risks and internal controls

3. Interaction - sound governance requires effective interaction among board, management, external auditor, internal auditor and legal counsel

4. Independence - independent director must objective in judgements

5. Expertise and Integrity - relevant expertise and unblemished records of integrity

6. Leadership - Roles of Board Chair and CEO must be separate

7. Committees - audit, compensation and governance committees of the board should have charters authorized by the board that outline how the committee will be organized, its duties and responsibilities and how they report to the board

8. Meetings and Information - Board and committees should meet frequently for extended periods of time and have unrestricted access to information and personnel needed to perform their duties

9. Internal Audit - reports directly to audit committee of BoD through Chief Audit Executive

10. Compensation - carefully consider compensation amount and mix for executives and directors

11. Disclosure - proxy statements and other communications should reflect board and corporate activities and transactions in a transparent and timely manner.

12. Proxy Access - board should have a process for shareholders to nominate director candidates, including access to proxy statements for significant long-term shareholders

13. Evaluation - procedures should be in place to evaluate CEO, board committees, full board and directors on an annual basis

Hierarchy of Corporate Governance

1. Articles of Incorporation

2. Bylaws

3. Policies and Procedures

Important things detailed in the Articles of Incorporation

1. Name of the corporation

2. Length of corporation’s life, usually perpetual

3. Purpose and nature of its business

4. Authorized number of shares of capital stock

Examples of bylaws specified

1. Requirements for annual meetings of shareholders

2. How directors are to elected, no of directors, length of their terms

3. Specifications for payment of dividends

4. Amendment of bylaws

5. How officers are to be elected

6. Methods of calling special shareholders’ meetings

What do policies and procedures do?

Policies - establish what is expected. Accountabilities and responsibilities should be clearly specified

Procedures - put the policies in action. Should be clear about what the responsibilities of the personnel performing the procedures are.

Responsibilities of Board of Directors

The board’s responsibility is to provide governance, guidance and oversight to the management of the company.

Specific Responsibilities:

1. Select and oversee management

2. Determine what is expected of the management in terms of ethics and integrity

3. Set corporate strategy, overall direction and vision

4. Be involved with company’s internal control activities.

5. Ensure corporation’s compliance with laws and regulations

6. Be familiar with company activities and environment

7. Investigate any issues they consider important

8. Be independent of the company

Definition of an Audit Committee under Section 205 of the SOX Act

• A committee(or equivalent body) established by and amongst the board of directors of an issuer for the purpose of overseeing the accounting and financial reporting processes of the issuer and audits of the financial statements of the issuer; and

• If no such committee exists wrt to an issuer, the entire board of directors of the issuer

Requirements for Audit Committees and Audit Members

1. The committee must consist of at least 3 members (not as per SOX)

2. All members should be independent of the company and so may not be employed by the company in any capacity

3. A 5-year cooling-off period is required for former employees or independent auditors to serve on the audit committee (not as per SOX)

4. One member of the committee must be a financial expert. (SOX doesn’t mandate, but asks for disclosure if there is no financial expert)

5. All members must be financially literate at the time of appointment

Responsibilities of the Audit Committee

1. Primary responsible for

   • Selecting and nominating the external auditor

   • Approving audit fees

   • Supervising the external auditor

   • Overseeing auditor qualifications and independence

   • Discussing with auditors matters required under GAAP

   • Reviewing audit scope, plan and results

2. NYSE Listing Manual requires that listed companies have an audit committee charter that addresses the committee’s purpose

3. As per SEC, establish procedures for

   • receipt, retention and treatment of complaints received by issuer regarding accounting, IC controls, or auditing matters

   • confidential anonymous submission by employees of concerns regarding questionable accounting or auditing matter

4. Requirements as per NYSE

5. Monitor iC processes, as per Blue RIbbon Committee report

Purpose of the Audit Committee according to NYSE

1. Assist board oversight of

   • Integrity of FS

   • Compliance

   • Independent auditors’ qualification and independence

   • performance of internal and external auditors

2. Prepare an audit committee report as required by SEC

NYSE’s requirements of an audit committee

1. Review annual and quarterly FS and MD&A in annual report filed with SEC and discuss them with management and independent auditors

2. Meet periodically and separately with management and internal and independent auditors.

3. Review any audit problems with independent auditors

4. Set clear hiring policies for employees or former employees of independent auditors

Stakeholders of IC policies and procedures

1. Investors

2. External Auditors

3. Legislative and Regulatory Bodies

4. Employees

5. Customers

Definition of Internal Controls

Internal control is a process effected by an entity’s BoDs, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives relating to operations, reporting and compliance.

Operations Objective

Effectiveness and Efficiency of operations

Reporting Objective

pertaining to internal and external financial and non-financial reporting

1. reliability

2. timeliness

3. transparency

Compliance Objectives

Relating to organisation’s compliance with applicable laws and regulations

Fundamental Concepts of IC

1. The purpose of IC is to help the company achieve its objectives related to operations, reporting and compliance

2. IC is an ongoing process

3. IC is accomplished by people

4. IC procedures can provide reasonable assurance only - not absolute assurance and not a guarantee

5. IC must be flexible to be adaptable to the entity’s structure

Components of Internal Control

1. Control Environment

2. Risk Assessment

3. Control Activities

4. Information and Communication

5. Monitoring Activities

Control Environment

• Includes the standards, processes, and structures that provide the foundation for carrying out internal control

• Provides the organisation’s ethical values

• Influences control consciousness of all the people in the organisation

5 Principles of Control Environment

1. Commitment to Integrity and Ethics

2. BoD demonstrates independence from management and exercises oversight

3. Management establishes structures, reporting lines and appropriate authorities and responsibilities

4. Commitment to attract, develop and retain competent individuals in alignment with objectives

5. Hold individuals accountable for their internal control responsibilities

What is risk?

Risk is the possibility that something will occur that will adversely affect the organisation’s achievement of its objectives.

Inherent Risk

Susceptibility to a material mistake that simply exists and is natural

Control RIsk

Risk that an internal control will not prevent or detect material misstatement in a timely manner

Detection Risk

Risk that a material misstatement in an account balance or class of transactions that could result in material weakness for the company will not be detected

What 3 risks are the management responsible for assessing?

1. Inherent risk

2. Control Risk

3. Detection Risk

What is risk assessment?

It is the process of identifying, analysing and managing risk that have the potential to prevent the organisation from achieving its objectives, relative to the organisation’s established risk tolerance

4 Principles of Risk Assessment

1. Objectives must be specified clearly enough so that the risks to those objectives can be assessed

2. Identify risks to the achievement of objectives and analyze them

3. Consider the potential for fraud

4. Identify and assess changes that could impact the organisation’s system of internal control

Steps in Risk Analysis

1. assess likelihood or frequency of risk occuring

2. estimate impact of risk

3. consider how each risk should be managed

Risk Responses

1. Acceptance

2. Avoidance

3. Reduction

4. Sharing

Control Activities

Actions established by policies and procedures that help ensure that management’s instructions intended to limit risks to the achievement of the organisation’s objectives are carried out

Preventive Controls

Controls designed to avoid an unintended event such as an error or fraud befo

Detective Controls

Controls designed to discover an unintended event after it has occurred but before the ultimate objective has occurred

3 Principles of Control Activities

1. Control activities to reduce identified risks to acceptable levels are selected and developed

2. General control activities over technology are selected and developed

3. Control activities are deployed through policies and procedures

3 Principles of Information and Communication

1. Relevant, quality information is obtained or generated and is used

2. Information is communicated internally

3. The organisation communicates with external parties

2 Principles of Monitoring Activities

1. Ongoing and separate evaluations are performed of the interal control system

2. Internal control deficiencies are evaluated and communicated for corrective action

Objectives of Transaction Controls

1. Validity

2. Segregation of Duties

3. Physical safeguards and security

4. Error handling

5. Accuracy

6. Authorization

7. Completeness

Types of Transaction Control Activities

1. Verifications

2. Supervisory controls

3. Physical controls

4. Authorization and approvals

5. Reconciliations

6. Controls over standing data

What are the four functions that must always be performed by different people?

1. Authorizing a transaction

2. Recordkeeping

3. Keeping physical custody of related asset

4. Periodic reconciliation of physical assets to recorded amounts

Example for segregation of duties for an activity (credit sales, cash collections, inventory purchase, etc)

1. Authorization - manager

2. Recordkeeping - said dept’s personnel

3. Custody - offices (treasurer’s office)

4. Reconciliation - accounting dept personnel

When does collusion occur?

It occurs when two or more individuals work together to overcome the internal control system and perpetrate a fraud.

What are the major provisions of the Foreign Corrupt Policy Act (FCPA)?

1. Anti-bribery provision

2. Internal control provision

Anti-bribery provision

• Applicable to ALL companies, both private and publicly traded

• Under FCPA, it is illegal for any company or anyone acting on behalf of a company to bribe any foreign official to obtain or retain business

• The entire company, not just on individual or position in the company, is responsible for ensuring that all payments are legal and lawful

What is a corrupt payment?

A corrupt payment is one that is intended to cause the recipient to misuse his or her official position by wrongfully directing business to the payer, regardless of whether the payment leads to the desired outcome

Internal Controls Provision

• Corporate management is required to maintain books, records, and accounts that accurately and fairly reflect transactions and to develop and maintain a system of internal accounting control

• Only applicable for publicly traded companies

Titles of the SOX Act

Title I: Public Company Accounting Oversight Board (PCAOB)

Title II: Auditor Independence

Title III: Corporate Responsibility

Title IV: Enhanced Financial Disclosures

Responsibilities of the PCAOB

1. Register public accounting firms that audit public companies.

2. Establish auditing and related attestation standards, ethics and quality control standards for securities issuers.

3. Conduct inspections of registered public accounting firms (>100 issuers - annually, <100 issuers - at least every 3 years)

4. Enforce compliance with the Act, the rules of the Board, professional standards and securities laws relating to audit reports and obligations of accountants

5. Conduct investigations and disciplinary proceedings, and impose appropriate sanctions for violations of any provision of SOX, professional standards, rules of the Board, etc

6. Management of the operations and staff of the Board

RECECM

Title II: Auditor Independence

Section 201: Services Outside the Scope and Practice of Auditors

Section 203: Audit Partner Rotation

Section 204: Auditor Reports to Auditor Committees

Section 201 of SOX Act

Services Outside the Scope and Practice of Auditors

External auditors can’t provide the following non-audit services to clients to avoid fundamental conflict of interest:

• bookkeeping services

• financial information systems design and implementation

• appraisal or valuation services

• internal audit outsourcing services

• management functions

• actuarial services

• HR services

• legal services

• investment adviser, broker, IB services

Section 203 of SOX Act

Audit Partner Rotation

Lead audit partner and concurring review audit partner - rotate after 5 years for 5 years

Other audit partners - rotate after 7 years for 2 years

Section 204 of SOX Act

Auditor Reports to Audit Committees

Things to be reported by the public accounting firm:

1. All critical accounting policies and practices to be used

2. All alternative treatments of financial information within GAAP that have been discussed with issuer’s management, its ramifications, and treatment preferred by the registered public accounting firm

3. Material written communication b/w public accounting firm and issuer’s management

Title III - Corporate Responsibility

Section 302: Corporate Responsibility for Financial Reports

SOX requires that each annual or quarterly financial report filed or submitted to SEC must include certifications by the company’s principal executive and financial officer.

Signing officers responsible for FS certify that,

• F/S and other financial information included in the report are fairly presented in all material respects

• The report does not contain any material misstatements or omissions that would make the F/S misleading

Signing officers responsible for I/C certify that they,

• Acknowledge their responsibility for establishing and maintaining ICFR (IC over FR) and other disclosures

• Have evaluated the effectiveness of ICFR within previous 90 days, presented their conclusion as to effectiveness and disclosed any material changes in the company’s ICFR

Title IV: Enhanced Financial Disclosures

Section 404: Management Assessment of ICFR and Independent Auditor’s Attestation to Management’s Assessment of ICFR

Section 407: Disclosure of Audit Committee Financial Expert

Section 404 of SOX Act

Section 404(a):

Requires 10K to

• state management’s responsibility for adequacy of company’s ICFR

• contain an assessment by management of the adequacy of company’s ICFR

Section 404(b):

Requires company’s independent auditor to report on and attest management’s assessment of effectiveness of ICFR

Section 404(c):

Provides that 404(b) is not applicable to ‘non-accelerated filers’

Non-accelerated filer

• public company with public float< $75 million

• 10K filing - within 90 days of end of fiscal year

• 10Q filing - within 45 days of end of fiscal year

Accelerated filer

• public float - >$75 and < $700 million

• 10K filing - 75 days

• 10Q filing - 40 days

Large, Accelerated filer

• public float > $700 million

• 10K filing - 60 days

• 10Q filing - 40 days

What guidance does both SEC and PCAOB prescribe for evaluating ICFR

Top-down, risk-based approach

Begins at F/S level

F/S level —→ Entity level —→ Transaction level

Sec 407 of SOX Act

Disclosure of Audit Committee Financial Expert

Issuer must disclose whether or not the company’s audit committee consists of at least one member who is a financial expert

External Audit Opinions

• Unqualified- ‘financial statements present fairly, in all material aspects, the financial position’

• Qualified - except for the specific, named, matter, ‘F/S present fairly,….’

• Adverse - FS is not presented in conformity with GAAP

• Disclaimer - auditor does not have sufficient information to express an opinion

Elements of a basic Internet Security System

1. User Account Management - process of assigning people accounts and passwords

2. Firewall - serves as a barrier between the internal and external networks and prevents unauthorized access to the internal network

3. Antivirus Software - recognizes and incapacitates viruses before they can do damage

4. Encryption - converts data into a code; a key is required to convert the code back to data

Criteria for something to be considered a virus

1. it must execute itself

2. it must replicate itself

Difference between trojan horse and a virus

A trojan horse can’t replicate itself